SunPower Q3 2007 Earnings Call Transcript

Oct.19.07 | About: SunPower Corporation (SPWR)

SunPower Corporation (NASDAQ:SPWR)

Q3 2007 Earnings Call

October 18, 2007 1:30 pm ET

Executives

Tom Werner - CEO

Manny Hernandez - CFO

Howard Wenger - VP of Global Business Units

Peter Aschenbrenner - VP of Marketing

Julie Blunden - VP of Public Policy and CorporateCommunications

Mike Umstein - VP of Finance

Analysts

Steve O’Rourke -Deutsche Bank

Sanjay Shrestha -Lazard Capital Markets

Satya Kumar - CreditSuisse

Rob Stone - Cowen

Vishal Shah - LehmanBrothers

David Edwards -Morgan Stanley

Al Kaschalk - WedbushMorgan

Michael Carboy -Signal Hill

Pavel Molchanov -Raymond James

Jeff Osborne - ThomasWeisel

Mark Hiller - MerrillLynch

Stuart Bush - RBC Capital Markets

Michael Millner - Goldman Sachs

Pierre Maccagno - Needham& Company

Jesse Pichel - Piper Jaffray

Michael Horwitz - Pacific Growth Equities

Paul Leming - Soleil Securities

Tim Luke - Lehman Brothers

Colin Rusch - Broad Point Capital

Paul Clegg - Jefferies & Company

Mark Manley- Natexis Bleichroeder

Brian Gamble – Simmons

Kadlin Wilfred – Kellis Management

Mark Rodgers – Egmont Securities

Operator

Welcome to the SunPower third quarter earnings release conferencecall. (Operator Instructions) I wouldnow like to turn the call over to Mr. Tom Werner, CEO of SunPower. Sir, you maybegin.

Thomas H. Werner

Thank you for joining us today. Today we will report on ourthird quarter 2007 manufacturing technology channel and financial results andprovide guidance for the fourth quarter of 2007 and 2008.

We had another solid quarter, as our third quarterperformance beat our top line and bottom line performance. Our Q3 2007 revenue was$234.3 million, up 35% from our Q2 2007 revenue, comparable to our 2006 full yearrevenue of $236.5 million. Our systems revenue was $157.7 million, a 51.6%increase compared to Q2, and our components revenue was $76.6 million, a 9.9%increase from the prior quarter.

Note that some power panels used by our systems businesssegment are accounted for within the systems financial results rather than thecomponent segment results. Later in the call Andy will go into more detail onour EPS performance. Note that we beat EPS guidance in Q3 and therefore aregoing to exceed our guidance for the year, and Andy will go into more detail onthat after I finish.

Now let me start with strategy. I’d like to highlight ourSolar America Initiative contract, which we signed in September. We wereawarded a $24.7 million, three-year contract by the Department of Energy, thelargest of any company. We believe this reflects confidence in our verticalintegration strategy as a means to wring any inefficiencies out of the valuechain, lower installed system cost.

After three quarters of working as an integrated companyafter our PowerLight merger, we are more confident than ever that ourintegration strategies are already creating value to our customers andshareholders.

Now let me walk you through the value chain to reflect onthe progress we’re making at improving efficiencies and lowering costs. Firstlet me cover silicon. It remained in a very dynamic environment with the nextgeneration of major new polysilicon supply capacities beginning to ramp tosignificant production. In the third quarter, one of our silicon partners, M.Setek continued to ramp their firstpolysilicon manufacturing plant, which will ultimately support their increaseddelivery of monocrystalline ingots to us. We can report substantial progresswith M.Setek. They have received Japanese government approval to install andcommission their plant to a planned 3,000 metric tons capacity.

To accomplish this M.Setek is converting to producing their own TCS gas. This transition requirestheir plant to decommission briefly. We expect M.Setek to recommission the plant in Q4 with fullcapacity brought online with in-house production of TCS gas to support theexpected reactor capacity.

In Q3, we provided M.Setek’s efficient deliveries ofpolysilicon to ensure that our ingot production continued in adequate volumes.We expect to continue to support M.Setek with polysilicon in Q4 withdiminishing quantities as they begin production of their own TCS gas.

Now let me speak to DC Chemical. They’ve made significantprogress in their polysilicon plant, and it is on schedule for meeting theircontract delivery deadline in the first quarter of 2008.

It’s also important to note that DC Chemical is starting theirfactory with their own TCS gas production, and that they have significantexperience through their subsidiary, Seoul Dev producing TCS gas.

Now let me discuss progress on the silicon agreement front.Our success in partnering with M.Setek in DCC to expand the ranks ofpolysilicon manufacturers is part of our portfolio approach to rationalizingour long-term silicon supply chain from polysilicon to ingots and wafers. Inthe last quarter, we have taken several major steps to expand our siliconsupply. First, we signed a 2-gigawatt, ten-year agreement with Hemlock whichbegins in 2010. Additionally, we signed a 53 megawatt agreement with Wacker andthis three-year agreement is our third with Wacker and it begins in 2009.

Now let me speak to progress on turning polysilicon intoingots. We signed an outsourcing agreement with a company called NorSun toproduce ingots with polysilicon that we procure primarily from Hemlock.

Further down the supply chain in terms of wafering, wesigned another outsourcing agreement with First Philip Electric, a localPhilippine partner with extensive relevant manufacturing experience. As aresult of this JV, we will have more space in our second fab and now plan toinstall 12 lines. That's two more than originally planned.

In general, we continue to focus on working with partners ordeveloping JVs around areas of the value chain where vertical integration isless of an advantage, where partners can add value.

Now let me speak to manufacturing. In manufacturing, weexpect our nameplate capacity for fab 2 to grow from 330 megawatts annually to466 megawatts by the end of 2009 due to two adjustments we've made to ourplant. Two extra lines that I mentioned earlier in fab 2 will add 80 megawatts,thanks to space created with that joint venture with First Philip. We expect toincrease throughput on each of our lines to 40 megawatts from 33 megawattsbeginning with line 7, which will begin ramping production at the end of Q4.

So to summarize, Fab 2 has lines 5 and 6 currently rampingto 33 megawatts annually. Then we will add ten more 40-megawatt lines. One ofthese lines, line 7, begins production at the end of this quarter. Five morewill ramp next year and the last four will ramp in 2009.

Our manufacturing success in fab 2 has now reduced oursilicon utilization to less than 7 grams per watt, paying dividends by offsettingshort-term contract pricing which has increased 15% to 20% over 2006 pricing.We believe that through R&D, supported by our SAI contract, we will be ableto combine additional efficiency gains in cells and panels with thinner wafersand achieve a silicon utilization of less than 6 grams per watt within a few years.

On the efficiency front, we are pleased with the success ofour generation 2 solar cells now in mass production. As reported in Milan,we have achieved median efficiencies of 22.4% cell efficiency in production.When assembled into a solar panel, India National Lab has measured our panelefficiency to exceed 20%. You would think of this as something like breakingthe 4-minute mile equivalent in the solar world.

On wafer thickness, we've been running sample lots of ourproduction lines with 145 micron wafers.

Let me end with a description about our channel strategy. Asour solar technology continues to draw strong demand and command a premium inthe market, our strategy is to ensure that we have a diversified approachacross customer segments, applications and geographies to match the high valueplaced on our efficiency and aesthetics.

For smaller scale applications, we see both retrofit and newhomes performing well. In residential retrofit we now work with more than 125dealers in 25 states to deliver solar systems on residential and smallcommercial roofs. We have trained more than 400 installers from these dealercompanies and have established a premier dealer network offering training,financing services, lead generation and logistics.

For new homes we were happy that our partner Lennar receiveda major industry award at our national conference at Long Beach, recognizing their leadership in implementingsolar as a standard feature across California.We are also working with over a dozen other homebuilders in California,representing a major share of the market and finding substantial interest insolar as a differentiator and sales velocity improvement tool in a down housingmarket.

In large commercial systems, we are on schedule to deliverour first systems under our multi-site contracts with Macy's and Wal-Mart, aswell as having sold several new systems in the last quarter. We have soldsystems to AC Transit, Agilent Technologies and the San Jose Tech Museum ofInnovation, as an example of our SunPower Access power purchase program and howit's expanding. This is where our customers buy power from their solar energysystem instead of buying the system outright.

In power plants, we are on schedule for construction of theNellis Air Force base solar power plant, which will be the largest photovoltaicplant in the United States.We signed a contract in Spainat a location called Olivenza for our largest EPC agreement to date. The sizeof that contract is 18 megawatts. This facility called Olivenza will be thefirst application of our next generation Tracker. This is the European versionof the Tracker that we use at Nellis, which generates up to 30% more energyfrom the same solar panel as a fixed tilt application.

Additionally, we're excited to see Koreamoving forward as well with another 2 megawatt power plant at Jeonju. Expansionof our channel strategy is where we have the most tangible evidence of thevalue of integration SunPower PowerLight completed at the beginning of thisyear. Market visibility we have through direct customer contact has affectedour market entry and expansion plans, technology road maps and our growthstrategy. A combination of high efficiency solar panels from SunPower and highenergy delivery from the systems technology that originated with PowerLight isa potent combination for our customers which allows us to win business and planfor aggressive cost reduction over the next few years.

We will be able to serve more of our systems businesssegment's solar panel supply from SunPower as we grow our manufacturing in thePhilippines, which will improve our systems margin, as well as meet the needsof customers with space constraints on both their roofs and in power plantsites.

I would like to turn the call over to Manny Hernandez whowill report details of our Q3 reports and provide guidance for Q4 2007 and acouple comments for 2008.

Manny Hernandez

Thanks, Tom. Good morning everyone and thank you for joiningSunPower's earnings conference for the third quarter of 2007 which endedSeptember 30th of this year. I'd like to remind everyone that during theconference, management made and will be making statements that are nothistorical in nature. Please consider those statements as forward-lookingpursuant to the Private Securities Litigation Reform Act of 1995.

Those statements are based on our current expectations andare subject to certain risks. Please refer to our press release and our SECfilings for a more detailed discussion of those risks.

I will now give you a summary of our 2007 third quarterfinancial results for the combined company. Revenue for the third quarter was$234.3 million, up approximately 35% from the prior quarter revenue of $173.8million and up approximately 260% from the year ago third quarter revenue of$65.3 million.

The component segment of our business accounted for $76.6million of the third quarter revenue, approximately a 10% increase from theprior quarter revenue of $69.7 million.

Our systems segment accounted for $157.7 million of thequarter's revenue, up approximately 52% from the prior quarter revenue of $104million. Our systems segment represented a greater portion of the totalcompany's revenue this quarter, representing 67.3% of total company, versus59.8% last quarter.

The faster than anticipated completion of certain projectsin North America and Spain,most notably the Nellis Air Force base project that Tom mentioned, contributedto a very strong systems performance during the quarter. Now as Tom notedearlier, the eventual sale of SunPower manufactured components which areallocated by the company to the system segment is reflected as revenue of thesystems segment. In the 2007 third quarter, approximately 25% of panelsinstalled in systems projects were SunPower manufactured panels. That's up from21% last quarter.

On a GAAP basis, SunPower reported operating income of $6.8million and net income equivalent of $0.10 per share. This figure includesnon-cash charges for amortization of purchase accounting intangibles of $6.9million and non-cash stock-based compensation of $13.4 million.

On a non-GAAP basis, adjusted to exclude non-cash charges foramortization of intangibles, stock-based compensation and their related taxeffect, SunPower reported a total operating income of $27 million and dilutednet income of $0.33 per share. This compares with the prior quarter's operatingincome of $22 million and $0.25 diluted net income per share.

The total company non-GAAP gross margin for the 2007 thirdquarter was 20.4% compared to gross margin of 23% in the prior quarter. Thisthird quarter gross margin was influenced largely by the higher mix of revenuein the systems segment which achieved gross margin of 18.7%, while thecomponent segment achieved gross margin of 24.1%.

A couple of notables on gross margin. Our systems segmentachieved gross margin within our guided range and was largely influenced by theNellis project, which accounted for approximately 39% of the system segmentrevenue for the quarter.

Our component segment also achieved gross margin within ourguided range and was influenced by our need to procure additional polysiliconto support our ingot partner M.Setek, who is in the process of ramping itsfirst polysilicon factory. This resulted in a slightly nonlinear supply ofsilicon during the quarter, which impacted our opportunity to produce moreunits.

Absent this issue, however, we would have been in the higherend of our guidance. The key takeaway here is that as a vertically integratedand diversified company, we are able to mitigate issues like this and stilldeliver great results.

Briefly on the combined balance sheet, we ended the thirdquarter with cash including short term investments and restricted cash ofapproximately $495 million, which reflects the financing transaction that wecompleted during the quarter.

Note that during Q3 the company completed a financingtransaction where we issued $235 million in convertible debenture and soldapproximately $174 million of common stock. Our DSO improved to approximately32 days, while our net inventory closed at approximately 49 days. Capitalexpenditure for the year is now estimated at $210 million and full year'sdepreciation is estimated at $29 million.

As we have noted in prior calls, our business results mayreflect quarterly shifts in mix between systems and component segment revenue.Also from quarter to quarter, we expect shift even within the systems segment,due to size and type of project and percent completion factors that could leadto non-sequential or marginal growth in revenue, margins or earnings.

The second half of 2007 is essentially shaping up as weguided you last quarter. Specifically, that we expected a very strong Q3followed by a slight decline in Q4, influenced largely by previously committedproject schedules.

Notwithstanding our better than expected Q3 results,however, we are holding our previous guidance for Q4. The following is ourguidance for the fourth quarter and for the fiscal year 2007.

For Q4, our total company estimated non-GAAP results are asfollows: revenue of $210 million to $220 million, gross margin of 24% to 25%and earnings per share of $0.33 to $0.37 per share.

For 4Q07 by segment, our non-GAAP estimates are as follows:systems segment revenue of $120 million to $125 million and component segmentrevenue of $90 million to $95 million. In the fourth quarter, we expect anincrease in planned allocation of SunPower panels to the systems segment due tostrong internal demand such that approximately 35% of panels installed in oursystems projects will be SunPower panels versus 25% in the third quarter.

We expect our component segment gross margin to improve byas much as 200 basis points to 25% to 26%. This gross margin guidance includes thecontinued ramp of lines 5 to 7 with line 7 coming on towards the end of thequarter. It also includes some additional procurement of polysilicon to supportM.Setek.

As noted by Tom earlier, supply of polysilicon to M.Setek willdiminish during the quarter as they begin poly production with their own sourceof TCS gas. This should no longer be an issue going forward, and we should getback on track as far as hitting our gross margin model of 30% early next year.

Our systems segment gross margin for the fourth quarter isexpected to increase over 600 basis points in the 23% to 24% range, benefitingfrom OEM sale of balance of SystemTracker systems with are deliverable in thequarter. Collectively, we expect total company gross margin to improve byapproximately 400 to 500 basis points from 20% in Q3 to 24% to 25% in Q4.

For the fiscal year 2007, we now expect the followingnon-GAAP results: revenue of approximately $760 million to $770 million; earningsper share of $1.20 to $1.24. These earnings are based on our non-GAAP tax rateof 11.5% for the year.

Lastly, as noted in the press release for fiscal year 2008,we now estimate total company revenue of $1.1 billion to $1.25 billion, and anon-GAAP EPS of approximately $1.90 to $2.05 per share.

Let me now turn it over to Tom to lead us through theQ&A session.

Thomas H. Werner

Thanks, Manny. We are going to go to questions in a moment.First I would like to introduce who will answer questions with me. We haveHoward Wenger, our VP of Global Business Units; Peter Aschenbrenner , our VP ofMarketing; Julie Blunden our VP of Public Policy and Corporate Communications;Mike Umstein, our VP of Finance.

So we have adequate time and you don’t beat me up for goingtoo long on the call, if you would please limit yourself to one question andone follow-up, and if there are more questions that you have, if you could getback in the queue we would appreciate it.

We will do something a little differently than we have donepreviously on our calls. There were three homework assignments we took from thelast call and we will just briefly cover those, and then we will go toquestions.

The first two of those homework assignments, the first onewas on our cost reduction road map our commitment of 50% cost reduction by2012, what does the profile of that look like?

I'll just say that it depends on which part of the costreduction you're looking at. In terms of the downstream channel cost reduction,that will tend to be more back end loaded, meaning that will be in the outyears, whereas in terms of cell and module cost reduction, that is more frontend loaded so as we get into '08 we'll probably start to give you some specificmeasures to track us to the 50%. It's mixed is the answer to that question.

The second one that we tabled was, what are your siliconcosts doing in 2008, because we have talked about long-term contracts coming online in 2008. We've spoken to our silicon vendor partners and they are notcomfortable with us giving any guidance on silicon cost so unfortunately, wecan't give you precision on that, although we appreciate the question.

The third question I'll turn to Manny and then we'll go toyour live questions.

Manny Hernandez

The third question was how much synergy or benefit do wederive from big scale projects?

For the purpose of responding to that question, we're using2 megawatts or bigger and it's actually a great question because we do getscale in economies from big projects like this, from a profit contributionstandpoint, not just gross margin.

You do benefit from lower overhead support because you don'thave to increase the support for a bigger project, necessarily and you also getoperating expense leverage for huge projects like this.

As you can appreciate, since this is largely a negotiationtool, we'll give you a range. The benefit for large scale projects is anywherefrom zero to 5% of the historical dealswe've done; it could be as much as zero if you want to use the benefit to morecompetitively bid on a project, for example. Thanks for the question.

Thomas H. Werner

Okay. So Michelle,we'll go to questions in the queue.

Question-and-AnswerSession

Operator

Your first question comes from Steve O'Rourke - Deutsche Bank

Steve O’Rourke - Deutsche Bank

What will your internal sourcing for PowerLight be in Q1 andgoing out to 2008? Does it hold to the prior comment you made on percentages orwill it go up?

Manny Hernandez

The answer is yes. The stated goal of the company has beenthat 30% of installed systems would use SunPower material this year and we'recertainly trending that way; estimated to increase to 50% in '08 and evenhigher, approaching maybe 70% to 80% in the ensuing years.

One caveat to that is we obviously as a company want theflexibility of being able to redirect modules appropriately, depending on thebusiness at hand. But those ranges are good for planning purposes.

Steve O’Rourke - Deutsche Bank

Tom, if I could ask one other. Can you articulate yourlonger-term strategy for selling energy rather than simply selling systems? Iknow you're moving in that direction. But where might it make sense to startdoing that more aggressively around the world in the next year or two?

Thomas H. Werner

Selling energy?

Steve O’Rourke - Deutsche Bank

Electricity.

Thomas H. Werner

It reduces the friction in the selling cycle becausecustomers are used to paying for energy. For customers like Wal-Mart and Macy'sas two examples, they're buying power in some cases and not necessarily buyinga solar system so that when they justify it to their board they justify it onthe economics of buying power. Then they have the added benefit of they'redoing something good for the environment.

So in the enterprise channel, it's a natural fit because ofthe nature of how those projects are justified internally. By the way, that's doneas well on power plants and that's pretty much the norm in Europe.

It will be interesting to see our ability to move that intoother parts of the market. We believe we will be able to do that. We believewe're uniquely situated to do that because of our scale and because the amountof transactions we do in the other parts of our business.

Howard, did you want to add anything else?

Howard Wenger

No, I have nothingfurther to add.

Thomas H. Werner

Okay, Steve, thathopefully answers your question.

Operator

Our next questioncomes from Sanjay Shrestha – Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets

First, you talked about the component margin gettingimpacted on a sequential basis. Can you give us some more detail on how much ofthat impact was related to having toprovide poly to support M.Setek and how much of that was related to the ramp-upcost?

Thomas H. Werner

I'll turn it to Mannyin just a second. He can give you a rough split. As you can imagine, as yougrow as rapidly as we're growing that you're not going to have perfectlinearity. Deliver, as you correctly ask the question, it does split intolinearity of delivery as well as buying a little more poly.

Manny Hernandez

Just to give you a bit of a range, using the high end of ourcomponent margin guidance as the benchmark, I would characterize the impact of two-thirdssilicon related, one-third ramp related.

Sanjay Shrestha - Lazard Capital Markets

Given what just happened here in the near term out of thepoly availability that we're talking about for 2008, obviously you guys have aportfolio approach. There's a lot of cushion there. I understand that. But canyou sort of talk about how much do you actually expect to get from M.Setek andDCC during 2008?

Thomas H. Werner

When we plan silicon the way we do it, Sanjay, is we use anexpected value so we have a supply multiplied times the probability, that givesyou an expected value. We havesufficient silicon to match our guidance based on that. As we have saidpreviously, some of M.Setek DCC is north of half of our supply next year.

Operator

Your next questioncomes from Satya Kumar – Credit Suisse.

Satya Kumar - Credit Suisse

I just wanted you to explain the dynamic here. You're notactually increasing your megawatts of silicon available for next year but youare increasing your revenues and earnings for next year. What's driving that?

Manny Hernandez

The benefit of having an integrated company now is weactually have opportunity to upside one or the other side of the house, so someof our tweaking for our guidance is largely just a mix between component andsystems.

Satya Kumar - Credit Suisse

A quick follow-up to that. You recently talked about having100 megawatts of cumulative orders in Spain.Can you talk about what part of the orders have been posted so far and also ifyou can also tell me what your megawatts of component production was in thequarter? Thanks.

Thomas H. Werner

We'll take that as two separate parts. Manny can talk tomegawatts production and I would ask Manny to cover once again Q3 and as longas we're answering it, we'll give a flavor for what Q4 looks like. Then we'llturn it to Howard who can answer the first part of your question.

Manny Hernandez

The megawatt answeris flat from last quarter. If you recall last quarter was 24.5 megawatts, so wewere practically flat in Q3. Going forward though, with the lines ramping andbetter visibility on silicon, our estimated output is 34 megawatts, or at least40% increase from the prior.

Howard Wenger

I'll respond to the 100 megawatt question in Spain.We are in various stages of completion of those 100 megawatts from bookedorders that have not started, so zero percent, through to 25%, 50%, 75%completion on those projects. I would say that the majority has not been fullyconstructed.

Operator

Your next question comes from Rob Stone – Cowen.

Rob Stone - Cowen

The way you guys describe the transfer of production fromcomponent to systems seems like it's a little harder to calculate than if youwould describe it as the proportion of your production that's going to the systemsbusiness since it's hard to know how much the systems business may be doing inmegawatts of product coming from third parties. Could you restate the targetsfor supply of megawatts from the components to the systems business that way?

Thomas H. Werner

Rob, we thought we worked it out with all of you folks onwhich way to do that. We'll continue to evolve it with you, we're certainly nottrying to be difficult. I'll let Mannytry to add clarification and perhaps with the follow-up calls we can make surewe're honing in on the best way to communicate it.

Manny Hernandez

Rob, the way we are providing answers to that question nowwhere we say 30% of systems installed product utilize SunPower modules, thenthe reciprocal is therefore the derived third-party module.

Rob Stone - Cowen

I understand that.But that presumes that you know what the total megawatts is of the systemsbusiness. It's much easier actually to track the megawatts that you areproducing. In other words, I'm asking the question a different way. If we werelooking at the total megawatts that you produce, what portion of that is soldexternally versus transferred to the systems business?

Thomas H. Werner

Rob, we got it. Let us table that for now. We'll come backto it perhaps later in the call. Certainly we can do it as a follow-up. Iunderstand you're basically asking for the split of the output, so give us alittle bit of time on that one.

Rob Stone - Cowen

On the systems business, can you give us some flavor for howmuch relative proportion balance of systems components, the mounting andtracking systems contribute to overall revenues?

Thomas H. Werner

Sure. We had the dynamicat the beginning of the year where we called that a significant one-time event.We're looking back on that feeling like that wasn't a good characterization. Itis part of our ongoing business and you should consider it as part of the waywe do business as part of our channel strategy.

Having said that, I'll turn it to Howard who can give you asense for that split.

Howard Wenger

Yes, Tom. It's approximately 5% to 8% of our total businessin the systems channel.

Rob Stone - Cowen

I'm sorry, I missedthat percentage.

Thomas H. Werner

5% to 8% in thesystems channel.

Rob Stone - Cowen

5% to 8% of systems.Thank you very much.

Operator

Your next questioncomes from Vishal Shah- Lehman Brothers.

Vishal Shah - Lehman Brothers

Tom, one of your largest competitors in Japanrecently announced plans to start mass production of thin film based solarcells and he said that the move was being made to keep them competitive againstrising prices of silicon.

I just wanted to know what your thoughts were with respectto thin film technology given the tightness of the polysilicon market and ifyou have any plans going forward? Thank you.

Thomas H. Werner

I have several thoughts on this. One is that it was a reallygood question earlier about selling energy and moving towards a selling ofenergy so when we make a strategic decision about high efficiencycrystalline-based silicon versus thin film we're using the metric of levelizedcosts of energy -- or just think of it as the cost of energy -- and we believethat our solution will be the most effective for our customers on levelized costof energy, or the cost of energy. If wefelt differently of course, we would either organically or acquire our way intothin film and we're not planning on doing that currently.

The other comment I'd make is we do expect that silicon willcome into balance and that there will be a significantly increased availabilityof silicon in the back half of 2008 and 2009. So it's a little bit of a buyhigh, sell low for us at this point if we jumped into thin films in reaction toa tightness in silicon, because we think it's going to improve certainly for usas a company is improving over the next six to 12 months. We wouldn't want tooverreact to something that we believe we're solving another way. So that wouldbe the two aspects of how we think of that.

Operator

Your next question comes from Mr. David Edwards – MorganStanley.

David Edwards - Morgan Stanley

A question for you about Spain.I understand that a couple weeks back the Spanish government released aproposal for what the program should look like starting in 2009. Now we'rehearing that the negotiations may actually bump up the volume and bring up thetariff price. I was wondering if you guys have any comments on that?

Thomas H. Werner

Yes, we do. Howardwill make most of them. I would just give you the context that there's a reasonwhy we have a 50% cost reduction plan by 2012. It's that we expect and it'sbuilt into most of the incentive systems that the incentives will go down intime and it's our part of the deal that we'll reduce costs such that theeconomics to the customer remain excellent.

Now, of course your specific question is the dynamic in Spain.I'll let Howard speak to that.

Howard Wenger

First I would like to say that we're happy with what theSpanish government is doing because historically in our industry, if you lookback five or eight years ago, policy and incentives were very stop and go kindof a proposition. Now since our industry has reached critical mass in myopinion, governments are paying a lot more attention to being very proactiveabout ensuring continuity in markets. So we're very happy that the Spanishgovernment has taken a stand and said okay, we're going to increase the capfrom 371 megawatts to 1,200 megawatts and we're actually thinking of going to2,000 megawatts. That's good and that's actually given a fair amount of clarityin the market already.

With respect to the tariff, there have been a lot ofdiscussions and so forth and numbers thrown around. That's still in play. It'smoving in the right direction from our perspective in terms of the reductionand so we expect that market to continue to be very strong for us goingforward.

Operator

Your next question comes from Al Kaschalk - Wedbush Morgan.

Al Kaschalk - Wedbush Morgan

Tom, I just wanted to follow up on the silicon question andif you could give a little bit more granularity as we roll into '08 andspecifically the front half versus the second half. How much are you using spotversus more mid-term and long-term contracts?

Thomas H. Werner

Al, thanks for the question. We purposely said short termversus spot so I'll answer your question, spot is a very small percentage ofwhat we buy, below 5%. Now, let me further answer your question, however. Theway we characterize short term is within a year and buying from existingpartners and therefore it's a significantly different dynamic than spot. It tendsnot to be a one-time transaction at a very high price. That percentage variesby quarter and that still is a very small number as well, but that's less than10%.

Al Kaschalk - Wedbush Morgan

In terms of margin improvement, and I know this is reallykind of granular here, but in terms of what you're setting up for '08 marginexpansion opportunities, how much of that is due to the silicon pricing dynamic?In other words, your mid or short term coming online at a greater level?

Thomas H. Werner

Let me just paint a broadpicture and then drill down to your question. We have significant improvementsin our factory in the Philippines.We are getting more watts per wafer out of our first generation technologythrough manufacturing improvements and of course our second generationtechnology has median efficiencies that is almost two points higher, so we getmore watts per wafer. We're also using thinner wafers and therefore we end up with less grams per watt.That's a huge driver in terms of cost reduction in 2008.

And of course, as we scale, then we absorb the overhead ofthe second fab as well as the pre-op. I don't recall if Manny specified the pre-opfor the quarter but the pre-op number is significant and that goes away as weramp that facility so we get the benefit of that as well.

You're right, silicon is an important part of the costreduction and it's roughly 25% to 50%. It depends on the time of year and ofcourse it depends on the execution of our partners, but 25% to 50% of our costreduction in solar cells in 2008.

Operator

Your next question comes from Michael Carboy – Signal Hill.

Michael Carboy - Signal Hill

Let's focus on the upside of PowerLight this quarter.Normally construction schedules are things that are pretty well known andunderstood. Could you give us a little bit of insight into what suddenlyaccelerated the programs, Howard, and how do we deal from a planning perspectivewith the opposite side of the coin, when perhaps schedules may drag out?

Howard Wenger

It's a good question. We're doing a number of things toshorten our basically book-to-bill time, and one of them is in the area oftechnology innovation. So for example, in the Nellis project which we realizeda good amount of revenue in the third quarter, we implemented our new Power Trackingtechnology which does not rely on ground penetration so we're actually modelingit on our leading roof technology which also has no roof penetration; we have transportedthat idea to the ground. So it enables us to install much faster, much morepredictably. We're doing it, a lot of that construction in a manufacturingfacility and taking it to the site. That improves quality control as well.

So in terms of going forward, the mix of our projects, thesize of our projects, where they are geographically, all bear on constructionschedules and I believe that we guided in the past from book-to-bill on theorder of six to nine months and we're looking to shorten that time. I think inthe future we'll be able to provide more information as we go forward andimplement more of our leading power tracker technology in the field.

Peter Aschenbrenner

The Nellis project, which was in the last quarter largely,that was the first project that utilized this new T20 tracker technology. Wewere a little bit conservative on our schedule because of that, our planningschedule, because it's the first time we had fielded it. As we got into it we realizedthat we were exceeding or hitting our original estimates and being able toinstall on the rate of a megawatt a week which is unprecedented. That's reallywhat helped accelerate that project schedule, which was a big piece of Q3.

Thomas H. Werner

Sorry to extend this. Michael, I appreciate the question.The other thing I would say is great execution by Dan Sugar and his systemsteam and the team in the field. They did an exceptional job. So we're reallythrilled with the work that the folks in the field did.

We have 18 questions in queue and so we're going to belittle less eloquent in our answers so we get through them. Next question,please.

Operator

Your next question comes from Pavel Molchanov – RaymondJames.

Pavel Molchanov - Raymond James

Right now something like 95% of the PD market is in OECDcountries. When or how do you think that changes whereby emerging marketsbecome hopefully over time the major drivers in this business?

Thomas H. Werner

We'll have Peter take that question.

Peter Aschenbrenner

Yes, we believe that the majority of the market willcontinue to be in the OECD countries for the foreseeable future. What we dobelieve will happen is that the percentage of the total market that those fiveor six top markets comprise will diminish over time. So if you look at the topfive or six countries today, they are something in the order of high 70% or 80%of the total market and we see that falling over the next three to five yearsto something closer to perhaps the mid-60%.

So the new markets will grow and grow very fast, but theywon't outgrow the OECD markets.

Pavel Molchanov - Raymond James

Who do you think that second tier of markets is that isgoing to be ramping up?

Peter Aschenbrenner

I think it's probablythe logical candidates: India,China, perhaps Brazil,that's the quick answer.

Operator

Your next question comes from Corey Tobin – William Blair.

Corey Tobin - William Blair

Anything on pricing with respect to average price per wattor just general comments on pricing? Any change to the timing of achieving thelong-term margin model that you've discussed in the past? Thanks.

Thomas H. Werner

Howard will take thefirst part. Manny the second.

Howard Wenger

The demand is very strong. We expect ASP to remain steady ona global basis in Q4 and into 2008. That's the short answer.

Manny Hernandez

Long term, gross margin milestone or model is the same. Weare hoping to achieve it fourth quarter of '08 or first quarter of '09.

Operator

Your next question comes from Jeff Osborne – Thomas Weisel.

Jeff Osborne - Thomas Weisel Partners

I just had a follow-up on the pricing question. Do you haveany thoughts on the pricing for next year? Do you think it's down 5% or alittle less than that? And then just for Manny, any thoughts on tax rate andCapEx for '08?

Howard Wenger

I'll take the first part. Pricing, as I mentioned before, wethink will remain steady going into 2008. Of course it depends on geography andmix. So in the more mature markets like Japan,it is the second largest market in the world but has the lowest ASP, contrastedby Spain and Italy,emerging markets that have better incentives, higher ASPs. So it really dependson the mix.

I do want to echo something that Tom mentioned previouslywhich is we are driving to a model to be competitive with the electric brandand we expect ASPs overtime to increase our competitiveness.

Jeff Osborne - Thomas Weisel Partners

Are you saying youpenetrated Japan?I thought you weren't selling anything materially to that market.

Howard Wenger

That's correct atthis time.

Jeff Osborne - Thomas Weisel Partners

Manny, any thoughts on tax and CapEx?

Manny Hernandez

Tax rate for 2008 non-GAAP is 22.5% and GAAP tax rate of26%. As far as capital expenditure for 2008, our early estimates are in the $250million to $300 million range. Note that the following capital activities willbe covered by that: One is five more manufacturing lines; three module lines inthe beginning of the expenditure for fab 3 which is our third facility.

Operator

Mark Heller, you may go ahead and please state your companyname.

Mark Heller - MerrillLynch

Manny, I just had a clarification -- I guess I’m stilltrying to figure out the margin dynamics for Q4. You are lowering yourcomponent gross margin guidance because you are sourcing I guess morepolysilicon from the spot market and your systems gross margin is going upsequentially because you are souring more solar cells or panels from SunPowerinto PowerLight. I just want to confirm that that’s the case.

Manny Hernandez

Those are both accurate, plus I would only add that on thesystems side, they are also going to benefit from OEM sale of certain balancessystems that is going to help the margin in the quarter as well.

Thomas H. Werner

And implementing the new products that Howard spoke about.

Mark Heller - MerrillLynch

Okay, got it, and in terms of the gross margin, have youguided to a gross margin for 2008 and where is the -- is the improvement moregoing to come from the poly side or is there some other parts of the supplychain that gross margin improvement is going to come from?

Thomas H. Werner

We’ll get to more -- closer to 2008 and in other wordsprobably in the next earnings call. In terms of the breakdown, we providedoverall guidance on where the cost reduction comes from. I think of a target of50% where 40% or 50% of that 50% comes from downstream scaling silicon. Andwhen I say silicon, I’m thinking of polysilicon ingot wafer, so the combinationof those things could be 20%, conversion efficiency, 15%, and then scaling thefactory will give you another 5% or 10%, in terms of a rough overview.

You should add up, if my math is correct, you’ll add up to60% because we are giving ourselves some room that not all the plans will cometo fruition and that will get us to our 50% target. So that’s a long way ofsaying silicon is 20 points and as I said, that’s a combination of long-termpartner contracts coming online, starting in the first quarter of next year andthen throughout the year. That’s also higher efficiency, even on our firstgeneration technology, and that’s also using thinner wafers.

So it’s a combination of those things.

Mark Heller - MerrillLynch

Thank you.

Operator

Stuart Bush, you may go ahead and please state your companyname.

Stuart Bush - RBCCapital Markets

My question is about Germany.It looks like the government there is going to be reducing the tariff levelssignificantly more than we expected before, starting in ’09 with a one-timedown charge. Are you factoring in to your estimates for ’08 a pull-through ofdemand into ’08 from ’09? And the second question is what percentage of yoursales are you factoring into be through Germanyfor that year?

Thomas H. Werner

We’ll split this question into two. I’ll let Howard commenton percentage breakdowns in region. Julie Blunden will speak to the marketdynamics.

Julie Blunden

The German Government has given everybody lots of visibilitythat they intend to change, or evaluate and likely change, EEG across theboard, including PV. And certainly everybody has got good understanding of whenthat transition would happen, no sooner than 1-1-09.

I think as with all adjustments in program rules, there islikely to be some folks that are looking to get in before the adjustmentchanges, so it is entirely possible that you will see an up-tick in Germanyjust due to that factor, irregardless of what the results end up being if theyresolve the question of exactly what their tariff level will be post-transition.

But we’ll have pretty good visibility on that. The Germansare pretty good about that, so I don’t think there will be any real surprisesthere.

Howard Wenger

Regarding the amount of product that flows into Germanyfrom SunPower is less than 10% of our total, so we are not very dependent onthat country at the moment. But it is a very important market in sales, numberone, and we do expect it to continue to be a viable market, especially for ourproduct where space is a premium en route to Germany.

Stuart Bush - RBCCapital Markets

Great. Thanks a lot.

Operator

Michael [Millner], you may go ahead and please state yourcompany name.

Michael Millner -Goldman Sachs

Good afternoon, everyone. Just a couple of quick ones; if welook at the three buckets of end users as you described, retrofit, new homesand large-scale commercial, let’s call it, can you give a rough breakout ofyour sales in each of these buckets for the systems and components segment?

And secondly, what bucket do you expect to drive U.S.demand the most over the next one to three years?

Thomas H. Werner

So the way we would split that, we have a slide that wepresent most of the places we’re at that has customer end segments. We combinedretrofit and new homes. I call that the residential market. Commercial public,we call that Microsoft, Macy’s,Wal-Mart, Tiffany’s, Agilent, et cetera; andthen the power plant business. And in terms of split, I think Manny will havethat in just a second.

In terms of forward-looking where we think in the U.S.we expect those sales to -- biased, and I’ll let Howard answer that and we’llgo back to Manny.

Howard Wenger

So in the U.S., we have concentrated efforts and programs todeliver our products and services in all of the channels, meaning new homes,retrofit homes, small commercial, medium commercial, large commercial, powerplant. And we are leading in all of those areas and so in terms of emphasis, weare going to continue to emphasize all of those panels, if you will, insegments because they are all growing.

In terms of balance, I would expect it to lean a little bittowards the commercial and power plant, maybe 60% and 40% residential as we goforward.

Manny Hernandez

For the third quarter itself, these are approximate numbersbut close, residential accounted for about 30% of our business; commercialabout 30%; and power plant, about 40%.

Michael Millner -Goldman Sachs

Thank you, guys.

Operator

Pierre Maccagno, you may go ahead and please state yourcompany name.

Pierre Maccagno - Needham & Company

Congratulations on the quarter. Can you talk a little bitabout thickness of your cells? My understanding is that thicknesses that arebetween 100 and 200 microns, those are very difficult to put into modules. Theybreak quite easily. If you go to 100, at that point they become flexible andsomewhat easier. Do you have a special method of reducing the breakage ofwafers in the range of 100 to 200 microns when you install them in modules?

Thomas H. Werner

We are currently in production of all of our solar cells are165 microns. We believe this is leading edge but we certainly don’t know whateveryone else is doing.

We are experimenting on sample lots with 145 micron, and theways that we are doing, a credit to the R&D team and the manufacturingteams. R&D because the architecture of our cell is actually preferentialfor thin wafers. We get higher efficiency the thinner it goes. We also, becauseit is all-back contact and all-back architecture cell, it is inherently moreeffective when assembling into a module to all soldering and the back contacton architecture also adds stability to the product.

In terms of manufacturing contributions to this, thinnerwafers is actually the biggest challenge -- that is, not necessarily cuttingthe wafer, it’s actually handling it in the fab. And our employees on themanufacturing line are all part of SPC teams that implement improvements, andone of the focus areas has been wafer handling and they’ve designed into theequipment ways of handling thin wafers, and you’re right; putting a very thinwafer into a cords boat for a diffusion, for example, gets very difficult as itgets very thin. And our teams have innovated on ways to handle wafers,different configurations and different carrying methods that allow us to dothat.

In terms of making it into a module, we spoke quite a bit ayear ago about investing in automation in terms of module assembly and both themanufacturing and R&D teams have done a really job of characterizing thatautomation in terms of thin wafers. They’ve actually done some finite elementanalysis and modeling of characteristics of thin wafers, such that theautomation is compatible with very thin wafers, and we in fact are assemblingnodules with sampling with 145 micron wafers because of the automation workthat’s been invested over the last year.

Pierre Maccagno - Needham & Company

And a short follow-up; what is the interest rate on thedebt?

Manny Hernandez

The interest rate on the last convertible was 1.75%.

Pierre Maccagno - Needham & Company

Okay, thanks.

Thomas H. Werner

Our Treasurer here is changing --

Manny Hernandez

Three-quarters of a point -- 0.75.

Pierre Maccagno - Needham & Company

Thank you.

Operator

Thank you. Jesse Pichel, you may ask your question andplease state your company name.

Jesse Pichel - PiperJaffray

Do existing installers with the PPA model have anycompetitive advantages versus PowerLight? And will PowerLight need to own theinstallation assets on the ground to move towards the IPP model? And I have afollow-up.

Thomas H. Werner

We think as the market moves to PPAs and particularly, thecommercial market that that favors SunPower because of the scale of our companyand also that PowerLight was actually the first to use a PPA structure manyyears ago, so we have quite a bit of knowledge and experience internally. Andof course, as we use its scale advantage, we should get very competitive terms.

There are other market dynamics in terms of when you set upa PPA, the financier has very strict requirements, and Jesse, I know you arefamiliar with quite a few of them, very strict requirements of who they want towork with and the track record of that company and the fact that we have -- weourselves have done the most installations of any company in the market. Thatgive us another advantage.

Howard, did you want to add a couple more comments, or --

Howard Wenger

Sure. Just to say that the barriers to entry actually arerelatively low when it comes to the solar business. There are a lot morecompanies out there, but the barriers to success are actually quite high.

Just echoing Tom’s comments, when you start, especially inthe PPA model, when you start to peel it back, the owners of the systems andthe financiers of the systems are looking not only at the technology, which isimportant, and the reliability of the systems but the credibility in thebalance sheet of the companies behind it.

So we are finding increasing success, actually, as theopportunity expands and each of the opportunities gets bigger, like the Macy’s,the Wal-Marts, we’re actually finding that we are enjoying more success.

Jesse Pichel - PiperJaffray

So you don’t need to own the guys on the ground, then?

Thomas H. Werner

Sorry, Jesse, if you could repeat that, but we didn’t answeryour question completely. The other part was will SunPower end up having to bethe owner? Not necessarily. There are structures where that will be the caseand of course --

Jesse Pichel - PiperJaffray

And a question for Manny, if I could; Manny, why are thebalance of system components on the system sales recognized apart from theoverall system? It seems like you had a margin pick-up I guess the firstquarter as an integrated company on this same issue, which I assumed was therecognition of the power tilt or the trackers, apart from the overall system.Could you explain that?

Manny Hernandez

The sale of what you call balance of system is essentiallyno different than selling a component, so it is recognizable upon sale, title’stransferred, no further obligation. So that’s why it’s -- however, it’s stillnegotiated, targeted, and [sought] by the systems guys that are trying toimplement the system, so we either win it through an EPC where we implement itall the way, or if we can’t do that for whatever reason, we want to win it as aseller of material as well.

Jesse Pichel - PiperJaffray

So you are recognizing -- you are selling just the materialthen next quarter, which is improving your margin?

Thomas H. Werner

Yeah, and I think, Jesse, that -- there is that it canactually be turns business, even within a quarter because the sales cycle ismuch short.

Jesse Pichel - PiperJaffray

Thanks a lot.

Operator

Michael Horwitz, you may go ahead and please state yourcompany name.

Michael Horwitz -Pacific Growth Equities

A little bit of follow-up; on the PowerLight business, howmuch -- going forward to the competitive landscape, how much of an advantage isit for you to be using your own product, rather than somebody else’s? And how doyou view larger EPC companies coming in to that market?

Thomas H. Werner

That’s an interesting question, one that was thought aboutquite a bit before we merged with PowerLight and I get to think about it a lotmore because the sales force project teams are doing a very capable jobinternally now of motivating the group in the Philippines to ramp faster,because they want more SunPower product.

We’ll start seeing the benefits of an integrated company interms of product design over the next couple of years where because you arevertically integrated, you can design the cell and module to be best suited forthe end product. We’ll be able to cite some of that certainly in 2008. So youhave a better selling proposition and you are going to have a customizedproduct over time that obviously gives you an advantage over a less verticallyintegrated EPC, because you also control your own destiny and the folks in thesales and project teams are very effective at raising priorities internally.

Howard, did you want to comment further?

Howard Wenger

The only thing I would add is as a weapon in the field ofbattle in the landscape, that SunPower provides a terrific weapon. For example,if we are with a customer and we have SunPower versus a competitor that has a conventionaltechnology, we can build a 1-megawatt system on the roof and the competitor canbuild say a half-megawatt, or 600 or 700 kilowatt system. And so the magnitudeof the savings to the customer and the impact on their carbon footprintassessment priorities and the magnitude of the financials greatly improves forthe customer. So it’s a terrific weapon for us.

Michael Horwitz -Pacific Growth Equities

A quick follow-up; in terms of margin in that business overtime, is the Nellis project something that we can look at and derive any hintsat how you are going to develop that business and the margins around thatbusiness going forward, given that was a rather large project?

Thomas H. Werner

The Nellis project benefited -- the short answer to your questionis kind of, but I think more so Olivenza -- and I’ll elaborate just reallyquickly. The Nellis project had the benefit of a new system design and to somedegree, SunPower modules as well, albeit that was a subset of the projectitself. But there were some rather heroic efforts by our folks in the fieldbecause they were the first ones to use that product and they had to -- theywere able to let’s say recommend some design improvements that are beingimplemented and we’ll capitalize on at Olivenza and then subsequent projects,so I think Olivenza is going to be a better example of getting to model in thesystems business which again is 30% gross margin when we are verticallyintegrated.

Michael Horwitz -Pacific Growth Equities

Great. Thanks, Tom.

Operator

Paul Leming, you may go ahead and please state your companyname.

Paul Leming - SoleilSecurities

Good afternoon. Two questions on polysilicon; first, couldyou tell us what quarter in 2008 M.Setekwill be running at a 3,000 ton rate? And then the same question for D.C.Chemicals?

And as a follow-up, are there any new polysilicon projectsin China movingforward that you find particularly interesting or intriguing?

Thomas H. Werner

Yes. Let me clarify; with M.Setek, we buy ingots, notpolysilicon. We buy ingots and wafers, so there is a layer of insulationbetween us and -- isolation, I should say, between us and the actuallypolysilicon brand. I understand that the group at M.Setek fields calls fromanalysts, so it’s probably best you get their ramp plan from them.

I think it is very aggressive and you should think of it aslargely starting now, and it’s significant, what I said, that the Japanesegovernment has approved their expansion of TSC gas and reactors -- let me bemore precise about that; they have four reactors online today, I believe,four-ish. Again, they should clarify that, and will be ramping to somewhere inthe low teens. And they had to get approval from the Japanese Government.That’s done, so I think -- my impression is it is certainly south of the yearto ramp up to that capacity.

D.C. Chemical is first of all, our Chief Operating Officeris meeting with them next week and Iunderstand that they have an earnings call in about a month, so again, you canget better information from them. They’ve been very aggressive in terms ofconstruction and are finding favorable test results in terms of gas production,largely because they already produce the gas, but now they are scaling itrather substantially. So I think of that as being very aggressive and I thinkhappening in 2008 as well.

In terms of China, I think one of the dynamics in siliconthat I didn’t necessarily call right was that some of the new entrants forpolysilicon in China and Russia and other parts of the world have been a littleslower to develop than at least I personally thought they would be.

However, there are some Chinese companies coming online withpolysilicon production on, as far as I know, mostly below 1,000 metric tons.There is at least one of those that I understand is considering going public inthe next six months. That company, yes, we find very interesting as a potentialpartner.

But as they work on their S1 and if my information iscorrect, then of course you’ll become aware of who that is.

Paul Leming - SoleilSecurities

Thank you.

Operator

Tim Luke, you may go ahead and please state your companyname.

Tim Luke - LehmanBrothers

Thank you. This if for Manny; in thinking about the shape ofmargin improvement next year, I was wondering if you could give us some feelfor how you think that will develop with the different elements of the ramp ofthe lines and possible improvement in supply of raw material? And then whetheryou have some seasonality associated with PowerLight at the beginning of theyear and how we should think about putting those elements together, broadly?Thanks.

Manny Hernandez

We have not really provided guidance for 2008 margins,certainly on a quarterly basis. Although one of our stated goals is to achieveour gross margin model of 30% potentially in the fourth quarter of ’08 or thefirst quarter of ’09.

So this is not going to sound too sexy, but you couldliterally relatively improve our margins over time and that should work out aswell for planning purposes.

Tim Luke - LehmanBrothers

Okay, so reasonably assume a steady improvement,notwithstanding seasonality?

Manny Hernandez

Correct. Because there are so many dynamics that arecontributing, puts and takes, as we ramp the lines, they are improving ourutilization. On the other hand, you are ramping more lines so you’ve got threeoperating expenses. Silicon is going to start to come down, so all those allthrown in, we should be able to ratably improve margins quarter on quarter.

Thomas H. Werner

Tim, with the significant growth in the company projectedfor 2008, just by virtue of the fact that it is growth, we will be back-endloaded in the year, in terms of scale.

Tim Luke - LehmanBrothers

Thank you, guys. Good luck.

Operator

Colin Rusch, you may go ahead and please state your companyname.

Colin Rusch - BroadPoint Capital

My question is about the MPV of ongoing costs. I’mestimating land cost O&M, inverter replacement insurance, and overhead tobe close to $0.50 per watt on an MPV basis. Could you give us some insight onhow those costs are accounted for in your sales agreement and how you expectthem to evolve relative to system price and margin going forward?

Thomas H. Werner

Howard will speak to that. Let me just do a littlehousekeeping; we are well aware of the fact that we are into it an hour and 15minutes. We have seven people in queue, so we’ll be brief with our answers.Howard.

Howard Wenger

Those costs that you mentioned, O&M, land, inverteralso?

Colin Rusch - BroadPoint Capital

Inverter replacement.

Howard Wenger

Inverter replacement, okay. So those are all factored intothe cost of energy and are embedded in, either in the case of a PTA, the centsper kilowatt hour that’s offered to the customer, or in the case of an EPC andthen the service agreement into those contracts.

So you calculated all those at $0.50 per watt MPV. I thinkit really depends on the size and scale of the project. I would be happy tofollow up later on that one.

Thomas H. Werner

We’ll take that as homework, Colin.

Colin Rusch - BroadPoint Capital

That sounds great and then the second one is just about thesales cycle going forward. We’ve got the construction cycle but how long is ittaking you from initial contact to closing a deal with a lot of your customers?

Thomas H. Werner

That’s very end market dependent. Residential is muchfaster, obviously, and that can be within -- certainly within a quarter.Commercial and power plants can range rather dramatically. Howard

Howard Wenger

That’s right. So for the larger project with commercialcustomers and for the power plants business, that can be anywhere from threemonths to two years. It just depends.

Colin Rusch - BroadPoint Capital

Great. Thanks, guys.

Operator

Paul Clegg, you may go ahead and please state your companyname.

Paul Clegg -Jefferies & Company

Just kind of a macro question; do you see any othergeographic markets, or market, if you will, that in the short-term, say in2008, it had the same type of meaningful impact of the type that Spain has hadthis year on the global market? Maybe Italyor South Koreaor some other market that we should keep our eyes on for a big surpriseperformance in 2008?

Peter Aschenbrenner

We are quite bullish on the Italian market. We believe thatthat has probably the best chance for a meaningful impact in the scope of thecurrent business in 2008.

Paul Clegg -Jefferies & Company

And could I get you to make a couple of comments onCalifornia and the strength you are seeing there as you step down the PBI intostep four and you see the incentives come down?

Julie Blunden

We’ve had a lot of success in Californiathis year. Obviously the fact that we are in the porch steps of a 10-yearprogram in the second year of the commercial cycle is evidence of the success todate.

There is no doubt that we’ve slowed down a little bit on thecommercial side from the really heated pace that we saw earlier this year,which is entirely expected and exactly how the market was designed.

I think that Californiais ironing out all of the operational details to make the program reallysuccessful.

Paul Clegg -Jefferies & Company

Okay, so that’s slowed down and it’s really in reservationsand you shouldn’t really see that hit reported numbers -- not yours,necessarily, but just in installations themselves being connected until wellinto 2008?

Julie Blunden

I think it is fair to say that if you look at the CPC datathat’s up on their website, there is a substantial backlog, so that will --people will be working through that for a little while.

Paul Clegg -Jefferies & Company

Thank you.

Operator

Your next question comes from Mark Manley- NatexisBleichroeder.

Mark Manley- NatexisBleichroeder

Any chance you couldbreak out the residential segment into new construction and retrofit and maybegive a sense of the trend there?

Thomas H. Werner

While I buy time forthe finance guys, the way to think of new production homes is attach rate. Youhave an increasing attach rate but you have a decreasing sales rate, generallyin the market that everybody knows and is very well informed of.

When you put those two things together you've got asignificant growth in new production homes and residential retrofit fits ourproduct portfolio excellently, so we've got great growth in that as well. AsManny mentioned, it's 30% of sales and in terms of a breakout?

Manny Hernandez

Of the 30% total residential, the new homes or new homesmarket portion of that is about 3% to 5% of the 30.

Mark Manley- NatexisBleichroeder

On the efficiency side of things you talked about going upto 40-megawatt nameplate. How much of that is driven by improvements in cellefficiency?

Thomas H. Werner

The question is ifthe module efficiency going up, how much is driven?

Mark Manley- NatexisBleichroeder

Of the line capacitygoing from 33 to 40 megawatts per line, how much of that is driven by justimprovements in cell efficiency?

Thomas H. Werner

It's a combination of improved UPH, or units per hour, ofthroughput of the equipment and efficiency. I don't have the precise math. Ican give you an educated guess and take that as homework. I think we'll have todo that. It's probably a little less than 50% the conversion efficiency and alittle more than 50% is the throughput of the equipment.

Operator

Your next questioncomes from Brian Gamble – Simmons.

Brian Gamble –Simmons

I was wondering with the success of the 145 micron thickwafers on the test lots, what's your estimated time for being able to movethose to some sort of commercial scale?

Thomas H. Werner

I think we would gointo production of 145 micron, assuming our sample lots go well, we'll see someproduction certainly in 2008, probably in the first half.

Brian Gamble –Simmons

You talked about Germanyand about Spainon the subsidy side. Could you talk a little bit about the U.S. Energy Bill andwhat you're hearing most recently as far as how that's going?

Thomas H. Werner

Julie will speak tothat of course and do so in great depth. Please do try to influence that. Ourindustry group is CEA and you can find them easily on the web and you can makeyour voice heard and you can also contribute to them. So please help us putmore wood behind that arrow. Julie?

Julie Blunden

I actually just got back this morning from DC where I spent yesterdayon the Hill. You know, this is a very exciting week on the Hill, a lot goingon. The Energy Bill is very much in play. I think the Speaker has put asubstantial amount of her personal time and effort into ensuring that we willhave an Energy Bill this year. It doesn't guarantee that we will. But I have tosay, all of the activity on the Hill suggests that people are trying reallyhard to find compromise between the Senate and House bills and take somethingthat is veto proof.

Brian Gamble – Simmons

Julie, from a compromising standpoint, what is that going tomean for solar? Are we going to have to take a huge hit in order to getsomething through? Or is there something agreeable on both sides that is beingpointed to right now?

Julie Blunden

Yes, I have to say Idon't think solar is on anybody's plate as a major part of the chess game, Iwish that would be the case. But it's a real big question as to whether there'sa tax title as part of the overall energy bill or whether they split it up intopieces, I think. So as long as there's a tax title, I think we've got a goodshot of having solar get something that looks pretty similar to either theHouse, the Senate or in the best case, a complement of the two.

Thomas H. Werner

We have four more and we'll stop at the fourth one and we'lldo these quickly.

Operator

Thank you. [KadlinWilfred – Kellis Management].

Kadlin Wilfred –Kellis Management

In light of the capacity add to 12 lines through '09, do Ihave that correct, it was 12 you said?

Manny Hernandez

12 lines will be the new capacity of the fab 2, which wasoriginally estimated as ten. It's now 12 lines.

Kadlin Wilfred –Kellis Management

Is there any update or have you updated recently a guidedCapEx per watt number that would carry us between now and into the end of '09?

Thomas H. Werner

The answer to yourquestion is no. We have talked broadly about a 5% plus reduction for each newline. We'll take that I think as our third homework assignment because I thinkit's something we're comfortable communicating. We just need to make sure we'vegot it right.

Kadlin Wilfred –Kellis Management

It had kind of fallen out of the call recently, but I knowthat maybe in my notes I have a specific number. Can you comment on the trend,whether it's flat or down?

Thomas H. Werner

It's definitely downand it's however got a counterweight that if we buy a lot of equipment in eurosand of course the dollar has depreciated against the Euro so it's offset, butwe have a better design and we of course buy more quantity and of course, we'vedone some things in manufacturing to utilize equipment more effectively. So thecombination of those things ends up with a definite decline, largely in therange of what I said.

Operator

Your next question comes from Mark Rodgers – EgmontSecurities.

Mark Rodgers – EgmontSecurities

Do you see these residential solar developments as largerevenue generators for the future? If you do you have any percentages onrevenue generation? That would be great.

Howard Wenger

The answer is yes and yes. The new home part of our businessactually is the fastest growing segment of our company. It's smallish, as Mannynoted right now, but it's the fastest growing and we do believe that it will bea significant part.

I just want to make one comment is that we're working withsome of the largest home builders in the U.S., builders like Lennar, Centex andDR Horton, and they're making solar standard. At first, they were contemplatingone community at a time, 50 or 100 homes. Now they're looking at multiplecommunities in the State of California,making solar standard.

Mark Roberts - Wachovia Securities

The other question Ihave, the Olivenza project to date, someone said the revenue from that projectwould be as high as $125 million. How much do you think this project can add torevenue and how are you seeing SunPower fit into the competitive landscape?

Thomas H. Werner

Howard can maybe take a shot at revenue. When we talk about2008, we consider the portfolio projects. We of course know what's in ourpipeline. So Olivenza certainly was part of our guidance. I don't know thatwe'll go further into that. I think when you add it up, you get to install plusbacklog of over 100 megawatts, I think it's a 107 megawatts, that's asubstantial part of the Spainmarket. Our competitive position is excellent.

It's because of the great EPC capability that we have, thegreat system design and of course the efficiency to manage with our cellmodules and it fits well in that market.

We'd note that that's also true in Korea.Korea is evenmore land constrained and has a higher value on efficiency. In terms of therevenue impact of that specific project, I don't think we're going to guidefurther on that.

Operator

Your next question comes from Satya Kumar – Credit Suisse.

Satya Kumar - Credit Suisse

Howard, you mentioned that pricing would be flat in thefirst half of next year. I just wanted to make sure I got captured that.

Howard Wenger

I mentioned that Iexpected it to be steady going into next year. We're not giving guidance beyondthe first quarter. We can think of it in 4Q'07 and entering into 2008.

Satya Kumar - Credit Suisse

It is steady in the Spanish environment, I guess?

Thomas H. Werner

I didn't quiteunderstand.

Howard Wenger

He's just trying to calibrate it. It's essentially flat.

Satya Kumar - Credit Suisse

On 5%, would you call that a penny or…?

Thomas H. Werner

Think flat.

Operator

Your final question comes from Michael Carboy - Signal Hill.

Michael Carboy - Signal Hill

Thanks very much for the follow-up here. Howard, can yougive us a quick rule of thumb for PowerLight system install costs or I shouldsay price per watt, the overall project test there?

Howard Wenger

It depends on geographies and some system sizes, so I cangive you a range of somewhere between $4.55 per watt on the low end up to $8.00per watt on the high end.

Operator

Thank you. At this time I'm showing no further questions.Mr. Werner I will now turn the call over to you for any closing comments.

Thomas H. Werner

A 20 second wrap-up. I thank you very much for your time.There are lots of moving parts in our business. We believe we're managing themwell. We're very positive about our future. We appreciate your time and attention.Thank you.

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