MEMC Electronic Materials Q3 2007 Earnings Call Transcript

MEMC Electronic Materials Inc. (WFR)

Q3 2007 Earnings Call

October 25, 2007 5:30 pm ET

Executives

Bill Michalek - Director of IR

Nabeel Gareeb - President and CEO

Ken Hannah - CFO

Analysts

Brett Hodess - Merrill Lynch

Jesse Pichel - Piper Jaffray

Steve O'Rourke - Deutsche Bank

Tim Luke - Lehman Brothers

Paul Leming - Soleil Securities

Stephen Chin - UBS

Jeff Osborne - Thomas Wiesel Partners

Chris Blansett - J.P. Morgan

Adam Hinckley - CIBC World Markets

Pierre Maccagno - Needham

Krishna Shankar - JMP Securities

Mehdi Hosseini - FBR

Timothy Arcuri - Citigroup

Arnold Kalegeropoulos - EN Advanced

Stuart Bush - RBC Capital Markets

Jerry Nimitz - Stifel Nicolas

Satya Kumar - Credit Suisse

Neal Jacobs - Bodri Capital

J.D. Abushar - GRT Capital

Steve Tabb - Tocqueville Asset Management

Presentation

Operator

Good afternoon and thank you all for holding. I would like to inform all parties that your lines have been placed on a listen-only until the question-and-answer session. (Operator Instructions) This conference is being recorded. If you have any objections, you may disconnect.

I would now like to turn the call over to Mr. Bill Michalek, Director of Investor Relations. Sir, you may begin.

Bill Michalek

Thank you. Good afternoon and thank you for joining our Third Quarter Earnings Call. Nabeel Gareeb, President and Chief Executive Officer and Ken Hannah, Chief Financial Officer, are with me today.

Before we begin, please note that this call will include forward-looking statements that involve risks and uncertainties that could cause the actual results to differ materially from management’s current expectations. These risks are described in the earnings release published today, in our 2006 Form 10-K.

I’ll now turn the call over to Ken Hannah, who will present an overview of the financial results.

Ken Hannah

Thanks, Bill. MEMC had a solid third quarter despite the impact associated with the previously disclosed construction incident. In the third quarter of 2007, sales came in $472.8 million which is basically flat with the second quarter and represents growth of almost 16% over the third quarter of 2006.

Gross margin in the quarter was $238.8 million or 50.5% of sales, down from 52% of sales in the second quarter, primarily as the result of the impact of the August power outage at our Pasadena, Texas facility. Compared to the same quarter last year, gross margin dollars grew by 24% or by 330 basis points as a percentage of sales.

Operating expenses increased slightly to 8.2% of sales from 8.1% of sales in the previous quarter, due to the higher R&D expense. Operating income was $200.1 million or 42.3% of sales compared to the second quarter's $207.3 million or 43.9% of sales. This represents an increase of 25% versus the same quarter a year ago.

Total stock-based compensation expense in the third quarter was $8.6 million or 1.8% of sales. Using our estimated effective cash tax rate of 15%, non-GAAP net income in the third quarter was $188.1 million, or $0.81 per share, which is flat with the previous quarter and up 45% versus the year ago quarter.

GAAP net income was $151.5 million or $0.65 per share, using a book tax rate for the quarter of 31.6%. Both GAAP and non-GAAP earnings per share figures include a $0.03 per share impact relating to stock compensation expense, and a $0.03 per share benefit relating to the valuation of the Suntech warrants.

The Company generated operating cash flow of $266.6 million or 56.4% of sales, compared to $197.6 million or 41.8% of sales in the second quarter. The sequential increase was driven by higher customer deposits and improvements in working capital.

Capital expenditures for the third quarter totaled $71.3 million or 15.1% of sales, and free cash flow, which is operating cash flow minus capital expenditures, was $195.3 million or 41.3% of sales.

MEMC's consistent strong free cash flow generation led to the implementation of a share repurchase program in June. The third quarter therefore, represented the first full quarter with the repurchase plan in place, and the Company repurchased $44 million worth of MEMC shares, more than offsetting dilution from stock option exercises.

Turning to the balance sheet, despite using $44 million in cash for our buyback program, cash in short-term investment balances increased by over $216 million to over $1.2 billion with almost no debt. Overall, the balance sheet is in excellent shape.

Turning to business conditions, inventory levels in the semiconductor space appear to have declined from the second quarter levels, resulting in improved demand dynamics from some semiconductor customers in the current quarter. In addition, the solar market continues to be strong.

For the fourth quarter, we are targeting revenues of between $540 million and $545 million. This range of revenue would represent growth of 14% to 15% over the third quarter, and a recovery of a portion of the last third quarter sales. We are also targeting gross margin to be up sequentially by approximately 250 basis points to 53% of sales, representing incremental gross margins of over 70%. Operating expenses should be approximately $39 million in the quarter.

Let me now turn the call over to Nabeel.

Nabeel Gareeb

Thank you, Ken. Although we would have liked to have avoided the excitement associated with the power outage in Pasadena in Q3, I am pleased that MEMC was able to report healthy sales margins and cash flows during the quarter with strong year-over-year comparisons. To give an update on Pasadena, as you know, a construction incident caused by electrical subcontractor resulted in a power outage to our Pasadena polysilicon manufacturing facility.

As we ramped the plant, there were complications that prevented us from recovering to our desired run rates in the plant manner and timetable. We were able to approximately meet the pre-announced revenue targets in part by drawing down inventory. However, the lower than anticipated poly production resulted in lower utilization at our wafer manufacturing sites, thereby impacting our gross margin to a greater than anticipated extent.

We have recovered from this discrete event to a steady state rate of production and are pleased to indicate that we are targeting to achieve the level of Q4 revenue targeted prior to the construction incident and be able to recover some of the lost revenue from Q3. In addition, we have made no change to our target of achieving 2007 year-end polysilicon capacity of over 6,000 metric tons per year.

While I am pleased to be able to report on our recovery in Pasadena and our strong targets for the current quarter, I am also increasingly excited about our prospects for continued growth over the next several years. Last quarter, we announced our plans for 300 millimeter and polysilicon capacity expansions through the end of the decade. Today we have announced that we have signed two additional solar wafer agreements worth between $8 billion and $9 billion over the next 10 years.

This represents a doubling of our previously announced total to between $15 billion and $18 billion in solar wafer agreements, which represents nearly half of our long-term revenue targets on an annualized basis. The larger of the two agreements announced today, is a $7 billion to $8 billion agreement with Conergy, the world's largest installer of the photovoltaic systems. Under the terms of the agreement, MEMC will supply solar wafers to Conergy over a 10 year period, with predetermined pricing on a take or pay basis beginning in the third quarter of 2008.

MEMC will also participate in 5% of the increase in the value of Conergy's solar cell and module subsidiary. The second agreement announced today is a $700 million to $800 million amendment to our agreement with Gintech Energy in Taiwan. The incremental volume and pricing to Gintech will begin in 2008 on a take or pay basis. This amendment brings the total for the Gintech agreement to between $3 billion to $4 billion.

With Suntech, Gintech and now Conergy our select group of industry partners in the solar space is very strong. They are diversified with headquarters and manufacturing in China, Taiwan and Germany, have distribution capabilities across the globe and are leaders in solar cell and module manufacturing and installation. When combined with MEMC's global network and long history in the wafer business, we are excited about our future growth.

In summary, I am pleased with our ability to deliver solid results despite the hiccups in Q3. We continue to generate strong operating profit and free cash flow and we continue to strengthen our balance sheet while investing and strategically positioning ourselves for the future. As the company expands its production capabilities to fuel the fast growing markets for 300 millimeter wafers for semiconductor applications and 156 millimeter wafers for solar applications, the company remains very well positioned and we look forward to capitalizing on our market position as we move through the second half of this decade.

With that we will now take your questions. Operator?

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions). Brett Hodess with Merrill Lynch your line is open.

Brett Hodess - Merrill Lynch

Good afternoon, Nabeel I am wondering on the two new contracts, if you can, I know you want to give the specifics, but if you could talk to a little bit about how these are setup relative to the previous contracts, are they similar in terms of pricing and in terms of you know, if you offer, higher efficiency through you wafer materials, do you get a differential pricing and or is their price declines built-in overtime, if you could talk a little bit about that for us?

Nabeel Gareeb

Sure Brett I'll talk about two sets of things. One is the little bit of the color on the (inaudible) season. The second is the structure. Let's start with the structure first. These are very similar in structure if you will in terms of fix tenure price reduction curves as well as based on dollars per watt, so if we provide efficiency improvements based on the inherent nature of the wafer we get to keep that benefit. So that type of the structure is very similar. In addition when you look at the three basic fundamentals of these agreements, the pricing, the terms and conditions and then obviously the end objective, these new agreements were negotiated in 2007 and obviously pricing has to be based on market conditions and market conditions for us were more favorable in 2007 versus 2006.

The terms and conditions are at least as good as what we had in the prior agreements and then obviously the objective is for all our partners to help enable them to be able to deliver products that enabled solar energy to be at grid purity without subsidies. If oil is at $40 a barrel as we have said, by the end of the agreement. So we believe all these agreements and amendments are achieving those goals in parallel.

Brett Hodess - Merrill Lynch

Great. And then a quick follow-on if I could. When you look at the jump back in the margin this quarter, gross margin, that has specifically did you guess with, A: That you don't have the inefficiencies hopefully of a breakdown like we had last quarter? But B: Is it just volume-driven or is there a mix component to that increase in margin again?

Nabeel Gareeb

Right. So, from a margin perspective, obviously, we are anticipating some sort of a price reduction in Q4 over Q3 in the low single-digits. And inspite of that, as you pointed out, we're guiding the margins up in a reasonable fashion, and some portion of it is tied to volume, but there is absolutely a mixed portion of it as well, because the growth is primarily going to come from 300 millimeter and 156 millimeter, both of which have margins above the average.

Brett Hodess - Merrill Lynch

Great, thank you.

Nabeel Gareeb

Thank you.

Operator

Jesse Pichel with Piper Jaffray. Your line is open.

Jesse Pichel - Piper Jaffray

Yes, thank you. Congrats on pulling up the quarter in guidance, and also on Conergy. On the Conergy, can you explain the 5% interest you have in their cell and module operations, and how that investment will be monetized on a quarterly basis? Is that based on the Conergy stock price or based on the health of that business in some type of tracking mechanism?

Nabeel Gareeb

Yeah. At this stage I wouldn’t feel comfortable going into all the details of wherever the alls of that particular part of it, Jesse. But fundamentally, you can think of it almost as a phantom stock or tracking stock type of vehicle, and it would be done by a third party.

Jesse Pichel - Piper Jaffray

And, could you just talk, how can investors and analyst get comfortable with the status of your polysilicon plant expansion? Can you give us any more color on, is everything ordered? What's the status of the site right now?

Nabeel Gareeb

Sure. I think, we had said obviously that in Q3 as a result of this incident, we expected the expansion to get delayed, and it certainly did because we are focused on trying to recover the basic output of the current facility. We are running obviously that facility at a steady state, now. And the expansion although delayed is in the final stages of checkout, if you will and acceptance, and we anticipate that it was slowly start ramping in the late part of November.

Jesse Pichel - Piper Jaffray

And if I could just fit in a short one, does the electrical contractor that made a mistake have insurance that would allow you to make some kind of claim on your Q3 variance versus your plan?

Nabeel Gareeb

Yeah. I wouldn’t feel comfortable commenting on that, as it maybe a litigious issue.

Jesse Pichel - Piper Jaffray

Thank you so much. Congrats.

Operator

Steve O'Rourke with Deutsche Bank. Your line is open.

Steve O'Rourke - Deutsche Bank

Thank you. Good afternoon. Nabeel, TSMC this morning said, they are going to take CapEx down significantly in 2008, and we have some real and potential CapEx customer memory manufacturers. It raises the specter that wafer start growth might be a little weaker in '08 than maybe expectations were. How do you look at this with respect to semiconductor wafer pricing, how it might impact contract negotiations this quarter and next, and what it might mean pricing overall?

Nabeel Gareeb

So, from a pricing standpoint, certainly, obviously, the growth in units -- actually, I guess, a couple of things. One, CapEx in '08 will have an impact on wafer start to some degree as you know Steve in '08, I think more in the '09 time-table, because the wafer starts that are occurring in the first half of '08, the CapEx, most of that was spent basically a year ago and through this year.

The second is the wafer pricing environment, we won't know for '08 until our contracts are negotiated at the end of December, if you will, for the first quarter, as well as some of them for an annual basis on '08. However, we know that obviously, 200 millimeter is soft; 300 millimeter is going to continue to be competitive, because there is additional capacity coming online. And if that capacity is more than the anticipated demand and there will be continued competition.

But more important than just the pricing itself, which we call mix normalized pricing is the change in mix, specifically for MEMC. As 300 millimeter continues to be an engine of growth for the semiconductor applications, and a 156 millimeter continues to be the engine of growth for the solar applications, both of which have higher than average margins, then that would help offset some of the price decline, as well as obviously the cost reduction.

So pricing, I don’t have a crisp answer for you, but we have, we believe we have some knobs, if you will, that should help offset some of that.

Steve O'Rourke - Deutsche Bank

Is there a way to quantify, or at least give an idea of quantification of how much mix can offset if you get a 5% decline in ASP, for examples, blended. Would that be offset by mix, the way you see mix evolving through 2008?

Ken Hannah

Yeah, I think it's hard for me quantify it in that fashion, because I think you've got the models to be able play around a little bit. If you just look at the incremental margins that we talked about this quarter in terms of volume, and the mix shift combined, that might give you an indicator, obviously you would have to take pricing reductions off of that.

Steve O'Rourke - Deutsche Bank

Okay. And one other question on separate subject: With respect to these new contracts, how much of your polysilicon capacity expansion is full spoken for?

Ken Hannah

A good question, Steve. We still have capacity out of our expansion to be able to do one other deal, about the size of the original or the combined Gintech deal.

Steve O'Rourke - Deutsche Bank

And if I could ask one variation on that question: Over the next, say five years, how much of that capacity is spoken for. Is there a number there?

Ken Hannah

Again, over the next five years, over the expansion period that we announced through the 2010 period, we have ability to add another deal, the size of the total deal of Conergy, the old one plus the new addition.

Steve O'Rourke - Deutsche Bank

I see. Okay, thank you.

Ken Hannah

No, so not Conergy, I'm sorry, I meant Gintech.

Steve O'Rourke - Deutsche Bank

Gintech. Okay, thank you.

Operator

Tim Luke with Lehman Brothers your line is open.

Tim Luke - Lehman Brothers

Congratulations on you deals and my question Nabeel, was if you could talk about how you perceived inventory levels in the semi arena to be trending and what's, your preliminary thoughts, with respect to seasonality as you begin 2008? Thank you.

Nabeel Gareeb

Inventory, Tim, I think has moderated downwards. Our production from wafer standpoint probably also helped that situation a little bit. And I think its resulting basically in the channel inventories becoming better to a larger -- to a greater extent, let's put it that way. That's resulting in better demand indicators here for us in Q4. The trick is going to be obviously Christmas sales and what happens post Christmas and into New Year and that's going to be something we are going to have to watch and wait, which leads into the second part of questions on seasonality.

Seasonality is probably going to be typical unless there is a massive build-up of inventory in the Christmas sales. For us it's typically -- we typically see that effect in December because that reflects orders that are being used for consumption in Q1. Again we also have continued ramps if you will on the 156 millimeter side that will help offset that seasonality effect not just in Q4, but also perhaps in Q1. And then the last point is again irrespective of the seasonality or inventory the engines of growth continued to have pretty strong demand on 300 and 156.

Tim Luke - Lehman Brothers

And then how should we think about that in terms of typical seasonality, last year, you actually saw sequential growth and to the beginning of '08?

Nabeel Gareeb

Yeah, so I -- I can't give you guidance for '08 at this stage, but again the 156 millimeter part of it should help offset some of that seasonality potential.

Tim Luke - Lehman Brothers

Thanks. If I may, just one last thing, with respect to the Gintech relationship and then [may wafer sale] on Conergy. You and Conergy talked about revenue beginning in this third quarter of '08 and Gintech, you just say '08 in terms of the extension. Could you clarify when one might see some lift from the Gintech extension if that's the only way to do for the second half of the year?

Ken Hannah

It would be a ramp up, similar to what the original contract was. It would be some sort of a ramp for the extension over the number of years and even within the years.

Tim Luke - Lehman Brothers

Thank you very much.

Ken Hannah

Thanks.

Operator

Paul Leming with Soleil Securities, your line is open.

Paul Leming - Soleil Securities

Good afternoon. I mean congratulations on the Conergy deal. I had two questions. One, could you just remind me of what the strike price on the SunTech warrant, was as part of that deal? And then on the Conergy deal, I think you've indicated in the past that the SunTech and Gintech deals the revenues in those contracts increased by a roughly equal amount each year over the 10-year life. Is the Conergy deal similar also on in that respect?

Nabeel Gareeb

Yeah, so -- I'll answer the second question first. I think yes, so the Conergy deal is similar in that respect that you can probably, if you want to model it out you can probably assume reasonably equal increments over a 10-year period starting over the first 12-month period somewhere in the triple digits and it moves from there. And obviously, in a way it's just for the half of the year. And then the strike price can probably --

Ken Hannah

Yeah, Paul it's based on the price of SunTech back in the July time period of a year ago which was around $27.

Paul Leming - Soleil Securities

Okay. Thank you very much.

Operator

One moment please. Our next question comes from Stephen Chin with UBS. Your line is open.

Stephen Chin - UBS

Great, thank you. So, yeah, congratulations on the signing of the new solar deals. A couple of questions on them, given the sheer size of this Conergy deal at $7 billion to $8 billion, does the Conergy deal replace any of MEMC's future semiconductor revenues or should we consider this Conergy deal to be all incremental to MEMC's longer term goal?

Nabeel Gareeb

Yes. This is certainly incremental to the semi business and part of the longer term targets that we had set for us. As you recall Steve, we were talking about the fact that we needed to have additional deals to continue to achieve our three to five year targets and obviously this falls into that pattern.

Stephen Chin - UBS

Okay, thanks. And then given the amount of solar wafers that MEMC will now have to make, can you share with us any update on your plans to bring solar wafer manufacturing in-house and will you consider terminating the manufacturing outsourcing arrangement that you have with LBK.

Nabeel Gareeb

I will answer the second part first Steven, we don't comment on who our suppliers are and we basically kind of tap dance around that, those sorts of questions. We do have multiple suppliers and we moderate our business with them or increase our business with them based on their performance and according to what contracts and contractual obligations they have, which may or may -- which include things like non-competes et cetera.

Over the long haul, we have said that, actually in the past we've said that we would be looking to bring some of our capacity of our manufacturing in-house over an 18 month to 24 month period and that would basically puts us somewhere on the '09 timetable. We are still looking at sites type of thing doing the site selection piece of that and we anticipate that once that comes in-house that does not eliminate the need for subcontract capacity. There is a healthy balance that can still continue, given the growth rates we require. So, I don’t see subcontracting going away completely, and as we grow, maybe a larger portion of the growth might be serviced from in-house.

Stephen Chin - UBS

Okay. And then one question on the guidance, with the sales guidance of $540 million to the $545 million, are you assuming that both MEMC semiconductor sales and solar sales will both be able to grow sequentially in the quarter. Was that assumption that what you are trying to convey, Nabeel?

Ken Hannah

Yeah, the assumption is that, the major engines of growth, if you will, from Q3 to Q4 will be 300 millimeter and 156 millimeter, yes.

Stephen Chin - UBS

Okay. And then if I can squeeze one last one in, can you talk about some of the short-term actions that MEMC can take to prevent the build up of any semiconductor wafer inventory. For example, how effective is temporarily shutting down facilities, and can you help us quantify how that decision could benefit, either with sales or gross margins?

Nabeel Gareeb

Well, if I temporarily shut down facilities, it doesn’t really -- that’s a lower utilization, so that has an impact more than anything else on gross margin. But obviously, the demand isn’t there, I am not just going to chase after the business to build inventory at customers, if you will, because it's going to hurt at one point or another. I would rather basically perhaps reroute that poly into a 156 millimeter wafers, and provide our partners more upside on that sort of thing.

Stephen Chin - UBS

Okay. Thank you and congratulations again.

Ken Hannah

Thanks again, Stephen.

Operator

Jeff Osborne with Thomas Wiesel Partners. Your line is open.

Jeff Osborne - Thomas Wiesel Partners

I had a follow-up question to Stephen's question there on the outsourcing of the wafers; does the fee materially change at all when you are moving from 5 to 6 inch sort of wafers? And what do you expect that outsource fee to do in 2008, in terms of a percentage decline?

Nabeel Gareeb

The fee, you mean the processing fee?

Jeff Osborne - Thomas Wiesel Partners

Exactly. I think you paid probably $0.30 to $0.40 a watt, outsource fee.

Nabeel Gareeb

The fee doesn’t -- well, I won't feel comfortable commenting on the specifics. The fee is competitive, we don’t really supply, we were supplying 156 millimeters, so we are not really supplying the 5 inch. And so, overtime really, the processing fee changes as a result of volume; it changes as a result of the thickness of the wafer because of how many wafers you have to cut, all those sorts of things. But those are more relevant than the size for us.

Jeff Osborne - Thomas Wiesel Partners

I understand. And then, in terms of the site exploration, have you decided to do anything with the land that you received as part of the Gintech contract?

Ken Hannah

Well, that’s certainly part of the consideration.

Jeff Osborne - Thomas Wiesel Partners

Very good. And then the last question I has is, would you consider in the future deal that you could sign of eliminating the requirement that a solar cell company could not make ingots and wafers, because I think that’s one of your current requirements which, and it goes against the strategy that many of the Asian solar cell producers are seeming to undertake?

Ken Hannah

Well, so far, it seems to have worked okay for us. So, I don’t see us going away from that any point soon, and to some degree, because that’s been our strategy, and we think it’s a good one. The other thing is now we have established a precedence with our partners, which we believe are pretty darn good partners, so we wouldn’t want to upset them either.

Jeff Osborne - Thomas Wiesel Partners

I understand. Congratulations on the deal.

Ken Hannah

Thank you.

Operator

Chris Blansett with J.P. Morgan. Your line is open.

Chris Blansett - J.P. Morgan

Hi guys, thanks. Two things here, somehow your inventories have gone down even further, and I wasn’t sure if you're kind of basically operation hand and mouth here to try to meet you contractual agreements?

Ken Hannah

Basically, like I said in the prepared remarks, Chris, that we drilled down inventory to basically, approximately meet the revenue figure, given the short fall in poly production. And obviously, that had an impact on our wafer manufacturing facility utilization, and so that affected our gross margins as well. Obviously, we are one hour back to steady state, so we don't anticipate doing that, and perhaps hopefully building a little bit.

Chris Blansett - J.P. Morgan

I guess, going forward over the next few quarters, are you planning on rebuilding some inventory or should we expect them at these low levels?

Nabeel Gareeb

Yeah, I mean, there is the opportunity certainly to rebuild some and, but not to the levels that we used to have because if I can flush inventory out of factories and keep them operating at a lean level, that's actually preferred to me.

Chris Blansett - J.P. Morgan

Alright, and then, kind of just to go back on the Conergy contract and modeling the revenue generation, you are basically assuming that these contracts will account on a revenue basis, be more of a linear trend over the duration or was it more of a multiplier effect on an annual basis?

Ken Hannah

I'm not sure I understand what you mean by multiplier effect?

Chris Blansett - J.P. Morgan

Whether or not, it just kind of grows 20% growth every year or --

Ken Hannah

I see. I think when we had announced the SunTech deal, and the same, and the Gintech deal last year, a same principal I would use. You start with the first 12-month period and at least remember Conergy starts in the third quarter. Take the first 12-month period, start it let's say in the triple digits, go out to the last year and for the 10 years and add it up to a total of $7 billion to $8 billion, and approximately equal increments and you get a reasonable idea.

Chris Blansett - J.P. Morgan

Alright. And then lastly, do you have a specific quarter when these additional Gintech shipments are going to occur or is it just right when the year starts?

Ken Hannah

Yeah, basically we've said that it's for 2008, and it's going to be some sort of a ramp similar to the ramp we have in the existing agreement.

Chris Blansett - J.P. Morgan

Alright. Thanks a lot guys.

Ken Hannah

Thank you.

Operator

Adam Hinckley with CIBC World Markets. Your line is open.

Adam Hinckley - CIBC World Markets

Hey guys, congratulations on the deals. Just a quick question on the pricing of the solar wafer contracts, is it fair to assume that say, if you look at the 3Q '08, the price that Conergy, SunTech and Gintech are paying on a per watt basis is exactly the same or is their differences based upon the size of the agreements?

Ken Hannah

Well, there is certainly, obviously would be some differences based on the size of the agreements and based on the market conditions under which they were negotiated.

Adam Hinckley - CIBC World Markets

So, are you seeing any reluctance in terms of signing up with some solar wafer customers given the fact that some Chinese poly guys are signing agreements with costs lower than yours?

Nabeel Gareeb

Well, yeah, I mean I think there is plenty of demand; we are number one to go around. Second, we are being what I would call, we are trying to pick the partners that we believe (a) want us; (b) we think that are going to win over the long haul and keep in mind our criteria works four folds.

Number one, we needed to have partners who understood the distribution channel perfectly and obviously Conergy being the largest installer of PV systems, a very, very good partner in that respect. The management team and we are very impressed with Conergy management team and the Gintech management team as well as SunTech and then obviously the cost structure and we used to talk about the fact that we felt companies in China and Taiwan et cetera would have a much better cost structures but we have been very impressed with Conergy's cost roadmaps.

And then last obviously is the financial wherewithal of the company to be able to sign up for a deal like this and then honor it over a period of time and we believe that these partners are representative of that.

The rest of the people who they are signing with et cetera, I don't want to comment on much more than there are new players in the market, they are announcing poly expansions and hopefully they will be successful and if they are not then hopefully we will be there to participate in that.

Adam Hinckley - CIBC World Markets

Is there any change in your thoughts on where industry capacity of poly will be say you are down the road, I mean previously you've been pretty embarrassed on the outlook of lot of these Chinese companies entering the market, has that changed at all over the past couple of months?

Nabeel Gareeb

I mean we try to provide charts in the public forums we attend where it shows that the capacity, not the output. The announced capacity will exceed -- is projected according to all industry sources, that was projected to exceed and announce the demand in some time in 2008. However, that capacity is nameplate capacity, that's not necessarily output. If somebody says they are going to have a 6,000 metric ton facility in 2008, it doesn't mean that they are going to produce 6,000 metric tons. It will probably take them a year or so to ramp to full capacity.

So, when you look at the output picture and paint some more bearish picture, but a lot of it will depend on the success of the new entrance ramping up in the short and aggressive time tables they've established. As well as the demand and what it does as larger players get into the picture. So, both of those are going to be interesting certainly for 2008, we see robust demand.

Adam Hinckley - CIBC World Markets

Okay. And one last quick question, as you said in your prepared remarks that $15 billion to $18 billion of solar wafer contracts represents about 50% of revenues on an average yearly run rate. Is there a specific cross over time, you guys are expecting to that 50% mark coming from solar?

Nabeel Gareeb

Yeah, let me clarify what that 50% was referring to. I was talking about I said it was, it represented 50% of our long-term targets that we had established -- revenue targets on an annualized basis. So, at the mid-point of those it would represent that having achieved if you will, 50% of those revenue targets.

Adam Hinckley - CIBC World Markets

Okay, great. Thanks, guys.

Nabeel Gareeb

Thank you.

Operator

Pierre Maccagno with Needham, your line is open.

Pierre Maccagno - Needham

Congratulations on the quarter, Nabeel and Ken.

Ken Hannah

Thank you.

Nabeel Gareeb

Thank you.

Pierre Maccagno - Needham

[After leaving on a corner] Nabeel, this is first time that you chose, a [mainline] exporter rather than a cell manufacturer. And just wanted you to give some comments on that, is there a change of philosophy or strategy?

Nabeel Gareeb

Not really, Pierre. I think we've talked about in the past very clearly our four criteria as I mentioned a little bit earlier on selecting a partner. One we wanted to have somebody who had a clear handle on the distribution channel. And in the past we've paid people that have been cell manufacturers for example, Gintech cell and module. For example, SunTech, SunTech has also gone into the further downstream as well and then obviously Conergy who has started in the installation and has moved backwards in terms of cell and module production and they've got basically over 200 to 250 megawatts of capacity here in '08. So, that's very, very consistent with the strategy we've established and the selection criteria we have been using.

Pierre Maccagno - Needham

Thanks and just one clarification on the previous question, I just could not understand, when did you say you would reach the crossover point?

Nabeel Gareeb

Yeah there is no crossover point. All I was trying to point out is that these take or pay deals which add up to about $15 billion to $18 billion over a 10 year period if you divide by 10 assuming a mid-point that dollar figure would be nearly half of the long-term revenue targets that we had established of $3 billion to $4 billion. So long-term revenue target we had established and we basically got almost half of it in take or pay deals.

Pierre Maccagno - Needham

Okay thanks.

Nabeel Gareeb

Thank you.

Operator

Krishna Shankar with JMP Securities, your line is open.

Krishna Shankar - JMP Securities

Yes, Nabeel and Ken, congratulations on the [10 year] contract and can you give us some sense for you know the scenario, I mean, what kind of pricing assumptions are you sort of assuming, I know its tough, but over the next several years in terms of achieving this contract prices, which you know presumably good down overtime? And what does it take in the market for all these customers to come back to the table and review these contracts, can you give us some sense for the background behind these contracts and what pricing you are assuming?

Nabeel Gareeb

Yes I think the pricing philosophy in all of these contracts is very, very similar. They are certainly start at long-term pricing in the current market environment and then they come down once a year over a 10 year period with the objective that by the end of the agreement we need to help enable our partners to be able to deliver products that achieve grid parity for solar energy without subsidies, if oil is at let's say around the $40 mark as a proxy. So, you can get some pretty good ideas of how that occurs and obviously you know there are nowhere close to spot prices at the start and obviously go down to very -- basically grid parity levels. Other than that I can't comment, well, actually there is another comment; these are take-or-pay deals. These aren't -- come in the middle and renegotiate the price. The prices are fixed for that duration of the agreement on for every year.

Krishna Shankar - JMP Securities

I see. So, in each of these contracts you started somewhere in your contract pricing now, and then in ten years that customer would achieve grid parity at that point in time?

Ken Hannah

That's the goal, that’s certainly the objective is to help enable them, because at that point and that's where the shared vision comes in with our partners, where if you can help them enable that, that creates almost infinite demand, if you will.

Krishna Shankar - JMP Securities

Okay. And I'm not sure whether you touched on this before, but can you give us an update on your poly capacity expansion plans and whether it gets accelerated with these new contracts?

Nabeel Gareeb

Yeah, these agreements basically fit into the envelope of those expansions. So, those expansions basically, we have talked about that, we wanted to achieve over 6,000 metric tons by the end of this year and that's on-track to achieve that. And then basically another, we were going to achieve about 8,000 metric tons by the end of next year, and then we said 15,000 metric tons by the end of the decade. So, all of these fit into that envelope, and we have space within that envelope, if you will, to execute one more deal, the size of the combined Gintech deal which is the last year plus this amendment.

Krishna Shankar - JMP Securities

And my final question is, you are still on target with that long-term earnings model of $5 to $7, with $3 billion to $4 billion in revenues in the 2010-2011 timeframe?

Ken Hannah

Yeah, I will tap dance around that little bit, Krishna, because if I do that, if I respond affirmatively or negatively, it will be reconfirming guidance or whatever it's called, I forget. So, fundamentally, you can do the math on these deals and on the growth rate, etcetera, and I think we are in pretty decent shape.

Krishna Shankar - JMP Securities

Great, thank you.

Operator

Mehdi Hosseini with FBR. Your line is open.

Mehdi Hosseini - FBR

Yes, thank you. A couple of questions. Going back to the pricing dynamics of these two new contracts and what one of your existing customer, SunTech said this morning, how should I think about the pricing dynamic? Specifically, SunTech we are seeing early this morning that the pricing environment for the new contract is below existing one. So should I assume that your contracts today also discount the new realities or the new pricing environment, which is lower than when you signed the previous contracts?

Ken Hannah

It’s a good question, Mehdi. I hadn't heard that. Certainly, in my experience that's not the case. If you just go out and ask somebody what its costs to buy poly, it's certainly not lower than it was a year ago. So, our demand, our environment is certainly different from that environment that was stated.

Mehdi Hosseini - FBR

Okay. So, as I look at these contracts, ten year in length, how should I think about the cost structure to your customer in terms of reaching the grid parity? Would that be 2010, 2011, can you help us understand?

Ken Hannah

Yeah, I mean I think each customer, obviously will have a different cost structure, but our goal was to help enable our partners to achieve parity without subsidies, if oil is at $40 by the end of the agreement. So now, obviously in the middle of their subsidies this can be achieved in the middle of the agreement if oil is higher price as a proxy, then obviously that can be accelerated even more. So, we just established what we would call a very aggressive goal that by the end of these agreements, we should be able to help enable grid parity without subsides being the operative word or phrase.

Mehdi Hosseini - FBR

Sure. Okay, and for the purpose of modeling, how should we think about the current mix of revenue? I assume the mix of revenue from selling poly into the spot market is less 10% and how should we think about it going forward and same thing with sale of solar wafer. And I do understand what you said about 50% of all the contracts accounting for about half of your targeted revenue for 2010. But how should we think about the mix or the progresses?

Ken Hannah

So, I think, first of all we don’t breakout the poly and the 156 and the 300, etcetera. But as we stated before, we were trying to keep poly, spot poly sales for example relatively flat. And as a matter of fact, from Q2 to Q3, our spot poly sales actually declined a little bit as a result of this incident, etcetera.

In terms of the long-term, we've always said that solar applications could account for approximately a third of our revenue stream. So, somewhere during that long-term target period, you can probably expect to see that percentage approached or exceeded.

Mehdi Hosseini - FBR

Okay. And this one-third solar includes solar wafer as well as selling poly?

Ken Hannah

Yeah, it would be to the solar applications.

Mehdi Hosseini - FBR

Got you. And just one final question, how should we think about the semi prices from Q2 to Q3, and then Q3 to Q4 in terms of the just the blended pricing environment?

Ken Hannah

Yeah, so what we call mix normalized pricing or like-for-like part numbers, Q2 to Q3 pricing we basically said was down in the low single-digits, which is what we had expected. We anticipate the similar environment for Q4. We expect a similar environment for Q4, and obviously for Q1 onwards we won't know until the end of December.

Mehdi Hosseini - FBR

Got you. Thank you.

Ken Hannah

Thank you.

Operator

Timothy Arcuri with Citi. Your line is open.

Timothy Arcuri - Citigroup

Hi Nabeel, I think you said in July you gave full year guidance, but you thought you could do non-GAAP earnings of more than $3.30 for the year. (a) Do you still think you can do that if -- it looks like you got some benefit from the SunTech warrants in September and it looks like that's a big factor to you making that number, so do you still think you will make that number?

Nabeel Gareeb

Yeah, Tim, if you look at the guidance that we provided the 540 on the top end would put EPS at $3.30 for the year.

Timothy Arcuri - Citigroup

Okay, so you are going to reaffirm that. Okay, Ken what kind of assumption you are making for other income within that?

Ken Hannah

Look if you take the revenue that we provided the margins and the operating expense you can back into the other income.

Timothy Arcuri - Citigroup

Yeah, okay, all right. I guess my other question is -- is it fair to assume that the pricing difference between spot and spotted poly on a per watt basis is roughly 2:1, is that the right way to think about it that spot is roughly double where the, you know, contract would be on a per watt basis?

Ken Hannah

Yeah I don't -- you know you couldn't compare per se on a -- what the easier comparison would be on a per kilogram basis.

Timothy Arcuri - Citigroup

Right.

Ken Hannah

Because when you get into per watt you get into what your efficiency assumptions are et cetera. So if you do on a per kilogram basis what we simply talk about is long-term poly pricing versus long-term wafer pricing when basically we say that long-term wafer pricing is typically 2x of that of a dollar in long-term poly pricing. Other than that we don't comment on what spot pricing multiples are or aren't.

Timothy Arcuri - Citigroup

Okay then I guess Nabeel can you then at least give an idea of the margin on the contract business you have, the margin on the contract wafers. Is that -- would it be fair to say that's at least 10,000 basis points higher than the higher margin semiconductor wafers that you're selling?

Nabeel Gareeb

Yeah, we've never quantified that in that fashion. But I think if you go back to the information we provided for Q1 to Q2, both in terms of guidance on our actual results, I think there is enough information there to make some deductions.

Timothy Arcuri - Citigroup

Okay.

Operator

Thank you. Our next question comes from [Arnold Kalegeropoulos with EN Advanced]. Your line is open.

Arnold Kalegeropoulos - EN Advanced

Yes. Hello Nabeel, congratulations again on the great quarter.

Nabeel Gareeb

Thank you.

Arnold Kalegeropoulos - EN Advanced

I was just wondering if you could give indication of what your -- the industry's 300 millimeter mix was square inches?

Nabeel Gareeb

300 millimeter is anticipated to be somewhere in the 30's as a percent of total square inches or for the industry.

Arnold Kalegeropoulos - EN Advanced

In Q4 or exiting for the --

Nabeel Gareeb

Exiting our '07.

Arnold Kalegeropoulos - EN Advanced

Okay, got it. And then another question was, in terms of additional capacity are these -- is the additional capacity coming from additions to existing plans or would there be new plans being built here?

Nabeel Gareeb

Yeah, we basically have said that, we've obviously not ruled out additional -- our Greenfield pieces but the vast majority of the expansions are primarily coming from existing sites.

Arnold Kalegeropoulos - EN Advanced

Okay. And then, just, maybe two quick questions, 200 millimeter versus 200 millimeter pricing or 200 was weaker?

Nabeel Gareeb

Yeah, 200 was softer than 300 because 300 has the growth. 200 isn't growing. That standpoint you had gives a different color.

Arnold Kalegeropoulos - EN Advanced

Okay. And then last question, at this rate cash on the balance sheet could be $2 billion within a year. I was just wondering if you have any ideas for perhaps, maybe a comment on accelerating the purchase plan because you haven't really buyback that many shares?

Ken Hannah

We even looked at the cash and obviously there is three things that you can do with the cash. You can look at stock buybacks, you can look at dividends, you can look at cash acquisitions and the Board has taken a checking account theory on that in terms of allocation pieces to it. And obviously, we just started up the buyback program. There are certainly the opportunities to accelerate it and as it makes sense, I am sure as a Board will consider it and see what we do or don't want to do with it.

Arnold Kalegeropoulos - EN Advanced

Okay, great. Thanks a lot.

Ken Hannah

Thank you.

Operator

Stuart Bush with RBC Capital Markets, your line is open.

Stuart Bush - RBC Capital Markets

Yeah, hi, good afternoon. Congrats on the Conergy deal.

Nabeel Gareeb

Thanks.

Stuart Bush - RBC Capital Markets

Can you give us any color on what the average wafer thickness for the 156 millimeters wafer quarter and any commentary on the trends there?

Nabeel Gareeb

Yeah, I mean I don't think we've disclosed that Stuart, so I might get into a little bit of trouble but basically the industry averages are probably in the -- obviously start with the two right, as an average. Some guys are talking about being below 200 microns but most of the guys are above 200 microns. So you can assume that we are in the pack as well.

And in terms of trends obviously people are continuing to talk about thin wafers but I think also the pace at which that is occurring or the pace that is in which that is anticipated to occur and the bottom end of that has been tempered by reality a bit, which I think is good because were talking about such thin wafers and you couldn't even handle them but now that the experience has come through in terms of breakage rates et cetera. People have started to get more rational about those expectations.

Stuart Bush - RBC Capital Markets

Okay. And I know you said you still have a capacity from your poly extension for another Gintech size deal, is that still on contracted capacity evenly spread out over the next few years or would an additional contract need to start post 2008?

Nabeel Gareeb

There would be an opportunity to contribute something in 2008 as well.

Stuart Bush - RBC Capital Markets

Okay. And then lastly about the way the price is structured in these contracts, I know you said there is decline still there in their take-or-pay, but if the ASPs of the cells that your customers happens to come down faster your assumptions. Are you saying that the only resolution would be litigation per contract law or is there any mechanism at all for reconfiguring the price?

Ken Hannah

Well, there is always the mechanism for reconfiguring the price if we chose to do so. But that’s the only mechanism. There is nothing built into the agreement as an automatic reconsideration.

Stuart Bush - RBC Capital Markets

Okay, great. Thanks a lot.

Ken Hannah

Thank you.

Operator

[Jerry Nimitz] with Stifel Nicolas. Your line is open.

Jerry Nimitz - Stifel Nicolas

Any thoughts on the stock dividends or stock split in the near future?

Ken Hannah

Not at this stage, but certainly those are items that would be on the table.

Jerry Nimitz - Stifel Nicolas

Thank you very much.

Operator

Satya Kumar with Credit Suisse. Your line is open.

Satya Kumar - Credit Suisse

Yeah, hi. Thanks for taking my question. Can you give us a sense as to whether your sales of poly spot market, will remain approximately constant as we look out into '08?

Nabeel Gareeb

We haven’t provided '08 guidance. So, I don’t know that I would feel comfortable commenting on that. But the goal certainly as we articulated earlier this year, and I have presented in our conferences, etcetera, is to keep our poly flattish, both spot poly sales relatively flattish, so that the growth primarily occurs from the 156 millimeter and 300 millimeter engines.

Satya Kumar - Credit Suisse

So, if you want to, you could actually take the poly spot sales and your additional contracts in '08? Is that possible?

Ken Hannah

That is certainly an opportunity, but here is the other part of it, Satya. We use the spot poly, if you will, as our buffer, just for example what happened in Q3. Those types things occur in chemical factories, and if we can use our, we need to some sort of buffer in production, somewhere. So, if we have access as a result of producing it, we’ll sell it, i.e. we didn’t use our buffer, but yes. If we want to, yes. We could certainly convert it into wafers as well.

Satya Kumar - Credit Suisse

Okay. Can you give us a sense of; I’m trying to assess the profitability of the different businesses. Is the combined solar businesses today, more than half of your EBIT margins at this point?

Nabeel Gareeb

I don’t know that I could comment on that. I think you would have to make whatever assumptions you are going to make, but the one thing we do say is that 300 millimeter and 156 millimeter margins are above the average, and obviously the spot poly is as well.

Satya Kumar - Credit Suisse

Okay. I was trying to get some granularity on the poly production as well. I know you have said that you will be at 6,000 tons at the end of this year. Does that mean you are producing about 1,500 tons in the fourth quarter?

Ken Hannah

Yeah. So, and just one falloff to your last question, Satya. One of the reasons why I can’t, I was pausing there is, we don’t really break it out or look at it that way, we do look at diameters in aggregate, but other than that, we really don’t .look at business, if you will, per se.

But second, on the 6,000 metric ton, so that was a yearend capacity figure, and I think I alluded to it a little bit in the call that we’re in the final stages of our expansion checkout and startup and acceptance piece, and we anticipate starting that ramp late November.

Satya Kumar - Credit Suisse

Okay. So you would be slightly under that in Q4 and at the full ramp rate in Q1?

Ken Hannah

That will certainly be the hope.

Satya Kumar - Credit Suisse

And at the end of ’08, are you still looking at 8,000 tons annualized capacity?

Nabeel Gareeb

Yes.

Satya Kumar - Credit Suisse

And how is that ramp on quarterly fashion next year?

Ken Hannah

Well, again that was second half, that’s where we had left it, that it would be in the second half of next year, and we didn’t provide any more granularity than that.

Satya Kumar - Credit Suisse

Okay. The reason, Nabeel, I asked you about the EBIT margin questions was, in my estimate, I think that maybe you guys are close to the 50% mark in terms of your solar EBIT. And I guess if your solar EBIT is marginally comprised of spot sales, and I think there was an earlier question from Tim on the call, that perhaps the spot profitability is twice that of contract. The question that I thought I was trying to get at was, as we look into '08, how should we think of the profitability, should there be for example, a decline in semi-pricing environment or the spot poly pricing environment? Can the contracts that will make up for that and that’s where I was sort of trying to get some sense as to where your profitability might be by -- I mean, not necessarily for spot of for solar wafers, but just solar as the bucket, are we sort of approximately closer to deploying those?

Ken Hannah

Yeah, I think, again, we don't break it out that way. So I don't have data readily available to show you as a comparison or what have you, but let me just make some points, and maybe there will be an answer somewhere in there.

Number one, obviously, we've talked about the fact that 300 millimeter and 156 are higher than our averages, so as they grow in mix, they will help pull up the margins. Second, lets assume for a moment that pricing changes so dramatically, that the gross margins at some point in the future flatten, well, then operating margins aren't necessarily flat because of our operating expense leverage, they continue to grow, and our third is our long-term, this is the fundamental point, because that's important is our long-term targets that we had articulated, and January, we assumed really no real margin improvement. And in spite of that we were talking about $5 to $7 a share and $3 billion to $4 billion in revenue which was pretty significant EPS growth.

So, people get a little panicked about the pricing environment rightfully, but there are some mitigating factors we have within our control such as cost reduction, others, as a result of mix that can help offset it. And then, all of that combined when you compare it to the long-term targets, I think we're in decent shape. But we'll see how the market evolves.

Nabeel Gareeb

And then all of that combined when you compared to the long-term targets. I think we are in decent shape but we'll see how the market evolves.

Satya Kumar - Credit Suisse

And then one last question sorry to ask you so many questions here but SunTech had signed a deal with Asia Silicon earlier this morning and I think it was probably one of the first time that I've seen a contract announcement where it actually talked about the pricing level. And it was a fairly low price level of under $40 in seven years. Does that surprise you that they should actually mention that and I know your contracts with SunTech and Gintech were signed last year. Obviously the pricing levels were a lot lower and clearly it's moved up. But over the last thee months have the terms of contracts actually changed it all, knowing obviously that you guys didn't sign a contract three months ago. But over the last few months have become clearly changed?

Nabeel Gareeb

Not for us -- for us they have only gotten -- they've only improved in a tighter environment. But obviously if you are a new player trying to get in the business may be you'll be more aggressive. And I think you know SunTech is doing smart things in terms of looking at their other part of their supply stream that they need to fulfill and they are signing wafer contracts and poly contracts and hopefully that will make them more competitive, which is great because we want to be aligned with a competitive partner. So for me this is all good news.

Satya Kumar - Credit Suisse

Great. Thank you and congratulations on the contract.

Nabeel Gareeb

Thank you.

Operator

Paul Leming with Soleil Securities your line is open.

Paul Leming - Soleil Securities

Hi just a follow-up question you gave us like-to-like pricing on semiconductor wafers earlier down in low single-digits. Could you actually give us a blended ASP number for the quarter for semi wafers?

Ken Hannah

It's probably flat to slightly up Paul.

Paul Leming - Soleil Security

Thank you.

Operator

Jesse Pichel with Piper Jaffray your line is open.

Jesse Pichel - Piper Jaffray

Some of the 156 solar wafer suppliers are mixing in only 20%-25% virgin poly and the rest is scrap. Do you subscribe to a blended recipe under your contracts to your solar customers and if so you've talked about this 6,000 metric ton capacity, if you included the scrap from your semi business. What would that capacity be?

Nabeel Gareeb

Let's answer the second one first. Scrap from semi business is really derived from that 6,000 metric tons right. I mean…

Jesse Pichel - Piper Jaffray

Right.

Nabeel Gareeb

I mean you don't produce the scrap until you consume it. So, it kind of, you can't double count if you will. And then going back to the first question, I mean there is certainly always a blend of the scrap, if you will, what is called scrap. I mean some of the scrap is really [pops-and-tails], which is very refined poly, so it's pure than the raw poly that goes in. But yes, there is a blend, are blends aren't that low and if the subcontractor chooses put in a blend, that's not what we would like or doesn't make sense. We look at that very carefully to make sure, that it meets the speck and then fix it moving forward.

Jesse Pichel - Piper Jaffray

And Conergy put out a press release talking about that it may opt to get mono wafers from you and I am wondering if there is some shift in your outsourcing strategy there?

Nabeel Gareeb

Mono wafers are an option for both obviously. Conergy they were option for in the SunTech arrangement as well. So, that's been if the customer wants it, we will look at all those aspects of it and if we need to go outsource it, we will otherwise we will build it in house.

Jesse Pichel - Piper Jaffray

And last, just housekeeping. The inventory on your books, is that virgin poly at cost, or is it semi wafers at cost?

Ken Hannah

It's probably both, it's probably both, right.

Nabeel Gareeb

Yeah. It's got raw material within and finished goods, Jesse?

Jesse Pichel - Piper Jaffray

Can you say, is it mostly raw or just trying to see what the revenue, what's the per (inaudible) revenue off of that inventory number?

Nabeel Gareeb

Yeah, you will see that when we file our Q here in November.

Jesse Pichel - Piper Jaffray

All right, great. Thanks so much.

Nabeel Gareeb

Thank you.

Operator

Mehdi Hosseini with FBR your line is open.

Mehdi Hosseini - FBR

Yes, one final question from me, going back to a couple of years ago, if I recall correctly, you were purchasing as much as 10% of your poly requirements from third party vendor like [Tokayama], can you give us an update and if you are still purchasing limited amount what would it be?

Nabeel Gareeb

Yeah we are purchasing a very limited amount basically through the end of this year and then subsequent to that I don't know that we will be purchasing anything from anybody.

Mehdi Hosseini - FBR

Sure and would it be considered that [how would you list the] 5% of your poly requirement and is outside of the 6000 metric ton?

Nabeel Gareeb

Yes.

Mehdi Hosseini - FBR

Okay these are obviously contract prices not -- you are not buying them for more than $75?

Ken Hannah

Yeah these have typically been one year price -- one year contract so other than I won't feel comfortable commenting on that.

Mehdi Hosseini - FBR

Got you. Thank you.

Operator

Krishna Shankar with JMP Securities your line is open.

Krishna Shankar - JMP Securities

Yes I don't whether you test on this but how many wafers subcontractors do you have and, have you said anything about LDK publicly being one of you wafer subcontractors and you know what steps are you taking to -- there has been some obviously controversy on that and can you talk about how you are doing quality control inspection of your wafer subcontractors and your plans to bring that in-house?

Nabeel Gareeb

We saw that a little bit but basically we -- you know the number of subcontractors we have typically said we have a handful. We don't quantify exactly how many. The second -- we have not talked about who our subcontracting partners are. Third is in terms of -- we do have a dedicated subcontract management team, which includes looking at delivery performance, performance to specifications, quality all of those good things and that's just normal in a subcontract management operation, so that occurs across all our subs.

Krishna Shankar - JMP Securities

And your plans to bring this stuff in-house?

Ken Hannah

Yeah, we talked about that little bit as well. We said that it would be 18 to 24 months, which we put it in the 2009 timeframe. We are looking at different sites, etcetera, taking our own sweet time to see what becomes available as well in the meanwhile. So that's kind of the timetable. We don't see subcontracting going away as part of the mix, we see that has being very complimentary to our in-house manufacturing.

Krishna Shankar - JMP Securities

Do you still feel that valuations are frothy out there or would you use the cash you have to make an acquisition to quicken this?

Ken Hannah

Yeah, I mean I think the valuations are -- people are valued at 363 PEs. It's hard to justify acquisitions.

Krishna Shankar - JMP Securities

Thank you.

Ken Hannah

Thanks, Krishna.

Operator

Neal Jacobs with Bodri Capital. Your line is open.

Neal Jacobs - Bodri Capital

Yes, thanks for the call. Congrats on the two new contracts. My question relates to poly capacity. Remind me, you've talked about getting the 8,000 by the end of next year. And have you announced anything firmly beyond that, and how much poly will you need by 2016 at the end of these contracts?

Ken Hannah

Yeah, Neal, we announced in July that we would be targeting to achieve 15,000 metric tons by the end of the decade. And so, obviously and that's the only announcement we've made beyond the 8,000. We have not talked about what would be beyond that or in the middle of the next decade, etcetera. So I won't feel comfortable commenting on that.

Neal Jacobs - Bodri Capital

Okay. Thank you.

Ken Hannah

Thanks.

Neal Jacobs - Bodri Capital

Congratulations.

Ken Hannah

Thank you.

Operator

[J.D. Abushar] with GRT Capital. Your line is open.

J.D. Abushar - GRT Capital

I appreciate you taking my question. Can you help me on just what the additional CapEx will be for next year to add the 2,000 tons?

Ken Hannah

J.D., I think we have basically established our long-term model where we say CapEx is going to remain in the range of 10% to 15% of revenues. So whatever your assumption on revenues is, if you take a 15% number off that, at the high-end you should be in pretty good shape.

J.D. Abushar - GRT Capital

Okay. And then, obviously CapEx has been going up the last couple quarters, and depreciation has not changed. What will deprecation be in Q4 as you fire the plan, obviously, you start to depreciate it?

Ken Hannah

Yeah, you have touched on the heart of our operational success, if you will. And that is, because of our assets turns, if we spend a dollar on CapEx, we try to generate $1.5 of revenue out of that. So, if you follow that, even on a lag basis, increasing CapEx won't necessarily result in an increasing deprecation figure as a percent of revenue.

On dollar term, certainly it will as the revenue ramps and the depreciation is added, but as a percent of revenue it won't necessarily go up.

J.D. Abushar - GRT Capital

So, you are saying that depreciation will never equal CapEx?

Ken Hannah

As long as revenue growth outpaces the CapEx growth which is the beauty of our asset turns model, that tends the whole true.

J.D. Abushar - GRT Capital

Great. Thank you.

Ken Hannah

Thanks.

Operator

Timothy Arcuri with Citi. Your line is open.

Timothy Arcuri - Citigroup

Hi, can you help us somehow get a handle on what you think the other income line will look like in '08, because it look like you are getting quite a bit of benefit from the revaluation of the SunTech warrants. I think, if you didn’t have those, the earning would have been a little light in September. So I guess, I'm just trying to figure out, how do we think about maybe what's the right way to model other income this next year. I know its tough, but?

Ken Hannah

Yeah, Tim, I think what you want to do, is you want to look at your assumptions around our cash generation and, we've broken out the earnings associated with the SunTech valuation each quarter in our release, to make sure that’s very clear. And so, in any of those quarters, you can just subtract that out, and you will see what the interest income generated is, and if you just project that growth, based on revenue earnings and cash growth overtime. And use a nominal return on that from a cash standpoint, you should be able to get to that interest income number.

Timothy Arcuri - Citigroup

Right. I guess my point, Ken, was when you gave this number for the year, when you gave this $3.30 for the year, where you expecting to get as much as you've gotten in the revaluation of the SunTech warrants, because if you took that away, you actually wouldn’t get to that number?

Ken Hannah

What we said in July, Tim, was that the, revenue associated with our Q3 and Q4 outlook would generate $3.30 a share, and that we were not anticipating any further changes associated with the valuation from SunTech.

Timothy Arcuri - Citigroup

Okay. So the guidance did actually include some of the valuation of SunTech warrants or it didn’t?

Ken Hannah

It did include the valuation associated with what had already been booked.

Timothy Arcuri - Citigroup

Okay. Maybe we can talk offline, thanks.

Ken Hannah

Okay, thanks.

Operator

Steve Tabb with Tocqueville Asset Management. Your line is open.

Steve Tabb - Tocqueville Asset Management

Okay, thanks. Doing a great job, guys. Your contracts with the solar distributors, I got to call for you reducing the price of the solar wafers in order to meet this $40 oil comparison price, and therefore you're going to have to get greater efficiencies. I am trying to figure out where they're going to come from, especially since you are using outside manufacturers to a great extent. Will your gross profits be going down, and your margins be going down?

How will this -- how will your margins hold up as you have to, I assume deliver on lower prices, polysilicon will be coming down, as you say as more production comes on, over the next few years, but I assume you are counting on some manufacturing efficiencies, where an [alloy will] be produced?

Nabeel Gareeb

I think it's a good question, Steve. Yes. There are manufacturing efficiencies assumed for example thinner wafers, better yields, higher productivity et cetera. Number two, obviously is bringing some of that in-house to achieve those efficiencies on top of what the subcontractors can provides us.

Third is also the improved efficiency of the wafer itself. Please, please remember that we have priced them in dollars per watt, so that if we prove the efficiency, inherent efficiency of the wafer, we would get to keep some of that.

So those I would call operational and R&D improvements. The next piece is, even though price has come down and costs have come down, and even if the margins are down slightly from where they might be today, those margins would still be probably in excess of where the average is today.

So in aggregate the mix would cause the average margin to come up. And the last point is that in our three to five year targets, we did not assume any margin improvements per se, so this would obviously provide some benefit.

Steve Tabb - Tocqueville Asset Management

Alright. And as was stated, you've accumulated a lot of cash, you're accumulating more cash. You have mentioned your options, and also one of the possibilities of building your own solar plants, and you said, it's too expensive to buy existing solar manufacturing plants, because -- wafer plants, because they are selling at terrific multiples. What is the ballpark amount for a certain amount of production to create a Greenfield plant?

Nabeel Gareeb

Yeah, I mean I think there is a lot of ratios out there but -- and I won't feel comfortable commenting on ours but it's not, it's much, much lower than the valuations of some of the companies out there like, we are much, much lower.

Operator

Thank you. Our last question comes from Paul Leming, Soleil Securities. Your line is open.

Paul Leming - Soleil Securities

Good evening. I just wanted to ask a quick follow-up on the inventory question. Do you book polysilicone as [WEP] or as finished goods in your inventory?

Nabeel Gareeb

It's actually in raw material.

Paul Leming - Soleil Securities

The poly you produce is in raw material?

Nabeel Gareeb

That's right.

Paul Leming - Soleil Securities

Thanks.

Operator

I would now like to turn the call over back to for closing remarks.

Bill Michalek

Thank you all for participating. Good night.

Operator

This does conclude today's conference call. You may disconnect at this time.

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