SunPower Corporation (SPWRA) Q3 2009 Earnings Call October 22, 2009 4:30 PM ET
Bob Okunski - Senior Director of IR
Tom Werner - CEO
Dennis Arriola - CFO
Julie Blunden - VP of External Affairs
Howard Wenger - President, Global Business Units
Jesse Pichel - Piper Jaffray
Vishal Shah - Barclays Capital
Steven Chin - UBS
Satya Kumar - Credit Suisse
Steve O'Rourke - Deutsche Bank
Rob Stone - Cowen and Company
Michael Horwitz - Robert Baird
Pavel Molchanov - Raymond James
Good afternoon and welcome to SunPower Corporation’s third quarter 2009 earnings conference call. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.
I would now like to turn the call over to Bob Okunski, Senior Director of Investor Relations at SunPower Corporation. Sir, you may begin.
Thanks Andrea. I would like to welcome everyone to our third quarter 2009 earnings conference call. On this call, Tom Werner will give an overview of our Q3 performance followed by Dennis Arriola will go into greater detail on our financials. Tom will then discuss our outlook for the balance of 2009. Following our prepared remarks we will open it up for questions for the remainder of this call.
During today's call, we will make forward-looking statements that are subject to various risks and uncertainties that are described in our most recent 2008 10-K filed with the SEC in February of 2009 and our today’s press release with our Q3 results. Please see our 10-K and press release for those factors that may impact these forward-looking statements.
As you can see on slide two is our Safe Harbor statement. To enhance this call we have posted a set of PowerPoint slides which we will reference on this call on the Event and Presentations of our Investor Relations website. In the same location we have posted a supplemental data sheet related to our historical performance. As usual we will keep this call to one hour, including questions.
With that I'd like to turn the call over to Tom Werner, CEO of SunPower.
Q3 was another strong quarter with record revenue and production. As our vertically integrated strategy and diversified market approach provided solid quarterly results. Our strategy of brand, technology, cost, and people is paying off as customers continue to look to SunPower as their first choice solar supplier because of our experience industry leading technology, and levelized cost of energy.
On this call, I will cover an overview of our financial results, recap progress on our brand, technology, cost, and people strategies, review our competitive position by market segment, provide 2009 financial guidance, and provide some color on market dynamics.
Let me begin on slide three of our earnings slides posted on the events and presentations page of our Investor Relations website. Our third quarter results reflect the continued strength of our integrated model and diversified market and channel strategy. Quarter was characterized by strong demands, mobile geographies and market segments. Revenues for the quarter were up 57% sequentially as we continue to gain share globally leveraging its own small commercial market and extended our leadership position in the power plant market.
Over the quarter, we produced 110 megawatts, representing a 57% increase compared to last year. Inventory was done 10%, reflecting the success of our demand driven manufacturing model. And we ended the quarter with over $800 million in cash and investments. The financing environment that we see is improving, demonstrated by our announced 24 megawatt Montalto power plant in Italy and we continue to see progress in financing other power plants.
The third quarter was a big one for us as power plant construction with more than 60 megawatts of SunPower power plants under construction, the largest construction effort in our history. We completed North America's largest photovoltaic power plant two months ahead of schedule and transferred it to Florida Power and Light earlier this month.
Moving onto the elements of our brands technology cost and people strategy, first brand and channel. We increased our global dealer network by more than 50% in one quarter, expanded into three new markets which I will discuss further on slide four. Second, technology. We're on plan with Fab 3 and Gen 3 solar cell launch next year which will lead us to higher efficiency and lower costs. We have produced Gen 3 cells in our production facilities with 24% efficiency. Third, cost. We are executing on our cost reduction road map and we have completed to built out of Fab 2 in the Philippines.
Later on my remarks, I will detail our panel cost reduction road map which improves from less than $2 a watt in Q4 to less than $1 a watt in 2014. Fourth, people; we hired Gian Maria Ferrero to run our European Utility business and launched our SunPower foundation with a mission to inspire, motivate, and empower a new generation of solar leaders.
Let's now take a look at our end market segments. Turning to slide four, our brand and industry leading technology continues to give us an advantage in the residential segment. We increased our dealer network to approximately 900 dealers by the end of Q3 and we expanded our footprint to France, Korea, and Canada. Our rapid growth and our dealer network allowed us to grow our component segment, business segment 58% in Q3 with a strong surge in Germany as well as share growth in California and Italy. The rapid expansion of our dealer model demonstrates that it is highly scalable. We can quickly enter new markets, establish our presence and begin to offer value added services to our partners and customers, a distinct competitive advantage.
During the rapid growth in our footprint, we remain committed to quality and driving a superior customer experience. We are selective about who we invite to be a dealer and only work with those dealers that can excel with our service offering. As part of our value proposition, we provide training for our partners. To reinforce our commitment to quality, our dealer training program has recently received the institute for sustainable power quality certification for quality in the renewable space, first solar company to be awarded the service certification. Our model enables us to leverage our global scale and provide value added programs to our partners.
Our strong performance in residential is a direct result of our successful brand building efforts built on our experience and our industry leading panel efficiency which leads to the best return on investment for our customers. These advantages and the value added services we offer enabled us to continue to enjoy a higher average selling price in the marketplace during the quarter. As a reminder, we offer our dealers a significant amount of value added services that reduce our dealers cost structure.
Let me now touch a bit on pricing. As you know, our channel strategy was designed for the current environment; it gives us the ability to adjust our pricing as a result of market conditions and long-term strategy. In Q3 we saw blended ASPs down less than 10% sequentially and in line with our forecast. For Q4, our guidance allows for ASP declines similar to Q3.
Moving on to slide five, in the commercial and government segment, we saw continued progress during the quarter as financing conditions continued to improve. Building off of our more than 75 megawatt fleet of installed commercial systems, we announced our first major supply agreement for commercial roof tops in France with the Casino Group, a leading grocery chain. SunPower will supply casino with 14 megawatts panels by the end of the year, including our 315 watt panels with module efficiency of 19.3%, the best in the industry. Casino will use our panels for roof top systems ranging from 900-kilowatts to five megawatts.
In the US, we continue to gain traction with our innovative $100 million Wells Fargo financing program and added to our industry leading US commercial installed base. We believe a $100 million agreement with Wells Fargo supporting PPA market is a litmus test for the accessibility of private financing for large scale solar systems. We continue to utilize the Wells Fargo facility as we added a 1.8 megawatt roof top project for educational testing services in New Jersey. We expect continued strength in the commercial market as we signed a number of contracts with customers such as Toyota and Harvard University. Both educational testing services and Harvard were engineered using our DOE-funded T-5 roof tile system.
As we mentioned on the last earnings call, the SunPower T5 system offers the most powerful roof systems in the industry. Up to twice the power per roof as compared to conventional systems and up to four times as much as thin cell. It is also the industry's first all in one non-penetrates photovoltaic roof system that combines solar panel, frame and mounting system into a single pre-engineered unit, driving quick installation times and the best MPV of any solar roof system and attractive returns on investment. The T-5 roof system is a patented technology and adds to our portfolio of over a 120 patents. This is an asset to SunPower that we plan to protect.
Earlier this quarter, we settled the patent infringement lawsuit against SunLink Corporation relating to technology that covers our rooftop mounting systems including tower guard and T-10 roof tile. SunLink conceded infringement, acknowledged the validity of our patents and agreed to pay confidential consideration to settle the suit. This outcome should make clear that we will protect our intellectual property.
Moving to slide six for distributed power plants, this is an area where SunPower has a number of strengths. (inaudible) recently financed in Montalto, Italy power plant as a case study of our success. At 24 megawatts, this will be the largest PV power plant in Italy (inaudible) this year. And international consortium of banks financed the power plant, providing evidence of an improving environment for PV power plants today. We are working with our customer to finance additional products. Combination of our five specialty panels and proprietary tracking technology has enabled us to be a pioneer in this space since with allow our customers to maximize and their energy production per acre and thus their MPV. Looking forward we see the 1 to 25 megawatt distributed generation market segment as a strong growth segment driver for our business for several reasons.
First, financing. As Montalto growth shows, smaller projects are easier to get financed in the current credit environment. Second permitting, smaller projects tends to move faster through permitting processes. Third, design, the modular design of distributed systems allows the developer to optimize land use using disconnected parcels or avoiding areas that would require substantial grading or extensive preparation. In each of these areas, SunPower is uniquely positioned due to our high energy density technology and proven track record to yield a favorable return for our investors.
Moving on to slide seven, in the utility market we continue to execute in both our existing project as well as driving new opportunities. We now have more than 500 megawatts of power plants operating or under contract. Our experience plus industry leading technology maximizes customer return, positions us as a top choice of any utility’s list solar power plant suppliers. In the quarter, we had more than 60 megawatts of power plants under construction. And earlier this month we delivered 25 megawatt Florida power plant the FPL now the largest operating PV power plant in the country. Other projects and construction include 10 megawatts for Florida power and light. And an 8 megawatt project in Chicago for Exelon, other projects in permitting included 17 megawatt project for Xcel in Colorado. Our 210 megawatt power plant for PG&E in California. We leverage this experience to continuously improve on our system's technology for which we hold more than 60 patents. As an example, our patented T-20 trackers allow customers to choose between maximum watts per acre or maximum capacity factor.
With our technology advantage, we are seeing sales success directly related to the fact that we can offer our customers a levelized cost of energy competitive with conventional gas peaking power plants. Our customers and banks are telling us that we are considered the most bankable technology and EPC contractor in the industry today. In the current environment, that preferred position means lower financing costs and a better levelized cost of energy for our customers. Given our competitive cost position, our bidding strategy in the third quarter reflects a scale of the utility and power plant market opportunity. We bid more than two gigawatts power plants to utilities and IPPs in North America and that we believe, we offer a strong value proposition for our customers. Many of those bids will take a year or more to develop into firm contracts. We will announce contracts as they are signed or submitted to regulators for approval.
Turning to slide eight, let me reinforce the statement on bankability. Utilities and finance partners want to reduce risks and look for companies who can deliver on time, on budget and with guaranteed performance. As this chart illustrates our actual system performance demonstrates this low risk proposition. In other words, our systems outperform with the banks used in their models. Looking at an empirical system performance relative to guaranteed energy delivery at five of our recent power plants in Spain and Portugal. We see that our power plants deliver superior performance based on our leading technology and global experience as a solar EPC contractor. As we've previously communicated, our power plants in Germany and US have also exceeded our customers' guarantees. In short, our customers’ investors can look to this experience as clear evidence of our ability to deliver on a budget guarantee.
On slide nine, you can see that bankability is one element of the cost of capital drivers of that levelized cost of energy. Let me review our leadership position in each of the main drivers of LCOE. Those being capital costs, capacity factor, and cost of capital. First, capital costs. These include panel, balance system, and land cost. As we discussed on our Q2 call, we will manufacture panels at less than $2 per watt this quarter and expect to reach less than $1 per watt in 2014.
On the balance system side, panel efficiency, experience and scale are the drivers. Land is also an important factor in the total system cost. Our high energy density leads to a significantly lower balance of system cost and smaller footprint for the system. Positioning us favorably on capital costs. Second, capacity factor, this is where SunPower really shines. Capacity factor measures the actual output of the given plant over a period of time with our tracking technology; we can achieve an annual capacity factor of more than 30% AC.
Traditional fixed-tilt systems with standard PV Technology are limited to capacity factors in the low 20s. This means we delivered substantially more energy during peak demand periods.
Finally, cost of capital. Cost of capital means lower risk which means lower costs. Our proven performance using proven technology and an EPC team that has delivered power plants on three continents yields the most bankable power plants in the world.
As you know, financing was fairly difficult in the first half of the year. But is improving as indicated by the recent financing of our 24 megawatt Montalto power plant in Italy. Before turning the call over to Dennis to go through our financials, I'd like to turn to slide 10 to provide a little more color on our panel cost reduction effort.
Expanding on our panel cost reduction slide from our Q2 earnings call we detailed the elements of our plant to improve our panel cost structure from less than $2 per watt in Q4, 2009 to less than $1 per watt in 2014.
Moving from left to right, let's start with panel and cell conversion costs. Both panel and cell costs will improve with manufacturing and supply chain scale. Panel cost are benefiting from our regional MODCOs strategy which will dramatically reduce our logistics costs.
In 2010, we plan to locate MODCOs in both the US and Europe. For wafer and ingots we are seeing great gains by our JV partners who are singularly focused on those parts of the value chain developing innovative solutions faster than expected.
And finally, with poly silicon given our portfolio approach to poly supply, we fully anticipate reduced poly costs as we ramp our capacity. We will not only benefit from lower raw silicon but also from our more efficient use of wet poly as we further improve our silicon utilization.
With that I’d like to turn the call over to Dennis Arriola. He will discuss our financial results in greater detail. Dennis
Thanks, Tom and good afternoon. I'd like to start with slide 11 and begin with an overview of our financial results for the third quarter. As Tom mentioned SunPower performed solidly in the third quarter. As we had strong performance across all segment of our business both in US and in Europe. Revenue in the third quarter was $466 million, a 57% from the second quarter of 2009.
This record performance was stronger than the 40% quarterly increase we forecasted in our second quarter conference call in July. Revenue for our component segment was $298 million in the third quarter, up 58% from the second quarter of 2009, and up 62% compared to the third quarter of 2008.
Our components business primarily provides products and services to residential and light commercial customers. In the third quarter, we added approximately 300 dealers to our global network. With almost 900 dealers around the globe we continue to attract partners that want to be associated with the world’s most advanced solar technology available on the market. We experienced substantial growth quarter-over-quarter in our components business in our three strongest markets North America, Germany, and Italy. While our increased marketing focus in Germany and Italy is showing a positive payback, we also reported strong revenue gains in Belgium, France, Australia, and Greece.
Our systems business also had a strong quarter, as revenue increased to $168 million, up 55% over the prior quarter of $109 million. The main driver to our third quarter performance in systems was our 24 megawatt Montalto project in Italy.
Approximately 48% of the project's revenue was recognized in the third quarter, and we plan to complete the power plant in the fourth quarter of this year. This project is another example of why SunPower is succeeding in this challenging financial environment. By combining the reputation of SunPower’s technology, ETC services and operating history with an experienced local partner, the project was able to secure the bank financing for what we believe is the largest solar project financed this year.
Let's move to gross margins. On a non-GAAP basis, the consolidated gross margin was 20.7% versus 22.6% in the second quarter. The pricing environment remained challenging in the third quarter as we experienced decrease in our blended average selling prices or ASPs of less than 10%. The reduction ASPs however was partially offset by the ramp-up of all of our manufacturing lines in the Philippines, which reduced the higher unabsorbed cost we experienced in the second quarter.
Our demand driven manufacturing strategy is working well, and we expect all of our sat lines to ramp up to full capacity by the end of the year.
Gross margins were also impacted by our decision to sell and reposition some older third party inventory at competitive market prices. As a result of these actions, we incurred a one time expense of $8.5 million in the quarter, with 5.2 million of the expense allocated to our components segment. And 3.3 million allocated to our systems business.
Our systems gross margin also includes a $1.2 million, one time property tax payment related to a previously closed project. Adjusting for these one time items, our reported non-GAAP gross margins on a consolidated basis and for the component and segment and system segments would have been 22.8%, 25.2%, and 18.7% respectively. We've included a table in our supplementary slide that has all the details on both a GAAP and non-GAAP basis.
Operating income on a non-GAAP basis nearly doubled from 26.8 million in the second quarter to 52.1 million in the third quarter.
The improvement was heavily driven by our continued focus on effective cost management. For the quarter, operating expenses on a non-GAAP basis were reduced to 9.6% of revenue from 13.5% in the second quarter. On a GAAP basis, operating income improved quarter-over-quarter from $9.9 million to $34.6 million.
Also on a GAAP basis, operating expenses as a percentage of revenue were reduced to 11.7% this quarter from 16.3% in the second quarter. Now, while we continue to invest prudently in key parts of our business, such as research and development and new market developments, we're pleased with the results for the expense control strategy we put in place for the first part of this year.
Other income and expenses on a non-GAAP basis was a $4.4 million expense and a $9.3 million expense on a GAAP basis. Recall that last quarter's GAAP results included a one time non-cash $21.2 million benefit related to our capital raise in May.
Our effective tax rate for the third quarter on a non-GAAP basis was 21.2% compared to 23.2% for the second quarter. On a GAAP basis our third quarter tax rate was abnormally high at 59.7% compared to 16.2% in the second quarter which included the one time after tax benefit from the capital raise.
The third quarter GAAP effective tax rate reflects a catch-up to the normalized rate we expect for the full year as well as a true up for our 2008 federal tax return.
Looking forward, we expect our full year 2009 non-GAAP tax rate to be in the range of 22% to 23% and the GAAP tax rate to be in the range of 45% to 46%. The actual effective tax rates could obviously differ, depending upon the final geographic mix of our business in the fourth quarter.
Net income on a GAAP basis was $12.8 million, compared to 24.2 million last year. And earnings per share on a GAAP basis was $0.13 per share compared to a reported $0.26 per share in the second quarter. Once again the second quarter included that one time benefit of 21.2 million or $0.21 per share.
On a non-GAAP basis, net income was $40.3 million, an increase of 77% over the $22.8 million recorded in the second quarter. Non-GAAP earnings per share on a fully diluted basis was $0.42 per share a 75% increase over the $0.24 per share we recorded in the second quarter.
For the purpose of calculating the diluted share count in our earnings per share figures we used the non-converted method as required by GAAP rules and consistently applied it to our non-GAAP results. The GAAP and non-GAAP reconciliations to our financial presentation are included in the appendix of our slides on SunPower's website as well as the slide that provides additional details on the earnings per share calculations.
If you turn to slide 12 I'd now like to spend a moment on our balance sheet and cash flow management. In addition to managing the sales and operational aspects of our business we also spend a significant amount of time focusing on the quality of our balance sheet, and our overall liquidity position.
During the third quarter our balance sheet continued to strengthen as we finished the quarter with over $800 million in cash and investments. Over $480 million was un-restricted and available for operational investment purposes.
In addition, we currently have $50 million of liquidity available under our committed revolving credit facilities and a $125 million available under our Malaysian government loans. During the quarter we repurchased an additional $8 million of convertible debt, and plan to retire the remaining 144 million of our .75% converts over the next year.
Overall, I'm very comfortable with our financial and liquidity position. On a working capital prospective I am pleased with the progress we've made over the last couple of quarter to improve the efficiency of our operations.
The quality of our receivables remain strong, as we've grown our revenue base and continue to experience as scheduled payments from our customers. Another example of our working capital focus is our inventory levels which were reduced quarter-over-quarter from $265 million to $239 million.
Inventory turns increased from under two turns in the first quarter of 2009 to more than six turns in the most recent quarter. We will continue this intense focus on working capital optimization and expect to see further improvements in the future.
Capital expenditures in the quarter were $38 million as we completed the full build out of Fab 2 in the Philippines, and continued the construction of Fab 3 in Malaysia. For the first three quarters of 2009 CapEx spend totaled a $150 million and we expect the full year to be in the range of $200 million to $225 million.
So majority of the expected spending for the remainder of this year is related to our new Fab 3 in Malaysia. And the resources to fund the 2009 expenditures will come from the Malaysian government loans. We expect to have our first lines in Malaysia in production by late 2010.
Before, I turn it back to Tom; I'd like to spend a moment on the financing markets. Although the banks remain very selective as to which projects and companies they're willing to finance, we are finding that SunPower is a company that banks want to do business with around the world.
Based on meetings we've had with many banks over the last several months, the feedback we received is consistent. First, since capital is scarce and costly, banks want to build relationships and not just finance the transaction. They also wanted to avoid technology risk and prefer to finance established companies with product that is have a competitive or differentiated advantage to other players. In addition, banks want to know that a company has the financial strength to be around for the next 25 years to stand behind their products. And lastly banks want to know that companies can design and build projects on time and within budgets.
Those are the reasons why in these difficult financing markets banks are willing to work with and lend to Sun Power projects around the world. We are currently working on several large projects that we hope to close on the financing before the end of the year. Overall, we are very confident in our ability to attract the necessary financing that will help us finish the year strong. And position the company solidly to continue our successes 2010.
With that, I'll turn it back to Tom.
Thanks Dennis. Now I'd like to turn to our guidance on slide 13. Given our strong Q3 results and visibility into our systems and residential pipeline, we are narrowing the range of our revenue guidance for 2009 to $1.425 billion to $1.5 billion. We are raising the bottom end of our guidance due to better visibility to reflect our confidence in the financing of a few large projects we mentioned last quarter.
And we remain very confident in the system's backlog for Q4. We expect to complete construction of several power plants, including 10 megawatts Florida Power and Light, 24 megawatts Montalto, eight megawatts for Exelon as well as fullfill our 14 megawatts supply agreement with Casino group. We expect our gross margins to improve sequentially as our ASP reductions are more than offset by cost reductions.
Moving on to EPS. Our revised 2009 non-GAAP earnings per share guidance is $1.15 to $1.25. We will provide specific guidance related to 2010 on our Q4 call in January. However, let me offer a bit of color on the drivers for 2010 by geography and end market segment. We see strong demand continuing into 2010 beyond our planned production of approximately 575 megawatts.
For the residential segment, and increasingly for the commercial segment we see continued strength building in all markets, especially Europe, as we further build out our dealer channel. We've gained share in Germany during our rapid expansion in the market this year. We see an opportunity to further increase our dealer base, serve the rooftop market in 2010.
Power plant utility, we see tremendous opportunities in the US and in Europe, as we leverage our model and technology to drive the competitive levelized cost of energy. With California's push to drive the distributed solar power plant market with the utility programs and the feed and tariff program we expect to further increase our penetration in that market both directly and through partners in 2010.
In conclusion, our Q3 performance reinforces the advantage of our vertically integrated model and our ability to respond quickly to changes in demand. Our backlog and pipeline, as well as our progress on our cost reduction road map, give us confidence going into Q4 and beyond.
With that, I'll open the call to questions, with me. I have Howard Wenger our President of Global Business Units, Peter Aschenbrenner our Vice President of Corporate Strategy, and Julie Blunden our VP Public Policy Corporate Communications. And finally Bob Okunski, our Senior Director of Investors Relations so they may provide some of the answers. To provide ample time to address as many questions as we can, we ask that you limit yourself to one question and a follow-up and then we invite those of you who would like to jump back in queue and we'll see if we can get back to you. So Bob lets go to questions, Andrea.
Great let get the questions on air. Thank you.
(Operator Instructions). Now our first question comes from Jesse Pichel, your line is open and please state your company.
Jesse Pichel - Piper Jaffray
Jesse Pichel, Piper Jaffray. Good afternoon. So, excluding this 8.5 million charge the gross margin of panels looks like it went up sequentially. Can you confirm that? And give us some more color on really what this 8.5 million is. Whose panels were they? And is there any inventory left that would cause another charge to hit? So basically, what I'm looking for is what your expectations are for gross margins of the two divisions and the Q4 in 2010? Thank you.
Jesse I'll briefly comment. This is Tom and then I'll hand it to Dennis. You are right if you exclude the one time charges, you'll see that for the company, our margins were exactly as we said they would be in line with Q2, maybe lightly better. In terms of what they are we're not going to attribute them to a certain supplier. However, Dennis can give you some background data on the balance of your question. Dennis.
Jesse you are right, in the second quarter our consolidated gross margin was 22.6%. So when you make these adjustments, we were up slightly for the quarter. As far as what's left on the balance sheet, we obviously every quarter take a pretty close look at what we have, and we feel that the balance sheet and the inventory levels that we have can be sold into the competitive market. SO we do not anticipate there is going to any further write downs going forward.
I think it would be fair to say there is a small amount of more of those panels.
Jesse Pichel - Piper Jaffray
Okay. Thank you very much.
The next question comes from Vishal Shah. Your line is open. Please state your company.
Vishal Shah - Barclays Capital
Thank you Barclays Capital. Tom can you just comment on your exposure to the German market in Q4 and also what do you think about the German market subsidies in 2010? And then secondly if you look at your systems backlog with the FPL’s project to a 100 megawatts for next year and some of the other projects out there are you able to quantify may be a range of backlog for the next year based on some of the financing constraints. Thank you.
Okay. Let me split your question into two. I'll give the first part to Julie and the second part to Howard. Julie will talk about the German market and German policy and then Howard can speak the backlog. Let me just briefly comment and make it clear that our backlog position is as strong as we've seen perhaps ever. But it's very strong. Not only going into Q4, but the projects that we mentioned in my prepared remarks give you a sense of the pipeline going into the first half of next year. If Howard can expand a little bit that not only restricted to the power plant market so with that as an introduction. Julie why don’t you talk about Germany. And then we’ll turn it to Howard.
Sure. Germany has been obviously quite strong in the late summer into the fall and we would expect that to continue towards end of the year with the expected annual feed and tariff [digression] coming in January certainly the visibility into the vertical process around the feed and tariff has improved over the course of last couple of months, and one thing we know for sure is that even with the change of government, there is a very substantial interest across the parties to ensure that the solar market continues unabated in Germany. It's just a question of when and how and where additional feed-in tariff digression to come which are logical given the change of market condition.
And we're very comfortable that the rooftop market is particularly well positioned politically, given all of the activity and we've been directly involved in advocating for market transitions that will be logical and allow the market to grow robustly into next year.
Vishal this is Howard Wenger. Speaking of backlog, going in to 2010 of Q4 in 2010. As Tom mentioned, we have a number of utility scale and distributed power plant projects that are under construction that will go into next year as well. The Exelon project, Florida Power and Light projects and we're working on a number of projects that are announced and not announced, that we plan to finance in Q4, Xcel in Colorado a 17 megawatt project being one of them. And then we have several others in North America and Europe that we're working on financing that will also contribute to our backlog for 2010.
On the residential and commercial side, we're essentially sold out in Q4 and building backlog now for Q1 of next year. And so demand in that channel as Tom has mentioned is very strong. So, we're in a very bullish position going into 2010 on backlog.
Vishal Shah - Barclays Capital
Just to clarify, if I do a rough back-of-the-envelope calculation of your backlog for next year, I get about a billion dollar number. Am I in the ballpark or do you think that’s just way too high?
Well, Vishal I think it depends on what you're doing is you're taking the FPL agreement and you're putting the dollar amount on that.
Your next question comes from Mehdi Hosseini. Your line is open and please state your company.
Two questions. First, Tom going back to analyst day from last November when there was a slight talking about the system cost down and how you are on track to essentially complete two-thirds of that cost down by 2010 and today we have an update on the module cost down. So, can you please help me reconcile the updated module cost down today versus the system cost down that we touched base almost a year ago? And the follow-up question has to do with the grams per watt. Is this something that steps down every fourth quarter and to that extent, would we expect 5.6 grams per watt to step down in the fourth quarter?
For everybody on the phone, we went in a black hole there for a few moments because our mainline went out and so we switched phones. So, you'll note that the audio sounds a little bit different that’s why and sorry for the break.
First, your question about on the cost roadmap that we have previously published. We started publishing that sometime around 2006. We said we would get half the cost of an installed system out by 2012 and two-thirds of that by 2010, and what I would say to you is that we will accomplish that and the new road map that we're providing for panel on starts at but we're consistent with that commitment back in 2006. In terms of the panel as a subset of the overall installed cost.
I think you brought up a good point and perhaps in subsequent calls we can give a sense of the overall system cost reduction in the same time frame is what we've indicated per panel. So, thank you for that question.
The second piece is a grams per watt. It’s a good observation. In fact, you do see a step down that's coincident with fourth quarter. It's going to change however, and the reason for that, this year was because we were at the same time is introducing thinner wafers throughout all of our production lines in our second fab. We're also ramping new lines, and those new lines tended not to yield as effectively as a ramp. And so you had two offsetting things going on. One, favorable, one unfavorable. We've now ramped those lines and materially ramped those lines so we don't have the unfavorable impact of ramping lines. So, yes you will see grams per watt go down. It will be this quarter somewhat, but particularly in the early part of next year. Thank you.
The next question comes from Steven Chin. Your line is open, please state your company.
Steven Chin - UBS
Hi Steven Chin from UBS. Tom, question on sales to the US market. They were relatively flat here in the third quarter on a sequential basis. Wondering if you could just share some color on the dynamics here in the third quarter. Do you think you lost any share? Or was there some seasonality? And my follow-up would be, can you share some color on expectations for sales in the US market in the fourth quarter or even 2010? Thanks.
Steven sorry I missed the first part of your question. Your question is about demand in share. What was the first part please?
Steven Chin - UBS
Sorry. Sales to the US market were relatively flat for SunPower here in the third quarter on a sequential basis. Just wanted to know if you thought you lost share there or was there seasonality in the US in sales to the US market?
Let me just give you a short data and then I'll turn it to Howard. You can interpret our Q3 and what looks like the Q4 as well as being sold out, and so it's a question of allocation of product. We have more demand than we can supply, and we think that environment goes well into 2010. Having said that, so therefore it's largely an allocation decision, but Howard, can you add some color?
Yeah, we actually believe we maintained a share and gained share in some segments in the US. So, that would be in the residential and commercial part of the business. Part of the allocation has to do with going from system sales to component sales and so differentially we actually had higher overall sales on a revenue basis in North America on the component side. So, we either held or gained share in Q3 relative to Q2.
Steven Chin - UBS
And any outlook for the fourth quarter, Tom?
When you say any outlook, in terms of share or…
Steven Chin - UBS
No. For sales to the US. Would you expect that to increase again?
We believe that overall sales will increase sequentially on a percentage of our total revenue basis. So, can stick around 30 or 35% of our total revenue in the US in Q3. We believe that will go up to around 40% plus or minus in Q4.
And our next question comes from Satya Kumar. Your line is open. Please state your company.
Satya Kumar - Credit Suisse
Yeah thanks Credit Suisse. Hi Thomas. When I look at the sort of rolling four quarter average of your components revenues as a percentage of your overall revenues, it increased steadily from the mid-30s middle of last year to about 60% of the most recent quarter, and a track with sort of an increase in your dealer network. Few questions around that. What's the right way to think about the venture of global size of a dealer network. What's the inventory of your panels in the dealer channel and how do you tack that? And what are the typical terms of selling to dealers and how (inaudible) happens to the dealer channel? Thanks.
Okay. Great. Thank you for the question. Let me take it and say that first of all your correlation of number dealers to revenue is a very good correlation. I would say the for the statisticians on the phone, the R squared will go down a little bit, because the revenue per dealers, because as we expand the dealer network, the revenue per dealer reduces just a little bit. So, it won't be completely a direct correlation but close. So, that's a very fair observation.
We think in terms of thousands of dealers Satya. So, we're in the early stages of expansion, and when we say a dealer, it's not some vague term that we sold the module to them. It's a signed contract with the services agreement. So, it's a big deal as we expand that part of our network.
One of the services that we offer our dealers is inventory. We hold the inventory, not the dealer. Generally speaking, the dealers have no SunPower inventory. We're very close to none. So there is no channel inventory. So when Dennis reports an inventory number, that is the channel, includes the channel inventory for our dealers. That is incredibly relevant as in previous calls some people have been worried about channel inventory and the dealer network. There is none generally speaking. We are the ones that have that inventory.
In terms of separating that out and getting the terms number, we would have to separate out of our total inventory as a company, how much is attributed to that segment. I don't think we'll have that number live but we'll be happy to work it out in a callback get that to you. The turn number is going to be extremely high. What it's going to be driven by is the logistics. Whether we built the panel in region or it was shipped on the ocean, but you in all likely are going to have very high turns. In terms of (inaudible) it's sold to the dealer and the dealer almost immediately installed it again. There is no stocking. Is that correct Dennis?
That's correct. That as far as the term Satya, really does depend upon the region in the market, but in general the terms that we give them are 45 to 60 days.
Your next question comes from Steve O'Rourke. Your line is open. Please state your company.
Steve O'Rourke - Deutsche Bank
Thank you. Steve O'Rourke from Deutsche Bank. So my question on sort of capital spending and maybe some implications, you took capital spending down for this year from your forecasts of what it would be. A lot of that I'm assuming would have gone to Malaysia. Is that efficiency building into capital spending? Is it an implicit comment on king of 2010 with demand? Does it mean that third party modules that project the prices make more sense to buy? Can you help clarify how you're thinking about that?
No, it doesn't. It's a timing issue. So the short answer is no. I don't know how many people where we have hundreds if not a thousand people on site in Malaysia building our first half of our new fab and we are driving our operating team to get that done as soon as possible, because our sales team can more than allocate all of 2010's production, and they badly want more products. So, no, it would not be the case.
Now, just to add a little color, however, we will supplement our production since we can't make enough with some third party. And that's part of the work we're doing in November and December is to figure out how much of that is and how that will be deployed strategically. So, it’s a good question but it turns out that its just timing and we are aggressively implementing our third fab. But the net answer is yes, there will be third party in 2010.
Your next question comes from Rob Stone. Your line is open. Please state your company name.
Rob Stone - Cowen and Company
Tom I wonder if you could just follow up a little bit on your comment a minute ago. What are the implications if you're going to be capacity constrained for the first half of next year? Will you have to see lower margins and components? For instance as you pass through more third party modules. And related to that, although I know you're not giving 2010 forecasts yet, how should we think about seasonality as possibly relieving a little bit of the pressure maybe in the first half?
So that the profile of the year, I think I'll let Howard speak to a little bit. The profile will be a little bit like this year, and we don't expect Q1 to be similar. So, if you look at two halves of the year, I think that would be fair. And so, you are correct. There is more pressure on SunPower production in the second half of the year. That’s due to timing of large scale projects, which we believe are becoming more and more predictable as we look at our pipeline and the process of permitting and financing the projects.
Again, I'll let Howard comment more on just a minute on that. On third party, we have not signed any new contracts for third party for 2010. So, we don't have the gross margin calculated yet. It would be fair to say it's unlikely to be as good as it is, as it hasn't been for historically. But we don't have a gross margin yet because we haven't signed any contracts and you can imagine we're diligently looking at options there, and there are a lot of options. You want to comment on the profile of 2010, Howard?
Sure, Rob, this is Howard. I'll just comment specifically on the components part of the question. We do not expect in the first half of the year a substantial erosion of gross margins due to third party in the components part of our business in the first half of the year, and so we're actually weighted to the second half with respect to utilization. Third party as Tom mentioned and much of that in the systems part of our business. Regarding seasonality, I think Tom covered that well. We do expect normal seasonality with really related to weather, somewhat on policy for the first quarter of 2010. It's normal for our industry going back many years, but we do not expect it to be nearly of the magnitude of the first quarter of 2009.
Rob Stone - Cowen and Company
So in the meantime, until you get your first production from the new fab in the second half, by how much versus the 110 megawatts you produced in Q3 can you increase output in the Philippines?
In terms of the run rate, actually it's pretty substantial, Rob. In fact, the level of output we expect next year is almost exclusively by running the first two fabs at full capacity for the entire year. The contribution for the third fab is not that significant. So, it's almost all from the first two fabs running at full capacity.
Rob Stone - Cowen and Company
So, when you say you're looking at allocation, it's because the demand is growing even faster, not because you won't still be growing your output.
Our next question comes from Sanjay Shrestha. Your line is open. Please state your company.
Quick questions. So, Tom appreciate that you guys narrowing the range for 2009, but one question I had was, so we did bring the top end down here for the year and from what I hear I do think financing is doing better, is getting a lot more traction, even winning market share. So, is it one of those situations where its timing related? And opportunity pushed to '10 making '10 even stronger here. Can you talk about that a little bit?
I wish you wouldn't have added that last part, because you talked about it a little bit, because the answer to your question is yes. So, that's very short talk I guess. What we said in our prepared remarks, just to expand a little bit, is that financing is improving. Of course that's relative to an incredibly difficult time period, and so things aren’t nearly as fast as they were say, few years ago.
And what you see of course is a new group of investors, and other investors, the mix of investors that are financing these projects are considerably different than they were a year ago, and that's going to take time as new investors come online as well. So, we're seeing financing happen. It's taking longer. So, these are real projects in our pipeline that are just moving from '09 to '10. That’s exactly right.
One quick follow-up on similar type question, then guys, so, when we strip out all the inventory charge for Q3 and take into consideration even the ASP decline in Q4, but at the high utilization, ongoing traction at cost out so, is it fair to say that we should expect pretty nice uptick on the margin in Q4?
I'll let Dennis comment on that. And you can talk to our operating team. But I'll let Dennis comment on that. We'll take one or two more questions.
I'll let Dennis comment on that Sanjay. I think we'll invite you to our next operations review and you can talk to our operating team. But I'll let Dennis comment on that and we're virtually out of time. So, we'll take one or two more questions. Dennis?
Yes Sanjay. There's a couple of factors there, that the base answer is yes. You should see some improvement, but obviously it depends upon what the final ASP numbers come in during the quarter. As Tom said, we're looking for continued pricing pressure that was similar to what we experienced here in the third quarter, but we're continuing to do
Things to bring our costs down. Capacity utilization is continuing to improve which means we are having (inaudible). All right so, one time items will go away. So, look for on the gross margins, similar to second quarter to slightly stronger.
Terrific. Thanks a lot and look forward to seeing you guys next week.
Likewise. Let's take two more questions please.
Okay. Our next question comes from Michael Horwitz. Your line is open. Please state your company.
Michael Horwitz - Robert Baird
Robert Baird. Thanks for taking my call. A question regarding price. Given some of your earlier comments about allocation and then taking into account the segments that you operate in and some of the new push that you're having in some of the European countries, should we start thinking about price differently in 2010 as it relates to some of your competitors? Will there be some firmness and some differentiation in price and is there a scenario where the elasticity of demand enters the market again and we could actually have some stability in price
I'm going to let Howard take that after a really, really brief comment that your general thesis is I think right on track. There has been quite a bit of price reduction and may be a little bit of momentum going in to Q4 for a little bit further price reduction. But it's abating some, and the only comment I want to make is, remember our long-term strategy here as the company and that is to sell to a diverse market set and so that as policy changes, we don't have to quick rearrange things.
And so, we're not necessarily as a company maximizing margin by focusing on a certain market. I just wanted to make that point because over the next few months, we're allocating product and making decisions that are not just for 2010, but setting ourselves up for continued strength for next few years. Howard, can you give a little more detail though?
Sure. Michael, we do expect ASPs to moderate and stabilize into 2010. However, we are planning on continued reduction in ASP. That's the model for the industry, it's a model for SunPower because demand is price elastic and that's a good thing. The delta between our product in pricing versus other products exists today, we expect that to continue to exist and that's because we're differentiated not only on the product and technology ad efficiency and megawatt hours per roof area and per acre, but also because of all of the ancillary services that we provide in the different channels. So, with the new segments and as you mentioned in the new geographies that we're going into, we expect us to maintain our differentiated model going into 2010 and beyond.
Our last question comes from Pavel Molchanov. Your line is open. Please state your company.
Pavel Molchanov - Raymond James
Raymond James. Thanks for taking my question. On roadmap to below dollar watt panel do you talk about a 10% poly reduction cost over the next five years. Does that imply that industry wide poly costs will be down 10% or just SunPower's individually?
Hey Pavel and she did a pretty good job name on your last name there. The answer to your question is we're talking on specifically of SunPower, and to be frank, I think that as new production of polysilicon comes online, that there's going to be price pressure in that market. What we're doing is indicating a combination of contracted polysilicon for us as well as better utilization and obviously, the impact from this point going forward. So, that's actually a comment about SunPower specifically.
Thank you everybody for joining us today. We really appreciate your support. Look forward to reporting to you on our Q4 results and 2010 guidance in January. Thank you very much.
Thank you. This concludes today's conference. You may disconnect at this time.
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