Solarfun Power Q1 2007 Earnings Call Transcript

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Solarfun Power Holdings Co., Ltd. (SOLF)
Q1 2007 Earnings Call
May 30, 2007 8:00 am ET

Executives

Tip Fleming - Christensen
Yonghua Lu - Chairman and Chief Executive Officer
Xihong Deng - Executive Vice President, International Business Development
Kevin Wei - Chief Financial Officer
Hanfei Wang - Chief Operating Officer

Analysts

Jeff Osborne - CIBC World Markets
Jesse Pichel - Piper Jaffray
Paul Clegg - Natexis Bleichroeder
Cheryl Tang - Goldman Sachs
Tien Yu Sieh - Merrill Lynch
Satya Kumar - Credit Suisse
Sunil Gupta - Morgan Stanley
Kim DePaoli - GGHC
Alberto Bassetto - Jayhawk Capital

Presentation

Operator

Good morning, ladies and gentlemen. This is Howard and I will be the operator for this conference call. I would like to welcome everyone to the Solarfun Power Holding Company’s first quarter 2007 earnings conference call. (Operator Instructions) Now I would like to transfer the call to the moderator, Mr. Tip Fleming of Christensen.

Tip Fleming

Thank you. Good morning and welcome, everyone. My name is Tip Fleming. I am with Christensen. Sorry for our delay in getting started. We had a few members of management flying in for the call today and they unfortunately ran into some Shanghai traffic on the way.

As a reminder, this conference call is being recorded. A replay of this conference call will be available via webcast on the company’s website at www.solarfun.com.cn. Today with us here is the whole management team of the company: Chairman and CEO, Mr. Yonghua Lu; Mr. Kevin Wei, CFO; Mr. Hanfei Wang, COO; and Ms. Xihong Deng, Executive Vice President in charge of International Business Development.

After they finish their remarks, there’ll be time for you to ask questions. Now before I start and turn the call over to Mr. Lu, I have to remind you that this call will include forward-looking statements which are subject to risks and uncertainties. The company claims the protection of Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed and therefore I refer you to a more detailed discussion of the risks and uncertainties in the company’s filings with the Securities and Exchange Commission.

In addition, any projections as to the company’s future performance represent management’s estimates as of today, May 30, 2007. Solarfun assumes no obligation to update these projections in the future as market conditions change.

Now, it is my pleasure to turn the call over to Solarfun's Chairman and CEO, Mr. Lu.

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Yonghua Lu (Translation)

Thank you, Tip. Ladies and gentlemen, we are very pleased to have you join our conference call today. Solarfun had a challenging first quarter performance. Now I would like to specify some main reasons of this performance.

One of the reasons is because of the delayed announcement of the solar incentive legislation in Spain and Italy. Some of our major customers’ target market have been impacted by the, have built up their inventory so our original sales order made based on framework has been delayed. Secondly, we have a young international team so we are in the middle of building our international sales and marketing efforts.

By recognizing the challenges we are facing in the first quarter, our management team has taken the following actions. We already started to strengthen our international team. Recently we have hired a senior executive from one of the top 10 PV companies to head up our international purchasing, sales and marketing effort. In addition, we also hired a senior executive from a U.S. public company in the semiconductor industry to take charge of our international business development.

We still continue recruiting more experienced international talent and we are in the middle of establishing our business development office in Germany, Spain and the U.S. to take advantage of the newly launched partner incentive programs. We are going to fully explore the -- by taking advantage of that, we just obtained a U.S. certificate to further penetrate the U.S. market.

In addition, we are going to continue to expand our production capacity to fulfill the market demand and also we are going to take advantage of our scaled production of PV cell and modules to reduce our further cost. We are also carrying out a strategic alliance with [Ecostream] [inaudible] panels to further reduce our wafer costs.

In addition, we also have to work out the near-term and the long-term silicon suppliers with overseas partners and trying to secure further long-term and mid-term suppliers in the near future.

Overall, we have full confidence to realize the annual guidance and that we will be capable of improving our operation to further satisfy our shareholders. Thank you.

Now I would to turn the call over to Xihong Deng, our EVP of International Business.

Xihong Deng

Thank you, Chairman Lu. As already indicated before, Solarfun did have a challenging quarterly sales result. One of the main reasons for that is mainly caused by the delay of the sales order from some of our major customers in Spain and Italy due to the delayed solar subsidy legislation announcement.

By recognizing the challenges we are facing in Q1, we are taking four actions, as following: number one, we will further diversify our partner base and further penetrate other new markets. In Q1 actually we engaged a few new orders from our new customers in Spain and the Netherlands. In January 2007, we entered into a supply framework agreement for PV modules with Dutch company Ecostream. They have indicated their intention to procure 182 megawatts of PV modules from Solarfun between the years 2007 and 2010. Ecostream firmly committed to purchase 12 megawatts of PV modules from us in the year 2007.

We also made efforts to further diversify our customer base, such as engage new customers in Spain, like we announced before of one of our customers, UB, who also committed to purchase 12 megawatts from Solarfun in 2007.

The second action we are taking is further strengthening our international team by recruiting more experienced international professionals. As our Chairman also already mentioned, we recently hired two senior executives. One comes from one of the top 10 PV companies in the world and another comes from a public traded U.S. semiconductor company. They will head our international sales and marketing teams. In addition, we are going to continue to hire more local sales people in Germany, Italy, and Spain and the U.S.

We are also pleased to announce that in February with the obtaining of the U.S. certification and the CEC approval, we enhanced our U.S. team by hiring two more local people.

Overall, we believe that with our enhanced international team and a more diversified and large customer base, and a dramatically improved end market in Spain, Italy and the U.S., we are confident that we can achieve our annual sales target.

Now let me turn to talk about the technology. Our conversion rate remains in the 16.3% to 16.4% range. We will continue to make efforts in our R&D to get this close to 17% by year-end. We are also working hard to reduce our breakage ratio and to further increase our production efficiency.

The expansion of our production line continued on schedule. We are able to produce 120 megawatts annually now. We will have two more production lines completed by the end of June with an annual production capability for 180 megawatts. Our actual annual production output will reach to 90 to 100 megawatts.

We are currently working very hard with the domestic and international silicon suppliers to further enhance our supply situation. Currently we have around 80% of our silicon supply is secured at a fixed price and we have not locked up the remaining 20% because we are expecting the wafer price will drop towards the end of the year.

In addition, we are in discussion with a few major mid- and long-term silicon wafer supply producers with major overseas players.

With that, let me turn the call over to Kevin, who will go through our financial guidance for the year.

Kevin Wei

Thank you, Xihong. For the first quarter of 2007, our total net revenue was RMB190.7 million, representing a decrease of 22.2% sequentially and an increase of 85.7% over the first quarter of 2006.

Total net shipments were 6.5 megawatts, down from the 7.8 megawatts in the fourth quarter of 2006 and up from 2.9 megawatts in the first quarter of 2006. Our first quarter average selling price was $3.77 compared to $3.96 in the fourth quarter of 2006 and $3.98 in the first quarter of 2006. In the first quarter, almost all of our total net revenue came from our PV modules.

Gross profit in the first quarter 2007 was RMB32.8 million, representing a decrease of 50% sequentially and a decrease of 8.4% year over year. First quarter gross margin was at 17.2% compared with 26.8% in the fourth quarter of 2006 and 34.9% in the first quarter of 2006.

The declines in sequential and year-over-year gross margin were mainly due to the lower ASP and also high cost of non-silicon module materials in the first quarter of 2007.

Operating expenses in the first quarter of 2007 were at RMB28.6 million and showed a sequential decrease of 5.7% and a year-over-year increase of 704.3%. The sequential decrease was mainly due to an allowance of doubtful accounts of RMB11.3 million recorded in the fourth quarter of 2006 while there was no such allowance recorded in the first quarter of 2007.

The year-over-year increase was primarily due to the high selling expenses, G&A expenses, as well as R&D costs as a result of the rapid expansion of our business this year.

First quarter share-based compensation charge was RMB8.4 million compared with RMB2.9 million in the fourth quarter of 2006 and nil in the first quarter of 2006. The share-based compensation charge recorded in the cost of goods sold was at RMB0.4 million for this quarter.

Depreciation expense amounted to approximately RMB3.8 million for this quarter. The operating income in the first quarter 2007 was RMB4.3 million, representing a decrease of 87.9% sequentially and 86.8% year over year.

First quarter operating margin was at 2.2% compared at 18.0% in the fourth quarter of 2006 and 31.5% in the first quarter of 2006. The sequential decline in operating margin was mainly due to the gross profit decrease and a relatively constant total operating costs.

Interest expense in the first quarter of 2007 amounted to RMB5.3 million compared to RMB4.5 million in the fourth quarter of 2006, as well as RMB0.4 million in the first quarter of 2006. The increase was caused by a slightly higher short-term borrowing in the first quarter of 2007.

In the same quarter, interest income increased significantly to RMB9.6 million from RMB0.8 million in the fourth quarter of 2006 as a result of higher cash balance.

First quarter, the exchange loss was RMB11.3 million, up from RMB4.3 million in the fourth quarter of 2006 and almost nil in the first quarter of 2006. The increase was mainly due to the impact of RMB appreciation against the U.S. dollar on our U.S. dollar denominated IPO proceeds.

Net income tax expenses for the first quarter were RMB0.4 million, which is including an estimated income tax expense of RMB0.9 million net of an income tax benefit of RMB0.5 million.

In the first quarter of 2007, the company suffered a net loss of RMB2.5 million, representing a decrease of 107.7% sequentially and 107.6% year over year.

Net loss per basic ADS was RMB0.053 in the first quarter of 2007 compared to RMB1.03 in the fourth quarter 2006 and RMB1.65 in the first quarter of 2006.

Turning to our balance sheet as of March 31st, the company has a cash balance of RMB757.8 million, working capital of RMB1.417 billion, and RMB260.9 million in short-term and long-term debt. Our debt-to-equity ratio stood at 21.4% at the end of the quarter.

Accounts receivable balance at the end of the first quarter increased to RMB238 million from RMB147.8 million at the end of last quarter. Both balances were net of the allowance of doubtful accounts of RMB11.3 million. Subsequent to March 31, 2007, we have collected approximately RMB214 million.

Inventory balances increased to RMB482.9 million at the end of this quarter mainly due to the build-up of our raw materials inventories as well as higher inventories of PV modules.

First quarter capital expenditure was approximately RMB76.7 million. These expenditures were mostly used for our new cell line capacity expansion. For full year 2007, we expect capital expenditure to be approximately $42 million to $45 million.

Next I would like to update our business outlook for 2007. Based on our current operating conditions, the company revised its previous annual estimates for the full year of 2007. The new guidance for 2007 includes PV product shipments of 70 megawatts to 80 megawatts for the year and we estimate the net revenue will be in the range of $250 million to $270 million. Our annualized total PV cell production capacity remains unchanged at 240 megawatts by the end of 2007.

With that, I will turn it back to -- let’s go to -- next.

Tip Fleming

With that, we will open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Mr. Jeff Osborne. Mr. Osborne, your line is open.

Jeff Osborne - CIBC World Markets

Thank you. Just a couple of questions, Kevin; could you talk about how many customers you actually have in Italy and Spain, and is it just one particular customer or are you finding that there’s regions of the world that are having a pervasive problem across the industry?

Xihong Deng

Jeff, let me answer this question. I think about the first quarter, the early first quarter we only had limited customers in Spain and Italy, so that’s why we are -- our framework and contract and also said for the -- you mainly rely on those limited customers, so with the unexpected continued delay of this announcement, the customers do have some inventory problems. So they have delayed orders which were supposed to be a total of 5 megawatts for Q1. We are trying to control the credit risk and as well as to maintain our cash flow, so we are not executing those sales orders.

Also, we realize that we are trying to realize the challenges, so we started to develop new customers, as we announced another customer, UB, which has a strong financial background, as well as other Italian clients. So those have been done towards the second half of Q1, but those are for -- they were not in effect in Q1. It is more for the effect on an ongoing basis.

Jeff Osborne - CIBC World Markets

Okay, so it looks like you obviously had to discount in the quarter. Could you have discounted to a greater degree? Just based on the DSOs, it looks like you provided greater credit terms. Could you have done that more to get the 5 megawatts done or -- I’m just trying to get the sensitivity of those customers. How do you know it’s not a market share loss issue?

Xihong Deng

Currently, we announced -- not excluding those framework, frame contracts, we are now engaging other customers with over 60% of our annual sales, not including those two customers we are talking about. But at the same time, we are renegotiating with those customers because the policy now, the Spanish policy just announced two days ago, on May 25th. Also, with the Italian probably to announce at the end of the first quarter. We are renegotiating the frame contract and trying to be down to the level where we state certain credit risk control, so we will make more announcements once those revised agreements have been reached.

Jeff Osborne - CIBC World Markets

I understand. Just a few more questions here, just two clarifications; I think you had mentioned at the end of June you would have two more lines coming on, so capacity going to 180 megawatts, and then I believe you made a statement that actual production output would go to 90 to 100 megawatts, yet the guidance is much lower than that. So what actually does “actual production output” mean?

Xihong Deng

I think by capacity what we mean was the theoretic number, as we mentioned before, that if we produce one production line with a six-inch wafer, normally each production line was currently on 30 megawatts with the annual capacity. So when we talk about capacity, we are using each line as 30 megawatts times the number of lines, so that’s where we come up with those numbers.

Jeff Osborne - CIBC World Markets

And that’s assuming six-inch, but most of your wafers are five, right?

Xihong Deng

Yes, with the five inches, it is 22.5 megawatts per line per year. Also, because of the time sequence that we installed those lines, two lines by the end of March, two lines by the end of this quarter and two more in the third quarter and fourth quarter, that is how we calculated the actual production output, which is between 90 to 100.

Jeff Osborne - CIBC World Markets

I understand. Just another clarification -- I believe Kevin made a comment that non-silicon costs rose in the quarter and that adversely impacted gross margins. Can you just maybe take a step back and talk about your costs per watt, what you are seeing in terms of wafer costs at a five-inch level? And then just clarify why non-silicon costs went up sequentially?

Kevin Wei

The simple answer to the non-silicon module costs, we actually changed to some imported components to further improve our module qualities at a request of our clients, et cetera. So as a result, that contributed to a certain margin loss for this quarter. We have not seen any significant increase in the silicon costs, particularly in this quarter. As I think Xihong mentioned earlier, maybe towards the end of the year we also would anticipate some decreases in the silicon costs.

Jeff Osborne - CIBC World Markets

Right, so you are still in that kind of $5.25 to $5.40 range for five-inch wafers? Is that what you are seeing in the market?

Kevin Wei

Are you referring to --

Jeff Osborne - CIBC World Markets

U.S. dollars per five-inch wafer.

Kevin Wei

Per wafer?

Jeff Osborne - CIBC World Markets

Correct.

Kevin Wei

We haven’t really changed much with the cost structure, but I probably should not go through too much detail about that.

Jeff Osborne - CIBC World Markets

Okay, sure. And I believe the filing for your IPO had a substantial potential contract that was due to start in July with the Chinese wafer producer that pricing was not determined. Could you just update us on where you stand with these new potential suppliers and what the pace of negotiations are and how confident you are that prices will actually be lower in the second half?

Xihong Deng

Sorry, Jeff. We are trying to convert RMB to the U.S. dollar. Give us one second. For the mono 125 by 125, it’s around $5.40. This is not including tax. The multi 125 by 125 is $5.25. Now we are going to produce more 156 by 156, so the price is around RMB78, for mono it is RMB85. This is including tax. We can provide you more dollar-based later.

Jeff Osborne - CIBC World Markets

I can calculate, that’s fine. My last two questions I had for Kevin in terms of modeling, just with the increased hiring and sales force focus and penetrating these new regions, could you just talk about how we should think about expenses going forward? Also, I think you made some commentary on the last earnings call about a greater ramp up in cell processing, which obviously carries lower ASPs. Is there any cell processing megawatts in the new revised guidance?

Kevin Wei

The current guidance, which is lower from the previous one, again still focused on that majority of the PV module sales but as the current operational plan we look at, we haven’t really locked in PV cell processing contracts, so management is also open to other product offerings, such as the PV cell sales. As such, our current revenue guidance is based on again a mix of expectation of future module sales as well as potentially PV cell sales.

Jeff Osborne - CIBC World Markets

Okay, and just on the expense issue?

Kevin Wei

The expenses I think, as our other colleagues have mentioned, we will continue to establish a stronger, maybe more extensive international sales and marketing network so we will continue to see a gradual increase in the selling and G&A expenses. But probably by the end of the year, the SG&A percentage will fall under a more reasonable percentage as compared to our peers, too.

Jeff Osborne - CIBC World Markets

Very good, thanks a lot.

Operator

Our next question or comment comes from Jesse Pichel from Piper Jaffray. Mr. Pichel, your line is open.

Jesse Pichel - Piper Jaffray

Good evening. Jeff asked most of my questions but to follow-up on some of his points, you have fixed price wafer contracts, thus your wafer price did not increase sequentially. Is that correct?

Kevin Wei

Jesse, let me answer your question -- just very slightly.

Jesse Pichel - Piper Jaffray

Very slightly, so the margin decline was mainly due to 5 points of ASP decline and the rest in non-silicon costs? Is that correct?

Kevin Wei

Not all in the non-silicon. It is probably about in total a 9.6% drop in the margin, that 1.9% were related to the non-silicon module material. The remaining major items actually were the depreciation of the U.S. against the RMB and the rest of the balance is more related to as a result of the lower volume to spread these fixed costs.

Jesse Pichel - Piper Jaffray

You’re billing a lot of your modules in dollars, is that it?

Kevin Wei

Yes, we’re selling in U.S. dollars.

Jesse Pichel - Piper Jaffray

You’re selling in U.S. dollars. Will you potentially change that and sell in Euros or RMBs?

Kevin Wei

We have that combination starting already.

Xihong Deng

Yes, starting in Q2, our major sales contracts are in Euros.

Jesse Pichel - Piper Jaffray

How do you expect the wafer price to change through the rest of the year? Did you mention that it might go down by Q4?

Kevin Wei

It is probably toward the end of the year, between 2% to 3%.

Jesse Pichel - Piper Jaffray

Decline?

Kevin Wei

Yes.

Jesse Pichel - Piper Jaffray

And how do you see ASPs progressing through the balance of the year?

Xihong Deng

They will be down up to 10%.

Jesse Pichel - Piper Jaffray

Down 10%?

Xihong Deng

Up to.

Jesse Pichel - Piper Jaffray

As much as 10%? Okay. What are your credit terms, because your DSOs are now, your average DSOs are 112 days so I’m wondering what are some of your terms?

Xihong Deng

I think in our previous customers for the last year and in Q1, it is pretty long. Even though we encountered the challenge in Q1, now we are needing credit and risk control so our average credit now is less than two months, [inaudible].

Jesse Pichel - Piper Jaffray

But some of your customers have 120 day terms or more?

Xihong Deng

No, so far those are the older customers which we are not shipping anymore product. There is one contract where we revised the contract already, shortened the three months credit to one month.

Jesse Pichel - Piper Jaffray

You get some of your polysilicon from one of the Chinese polysilicon makers. Is that correct?

Xihong Deng

Yes, from [Ermay].

Jesse Pichel - Piper Jaffray

Can you comment on how their ramp is proceeding and how other Chinese poly plants are ramping?

Xihong Deng

Okay. Let me talk to Yonghua about this. I can add more comments, okay?

Jesse Pichel - Piper Jaffray

Thank you.

Yonghua Lu (Translation)

Regarding [Ermay], we monitor closely with the project and so far it seems that goes smoothly. Also, we basically normally are pre-payment based on the project milestone, so we have the people there to monitor the process and so far things are going as we expected.

For [Ermay], the company also contributes to another extension in addition to this 500 tons to another 1,500 ton project ongoing investigation. There is another Chinese player call Jiangxi Gangyuan, which has started construction last year and by early this year, they already successfully have the trial production with a very satisfactory result. That is the first one is 1,000 pounds and we are watching very closely how quickly they can expect it to do big volume commercial production.

Another very interesting project is in [inaudible]. This is also the project started last year and the first one is 1,500 pounds. We expect that they are going to have their trial product by either the third quarter or the fourth quarter of this year. We also have a very good relationship with this company and we are in discussion for some silicon collaborations with them in the future.

Jesse Pichel - Piper Jaffray

Thank you very much for the comments. Good luck.

Operator

Our next question comes from Mr. Paul Clegg. Mr. Clegg, your line is open.

Paul Clegg - Natexis Bleichroeder

Thank you. Could you just please give a geographical breakdown of revenues in the quarter and how you expect to see that change throughout the year as you target key markets?

Xihong Deng

In Q1, we have 25.5% coming from Germany; Spain is 47%; France is 14% -- this is a new market and EDF, they are the client; and we have The Netherlands, 14.6%.

Back to whatever we locked up now, we have locked up over 48 megawatts. This is not including the framework we signed with the Spanish and Italian clients. We have in addition 48 megawatts locked up for the whole year and the total geographical allocation comes from 45% from Spain; 11% from Germany; 24.8% from The Netherlands; 4% from France; and 12% from Belgium; and then 3% or 2% from other parts of the country.

Paul Clegg - Natexis Bleichroeder

Thanks. Could you also give cell efficiency levels currently and where you see those trending? Average cell efficiency?

Xihong Deng

Let me refer this question to our COO.

Hanfei Wang

In the first quarter, our efficiency is the same as the last one, the fourth quarter. But in the second quarter, it will climb to 16.4. The third quarter, it will climb to 16.8, and at the end of this year, we try to get to 17%.

Paul Clegg - Natexis Bleichroeder

17% by the end of the year.

Xihong Deng

So 16.4% Q2, 16.8% in Q3, and 17% by the end of the year.

Paul Clegg - Natexis Bleichroeder

Okay. Perfect. Thanks very much.

Operator

Our next question comes from Ms. Cheryl Tang from Goldman Sachs. Ms. Tang, your line is open.

Cheryl Tang - Goldman Sachs

I have a question on the silicon supplies. 80% of silicon secured for ’07 production. I’m wondering if I can have further comment on who are key suppliers for ’07 and how much comes from [Ermay]?

Yonghua Lu (Translation)

Basically, we see the main, the similar suppliers as we disclosed in our [prospectus]. The major supply is still coming from LDK and also the [Shanghai Jinneng] and the [Jiangxi Gangyuan]. With [Ermay], we are going to have a total of 1.6 megawatts. And [inaudible] is another major one, with around 19 megawatts for this year.

Cheryl Tang - Goldman Sachs

How much from [inaudible]? I didn’t get it clearly.

Yonghua Lu (Translation)

Seven megawatts, right? No, 1.6 from [Ermay] because their ramp up will be coming next year, early next year, this 500 tons.

Cheryl Tang - Goldman Sachs

So that represents 80% of the silicon requirements for ’07, but the numbers seem like below that.

(Translation Unavailable)

Xihong Deng

We’ll send you the detail allocation for our supplies after the call, but basically your question is regarding how much is the total volume we locked up for the silicon supplies, so around 70 megawatts we locked up.

Cheryl Tang - Goldman Sachs

I have another follow-up question in terms of the shipment. How should we expect the shipments for Q2 to Q4? Is there any seasonality?

Xihong Deng

We think the next few quarters, the market will be improved and our sales situation will improve quite a bit, given the fact that the Spanish Government just announced its new law on May 20th and also now they try in the U.S. market already have a very positive law, so we definitely expect that the sales shipment will be improved very much. That’s why we remain confident that we are going to achieve our annual sales target as we specified in this conference.

Cheryl Tang - Goldman Sachs

Thank you.

Operator

Our next question comes from Tien Yu Sieh from Merrill Lynch. Mr. Sieh, your line is open.

Tien Yu Sieh - Merrill Lynch

Good evening. I guess I wanted to ask a little bit more about the market conditions. Some of the other companies in the space have basically seen a soft start to the first quarter but then have seen a very strong pick-up in March and in April and in May. I was just wondering if you could put a little bit more detail in your sales profile in the first quarter and into the second quarter, whether you have seen a similar acceleration into March and April and May, or whether this -- what sort of monthly profile are you seeing as far as your sales activity is concerned?

Xihong Deng

I think your observation is consistent with what we observed in the market as well. As I mentioned that starting in March, we already engaged some new customers in France, which is the EDF, one of the largest energy companies in the world. We also have a contract with Ecostream, which is one of the largest turn-key solution providers in Europe. So we do have the long-term relationship with those new customers. We’ve diversified in the market as well, now that the Spanish market is turning around, which we expected, there is a lot of -- the sales activity will be very positive for us starting in the next few weeks and next few months.

I think we are pretty much in line with your observation of the market activity.

Tien Yu Sieh - Merrill Lynch

Okay, and a follow-on question; your earlier comments about ASP decline of up to 10%, is that -- 10% against what? Is that from first quarter or from --

Xihong Deng

Last year’s end price, which is around $4.

Tien Yu Sieh - Merrill Lynch

$4, okay. In terms of the, in respect to that pricing situation then, when you go out and engage customers today, what is the nature of the discussion? Is there a high degree of price sensitivity or do you feel that that’s really not the main thing on the agenda right now?

Xihong Deng

That’s a very good question. I think every market behaves differently. We are observing Germany, in particular with the reduction of this 5% of the incentive every year, we do see a lot of pricing pressure from this market, even though Germany still remains the largest market in the PV market. However, in Spain and Italy, those are -- because given the incentive program which was just issued, we think there’s much more room for the investors in the downstream for making more money, so there’s much more flexibility in terms of ASP.

Our internal sales strategy is for the big customers, especially in the new markets, we may also have a flexible pricing strategy in order for us to penetrate those new markets. But for the existing markets, we are trying to develop some model with some good pricing to balance our net profit margin.

Tien Yu Sieh - Merrill Lynch

One last follow-on question then is I see you’ve got the qualification or the certification for the U.S. market, but you didn’t really mention the U.S. market as far as this year’s sales mix is concerned. Can you give us an update on what your expectations are for the U.S.?

Xihong Deng

Sure. By the end of February, we received the UL certificate for all our major products, which means 156 by 156 and 125 by 125, both mono and the multi modules, and we also got the CEC approval, which is specifically required for the California market for all the PV products. So that is by the end of April. So with that, we already build a U.S. team with some local hires and also we are trying to build a rep office there. We expect that we have some small sales coming in the Q2, but the momentum will build up in the next few quarters.

Tien Yu Sieh - Merrill Lynch

Great. Thank you very much.

Operator

Our next question comes from Satya Kumar from Credit Suisse. Mr. Kumar, your line is open.

Satya Kumar - Credit Suisse

Thanks. Most of my questions have been answered, but I just had a quick clarification question. I missed some of the numbers that you gave out earlier on wafer pricing from one of your suppliers in July. Could you repeat those numbers for me, please?

Xihong Deng

For 125 by 125 mono, $5.40; 125 by 125 multi, $5.25; 156 by 156 multi, it is around $8.50; and for mono 156 by 156, it is round $9.20.

Satya Kumar - Credit Suisse

Could you help me understand where pricing, where your cost is to date for some of these products?

Xihong Deng

Excuse me, what is your question?

Tip Fleming

Could you repeat your question, please?

Satya Kumar - Credit Suisse

What is your current cost in Q1 for wafers?

Kevin Wei

It is in the range of about, if we just calculate it by per watt, it is probably around $2.40 to $2.50 a wafer.

Satya Kumar - Credit Suisse

$2.40 to $2.50?

Kevin Wei

Yes.

Satya Kumar - Credit Suisse

Thank you.

Operator

Our next question comes from Sunil Gupta from Morgan Stanley. Your line is open.

Sunil Gupta - Morgan Stanley

Good evening. I have a couple of follow-up questions in terms of your silicon sufficiency. Could you repeat -- you have silicon sourcing for 2007, you mentioned LDK and then [Jiangxi Gangyuan], [Ermay], and a couple of names. Could you just give us the numbers again slowly so that we could get it down?

Xihong Deng

Are you asking for the sales conversion efficiency?

Sunil Gupta - Morgan Stanley

No, no, silicon -- silicon sourcing or those --

Xihong Deng

Silicon, yes. Okay. From [Ermay], in total we are going to get around 5 megawatts, and for [inaudible] it is about 19 megawatts -- and I’ll just mention some major ones -- so the LDK around 19 megawatts. And the [Shanghai Jinneng] is around 14 megawatts. [Jiangxi Gangyuan] around 15 megawatts. The others are just small suppliers.

Sunil Gupta - Morgan Stanley

And you mentioned that this year’s production is likely to be 70 to 80 megawatts. It looks like you are pretty much there. It looks like you’ve got 70 megawatts secured for this year. Am I reading this correct?

Xihong Deng

Our total production output is between 90 to -- but our sales indication is 70 to 80, so we are using that as a base.

Sunil Gupta - Morgan Stanley

So you’ll produce 90 but you’ll at least sell only 70 to 80?

Xihong Deng

Because our last two lines are starting in December, so we are just -- just in case if there is -- the production, if they produce in the middle of December, it’s a slow season and we are not able to build a little inventory by the year-end.

Sunil Gupta - Morgan Stanley

All right, and have you started securing any of your wafers for 2008?

Xihong Deng

It is around 30% to 40% secured. But also, as I mentioned before, we are now enhancing our overseas procurement activity with our new hires -- we hired those senior executives from other companies as well as we are in the middle of discussions with a few major silicon wafer and silicon partners for the silicon supply starting next year.

Sunil Gupta - Morgan Stanley

What kind of pricing that you got for 2008, for the 30% to 40% that you secured?

Yonghua Lu (Translation)

For the [Ermay] deal, we already locked the price. We’ll be declining at least 5% from the current market price, 5% to 7%.

Sunil Gupta - Morgan Stanley

And how about LDK or [inaudible]?

Yonghua Lu (Translation)

For those, LDK and [inaudible], we are one of their biggest companies. They have also been major suppliers for us for the last three years so we have a good relationship, so we are only locking the [inaudible] but we’ll be subject to further negotiations based on market conditions, which we expect the silicon might be dropping or declining towards the end of this year.

Both [inaudible] and LDK actually they treat us as one of their top three customers.

Sunil Gupta - Morgan Stanley

Okay, and when you mentioned that you have 30% to 40% secured for 2008, what would that translate to in terms of megawatts?

Yonghua Lu (Translation)

60 to 70 megawatts.

Sunil Gupta - Morgan Stanley

Okay, and a question on your conversion efficiency now. You mentioned earlier that right now, the conversion efficiency is about 16.3% and by the end of this year, by Q4 you expect it to go to 17%. How are you taking it to 17%? What are you doing to your conversion efficiency?

Yonghua Lu (Translation)

The first step we are doing, we have also built a 2 megawatt trial line at the research center and now we are developing to improve our process to further enhance our conversion efficiency. Once it works very well, so far some of the key steps and process works very well, we then converge it into the commercial line.

Secondly, we implemented some new designs of the production line and using some of the latest advanced equipment into our production line.

Thirdly, we are further enhancing our management and quality control and also further training our workers to enhance the quality of their work.

Overall, we remain confident to achieve the 17% target by the end of this year.

Sunil Gupta - Morgan Stanley

Could you be more specific about what kind of improvements in process steps you have made? Because 16.3 to 17 is quite a significant improvement in efficiency, so I’m just very curious to understand what sort of process improvements you are making.

Yonghua Lu (Translation)

The first one, we improved our [etching] process. We implemented a new paste with critical material in the printing process. This will further enhance our conversion efficiency. Those measurements have already taken place in our R&D center and already show very, very good results.

Sunil Gupta - Morgan Stanley

Okay, and the last question for me, I just want to understand Q1. You mentioned there were some difficulties with your customer base in Q1. Can I ask what was the amount of silicon wafers that you were able to secure in Q1 and if that was any constraint at all in terms of your Q1 achievement?

Xihong Deng

You are asking what is the silicon wafers we secured in Q1?

Sunil Gupta - Morgan Stanley

That’s right.

Yonghua Lu (Translation)

10 megawatts we secured from LDK.

Sunil Gupta - Morgan Stanley

So 10 megawatts from LDK in Q1?

Xihong Deng

Yes.

Sunil Gupta - Morgan Stanley

And how much did you produce, actually?

Yonghua Lu (Translation)

We produced 11.6 megawatts.

Sunil Gupta - Morgan Stanley

So your finished goods inventory has increased fairly significantly in Q1, is that what’s happened?

Xihong Deng

It has gradually increased because our third and fourth lines started in March, so that’s why there is some inventory build-up which will be digested in Q2.

Sunil Gupta - Morgan Stanley

Thank you very much.

Operator

Our next question comes from Kim [DePaoli] from GGHC. Ms. DePaoli, your line is open.

Kim DePaoli - GGHC

Thanks. That was a close pronunciation. Just if you could repeat, what do you expect your production capacity to be in ’08, what do you expect your output will be in ’08, and then again if you could just repeat how much silicon you have secured for next year.

Kevin Wei

Our current policy is we do not give official guidance on 2008.

Kim DePaoli - GGHC

Of what you expect your output to be? Okay.

Hanfei Wang

Probably 200 megawatts in 2008.

Kim DePaoli - GGHC

Of shipped megawatts, you expect?

Kevin Wei

Like I said, we do not give any guidance on 2008. Sorry.

Kim DePaoli - GGHC

Okay. Thank you.

Operator

Our next question comes from Mr. Alberto Bassetto from Jayhawk Capital. Mr. Bassetto, your line is open.

Alberto Bassetto - Jayhawk Capital

I think it’s a question for Kevin. Kevin, would you mind to clarify to me once again the gross margin decrease for Q1? My understanding is that the silicon material costs from Q4 did not change much and so the squeeze in gross margin comes from ASP and not silicon material. Would you mind to clarify a little bit more that point?

Kevin Wei

Sure. The ASP drop pretty much accounted for 4.4% of the total percentage drop, which was 9.6%. The wafer cost increased slightly, probably only accounted for 1%. Like we mentioned earlier, these non-silicon module materials cost increased because we switched to some imported material. That accounted for about 1.9%. The next, more of a bigger item is actually depreciation of the U.S. dollar against RMB, and that’s about 1.5% of the drop. The remaining is much more other depreciation, et cetera, that is basically spread out on a much lower volume which contributed to margin declines.

Alberto Bassetto - Jayhawk Capital

I see. Thanks for that. How much in Q1 sales were under contracts or with prices pretty much fixed, and how much more that will be for 2007?

Kevin Wei

Could I just clarify a little bit more? You are asking about the Q1 sales price?

Alberto Bassetto - Jayhawk Capital

Yes, under contract in Q1, how much of that was under contract and how much for 2007 you secured under contract in terms of sales?

Kevin Wei

For the first quarter, the vast majority actually were part of the contracts we already entered into. I would say probably more than 60%. The remaining for 2007, based on our current guidance of 70 to 80 megawatts, we have secured more than 65% sales under contract.

Alberto Bassetto - Jayhawk Capital

My last comment, which is not a question, if you could just provide your point of view -- the average selling price in Q1 is I think you said $3.77 per watt. We see that the spot price is already below that level currently. Can you comment on that from your industry perspective?

Xihong Deng

As we mentioned, we expect the average for the whole year, the ASP drop will be up to 10%.

Alberto Bassetto - Jayhawk Capital

Thank you very much.

Operator

Our next question is a follow-up from Ms. Cheryl Tang from Goldman Sachs. Ms. Tang, your line is open.

Cheryl Tang - Goldman Sachs

Okay, I have a question for Kevin. In terms of share-based compensation, what should we expect for Q2 or the rest of the year?

Kevin Wei

The rest of the year in total is about $3.9 million. Again, that could potentially increase a bit more should the company continue to grant share options. For Q2, we do not give specific guidance but you could expect a similar pattern as Q1.

Cheryl Tang - Goldman Sachs

Thank you.

Operator

Our next question is a follow-up from Mr. Sunil Gupta from Morgan Stanley. Mr. Gupta, your line is open.

Sunil Gupta - Morgan Stanley

Thank you. I just wanted to follow-up on your earlier comments about your wafer costs. Did you say that your wafer costs are fixed for the rest of the year?

Xihong Deng

The 80% we secured are fixed.

Sunil Gupta - Morgan Stanley

At an average of about $5.25?

Xihong Deng

Well, it’s different products at different prices. Five-inch different, six-inch -- the policy for price.

Sunil Gupta - Morgan Stanley

Sure, I understand but 80% or so, so that is 70 megawatts of the total -- give us an indication, all these are fixed prices?

Yonghua Lu (Translation)

We think because we are locking in up to 80%, for the remaining we still leave it open so our expected average, the total silicon wafer price will drop maybe around 2% to 3%, as Kevin indicated. We think we still have room to negotiate with [Ermay] because our price is tied up with the market price with a discount.

Sunil Gupta - Morgan Stanley

In Q1, did you buy anything in the spot market at all?

Yonghua Lu (Translation)

Yes, mainly from those major suppliers we specified before.

Sunil Gupta - Morgan Stanley

So nothing in the spot market?

Yonghua Lu (Translation)

I think our price is lower than the spot market because some of those major suppliers, we prepaid quite a lot of money last year and have a good relationship.

Sunil Gupta - Morgan Stanley

For the rest of the year, do you have any plans to secure any wafers in the spot market, or will you rely on these long-term suppliers?

Yonghua Lu (Translation)

We will still rely on the existing suppliers, given the fact that we maintain a very good relationship for the long-term. In particular, our current suppliers are expanding their capacity dramatically.

Sunil Gupta - Morgan Stanley

I wanted to go back to your earlier comments about ASP decline. You mentioned that ASP could decline by about 10% compared to Q4 of ’06. Some of your competitors recently had said that the ASP pressures are less severe or more benign than we earlier expected. Are you seeing anything of that sort in any of your end markets or do you think a 10% decline in ASP is similar to what you said about three months ago?

Xihong Deng

It’s the same as three months ago. When we talk about up to 10% as compared to the year end price, the Q4 last year. Actually, the price decline, when we talk about the average ASP declining up to 10% for the whole year.

Sunil Gupta - Morgan Stanley

Thank you.

Operator

Ladies and gentlemen, there are no more questions in the queue at this time. This concludes our call. I will turn the conference back over to Mr. Fleming.

Tip Fleming

Thank you to everyone. Just so you know, a live webcast of the conference call will be available in the investor relations section of the company’s website at www.solarfun.com.cn. A replay of the webcast will be available for one month. The dial-in replay will be available for 24 hours after the conclusion of this call. The dial-in number will be 888-266-2081 for U.S. callers and 703-925-2533 for international calls. The access code will be 1088867. If you have any additional questions, please feel free to contact Mr. Tony Wang of the Investor Relations group at Solarfun. His number is 8621-6306-8907, for e-mail, [e-mail]. You can also contact us at 852-2117-0861. That’s Christensen’s number in Hong Kong, or 212-618-1978 in the U.S.

Thank you all again for joining us today. Have a nice day. Good-bye.

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