Executives
Rory MacPherson – Director, IR
Zhengrong Shi – Chairman and CEO
Andrew Beebe – Chief Commercial Officer
David King – CFO
Analysts
Min Xu – Jefferies
Brandon Heiken – Credit Suisse
Sanjay Shrestha – Lazard
Robert Stone – Cowen and Company.
Vishal Shah – Deutsche Bank
Daniel Ries – Collins Stewart
Edwin Mok – Needham and Company
Kelly Dougherty – Macquarie
Lu Yeung – UBS
Paul Clegg – Mizuho
Colin Rusch – ThinkEquity LLC
Pranab Sarmah
Sam Dubinsky – Wells Fargo
Brian Gamble – Simmons & Company
Mark Bachman – Avian Securities
Pavel Molchanov – Raymond James
Mehdi Hosseini – SIG
Suntech Power Holdings Co., Ltd. (STP) Q2 2011 Earnings Call August 22, 2011 8:00 AM ET
Operator
Good day ladies and gentlemen and welcome to the Second Quarter 2011 Suntech Power Earnings Conference Call. My name is Stephanie and I will be your conference moderator for today. At this time all participants are in listen-only mode. Later we will conduct a question and answer session towards the end of today’s call. (Operator Instructions)
I will now like to turn the conference over to your host for today Mr. Rory MacPherson, Director of Investor Relations. Please proceed.
Rory MacPherson
Thank you. Hello everyone and welcome to Suntech’s second quarter 2011 earnings conference call. My name is Rory MacPherson, Suntech’s Director of Investor Relations. On the call today Dr. Zhengrong Shi, Suntech’s Chairman and CEO will give an overview of our performance and operational initiatives. Andrew Beebe, our Chief Commercial Officer will discuss sales and markets and David King, our Chief Financial Officer will discuss our financial performance.
During this conference call, we will make certain forward-looking statements in an effort to assist you in understanding the company and its results. The forward-looking statements will be made under the Safe Harbor provisions of the U.S. Private Securities Reform Act of 1995.
Forward-looking statements involve inherent risks and uncertainties. As such, Suntech’s future results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our earnings release issued today and our SEC filings. Suntech does not undertake any obligation to update any forward-looking statements except as required under applicable law.
To enhance our presentation of information and data during this conference call we have provided a set of top link flag field reference. This presentation is posted on the main page of the Investor Relations section of our website after this call. We have allocated one hour for the conference call and we’ll endeavor the field there is any questions as possible within that timeframe. Please limit questions to one question and one follow-up.
As a reminder, this conference call is being recorded and a webcast replay will also be available on the Investor Relations section of Suntech’s website after this call. Please note that all figures mentioned during this conference call are in U.S. dollars unless otherwise specified.
I will now turn the call over to Suntech’s Chairman and CEO, Dr. Zhengrong Shi.
Zhengrong Shi
Thank you, Rory. Hello and thank you for joining us. Please turn to page four. Despite a competitive market and ongoing macro challenges in Europe and in the U.S. Our corporation performed well during the second quarter. Due to our field diversification and a solid demand for cost effective and a bankable solar products.
We met our shipments guidance and hit our ASP target. Additionally, we are well positioned to gain market share in the second half of the year. The highlights of the second quarter was – first to the revenue increased 33% year-over-year to $831 million and the second our total PV shipments increased 2% sequentially and 48% year-over-year.
This quarter one time charges related to the termination of a long-term supply agreement with MEMC and a discontinued operations of CSG Solar impacted below the line results. And we’ve recorded a net loss of $260 million in the second quarter, and the non-GAAP loss of $34 million or $0.19 per diluted ADS.
Turning to operational initiatives, please turn to page five. During the quarter, we took two steps to enhance the flexibility of our supply chain. First, we continued to build our internal wafer capacity and ended the quarter with 1.2 gigawatt, which can supply 50% of our wafer needs. The experienced management team of our wafer operation has executed extremely well in expanding of this facility from 370 megawatt in the fourth quarter of 2010 and have met great progress in both costs reductions and a new technology development.
We believe that fairly integration of wafer capacity will ultimately enable us to lower our cost structure and have decided to expand wafer capacity to 1.6 gigawatt by the end of this year. Second, we just continued our long-term supply agreement with MEMC and it was not suited to the finance processing amendments and the market conditions that we see today.
As a result some that is no longer required to purchase approximately 4.6 gigawatt of wafer between 2011 and 2016. These initiatives will allow us to optimize our assortment strategy and it lead to estimated cost savings of over $400 million in the next five years. We still maintain a strong relationship with MEMC and we’re continuing to work with them by silicon wafers and the supply modules to their project development division.
Early initiatives will enable Suntech to benefit from the decline in silicon prices that we have in over the past few months and allow to adjust our supply chain to reflect market conditions. We expect that the price of silicon will continue to decline in 2012 through our semi-integrated strategy very critical to maintaining our competitive cost structure.
At the cell and module level, we added 200 megawatt of capacity taking us to 2.4 gigawatt at the end of the second quarter. This includes 600 megawatts of cell capacity that is operated by Suntech joint venture and are co-located at our main Wuxi campus. In addition to improvement in our cost structure, we continue to be at the forefront of solar innovation.
In the second quarter we introduced high performance product in all of our key geographies. Specifically these products are based on the Pluto cell processing technology and recover mono wafer process, which we recently commercialized at our internal wafer facility. Both of these technologies generate about 10% more power than conventional crystalline silicon technology. And it differentiates not only Suntech but our customers as well.
In the competitive environment, the superior power enables our customers to generate more revenue and a boost to profit. We hired a 450 R&D professionals based in China Australia, Germany and the U.S. we are confident that we have the research infrastructure to stay at the forefront of solar innovation and a continued to develop differentiating IP.
Before turning the call over to Andrew, please turn to page six for update on our investment in GSF. In 2010, GSF investee companies completed construction of 105 megawatt of solar project in Italy of which 87 megawatts were connected to the grid before the end of June. The remaining 18 megawatts have soon been connected to the grid and are receiving a lower feed-in tariff than originally anticipated.
In addition, GSF investee companies completed the further 37 megawatts of project in the second quarter. All of this projects have received approval to the connected in the second half of 2011 in accordance with the new registration process for last 12 month solar system in Italy.
The completion of this project resulted in an increase in the fair value of GSF in the second quarter of 2011. This valuation increase was mostly offset by decrease in fair value of 18 megawatts of projects that were connected in July and August. In sum, the fair value of our investment in GSF was flat with the fourth quarter.
GSF is currently exploring some strategic options to monetize the assets and we’ll update you in the coming quarters. Lastly, GSF receivables declined from 45 million after the end of the first quarter to 27 million after the end of the second quarter. We expect to collect the outstanding receivables in the second half of 2011.
Looking forward, we are confident that we have the manufacturing, supply chain, and technology infrastructure in place to maintain our leadership in the solar industry. Price decline, but with this decline come optimistic. We are seeing elastic response to change in pricing and expect strong demand core in the third quarter, as customers continue to demand bankable products.
I’d now turn the call over to our Chief Commercial Officer, Andrew Beebe, who will give you further insights into our global sales and marketing initiatives. Andrew?
Andrew Beebe
Thank you, Dr. Shi. Please turn to page seven. We are pleased to have achieved our shipment guidance, especially given the challenging dynamics related to policy changes in Italy and concern about debt levels globally. Our strategy to diversify our shipments more evenly among global solar markets insulated us from market specific issues and we now have a solid footing for substantial sales growth in the second half of the year.
As of the end of the second quarter, we have completed around 45% of our annual shipment target and are on-track to achieve our full year guidance of 2.2 gigawatts of PV shipments. Looking to page eight, shipments for the second quarter increased 2% sequentially versus the first quarter and 48% versus the second quarter of 2010. In line with our diversification strategy, our sales were well distributed amongst our three sales regions.
As previously projected just over 50% of revenues were generated from the European markets, just over 20% came from the Americas and around 25% were generated from Asia Pacific, Middle East and Africa or as we say EMEA.
Now turning to page nine. Our sales in Europe were underscored by weak demand in Germany and Italy in the first half of the quarter and gradual growth throughout the second half of the quarter. Due to slower than expected interconnections in Germany between March and May there was no mid-year cut in the feed-in-tariff.
While this shows the demand outperformed expectations – underperformed expectations in the first half, it increases market optimism for growth in the second half of 2011.
With current module pricing projects will yield attractive returns in Germany in the second of the year and because of this we’re seeing significant demand right now. One example, this is our 190 megawatt partnership with SolarHybrid, a leading solar developer in Germany.
With the national goal to face out nuclear energy by 2022, we are optimistic about the strength of the German PV market in the future years. So to bolster our presence there, we have recently become the primary sponsor of Bundesliga football team 1899 Hoffenheim. This will drive excellent exposure in the best attended football league in the world.
It does also help us build a strong relationship with one of Hoffenheim’s co-sponsors Wirsol. And I’d also like to congratulate the team on a huge win in this past weekend. The Italian market has recovered more slowly than expected. However, it is also poised for a stronger second half due to the clarification on the solar quality and high returns for solar investments.
There remain some friction points in the Italian market as downstream players realigning their channels to focus on the uncapped rooftop segment and navigate the new regulations. The demand is building month-on-month and our customers are adapting to the new environment.
The Americas continue to be a strong geography for Suntech, where we continue to be the market leader. Sales for the Americas increased to 21% of revenues versus 18% in the first quarter reflecting both growth and our increased penetration. We are particularly pleased by the demand for utility skilled solar projects in the Americas in fact we recently signed an agreement to provide economic developer with over 200 megawatt of modules in the next two years.
Bank ability is the essential component of winning these fits, and customers are appreciative of the unmatched track record cutting edge technology and in-house project engineering support that we bring to the table.
In the APMEA region, the China market is insuring into a global leader not just in manufacturing, but in solar installation as well. In a critical step the government recently announced China’s first ever national feed-in tariff sell at 1.15 RMB per kilowatt hour for projects approved in the first half of 2011.
Well quite low by international standards this tariff is sufficient to attract investment particularly in utility projects in the Western Provinces that enjoy a rich solar resource. Of note we’ve recently won a big supply 50 megawatt of solar panels for project in Qinghai that are to be completed before September. We’ve been working with China very successfully for many years and we are pleased to see demand accelerate. We anticipate the country becoming a multi gigawatt market in 2012 and beyond.
In line with our strategy to diversify our sales, we continue to invest in global channels and high potential markets. During this quarter we during this previous quarter we established a new local office in Thailand which will enhance our penetration throughout the Southeast Asian markets.
Turning now to our average sales price. For the second quarter ASP decline around 7% in the first quarter 2012 in line with our expectation. With the rapid shipment silicon and wafer prices over the past few months we’ve been able to lower prices to keep pace with the changing market and we expect mid to high teen price declines in the third quarter.
While this is a steep decline we are pleased to see pricing levels start to getting out in the third quarter as demand increases in all of our key markets. At the end of the second quarter we achieved 45% of our annual shipment target. As a remainder typically shipments in the second half of the year account for roughly 60% of our annual shipments. So we are quite comfortable that we’ll be able to meet our target 2.2 gigawatt for the year.
Looking into the third quarter we are encouraged to see strong growth and demand across all of our regions and we expect an increased shipments by more than 15% from the second quarter. Along with the seasonal pickup, we are also gaining excellent traction due to our high performance Pluto and cast-mono products. Because of the high performance products, we are continuing to deliver one of the best profit performance ratios in the industry.
Although it is a very challenging environment, we believe that we are gaining market share because more now than ever customers are focused on the bank ability of their suppliers. We have seen multiple solar companies struggle to survive in these market conditions and customers are aware that Suntech is well positioned to meet the challenges and continue our role as the industry leader.
I would now like to turn the call over to our CFO, David King for a review of the financials.
David King
Thank you, Andrew. Begin with there are a couple of items that I would like you to – I like to bring to your attention. Please see slide 10. First on the call today I will refer to our non-GAAP numbers excluding the impact on the one-time charges related to the MEMC settlements and CSG Solar discontinuation we previously announced. These numbers give a better indication of our normal operations. We have included a reconciliation of non-GAAP numbers with GAAP results in the press release issued today and in our presentation.
Second, from this quarter going forward we have reclassified freight expense from cost of revenues to sales expense which is within operating expenses. We did this to confirm to the accounting treatment adopted by many of our peers. This will assist you in comparing the cost structure amount and between solar companies.
Please turn to page 11 for a discussion of the second quarter results. Our revenue increased 43% year-over-year to $831 million. Sequentially, the revenue was down 5% due to the decline in average selling prices, which was partially offset by increase in shipments.
Approximately 97% of the revenue was generated from PV market sales. Gross profit was $34 million and gross margin was 4.1% to the second quarter of 2011, compared to $123 million and 19.7% in the year ago period.
Second quarter 2011 was impacted by a $92 million one-time non-cash charge of MEMC warrants. Including this charge, non-GAAP gross profit was $126 million and non-GAAP gross margin was 15.1%. In the second quarter we also took an inventory provision of $30 million which had a 3.5% impact on both GAAP and non-GAAP gross margins. We will continue to manage our inventory efficiently and monitor its market value regularly.
As I mentioned earlier, we reclassified freight expenses from cost of goods sold to operating expenses so that you can conduct an apples-to-apples comparison with our peers. In the second quarter, freight expense was $17 million note that historical gross margins in our financial statements had been adjusted to sort the classification and for Q1 of 2011 it was $16 million and for the same quarter Q2 of last year was $9 million for your information.
Wafer to module non-silicon conversion costs remained flat at $0.54 per watt. With commodity prices at elevated levels we expect the conversion costs to stabilize at this level in the near term before resuming the downward track. At our wafer facility, the wafer conversion cost was $0.22 per watt. Operating expenses increased to $204 million compared to $142 million or 22% of revenue in the second quarter of 2010.
The second quarter 2011 was impacted by $120 million settlement charge with MEMC to terminate its supply agreement. The year ago period was impacted by charges of thin film equipment and prepayments to our suppliers.
Excluding the one-time charges, non-GAAP OpEx was $84 million in the second quarter of 2011 compared to $63 million in the second quarter of 2010.
Loss from operations in the second quarter of 2011 was $170 million and operating margin was negative 20.5%. Excluding the impact for MEMC our non-GAAP income from operations was $42 million. This compares to non-GAAP income from operation of $61 million in the second quarter of 2010.
Please now turn to page 12. Net interest expenses was $32.5 million up from $22.6 million in the second quarter of 2010 of which $10.1 million of interest expense in the second quarter of 2011 was non-cash. The increase was primarily due to an increase in borrowing and a slightly higher interest rate.
We realized a foreign exchange gain of $12 million in the second quarter of 2011 which was offset by hedging loss, hedging loss is up $41 million. As a result we realized a net FX related loss of around $30 million which was in line with our guidance. Tax expense was $17 million in the second quarter of 2011, the majority of this was due to a tax expense at our profitable wafer subsidiary. We are in the process of applying for high tax before tax status at our wafer operation.
As I mentioned earlier, we also incur a $14 million one-time charge related to a discontinuation of CSG Solar in the second quarter. Net loss was $250 million or $1.44 per diluted ADS. Excluding the $266 million of one-time charges related to MEMC and CSG Solar, non-GAAP net loss was $34 million or $0.19 per diluted ADS.
Turning to some key balance sheet items on page 13 and 14. Our cash and cash equivalents totaled $648 million compared to $766 million as of March 31, 2010. Our inventories increased from $382 million in the second quarter of 2010 to $571 million in the second quarter of 2011.
Sequentially inventories only increased by $20 million reflecting our good inventory management. Day sales outstanding increased to 93 days from 58 days in the second quarter of 2010, the increase in DSOs in the second quarter 2011 was due mainly to large sales to – two major project customers as well as the majority of sales occurring in the month of June.
While we’re continuing to proven, manage our working capital. We do see an industry trend of expanding credit to compete. So, we expect DSO to remain at growth of the elevated level in the coming quarters. Nevertheless, we believe we have room to improve DSO by along 10 days by year-end. Net debt increased from 852 million in the year ago period to 1.79 billion in the second quarter of 2011. The increase in borrowing was used to invest in CapEx and working capital.
Please turn to page 15. Now I’m pleased to introduce our cash flow statement this quarter for the first time as I previously promised. We hope this will provide you with great insight through our operation.
I’d like to highlight the major non-cash items in the second quarter these include share-based compensation charges of $3 million depreciation and amortization of $32 million. Non-cash interest expense of $10 million inventory provision of $30 million, $92 million related to MEMC warrants and $14 million related to the discontinuation of CSG Solar.
In the second quarter of 2011 cash provided by operation was $2 million compared to cash used of $14 million in the second quarter of 2010. Total CapEx for the quarter was a $120 million which was related mainly to the expansion of our wafer and ingot slicing facilities.
Turning to our FX sensitivity on page 16. We currently expect a net FX loss of approximately $30 million in the third quarter based on current exchange rate of US$1.44 to the euro. The main reason for the hedging loss is because we enter into a number of contracts in late 2010 at an average rate of 1.29. Please note this is an estimate. Looking forward we have entered into various hedges at 1.40 and above in the second and third quarters of 2011 which will reduce FX impact from the fourth quarter 2011 onwards.
Now turning to the guidance of our – turning to guidance on page 17. For the third quarter 2011, we expect PV shipments to increase by more than 15% from the second quarter. In light of the increase if not irrational competition that we are seeing in the market, gross margin is expected to be in the range of 11% to 13%. For the full year 2011, we reiterate our shipments slightly up 2.2 gigawatts as Andrew mentioned previously. We’ve decided to slightly adjust our full year revenue guidance to 3.2 billion to 3.4 billion and our full year gross margin to the range of 13% to 15% excluding one-time charges in Q2. This reflects greater than expected pricing pressure.
Looking at capacities, we plan to expand our wafer capacity to 1.6 gigawatts by the end of 2011 in order to improve operational synergies. As Dr. Shi indicated in his remarks, we believe that semi integrated wafer capacity will ultimately enable us to continuing to lower our cost structure. As a result, full year 2011 capital expenditures are expected to be in the range of 340 million to 36 million. We will maintain our cell and module production capacity at 2.4 gigawatts for the time being.
Before I ask, let me say a few words about the quarters are ahead of us and what actions need to be taken. There is no doubt we are entering through challenging times as an industry. In terms of profitability, we will continue to manage our cost down in order to in addition to our ability to buy more effectively, we continue to focus on improving our process efficiency.
In the coming month, we will take specific measures to control OpEx. On balance sheet, we will improve our working capital with the combination of DSO reduction as I mentioned earlier and to secure longer term debt with the goal to reduce net debt by $200 million by the end of 2011.
Now, I will turn the call to Q&A. Operator.
Question-and-Answer Session
Operator
Thank you. (Operator Instructions). Your first question comes from the line of Jesse Pichel with Jefferies. Please proceed.
Min Xu – Jefferies
Hey, good evening gentlemen, this is Min Xu for Jesse. Thanks for taking my question. We think it’s a great move to terminate high priced wafer contract and we believe the savings could be potentially higher than the 400 million you estimated. Can you give us some color on what is the internal and external wafer prices in Q2 and how much wafer you produced versus purchase and the trend in Q3 and Q4?
David King
Yes, in Q2 our internal wafer production versus purchase from externally produced about 40% to 60% ratio. And going forward it’s approaching to 50%.
Min Xu – Jefferies
How about the price difference?
Rory MacPherson
Price difference is really depending on the silicon price and at this moment our processing cost for wafer price around $0.22 per watt.
Min Xu – Jefferies
Okay. And a quick follow-up what are the revenues and megawatts from non-module sales such as equipment, system and sales?
Rory MacPherson
Yes. It’s very negligible.
Zhengrong Shi
About 3% as I mentioned.
Min Xu – Jefferies
About 3% of the total revenue?
Rory MacPherson
Yeah.
Min Xu – Jefferies
How about shipment megawatts, about the same percentage?
Rory MacPherson
What was the need?
Min Xu – Jefferies
In terms of –
Zhengrong Shi
Can you please explain your question please?
Min Xu – Jefferies
In terms of megawatts from system and sales?
Rory MacPherson
We like system in Q2 sales is also very negligible. It’s probably in the 2% to 3%.
Min Xu – Jefferies
Okay, great. Thank you very much.
Rory MacPherson
Yeah.
Operator
Your next question comes from the line of Satya Kumar with Credit Suisse. Please proceed.
Brandon Heiken – Credit Suisse
Hi, this is Brandon Heiken speaking on behalf of Satya Kumar. Thank you for taking my question. I was wondering if you could talk about the China market and what you see developing there.
David King
Yeah, China market is actually very encouraging as we all are aware recently the government in particular NDRC has announced feed-in tariff of 1.15 RMB per kilowatt hour for the system which was connected before the end of the year. So, I think in China market this year probably the volume is going to be around 1.2 to 1.5 gigawatt this year. And, I believe next year we’ll be happily double.
Brandon Heiken – Credit Suisse
Great, thanks. And, can you talk about potential capacity expansion plan beyond this year please?
Rory MacPherson
At this moment we as that we have mentioned the wafer capacity will reach 1.6 gigawatt and the solar cell – module – solar cell is already around 2.4 gigawatt at this moment we will see whole market develop in before we decide whether or not we should expand how much we should expand.
Brandon Heiken – Credit Suisse
Thank you.
Operator
Your next question comes from the line of Sanjay Shrestha with Lazard. Please proceed.
Sanjay Shrestha – Lazard
Thank you two questions please. Could you elaborate a little bit on the magnitude of volume pickup you are seeing in key markets such as Germany and Italy so far?
David King
Andrew?
Andrew Beebe
Sure. You mean so far in Q2 or do you mean currently and in the future?
Sanjay Shrestha – Lazard
Currently and in the future?
Andrew Beebe
Yes. I mean I think globally we’re seeing strong markets but in Europe where things were depressed we’re starting to see real pickup. So I think across the Europe we’re expecting significant growth in the second half. There are some markets like France where I think we’re still waiting to see exactly how things will develop. But in general, we’re going to see strong growth in the second half of Germany and Italy. We expect Germany on the full year to be something like 6 to 7 and we see Italy doing something like 2.5 to 3.
Sanjay Shrestha – Lazard
Great. And second question is on China. Given the current pricing environment how much capacity currently is being taken off-line in China and then how do you sort of – like how do you – at what point would you expect some of that capacity to go away?
Andrew Beebe
Yeah.
Rory MacPherson
Unit production capacity or market production.
Sanjay Shrestha – Lazard
Production capacity in China given the current pricing environment?
Rory MacPherson
Okay, I think the capacity through the capacity in China this moment there is a lot of report I think it varies around from 20GW to 25GW is the range. And but I think there is a lot of two Tier 3 manufactures the production are sitting idle. So I think they certainly I believe for Tier 1 manufactures all production lines at full speed. So I think impacted production capacities in a probably somewhere around 15 to 20GW.
Sanjay Shrestha – Lazard
Got it. Thank you.
Operator
Your next question comes from the line of Rob Stone with Cowen and Company. You may proceed.
Robert Stone – Cowen and Company.
Hi guys. I was wondering,
David King
Hi, Rob.
Robert Stone – Cowen and Company.
You said that prices going to be down a bunch this quarter but you’re starting to see you’re hoping to see some flattening out. I wonder if you could just comment on what your expectations are implied in your full year gross margin guidance for pricing through to the end of the year.
Rory MacPherson
Yeah sure Rob as I said the mid to high teen declined is what we expect in Q3 and then I would say its flat was slightly down in Q4 and we have significant quarters in placed for Q3 pretty much locked on the quarter and Q4 we’ve got now finally very strong visibility into those numbers.
Robert Stone – Cowen and Company.
Okay. And on the input side I wonder if you could just comment I think Dr. Shi you said you expected poly counts to go down or what can you say what you think you’ll be paying for poly and purchase wafers in Q4 and how does your poly supply looks in terms of expected cost reduction going into next year?
Rory MacPherson
Yeah. If you look at gross margins for the whole industry is clearly the margins has been eroded and on the other hand we still believe that the gross margin have the silicon manufacturers pretty fixed.
So it’s clearly I think silicon product has to drop and I think in Q3 the silicon product probably around $45 to $50 I think in Q4 towards the end of the year and the next year probably somewhere $35 to $40. So I think – we with the product reduction of polysilicon I think from room for us to reduce the cost on modules.
Robert Stone – Cowen and Company.
Okay. My final question is for David. You said you’re going to take steps to control operating expenses. Should we be thinking in absolute dollar terms of lower expenses in Q3 or can you give us a sense?
David King
I’m – we’re currently have a plan put in place and not at least close to this. But we will try to do the best we can to contain and prepare for our the quarters ahead.
Robert Stone – Cowen and Company.
Okay. Thank you.
Operator
Your next question comes from the line of Vishal Shah with Deutsche Bank. Please proceed.
Vishal Shah – Deutsche Bank
Yeah, hi thanks for taking my question. Just wanted to clarify your expectations for gross margins based on the visibility that you’re seeing today in the pricing environment. Do you expect margins to improve from Q3 levels and also can you talk a little bit about your poly sourcing strategy, what percentage of your poly contracts are tied to spot market today? Thank you.
David King
Okay. As I said our gross margin guidance for Q3 is based on the current procurement cost and the ASP for the orders we booked for Q3 and going forward is really like the industry is very dynamic.
And from a ASP point of view I think as you guys know there is some irrational price going on at this moment which we believe is more sustainable and but again as I said the supply side polysilicon margins were 36. So, I think we’ve probably allowing the whole value chain even out I think in everybody we have some reasonable gross margin.
Vishal Shah – Deutsche Bank
But if prices are down slightly from Q3 levels what kind of margins then you achieve?
Rory MacPherson
As I said it depend on imports.
Vishal Shah – Deutsche Bank
Okay. What percentage of your contracts of Q4 –
Rory MacPherson
Yes, for polysilicon contract actually 90% of our contract is actually negotiable and so which kind of just according to the spot price.
Vishal Shah – Deutsche Bank
Great. And then what percentage of your Q4 volumes today are contracted out?
Rory MacPherson
For poly we only have 50% of cost.
Vishal Shah – Deutsche Bank
Not poly, overall Q4 shift?
Rory MacPherson
You say Q4?
Vishal Shah – Deutsche Bank
Yes.
Rory MacPherson
Yes, I mean I think roughly the number is probably the majority of them and where they’re not contracted as we said in previous quarters we have said strong visibility with our distribution customers on expected orders. And on the number of distributors that we have in each region has now been increasing quarter-over-quarter. So, not only we had visibility with our current and we have visibility with new customers as well.
Vishal Shah – Deutsche Bank
Okay, thank you.
Operator
Your next question comes from the line of Dan Ries with Collins Stewart. Please proceed.
Daniel Ries – Collins Stewart
Hi, thanks for taking the question. In the prepared remarks it was mentioned that you’re working to control expenses, I was hoping to ask a little bit about the production strategy, while we are hopefully entering the strongest month’s demand right now, there is a school of thought that the end of the year in early 2012 may be relatively weak?
Last year vendors produced in the first quarter led to a big inventory overhang and all the negative repercussions of that. In your planning what I’m wondering is, as you get it into December in the early month of 2012, will you base your production on actual orders or will it be on your forecast of orders. In other words, where you have utilization vary much more in the future to avoid some of these big inventory builds?
Rory MacPherson
Yeah. I think that’s a good point. And we think that’s neither very dynamic and we review our orderbook and plan very carefully to manage inventory more correctly. And if you look at our gross volume and our inventory control I think when we compare to our peers we’ve had been doing job in the last two quarters. So, we are continuing to improve our inventory control in the future, especially during this seasonality.
Daniel Ries – Collins Stewart
In 2011 it seem like a lot of orders not just the Suntech where I mean lot of production was based on framework agreements that ultimately don’t have the same level of certainty that a purchase order would, have you changed your policy at all with regard to production based on framework agreements versus purchases orders?
Rory MacPherson
Yeah I’ll update that. We have charging our planning and even making sure much better in the last quarter and has reflected from our account book.
Daniel Ries – Collins Stewart
Thank you very much.
Rory MacPherson
Yeah.
Operator
Your next question comes from the line of Edwin Mok with Needham and Company. Please proceed.
Edwin Mok – Needham and Company
Hi, just one clarification on the gross margin guidance for the full year, is that GAAP or non-GAAP?
David King
I didn’t hear. For full year gross margin guidance what was that?
Edwin Mok – Needham and Company
Was that GAAP or non-GAAP gross margin guidance?
David King
Non-GAAP. As we indicated it was excluding the Q4 one-time charges.
Edwin Mok – Needham and Company
I see. So, if I look at that.
David King
I’m sorry. Okay.
Andrew Beebe
Sorry.
Edwin Mok – Needham and Company
Okay. So – that’s helpful. So, if I look at that that imply that you guys expect margin improvement in the fourth quarter, so is that more come from just cost reduction or do you see any kind of possibility for price improvement in the fourth quarter?
David King
The non-GAAP gross margin was weighted throughout the year with volume. So, it’s what we guided 11% to 13% for Q3 and that’s what we weighted the whole year.
Andrew Beebe
Obviously on the pricing side I think while there is potential for upside in Q4, I am certainly seeing some theory that pricing would increase. We are not planning on it.
Edwin Mok – Needham and Company
I see. And then one specific question on lately related to U.S.A., how do you see that market progressing on the second half of this year, is that being in line and in terms of your business and U.S. do you expect that to grow in similar rate and above 15% shipment or how do you look at that?
David King
Yeah, so the U.S. is becoming more than 15% of the shipments. And I would say it’s right in-line with our expectations. We’re expecting to ship as we previously guided, 500 megawatts in the U.S this year. And we expect a strong finish to the year, but it’s been pretty consistent and the strong market for us.
Edwin Mok – Needham and Company
Great. That’s all I have. Thank you.
Operator
Your next question comes from the line of Kelly Dougherty with Macquarie. Please proceed.
Kelly Dougherty – Macquarie
Hi, thanks for taking the question. I just want to focus a little bit on interest rates and your net debt. Just wondering what your average interest rate was, and how much of that is variable with the Chinese rate movements?
Andrew Beebe
Our average rate is about 6% and it’s mostly. Anyway our average rate is about 6%.
Kelly Dougherty – Macquarie
And that’s variable based on where rates move in China?
Andrew Beebe
Yes.
Kelly Dougherty – Macquarie
Okay. And then, just wondering how you intend to lower net debt by $200 million by the end of the year, especially as you’ve just raised your CapEx guidance for this year so, maybe if you could help us to think about that?
Andrew Beebe
Right, I mentioned in the script, the DSO improvement is about 10 days it’s a $100 million right there. And we have expense target and so, and they are harbor management that we put in place and we will – we will do what we can do to get there.
Kelly Dougherty – Macquarie
So you are looking to repay some of that or just to increase the cash part of the net debt calculation?
Andrew Beebe
Yeah, we will be looking at all harder measures for example, looking at longer-term debt. And so our cash floating will not be in attrition as we have today.
Kelly Dougherty – Macquarie
Does the longer-term debt have a lower interest rate so I was just trying to think about the interest burden as we move forward.
Andrew Beebe
Yeah, that’s what we have in the plan.
Kelly Dougherty – Macquarie
Okay. And then you just mentioned that processing costs or non-silicon costs again stabilize around $0.54 in the near term, can you give us a sense of when you think that will start to improve and maybe where you think you can lower processing cost into 2012?
Andrew Beebe
Of course, yeah, there is room for to continue to improve the cost. But as we just indicated the commodity price has been going up in the last few quarters. So you have those silicon price has increased by 30%, 40% and also oil price, because some of materials depend on the extracts of the oil.
So, – but I didn’t do well – I do want to point out one key difference what would be unique perhaps from some of you as there are a variety of materials available in the market and which have different quantities, so it’s something that has the leading brand and leading trail we pay very much attention to the quantity.
So, we don’t want to compromise any quantities for cost. So because we guarantee the product for 25 years that led through the important of bank ability, so just to give you a sense and for guarantee the quantity material I think as I said because of commodity prices going up, so that’s why the material prices sort of hold steady at this moment.
Kelly Dougherty – Macquarie
Okay. I understand that, but I mean as you improved conversion efficiency and consumable cost, I don’t think –
Andrew Beebe
That will give the cost, yes.
Kelly Dougherty – Macquarie
Right. But do you have kind of the target maybe for where you can be for processing cost in 2012?
Andrew Beebe
No, we try to just bound to $0.45 per watt in 2013 – sorry, per watt in 2012.
Kelly Dougherty – Macquarie
45 from 54 right now?
Andrew Beebe
Yes.
Kelly Dougherty – Macquarie
And how much of that comes from conversion efficiency versus other things?
Andrew Beebe
Conversion efficiency we at this moment we’ll increase our conversion efficiency of our output in a probably about 5% to 7% and the rest is by like using the improve the material with this.
Kelly Dougherty – Macquarie
Okay, great. Thank you.
Operator
Your next question comes from the line of Lu Yeung with UBS. Please proceed.
David King
Hello.
Lu Yeung – UBS
Can you hear me. Can you hear me?
David King
Yes.
Lu Yeung – UBS
Hello.
David King
Yes.
Lu Yeung – UBS
Hi. My question is the inventory at the end of the second quarter maybe you can help us a little bit understand the breakdown of each component and maybe the cost basis at the end of the quarter. I just want to and have to see the impact of higher pricing into your third quarter margin guidance?
David King
Yeah, yeah we are we don’t disclose the information.
Lu Yeung – UBS
The cost basis or the breakdown the inventories?
David King
We do not disclose future inventory information.
Lu Yeung – UBS
Okay. Maybe we see a little bit can you help us understand the second half shipment of Pluto and your maybe annual target?
David King
Yeah for Pluto shipment we are on track to deliver the volume about 200 megawatts.
Lu Yeung – UBS
And how much is do you expect that should be in this third quarter?
David King
In the third quarter.
Andrew Beebe
Third quarter probably around 80 megawatt in the third quarter.
Lu Yeung – UBS
And do we see like some of pricing premium for the products?
David King
Yes I mean, all of our premium products in the marketplace had been very well received in any market that we’ve introduced them, and in all those places we receive premium.
Lu Yeung – UBS
Can you maybe quantify a little bit?
David King
I mean generally speaking, it depends obviously volume pricing customer type introductions but, in that 5% to 10% range premium.
Lu Yeung – UBS
Sure. And how should we understand your processing cost side if you could tell how does that help or trend where you’ve got a overall processing cost?
David King
At this moment because of the volume are not quite off there yet compared to our for example like in the 2 gigawatt amount of sales is that the profit and cost for Pluto very higher. But we with the ramp-up of the volume there that cost is coming down quite quickly to the level of comparable to the conventional sales and modules.
Operator
(Operator Instructions). Your next question comes from the line of Paul Clegg with Mizuho. Please proceed.
Paul Clegg – Mizuho
Hi thanks for taking my question. David, you made an interesting comment that credit terms are increasingly a competitive weapon, I guess in this tough market environment I was hoping to get a little bit more detail there?
David King
I think we have seeing not only pricing pressure but we’re also seeing some peers actually sending credit to win business.
Paul Clegg – Mizuho
And, I guess what are you doing to protect yourselves in that environment. Are you tightening credit terms or anything to make sure that you don’t have an uptick in bad debt expense?
David King
I’m pleased to say that as of today we have minimal bad debt expense. And we will continue to compete, but we will try to balance between price premium and credit terms and as we believe as Andrew mentioned there is a flight to quality seeing them in the marketplace as Tier 2, Tier 3 starts to struggle and starts to stretch, we – our ability to maintain and then the – our maintaining quality and the shipments I think it’s how we are seeing that in the marketplace.
Paul Clegg – Mizuho
Okay. I guess some –
David King
I mean this just as our customers are looking for bankable products. They’re also looking for a bankable vendor. So they are looking to make sure that we are holding reasonable credit terms and have reasonable bankability ourselves. And I think in the industry where it’s increasingly critical that people are moving towards and coming into this flight to quality, we’re in a great position to continue with that leadership role and not sort of constantly fight the rational pricing and a rational credit terms.
Paul Clegg – Mizuho
Okay. I guess I’m just trying to reconcile with the comment earlier about trying to improve working capital because it seems like your credit terms are being moving in the opposite direction?
David King
Yeah, right and I think 93 basis on the high end of what we can tolerate. And so we will try to improve that and we need to realize that – it will be some reality in terms of few days of tiers if you will – credit terms.
Paul Clegg – Mizuho
Okay. And if I may just quick on the sales channel expansion that you mentioned is being one of the reasons for OpEx expenses pushing up. Could you give us a little bit more detail on that and where you can expect OpEx overall to flat not as a percentage of revenues overtime?
David King
Could you repeat the question again?
Paul Clegg – Mizuho
Sure. I was looking at your OpEx, which is up quarter-over-quarter and one of the rationales that you gave for it was sales channel expansion which makes sense. But I was hoping to get a little bit more details on where you are spending the money, geographically, specifically and then where you would expect OpEx as a percentage of revenues to revert over time?
David King
I’ll let Andrew answer to your channel, but I believe we have very, very deep channels in Europe and U.S. our strategy is more and more large scale utility market and so channels are also well established. And we’re currently running at a 10% OpEx versus revenue margin and our goal is to get down to 9% range.
Paul Clegg – Mizuho
Okay.
David King
In the coming quarters.
Andrew Beebe
In all regions including Japan, we now have fully established CEUs. The only place in that – that includes China as well where we’ve had a large stake for a while on the sales side. In place where we will see some expansion is in the Asia Pacific, Middle East and Africa regions and those will be highly selective and very low cost. So there – there won’t be growth in that sales channel OpEx percentage.
Paul Clegg – Mizuho
Great. Thanks very much.
Operator
Your next question comes from the line of Colin Rusch with ThinkEquity LLC. Please proceed.
Colin Rusch – ThinkEquity LLC
Thanks so much. Could you guys talk about next generation R&D efforts that you’re working on, if you’re looking at ion implant technology and type and other efforts that you’re making on the wafer side to improve efficiency and reduce material consumption?
Andrew Beebe
Yeah we have constantly looking out for innovation and especially now we have in-house wafer facility to work on the integration of our profits from wafer sales module and then try to improve the material quality in a sale processing.
And at this moment, as I said earlier, our Pluto process and is constantly produce monocrystalline silicon sale with efficiency over 19% and multicrystalline silicon efficiency over 17%. Our next generation Pluto technology efficiency is way about 20%. So, I think what is constantly monitoring the new technology such as ion implantation in another, but the most important is whatever new technology will try to adopt, which has to be engineering feasible and also compatible to our existing production line and also in a cost wise should be also competitive and otherwise is probably don’t make sense in a long-term.
Colin Rusch – ThinkEquity LLC
And just one quick follow-up. Would you consider moving away from your close working relationship with the 48th Research Institute to start working with more vendors and get them more comfortable that their technology would be safe in terms of working with you guys going forward?
Andrew Beebe
We have our in-house research and engineering team and of course we have to simultaneously work with vendors in material supply and also some equipment supply to make sure our initiatives can be realized.
Colin Rusch – ThinkEquity LLC
Great. Thanks so much.
Andrew Beebe
Yes.
Operator
Your next question comes from the line of Pranab Sarmah. Please proceed.
Pranab Sarmah
Hi, good afternoon. Thank you for taking my questions. My first question is on your wafer costing side. When do you think that your wafer cost will meet their current spotting price cost because currently the spot price is about $0.50 per watt roughly and when you think that you will be able to achieve that cost structure with your – for your wafer?
David King
You know how the wafer cost structure is very much in line with the industry cost structure. So, I would say that it depends – really depends on the silicon price and if we’re talking the silicon price at $50 per kilogram that’s probably we’re talking probably under $30 – sorry, on the $0.30 maybe $0.28 or even lower per watt plus $0.22 processing is about $0.50 or lower per watt.
Pranab Sarmah
Now since the MEMC contract is not there can you assume like at least by 4Q this year you will be able to achieve your wafer procurement cost just quite comparable to what is called spot market at that point?
David King
I think so.
Pranab Sarmah
Okay, that’s very good.
David King
Yes.
Pranab Sarmah
The second question is on shipment side, I think you’re guiding for 4Q more than 600 megawatt shipment if I assume like you are going to meet your target shipment guidance, how much of that 600 plus megawatt you have from contractor deal?
David King
I am sorry, for which quarter?
Pranab Sarmah
For Q4.
David King
Yeah.
Pranab Sarmah
If I take your full year guidance and if I take your 3Q shipment guidance, 4Q should be more than 600 megawatt.
David King
Yeah, in the majority of Q4 that’s been booked and I would say again that the remainder not the entire remainder but the vast majority of the remainder also will come from pre-existing customers where we have greater and greater flexibility into their forecast.
Operator
Your next question comes from the line of Sam Dubinsky with Wells Fargo. Please proceed.
Sam Dubinsky – Wells Fargo
Hey guys, I know you keep on saying that your internal wafer cost you predicated and we’re poly it. But if you look at all the major wafer suppliers now they’re currently either half poly capacity or ramping poly capacity pretty aggressively and are really trying to some more wafers and straight poly.
And so I guess my question is in theory, internal wafer supply, if the market stays oversupplied, your internal wafer production ever really be cost competitive. And if it’s not what’s the goodwill associated with some of these assets from acquisitions, risk of a write-down some point next year
Andrew Beebe
Well we’ve – our in-house wafer facilities are strategic and we want to mitigate our supply freight. And to give us some more flexibility in supplier portfolio and we believe our cost structure wafer, in-house wafer facility is actually at least in line with industry average could be better. So actually, we – because we have to continue to improve our process, to be competitive in the future.
Sam Dubinsky – Wells Fargo
With our module capacity give any of that and then I just have one last follow up.
Andrew Beebe
It is the most – we in mainly multi.
Sam Dubinsky – Wells Fargo
Do you strategically do you think it may make more sense to do more module capacity going forward, just it seems like there has been more under investment in that segment of the wafer supply chain?
Andrew Beebe
No, we were not do mono.
Sam Dubinsky – Wells Fargo
Okay.
Andrew Beebe
We remain with multi.
Sam Dubinsky – Wells Fargo
And just my last question is and just on China projects. Can you just discuss with the panel ASPs are the system ASPs and what the target returns for a project in China is based on today’s subsidy?
Andrew Beebe
Well, I don’t tell you’ve, like, I think can look at our sales with 1.15 R&D per kilowatt hour, right with like in most wafer of China with refractive radiation and probably about R$1700 to R$2000 per year you sort of account what capital, what is the with 8% to 10% of our capital sales target.
Sam Dubinsky – Wells Fargo
So that’s the target return of 8% to 10%?
Andrew Beebe
Sorry.
Sam Dubinsky – Wells Fargo
That’s the target return of 8% to 10%?
Andrew Beebe
Yes.
Sam Dubinsky – Wells Fargo
Okay, great. Thank you very much.
Andrew Beebe
Yep.
Operator
Your next question comes from Brian Gamble with Simmons & Company. Please proceed.
Brian Gamble – Simmons & Company
Yes, hi guys. On your comment on the monetization of some of the GSF projects, is that something that you are looking to do in the short term or you are waiting for market improvement before you actually sell those – some of the projects it seem to be sold recently been done, it’s pretty low numbers, how long you will into wait to sell those projects?
Andrew Beebe
Well basically like GSF is our invested company and GSF management we decide to when and how to monetize the asset. So, I think we actually update once we have some update and information from them.
Brian Gamble – Simmons & Company
And then your geographic breakout between markets obviously doing a good job being under the market for European exposure this year as the European market continues to improve back half and into ‘12, do you expect your ratios to shift between the three breakout segments?
Andrew Beebe
No, I mean the ratio that we had given for 2011 is the ratio that we expect to end with and I think going into 2012 that’s going to suit us well in the first couple of quarters which will continue to be soft in Germany and Italy.
Brian Gamble – Simmons & Company
Thanks guys.
Operator
Your next question comes from the line of Mark Bachman with Avian Securities. Please proceed.
Mark Bachman – Avian Securities
Thanks for taking my question. Andrew, curious about your expectation in the upcoming PV Tech show, do you need significant contracts here in order to make that Q4 against what your 2011 guidance?
Andrew Beebe
No.
Mark Bachman – Avian Securities
So, can you assign a probability here of upsizing the 2.2 gigawatts of annual shipments?
Andrew Beebe
Yes, I mean it’s very high, it’s our guidance, and it’s a number that we start to I think really throughout the year and I think for the first two quarters we’ve seen a strong targetability, I guess I would remind you that we’re at 45% shipment at the end of Q2 and normally we’ve been historically with that 40% shipment at the end of Q2.
There is I mean not every year is the same in the solar industry but that sort of seasonality and the late stage course in Q3 and Q4 should absolutely repeat this year if not the little bit slight you’re going to have in the past because we saw such a slow start to Germany and we saw a slow start to Italy.
As I said in the comments I mean Italy really is sort of getting a seat back under itself from the challenges that it faced at the beginning of the year and in Germany we saw a real holdback or hesitation in Q1 and Q2 due to the pricing declines.
As the pricing has started to level out and as really the returns are just too good to wait in Germany and in both countries they face a challenge with the increasing feed-in tariffs in the beginning of Q1 I think you’re going to see this ongoing strong demand as we already have and you guys start starting seeing your channel checks. And the real difference in September, October, November is that they’ve all brought in through their inventory from the first two quarters.
Mark Bachman – Avian Securities
Got it. So do you think there is a probability – what do you think the probability is seating back to 2 gigawatts of annual shipments?
Andrew Beebe
I think as time goes on we got less and less time to push above the 2.2, so we’re now two-thirds of the way through Q3, so, really talking about a very limited portion where we can exceed that, but I think that there is some potential upside. And I think the U.S. creates a spiky opportunity because of the cash grant as well and that will be some political challenge to the very end to see that gets extended or not, but many of our customers are planning accordingly i.e. planning for not to get extended and that could create certain higher than expected volume.
Operator
Your next question comes from the line of Pavel Molchanov with Raymond James. Please proceed.
Pavel Molchanov – Raymond James
Thanks for taking my question. My question is for David. I think you mentioned in your remarks that you’re characterizing the current competition in the marketplace as irrational. First of all, kind of what do you think I guess explains that or if you can just elaborate in that statement? And then secondly, what are the measures that you would like to be taking to in that dynamic in the market?
David King
Well, we have heard – Andrew can echo. We have heard pricing at the – much lower than what we step ourselves as a bottom and especially some of tier one competitors in mostly from tier two, tier three competitors. And again this is probably driven by capacity and try to keep the factory running and I believe this is specific – this is a kind of error that big and strong company going through the next few quarter going to be bigger and stronger.
Andrew Beebe
Okay. Also I just want to add one more comment. This industry is still young, still young which required continued innovation and investment. So, if our industry or player if we anybody that have not have the reasonable profitability. I think it’s not going to be substantial. So, that’s why I think it is in rationale behavior at the moment. So, this is a wonderful industry I mean Suntech as a leader we have to behave like a leader okay to lead the industry through this downturn.
Pavel Molchanov – Raymond James
Okay. May I also ask how many panel makers are you aware of currently operating in China, and how much do you expect that number to shrink over the next let’s say, 6 months to 12 months?
David King
All right let me give you some color for this industrial rainbow. And I think at this moment probably like most of Tier 1 manufacturer running at full capacity. And Tier 3 I think they’re either running at half full, totally idle. And among this new player is an element that most of them came in last year.
And some of them probably lot of them they actually see PV as a new growth area, because they have some other dividend. So I think if for a couple of quarters, so if the industry kicks like that many manufacturers would decide to exit, because they have some other main stream business – main core business to rock. So, I can tell all of you have some capacity exhibit from the industry. So I think that has a fairly an effective capacity will be probably around 20 gigawatts.
Operator
The final question will come from the line of Mehdi Hosseini with SIG. Please proceed.
Mehdi Hosseini – SIG
Yes, thanks for taking my question. Just a clarification, early on you mentioned that it is getting harder to get line of credit, but you also said that you’re going to work down your days of – DSOs to less than a quarter. So what gives the confidence that some of your customers are going to be able to actually pay for the modules or products that they have received?
David King
But credit term is only one of the many ingredients to sell to your customer and to emphasize again bankability, bankable supplier, bankable product and we intend to as Dr. Shi also said we will behave like a leader and we will fit between price and volume and we will fit within prior to credit term and do everything we can to maintain the leadership.
Mehdi Hosseini – SIG
Sure.
David King
I mean I just to add on the customer side we also have spend the last few quarters making sure that we have the right customer set and being selective about exactly who we work with. As the leader we’re looking to work with leaders within their segments and their spaces and that served us well, not just because it’s nice to work with leaders, but because those leaders tend to have stronger credit positions and that goes to the bad debt and other things.
And then I would just also note that here are other components to the sales as David said and one of those things that David has mentioned in previous calls that we are working increasingly with customers on target finance support and other mechanisms and other partners that we can bring to the table to deal with real partnerships beyond the panel and that has been very effective in really every region around the world, just getting started.
Operator
Ladies and gentlemen that concludes the question and answer session. I will now turn the call over to Dr. Shi, Suntech’s CEO. Please proceed for any closing remarks.
Zhengrong Shi
Thank you for being in our call today. If you have any further questions please follow-up with our investor relationship department and/or David or myself or Andrew and thank you. Have a nice day.
Operator
Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.
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