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Executives

Paul Combs - VP of Strategic Planning

Harold Hoskens - CEO

Amy Liu - CFO

Analysts

Burt Chao - Simmons

Paul Clegg - Jefferies

Josh Baribeau - Canaccord Adams

John Hardy - American Technology Research

Jason Wright - Merrill Lynch

Paul Leming - Soleil Securities

Gaurav Mehta - Credit Suisse

Dan Ries - Collins Stewart

Cheryl Tang - Goldman Sachs

Joe - Lazard Capital Markets

Adam - Oppenheimer

Rocky - FBR

Daniel Backmen - ILG

Emily Lu - Areth Research

Peter Pang - ThinkPennuer

Till Stenzel - Hazel Capital

Solarfun Power Holdings Co., Ltd. (SOLF) Q2 2008 Earnings Call Transcript August 27, 2008 8:00 AM ET

Operator

Good morning, ladies and gentlemen. This is Dan, and I’ll be the operator for this conference call. I would like to welcome everyone to Solarfun Power Holdings 2008 Second Quarter Conference Call. All lines have been placed on mute to prevent background noise. After the presentation, there will be a question-and-answer session. Please follow the instructions as given at that time if you would like to ask a question. As a reminder, this conference call is being recorded. A replay of this call will be available via webcast on the company’s website at www.solarfun.com.cn.

Now, I’d like to transfer the call to the moderator, Mr. Paul Combs, Vice President of Strategic Planning at Solarfun.

Paul Combs

Thank you, Dan. Good morning, everyone. Welcome to the call, and thank you for your interest in Solarfun. Joining me today is Harold Hoskens, our CEO, and our CFO, Amy Liu.

Before I continue I need to take a moment to remind you of the company’s Safe Harbor policy. This call will contain forward-looking statements, which are subject to risks and uncertainties. Actual results may differ from those discussed today and therefore we refer you to a more detailed discussion of the risks and uncertainties in the company’s filings with the Securities and Exchange Commission.

In addition, any projections about the company’s future performance represent management’s estimates as of today, August 27, 2008. Solarfun assumes no obligation to update these projections in the future as business and market conditions change.

We’d like accomplish key objectives on the call today. First, to review the second quarter just concluded. You have seen the numbers by now, and you can see that we met our previous guidance both in terms of volume and earnings. We continue to be burdened by tight supply and higher costs for polysilicon and wafers.

Frankly, it not only impacted our gross margin, but constrained to some extent our ability to ship higher volumes. We do see some signs of relief, however, in the second half, particularly in the fourth quarter. More on that later. Most importantly, we remained optimistic for the remainder of 2008, and in particular, for our 2009 outlook.

With that in mind we hope to offer some of our thinking on the prospects for next year and add a degree of transparency that can build your confidence in our ability to meet our goal. Additionally, we had a number of vary significant accomplishments following the close of the quarter and would like to highlight the importance of those.

Now Amy Liu, our CFO, will touch on some of the second quarter financial highlights. Amy?

Amy Liu

Thanks Paul. Hopefully, you’ve had sufficient time to digest the numbers. So, I will try and focus on some of the key metrics and variances. Although we report in RMB, for the purpose of this call all numbers will be in US dollars. First, some income statement trends.

Our previous guidance for shipments was between 40 to 45 megawatts and we ended up right in the middle of that range at 43.1 megawatt. As Paul mentioned earlier, a tight supply of polysilicon and wafers had some constrained impact on our top line. Demand was quite good, and pricing was firmed. Our ASP actually improved to $4.17 for the second quarter. Revenues reached to $197 million, a 12.7% increase over the first quarter and almost 192% over last year.

We also sold the 5 megawatt of cells with specification levels that are different than our mainstream business. For these sales, there is a market, but gross margins are lower. As we anticipated, as a result of the pending regulatory changes in Germany and Spain. Our geographic presence [shift towards] a higher compensation of sales in Germany versus Spain. We expect the change to continue throughout the remainder of the year.

For the second quarter Germany represented 56% of revenues, Spain 33% and France 5%. No other country accounted for more than 5%. As most of you know about 80% of cost of goods sold is silicon related. We experienced the increase of prices during the second quarter, particularly from our domestic suppliers. Gross margin, therefore, declined to 13.7% from 15.8% in the first quarter of this year. We think gross margins will improve during the second half of 2008, but probably not until the final quarter.

Our operating expenses as a percent of revenues was a little over 5%, which is a return to a more normal levels as we continue to invest in infrastructure, people and technology development. Unlike some of our peers, we reported a currency gain of 600,000. Management has been actively exploiting and implementing foreign hedging strategies, and we will continue the efforts in order to minimize currency exposure going forward.

Net income rose 285% to $11.4 million over the same period last year and earnings per basic ADS came in at $0.24.

Now over to the balance sheet. We have focused quite aggressively on working capital management and saw continued improvement in reducing accounts receivables, inventory return over days. We ended the quarter with cash of $81 million and working capital of $323 million, despite the revenue growth, our AR balances has declined compared to the first quarter.

DSOs dropped again sequentially to 37 days. The inventory balances showed a small increase quarter-over-quarter which is well inline with our business growth. Inventory turnover days further improved to 63 days from 68 days last quarter.

Our total capital outlays for the second quarter was $57.2 million of which $42.4 million was for capital expenditures and $14.8 million for pre-payments to suppliers. Additional capital outlays for the remainder of the year expected to approach $90 million for CapEx and additional $70 million to $80 million for pre-payments to suppliers and LYG equity acquisition.

We are comfortable that our cash on hand combined with assets to additional commercial debt facilities will meet our financing needs for the remainder of 2008. In August, we also completed market equity offering with net proceeds of $71.9 million.

Now Harold will highlight some of the most recent accomplishments as well as give you some brief outlook for the remainder of this year as well as 2009.

Harold Hoskens

Thank you, Amy. Good day to all participants at the different continents. Before going on to the business side, I would like to briefly hold on the occasion in July of the death of our COO, Hanfei Wang one of the founding members of this company. Hanfei has contributed the significant part to the company to point where it is today. We received many messages from also people on the call expressing support for people in our company, but also Hanfei’s family. Allow me to use this occasion to thank you for that.

Back to the business. Our management team is positive on the traction for our business going into 2009. Let me share some background here and starting there with some views on our market and related customer demand.

Much discussion is going on in our industry about the demand for PV products going into ‘09 especially given the earlier announced changes to tariff structures in Germany and the changes that are currently being discussed in Spain. Some observers take [net of] view that overall demand would be less buoyant. We see, however, quite a lively demand going into ‘09. We see that customers operating in the more traditional markets, Germany and Spain are successful in expanding their geographical reach into the newer markets in southern Europe or even partly also into areas like the Middle East and the Americas. Next to that, we see, that customers originating in these markets for themselves demonstrate the ability to generate quite significant sales volumes.

With our key customers we are now discussing the contracts for ‘09. As you can see from our earlier press releases we have already signed with some of them, and with some others we are having discussions. These contracts cover supply into the more traditional markets in Europe but again, as you can see in these releases they also cover newer areas in the Middle East and southeast Europe including growth markets such as Portugal, Italy, Greece and the north of Africa.

In 2009 they will be also more focused on the contents of the customer contracts. With our key customers we discussed a contract framework, which is clear on some on volumes and pricing including upfront payment commitments and provision in case of customers would not be able to absorb full volumes. From the discussions around these contracts we see a relatively small decline in pricing, going from ‘08 into ‘09. I may highlight here that most of these prices are expressed in Euro.

As you may have seen, we have just announced earlier today, a Letter of Intent with Q-Cells for a three-year module supply agreement with minimum commitment for 100 MW of PV modules per annum. It is the first step of what we hope is a long-term and fruitful relationship between both companies. Importantly, the LOI anticipates an agreement to cooperate in creation and production of higher efficiency modules at a reduced and comparative cost. From past experiences, it is my view that cooperation between companies best start with actually exchanging business volumes. These actual module volumes gives us a good reason to get a closer interaction going and to know each other more in-depth.

For our shareholders, it will provide for the period mentioned stable flow of revenues. For people in both companies it will offer platform on which we can jointly build our further cooperation.

Moving on, I would like to highlight a couple of aspects on how we are going to realize these market volumes. First, an update on our firstly integrated manufacturing activities. In the second quarter we made good progress with the execution of our vertical integration strategy, and particularly our broadening of the industrial and innovation footprint with ingot making and wire saw activities.

With reference to our ingot making facility at LYG Linyang, we now have acquired the remaining 48% interest in this ingot facility giving us 100% ownership. This purchase in concert with our new US $60 million wire saw facility in Qidong is one of the key elements in the integration strategy and allows us to align quality and product specification all the way through the value chain. With this we create a much enhance ability to manufacture products at optimized cost and performance for our products.

The ingot production at that facility and our internal wires [a better slicing] as compared to the current model where we buy wafers from third parties should contribute about 20% of our total volumes by year-end '08, and growth to about 40% of the higher total volumes for 2009.

On the capacity expansion, we have completed by early July the commissioning of our new cell lines 9 to 12 and the corresponding additional module capacities. This takes our nameplate capacity to 360 megawatts. For 2009, we are now preparing for our next expansion another four cell lines and related module capacity. Also we are in the process of expanding the module capacities to support the business volumes related to the LOI just discussion with Q-Cells. So we feel that we will end 2009 with a good momentum towards volume growth.

On the supply front, we have earlier announced that we secured and eight year commitment from GCL Silicon Technology for virgin polysilicon equivalent to about 1.2 gigwatts of PV module capacity. This year we already started to supply and getting the good cooperation from GCL and LYG facility. There is firm based for the expansion of the manufacturing activities about ingot making facility [mainly in] Europe.

We expect that the progress coming out of [Linyang] will help to lower our average product manufacturing costs in '09. Allow me to illustrate the quality of data above with some specific numbers. We see continued strong demand. As previously indicated, we now see 2008 shipments of 175 megawatt to 190 megawatt, which is higher than our previously indicated range of 160 megawatt to 180 megawatt.

Our gross margins is going to improve in the second half as a whole from current levels with the best leverage coming in the final quarter as we see signs of supply improvements and benefits from growing scale at our internal ingot making and wire saw facilities. We don’t expect margin improvement in the third quarter.

Operating expenses will grow in absolute terms along with our business, but as the percent of revenue we see them stabilizing in the 5% to 6% range.

Let me jump from '08 into '09. We believe we have a firm and quite good outlook for '09, some number on them. Total sales volume in megawatt shipments our forecast is to arise 50% above the 2008 forecasted range. ASPs are anticipated to decline between 5% to 10% in constant euro terms. These two projections are based on the visibility of the contract discussions with our key customers that I just mentioned before. We have a good visibility on 200 megawatt in sales volumes, one half of which is already secured through signed contracts.

On the supply side, we have secured silicon related materials to support this projected shipment volume. About two-thirds of that is locked in the long-term supply contracts. Lower cost of silicon related materials reduced costs resulting from our vertical integration will allow a gross margin expansion of about 500 basis points from year-end 2008 levels.

We are planning to add 120 megawatt in nameplate capacity plus a further expansion in module capacity in support of the execution around the agreement with the Q-Cells as earlier indicated in the LOI. This guidance is based on following factors; a constant currency, and particularly euro versus US dollars; our ability to round scale and reduce cost at our [Linyang] facility and to a lesser extent the timely delivery of silicon and wafers from our suppliers.

Hopefully, this gives you enough transparency to support our expectations for the remainder of this year and next and to understand why we are quite optimistic about our longer-term prospects.

With that, I’d like to thank you for your interest and continued support for Solarfun. We would be happy to respond to any questions that you might have at this point in time.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Burt Chao from Simmons. Please proceed.

Burt Chao - Simmons

Hi. Good evening. Thanks for taking the questions. I just had two real quick questions. First of all on that, congratulations on the Q-Cells agreement. What are the basic economic behind here – maybe just on the gross margin level, are you looking at gross margins better than what you are doing or because of just module assembly at this point, it is something that you are going to experience lower gross margins. And ultimately, is this a trend that we will continue seeing Solarfun getting into the module assembly business from third-party external customers?

Harold Hoskens

To start with your second point may be first. We believe that this is the first step in cooperation with the Q-Cells and we would like to see the expansion in broadening that cooperation. That’s first remark I would like to make more than that this is a first trend in going very broad in making module as a core business so to say.

The second point, we have looked at the business parameters of this. The business parameters are accretive to our overall results, and in that sense, we think it’s a good business deal and that’s also again one of the attractions like I said in starting.

Burt Chao - Simmons

Okay, great. And then also touching on your vertical integration strategy, the wafering getting is obviously a critical component of that, have you explored other options in the downstream or looking at partnering with perhaps partners in the downstream in order to broaden your vertical integration that way?

Harold Hoskens

I think we would like to have a significant enough footprint through integral value chain. The key aspect of that is that we hope from that or we expect from that we can optimize the product performance of the integral product. Later on, we can augment, based on that knowledge augment that capacity with buying in certain manufacturing stages capacity their research. But we believe that first making an internal footprint and then from there to see how we arrange further expansions is the more prudent order of things.

Burt Chao - Simmons

Okay, wonderful. Thanks so much for taking my questions.

Operator

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

Paul Clegg - Jefferies

Good evening. Thanks for taking my question. I am trying to understand whether or not Q-Cells is in your total shipment guidance for 2009 or if it’s incremental to that 50% increase over ‘08 shipment guidance. And then also what if you could talk about the timing on having that LOI finalized into a contract?

Harold Hoskens

I get this the second question a bit earlier. We have taken in the LOI about four weeks to finalize it into a final contract. That’s first part. The second point our shipment guidance is based on the output from our cell module operation. So, that guidance excludes the business which starts with – we anticipate to start on this LOI.

Paul Clegg - Jefferies

Okay. And so would Q-Cells contract then have, on the blended basis, would’ve have a favorable or unfavorable impact on your gross margins. You kind of addressed that a moment ago but I think it would depend on how you account for it. It’s accounted for as a tooling agreement or –

Amy Liu

Yes, in general, we will see the Q-Cells business will show a relatively good gross margin in our financial performance, and basically, we think this, we went thought the financial analysis for this business and we think it makes sound financial meaning to take the business. So, in short, it will have positive financial impact to our P&L.

Paul Clegg - Jefferies

So, when you talk about that 500 basis points of gross margin and improvement, it would –?

Amy Liu

This one is not included there.

Paul Clegg - Jefferies

Doesn’t included.

Amy Liu

The 500 basis point improvement, this is mainly to our traditional cell and module business.

Paul Clegg - Jefferies

Yes, I was wondering if it would shrink or grow that 500 basis point number or whether that would just [leave] that even.

Amy Liu

It will be a positive impact over our projection.

Paul Clegg - Jefferies

I see. Okay. And then if you, maybe just as a follow-up, a visibility on the pricing for ‘09 being down 5% to 10%, you could talk about how those contracts are structured and how much opportunity there is for pricing to be revisited if there are changes in market pricing or incentives, or if there are bans in the contract?

Harold Hoskens

Like I said in my introduction, we try with our key customers to go for clear and firm way of pricing, and although contract of course vary in language between individual contracts as you may imagine. In general, we try to go for clear outlooks on pricing for the whole of ‘09 in the contracts with these key customers.

Paul Clegg - Jefferies

Okay. I am sorry. But I am not understanding that whether that means if there is any opportunity for them to come back and revisit that.

Harold Hoskens

These contracts in general are based on volume and pricing agreements for 2009 which are expressed now.

Paul Clegg - Jefferies

Okay.

Paul Combs

There are provisions if they do not accept delivery to protect our margins. There are prepayments involved in most cases and they are backed by guarantees and letters of credits. So, these are framework agreements that are negotiable at very firm and specific contracts.

Paul Clegg - Jefferies

Okay, very good. Thanks. I’ll jump back in the queue.

Operator

Your next question comes from the line of Jed Dorsheimer from Canaccord Adams. Please proceed.

Josh Baribeau - Canaccord Adams

Hi. This is actually Josh Baribeau for Jed. Just a question for you on the margin pressure at this quarter. You said it was mainly on increases of domestic suppliers raising their prices. Were those at all related to what was once a fixed contract or was that more of a spot type of agreement?

Amy Liu

Well, basically I think it was even mentioned that these all coming from domestic suppliers. I think in a general market condition, we see a very tight polysilicon and wafer supply situation in the second quarter and this situation may continue in somewhat manner into third quarter. So, this is a general wafer price increase from our suppliers.

Josh Baribeau - Canaccord Adams

Right. But was any of it previously supposed at fixed contract price that they had renegotiated with you or raised prices unexpectedly.

Amy Liu

Yes. I think this situation does happen occasionally with some of our suppliers.

Josh Baribeau - Canaccord Adams

So, looking forward towards the end of the year, the back half of this year, do you expect that to happen again; meaning, whatever you have contracted might actually increase and therefore hurt some of the margins again?

Amy Liu

In general, we see the supply environment is improving towards the later of this year; and secondary, our vertical integration strategy would have executed and the volume from our in-house wafer production both from the LYG ingot making facility and also wire saw, wafer sawing facility will ramp up, and then we would see the benefits coming out from that execution. So, combining these two factors together, we think the wafer costs would be improved quite significantly in the fourth quarter of this year.

Paul Combs

Josh, and the most significant of those fixed-price contracts that have been under renegotiation have been re-secured. So, we have high visibility on our volume and we have a high level of confidence that those prices will not go up again.

Josh Baribeau - Canaccord Adams

Okay. And just one more and I’ll jump back in the queue. Could you give us somewhat of an estimate about what it will cost you the CapEx for the Q-Cells expansion?

Amy Liu

The Q-Cells expansion, basically – well what we’re looking at as we mentioned in earlier that we are looking forward to invest another $90 million in CapEx for the remainder of this year, which does not including the CapEx investments for the Q-Cell module capacity. However, this module CapEx will be basically included in our ‘09 CapEx spending expense, which we think, will be financed properly.

Paul Combs

Josh, I think it’s fair to assume that we invest $7 million to $8 million on an average to add 30 megawatts of a cell line, it’s a significantly less than that. Module capacity is less expensive than cell capacity. And the margins in this business are reasonably good, and most importantly, our return on invested capital is quite attractive with a fairly short payback period.

Josh Baribeau - Canaccord Adams

Okay. That’s it from me. Thanks.

Operator

Your next question comes from the line of John Hardy from American Technology Research. Please proceed.

John Hardy - American Technology Research

Hello, everyone, thanks for taking my call. I had a quick question on 500 basis points improvement in gross margin through ‘09? I was wondering if there is anyway you could break that out in between decrease in Poly cost, what benefits do you see from the further vertical integration, whether some of that is coming from efficiency improvements or any other important components you might add onto those?

Amy Liu

Well, in general, I think you have basically captured all the points there, you know, well contributed to this 500 basis point improvement in the gross margin ‘09. Basically, I think largely it will come from, one, the wafer cost and also the polysilicon cost we see. We have the visibility from the signed contract, this cost will go down significantly in ‘09, and secondly, and the most importantly, by in ‘09 our vertical integration strategy will be executed to the level that the volume will be significant to basically lower down the overall material cost for our business. So, basically main contribution coming from reduction of the material costs.

John Hardy - American Technology Research

Okay. And by main, would you say 75% plus is coming from --

Paul Combs

I think we are prepared to quantify that John. I think it’s fair to say at 80% of our cost of goods sold are silicon related. You know they are currently high. There is very good visibility on our contracted volume for ‘09. So we have a high degree of confidence in that margin assumption. We are ramping up the LYG and the wire saw facility. So, that being said, even at small volumes currently with high input cost for polysilicon we have decent visibility on the margin side there to support that contention on gross margin expansion. In addition, in terms of efficiencies we think we can overtime make a wafer that’s of a higher quality and will allow us to generate a higher efficiency sale. So, I think you hit the three highlights, we are just unable to specifically quantify it for you at this time. But we do have a high-level of confidence and we internally can support that 500 basis point assumption.

John Hardy - American Technology Research

Great, thanks for that. Quickly on the cash balance, you say for the back half of '08 and that’s great, I was wondering your thoughts on '09 and some of the different moving parts there and maybe perhaps what you think someone mentioned before the module CapEx per watt, I was just wondering if you could breakout what do you think your total CapEx per watt will stand in '09 so we can get a better idea of '09 capital requirements?

Amy Liu

Yes, basically for '09, the management is thinking about investing for additional new lines both in cell and the module. So that is approximately US $30 million and first the investment for the additional module capacity that will be committed to the Q-Cell or manufacturing needs. So, basically was looking at our moderated CapEx investment for '09, however, with the visibility we have on current business projection we think our current funding and access to the commercial debt facilities will be adequate to support this business plan. However, having said that, if we decided, if the management decided to aggressively further expand our capacity or we opportunistically signed any new additional long-term supply contract which require pre-payment, we may go back to the market and [release] funds.

John Hardy - American Technology Research

Great, thanks then one quick last one. I was curious if you experience any issues with lead times for that plan ramp for '09 in terms of equipment delivery?

Harold Hoskens

I think we are in discussions with the suppliers to meet our schedules. I think the equipment lead times in the industry are still quite long, but in our planning we have taken that into account. I still would hope that the equipment lead times could become a bit shorter.

John Hardy - American Technology Research

Great. Thanks for the answers and congratulations on the gains.

Operator

Your next question comes from the line of Jason Wright from Merrill Lynch. Please proceed.

Jason Wright - Merrill Lynch

Hi, guys. Congratulations on a quarter that you had. We take your company is pretty much undervalued here and I am just wondering if there’s possibility that you guys make your share buyback?

Amy Liu

At this point the management hasn’t think about buying back the shares, but I think there might be one of the possibility we would think but we don’t have the plan for the time being.

Jason Wright - Merrill Lynch

I was looking at the peers in your sector I mean you guys are really undervalued here I mean your great growth, your earnings have been great. You are not being recognized like you should be, we just want to wish you guys a lot of luck and continue the great numbers that you guys have been producing.

Amy Liu

Thanks for the compliment. But as a business we wanted to have a healthy balance sheet and we wanted to utilize the leverage available cash to develop and grow the business in further that's our priority for now.

Jason Wright - Merrill Lynch

Okay, great. Have a good day.

Operator

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

Paul Leming - Soleil Securities

Good evening. And I just have two questions. First some questions surrounding currency, could you talk about your heading strategies? How much of your revenue, what percentage of your revenue do you hedge, how far out do you go with the hedges and what your dollar rate you are currently locking in. Also, on the cost side, could you talk about how your raw material costs are denominated from a currency standpoint whether it’s poly or wafers are your raw material cost mostly denominated in U.S. dollars or in RMB?

Amy Liu

Okay, thanks you. I’ll probably address your later question first because when we talk about hedging, we wanted to think about nature of hedging first. Our currency, the situation for our business is -- seems quite mature percentage of supply coming from domestic suppliers. So, wafer cost basically with the big portion denominated in RMB. Majority of our revenues, I would say, more than 70% of our current revenues are denominated in U.S. dollar. So, right now we are not in a good position of nature of hedging.

However, having said that we are trying to secure more supply through international supplier which mostly denominated in U.S. dollar and coming into the second half of '08 and more towards 2009. That portion of the U.S. dollar denominated supply is going to increase and proportionally domestic RMB denominated pricing is going to decrease over time. So, that’s the part on this one.

The second question to answer your question on the hedging strategy. Yes, the management has been actively exporting and analyzing the hedging strategies and we have been starting to increment our hedging strategies since second -- early this year. So, we will continue to basically implement our hedging strategies and hopefully we can cover a good portion of our revenue, euro income revenue, in order to basically help us minimize the currency exposures.

Paul Leming - Soleil Securities

I think I heard two different numbers this morning and I think I just heard you said that 17% of your revenue is denominated in U.S. dollar and I though I had heard about the same number earlier related to being a large portion of your contracts is being denominated in Euro. Can I just ask the question this way, as you look at your 2009 revenue on the contract you had in-hand today? The revenue you are anticipating for 2009, what percentage is denominated in Euro and what percentage of that revenue is denominated in US dollars?

Harold Hoskens

Paul, we make that very clear and correct. We are predominantly in Euro in our revenues. That’s 70% that we talked about at the current level for Euros. We would expect that number to be equal to that or even higher. We are trying to contract in Euros, going forward in ‘09. I think, the number of that we talked about on the other side is that the majority of our costs are in RMB.

Paul Leming - Soleil Securities

Okay. Thank you.

Amy Liu

Sorry just a supplement, we are trying to -- going into ‘09, we are basically also trying to apply more natural hedging in our revenue stream too, so, which meaning we probably will go for more U.S. dollar pricing than Euro pricing, but in general we are trying to apply more natural hedging, plus our currency hedging strategy together.

Paul Leming - Soleil Securities

Okay. And if I could shift gears and just ask a second question, could you talk about the volume ramp in at least in general terms in the GCL contract? Are volumes constant over time? Do they grow over time? I am just trying to get some sense of how the total volume that you have indicated you will receive from GCL is spread out over the years in the contract?

Harold Hoskens

We grow the volumes and the volumes go, I think, in a certain way to get a rid of the capacity expansions of which you probably will pick up through different channels, through GCL like they are projecting our volumes grow with that. So, our volumes were very low on a spot basis in the very early part of this year. We signed a contract. We started to see material volume and that will increase during the periods to come.

So, already in ‘09 the run rate, the tons per month will be significantly higher than they are right now, and then they will further increase. I don’t have the figures at the top of my mind, so 10. But, yes, it will be a gradual increase, and then at a certain point it will come to a certain level [letting] out.

Paul Leming - Soleil Securities

Thank you very much.

Operator

Your next question comes from the line of Gaurav Mehta from Credit Suisse. Please proceed.

Gaurav Mehta - Credit Suisse

Hi. Most of my questions have been answered. I have got so one quick follow-up. Just curious to know the 5 megawatt of cells that shipped which were like of a different quality, which geography did they go into? And do you expect to ship further cells into the coming quarters as well?

Amy Liu

Yes. As part of the normal manufacturing process, you will come up with some different degree – different grade of products, and we do the same too. This 5 megawatt product basically we’re using them for to channel through the new emerging market for [Eastern] China, and secondary we also sell those cells at lower pricing. Basically, we sell those cells with clean warranty obligations, which means, we don’t provide warranty for those cells.

Gaurav Mehta - Credit Suisse

Okay, so it was not in Spain definitely?

Amy Liu

No, it’s mostly in China.

Gaurav Mehta - Credit Suisse

Okay.

Harold Hoskens

We can not always trace where our modules go and as far as can see the value chain.

Gaurav Mehta - Credit Suisse

Alright. Thank you very much.

Harold Hoskens

Where modules for these cells going observed.

Operator

Your next question comes from the line of Dan Ries from Collins Stewart. Please proceed.

Dan Ries - Collins Stewart

Hi, guys. Nice quarter. Couple of questions. You mentioned that pricing is stable for the rest of the year, was that a comment referring to euros or dollars as the two have diverse a bit here?

Amy Liu

It’s in constant currency which means the euro.

Dan Ries - Collins Stewart

Okay. So, let’s say year-end where do you see your wafer capacity and cell capacity year-end ‘08?

Harold Hoskens

Cell capacity, like I said we have concluded the expansion towards the 360 megawatt nameplate capacity in July and that picture will not change until year-end. We are ramping up our wire saw capacity on a run-rate basis, that will contribute 20% to our overall output volumes by the end of ‘08.

Dan Ries - Collins Stewart

Okay. Now, if I take your guidance for 2009, it looks like you’re pointing to the up 50% in volume with point of 275, why would you consider adding more cell lines above 360s since that already implies that you wouldn’t be fully utilized in the lines as oppose to using the money to just build more wafer capacity?

Harold Hoskens

I think it is important to recognize that like in every year up to now in [solar] there, the growth quarter-to-quarter is quite significant. So, we need to look not only at the installed capacity over the year, but especially how much do you need to do in the second half of the year on a run rate basis. And then you will see that also with maintaining a certain level of flexibility in your lines become to the need for additional investment.

Dan Ries - Collins Stewart

Okay. And then the Q-Cells tooling agreement, I think there is – I was trying to get a sense for, is the gross – would the gross margin to be accretive to the average gross margin or because from an ROIC basis you wouldn’t probably need a gross margin that high as a very good ROIC on that business. But would it actually add to gross margin or do you think that that would be come in slightly below the corporate average?

Paul Combs

I think, Dan, it’s fair to say it would be accretive to current gross margins. I think it would be potentially less than eventual gross margin it’s somewhere in between.

Dan Ries - Collins Stewart

Okay. Yes, because I missed it. And you kind of mentioned that the module CapEx is like to $7 million to $8 million for 30 megawatt line. My understanding is that that was for cell CapEx. For module CapEx it should only be something like, a nickel or water something, isn’t it some in that range, or 500 million per hundred megawatts?

Harold Hoskens

I think we look here at an investment to make a significant capacity and dedicated fashion available. We still care about dedicated module lines for certain things (inaudible) and they fortunately involve some CapEx, which is not immaterial.

Dan Ries - Collins Stewart

Okay. Well, thank you very much.

Operator

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

Cheryl Tang - Goldman Sachs

Thanks for taking my questions. Two questions; the first, among the total, a long-term contract for ‘09, how much is in RMD term? Hello.

Harold Hoskens

Sorry.

Amy Liu

The RMB terms.

Cheryl Tang - Goldman Sachs

Yes. How much?

Harold Hoskens

In RMB terms, let me briefly look, I think – I don’t know the exact RMB – I can only talk about the domestic part, which will be roughly 40%, 45% of our total incoming supply, and I think it will be safe to assume that most of that is going to be denominated.

Amy Liu

Yes, right.

Cheryl Tang - Goldman Sachs

You means, among two-third of the long-term contracts is 40% to 45%?

Harold Hoskens

40% to 45% of the contract is domestic and they will be denominated.

Cheryl Tang - Goldman Sachs

Okay. And my second question is a clarification for the margin improvement of 500 BP, and is it from the Q2 levels or from the full year ‘08 average level?

Amy Liu

It is from the ‘08 average level.

Cheryl Tang - Goldman Sachs

Okay. My last question is in terms of the in-house supply of the wafer, how much is in Q2 and how much is expected in ‘09?

Amy Liu

In Q2, we see there is approximately 10% of our total supply, and going into Q4 as Harold mentioned earlier, it will be accounted for about 20% of our total supply and going into ‘09, we think it will reach to about 40%.

Cheryl Tang - Goldman Sachs

Okay. Thank you.

Operator

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

Joe - Lazard Capital Markets

Hi guys. This is actually Joe calling in for Sanjay. Just a couple of quick questions, the first one is if you can provide a little more detail on the poly coverage for the rest of ‘08 and ‘09 as far as which percentage is coming from which of your suppliers? And then also for GCL over the term of the contract, what percentage of your supply is coming from that?

Harold Hoskens

I have the figures for ‘09 here in front of me for ‘08. I am not having it completely in detail in front of me. The majority of ‘09 contract is on the long-term basis, I would say that about 66 in that area is long-term contracts. The majority of that is long-term wafer and slight majority, and there is also long-term silicon involved in that. Does that give enough?

Joe - Lazard Capital Markets

Can you tell us as far as which suppliers is coming from?

Harold Hoskens

We have announced a long-term wafer contract in the past like a [short].

Paul Combs

Yes, I think about 50 megawatts of that will come from the three non-domestic suppliers, we have a LDK and [e-mail] contracts, and I think to answers within those are larger ones – a larger percentage of the total, I think and to respond to your GCL question, it would be less than 30% to 40% of our total.

Joe - Lazard Capital Markets

And does that shift through the term of the contract? Is it higher in ‘09 than it is in ‘010 or –?

Harold Hoskens

It’s higher in ‘09 than that it is in ‘08 and it would be higher in ‘010 than that it is in ‘09.

Paul Combs

In volume however [Multiple Speakers] ratio. That’s a bit of difficult math going on.

Harold Hoskens

Yes, I am talking about absolute volume not in terms of ratio.

Joe - Lazard Capital Markets

Okay. Okay, great. Thanks guys.

Operator

Your next question comes from the line of Sam Dubinsky from Oppenheimer. Please proceed.

Adam - Oppenheimer

Hey, guys. This is Adam in for Sam. Quick question. How much module processing business you guys expect in ‘09?

Harold Hoskens

Like I said, the Q-Cell Letter of Intent we hope to materialize into an agreement that will be 100 megawatt and that will be by far the most significant part of that business, there will be smaller possible volumes but this will be the largest one.

Adam - Oppenheimer

Okay. And also on your secured supply for ‘09 for Poly, what price decline are you seeing or cost decline do you guys expect?

Paul Combs

That is a multi-faceted answer we need to give there. First of all, you see more long-term wafer contract starting to materialize volumes. So that is, let’s say a new source of supply, how do you account for that in terms of price decline, that’s a difficult question. Secondly, we see that we buy more at the lower level of integration, so to say we buy more silicon relatively as a share that we buy in ‘08. So that has also a cost decreasing effect in terms of material purchases. So, to get from that, a real cost decline on apples-for-apples basis is quite a difficult one, because several factors are component here. I think it is, like Amy is saying, one of the key factors contributing to that 500 basis points we discussed earlier. That’s where it materializes so to say for a very significant part.

Harold Hoskens

And we are giving you two metrics, Adam. If it's accretive, you can probably do some math here. 80% of our cost of goods sold is polysilicon related and we have given you a 500 basis point increase in gross margin. So, I think, between those two points you should -- an ASP trend you should be able to come reasonably close.

Adam - Oppenheimer

Okay, great. Thanks, guys.

Operator

Your next question comes from the line of [Maher Fannie] from FBR. Please proceed.

Rocky - FBR

Actually this is [Rocky] for [Maher]. I have a question on your demand trend for second half of this year, where do you expect the demand is coming from for the second half? You mentioned 56% of sales were from Germany in second quarter.

Harold Hoskens

Correct, we expect Germany to continue to be quite strong in the second half in front of their incentive changes, so I think it's fair to say that Germany will become a larger percent of our business in the second half and Spain will become a smaller part, either all back contracts.

Paul Combs

Where as we have to add that our invoice too is becoming less and less relevant in determining where the final module ends up so to say, because more and more of our customers although we invoice to a headquarter in Germany or in Spain or in Italy they may ship that product we ask to other territories. So it's more difficult to predict from our invoicing so to say.

Rocky - FBR

And the next one is Q-Cells; do you know where this module they are going to go, are these for [rooftop, or ground mount] which country specific?

Harold Hoskens

We don’t know specifically, I think you will have to ask Q-Cells that question.

Rocky - FBR

Okay. And any particular range that you can think of for wafer price decline for next year, percentage wise?

Harold Hoskens

I think we just responded to that question, I think we’re unable to give specific percent but we are giving you the guidance line that 80% of our cost of goods sold is wafer related, polysilicon related and you know our projections for gross margin in ASPs are so you should be able to get to that number.

Rocky - FBR

Is that going to decline more toward the second half of next year, any idea?

Harold Hoskens

I think we focused here on the compounded with silicon related costs, and like I try to indicate earlier there are many factors playing into this and we will expand our vertical integrated capacity so from that you may find a contributor to improving our total silicon cost position as we go forward. To put it again into if you buy wafers what is exactly the cost declined I would not have that number here now on hand.

Rocky - FBR

Thank you very much.

Operator

Your next question comes from the line of [Daniel Backmen] from [ILG]. Please proceed.

Daniel Backmen - ILG

Hi. Thanks for taking my call. With the Q-Cells agreement differ are there standard cells or that differ there upgraded metallurgical cells?

Harold Hoskens

We will work with Q-Cells to make products according to their specification. I think to discuss what exactly the technology is they are going to use that you would need to put that question but…

Daniel Backmen - ILG

Or maybe just asking in other way will you be able to take a metallurgical cell and put into a module or is that not anything that you contemplated yet?

Harold Hoskens

I think we would be able to do that.

Daniel Backmen - ILG

Okay. And would you be warranting that module or would they be warranting it?

Harold Hoskens

And I think that goes details into the agreement and we at this point in time would not prefer to disclose details of an agreement which we are implementing?

Daniel Backmen - ILG

Just generically would you be able to warranty an upgraded metallurgical cell?

Harold Hoskens

This builds on a couple of ifs, which is maybe to hypothetical with all the ifs you accumulate for me to answer right now?

Daniel Backmen - ILG

Okay. Thank you very much.

Operator

Your next question comes from the line of [Emily Lu] for [Areth Research]. Please proceed.

Emily Lu - Areth Research

Hi. Thank you for taking my question. I have a quick question regarding capacity ran Jiangsu Yangguang. When I model this do I assume 100% of the capacity is for internal consumption of the Solarfun.

Harold Hoskens

Far majority of the internal capacity is meant for internal consumption. It doesn’t mean that if at a certain point of time we have a smaller overhang, we’d not contemplate too briefly, to provide services for somebody else but the majority of the capacity is meant for internal use.

Emily Lu - Areth Research

Okay, thanks.

Harold Hoskens

Far, far majority.

Operator

Your next question comes from the line of [Peter Pang] from [ThinkPennuer]. Please proceed.

Peter Pang - ThinkPennuer

Hi, thank you for taking my questions. Actually, quick one, what is the assumption of the [grams] watts on your 1.2 gigawatt purchase contract with GCL?

Harold Hoskens

That is a good question. I don’t have that figure on the top of my head we have in making these announcements. That is one digit behind the (inaudible), you will probably anticipate that the one digit does not offer a high level of accuracy for several kilos, the several tones or maybe even kilo tones involved. I would not have that figure on top off my head. It will also vary over the years. It will vary between nano and multi. I don’t think we have a very detailed calculation, which could lead to an operational indicate to fund that in amounting this 8-year contract.

Peter Pang - ThinkPennuer

Okay, on the other hand then, what will be sort of average grams watts on your assumptions for going forward with the LYG facility and wafer facility and how does that compare to the wafer that you’re buying from third party producers.

Harold Hoskens

We think that the wafer integrated products lead to a lower integral cost than the products we buy as wafers. This cost differences come from a couple of areas. First of all it's the production cost, the cost of making a slice, the cost of making an ingot. Secondly, we see that with our facility, we hope to realize a better material efficiency for instance to get more wafers out of a kilowatt ingot that as well currently in to market standard. The market standard is also, maybe, not always the operational performance, but maybe that also some of the slices, (inaudible) simply a number of wafers, which they can achieve and maybe keep one or two wafers also for other use. So, all of these leads to us to say we can through operational excellence achieve a better integral cross position and you can expose that in grams per watt, internally we prefer to put it in dollars per watt. And that’s the indicator we use.

Peter Pang - ThinkPennuer

Okay. Well, in terms of the grams per watt, it should help us to model based on your polysilicon price and then comes down to the wafer cost. So, it’s a very useful factor there. And I also noticed that [LVK] is reporting that they are having wafers 6 grams to 7 grams per watt at this point. So, I am just wondering if you guys are at the same level or can you better or is it going to be a little bit behind?

Harold Hoskens

Like I said our main indicator which we internally use as dollar per watt, I could not express at this point of time in grams per watt. Maybe with the further increase of volumes we get to our integrated manufacturing. We go to that indicator but currently we keep it at dollar per watt.

Peter Pang - ThinkPennuer

Okay. Thank you.

Harold Hoskens

We did it mainly it's augmentation but like I said we do it at this point in time in this way.

Peter Pang - ThinkPennuer

Okay. Alright. Thanks.

Operator

(Operator Instructions). Your next question comes from the line of Till Stenzel from Hazel Capital. Please proceed.

Till Stenzel - Hazel Capital

Yes. Hi. Thanks for taking my question. Just a quick question on your gross margin expansion, can you – you also – you already partly on to this question. I just wanted to fill up and ask in terms of the efficiency stats you get from the vertical integration and the polysilicon supply contracts. Can you not quantify to some extent the price or ASP reduction even on the dollar per watt basis that you expect in ‘09? So, since you said that this is your internal metric that you are using?

Harold Hoskens

Yes, I think from the internal metric, likely are using we can see that improvement of these high filler basis points, and netting out all the other effects. I mean it’s a compounded result of course out there and taking into the account the ASP situation, the operational efficiencies, the cost of the goods purchased plus down at which level of the value chain do you purchase them. Under that header we are comfortable in doing that. I don’t think we are, at this point in time, prepared to go in publicly sharing all the details on the dollar per watt trend through the different elements of that.

Till Stenzel - Hazel Capital

Okay. And then just a quick question, in terms of you mentioned the supply security you expect for 2009 through your contracts. Can you say how much of that is for wafers and how much is for polysilicon?

Harold Hoskens

I think I said earlier that more than 50% of our demand next year, slightly more than 50% or our demand of our volume next year is in wafers, slightly less than 50% others.

Till Stenzel - Hazel Capital

And that is based on the 50% increased production level for 2009?

Harold Hoskens

That is correct. That is correct.

Till Stenzel - Hazel Capital

And then just a last question on the Q-Cells LOI, what role could energies play in sort of brining together the two parties and facilitating this?

Harold Hoskens

I think there is a deal between two companies in such a deal where the importance, we go of course as an executives team towards through our internal metrics on this, from our ROI etcetera point of view, a good proposal, and then we share it with our Board, where various members are represented among them, directors representing shareholders among them independent directors, and in our case – and I can not allow – allowed to speak for Q-Cells. Our Board has given its support to working on this, working further on this LOI.

Till Stenzel - Hazel Capital

Okay. Thank you.

Operator

Your next question is a follow-up from Paul Clegg from Jefferies. Please proceed.

Paul Clegg - Jefferies

Hi. Thanks for taking the follow-up. I want to revisit the 5 megawatts of cells with different specs in the mainstream business. First of all, is that included in the 43.1 shipments? And then if you could talk about the gross margin impact also?

Amy Liu

Yes, this clearly does not include in the 43.1 megawatt, which is purely the normal module shipments. The 5 megawatt cell revenue comes with the 6% margin which is a much lower than our mainstream business.

Paul Clegg - Jefferies

And as a second, can you characterize the pricing, how much less than your average ASP would typically be?

Paul Combs

Yes, just to clarify, Paul. The question is the ASP for the 5 megawatt cell, how much lower would it be? And I reported ASP, by the way, excludes those cells as the volume.

Paul Clegg - Jefferies

Okay. So if we can break –

Paul Combs

5 megawatt the average selling price, do you have any idea?

Amy Liu

No, actually we don’t measure the selling price, although, it has come to with the ASP. But for our business, we want to focus on the module ASPs. For the cell sale revenue as I mentioned before it’s meant to basically [involve] a emerging market and sale at lower margin, but without a warranty support.

Paul Combs

Paul, it’s in our financials as we report them and then in part of the earnings release break down four components of revenues one of which is sale as well as the cost. So you know it’s 5 megawatt, so you should be able to get pretty close.

Paul Clegg - Jefferies

So, it’s in the cell. It’s in the photovoltaic cell number there?

Harold Hoskens

Yes, yes.

Paul Clegg - Jefferies

Okay. And just to understand, what’s driving of the [aspect] cells and whether or not this is going to be sort of an ongoing thing. Is it a function of wafer quality right now? And you have talked before about issues with the wafer quality in the current market environment, do you expect to see some of the 5 megawatt per quarter number go down as wafer quality improves, as your access improves?

Harold Hoskens

I think some of this basket comprises some elements like Amy says. In some cases we used cells to spot certain smaller market segment, so that’s in here. Secondly, you are right in a sense that there are also products in there with specifications, which do not meet our normal product portfolio so to say. That in turn is for a [applied] cost by varying wafer quality, variations in wafer quality which you can not always find out in incoming inspections, etcetera. We expect that with the enhanced availability of product, that will somewhat decrease. I think it’s a bit early to see how that all, let’s say, net out. But in general, over time I would say that is decreasing, yes.

Paul Clegg - Jefferies

And if I may, the 80% of COGS that’s related to silicon, is that including the wafer cost or is just wafer and wafering cost, or is it just the poly portion of which you’re bringing in both wafers of poly?

Amy Liu

It does include a wafer cost too.

Paul Clegg - Jefferies

Okay. Thanks very much.

Harold Hoskens

Everything which carries silicon we buy from the outside.

Paul Clegg - Jefferies

Okay. Thank you.

Operator

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

Paul Leming - Soleil Securities

Good evening. I’d like to follow up on the question that was asked couple of minutes back on the GCL contract and the plans for what assumption in the contract or in your press release, I guess I should say, you gave a megawatt number over the license of contract, but you really backed away from giving us any sense of the grams per watt you’re assuming over the life of the contract.

Could you just help us walk through how we should think about the tonnage that you’re going to get to GCL over the life of the contract or give us some sense of how you arrive at that total megawatt or gigawatt number that you put in the press release? Thank you.

Harold Hoskens

I think from the 1.2 number of gigawatt which is an enormous amount, you can see that it’s also, in that hand not very specific. You can imagine that this is an amount which is on just on one side, or just to other side of the 10 kilo tones. Do I say it correctly? It’s a lot of silicon if you use the metrics which are normally applied in the industry. I don’t think what is [AGA] period that we have tried to completely go six inches behind the comp or what operational efficiencies, etcetera, could be achieved, because also part – you do not know the exact part of the standard at that point in time.

So, I think this is really a two digit number, yes, giving the level of accuracy. With that actually giving you a level of accuracy we have on that one. We deliberately do not go to 1.27778 gigawatt. It’s really a rough cut number, not really aiming at encompassing all the details of personal performances.

Paul Combs

Paul, and to just to give you a little bit of help here, I think on an annual basis over the eight years, you can assume something less than 200 metric ton in an earlier years, and something north of 1,500 metric tons in a later year.

Paul Leming - Soleil Securities

Thanks very much. That’s very helpful.

Operator

That concludes our call today. A live webcast of the conference call will be available on the Investor Relations section of the company’s website at www.solarfun.com.cn. A replay of the webcast will be available for one month. A telephone replay of the call will be available for 24 hours after the conclusion of the conference call. The dial-in details for the replay are as follows; US toll-free number, +1-888-286-8010; international dial-in number, +1-617-801-6888. Passcode is 42684940.

If you have any additional questions, please feel free to contact Solarfun directly at ir@solarfun.com.cn. You can also contact Christensen at 852-2117-0861 in Hong Kong or 480-614-3000 in the US.

Thank you all again, and have a good day. Goodbye.

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Source: Solarfun Power Holdings Co., Ltd. Q2 2008 Earnings Call Transcript
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