Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Bob Okunski - Senior Director, IR

Tom Werner - CEO, Director

Dennis Arriola - SVP and CFO

Howard Wenger - President, Utility & Power Plants

Jim Pape - President, Residential and Commercial

Analysts

Satya Kumar - Credit Suisse

Vishal Shah - Barclays

Rob Stone - Cowen and Company

Peter Kemp - Deutsche Bank

Michael Horwitz - Baird

Timothy Arcuri - Citigroup

Pavel Molchanov - Raymond James

John Hardy - Broadpoint

Chris Blansett - JPMorgan

Colin Rusch - Thinkequity

Stephen Chin - UBS

Edwin Mok - Needham & Company

Gary Hsueh - Oppenheimer

Dan Ries - Collin Stewarts

SunPower Corporation (SPWRA) Q1 2010 Earnings Call May 11, 2010 4:30 PM ET

Operator

Good afternoon and welcome to the SunPower Corporation’s First Quarter 2010 Earnings Conference Call. Today’s conference is being recorded. If you have any objections you may disconnect at this time. I’d now like to turn the call over to Mr. Bob Okunski, Senior Director of Investor Relations at SunPower Corporation, sir, you may begin.

Bob Okunski

Thank you, Ed. I would like to welcome everyone to our first quarter 2010 earnings conference call. On the call today, we will start out with our first quarter overview and strategy discussion from Tom Werner, SunPower’s CEO followed by Dennis Arriola our CFO who will go into greater financial details on the quarter. Tom will then discuss our outlook for 2010 before opening up the call for questions. We have allotted 60 minutes for today’s call and our replay will be available later today on the Investor Relations page of our website.

During today’s call we will make forward-looking statements subject to various risks and uncertainties that are described in our 2009 10-K as well as today’s press release. Please read those documents for additional information regarding those factors that may impact these forward-looking statements. To enhance this call we have also posted a set of PowerPoint slides which we will reference during this call on the Events and Presentations page of our Investor Relations website. In the same location, we have also posted a supplemental date sheet related to our historical performance.

On slide two of our PowerPoint presentation you will find our Safe Harbor statement. With that I would like to turn the call over to Tom Werner, CEO of SunPower who will begin on slide three.

Tom Werner

Good morning, thanks Bob and thank you all joining us today. I will start by giving a brief overview of the quarter and provide detail on our expectations for balance of 2010. I will focus on demand visibility and our competitive cost position. Our prepared remarks will run approximately 25 minutes which will allow plenty of time for questions.

SunPower continues to experience very strong demand in all geographies and market segments. We were sold out in Q1, we remain sold out in Q2 and our production of approximately 550 megawatts fully allocated based on anticipated bookings for the rest of this year. Our SunPower panel supply will increase as Fab 3 begins to manufacture significant volumes in 2011. In the mean time, as we indicated in March, we are also capitalizing on third party solar cell supply to meet demand and provide revenue upside in 2010. We are marketing in this third party solar cell supply at SunPower’s Serengeti brand and managing panel manufacturing to ensure our high standard quality. Our strong [down street] position in key global rooftop markets in the utility and power plants business provides clear revenue visibility into the second half of 2010 and 2011. I will elaborate on this point later in my remarks.

Turning to cost, our panel cost reduction initiatives are on track and we forecast continued cost improvements through out 2010 commence or equip our expectations for ASP reductions. SunPower’s superior high efficiency technology and value added services provides clear advantages in the downstream value chain and create a sustainable proven ASP premium.

In addition, this morning we announced our new Oasis modular power plant, Oasis drives on SunPower’s unparallel solar power plant experience with the past decade and provides our customers with a standardized, fully integrated approach to distributed and central station power plants that can reduce balance system cost by up to 25%.

Finally, we were pleased to announce in April our first US panel manufacturing facility in Silicon Valley together with our partner Flextronics. This facility will bring a 100 manufacturing jobs back to Silicon Valley and will provide SunPower with 75 megawatts of local panel manufacturing capacity. We would like to thank the US Department of Energy, in the city of Milpitas and Governor Schwarzenegger’s team for all their help in making this happen.

Our financial performance in the first quarter reflects continued strength of our vertically integrated business model and diversified channel strategy. Revenues for the quarter were $347 million, up 64% year-on-year. We continue to gain share in our most important markets and segments. We finished the quarter with the gross margin of 22.5% and non-GAAP EPS of quarter was $0.05 a share in line with our previous guidance.

Our results include projects under construction that will not have revenue recognized until Q4. SunPower’s balance sheet remains strong and as we entered the quarter with $877 million in cash and investments.

Now I would like to explain the basis for our revenue outlook for the second half of 2010 and into 2011. Please turn to slide four, this chart shows the high level view of our current utility and power plant pipelines. Our UPP group is well positioned for strong future growth with multi gigawatt pipeline in EMEA and North America. We expect to install more than 155 megawatts in our UPP business for 2010 including a 19 megawatt power plant under a PPA with Xcel in Colorado.

More than a 100 megawatts of power plants in Europe including more than 60 megawatts of power plants through SunRay in Italy from which we will recognize revenue in the fourth quarter or earlier. We will deliver 12 megawatts of Q5 solar roof tiles in Southern California Edsion under our five-year supply agreement. In addition, we plan on more than 25 megawatts delivered to other UPP customers worldwide. In California, we expect to permit our 250 megawatt CBSR project for PG&E in 2010 which now includes an incremental 40 megawatts that we announced just last week.

Now, moving onto slide five. Unlike to provide a better understanding of our expected 2010 UPP revenue recognition signing. Our SunRay acquisition established SunPower as a major project developer in EMEA, complimenting our existing North American development efficient. I will explain shortly, the advantage of our involvement in the project development business, this higher gross profit per megawatt and visible demand in 2010, 2011 and beyond. When we act as a project developer, we will not recognize revenue upon a percentage of completion basis instead we defer revenue recognition until the power plant fully financed and sold to a third-party investor, this slide illustrates that although we will be constructing more than 60 megawatts of project in Q2 and Q3, we won’t recognize a substantial portion of our UPP revenue related to our development activities as of Q4, 2010. We are, as Dennis, will explain shortly, working diligently to monetize these power plants as quickly as possible. 2011, we expect more balance UPP revenue.

Slide six illustrate our fully integrated position in the downstream power plant value chain allows SunPower to maximize absolute gross profit per watt. Using the example of a typical Italian Power Plant, this chart illustrates how we add value of panel through engineering, procurement, construction for EPC new project development in order to generate in this example absolute gross profit of $1.70 per watt. This corresponds to a gross margin of 24% on a vertically integrated basis, higher than the gross margin of any of the individual value change steps. By building additional margin across the value chain, we expect to realize gross margin at or above 20% from any of our large scale UPP projects.

In summary, with respect to our global UPP business, we have a large and growing pipeline, power plants that provides us with clear demand visibility to the second half 2010 and beyond with improved margins. We are confident with the demand for SunPower’s high performance product in our residential and commercial business for R&C. Slide seven show the expansion history of our residential and light commercial dealer base and the strong co-relation to revenue growth. For the past five years, we have built what we believe to be the industries preeminent dealer network with more than a 1000 dealer’s worldwide.

During 2010, we expect to further grow our dealer network to more than 1500 dealers. This larger base of dealers will be the primary revenue growth driver for our R&C business. The reason we can consistently attract high quality new dealers through our network is straight forward. SunPower sells a better product to deliver to secure customer value proposition. Slide eight shows a comparison between a typical SunPower residential roof top system and a conventional crystalline silicone system. As you can see, our dealers are willing to pay a fair ASP premium for our panel and value added services.

Higher efficiency panels allow for cost savings on Dallas’s [ph] systems cost in installation labor. Customers are willing to pay more for SunPower system because our system generates more kilowatt hours from their roof and thus increase their system NPV. Slide nine includes a quote from Mark Nelson at South California Edison, specifically addressing this (inaudible) with respect to our five year 200 megawatt PC T5 supply agreement.

Sophisticated customers like Southern California Edison recognized that system returns is not solely defined by panel cost per watt but rather by the total installed system cost and its performance over time. This NPP benefit accrues through most rooftop system owners that is particularly powerful with feed and tariff structures and incentive regimes including net gathering [ph] or self consumption rolls such as those in the US, Japan, Italy and Germany.

Now let me move to our cost reduction initiative shown on slide 10. We are working across the entire value chain to accelerate cost reduction and all facets of our business leads to system performance and reliability. Our R&D group continues to drive higher sale efficiency for next gen technologies as well as delivering yield and productivity improvements on our 15 fab lines. For 2010, we expect overall panel cost reductions be in line with our forecast with ASP decrease of up to 20%. We continue to increase conversion efficiencies in Fab 1 and Fab 2 and we will be shipping majority of our panels as E19 by the end of this year.

2011, a Gen 3 Cell Technology, the conversion efficiency is greater than 23%. We’re shipping sufficient volumes to contribute to our cost reduction program. In our supply chain, we are leveraging our scale as we expect our material costs to decline by more than 10% this year. In addition, our regional panels manufacturing strategy will begin to reduce logistic costs and working capital needs by the end of 2010.

R&D team is investing in several major initiatives to reduce capital expenditures per lot. Improved return on invested capital and increased overall equipment effectiveness. Our cost reduction strategy focuses on both our existing fabs in the Philippines as well as our new Fab 3 in Malaysia. For example, we see significant opportunity to improve throughput and yield as line productivity is expected to increase by 15% this year. Importantly cost improvements are not limited to manufacturing.

Turning to slide 11, we will see the results of our investment systems cost reduction. This morning we announced our new Oasis Modular standardized power plant that it reduces balance-of-system costs by up to 25%. Each Oasis power block integrates SunPower T0 trackers with high efficiency SunPower 400 watt utility solar panels, pre-manufactured system cabling and a dedicated inverter and operating control system. This configuration offers project flexibility, rapid installation times and, easily scales from a one megawatt distributed power plant for a larger central station power plant.

Oasis demonstrates SunPower’s ability to combine leading edge solar cell technology with low cost balance for system design and implementation to create a highly competitive solar power plant product offering. We expect revenues from Oasis beginning in early 2011. These are the demand creation and cost reduction strategies we are implementing that will help us meet our 2010 and 2011 goals.

With that I’d like to turn the call over to Dennis to go over our financial details in greater detail. Dennis?

Dennis Arriola

Thanks, Tom. Let me remind you that when we issue our second quarter results in August, we will begin using our new business segments which are residential and commercial or R&C and utility power plants or UPP. We will also report prior periods using this new segment definitions so the investors may analyze our financial results on comparable basis.

Now, please turn to slide 12. Revenue in the first quarter of 2010 was $347 million, a 64% increase from the first quarter of 2009. The improvements in our revenue base was driven by our strong performance in all of our major residential and components markets. In the US megawatt sold nearly doubled over the first quarter of 2009 and were up over fourfold in Germany.

Our components business was up more than a 160% from Q1, 2009 with revenues of $283 million. We experienced strong year-over-year growth in all of our major markets with the US, Germany and Italy being the largest contributors. In our systems business, we reported revenues of $65 million in the first quarter of 2010 compared to $104 million in the same quarter of 2009. The first quarter was impacted by typical seasonality; some delayed projects as well as deferred revenue as a result of our acquisition on SunRay.

Consolidated gross margin on a non-GAAP basis for the quarter improved 22.5% from 17.2% in the same quarter in 2009 and from 21.7% from the fourth quarter of 2009. For our components group non-GAAP gross margin for the quarter was nearly 26% as we continue to grow our market share in Italy, Germany and France and we maintain our leading position in North America.

As Tom mentioned, the growth in our global dealer base will continue to pay dividends as more and more customers get access to SunPower’s products around the world. Let me spend a moment on our system’s gross margin. In Q1 of 2002, we reported a non-GAAP gross margin of 8.3%. Now let’s dive into that number a little more.

You can basically break down our systems' cost of revenue into two buckets. The cost directly associated with projects that generated revenue in the quarter and unabsorbed costs and LIBOR in the quarter. For those projects that recognize revenue in Q1 of 2010, the corresponding gross margin was approximately 18.3%. However there was about $6 million of unabsorbed overhead associated with projects that have shifted in timing and are scheduled to be completed later this year.

As part of our cost optimization strategy, we are evaluating ways to reduce the proportion of fixed cost in our system’s business, which will allow us to leverage more often variable cost so that we can scale up or down depending upon the overall level of business in that quarter. Given the projected level of systems business for the remainder of the year and our bookings year-to-date, we expect the gross margin for the business segment to be over 20% in all of 2010.

Operating expenses in Q1 of 2010 were $64.6 million on a non-GAAP basis compared to $58.4 million in the fourth quarter of 2009. The increase in operating expenses for the quarter included approximately $11 million pretax related to the accounting investigation and our acquisition of SunRay.

For full year 2010, we expect our operating expenses as a percentage of revenue, to be in the 10% to 11% range excluding the $11 million in cost just mentioned. Other income and expenses on a non-GAAP basis was a $10.8 million expense compared to the $6.3 million expense in the fourth quarter in 2009. The increase was primarily related to the costs of our foreign exchange hedging program. For the remainder of 2010, we have about 72% of our Euro exposure hedged at a US rate of $38 per Euro. Our non-GAAP effective tax rate for the quarter was 26% compared to 20% in the fourth quarter of 2009. The increase in the quarter’s tax rate was driven by one-time foreign tax payer. For the full year, we still expect our non-GAAP tax rate to be in the 19% to 22% range.

Our GAAP tax rate needs a little a little more explain. First, like most companies we estimate our 2010 tax rate based on our projected profit before tax is for the full year. Since the majority of our profit before tax will be generated in the second half of the year and we incurred a GAAP loss before taxes in the first quarter, we actually recorded a tax benefit for Q1, 2010.

As a result of the tax benefit, our GAAP earnings per share for the quarter were positive $0.13 per diluted share. With the deferred timing of our expected profits into the second half of 2010, it makes sense to provide investors with a forecasted full year GAAP tax provision rather than quarterly tax rate estimates since there can be wide range in the actual quarterly GAAP tax rate results. As well as the reported GAAP earnings per share results.

We expect the full year GAAP tax provision to be in the range of $40 million to $50 million. Depending upon the quarterly allocation of that provision, the GAAP quarterly tax rate may fluctuate significantly. Having completed the SunRay’s purchased price allocation and with higher non-cash expense related to our new convertible bonds. We now expect our GAAP earnings per share for the year to be in the range of a loss of $0.20 per share to a positive $0.25 per share including the GAAP tax provision as mentioned.

Net income on a non-GAAP basis for Q1 was $5.2 million or $0.05 per diluted share consistent with the guidance we provided on our fourth quarter conference call. Once again this includes the $11 million in expenses related to the accounting investigation in SunRay acquisition which is approximately $0.08 per share after tax. So overall, it was a solid quarter and consistent with the expectations we laid out earlier this year.

Let me turn to the balance sheet and our liquidity update on slide thirteen. Our balance sheet remains strong as we completed the acquisition of SunRay prior to the end of the quarter, and we took further steps to improve our overall liquidity. We ended the quarter with $877 million in cash and investments which includes nearly $500 million that is available to help fund our operations in capital expenditure program. We completed a $250 million convertible debt issuance and also closed a new $350 million letter of credit facility with the syndicate of major international banks.

This new letter of credit facility provides us with additional flexibility since it requires 50% cash collateral compared to our formal letter of credit facility which required 100% cash collateral.

In addition, we announced on Monday that we have arranged a new $75 million term loan with International Finance Corporation for our operations in the World Banks. We believe that maintaining our strong balance sheet and improving our financial flexibility are improving, especially given the advance in the financial markets over the last couple of weeks.

Let me spend a moment now on our European financing program at SunRay. One of the many benefits of acquiring SunRay is its successful project finance team. This team leads the financing with Montalto project last year and has been actively coordinating the debt and equity financing for additional 60 megawatts this year.

We expect to monetize that the Montalto 24 megawatt project before the end of the third quarter and use the cash proceeds to finance the working capital requirements related to the other accounting projects this year.

I am pleased with the progress we have made in negotiating the debt financing and the sale of project equity to different investors, and I am confident that we will be making some announcements soon. As we debt finance these projects and monetize the equity, we will begin recognizing the revenue related to those projects.

The Italian portfolio of SunRay projects consisting of more than 60 megawatts are on schedule to be constructed and hooked up to the grid by year end 2010. Based on our advanced discussions with bank and project equity investors, we are confident that we will recognize the revenue and arrange for these assets in 2010. In total, we expect to recognize revenue for more than 100 megawatts of power plant projects in Europe this year. Overall, we are on track with our 2010 financial plan.

With that I would like to turn it back to Tom for our 2010 outlook and guidance.

Tom Werner

Thanks, Dennis. Now I would like to turn to our guidance beginning on slide 14. The slide shows our expected revenue using our new business segmentation. As I mentioned in my opening remarks our manufacturing capacity is fully allocated for 2010, and we have clear demand visibility in our rapidly growing UPP business in 2011. We have a high degree of confidence in our 2010 revenue guidance of $2.25 billion representing in excess of 33% growth versus 2009.

As we laid out on slide five, our UPP business under construction in the second and third quarters will lead to a strong fourth quarter in terms of realized revenue from SunRay as well as completed EPC business. We are confident that we will finance, monetize and execute on more than a 155 megawatts UPP business in 2010.

On slide 15, you’ll see our guidance summarize. Over the past year, we expect gross margins over the year; we expect gross margins in the 20% to 22% range. Those range assumes ASP declines for 20% year-on-year in our R&C business. We reaffirmed non-GAAP earnings per share in the range of $1.25 to $1.65 from last quarter. As we have mentioned, 72% of our euro exposure for the remainder of the year is hedged at a US dollar rate of $1.38 to EUR 1.

Our guidance also assumes a non-GAAP tax rate of 19% to 22% 2010. Our production plan remains approximately 550 megawatts with additional 50 to 100 megawatts coming from third-party solar cell supply. That three which will begin initial cell production in late 2010 will be the driver of the majority of $375 million - $475 million capital expenditure program this year.

With that, I’ll open the call to questions now. In addition to Dennis, I also have with me Howard Wenger, President of our Utility and Power Plant Group, Jim Pape, President of our Residential and Commercial Segment, Julie Blunden, our UPP of Public Policy And Corporate Communications, Navneet Govil, our Vice President, Treasurer and Bob Okunski, our Senior Director of Investor Relations, so that they may provide some of our answers.

With that, let’s take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first one comes from Satya Kumar with Credit Suisse. Your line is open. Mr. Kumar?

Satya Kumar - Credit Suisse

A couple of questions firstly on the Euro. What’s the assumption on the un-hedged portion for the currency exchange rate, can you give us an estimate of how every penny you know depreciation can affect your total net income?

Tom Werner

Satya, do you have two parts of your question below there is a finance team…

Satya Kumar - Credit Suisse

The other one is on the Italy. So I can ask you after this if you want?

Tom Werner

Yeah, lets go ahead with Italy while they do –

Satya Kumar - Credit Suisse

On Italy, you had a pretty good slide talking about $1.70 gross profit per watt at a system level which was about 24% gross profits. Couple of questions that follow from that can you help me understand how to think about the operating margins at the EPCN project development portions of that? And as we look into 2011, Italy is considering to lower the [filling tiles] by 25% on ground mounted systems. Given that, that’s about the gross margin percentage that you have in 2010, how would the fact for profits look like in 2011 for the Italian projects? Thanks.

Tom Werner

Okay. So CapEx for the un-hedged portion in our Italy and I think Howard captured the couple of question you had on Italy. So why don’t I turn first to Dennis on FX and then we’ll go to Howard.

Dennis Arriola

Sure. Satya, based upon our un-hedged position and recognizing that it’s over three-quarter period, a $0.01 change in the exchange rate is equivalent to about $4.5 million on a revenue basis and roughly $2 million on an operating profit basis.

Howard Wenger

Plus this is Howard Wenger on Italy, you had a couple of question, the first one had to do with margin and how that stacks up. What we do is we bifurcated the panel from the ECC portion of the system. And we are at about 20% gross margin on both those pieces. We do not include the panel in the DPP build up on that. And then, we add on top of that the project development margin and that’s how we get 24% from the full stack. And the full stack is based on the sale price to the equity and the debt.

With regard to 2011, our process in Italy with feed-in-tariff going down. We are in really great position in Italy, we as you know we purchased a company called SunRay which is a premier developer in Europe if that [80 people] who were on the ground and were putting in place land positions in Italy for 2011 built and our analysis shows with the feed-in-tariff, a reduction which we are anticipating will be between 20% and 30%. We will still be plenty profitable for those projects in combination with our cost reduction program and other product role out such as Oases.

Tom Werner

Yeah so, Satya just to recap with (inaudible) new product to roll out and cost reductions on the existing sell end module.

Operator

Our next question will come from Vishal Shah from Barclays. Your line is open sir.

Vishal Shah - Barclays

Yeah. Thanks for taking my question. So on the systems business, you showed that slight 100 megawatts plus to the Europe and UPP business that $7 a watt and 20 foots of gross margins and your total margin guidance for the systems business is 20%. So I am trying to understand whether the gross margins in the systems business, outside of Europe is going to be below 20%. Is that your assumption to begin with and then secondly your component gross margins in the quarter were really good at 25%, yet it seems to me that your total margins for that business, also for the full year is around 20%? Can you help me reconcile that especially when you are talking of costs coming down in line with ASPs during the year?

Tom Werner

So we will split this into two, I will first go to Howard on the mix involved with the systems math that you were doing and then we will go to Jim Pape on the margin question about components.

Howard Wenger

We anticipate margins in excess of 20% of projects in the European portion of our utility business and margins below 20% in 2010 for the North America portion of our utility business.

Vishal Shah - Barclays

Let’s go to the component’s question which was if you are 25% now, how are you into 20%, Jim?

Jim Pape

There is pressure, Vishal on pricing post-German fit, so we are expecting to see some pressure there built into our plan and into our structure. We think the north of 20 plan going through the end of the year is absolutely achievable and we are highly confident that we can continue to deliver in that north of 20 range given even with all the variables in the mix.

Howard Wenger

On the component side there is a timing element. So you assume an instantaneous price decrease consistent with the feed in tariff. However your cost reductions are instantaneous so to integrate the area under the curve over the second half of the year.

Operator

Our next question comes from Rob Stone from Cowen and Company

Rob Stone - Cowen and Company

First of all follow-up to the euro sensitivity, you mentioned what the delta was on $0.01 change, but you didn’t say what you were assuming for an average unhedged rate underlying your guidance for the rest of the year?

Tom Werner

Rob, verifying, can you go ahead with the second part for the question.

Rob Stone - Cowen and Company

My second question has to do with having a lot of revenue that’s going to be recognized, going monetizing these projects in the fourth quarter. What are the factors that could lead to potentially earlier or later possibility of slipping out recognized revenue into Q1 of next year?

Tom Werner

Let me put a little bit of color to your second question. Dennis if you could add to euro assumption for this 28% it's unhedged. In terms of timing there would be what SunPower would choose to do and there is a rate of return that both the debt and equity acquirers would require and the less risk and the more certainty the project i.e. the later is in the built stage in the project is, the lower the return that they would require, it’s a risk offset by return. So that would be our decision when they sell and as Dennis can elaborate we are in active discussions on everything that we showed.

The flip side would be of course the environment change and those people that we were talking to choose to make decisions differently than what they are currently projecting which would be a change something external we have to change their posture that what we are currently being told and working with them in terms of timing.

Dennis Arriola

Let me just add to the FX one, then I will come back to what Tom was talking about as well. On the FX if you look at our unhedged position at this point in time on a weighted average basis, we are assuming 127. So, we are looking at what’s going on currently in the market and incorporate that into our outlook and maintaining our guidance. As far as where we stand with the financings and the equity, we are very encouraged by the response both of the bank as well as the equity investors.

And I think one of other things that we found is that Europe is actually a much more mature market and seasoned when it comes both to the project finance bank and the equity investors and what we found is that the project finance banks and given their experience both on the wind side as well as all of the projects that they have done in Spain on the solar side, they are very familiar with structures and in general they are willing to provide leverage of more than 80% for technologies that they are comfortable with and companies that they are comfortable with. And I think that’s one of the competitive advantages that we have right now in the market is that there are a lot of banks that have done their homework, know our technology and want to work with us in order to make money for themselves. So we are excited about that.

Rob Stone - Cowen and Company

So, you are not seeing especially in the West couple of weeks of chaos over there, any inclination towards the stretching out financing schedules?

Dennis Arriola

No, we really haven’t. If anything I think banks that have started the credit approval process are trying to accelerate it so that they can avoid any delays down the road.

Operator

Our next question comes from Steven O'Rourke from Deutsche Bank.

Peter Kemp - Deutsche Bank

This is Peter Kemp for Steven O’Rourke. I had a quick question about your example of the Italian installation, the 24% gross margin example. Does that include the use of the Oasis that you guys just released?

Tom Werner

I’ll comment on that briefly and if Howard if you want to add it you can. The answer in the example is no that Oasis is just to 2011 and that will offset the earlier question of the any further feed in tariff drops.

Howard Wenger

I have nothing further to tell.

Peter Kemp - Deutsche Bank

A quick follow-up. It looks your Q3 gross margin estimates; the revenue breakout looks like that your smaller systems ONR, ONC commercial and real estate. A portion was larger in terms of revenue and so I was wondering is the R&C gross margins lower than your UPP margins?

Howard Wenger

I think the profile that you’re looking at is included the R&C would have up to 20% price decrease in the second half of the year and so what you can conclude is that like the question earlier that the combined first half, the second half performance will end up in the 20% to 22% range, anything that Dennis or Jim want to add?

Okay, so in the system business is materially somewhat so I think you can assume that we exit the year with the very similar gross margins.

Operator

Our next Michael Horwitz from Baird, your line is open, sir.

Michael Horwitz - Baird

Can you walk through what the economics are going to look like on some of the third-party sales that you will be using, and I think that in your prepared remarks you mentioned something about that allowing for some upside in revenue, and I don’t know if I was mistaken when I heard that.

Tom Werner

Yes, you heard the outside revenue correctly Michael and that would explain the range in our guidance. We also a had very broad range in terms of third party utilization. So of course we are at the extreme positive end of that we could be pushing to positive end of our guidance for sure. Perhaps you can slightly north of that because of a variable large range of that third party supply. The economics of third party supply very significantly over time just almost directly correlated to pricing that you see for a call it a core commodity type module that which you could buy from China. And so the pricing on those modules has changed that we were lower, early past at the end of last year then it is today but not by a lot. Frankly, we expect that pricing to decrease and so the economics on third party supply is in fact the lower gross margin today but we expect that gross margin to approve throughout the year.

Michael Horwitz - Baird

Okay, great that was helpful and then quickly on slide eight when we look at Conventional versus SunPower and you walk through panel balance system installation dealer margins. What I was find interesting about these kinds of charges that I never really see much change going on in dealer margin or installation in terms of any benefits that may occur or any margin decrease that those parts of the value chain may need to accept to maintain their positions in the market. Can you just walk through that down stream part and why those people are still getting that kind of margin?

Tom Werner

That is fair enough Michael, I will comment if you want to add something you can. Our dealer partners will not react favorably as we forecasted for them with their margins we are going to do. And so frankly Michael as you correctly point out on both of those we held those specs, which as those being equal as compared. Clearly on installation, we are on full out of sold on the cost to install a system. As you can see with the picture, it’s a substantial part of the cost and obviously a higher efficiency panel is one of the ways of doing that of course, we are increasing the efficiency in both our cell and our panel to accomplish that but things like Oasis for utility will be doing similar things in the other parts of our business, where it will be standardizing at point cost out per sure.

The more dealers you have, the more competitive the environment is and that probably will influence margins. Its the last thing I’d say about the dealers margins. Jim, do you want to add anything.

Jim Pape

I mean just to build on asset, I would say that as markets mature you see that margin expectation by dealer by job compressed and that’s the kind of maturity path across the plant. And so with the question you asked was dynamic, the picture we have showed just is kind of static but there is a difference there.

Michael Horwitz - Baird

Okay, thank you.

Howard Wenger

Materially it’s more the way Jim experienced in training.

Operator

Next question comes from Timothy Arcuri from Citigroup

Timothy Arcuri - Citigroup

Couple of things, first a module questions, second a guidance question. First on modules, can you give us some sense of ASPs relative to Q4 and the percentage of modules that were captive in this systems business? And second of all, in guidance, if I look at slide 14, the UPP versus the new segment reporting, the UPP guidance is higher than the traditional systems revenue that you reported for the quarter. So, I’m wondering whether you can give some guidance in your current revenue break out. So can you guide sort of component systems as you currently report? Thanks.

Tom Werner

So Tim, I’m going to ask the finance team to answer both of those. The second question sounded like can you forecast the way you currently report through the next three quarters and the first question is ASP for module and a percent captive being that would just consumed in systems business. Dennis, can you take those?

Dennis Arriola

Yes. As far as if you look at the current segmentation and our new segmentation going forward, this year they are not going to change substantially. I mean its actually going to be about 50-50 under the old version and under the new segments as well. So, don’t expect very much there. Going forward with what’s going on in our UPP business, you will see more growth out of UPP in the future. As far in the second question

Tom Werner

ASP for modules and percentage of modules going to the systems business.

Dennis Arriola

Remember that we talked about blended ASP in time for our residential and commercial business. And from quarter-to-quarter, it was down about 10%.

Timothy Arcuri - Citigroup

Okay. And then, I think we may have to look up.

Dennis Arriola

Yes. We will get back to you on the other question Tim give us a second. Thanks.

Operator

Next question comes from Pavel Molchanov from Raymond James. Your line is open, sir.

Pavel Molchanov - Raymond James

First on the house keeping item on taxes, when you said $40 million to $50 million tax provision, given the benefit of $30 million in Q1, does that mean $70 million of provision in the later three quarters of the year?

Tom Werner

Well, with the way that you need to think about is once again, we look at what our expected profit before tax is going to be in for the full year and then we have to go back, depending upon what the quarterly numbers are. So the 40 to 50 is for full year on an expense spent. We had a benefit in the first quarter. So what you can expect when we do brought the substantial amount of revenue in the fourth quarter, there will be a larger than expected tax expense to offset the benefit in the first quarter.

Pavel Molchanov - Raymond James

Okay, understood. Then on SG&A, with SunRay closed, can you tell us how much that line item should move up given the extra headcount?

Tom Werner

We haven’t broken that specifically. What I can tell you is that the overall SG&A the operating expense range that I gave you a 10% to 11% for the year excluding the $11 million for the acquisition and the accounting investigation includes the SunRay OpEx or SG&A. So it will be in line with what we have had previously.

Operator

Next question comes from John Hardy from Broadpoint. 0Your line is open sir.

John Hardy - Broadpoint

Yeah, thanks for taking my question. One quick one, what was the third-party component revenue in the quarter?

Unidentified Company Speaker

Okay. So we’ll add that to the percent of modules that when the system’s would be third-party component revenue.

Tom Werner

Yeah. Let me answer Tim’s question first out of the slightly under 100 megawatt about just under a quarter of them went for the system’s business. Okay, then on third party revenue it was less than 5%.

John Hardy - Broadpoint

Okay, thanks. And then a quick follow up on the very interesting slide six. If I look at that 24% gross margin number, its on a pretty rich ASP consistent with what’s going in Italy right now. But as you move forward and you have more of your UPP business in the US in 2011 I’d say a 30% lower number than that $7 number on slide six. What are some of the differences on the cost side moving to the US. [Steve] get to you close to that 20% target.

Tom Werner

Lower ASP and America versus Italy, how do you hold margin Howard?

Howard Wenger

So several ways. Number one is scale. Scale of the projects that were developing and building in the US are much larger. Number two is the type of sites that we have in Europe they tend to be some of more challenging, more solely not big square flat size; we have better size in the US. And then when you couple our work on this Oases project which I can take a minute to go through that what we’re doing with Oasis, what that is the standardized power plant. We call it internally power plant in a box if you will. What we are doing we are product (inaudible) the power system. We are taking our 15 years in the systems business and is a vertically integrated company. And we are shifting the products from being one of panels and one of the systems which is what our customers want.

This order place for car, they don’t want an engine, they want to buy an engine if it qualifies the higher they want to buy the whole vehicle and that’s what we are providing. And so we are designing from A to Z the entire system or standardizing it. And what that does, is it lowers the cost in three ways. We are able to decrease installation time, we are able to design out certain elements of customized systems such as fewer connections, and better wiring layout, better power block configuration and then we are also because we are standardizing our one-by-one power block we are able to realize some economies of procurement. So with those three elements we are able to drive to a 25% higher cost reduction with our Oases power block. So all those things in combination get us to a better first margin for a sustainable gross margin profile in the US. We will have one thing which is the Oases product is being rolled out first in the US. So we are really targeting that market first in 2011. The last thing I would say is if you look at the profile of our UPP revenue it is materially skewed towards Europe its in the near term and the US revenue is out a few years, 2010 and beyond. So you benefit from the significant cost reduction curve that we have in the company.

Operator

Our next question comes from Chris Blansett from JPMorgan

Chris Blansett - JPMorgan

Couple of housekeeping questions, one was wondering if you can give us an idea of free cash flow quarterly throughout the year and then the other one I wasn’t sure if you could talk about your regional revenue breakout during the quarter.

Dennis Arriola

Chris do you want regional breakout for Q1?

Chris Blansett - JPMorgan

Yes and maybe if you can give some color on how you expect that to shift throughout the year as well?

Tom Werner

So regional breakout Q1. Dennis?

Dennis Arriola

Let me start with the cash flow. We haven’t broken out the free cash flow before the quarterly basis, what I can tell you is, with the acquisition of SunRay in the first quarter we were obviously free cash flow negative. Given that we are developing the projects especially with the SunRay acquisition in Europe. We’ll continue to be a cash user in the same quarters two and three and it will be free cash flow positive in the fourth quarter. But on an overall year basis, primarily because of our CapEx program and because of the SunRay acquisition, we will be free cash flow negative for the full year.

As far as if you look at the revenue and our megawatts by country, the United States continues to be our most important market with nearly a quarter of our overall megawatts and roughly 30% of revenues. Over the quarter, Germany and Italy were very close, close to second and France we had a substantial improvement and growth in France. So, those are the four main countries that continue to be great contributors for us.

Going forward in the rest of the year you will see once again because of the SunRay portfolio, you will see Italy contribute a substantial amount of our revenues and megawatt allocated to us in the third and fourth quarter. But you’ll see also in North America throughout the year our R&C business and especially the residential business will remain strong in the United States. So, expect to see the US continue for the overall year be the our main market, our strong presence in Germany and Italy coming on strong in the second-half of the year.

Chris Blansett - JPMorgan

Then I had just one quick question about your Oasis product, is this something what that’s going to pretty much be assembled at our offside factory somewhere may be in the Philippines and then shipped in large assemblies to wherever the systems go or is this still assembled largely onsite, just from components?

Tom Werner

It will be largely assembled near the site in strategically located assembly areas, not necessarily onsite, but near the locus of project activity.

Howard

And of course there will be minimal onsite assembly because it will be prepackage so to speak in several location and as you point out that will be a low cost [location].

Chris Blansett - JPMorgan

So this is kind of a way of just bringing system integration up one more step before you actually shift to the site?

Tom Werner

Yes, but I think that there’s a pre-designed element to it that allows you to standardize components that gives you scaled purchasing as well as less or lower cost components, but yes to your question with these other two things.

Operator

Next question will come from Colin Rusch from Thinkequity.

Colin Rusch - Thinkequity

Can you give us an update on Australia sales into Japan as well as Ontario for this year and next year?

Tom Werner

Colin your question was Ontario, Japan and Australia? I will comment overall and Jim or Dennis you can quantify. Let me start with Australia. The Australian market is doing fine. If again we are supply constraint, so our problem is where to allocate product and we’ve got a good presence in Australia and I think that we’ll see it ticking up the rest of the year. Japan, our Toshiba agreement is going great. They are seeing great sell through of our product and as we sit here we can’t make it fast enough for the Japanese market. Ontario is not a market that we participated.

Jim

No, Australia is going great, exceeding all our expectations.

Unidentified Analyst

Have you considered adding any module-based in capacity or is Flextronics looking at other areas in Asia for finishing the modules for you?

Tom Werner

To answer your question is yes, we do, we are looking for a more reasonable micro capacity and see as to other things with module assembly in region. I wouldn’t necessarily point to you any certain contract manufacturer or any certain region because we are going to be modifying the way we make modules over the next five quarters and it will include both of those things different manufacturers in different regions.

Operator

Our next question comes from Stephen Chin from UBS.

Stephen Chin - UBS

Just a follow up question on Slide 14 Tom, if I eyeball the residential and commercial sales, it look like the business can be up about 30% to 40% in that second half of this year versus the first half of the year. What do you see that confidence or is it number of dealers you are signing up or your new product.

Jim Pape

So both businesses are accelerating, the North American system business is building backlog and growing throughout the year, finishing strong and as you answered the question correctly on a residential side, the dealer additions, the other slide was intended to show that correlation and dealer additions to revenue growth, and we continue to expect that obviously we continue that's a very, very strong play for us and it is going to continue to drive us to the end of the year.

Tom Werner

Yes both the R&C business includes the residential and the all commercial business, but both of those business will see substantial growth. I think the systems business maybe slightly higher growth. Our East Coast team based on New Jersey is doing a wonderful job, and having a great start to the year. I think that’s going to pay significant dividends in the back half of the year that you probably are aware that New Jersey is a very strong market in general, and extremely strong market for SunPower. So number of dealers, yes, new product with Serengeti to compliment our existing supply and the thing is on allocation, so the more you can give, the more you can sell in accelerating systems business.

Stephen Chin - UBS

The second question I have is just on the inventory build that might be needed to support the big UPP sales in the fourth quarter, is there going to be a quarter where we will see a big step function increase in inventory, and so quarter will that be in any magnitude of what to expect on the balance sheet going forward?

Tom Werner

Dennis will give us inventory guidance. We are increasing inventory velocity in the company and working capital velocity and the same time as rightly point out that you will see a work in process build up for systems business, you are seeing better working capital management in the rest of the company.

Dennis Arriola

Yes, if you look at where we ended the quarter with roughly $252 million in inventory. You are going to see a slight increase in the second and third quarter, but it's not going to be anything material, it's generally going to be within 5% of that, and then you will see it comes down a little bit on the fourth quarter. But remember that our business profile beyond the fourth quarter is strong as well. So, we are going to need to make sure that we maintain a sufficient level of inventory. We are also able to actually bring it down. I mean it actually lower than it has been at peak period, in the past and that’s really through our regional micro strategy. So, that’s helping us optimize our working capital as well.

Operator

Next one comes from Edwin Mok from Needham and Company.

Edwin Mok - Needham & Company

Tom, you mentioned so many times that you are guys are sold out. So, how do you balance between panel that you produced for dealer versus your own UPP project development project business?

Tom Werner

I think that’s a really, really important question as you look at SunPower because if we would take all of our panels and sell them as components then obviously our gross margins would have been north of 25% or 30% as a company. So we are making a trade-off decision to prepare ourselves for a long-term company and we are supporting our UPP business both in Europe and North America, and the way we make that decision is we believe that over the next few years it's going to be more of a demand driven market and as we have said over the last five years, we believe only in the up down channel allows us to control our destiny, and so in fact you see this preparing for the future in our current profile and if weren’t doing that then the financial performance with the company would be markedly different in Q1 and Q2. So it is investment in the future that we’re cautiously making.

Edwin Mok - Needham & Company

Okay. And then I guess my third will be on regarding the slide four, you show us that EM, your UPP business at 1.2 gigawatt and it shows that there’s three yellow boxes and why do you expect finish the whole 1.2 pipeline within the next three years, basically?

Tom Werner

Yeah. Why don’t I let Howard that take question?

Howard Wenger

Yeah that’s right. Over the next three year is just about right.

Tom Werner

And so, that would tell us that the pipeline that we acquired yes, now those 80 people are acquiring new land as Howard alluded to and so that pipeline will increase obviously over that time.

Edwin Mok - Needham & Company

Great. Thanks. That’s all I have.

Tom Werner

Okay, next question please.

Operator

Next question comes from Gary Hsueh from Oppenheimer. Your line is open sir.

Gary Hsueh - Oppenheimer

Great, thanks for taking my questions. Just looking at your near-term guidance for 2010, with growth margins dipping down to 18% or 20% in Q3 am I to understand that that’s because are the mix kind of going more toward the R&C side of the house? And then to follow that, if you look at Q4, if you use that same logic that R&C is somewhat depressing kind of gross margin expansion in Q3, isn’t there a possibility you can see much better kind of gross margin range in Q4 than the 20% or 22%, may be north of 22% to 24% in Q4, is it more UPP rich there?

Tom Werner

Sure. Your question, your general hypothesis to your question is fair and we are mix dependent. And in Q4, if there were more systems business then that mix would push us to the high end of our gross margin range. And I also think that there is more of out seeing for cost reduction in that business which you are seeing in Q3 of course is that we built into our company, the ASPD crescent of the early part of that Q3 and close to the cost reductions don’t happen instantaneously. So that you are seeing that disconnect. And the way we have guided or the way we have built the back half of the year.

Gary Hsueh - Oppenheimer

Okay. Just a quick follow up here on the Oasis. I mean I think if you look at slide six, you know are we to look at that slide and say that basically if you kind of port that slide outside of Italy and lower IRO regions that Oasis is probably one of the key mechanisms in how SunPower is going to be able to sustain kind of 24% project gross margins outside of Italy? Is Oasis the key mechanism for that and are there any other leverage that kind of maintaining that kind of margin structure outside of Italy besides Oasis?

Tom Werner

Sure. Let me make two comments with as more of join off what Howard said earlier. Outside Italy, you tend to have too many stage tend out larger scale projects tend to be on easier sites that are easier to install and yes, we can exploit Oasis particularly well and plan to in that market. So that would be yes but I would add to that make no mistake, we are all over cost reduction in our solar cell and module business. And I can assure you that there is quite a few people that have respect for our charts and 3W plans on support the slide that we showed with the cost reduction from that part of the business as well. We are very capable of tracking divestment cost, marginal cost in the industry and I can assure you we are focused on keeping pace.

Operator

Our last question will come from Dan Ries from Collin Stewarts.

Dan Ries - Collin Stewarts

The questions regarding the target to increase dealers, is there any difference in the approach to residential versus commercial installers with that target? Just the questions is really that, it seems like the market share in California has been sustained in the residential space but maybe lost a bit in the commercial space. So I am wondering anything in the plan to address that? I think (inaudible) may also address that? Is that is there anything to that?

Jim Pape

Yeah Dan, you did my work for me. Yes, still holding on to number one share in California have seen some pressure. There. The commercial piece where we would call it neck-in-neck with the competitors and a strong first place through Q1 in residential, all combined. We call that a strong first place and feel good about that. Your question started with -- is there a difference in how you approach them? The answer is yes. We have a light commercial-only dealers, we have residential-only dealers and we have combination dealers and we do indeed recruit them in a slightly different way.

Tom Werner

I would just say that don’t forget the large scale commercial, we do the ETC ourselves and we don’t pursue with dealer and sometimes that line is a little grey. The mix of our business. Jim had suffered from inability to get SunPower product. So we starve that business. We will not starve with it as much in the back half of the year and have a great product, our great pipeline of projects in the back half of the year in that commercial business both small and large.

Dan Ries - Collin Stewarts

I guess the allocation issue is what I guess getting it. When would that have started with the allocation made it tough to feed all those markets and is that what led to Serengeti because Serengeti could have done years ago but you’re doing it now. Was that tie that the allocation issue arose?

Tom Werner

Yeah Dan. I mean I have to answer that and then wrap it up. If you appreciate the question be happy to call back. We have recalled the quarter power line January 2007. Our PowerLight did not make module to speak of. So they we are exclusively third party. And when we acquired PowerLight, we continued that strategy. And so they did actually in our history to acquire a new third party modules what’s unique about Serengeti is we’re acquiring the solar cell and we’re managing the, both the quality and the manufacturing of the products.

And its going through quite bit of quality and realize already testing. So that the shift is the way we are managing the supply chain. It just happens if there is appreciating credit where there wasn’t lot of third party use, although we did use third party in every quarter of last year. So I hope that helps. It turns out the case a long time to build the billion dollar fab and that fab is coming online at the end of this year. So our plan would be to have Serengeti help us get to our fab and then we will continue to capitalize on what we believe is going to be a very competitive module market. And we think can capitalize on that with our great up-down channel. Dan I am going have to wrap there. Thank you very much time. We appreciate everybody joining our call. We look forward to reporting our results in Q3 and Q4 and complete the story of our transition to a utility scale project developer. Thank you very much.

Operator

At this time, that will conclude today’s conference, you may disconnect. Thank you for your attendance.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: SunPower Corporation Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts