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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 Corporate Communications

Mike Umstein - VP of Finance

Analysts

Steve O’Rourke - Deutsche Bank

Sanjay Shrestha - Lazard Capital Markets

Satya Kumar - Credit Suisse

Rob Stone - Cowen

Vishal Shah - Lehman Brothers

David Edwards - Morgan Stanley

Al Kaschalk - Wedbush Morgan

Michael Carboy - Signal Hill

Pavel Molchanov - Raymond James

Jeff Osborne - Thomas Weisel

Mark Hiller - Merrill Lynch

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 conference call. (Operator Instructions) I would now like to turn the call over to Mr. Tom Werner, CEO of SunPower. Sir, you may begin.

Thomas H. Werner

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

We had another solid quarter, as our third quarter performance 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 year revenue 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 business segment are accounted for within the systems financial results rather than the component segment results. Later in the call Andy will go into more detail on our EPS performance. Note that we beat EPS guidance in Q3 and therefore are going to exceed our guidance for the year, and Andy will go into more detail on that after I finish.

Now let me start with strategy. I’d like to highlight our Solar America Initiative contract, which we signed in September. We were awarded a $24.7 million, three-year contract by the Department of Energy, the largest of any company. We believe this reflects confidence in our vertical integration strategy as a means to wring any inefficiencies out of the value chain, lower installed system cost.

After three quarters of working as an integrated company after our PowerLight merger, we are more confident than ever that our integration strategies are already creating value to our customers and shareholders.

Now let me walk you through the value chain to reflect on the progress we’re making at improving efficiencies and lowering costs. First let me cover silicon. It remained in a very dynamic environment with the next generation of major new polysilicon supply capacities beginning to ramp to significant production. In the third quarter, one of our silicon partners, M.Setek continued to ramp their first polysilicon manufacturing plant, which will ultimately support their increased delivery of monocrystalline ingots to us. We can report substantial progress with M.Setek. They have received Japanese government approval to install and commission 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 requires their plant to decommission briefly. We expect M.Setek to recommission the plant in Q4 with full capacity brought online with in-house production of TCS gas to support the expected reactor capacity.

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

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

It’s also important to note that DC Chemical is starting their factory with their own TCS gas production, and that they have significant experience 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 of polysilicon manufacturers is part of our portfolio approach to rationalizing our long-term silicon supply chain from polysilicon to ingots and wafers. In the last quarter, we have taken several major steps to expand our silicon supply. First, we signed a 2-gigawatt, ten-year agreement with Hemlock which begins in 2010. Additionally, we signed a 53 megawatt agreement with Wacker and this three-year agreement is our third with Wacker and it begins in 2009.

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

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

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

Now let me speak to manufacturing. In manufacturing, we expect our nameplate capacity for fab 2 to grow from 330 megawatts annually to 466 megawatts by the end of 2009 due to two adjustments we've made to our plant. 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 to increase throughput on each of our lines to 40 megawatts from 33 megawatts beginning with line 7, which will begin ramping production at the end of Q4.

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

Our manufacturing success in fab 2 has now reduced our silicon utilization to less than 7 grams per watt, paying dividends by offsetting short-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 able to combine additional efficiency gains in cells and panels with thinner wafers and 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 of our 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 panel efficiency to exceed 20%. You would think of this as something like breaking the 4-minute mile equivalent in the solar world.

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

Let me end with a description about our channel strategy. As our solar technology continues to draw strong demand and command a premium in the market, our strategy is to ensure that we have a diversified approach across customer segments, applications and geographies to match the high value placed on our efficiency and aesthetics.

For smaller scale applications, we see both retrofit and new homes performing well. In residential retrofit we now work with more than 125 dealers in 25 states to deliver solar systems on residential and small commercial roofs. We have trained more than 400 installers from these dealer companies 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 received a major industry award at our national conference at Long Beach, recognizing their leadership in implementing solar 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 in solar as a differentiator and sales velocity improvement tool in a down housing market.

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

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

Additionally, we're excited to see Korea moving forward as well with another 2 megawatt power plant at Jeonju. Expansion of our channel strategy is where we have the most tangible evidence of the value of integration SunPower PowerLight completed at the beginning of this year. Market visibility we have through direct customer contact has affected our market entry and expansion plans, technology road maps and our growth strategy. A combination of high efficiency solar panels from SunPower and high energy delivery from the systems technology that originated with PowerLight is a potent combination for our customers which allows us to win business and plan for aggressive cost reduction over the next few years.

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

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

Manny Hernandez

Thanks, Tom. Good morning everyone and thank you for joining SunPower's earnings conference for the third quarter of 2007 which ended September 30th of this year. I'd like to remind everyone that during the conference, management made and will be making statements that are not historical in nature. Please consider those statements as forward-looking pursuant to the Private Securities Litigation Reform Act of 1995.

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

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

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

Our systems segment accounted for $157.7 million of the quarter's revenue, up approximately 52% from the prior quarter revenue of $104 million. Our systems segment represented a greater portion of the total company's revenue this quarter, representing 67.3% of total company, versus 59.8% last quarter.

The faster than anticipated completion of certain projects in North America and Spain, most notably the Nellis Air Force base project that Tom mentioned, contributed to a very strong systems performance during the quarter. Now as Tom noted earlier, the eventual sale of SunPower manufactured components which are allocated by the company to the system segment is reflected as revenue of the systems segment. In the 2007 third quarter, approximately 25% of panels installed in systems projects were SunPower manufactured panels. That's up from 21% last quarter.

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

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

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

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

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

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

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

Note that during Q3 the company completed a financing transaction where we issued $235 million in convertible debenture and sold approximately $174 million of common stock. Our DSO improved to approximately 32 days, while our net inventory closed at approximately 49 days. Capital expenditure for the year is now estimated at $210 million and full year's depreciation is estimated at $29 million.

As we have noted in prior calls, our business results may reflect 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 lead to non-sequential or marginal growth in revenue, margins or earnings.

The second half of 2007 is essentially shaping up as we guided you last quarter. Specifically, that we expected a very strong Q3 followed by a slight decline in Q4, influenced largely by previously committed project schedules.

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

For Q4, our total company estimated non-GAAP results are as follows: 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 segment revenue of $90 million to $95 million. In the fourth quarter, we expect an increase in planned allocation of SunPower panels to the systems segment due to strong internal demand such that approximately 35% of panels installed in our systems projects will be SunPower panels versus 25% in the third quarter.

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

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

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

For the fiscal year 2007, we now expect the following non-GAAP results: revenue of approximately $760 million to $770 million; earnings per share of $1.20 to $1.24. These earnings are based on our non-GAAP tax rate of 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 a non-GAAP EPS of approximately $1.90 to $2.05 per share.

Let me now turn it over to Tom to lead us through the Q&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 have Howard Wenger, our VP of Global Business Units; Peter Aschenbrenner , our VP of Marketing; 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 going too long on the call, if you would please limit yourself to one question and one follow-up, and if there are more questions that you have, if you could get back in the queue we would appreciate it.

We will do something a little differently than we have done previously on our calls. There were three homework assignments we took from the last call and we will just briefly cover those, and then we will go to questions.

The first two of those homework assignments, the first one was on our cost reduction road map our commitment of 50% cost reduction by 2012, what does the profile of that look like?

I'll just say that it depends on which part of the cost reduction 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 out years, whereas in terms of cell and module cost reduction, that is more front end loaded so as we get into '08 we'll probably start to give you some specific measures 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 silicon costs doing in 2008, because we have talked about long-term contracts coming on line in 2008. We've spoken to our silicon vendor partners and they are not comfortable with us giving any guidance on silicon cost so unfortunately, we can't give you precision on that, although we appreciate the question.

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

Manny Hernandez

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

For the purpose of responding to that question, we're using 2 megawatts or bigger and it's actually a great question because we do get scale in economies from big projects like this, from a profit contribution standpoint, not just gross margin.

You do benefit from lower overhead support because you don't have to increase the support for a bigger project, necessarily and you also get operating expense leverage for huge projects like this.

As you can appreciate, since this is largely a negotiation tool, we'll give you a range. The benefit for large scale projects is anywhere from zero to 5% of the historical deals we've done; it could be as much as zero if you want to use the benefit to more competitively 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-Answer Session

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 and going out to 2008? Does it hold to the prior comment you made on percentages or will it go up?

Manny Hernandez

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

One caveat to that is we obviously as a company want the flexibility of being able to redirect modules appropriately, depending on the business 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 your longer-term strategy for selling energy rather than simply selling systems? I know you're moving in that direction. But where might it make sense to start doing 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 because customers are used to paying for energy. For customers like Wal-Mart and Macy's as two examples, they're buying power in some cases and not necessarily buying a solar system so that when they justify it to their board they justify it on the economics of buying power. Then they have the added benefit of they're doing something good for the environment.

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

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

Howard, did you want to add anything else?

Howard Wenger

No, I have nothing further to add.

Thomas H. Werner

Okay, Steve, that hopefully answers your question.

Operator

Our next question comes from Sanjay Shrestha – Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets

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

Thomas H. Werner

I'll turn it to Manny in just a second. He can give you a rough split. As you can imagine, as you grow as rapidly as we're growing that you're not going to have perfect linearity. Deliver, as you correctly ask the question, it does split into linearity 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 our component margin guidance as the benchmark, I would characterize the impact of two-thirds silicon related, one-third ramp related.

Sanjay Shrestha - Lazard Capital Markets

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

Thomas H. Werner

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

Operator

Your next question comes from Satya Kumar – Credit Suisse.

Satya Kumar - Credit Suisse

I just wanted you to explain the dynamic here. You're not actually increasing your megawatts of silicon available for next year but you are increasing your revenues and earnings for next year. What's driving that?

Manny Hernandez

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

Satya Kumar - Credit Suisse

A quick follow-up to that. You recently talked about having 100 megawatts of cumulative orders in Spain. Can you talk about what part of the orders have been posted so far and also if you can also tell me what your megawatts of component production was in the quarter? Thanks.

Thomas H. Werner

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

Manny Hernandez

The megawatt answer is flat from last quarter. If you recall last quarter was 24.5 megawatts, so we were practically flat in Q3. Going forward though, with the lines ramping and better visibility on silicon, our estimated output is 34 megawatts, or at least 40% 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 booked orders 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 fully constructed.

Operator

Your next question comes from Rob Stone – Cowen.

Rob Stone - Cowen

The way you guys describe the transfer of production from component to systems seems like it's a little harder to calculate than if you would describe it as the proportion of your production that's going to the systems business since it's hard to know how much the systems business may be doing in megawatts of product coming from third parties. Could you restate the targets for 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 on which way to do that. We'll continue to evolve it with you, we're certainly not trying to be difficult. I'll let Manny try to add clarification and perhaps with the follow-up calls we can make sure we're honing in on the best way to communicate it.

Manny Hernandez

Rob, the way we are providing answers to that question now where we say 30% of systems installed product utilize SunPower modules, then the 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 systems business. It's much easier actually to track the megawatts that you are producing. In other words, I'm asking the question a different way. If we were looking at the total megawatts that you produce, what portion of that is sold externally versus transferred to the systems business?

Thomas H. Werner

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

Rob Stone - Cowen

On the systems business, can you give us some flavor for how much relative proportion balance of systems components, the mounting and tracking systems contribute to overall revenues?

Thomas H. Werner

Sure. We had the dynamic at 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. It is part of our ongoing business and you should consider it as part of the way we do business as part of our channel strategy.

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

Howard Wenger

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

Rob Stone - Cowen

I'm sorry, I missed that percentage.

Thomas H. Werner

5% to 8% in the systems channel.

Rob Stone - Cowen

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

Operator

Your next question comes from Vishal Shah- Lehman Brothers.

Vishal Shah - Lehman Brothers

Tom, one of your largest competitors in Japan recently announced plans to start mass production of thin film based solar cells and he said that the move was being made to keep them competitive against rising prices of silicon.

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

Thomas H. Werner

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

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

Operator

Your next question comes from Mr. David Edwards – Morgan Stanley.

David Edwards - Morgan Stanley

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

Thomas H. Werner

Yes, we do. Howard will make most of them. I would just give you the context that there's a reason why we have a 50% cost reduction plan by 2012. It's that we expect and it's built into most of the incentive systems that the incentives will go down in time and it's our part of the deal that we'll reduce costs such that the economics 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 the Spanish government is doing because historically in our industry, if you look back five or eight years ago, policy and incentives were very stop and go kind of a proposition. Now since our industry has reached critical mass in my opinion, governments are paying a lot more attention to being very proactive about ensuring continuity in markets. So we're very happy that the Spanish government has taken a stand and said okay, we're going to increase the cap from 371 megawatts to 1,200 megawatts and we're actually thinking of going to 2,000 megawatts. That's good and that's actually given a fair amount of clarity in the market already.

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

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 and if you could give a little bit more granularity as we roll into '08 and specifically the front half versus the second half. How much are you using spot versus more mid-term and long-term contracts?

Thomas H. Werner

Al, thanks for the question. We purposely said short term versus spot so I'll answer your question, spot is a very small percentage of what we buy, below 5%. Now, let me further answer your question, however. The way we characterize short term is within a year and buying from existing partners and therefore it's a significantly different dynamic than spot. It tends not to be a one-time transaction at a very high price. That percentage varies by quarter and that still is a very small number as well, but that's less than 10%.

Al Kaschalk - Wedbush Morgan

In terms of margin improvement, and I know this is really kind of granular here, but in terms of what you're setting up for '08 margin expansion 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 broad picture and then drill down to your question. We have significant improvements in our factory in the Philippines. We are getting more watts per wafer out of our first generation technology through manufacturing improvements and of course our second generation technology has median efficiencies that is almost two points higher, so we get more 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 of the second fab as well as the pre-op. I don't recall if Manny specified the pre-op for the quarter but the pre-op number is significant and that goes away as we ramp that facility so we get the benefit of that as well.

You're right, silicon is an important part of the cost reduction and it's roughly 25% to 50%. It depends on the time of year and of course it depends on the execution of our partners, but 25% to 50% of our cost reduction 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 and understood. Could you give us a little bit of insight into what suddenly accelerated the programs, Howard, and how do we deal from a planning perspective with 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 to shorten our basically book-to-bill time, and one of them is in the area of technology innovation. So for example, in the Nellis project which we realized a good amount of revenue in the third quarter, we implemented our new Power Tracking technology which does not rely on ground penetration so we're actually modeling it on our leading roof technology which also has no roof penetration; we have transported that idea to the ground. So it enables us to install much faster, much more predictably. We're doing it, a lot of that construction in a manufacturing facility and taking it to the site. That improves quality control as well.

So in terms of going forward, the mix of our projects, the size of our projects, where they are geographically, all bear on construction schedules and I believe that we guided in the past from book-to-bill on the order of six to nine months and we're looking to shorten that time. I think in the future we'll be able to provide more information as we go forward and implement 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. We were a little bit conservative on our schedule because of that, our planning schedule, because it's the first time we had fielded it. As we got into it we realized that we were exceeding or hitting our original estimates and being able to install on the rate of a megawatt a week which is unprecedented. That's really what 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 systems team and the team in the field. They did an exceptional job. So we're really thrilled with the work that the folks in the field did.

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

Operator

Your next question comes from Pavel Molchanov – Raymond James.

Pavel Molchanov - Raymond James

Right now something like 95% of the PD market is in OECD countries. When or how do you think that changes whereby emerging markets become 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 will continue to be in the OECD countries for the foreseeable future. What we do believe will happen is that the percentage of the total market that those five or six top markets comprise will diminish over time. So if you look at the top five 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 years to something closer to perhaps the mid-60%.

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

Pavel Molchanov - Raymond James

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

Peter Aschenbrenner

I think it's probably the 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 watt or just general comments on pricing? Any change to the timing of achieving the long-term margin model that you've discussed in the past? Thanks.

Thomas H. Werner

Howard will take the first part. Manny the second.

Howard Wenger

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

Manny Hernandez

Long term, gross margin milestone or model is the same. We are 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 have any thoughts on the pricing for next year? Do you think it's down 5% or a little less than that? And then just for Manny, any thoughts on tax rate and CapEx for '08?

Howard Wenger

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

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

Jeff Osborne - Thomas Weisel Partners

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

Howard Wenger

That's correct at this 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 of 26%. As far as capital expenditure for 2008, our early estimates are in the $250 million to $300 million range. Note that the following capital activities will be covered by that: One is five more manufacturing lines; three module lines in the beginning of the expenditure for fab 3 which is our third facility.

Operator

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

Mark Heller - Merrill Lynch

Manny, I just had a clarification -- I guess I’m still trying to figure out the margin dynamics for Q4. You are lowering your component gross margin guidance because you are sourcing I guess more polysilicon from the spot market and your systems gross margin is going up sequentially because you are souring more solar cells or panels from SunPower into PowerLight. I just want to confirm that that’s the case.

Manny Hernandez

Those are both accurate, plus I would only add that on the systems side, they are also going to benefit from OEM sale of certain balances systems 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 - Merrill Lynch

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

Thomas H. Werner

We’ll get to more -- closer to 2008 and in other words probably in the next earnings call. In terms of the breakdown, we provided overall guidance on where the cost reduction comes from. I think of a target of 50% where 40% or 50% of that 50% comes from downstream scaling silicon. And when I say silicon, I’m thinking of polysilicon ingot wafer, so the combination of those things could be 20%, conversion efficiency, 15%, and then scaling the factory 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 to 60% because we are giving ourselves some room that not all the plans will come to fruition and that will get us to our 50% target. So that’s a long way of saying silicon is 20 points and as I said, that’s a combination of long-term partner contracts coming online, starting in the first quarter of next year and then throughout the year. That’s also higher efficiency, even on our first generation technology, and that’s also using thinner wafers.

So it’s a combination of those things.

Mark Heller - Merrill Lynch

Thank you.

Operator

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

Stuart Bush - RBC Capital Markets

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

Thomas H. Werner

We’ll split this question into two. I’ll let Howard comment on percentage breakdowns in region. Julie Blunden will speak to the market dynamics.

Julie Blunden

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

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

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

Howard Wenger

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

Stuart Bush - RBC Capital Markets

Great. Thanks a lot.

Operator

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

Michael Millner - Goldman Sachs

Good afternoon, everyone. Just a couple of quick ones; if we look at the three buckets of end users as you described, retrofit, new homes and large-scale commercial, let’s call it, can you give a rough breakout of your 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 we present most of the places we’re at that has customer end segments. We combined retrofit and new homes. I call that the residential market. Commercial public, we call that Microsoft, Macy’s,Wal-Mart, Tiffany’s, Agilent, et cetera; and then the power plant business. And in terms of split, I think Manny will have that 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’ll go back to Manny.

Howard Wenger

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

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

Manny Hernandez

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

Michael Millner - Goldman Sachs

Thank you, guys.

Operator

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

Pierre Maccagno - Needham & Company

Congratulations on the quarter. Can you talk a little bit about thickness of your cells? My understanding is that thicknesses that are between 100 and 200 microns, those are very difficult to put into modules. They break quite easily. If you go to 100, at that point they become flexible and somewhat easier. Do you have a special method of reducing the breakage of wafers 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 are 165 microns. We believe this is leading edge but we certainly don’t know what everyone else is doing.

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

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

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

Pierre Maccagno - Needham & Company

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

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 and please state your company name.

Jesse Pichel - Piper Jaffray

Do existing installers with the PPA model have any competitive advantages versus PowerLight? And will PowerLight need to own the installation assets on the ground to move towards the IPP model? And I have a follow-up.

Thomas H. Werner

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

There are other market dynamics in terms of when you set up a PPA, the financier has very strict requirements, and Jesse, I know you are familiar with quite a few of them, very strict requirements of who they want to work with and the track record of that company and the fact that we have -- we ourselves have done the most installations of any company in the market. That give 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 are relatively low when it comes to the solar business. There are a lot more companies out there, but the barriers to success are actually quite high.

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

So we are finding increasing success, actually, as the opportunity 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 - Piper Jaffray

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 answer your question completely. The other part was will SunPower end up having to be the owner? Not necessarily. There are structures where that will be the case and of course --

Jesse Pichel - Piper Jaffray

And a question for Manny, if I could; Manny, why are the balance of system components on the system sales recognized apart from the overall system? It seems like you had a margin pick-up I guess the first quarter as an integrated company on this same issue, which I assumed was the recognition 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 essentially no different than selling a component, so it is recognizable upon sale, title’s transferred, no further obligation. So that’s why it’s -- however, it’s still negotiated, targeted, and [sought] by the systems guys that are trying to implement the system, so we either win it through an EPC where we implement it all the way, or if we can’t do that for whatever reason, we want to win it as a seller of material as well.

Jesse Pichel - Piper Jaffray

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

Thomas H. Werner

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

Jesse Pichel - Piper Jaffray

Thanks a lot.

Operator

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

Michael Horwitz - Pacific Growth Equities

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

Thomas H. Werner

That’s an interesting question, one that was thought about quite a bit before we merged with PowerLight and I get to think about it a lot more because the sales force project teams are doing a very capable job internally 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 in terms of product design over the next couple of years where because you are vertically integrated, you can design the cell and module to be best suited for the end product. We’ll be able to cite some of that certainly in 2008. So you have a better selling proposition and you are going to have a customized product over time that obviously gives you an advantage over a less vertically integrated EPC, because you also control your own destiny and the folks in the sales 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 of battle 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 conventional technology, we can build a 1-megawatt system on the roof and the competitor can build say a half-megawatt, or 600 or 700 kilowatt system. And so the magnitude of the savings to the customer and the impact on their carbon footprint assessment priorities and the magnitude of the financials greatly improves for the 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 over time, is the Nellis project something that we can look at and derive any hints at how you are going to develop that business and the margins around that business going forward, given that was a rather large project?

Thomas H. Werner

The Nellis project benefited -- the short answer to your question is kind of, but I think more so Olivenza -- and I’ll elaborate just really quickly. The Nellis project had the benefit of a new system design and to some degree, SunPower modules as well, albeit that was a subset of the project itself. But there were some rather heroic efforts by our folks in the field because they were the first ones to use that product and they had to -- they were able to let’s say recommend some design improvements that are being implemented 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 the systems business which again is 30% gross margin when we are vertically integrated.

Michael Horwitz - Pacific Growth Equities

Great. Thanks, Tom.

Operator

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

Paul Leming - Soleil Securities

Good afternoon. Two questions on polysilicon; first, could you tell us what quarter in 2008 M.Setek will 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 projects in China moving forward that you find particularly interesting or intriguing?

Thomas H. Werner

Yes. Let me clarify; with M.Setek, we buy ingots, not polysilicon. We buy ingots and wafers, so there is a layer of insulation between us and -- isolation, I should say, between us and the actually polysilicon brand. I understand that the group at M.Setek fields calls from analysts, so it’s probably best you get their ramp plan from them.

I think it is very aggressive and you should think of it as largely starting now, and it’s significant, what I said, that the Japanese government has approved their expansion of TSC gas and reactors -- let me be more precise about that; they have four reactors online today, I believe, four-ish. Again, they should clarify that, and will be ramping to somewhere in the 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 year to ramp up to that capacity.

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

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

However, there are some Chinese companies coming online with polysilicon 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 in the next six months. That company, yes, we find very interesting as a potential partner.

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

Paul Leming - Soleil Securities

Thank you.

Operator

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

Tim Luke - Lehman Brothers

Thank you. This if for Manny; in thinking about the shape of margin improvement next year, I was wondering if you could give us some feel for how you think that will develop with the different elements of the ramp of the lines and possible improvement in supply of raw material? And then whether you have some seasonality associated with PowerLight at the beginning of the year 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 achieve our gross margin model of 30% potentially in the fourth quarter of ’08 or the first quarter of ’09.

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

Tim Luke - Lehman Brothers

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

Manny Hernandez

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

Thomas H. Werner

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

Tim Luke - Lehman Brothers

Thank you, guys. Good luck.

Operator

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

Colin Rusch - Broad Point Capital

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

Thomas H. Werner

Howard will speak to that. Let me just do a little housekeeping; we are well aware of the fact that we are into it an hour and 15 minutes. 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, inverter also?

Colin Rusch - Broad Point Capital

Inverter replacement.

Howard Wenger

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

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

Thomas H. Werner

We’ll take that as homework, Colin.

Colin Rusch - Broad Point Capital

That sounds great and then the second one is just about the sales cycle going forward. We’ve got the construction cycle but how long is it taking 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 much faster, 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 commercial customers and for the power plants business, that can be anywhere from three months to two years. It just depends.

Colin Rusch - Broad Point Capital

Great. Thanks, guys.

Operator

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

Paul Clegg - Jefferies & Company

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

Peter Aschenbrenner

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

Paul Clegg - Jefferies & Company

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

Julie Blunden

We’ve had a lot of success in California this year. Obviously the fact that we are in the porch steps of a 10-year program in the second year of the commercial cycle is evidence of the success to date.

There is no doubt that we’ve slowed down a little bit on the commercial 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 California is ironing out all of the operational details to make the program really successful.

Paul Clegg - Jefferies & Company

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

Julie Blunden

I think it is fair to say that if you look at the CPC data that’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- Natexis Bleichroeder.

Mark Manley- Natexis Bleichroeder

Any chance you could break out the residential segment into new construction and retrofit and maybe give a sense of the trend there?

Thomas H. Werner

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

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

Manny Hernandez

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

Mark Manley- Natexis Bleichroeder

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

Thomas H. Werner

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

Mark Manley- Natexis Bleichroeder

Of the line capacity going from 33 to 40 megawatts per line, how much of that is driven by just improvements in cell efficiency?

Thomas H. Werner

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

Operator

Your next question comes from Brian Gamble – Simmons.

Brian Gamble – Simmons

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

Thomas H. Werner

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

Brian Gamble – Simmons

You talked about Germany and about Spain on the subsidy side. Could you talk a little bit about the U.S. Energy Bill and what you're hearing most recently as far as how that's going?

Thomas H. Werner

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

Julie Blunden

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

Brian Gamble – Simmons

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

Julie Blunden

Yes, I have to say I don't think solar is on anybody's plate as a major part of the chess game, I wish that would be the case. But it's a real big question as to whether there's a tax title as part of the overall energy bill or whether they split it up into pieces, I think. So as long as there's a tax title, I think we've got a good shot of having solar get something that looks pretty similar to either the House, 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'll do these quickly.

Operator

Thank you. [Kadlin Wilfred – Kellis Management].

Kadlin Wilfred – Kellis Management

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

Manny Hernandez

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

Kadlin Wilfred – Kellis Management

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

Thomas H. Werner

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

Kadlin Wilfred – Kellis Management

It had kind of fallen out of the call recently, but I know that 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 down and it's however got a counterweight that if we buy a lot of equipment in euros and of course the dollar has depreciated against the Euro so it's offset, but we have a better design and we of course buy more quantity and of course, we've done some things in manufacturing to utilize equipment more effectively. So the combination of those things ends up with a definite decline, largely in the range of what I said.

Operator

Your next question comes from Mark Rodgers – Egmont Securities.

Mark Rodgers – Egmont Securities

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

Howard Wenger

The answer is yes and yes. The new home part of our business actually is the fastest growing segment of our company. It's smallish, as Manny noted right now, but it's the fastest growing and we do believe that it will be a significant part.

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

Mark Roberts - Wachovia Securities

The other question I have, the Olivenza project to date, someone said the revenue from that project would be as high as $125 million. How much do you think this project can add to revenue 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 about 2008, we consider the portfolio projects. We of course know what's in our pipeline. So Olivenza certainly was part of our guidance. I don't know that we'll go further into that. I think when you add it up, you get to install plus backlog of over 100 megawatts, I think it's a 107 megawatts, that's a substantial part of the Spain market. Our competitive position is excellent.

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

We'd note that that's also true in Korea. Korea is even more land constrained and has a higher value on efficiency. In terms of the revenue impact of that specific project, I don't think we're going to guide further 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 the first half of next year. I just wanted to make sure I got captured that.

Howard Wenger

I mentioned that I expected it to be steady going into next year. We're not giving guidance beyond the 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 quite understand.

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 you give us a quick rule of thumb for PowerLight system install costs or I should say price per watt, the overall project test there?

Howard Wenger

It depends on geographies and some system sizes, so I can give you a range of somewhere between $4.55 per watt on the low end up to $8.00 per 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 them well. We're very positive about our future. We appreciate your time and attention. Thank you.

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Source: SunPower Q3 2007 Earnings Call Transcript
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