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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

First Solar, Inc. (FSLR) Q3 2007 Earnings Call November 7, 2007 4:30 PM ET

Operator

Good day, everyone, and welcome to the First Solar Third Quarter 2007 Conference Call. Today's call is being webcast live on the Investor section of First Solar's website at www.firstsolar.com. At this time all participants are in a listen-only mode. As a reminder, today's call is being 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 for First Solar's third quarter 2007 conference call. Shortly after market close today, the company issued a press release announcing its third quarter 2007 financial results.

If you did not receive a copy of the press release, you can obtain one from the investor section of First Solar's website at www.firstsolar.com. You may listen to an audio replay of this conference call by 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 replay will remain available until November 12th at 11:59, Eastern time. Also, a webcast replay will be available in approximately two hours, in the investor section of the company's website, and if you are a subscriber of FactSet, you can obtain a transcript within two hours.

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

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

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

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

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

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

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

Mike Ahearn

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

We more than doubled our revenues sequentially over the second quarter to $159 million, posted net income of $38.5 million before giving effect to the release of valuation allowances against certain foreign deferred tax assets--which brought our total GAAP net income to $46 million--and reduced our manufacturing costs to $1.19 per watt, which included $0.04 per watt of stock-based compensation expense.

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

During the third quarter, we more than doubled production sequentially over the second quarter to 69.4 megawatts, with the increase resulting from the operation of all seven of our production lines at full capacity for substantially the entire quarter, and also from improvements in module production throughput and conversion efficiencies. The third quarter production 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 our progress, it's important to note that these improvements are events rather than time-driven. They do not establish a linear trend, and future improvements will become increasingly more difficult to achieve.

Since our last call, we announced our intention to construct two additional factories in Malaysia consisting of four lines each, bringing our total announced Malaysia manufacturing center to four factories and 16 production lines, with a total annual production capacity of slightly over 600 megawatts, based on our third quarter run rate.

Construction of our first factory in Malaysia is proceeding according to schedule, and we expect initial equipment delivery this quarter. We started site preparations for our second and third Malaysia factories in August and October, respectively, and expect to start site preparation for the fourth factory by the end of the fourth quarter.

We expect to be at full capacity with all four factories by the end of 2009, which will bring our total announced company-wide annual production capacity to approximately 900 megawatts based on our third quarter run rate.

Our announced factory expansions in Malaysia imply an accelerated timeline for breaking ground and constructing new factories, as compared to our historic pace of construction, while we believe the accelerated pace is appropriate to meet market demand and within our capability, it does represent a new challenge to First Solar and our suppliers, and carries some additional execution risk that we had not previously encountered.

Turning to the market, demand for our products remained robust during the third quarter, and we continue to experience market demand in excess 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 has sold 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 that we believe is sufficient to enable our customers to develop robust demand pipeline for large ground and roof-mounted solar systems, and we've reduced the price of approximately 6.5% per year, year-over-year, through 2012.

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

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

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

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

I should also mention that we were scheduled to begin shipments to SunEdison in October under a 25-megawatt contract to support projects in Ontario, Canada. Because of implementation delays in the Ontario feed-in program, First Solar and SunEdison jointly agreed to cancel the existing agreement and revisit a supply agreement, when the Ontario market is operational. In the meantime, we've re-allocated these modules to other customers.

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

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

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

Most importantly, these long-term agreements and customer relationships are enabling us to scale our business and thereby reduce costs and to validate the performance and economics of large-scale solar electricity in preparation for wider market adoption.

First Solar is currently pursuing revenue growth on two fronts. First, we believe additional growth remains in markets supported by feed-in tariff incentive structures, including countries in Europe as well as South Korea and Ontario, Canada.

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

We do not believe that the subsidy programs currently fueling the PV industry will sustain market growth rates and profit margins at current levels over the long term, but rather, are intended to support initial production in market scale leading to lower prices for solar electricity and reduced subsidy dependence.

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

We believe these efforts will continue to result in a financially attractive business model with a reduced subsidy risk profile and facilitate 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 are developing plans for entering the US utility market, but we believe low-cost PV represents an attractive solution for regulated utilities seeking to meet RPS quotas. Although we're not prepared to make any announcements today, we do expect to realize revenues from this evolving market beginning in 2008, in line with our previous communications.

In conclusion, we are pleased with our progress during the third quarter and the strong contributions made by the entire First Solar team that have enabled us to remain on plan to reaching our midterm goal of reducing solar electricity prices to levels competitive with retail conventional electricity.

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

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

And, with that, I would like to turn this discussion over to Jens 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 of 2007 concludes another important milestone for First Solar, as we essentially reached our next steady state quarter of full capacity utilization.

Revenues for the third quarter were $159 million, an increase 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 cost experienced in the second quarter.

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

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

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

As we get closer to production start at our Malaysian factory, we intend to add further contracts to mitigate income state and volatility.

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

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

The remaining increase of $1.2 million related to increased compensation expense, as a result of further hiring. Operating expenses, excluding plant startup costs, were 19.5% of sales in the third quarter and declined from 27.3% in the second quarter, as we experienced significant operating leverage due to the strong revenue growth that came with little incremental fixed cos,t as most of this year's infrastructure build-out had occurred 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 the construction of our first Malaysian plant. Operating income for the third quarter was 30.4% ,or $48.3 million, compared to 7.5%, or $5.8 million, during the second quarter, and $5.1 million during the same period of 2006.

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

An underlying assumption of this model is that we will be willing to reduce our average sales price from current levels, where appropriate, to expand markets and reduce subsidy dependence, provided we meet the minimum 20% runoff threshold.

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

During the third quarter, we significantly exceeded our P&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 will seek to open new markets that represent attractive tradeoffs between lower prices and higher long-term volumes, coupled with less subsidy dependence.

In the future, as we create and expand these types of markets, we continue to believe that First Solar's financial performance will be 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, reflecting an average pretax yield of 5.8%, and compared to $3.8 million in the second quarter of 2007. The increase in interest income was driven by a higher average cash and marketable security balance in the third quarter, due to the proceeds from our secondary offering completed in August.

During the third quarter, we recognized a one-time tax benefit of $7.5 million, or $0.09 per share, due to the release of valuation allowances against certain foreign deferred tax assets. The tax rate for the third 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 share on a fully diluted basis, excluding one-time events, and compared to $44.4 million, or $0.58 per share on a fully diluted basis for the second quarter of 2007, 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 per fully diluted share, excluding the impact of the one-time tax benefit realized during both quarters. Cash on marketable securities increased $681.8 million during the third quarter.

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

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

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

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

As a result of our 2007 operating margin is expected to be 24%-25% of sales. With the release of our valuation allowances, the tax rate for the fourth quarter is expected at 29%-30%, and the fully diluted year-end share count is expected at approximately 82 million shares. CapEx for 2007 is expected at $280 million above our previous guidance, due to the faster capacity 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 exchange fluctuations.

Revenue in the first half of 2008 is expected to decline sequentially over the fourth quarter of 2007 levels, due to our contractual price decline, foreign exchange rate assumptions, and the anticipated timing of incremental capacity contributions from our Malaysia plants.

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

We modeled stock-based compensation of $24 million-$25 million with approximately 25% allocated to cost of book sold for 2008. GAAP operating margin is expected between 23% and 27% and is subject to the timing of 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 capital expenditures, reflecting a CapEx rate of approximately $1 per watt, or $165 million per four-line plant.

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

Question-and-Answer Session

Operator

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

David Edwards - Morgan Stanley

Good afternoon. Couple of questions, just on the wider adoption that you were talking about, in terms of moving the company beyond that. Can you talk a little bit about whether the new contracts you've got are focused on expanding in the new markets, and give some thought in terms of what you think the direction will be that you'll need to take in terms of ASPs, as you move beyond the core markets of Germany and Spain?

Mike Ahearn

Yeah, David. The contracts we announced are addressing the European feed-in markets. They would not be oriented towards expansion markets that I was alluding to. I think the near-term market, for us, by way of expansion, 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 holding discussions. But I think it's pretty clear that to be competitive in terms of the renewable energy solution for utilities, the pricing perhaps will come down from 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 with Deutsche 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 here in these new contracts; what is their involvement? Is it project management and financing?

Mike Ahearn

I would refer to it as turnkey development, Steve. It's comparable to our other customers in Europe so it would include 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 into place, and maybe your move toward the utilities here in the US, what are your intentions--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 business model that will best penetrate the utility segment and drive attractive economics and, historically, that's been through a PPA offering the utilities in the US.

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

So, we're most likely going to have a business model that's flexible and open to energy sales, either directly, or through partnering relationships. 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 that in…

Mike Ahearn

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

Steve O’Rourke - Deutsche Bank

Okay. And one last quick question; then I'll jump back in the 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 on the 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 way to look at our production--going forward.

Rob Stone - Cowen & Company

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

Mike Ahearn

Yes, the average watts-per-module is 70. There's a distribution 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 Lehman Brothers.

Vishal Shah - Lehman Brothers

Yeah. Hi, thanks for taking my question. Can you talk about your flexibility to increase 2008 capacity. I believe, if I look at the current plans, 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 than expected?

Jens Meyerhoff

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

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

Vishal Shah - Lehman Brothers

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

Jens Meyerhoff

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

Vishal Shah - Lehman Brothers

Okay, great, and then one other question on the US market. You said what percentage of the capacity would you allocate for new markets? 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 think you're talking probably in the sub 10% range, and the higher end of production output--the incremental capacity--would be allocated to those emerging markets.

Vishal Shah - Lehman Brothers

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 execution here, 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-reduction standpoint efficiency gain, so is it going to be one of those where you kind of wait for the investment tax credit to move forward before we really start to see some sort of gain on long-term contract in place for you guys, or is it going to be one of those where, given your significant cost advantage than the potential for ASP to go down, are you going to say, maybe, like structured a contract for a year or two, and as we go forward, maybe we can evaluate that further…how should 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 will be extended. If it were not extended, there's a permanent 10% IPC in the internal revenue code. So, we're prepared to move forward under either of those scenarios.

Sanjay Shrestha - Lazard

Great, great. And then, in terms of sort of thinking about the 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-scale application, 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 the concentrated PV guys, or even versus the wind guys, when we started to think about delivering electricity, to really address this RPS standards?

Mike Ahearn

Yeah, I think, the way to look at the economics is to look at the value of the conventional electricity that's being replaced. So, wind is mostly replacing base-load solar. Both PV and solar thermal is mostly replacing either 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 price per kilowatt-hour with solar than you could for wind.

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

It's modular and scalable, so we can achieve compelling economics with projects as small as 5 megawatts and up. CSP has to be much larger in order of scale. It's much less proven at this point, and we don't require any water.

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

Operator

Our next question comes from Adam Hinckley, with CIBC World Markets.

Adam Hinckley - CIBC World Markets

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

Jens Meyerhoff

Yes. So, I think on this one, I'll probably have to announce a 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 production capacity and output on a consolidated basis. So, we're probably not going to go to that level of detail any longer.

Adam Hinckley - CIBC World Markets

Okay, well then could you, maybe at least just comment on how 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, I continue to trend favorably over Perrysburg, I think historically, we said about $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 Malaysia when compared to Perrysburg, and obviously, that's been--or might as well a model has been--in our model for a while. We will update that as we commence production and reach full capacity at our first Malaysian plant.

Adam Hinckley - CIBC World Markets

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

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

Bruce Sohn

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

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

Adam Hinckley - CIBC World 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 we think about the lines and the throughput gains, when you make gains, you are able to apply it, I guess, fairly quickly to the other lines; is that the way we're supposed to think about it now? Each line will be 9.9 per quarter. Is that the way to think about it?

Bruce Sohn

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

Michael Molnar - Goldman Sachs

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

Jens Meyerhoff

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

Operator

Jesse Pichel, with Piper Jaffray.

Jesse Pichel - Piper Jaffray

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

Jens Meyerhoff

I think the key driver here, Jesse, was a favorable Euro exchange rate quarter-over-quarter, and we had some slight customer mix implications.

Jesse Pichel - Piper Jaffray

Okay, and just so that we're all clear on modeling. We should also model Malaysia at 39.6?

Jens Meyerhoff

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

Jesse Pichel - Piper Jaffray

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

Bruce Sohn

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

Jesse Pichel - Piper Jaffray

So, really, we won't see a major impact in any one particular 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 the same device structure on altered device structures, perhaps somewhat of an update 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 percentage point per year. We have a roadmap out in the future, and we continue to work on that. As we do in one factory, as we prove them out in one facility, well, levels out to the other factories as quickly as we can.

Operator

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

Satya Kumar - Credit Suisse

Yeah, thanks for taking my questions. My question is on plant startup costs. I was actually modeling startup costs of $25 million-$30 million for a 120 megawatt line. I see that you're producing close to about 180 megawatts more. I just thought that you would have had a higher startup cost next 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 the guidance for the startup cost is.,I think, fundamentally…the profile. I think that we have used in the past, really hasn't changed here. However, we do see, since there is compensation expense component in the plant startup costs, right as we're bringing on the employees for each plant's. Given now that we're moving from Frankfurt/Oder to Malaysia, we do see some benefits due to the lower salaries there.

Satya Kumar - Credit Suisse

Okay, okay. So which quarter should I expect the first contribution from the Malaysia 1 factory to come in?

Bruce Sohn

The factory is going to startup similar to the FFO operation last year. So we saw first revenue out of FFO in Q2 of 2007. We expect to see first 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 - Credit Suisse

On the fully ramped quarter--that was my other question--it seems like you've produced Frankfurt at full capacity in Q3. So why should I not expect that you could start up the Malaysian plants at that one quarter cadence. Or should I expect the first Malaysian plants to have a slightly slower startup?

Jens Meyerhoff

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

Satya Kumar - Credit Suisse

And when you do these multiple factories, I think, Bruce, you talked about seeing potentially some increased levels of risk with your suppliers. Can you elaborate a little bit on that? What kind of capacity do your 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 risk bringing up four facilities immediately following each other and on an accelerated schedule that we haven't encountered previously. However, we do work very closely with our equipment suppliers, and we work very closely with our material suppliers to ensure that they are ready as we bring up these factories and we announce them. We go through a rigorous process to ensure their readiness, and we feel like they're well positioned for the upcoming ramps for the four factories.

Operator

(Operator Instructions) We will move now to Michael Carboy with 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 raw materials, can you comment on any concerns you may have with regard to the logistics of delivery and provisioning of those materials of facilities at the rates here you talked about?

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

Mike Ahearn

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

On the PPA front, I think it's unlikely that we would be the owner of a project that's utilizing the federal tax incentive and accelerated depreciation. I don't think we're likely to be able to utilize that from a tax benefit 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 that you would have to take as a company. But for us, more importantly, we do not expect to be a cash taxpayer in the US for 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 Collins Stewart.

Dan Ries - Collins Stewart

Hi. Most of them have been answered, but could you give any color on maybe your split of business in Germany versus Spain during the quarter?

Mike Ahearn

Dan, I don't have the quarterly number, but the annual target is somewhere around 75%, 80% for 2007, declining fairly significantly in 2008.

Dan Ries - Collins Stewart

That's Germany?

Mike Ahearn

Yeah, declining, that's Germany--as a consequence of the existing customers that we've had on Board for some time now, 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 pipelines coming 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 not German-centric, or even necessarily participating in Germany. So, it will start to shift in 2008, more dramatically.

Dan Ries - Collins Stewart

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

Jens Meyerhoff

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

Dan Ries - Collins Stewart

Thanks very much.

Operator

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

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 new locations in Malaysia and elsewhere?

Mike Ahearn

We have a team, there is a replication team that's organized around the Copy Smart technology that Bruce mentioned, has an ongoing process for 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 new locations?

Mike Ahearn

I don't know. I mean you find these incentives come in different structures. I mean, if you look at what we got in Germany it's also significant benefit that was structured differently it's hard to say where 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 holiday doesn'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 go into 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 tax rate is subject to global cash availability. So we feel comfortable at this point 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 was dependent on the lower exchange rate than this year, is that right? What exchange 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, with Deutsche Bank for follow-up.

Steve O'Rourke - Deutsche Bank

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

Mike Ahearn

It's typically 60% ground mount, 40% roof mount, Steve, and that's for the year. That's in the ballpark. How it will change in '08, I think somewhat as a function of our allocation of modules into existing versus new markets. And, of course, if they come into the US utility market, that will be predominantly ground mount. So I would say if it moves, 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 you directly monitor, what's the average annual percent degradation in energy output that you're seeing?

Mike Ahearn

Well, the standard power warranty implies 0.8% annually, but what we're seeing is actually somewhat better than that. It's probably closer to 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 that you showed in the quarter, is that a one-time item, or is that something that carries forward?

Jens Meyerhoff

No, actually, the depreciation benefit I mentioned is really right 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 plant investments.

Essentially, one-third was paid by the German government, so it's lower fixed asset base there that translates approximately into $8 million of 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 go ahead, sir.

Jesse Pichel - Piper Jaffray

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

Are you getting a lot of inbound calls there from other markets, potentially in Asia, asking you to put up new lines? Is there a pipeline of additional customers that are unmet by your current production?

Jens Meyerhoff

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

Jesse Pichel - Piper Jaffray

Do you have unmet demand at this point?

Bruce Sohn

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

And so we create expansion windows--or investment windows where we would consider expanding--and as we come up to those windows, we look at the question of whether there is multiple years of visible demand to take the 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 our hands full today, literally. But there will be another expansion window, or investment window, coming up in the future, and so the goal is to have the demand secure to make an affirmative decision, and that's basically how we proceed.

Jesse Pichel - Piper Jaffray

Thank you very much.

Operator

At this time, that would conclude our question-and-answer session. We would like to thank everyone for your participation on today's conference, 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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