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First Solar, Inc. (NASDAQ:FSLR)

Q3 2007 Earnings Call

November 7, 2007 4:30 pm ET

Executives

Erica Mannion - IR

Mike Ahearn - Chairman and CEO

Jens Meyerhoff - CFO

Bruce Sohn - President

Analysts

David Edwards - Morgan Stanley

Steve O’Rourke - Deutsche Bank

Rob Stone - Cowen & Company

Vishal Shah - Lehman Brothers

Sanjay Shrestha - Lazard

Adam Hinckley - CIBC World Markets

Michael Molnar - Goldman Sachs

Jesse Pichel - Piper Jaffray

Satya Kumar - Credit Suisse

Michael Carboy - Signal Hill

Dan Ries - Collins Stewart

Eric Brown - Banc of America

Operator

Good day, everyone, and welcome to the First Solar ThirdQuarter 2007 Conference Call. Today's call is being webcast live on theInvestor section of First Solar's website at www.firstsolar.com. At this timeall participants are in a listen-only mode. As a reminder, today's call isbeing recorded.

I would now like to turn the program over to Erica Mannion,Investor Relations, First Solar. Please go ahead, ma'am.

Erica Mannion

Good afternoon, everyone, and thank you for joining us forFirst Solar's third quarter 2007 conference call. Shortly after market closetoday, the company issued a press release announcing its third quarter 2007financial results.

If you did not receive a copy of the press release, you canobtain one from the investor section of First Solar's website atwww.firstsolar.com. You may listen to an audio replay of this conference callby dialing 888-203-1112 within the United States,or 719-457-0820 if you are not within the United States.

Please enter reservation number 6614343. The audio replaywill remain available until November 12th at 11:59,Eastern time. Also, a webcast replay will be available in approximately twohours, in the investor section of the company's website, and if you are a subscriberof FactSet, you can obtain a transcript within two hours.

With me today are: Mike Ahearn, Chief Executive Officer andChairman; Jens Meyerhoff, Chief Financial Officer; and Bruce Sohn, President.Mike will begin an overview of the company's achievements and progress in thethird quarter of 2007. Jens Meyerhoff will provide you with third quarterfinancial results, and the financial guidance for 2007 and 2008. We will thenopen the call up for questions.

All financial numbers reported and discussed on the calltoday will be based on Generally Accepted Accounting Principles. The companyhas allocated approximately one hour for today's call. During the Q&Aperiod, as a courtesy to those individuals seeking to ask questions, we askthat participants limit themselves to one question, and one follow-up question.

Now, I would like to make a brief statement regardingforward-looking remarks that you may hear on today's call. During the course ofthe call, the company will make projections and other comments that areforward-looking statements within the meaning of the Federal Securities laws.These statements are based on current information and expectations that areinherently subject to change and involve a number of risks and uncertainties.

We wish to caution you that actual events or results maydiffer materially from those in any forward-looking statements due to variousfactors, including but not limited to, the availability of government subsidies,the demand for solar modules, the cost of capital available to our customersand end-product users, the field performance and reliability of our products,the company's ability to successfully replicate production at its German andMalaysian plants, and the company's relationships with customers and keysuppliers.

Additional information concerning factors that could causeactual events and results to differ materially from those in anyforward-looking statements is contained in the company's filings with the SEC,and in Safe Harborlanguage of the press release that was sent out today.

The company assumes no obligation to update any statementmade during today's call to revise any forward-looking statements, or to updatethe reasons why actual events may differ materially from those anticipated inany forward-looking statements.

Before I turn the call over to Mike Ahearn, I would like tomention that during calendar Q4, the company will be speaking at the PacificGrowth Equities Clean Energy and Industrial Growth conference in San Francisco on Thursday, November 8th and at the LehmanGlobal Technology Conference in San Franciscoon Thursday, December 6th. It is now my pleasure to turn the call over to MikeAhearn, CEO and Chairman of First Solar. Mike?

Mike Ahearn

Thank you, Erica, and thank you for participating in today'sthird quarter 2007 earnings call. During the third quarter, a number of thebusiness initiatives that we've been working on this year came to fruition andbegan to produce strong operating and financial results.

We more than doubled our revenues sequentially over thesecond quarter to $159 million, posted net income of $38.5 million beforegiving effect to the release of valuation allowances against certain foreigndeferred tax assets--which brought our total GAAP net income to $46 million--andreduced our manufacturing costs to $1.19 per watt, which included $0.04 perwatt of stock-based compensation expense.

I'd like to briefly summarize our progress on the keyinitiatives that underlie these results, starting with module production.

During the third quarter, we more than doubled productionsequentially over the second quarter to 69.4 megawatts, with the increaseresulting from the operation of all seven of our production lines at fullcapacity for substantially the entire quarter, and also from improvements inmodule production throughput and conversion efficiencies. The third quarterproduction volume implies an annual production rate of 39.6 megawatts per line,which represents a substantial improvement over prior periods.

I should point out that while we're pleased with ourprogress, it's important to note that these improvements are events rather thantime-driven. They do not establish a linear trend, and future improvements willbecome increasingly more difficult to achieve.

Since our last call, we announced our intention to constructtwo additional factories in Malaysiaconsisting of four lines each, bringing our total announced Malaysiamanufacturing center to four factories and 16 production lines, with a totalannual production capacity of slightly over 600 megawatts, based on our thirdquarter run rate.

Construction of our first factory in Malaysiais proceeding according to schedule, and we expect initial equipment deliverythis quarter. We started site preparations for our second and third Malaysiafactories in August and October, respectively, and expect to start sitepreparation for the fourth factory by the end of the fourth quarter.

We expect to be at full capacity with all four factories bythe end of 2009, which will bring our total announced company-wide annualproduction capacity to approximately 900 megawatts based on our third quarterrun rate.

Our announced factory expansions in Malaysia imply anaccelerated timeline for breaking ground and constructing new factories, ascompared to our historic pace of construction, while we believe the acceleratedpace is appropriate to meet market demand and within our capability, it doesrepresent a new challenge to First Solar and our suppliers, and carries someadditional execution risk that we had not previously encountered.

Turning to the market, demand for our products remainedrobust during the third quarter, and we continue to experience market demand inexcess of supply. We sold 64.2 megawatts of module at an average sales price of$2.48 per watt, resulting in revenue of $159 million.

As we've discussed previously, First Solar historically hassold most of its modules to a select number of customers under firm take-or-pay,long-term contracts, that run through 2012.

Under these contracts, First Solar commits to pricing thatwe believe is sufficient to enable our customers to develop robust demandpipeline for large ground and roof-mounted solar systems, and we've reduced theprice of approximately 6.5% per year, year-over-year, through 2012.

We reserve a small portion of our module production toestablish new customer relationships and open new markets. During 2007 we madethree announcements of expanded volumes under these types of long-termagreements--the most recent this past Monday, when we announced 557 megawattsof long-term agreements with Babcock & Brown and Ecostream--both underterms comparable to our previously announced long-term contracts.

These newly announced agreements represent approximately $1billion of revenue through 2012, at an assumed exchange rate of $1.30 per Euro.Babcock & Brown is a well-known global investment advisory and developmentfirm that specializes in real estate infrastructure and renewable energy projects.

Ecostream specializes in the development, design, andconstruction of commercial PV projects across Europe,and is a subsidiary of Econcern, a Netherlands-based company that providessustainable energy and energy conservation products and services.

These latest contracts continue the expansion of rawresourced energy firms into the solar sector, a trend that we believe willcontinue to reduce the non-module portion of the system cost, and acceleratethe development and expansion of the PV industry.

I should also mention that we were scheduled to beginshipments to SunEdison in October under a 25-megawatt contract to supportprojects in Ontario, Canada.Because of implementation delays in the Ontariofeed-in program, First Solar and SunEdison jointly agreed to cancel theexisting agreement and revisit a supply agreement, when the Ontariomarket is operational. In the meantime, we've re-allocated these modules toother customers.

To recap our market expansion in 2007, we've increased totalvolumes under our long-term contracts by 1.8 gigawatts, representing $3.4billion of revenue for 2012 at an assumed exchange rate of $1.30 per Euro.

We've doubled our long-term customer base, from sixcustomers at the beginning of 2007 to 12 customers currently, and expanded ourgeographic market scope to virtually every EU country with a meaningful feed-inand center program for solar power.

We believe we have assembled a customer base that is amongthe best positioned in the industry to develop meaningful project pipelines forlarge ground and roof-mounted projects across the European Union.

Most importantly, these long-term agreements and customerrelationships are enabling us to scale our business and thereby reduce costsand to validate the performance and economics of large-scale solar electricityin preparation for wider market adoption.

First Solar is currently pursuing revenue growth on twofronts. First, we believe additional growth remains in markets supported byfeed-in tariff incentive structures, including countries in Europeas well as South Koreaand Ontario, Canada.

Second, and more importantly, First Solar is seekingopportunities to open new markets that are not dependent upon the level ofsubsidies that traditionally have supported the PV industry.

We do not believe that the subsidy programs currentlyfueling the PV industry will sustain market growth rates and profit margins atcurrent levels over the long term, but rather, are intended to support initialproduction in market scale leading to lower prices for solar electricity andreduced subsidy dependence.

First Solar is seeking to open new markets that representattractive opportunities to trade off lower prices for higher volumes, greaterdemand visibility, and reduce subsidy dependence.

We believe these efforts will continue to result in afinancially attractive business model with a reduced subsidy risk profile andfacilitate the transition of the solar industry from subsidy dependent markets,both playing a key role in the global electricity infrastructure.

As an example, I mentioned in earlier calls, that we aredeveloping plans for entering the USutility market, but we believe low-cost PV represents an attractive solutionfor regulated utilities seeking to meet RPS quotas. Although we're not preparedto make any announcements today, we do expect to realize revenues from thisevolving market beginning in 2008, in line with our previous communications.

In conclusion, we are pleased with our progress during thethird quarter and the strong contributions made by the entire First Solar teamthat have enabled us to remain on plan to reaching our midterm goal of reducingsolar electricity prices to levels competitive with retail conventionalelectricity.

With our German plant at full capacity, we have validatedthe robustness of our Copy Smart process for replicating factories, which is akey ingredient for our future growth.

In the third quarter, we were also able to demonstratestrong operating leverage underlying that growth, a key component of our costleadership, and our long-term financial model.

And, with that, I would like to turn this discussion over toJens Meyerhoff, our CFO, who will discuss our third quarter financial results,our guidance for the remainder of 2007, and our guidance for 2008.

Jens Meyerhoff

Thank you, Mike, and good afternoon. The third quarter of2007 concludes another important milestone for First Solar, as we essentiallyreached our next steady state quarter of full capacity utilization.

Revenues for the third quarter were $159 million, anincrease of $81.8 million over the second quarter of 2007, and an increase of$118.2 million compared to the same period of last year.

Gross margin for the third quarter was 51.6%, up from 36.7%in the second quarter of 2007, and up from 39.9% in the same period last year.Gross margin benefited from the rapid capacity ramp at our Frankfurt(Oder) plant, effectively eliminating the ramp costexperienced in the second quarter.

Gross margin also benefited from favorable pricing, due to acontinued strong Euro, higher module throughput, and an increased sellablewatts per module, driven by higher conversion efficiencies.

During the third quarter, the average Euro conversion ratereached $1.37 per Euro, compared to a three-year historical average ofapproximately $1.28. While the near-term weakness of the Euro, especially aftertoday, appears to be an unlikely scenario, we continue to evaluate ourperformance against our long-term model, which assumes a less favorable, morehistorical exchange rate environment.

The strong Euro contributed year-over-year 3.4 percentagepoints to our gross margin. In order to mitigate volatility around the Euro, wehave executed forward contracts between now and the end of 2008 that allow usto sell €133.6 million, at an average exchange rate of $1.44, hedgingapproximately 15% of our expected 2008 revenues.

As we get closer to production start at our Malaysianfactory, we intend to add further contracts to mitigate income state andvolatility.

Our cost-per-watt for the third quarter reached a new lowwith $1.15 per watt excluding stock-based compensation expenses. Ourcost-per-watt declined, due to higher throughput and module conversionefficiency, as well as realized economies of scale and lower depreciationexpenses at our German plant.

We expect to achieve an annual cost-per-watt decline of atleast 10% for 2007 over 2006, in line with our goal to achieve 40% to 50% costreduction by 2012. Operating expenses, excluding plant startup costs, were$30.9 million in the third quarter of 2007, up from $21 million in the secondquarter of 2007, and included $13.4 million of stock-based compensation, ofwhich $8.7 million are nonrecurring.

The remaining increase of $1.2 million related to increasedcompensation expense, as a result of further hiring. Operating expenses,excluding plant startup costs, were 19.5% of sales in the third quarter anddeclined from 27.3% in the second quarter, as we experienced significantoperating leverage due to the strong revenue growth that came with littleincremental fixed cos,t as most of this year's infrastructure build-out hadoccurred during the first half of 2007.

Plant startup costs increased by $1.3 million, sequentially,to $2.8 million during the third quarter, as we are nearing completion of theconstruction of our first Malaysian plant. Operating income for the thirdquarter was 30.4% ,or $48.3 million, compared to 7.5%, or $5.8 million, duringthe second quarter, and $5.1 million during the same period of 2006.

You may recall that our long-term financial model is guidedby a minimum return on net assets of 20%, which, as the currently expectedcapital to structure translates into an operating margin of 25%, and grossmargins of 35% to 40%.

An underlying assumption of this model is that we will bewilling to reduce our average sales price from current levels, whereappropriate, to expand markets and reduce subsidy dependence, provided we meetthe minimum 20% runoff threshold.

We believe this approach assures superior returns oninvested capital, while promoting price reductions to expand markets, and isimportant in transitioning the solar industry from a subsidy-dependent industryto a key component of the global electricity infrastructure.

During the third quarter, we significantly exceeded ourP&L target model, due to a strong Euro, a high mix of subsidized revenues,and continued cost reductions. As Mike mentioned, as we move into 2008, we willseek to open new markets that represent attractive tradeoffs between lowerprices and higher long-term volumes, coupled with less subsidy dependence.

In the future, as we create and expand these types ofmarkets, we continue to believe that First Solar's financial performance willbe best judged by our ability to achieve the minimum 20% runoff threshold,underlying our long-term financial model.

Interest income for the quarter was $5.3 million, reflectingan average pretax yield of 5.8%, and compared to $3.8 million in the secondquarter of 2007. The increase in interest income was driven by a higher averagecash and marketable security balance in the third quarter, due to the proceedsfrom our secondary offering completed in August.

During the third quarter, we recognized a one-time taxbenefit of $7.5 million, or $0.09 per share, due to the release of valuationallowances against certain foreign deferred tax assets. The tax rate for thethird quarter, excluding this one-time event, was 28%.

Net income for the third quarter of 2007 was $46 million, or$0.58 per share on a fully diluted basis, or $38.5 million, or $0.49 per shareon a fully diluted basis, excluding one-time events, and compared to $44.4million, or $0.58 per share on a fully diluted basis for the second quarter of2007, and a net income of $4.3 million for the third quarter of 2006.

Net income grew sequentially by $33.3 million, or $0.42 perfully diluted share, excluding the impact of the one-time tax benefit realizedduring both quarters. Cash on marketable securities increased $681.8 millionduring the third quarter.

Cash flow from operations during the third quarter of 2007was $80.9 million, due to higher cash-based earnings. We spent $74.1 million incapital expenditures during the third quarter, against depreciation of $6.6million.

Cash flow from financing activities was $354.9 million, dueto proceeds of $366 million from our secondary offering, and proceeds of $3.9million from the exercise of employee stock options. This was partially offsetby debt repayments of $28.3 million during the third quarter.

This brings me to our guidance for both 2007 and 2008. Forthe year 2007, we are increasing our revenue guidance to $480 million-$485million. We expect total production output for 2007 of approximately 200megawatts.

Plant startup costs for 2007 are expected at the lower rangeof our previous guidance of $18 million-$20 million, while stock-basedcompensation is expected at $39 million-$40 million, as a result of furtherstock price appreciation.

As a result of our 2007 operating margin is expected to be24%-25% of sales. With the release of our valuation allowances, the tax ratefor the fourth quarter is expected at 29%-30%, and the fully diluted year-endshare count is expected at approximately 82 million shares. CapEx for 2007 isexpected at $280 million above our previous guidance, due to the fastercapacity ramp.

For 2008, we expect 370-390 megawatts of production output,subject to the ramp schedule of our two Malaysian plants. We expect revenues of$760 million-$800 million subject to customer mix and foreign exchangefluctuations.

Revenue in the first half of 2008 is expected to declinesequentially over the fourth quarter of 2007 levels, due to our contractualprice decline, foreign exchange rate assumptions, and the anticipated timing ofincremental capacity contributions from our Malaysiaplants.

We expect plant startup costs of $28 million-$33 million, upfrom $18 million in 2007. Please be mindful that the startup of each plant hasa significant impact on both operating and gross margins before we reach fullcapacity, as seen during the first and second quarter of 2007.

We modeled stock-based compensation of $24 million-$25million with approximately 25% allocated to cost of book sold for 2008. GAAPoperating margin is expected between 23% and 27% and is subject to the timingof our plant starting up and ramping on time.

Our tax rate for 2008 is expected to be approximately 30%,and will not yet benefit from tax holidays, which will take effect in 2009.Year-end 2008 share count is projected at 84-84.5 million shares.

We expect to spend approximately $450 million in capitalexpenditures, reflecting a CapEx rate of approximately $1 per watt, or $165million per four-line plant.

This concludes our prepared remarks, and we open the callfor questions. Operator?

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question will come fromDavid Edwards, with Morgan Stanley with Morgan Stanley. Please go ahead.

David Edwards -Morgan Stanley

Good afternoon. Couple of questions, just on the wideradoption that you were talking about, in terms of moving the company beyondthat. Can you talk a little bit about whether the new contracts you've got arefocused on expanding in the new markets, and give some thought in terms of whatyou think the direction will be that you'll need to take in terms of ASPs, asyou move beyond the core markets of Germanyand Spain?

Mike Ahearn

Yeah, David. The contracts we announced are addressing theEuropean feed-in markets. They would not be oriented towards expansion marketsthat I was alluding to. I think the near-term market, for us, by way ofexpansion, would be the utility segment, if you will, in the US.

And I can't give you any specific ASP indication yet,because we're still working through the market analysis and holdingdiscussions. But I think it's pretty clear that to be competitive in terms of therenewable energy solution for utilities, the pricing perhaps will come downfrom where PV has historically been priced. So we are imagining some reduction.

David Edwards -Morgan Stanley

Alright, great. Thanks a lot.

Operator

And our next question will come from Steve O'Rourke withDeutsche Bank. Please go ahead, sir.

Steve O’Rourke -Deutsche Bank

Thank you. Good afternoon.

Mike Ahearn

Hi, Steve.

Steve O’Rourke -Deutsche Bank

How are you? The Babcock & Brown as a relationship herein these new contracts; what is their involvement? Is it project management andfinancing?

Mike Ahearn

I would refer to it as turnkey development, Steve. It'scomparable to our other customers in Europe so it wouldinclude siting, financing, developing, and overseeing the construction,O&M, the full range.

Steve O’Rourke -Deutsche Bank

Okay. When you think about that and new contracts going intoplace, and maybe your move toward the utilities here in the US, what are yourintentions--First Solar's intentions--towards selling energy longer-term,rather than simply selling modules?

Mike Ahearn

Well, broadly speaking, our intention is to take a businessmodel that will best penetrate the utility segment and drive attractiveeconomics and, historically, that's been through a PPA offering the utilitiesin the US.

And if you look at what wind has done, for example, it's notclear--it's not a foregone conclusion--that the PPA model is what will evolvein the US. It'sfrom our point of view, because there are issues pending in the current energybill that would have some impact on that, for example.

So, we're most likely going to have a business model that'sflexible and open to energy sales, either directly, or through partneringrelationships. I think we'll let the customer dialog flush that out.

Steve O’Rourke -Deutsche Bank

Fair enough. And the markets you would first look at thatin…

Mike Ahearn

…would be regulated utilities in the USthat are under RPS obligations, or quotas that have not been fulfilled at thispoint.

Steve O’Rourke -Deutsche Bank

Okay. And one last quick question; then I'll jump back inthe queue. What was conversion efficiency in the quarter?

Mike Ahearn

Average conversion efficiency was 10.5%.

Steve O’Rourke -Deutsche Bank

Thank you.

Operator

And our next question comes from Rob Stone, with Cowen &Company.

Rob Stone - Cowen& Company

Hi. I wonder if you could just shed a little more color onthe volume gains in the various factories. Did you achieve the same throughput?I didn't quite catch the annualized volume per line that you mentioned, Mike.

Jens Meyerhoff

That was 39.6 megawatts.

Mike Ahearn

Yes. 39.6 was the average, Rob, and that's a reasonable way.Now that we're steady state with seven lines, I think that's a reasonable wayto look at our production--going forward.

Rob Stone - Cowen& Company

Okay. Can you comment on the watts-per-module output…ifthere is higher efficiency now?

Mike Ahearn

Yes, the average watts-per-module is 70. There's adistribution range around that, but for the third quarter it was 71.

Rob Stone - Cowen& Company

Right, thank you.

Operator

We take our next question from Vishal Shah, with LehmanBrothers.

Vishal Shah - LehmanBrothers

Yeah. Hi, thanks for taking my question. Can you talk aboutyour flexibility to increase 2008 capacity. I believe, if I look at the currentplans, you are looking at about 440 megawatts of capacity by the end of 2008.What flexibility do you have to bring the Malaysian lines made up faster thanexpected?

Jens Meyerhoff

Well, I think, maybe I have to answer this question a littlemore broadly. So obviously our triggers to further expand capacity are the sameas we have experienced them here historically. So its increase inthroughput--unit throughput--plus increase in conversion efficiency, and thenit's the timing of the ramp.

So, if you look at the 2008 guidance we have given, we havemodeled the upper range of the guidance along successful bring up of ourFrankfurt/Oder plant.

Vishal Shah - LehmanBrothers

Okay. Fair enough. And would you assume, namely, capacitydecreases about 40 megawatts by the end of '08?

Jens Meyerhoff

I think what we've seen, historically, is that we've modeleda year-over-year throughput improvement of about 3%, which we exceeded in 2007.Obviously, and we've historically demonstrated 50 basis points off conversionefficiency gain, so if you applied those metrics, the answer would be, yes--itwould exceed that metric you mentioned.

Vishal Shah - LehmanBrothers

Okay, great, and then one other question on the USmarket. You said what percentage of the capacity would you allocate for newmarkets? Roughly speaking, would be 10%, or more than tha,t or less than that?

Jens Meyerhoff

Well, I think in the lower end of the guidance; I thinkyou're talking probably in the sub 10% range, and the higher end of productionoutput--the incremental capacity--would be allocated to those emerging markets.

Vishal Shah - LehmanBrothers

Great, thank you.

Operator

Our next question comes from Sanjay Shrestha, with Lazard.Please go ahead.

Sanjay Shrestha -Lazard

Great. First of all, congratulations on a great executionhere, guys. Just couple of quick questions. Kind of staying with the US market,and given the traction that you guys are getting here from your cost-reductionstandpoint efficiency gain, so is it going to be one of those where you kind ofwait for the investment tax credit to move forward before we really start tosee some sort of gain on long-term contract in place for you guys, or is itgoing to be one of those where, given your significant cost advantage than the potentialfor ASP to go down, are you going to say, maybe, like structured a contract fora year or two, and as we go forward, maybe we can evaluate that further…howshould we think about how this is going to unfold for you guys?

Mike Ahearn

Of course, there's a 30% investment tax credit in place now [federally]that sunsets the end of 2008. We think it's more likely than not that that willbe extended. If it were not extended, there's a permanent 10% IPC in the internalrevenue code. So, we're prepared to move forward under either of thosescenarios.

Sanjay Shrestha -Lazard

Great, great. And then, in terms of sort of thinking aboutthe large-scale power plant type application. Given that you guys are going to,naturally, have a much lower balance to system cost even it's going to be a larger-scaleapplication, how would you stack up, let's say fast forward another 12 months,versus the solar thermal, or even, let's say there was some traction with theconcentrated PV guys, or even versus the wind guys, when we started to thinkabout delivering electricity, to really address this RPS standards?

Mike Ahearn

Yeah, I think, the way to look at the economics is to lookat the value of the conventional electricity that's being replaced. So, wind ismostly replacing base-load solar. Both PV and solar thermal is mostly replacingeither peak, or shoulder peak, type load, which is more expensive electricity.So, you could get to the same sort of parity point at a higher ASP, or priceper kilowatt-hour with solar than you could for wind.

As compared to solar thermal, I think there are some prosand cons that PV has. Some of the pros it's proven, we have data, there arereal projects that have been done in Europe now withgood data and demonstrated economics, in our case. It's available to be deployedstarting in 2008.

It's modular and scalable, so we can achieve compellingeconomics with projects as small as 5 megawatts and up. CSP has to be muchlarger in order of scale. It's much less proven at this point, and we don'trequire any water.

So, we have some things going for us that way. In situationsyou might find load shifting or generation shifting capabilities with the CSPthat could make sense in a given situation, but on balance, I think, we competevery favorably and there's an immediate opportunity an immediate need on thepart of utilities to meet RPS quotas and so, we think we've put together apretty compelling solution.

Operator

Our next question comes from Adam Hinckley, with CIBC WorldMarkets.

Adam Hinckley - CIBCWorld Markets

Hey, guys, thanks for taking my question. First, just goingback to Rob's question earlier, did you comment on what the production was byfacility and also talk about cost for the margin by facility?

Jens Meyerhoff

Yes. So, I think on this one, I'll probably have to announcea little disappointment here. I think consistent with what we said earlier,since we're done with the ramp, until we ramp new plants, report our productioncapacity and output on a consolidated basis. So, we're probably not going to goto that level of detail any longer.

Adam Hinckley - CIBCWorld Markets

Okay, well then could you, maybe at least just comment onhow much lower cost is Germany,relative to Ohio? And then,possibly, what the expectations are for cost of Malaysia,relative to Germany?

Jens Meyerhoff

Yes. I think with respect to the German cost per watts, Icontinue to trend favorably over Perrysburg, I think historically, we saidabout $0.07. We've exceeded that, so the favorable FFO compared to Perrysburg,is about $0.10 of a cost advantage, due to the fact I mentioned.

We expect at least a $0.20 cost per watt decline in Malaysiawhen compared to Perrysburg, and obviously, that's been--or might as well amodel has been--in our model for a while. We will update that as we commenceproduction and reach full capacity at our first Malaysian plant.

Adam Hinckley - CIBCWorld Markets

Great. And if I could just sneak in one more--it looks likeoff of the improvement in the nameplate per line this quarter was very highlydriven off of throughput improvements, and the quarter-over-quarter throughputimprovement it was an excess of what you're saying your annual targets are.

Could you just give us a little color as to why thatthroughput improvement was so high and why we shouldn't expect that to continuegoing forward at that level?

Bruce Sohn

Yes. This is Bruce. The performance and the output per linewas up significantly to the 39 megawatts per line that both Mike and Jensmentioned earlier, and that's really a reflection of the continued refinementand elimination of various bottlenecks in the line, improvements ofproductivity throughout the factory, and so forth. Similarly, you will noticethat we are currently talking about the R&D coder at this stage as a resultof the work we've been able to do.

The R&D coder we’re able to use more effectively to workon our research and future scientific applications. And so, as a part of theline, we’re now reporting in aggregate as Jens reported. And consistently we’vealso continued to improve the efficiency steadily, over time. As Mikementioned, averaging at the 70 watts skews.

Adam Hinckley - CIBCWorld Markets

Thank you.

Operator

We'll go now to Michael Molnar, with Goldman Sachs.

Michael Molnar -Goldman Sachs

Just…most of my questions have been answered, but when wethink about the lines and the throughput gains, when you make gains, you areable to apply it, I guess, fairly quickly to the other lines; is that the waywe're supposed to think about it now? Each line will be 9.9 per quarter. Isthat the way to think about it?

Bruce Sohn

Yeah, the Copy Smart technology that we're using forreplicating the plants is also used to maintain consistency in lockstep betweenthe facilities as well. So we're able to leverage and speed improvements byidentifying them in one facility, validating them, and quickly rolling them outto the other lines. That's one of the significant advantages of the Copy Smarttechnology even after we've started up.

Michael Molnar -Goldman Sachs

Okay, great, and just one. I didn't catch the GAAP operatingmargin for 2008. Jens, could you just repeat that?

Jens Meyerhoff

Okay, the GAAP operating margin for 2008 was expectedbetween 23% and 27%.

Operator

Jesse Pichel, with Piper Jaffray.

Jesse Pichel - PiperJaffray

Yes, congratulations, as well. I have a few questions. WereASPs up 4.5% sequentially? Could you explain why that may be?

Jens Meyerhoff

I think the key driver here, Jesse, was a favorable Euroexchange rate quarter-over-quarter, and we had some slight customer miximplications.

Jesse Pichel - PiperJaffray

Okay, and just so that we're all clear on modeling. Weshould also model Malaysiaat 39.6?

Jens Meyerhoff

Yes, at this stage you can probably tell from our tone, weare a little bit departing from the nameplate concept and find the basiccapacity off the demonstrated run rate. So the answer would be yes.

Jesse Pichel - PiperJaffray

Okay, that's great, and could you talk about any kind ofscheduled plant shutdowns you have for maintenance or is maintenance ongoing incleaning the coders, for instance?

Bruce Sohn

We have a routine schedule for the coders as well as all ofthe pieces of equipment in the factory. There is a variety of scheduledmaintenance, and all of that's baked into the guidance numbers that Jensmentioned.

Jesse Pichel - PiperJaffray

So, really, we won't see a major impact in any oneparticular quarter from any kind of shutdown. Could you give us an update,Bruce, on what you guys are seeing in terms of efficiencies in the lab on thesame device structure on altered device structures, perhaps somewhat of anupdate to the data that you presented at NREL six months ago?

Bruce Sohn

Yes, we continued to do our research and, as you know,Jesse, we've historically had improvement rates of about a half a percentagepoint per year. We have a roadmap out in the future, and we continue to work onthat. As we do in one factory, as we prove them out in one facility, well, levelsout to the other factories as quickly as we can.

Operator

And we take our question now from Satya Kumar, with CreditSuisse.

Satya Kumar - CreditSuisse

Yeah, thanks for taking my questions. My question is onplant startup costs. I was actually modeling startup costs of $25 million-$30million for a 120 megawatt line. I see that you're producing close to about 180megawatts more. I just thought that you would have had a higher startup costnext year. Is there a change in the way I should think about startup costs?

Jens Meyerhoff

Well, I think, Satya, what you see in the guidance and theguidance for the startup cost is.,I think, fundamentally…the profile. I think thatwe have used in the past, really hasn't changed here. However, we do see, sincethere is compensation expense component in the plant startup costs, right aswe're bringing on the employees for each plant's. Given now that we're movingfrom Frankfurt/Oder to Malaysia,we do see some benefits due to the lower salaries there.

Satya Kumar - CreditSuisse

Okay, okay. So which quarter should I expect the firstcontribution from the Malaysia1 factory to come in?

Bruce Sohn

The factory is going to startup similar to the FFO operationlast year. So we saw first revenue out of FFO in Q2 of 2007. We expect to seefirst revenue from KLM 1, the first factory in Malaysia,in Q2 of next year, and to see the first fully ramped quarter in Q4 of '08.

Satya Kumar - CreditSuisse

On the fully ramped quarter--that was my other question--itseems like you've produced Frankfurt at full capacity inQ3. So why should I not expect that you could start up the Malaysian plants atthat one quarter cadence. Or should I expect the first Malaysian plants to havea slightly slower startup?

Jens Meyerhoff

I think, technically, I think while we are very pleased withthe output of Frankfurt/Oder in Q3, there was still an elemental brand builtinto July. I think one thing, what I think you see us with the productionguidance for 2008, we are bringing up now multiple plants in much faster atmuch faster replication speed, and we believe that possibly can increase as therisk of bringing up these factories and we tried to build that into ourguidance.

Satya Kumar - CreditSuisse

And when you do these multiple factories, I think, Bruce,you talked about seeing potentially some increased levels of risk with yoursuppliers. Can you elaborate a little bit on that? What kind of capacity doyour key equipment suppliers have and the material suppliers, like (inaudible)suppliers have, to support your accelerating capacity expansion?

Bruce Sohn

As Mike mentioned, there is obviously some added riskbringing up four facilities immediately following each other and on anaccelerated schedule that we haven't encountered previously. However, we dowork very closely with our equipment suppliers, and we work very closely withour material suppliers to ensure that they are ready as we bring up thesefactories and we announce them. We go through a rigorous process to ensuretheir readiness, and we feel like they're well positioned for the upcomingramps for the four factories.

Operator

(Operator Instructions) We will move now to Michael Carboywith Signal Hill. Please go ahead.

Michael Carboy -Signal Hill

Good afternoon, ladies and gentlemen. Two questions for you,and sort of a follow-on to the last one. Aside from availability issues of rawmaterials, can you comment on any concerns you may have with regard to thelogistics of delivery and provisioning of those materials of facilities at therates here you talked about?

And then, back to the earlier PPA issue. If, First Solar wereto actively engage in participating in the PPA, as principal in them, can youexplain to us how you plan on utilizing the passive tax losses and gains, giventhat you're an operating company? Thank you.

Mike Ahearn

Yes, Michael. This is Mike Ahearn. I think as far asconstraints with respect to factory expansion, we think we're managing thatpretty well and carefully. We don't see any obvious constraints with respect toequipment or material to support the plan rapid scale up. So I think we're wellpositioned in that respect.

On the PPA front, I think it's unlikely that we would be theowner of a project that's utilizing the federal tax incentive and accelerateddepreciation. I don't think we're likely to be able to utilize that from a taxbenefit point of view. We would use some other structure.

Michael Carboy -Signal Hill

I think it’s…you'd rely on a financing partner?

Mike Ahearn

Yes.

Michael Carboy -Signal Hill

Okay. Thanks.

Jens Meyerhoff

Yes, I think maybe to add real quick, Michael. Right,. So far,given the current regulations around--number one, there is an AMT hurdle thatyou would have to take as a company. But for us, more importantly, we do notexpect to be a cash taxpayer in the USfor the next four to five years given the deferred tax effect on our books.

Michael Carboy -Signal Hill

Thank you.

Operator

And now we take our questions from Dan Ries, with CollinsStewart.

Dan Ries - CollinsStewart

Hi. Most of them have been answered, but could you give anycolor on maybe your split of business in Germanyversus Spainduring the quarter?

Mike Ahearn

Dan, I don't have the quarterly number, but the annualtarget is somewhere around 75%, 80% for 2007, declining fairly significantly in2008.

Dan Ries - CollinsStewart

That's Germany?

Mike Ahearn

Yeah, declining, that's Germany--asa consequence of the existing customers that we've had on Board for some timenow, developing project pipelines outside of Germany,there's a lead time from the development of those to realization.  But as a result of the project pipelinescoming into fruition next year, you'll see a shift, to some extent, outside Germany,and then, of course, a lot of the newer customers we've added this year are notGerman-centric, or even necessarily participating in Germany.So, it will start to shift in 2008, more dramatically.

Dan Ries - CollinsStewart

Just a quick follow-up. 10.5 was the average efficiency forthe quarter--can you say if you are consistent with that now, or was itsomething--9.7 for the first month of the quarter, and then higher for the lasttwo months, or something like that?

Jens Meyerhoff

It's the average; it's the average, Dan, I think that'sprobably the extent of granularity we have there.

Dan Ries - CollinsStewart

Thanks very much.

Operator

We’ll take our next question from Eric Brown, with Banc ofAmerica.

Eric Brown - Banc of America

Hi. Now that you've announced all four facilities in Malaysia,you've kind of tapped out your land there, I think. Are you looking at newlocations in Malaysiaand elsewhere?

Mike Ahearn

We have a team, there is a replication team that's organizedaround the Copy Smart technology that Bruce mentioned, has an ongoing processfor site identification and analysis of various locations. So that's ongoing,and we've got potential sites in the queue.

Eric Brown - Banc of America

Do you think you can get the same tax holidays in these newlocations?

Mike Ahearn

I don't know. I mean you find these incentives come indifferent structures. I mean, if you look at what we got in Germanyit's also significant benefit that was structured differently it's hard to saywhere we would end up and exactly what we would get at this point.

Jens Meyerhoff

It certainly sets the stage for any negotiation.

Eric Brown - Banc of America

Okay. And then, Jens, I think you said that the tax holidaydoesn't kick in until 2009, is that right?

Jens Meyerhoff

Yes, that is correct, because as you bring up the plants,you have to sum up from running losses that we wanted to say again before we gointo the tax holiday.

Eric Brown - Banc of America

So what should we model for the Malaysian output after 2008?

Jens Meyerhoff

So, I think, as I mentioned before, is the long-term taxrate is subject to global cash availability. So we feel comfortable at thispoint in time that it could possibly middle in the mid-20s, long term.

Mathematically, that rate could be significantly lower,however, than you could deal with taxation on cash repatriation in our years.

Eric Brown - Banc of America

Okay. And then I think you said your '08 revenue wasdependent on the lower exchange rate than this year, is that right? Whatexchange rate are you assuming in that revenue forecast?

Jens Meyerhoff

$1.31.

Eric Brown - Banc of America

Okay. Thank you.

Operator

(Operator Instructions) We go now to Steve O'Rourke, withDeutsche Bank for follow-up.

Steve O'Rourke -Deutsche Bank

Thank you. A few questions here, can you tell us what thesplit of ground mount versus building mount systems will be in 2007, and how doyou think that will change in '08?

Mike Ahearn

It's typically 60% ground mount, 40% roof mount, Steve, andthat's for the year. That's in the ballpark. How it will change in '08, I thinksomewhat as a function of our allocation of modules into existing versus newmarkets. And, of course, if they come into the USutility market, that will be predominantly ground mount. So I would say if itmoves, it will move more toward ground mounted.

Steve O'Rourke -Deutsche Bank

Okay. And for the 20% or so of systems in the field that youdirectly monitor, what's the average annual percent degradation in energyoutput that you're seeing?

Mike Ahearn

Well, the standard power warranty implies 0.8% annually, butwhat we're seeing is actually somewhat better than that. It's probably closerto 0.5.

Operator

We’ll turn now to David Edwards, with Morgan Stanley.

David Edwards -Morgan Stanley

Hey, just one quick follow-up--the depreciation benefit thatyou showed in the quarter, is that a one-time item, or is that something thatcarries forward?

Jens Meyerhoff

No, actually, the depreciation benefit I mentioned is reallyright embedded in the financing of the Frankfurt/Oder plant in Germany.As you may recall, we did get some subsidies there on to support the plantinvestments.

Essentially, one-third was paid by the German government, soit's lower fixed asset base there that translates approximately into $8 millionof annual depreciation savings.

David Edwards -Morgan Stanley

Okay. So that's a Germany-only item at this point?

Jens Meyerhoff

Yes, that is correct.

Eric Brown - Banc of America

Okay. Thanks.

Operator

And we take our next question from Jesse Pichel. Please goahead, sir.

Jesse Pichel - PiperJaffray

Yes. I'm wondering about what you would think about analystsmodeling additional lines above and beyond your announcement, your planned capacityexpansion at this point. Can you comment?

Are you getting a lot of inbound calls there from othermarkets, potentially in Asia, asking you to put up newlines? Is there a pipeline of additional customers that are unmet by yourcurrent production?

Jens Meyerhoff

Well, I think you laid out the answer here I would  give to that. I mean, we have announced rightnow the build out of Malaysia, right, and the timing and our build out offurther capacity, right, we will be subject our evaluation of demand in themarket.

Jesse Pichel - PiperJaffray

Do you have unmet demand at this point?

Bruce Sohn

Yeah, Jesse, the way we look at this is around visibledemand over a time period that would repay investment in incremental capacityexpansions. So, if we said, today, in the short-term there is unmet demand--that'sreally not a justification in our minds to build additional productioncapacity.

And so we create expansion windows--or investment windowswhere we would consider expanding--and as we come up to those windows, we lookat the question of whether there is multiple years of visible demand to takethe production from that plant, and that's the basis for a go-forward decision.

So we don't really have to address it now, and we have ourhands full today, literally. But there will be another expansion window, orinvestment window, coming up in the future, and so the goal is to have thedemand secure to make an affirmative decision, and that's basically how weproceed.

Jesse Pichel - PiperJaffray

Thank you very much.

Operator

At this time, that would conclude our question-and-answersession. We would like to thank everyone for your participation on today'sconference, and you may disconnect at this time.

Jens Meyerhoff

Thank you very much.

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Source: First Solar Q3 2007 Earnings Call Transcript

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