First Solar, Inc. Q3 2008 Earnings Conference Call Transcript

 |  About: First Solar, Inc. (FSLR)
by: SA Transcripts


Good day everyone, and welcome to the First Solar Third Quarter 2008 Earnings Conference Call. This call is being webcast live on the Investor Relations section of First Solar's website, at At this time, all participants are in listen-only mode. As a reminder, today's conference call is being recorded.

I would now like to turn the call over to Mr. Larry Polizzotto, Vice President, Investor Relations for First Solar Incorporated. Mr. Polizzotto, you may begin.

Larry Polizzotto - Vice President, Investor Relations

After the markets closed [ph], the company issued a press release announcing its fiscal third quarter 2008 fiscal... financial results. If you did not received a copy of this press release, you can obtain one from the Investors section of First Solar's website, at In addition, we are posting to the IR website for the first time, key quarter statistics and historical data, and financial and operating performance. This will allow us to discuss in more detail, some of the analytics in this call.

An audio replay of the conference call will also be available approximately two hours after the conclusion of the call. The audio replay will remain available until Friday, October 31, 2008, at 8:59 PM, Mountain Standard Time, or 11:59 PM, Eastern Daylight Time, and can be accessed by dialing 888-266-2081. If you are calling from the United States, 4703-925-2533. If you are calling from outside the United States and entering ID access number 1288925. A replay of the webcast will be available for 90 calendar days, approximately two hours after the conclusion of this call. If you are a shareholder of... subscriber to Factset, you can obtain a written transcript within two hours.

With me today are Mike Ahearn, Chief Executive Officer; Jens Meyerhoff, Chief Financial Officer; Bruce Sohn, President of First Solar. Today Mike will begin with an overview of the company's third quarter achievements, then provide a market update and an assessment of the economy and current credit crises impact on our business. Jens will provide you with the third quarter 2008 financial results update guidance for 2008 and provide guidance for 2009. We will then open up the call for questions.

I will remind you that all financial numbers reported and discussed in today's call will based on generally excepted accounting principles. The company has allocated approximately one hour for today's call. During the Q&A period, as the courtesy, those individuals seeking questions, we ask that all participants limit themselves to one question and one follow-up question.

Now I would like to make a brief statement regarding forward-looking remarks that you might here on today's call. During the course of the call, the company will make projections and other comments that are forward-looking statements within in the meaning of the federal securities laws. The forward-looking statements in this call are based on current information and expectations and are subject to uncertainties and changes in circumstances and do not constitute guarantees of future performance.

Those statements involve a number of factors that could cause actual results to differ materially from those statements. Including the risks as described in the company's recent report on Form 10-K and other filings with the Securities and Exchange Commission.

First Solar assumes no obligation to update any forward-looking information contained in this call or with respect to the announcements described herein. Before I turn the call over to Mike Ahearn, I'd like to mention that we have decided to limit our participation at conferences during the fourth quarter and postpone our Analyst Day to future date to remain highly focused on our business.

It's now my pleasure to introduce Mike Ahearn, CEO of First Solar. Mike?

Michael J. Ahearn - Chairman and Chief Executive Officer

Thank you, Larry and thank you for participating in our third quarter 2008 earnings call. We continue to perform at high levels throughout the third quarter. Third quarter production was a 137 megawatts, up 20% quarter-over-quarter and 97% year-over-year. This represents an annualized capacity of 49.3 megawatts per line.

Net sales for the third quarter were $348.7 million, up 30.6% quarter-over-quarter, resulting in net income of $99.3 million or $1.20 per diluted share. Cost per watt in the third quarter was $1.08, including $0.04 of KLM ramp cost, representing a 9% decline quarter-over-quarter. We continue to solidify our position as the lowest cost manufacturer in the industry.

The start up of our Malaysia manufacturing center continue to progress on plan. Plant 1 is operating at steady state and performing well. Plant 2 product qualification tests were completed successfully and product shipments have commenced and we expect to reach full capacity for Plant 2 by the end of this year, ahead of our original schedule.

We generated $41.6 million of free cash flow in the third quarter, while continuing to fund high levels of growth. Our cash and investments grew to $729 million. And today, we announced a total of 625 megawatt of contract volumes, including contracts with European customers totaling 525 megawatts and contracts with the US customers totaling 100 megawatts. This represents a total of $1 billion of revenue at an assumed exchange rate of $1.15 per euro.

We have been diligently assessing how the negative economic events are folding worldwide could impact our markets and our business going forward. I'd like to share our findings to-date with the understanding that this is an interim report and our findings and conclusions could change as the dynamic financial and economic conditions continued to revolve and their impact on the solar industry becomes clearer.

We start with the status of the subsidy programs that drive the vast majority of the industry demand. During the past three weeks we have met or spoken with officials at each of the major feed-in tariff programs in Europe, including Germany, Italy, France, Spain Czech Republic and Greece. In addition, we've talked to officials in the other markets served by our European customers including South Korea, Ontario Canada, California and New Jersey, regarding their programs.

Although subsidy programs are political in nature and therefore inherently unpredictable. Discussions with these political and regulatory authorities have confirmed that there are no plans to cut programs in any of these markets and that material, near-term subsidy reductions across these markets are unlikely. There are several reasons for this; first any significant reduction in these programs could result in job loss and reduced economic activity, at a time when local economies cannot afford it and in fact seek stimulus.

Second the cost of the solar programs is generally modest in relation to other programs and largely factored into existing electricity rates. And third those countries that felt the need to moderate growth, mainly Germany and Spain, have already modified their programs, while the remaining countries are still in the ramp stage.

We believe these subsidized markets offer opportunities for further growth and we plan to continue diversifying into them from our strong market base in Germany. At the same time, we continue to drive to open new markets that do not depend on traditional PV subsidiaries, and can offer significant long-term growth, such as the California RPS market for utility scale generation.

We've also reviewed the adequacy of capital availability in Germany to finance Solar PV projects that use our modules in light of the current credit market conditions. Approximately 70% of our 2008 module volumes will be deployed in Germany and we estimate that at least 60% of our 2009 module volumes will be deployed in Germany. We have several... I should say seven customers based in Germany.

Over the past three weeks, we've met with the German Ministry of the Environment, KFW, which is the German Reconstruction Bank and a number of German banks that we believe represents the leading lenders to solar projects in Germany. We have also spoken to a variety of European Banks that have been active in financing solar projects across the rest of Europe.

In Germany, solar project loans typically have been made on terms that include interest rates of approximately 5%, leverage ratios of 70% to 80%, and loan maturities of twelve years and more. These favorable loan terms have been facilitated by an indirect subsidy provided by KFW. Under this program, KFW provides funding for solar project loans that are originated by banks to finance projects owned by German equity investors and the KFW program applies to projects located throughout the EU, not just in Germany.

Effective January 1, 2009 in a modification unrelated to the current economic issues, KFW intends to consolidate and simplify its programs and will provide project financing up to €10 million per project, which is generally sufficient to fund projects up to 4 Megawatts approximately in size. Prior to this modification, the KFW programs had a combined €10 million per project limitation but also had an exception process to enable approval for larger funding and it's our understanding that this exception processes will be removed as of January 1, 2009.

Based on our customers 2009 projected market and application mix, we estimate the approximately 85% of our Germany volumes in 2009 will continue to be fully eligible under the revised KFW program and the remainder will need to be financed outside of the KFW program.

So, turning to the credit market outside of KFW. Although German bank lending has slowed, some regional and national banks continue to lend to establish developers and integrators. Among active lenders, we believe interests rates are currently ranging from 7% to 8% with most projects requiring syndication. We're also seeing evidence that state government-backed financial institutions are becoming involved in providing solar projects loans and the small local banks not negatively impacted by the credit crisis are making relationship-based loans for local projects in some areas.

In total, the credit situation in Germany aided by the liquidity provided by the KFW program, appears adequate as of today to support out planned 2009 sales into the German market, even though constraints and inefficiencies could cause some of customers operating outside the KFW program to experience near-term delays.

The availability of project equity in Germany is more difficult to assess. Historically, the equity market has been a fragmented market dominated by individual and high network investors and small pools of fund investors, with institutional investors providing financing to some of the larger projects. Fully leveraged free-tax returns in Germany have traditionally ranged from 6.5% to 8%. In attempting to assess where equity returns may move in 2009, we found the information to be highly anecdotal and uncertain.

As a base case, we're assuming that any increase in equity returns would not impair the sale of our modules at current price levels. We based this in part on the resilience we built into our module prices today and also on our expectation from moderate equity return adjustments based on the low-risk nature solar project revenues and cash flows, based on the cash flows resulting from highly predictable long-term solar generation and national laws [ph] that is sure, sale of a 100% of the solar generation at attractive prices over an extended period of time.

However, because of the uncertainty over how the capital costs and availability will evolve in 2009, we also believe it's sensible to model the contingency scenario in which First Solar provides financial support to enable higher project returns if needed to support the market. The effects of our contingency plans are incorporated into our guidance that Jens will be sharing with you in a few minutes.

We've also reviewed the adequacy of project financing in the rest of Europe. Approximately 25% of our 2008 project volumes will be deployed in European markets outside of Germany in 2008 and we estimate that up to 40% of our 2009 project volumes may be deployed in these markets. We have nine customers based outside of Germany serving the European market. Most of our volumes sold into Germany are deployed by customers who typically develop projects and sell them to third party investors. By contrast, most of our volumes sold in the non-German European markets are deployed by customers who act as independent power producers. Under their business model, independent power producers generally own and operate solar generation projects for the long term and finance them with a combination of debt and their own equity.

Our review indicates that solar projects lending outside of Germany has essentially stopped for the time being. However, we believe most of our IPP customers have adequate funding to bridge lending delays into 2009 and we assume that neither these delays nor higher debt costs will impair project economics for our customers at First Solar's current module prices. And we've based this assumption in part on the resiliency provided by First Solar's module pricing, the current contracts and also on the relatively high equity returns that can be achieved in European markets outside of Germany due to favorable combinations of irradiance and feed-in tariff rates.

As part of our review, we also assess the financial and execution capabilities of our customers. It has been our practice to partner with customers based on their abilities to develop and execute upon multiyear pipelines of business in diversified geographic markets. We work closely with our customers and allocate additional module volumes to them over time based on the visibility of their pipelines, our understanding of their executional capabilities and other strategic considerations. Although no business is independent [ph] of pressure under the current financial conditions and we do observe some variability in the financial health for some of our customers, we believe our customer base on the whole, sound and able to execute the planned volumes in 2009.

Today, we have identified potential financial risk in our customer base that represent approximately 15% to 20% of our planned sales in to Europe in 2009 and we have identified the demand to reallocate such volumes it's in the horizon.

We have also considered the potential effects of module oversupply on our business in Europe and specifically the possibility as some analysts have recently suggested that module oversupplies may force unplanned reductions in the price charged by First Solar. To put this issue in perspective, First Solar's long-term contract price in 2009 is a €1.54 per watt, which is substantially below the current marked level of crystalline silicon module prices and likely below most suppliers' estimated cash costs.

We do not envision a realistic scenario in which crystalline silicon modules would be able to achieve cost levels that enable competitive pricing with First Solar's existing contract prices and we therefore assume that any price competition is unlikely to have a sustained impact on First Solar.

In fact strong customer demand continues for our modules at current price level, as evidenced by agreements we announced today with European customers. Now to summarize this briefly, we amended our existing framework agreement with Ecostream to add 370 megawatts under pricing and terms consisting with our existing framework agreement. Ecostream is subsidiary areas of the Econcern a Netherlands-based company that provide sustainable energy and energy conservation products and services. Ecostream operates in multiple solar markets and has captive sources of equity finance as well as significant debt financing capability.

We amended our existing framework agreement with EDFEN to add 75 megawatts under pricing in terms consistent with our existing framework agreement. EDFEN is a publicly-traded affiliate of one of the largest utilities in Europe. We entered into a 25-megawatt agreement with Sorgenia the fourth largest utility in Italy to deploy ground-managed systems. The Sorgenia agreement adds to our existing agreement with NL to form a strong utility customer base to support future growth in utility skilled projects in Italy.

We entered into a 40-megawatt agreement with UB to support planned project development with a specific financial sponsor. And finally, we expanded our contract with Phoenix Solar over 15 megawatts to serve specific identified opportunities in Italy in 2009.

Turning to the US, the recent extension of 30% ITC through 2016 removes a major market uncertainty and combined with a number of state RPS programs positions the US utility segment for strong long-term growth prospects. In the short-term, our review indicates that the traditional investors in tax equity, financial institutions have largely stopped participating. We assume some of these investors will return to the market in 2009, but the timing and future cost of this funding is difficult to predict. The possibility of more expensive tax equity and its impact on solar electricity prices for both new and pending projects remains a major uncertainty going into 2009.

The recent ITC extension broadened the potential investor base for US solar projects in two ways. First; the ITC has been extended to regulate utilities. Second; the alternative minimum tax treatment has been eliminated making the ITC available to corporate investors. We believe opportunities exist to tap both of these new sources in order to make solar project equity more robust and less costly in the US over time.

And entering into the US utility market, First Solar has taken a diversified approach that includes working directly with utilities and utility-affiliates as well as pursuing PPA structures with financial investors. We are continuing to make good progress in entering the US utility markets.

We have executed a framework agreement with Edison Mission Energy, the non-regulated developer subsidiary of Edison International. The framework agreement creates a strategy relationship between First Solar and Mission, under which Mission and First Solar will work together to develop large solar utility projects within the United States for identified customers. Under the agreement, First Solar will provide design... I should say, we agreed to provide design, engineering, procurement and construction services for such projects, subject to the satisfaction of certain contingencies and entering into definitive agreements for these services for each project.

By combining Mission's extensive track record of power project development with First Solar's low-cost systems and construction capability, we believe we've created a powerful engine for future growth in the US utilities segment.

The 2.4 megawatt DC rooftop project we previously announced with Southern California Edison has been completed. We are on-plan to completing the 12-megawatt DC project that we're currently constructing for Sempra by end of the year, providing important validation of our EPC capability. We also remain involved in a number of discussions to expand our relationships to serve the utility market.

In addition, to expanding our presence in the utility market, we also announced an important expansion of our business model. Our entry into the US residential market through a strategic alliance with Solar City. First Solar and Solar City have entered into a five-year 100 megawatt module purchase and supply agreement.

And in addition, First Solar has invested $25 million in Solar City in exchange for a minority equity interest, in order to help fund Solar City's expansion in the new geographic territories and market segments. Solar City is a market leader in the residential system integration business in the US. It operates in California, Arizona and Oregon and has plans to expand through additional geographic markets in 2009. The company operates a business model that drives continuous cost reduction and strong economies of scale. Solar City and First Solar share a common goal of making solar electricity an affordable option for homeowners and businesses.

So, to sum up our market view for 2009, we expect that approximately 85% of our contract volume in Germany can be fully financed through KFW on attractive loan terms. We assume solar projects will remains an attractive equity investment in Europe due to predictable low risk revenue and cash flow streams, to hedge the risk of higher than expected equity returns requirements we're developing plans to provided financial support to a enable to the market if necessary and we're including the impact of these plans in our 2009 guidance.

We believe most of our European customers outside of Germany have sufficient balance sheet strength to bridge any near term projects delays and to comply with their obligations under our take-or-pay contacts. We assume they will continue to run attractive returns on solar projects even if that costs increased. We've identified potential financial concerns within our customer based that impact 15% to 20% of 2009 volumes. And we've identified demand that could provide a reallocation of these modules to other customers if the need arises.

As the industry cost leader, we are already priced well below competing products and continue to experience demand for our module in current price levels. We give the US utility market as an attractive market over the next several years and we're establishing the foundation for this next-stage of growth. And finally, we are extending into distributor-generation market in the US and have formed a alliance with Solar City to begin implementing our strategy.

In times of uncertainty these are assessments in the risks and opportunities, strategies and plans could change quickly and dramatically. Our business philosophies however, will remain constant and are worth repeating briefly.

First, we favor long-term visible pipelines of demand backed by take-or-pay contracts, framework agreement or other structures that establish long-term business relationships. We have been willing to trade our short-term opportunistic profits with a visibility, and market positioning provided by our long-term approach.

Second, we matched production capacity to bottoms-up visibility into demand for our modules. Our strategy has always been to expand production incrementally to match attractive market demand. By matching capacity to demand rather than building production capacity on speculation, we have avoided taking excessive risk with expansion capital or knowingly putting ourselves in a position that requires us to deviate from our preferred markets and customers, simply to fill a new factory of orders.

Third we manage our financials prudently, with a rapidly growing technology-oriented business; it is not always easy to balance the demands for growth and development with a need for financial discipline and soundness. At First Solar, striking this balance has always been part of our culture. We achieved profitability in 2006 at an annual production rate of 75 megawatts, one of the lowest breakeven points in the history of the industry. We consistently avoided taking on excessive leverage and we have maximized our networking capital position with rapid payments terms under long-term agreements. We have focused on achieving positive free cash flow as soon as prudently possible.

And finally we are grounded in reality and we take a pragmatic approach to risk. We do not knowingly ignore uncertain events that could meaningfully impact our business, but rather attempt to identify them, convert them to opportunities where possible and mitigate them where appropriate. We have always tried to be transparent with our key stakeholders with regard to our views and approach to the business and its risk.

So with that I would now like to turn the discussion over to Jens Meyerhoff, who will discuss our third quarter 2008 financial results, update the financial guidance for 2008 and provide First Solar's 2009 financial guidance.

Jens Meyerhoff - Chief Financial Officer

Thank you Mike and good afternoon. Net sales for the third quarter of 2008 was $348.7 million, an increase of 30.6% over the second quarter of 2008. The increase was primarily driven by continued strong demand supported by the ramp of Plant 1 in Malaysia and higher line throughput slightly offset by currency fluctuations as the euro declined sequentially from a $1.56 in Q2 to a $1.51 in Q3.

Manufacturing cost per watt for the third quarter was $1.08, down 9% quarter-over-quarter and included $0.04 of Malaysia ramp up and $0.03 of stock-based compensation expenses. Excluding these expenses, core manufacturing costs per watt are now at a $1.01 and are expected to continued decline with the ramp of all plants in Malaysia. Cost per watt also benefited by $0.02 from the decline in euro.

Gross margin for the third quarter was 56.1% and benefited from the significantly lower production cost offsetting the unfavorable impact of the euro decline and the ramp out from our plants in Malaysia. Gross margins is expected to decline sequentially due to the further decline of the euro exchange rate and continued ramp penalties from bringing up production capacity in Malaysia in the fourth quarter.

Operating expense growth slowed in the end of the quarter, a trends we expect to continue through the remainder of 2008 and into '09, as we are reaching infrastructure scale in most areas. Operating expenses excluding plant startup costs were 16.9% of sales in the quarter. These plant startup costs increased by $1.7 million sequentially to $6.3 million in the third quarter as Plant 2 and Malaysia commenced production and we continued to incur startup expenses for Plant 3 and 4.

Operating income for the third quarter was $130.2 million or 37.3% of net sales and included $17.3 million of stock-based compensation expenses. The third quarter continued the strong underlying operating leverage in our business model with variable margins remaining above 70% and an incremental operating margin of over 50%. Net income for the third quarter of 2008 was $99.3 million or $1.20 per share on a fully diluted basis and included $5.3 million of interest income at a tax rate of 25.4%.

Cash and all other marketable securities increased by $68.2 million to $729.4 million in the third quarter. We generated $41.6 million of free cash flow and expect to be free cash flow positive in 2009. Cash flow from operations during the third quarter of 2008 was $137.3 million. And it was impacted unfavorably by an increase in working capital of $30.8 million driven by both revenue growth and the actual and pending startups of our various plants in Malaysia. We've spent $95.7 million on capital expenditures during the third quarter against a depreciation of $16.9 million.

Before I get to the specific guidance for the fourth quarter of 2008 and the year of 2009, I would like to explain the underlining assumptions and potential risks we are trying to address with this guidance. Starting with foreign exchange rates; for the fourth quarter 62% of our expected net sales are hedged at an exchange rate of $1.46 per euro. In addition, our actual hedge brings the net income hedge ratio to 77% for the fourth quarter. We assume an average exchange rate of $1.20 to the euro for the unhedged portion of our Q4 guidance.

For 2009, 26% of our expected net sales are hedged at an average rate of $1.42 per euro. In addition, our national hedge bring the net income hedge ratio to 33% for 2009. Since we layer our hedges, the net income for the first and second quarter of 2009 are hedged to 52% compared to the second half of 2009 at 12%.

We assume an averaged exchange rate of $1.15 per euro for the unhedged portion of our 2009 guidance bringing, the overall assumed average euro exchange rate to $1.22 per euro for 2009. For 2009 a $0.01 fluctuation in euro impact our revenues by approximately $11 million and our operating income by approximately $10 million.

Risk number two; risk in our guidance is the cost of capital to finance project. While near-term liquidity shortages could impact certain markets, our guidance assumes the general availability of capital for reasons outlined by Mike earlier. But we expect the cost of such capital to be as much as 200 basis points at 2008 levels.

We had to evaluate project economies in different market segments based on these assumptions. And we're prudent to have incorporated contingences. However, we do not expect these contingencies to reduce the economics of our long-term contracts, but these contingencies could have an impact on our financial statements due to certain accounting requirements.

With that, let me go to for our guidance for 2008. 2008 net sales are expected to range from $1.220 billion to $1.240 billion subject to customer mix, foreign exchange fluctuations and the ramp up of our second plant in Malaysia. We expect annual plant startup cost of approximately $34 million unchanged from our prior guidance.

Stock-based compensations is estimated at $61 million to $62 million for 2008, with approximately 20% allocated to cost of goods sold, consistent with our prior guidance. GAAP operating margin for 2008 is expected between 34% and 35%, subject to the net sales in foreign exchange rate assumptions. Our tax rate for 2008 is expected not to exceed 26%, down from the 28% in our prior guidance. Year-end 2008 fully diluted share count guidance remains unchanged at an estimated 83 to 84 million shares. Capital expenditures for the year remains essentially unchanged at approximately $540 million. This concludes the guidance for 2008 and let me with that address our guidance for the fiscal year 2009.

We expect net sales of $2.0 billion to $2.1 billion for 2009 subject to customer mix, foreign exchange rate fluctuations, credit market conditions and the ramp of Plant 3 and 4 in Malaysia. We expect plant startup cost of $13 million to $18 million and stock-based compensation at a range of $80 million to $85 million with approximately 20% allocated to cost of goods sold. Our expected GAAP operating margin for 2009 is between 33% and 34%, subject to net sales.

Our tax rate for 2009 is expected not to exceed 11% as we benefit from our long-term Malaysian tax holiday. Year-end 2009 fully diluted share count guidance is an estimated 84 million shares. CapEx for the year is expected to be approximately $325 million for the investment in the completion of our plants 3 and 4 Malaysia and our Pearisburg expansion and various infrastructure needs.

This concludes our prepared remarks and we open the call now for questions. Operator?

Question And Answer


Thank you. [Operator Instructions] Our first question comes to us from Mark Heller of Merrill Lynch.

Mark Heller - Merrill Lynch

Thanks. I was just wondering if you could update us on the company's current... total current backlog, both in megawatts and sales at this point?

Jens Meyerhoff - Chief Financial Officer

For 2008 or for 2009?

Mark Heller - Merrill Lynch

Going forward in total.

Jens Meyerhoff - Chief Financial Officer

I think in total I think the total backlog for the company right now under long-term contract is at approximately $6.3 billion.

Mark Heller - Merrill Lynch

That assumes what exchange?

Jens Meyerhoff - Chief Financial Officer

That assumes an exchange rate are of $1.15 consistent with guidance we gave.

Mark Heller - Merrill Lynch

Your outlook for the utility market in the US, do you think it's an '09 opportunity for you guys or is it more looking at 2010 and beyond?

Michael J. Ahearn - Chairman and Chief Executive Officer

It's already been planned 2010 and beyond just because of the timelines involved in getting through, permitting approval processes, the RFP processes and so forth. So, there are small volumes planned. We continue to do these pilot projects and due to format of work that we are thinking second half of 2010 just went through larger volumes with start.

Mark Heller - Merrill Lynch

And just a sort of housekeeping question. It seems like production was 136.5 megawatts, but how much were sales in megawatts?

Jens Meyerhoff - Chief Financial Officer

So I think you get all the statistics I think on our website there, Mark. With respect to ASPs and production volumes sold, we will not guide to that or share that information going forward as it tightened to pricing and pricing is becoming much more competitive discussion going forward and we will probably going to like to keep that to ourselves.


Thank you. Our next question comes from Vishal Shah from Barclays Capital.

Vishal Shah - Barclays Capital

Thanks for taking my question. Jens I wanted to just ask you about your guidance for 2009 of operating margins. It looks like given your cost structures were improved significantly as you ramped Malaysia and you demonstrated that, but it looks like your operating margin guidance is flat and moved slightly down for next year. Can you, maybe help us understand some of the moving parts there?

Jens Meyerhoff - Chief Financial Officer

Yes, I mean I would say generally, a big driver of that is obviously the decline in the euro that we factored into the 2009 guidance right. By applying $1.15 exchange rate for the unhedged portion that obviously puts a sequential decline right into both, the revenues on a one-for-one basis but then also gross margin and operating margins. And I think, I would like to remind people on many calls prior to this one, we have always highlighted the benefits of the euro provided at exchange rates of a $1.50 to a $1.60. So here we're taking a conservative stance. We are not experts on predicting foreign exchange rates. I do not know who is but that's essentially underlying assumption there.


Thank you. Our next question comes from Rob Stone of Cowen and Company.

Robert Stone - Cowen and Company

Hi guys. Jean say the 2008 tax rate is a lot lower than we were assuming, I think this 3.2. Can you comment on what the sustainable tax rate might be, so we are in 2010 and next couple of years?

Jens Meyerhoff - Chief Financial Officer

So, the tax rate is so if you look at 2008 tax rate it essentially takes into account the full benefit of the tax holiday and obviously with having all the capacity up in running in Malaysia write that on a profit rata basis, it becomes very meaningful. So now, as we move into these outer years Rob, you could assume that if we never were to repatriate any cash within the near term rate we don't believe we'll be the fact, that we would remain right in this low teens. However, if we were to decide to repatriate cash back into the United States and then repatriation, we will be taxed at a US tax rate driving the effective rate up. We'd obviously advise you of such plans on a going forward basis.

Robert Stone - Cowen and Company

For the next couple of years probably it stays in the low teens?

Jens Meyerhoff - Chief Financial Officer

Yes, we assess and these were with respect to the global liquidity requirements right and were the cash if needed on an ongoing basis. I think through '09 right now that assessment has resulted in an answer where we do not believe the repatriation is required.

Robert Stone - Cowen and Company

Last question if I may, I am a little bit of puzzled by the contrast between your comments about contract extensions where you say that they have essentially been extended under the same terms that we're all aware of before and yet you have elected not to provide details regarding ASP in the future. So, since your annual 6.5% decline in euro pricing was already well known, the less you are changing that which it didn't sound like you were intending to say, why are you no longer going to disclose?

Jens Meyerhoff - Chief Financial Officer

Well, I would say I think pricing, I mean I believe we are probably one of the very few companies across various industries that has been giving this type of level of detail and generally, I would say that that is closer has not surfaced to well and negotiations as we move into new markets and open up new customers and therefore we want to be slightly more guarded. You shouldn't imply anything around the long-term contact out of that change.


Thank you. Our next question comes to us from Stephen O'Rourke of Deutsche Bank.

Stephen O'Rourke - Deutsche Bank Securities

Thank you, good afternoon. Jens you gave a capital spending number in '09 that would include the build-out of Malaysia 3 and 4 and the Pearisburg facility. In this environment how are you thinking about further expansion and for a decision that you make in '09, what would be the lead time from that decision to bringing a factory into production?

Jens Meyerhoff - Chief Financial Officer

So, since I have Bruce here with me, I'll probably tackle the first part of your question and then let Bruce talk through the timing. So, I would say, generally, we're obviously as I mentioned before, on a consistent basis try to map demand and supply, and that has resulted right historically in decisions to build more capacity of primarily against long-term commitments coming from our customers, as Mike mentioned.

I don't think we have changed that profile has not changed. So that is an ongoing process. So now I would say, given where we're standing today, this may not be today as a right time to build out massive capacity, even though I think we always maintain a stage of readiness and optionality to do so. But I think the next few weeks for themselves will give us more clarity around the situation in the market and the especially the liquidity situation around the credit market. And from thereon I think we can resume the profit under the lead times I think that Bruce will explain to you.

Bruce Sohn - President

Yes, typical lead times that would be that about five to six quarters between the time that we actually breaks ground than the time that we begin shipping, in this environment probably limited predominantly by our ability to actually construct and depending on the exact location where we chose to site the facility.


Thank you. Our next question comes from Timothy Arcuri of Citigroup.

Timothy Arcuri - Citigroup

Hi two things, I guess first of all has your concept of good clarity and really how you price, has it changed given that we've seen natural gas prices get cut in half during the last few months. Does that make you when you're signing these contracts, does it make you have to get anymore aggressive with your ASP profiles into the out years and then I have a follow-up question? Thanks.

Michael J. Ahearn - Chairman and Chief Executive Officer

No, it doesn't have any impact on these kind of price discussion at all Tim. In the European markets, the discussion... the market demand is really driven by the feed-in tariff rates which are fixed by law and don't respond our modify relation to changes in gas prices or anything else. And so, our customers and that whole channel for that matter is really gauging economics after feed-in tariffs and plant digression rates in the tariffs. So it's invariable there, I think we have more to do with cost of capital.

In the US, I don't think it really has worked that way, either I mean the RPS programs are in place, the targets are there, the pipelines and the whole process of securing business works on a long-term basis. In California, they set a market price reference periodically that will update for changes in forward gas prices but it's not... this isn't a very immediate reactive market in that fashion. So we don't see that, have not seen that as an issue.

Bruce Sohn - President

And for the same time, we really didn't see a benefit out of the rise... temporary rise to certain gas prices either.

Jens Meyerhoff - Chief Financial Officer

Yes, that's true.

Stephen O'Rourke - Deutsche Bank Securities

Of course right okay. And then Jens last thing for you; so it looks like the CapEx next year is a lot less than I actually though it would be. I guess if that... it seems to imply that there is not going to be any spending on anything beyond Malaysia next year. So if that's the case then what's the earliest that we could expect to have production out of the next fab. It would seem that even the first half of 2010 if you are not spending anything in 2009, if I wouldn't be getting any production out of the new fab in the first half of 2010?

Jens Meyerhoff - Chief Financial Officer

Yes, I wouldn't imply, I mean what we are implying right now in the CapEx guidance is to cover both the Pearisburg expansion and completion of Malaysia. And if it... I would not imply out of this guidance that we have decided not to build another plant in 2009. We just happened to announce loan and as the time we believe as the right time to announce that we would obviously update that guidance. The comment around being a free cash flow positive in 2009 will tolerate of significantly higher CapEx number than the one underlying our '09 guidance.


Thank you. Our next question is from Nick Allen of Morgan Stanley.

Nick Allen - Morgan Stanley

Hi, can you talk a little bit more about the contingency plans regarding your other customers that may affect accounting in 2009?

Jens Meyerhoff - Chief Financial Officer

Well, I would say probably at this point of time I will not talk about this in too much detail, Nick honestly. I mean fundamentally right now as we assessed our pipeline, we believe that the economics are robust under the current long-term contracts. So there is essentially more or less a contingent scenario around either unique customer-specific scenarios and circumstances or we'll provide contingency against maybe unlikely but possible significant further deterioration of a cost of capital.

Nick Allen - Morgan Stanley

Thank you.


Our next question is from Satya Kumar of Credit Suisse.

Satya Kumar - Credit Suisse

Hi thanks. Jens, can you talk a little bit about the cost reduction, the efficiency seems to have plateaued around 10.6% plus-minus? Can you talk a little bit about where your balance of system costs are now for larger projects in Germany and how much progress you're making towards splitting that account to the dollar for what target? And how we should think about the efficiencies improving over the next few quarters?

Jens Meyerhoff - Chief Financial Officer

I'd say so essentially obviously the dollar target does not necessary apply to Germany because the balance of plant costs drive in the German, European markets are predominately managed for customers there as them being the integrators. So our long-term target to get to a dollar per watt on the balance of plant side right, essentially applies to our own efforts designing our own solution of optimizing the construction profits right and gaining economies of scale. And that obviously is combined with the ability of the module to have a higher watt and higher conversion efficiency.

So I would say based on what we have learned out of all pilot projects, we have not only seen I think in some cases that we outperformed our initial estimates but also that we learnt, we learnt a lot that indicates to us that there is a significant opportunity to further lower the balance of plant cost.


Thank you. Next we will hear from Kelly Doherty of McCoy Capital.

Unidentified Analyst

Hi thanks for taking my questions. Previously you have been talking about focusing just on U.S. utility, so I am wondering if you can give us a little bit more insight into your decision enter the residential market. Obviously credit is tough and the housing markets specifically in California is a little bit difficult. So I am wondering what do you find so compelling about the market or perhaps it was the opportunity to invest with Solar City itself?

Michael J. Ahearn - Chairman and Chief Executive Officer

Kelly we have actually been, we have been talking to Solar City following them and talking to them for about 18 months and thinking about our strategy for entering the distributed generation side of the market in the US. And we started with utility scale because that plays very well to our core business and our strengths and we saw opportunities to hit a price point on this large projects. But, the distributive side of the market in the US, we think is going to be very significant. The problem is it's highly fragmented and until that 30% ITC was extended it didn't had no visibility into whether there be a market over the next several years that would warrant investing the resources and time.

So, as the ITC was extended we started to refine our thinking a little bit and we believe, Solar City provides a way to a partnering relationship for us to drive some pretty significant growth into the distributed side. We think there's price elasticity in some of these markets that hasn't been tapped with higher cost modules and we think that Solar City is very good at things that we don't want to do, which is aggregate demand and do the hand-to-hand work with the end user in the tranches. So, it's an alignment that will allow our business module to work and we think we can expand market and move away from subsidy dependence, just like we're doing on the utility side.


Thank you. We have time for two questions from the phone. This one from Jesse Pichel of Piper Jaffray.

Jesse Pichel - Piper Jaffray

Thank you for taking my question. Can you talk a little bit about efficiency improvements on the horizon and what significant milestones should we look for?

Michael J. Ahearn - Chairman and Chief Executive Officer

As of reverse, yes so the efficiency internally we maintain a roadmap that really looks at the gamut of opportunities to improve the performance of the modules ranging from transmission of the light into the module, the conversion of the light into current and then heating it outside of the modules through the back contact. And we continue to have a range of engineering solutions that should allow us to continue to improve the performance of the module over time. And as we have stated many times before these improvements tend to be event driven, they don't occur in individual quarters, particularly in order they come out linearly as perhaps say, growth rate or something that like that much look at. Nevertheless, we believe we are still on track for a long-term plan to achieve our long-terms financials, given the roadmap that we have laid out for ourselves and the laid out which the engineers are able to deploy and qualify new improvements.


Thank you. Our final question comes from Michael Molnar of Goldman Sachs.

Michael Molnar - Goldman Sachs

Good afternoon. Thanks for taking my question. Just a quick one as most of my questions have been answered. The longer term goal of $0.70, a lot production cost from 2010 to 2012 I think. First, can you tell us given that we are getting very close to 2009, any color on if that's likely to happen more towards the beginning or end of that goal. And second, if you can remind me if that includes or excludes stock-based comp costs?

Jens Meyerhoff - Chief Financial Officer

Yes it includes that. It includes SPC and no, we don't give any thing that granular Michael. I mean I can state that we are continuing to track to all the milestones that would get us to that level within that timeframe. So, in that respect, we feel we'd continue to feel confident but we wouldn't provide that kind of guidance or visibility right now.

Michael J. Ahearn - Chairman and Chief Executive Officer

I mean there's maybe, some more visibility into this. We have multiple plants that are producing at this point in time at a sub-one dollar level.


Thank you. Ladies and gentlemen, thank you for your questions and for your participation in today's conference. This does conclude our program. And you may now disconnect. .

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