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Energy Conversion Devices, Inc. (NASDAQ:ENER)

F2Q10 (Qtr End 12/31/09) Earnings Call Transcript

February 9, 2009 10:00 am ET

Executives

Mark Trinske – VP, IR & Communications

Mark Morelli – President and CEO

Harry Zike – EVP and CFO

Analysts

Colin Rusch – ThinkEquity

Sanjay Shrestha – Lazard Capital Markets

Steve O'Rourke – Deutsche Bank Securities

Jesse Pichel – Piper Jaffray

Satya Kumar – Credit Suisse

Vishal Shah – Barclays Capital

Burt Chao – Simmons & Company

Rob Stone – Cowen & Company

Kelly Dougherty – Macquarie Capital

Paul Clegg – Jefferies & Company

Operator

Hello. My name is Vanessa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Energy Conversion Devices conference call to discuss the company’s second quarter financial results for fiscal year 2010. As a reminder, today’s call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) I would now like to turn the call over to Mr. Mark Trinske, Vice President of Investor Relations and Corporate Communications. Please go ahead, sir.

Mark Trinske

Thank you, Vanessa. Good morning, everyone, and thank you for joining us on our fiscal 2010 second quarter financial results conference call. Participating on this call today are Mark Morelli, our President and CEO, and Harry Zike, our Chief Financial Officer.

This morning’s presentation will include the use of several slides. We will be controlling the advancements of the slides and providing a commentary on each. A downloadable copy of the slide presentation and our second quarter earnings press release are available on our website at www.energyconversiondevices.com.

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

I would like to remind you that the following discussion may contain forward-looking statements within the meaning of the SEC’s Safe Harbor provisions. Such statements are based on assumptions, which ECD believes to be reasonable and appropriate as of the date of this call. We caution you that the facts and conditions that may exist in the future could vary materially from those upon which these statements are based. Please review the risk factors identified in the ECD filings with the SEC, including our most recent 10-K and our second quarter 10-Q, which was filed this morning, and recent 10-Q.

Now I would like to turn the call over to ECD’s President and CEO, Mark Morelli. Mark?

Mark Morelli

Thank you, Mark. Please turn to the next slide. In our fiscal second quarter, we continued to deploy the business model that we described in our last earnings call, which focuses on selling scale projects. Our fundamental value proposition remains strong and demand is growing. Several large scale project wins over the past few months gives us greater confidence that our business is gaining traction.

During the fiscal second quarter, we increased revenues by 23% compared to the first quarter. This was our first quarterly increase in the last four and represents important progress in the development of our business. The project expertise gained through our Solar Integrated Technologies acquisition was an important contributing factor to the quarter’s increased revenue. In fact, we are building on these capabilities to grow our demand generation engine.

While revenues in the quarter increased, our net loss also increased. We announced a restructuring program in the quarter, but we clearly understand that the key to profitability lies with continued revenue growth and strength in gross margins. We are focused on expanding our business model beyond BIPV leadership to large scale projects and select BAPV segments. This will drive our return on profitable growth.

Let me speak to this in greater detail. Turn to the next slide. Our strategy continues to focus on key value drivers. First, we are the leaders in building integrated PV solutions or BIPV market. The unique attributes of our solar products and our established building materials channel are the reason we continue to be the leader in BIPV. Though we are strong in this segment, the new and re-roofing market is weak. We need to grow stronger and more competitive where the market is currently showing strength.

Our focus is to arrange and sell large scale multi-rooftop projects. These efforts are gaining traction. In fact, since the end of the second quarter, we signed more than 35 megawatts of large scale projects. Uni-Solar continues to be a differentiated PV solution that has low impact on rooftops. We are now selectively targeting the building applied or BAPV market with new product for markets that don’t need a new or re-roof. Moving forward, we are continuing to develop innovative technologies, which will result in the next generation of low-cost, high-efficiency products, with a target of 12% conversion efficiency and $2.50 total systems cost per watt.

Finally, our products and technology have a long and proven track record. Our company’s growth from a technology developer into a full scale manufacturer took many decades. We believe our experience is a competitive advantage compared to new comers in the solar market and the companies that have yet to ramp their technologies. Using these value drivers, we will build a high-growth profitable business.

Let me review some of the progress we have made since the last call. Please turn to the next slide. I want to spend a moment discussing our progress securing large scale multi-roof projects. We are excited about this recent win. Last week we announced a marquee project with Italy’s Enel Green Power. We will install up to 25 megawatts on this single project alone. It’s one of our largest projects to date, and more importantly, it represents the type project that working towards with our initiative.

Our solar laminates will be installed on the rooftop of nearly all the buildings you see in this photo. Enel chose our solution because it fits perfectly with the characteristics of these buildings. The Enel solar laminates are light-weight. They met the roof load capacity and have the ability to withstand high wind gusts of up to 160 kilometers per hour. As a low impact rooftop solution, Uni-Solar laminates are unparalleled in the industry. We are currently working on many large scale projects with quality partners in our target markets. But as we’ve said before, these projects are complex and their timing is difficult to predict.

Please turn to the next slide and take a look at this one. This is a 4.8-megawatt project that we announced with recurring energy where our laminates will be installed in the rooftops of eight buildings owned by ProLogis in Spain. This is another example of a large scale, multi-site project, this time with us acting as the EPC. As some of you may recall, ProLogis is a repeat customer of Uni-Solar systems on roofs in the US, France, and Spain.

Please turn to next slide. You may have seen this one. Recently we announced the completion of a 1.1-megawatt installation on the rooftops of Flanders Expo. This one has the largest solar rooftops installed in Belgium. The project developer Enfinity and our channel partner Derbigum chose Uni-Solar laminates because they are lightweight, durable, they don’t put holes in the roof, and they have excellent performance in the fuse light.

Please turn to slide eight. In December, we announced a 3-megawatt project within desktop to install Uni-Solar laminates on the rooftops of two Coca-Cola bottling centers in Spain. These bottling facilities show our ability to develop repeat business with important customers. We now have large scale projects on Coca-Cola facilities in Spain and the United States. Taken together, these recent projects give a sense of how we are moving forward with our project business.

Let me now touch on other developments in the market. Next chart. We love the French market. This is one of our most important markets and one where we have a clear competitive advantage. Last month, the French government updated its solar PV feed-in-tariff program. Under the new program, BIPV installations, where we have a leadership position, will continue to receive the highest tariffs in the world.

This is important because the new tariffs include a more stringent BIPV definition that’s really positive for our business and will lead to favorable project IRRs and more sustainable demand for our products. Also the new BAPV regulations require the PV to follow the roof inclination and ensure waterproofing. This makes it more difficult for our competitors to expand cost-effectively into the French rooftop market with their current offerings. We are excited by France’s support of the PV market and our competitive position in the country.

Turn to next slide where we are going to talk more about new products. As we’ve demonstrated, we have an excellent solution for the building integrated market segment. Now we have broadened our product offerings to include a differentiated building applied solution. Recently we announced the PowerTilt product for building applied rooftops. PowerTilt offers a lightweight building applied rooftop solutions. It’s ideal for the low load bearing segment of the rooftop market, which is underserved by traditional flat panel products in the market today. And we continue to make progress with new products for the residential market.

In 2009, we announced an agreement with certainty [ph] to develop superior residential solar products based on our Uni-Solar technology. In January, we announced the first of these products, which is shown in the photograph on the Governor’s Residence in Michigan. We are looking forward to the next generation of residential products, including a completely integrated shingle.

Please turn to next slide. We are reducing our total installed systems cost and improving our product efficiency. Let me first discuss our plan to reduce total cost. As the chart on the left shows, we’ve already reduced fully installed systems cost by over 40% between 2008 and 2010. We intend to reduce cost to $2.50 per watt. Importantly, that figure includes a reduction of our laminate cost to less than $0.95 per watt. We expect to achieve these total system cost savings by lowering material costs and balance of system costs by more a cost-effective product design and by improvements in manufacturing throughput and yields. I’ll speak to the last two items in more detail in a moment.

In the middle of the slide, you will see the energy yield advantage that our current Uni-Solar technology has over other types of solar PV. In real world installations, our products wake up earlier, go to bed later, and produce more energy and low light conditions. As a result, our products already generate from 10% to 20% more electricity per rated watt. As pioneers in solar, we have demonstrated world record conversion efficiency of 15.4% for amorphous silicon in the lab. Our experience gives us the confidence that we can boost the conversion efficiency of our products to 12% in production.

The next slide shows the specific technology initiatives we are developing to both reduce costs and improve efficiency. Please turn the slide. Our roadmap to $2.50 total systems cost and 12% conversion efficiency includes enhancements to product technology and design and improvements in our manufacturing processes. Conversion efficiency will be improved this year as we introduce an enhanced laminate back reflector that will better reflect the light within the cell to generate more power.

Systems cost will be improved by increasing the activity of our laminate through an improved product design that will cost less to manufacturer and will use fewer raw materials. Both conversion efficiency and systems cost will be improved by increasing output of our manufacturing lines. We will use a higher frequency deposition method, which will increase main play capacity from 30 megawatts to 50 megawatts per line.

This new technology is currently being implemented at our Auburn Hills 1 facility. We are confident in our product technology roadmap because we have a 25-year proven track record of scaling solar manufacturing and bringing new products to market. We are planning to webcast this spring to discuss our product technology roadmap in greater detail. We will send out a special notice with the specific date and times later.

Please turn to slide 13. We are pioneers in solar PV. One of our first one-half megawatt machine was built almost 25 years ago. And we have products installed in the field for more than two decades. To date, more than 400 megawatts of our solar products have been installed worldwide. We also have a history of operating excellence that includes numerous process and efficiency improvements, reduced material costs, and a flexible manufacturing model that allows us to mask production with near-term demand.

Our technology roadmap illustrates our path to 12% conversion efficiency and total systems cost of $2.50 per watt, making our cost of energy one of the best in the industry. And we are seeing more traction on our expanding business model. The recently announced large scale multi-roof project with Enel is an important step.

We are working to fill our project pipeline with other large scale deals. We’re launching new products to reach a greater portion of the BAPV market and Enel residential market. Our experience, our proven track record, and expanding business model give us confidence that we can weather the near-term challenges in the solar PV market and return this company to profitability in the future.

Now I’ll turn the call over to our CFO, Harry Zike.

Harry Zike

Thank you, Mark. Please turn to slide 14. As Mark discussed earlier, our revenues increased by 23% in the second quarter of our fiscal year, driven primarily by the increase in megawatts sold. Our net loss increased in the quarter to $39.1 million due to a number of factors, including unabsorbed factory overhead, restructuring-related costs, reduced average selling prices, and a full quarter of SIT operating expenses. As anticipated, we ran our factory that significantly reduced capacity impacting both net income and cash flow from operations. I’ll speak in much more detail about the second quarter’s net loss and cash flow in a moment.

Please turn to slide 15. I’d like to highlight a few other items of importance for the second quarter. We made significant progress integrating SIT. Sales and marketing organizations have now been combined, and we are shifting production from SIT’s facilities to United Solar’s facilities. We will substantially complete the remaining integration of SIT in the third quarter. We accelerated the restructuring of the SIT business, which resulted in a non-cash inventory write-down of $2.5 million charged against cost of sales, a non-cash asset impairment of $1.3 million, and restructuring expenses of $1.3 million.

In total, SIT integration activities this quarter resulted in $5.1 million of restructuring-related costs. We also recorded $1.1 million of restructuring expenses related to reductions in the United Solar’s operations and corporate staff. Costs for current restructuring activities will total approximately $9 million in the fiscal year and will result in approximately $17 million of annualized savings next year.

With respect to inventory, we turned more of our shipments to revenue and began to manage our inventory levels downward as part of our overall focus on working capital. In addition, we took steps in the quarter to flex production down. We anticipate that we will continue to run our factories at reduced levels for the next two quarters to further reduce our inventory levels. As a result, under-absorbed factory overheads will also increase.

Please turn to slide 16. Cash flow from operations was a negative $34.2 million during the second quarter. Of that amount, $9.3 million was attributable to decreased accounts payable and other changes. The decrease in payables primarily resulted from our decision to reduce manufacturing levels during the quarter. The balance of the negative operating cash flow was a direct result of the quarter’s net loss, which I’ll address in the next slide. In addition to operating cash flow, we paid the final portion of SIT’s debt, amounting the $8 million during the quarter and we invested $6.6 million in capital expenditures.

Please turn to slide 17. I would like to add some color on certain of the large items included in the net loss for the quarter. We managed our inventory levels and reduced factory production, which resulted in unabsorbed factory overhead costs of $7.4 million. We also accelerated plan restructuring, which had a cost of $6.2 million, and as we anticipated, ASPs declined by approximately 10% and accounted for $3.9 million of the quarter’s loss. Our acquisition of SIT accounted for an incremental $2.3 million of operating expenses in the second quarter and the remaining loss was attributable to ongoing operations.

Let me now address our plans for each of these items. Unabsorbed factory overhead costs in the second quarter resulted from our decision to reduce manufacturing activity to manage our inventory levels down. We will continue to manage our inventory downward, and as a result, unabsorbed overhead costs will continue and may grow over the next couple quarters. However, as our project demand grows, we will flex our production levels upwards and reduce these unabsorbed costs.

In the second half of the fiscal year, we anticipate restructuring costs of about $2 million related to the SIT integration. All of the restructuring actions announced to date are expected to provide annualized cost savings of approximately $17 million. We will start to see these savings in the third of fourth quarters with the full ramp by the beginning of 2011, and we will continue to examine all areas of our business as part of our ongoing cost-out programs. ASPs during the quarter declined in line with our expectations to the geographic and customer mix.

Please turn to slide 18. At the end of the second quarter, we had approximately $200 million in cash and cash equivalents and approximately $340 million in working capital. Our focus is to return to profitability and achieve positive cash flow from operations. To achieve these goals, we must grow our revenues to be able to run our factories and eliminate unabsorbed overhead costs; second, reduce operating expenses through our cost-out programs and continued restructuring; next, improve working capital, for example, by continuing to reduce our inventory levels; and finally, arrange project financing to support our evolving business model.

Now I’ll turn the call back to Mark.

Mark Morelli

Thanks, Harry. Please turn to the next slide. Our project focus represents an evolution of our business model. We anticipate the results in the near-term will be lumpy with inconsistent financial results. Revenues are difficult to predict in a given quarter. In this dynamic market, we’ve taken and will continue to take the necessary actions to improve our business. As a result, our revenue was up and the quality of our pipeline is improving, which gives us confidence this trend will continue.

Let me reiterate the core values that will drive our top-line growth and return the company to profitability. We are the leaders in BIPV. We are expanding our business to include more scale process and broadening our reach into select BAPV markets. We have a different set of solution that has low impact on rooftops. We have a roadmap to deliver better technology at lower cost and a proven track record on developing new technologies and bringing products to market.

We will now take your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Colin Rusch from ThinkEquity.

Colin Rusch – ThinkEquity

Good morning, gentlemen. We’ve seen a number of deals delayed and some cancellations in France due to the new tariff rules and some of the associated regulations. Can you talk about your expectations for the length of the sales cycle in France and the size of the opportunity there in the next 12 months?

Mark Morelli

We’ve working on the French market very diligently. And we agree with you, we did see some deals being pushed out the last quarter. In fact, specifically on that point, our ASPs came down a bit. And the reason being is we essentially didn’t have any shipments into the French market all of last quarter. At the same time, we think, to get specifically to your question about that sales cycle, we are very bullish on our opportunities in the market. We’ve got a differentiated solution. As you know, we are the leaders in the BIPV segment where this feed-in-tariff program really favors our product. So we anticipate our focus on the French market will pay off.

Colin Rusch – ThinkEquity

All right. And can you give us an update on the same topic in Italy, what expectations for changes to the tariff regime there in the grace period and how that plays out for your business?

Mark Morelli

Italy is also a strong focus for our business because of the BIPV feed-in-tariffs. We anticipate there may be some revision in the April timeframe. We have a good pipeline of projects that we are working in the Italian market, and we should see some traction in the near-term.

Colin Rusch – ThinkEquity

Great. And then the final question, on the technology roadmap, can you give us just a sense of timing on how you see the new changes rolling out through the product line and when you will be able to achieve the 12% conversion efficiency?

Mark Morelli

Yes. We think that -- what we are showing here on our conversion efficiency roadmap that we can have a series of improvements over our product offerings in the short to medium-term. The best place for us to really lay this out in detail is on a specific conference call on this subject, where we are going to be talking about conversion efficiency combined with our laminate cost reduction program. As pioneers in the field, we are very confident on our approach and we look forward to having this conference call.

Colin Rusch – ThinkEquity

Great. Thanks so much, guys.

Operator

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

Sanjay Shrestha – Lazard Capital Markets

Yes. Good morning, guys. I’ve got a couple of quick questions. Kind of one follow-up on that question about France and Italy. So what’s the anticipated subsidy change sometime in April in Italy and some numbers out there and are talking about pretty big installation for ’09? And given the cap situation, what have you guys heard in terms of what might be the potential outcome there, given that you guys have been there pretty early? And two, in terms of France, how big do you guys think that market is going to be for your people in terms of your sales concentration over the course of next couple of years given the pretty attractive return profiles with BIPV stuff there?

Mark Morelli

Yes. About the Italian market, it’s a good market to us. We’ve got some high-quality repeat customers that we hope to be making some more announcements for this in the near-term. We think long-term some of the rhetoric that we are hearing is that the declines are going to be evident, but probably not that appreciable. In fact, if you look at the solar radiation in Italy, it’s probably going to be the first market to great parity probably in the world combined with the sun and feed-in-tariff. So we are very bullish on the opportunities in Italy. The second part of the question you asked is about the French market. It’s a pretty small market today. In 2009, maybe about 200 megawatts, and by 2011, we see that market more than doubling. In fact, this is greater than a 40% CAGR. So it’s a great opportunity for our product. It’s got a very specific feed-in-tariff that favors our product, and the differentiation allows us to get higher ASPs.

Sanjay Shrestha – Lazard Capital Markets

Okay, got it. Got it. So another question. Mark, you guys are talking about your technology roadmap. You are in a bit of a Catch-22 situation here and I hate to state the obvious, but -- so how exactly do you see that $0.95 cost goal, the way you sort of get to accomplishing that? Because near-term you can't ramp up, without ramping up you can't come down the cost curve. How much of that cost reduction benefit can you get from technology improvement before you have to really sort of build the channel and really start to build scale?

Harry Zike

Yes. The $0.95 goal is a combination of improvements that we can make, which are engineering improvements to laminate, helped reduce the inactive area on the cell. And that’s pretty straightforward. The other part of that is the continuation and evolution of our business model with evolving our technology. The good news is that we have a proven and established track record. We’ve got more than 400 megawatts installed, and this -- our technology focus has really enabled us to continue to ramp this technology and bring our cost down. One of the points I would like to make, and I think it more gets directly at your question about how to get to that $0.95, we’ll talk more about this on the call, is that we think it’s about a third direct materials, about a third throughput and yield -- manufacturing yield improvements, and the other third is going to come through the improved physics of conversion efficiency.

Sanjay Shrestha – Lazard Capital Markets

Got it. One last question, guys. I think, Mark, you touched on it a little bit as to the PPM model and sort of focusing on the downstream side of the business, now that certainly has positives as potentially pretty attractive operating margin once you fully build it out, but near-term it has an issue of kind of draining the balance sheet. What's your thought process? What's the optimal mix there? How do you sort of see you really going after that market without really putting any further strain on the balance sheet given the near-term challenges of cash flow and profitability and things like that?

Mark Morelli

Our project business is based on us arranging financing. We will leverage the balance sheet a little bit where we may be paying for some permits in the short-term. But a lot this, what you see what we’re implementing is that we are not extending much of our balance sheet here and it’s focused on making those arrangements. In terms of the split between our projects business, our two-step distribution model, we think particularly in the near-term that this is probably going to be more of this project focus. But keep in mind, we are the leaders in the BIPV segment with an established building materials channel that really focuses on the new roof or re-roofing market to essentially spring back. As the economies worldwide begin to come out of this recession, we also anticipate that that channel once again will be able to deliver high volume for us.

Sanjay Shrestha – Lazard Capital Markets

Okay. That’s great. Good to hear that. Thanks, guys.

Operator

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

Steve O'Rourke – Deutsche Bank Securities

Thank you. Good morning. And thanks for taking my questions. First, can you quantify ASP declines in the quarter, at least give us a some idea? And then what are your expectations through the year and your assumptions for the year on pricing?

Harry Zike

Yes. Our ASPs were just about $2.10 for the quarter that we just finished. This was along the lines that we guided to. Essentially what impacted that, and it did bring it down as anticipated, was that we didn’t’ sell much into the French market. In fact, hardly any of our sales at all went into that French market. And we had some sales going into the Germany market, which is typically not a market that we served. In terms of how we go forward on ASPs, we think that in fact they will be a bit flattish in the quarter that we are currently in. And the reason being as well we will have some more balance to the kind of business that we’d like to see in our pipeline. We are also moving out little bit of our slow-moving inventory as well. So we think about a flattish ASP is responsible. To get to the last part of your question, how we see that going forward? It’s hard for us to say. I think we need to focus on our differentiated solution with low impacts on the roof and focus where we play in a differentiated sense where it can also get volume.

Steve O'Rourke – Deutsche Bank Securities

Okay. And one follow-up question. In one of your slides you talked about 2010 system costs of $3.50 roughly. Is that an SIT, your subsidiary, installed system cost? And when you think about -- how much of that is more soft costs than, say, material costs?

Mark Morelli

Yes. The first part of your question is that offered by SIT. SIT really has an EPC capability, and they can offer it. One of the important aspects of the SIT acquisition is that we hope that it drives down the total installed cost that we can make available to other folks as well. So we think that that’s an important aspect of taking advantage of that acquisition. In terms of soft costs, I don’t quite know what you mean by that question. If you could perhaps restate it in a different way, I’d appreciate it.

Steve O'Rourke – Deutsche Bank Securities

Just curious how much is material cost and how much is other than material cost? That is the laminate [ph] plus everything else, yes.

Harry Zike

It’s tougher to judge in terms of an overall generality. But I will talk to you about some of the benefits. First of all, the material costs are really low because it’s a lightweight solution. You’re talking about adhesives, how it gets bonded to the roof. And when you look at that compared to some of the structures that other people have on the roof, clearly you can see the material is less. We may have a bit of labor in that because it’s associated with how you put that up there on the roof. So it’s probably more of a labor function. We are currently studying that labor aspect, and we are using our industrial engineers in terms of trying to time the study and train our folks better on installation cost to bring that labor content down.

Steve O'Rourke – Deutsche Bank Securities

Fair enough. Thank you.

Operator

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

Jesse Pichel – Piper Jaffray

Is there any way for you to break out the SIT versus component sales gross margin in megawatts, or are you not providing that level of detail?

Harry Zike

Yes, Jesse. As we’ve said before, our integration of SIT is pretty far along and we will finish in the third quarter. So all of these things are now have been integrated within the S -- into the ECD business as a whole. So we no longer breakout, that’s SIT. As we look forward through, we are breaking out our business into more of the projects area, which is our main focus. But for this quarter, we’re not giving that breakout.

Jesse Pichel – Piper Jaffray

In the past, you’ve disclosed the component cost per watt? And I was wondering since you’ve given us the cost roadmap of $0.95, can you tell us what the cost component is today out of that $2 intense on ASP what the cost is?

Mark Morelli

Yes. Our manufacturing cost per watt clearly is up because we are intentionally running the factories less. And as you know, we’re going to have higher unabsorbed costs. An important number for us that target on a fairly near-term is if we can run our factories at near our production capacity, we can get to a manufacturing cost per watt of $1.50. So we think that that’s an important marker that we have out there, as we begin to run our factories more. In the near-term, we said we are going to run our factories less. So you can expect our manufacturing cost per watt to go up, because there is no other absorption issue.

Jesse Pichel – Piper Jaffray

And two more quick ones. You burned -- it looked like $60 million from operations in the quarter. Do you have any type of forecast of what that run rate may be for the next or two?

Harry Zike

Yes, Jesse, just a couple thoughts on that. During the quarter, our total cash usage was about $50 million. But we did end the quarter with an excess of $200 million in cash and cash equivalents. As we look forward in the next couple of quarters, we believe our cash burn will be less than that, both for Q3 and Q4.

Mark Morelli

Yes. Let me now say what I think about cash because I think it’s important. Clearly we are going to run our factories less in the near-term, that flushed out our inventory while our sales will be growing. At the same time, our focus on differentiated solutions in market should give us a relatively attractive ASP. And our traction on our business model to get this top-line growth, we think is showing promise. So they spoke us on our large scale rooftop to get this volume to return to profitability and generate positive cash flow is very important.

Jesse Pichel – Piper Jaffray

Two more, if I may. Do you intend the SIT to sell any other solution other than the flexible laminate? Could they potentially also sell a Chinese module, for instance?

Mark Morelli

Our capabilities that we are developing in the field, I think are generally applicable, particularly because we have strong rooftop applications expertise. At the moment, we are focused on a low load bearing roots, which we think is a very significant part of the market. In general, it’s about 20% of the market. But if you look in markets like France and Southern California, this is a large part of the commercial rooftop market. In fact, the French market is estimated about 70% to 80% of commercial rooftops are these low load-bearing roofs. So our focus right now is to be able to go to where our product is differentiated. We’ve got excellent applications expertise on the roof and would be able to sell our differentiation into these markets getting higher ASPs.

Jesse Pichel – Piper Jaffray

Your competitor just reported numbers and really is appealing for health, while the administration is trying to create jobs. You are in Michigan, and obviously unemployment is an issue. And just about the last four or five sitting presidents have visited your facility. What is the administration doing there to create a domestic industry because everything you’re talking about is really overseas at this point? That was France and Italy.

Jesse Pichel – Piper Jaffray

Yes, your points are very voltaic. And our strong shoe is in France and Italy. And it’s a lot because of our involvement with the governments and our ability to be responsive. The rhetoric that we’ve had in our conversations with folks both in the state as well as in Washington DC are always very positive. They are very encouraging. There is some frustration on our part because we’ve seen incentives moving very slow. An example, our DOE loan guarantee program, which those of you that may follow that, we passed through the first phase of that and quite successfully. However, things are slow. Our democratic process, we have a lot of respect in, but at the same time, we would love to see things accelerate and we are working very actively to try to get things accelerated.

Jesse Pichel – Piper Jaffray

Okay. Thank you very much.

Operator

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

Satya Kumar – Credit Suisse

Yes. Hi, thanks. Did you say that there was any project phase at all in the December quarter?

Mark Morelli

I’m sorry, Satya, can you repeat that question again?

Satya Kumar – Credit Suisse

Was there any project phase in the December quarter?

Mark Morelli

Yes, in the December quarter, we had sales into projects. However, they were recognized in a large part as revenue. What you saw in the previous quarter, we had a category of project sales. But that was where we acted as the EPC. Not everywhere where we have a project did we act as the EPC. So what you saw is project sales where we are not as acting as EPC. We are able to turn that into a revenue recognition earlier, which is obviously good near-term for our P&L.

Satya Kumar – Credit Suisse

Okay. In terms of production and shipments, could you provide some qualitative color at least in terms of how you expect those metrics to tract in March versus December?

Harry Zike

Yes. Our production side for the second quarter, we’ve rented about 50% of our productive capacity, which -- equate it around 20 megawatts, which is pretty much equal to our sales. As we look forward, we will ramp up and down our facilities based upon our near-term demand. In the third quarter, we anticipate ramping down our facilities again. We will be at about 25% of our productive capacity.

Satya Kumar – Credit Suisse

Would you expect shipment given that we are almost half way through the quarter to -- could you give some color on the directionality of shipments?

Mark Morelli

As we ramp down the production, our goal is to get the inventory down and convert that to cash. We do see, as we look forward into the third quarter and the fourth quarter, our sales will be exceeding our production.

Satya Kumar – Credit Suisse

Okay.

Mark Morelli

Specific, Satya, maybe this will help. We believe that our sales will be going up that we’ve seen that bottom and that we are on an upswing of sales. At the same time, as you’ve heard, we are going to be producing less. So we are going to have a divergence in our production equals demand, a philosophy to try to flush our inventory out quicker. This we think will get us on a better footing to profitable growth in the near-term.

Satya Kumar – Credit Suisse

Why do you then expect operating cash flow to be negative? I guess, can you help me understand what -- is there a production level that I can think of your breakeven operating cash flow?

Mark Morelli

Well, we have to be certainly operating north of 50%, and I think what we are seeing in this quarter that we are in currently now, we are going to produce less. To be more specific about that, we think we are going to be producing at about 25% of our capacity rate to flush our inventory out quicker. Why are we doing this? Essentially because we have a good ability to flex up and we’ve got greater confidence in our ability to flex up, and it’s more of a strategy to be able to accelerate our flushing of inventory out quicker.

Satya Kumar – Credit Suisse

Okay. Lastly, there was a new company or a private company, Solyndra, that recently filed for an IPO. They also claim to be lightweight and have pretty high efficiency of 12% and claim that they have lower installation cost. Do you view them as a meaningful threat? How do you see competition with those guys in European markets and domestic markets?

Mark Morelli

Yes. We really haven’t seen Solyndra on the scene. I think one of the important aspects, particularly in this market, is have the ability to be bankable. We’ve got more than 400 megawatts installed in the field. We have a differentiated solution that also takes advantage of a BIPV feed-in-tariff market, which essentially makes other folks such as Solyndra more difficult to compete in that market. I’m sure they have got a very good technology in front of them and can offer a value proposition to the market. But in combination, what we’ve got to go and what we’ve got to work on, I think we’ve got a very attractive path in front of us.

Satya Kumar – Credit Suisse

Got it. Thank you.

Operator

Your next question comes from the line of Vishal Shah from Barclays Capital.

Vishal Shah – Barclays Capital

Thank you for taking my question. Mark, can you talk about what kind of growth rate we should expect for your business over the next couple of quarters? It looks like a very different sales cycle. What are some of the hurdles you are facing? Is it still financing or -- besides what you talked about in the call, can you quantify some of the other things that you're seeing?

Mark Morelli

Yes. A specific growth rate number is difficult for us to guide to. You are absolutely correct. This is a different type selling cycle and a different type scale. And what makes that particularly tricky for us to provide guidance at this point is that it’s rather lumpy. As you can see, these are a very significant size and it’s very difficult for us to predict anything from quarter to quarter. We currently do see an upswing in our revenue that we believe that will occur. It’s very tough for us to give the specific numbers there.

The other part of your question had to do with arranging of the financing. It’s been a tough headwind for us historically because we’ve been impacted by the financial markets like most folks have. However, we are getting much better at arranging these large projects and also pulling in the financing that is required. This is the competency that we have to work on. We are encouraged by what we are doing and the results that we are seeing. It does take time, but we believe this traction in our business model is showing some promise.

Vishal Shah – Barclays Capital

Is financing an issue in France and Italy as well?

Mark Morelli

I don’t think that financing per se is the issue. It is the arranging of the financing that can take time. Our product is bankable. We’ve got a new bankability document that we are putting out that I think is a very good document. It helps banks that are new to us, see that value proposition. It’s really arranging the type parties for the specific projects that we’ve got. And sometimes this does take time. So we are seeing some of the credit issues fall by the wayside, but once again it takes time for us to work out these complex conditions.

Vishal Shah – Barclays Capital

Okay. So the 35 megawatts projects that you’ve talked about, are they -- can you expect to recognize the revenue for all of them this year -- this calendar year?

Mark Morelli

Yes.

Vishal Shah – Barclays Capital

Okay. And does it make sense to maybe talk about some of the previous backlog or some of those contracts are no longer valid?

Mark Morelli

Perhaps you mean by the previous backlog some of our take or pay contract --

Vishal Shah – Barclays Capital

Correct.

Mark Morelli

Some of our traditional, the channel. I don’t think they are no longer valid. As we have discussed in previous earning calls that we have negotiated some of those take or pay contracts to be more reasonable with the current headwind is due to the lack of financing, also the limitations with some of those channels in the market. We have had some negotiations with folks that see the value proposition of our product, and in other areas, we’ve also stood a bit firm. I do believe that they are valuable relationships with us and that there are some of aspects of those contracts that take us forward and make a lot of sense. But in particular, that channel will be much more effective when traditional regrouping and new construction comes back a bit in the medium term. And when that really -- that part of the economy begins to recover, then we should hopefully begin to see the strength of that channel again as well.

Vishal Shah – Barclays Capital

Are you able to quantify that number? Should we assume a risk adjusted number into the megawatts for this year?

Mark Morelli

No, it’s difficult for us to quantify how much would be our traditional bill and materials channel or projects business. But you can clearly see more of an emphasis towards these larger arranging of these projects in the near-term.

Vishal Shah – Barclays Capital

Okay. And then one final question. What do you think your OpEx is going to look like over the next couple of quarters?

Harry Zike

OpEx this past quarter was about $17 million, up slightly from last quarter because of SIT, but that’s -- we've actually got about $1 million out of the OpEx this quarter. We anticipate this -- another $1 million out in the following quarter and the one after that as well. So that will be a continual focus of ours as our cost-out program.

Vishal Shah – Barclays Capital

Thank you.

Operator

Your next question comes from the line of Burt Chao from Simmons & Company.

Burt Chao – Simmons & Company

Hey, guys, thanks for taking the questions. Just taking a quick step back, you talked a lot about France and Italy and obviously there's a lot of attractiveness for BIPV there. Last quarter we talked a little bit about Canada. Can you guys go over maybe how that's developing, your opportunity there, and maybe some other markets that you might be looking at once -- not that France and Italy get saturated, but just to diversify where you look for potential market opportunity?

Mark Morelli

Yes. Let’s talk about the Canadian/US market for a second. Obviously our strong focus in France and Italy are important to us. At the same time, Ontario is a very good opportunity. If you look at a 250-kilowatt rooftop application, you are north of $0.50 per kilowatt-hour feed-in-tariff in the Canadian -- excuse me, in the Ontario market in Canada. This is a very attractive feed-in-tariff. I think that if you look at where we can get the growth, clearly you will see us in that Ontario rooftop market. California also represents strong opportunity. We think the US market is poised for significant growth over the next year to two years. And we intend to add more sales resources to build on our current capabilities in the US market, in California specifically, and also to sell opportunistically into New Jersey.

Burt Chao – Simmons & Company

Okay, great. And with the diversification of kind of just the international markets, especially with the euro, a lot of the other companies have had pretty significant foreign exchange exposure. Can you guys review what your policy on hedging out that exposure might be for US dollar, euro fluctuations and maybe with other countries as well?

Harry Zike

Let me talk to that. When we have firm commitments with our customers or folks in our supply chains, we hedge immediately to lock in those profits. In the past, we’ve had mostly a dollar-denominated sales as well as cost-based. And we have that as well in this quarter. As we look forward, as we break into the French market and the Italian markets, we will have more of your exposure. But we will hedge immediately once we lock in those firm commitments.

Burt Chao – Simmons & Company

Okay, great. And then there's a lot of talk about Germany and obviously they sure about today. There has been pretty much every day about the situation with the EEG in Germany. Given your unique product in somewhat, do you find that you'd be a little bit more insulated from the effects of ASP declines or the EEG decline in Germany? How are you guys looking at that internally?

Harry Zike

I don’t think that the German -- changes in the German market will impact us directly on the ASPs. Traditionally we’ve not focused or sold well into the German market. There is a roof construction that really doesn’t pay for our product directly, and then the light -- the sunlight, as well as there is not a specific feed-in-tariff. So if you are able to part our opportunities, I think it’s quite logical that we ended up into the France and accounting markets early as we have. Of course, as always, if there is something that’s bad for the industry, it’s probably not good for us, generally speaking. It’s important that we sell our differentiated a value proposition in the markets that make sense. We’ve got a leadership position and we need to take advantage of that to get higher ASPs.

Burt Chao – Simmons & Company

Great. Well, thanks again for taking my questions.

Operator

Your next question comes from the line of Rob Stone from Cowen & Company.

Rob Stone – Cowen & Company

I know you are planning on going into much more detail about this later on on the webinar, but I had two questions related to your new deposition technique. One is, can you give a little more color on ramping up this process at Auburn Hills 1? Is that pilot stage, you think it's going to work, you know it's going to make usable product? And then the second question is related to how going to 50 megawatts in deposition will affect your back end capacity and what the impact in the near-term will be on capital spending to make these changes?

Mark Morelli

Okay. What we are doing at Auburn Hills 1, as you know, that is a production facility where we have a production machine there. We’ve had that machine down for some time where we are taking this technology out of our development lab and putting them for the manufacturing floor. The specific color there is that when you increase the frequency of deposition that you’re going to have to change all the amplifiers, so you use a lot of the existing equipment, but you change that frequency of that plasma-enhanced vapor deposition, which enables you to speed up the process. You have to change out some of the drives as well because they are re-rated at a higher speed. That’s all very important for us to be able to demonstrate this in actual production machinery. In terms of -- I'm sorry, Rob, I missed the other part of your question. If you could repeat that?

Rob Stone – Cowen & Company

So this is the first step to demonstrate your laboratory process at production scale, right?

Mark Morelli

That’s correct.

Rob Stone – Cowen & Company

So the second question had to do with the impact of adding that much to deposition capacity, how that affects your backend process steps and CapEx cost to make those front end and back end changes over the next few quarters.

Mark Morelli

Yes. But I think over the next few quarters, you’re not going to see an impact. One of the good things about this technology is that it really leverages a lot of our existing [ph] capital spend. So when you make these retrofits, the machine that we are talking about, it’s really changing how the machine rate operates with some very little other changes in that. The good news is that our existing footprint can also, with very little capital spend, ramp us up more in the longer term. So we see that as obviously a benefit. And if you look at your CapEx per watt, if you do some calculations on that, really the CapEx per watt is very attractive.

Rob Stone – Cowen & Company

Great, thanks.

Operator

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

Kelly Dougherty – Macquarie Capital

I'm just trying to think about the linearity or maybe the lack thereof of the underutilization charges. If they were $7.4 million at 50% capacity, how should we think about that when you produced at around 25% capacity during this coming quarter?

Harry Zike

Yes, Kelly. Obviously when we go down to about 25% capacity, the under-absorbed charges will increase. They are to some extent a little bit linear, but without getting into a lot of a fixed and variable costs, I think if you work with the number of around plus $10 million at a 25% capacity level, this is where we are looking right now.

Kelly Dougherty – Macquarie Capital

And is that a level that you think in the fiscal fourth quarter is probably a good level too for around 25% capacity or that depends on how things shake out over the next few months?

Harry Zike

It really does. As Mark talked before, we -- this project business does have a tendency to be quite lumpy. So when you look at large projects like 25 megawatts and the other ones that we are working in our pipeline, we get a large project, we are going to ramp up that facility in Q4. And the goal here with us in bringing the production down is to get the inventory down to drive up cash flow from operation and get down to a level of manageable inventory for the business. If that goes down, the large projects start to come in, and we have the ability to ramp up again.

Mark Morelli

Just an important marker there as well is that we think that the right level of inventory for us to hang on to serve this larger scale project business is about 8 to 12 megawatts. Once you reach that level, then we will start ramping the factories back up to higher to turn the company to profitability.

Kelly Dougherty – Macquarie Capital

Okay. And then just kind of switching gears to the project business, now that you're going to be getting involved in equity stakes, should we think of it as primarily putting the laminates into the projects and not really any kind of cash?

Harry Zike

Yes, Kelly, I think that’s the best way to look at it. As we look at these equity stakes, as Mark said before, we are not going to leverage our balance sheet into these projects. We are going to start looking to arrange the financing for these projects. As we take equity positions, if required, we will start with looking at putting laminates on.

Kelly Dougherty – Macquarie Capital

Okay.

Mark Morelli

Yes. That’s not a preferred path for us. It’s to have equity into the project. It’s more to arrange that. So I think that’s more the way you should view that we think about it.

Kelly Dougherty – Macquarie Capital

Okay. And then just the final question, if you did take these equity stakes, does that then change how you recognize the revenue? Do you have to wait until the whole project is sold? I think First Solar had an issue like this not too long ago. Or can you still use percentage of completion even though you are holding a stake?

Harry Zike

Yes. It’s a complicated one. It depends upon how much control one has on that entity. Clearly if you have control of the entity, there will be no revenue recognition. We will just recognize the sale of the whole project when it is completed.

Mark Morelli

Let me also reiterate. I mean, this is not an area that you should see us moving into to move to take strong equity positions in projects. It’s something that, if it occurs, is going to be very minimal and very controlled.

Kelly Dougherty – Macquarie Capital

Okay. Thanks very much.

Mark Morelli

Thank you.

Operator

Your next question comes from the line of Paul Clegg from Jefferies.

Paul Clegg – Jefferies & Company

Hi, guys. Thanks for taking my question. I may have missed this, but did you actually say how many megawatts of inventory you actually do have at this point?

Harry Zike

The amount of megawatts we have in finished goods inventory is about 44 right now.

Paul Clegg – Jefferies & Company

Is about 44. And so based on the last questioner's comments, at what point do you think you can see that inflection point where under-absorbed overhead starts to decline? It sounded like you were saying past the fourth quarter.

Mark Morelli

Yes. It’s tough for us to exactly guide. This business is a bit lumpy. But I think what you see us doing is, as our sales are going to be growing, we are also going to be running our factories less to accelerate the fact that we can flush this out quicker. This, we think, will get us on a firm footing to back to profitable growth. And it’s important here to watch markers. And the markers that we watch it and pay attention to is how we are selling these large multi-site scale projects.

Paul Clegg – Jefferies & Company

Okay. And you mentioned kind of a product mix issue with respect to ASPs in the French market. How much of a premium do you actually get in the French market versus the mix that you saw in 2Q? And then how does the feed-in-tariff adjustment in France affect that?

Mark Morelli

We don’t disclose our specific ASPs by market segment. We are very encouraged because these BIPV feed-in-tariffs are the highest in the world where we have a differentiated solution and capacity certification to get in there really limit your competition significantly. It’s an important market for us to continue to focus on. In fact, you will see us putting more resources into that French market.

Paul Clegg – Jefferies & Company

Okay. So no way to sort of get a sense of the relative benefit of selling into France versus other markets generally?

Mark Morelli

It’s fairly more advantageous to us.

Paul Clegg – Jefferies & Company

And then just finally, what level of -- another questioner hit on this, but I wanted to see if we could go there again. What level of internal module throughput into your downstream is a good target for you in the longer term? And are you rethinking this as you move forward?

Mark Morelli

Well, our focus on this project model is certainly something that we think is complementary to our existing channel. I think we will balance that based on where we see the opportunities for us to get volume at the right ASPs and to be able to flex that accordingly. It’s tough for us to give a very specific number on how we see that split playing out. Alternatively in the near-term, as you may know, the residential -- excuse me, the re-roofing markets, both in terms of new and re-roofing itself on existing sites, is certainly down. So it’s important that we expand this business model the way that we are describing it and complementary fashion, we think these two channels are going to work very well together.

Paul Clegg – Jefferies & Company

Okay, great. Congratulations on the recent wins.

Mark Morelli

Thank you.

Mark Trinske

Operator, I think we’ve run out of time. So if we can just wrap up with our closing comments.

Mark Morelli

Well, thanks again for joining on today’s call and your continued interest in ECD. We look forward to talking with you in the future as we continue to gain traction on our expanding business model and turn this business to profitable growth. Thanks. This concludes today’s call.

Operator

This concludes today’s conference call. Thank you for your participation. You may now disconnect.

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Source: Energy Conversion Devices, Inc. F2Q10 (Qtr End 12/31/09) Earnings Call Transcript

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