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First Solar, Inc. (NASDAQ:FSLR)

Q1 FY08 Earnings Call

April 30, 2008, 5:00 PM ET

Executives

Larry Polizzotto - VP - IR

Mike Ahearn - CEO

Jens Meyerhoff - CFO

Bruce Sohn - President

Analysts

Vishal Shah - Lehman Brothers

Stephen Chin - UBS Securities

Robert W. Stone - Cowen and Company

Jesse Pichel - Piper Jaffray

Jonathan Dorsheimer - Canaccord Adams

Mark W. Bachman - Pacific Crest Securities

Al Kaschalk - Wedbush Morgan Securities

Satya Kumar - Credit Suisse

Daniel Ries - Collins Stewart LLC

Michael Molnar - Goldman, Sachs & Co.

Mehdi Hosseini - FBR Capital Markets

Jonathan Hoopes - Thinkequity Partners

Operator

Good day everyone and welcome to the First Solar First Quarter 2008 Earnings Conference Call. This 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 will now like to turn the call over Mr. Larry Polizzotto, Vice President, Investor Relations for First Solar Incorporated. Mr. Polizzotto, you may begin.

Larry Polizzotto - Vice President - Investor Relations

Thank you. Good morning everyone and thank you for joining us for First Solar's first quarter 2008 conference call. This morning the company issued a press release announcing its first quarter 2008 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 also may listen to an audio replay of this conference call by dialing 888-266-2081, if you are within the United States or 703-925-2533, if you are not within the United States and also enter reservation number 1227426. The audio replay will remain available until May 5, 2008 at 11.59 PM Eastern Daylight Time. Also, a webcast will be available in approximately two hours on the Investor section of the company's website. And if you are subscriber of FACTSET you can obtain a written script within 2 hours.

With me today are Mike Ahearn, Chief Executive Officer; Jens Meyerhoff, Chief Financial Officer, and Bruce Sohn, President of First Solar. Mike will begin with an overview of the company’s achievements and progress during the first quarter. Jens will provide you with the first quarter 2008 financial results and update to financial guidance for 2008. We will then open up the call for questions. All financial numbers reported and discussed on today's call 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 all participants limit themselves to one question and then 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 may involve a number of risks and uncertainties. We 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 our changes in government subsidies, changes in government laws or regulations regarding the sale or use or disposition of solar modules, the demand for solar modules, the cost of capital available to our customers and end product users, the fuel performance and reliability of our products, the company's ability to successfully replicate production at Malaysian plants, the availability of raw materials and the company's relationship with its customers and key suppliers. Additional information concerning factors that could cause actual events or results to differ materially from those in any forward-looking statement is contained in the company's filings with the Securities and Exchange Commission and in such Safe Harbor language of the earnings 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 results could 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 the second calendar quarter of 2008, the company will be speaking at three conferences. First, Goldman Sachs Third Annual Alternate Energy Conference in New York, New York on Monday, May the 5th 2008. Second, JPMorgan's 36th Annual Technology Conference in Boston, on May the 20th 2008 and lastly, MainFirst Bank AG's Solar Conference during the Inter Solar Trade Fair 2008 in Munich, on June 12, 2008. It's now my pleasure to introduce Mike Ahearn, CEO of First Solar. Mike?

Mike Ahearn - Chief Executive Officer

Thank you, Larry and thank you for participating in today's first quarter 2008 earnings call. During the first quarter of 2008, we’ve remained focused on the qualification and ramp of our first plant in Malaysia while continuing to leverage our cost leadership position toward developing new market opportunities for large-scale PV system deployments.

First quarter production was 79.4 megawatts, representing an annual line capacity of approximately 45 megawatts per line, a 3% increase over the fourth quarter which resulted from continuous throughput improvements on our production lines. Conversion efficiency was flat at an average of 10.6% for the quarter. Cost per watt was a $1.14, which included $0.02 of stock-based compensation expense, revenue for the first quarter were $196.9 million which provided us with a GAAP net income of $46.6 million or $0.57 a share.

The construction of our Malaysian manufacturing center is progressing well, Plant I construction has been completed, we started producing modules and expect to ship them later during the second quarter upon completion of our long-term product qualification processes. We anticipate being in full production in the third quarter of 2008, the initial results of our production lines are favorable, as compared to our experience at the Frankfurt Oder plant during its ramp which is allowing us to increase production estimates for 2008.

Jens will cover our revised guidance later in the call. Malaysia plants II, III and IV are in different stages of construction and are progressing in line with our previously announced capacity expansion plan.

Turning to the market, demand for our products remained robust during the quarter and we continued to experience market demand and excessive supply. We sold 79 megawatts of modules at an average sales price of $2.45 per watt. As mentioned on prior calls, First Solar is pursuing revenue growth on two fronts.

First, we believe additional growth remains in markets supported by feed-in tariff intensive structures. In the first quarter, we increased our contracted volume of EDFEM and also added a new contract with AES Solar Energy Limited, which is a joint venture between AES Corporation and River Stone Holding LLC.

Those volumes under the AES contract would be shipped between 2008 and 2010. These new contracts bring our total volume to be shipped under long term contract to 3.4 gigawatts or $6.4 billion in an exchange rate of $1.30 per Euro. As discussed previously First Solar is also seeking opportunities to open new markets with limited or no dependence on traditional PV subsidies. Our core focus in this regard is the U.S. utility market, where we believe low-cost PV represents an attractive solution for regulated utilities seeking to meet renewable portfolio standard quotas.

As I stated on our last conference call, our objectives in 2008 are to secure several pilot projects that will enable us to validate the cost and performance of our large scale systems before a broader rollout and to secure initial working relationships with one or more U.S. utilities. Our assumption which we continue to test through discussions with selected utilities is that demand for utility scale solar power exists in the Southwestern U.S. at solar electricity prices in the range of $0.12 to $0.15 per kilowatt hour.

We're continuing to make good progress towards our objectives of securing these pilot projects and initial relationships, an example is this 7.5 mega watt AC ground bound pilot project with Southern California Edison in Blake California that is currently under review by the California Public Utility Commission. This project has an option for future expansion up to 21 megawatt AC and assuming CPUC approval would be First Solar's first TPA based turnkey system. Since we're still in various stages of securing the initial projects which ranges from discussions and negotiations to securing regulatory approval. We believe it's premature to comment publicly on any of the specifics at this time.

In conclusion, we continue to see strong execution by our operations team, we're making solid progress in Malaysia, market demand for our products remain strong, our long term contracts provide embedded revenue growth over the next several years. And our initial entry into the U.S. utility segment is proceeding on plan.

With that I would like to turn the discussion to Jens Meyerhoff, our CFO who will discuss our first quarter 2008 financial results and provide an update to our guidance 2008

Jens Meyerhoff - Chief Financial Officer

Thank you, Mike. And good morning. Net sales for the first quarter of 2008 were $196.9 million, a decline of $3.9 million over the fourth quarter of 2007 and an increase of $130 million compared to the same period of 2007. The decline in net sales was driven by the annual contractual price decline of approximately 6.5% underlying our long-term contracts and by customer mix impacting net sales and pre-tax income by $15.7 million. This decline was largely offset by an increase on watt sold totaling $8.4 million and a further strengthening euro which contributed $4.1 million to our net sales during the first quarter.

Gross margin for the first quarter was 53%, down from 55.3% in the fourth quarter of 2007 and up from 44.9% in the same period of 2007. Gross margin was impacted by 4.1 percentage points due to the quarter-over-quarter price decline partially offset by foreign exchange benefits and higher overhead absorption due to incremental product shipments at a variable margin in excess of 70%. Please remember that our gross margin will decline in the second quarter due to the ramp of our first Malaysian plant, as all previously recorded start-up expense were reclassified to cost of goods sold in the second quarter.

In order to further reduce volatility around our euro exposure. We maintained a 37% hedge of our expected 2008 euro revenues and an exchange rate of $1.45 per euro. Given the natural hedge at our Frankfurt Oder facility, approximately 53% of our expected 2008 earnings are hedged at this point. Our cost per watt for the first quarter averaged $1.14 including $0.02 of stock-based compensation and was negatively impacted by $0.03 of foreign exchange rates quarter-over-quarter.

Please note that our cost per watt will increase in the second quarter due to the ongoing ramp at our first Malaysian plant and the corresponding lower overhead absorption during that time. Operating expenses excluding plant start-up costs were $33.4 million in the first quarter of 2008, up from $28.6 million in the fourth quarter. The increase of $4.8 million is primarily due to increased compensation expenses as a result of the acquisition of Turner Renewable Energy in December of 2007, further hiring and higher payroll taxes driven by option exercises during the quarter.

Operating expenses excluding plant start-up cost were 17% of net sales in the first quarter, up from 14.3% in the prior quarter due to the decline in net sales and the increase in spending. Plant start-up costs increased by $8.7 million sequentially to $12.8 million in the first quarter, as we completed a substantial part of the hiring at our first Malaysian plant and commenced depreciation of the equipment. Start-up expenses will decline sequentially in the second quarter of 2008 and then increase again in the third and fourth quarter due to the pending start-up of plants II, II and IV at our Malaysian manufacturing centre.

Operating income for the first quarter was 29.5% of net sales or $58.1 million, compared to 39% or $78.3 million during the fourth quarter and $4.8 million during the same period of 2007. The sequential decline was driven by our contractual price decline, higher plant start-up cost and operating expenses, partially offset by higher production volumes and foreign exchange benefits.

First quarter 2008 operating income, included $10.9 million of stock-based compensation. Interest income for the quarter was $6.7 million reflecting an average pre-tax yield of 4%, compared to $7.2 million in the first quarter of 2007. The decline in interest income was driven by lower interest rate and an average portfolio maturity of less than 90 days. Net income for the first quarter of 2008 was $46.6 million or $0.57 per share on a fully diluted basis, compared to $62.9 million or $0.77 per share on a fully diluted basis on the first quarter. Our tax rate for the first quarter of 2008 was 28.5%.

Cash and all other marketable securities increased slightly to $709 million from the first quarter, cash flow from operations during the first quarter of 2008 was $63.2 million. We spent $101.1 million in capital expenditures during the quarter against depreciation of $10.1 million. Cash flow from financing activities was $20.2 million due to proceeds of $35.7 million from government grant payments in Germany and the exercise of employee stock options partially offset by debt repayments.

This brings me to our updated guidance for 2008. For 2008, we expect to sell 420 megawatts to 460 megawatts based on our demonstrated first quarter run-rate, an upside in the second half of 2008 from the ramp up of our Malaysian factories. We expect revenues of $975 million to $1.50 billion subject to customer mix and foreign exchange fluctuations.

Revenues in the second quarter of 2008 are expected to grow modestly over the first quarter 59% to 60% of the annual net sales are expected to occur in the second half of 2008. We expect plant start-up cost to increase to $36 million to $39 million due to a possible pull-in of $8 million in plant start-up cost for plants III and IV of Malaysia that were previously planned for in 2009.

We have increased our estimate for stock-based compensation to $50 million to $52 million with approximately 20% allocated to cost of goods sold due to changes in the calculation parameters such as stock price volatility, forfeiture rates, investing schemes and further expansion of workforce.

GAAP operating margin is expected between 25% and 30% 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 28% to 30% and would not yet benefit from tax holidays taking effect in 2009.

Year-end 2008 fully diluted share count remains unchanged at an estimated 83 million to 84 million shares. CapEx for the year remains unchanged at approximately $500 million and is based on the currently announced capacity expansions through plant IV of our Malaysian manufacturing center and infrastructure related investment.

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

Question And Answer

Operator

[Operator Instructions]. Our first question comes from Mark Heller.

Mark Heller – Merrill Lynch

Thanks good morning, I was wondering if you could discuss your raw material supply in terms of glass and tellurium, do you see any constraints in that market and are you seeing any martial price changes?

Mike Ahearn - Chief Executive Officer

Bruce... let me direct it over to Bruce Sohn.

Bruce Sohn - President

Yes, on the tellurium front, we are not seeing any supply issues for tellurium, we have got a couple of sources and we locked out long term contracts for our raw materials and that's helped us maintain the supply as well as the price. On the glass front we also have good relationships with our suppliers for glass and aren't currently seeing any issues for that as well, as we contract… as we make decisions for our plants we always review the capability to source the raw materials and base our plant investments on that.

Mark Heller – Merrill Lynch

Great and I was wondering if you could provide some thoughts on fab expansion beyond Malaysia?

Bruce Sohn - President

Yeah, we look at expansion periodically and we are thinking about that in terms of supply match to demand. So there is a couple of variables there is a few variables one is the level of demand, the other is a level of production we are getting out of the existing factories as we bring them up as you can see from the data on production per line we are continuing to drive higher production on a per line basis. So, we got a couple of factors there and we don't have a set time schedule we have got our hands full now. We are trying to bring these four factories in Malaysia up on time and on budget. But we are looking at it periodically and we don't have anything to announce today, that’s what I'd say, we are continuing to look at it.

Mark Heller – Merrill Lynch

Thank you.

Operator

Thank you. Our next question comes from Vishal Shah of Lehman Brothers.

Vishal Shah - Lehman Brothers

Yes, hi thank you very much for taking my question. Can you talk about your strategy of allocating the capacity between Europe and US markets? If you look at our native capacity at the end of this year and you would have sufficient capacity to go out and sell or enter into more contracts in the European markets in 2009?

Mike Ahearn - Chief Executive Officer

Yes, well Vishal so we look at this on a segment-by-segment basis and we would like to open up this US utility market segment. So, we start with the idea that we have to reserve sufficient capacity to execute this initial round of pilot projects and have some trajectories some growth trajectory off of that. And so we will give that some priority on a reserve basis and then filling in around it additional volume in Europe. If markets develop differently than we currently anticipate, we’ll try to reserve some optionality to alter the mix. We look at that pretty frequently, but I guess the essential thing is we reserve enough product to seed and initially grow new markets and there are also some beyond just the U.S. utility market that we are exploring and reserving a bit of product.

Vishal Shah - Lehman Brothers

Great and just one follow-up on the tellurium question. Can you talk about your plans to start in-house tellurium production are you thinking about that or you are not looking at it all?

Mike Ahearn - Chief Executive Officer

We don't talk publicly about the details of the supply chain strategy, but I think you could say in general with respect to… you could look up-stream and down stream from our factories and say that we would look across the entire range of being fully vertically integrated to simply having a supplier customer relationship. I think across the entire range and there is a set of strategic and financial considerations that go into that thinking. If we were to carve it out and talk specifically about tellurium I think it would be… it would disadvantage us competitively and otherwise. So we don't get that granular.

Vishal Shah - Lehman Brothers

Great, Thank you very much.

Operator

Thank you, our next question comes from Steven Chin of UBS.

Stephen Chin - UBS Securities

Hi thanks, good morning and congratulations on the good Malaysia ramping-up. Jens, I want to know, are sales to U.S. based customers in the new full year 2008 guidance that you gave or is that potential further upside to the guidance that you're able...

Jens Meyerhoff - Chief Financial Officer

The guidance was based on our current stock on allocation between the different markets. So, it would include that.

Stephen Chin - UBS Securities

Okay and then in terms modeling the gross margin in the second quarter, since you said that the Malaysia ramp was a little bit more favorable than the ramp that you saw in Frankfurt last year. Should we expect the gross margin decline in the second quarter to be less than the declines seen last year? Is that the message you are sending?

Jens Meyerhoff - Chief Financial Officer

Yes, I think you will see a lesser percentage decline, a percentage point decline in the gross margin coming out of Malaysia ramp when you compare to Frankfurt Oder as the primary reason for that is actually the pure math on the scale. So, you are calculating over much higher revenue and gross margin dollar base and the upside coming from the Malaysia plants actually is a little more geared toward the second half of '08.

Stephen Chin - UBS Securities

Okay, thanks that was helpful.

Operator

Thank you, our next question comes from Rob Stone of Cowen and Company.

Robert W. Stone - Cowen and Company

Hi guys, you are doing extremely well on the rate of line throughput improvement. I think you previously talked about the achieving maybe 3% per year as opposed to per quarter; can you put any more granularity on what are the things that result in that improvement and your outlook for the balance of this year?

Mike Ahearn - Chief Executive Officer

Yes, Bruce, why don't you take that

Bruce Sohn - President

Yes, the Rob... as you noted we did have a particularly good quarter with about 3% improvement up to about 45 mega watts per year, run rate, our long-term model dictated that we need to continue to do this at the rate of about 3% per year. What our engineers and our operations personnel are doing, is they are really focused on the improvements in three different ways. The first one is really looking at equipment utilization to make sure that we get more out of the equipment as much out of the equipment as we possibly can, the second is generally improving the yield that we get out of the line and the third is the run rate at which the factory moves material and we are making steady improvements on each of those they tend to occur kind of inconsistently and be event driven over time. And so we anticipate that we’ll be able to continue to make progress on this

Robert W. Stone - Cowen and Company

Okay, related to the line throughput improvements as well as the fact that you're accelerating a little bit the timing of the subsequent expansions in Malaysia, I think you previously said you would exit 2009 with about giga watt of capacity. It sounds like that figure should be higher now, could add anything to that?

Jens Meyerhoff - Chief Financial Officer

I was saying if you look at the last guidance we gave essentially is always based on the demonstrated run rate. And so, at this point of time you would essentially take all 23 lines multiplying by the 45 megawatt demonstrated run rate like which would get you above the giga watt level.

Robert W. Stone - Cowen and Company

Great. Thanks very much.

Operator

Thank you. Our next question comes from Jesse Pichel of Piper Jaffray.

Jesse Pichel - Piper Jaffray

Hi. Congratulations on a good quarter. Jens, regarding your Q2 guidance, I'm coming up with a 193 to 226.9 million, and I'm wondering if you can discuss that range a little bit and what would represent the low end of that range and what would represent the high end of the range and are you expecting throughput improvements in Q2?

Jens Meyerhoff - Chief Financial Officer

Yeah. I think what we gave you was necessary to intend to a quarter or remaining focused on annual guidance. And so, we wanted to give you a little color around the trend and the year, and obviously the second quarter performance is largely dependent on the ramp of the first Malaysian plant and on shipping that product… completing final product qualification in the quarter.

Jesse Pichel - Piper Jaffray

Regarding the product qualification, is that... that’s ongoing with how many customers and have you experienced any difficulties?

Jens Meyerhoff - Chief Financial Officer

These are not necessarily customer qualifications, these are all long-term product reliability test. Very similar to what we did in Frankfurt Oder last year.

Jesse Pichel - Piper Jaffray

And what specifically is going better in Malaysia versus Frankfurt Oder?

Jens Meyerhoff - Chief Financial Officer

I will let Bruce answer that.

Bruce Sohn - President

Yes, Jesse so, basically what you are seeing is the effect of our copy smart technology applied to subsequent replications. We learned quite a bit as we started up our Perrysburg plant a couple of years ago, we learned more as we started up our Frankfurt Oder plant and each time we do one of these startups we get smarter about handling the equipment stabilization and installation phases as well as the process stabilization and qualification phases so we are getting smarter and smarter and that basically enables us to start-up the facilities more effectively.

Jesse Pichel - Piper Jaffray

Bruce how are we doing on the efficiency improvements on the product and do you anticipate that the efficiency improvements would be started in Perrysburg and then roll out to the other plants a quarter or two after that?

Bruce Sohn - President

Yes, so again consistent with our copy smart philosophy what we do is we make improvements to efficiency and then all of the improvements are propagated out to all of our factories so that we maintain lock step alignment in terms of the process in all of the factories and so yeah as we make improvements, that will roll out to the other facilities and we gauge each of the facilities against each other using copy smart each of the factories should and do maintain the same efficiency profile over time.

Jesse Pichel - Piper Jaffray

Do you have any efficiency improvements in your near-term plan for the next quarter or two?

Bruce Sohn - President

Well we have got a roadmap of efficiency improvements and as we said in the past the implementations of those tend to be event driven and as we factor those into the line and we qualify them, those will roll-out appropriately to the others factories.

Jesse Pichel - Piper Jaffray

Thank you, good luck.

Operator

Thank you our next question comes from, excuse me if I pronounce this wrong, Jon Dorsheimer of Canaccord Adams.

Jonathan Dorsheimer - Canaccord Adams

Hi, and thank you and thanks for taking my question, I was wondering if you could comment on your average balance of systems cost in the past quarter and then as you target the $0.12 to $0.15 a kilowatt hour in the US, what balance of system cost is needed to achieve that. Thanks.

Jens Meyerhoff - Chief Financial Officer

We don't get that granular, right now in terms of breaking out of the systems component, I think what we have… the other thing is... we don't really have projects utilities skill deployed in the US yet to talk about, and we tried to state the historical. But a data point I can provide that’s helpful that we have talked about in the past is whatever we’ve seen in Europe and specifically on some of the larger ground-mounted projects in Germany, and that sits at about a $1 or I should say a Euro1.55 or thereabout, that doesn't mean it will necessarily translate into US, but I think it's the data point... anyway.

Jonathan Dorsheimer - Canaccord Adams

I guess as we look for the pricing coming down to achieve that cost per kilowatt hour I was wondering maybe you could comment on, do you see the greatest price reduction coming from efficiency increases, and do you see that the price on the module side coming down or do you think it will be shared equally on the installation cost?

Mike Ahearn - Chief Executive Officer

Well, in terms of overall system costs, I think it'll be spread across the system components and installation and I mean if you think about what could a companyat the company level afford to sell a system for… there is also an overhead absorption piece that is important. So, some of this is business model related how efficiently can you develop a business model to drive throughput to minimize the contribution margin or maximize the absorption of overhead… better way to put it. So I think you really have to look at all of those components, module price coming down, some reduction balance of system cost components a reduction in installation and labor as a result of primarily with more rapid installation time, and then a business model that's scalable, that allows you to drive high throughput of system sales across a fairly lean fixed cost base

Jens Meyerhoff - Chief Financial Officer

Just on quick add to this. I think if you look at the cost reduction roadmap for the balance of systems that we published, it indicates us coming from $1.50 to $1.60 which we’ve seen in Europe down to a $1 and about one third of that is efficiency driven, followed by bill of material savings and then the scaling that Mike mentioned

Jonathan Dorsheimer - Canaccord Adams

That's helpful, thanks and as a follow up question, more technical, I was wondering if you could comment at all on the grams per watt currently used in your panels on the tellurium side.

Unidentified Company Representative

We don't get that granular in terms of breaking that content down.

Jonathan Dorsheimer - Canaccord Adams

Thank you

Operator

Thank you, our next question comes from Mark Bachman of Pacific Crest Securities.

Mark W. Bachman - Pacific Crest Securities

Sure, hey Jens your hedging comments, you said 37% was hedged at the rate of $1.45, but then you said 53%, I believe was the combined with natural hedge, does that mean 47% of your revenues are un-hedged?

Jens Meyerhoff - Chief Financial Officer

Now, if you look at that, you got to look at that on a income statement geographical basis. So, 37% of the revenues are hedged. So on a pure revenue line basis you got 63% floating with the Euro. However since we've got the euro denominated expenses on Frankfurt Oder, that translates into the 53% on an earnings basis being hedged naturally or by derivatives.

Mark W. Bachman - Pacific Crest Securities

Which would result then in 47% of your revenues throughout 2008 being un-hedged is that correct?

Jens Meyerhoff - Chief Financial Officer

Overall income, yes.

Mark W. Bachman - Pacific Crest Securities

Yes, okay and then I think you guys don’t want to talk about Blythe at all. Is it possible that maybe you could talk about other developments that you're seeing on the utility side of the business and then likewise as efficiencies continue to increase for your product here, obviously last quarter you gave us a metric for how much of your product was actually going into roof-top applications. And I'm wondering what else you're doing here in the U.S. to address the commercial market at the same time you are back in the utility market?

Mike Ahearn - Chief Executive Officer

Our focus at least for the initial market entry is around U.S. utility as opposed to commercial industrial users consumers. We just think it’s a more appropriate way given our business model and our product offering to start in a market. And so we have been having a lot of discussions with utilities which driving the demand are these renewable portfolio standards. The most significant RPS program in our view is in California although there are a number of other states that have active programs and number of utilities that have a demand to meet RPS requirements. So those are the discussions in under those programs there is typically not always but typically there is no break out for PV, no separate set of quotes for PV. So PV is competing with other renewable energy sources under a set of criteria that the lease in California center around lease cost best fit generation renewable resource under all of the circumstances of their grid.

So the discussions have centered around that, how does our offering match up on a least cost best fit basis, what are the relevant price points and what's the appropriate path to market, whether the development cycle… there is a lot of learning involved here and a quite a bit of difference from the feed-in tariff market that you see in Europe. That's basically how we are proceeding.

Mark W. Bachman - Pacific Crest Securities

Okay if I could just follow up on that real quick it would seem, I am surprised by your comment that you think the RPS is the best in California, I mean the RPS is quite frankly a joke because they have no teeth to them. But if you look at New Jersey you finally have a market there exactly where you bought a company to address this utility needs and you now have an RPS there that actually has penalties to go along with it. And so maybe you can comment there about expanding into an RPS that actually has some bite to it and then second of all, are you just then allowing your integrators in your installation in the US to worry about the commercial market?

Mike Ahearn - Chief Executive Officer

Yes, I mean I guess California versus New Jersey... we would welcome any RPS program that has bite to… it creates real demand we have looked at both of those RPS program and others, and I don't mean to slice New Jersey I think it’s great too. So, we are looking at a variety of programs and we haven't really announced other than the Blythe project, we haven't really announced these initial set of projects and even totally defined in our mind where will that initial traction be. So, I think everything is open for consideration. We are spending an awful lot of time in multiple states. So, I didn't mean to imply it’s just aCalifornia focus at this point. In terms of our customers we do have a set of customers in Europe operating under these long term take-or-pay agreement that are permitted under the terms of our agreement to sell product in the U.S. and we know in some cases that they are infact making plants to do that and have started to do that. So I would expect that we would see some of our modules showing up on the roof tops via our customer/integrators that's a good point.

Operator

Thank you our next question comes from Al Kaschalk of Wedbush

Al Kaschalk - Wedbush Morgan Securities

Good morning, Mike I just wanted to follow-up on, I will leave the margin questions alone but on the utility side in the U.S., what is the, I won’t say the time or data point, but what are you trying to get your arms around to accelerate or at least to begin these project announcements that you are touching on?

Mike Ahearn - Chief Executive Officer

We'd like to have by the end of the year, several projects, let’s call it 2 to 4 projects approved, underway, being executed at various stages. These are would be multi megawatt typically ground managed projects although wouldn't have to necessarily be ground managed could also be large roof top by working with the utility as an uptick. Would like to have several of those underway and we'd like to be working closely with multiple utilities and using these projects as a way to in essence as a gate toward a larger volume flow. So that’s where we are working to now and I think with this said I think we are on plan to that and we haven't got a lot of these concluded yet, but I think we're making pretty good progress.

Al Kaschalk - Wedbush Morgan Securities

But would it be fair to say, and sorry if I appear to be pushing you on this but, lets go for it would it be fair to say that you are tracking towards your internal targets on this opportunity and there is maybe some frustration just at the speed and which may be your potential end customers moves?

Mike Ahearn - Chief Executive Officer

No I don't think so. I got things there is... I think there is a fair amount of urgency on the end customer side. But there are regulatory requirements here there are permitting requirements... there is certainly a more elaborate process in just the project development cycle than you see in some markets in Europe, I could point to other markets in Europe though, I mean Spain two years ago and Italy last year that were very elongated. So, I think we are seeing about what we expected frankly in terms of the development cycles and improvements and approval processes and we are observing a fairly high sense of urgency on the part of some of these utilities to procuring renewable energy to meet the quotas and I think that utility commission at least in some states are putting a fair amount of pressure on utilities to comply. So I really think were about were we expected?

Jens Meyerhoff - Chief Financial Officer

I think if you just simply look at the size... the possible size of the pilot in Blythe I mean that project size wise could be deemed as one of the largest project installation in the United States?

Operator

Thank you our next question comes from Satya Kumar of Credit Suisse.

Satya Kumar - Credit Suisse

Yes, hi thanks for taking my question just a quick clarification of the inventory, and you produced about as much as you sold, but base inventory went up a bit, could you clarify what was driving that, whether it’s Malaysia or...

Jens Meyerhoff - Chief Financial Officer

Yes, so every time we are bringing up a new manufacturing site obliviously if you start producing, you take a step function in both raw materials and work-in progress that commensurate with that pampering up.

Satya Kumar - Credit Suisse

Okay. So, it sounds like Malaysia. On the cost reduction, the costs were up a little bit in the quarter, you mentioned currency. I was wondering if you could have a little bit more granularity, is there any cost inflation from raw material like cadmium telluride, and also can you remind us what Malaysia will give you once it’s fully ramped in terms of cost reduction?

Jens Meyerhoff - Chief Financial Officer

No, I think if you look at the cost per watt we saw on the first quarter actually, if you compare quarter-over-quarter, there is a $0.03 foreign exchange impact. So, absent of that, actually our cost per watt declined which actually was slightly better than what we expected on the quarter-to-quarter trend basis. With respect to Malaysia, I think we stated this before that when compared to Perrysburg, we would expect about $0.20 per watt decline and I think we can give updates on that probably in the second half of this year. As the plant actually... the first plant gets a full production, will get full validation of that.

Operator

Thank you. Our next question comes from Daniel Ries of Collins Stewart.

Daniel Ries - Collins Stewart LLC

All right. Thank you for taking for taking my question. I was curious if you could maybe help us with... what percentage of 2008 volume is sold under the long term agreements that you've had with multiple parties at this point? How much do you have on the side for seeding new accounts and may be in 2009, how many would be affected by that 6.5% if your reduction that would hit January 1st as of, the vast majority is 90% something like that?

Mike Ahearn - Chief Executive Officer

On 2008 which is really what we… we sort of limit the discussion to '08 because '09, since it's a dynamic process allocating products. So, it's hard to say what it will be in '09, but in '08 we sit at about 80% contracted under long term contract. And then we make decisions at the margin based on market dynamics in terms of whether to allocate portions of that 20% to existing customers, to increase their volumes, move it into the US, seed other opportunity, it’s an ongoing process as I had mentioned... I mean demand continues to exceed supply and we have contractual put options in our customer agreement. So we feel like we can preserve a fair amount of optionality here because the European market is strong to give ourselves an opportunity to seed some of these other things and so we manage it in that fashion.

Operator

Our next question comes from Michael Molnar of Goldman Sachs.

Michael Molnar - Goldman, Sachs & Co.

Good morning, everybody.

Unidentified Company Representative

Morning, Michael.

Michael Molnar - Goldman, Sachs & Co.

Quick question for you, the $1.14 I want to make sure I understand, is that the cost per watt in COGS or your production cost?

Jens Meyerhoff - Chief Financial Officer

That's the production cost.

Michael Molnar - Goldman, Sachs & Co.

Got it.

Jens Meyerhoff - Chief Financial Officer

And, so the way we calculate it, you can calculate it purely on a COGS basis because it includes the inventory component.

Michael Molnar - Goldman, Sachs & Co.

Got it, okay.

Jens Meyerhoff - Chief Financial Officer

Total manufacturing cost in the period divided by total watts produced.

Michael Molnar - Goldman, Sachs & Co.

Okay and were there any sort of other cost related to Turner I think there was a couple of million in the first quarter?

Jens Meyerhoff - Chief Financial Officer

Well I think really what your are seeing in the first quarter is in Q4, you essentially had a month of expense run-rate, while this quarter we have had a full quarter of fixed cost.

Michael Molnar - Goldman, Sachs & Co.

Okay. And second question is given that PV large-scale installations have not been done in U.S. but at the same time the technology is fairly modular, can you help us understand some of the concerns or maybe better said challenges as people consider very large scale 100, 200 megawatt or more installations, what are some of the challenges that you talk about with utilities as a modular technology scales up to those types of level?

Mike Ahearn - Chief Executive Officer

Sure I mean what I guess if you start at the top and say the economics are more challenging here I mean if you think about that $0.12 to $0.15 of kilowatt-hour if you really need to be in that range, then the economics are more challenging. And as you make assumptions about how all of your costs are going to roll up to a turnkey system cost, which then derives your cost per kilowatt-hour those assumptions have to... they are finer with smaller ranges of air.

And so part of this validation piece is really around before we start, we turn on the faucet and really start running big volumes. But let's make sure we have got these parameters nailed down around the economics, and make sure we understand from the utilities where we really need to be on price. I mean obviously we don't want to be dramatically lower on price than we need to be to open up the market.

So there is a little bit of testing that goes on there. Once you sort of get past that then you have these supply chain and EPC capacity issues at your point. This large scale PV really hasn't been done, then there are some supporting pieces beyond simply a flow of modules that need to be put in place to be able to get large volumes and systems and for projects installed, deployed and completed on time. I don't think that's a insurmountable issue, but it does require some development of the downstream channel.

So the initial projects are used in our view to put together that team if you think about it like our copy smart process before you start building lines at rapid intervals quickly you take sometime at the front to gather your partners to find the processes and the metrics and then make sure you have a plan to not only improve internally, but bring our partners in the supply chain along with us that's pretty key.

I guess the center piece is really flushing out the fit of distributed PV on grid because it is modular. We can build PV projects in smaller increments, say 25 megawatts and place them strategically around the existing grid and existing transmission constraints in a way that allows utilities to get to market rapidly with renewable energies as opposed to waiting on transmission projects to be built. But that takes some resource planning and some integration on the utility side. So, there are a set of discussions there that need to take place as well. But those are the some of the issues Michael that we're working through now.

Operator

Our next quarter comes from Mehdi Hosseini of FBR.

Mehdi Hosseini - FBR Capital Markets

Yes, thanks for taking my question. Can you please remind me with the existing long term contracts. Is there any clause that would enable your customers to push out shipment on a quarterly basis?

And my second question has to do with the U.S. market RPS programs where your customers maybe evaluating photovoltaic versus other means of solar options. How are those market dynamics tracking especially in regards to CSP and then outside of RPS not knowing what the ITC… when ITC is going to be extended and also not knowing what the seed-in tariffs are going to look like in Europe. Can you please elaborate on some of the market dynamics you are seeing that would impact some of your projects beyond '08? Thank you.

Mike Ahearn - Chief Executive Officer

Okay on the first question there is no ability to push out per quarter on the part of our customers under these contracts. So the quarter is a lock down with respect to volume. On the U.S. utility market, these regulated utilities or load serving entities are looking at, as I had mentioned, the whole range solar thermal, wind, geothermal PV, then a number of solar thermal contracts announced recently or bids at least and so that's a competitor for us and so the way we think about that, what that means is initially we have to be at a same price range. The economics have to be comparable to solar thermal.

There are some pluses and minuses in the PV versus solar thermal comparison beyond economics that I think really have to do with the circumstance of the utility and the state of their grid and other generation mix, and based on that, and we can find situations… a lot of them where PV is a great fit, it’s modular, it’s scalable, it doesn't use any water, it’s proven, we don't have a lot of moving parts, we don't have any moving parts. The operation and maintenance or variable expenses are minimal. So, there is a variety of things to bring to bear but to get to the table you have to be talking generally in the same economic range as the CSP, and that's why I say when we were testing at just probably $0.15 a Kilowatt hour range? That's anecdotally where the CSP bids come in. Whether they ultimately get delivered in that price range or not, I think that remains to be seen, but since the bids are out there we have to be prepared to talk in that range as well.

Let see on the ITC, I don't think we bring any special insight here, it’s been pretty well chronical publicly the trials and tribulations in extending the 30% ITC, I... we just don't know, I mean in that situation the best you can do is to be robust in your business model against the various outcomes. We think if the ITC is not expanded, which feels like less then a 50% out come but it's a distinct possibility, if it’s not extended, then that will hurt the U.S. Market, there is no question about that, I mean you can do the math and see that the system cost go up somewhere between 25% and 30% if that ITC is not extended, fortunately we have other markets and that's where the optimality comes in to be able to redeploy and move where it makes economic sense.

So we are long term players in the U.S. utility market I would say the short term timing could be negatively influenced by a bad result on the ITC and we are watching it closely and just trying to be robust against the range of outcomes.

Operator

Thank you our next question comes from Paul Leming of Soleil Securities.

Paul Leming – Soleil Securities

Good morning, I know that the efficiency gains you realized in your modules tend to be somewhat lumpy in realizing, they come in fits and starts and I was wondering if you could talk a little bit about the increase in physical throughput down the line? This was probably, as I run the numbers, the lowest quarter of growth that you’ve had since you’ve come public in the physical output per line. Does that seem to imply that you are finally beginning to approach some kind of asymptote and further increases are just going to become tougher to come by or was this just one of those lumpy quarters where you didn't realize a lot and we could bounce back to the 5%, 6%, 7% quarter-to-quarter growth that we have actually seen in a lot of quarters over the last year.

Mike Ahearn - Chief Executive Officer

Yes, the performance this quarter is, as you said was up about 3% to about 45 megawatts per line per year. That's been something that has been steady overtime for us to hit our long term 2010 and 2012, cost targets, we we really need to be able to improve at the rate of about 3% per year. We expect to have ongoing improvements, the improvements as I mentioned earlier, really around 3 areas the improvement in equipment utilization, the improvement in yields out of the factory, and general improvements in the run rate of the factory itself and we have ongoing work and expect to see improvements factor in at various points in time in the future.

Larry Polizzotto - Vice President - Investor Relations

Operator, we would like to take one more question please.

Operator

Yes sir, final question comes from Jonathan Hoopes of Thinkequity.

Jonathan Hoopes - Thinkequity Partners

Thank you. I'd like to better understand generally speaking if you are delinking your production capacity to pre-contracted sales and also if you could provide a bit more clarity around your pricing, specifically is there a market or a spot component to any of you contracts or is all of the pricing fixed at the time of signing?

Jens Meyerhoff - Chief Financial Officer

I think we answered that question earlier between contract demand... contract we said about 80 to 85% of the production output was contracted plus the underlying optionally and ability via put auction to place more volume into a strong demand environment in Europe. And with respect to the pricing we really don't have, we are not serving the spot market. So, essentially this long term contracts, when I do talk about customer mix they are usually… can relate to a pilot project with potential new customers not all of those come to fruition but some of them do like you see with some of the announcements we had today on the call.

Operator

That does conclude today's Q&A session. Ladies and gentlemen thank you for your participation in today's conference this concludes the program. You may all disconnect. Thank you and have a nice day.

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Source: First Solar, Inc. Q1 2008 Earnings Call Transcript
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