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Executives

Christopher Chaney -

Bill Michalek - Director of IR & Corporate Communications

Ahmad R. Chatila - Chief Executive Officer, President and Director

Mark J. Murphy - Chief Financial officer, Principal Accounting officer and Senior Vice President

Analysts

Stephen Chin - UBS Investment Bank, Research Division

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Timothy M. Arcuri - Citigroup Inc, Research Division

Aditya Satghare

Satya Kumar - Crédit Suisse AG, Research Division

Jesse Pichel - Piper Jaffray Companies, Research Division

Krish Sankar - BofA Merrill Lynch, Research Division

Edwin Mok - Needham & Company, LLC, Research Division

Vishal Shah - Deutsche Bank AG, Research Division

MEMC Electronic Materials (WFR) Q3 2011 Earnings Call November 2, 2011 5:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the MEMC Third Quarter Earnings Conference Call. [Operator Instructions] And as a reminder the conference is being recorded. I'd now like to turn the conference over to our host, Chris Chaney, Director of Investor Relations from MEMC. Please go ahead.

Christopher Chaney

Thanks, Lauren [ph]. Good afternoon, and thank you for joining MEMC's Third Quarter 2011 Earnings Conference Call. I am Chris Chaney, Director of Investor Relations. With me today are Ahmad Chatila, President and Chief Executive Officer; and Mark Murphy, Chief Financial Officer.

After my remarks, Ahmad will provide an overview of the significant events and commentary on the company's third quarter performance, and Mark will then review the financial results. Mark's discussion will reference slides we've made available in the Investor Relations section of our website at www.memc.com.

Our discussion today will refer to certain non-GAAP financial measures. A reconciliation of these non-GAAP measures has been provided in our earnings press release financials. Please note that this call will include forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statement contained in the earnings release and slides published today for a more complete description.

And now I will turn the call over to Ahmad Chatila, our Chief Executive Officer.

Ahmad R. Chatila

Thank you, Chris. Good afternoon, everyone. During the third quarter, we continue to drive our semiconductor consolidation efforts and our solar PV downstream integration strategy, providing some insulation to the upheaval in our markets. The semiconductor industry is in a cyclical downturn that we believe will last into early 2012. We are well positioned in this market, and we continue to gain share while remaining disciplined on pricing.

The solar PV industry is in a supply-induced correction exacerbated by policy uncertainty particularly in Europe. This is a challenging time in our industry, and in the face of this challenge, we delivered a 50% year-over-year improvement in non-GAAP revenue and grew cash $134 million sequentially, ending the quarter with a cash balance of $786 million. Gross margin was negatively impacted primarily by the overcapacity in Solar Materials.

In our Semiconductor business, we are ramping our 200-millimeter facility in Ipoh, Malaysia and 300-millimeter facility in Korea while maintaining pricing in a weak environment. We will be disciplined on pricing, and we will control capital expenditures to weather this mild storm and expect to emerge stronger in the second half of 2012.

In our Solar Materials business, we rent our wafer JV in China and are optimizing our facility in Kuching, Malaysia ahead of a full ramp. Further capital expenditures will be nominal. Fully diluted cost and cash cost of the China JV are $0.23 a watt and $0.20 a watt, respectively. We expect continued productivity gains at this JV in the foreseeable future.

Our Kuching facility is delayed as we have not fully optimized operating metrics. In today's weaker demand environment, it makes sense to ramp our China JV, with which we have competitive costs and optimized metrics at our Kuching facility, before ramping further. Through technology-driven productivity, I'm confident that this facility will deliver best-in-class cost. Kuching will be the lowest cost factory.

In our SunEdison business, we added substantially to our pipeline with acquisition of Fotowatio Renewable Ventures. We ended the quarter with 3 gigawatts of pipeline, up from 2.5 gigawatts at the end of second quarter. We grew our pipeline organically as well and installed approximately 100 megawatts in the quarter, but also removed 300 megawatts U.S. project because transmission costs rendered the project uneconomical.

We also removed several European projects from our pipeline due to changes in feed-in tariff policy. These projects are not gone but presently no longer fit our criteria for pipeline. We continue to have a healthy business in Europe. Finally, we will continue to focus on building our pipeline and believe a diversified approach in geography, market and project size best mitigates risk.

Going forward, we are focused on cash generation and cost reduction, including operational expenses. We have reduced capital spending substantially and do not see a need to increase it in the near term. We will ramp our semiconductor factories in Ipoh and Korea and our solar wafer facility in Kuching with a keen focus on cost control and cost reduction. We will also continue to grow our pipeline and diversify geographically.

The semiconductor industry is going through a mild downturn, but the solar PV industry is at an inflection point. We believe the next year or 2 will be difficult but will define the future shape of the solar energy industry, and the company is most likely enable to capitalize on it. These are challenging times, but I'm confident we are well positioned to emerge as stronger, better positioned company, driving leadership positions in both our industries.

Now I will turn things over to Mark, who will review the financials and provide guidance.

Mark J. Murphy

Thank you, Ahmad, and good afternoon, everyone. My comments today will reflect information found in the press release and attachments we released shortly after the market closed today. And we'll reference the third quarter 2011 earnings conference call presentation, which we posted on our website. These documents can be found in the Investor Relations section of our website.

Chris has already reviewed the Safe Harbor statement, which you will find on Slide 3 of the presentation. So please turn to Slide 4, where you will find our summary results.

The third quarter presented a number of headwinds for MEMC, but we believe our business structure, actions over the past few quarters and plans underway position us to navigate this difficult environment. Before reviewing the P&L, I want to remind you of the non-GAAP measure introduced last year, which adjusts revenue and certain expense items as if they were recognized under traditional SAB 104 revenue recognition, rather than under real estate accounting rules. The specifics are detailed in the appendix of the PowerPoint. We believe this measure better describes the operational performance and cash profile of SunEdison, and over time, we expect non-GAAP EPS to approximate GAAP EPS.

Third quarter revenue was $516 million and a non-GAAP revenue was $859 million. The difference of $343 million was due to the sale of several direct sale and sale leaseback solar energy projects during the quarter that were not recognized under GAAP. I will discuss this in more detail in the SunEdison section.

Non-GAAP EPS for the quarter was a loss of $0.22, and excluding the goodwill impairment charge of $56 million, was $0.03 of income. My comments on Slide 5 and the following slides will refer to non-GAAP figures unless otherwise noted.

Total non-GAAP revenue for the third quarter of 2011 grew 10% sequentially, even though the second quarter included $149 million of revenue from the contract resolution with Suntech. Excluding the onetime Suntech revenue in the second quarter, non-GAAP revenue increased 36%. SunEdison installations more than doubled and these results were the primary driver of the increase from the second to third quarter. On a year-over-year basis, total revenue grew 56%, again, driven by higher solar energy system sales of SunEdison.

Gross profit margin in the 2011 third quarter fell to 14.5% from 25.2% in the prior quarter. While the decline was primarily driven by the Suntech contract resolution noted earlier, we also experienced sharply lower pricing in Solar Materials. Consistent with weaker demand and the overall oversupply for solar wafers, our solar wafer average selling price fell approximately 20% sequentially, following a 17% sequential drop last quarter, while our pace of cost reduction has not yet caught up with the price decline. Continued improvements to our cost structure to more than offset these price declines will be a primary focus in the coming quarters.

Operating margin was negative 4.4% in the third quarter of 2011, down from 8.6% last quarter, driven primarily by the effects of the Suntech contract resolution in the second quarter, continued price declines in solar wafers and the third quarter goodwill impairment charge. Among the actions we are taking to improve our operating performance are tighter cost controls and a focus on improving productivity across all segments.

Our operating expense as a percentage of sales declined from 17% last quarter and 14% in the year-ago quarter to 12% in third quarter, excluding the goodwill impairment charge. Our third quarter non-GAAP EPS was a loss of $0.22 or a $0.03 EPS profit excluding the goodwill impairment. This is compared to $0.29 last quarter, which included the Suntech contract resolution.

Turning to Slide 6. I'll cover -- I want to highlight the present state of markets we serve. The solar PVs module supply chain remains an oversupply as reflected in the sharp price declines over the past 2 quarters. We expect that solar wafer prices will continue to decline into the fourth quarter due in part to falling polysilicon prices. Given the present dynamics of Feed-In Tariff Programs in the largest European markets, solar market conditions are expected to remain challenging during the remainder of 2011 and through 2012. In this environment, we believe competitive technology, such as FBR high-purity silicon production and advanced wafering and scale such as we have in SunEdison, will drive best-in-class costs and drive demand.

The semiconductor wafer market is also slowing, indicative of a moderate cyclical downturn in a mature industry. Despite the slowing, semiconductor wafer pricing was relatively firm in the third quarter.

Our strategic priorities are unchanged: drive to world-class cost through productivity and advanced technologies, sharply limit polysilicon and wafer CapEx to assets that offer sustainable and differentiated advantage, and build scale and greater efficiency in downstream solar. Our short-term priorities are clear in this environment: reduce additional costs through select restructuring and other productivity initiatives, focus on cash flow and preserve the quality of our balance sheet, and grow the business to best leverage our existing capacity and vendor relationships. Against this backdrop, I will now review the operating results from our 3 business units on Slide 7.

Each of our business segments faced challenges during the quarter. Although we cannot control the business economic environment, actions taken in recent quarters have better positioned us to navigate this period.

Our Semiconductor business is becoming increasingly cost competitive as we recovered ahead of schedule from the Japan earthquake and as we continue our global consolidation efforts. We expect to largely complete the U.S. plant shutdowns by the end of this year and realize higher cost savings early next year. Although our Semiconductor Materials segment experienced a general slowdown in demand, our 300-millimeter wafering expansion in Korea has enabled us to gain share. However, in the current market environment, we have pivoted aggressively to productivity and are planning additional restructuring actions.

We generated positive free cash flow on our Solar Materials segment through improved working capital management and reduced capital spending following the completion of our Kuching facility and tighter CapEx controls. We increased MEMC-branded module production through our partnership with Flextronics to support SunEdison's project growth. Although we have made much progress in Kuching and have line of sight to world-class cost, our manufacturing ramp is behind schedule contributing to higher cost wafer production than expected.

Finally, we closed on the acquisition of Fotowatio and secured $300 million in additional project financing to help support our rapid growth downstream. At the end of the third quarter, we had over 300 megawatts of projects under construction.

Now turning to the Semiconductor Materials business unit update on Slide 8. Revenue declined 3% sequentially but grew 3% year-over-year. The sequential decline was driven by lower volume but was partially offset by slightly higher average selling prices, which also led to the positive comparison to the same period last year.

Semiconductor Materials operating profit continue to improve post-Japan earthquake, increasing over fivefold sequentially. Third quarter operating results still included $2.9 million residual earthquake expenses. Lower year-over-year comparison was also driven by $10 million foreign exchange effects, partially offset by $6 million due to productivity improvements and restructuring efforts.

Turning to the Solar Materials business update on Slide 9. Revenue in Solar Materials fell 38% sequentially to $199 million in the third quarter. We recognized $149 million from the contract resolution with Suntech in the prior quarter, which drove the negative sequential variance. Absent the second quarter benefit, revenue increased 15% sequentially with higher volumes offset by a roughly 20% decline in wafer prices.

Solar Materials operating profit fell sequentially from a profit to a loss in the 2011 third quarter. Although our tolling cost came down and Kuching made progress towards its cost target, our cost reduction in polysilicon and wafer production lagged behind price declines. Year-over-year, lower operating profit was driven primarily by price declines, again, partially offset by cost reduction.

Third quarter operating loss includes a $56 million noncash charge for the impairment of goodwill in Solar Materials. In addition, third quarter results also include benefit from revised estimates related to supplier-contract charges in the second quarter, offset primarily by charges related to low utilization levels at Kuching.

Productivity is a focus at our solar wafering plant in Kuching. Kuching CapEx spend is largely complete, and current efforts are focused to reach planned cost targets and increased utilization of this advanced wafering technology. We have line of sight in this plant performing at best-in-class cost by mid-2012, and together with our joint venture arrangements in cells and modules, Solar Materials can provide an attractive cost structure for our SunEdison business.

Now let's turn to our Solar Energy segment on Slide 10, SunEdison. Because the adjustments defined by our non-GAAP metric are limited to SunEdison business, all the financial numbers on this page are non-GAAP.

Third quarter non-GAAP revenue is $391 million, which more than doubled sequentially and included $34 million of energy revenue. The significant sequential revenue increase was due to higher project completions, partially offset by lower average selling prices as a function of both project mix and system pricing. During the third quarter, 3 megawatts of project were recognized revenue under GAAP and 82 megawatts revenue under non-GAAP. A total of 85 megawatts of projects were interconnected during the quarter.

In the third quarter, we had a large variance between our non-GAAP and GAAP revenues. Of the $343 million variance, $151 million relates to sale leaseback transactions. $192 million relates to direct project sales, of which we expect approximately $170 million to be recognized under GAAP over the 2011 fourth quarter and 2012 first quarter.

Real estate accounting requires a short-term deferral due primarily to contractual causes that are related to highly remote indemnifications and are economically insignificant. Outside of real estate accounting, we would have been able to recognize more GAAP revenue for the direct sale projects.

We've walked through the details of SunEdison non-GAAP accounting in prior earnings calls, so I will not do so again today. But the appendix of this presentation includes an illustration demonstrating how our non-GAAP P&L reflects underlying cash flows and better represents SunEdison economics.

Operating profit for the third quarter was up $29 million sequentially, driven by higher project completions partially offset by higher operating expenses. Over the last couple of quarters, SunEdison operating expenses have grown to support rapidly growing project installations. Now that the business has reached sufficient scale, we are turning more aggressively to OpEx in the business and expect OpEx efficiency to improve dramatically over the next several quarters.

Moving to Slide 11. I'll review some key metrics of our pipeline. You can see on the chart on the left that our interconnections nearly tripled from the second quarter to the third quarter this year, increasing from 30 megawatts to 85 megawatts. Also note that megawatts under construction, the black line, shows a similar pattern, growing from 160 megawatts to 330 megawatts, from the second quarter to the third quarter reflecting higher forecasted project completions over the next several quarters.

On the right side of the page, you will find pie charts showing our pipeline broken down by region and size. Nearly 3 quarters of our 3-gigawatt pipeline is in North America, a region we believe to be one of the most stable and less vulnerable to changing subsidies and demand volatility. The acquisition of Fotowatio increased both the mix of our North America and utility scale projects in the third quarter. While growing the utility segment, the majority of our projects are still below 100 megawatts, reducing our dependence on a few large projects and the associated earnings risk.

Slide 12 provides the second to third quarter walk on our SunEdison pipeline. Our pipeline definition remains unchanged and can be found in the press release published this afternoon.

SunEdison ended the third quarter with 3 gigawatts of pipeline, up 500 megawatts from the 2.5 gigawatts in the second quarter. While we did grow our pipeline organically in both the utility and commercial segments during the quarter as previously mentioned, we removed a select U.S. utility project as transmission costs made the project uneconomical, as well as several European projects due to risks associated with changes in policy. As Ahmad mentioned previously, these projects are not gone, but no longer fit our criteria for pipeline.

As you can see from the pie chart, on the right of this page, about 1/3 of our pipeline is supported by either PPA or Feed-In Tariff structure. Of this, about 3/4 is in North America where direct sales and sale leaseback transaction structure leverage the still healthy tax equity market in the U.S. The remainder is in Europe, Latin America and Asia. We believe a diversified approach to building our pipeline across project size, location and sales structure provides prudent risk management for SunEdison. We remain committed to increasing disclosure on our pipeline.

On Slide 13, we provide a walk of our quarterly cash flows. Our focus on cash management is evident in the third quarter results. In a difficult market, we're pleased to have generated positive operating free and net cash flow. Operating cash flow was $188 million in the third quarter driven by deferred revenue and customer deposits. Free cash flow was positive $284 million from sale leaseback nonrecourse financing and lower capital expenditures. We project CapEx to drop again in the fourth quarter from a year-to-date low of $82 million in the third quarter. Net cash flow, which then subtracts cash spent on acquisitions and restricted cash for lease payments, was $130 million -- $134 million for the quarter.

Slide 14 provides a balance sheet overview. As we stated last quarter, we remain committed to a healthy balance sheet with a focus on prudent cash management. Our quarter-end cash position increased to $786 million, up $134 million sequentially. Liquidity remained strong at $1.1 billion, which includes our cash balance and $283 million of unused credit facility. This excludes $300 million of additional nonrecourse working capital facilities added in the quarter.

Our liabilities largely consist of our $550 million debt offering and nonrecourse debt funding for solar energy assets. Nonrecourse debt of $1.3 billion is excluded from leveraged calculations for purpose of debt covenants.

Slide 15 provides an update to our guidance. We are revising our full year guidance down to reflect the third quarter goodwill impairment and exceptionally difficult market conditions. While our non-GAAP revenue guidance remains $3.3 billion to $3.6 billion, we are lowering our non-GAAP EPS guidance to a range of $0.16 to $0.36, largely due to solar wafer pricing, a slowdown in the Semiconductor Materials segment and the third quarter goodwill impairment charge.

We see headwinds in the near term including, but not limited to, weaker volumes and pricing in semiconductor, continued price pressure in solar wafers due to a market weakness, lower poly prices and project completion and financing risks for solar energy systems, primarily in Europe. Helping to offset these headwinds, we see lower module costs benefiting SunEdison, an additional cost savings from current productivity programs and additional restructuring activities.

On Slide 16, we provide an outlook on a few key metrics and priorities as we head into the next quarter and early 2012. For Semiconductor Materials, we will leverage our customer service and recent capacity investments in Malaysia and Korea to help offset lower industry volumes. Our continued ramp and associated efficiencies from shutdown of high-cost locations and consolidation in Ipoh will help offset potentially lower utilization elsewhere in the market.

In Solar Materials, as we expect weaker revenue in the near term, we will grow profitable volume to help offset further price deterioration. We will continue to reduce our cost structure by ramping Kuching, debottlenecking our poly plants to improve productivity and working with our tolling partners to lower tolling costs.

At SunEdison, we're focused on profitably and being as -- on profit and being as cash neutral as possible and developing our pipeline. We will continue to add pipeline both organically and opportunistically through acquisitions.

Finally, we are evaluating actions to take in the fourth quarter to improve OpEx efficiency at SunEdison. Overall, our near-term priorities are clear: reduce costs; focus on cash flow through earnings growth, working capital management and lower CapEx; and grow our downstream business.

With that, we will open the call for your questions. Operator, you may begin the Q&A session now.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question from the line of Tim Arcuri with Citi.

Timothy M. Arcuri - Citigroup Inc, Research Division

Mark, 2 things. First of all, if you look at the poly cost in Italy, your cost seems to be somewhere in the high $30 per kg. And if you look at where poly spot prices are right now, they're sort of pretty close to what the cash cost seems to be at that site. So I know that you want to produce as many wafers as you can so that you can ultimately feed them into SunEd. But is there an argument that maybe at some point Merano is not really a competitive site any more and you should strategically rethink that site? And then I had a second question.

Mark J. Murphy

Yes, Tim, you're correct. Merano is not a low-cost site. However, it's a very important site to us. It produces high purity polysilicon. We do use that poly to feed our semiconductor wafer business. So it's an important part of our plant network. However, we are looking at our polysilicon production assets, and we're looking at actions to improve our polysilicon cost structure in the future. You do recall that we announced that our future polysilicon expansions we'll be using FBR, and so we see a path to being -- having world-class cost using FBR technology. And in the fourth quarter, we're going to determine how best to utilize the assets that we do have in Merano.

Timothy M. Arcuri - Citigroup Inc, Research Division

Okay. Mark, can you tell us -- last question. Can you tell us what the replacement cost is for the FBR CapEx? So if you look at Siemens, the average is about $65 per kg. What is the CapEx for the FBR?

Ahmad R. Chatila

Similar number to that. Very close.

Operator

And our next question from the line of Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank AG, Research Division

Just wanted to follow up on SunEdison. Your non-GAAP revenue seems to suggest that you're getting about $4 a watt in that business, yet your operating profit is somewhere around $0.40. So wanted to just get a sense of what kind of gross profit you're making especially in the current module pricing environment. And secondly, your wafer business, are you making any money on a per watt basis? Can you give us some indication of where wafer prices would be in the fourth quarter, especially given we hear about $0.40 per watt wafer price in the spot market?

Mark J. Murphy

I think the first question -- prices have gone down on the downstream. And we experienced about 20% sequential decline in our portfolio on a dollar per watt basis. Fortunately, our costs went down about the same, a little bit less but about the same. Year-over-year, prices are down about 30%, and costs have gone down more than that. So our gross margins have actually held up fairly well in that business. We're looking at sort of 20-plus percent gross margins in that business, and that's what we would expect going forward. I think that hopefully that covers your question on SunEdison and pricing.

Vishal Shah - Deutsche Bank AG, Research Division

Yes, on the wafer market, can you talk about what kind of wafer profits you're making right now on a gross profit basis?

Mark J. Murphy

Yes, we haven't given that level of detail. What I can say is that we feel we've been able to enjoy a premium on wafer pricing due to the way we structure the company. As we look at the spot wafer market, we are above that price. So hopefully that gives you some context.

Operator

We have a question from the line of Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank, Research Division

In terms of trying to look ahead to 2012, given all the challenges you have in Japan and solar wafers this year, Ahmad, does the MEMC operating model still hold true that you might be able to earn $1 in earnings at sales of $3.5 billion? Because in 2012 in our model, it does seem pretty clear that you should be able to generate sales of $3.5 billion just from SunEdison and Semiconductors. And then I had a follow-up question.

Ahmad R. Chatila

Yes, we didn't give guidance for 2012. But we have 2 businesses that will continue to be healthy, and it's under our control to improve their structure, Semi and SunEdison. And we'll give you guidance in the next couple of months, Steve, actually in 3 months from now. So we'll give you that guidance. But I think you're thinking is right in terms of which businesses will drive our revenue. It's really Solar Materials and Semi.

Stephen Chin - UBS Investment Bank, Research Division

And then the follow-up question, just on SunEdison, Ahmad. The construction level you reported grew nicely to about 330 megawatts. Can you share any color on the visibility that SunEdison has looking past the fourth quarter with this large in construction level?

Ahmad R. Chatila

Look, the business continues to be healthy. I would say that what keeps me up at night is Europe at this moment, not the construction. But I want us to be very disciplined on pricing, and the financing environment is a little bit difficult in Europe at this time. So that's why we're a little bit shy in that business. The visibility in the U.S. is very strong, and Canada as well as Asia. I think the next 3 to 6 months is going to be very interesting to see what's going on in Europe, especially with the surprise that we heard from Greece yesterday. We want to know what that means to our business.

Operator

And we have a question from the line of Sanjay Shrestha with Lazard Capital.

Aditya Satghare

It's Aditya Satghare from Lazard Capital Markets, 2 questions please. One is on SunEdison. So given the decline in market prices and the current market dynamics, does that change the portfolio, the pipeline realization for SunEdison? And how should we think about the potential impact on the margins going forward?

Mark J. Murphy

I think right now, we've historically experienced around 60% yield on our pipeline, and it's 60% to 70%. And we would think that right now, we don't see anything that would lead us to believe that it would be less than that at this point. If we see that, we will update our yield guidance. We do expect prices to continue to decline. However, we've been successful in managing -- balance the system costs and module cost and see a path to maintaining margins, actually expanding the ability to expand margins. I think one last comment related to the previous question, we do have concern about Europe. But fortunately, the largest part of our pipeline in construction and sales over the next several quarters is in the U.S. So that's all I have on that.

Aditya Satghare

Great. My follow-up question is on the solar wafer business. Can you touch on any kind of market share shifts or customer mix changes you are seeing in the solar wafer business given the challenging market environment?

Ahmad R. Chatila

Thank you for the question. It's actually very challenging. The demand is lower, and the price is lower than anything that we expected and hence, our reduced guidance. We see still some demand from China and Taiwan. We don't see it from other region as much. Okay.

Operator

We have a question from the line of Krish Sankar from Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch, Research Division

I have 2 of them. Ahmad or Mark, looks like you guys are focusing more on productivity improvement rather than capacity. So if I look at your Solar Materials business, with the current cost structure, where do you think the breakeven revenue level is and where do you think it will be once you realize cost efficiencies in the Kuching facility?

Ahmad R. Chatila

Maybe I'll try to do this one. Remember, Krish, last quarter I said one of the key metrics is the ratio between SunEdison and our internal capacity. And right now, our mindset is that capacity has to be lower than the SunEdison installation. That's how we're thinking. The good news is in some segments of our capacity, we're very flexible -- like in wafering. So that's one. We have to, of course, deal with the polysilicon capacity and that's what Mark was talking about. We're open to a lot of ideas here to deal with it. So that's how we're thinking about the business. It's being as flexible as possible. We don't have assets we have to utilize because frankly speaking, the price is just too low. I think there's a lot of desperation in the market. People are selling at, really, cash cost. And this is not a game we want to play. We have -- as Mark said, we have premium on our pricing, but that could be also an opportunity in the long run to reducing our costs further for SunEdison feed. And Mark, I don't know if you had a comment there or not.

Mark J. Murphy

I think, Krish, I think that you can sort of pick apart the financials and conclude that if you strip out the goodwill and you see -- we're at, basically, a modest operating loss in Solar Materials segment right now. And that's with -- without the cost structure that we have clear line of sight to. So we believe at this point that we're going to see greater cost reductions and the market will continue to decline. So on a cash basis, it's near breakeven. So I think at this point, you said it well. And the focus in that business right now is on productivity, utilizing the assets we have, making those assets world class so that we can support the downstream business.

Krish Sankar - BofA Merrill Lynch, Research Division

And then a final follow-up is, Ahmad, you mentioned that the semi weakness will probably continue for a while. Just want to get a sense of where your Semiconductor factory utilization is for you guys, and where you think it will be probably let's say Q1 or Q2 -- somewhere in the first half if the current downdraft in semis continues into like Q1?

Ahmad R. Chatila

All right. So our leading customers have told us a while back -- actually in July, that this is going to persist until end of Q1 and comes back in Q2. I mean, that's their opinion of course. The utilization on 300 millimeter is pretty good, pretty high. But our 200 millimeter and 150 millimeter utilization is around 2/3, 55%? -- 75% to 80%. So it's kind of soft, more than we would like it to. 300 millimeter is still pretty strong for us.

Operator

Our next question from the line of Satya Kumar with Credit Suisse.

Satya Kumar - Crédit Suisse AG, Research Division

On semis, what do you expect the semiconductor wafer volumes to be in Q4? And what's your expectation for semi wafer pricing in Q4, in your Q4 guidance?

Mark J. Murphy

Yes, I mean, we're looking at volumes to be down about 5% to 7%.

Ahmad R. Chatila

No more. I think volumes are like 15% down. Yes. And the price is declining a little bit.

Satya Kumar - Crédit Suisse AG, Research Division

Sorry, did you say volume is down 15% and prices down a bit?

Ahmad R. Chatila

Yes. That's what I said, yes. And pricing down just a little bit because we negotiate this pricing before.

Satya Kumar - Crédit Suisse AG, Research Division

Do you think that the volumes are down equally for your peers as well, or is your volumes are performing in Q3 and perhaps catching up to your peers in Q4?

Ahmad R. Chatila

Sorry, come again?

Satya Kumar - Crédit Suisse AG, Research Division

Do you think your peers are also down as much for volumes in Q4? Or do you think that your volumes held up better in Q3 and are catching up to your peers in Q4?

Ahmad R. Chatila

No, I think we're on the same boat. I talk to customers a lot. I've been around -- just checking everybody, and our volumes held year-on-year pretty nicely versus others that announced. So I think all of us are in the same boat in Q4 to a large extent.

Satya Kumar - Crédit Suisse AG, Research Division

A question on SunEdison. Just wanted to clarify, looks like you de-booked 300 megawatts in the U.S. you said and some in Europe. But you mentioned that the net organic pipeline additions were a negative 400 megawatts. So I want to understand if in Q3 there were any meaningful growth additions outside of Fotowatio. And in some markets in the U.S., there've been some big declines in the SRAC. Do you feel that you need to take further pipeline write-downs to reflect these reductions in SRAC? And I guess like the level of project construction is nice to see that number. It will be really useful for us to have some sense as to how to think about the megawatts that you could potentially have as we look into next year. Can we just simply double that, just looking at the construction activity that's going on right now for 2012?

Mark J. Murphy

I don't -- I can't comment specifically on -- I don't believe we have a sort of a material SRAC exposure on our pipeline. In fact, I'm only aware of one project that we're doing that sort of SRAC-dependent. And we're in a position right now that we need to build that in order to generate the SRAC. So I think that -- I don't think it's a material exposure but based on your question, I'll go back and research it and we'll disclose it next publicly. And then as far as forward-looking volumes on SunEdison, I think your best indicator of future volume or interconnections is based on that 330 megawatt number in construction. Beyond that, we haven't given any guidance on future development of that pipeline.

Satya Kumar - Crédit Suisse AG, Research Division

And about the gross additions outside Fotowatio in Q3, were there meaningful gross additions to the pipeline?

Ahmad R. Chatila

Like 100 megawatts, 110 megawatts something like that. So it's not that high, but good enough.

Satya Kumar - Crédit Suisse AG, Research Division

Is that -- I mean, the gross addition number is a lot lower in Q3 than we've seen in previous quarters. Just was wondering if there are some color on that.

Ahmad R. Chatila

Well, look. It fluctuates, right? I wouldn't conclude anything out of that. We have another metric that we have internally, which is leads, which is all the deals being negotiated and that's incredibly healthy. So don't read too much into that. If it was, I will let you know.

Operator

And a question from the line of Mehdi Hosseini with Susquehanna International.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

I noticed your solar wafer shipment was up 35% on a sequential basis. So we have a very severe pricing pressure, but the units are pretty strong. And I'm wondering where these wafers or modules are going to.

Ahmad R. Chatila

They're mainly going -- Mehdi, thank you for the question. They're mainly going to China and Taiwan, some of our LTE customers. We have 9 LTE customers. And also, we have pull-through from SunEdison construction, and again, mainly China and Taiwan.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

So do you think that there is still excess inventory of modules downstream? Is that what you see when you negotiate for margin prices?

Ahmad R. Chatila

Well, clearly, the module pricing is declining very rapidly, right. And...

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

But is that helping to clear inventories?

Ahmad R. Chatila

Well, I really don't know. I really don't know. I hear rumors like you do about massive inventory, but that's rumors. I don't have data. Clearly, the price of modules in silicon technology is incredibly competitive right now. I would go as far as being competitive with the leading technologies in the world.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

And then Mark, for the purpose of modeling, how should we think about the debt you're accumulating and therefore, the interest expense? Because it's that -- you have continued to leverage the balance sheet especially given the downstream requirements, and I'm just wondering how we should think about interest expense going forward.

Mark J. Murphy

I think that the -- I mean, we've got the primary debt that's being brought on as related to the sale leasebacks. And as you know, that's nonrecourse debt supported by the energy revenues of the subs, and it's a nonrecourse debt. So the other debt that was materially increased in the quarter was nonrecourse construction facility debt, which we increased about $200 million. And again, that's nonrecourse in nature related to completion of projects in short term. And the financing rates on that are quite competitive, so we feel it's an attractive alternative to fund some working capital requirements. Other than that, we have no plans to raise recourse debt, and we'll continue to moderate our growth to maintain a healthy balance sheet. We have biweekly cash meetings. We focus on cash and we're focused on productivity to drive cash flow in the business.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Should we assume interest expense of somewhere around $15 million to $20 million per quarter?

Mark J. Murphy

I think that's a reasonable assumption.

Operator

And our next question from the line of Jesse Pichel with Jefferies.

Jesse Pichel - Piper Jaffray Companies, Research Division

I'd like to follow up on that last question, and think about just -- not in terms of interest expense but in terms of net debt additions relative to SunEdison revenue. So I think you said this quarter you added $300 million of nonrecourse financing for 35 megawatts of sale leaseback and then construction financing. How much more debt will you would need to take on in Q4 to execute on your guidance? And how should we think about the amount of nonrecourse debt you need for the pipeline for 2012?

Mark J. Murphy

Well, I think that we haven't given balance sheet guidance on 2012. We had a combination of -- what I spoke to was nonrecourse working capital debt. That was about $200 million. And then the sale leaseback, that was about another $200 million. So close to -- that's the $400 million, I think, you're referencing. I think a back of the envelope for the amount of sale leaseback that you could assume -- if we do -- let's say 3 quarters of our projects were U.S. projects and let's say that 60% to 80% of those were -- or maybe 60%, 70% of those were going to be sale leaseback, then you can model in those rough terms what the addition of sale leaseback nonrecourse debt would be. The remaining sales in the U.S. you can assume they'd be direct sales.

Jesse Pichel - Piper Jaffray Companies, Research Division

Direct sales. And for my follow-up question, it would appear that your system ASP of around $4 a watt is much higher than what we're seeing in new negotiations today. And can we assume that, that was impacted there by the 33-megawatt KGAL announcement? And how should we think of system ASPs going into next year?

Mark J. Murphy

I think that you can -- our assumption is that we're going to be able to hold or expand gross margins. So we haven't given guidance on what our price assumptions are for 2012. I think given where the market is, you can assume that they will go down, not up. However, we think our cost structures will go down as much as price at least.

Jesse Pichel - Piper Jaffray Companies, Research Division

Can I fit one more in? When we're modeling in the profit per watt on the systems business? It would be helpful if we knew how much of those systems were SunEdison developed systems versus your partner projects? Because I would think your profit per watt would be much higher on your SunEdison developed projects relative to when you're stepping in and providing the construction financing and sale leaseback to some of your development partners.

Ahmad R. Chatila

Jesse, that's a good input. We'll assess that and let you know.

Operator

And I believe we have time for one last question. That is going to be from the line of Edwin Mok with Needham & Company.

Edwin Mok - Needham & Company, LLC, Research Division

A question on the semi wafer business. I remember last quarter you guys talked about EBITDA target for around $50 million for the second half of this year and maybe higher in 2012. Is that still your target? Can you update us on that?

Mark J. Murphy

Edwin, can you repeat the question?

Edwin Mok - Needham & Company, LLC, Research Division

Yes, I remember last quarter you guys talked about the semi wafer business having an EBITDA target of around $50 million in the second half and higher in 2012. Any update there? Do you think you can still hit those targets?

Mark J. Murphy

EBITDA per quarter, right?

Edwin Mok - Needham & Company, LLC, Research Division

I think that's -- yes, that's what you target on.

Mark J. Murphy

Yes, and your question was a target in the second half of that and then higher next year?

Edwin Mok - Needham & Company, LLC, Research Division

Yes.

Mark J. Murphy

I think the answer to that would be yes.

Edwin Mok - Needham & Company, LLC, Research Division

So you still expect it at that. Even with the lower volume in the fourth quarter, do you expect to maintain this kind of level of profitability?

Ahmad R. Chatila

That's the only challenge actually. So it might be a little bit lower, but the reduction in Q4 is a mild cyclical downturn. It's not as severe by any means. People are talking about higher Q1. I didn't see it yet 100%. So the number is still valid. It's a little bit may be lower because of the 15% reduction in revenue versus Q3. It could be $35 million, could be $40 million, could be $42 million, could be something in that range. But clearly in next year, it will expand.

Edwin Mok - Needham & Company, LLC, Research Division

I see. That's fair. And then on solar...

Ahmad R. Chatila

[indiscernible] Sorry, Edwin, go ahead.

Edwin Mok - Needham & Company, LLC, Research Division

And then on the Solar Material, I just wanted to know kind of conceptually how you think about that business assuming price remained this low. We heard, actually, substantially lower spot price on solar wafer. Is it possible that you might actually walk away from the business given how weak prices are? And is that a risk that we may see over the next 1 or 2 quarter where volume will start to come in quite a bit?

Ahmad R. Chatila

Well, let me tell you my thinking about it. Number one, we're going to reduce CapEx in a significant fashion. Number two, we're going to reduce OpEx in a significant fashion. Three, that's why we have SunEdison because we can see the future at some point of overcapacity. And at that moment, no one wins by the way, not the best guy, not the worst company. Everybody loses. So for us, our focus is to ensure we protect our pipeline with that investment because when you go and strike deals, you need to ensure that the cost is going to be honored. So right now, we're in the mode of trying to figure out if the lower costs are structural in nature and forever, or are they just -- they might snap back. So that's where we're grappling with. But in the final analysis, much reduced CapEx, much reduced OpEx and try to synchronize the business to SunEdison fully -- even lower volumes of wafering business versus SunEdison installation.

Edwin Mok - Needham & Company, LLC, Research Division

I see. Great. So you kind of envision a scenario where your wafer to install relation ratio that you talked about last quarter may actually be lower than 2 to 1 that you have projected for next year?

Ahmad R. Chatila

Yes. I mean, if SunEdison grows very fast and the price is so low, no problem. I mean, why not buy it? Why should I build capacity? It doesn't make sense. At that kind of pricing, no investment is good by the way. So for us, better to buy and make a lot of profit on SunEdison. Of course, we need to keep some infrastructure to protect our commitment to leading corporations, like utilities and corporations that we signed PPAs with. But we don't have to have all the capacity inside. It doesn't make sense anymore.

Operator

I'll turn it back to our speakers for any closing remarks.

Bill Michalek

Thank you, everybody, for joining us for our third quarter conference call. That will conclude our call. Thank you.

Operator

And ladies and gentlemen, this will concludes our conference call for today. We thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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