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Suntech Power Holdings Co., Ltd. (NYSE:STP)

Q2 2007 Earnings Call

August 9, 2007 8:00 am ET

Executives

Steven Chen - Chief Strategy Officer

Dr. Zhengrong Shi - Chairman and Chief Executive Officer

Amy Yi Zhang - Chief Financial Officer, Director

Stuart R. Wenham - Chief Technical Officer

Analysts

Robert Stone - Cowen and Company

Sanjay Shrestha - Lazard Capital Markets

Sunil Gupta - Morgan Stanley

Paul Clegg - Jefferies & Company

Jeff Osborne - Thomas Weisel Partners

Angello Chan - Credit Suisse

Tien Yu Sieh - Merrill Lynch

Michael Carboy - Signal Hill Group

Jesse Pichel - Piper Jaffray

Paul Leming - Soleil Securities

Julie Chen - Brean Murray Carret

Steve O’Rourke - Deutsche Bank

Cheryl Tang - Goldman Sachs

Pavel Molchanov - Raymond James

Satya Kumar - Credit Suisse

Pranav Sarma - Daiwa Securities

Dan Reese - Monett

Presentation

Operator

Good evening and thank you for standing by for Suntech’s second 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 Chief Strategy Officer.

Steven Chan

Hello, everyone and welcome to Suntech's second quarter 2007 earnings conference call. My name is Steven Chan, Suntech's Chief Strategy Officer. From 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 session 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 will now turn the call over to Suntech's Chairman and CEO, Dr. Zhengrong Shi.

Dr. Zhengrong Shi

Thank you, Steven. Hello and thank you for joining us today. I am pleased to report that we finished our output target in the second quarter of 2007. We shipped over 80 megawatts of PV cells and modules and achieved total net revenue of $317.4 million. That is about 148% higher than a year ago. We also delivered bottom line growth of 66% year over year on a non-GAAP basis, achieving a record $0.29 per share.

Once again, this strong revenue and earnings growth was probably due to the exceptional demand for our PV products in Europe as well as excellent execution from a manufacturing standpoint.

I will now take you through some of our key developments for the quarter.

On the sales front, we are pleased with the trend we are seeing in our key markets, particularly in Europe. The German market continued to be a key one for Suntech and over 50% of our second quarter revenues were generated from sales to distributors in this region. Suntech has been selling into Germany for five years now and there is widespread awareness of the high quality and performance of our PV modules among distributors and end users. We are currently in the process of negotiating contracts for 2008 and are confident of continued strength there.

Spain also continues to be one of our strongest markets. The majority of our Spanish solar projects are multi-megawatt and we are confident that we are one of the leading suppliers to this market. In the first half of 2007, we have already shipped over 50 megawatts of PV products to Spain.

We are also seeing positive developments in other parts of Europe, including France, Italy and Greece, and we expect to build sales in these regions in the coming quarters. And in North America, we are continuing to build our network and are already developing a strong pipeline for 2008.

Our established brand name, high product quality and deep sales penetration into key markets, especially Europe, has enabled us to grow faster than both the underlying markets and most of our competitors while maintaining stable [profit]. We are confident this trend will continue. In fact, we have already booked over 150 megawatts for 2008.

Turning to BIPV, while revenue contribution from this product line is relatively small, we are optimistic about the market potential, especially in space-confined markets such as urban areas. One recent project of note is the installation of our BIPV system in Kingspan Off-Site’s net zero carbon home in England. This is the first house designed to comply with the new sustainable building standard in Britain that will be compulsory for all new homes built in 2016.

As I mentioned earlier, our production team did an excellent job in producing and shipping over 80 megawatts during the second quarter. In this environment of surplus demand, we are determined to improve both our production efficiency and the capacity to capitalize on market opportunities and increase our market share. As we noted last quarter, we are doing this in two ways.

Firstly, we are expanding our high margin wafer to module capacity through the construction of our 1-gigawatt Wuxi facility. This is on schedule to be completed by the end of 2007 and we are already installing several new PV cell lines.

Secondly, we are building our capacity to manufacture modules from third-party cells. Last quarter, we transferred some of MSK’s module production facilities to China and we are very pleased with the result in terms of quality and profitability. We believe this is an excellent way to build market share and increase the bottom line.

Turning to our silicon position, I am pleased to report that delivery from our long-term silicon supply returned to schedule during the second quarter. This, combined with ASPs that were in line with our expectations plus availability of high performance sales from the implementation of our semiconductor signal technology on our first two production lines, led to improvement in our margins for the quarter.

In addition, we continue to do a good job of locking down our future silicon needs through our contract with Hoku Materials. A long-term, fixed price contract such as this gives us greater visibility to fulfill our capacity expansion target and allows us to maintain relatively high margins.

Through the rest of 2007, we will continue to look for reliable long-term partners to diversify our supplier base and build our silicon pipeline.

We made solid progress in the second quarter. We are determined to work even harder to achieve our sales development, silicon sourcing, and capacity expansion targets. Of course, another area that is essential to our ongoing success is technology and Dr. Stuart Wenham, our Chief Technology Officer, will now give you a brief overview of our developments on that front. Thank you. Stuart.

Stuart R. Wenham

Thank you, Dr. Shi. In our Q1 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. Even though this technology only currently makes up 10% of our total production, Dr. Shi referred to the positive impact this is nevertheless having on our gross margins.

Despite the success of this technology in terms of its performance and economic advantage over the conventional screen printed solar cells, we are pleased to announce that our new Pluto technology both outperforms the semiconductor finger technology while simultaneously being lower cost to manufacture.

During Q2, we have done extensive analysis of the two technologies in production and simultaneously compared them both with a conventional screen-printed solar cells that dominate worldwide manufacturing. While the semiconductor finger technology outperformed the conventional cells by 5% to 10% in relative terms, the Pluto technology achieved significantly higher efficiencies, outperforming the conventional screen-printed solar cells by 10% to 13%.

Perhaps just as importantly, the economic analysis revealed that the Pluto technology is also the lowest cost of the three technologies to manufacture. The reason the Pluto solar cells are so cheap to produce is because they avoid the use of semiconductor grade silicon wafers and other expensive materials and processes used by other technologies. As a consequence, Suntech has made the decision to implement the Pluto technology into large-scale manufacturing as soon as possible and cease retrofitting existing lines with the semiconductor finger technology.

The new facilities have been designed and corresponding equipment ordered. Large-scale production of the Pluto technology is now expected on the first line within 12 months, with the existing lines to be subsequently retrofitted during the following 12 months.

The first line is expected to operate at 18% to 19% efficiency, consistent with our current pilot production, but increasing to above 20% efficiency over the following 12 to 18 months, in line with our current laboratory devices.

The high performance of the Pluto technology is achieved by capturing many of the high efficiency attributes of the world record holding Pearl technology from the University of New South Wales in Australia. 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.

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

Amy Yi Zhang

Thank you, Stuart and hello to everyone on the call. Today I will provide some color on certain results from the second quarter 2007 and provide guidance for the third quarter 2007. I will discuss some tax performance, focusing principally on non-GAAP numbers that we believe give a clearer picture of the operating dynamics of the company.

Specifically, these measures exclude $7.1 million share-based compensation expenses; $0.1 million of MSK restructuring costs; and $0.4 million net income impact related to amortization expenses of the MSK acquisition. You will find a reconciliation of these measures in the financial tables at the end of our press release.

Net revenue for the second quarter was $317.4 million. That is about 147.7% higher than the year-ago period. Our wafer to module business accounted for approximately 86.5% of the total revenue.

As a result of an acceleration of our production capacity expansion and a strong sales effort, we shipped over 80 megawatts of solar products in the second quarter. Both our ASPs and wafer purchase costs stayed within our expectations and this enabled us to achieve a non-GAAP gross margin of 21.1% compared to 19.9% in the first quarter of 2007.

The sequential margin improvement primarily reflects the greater proportion of silicon from long-term fixed price contracts during the second quarter. The non-GAAP gross margin for our wafer to module business was 23.9% in the second quarter.

The share-based compensation expenses were $7.1 million, slightly higher than the first quarter. Of this amount, $2.6 million was recognized as costs of revenues; $0.4 million as selling expenses; $1.7 million as R&D; and $2.4 million as G&A expenses.

Non-GAAP operating expenses as a percentage of revenues increased from 6.2% in the first quarter of 2007 to 6.7% in the second quarter of 2007. The sequential increase was mainly due to a foreign exchange loss related to the appreciation of the RMB and an increase in provisions [inaudible]. The foreign exchange losses were offset by our foreign exchange gains from our hedging activities, which were recognized as a part of other income.

Non-GAAP operating margin was 14.4% compared to 13.7% in the first quarter of 2007. The operating margin rose sequentially, mainly due to the gross margin improvement, which was partially offset by the increase in operating expenses as a percentage of revenues.

Non-GAAP net income attributable to holders of ordinary shares was $48.9 million for the second quarter, or $0.29 per diluted ADS.

Capital expenditures, which were primarily related to the production capacity expansion and the construction of Wuxi and Luoyang production facilities, were $51.7 million in the second quarter, and depreciation and amortization expenses were $4.2 million.

Moving now to our balance sheet as of June 30, 2007, we had cash and cash equivalents of $520 million, down from $569.3 million at the end of March 2007. The sequential decrease was mainly due to an absolute increase in accounts receivable and purchases of equipment and property. We are introducing some new financial instruments to control up-front payments on CapEx by using financial or operating leases, which will not only improve the operating cash but also increase the return on total assets for the company.

During the second quarter, we continued to improve our inventory management. Our inventory balance rose only 4% from the balance at the end of March 2007, even though our total revenue increased by 28.7% sequentially.

Accounts receivable rose to $225.8 million from $163.8 million as at the end of March 2007, as we shipped a significant amount of modules in June 2007 and payments were settled one month later.

Property, plant and equipment balance increased by $42.3 million to $185.3 million as of June 30, 2007. The increase mainly reflected the capacity expansion at our Wuxi and Luoyang plants.

Turning to our guidance for the third quarter 2007, we expect total production output to be in the range of 94 megawatts to 96 megawatts.

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

Dr. Zhengrong Shi

Thank you, Amy. Once again, 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 will come from the line of Rob Stone with Cowen and Company. Please proceed.

Robert Stone - Cowen and Company

Dr. Shi, could you comment more specifically on ASPs you saw in the quarter and where you see the trend for the balance of the year?

Dr. Zhengrong Shi

ASPs were within our guidance we gave in the last quarter.

Robert Stone - Cowen and Company

Could you just remind us what that was on a price per watt?

Dr. Zhengrong Shi

Yes, in last quarter it was $3.78.

Robert Stone - Cowen and Company

Okay. With respect to the targeted output for Q3 of 94 to 96 megawatts, can you say roughly how much of that is going to be wafer to module versus third party cell business?

Dr. Zhengrong Shi

I think around 15% will be from cell to module.

Robert Stone - Cowen and Company

Fifteen percent of the megawatts will be cell to module?

Dr. Zhengrong Shi

Yes.

Robert Stone - Cowen and Company

Thank you.

Operator

Your next question comes from the line of Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Sanjay Shrestha - Lazard Capital Markets

Thank you. Good evening. On your Q2 shipment guidance number here, how much of that shipment will be supported by the long-term contract for silicon and wafer versus the spot purchase?

Dr. Zhengrong Shi

Steve, can you answer the question?

Steven Chan

It is about -- we are actually gravitating from Q1 where it was less than 30% for the long and medium term contracts and now we are up to about 50-50 between the long and medium term on the one had, and then the spot type contracts on the other hand. So we continue to make progress on that throughout the year.

Sanjay Shrestha - Lazard Capital Markets

Okay, great, and then a follow-up question on that -- I think there is a lot of different views as to the available silicon capacity coming out of China and given that you guys are closer to it than most other folks and you are one of the biggest ones there, what can you guys talk about in terms of what are you seeing from the actual success of some of these new players? Two, what kind of pricing are these people talking about? And three, how do you really see that playing out for you guys?

I have to imagine that as more capacity comes online, you probably have the first look at it and first opportunity to say whether you want to be a part of that or not. Can you talk about that a little bit and how does that then start to relate to your overall margin performance for the rest of the year?

Steven Chan

I think, Sanjay, as you know we are on this growth trend to becoming the largest essentially consumer of silicon in the solar space. So being based in China gives us a natural advantage to work with the Chinese silicon producers, and that’s not to exclude the international ones that we also work with as well.

But certainly within China, if you had asked us three months ago, we would have said that by 2010, we would see 5,000 annual metric tons of silicon coming out of China. That’s a conservative estimate and we are bumping that up now because we’re seeing a lot of progress in the past three months and more credibility with projects, and we are certainly involved with many of them in terms of getting procurement and even working on things that are a big more strategic than that. So we do feel like we are ahead of the curve in terms of procurement in China.

Operator

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

Sunil Gupta - Morgan Stanley

Thank you. Dr. Shi, I have a question on your technology and research, and maybe Stuart can take this. On the Pluto technology that you are talking about, when exactly do you expect this production to start? Will it be Q2 of 2008?

Also, you mentioned that on the first line you will get more than 18% conversion efficiency. Is this for mono or is this for multi wafers?

Stuart R. Wenham

With the first question, our best estimate at this stage for the new Pluto technology will be to have it into large-scale production by the middle of next year. It probably won’t be in time to see much impact on our Q2 figures but to the second half of the year, we will have the technology, large-scale production and be progressively then retrofitting our other lines to greater increase the percentage of production of that technology.

What was the other question, please, Sunil?

Sunil Gupta - Morgan Stanley

Yes, 18% plus conversion efficiency -- is this for mono or is this for multi on the first line?

Stuart R. Wenham

Our pilot production that we’ve been doing our analysis on has all been based on mono wafers, simply due to their consistency. You get more variability in the multi. The technology looks good on multi. We’re expecting in large-scale production to have the multi in the early stages in the 16% to 17% range and our expectation is to move the efficiencies on the multi up on average closer to the 17% over a period of time.

With the mono, we are expecting the 18% to 19% that I mentioned. These are mono-crystalline wafers in production and we are expecting that to move up to over 20% efficiency after about a year’s production with the technology.

Sunil Gupta - Morgan Stanley

Okay, great. Thank you.

Operator

Your next question comes from the line of Paul Clegg with Jefferies. Please proceed.

Paul Clegg - Jefferies & Company

Good evening. Could you quantify how much of the gross margin improvement during the quarter came from the implementation of semiconductor finger technology?

Stuart R. Wenham

Because the semiconductor finger technology made up such a small percentage of our production, it was less than 10% of our production, it only had a relatively minor impact. We wanted to mention it though because it is having a positive affect on our margins. Our expectation with the new technologies is that the semiconductor finger technology, for the pilot production that it did make, our expectation is that that technology gives us about a 4% improvement in margins. The Pluto technology we are expecting around about a 10% improvement in margins, relative to the conventional screen printed solar cell technology, so the challenge for us then is to put the Pluto technology into production on all our production lines so that all of our production gets the benefit of those increased margins.

Paul Clegg - Jefferies & Company

So you are talking about 400 basis points of improvement in margins?

Stuart R. Wenham

When I say 4%, that’s 4% in absolute terms.

Paul Clegg - Jefferies & Company

Okay, great, and if I may, just one follow-up along the same lines. It may be a little bit early to answer this but what do you -- when you look at BIPV, obviously you are bringing that on next year, what kind of margins would you expect to see on that when you are putting out amorphous silicon on glass?

Dr. Zhengrong Shi

Amorphous silicon on glass and production manufacturing costs will be certainly lower than that for crystalline silicon, and the ASP is also lower than crystalline silicon. Overall, the margin should be better than the GP margin for crystalline silicon at this moment.

Paul Clegg - Jefferies & Company

Better than the crystalline silicon at this moment?

Dr. Zhengrong Shi

Yes.

Paul Clegg - Jefferies & Company

Okay, thank you.

Operator

Your next question comes from the line of Jeff Osborne with Thomas Weisel. Please proceed.

Jeff Osborne - Thomas Weisel Partners

Good morning. I was just wondering -- it seems like you are a little bit more reluctant to give out specific information, just the wording in the release talks about over 80 megawatts. Could you just specify both what your megawatts shipped were? But also in regard to the guidance, I think last quarter you gave an estimated wafer cost of $5 to $5.10. Where did that come in and where do you think it will be in the third quarter?

Steven Chan

We’ve actually gone to reporting really on the revenue side and then the megawatts in a range for really competitive reasons. But it is fair to say that we are definitely ahead of what we projected on the megawatts, and then in terms of the ASPs, as well as the average purchase price of silicon, we are definitely within the range of what we guided to in the prior quarters. We are definitely either ahead of or on plan.

Jeff Osborne - Thomas Weisel Partners

Okay, since I can’t get a specific answer there, could you just talk about the range of the mix? You talked about 50% being long-term and mid-term contracts. How should we view that in the back half of the year and the related impact on margins?

Steven Chan

If you look at our guidance for the year of 325 megawatts of actual capacity, and then what is on the core wafer to module business as being 300, on that it will be about 60% long-term and medium term type silicon and about 40% on the spot type silicon. But to the extent that we outperform on that, then the mix will shift a bit.

Jeff Osborne - Thomas Weisel Partners

Okay, so it’s reasonable to assume a gradual ramp in gross margins in the back half, or kind of keep it flattish here?

Steven Chan

I would keep it flattish because there are also other trends with spot pricing and also ASPs, so I think it is fair to keep it flattish.

Operator

Your next question comes from the line of Angello Chan with Credit Suisse. Please proceed.

Angello Chan - Credit Suisse

Thank you. Good evening. I was actually going to ask a question about ASP too, but I just heard the answer to the other question. Can you tell us a little bit more about the volumes that was picked on between MSK modules, which is small, and Suntech in the second quarter? And how much inventory of MSK modules is left?

Amy Yi Zhang

As what we disclosed when we were doing the Q1 earnings release, the slow-moving stock balance left with MSK was around 7 megawatts. We have sold 5 megawatts out of the 7, so there are 2 megawatts left that we expect to clear out in Q3.

Angello Chan - Credit Suisse

Amy, can you tell me, how much out of the 5 megawatts did you say actually sold in the second quarter?

Amy Yi Zhang

Sorry, Angello, I didn’t hear you very clearly. Can you repeat, please?

Angello Chan - Credit Suisse

How much of that 5 megawatts did you sell in the second quarter versus the first quarter?

Amy Yi Zhang

First quarter was the -- the cell to module business sold for MSK in the first quarter was 7 megawatts.

Angello Chan - Credit Suisse

So you sold 7 megawatts in the first quarter?

Amy Yi Zhang

Yes.

Dr. Zhengrong Shi

And 5 megawatts in the second quarter.

Amy Yi Zhang

And 5 megawatts in the second quarter and there are 2 megawatts left that we expect to clear out in Q3.

Angello Chan - Credit Suisse

Okay, wonderful. And on wafer costs, could you tell us how much you spent on wafer costs in the second quarter, just total?

Amy Yi Zhang

You mean the total wafer costs, silicon and wafer costs versus the total cost of production?

Angello Chan - Credit Suisse

Yes, just a cost number for wafers in the second quarter.

Amy Yi Zhang

It’s 75% of the total cost of production.

Angello Chan - Credit Suisse

Total cost of goods sold?

Amy Yi Zhang

Yes.

Angello Chan - Credit Suisse

Thank you.

Operator

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

Tien Yu Sieh - Merrill Lynch

I was just wondering if you could elaborate a little bit in terms of the demand outlook into 2008. You mentioned that you had orders for 150 megawatts. How far does that extend to? Is it just still the rolling 12-month outlook, i.e. that 150 is really to be delivered in the first half of 2008, or are you seeing visibility now well into the second half of 2008? And also, if there is any sort of geographic shift that you might want to highlight or that we should be aware of in terms of the mix of sales for 2008.

Dr. Zhengrong Shi

Certainly demand is very strong. We believe the demand in 2008 is still stronger than supply, especially for a product that historically, you know, track records, we have been growing faster than the market average and our competitors. So this 150 megawatts actually has been booked with some of our customers, and all our customers have increased their demand from, say by a range of 30% to 50%, some even higher.

Our strategy actually at this moment that we do have for our long-term customers, we do have multiple year contracts in terms of volume. Each year, we will review the situation more closely to fix the volumes and also the price. So usually we will start fixing the next year’s delivered volume and price starting in Q4. This year, the situation has improved dramatically and we actually, our customers come to us to try to fix the volume and price now. So all the indications indicate the market will remain very strong in 2008.

Tien Yu Sieh - Merrill Lynch

Thanks. In terms of pricing, if I may, you previously indicated that some of the pricing that you had been hearing from your customers was going to be very firm with regards to 2007 into 2008. Is that still the case or are we actually seeing --

Dr. Zhengrong Shi

Yes, I think the price varies in the different geographic locations and the different type of customer projects. It varies and for some customers, the price is fairly firm and for some, it is like -- there is some reasonable decrease, as we expected. So yes, I think overall that is the situation.

Operator

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

Michael Carboy - Signal Hill Group

Good evening, ladies and gentlemen. A couple of things; first off, Amy, in the past you’ve commented on some incentive financing that’s been used to facilitate sales. I am curious as to whether there was any used here in the close of the second quarter. You had noted a high degree of non-linearity in the quarter.

Amy Yi Zhang

We are still talking to different banking partners to assess different solutions. In the end, our whole idea is to control the costs, which will allow us to utilize these financial instruments in a more [profitable] way.

Michael Carboy - Signal Hill Group

Okay, well, I’ll take that offline later.

Operator

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

Jesse Pichel - Piper Jaffray

Yes, I have two questions, please. Congratulations on your contracts for 2008. Should we assume that those are for Spain? And could you talk about the ASP degradation you are seeing under those contracts?

Dr. Zhengrong Shi

I already mentioned this 150 is not just from one country, it is from multiple customers. And the ASPs, they are not all the same because due to geographic location and different types of customers, so --

Jesse Pichel - Piper Jaffray

Well, we’re trying to assess on an apples-to-apples basis what type of ASP degradation we should expect for ’08, so is there any --

Dr. Zhengrong Shi

Not too bad. Still quite firm.

Jesse Pichel - Piper Jaffray

My second question is now that your largest long-term supplier, MEMC, has announced an expansion, should we expect that you will seek to expand your relationship?

Dr. Zhengrong Shi

I think at the current stage, we are going to execute our contract quite consistently, so we haven’t discussed anything beyond that.

Jesse Pichel - Piper Jaffray

Thank you very much.

Operator

Your next question will come from the line of Paul Leming with Soleil Securities. Please proceed.

Paul Leming - Soleil Securities

Good evening. One point of clarification -- can you tell us what your internal production of solar cells was in the quarter? And then, could you talk about to what degree you are currently using metallurgical grade silicon in your raw material mix? Are you using it at all? Is it as much as 5% or 10% of the silicon you are consuming? Thank you.

Dr. Zhengrong Shi

I will take the second question and maybe Amy will have the first question. At this moment, we do not use any metallurgical silicon for production but on the other hand, we are a silicon manufacturer. We purchase a lot of wafers. So maybe some of our wafer manufacturers, they will try to use metallurgical silicon but overall, I believe the chance is very small because there isn’t that much metallurgical silicon available in the market.

Amy Yi Zhang

Can you please repeat your first question again?

Paul Leming - Soleil Securities

What was Suntech's internal production of solar cells in the quarter?

Amy Yi Zhang

In Q2?

Paul Leming - Soleil Securities

In Q2.

Amy Yi Zhang

You are talking about the capacity?

Paul Leming - Soleil Securities

No, your actual production of cells -- I’m just trying to understand what you produced in the way of cells versus how much you purchased.

Amy Yi Zhang

You mean in-house produced cells versus third-party cells, right?

Paul Leming - Soleil Securities

Yes.

Amy Yi Zhang

It is around 87% produced in-house and 12%, including MSK, is actually produced from third party cells to modules.

Paul Leming - Soleil Securities

Thank you.

Operator

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

Julie Chen - Brean Murray Carret

I’m just doing some housekeeping. I’d just like to know in terms of geographic allocation, the revenue, how should I view it, particularly for Asia as well?

Dr. Zhengrong Shi

Our delivery to German customers is about 54%. That does not mean all sales will be in Germany. I think some of our customers actually resell our product to other parts of the world. And 34% is delivered to Spain and to the U.S., around 7%.

Julie Chen - Brean Murray Carret

And there is nothing in Asia or China at this time?

Dr. Zhengrong Shi

It is probably about 6% to the rest of the world.

Julie Chen - Brean Murray Carret

Thank you. In terms of installed production, total installed production capability, what is total installed production capacity right now?

Dr. Zhengrong Shi

Three-hundred-and-sixty megawatts.

Julie Chen - Brean Murray Carret

Thank you very much.

Operator

Your next question will come from the line of Rob Stone with Cowen and Company. Please proceed.

Robert Stone - Cowen and Company

I’m trying to parse Steven’s comment about flat margins for the second half of the year. If pricing is relatively stable and the mix of long-term versus spot silicon is steadily improving, what is declining that would cause the gross margins to be flat? I guess you are not going to install anymore higher conversion efficiency semiconductor finger lines, but if prices are stable and wafer costs are going down, what keeps the margins flat in the second half?

Steven Chan

We wanted to be cautious with our gross margin guidance, and so the one thing that we are just being cautious about is the potential increase in the spot market pricing of some of the silicon purchases -- not all, but some, and so we wanted to be cautious with the guidance on the gross margin.

Robert Stone - Cowen and Company

Is it also the potential that you would increase the overall output of third party cell to module business? That would certainly dilute the blended margin.

Steven Chan

I think when we are giving guidance on the gross margins, we like to give it on the core business because as Amy has said, that is like 87% of the business this past quarter. So that gross margin was 23.9%, and the incremental business is really an opportunistic business that, although the gross margin is a bit lower but it almost -- there is no real incremental operating expenses associated with that. So that business will probably, to the extent that we are optimistic, the run-rate on that might be a little bit higher than it has been in the historical quarters.

Robert Stone - Cowen and Company

Okay, and a question for Amy, please. Could you comment on your planned capital expenditures for the rest of this year?

Amy Yi Zhang

We are having a CapEx plan with the range of $120 million to $130 million to the end of this year.

Robert Stone - Cowen and Company

Any comments on CapEx for next year?

Amy Yi Zhang

Sorry?

Dr. Zhengrong Shi

CapEx for next year.

Amy Yi Zhang

For next year? I haven’t got that figure in front of me yet. I think probably we’ll be able to give you a more clearer picture when we get to the end of Q3.

Operator

Your next question will come from the line of Sunil Gupta with Morgan Stanley. Please proceed.

Sunil Gupta - Morgan Stanley

Thanks. I wanted to follow back on this issue about spot wafer sourcing and gross margins. Steve, as you expect the spot wafer sourcing to decline in Q3, what kind of decline would it be? If you had 50% in Q2, could we go down to less than 40% in Q3?

Dr. Zhengrong Shi

You mean from the cell to module business?

Sunil Gupta - Morgan Stanley

No, the sourcing of your raw wafers from the spot market.

Dr. Zhengrong Shi

Spot market wafers. Actually, what we observed, the spot silicon wafer price has gone up a little bit from the end of June up to now, so that is because the market demand is rising during this period of time. We expect because Q3 probably is the peak season in the year, so we expect the spot market price has risen about 5% since the beginning of the year and probably will maintain at this level for the rest of the year.

Sunil Gupta - Morgan Stanley

And in terms of your percentage sourcing from the spot like contracts, in Q2 you mentioned it was about half and half, half from long-term contracts, half from spot. So in Q3 when you expect it to decline, could it decline to less than 40%?

Dr. Zhengrong Shi

Yes, Steven mentioned it was about 40%.

Sunil Gupta - Morgan Stanley

And what was your average wafer cost officially in Q2 on a 5-inch coated wafer?

Amy Yi Zhang

The guidance we gave for that for Q2 was in the range of $5 to $5.10, and it is actually within that range.

Sunil Gupta - Morgan Stanley

And what do you expect this to be on a blended basis in Q3 if your spot mix reduces to 40%?

Dr. Zhengrong Shi

I think it will still be within that $5 to $5.10 range.

Operator

Your next question comes from the line of Steve O’Rourke with Deutsche Bank. Please proceed.

Steve O’Rourke - Deutsche Bank

Thank you. Good evening. Aside from your MSK business, what is your view and your strategy on owning the integrator installer portion of the food chain for some or all of your installation types, that is small versus larger? And is it in your longer term strategy to be able to sell electricity under PPAs in certain markets?

Dr. Zhengrong Shi

That is a very good question. We are in the process of evaluating this business model. We haven’t decided whether or not to pursue.

Steve O’Rourke - Deutsche Bank

Okay, and if I could ask one follow-up, how much work do you do with the integrator installers now to reduce the BOS costs? Is it a big focus for you, or will it become one?

Dr. Zhengrong Shi

Certainly we have done a lot of system installation projects in China, and to control various costs certainly is our goal in the future.

Steve O’Rourke - Deutsche Bank

Thank you.

Operator

Your next question comes from the line of Cheryl Tang, Goldman Sachs. Please proceed.

Cheryl Tang - Goldman Sachs

I have a question on MSK. When should we expect MSK to break even?

Amy Yi Zhang

Hello, Cheryl. I can’t hear you. You sound really far away.

Cheryl Tang - Goldman Sachs

Okay. My question is on MSK, as it is reduced in Q2 and when should we expect a turnaround or break-even at the operating level?

Amy Yi Zhang

Actually, MSK, as what we announced in early February, MSK has now been transformed to an entity on the Suntech group with the major function of BIPV application design and pilot production of BIPV products. So according to its nature of the business, it is being positioned as a cost center instead of a profit center.

But we are now in the process of assessing the probability of definitely from the rising demand from the BIPV end user market, we are assessing the probability of building a decent scale of BIPV production in one of the MSK plants in Japan. It actually depends on the progress of the demand side and also our plan to be executed, but currently I actually cannot talk more about the detailed timing of making break-even at the operating margin level.

Cheryl Tang - Goldman Sachs

Okay. My second question is for the geography split. For Q2, the U.S. market was 7% of the revenue. How about in Q3?

Dr. Zhengrong Shi

In Q3, I think it will be less because our absolute volume has been increased. I think Q3 it is probably around 5% to 6%.

Cheryl Tang - Goldman Sachs

So the incremental increase is coming from the European market?

Dr. Zhengrong Shi

Sorry?

Cheryl Tang - Goldman Sachs

So for the other market, Germany, how is the split in Q3?

Dr. Zhengrong Shi

Q3 probably will remain the same, about 50% to Germany, about 35% to 40% to Spain. Keep in mind, although we -- when you see this geographic split, the quarterly delivery may vary by percentage but absolute volume is always increased because our total production volume is increased. That is why it changes the percentage.

Cheryl Tang - Goldman Sachs

My last question is about -- [on your eight contracts] of 150 megawatts, is the pricing fixed or will it be negotiated later on?

Dr. Zhengrong Shi

You mean the 150 micron megawatts?

Cheryl Tang - Goldman Sachs

Yes.

Dr. Zhengrong Shi

The 150 megawatts, I think some is volume fixed and price fixed, some still in the final stage of determining the price.

Cheryl Tang - Goldman Sachs

Thank you.

Operator

Your next question will come from the line of Pavel Molchanov, Raymond James. Please proceed.

Pavel Molchanov - Raymond James

As the largest photovoltaic company in China, can you comment on the overall state of the domestic PV market? I recognize it is a small part of your business overall but just in general terms.

Dr. Zhengrong Shi

You want to know about the Chinese market?

Pavel Molchanov - Raymond James

Yes.

Dr. Zhengrong Shi

I think the Chinese market overall still is very small and having said that, we do feel actually the market actually grows about 15% to 20% per year. But if you look at volumes actually, heavier increase. I think overall absolute growth, absolute delivery of megawatts is actually increased.

This is due to several factors. Firstly, communications and transport type of applications like solar lighting has become increasingly popular in China. All the telecommunications companies, there are several projects about multi-megawatts telecommunications projects.

And in connected business, still we haven’t had any detailed incentive program from the Central Government yet, although we believe within the next two or three years, the government will decide to put up at least 150 megawatts, this green connected project, as a trial run to try to figure out what sort of incentive, [fitting tariff] the government needs to provide.

I think this 150 megawatts project progress starts to install in the beginning of 2008.

Pavel Molchanov - Raymond James

Got it. Thanks very much.

Operator

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

Tien Yu Sieh - Merrill Lynch

I just wanted to gauge your comments on the state of the market right now. Last year, we saw very strong demand in 2Q and into 3Q, and then things sort of backed up with inventory accumulation. We are kind of seeing pricing firming now. Are you at all concerned that there may be double booking or any kind of inventory build amongst your customers that might lead to any kind of instability in the market later, say in the fourth quarter of this year?

Dr. Zhengrong Shi

I think the PV industry is quite a young industry and we actually -- everybody is learning about the market and how the market develops. For example, the build-up of inventory in Q4 last year was a reflection of the immaturity of the market. I think going through this year, because the ASP has fallen about 5% to 10% this year, the market is getting stronger. I think now the industry believes the market is getting stronger is really true strength of the market. It is not a temporary type of situation.

I think it is unlikely there will be inventory build-up in December this year. Even if there is build-up, I think it is probably unlike last year. I think they will have customers to order because as I just mentioned, now a lot of customers came to us almost one quarter earlier to try to secure the supply for the next year because they are afraid of not getting enough product for next year.

Tien Yu Sieh - Merrill Lynch

Thank you very much.

Operator

Your next question comes from the line of Satya Kumar with Credit Suisse. Please proceed.

Satya Kumar - Credit Suisse

I think I might have missed this -- did you give us an outlook for your module ASPs in Q3?

Dr. Zhengrong Shi

Sorry?

Satya Kumar - Credit Suisse

Did you give us an outlook for module ASPs in Q3? Should we expect them to be flat?

Dr. Zhengrong Shi

Module ASPs for Q3 -- yes, I think it’s fairly flat.

Satya Kumar - Credit Suisse

Can you give us a sense of what your production capacity would be at the end of this year and as you end next year? And how much silicon do you have, wafers do you have available on contract for ’08?

Dr. Zhengrong Shi

Steven can take this question.

Steven Chan

We’ve given guidance of about 480 megawatts will be the capacity at the end of this year, and then we would look to hit 1,000 by 2010, so roughly speaking you can assume that’s growing by a little bit less than 200 megawatts per year.

And then in terms of your other question was about long-term type contracts for silicon for 2008, and that would be -- what we have a trend between now and 2010 is also to increase our silicon purchases from about 50% from long and medium term contracts to about 80% by 2010, and so between now and 2010 we will look to steadily increase the percentage coming from fixed price long term and medium term contracts.

Satya Kumar - Credit Suisse

Okay, that’s useful and last question for me; can you give us an update on your thin film progress? Are you still on track to ramp -- I think you said 40 megawatts second half of next year and --

Dr. Zhengrong Shi

We are in the process to building the manufacturing building and the equipment should be ready to install in the first quarter next year and gradually try to start production in Q2 next year.

Operator

Your next question will come from the line of [Pranav Sarma] with Daiwa Securities. Please proceed.

Pranav Sarma - Daiwa Securities

Thank you for taking my questions. The first one is on have you changed your 2007 total output guidance, which was 325 megawatts previously? Any changes on that number?

Dr. Zhengrong Shi

No, at this moment we stick with that number.

Pranav Sarma - Daiwa Securities

In that case, in the fourth quarter you will have sequentially flat to down output.

Dr. Zhengrong Shi

I think because in December it is usually the Christmas holiday, there is a seasonal adjustment which we have considered.

Steven Chan

We will look to update guidance at the next quarterly earnings results because we are always looking to do better in terms of expansion of the business. So we will update the guidance at that point.

Pranav Sarma - Daiwa Securities

Thank you. The second one is on the thin film side, some of your competitors have already talked about very large size thin film operations and you are starting with only a smaller size thin film operation. Do you have any plan to go for a very large size thin film operation in the next one or two years, or have you started any R&D on that type of technology?

Dr. Zhengrong Shi

We have been doing the R&D for quite a while. We have an R&D type of system, not to mention the production type set-up. Our manufacturing building is actually designed and built for multiple lines, so the first line production and the ramp up is successful, I think we should be in a position to add more capacity very quickly in the future.

Pranav Sarma - Daiwa Securities

Amy, could you give us any guidance when you are going to take impairment charges from MSK and which quarter you will book that part?

Amy Yi Zhang

We are actually getting close to the stage of the relative, the treatment of the Fugawa plant, one of the manufacturing plants of MSK in Japan. For the one that we want to keep, and also we have one in Tokyo, according to the new valuation done by the professional firm, it’s still maintained its original value and we wouldn’t expect any impairment costs incurred until we finally fix the price of selling the Fugawa plant with the potential buyers.

Operator

We have time one final question from the line of Dan Reese with [Monett]. Please proceed.

Dan Reese - Monett

I was hoping that you could elaborate on an earlier comment. I think you said that three months ago you were thinking that the Chinese polysilicon producers could do -- and I thought you said five metric tons in 2010 but that you’ve changed your view. Can you elaborate on what your view is now and how many you think will be producing more than one metric ton in 2010?

Steven Chan

It was silicon, just to clarify, it was 5,000 annual metric tons worth of capacity in 2010. And that was probably among the top five or so polysilicon producers. There are over 20 that are looking to start up in China. We haven’t really quantified how much higher that would be but it is a sizable increase and we are looking to procure a sizable percentage of that.

Dan Reese - Monett

Thank you very much.

Operator

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

Dr. Zhengrong Shi

Again, thank you for joining us today. If you have any further questions, please do not hesitate to contact any of our investor relations representatives. Thank you. Have a nice day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Have a good day.

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