Energy Conversion Devices F1Q09 (Qtr. End 09/30/08) Earnings Call Transcript

Energy Conversion Devices, Inc. (ENER)

F1Q09 (Qtr. End 09/30/08) Earnings Call

November 10, 2008 10:00 am ET

Executives

Mark Trinske - VP, IR and Corporate Communications

Mark Morelli - President and CEO

Harry Zike - VP and CFO

Analysts

Sanjay Shrestha - Lazard Capital Markets

Rob Stone - Cowen & Co.

Satya Kumar - Credit Suisse

Brian Gamble - Simmons & Company

Steve O'Rourke - Deutsche Bank

Stephen Chin - UBS

Elaine Kwei - Piper Jaffray

Timothy Arcuri - Citi

Sam Dubinsky - Oppenheimer

Al Kaschalk - Wedbush Morgan

Kelly Dougherty - Macquarie

Olive Werse - American Technology

Presentation

Operator

Welcome to Energy Conversion Devices' conference call to discuss the company's first-quarter fiscal year 2009 financial results. As a reminder, today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions).

I would now like to call over to Mr. Mark Trinske, Vice President of Investor Relations and Corporate Communications. Please go ahead, sir.

Mark Trinske

Thank you, Aquila. Good morning, everyone, and thank you for joining us on our first quarter earnings call. Participating on this call are Mark Morelli, our President and CEO, and Harry Zike, Vice President and Chief Financial Officer.

This morning's presentation will include the use of several slides, which will be on our webcast. We will be controlling the advancement of the slides and providing commentary on each. A downloadable copy of the slide presentation and our first quarter earnings press release are available on our website at www.ovonic.com.

Today's call will also be archived on our website. A special note for those participating via conference call today, we ask that you please select the "No Audio Slides Only" link when prompted during your webcast registration. This will allow conference call participants to view slides in sync with the audio.

I would like to remind you that the following discussion may contain forward-looking statements within the meaning of the SEC's Safe Harbor provisions. Such statements are based on assumptions, which ECD as of the date of this call believes to be reasonable and appropriate.

We caution you that the facts and conditions that may exist in the future could vary materially from those upon which these statements are based. Please review the risk factors identified in the ECD filings with the SEC, including our most recent 10-Q, which will be filed later today.

And now I would like to turn the call over to Mark Morelli. Mark?

Mark Morelli

Thank you, Mark. Please turn to slide three. We are pleased to report strong growth and profitability for our first quarter. Total revenues increased 16% from the fourth quarter to $95.8 million.

We produced a record 30.8 megawatts and due to higher than expected productivity, our solar gross margin was 33.4% and total consolidated gross margin was 34.1%. These substantial improvements drove operating cash flow for the quarter to $26.5 million, a 68% increase from the fourth quarter, a great way to start the new fiscal year.

Please turn to slide four. There are certainly near-term challenges facing the global solar market, including customer cancellations and postponements, tighter project financing, pricing pressures, and a rising US dollar. While these challenges are real, we firmly believe that we have the right product and the right strategy to not only weather these challenges, but emerge as one of the long-term leaders.

Before we get into specifics of the quarter results, I would like to reiterate our strategy and the fundamentals of our model that enables us to execute that strategy. We are the global leaders in PV on rooftops. We are focused on operational excellence.

We will expand gross margins while growing capacity. We are growing capacity one gigawatt through an expansion plan that is demand driven. Having the right strategy is not the only differentiator we have in today's market. We also are in a good position to execute our strategy without having to raise additional capital.

Please turn to slide five. One way that we will continue to grow is through diversification of our end markets, which also helps us better manage risk. Despite the current credit crunch, we still believe that the global PV market will grow exponentially in the years ahead.

We are currently focused on the commercial rooftop segment for several reasons. First, it's the fastest-growing segment of the market with a 50% compound annual growth rate. Second, rooftop installations receive higher government incentives than ground mount installations and have access to financing.

Third, the commercial rooftop segment is the optimal fit for the specific value proposition offered by our lightweight and flexible PV laminates. We are also diversifying our markets longer term to include residential. We have an existing presence and Europe through our customer, [Tegla Kendazy], which is the second largest asphalt shingle manufacturer in Europe.

Last month we announced an agreement with CertainTeed to develop roofing integrated PV products for the US residential market by 2010. With the recent extension of the US ITC we feel even more comfortable that these markets will grow and that we will be able to take advantage of this growth.

Please turn to slide six. Our business is also diversified in terms of geography. Many of you may be familiar with the information on this slide, but it is worth reiterating briefly. The majority of our sales continue to be in Europe and within this region we are further diversified across four countries; Italy, France, Spain, and Germany.

We are in these countries because they offer the highest feed in tariffs for rooftop and building integrated products, which will continue to fuel demand. It is important to note that all of our sales are denominated in US dollars eliminating foreign exchange risk.

While the rise in the US dollar against the Euro has impacted the returns on some European projects, we continue to be cautiously optimistic about our success in Europe, because government incentives are highest for rooftop and BIPV installations, which is our sweet spot. Also our total install costs are lower. In addition, because rooftop installations tend to be relatively smaller in size, they are easier to finance than large ground mounted solar farms.

We are also managing our risk through diversification. The advantage of being diversified across several countries and regions is that we have the ability to reallocate volume to those countries or regions with the greatest demand. And as I mentioned, we believe North America will grow as a percentage of our sales now that the US ITC has been extended.

Please turn to slide seven. We are also diversifying by distribution channels. While we continue to sell to customers and distributors in the traditional solar channel, nearly half of all our sales are to building material distributors and OEMs around the world. This is an important competitive advantage, since building material companies and roofing installers understand completely the value proposition of our laminates versus glass-based panels in rooftop installations.

A building applied or building integrated rooftop installation is a significant up-sell for this channel, so there is a built in incentive to sell a complete systems that includes our solar laminate. We continue to sign new strategic deals with large and financially stable companies around the world. Let me walk you through a few examples of these recent deals.

Please turn to slide eight. As we announced this morning, we signed a new multi-year agreement with Marcegaglia, one of Europe's largest manufacturers of steel building and roofing materials. This new agreement expands our relationship with Marcegaglia and shows how we are evolving and working more closely with building material OEMs.

What you see on the slide are photos from Marcegaglia's factory that show the current process. Today Marcegaglia buys completed UNI-SOLAR laminates and bonds them to their commercial roofing material inside their factory, which enables them to install a roofing integrated PV product in one step at the work site.

Under our new agreement, Marcegaglia is developing an improved process to integrate UNI-SOLAR cells into their metal roofing material to make a new BIPV product. As a result, total installed system cost will go down. We are excited by the potential that this deal represents and we look forward to working with other building material companies to innovate similar new processes and finished products.

Please turn to slide nine. In October, we announced our agreement with CertainTeed, a leader in roofing products in the US with a strong channel in the residential market. I wanted to review it this morning, because it represents growth into the US residential market and opens up a significant opportunity for us now that the ITC for solar projects has been extended.

As you can see from the photo of the prototype, the solar product is integrated directly into the roofing tile, which makes this product both easy to install and attractive.

Please turn to slide 10. We made excellent progress in our operations, including dozens of improvements in the first quarter. Let me touch on three of the most significant: First, we achieved a major milestone in our history this past quarter when total production on all of our fully ramped lines exceeded the aggregate nameplate capacity of built lines for the first time.

This achievement was partially due to the retrofit of our Auburn Hills 1 line, but also due to our ongoing commitment to operating excellence, which is resulting in higher yields and throughputs and reduced cycle times across all three steps of our manufacturing process.

Second, we were quickly able to ramp our Greenville 2 deposition machines demonstrating the benefits of our modified clone approach. We are also running the machines 10% faster than originally designed without sacrificing quality. These accomplishments were primarily due to certain changes in the machine design and we believe that this performance is sustainable and will be achieved in future installations as well.

Third, we continue to benefit from lower material costs as we aggressively manage our supply chain. For example, we introduced new polymer suppliers in the first quarter which resulted in more than 20% lower pricing for certain polymers. In total our material cost savings came to $3.7 million in the quarter.

Please turn to slide 11. You can see from this slide how successfully we have ran production over the last year. In the first quarter we produced 30.8 megawatts, almost triple the 10.4 megawatts we produced a year ago and nearly 18% higher than fourth quarter production of 26.2 megawatts.

Turn to slide 12. We are focused on demand driven expansion and we will build factories to meet the demand for greater output. Despite the short-term market uncertainties, we are confident that demand will grow over the long-term especially as we forge new relationships and enter new market segments and geographies.

Our plan remains to develop a new 120 megawatts facility every six months. We believe this expansion strategy continues to make sense both from a size and timing perspective. We have multiple points built into the process where we must authorize plant construction, the ordering of key equipment and materials, and the hiring and training of personnel. We continue to review these decisions to ensure that our capacity never outpaces demand.

I will now turn the call over to our CFO, Harry Zike, for a review of our financials. Harry.

Harry Zike

Thanks, Mark. Please turn to slide 13. As Mark pointed out in his introductory comments, ECD reports strong operating results in the first quarter. First quarter total revenues increased 104% to $95.8 million from the first quarter last year.

Comparing our performance with the fourth-quarter total revenues increased 16% fueled by higher sales volumes and slightly higher average selling prices. Since all of our sales are dollar denominated, there is no impact from foreign currency in these figures.

Please turn to slide 14. Operating income increased 77% from $7.8 million last quarter to $13.8 million in the first quarter. As you can see on the slide, this was a substantial improvement from the loss of $10 million for the comparable period in the prior year.

More importantly, operating cash flow improved substantially in the first quarter as we generated $26.5 million, almost as much as the $28.5 million we generated for all of fiscal 2008.

Please turn to slide 15. Our first quarter solar and total gross margins were better than anticipated. Solar gross margin in the first quarter was 33.4%, about the same as the margin in the fourth quarter of 2008.

This higher than anticipated gross margin resulted from the significant improvement in throughput and material costs that Mark mentioned earlier. These operational improvements offset the cost of our Greenville ramp and the retrofit in Auburn Hills both of which went better than expected, because Greenville is ramping faster than anticipated it is contributing to higher production output.

The first quarter marked a turning point for us, higher throughput and material cost savings are now expected to absorb the cost of ramping new facilities and production lines. This allows us to simultaneously expand margins while also growing our capacity.

Looking ahead to the second quarter, we expect solar gross margins to be approximately 33%, the same as in quarter four or quarter one as we continue to pay for our ramps through improved production, higher yields, and material savings. Total gross margins are expected to be about 34% for the quarter.

Please turn to slide 16. On slide 16 you can see we remain focused on cost optimization from sales and marketing to general administrative costs. Overall we are targeting SG&A as a percentage of sales at about 14% to 16% this fiscal year and our first-quarter results were in that range at 15.1%. More importantly, we are investing these below the line dollars in strategic selling and marketing opportunities. Overall SG&A spending was $14.4 million in the quarter, which is flat quarter-on-quarter.

Please turn to slide 17. Last year we refocused our research and development efforts on strategic initiatives that had the best possible near-term returns. Consequently, R&D as a percentage of sales has appropriately declined. Today we are primarily focused on solar initiatives and externally funded programs in our Ovonic Materials segment.

We spent approximately $4 million in total R&D in the quarter, but since our solar initiatives are primarily funded by government contracts from the Department of Energy's Solar America Initiative and others, our net R&D cost for the quarter were about $1 million or 1.2% of sales.

We are on track to spend between $12 million to $15 million in solar research and development on projects to improve manufacturing processes, increase solar product efficiencies, and develop innovative solutions for our customers.

Please turn to slide 18. Ovonic Materials continues developing our emerging technologies, primarily focused on our nickel metal hydrite battery business. Royalty income in this segment continues to grow, based on increasing consumer demand, especially the growing demand for hybrid vehicles. Additionally, we now see the benefits from the restructuring efforts we undertook last year.

Ovonic Materials generated operating income of $300,000 in the first quarter compared to a loss of $700,000 in the comparable period last year. It is our intent that all research and development costs in this segment be externally funded.

Please turn to slide 19. Let me take a moment to emphasize how our strong financial position is a strategic differentiator. As of the end of September 2008, we had approximately $500 million in cash, cash equivalents, and short and long-term investments. In addition, we have proven that our business model has the ability to generate significant positive operating cash flows.

Additionally, we also have approximately $300 million in tax net operating loss carry forwards that we also target as a future cash flows source. Our strong financial position helps us in several ways. First, and most importantly, it means that we don't need to raise additional capital in these volatile financial markets.

Second, our financial stability and viability provides assurances to our customers that we are a long-term player and reassures our suppliers that we can be a strong partner. Last but not least, this strength gives us the ability to further enhance our growth and improve shareholder value.

Please turn to slide 20. For the second quarter of fiscal 2009 we expect total revenues of $100 million to $108 million, with solar product sales representing $95 million to $103 million. Our solar gross margin in the second quarter is expected to remain strong at approximately 33%, which will result in a total gross margin of about 34%.

Reproduction costs will be $2 million to $2.5 million and restructuring costs will be $1 million to $1.4 million. We are maintaining our prior guidance for total revenues, which was $455 million to $485 million and solar product sales of $430 million to $450 million.

Given our stronger than expected first quarter performance, we are improving our full year solar gross margin guidance to approximately 34%. This is the high end of our prior guidance, which was a range of 32% to 34%. We expect total gross margin for the full year to be approximately 35%.

We are also maintaining our fiscal year 2009 preproduction cost guidance. However, we are lowering our full-year restructuring costs to a range of $1.2 million to $1.6 million, versus our prior guidance of $2.5 million to $3 million, as we will complete our restructuring program this quarter.

Now I would like to turn the call back to Mark.

Mark Morelli

Thanks, Harry. Let me summarize our outlook before we begin to take questions. Please turn to slide 21. The economic conditions facing the industry are challenging, but we have the right product and the right strategy.

Our unique value proposition for rooftops is the one that truly differentiates us in the current credit constrained market. Our projects qualify for higher incentives and are smaller natured than the large ground mounted projects, which makes them easier to secure funding.

We recognize the changing environment, both in terms of the potential effect of currency on how we compete in the global marketplace and the declines in pricing we are hearing from others in the industry, but we believe that we have the appropriate strategies in place to address these challenges.

We are the global leaders in PV on rooftops. We are focused on operating excellence. We will expand gross margins while growing capacity and we are growing our capacity 1 gigawatt through an expansion that is demand driven. This concludes our prepared remarks. We will now open the line for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Sanjay Shrestha of Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets

First of all, congratulations on a great quarter here. Just a quick question, can you guys update us on your backlog or the book of business number, which I think I believe at the end of the last quarter stood at about $1.8 billion with take or pay representing about $1.4 billion. Can you update us on that number?

Harry Zike

Yes, I can. Our backlog is approximately $2 billion. But for the number that you stated, its gone up about $200 million. Of course, this is net of deliveries we have made. At the same time, we have had a few customers that have come off that backlog and we don't believe that we are immune from this macroeconomic conditions, it really is impacting all businesses, including our industry. But the good news is that we have been able to sign new take or pay agreements and we have actually been able to grow our backlog with these headwinds.

Sanjay Shrestha - Lazard Capital Markets

That's fantastic. And out of that, Mark, how much would, you know about $2 billion be represented by take or pay?

Mark Morelli

Our take or pay number is approximately $1.6 billion.

Sanjay Shrestha - Lazard Capital Markets

Well, that's up pretty significantly too, great. Another quick question, so you guys also had a fantastic ASPs during the quarter with what seems to be like a pretty dramatic reduction for the crystalline prices. Are you clearly in this backlog number? Are you seeing sort of stable ASPs for you guys as we go through fiscal 2009 and into 2010? Are you starting to see any step down reduction or can you talk about that a little bit? And I have one last question.

Mark Morelli

I wouldn't read a lot into our ASPs in the quarter. They were $3.04 and that was mostly due to some customer mix issues. If you notice from quarter-to-quarter there is some fluctuation of a couple cents either way, so I wouldn't read too much into that in terms of pricing going up. However, it's a good opportunity for me to talk about our belief on pricing that we currently see for the rest of the fiscal year. We want to reiterate that even with the headwinds we believe that our pricing of flat to slightly down basis of last year's pricing is responsible guidance. So we are going to stick with that guidance.

Sanjay Shrestha - Lazard Capital Markets

Got it, that's great. One last question then. Guys, with the tax equity dynamics the way it is and the credit market being where it is, are you guys actually not seeing that because of the size of the projects and maybe the increasing appetite for the tax equity in the US given the smaller scale of your project? Can you talk about that a little bit? And maybe you can also touch on whether you guys have actually done some sort of an evaluation of the credit worthiness of the existing customer for this take or pay contract?

Harry Zike

Most of our sales that we have had in this past quarter have been primarily in the European marketplace. So for the past quarter that really didn't play a role. Going forward, we did talk about some of the headwinds we do face in foreign currency, access to capital, tax equity going down. But from our perspective, we are not immune to these kinds of headwinds, but nevertheless we still see some robust demands in our primary markets, which has been Europe.

Sanjay Shrestha - Lazard Capital Markets

Okay, that's great. Once again, congratulations, guys.

Harry Zike

Thank you.

Operator

Next question comes from the line of Rob Stone of Cowen & Co.

Rob Stone - Cowen & Co.

Hi, guys congratulations on the strong results.

Mark Morelli

Thank you.

Rob Stone - Cowen & Co.

I'm just wondering, you are increasing your efficiency yields throughput, you are ramping ahead of schedule, and yet you kept your solar product revenue guidance for the year unchanged. Is that just due to conservatism or are you seeing the indications of perhaps weakening customer demand that keeps you cautious?

Mark Morelli

I think given what's going on in the overall market that it's prudent to give responsible guidance. I think the guidance that we are giving you is very responsible based on the backlog that we currently see and our pipeline going forward. Certainly there are opportunities where we could exceed that guidance, but at this point there is a lot of year left and we still see continued strong demand plus the US opening up for us in the US ITC. And as we go forward, we will update you on how we are doing accordingly.

Rob Stone - Cowen & Co.

But in terms of the performance of the factories, things are trending ahead of plan, correct?

Mark Morelli

That's absolutely correct, and that's a great point because our focus on operating excellence is really paying off for us, particularly when you look at our yields, our throughputs. The wonderful news that we are announcing that we are actually speeding up the rates of our deposition machines is very good news. And our focus on operating excellence is absolutely paying off.

Rob Stone - Cowen & Co.

A couple of questions for Harry, if I may. Could you just give us the capital expense depreciation in the quarter and then revisit what you expect for CapEx and depreciation for the year and any general CapEx comment on F'10 if you can, please?

Harry Zike

Back at Investor Day we did talk about our cap expense ramp. At that time we had said we are looking at about $1.70, I believe and we are on a target to get down to about $1 CapEx. We have got about $70 million in CapEx that we have announced and you will see that in the 10-Q that we will file later today. The depreciation side will be in there as well, Rob, when you get that.

Rob Stone - Cowen & Co.

And with respect to the CapEx for F'09 in total and F'10 just based on the megawatts and the CapEx per watt figures that you just gave?

Harry Zike

I think for your purposes, when you look at the model you can assume that we are on target to get down to that round about $1 CapEx per watt, or this expansion that we have in Battle Creek were lower than the $1.70, but that's the $1.70 where we were last time.

Rob Stone - Cowen & Co.

Okay, but [definitely] $1 a watt is a further out target?

Harry Zike

Always how it has been, yes.

Rob Stone - Cowen & Co.

Perfect.

Harry Zike

The depreciation expense in the quarter, Rob just as you know is about $7 million.

Rob Stone - Cowen & Co.

Okay. A final question, it looks like the interest expense number was a bit higher than I expected. I wonder if you could just comment on interest expense and what rate you are earning on cash lately?

Harry Zike

Our cash for the quarter is earning returns of about slightly less than 2%. When you look at the interest you have to also take into consideration that because we are doing construction, a part of our interest expenses is well being capitalized, so you don't see a straight calculation with interest income, interest expense. But for the last quarter we earned slightly less than 2%.

Rob Stone - Cowen & Co.

Well, if part of your interest is being capitalized, then the interest expense seems high to me. What interest rate…

Harry Zike

We have 3% on the convertibles. Is that what you are referring to? And we are running about 2% of our invested moneys.

Rob Stone - Cowen & Co.

Okay, thank you.

Operator

The next question comes from the line of Satya Kumar of Credit Suisse.

Satya Kumar - Credit Suisse

Can you give me a sense of the amount of the cancellations you had in the quarter? Was it from one customer or multiple customers? Which geographies were you seeing these cancellations and where are the new orders coming from a geographical standpoint that increased the order book?

Mark Morelli

Well, we have had a few customers come out and we won't discuss any specific customer related issues. However, the good news is we have been able to reallocate that volume at convertible terms. We see that some folks are running into some problems related to aligning credit within some of the timing that they had originally projected. The great news is there is an excellent backdrop.

Given that we are focused on the rooftops, it's the largest growing segment of the market. There is very high feed-in tariffs there. We've got the right product for these segments and the project financing is available for projects that do make sense. That it's been quite manageable for us to reallocate that accordingly and for us to reaffirm our guidance for the full year.

Satya Kumar - Credit Suisse

Were the cancellations in fiscal '09 or was it beyond that?

Mark Morelli

No, it's more of a near-term issue. We don't see any view on the longer-term issue other than an extremely robust story.

Satya Kumar - Credit Suisse

That's good to know you've reallocated at the same price for the near-term. In terms of the 50% of your '09 sales that will be to building OEMs, can you give me a sense, as to if there is a portion of that where you think you are the sole source provider for these panels?

Mark Morelli

I would say it's all of the building OEMs. They really take a very favorable view of our product, because that enables them to really participate in the PV industry for rooftops. Many of these building OEMs know the rooftop market extremely well and they feel that they own rooftops.

So this really enables them to have a stake and in fact have an up-sell opportunity, particularly when they may see overall demand for their product lines on a slight decrease through the overall possible recessionary environment. So this provides a very unique value proposition for them as well and we think it's a source of competitive advantage for us.

Satya Kumar - Credit Suisse

Okay, fair with that. In terms of your current backlog, how does that look between the building OEMs and the distribution channels?

Mark Morelli

We think our pipeline is mostly representative of what we have shown you in the chart, which is roughly half. The interesting thing is that these building OEMs are also continuing to sign take or pays, and there is also very good demand that we see coming out of the building OEMs. The great news is that these folks tend to be a little bit more institutionalized. They certainly have the opportunity to have much better balance sheets and offer more stability in down markets.

Satya Kumar - Credit Suisse

All right, Mark. Lastly on the cost per watt in the quarter, I think it was roughly flat, maybe $0.01 lower than the previous quarter. Is that correct? What portion of that start-up was start-up cost related in the current quarter and if you can just give us the last quarter's number as well?

Mark Morelli

Well, we disclosed $2.03 of cost per watt in our Analyst Day and that was the last time that we have actually disclosed our cost per watt officially. The great news about that is that we have taken out about $0.50 or $0.55 in the prior year. We continue to make good progress on the cost per watt. I think it's indicative of our overall focus on operating excellence and bringing our cost per watt down.

We are not going to give specific numbers on our cost per watt that we are at right now due to competitive reasons. However, we will update it periodically. We are on track of our cost per watt for roughly $1.10 by 2012, and we see very good opportunities within our control to continue that cost per watt down.

Satya Kumar - Credit Suisse

Great, sounds good. Thanks a lot.

Operator

Next question comes from the line of Vishal Shah of Barclays Capital.

Unidentified Analyst

This is [Jake Greenglass] for Vishal Shah. I was wondering if you could give us any specifics on where you expect ASP prices to be for the coming year?

Mark Morelli

Yes, our ASPs as we said are flat to slightly down. We will make sure we reiterate that so that there is absolutely no miscommunication there. Overall our ASPs are slightly up for this quarter. We want to make sure that you don't read a lot into that, because we don't believe pricing is going up. We have signed longer term take or pays with a decrement of price going forward, but we have not disclosed what that pricing is. At the same time, we don't believe we see any cliff in our pricing or any change in our pricing policies based on what we currently see.

Unidentified Analyst

Okay, and could you tell us anything about the conversion efficiency and where you see that going for the coming year?

Mark Morelli

Our current conversion efficiency is roughly 8.5%. We have published the highest conversion efficiency for amorphous silicon, which is just over 15%. However, that is in the laboratory. We really have a great runway of improving our conversion efficiency over time. We believe to get to prepare a costing number will need to be about 10% conversion efficiency. I don't anticipate that in the first year and I think we are being somewhat conservative by saying we think we will see about a 10% conversion efficiency by 2012.

Unidentified Analyst

Okay, great. Thanks.

Operator

The next question comes from the line of Brian Gamble of Simmons & Company.

Brian Gamble - Simmons & Company

Yes, good morning, guys. I just wanted to touch back on the backlog just for a second. I think last quarter we mentioned 60% as a committed number for 2010 volumes, just an update there based on the new backlog. Then also I know that we have talked in the past about possibly rerating the lines given that you hit full capacity this quarter. Any thoughts to doing that?

Mark Morelli

Our 2010 backlog is obviously increasing slightly. We are not disclosing those numbers, but once we get appreciably sold for that pipeline for that year then we will obviously disclose the specifics on that. The second part of your question really relates to the nameplate capacity. In that case we are about 4% above our total nameplate capacity, which is great news, because if you think about it it's 104% of our nameplate capacity in aggregate. We will keep you updated as we make further progress on nameplate capacity. But I think it's our first quarter where it actually shows us going above nameplate capacity, so we consider that to be pretty good news.

Brian Gamble - Simmons & Company

A quick question on the Ovonic revenue for the quarter. Looked down slightly on an annualized basis, would fall short of the implied number. Is there some type of shift going on there we should be aware of or is that just a fluctuation for the quarter based on some sort of timing?

Harry Zike

In the quarter the sales are down quarter-on-quarter, which is really driven to the price of nickel since we pass through those costs. If the nickel price goes down, the sales will go down and so quarter-on-quarter you do see that. I think if you look quarter-on-quarter sequentially it's up slightly.

Brian Gamble - Simmons & Company

Thank you very much.

Operator

The next question comes from the line of Steve O'Rourke from Deutsche Bank.

Steve O'Rourke - Deutsche Bank

Thank you, good morning. Can you give us an idea of the magnitude of cancellations and postponements? Was it credit issues only that drove the postponements as well and can you give us an idea on the regional kind of bias of where these cancellations or postponements were?

Mark Morelli

We are not going to give specific numbers, but suffice to say we have seen some FX headwind. We have seen some customers trying to line up their credit within the timeframe they originally thought and they had some push outs accordingly. However, as we said, we think it's just great to show that we are reallocating that volume accordingly. We still see continued demand in our target markets and we continue to grow our pipeline.

Steve O'Rourke - Deutsche Bank

Do you see the near-term risk of this kind of going up over the next quarter or two? Is there a way you can help us think about that?

Mark Morelli

It's certainly that these economic conditions mean that you need to have a cautionary view. But we are optimistic that as we continue to see this progress that we are going to continue to see these great opportunities. We think one of the major reasons for that is that there is a really excellent backdrop for rooftop PV projects.

It's in part because of the excellent feed-in tariffs and the government backing that they enjoy. Particularly perhaps in a down environment when folks are looking for good returns that are backed with a very secure backing, such as government incentives, they may represent a very attractive opportunity for them.

Steve O'Rourke - Deutsche Bank

Okay, one last question. How should we think about the economics of selling solar cells for integrated products rather than selling laminates? Are there some comparative metrics you could help us with?

Mark Morelli

Well the way to think about that is that we are guiding towards our gross margins and so it would either be at the gross margin or better is one way. The other way to think about is what does this really unlock for an opportunity provided to the marketplace.

We think that in particular this Marcegaglia example and the CertainTeed example really unlock innovation, because these folks know very well about the commercial rooftop space or about the residential rooftop space. They are able to apply our technology in ways that we really didn't even think of. So we think long-term that this bodes well for improved innovation and increased sales.

Steve O'Rourke - Deutsche Bank

Fair enough, thank you.

Operator

The next question comes from the line of Stephen Chin of UBS.

Stephen Chin - UBS

I just wanted to ask another question about the backlog. Did the customers that came out of backlog, Mark, were those customers that had take or pay contracts had to be renegotiated or were those just customer project delays?

Mark Morelli

Well, we are not going to disclose any specific customer related issues. However, I think it's important that we do reiterate that the reallocation of those projects due to mostly delays really represents a great opportunity for us. And it represents the strength, I think, of our value proposition and of the overall economics that are represented in our target market segments.

Stephen Chin - UBS

The next question I have is about raising the full year solar gross margin to the 34% level. I guess my question is; when do you expect to see the solar division gross margin grow sequentially? Could it be as early as March quarter and when it does increase, would you expect it to be another major step function increase in the gross margin at some point in 2009, and is that the likely outcome?

Harry Zike

Stephen, we guided to the solar gross margin for the year to be about 34%. And you look at the first two quarters, we were at 33.5% for the first and 33.4% in the second. So when you run the math you could see that we are back ended and it will be larger gross margins as the third quarter goes and the fourth quarter goes. So we anticipate those quarters would be higher than in Q1 and Q2. So this will be a backend loaded ramp that we are facing.

Stephen Chin - UBS

A similar question on the full year solar revenue guidance. It looks like there could be a steady sequential revenue ramp in both the March 2009 and June 2009 quarters for sale. But are there any seasonal trends that you would see that would make the lumpiness worse or higher than expected in that March quarter? Is there anything seasonal that happens in your March quarter that would create more lumpiness in sales?

Mark Morelli

No, in fact, our business model of demand driven expansion is holding true. What is essentially happening is our ramp is really coming online as we have really stated before in the past in the second half. We also have our pipeline that we think is also reflective of these numbers that enables us to provide this responsible guidance.

Stephen Chin - UBS

One last question. About your comments about the North American market now that the ITC has passed, what is your thinking of how much your sales to the US could be going forward as a percentage of total sales?

Mark Morelli

Historically, our sales in the United States has actually been more than 25%. And we have seen in recent quarters really the uptake and very strong demand in the European markets. Given that the US ITC has been passed, you don't see that reflective in any of our numbers in this last quarter results that we are announcing. So we could very easily see 25% of our sales return relatively quickly in the US market. But certainly over a longer term it's really our home turf and we think that the US market is an excellent opportunity and we continue to want to drive our sales in the US market accordingly.

Stephen Chin - UBS

Thanks again for that, Mark. Congrats on the good operation in the factories.

Mark Morelli

Thank you.

Operator

The next question comes from the line of Jesse Pichel of Piper Jaffray.

Elaine Kwei - Piper Jaffray

This is Elaine Kwei in for Jesse. I was wondering for Europe, do you expect to be able to continue negotiating dollar denominated contracts given the recent volatility in ForEx?

Mark Morelli

Well, we won't comment on our future negotiations in terms of projects, but we haven't had a lot of pressure to renegotiate anything in a euro basis nor many conversations with folks on a euro basis at this point. So, we will have to see how our pipeline grows and what might make sense for the future, but at this point we are not anticipating that we will do that.

Elaine Kwei - Piper Jaffray

Okay, great. And given the dramatic decline in pricing for modules, I'm just wondering what gives you the confidence in your ability to maintain the flat to slightly down ASPs for the year?

Mark Morelli

There is really two reasons. The first of which, if you look at the poly prices over a period of time, that a number of years ago they were somewhat low and they peaked to around $4 per watt. During that time, we in fact did not appreciably increase our price when the rest of the industry was going up on price. So, we decided to take our very strong demand for our product line and instead of increasing the price, translate that into longer term take or pay contracts. We think that was the right decision to make for our business. I think we still stand by that.

So, once again, the first reason is we didn't increase price with the rest of the industry, so we don't feel like we should have to decrease price for the rest of the industry. The second reason is that there still remains to be very attractive returns, not only at the current exchange rate, but an exchange rate down to $1.15, $1 per euro. In Europe we still see very attractive returns in our target market as well.

Elaine Kwei - Piper Jaffray

Okay, great. Are any of the cancellations and postponements you are seeing related to the slowdown in the housing and building markets?

Mark Morelli

No, I don't think it is. I think it's more of alignment of credit for some specific projects. We think it's really a near-term issue instead of a longer-term issue.

Elaine Kwei - Piper Jaffray

Okay, great and just lastly. Can we get a sense of the size of the Marcegaglia agreement that was signed, that was announced for today?

Mark Morelli

We have not announced the size of that deal for competitive reasons.

Elaine Kwei - Piper Jaffray

Okay. All right thank you.

Mark Morelli

Thank you.

Operator

The next question comes from the line of Timothy Arcuri of Citi.

Timothy Arcuri - Citi

First of all, can you kind of walk us through what you think of in terms of balance of system cost as the -- I'm just trying to figure out where the crossover pressure point would be as crystalline prices come down. It seems you can buy cells right now in the market for [$2.70], something in that range. And I'm just wondering as crystalline prices come down, how do you think of your balance of system costs relative to crystalline costs? So maybe that would help us determine where the pressure point might be for you.

Mark Morelli

Well, I think the way to think of our balance system costs, we see a 10% to 20% cost advantage. But in particular, when you think of our focus versus perhaps some of the focus on the polycrystalline space, is that we are targeted as really experts on roofing and we only sell into the roofing space. Appreciably that market is quite large and there will be lots of competition over time in that market. In fact, at 1 gigawatt of nameplate capacity or even actual capacity will be less than 20% of our target market in terms of total sales.

So I think the way to think about our competitiveness in this segment is that we focus really our unique value proposition where it makes sense on the rooftop. So areas where there is no rack and ballast, there is total installed cost advantage, we have benefits in terms of wind loading, there is no roof penetrations for our product. This is where we are going to be focused to sell our unique value proposition at the pricing that makes sense.

Timothy Arcuri - Citi

Just to be clear, so you think that even if crystalline module prices were $2.60 to $2.70 and you are still at $3 or so you, think that there still would not be any pricing pressure because of the balance of the system advantage and also because of some of the other advantages?

Mark Morelli

Absolutely, there is a unique value proposition for us on roofing, and we are going to sell that unique value proposition.

Timothy Arcuri - Citi

Okay. Then I guess last question, what sort of contingencies do you have relative to defaults on some of these take or pays? I guess as you look in the poly space, stock prices have certainly said that these take or pay agreements don't really mean much. Those companies have pretty significant prepayments sitting on their balance sheets, so I'm wondering what specific contingencies you have relative to potential defaults on these take or pays?

Mark Morelli

Well, first of all, we didn't make any comments that anybody has defaulted on a take or pay agreement, so we don't want to mislead folks there. However, we do see the opportunity for us to reinforce our positions on take or pay if need be. We do have teeth in these agreements and we will protect the interest of our shareholders.

Timothy Arcuri - Citi

Can you talk to what the specifics are on the teeth of the agreements?

Mark Morelli

We do have specifics that are customer-by-customer would involve cash, would involve certain areas where we would apply leverage in terms of rights over those customers, and increasingly you can see some of the folks that are signing these take or pay are quite large companies. But we will not disclose any specific signings, particular customer related deal.

Timothy Arcuri - Citi

Okay, but you do have cash so there is actual significant prepaid cash that you are getting relative to these deals?

Mark Morelli

Some, some agreements do.

Timothy Arcuri - Citi

Some. Okay, thank you.

Operator

The next question comes from the line of Sam Dubinsky of Oppenheimer.

Sam Dubinsky - Oppenheimer

Guys, just a couple of quick follow-up questions. Just to be clear, for the customers you have seen cancellations from are they having issues? Is it the credit quality of the customer or is it the credit quality of the project? And then I have a follow-up.

Mark Morelli

We are not going to discuss any specific deals other than its credit related. We do see very good opportunities to reallocate that volume.

Sam Dubinsky - Oppenheimer

Okay. When you look at your contingency plan, when you pick customers to sell this to how do you evaluate new customers versus the older customers? How do you assess their credit quality?

Mark Morelli

The folks that are coming into the pipeline are really excellent and indicative of where we are headed. They tend to be larger, institutionalized players that both offer secure balance sheet situation, but also have a excellent distribution network to market. I think the deals that we are recently talking about in terms of Marcegaglia and CertainTeed, as well as other excellent players that we currently have already announced that are part of our pipeline, are really representative of where we are going.

Sam Dubinsky - Oppenheimer

Okay. Of your backlog can you just discuss what percent of your backlog you think is at risk or could be at risk from sort of lower credit quality customers? Of that backlog in general, how much of it is secured with a contingency plan?

Mark Morelli

I think our entire backlog is secure and all of our pipeline that we are talking about we have a path for in terms of either we feel very good about it or a contingency plan. I think what's relevant is that we have spent a lot of time trying to provide responsible guidance to the marketplace. We think what we are providing in terms of guidance is in fact responsible in terms of those factors.

Sam Dubinsky - Oppenheimer

Okay, thank you.

Operator

The next question comes from the line of Al Kaschalk of Wedbush Morgan.

Al Kaschalk - Wedbush Morgan

Good morning, guys. Just wanted to follow up on two questions, first, on the raw material savings or improvement in the quarter. If I hear correctly that you expect that to exceed the preproduction costs for the full fiscal '09?

Mark Morelli

I'm sorry your question came in a bit muffled. Could you please repeat it again?

Al Kaschalk - Wedbush Morgan

Sure. In terms of the raw material savings in the quarter and the guidance for preproduction costs, did I hear correctly that raw material savings would exceed the preproduction costs that you have guided?

Harry Zike

We had raw material savings in the first quarter of about $3.7 million. We are guiding on preproduction in the range of $7 million to $9 million. So when you look out for the next couple of quarters, those raw material costs will impact or exceed our preproduction.

Al Kaschalk - Wedbush Morgan

So that helps part of the explanation I guess on the…

Harry Zike

It helps. It's that plus, also we talked before the throughput that we are getting in the factories and our production yields are up as well. That's how we were able to achieve the 33.4% gross margin in the first quarter.

Al Kaschalk - Wedbush Morgan

Okay. And then just others have chatted about it. As you enter the agreements like you did this morning or announced and then the CertainTeed, how does that not add to some variability at least in the seasonal part of the business given that the residential or rooftop market generally follows construction activity? Just comment or maybe add a little bit of color to that. Or do you really expect some seasonality going forward?

Mark Morelli

I think seasonality is going to be a longer term issue from us. We are starting from a relatively low base in these markets. And as you begin to penetrate and then we don't expect a lot of penetration in our fiscal year 2009 in residential, it's really going to be a 2010 issue for us. So when folks are talking about seasonality, we are really responding to that in a near-term sense not in a longer term sense.

Al Kaschalk of Wedbush Morgan

Great, excellent operational quarter.

Operator

The next question comes from the line of Kelly Dougherty of Macquarie.

Kelly Dougherty - Macquarie

Thanks for taking my question. I just want to follow up again on the contracts. You definitely have a significant amount, but are you hearing any rumbling from building material customers on contract terms or do they just better appreciate the value proposition more than the traditional distribution channel? And if so, are you finding that the pricing conversations between the two different segments are much different?

Mark Morelli

Well, I don't think as were saying, that we are not immune to the macroeconomic conditions in the business. I think that it's affecting all industries, obviously solar is probably being impacted much less than any other industries. The very good thing about the building materials players is that they see this as an excellent opportunity for an up-sell for them. They also are in many cases very well capitalized. They have a lot of resources to bring to bear, to enter new market segments. And net, net I think what they see going on in the industry is solar is a great opportunity for them.

Kelly Dougherty - Macquarie

Great. I totally understand that, but are you finding that then the difference between conversations with that segment on pricing are a lot different than conversations with the traditional solar distribution channel?

Mark Morelli

I won't comment on the specific pricing that we have with any individual customer because we don't think that that's really in our best interest for competitive reasons. But I would definitely say that what we have been able to reallocate out of our pipeline are on comparable terms. We will just leave it at that.

Kelly Dougherty - Macquarie

Okay, great. Thanks very much.

Operator

The next question comes from the line of [Olive Werse] of American Technology.

Olive Werse - American Technology

Good morning. Can you give us an update on any potential changes to the French tariff programs coming up January 1 that you are hearing from your customers?

Mark Morelli

In terms of the French incentives, as you may know, it enjoys more than 80% higher feed in tariff for rooftop BIPV in its applications. We are one of the few customers that actually have a product that's certified and is able to sell into that very attractive market segment.

While there may be longer-term cap in place, that market segment is relatively large vis-à-vis the number of players that are currently selling into that space. So we think that it represents certainly a near-term as well as a medium term excellent opportunity for continued sales and growth.

Olive Werse - American Technology

Great, but are you seeing any sort of a reallocation of the tariff from the ground-based markets into the roof-based market at all yet?

Mark Morelli

Well, in general, I think folks are recognizing that the rooftop market is more attractive, and for the first time we are beginning to see more competition on rooftop. I don't think that's a specific French related issue, I think you see it in all the target markets where there is a specific feed in tariff for roof incentives.

Olive Werse - American Technology

Great, then going back to the gross margins, as you continue to ramp it looks like your absorption is actually going to improve pretty significantly over the next several quarters on the capital expense. Could you talk a little bit about when you start to reach an inflection point? And it looks like you have already started to reach that here in this last quarter.

Harry Zike

Yes, we mentioned the first quarter was really a turning point for us. We had much better than anticipated gross margins. In fact, our throughput yield and material costs more than paid for the ramp in Greenville as well as the retrofit of our Auburn Hills 1 machine. We anticipate that's going to only improve in Q3 and Q4, and that's why we went to the higher end of our guidance at 34% gross margin.

Olive Werse - American Technology

One final question, going back to Europe. It looks like you are actually; the product is actually competitive right now. Current pricing with a number of markets with electricity prices for commercial rooftops. Have you started to see any movement in Europe yet towards a non-subsidized market or structures that would support non-subsidized demand?

Mark Morelli

No, we don't quite see that yet. We think the majority of where everything is being sold is based on government incentives. However, the costs overall are coming down and we hope that our views on grid parity by 2012 are very realistic and we intend to achieve those in those timeframe.

Olive Werse - American Technology

Great, thanks so much.

Operator

There are no further questions at this time. Are there any closing remarks?

Mark Morelli

Yes, I would like to thank folks for joining us on today's call. Thank you.

Operator

Thank you. This concludes today's conference call.

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