Larry Polizzotto – VP, IR
Mike Ahearn – CEO and Chairman
Jens Meyerhoff – CFO
Steven Milunovich – Merrill Lynch
Satya Kumar – Credit Suisse
Timothy Arcuri – Citi
Stephen O'Rourke – Deutsche Bank
Vishal Shah – Barclays Capital
Rob Stone – Cowen and Company
Mark Bachman – Pacific Crest Securities
Stephen Chin – UBS Securities
Jesse Pichel – Piper Jaffray
Chris Blansett – JP Morgan
Kelly Dougherty – Macquarie
Gordon Johnson – Hapoalim Securities
Daniel Ries – Collins Stewart
Colin Rusch – ThinkEquity
Sam Dubinsky – Oppenheimer
First Solar, Inc. (FSLR) Q2 2009 Earnings Call Transcript July 30, 2009 4:30 PM ET
Good day, everyone, and welcome to the First Solar second quarter 2009 earnings conference call. This call is being webcast live on the Investors section of First Solar's web site at www.firstsolar.com. At this time, all participants are in a listen only mode. As a reminder, today's call is being recorded. I would now like to turn the call over to Mr. Larry Polizzotto, Vice President of Investor Relations for First Solar. Mr. Polizzotto, you may begin.
Thank you, Teresa. Good afternoon, everyone, and thank you for joining us for First Solar's fiscal second quarter 2009 conference call.
Today after the market closed, the company issued a press release announcing its second quarter 2009 financial results. If you did not receive a copy of the press release, you can obtain one from the Investor Section of First Solar's website at firstsolar.com. In addition, First Solar has posted the second quarter presentation for this call, key quarter statistics and historical data and financial operating performance on our website, on the IR website.
We will be discussing the second quarter presentation during this call and webcast. An audio replay of the conference call will also be available approximately two hours after the conclusion of this call. The audio replay will remain available until Tuesday, August 4, 2009, 11:59 PM Eastern Daylight Time, and can be accessed by dialing 888-203-1112 if you are calling from the United States or 719-457-0820 if you are calling from outside the United States, and then by entering conference ID 6443641.
A replay of the webcast will be available approximately two hours after the conclusion of this call and remain available for 90 calendar days. Investors may access the webcast on the Investor section of the company's website at firstsolar.com. If you are a subscriber of FactSet or Thomson One, you can obtain a written transcript within two hours.
With me today are Mike Ahearn, Chief Executive Officer, Jens Meyerhoff, Chief Financial Officer, and Bruce Sohn, President of First Solar. Mike will begin with an overview of the company's second quarter achievements followed by a market and business update. Jens will then provide you with a second quarter 2009 operational and financial results and provide an update to our 2009 guidance. We will then open up the call for your questions.
During the Q&A period, as a courtesy to those individuals seeking to ask questions, we ask that all participants limit themselves to one question. The company has allocated approximately one hour for today's call. I want to remind you that all financial numbers reported and discussed on today's call are based on US Generally Accepted Accounting Principles.
Now I would like to make a brief statement regarding forward-looking remarks that you may hear on today's call. During the course of this call, the company will make projections and other comments that are forward-looking statements within 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 most recent annual 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 announcements that we described herein.
Before I turn the call over to Mike Ahearn, I would like to mention that during the third calendar quarter of 2009, the company will be attending the following conferences
Pacific Crest Technology Conference in Vail, Colorado on August 11; Cowen's Clean Energy Conference in New York City on September 10; Citigroup's Alternative Energy Conference in New York City on September 15, and finally ThinkEquity's Growth Conference in San Francisco on September 17.
It is now my pleasure to introduce Mike Ahearn, CEO of First Solar. Mike?
Thank you, Larry, and thank you for joining our Q2 2009 earnings call. We had another strong quarter in Q2. Revenues were $525.9 million that drove net income of $180.6 million in turn driving diluted earnings per share of $2.11. Operationally, production was 290 megawatts, that is up 32% quarter over quarter. Malaysia plants I and II operated at full production for the full quarter and plants three and four by the end of the quarter were operating at full production as well.
Efficiency was 10.9% on average, that is up slightly over the prior quarter. Our annualized capacity per line increased to 51.7 megawatts. That is up 5% quarter over quarter driven by the small efficiency increase I mentioned and also improvements in our line throughput. Our manufacturing costs came in at $0.87 per watt for the quarter, that is down 6.5% quarter over quarter driven primarily by the Malaysian ramp and also bill of material cost reduction. In terms of the market, we previously announced a new manufacturing facility with EDF EN to develop French market, I will talk some more about that here in a few minutes, and then our pipeline execution in California has continued on plan.
So let me turn from that now to the market update and I will just start by making some general comments. If you think back to the end of 2008, early 2009, we saw the market constraints really in the project finance side where things pretty much came to a standstill. So everybody remembers that pretty well. And that combined with seasonality essentially dried up throughput and allowed for very limited visibility. Across Q2, we see that liquidity constraint migrating to some extent into the customer base, and so by that I mean, on one hand you have extended cash realization cycles, because debt financing on projects to the extent that it is available is approved and extended on a much longer cycle time. You still have some delayed installation rates in Q2 as inventories build balance sheets obviously are weaker. And working capital becomes constrained, because existing lines are drawn, but also difficulty in expanding lines to accommodate higher volume.
So that is a snapshot of what we see generally in system integrators and project developers across Europe over Q2. In terms of project finance, the call it a volatile pricing environment, was a reduction in pricing on the crystalline and silicon side, as the impacted project equity to some extent. Because we are seeing evidence that some project equity investors our deferring decisions to wait and see how these price reductions continue to play out. Project finance on the debt side outside of Germany, still somewhat constrained, there is some evidence of buying in some markets like Italy, but in general, we don't have a lot of robust visibility into debt financing outside of Germany. And then in the US, utilities generally continue to be in capital preservation mode.
Thinking about the second half of 2009, you know as some project finance conditions start to alleviate and whether we will see a big surge installations and sales that will collar to some extent the soft conditions in the first half, there are some reasons to think that could happen. There are also some issues though that could represent constraints. One is installation capacity, just the ability as we start to work into the second half for the value chain to organize some surge to a capacity, that actually demonstrates the kind of recovery you might expect. I think that could be a challenge.
Working capital and construction financing to the finance higher level of activity could well continue to be a challenge. And we're also seeing some continuation in the long lead times with respect to debt financing, credit underwriting, and the processing of those applications. So there is some generalized concerns here. I mean if we compare where we sit today to where we were last quarter and the quarter before, we would say it is generally it is more favorable. On the other hand, we expect to drive a lot of higher volumes here in the second half in Europe, that will be a test.
So turning from the general to maybe to more specific, we're going to talk about Germany, France, California and Ontario. These are all areas where we were active in the second quarter and expect to be active second half of this year. And I will start with Germany because we have made some decisions about specifically about pricing in Germany that we want to talk about. So I want to set the stage here by talking, just recapping what our market approach has been in Germany, what we saw in that market in terms of the environment, and the changes across the second quarter, what our objectives are for the balance of the year, as we think about the German market and then specifically what injections we are making to try to drive the desired results.
So I will just back – start then with the market approach and this may be a refresher for some but we entered Germany with a very specific focus on large free field markets and commercially roof top applications, so the larger roof to type structures versus residential small commercial. That continues to be our focus. We consider those core markets for First Solar. And as we talk about Germany, we took a number of measurements of projected demand and matched supply to demand in these core markets. But we have never intentionally put ourselves in a position where we sold volumes into the market that we didn't think had a home in the core markets and would be scattered about. This has always been a pretty careful process.
As we thought about building factory and capacity, we have always tried to match production capacity to the anticipated demand. And as you know, we have taken steps to go a little bit beyond that by locking up a good percentage of that under long-term contracts. So we have not been speculative builder of capacity and we have priced under those framework agreements to drive sell through economics, to allow systems to get built and financed at rates that would compensate the value chain at a reasonable level. That has pretty much the rationale up until today and we will continue to be subject to the things that we talk about.
So then across Q2, what we observed, as summarized on the next slide, of course crystalline and silicon modular oversupply as feedstock became more available and then some aggressive pricing behavior on the part of some manufacturers in order to drive sales into the German market. We saw some price reduction in Q4 and Q1, but in Q2, it obviously became more pronounced. As we look at not only our customer base, but integrators and project developers generally across Q2, installations remained slow, slower than normal resulting in a buildup of inventory through the channel. So the question we have been studying pretty deeply is what drove the slow – what constraint the installation, what drove the lower installation rates?
And there are several factors. One was certainly project and channel competition with the aggressive crystalline silicon pricing coming into the market. There is no question that had some impact. The deferred project equity investment that I alluded to earlier, where people began to sit on the sidelines and wait to see how the price reduction played out is another factor. Ongoing project debt constraints or at least delays continued to play a factor. And construction financing has become tight and at least caused some projects to be deferred or slow.
So, all of these things come into play at various levels. It is very difficult to assign specific causes or to attribute them across the board. It is pretty clear to us that price is not a constraint in all cases and so we have to do some parsing of these various factors. The other thing that is unclear is the duration of these conditions, really across the board, including the aggressive pricing. It is not clear to us for example that these things will continue, pricing will continue at a downward trajectory or even at a current plateau. So we basically have an uncertain picture that emerged across Q2 that we map against our 2009 objectives in the market.
So what we intend to accomplish in 2009 is to enable the planned level of installation volumes to occur in Germany in our core markets. We are willing to reduce price and I will talk about how we do that and then in situations where price rather than these other factors is the constraint to installation. And we are willing to reduce price for so long as but not beyond the period that it is necessary in light of market conditions. So what we're trying to think about is how do you take a rifle shot and address some issues about high throughput market.
So the injections if you will in the next slide, what we're going to do is initiate a rebate program that is focused exclusively on our core markets in Germany free field and commercial rooftop markets. So essentially as modules are installed in these core markets, a rebate will be made available that effectively improves the module economics. The way we calculate it, in general, we make a determination of what we consider the best in class crystalline silicon module benchmark price for the quarter to the period. We apply a discount to that benchmark price that in our view makes are offering at a system level attractive. That rebate is earned by the project is installed so the project financing has to be in place and completed. And then we reviewed the situation periodically to determine whether we need to steepen the rebate level, reduce it, or eliminate it altogether.
We're keeping our framework agreements in place, we are not altering anything else, this is pretty specific injection. The timing and the duration of this is flexible, we're going to try to ride this through and continue to look at it as situations develop. The net effect of this I mean we have had to make some assumptions about the overall impact on it, the net guidance, the guidance in total for 2009 remains unchanged and Jens will discuss that further with you.
So just to summarize this, a combination of silicon price reductions and financing constraints has slowed the pace of module installations. We expect some recovery in the second half. There are some potential constraints that I alluded to earlier that could come into play. The rebate program is intended to deal with price constraints where discount is necessary to defend our position here in these core markets. But the conditions could be temporary and we just don't know either way so we levered the scope and the duration and retained a lot of flexibility to react to the evolving market conditions.
That is Germany. France, I'll cover pretty quickly. France we think is a very attractive solar market. There is a high demand potential for solar because of the fact there is a lot of electricity load in France, there is good radiation. We see a lot of good sites for ground mounted and roof top PB deployment. The resource mix in France suggests that solar can play a large part of their overall mix in meeting their aggressive renewable energy goal. So you combine that with strong political leadership in France, there has been a very inclusive stakeholder process that they expect 2007 driven by President Sarkozy and the current administration that has resulted in a fairly deep and broad commitment to renewables and specifically solar. That is a 5.4 gigawatt target in place currently with room we think over time for improvement. They have expressed specifically a goal to develop into a globally leading solar market and they have made also explicit commitment to 23% renewable energy levels that will drive some underlying momentum here. We also like the fact that a feed in tariff program is in place, it is structured in a way that will drive we think cost effective and a rapid up tick in the market.
That was a lot behind the transaction we announced with EDF EN. I think everybody is generally familiar at about whether we can answer questions here in a few minutes on some ongoing issues. The rationale it positions us for a larger share of this market as it evolves over time. It solidifies our position with EDF EN who we regard as a key customer. The local investment and job creation we think can actually reinforce the market and help from a policy point of view as things move long. The economics meet our threshold and again we are matching – this is incremental demand and we are matching demand to capacity which is something we have always tried to be careful to do.
In terms of California and Southwest, nothing specific to report. This slide summarizes what we have announced today in terms of PPAs. We have got a lot of things we're working on now, they are moving along to our expectations. We just generally don't talk about it till there is time. We feel pretty good about our position right now in California but there is a lot of work to do. We're not taking anything for granted either. It is improving more or less.
Ontario, Ontario has had something in place called a Risa [ph] program that works in some ways like a feed in tariff. There is now formally a feeding tariff program that replaces it. The big issue from a practical point of view is the price of about two Canadian cents per kilowatt hour. We assume that a 220 megawatts AC pipeline, project pipeline as part of Opti transaction. We are now beginning or have began I should say construction on a 20 megawatts AC portion of that pipeline in Sarnia. The intent here is to build this and sell it to an investor. We expect to have the sale same completed by the end of the year, something we're still working on, and the construction is underway.
So to summarize, we saw continued strong operational execution across the company in Q2. We have taken the steps I described to address a dynamic market situation in Germany. We think it will be successful but a caveat to the uncertainties environmentally that I mentioned. Our market position in France we think has been significantly strengthened. We're continuing to build project pipelines in California along the lines of our expectations and we started a project construction in Ontario.
With that I will turn it over to Jens Meyerhoff who will take you through the financial results.
Thank you, Mike, and good afternoon. Moving to the next slide, net sales for the second quarter were 525.9 million, an increase of 26% over the first quarter of 2009. The increase was driven by greater volumes as Malaysia substantially completed its production ramp. Line throughput improved and by recognition of 26.6 million of deferred Q1 revenues related to the Lieberose project discussed on our Q1 earnings call. These factors were partially offset by the previously announced Q1 price reductions. The blended euro exchange rate was $1.39, flat quarter over quarter.
Let me provide you with some additional comments on the Lieberose project. Revenue recognition was triggered by the closing of the project's third-party debt financing in the second quarter. First Solar only holds subordinated debt in the capital structure of it today and the expiration of any right to the project equity. Year to date, we have recognized $84 million of revenues representing approximately 80% of the total project revenue. The project is currently being marketed for our customer Juwi.
We produced 290 megawatts during the second quarter as seen on the following slide resulting in an annual run rate of 51.7 megawatts, up 5% over the first quarter as line throughput improved and Malaysia plants I, II, III and IV were at full production by the end of the second quarter. This brings our existing total capacity to 1.2 gigawatts per year. Of the next slide, you see how the cost per watt. Cost per watt produced in the second quarter was $0.87, down $0.06 or 6.5% sequentially as we continue to realize the benefit from increased production in low cost locations, higher line throughput and lower material costs.
Cost per watt produced is expected to decline at a more moderate pace in the second half of 2009 as the ramp up of our Malaysia factory is substantially completed. However, we expect continued throughput efficiency and material cost improvement partially offset by ramp cost associated with the Paris expansion in line with our long-term cost reduction roadmap.
On the next slide, you see the gross margin for the second quarter was 56.7%, up 0.4 percentage points over the prior quarter mostly due to the lower manufacturing costs, which were partially offset by the lower ASPs. Our operating expense grew by $26.9 million sequentially and were impacted by $9.1 million of one-time items, predominantly driven by reserves taken against the outstanding accounts receivable balance of one of our customers. The remaining increase of $17.8 million is attributable to $6.9 million of R&D expenses driven by the continued execution of our technology roadmap, and $14.6 million of SG&A expenses due to higher personnel related costs, and the integration of the OptiSolar business.
Operating expenses were favorably impacted by the decline in plant startup costs of 3.7 million as all plants in Malaysia were in production and we began to incur a plan start up cost for our Paris work extension. On the following slide, you see operating income for the second quarter was $204 million, or 38.8% of net sales compared to $168.1 million or 40.2% during the prior quarter, and included $17.7 million of stock-based compensation costs. Net income for the first quarter was $180.6 million or $2.11 per share on a fully diluted basis.
Earnings per share were $2.11 compared to $1.99 which benefited from non-operating income and expenses of approximately $0.13 per share when compared to the second quarter of 2009. This was primarily driven by the longtime tax benefit of $11.5 million recorded in the first quarter, partially offset by one-time tax benefit built in the second quarter. The effective tax rate for the second quarter was 10.3%.
Account receivable increased by $166 million over the first quarter primarily due to the full quarter impact of our revised payment terms discussed on our last call, increased shipment volumes and to a lesser extent by the linearity in our second quarter shipments. Current inventory rose by $31 million sequentially due to a $34 million increase of finished goods, increase in days of inventory from 9 to 15 days. The finished goods bill was driven by the announced restructuring and subsequent sale of one of our customers and by the requirement of our utility scale project in North America for the second half of 2009.
Free cash flow was negative by 37 million in the second quarter, primarily due to the increase in working capital just described, and my scheduled tax payments in Germany. We spent 59.6 million for capital equipment during the second quarter against depreciation of 28.5 million. Cash and all other marketable securities decreased by $35 million quarter over quarter to $777 million in the second quarter principally due to the revised payment terms. This includes $49 million of restricted cash to pay off the IKB debt for our Perrysburg manufacturing facility after the second quarter close. Our debt to equity ratio remained low at 10%.
Rolling four quarter return on net assets was 29.4%, up from 27.4% in the prior quarter. We substantially completed the OptiSolar purchase price allocation during the second quarter. The total purchase price consideration is $400.8 million. Project assets were stepped up by $104 million based on the present value of the future project cash flows. Please note that these cash flows are market participant based meaning that the assumed module cost is based on the module market price and not based on First Solar's module production costs. The expected cash flow of margins generated by the module throughput of these projects is accounted for as goodwill after the purchase price consideration.
This brings me to our guidance for 2009 which remains unchanged. We have made several key assumptions underlying our guidance. First for the remainder of 2009, 60% of our expected net sales are hedged at an average rate of $1.33. In addition, our natural hedge brings a net income hedge ratio to 72% for 2009. Since we lay our hedges, net income for Q3 of 2009 is hedged at 80%, compared to 63% for the fourth quarter of 2009. We assume an average exchange rate of $1.15 per euro for the unhedged portion of our 2009 guidance bringing the average euro exchange rate to $1.26.
For the remainder of 2009, a one cent euro fluctuation impacts our revenue approximately $3 million and our operating income by approximately $2 million. We expect our gross margins to decline from Q2 levels in the second half of 2009 as a result of the rebate program that discussed by Mike, higher North American systems revenue mix, and the lower foreign exchange rate assumptions when compared to the first half of 2009.
Now, to the specific parameters of our guidance. We're maintaining our previous net sales guidance range of $1.9 billion to $2 billion. We expect plan start up costs of $10 million. Stock-based compensation is estimated at $75 million to $80 million with approximately 20% to 25% allocated to cost of goods sold. The GAAP operating margin is expected between 31% and 33%. We expect our 2009 tax rate to be between 9% and 11%. Year end 2009 fully diluted share count guidance is an estimated 86 million to 87 million shares. CapEx for the year is expected to be 270 million to 300 million for investment in the completion of the Malaysia plants III and IV and our Perrysburg expansion and other infrastructure related investments.
On a personal note, due to a back injury, my ability to travel during the (inaudible) will be limited which could impact my participation in certain conferences and investor events and so please don't interpret my absence at some of these events as anything but that. With that I think we can open the call for questions. Operator?
Thank you, gentlemen. (Operator instructions) And we will take our first question from Steven Milunovich with Merrill Lynch.
Steven Milunovich – Merrill Lynch
Thank you, good afternoon. Jens, could you talk a bit more about the receivables situation, you have gone from obviously very low receivable days to something much higher, but pretty normal for most companies. Does this reflect the extended cash realization cycle that Mike alluded to, could you maybe talk a bit more about the write off you took and what do you see in the second half with the economy perhaps bottoming, do you think your receivable days go up much from here, or what are your expectations?
So I mean I would say I would say number one was the balance obviously we presented to you, the Q2 balance. We collected subsequently over 100 million against that balance just to give you an indication of the continued cash flows. The core driver obviously for the AR balances I related to in my discussion is the change of our payment terms from 10 to 45 days, so that is now fully reflected in our AR balance. So we would not necessarily foresee any significant further increase other than continued growth in revenue to drive the AR balance up.
As it relates to the specific AR reserve we booked, we booked the reserve based on our assessment that collectability of that amount is unlikely at this point in time. Obviously we cannot discuss to which customer that relates specifically, but we felt it was prudent to take that provision based on the data presented to us. So I think the cash realization cycles that Mike talked about generally I think do port an overall liquidity constraint into the overall market system and channel.
I think at the same point in time I think Mike alluded to that generally the banking system and the lending environment is gradually improving and that is not only true for Germany but also we have to see first evidence of more project finance for example in other parts of Europe was extended ten years, and also some first signs even in the US market to gradually improving. So I think generally I think the overall liquidity situation, the market will be a function of continued improvement of the landing situation and the ability of the channel to turn inventory and drive installations, and I think Mike gave a good overview with respect to how we are trying to support and aid those cash realization cycles.
We will take our next question from Satya Kumar with Credit Suisse.
Satya Kumar – Credit Suisse
Yes, hi. Thanks, Jens and Mike, for taking my question. The question on the pricing, it seems like embedded margin guidance, operating margin guidance we have in the second half is about 25%. It seems like you are keeping an option to lower the price to somewhere between 1.15 to 1.30 euros depending on the exchange rate, at least at the low end that should be very competitive with silicon, is that the right way to think about it? And how do you define or determine what is the best in class crystalline silicon module pricing? Thanks.
Okay. So I mean obviously we have our own data and we spend obviously a lot of time I suspect talking to our customers, understand the situation in the channel. And based on these parameters, we try to effectively triangulate. We are participating in some of the projects realizations more closely I think the Turner project is a good example where we had quite a good degree of transparency of the overall economics. All these factors drive essentially into the rebate program that Mike described and allow us I think to set the pricing levels that we believe drives sell through and drive competitive position for our customers.
We will take our next question from Timothy Arcuri with Citi.
Timothy Arcuri – Citi
Hi, two things. First of all, you know if you kind of look at the guidance for the back half of the year, you know it is obviously building into fairly (inaudible) compression in your margins, and I'm wondering is there kind of any reason to believe why is that sort of margin level you know would not kind of be superimposed into 2010, i.e. if the market conditions do not improve and if pricing doesn't get better, since you are not really expanding capacity much, would you really be able to cut your cost meaningfully such that margin would go back up entering 2010? And then also, Jens, I wanted to see how – you previously said that if you offer one customer a pricing discount, that it is very tough to not offer everybody that discount, so I am wondering how you plan on kind of keeping that discounting program localized within Germany? Thanks.
So I mean I would say – so first of all I think, as Mike alluded, there is not enough transparency in the market I think to project any type of current levels beyond multiple quarters particularly probably not in 2010. So I think we probably need to essentially assess on a quarter by quarter basis and that is probably the main reason why we start to move over towards the rebate program. If we felt that pricing levels will be depressed on a long term basis, and then that would possibly result in just adjusting your contract prices period.
But now that that essentially means that margins as a result of the 2009 margin guidance essentially flows straight into 2010. Now that is completely a function, A, of our ability to lower cost, B, what pricing levels do we find? What is the mix with respect to market segments that we are operating in, how much systems business we will be driving and how will foreign exchange rate behave? So as we all know, those are essentially the key parameters. I think it'll probably be a little bit premature for just to assume capacity expansions are at a lesser pace in 2010. Therefore your cost reduction roadmap stalled. So that is certainly not how we're thinking about it.
With respect to the rebate program, every customer is eligible for the rebate program provided they are selling the modules into the German market and driving a module installation in the German market. That may be more applicable to some than others.
We will take our next question from Stephen O'Rourke with Deutsche Bank.
Stephen O'Rourke – Deutsche Bank
Thank you. Good afternoon and my apologies for kind of beating a dead horse here though. When you think about crystalline silicon module prices and what you have seen, how they have changed, how they continue to change, do you have a benchmark now that you can use to drive sell through?
I think we have established a benchmark I think how we're thinking about the rebate in the near-term. The rebate is structured in a way that it gets revisited on a quarterly basis but we have established a benchmark. So now how scientific and how exactly precise the benchmark is, Steve, I think we will get feedback out of the market against this but we believe it will be very competitive.
We will go next to Vishal Shah with Barclays Capital.
Vishal Shah – Barclays Capital
Yes. Thanks for taking my question. Mike, can you talk about what your expectations are for the size of the German market this year and some of the other markets out there, you know where do you think growth is going to come from in the second half? Thank you.
Yes, I think it is – I think the visibility there is kind of limited for us, Vishal. I mean what we're focusing on is our core markets, so if you think about the free field and the German roof top in Germany, basically our expectations are that we will sell our clients volumes, we just kind of wrapped our heads around what are those issues and where do they impact, and how do we execute this rebate program. Broader than that, I don't have, two gigawatts has been kind of the thinking range for some time now, plus or minus. And if the market recovers in the second half like it could, it doesn't seem out of line at all. I think there is a lot of variables out there obviously. So the other part of your question was what beyond Germany, some of the other markets. I don't remember the rest of that, Vishal?
Vishal Shah – Barclays Capital
What are your expectations for shipments to the systems business in the second half, are you looking at – still looking at to 10you’re your volumes going to the systems business?
We haven't really changed, Vishal, the bottom of that range.
We will take our next question from Rob Stone with Cowen and Company.
Rob Stone – Cowen and Company
I had a related question on systems which is how much did that contribute to the second quarter revenue? Was there something besides the Lieberose deferred revenue?
No. there were really no – nothing of material mention expected systems revenues in the second quarter.
We will take our next question from Mark Bachman with Pacific Crest Securities.
Mark Bachman – Pacific Crest Securities
Hi gentlemen. Nice results here today. Talk to us more about the rebate program and I think a little bit more in detail? It seems like you know when we talk to your customers, they are openly talking about wanting price reductions and clearly you're willing to deal here but it sounds like your rebate program, at least from the comments I got is only payable when the modules are installed. So two parts here, one did I interpret your comments correctly that the rebate is only applicable here if modules are installed? And then two, Jens, you're really meticulous you’re your calculation, can you help us here frame the magnitude of the gross margin decline in the second half of the year?
I mean number one is I think you heard right. Installation, proof of insulation through our end of life registration process is a prerequisite to drive rebate eligibility and obviously one soft process behind this is that we like to have utmost transparency with respect to not only our inventory situation but the inventory situation of the channel. We want to see that these rebate effectively drive sell through, right, so this is not about just what happens between First Solar and its customer, but also does it help to sell through for our customer, does it drive inventory turns right, and so forth. We maintain overall that we will consider a healthy channel inventory level and don't overbuild channel inventories as we move through the year. So now I think you're going to see I think disclosure in our 10-Q that roughly quantifies an estimated $40 million to $60 million out of this rebate program and so that is roughly a current assessment you will see in that disclosure.
We will take our next question from Stephen Chin with UBS.
Stephen Chin – UBS Securities
Thanks. Jens, how should we think about the ending of this rebate program? It sounds like the only way to prevent new pricing from these rebates from becoming permanent is to assume that crystalline channel prices will actually increase? A modeling question, how should we think about modeling gross margins in the second half of the year, should we model third quarter as having a bigger impact or should be fourth quarter? Thanks.
I mean I would say I mean essentially you probably got to carry =– again it is a completely a function right of how pricing of polycrystalline modules have developed, very much a function. So if we assume that pricing remains on a declining slope and those prices right will be driven forward into perpetuity, yes, then I think over time, there could be a likelihood that those rebate prices will become ultimately permanent prices. Right now the program in itself has a limit to itself with respect to the overall time duration. But at the same point, the end goal here right is to drive through put sales through installation, provide project economics and provide competitiveness of our customers. I think every analyst apparently I think have subscribed detailed model on crystalline silicon prices. They have seen most of the parameters out there that would help you to model I think these types of price declines for the respective quarter based on your assumptions of what is happening to polycrystalline products.
We will take our next question from Jesse Pichel with Piper Jaffray.
Jesse Pichel – Piper Jaffray
Congratulations on the strong results. For the purposes of determining the magnitude of the rebate, can you give us an idea for Q2, the percentage of revenues for the ground versus roof, and the percentage to sales in the various markets around the world, in particular Germany? Thank you.
I mean generally I think the mix on our rooftop versus free field has been anywhere from 40- 60, 40 rooftop, 60 free field to 50-50 in the ballpark. I recently I think recently we have seen more especially right now as the Lieberose project learning more towards the higher free field content. I mean I think if you look at the geographical breakdown and we talked about 5% to 10% of our sales going into the North American systems business, and I think with respect to Europe versus the rest of the world, I think we're probably somewhere in the like for Germany and like 60– 60 to 70% range overall volumes.
We will take our next question from Chris Blansett with JP Morgan.
Chris Blansett – JP Morgan
Hi guys. Two questions, two simple questions here. There's a lot of expectations this year that we're going to get quite a lot of installations in Germany. I want to make sure what your thoughts are more recently on the political environment and what your thought are for subsidies there next year, Germany will be the primary factor for pricing?
Yes. I think the German government has been committed to the EEG and to the continuation of the feed in tariff program. So we don't assume a change in that regardless of the outcome on the elections. The anticipated – the range of installation volumes in Germany this year don't seem to us as out of the range of political expectations where issues were created. So we're assuming at least at this point that that program continues to operate on a multiyear basis and Germany will continue to be a very important strong market.
We will go to Kelly Dougherty with Macquarie.
Kelly Dougherty – Macquarie
Hi, thanks. Just want to switch gears here and should we assume that the mini factory concept that you recently announced in France is something that we could see more of and have you been able to copy smart so that you can have attractive economics at about hundred megawatts?
Well, I wouldn't read – I wouldn't read that much, I wouldn't read too far into it. I think that what you could assume is that we are interested in building more capacity to meet incremental growth in demand. There are markets we are investing, it could be a factory or it could be some other level can serve as a catalyst to the formation of the implementation of these market programs. And particularly where we think the long-term fundamental nature of the market is attractive, we will try to do what we can, subject to our own operating model and financial constraint that catalyze the market. So in France it worked out that that was the injection, we got very comfortable with the two line factories is an initial step there and the economics worked to our standard. So we will just have to see going forward, I think we're pretty flexible as we look at these issues.
We will go next to Gordon Johnson with Hapoalim Securities.
Gordon Johnson – Hapoalim Securities
Thanks for taking my question. The first question is how are you guys going to execute on the OptiSolar deal with so little cash left? Are you guys looking to raise money? And then looking at I guess this rebate program and what people expect with respect to some of the I guess Asian module prices, the expectation is they could move an additional 30% lower by the end of this year from today's prices. How can you be confident in the guidance given that that rebate program is open-ended? Thank you.
Well, let me just say that guidance is just that. It is guidance. I mean it is our best view as we sit today. Our intent is to defend our position in these core markets and we do what we have to do to drive throughput really at the plant level. So we are the cost leader in the industry by a wide margin and we're going to do what we have to do. Conversely you know we are trying not to overreact here, so I think we are at the right balance to do what we need to do in Germany.
I don't quite understand the question on Opti, I mean we are sitting on a net cash position that is very strong at this point. The projects as they are built are not going to be on our balance sheet, that is not – that has never been the intent. Those are financed through an increasingly improving project finance market but that is still being riddled with short term issues and uncertainties. So it is right that we have to go work the project finance aspects of this, but other than that I think we are where we expected and wanted to be with respect to Opti.
Yes. I mean I would say, if you look at the current pipeline out in front that drives near term execution and capital requirement, we have been in the market with respect to marketing the project to investors. Some of these investors are investors that (inaudible) and will finance off their balance sheet. For other projects, we have been talking to more the traditional tax equity financial investor segment, and at this point in time, I think we see good traction and we see a healthy amount of activity in the financing of the project as they are outlined in front of us.
We will take our next question from Daniel Ries with Collins Stewart.
Daniel Ries – Collins Stewart
Hi. Looking at the CapEx year-to-date of something like 145 million, you would have – to reach the guidance you would have 125 to 175 more to go. If Perrysburg is launched, is only a one line facility, do you have ongoing CapEx for Malaysia III and IV, are those complete, and are there other projects out there that require CapEx?
No. I don't think – I mean for Malaysia not all CapEx has yet gone out on the numbers. Then we have got the Perrysburg expansion, which can spend slightly further than I would say just a one production line, there is that infrastructure investment that is happening there too. There is R&D related investment, there is IT related investments as well that make up the total sum.
We will go next to Colin Rusch with ThinkEquity.
Colin Rusch – ThinkEquity
Good afternoon. Mike, I wanted to follow up on your questions at the investor day and today about buyers being able to sort of pull the trigger. Can you talk in a little bit more detail about what the concerns are besides pricing and return and is there any risk to moving volumes in the second half?
Yes, I mean I think it is fair to say that project equity investors in the European markets have been delaying commitments to see if the price reductions that were exhibited in Q2 are a trend and whether they can enter at more attractive IRR points. I don't think there is a – I think that is true in isolated cases. I think there are already cases where equity investors have and will invest early, but I just think any time you have turmoil and uncertainty; it is going to cause people to defer decisions.
And I think on the credit side, it could just have a slower, more deliberate careful process in terms of the underwriting process of these loans, and those are mainly the factors that flow throughput. I think price, where does price becomes an issue for us or a constraint, our customers could lose projects, new projects or suffer reduced channel sales in the rooftop market, because crystalline silicon prices is available at more attractive rates at the system level, and so that is another factor. It is difficult to – it is very difficult to separate all these out and start assigning volumes and percentages to them, but that is in general, the mix.
Yes. And I think there is a natural balance here with respect to – you can wait out in the feed-in tariff based market so long because the feed-in tariff in itself right will re-adjust which is resetting the economy. So there is to some degree I think over reaching this point now where the project realization was those waiting out for better price starts to become I think a little bit of a conflict. And I think with respect to risk of moving volumes from the second half; I think, yes, there are risks I think we outlined. I think some of them deal with – there is a fairly significant amount of volume if you think about how the overall markets expectations lays out between the first half and second half volumes, which requires a lot of execution capabilities throughout the distribution channel in order to drive that amount of installation. We laid out the liquidity in the overall system as the liquidity adequate financing cycles occurring fast enough in order to drive the throughput. I think those are probably the risk I think we should also be all cognizant of.
And our final question today will come from Sam Dubinsky with Oppenheimer.
Sam Dubinsky – Oppenheimer
Hi guys. Just wondering given the recent price cuts, the rebate, can you just discuss what the project orders are in different geographic regions, levered and unlevered?
I mean I would say I mean I think the IRRs I think remain in all markets I think quite attractive I would say in the German market. I mean generally some of those waiting as we just discussed and it has probably started to put some upward pressure with respect to the return that equity investors are expecting saying that some of this depends also I think on the size of the project, the location and the quality of the project. But I would say generally probably equity return expectation have moved upwards. I think I would save at least in the 100, 150 basis points range in some of the European markets that we see. Some now Europe obviously still produces – I mean Germany I think is talking high single digits type return requirements. I think if you go outside of Germany, Italy, France, I think you're talking – you're talking return requirements that are double digits, that are in the low to mid-teens.
Thank you, ladies and gentlemen. This will conclude today's conference call. We thank you for your participation.
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