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Suntech Power Holdings Co., Ltd. (STP)

Q1 2007 Earnings Call

May 29, 2007 8:00 am ET

Executives

Steven Chan - Vice President, Business Development

Dr. Zhengrong Shi - Chairman, Chief Executive Officer

Stuart R. Wenham - Chief Technology Officer

Amy Yi Zhang - Chief Financial Officer

Boxun Zhang - Financial Controller

Analysts

Robert Stone - Cowen and Company

Tien Yu Sieh - Merrill Lynch

Paul Leming - Soleil Securities

Paul Clegg - Natexis Bleichroeder

Jeff Osborne - CIBC World Markets

Angello Chan - Credit Suisse

Sunil Gupta - Morgan Stanley

Michael Carboy - Signal Hill Group

Cheryl Tang - Goldman Sachs

David Edwards - ThinkEquity Partners

Pavel Molchanov - Raymond James & Associates

Julie Chen - Brean Murray Carret

Jesse Pichel - Piper Jaffray

Ming Yang - Piper Jaffray

Sapiat Sumar - Credit Suisse

Stephen Cheng - UBS

Mehdi Hosseini - FBR

Pranab Kumar Sarmah - Daiwa Securities

Presentation

Operator

Good evening and thank you for standing by for Suntech's first quarter 2007 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Steven Chan, Suntech's VP of Business Development.

Steven Chan

Thank you. Hello, everyone and welcome to Suntech's first quarter 2007 earnings conference call. For Suntech on the call today will be Dr. Zhengrong Shi, Suntech's Chairman and CEO; Amy Zhang, our Chief Financial Officer; and Stuart Wenham, our Chief Technology Officer. Also, Boxun Zhang, our Financial Controller and I will be participating in the Q&A following Dr. Shi’s closing remarks.

Before we continue, 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 statement except as required under applicable law.

As a reminder, this conference call is being recorded and a webcast of management’s prepared remarks will be available on the investor relations section of Suntech's website after this call.

Also, please make note that all figures mentioned during this conference call are in U.S. dollars.

I now turn the call over to Suntech's Chairman and CEO, Dr. Zhengrong Shi.

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Dr. Zhengrong Shi

Hello and thank you for joining us today. It is my pleasure to review our first quarter 2007 results. It is clear from our first quarter performance that there is exceptional market demand for Suntech's PV products and this helped us to beat both revenue and output guidance for the quarter.

We shipped 64.7 megawatts of PV cells and modules during the quarter and achieved total net revenues of $247 million, up about 175% year over year. The Spanish and German solar markets had an outstanding performance in the first quarter, absorbing about 27 megawatts of output each. The Spanish market is proving to be a particularly dynamic market, as we grew our sales there 26-fold from a year ago.

Our North American sales are growing as expected and we are excited by our 2007 top line. As an example, we recently won a contract to supply over 27,000 solar panels to an 8.2 megawatt solar plant in Alamosa, Colorado. We also won a second contract to be the exclusive supplier of solar modules to San Francisco International Airport. High profile projects such as these are building awareness of Suntech in the U.S. and we are starting to see momentum build in this market, reflecting the combined strength of MSK and Suntech.

We also signed a letter of intent with Open Energy to jointly develop next generation BIPV products and to co-promote Suntech and Open Energy BIPV products in North America.

Our sales in Asia outside of China are ramping up nicely, as demonstrated by multiple contracts that we recently won in South Korea totaling 5 megawatts, which is nearly 30% of last year’s South Korea PV market.

The rapid development of our sales in various countries which is more than doubling from last year verifies the strength of our sales and distribution efforts and our ability to quickly establish broad and deep sales channels in new markets. We are committed to diversifying our sales further in the coming quarters as opportunities arise.

With growing international recognition of Suntech's product quality and ability to deliver large volumes quickly and on schedule, demand for our product continues to outstrip supply. In fact, I’m excited to say that our output for 2007 is fully contracted for and we have already started signing contracts for 2008 output.

The strength in the demand for our products has not come at the expense of ASP pressure and we will continue to stick to our ASP guidance of down 5% to 7% from our average ASP in 2006.

This positive market demand environment gives us the visibility and the confidence to speed up implementation of key business initiatives, including expanding production capacity, developing our thin film and BIPV capabilities and researching new technologies to improve conversion efficiency.

Our customers are our first priority and we need to increase our capacity as quickly as possible to meet their near-term and long-term demand for our products. During the quarter, we worked aggressively to expand our capacity and output in two ways.

Firstly, we accelerated our capacity expansion as demonstrated by the installation of three new 30 megawatt production lines in our Luoyang facility. These lines were commissioned and operating at full capacity by the end of April, several months ahead of schedule. As a result, our current annualized PV production capacity is now 360 megawatts, up from 270 megawatts at the end of the fourth quarter of 2006.

Secondly, since discontinuing MSK Japan based production, we have begun producing additional modules utilizing MSK’s third-party PV cell contracts in China. As a component of MSK, this business was operating with a negative gross margin. However, after the transfer of MSK’s module production facility to China, we have successfully converted this into a profitable business, with gross margin of nearly 10%. The good thing is that there are almost no incremental operating expenses associated with this extra production, so it is solid net income accretive to our business.

As a result of this effort, we are pleased to be able to increase our full year production output guidance for a second time to 325 megawatts from our original guidance of 250 megawatts. This additional 75 megawatts of output is conservatively expected to contribute an incremental $270 million in revenues with solid profitability.

Our goal to achieve a multi-gigawatt manufacturing model that we highlighted at our analyst day in Hong Kong is well on the way with the construction of our 540,000 square foot, 1 gigawatt capacity production plan at Wuxi. We are on track to begin installation of the new production lines in June. We are looking forward to building capacity at this new facility.

We are also very pleased with the ground breaking of phase one of our new thin film plant this month and milestones that our R&D team have achieved in our 20% conversion efficiency Pluto technology. Our CTO, Stuart Wenham, will speak more about this shortly.

I want to speak briefly about our silicon situation. Our CFO, Amy Zhang, will talk more about the gross margin impact but I wanted to emphasize that during the quarter, we had to purchase additional silicon at market high prices when our contract silicon suppliers were unexpectedly delayed. The problem has now been rectified and our margins should return to guidance values.

During the first quarter, we continued to demonstrate the strength of the Suntech model to rapidly grow the sales of our high quality products and strengthen our low cost production base while building our capabilities in value-added products.

Stuart will now give you an overview of our recent achievements on the development front.

Stuart R. Wenham

Thank you, Dr. Shi. In our Q4 earnings release, we gave an update on the three technologies that have either recently gone into large-scale production at Suntech or else are expected to go into large-scale production in the near future. The first of these is our semiconductor finger technology that we developed jointly with the University of New South Wales in Australia. We are pleased to announce that this technology matched both its performance and yield targets on the first of our production lines during Q1.

Despite the success of this semiconductor finger technology, an even newer lower cost and higher performance solar cell known as the Pluto technology, has been successfully implemented into pilot production at Suntech during Q1 2007. In our last earnings release, we predicted that this pilot line will achieve efficiencies of 18% to 19% by the end of 2007, increasing to 20% efficiency during 2008. We are pleased to announce that we are well ahead of schedule, having already achieved pilot line efficiencies above 18% and so have decided to accelerate its implementation into large scale production, which is now expected early 2008.

The Pluto technology captures many of the high efficiency attributes of the world record holding Pearl technology from the University of New South Wales but avoids the expensive processes and materials required by other high efficiency technologies such as the need for semiconductor upgrade wafers. It is well-suited to both standard mono and multi-crystalline silicon wafers with record efficiencies of 17% expected for multi-crystalline silicon wafers in large scale production.

A core facet of this technology is that each solar cell is in fact lower in cost to produce than conventional spring printed solar cells by simultaneously achieving more than 10% increase in performance.

Regarding our thin film technology, Suntech has recently begun construction of its thin film R&D and manufacturing facility in Shanghai, China. The first phase of the new plant is expected to begin operation in 2008 with 50 megawatts of capacity. The product is to be produced primarily for the high value-added BIPV applications in conjunction with MSK.

Suntech's thin film module production will be based on a technology that deposits amorphous and micro-crystalline silicon thin film layers onto a glass substrate. The product will use less than 2% of the silicon required to manufacture equivalent wafer-based modules. We currently predict that the thin film modules will have a solar conversion efficiency of 6% to 9%. Initial output is expected to be about 6% efficient with an average production cost of approximately $1.20 per watt. This is forecast to continue to decline as both production scale and conversion efficiencies increase.

Suntech's thin film solutions are designed to offer the lowest balance of system costs of all the thin film technologies, with module sizes able to reach nearly six square meters.

I will now hand it over to our CFO, Amy Zhang, to cover our financials.

Amy Yi Zhang

Thank you, Stuart. Instead of repeating all the numbers in the press release, I will provide some highlights on certain key results for the first quarter 2007 and provide guidance for the second quarter and full year 2007. Today, I will discuss Suntech's performance, focusing principally on the non-GAAP numbers that we believe give a clearer picture of the operating dynamics of the company. Specifically, these measures exclude $6.5 million of share-based compensation expenses; $2.3 million of MSK restructuring costs and a negative $0.2 million net income impact related to amortization expenses of the MSK acquisition.

You can find a reconciliation of these measures in the financial tables at the end of our press release.

I will also break out some numbers for a wafer to module business and third party cell to module business to give you a clearer understanding of how these two segments contribute to our overall results.

The wafer to module business is essentially the core Suntech business and all of the modules produced from third party cells during the first quarter were from MSK. Going forward, Suntech will profitably product modules from third party cells in China. As Dr. Shi mentioned, the additional output will help us to meet surplus demand for Suntech products and capture additional market share and revenues.

Meanwhile, we will also help MSK to clear out their remaining raw material and module inventory.

Net revenue for the first quarter was $246.7 million, over $18 million higher than guidance and 174.5% higher than the year-ago period. Our wafer to module business accounted for approximately 91.3% of the total revenues.

As a result of accelerating our production capacity expansion, we shipped 64.7 megawatts of solar product in the first quarter, 2.7 megawatts above the top end of our guidance.

The ratio of revenues of PV modules to PV cells was 99 to 1 during the quarter. This reflects the strong success of our self-distribution channels to increase module sales and capture incremental revenues.

Suntech's non-GAAP gross margin for the first quarter of ’07 was 19.9%, compared to 20.5% in the fourth quarter of 2006 and 30.7% in the first quarter of 2006. The margin drop was due to two main reasons. Firstly, our utilization of high cost raw material inventory that wrote over from the fourth quarter of 2006 negatively affected our gross margin. In addition, the delivery of some long-term supply contracts was slower than we anticipated. This resulted in higher-than-expected raw material costs as we purchased more silicon at spot market prices to substitute. Delivery from our long-term supply contracts is now back on track and we expect this to have a positive impact on the second quarter margin.

Secondly, we cleared our inventory of slow-moving PV modules at lower price and before our halt in January, MSK produced PV modules in Japan at higher cost, each of which contributed to negative gross margin. We have now halted MSK Japan-based production. Our new China-based production of modules from third-party cells is expected to have a gross margin of about 8% to 10%.

The non-GAAP gross margin for our wafer to module business was 22.6% in the first quarter. Even though we had to rely more on spot market price for silicon than we would have liked this past quarter, our silicon purchase costs did decline. I feel that we are well on track to see our silicon purchase costs fall by about 10% from 2006 with most of that happening in the second-half of 2007. We have also secured enough silicon to supply our expanded and upgraded output target for 2007.

Total share-based compensation expenses for the first quarter of 2007 were $6.5 million. Of this amount, $2.4 million was recognized as cost of revenue; $0.3 million as selling expenses; $1.6 million as R&D; and $2.4 million as G&A expenses.

Share-based compensation expenses rose mainly due to the new options granted to certain suppliers and amortization of previous grants. We expect that share-based compensation expenses to stay at roughly this level for the rest of the year 2007.

Non-GAAP operating margin was 13.7% in the first quarter of 2007, compared to 15.7% in the fourth quarter of 2006 and 25.5% in the first quarter of 2006. The operating margin decreased sequentially mainly due to the decrease in the gross margin, which was partially offset by the reduction in operating expenses as a percentage of total revenues.

Non-GAAP net income attributable to holders of ordinary shares was $32.7 million for the first quarter, or $0.20 per diluted ADS.

Moving now to our balance sheet, as of March 31, 2007, we had cash and cash equivalents of $569.3 million, up from $225.5 million at the end of 2006. The increase was primarily due to the proceeds from the $500 million convertible bond offering that we completed in February this year.

During the first quarter, we enhanced our efforts to manage inventory. Our inventory balance decreased from $200.3 million at December 31, 2006 to $119.8 million at March 31, 2007, even though our production output increased by 16.8% sequentially.

Accounts receivable rose to $163.8 million, from $98.9 million as of December 31, 2006, as we shipped a significant amount of modules to our customers in the second-half of March, 2007, and the payments were actually collected around one month later.

Our long-term loans to supplier rose primarily because we lent around $65.6 million interest-free loan to MEMC in accordance with our long-term supply contract. There will be no more interest-free loans or prepayments to MEMC in the rest of ’07.

For the second quarter 2007, total production output is expected to be in the range of 76 megawatts to 78 megawatts. As a result of the faster-than-projected ramp of new cell production lines and additional third party cells module capacity, we have increased total PV production output targets for 2007 to 325 megawatts. We have also increased our end-of-year projected capacity by two production lines to 480 megawatts.

For the full year 2007, as a result of our accelerated capacity expansion, we are increasing our capital expenditures to be in the estimated range of $100 million to $120 million.

At this time, I would like to turn the call back to Dr. Shi.

Dr. Zhengrong Shi

Thank you, Amy. Thank you again for joining us today. I will now open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Rob Stone with Cowen and Company.

Robert Stone - Cowen and Company

Dr. Shi, I wonder if you could briefly discuss the ASP that you had in the quarter for the Suntech-based business and where you think ASP will be in Q2.

Dr. Zhengrong Shi

ASP for the first quarter, I think as we said, is $3.78 per watt and again this is within our guidance given before. For the second quarter, we believe it will be around $3.65 to $3.70 per watt.

Robert Stone - Cowen and Company

Thank you.

Operator

Your next question comes from the line of Tien Yu Sieh with Merrill Lynch.

Tien Yu Sieh - Merrill Lynch

I was just wondering if you could just comment on your wafer costs for the first quarter and what was the mix of long-term contract and spot in the first quarter? I guess maybe if you want to split it out again, long-term contract, spot and inventory, I guess.

Amy Yi Zhang

The average purchase price we paid for Q1 is $5.38 per piece of wafer. The mix of long-term versus spot purchase, actually spot purchase we had a higher portion shifted from Q4. The percentage of the total material utilized is around 72% from spot purchase versus 28% from the long-term delivery.

Tien Yu Sieh - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Paul Leming with Soleil Securities.

Paul Leming - Soleil Securities

Good evening. I just wanted to follow up on the comments you made about the impact of clearing slow-moving inventory out of your system and the impact that had on your gross margin. Could you just give us a little more insight into what exactly made up this slow-moving inventory? Was there somehow defective panels? I still get the impression that you are in an environment where you can sell anything you produce, so I would just like to understand better why some inventory is slower moving than others.

Amy Yi Zhang

The slow-moving stock clearance we mentioned in Q1 was mainly for the clearance of old stock for MSK, not for Suntech.

Paul Leming - Soleil Securities

So that’s mostly MSK manufactured product?

Amy Yi Zhang

Yes, the old stock made by MSK and normally, they are the panels with low output therefore the unit production cost is relatively higher. The second reason is simply because it’s the slow moving and stock product in the warehouse for longer term, so we actually have to sell that at a discounted average sales price. That’s why if we take a look at the segment and the stand-alone gross profit made out of this clearance of slow-moving stock, the gross margin was at a negative 10%, which has been quite a negative impact to the total consolidated gross margin at the group level.

Paul Leming - Soleil Securities

Thank you very much.

Operator

Your next question comes from Paul Clegg with Natexis.

Paul Clegg - Natexis Bleichroeder

Good evening. A follow-up on the question about long-term and short-term silicon supply sources. Based on your new guidance for a faster ramp, can you talk about roughly how much of your production do you expect to be met in 2007 with long-term sources versus short-term? In the past, you’ve given us a quarter-by-quarter expectation.

Dr. Zhengrong Shi

I think with additional volume we are going to produce, the volume of production of solar cells based on long-term contracts still around 60%.

Paul Clegg - Natexis Bleichroeder

60% for the full year?

Dr. Zhengrong Shi

Yes.

Paul Clegg - Natexis Bleichroeder

And what about for the second quarter?

Dr. Zhengrong Shi

Second quarter is about 45% to 50%.

Paul Clegg - Natexis Bleichroeder

45% to 50%. Okay, thanks very much.

Operator

Your next question comes from Jeff Osborne with CIBC World Markets.

Jeff Osborne - CIBC World Markets

Thank you. Congratulations on a great quarter. I was wondering if we can expand on the revised guidance in the MSK business for the quarter and also for the year, just what your assumptions are there and this new 8% to 10% gross margin commentary using third party cells. Is that what you would expect in the second quarter and where can that go once you have internally supplied Suntech cells?

Dr. Zhengrong Shi

At this moment, all the business from cells to modules is actually we inherited from third-party solar cell suppliers which MSK has contracted. As we mentioned before, we stopped manufacturing in MSK at the end of January, so all the new production is occurring in China with a gross margin of 8% to 10%. I think in Q2 there is still some inventory of MSK that needs to be cleared out so that’s why for the -- to answer your question in short, for the new products you have cell to module with a positive profit, 8% to 10%.

Jeff Osborne - CIBC World Markets

How much of MSK would you expect for the year?

Dr. Zhengrong Shi

MSK for the year total is -- you mean the total production from cell to module? Is that the question?

Jeff Osborne - CIBC World Markets

We can take it offline but I was just -- the revised guidance, how much output would you expect for MSK for the year now that you’ve moved manufacturing over to China?

Dr. Zhengrong Shi

I think it’s about 15 to 20 megawatts.

Jeff Osborne - CIBC World Markets

Very good. Thank you.

Operator

Your next question comes from Angello Chan with Credit Suisse.

Angello Chan - Credit Suisse

Hi, Dr. Shi, Amy -- can you give me some guidance on the total number of diluted shares? I noticed from your announcement that it is 164 million shares on a fully diluted basis. Does that include the shares that you will be granting to MEMC or shares that you would be issuing potentially for your CB?

Boxun Zhang

As of the end of Q107, our number of diluted shares is around 164 million shares, which includes about 5 million convertible bonds option in that. For the Q207, we believe the number of diluted shares will be around 170 million. There is around a 5 million increase. It is mainly due to our CB offering was finished in the middle of February when we performed the EPS calculation. We only can account 50% of the offering options in the calculation. For the Q207, it will be 100% included in our EPS calculation.

Angello Chan - Credit Suisse

Thank you. Does that mean that the number does not include anything for MEMC?

Boxun Zhang

It is also included.

Amy Yi Zhang

It is all included.

Angello Chan - Credit Suisse

Thank you.

Operator

Your next question comes from the line of Sunil Gupta with Morgan Stanley.

Sunil Gupta - Morgan Stanley

Good evening, Dr. Shi and Amy. I just wanted to follow up on your earlier comments about the --

Amy Yi Zhang

Hi, Sunil. We can’t hear you properly.

Sunil Gupta - Morgan Stanley

-- could you help us understand what kind of wafer costs do you expect to achieve in Q2, and also what would you expect gross margin to be in Q2?

Dr. Zhengrong Shi

Sunil, we cannot hear you properly.

Sunil Gupta - Morgan Stanley

Is it better now, Dr. Shi?

Dr. Zhengrong Shi

Yes, much better.

Sunil Gupta - Morgan Stanley

Okay, I’m sorry. Let me repeat the question. I just wanted to follow up on the wafer costs question earlier. What do you expect the wafer costs to be in Q2 and what will you expect your gross margin to be as a result of that in Q2?

Dr. Zhengrong Shi

I think it is better for Amy to answer this question.

Amy Yi Zhang

I think we are expecting to bring down the average purchase cost of wafer down to the range of $5 to $5.10 per piece of wafer in Q2.

Sunil Gupta - Morgan Stanley

Okay, and how about gross margin?

Amy Yi Zhang

Gross margin actually the average gross margin at group level, non-GAAP basis it actually depends heavily on the mix of the three segments I was talking about, which is first of all, wafer to module production pattern, which is the core business of Suntech and then the cell to module production pattern and within cell to module production capacity, we also have two parts. One is for Suntech alone cell to module, because we have higher demand from the end user side and also the other of the cell to module production was or is primarily from the MSK, the clearing of the old slow-moving stock.

So for the core business of wafer to module from Suntech side, it will give us a contribution of gross margin around 24% to 25%. And for the cell to module production for Suntech alone it is 8% to 10%. And for clearance of the slow-moving stock of MSK, it will be around negative 6% to 8% gross margin. Again, this is all based on a non-GAAP basis.

So in general, we are expecting definitely an improvement on the blended gross margin at group level, also non-GAAP basis, with 1% to 2% absolute point increase in Q2.

Sunil Gupta - Morgan Stanley

Thank you.

Operator

Your next question comes from the line of Michael Carboy with Signal Hill.

Michael Carboy - Signal Hill Group

Good evening, ladies and gentlemen. Dr. Shi or perhaps Stuart, could you elaborate further on what unique and proprietary technologies are within your Pluto technology for increased photovoltaic conversion efficiency?

Stuart R. Wenham

The Pluto technology, it’s actually a technology we’ve been talking about for a couple of years. We’ve been describing it as our 20% efficiency technology. The Pluto is the name that we’ve given to that technology. It is one that we’ve kept accelerating the implementation of it because our laboratory results have looked very good and it’s turned out to be easier to put into pilot production that we’d originally anticipated. So we’ve actually put it into pilot production now and in Q1, we were achieving efficiencies above 18% and achieving those efficiencies has come earlier than we originally expected, so we’ve now decided to implement that into large-scale production in an accelerated rate.

So we expect that to go into large-scale production now during 2008 and during 2008 we expect to get the efficiencies at pilot line level for that same technology up to about 20% efficiency.

Now, that’s a technology that we originally developed in conjunction with the University of New South Wales but at Suntech with our own R&D team we’ve made further developments on that technology, with new patents being taken out. So we’ve got two patents that we have applied for on that technology now with more to follow.

Dr. Zhengrong Shi

Just to add a bit more to Dr. Wenham’s comments, this Pluto technology, we actually tried to commercialize the solar cell structure, which still holds record high efficiency, 24.7% efficiency solar cell structure. That is why we tried to commercialize.

Michael Carboy - Signal Hill Group

Dr. Wenham, can you describe the advances as being more process oriented or more materials oriented?

Stuart R. Wenham

Materials wise, it actually uses pretty much the same materials as the conventional solar -- in other words, it’s compatible with all the same wafers, multi-crystalline and standard [Jachrowski] wafers that the whole industry uses. So it does not have any requirement for fancy materials or fancy processes. In fact, when we do have cost analysis on the technology it actually turns out to be a lower cost technology to make each solar cell than the conventional screen printed solar cell that most manufacturers are still producing.

In terms of sophistication, it’s actually a very simple technology and that’s why we’re so excited about it because it is not only low cost but it also is very high in performance.

Does that adequately answer your question?

Michael Carboy - Signal Hill Group

Yes it does, sir. Thank you very much.

Operator

Your next question comes from the line of Cheryl Tang with Goldman Sachs.

Cheryl Tang - Goldman Sachs

Amy, I have a question for you. You mentioned there were three factors will affect gross margins. One of them is cell to module business. Does that refer to the CRT PV business?

Amy Yi Zhang

No, actually we are talking about the January output of the total output of Suntech. It is not only the BIPV.

Cheryl Tang - Goldman Sachs

Yes, but one is the wafer modules and another is cell to module, which includes MSK, so what is the business? I did not understand.

Amy Yi Zhang

Okay, wafer to module is core business of Suntech alone. It has always been the core business. We purchase wafer. We produce cell. We laminate modules and that core business will contribute Suntech to like what I said for Q2, 24% to 25% gross margin. What I mean cell to module it is simply because we have higher demand from the end user side and as long as we can maintain the customer and wait for the facility to be ready for a new line coming on board, we will be able to deliver the output in the form of wafer to module but for the time being, we would like to purchase extra cells from qualified suppliers to produce extra modules to sell to them in order to maintain the installed based and channel. So that portion to be done by Suntech alone will give us 8% to 10% gross margin.

For MSK, because MSK’s core business is to laminate modules from the form of cell alone and because we have slow-moving stock with low output, so the unit production cost is higher and currently they are selling at lower ASP with a discount, so the margins from that portion is lower. Actually, it is negative 6% to 8%.

Cheryl Tang - Goldman Sachs

So does that mean there is a kind of a bottleneck for the PV cell capacity right now?

Dr. Zhengrong Shi

Actually, because the demand of the market is higher than what we planned, so in order to fulfill our customer demand we have to purchase additional solar cells to laminate them into modules to fulfill our customer demand.

Cheryl Tang - Goldman Sachs

When we’re talking about target at year-end, is the capacity of 480 megawatts, does that mean the cell has fully matched module capacity or still there is a bottleneck?

Dr. Zhengrong Shi

No, our module capacity -- module capacity is easy to expand. In other words, module capacity is higher than solar cell because we have expanded module capacity to take over MSK’s production business.

Cheryl Tang - Goldman Sachs

So does the 480 megawatts refer to the cell capacity?

Dr. Zhengrong Shi

Exactly.

Cheryl Tang - Goldman Sachs

Thank you.

Operator

Your next question comes from David Edwards with ThinkEquity.

David Edwards - ThinkEquity Partners

I was wondering if you could talk about geographic breakdown during the quarter and also projections for geographic breakdown for the rest of the year.

Dr. Zhengrong Shi

I think in Q1, Germany and Spain, the market share is almost the same. It is about 46% each and 7% from the U.S. and the rest from the rest of the world.

David Edwards - ThinkEquity Partners

And how do you see that changing later this year? Do you expect any shift in the geographic regions?

Dr. Zhengrong Shi

As we say, the Spanish market is very strong this year. We do see the increase of sales to the U.S., we increased in the second quarter and also to sales in Korea and Italy. Those countries, especially Italy and Korea, we barely had any sales into these countries in the past.

David Edwards - ThinkEquity Partners

Thank you.

Operator

Your next question comes from the line of Pavel Molchanov with Raymond James.

Pavel Molchanov - Raymond James & Associates

Good evening. As a follow-up on your question about the 20% PV cells, in 2008 what percentage of your total cell output do you think will be at 18% to 20% or higher?

Stuart R. Wenham

Our implementation strategy is to commence with one production line initially while we have a good chance to not only optimize the technology in large scale production but also to fully evaluate things like the yields and the processing parameter tolerances, et cetera. So we begin with one production line and then based on the performance there, we then retrofit our other production lines.

I guess the good thing from our perspective is that the new Pluto technology to give the high performance cells uses all the same equipment from our existing production line with some relatively minor modifications. We simply have to change the configuration of it, so it’s a relatively easier technology to retrofit on to the other production lines, so our expectation is that if the technology goes as well as we are expecting based on our pilot production of the technology, that throughout 2008 we will retrofit all our production lines so that by the end of 2008 we hope to have all our production done with this technology.

Pavel Molchanov - Raymond James & Associates

Thank you very much.

Operator

Your next question comes from the line of Julie Chen with Brean Murray.

Julie Chen - Brean Murray Carret

In terms of getting clarification, connect our thinking of this fully commercialized technology and the second thing as well is that you talked about the processing of materials -- there’s no fancy process involved, it’s the same material involved. How should we think about the gross margin changes?

Dr. Zhengrong Shi

As we indicated before, for 1% absolute increase of solar panel efficiency and gross margin changes about 8%, increases about 8%.

Julie Chen - Brean Murray Carret

And just a clarification on Pluto, is it fully commercialized technology at this moment or since you mentioned, there’s a pilot study you want to move forward with the pilot study, should we think about it’s a fully commercialized technology moving forward starting on the second quarter?

Stuart R. Wenham

Just to give you a bit of background on how it works, we start off developing a technology in the laboratory and we did that jointly with the University of New South Wales and when the technology is looking particularly good and when we’ve addressed all the issues that we think we need to to be able to put the technology into large-scale production using all the conventional materials that the industry uses, we then make the decision to put it into pilot production. We made that decision towards the end of last year. We put it into pilot production in the first quarter of this year.

Now, what pilot production really means is that we are using all the same sort of equipment and same processes and all the same materials that we would in large-scale production, so we’ve actually been doing that during Q1 with this technology. We’ve been able to, ahead of schedule, achieve the higher efficiencies that we were hoping for.

What that’s meant now is that we are going to put the technology into large-scale production earlier than we had originally anticipated. In fact, we are in the process now of designing the large-scale production lines. So going into large-scale production, we’ll be using all the same silicon wafers, all the same processes, all the same materials and pretty much all the same equipment, just at a scaled up version to suit the large-scale production.

But when you ask is it a fully commercialized technology yet, we’re not actually selling the modules based on that technology yet. We are producing solar modules that are demonstrating significantly higher performance than the conventional technology and we now have to do a whole range of tests and get certification on that new technology before we can actually then in large-scale produce the technology for commercial sales. Does that answer your question?

Julie Chen - Brean Murray Carret

Yes, thank you very much.

Operator

Your next question comes from the line of Jesse Pichel with Piper Jaffray.

Jesse Pichel - Piper Jaffray

Good evening. Dr. Shi, how should we think about the ASPs for modules in Spain versus Germany? Do you think the price premium in Spain will continue?

Dr. Zhengrong Shi

So far, I think probably in Spain it is still about 5% higher than in Germany, so we didn’t -- I think the prices are quite stable at this moment because demand is quite high, at least for Suntech products the demand is very high.

Jesse Pichel - Piper Jaffray

And for your thin film initiatives, congratulations on that, by the way -- does the equipment supplier offer you a guarantee with respect to the efficiency or the cost per watt?

Dr. Zhengrong Shi

The equipment supplier?

Jesse Pichel - Piper Jaffray

Yes, for your thin film initiative.

Dr. Zhengrong Shi

This equipment supplier supplies equipment based on our specifications so for example, the equipment supply, the equipment has a guarantee and satisfy the quality which we specify.

Jesse Pichel - Piper Jaffray

One question for Amy; thanks for the transparency for your Q2 there. You mentioned non-GAAP gross margins of 24% to 25% on the wafer to module segment. What would your blended wafer costs be under that scenario?

Amy Yi Zhang

We were talking about $5 to $5.10 per piece of wafer for Q2.

Dr. Zhengrong Shi

This is normalized to 5-inch.

Jesse Pichel - Piper Jaffray

5-inch, and that will yield the 24% to 25%, $5 to $5.50 per wafer?

Amy Yi Zhang

Yes.

Jesse Pichel - Piper Jaffray

Okay, and the cell to module, 8% to 10%, should we assume that your increased guidance for the year will come all from the cell to module business? Should we assume that?

Amy Yi Zhang

Not 100%. We definitely -- out of the 325 megawatts total output, we have altogether 25 megawatts will come from the production from cell to module and 300 still from the core business of wafer to module.

Jesse Pichel - Piper Jaffray

And of that 300, 60% is low-cost wafer?

Amy Yi Zhang

60% is from long-term supply.

Jesse Pichel - Piper Jaffray

Long-term supply. That’s great. Thank you very much.

Operator

Your next question comes from the line of Ming Yang with Piper Jaffray.

Ming Yang - Piper Jaffray

Congratulations, Dr. Shi and Amy, on a good quarter and strong guidance. Just to think about the rest of the native gross margins from MSK for inventory, how much of that is left? Do you think that will all clear in Q2?

Dr. Zhengrong Shi

Currently MSK still has an inventory of about 7 megawatts in module format. I think in the second quarter, they probably can sell around 4 megawatts and the rest, 3 megawatts, will be cleared out in the third quarter.

Ming Yang - Piper Jaffray

Okay, so that’s the drag on your margin over the next two quarters on a GAAP basis. What do you see the spot pricing is for wafer right now for Q2 and then for the rest of the year?

Dr. Zhengrong Shi

It depends on the purchase. I think even for Suntech, we still purchase our wafer at the spot price. It is still lower than I think most people purchase. I think our spot purchase is still below $5.30 a wafer, 5-inch wafer.

Ming Yang - Piper Jaffray

Okay, and then lastly, what is your expect CapEx for your thin film line? Is that one line or two lines? Thanks.

Dr. Zhengrong Shi

I think the initial investment was $45 million for the first line.

Ming Yang - Piper Jaffray

Okay, thank you.

Operator

Your next question comes from the line of [Sapiat] Sumar with Credit Suisse.

Sapiat Sumar - Credit Suisse

Thanks for taking my question. I was just wondering how I should think about the production growth that you are talking about. Three months ago you are projecting 280 megawatts. Six months ago you were at 250 megawatts. Can you help me understand how much of this increase is coming in from the higher efficiency process versus how much from the increased output at your factories?

Dr. Zhengrong Shi

As Dr. Wenham mentioned earlier, for Pluto technology it is still at pilot production. We try to advance its progress because it is ahead of our planned schedule. So for increased output from 250 megawatts to 325 megawatts, that is because after facing this huge demand from our customer, so we accelerated our expansion capacity. I can tell you if you come to our construction field, we have 1,000 people working 24 hours non-stop to speed up the construction of our manufacturing building so we can put in more production lines in the new building quickly. That enables us to raise our production output, especially we can basically produce solar cells based on our own production line up to 300 megawatts this year.

Sapiat Sumar - Credit Suisse

That’s very helpful but if I look at your Q1, you were actually having some difficulties securing wafers from your contract suppliers. For the additional silicon that will be needed for your production ramp in ’07, higher than --

Dr. Zhengrong Shi

Then we will have to purchase -- for example, the previous guidance we gave was based on 250 and later 280 megawatts type of production target. So now we raised our unit production volume so additional wafers we will have to purchase from either our existing suppliers, who will increase their supply volume to us.

Sapiat Sumar - Credit Suisse

It seems like you are basically able to procure more silicon wafers than is necessary for your ’07 production than your prior expectations. Can you help me understand if it is coming from -- where is this coming from, given the obviously --

Dr. Zhengrong Shi

Most of the suppliers, they also expand their capacity very aggressively. So for these additional wafers, I think the majority will still come from our increased delivery from our existing suppliers and of course we will also explore the new suppliers in the market.

Sapiat Sumar - Credit Suisse

Okay, and last question, do you have a view as to when you think the current constraints in polysilicon might start to ease up? It seems like in the second half, you’re expecting additional output than what you had expected before. As you look out into ’08 and beyond, how do you --

Dr. Zhengrong Shi

I think for Suntech, we will see delivery of more polysilicon from beginning of ’09. That’s also the trend of industry.

Sapiat Sumar - Credit Suisse

Thank you.

Operator

Your next question comes from the line of Stephen Cheng with UBS.

Stephen Cheng - UBS

Thank you. I have two questions. First, how much of the lower-than-expected gross margin in the first quarter was due to the fire at the green energy solar wafer factory? Was that the main reason?

Dr. Zhengrong Shi

That is one of the reasons, yes.

Stephen Cheng - UBS

Okay, and then my second question is if the 2007 solar demand continues to be stronger than expected, would you consider buying even more polysilicon or even more solar wafers on the spot market to increase your capacity even further than today’s announcement? Or is the cost to the gross margin becoming too high to expand any further?

Dr. Zhengrong Shi

At this moment, we believe although the spot purchase market, spot purchase price is higher than long-term contract but still the spot purchase price has been decreased about 10% based on an annual basis than 2006. At the current ASP level and this ATT level, we can see that by doing that we are still quite profitable.

Stephen Cheng - UBS

So as long as demand keeps growing, you’ll consider expanding capacity even further this year?

Dr. Zhengrong Shi

Yes.

Stephen Cheng - UBS

Thank you very much.

Operator

Your next question comes from the line of Mehdi Hosseini with FBR.

Mehdi Hosseini - Friedman Billings Ramsey

Thank you. I have two questions, or rather a follow-up; when you talk about disruption in solar wafer in the April quarter, are you expecting that mess in the April quarter to be delivered in the July quarter? In other words, over a time span of six months, all the long-term solar wafer delivery would be met?

The second question has to do, if you could provide any kind of commentary on your customers’ inventory situation.

Dr. Zhengrong Shi

The first question, so far, as we’ve said, we’ve learned to realize that in the first quarter, long term contract for wafer delivery was issued. As many of you already know, it is partially due to for a type of situation, like green energy, green technology type issue. So far, it has been rectified and so far the delivery up until now has been caught up. We believe the whole situation will be, the delivery will be caught up in Q2.

The second question, we don’t believe our customers have modules in inventories sitting out in their warehouse. I think it is more likely they don’t have enough. They know the market is tight and they want to push as many modules as possible for their existing project or projects in the next couple of months.

Mehdi Hosseini - Friedman Billings Ramsey

And just one clarification on the first question, so what you are saying is the amount of long-term solar wafer that was expected to be delivered over the time span of April to July quarter, that is going to be met, or the miss from April is pushed out to the July quarter. Is that correct?

Dr. Zhengrong Shi

According to the existing actual delivery and plan, it should meet

Mehdi Hosseini - Friedman Billings Ramsey

Thank you.

Operator

Your next question comes from the line of Pranab Sarmah with Daiwa Securities.

Pranab Kumar Sarmah - Daiwa Securities

Thank you for taking my questions. My first question is on, Dr. Shi, I think you have mentioned you are accelerating one gigawatt production capacity. Could you give us a timeframe for when you will have the one gigawatt now?

Second one is could you give us some idea about the restructuring charges for MSK for second quarter ’07 and 2007?

Dr. Zhengrong Shi

I am going to take your first question and Amy will take the second question. The first question, we still expect to reach one gigawatt capacity by 2010.

Pranab Kumar Sarmah - Daiwa Securities

So accelerating means it will be 2009, or it will remain 2010 still?

Dr. Zhengrong Shi

2010. Okay?

Pranab Kumar Sarmah - Daiwa Securities

Yes, and the second one?

Dr. Zhengrong Shi

The second one, okay, Amy.

Amy Yi Zhang

As what we communicated before, actually the raw material kept by MSK has all been relocated to China for staring the production in China in order to achieve relatively high gross margin. Secondly, we are helping them to clear all the old stock and sell them with a relatively reasonable ASP to the current market and current customers.

Regarding the plant property, equipment and fixed asset related items, we are still in the process of assessing these possibilities, trying to minimize the one-off cost to be hit to the P&L. But for the time being, without a detailed plan in place, I cannot really talk into any detail of the numbers with restructuring integration costs.

Pranab Kumar Sarmah - Daiwa Securities

Could you actually give us whatever book value or net asset you have on Japan at this point?

Amy Yi Zhang

Can you repeat your question?

Pranab Kumar Sarmah - Daiwa Securities

What amount of assets and what value of the assets you are holding in Japan currently?

Amy Yi Zhang

Actually, the total net book value of the total assets in the two manufacturing plants were around $29 million to $30 million. That’s the net book value of the assets for the time being.

Pranab Kumar Sarmah - Daiwa Securities

Okay, that’s fair enough. Thank you very much.

Operator

Your next question comes from the line of Rob Stone with Cowen and Company.

Robert Stone - Cowen and Company

Dr. Shi, you talked a lot about targeting the BIPV market. Can you say roughly how much of the 325 megawatts of output for this year will be for BIPV application?

Dr. Zhengrong Shi

This year, BIPV is still quite minimal. We consider the total output of 5 to 10 megawatts of BIPV product to be shipped in this year. This year, mainly we spend a lot of time to promote the concepts and the product and we find quite successful. So far, we see that in Japan, China, and the U.S., a lot of the interest -- they want to work with us to promote a BIPV product, especially for residential rooftop system, as the letter of intent we signed with Open Energy in the U.S.

Robert Stone - Cowen and Company

Of the remaining MSK inventory, you’ve got about 7 megawatts left, I guess, is that --

Dr. Zhengrong Shi

Most are standard module because BIPV, what we have produced has sold out.

Robert Stone - Cowen and Company

Thank you.

Operator

Your final question comes from the line of Paul Clegg with Natexis Bleichroeder.

Paul Clegg - Natexis Bleichroeder

Most of my questions have been answered. I’ll just ask you one follow-up; have you seen anymore movement at the provincial level on PV subsidies in China?

Dr. Zhengrong Shi

For that, both the provincial level and the national government level, they are working on some incentive. We should expect something maybe in Q3 or Q4.

Paul Clegg - Natexis Bleichroeder

Thank you.

Operator

We are now approaching the end of the conference call. I will now turn the call over to Suntech's Chief Executive Officer, Dr. Shi, for his closing remarks.

Dr. Zhengrong Shi

Thank you for joining us today. If you have any further questions, please do not hesitate to contact any of our investor relations representatives in the near future. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Suntech Q1 2007 Earnings Call Transcript
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