First Solar, Inc. (NASDAQ:FSLR) Q1 2009 Earnings Call April 29, 2009 4:30 PM ET
Larry Polizzotto - VP of IR
Mike Ahearn - Chairman and CEO
Jens Meyerhoff - CFO
Steve Milunovich - Merrill Lynch
Steve O'Rourke - Deutsche Bank
Satya Kumar - Credit Suisse
Nic Allen - Morgan Stanley
Vishal Shah - Barclays Capital
Timothy Arcuri - Citi
Al Kaschalk - Wed Morgan
Chris Blansett - JPMorgan
Jesse Pichel - Piper Jaffray
Mark Bachman - Pacific Crest
Good day, everyone, and welcome to First Solar First Quarter 2009 Earnings Conference Call. (Operator Instructions).
I would now like to turn the call over to Mr. Larry Polizzotto, Vice President of Investor Relations for First Solar Incorporated. Mr. Polizzotto, you may begin.
Today after the market closed, the company issued a press release announcing its fiscal first quarter 2009 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 firstsolar.com. In addition, First Solar has posted the first quarter presentation for this call, it's under a supplemental information, as well as key quarter statistics and historical data on the financial and operating performance for the quarter.
We will be discussing the first quarter presentation during this call, and it is being webcast as well. In addition, an audio replay of the conference call will also be available approximately two hours after the conclusion of this call. The audio replay will remain available until Friday, May 1, 2009, 8:59 PM Mountain Standard Time or 11:59 Eastern Daylight Time, and can be accessed by dialing 888-286-8010 if you are calling from within the United States or 617-801-6888 if you are calling from outside the United States, and entering ID number 93319217. A replay of the webcast will be available for 90 days approximately two hours after the conclusion of this call. If you are a subscriber of FactSet you can obtain a written transcript within two hours.
With me today are Mike Ahearn, CEO; Jens Meyerhoff, CFO; and Bruce Sohn, President of First Solar. Mike will begin with an overview of the company's first quarter 2009 achievements followed by a market and business update. Jens will provide you with the first quarter 2009 financial results and provide you an update for guidance for 2009. We will then open up the call for questions.
All financial numbers reported and discussed in today's call are based on US 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 the participants limit themselves to one 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 this call, the company will make projections and other comments that are forward-looking statements within the meaning of the federal securities law. The forward-looking statements in this call are based on current information and expectations, are subject to the uncertainties and changes in circumstances, and do not constitute guarantees of future performance. Those statements may involve a number of factors that could cause actual results to differ materially from those statements, including the risks described in the company's most recent annual report on Form 10-K and other filings with the Securities Exchange Commission. First Solar assumes no obligation to update any forward-looking information contained in this call or with respect to announcements described herein.
Before I'd like to turn this call over to Mike Ahearn, I would like to mention that during the second quarter of 2009 the company will be attending or hosting the following conferences; Intersolar Munich on May 28 and 29; First Solar's Shareholder Meeting in Phoenix on June 4; Deutsche Alternative Energy Conference in Washington, D.C. on June 11; and the 2009 Analyst Investor Meeting will be held in Las Vegas. We'll also be taking investors' analysis to see our El Dorado installation in Boulder City. That will be on June 24. It's now my pleasure to introduce Mike Ahearn, CEO of First Solar.
I'm going to walk through some slides in the presentation starting with slide five. If you can follow along, I'll speak mainly to these slides. The company, obviously, continue to execute at a very high level over the first quarter.
If you look at the financial metrics on slide five that's listed here briefly, revenue at $418.2 million, that's down slightly over Q4. Jens will explain it, but it primarily results from the planned annual price reductions we have at January 1 under our long-term contracts. That revenue drove net income of $164.6 million for earnings per share of $1.99.
From an operational perspective, the operating metrics that drove the financial results included production at 219.5 megawatts. That's up 26% quarter-over-quarter. Annual capacity per line was up to 49.4 megawatts, up 4% quarter-over-quarter, primarily driven by higher conversion efficiencies and aligned throughput. Conversion efficiency averaged 10.9 % for the quarter. That's up 0.1% quarter-over-quarter.
We operated KLM 1 and 2 at full capacity for the entire quarter. We also began shipping and ramping KLM 3. KLM 4 will begin shipping in Q2, and that will bring all four factories in KLM into production and full ramp ahead of schedule, so an excellent job at executing a major factory expansion for us.
Manufacturing cost declined to $0.93 per watt, 5% reduction quarter-over-quarter and 18% year-over-year, driven primarily by lower Malaysia costs as we averaged in higher volumes into our consolidated results and improved throughput and efficiency as I alluded to earlier.
From a market perspective, we were particularly pleased. We were able to sign up 479 megawatts of new volumes in Q1, particularly under the conditions that the industry has been dealing with. Those included 361 megawatts in Europe in increased contract module sales with existing customers, 23 megawatts contracted in Ontario, Canada, and then 95 megawatts in the US under two projects that we announced earlier, the project with Sempra that we referred to as Copper Mountain in Nevada and then the Tri-State project in New Mexico. These are DC numbers in case you compare them to the press releases which were reported in AC numbers. That will explain the discrepancy.
All in all, this is a very strong result in our view, particularly under the difficult financial and economic conditions that we've all been dealing with, but we're very pleased with the quarter. I'd like to spend some time now talking about the market dynamics which continue to drive uncertainty in the industry and occupy a great deal of our time and attention.
So, if we turn to slide six, this starts the discussion at a pretty high level, but the way we think about markets is to first classify them into two buckets, PV subsidized markets, which are primarily the European feed-in tariff market, and the US utility market. The classification is made because the characteristics differ quite a bit between these two buckets in terms of risks and opportunities and offering and so forth.
Geographically, Germany, Italy, France, Spain and now Ontario, Canada are our PV subsidized markets. Our offering in these markets is sale of modules as opposed to a more expanded offering. The customers we sell to consider us relative to other PV suppliers. Our competitors are, obviously, PV module manufacturers.
The pricing trend that we would expect over time is one of declining prices in keeping with declining subsidies. It's really PV-specific subsidies that drive demand in these situations. Those subsidies have to come down overtime. We believe that's a political reality and so do prices therefore.
The US utility market I mentioned is somewhat different. Our focus has been in California. We've expanded our thinking, and with the announcement of Tri-State into the Southwest US, but primarily we're focused in California. Our offering is around system level solutions as we've discussed previously. We think that's important to drive price points and the cost reduction trajectories in terms of solar electricity cost to serve this market.
We are competing here with the full range of utility scale renewable, so not just PV, but obviously wind, geothermal, concentrated solar. Therefore, to answer this market, the price point has to be a lot lower than it would have to be in a PV subsidized market.
So you're going to see a different pricing trend here as we get deeper into this market where our prices, including the imbedded module prices, start out at lower price point to gain entry. Overtime, we won't see the same kind of continued downward trajectory. We think these price points end up leveling off and actually stabilize as we become competitive relative to traditional alternatives.
Slide seven steps this down one more level with respect to PV subsidized markets and demonstrates how we think about these kinds of markets. Our primary concern is assuring that modules will sell through the entire market channel or system, and ultimately convert to an installed system and cash from an end user that feeds this channel.
This slide really breaks down the market channel or system into the five components that we look at. Starting from left to right, modules and other components have to be adequate. We've had situations from time to time in the past where there were concerns about inverter supply, for example, to drive the kind of installed volumes we would be contemplating. That's not a concern today, but this is an issue that has to be looked at.
Next would be project pipeline, whether its rooftop or large ground-mounted systems, are there permitting and approval processes that are transparent and working, are there opportunities in the queue with our customers that will accommodate the types of volumes that we plan to ship over the next rolling several quarters.
Assuming that's the case, then you get to this project development system integration execution capability. Customer financial and operational health and capability is critical if we're going to see these modules move efficiently through the channel.
Then we get to project finance, of course, are there adequate sources of equity of debt to financing these things. Finally, project economics, repricing the modules at levels that given the feed-in tariff rates and the radiance in the financing costs will allow all of the pieces of this channel to be adequately compensated to continue to drive a solution.
So those are the areas and there are obviously subcategories of this that we look at from a risk analysis and mitigation point of view. The bottom part of this slide indicates in red where we think the risk lie. I'll talk about those in a minute on some follow-up slide.
The two columns that aren't designated in red, we actually feel pretty good about. One of those is project pipeline. With the seasonal situation in Germany, basically frozen ground and snow on ground and rooftop, the visibility is a little bit limited. From what we can tell with respect to our customers and other integrators and channel players, there is a pretty good pipeline of opportunities queued up or available over the coming several quarters, certainly in Germany.
It's less visible in parts of Europe because permitting an approval process can tend to be delayed and opaque, nontransparent, not as predictable as we have in Germany. On balance, we think there's an adequate pipeline both rooftop and ground-mounted to accommodate our plan to our modules.
Similarly, on project economics, we're confident that our modules are priced at this point to enable a sell-through and for the channel, including our customers, to receive attractive compensation and drive economics that work for everybody.
Now, part of that is because we've priced the modules, as we mentioned on our last earnings call, to levels that drive sell-through economics and we've made pricing adjustments over the course of 2009. The fact that that's working I think is evidenced by the 360 megawatts that we've been able to sign.
So, let me turn to some of the risk factors here. If you go to slide eight, one risk which we've talked about on prior calls is that we'll see defaults under existing contracts with customers. We continue to see this impacting potentially 10% to 15% of our planned 2009 shipment. Situation really hasn't changed since last quarter.
I suppose the passage of time could be marginally helpful, but this is an area we're watching very closely. The mitigation in our case has to do with monitoring and trying to create excess demand or options to reallocate those volumes should that become necessary. So we'll continue on the watch list in that respect.
The other risk I'd call out on slide eight has to do with project financing. In Germany, if you think about small systems, anything below a megawatt, primarily mounted on rooftop, we're seeing evidence of pretty good financing flow. The bank debt comes largely from small savings banks in Germany that are relatively unimpaired by some of the credit conditions affecting other banks.
KFW support is available to the full extent on these projects. So that looks reasonably robust at this point. The situation is less visible with respect to larger projects, but in Germany we are seeing evidence of larger banks beginning to lend in some cases and actively underwrite and consider loans. So I think that that situation in Germany looks marginally better.
In Europe outside of Germany, we simply don't have visibility beyond what we've talked about last time, which is very limited. The reason for caution here is that, in general, the banking industry is not healthy in Europe. That's widely reported and known. There are additional write-downs that had to be taken, in our view, and some of that's a consequence of investments and toxic assets in the US. Some of it's a consequence of loans in Europe that are underperforming.
So, there's reason to be cautious, in our view, until you see credit actively flowing on these large projects. We're not really seeing that at this point outside of Germany and some specific large projects that we talked about.
So, one of the mitigating steps here which we've talked about earlier is for First Solar on a very selective basis to step-in and provide some kind of support or credit enhancement. We've actually accomplished that now in a large project in Eastern Germany with UV 53 megawatt Lieberose project in Brandenburg that was previous announced, which Jens will talk about a little bit more in his section.
I think it's a pretty good example of where we can use some capital, some balance sheet strength to facilitate a flow of capital. It doesn't imply a massive change to our business model, but right now having that capability situational is an important mitigator. The other would be public sector support. We do continue to have discussion both at the European Union level and in various member states in Europe about facilitating credit.
Let me go to slide nine. The third big risk here is, of course, oversupply in the marketplace. That's been reported and talked about a lot. There are some potential issues here in terms of short term price reductions in polycrystalline and silicon impacting First Solar.
If you look to the right column of the slide, you'll see our view on this continues to be that it's not impacting us in the near term. We've got long-term contracts with most of our customers that enable sell-through economics.
We're finding that investors and especially banks prefer stronger companies with proven quality. Our customer base is oriented towards long-term. So we're not a spot market vulnerable company by design and have not seen a real impact here to-date from the sort of dumping low price trends that have been evident.
Longer term, the question arises, could polycrystalline silicon cost reduce to the point that your competitive cost advantage is eroded? That's something we want to be very sensitive to and not have our heads in the sand on. Our approach on this is to compare a hypothetical best case on polycrystalline silicon to our own cost reduction roadmap, and we've talked about our cost reduction roadmap previously. Basically, it calls for a manufacturing cost in the area of $0.65 a watt by 2012.
There are a number of things we have to execute to get to that point. There are also levers driving this that we think continue beyond 2012 in terms of technology-driven conversion efficiency improvements, scale improvement by very low variable costs, and productivity continues to drive throughput.
If you look to slide 10 here, and this range represented by the gold bar has a mid point of $0.65 a watt, if we compare that to what we model as a hypothetical best case on polycrystalline silicon, which is represented by a green dotted line here, we look at where polycrystalline silicon cost could be at various silicon feedstock price points ranging from 150 down to $25 a kilogram, what it will demonstrate is that we've got a cost advantage, let's just take from $75 to $25 a kilogram the cost advantage of somewhere from $0.73 to $0.35 a watt or 55% to 35% on a relative basis.
If you look at slide 11, it's the same data adjusting for a balance of system penalty of $0.15 a watt, which is what you get assuming 12% conversion efficiency on First Solar modules versus 14% on polycrystalline silicon, and it demonstrates a range that while higher is still fairly significant.
So what this tells us from a mitigation point of view is we've got to be focused on executing our cost reduction roadmap. If we do what we've done in the past and we tend to [admitting], we can continue to move down the path here, open new markets and potentially widen the gap relative to crystalline silicon type offerings.
So that's in a nutshell what the PV subsidized markets in Europe look like to us today. Let me briefly talk about the US utility markets. If we go to slide 12, this stacks it up pretty nicely, starting with our market entry in '07, the Turner acquisition. 2008, as you'll recall, for us was all about getting some pilot projects done and some formative relationships to begin to build a presence here.
2009 has really been around building pipeline and I think we're not finished. This is ongoing work. We don't talk about things until they're done, but our hope would be to continue to build a pipeline. That pipeline project begins to get deployed in significant volume if everything works right in the latter part of 2010 and beyond. So this slide summarizes our view that things are progressing very well.
Slide 13, the key market risk with respect to US utility, one is just longevity or timing factor. The pipeline queues are long. Boeings were talking about 2010 and beyond. It's mainly driven by long permitting and approval times. The visibility and the precision around this timing factor is not as good as we would like. I think the way to mitigate that is build big pipeline.
Project financing today, if you had to finance in big volume, it would be very difficult. We assume somehow this is going to resolve over the next 12 months, 18 months before it becomes critical. We don't have a good bottoms-up way of seeing that right now. This is more of a top-down hope as opposed to a plan. So, we've got some things we need to work on there.
Low natural gas prices could have an impact in the short-term on expansion of state programs, although I will say we've got our hands full with California and a couple of other markets.
I think the policy issues everybody is pretty well familiar with. We don't really have anything new to add here. We continue to be very active in discussions and trying to influence things. I hope that US will join Europe in creating large viable markets, but I think federal intervention is going to be critical.
We're very concerned about the short term nature of the injections of the stimulus bill and the fact that in 2011 we'll revert back to an ITC structure, which in our view is not a workable way to attract big volumes of low cost project financing. So we are very active here from a lobbying front.
Slide 14, just to summarize, we're seeing continued strong execution across the company. The improved pricing in terms in Europe to enable sell-through has resulted in signing of additional volumes as we had hoped. The key areas of risk mitigation continue to be the contract default risk with respect to 10% to 15% of the volume and the project finance issues that, of course, affect the entire industry.
We assume and believe our continued cost reductions will offset any polysilicon module cost and price reductions that might result here from feedstock and excess supply. Our penetration into the US utility market is continuing on plan.
Before turning this over to Jens, I'd like to say a few words about an organizational announcement that we made just right before this call started. We announced that First Solar will begin a search for the next CEO. When we identify that person, I plan to remain as Executive Chairman in a full-time role and focus my efforts with our government affairs group to help create the policy and regulatory frameworks that we believe are needed for solar electricity markets to expand, not only in the US and Europe, but in developing countries.
I think this could be read to be some kind of sign of a pullback from me or half a step out of the business. That's not what's intended. This is really about expanding the leadership team and reallocating my time, so I can focus on external issues that I really think are becoming critical to the continued growth of the company and the industry.
There are three considerations about the timing of this move that the Board and executive staff and I have put a lot of thought into and ultimately concluded this was the right time. First, I think that these public policies and programs are going to become constraining for the industry relatively quickly if we and others continue to drive costs down as rapidly as we are.
We start thinking about what will it take to sell 5 gigawatts a year or 10 gigawatts a year for solar, we think it's going to take some fairly radical significant changes in the way these markets are structured from a regulatory point-of-view. That includes some of the developing world that can be addressed by price points that I believe we're going to get to.
So I have been spending more time in this area lately. I'd like to spend all my time on it. It will take that and more by a number of companies to bring about some of the changes we're going to need. So that's a significant consideration.
The second thing would be this is a natural evolution for me and the company. I've been in this role going on 10 years. It's healthy for the company to inject new talent at the leadership level, and this gives us an opportunity to broaden the team and take into account our growing size, geographic scope and complexity. So it actually works in a couple of different ways to expand the team at this point.
The third aspect was we concluded that the timing is right from the standpoint of the organization. We've got an excellent staff at the executive level and senior management team. We're executing very well right now across the company. The Board and I are very comfortable with the state of the organization as we begin to look for the right person here to be our next CEO.
So we haven't set a definitive timeframe and we'll take as long as we need to find the right person. The Board is conducting a search, but it's in close coordination with me and the rest of the executive staff. We've announced it now because we're planning to take some active steps along these lines and we just felt that it was appropriate to reach out to our stakeholders in keeping with the transparent way that we've done business.
So with that, I'd like to turn the call now over to Jens Meyerhoff to take us through the next slides.
On slide 15, you see our net sales for the first quarter were $418.2 million, a decrease of 3.6% over the fourth quarter of 2008. The decrease was primarily driven by price declines, customer mix as well as by sequential decline in the euro exchange rate from a blended $1.41 per euro in the fourth quarter to $1.39 per euro in the first quarter of 2009. These decreases were partially offset by higher shipping volumes from the ramp of plant 2 and 3 in Malaysia and higher line throughput.
Moving to slide 16, our cost per watt produced for the first quarter was $0.93, down 5.1% sequentially as we continue to realize the benefit from increased production and low cost locations, higher line throughput and lower material cost. Cost per watt included $0.02 of Malaysian land cost and long set of stock-based compensation expense. Cost per watt is expected to continue to decline with a ramp of plant 3 and 4 in Malaysia and continued throughput improvements.
Gross margin on slide 17 for the first quarter was 56.3%, up 2.4 percentage points over the prior quarter, primarily due to lower manufacturing costs and customer mix, partially offset by lower ASPs and the decline in the blend of euro exchange rate underlying our net sales.
Please note that our gross margin continued to benefit from foreign exchange hedges executed in the first half of 2008, which are phasing out as the year progresses. In addition, first quarter margins do not yet reflect the full impact of revised product pricing implemented during the first quarter.
On slide 18, our operating expenses declined $5.4 million quarter-over-quarter, due to a reduction in variable compensation expenses and a decrease in plan startup costs of $2.6 million, sequentially to $6.2 million, as Plant 2 and 3 in Malaysia commence production and we continue to incur startup costs for Plant 4 in Malaysia.
We expect our operating expenses to increase in the second and following quarters due to higher R&D spending as well as increased SG&A spending, primarily driven by the OptiSolar acquisition and the related ongoing project development expenses required to realize the full value of the acquired project pipeline. Operating expenses net of plant startup costs were essentially flat in the first quarter at 14.6% of the percentage of net sales.
On slide 20, you see our operating income for the first quarter was $168.1 million or 40.2% of net sales, up from $161.3 million or 37.2% during the prior quarter, and included $15.2 million of stock-based compensation expense. Net income for the first quarter was $164.6 million or $1.99 per share on a fully diluted basis.
On slide 22, you see that our APS was favorable impacted by non-operating income and expense items of approximately $0.06 when compared to the fourth quarter of 2008. This is primarily driven by a one-time tax benefit of $11.5 million from the reversal of Malaysian tax expenses as a result of the pulling of our Malaysian tax holiday into 2008, partially offset by non-recurring foreign exchange and hedge gains during the fourth quarter of 2008 and a reduction in interest income. The effective tax rate for the first quarter was 9.8% excluding one-time items.
Our free cash flow on slide 23 was negative by $22.7 million in the first quarter due to the one-time impact of changing our payment terms from 10 days to 45 days and higher shipment rates in the second half of the first quarter. Cash flow from operations during the first quarter was $63.7 million, driven by continued revenue growth and offset by increased accounts receivable balance and inventories to support growth.
We spent $86.4 million for capital equipment during the first quarter against depreciation of $25.8 million. Cash and all other marketable securities decreased by $10.2 million to $811.6 million in the first quarter, primarily due to the revised payment terms, while our debt-to-equity ratio remained low at 13%. Rolling four quarter, return on net assets was 27.4%, up from 22.4% in the prior quarter.
Before I get to the guidance for 2009, I'd like to provide an update on our activity of committing capital towards financing projects in Europe as shown on slide 25.
During the first quarter, we contributed EUR10.3 million to support the financing of the world's second largest PV plant in Germany. With this commitment, we were able together with our customer, UV, to obtain favorable financing terms for over 80% of the project capital in a challenging product finance market. Due to the structure and timing of the financing, we deferred approximately $27 million of net sales during the first quarter.
The intent, as you see on slide 26, is to sell this attractive project together with UV to a long-term equity investor, at which point we plan to represent less than EUR10 million of the project capital structure. For more information about the project, please refer to the press releases issued by both companies.
This brings me to our guidance for 2009, which remains largely unchanged. For the remainder of 2009, 50% of our expected net sales are hedged at an average rate of $1.35 per euro. In addition, our national hedge brings the net income hedge ratio to 59% for 2009. Since we lay our hedges, net income for Q2 of 2009 is hedged at 83% compared to 47% for the second half of 2009.
Please note that the exchange rate underlying these hedges will continue to decline as the year progresses, but are not expected to drop below current spot rates. We assume an average exchange rate of $1.15 for the unhedged portion of 2009 guidance, bringing the average euro exchange rate to $1.28 per euro for 2009. For the remainder of 2009, a $0.01 euro fluctuation impacts our revenue approximately $5 million and our operating income by approximately $4 million.
Our guidance reflects new pricing and contract terms designed to drive throughput and to take advantage of our superior product cost structure. We closed the OptiSolar acquisition on April 3rd, and our current guidance incorporates the financial impact, including the additional expenses from the project development team.
First Solar issued approximately 3 million shares of common stock, representing a dilution of about 3.5%. This is less than the approximate 5% dilution expected when the acquisition was announced. Our guidance doesn't yet includes the impact of the final purchase price allocation, which we expect to finalize in the second quarter.
As discussed by Mike, we're monitoring and mitigating certain business risks such as potential customer contract default risk due to either financial instability of customer, limited access to product financing or near-term competitive losses. Such risks are, as of today, not incorporated into our guidance due to our belief that our mitigation plans are sufficient.
In addition, we may be able to reach the required milestones and trigger events that allow revenue recognition of some of the deferred revenues excluded from our guidance as a possible further risk mitigation pass.
Now, to our guidance on slide 29. We maintain our previous net sales guidance range of $1.9 billion to $2 billion. We expect plan startup cost of $12 million to $13 million. Stock-based compensation is estimated at $75 million to $80 million with approximately 20% allocated to cost of goods sold. GAAP operating margin is expected between 31% and 33%, reflecting additional expenses of the OptiSolar acquisition.
We expect our tax rate to be between 9% and 11%. Yearend 2009 fully diluted share count guidance was an estimated 86 million to 87 million shares. CapEx for the year is expected to be $270 million to $300 million for investment in completing the Malaysia plant 3 and 4 and our Perrysburg expansion and other infrastructure requirements.
This concludes our prepared remarks and we open the call for questions. Operator?
(Operator Instructions). Your first question comes from the line of Steve Milunovich from Merrill Lynch. Please proceed.
Steve Milunovich - Merrill Lynch
You commented that we haven't seen the full impact of the price declines that you implemented in the first quarter. Do you think those will be significantly noticeable going forward or could be offset by other factors?
Obviously, these impacts are incorporated into the guidance that we gave today to the full extent. Obviously as the full effect becomes eminent, we're also reducing our costs further. So you have some offsetting trends all of lower cost reduction efforts.
Your next question comes from the line of Steve O'Rourke with Deutsche Bank. Please proceed.
Steve O'Rourke - Deutsche Bank
How should we be thinking about your manufacturing cost basis in Malaysia compared to the US or Germany?
I think we always gave an indication that over time we would expect roughly $0.20 benefit out of Malaysia compared to the US plant, which was the baseline. So I think we're seeing that trend come through. Having said that, however, as you gain more efficiency and throughput advances, the overall compensation element in the manufacturing cost declines as a percentage.
So today we're seeing a good mix of the overall throughput improvements. We're seeing efficiency improvements and we're seeing the lower cost structure all benefiting the aggregate manufacturing costs.
Steve O'Rourke - Deutsche Bank
The material cost in COGS, is that demonstrably lower also in Malaysia?
Steve O'Rourke - Deutsche Bank
Yes, when you think about material inputs?
No. Generally, I don't think there's a material impact. As a matter of fact, I think in the beginning as we ramp some of these plans, we utilized traditional sources for materials in the transitional stage. Some of that could have been slightly higher due to transportation costs. So we're scaling into that.
Your next question comes from the line of Satya Kumar with Credit Suisse. Please proceed.
Satya Kumar - Credit Suisse
I was just wondering if you could give us a sense as to what price of polysilicon you'd be competitive as you exit the year. Looking at the run rate for your guidance, you are assuming pricing is coming down fairly significantly through the year.
If you look at the slides that Mike walked through, which are essentially slides 10 and 11 in the deck we gave some sensitivity with respect to different type of poly price assumptions. You see the slides and I leave it to your judgment to take a point with respect to where and when we will be at certain poly prices.
We believe based on the pricing behavior that we see that our current price is highly competitive and drives sell-through. You can draw a scenario, obviously, on the slide here. If you draw $0.93 current manufacturing costs, you freeze it and you bring down poly costs to $25. That could theoretically create some near term pressures.
The purpose of the slide is actually to show that those pressures will be temporary and that our cost reduction roadmap is more than adequate to allow us to compete overtime very successfully, even with very; very low polycrystalline feed stock prices.
Satya Kumar - Credit Suisse
My understanding is that the Cottbus project was refinanced at extremely attractive [referral] rates. By my math, this project is cash flow positive for you, just looking at the percentage funded and your cost. I'm assuming that you could generate very high returns on equity.
The underlying economics of the Lieberose project are quite compelling, especially financing, essentially provided additional upside to the minimum 20% IRR that we described. Obviously, those 20% IRRs are billed based on our manufacturing cost item. The question really would be at what point would be the project clearing. We believe there are enough economics in this project for it to be very attractive for certain equity investors that we would target together with our customer.
Your next question comes from the line of Nic Allen with Morgan Stanley. Please proceed.
Nic Allen - Morgan Stanley
Can you talk about the breakdown for the quarter and for your yearly guidance between module sales and then system sales?
I think so far we have not broken this down. What we have said in the past was roughly that we expected about 10% of our volumes to essentially be placed in the US market. Some of that is obviously subject to the exact timing of some of these projects. I think Mike alluded to that permitting times and so on, our critical aspect of project realizations.
We realize that our investor community is very eager to understand the differences in the business model between the modular sales that we are having the European feed-in tariff versus a more integrated model in the US. Essentially our Analyst Day in June will explain this in a lot of details. So, that's going to be our core focus there to layout how we think about both aspects of our business.
Nic Allen - Morgan Stanley
Is there a general volume that we could think about where that system business becomes operating breakeven?
That would imply that it was losing money which I don't think we've generally disclosed that we were feeling or thinking about it this way. I think, generally, we will give you an overview of the economics, which obviously would include the degrees of profitability that we you would find in that business.
Your next question comes from the line of Vishal Shah with Barclays Capital. Please proceed.
Vishal Shah - Barclays Capital
First of all, what percentage of PR shipments in Q1 were to the German market and specifically to the ground-mounted market in Germany? And were you able to attract new customers by lowering prices in Q1? And if so, what's the total number of customers do you have as of today?
I'd say generally, we remained in the first quarter very euro-focused around our revenues. That's essentially our core markets still while the US is developing. I think I just laid it out for the year, Vishal, with respect to the percent of US business.
The volumes we signed off were primarily signed off with our existing customers, as Mike mentioned. Obviously, part of our sales and marketing efforts is to broaden the customer base out further.
Vishal Shah - Barclays Capital
So were you able to successfully sign any additional customers?
I think the volumes we placed under these contracts were with our existing customers. As you know, our existing customers essentially represent the very large share of market in the European markets.
Your next question comes from the line of Timothy Arcuri with Citi. Please proceed.
Timothy Arcuri - Citi
First of all, Jens, can you tell us the megawatt shipment number and how many of those megawatts went into the systems business?
I think Mike reported the megawatts produced. We do not generally report any longer the megawatt ship number due to sensitivity around pricing, but the production was 219.5 megawatt.
Timothy Arcuri - Citi
Okay. Then, I guess, secondly, if you kind of normalize for some of the balance of system costs, right now you have kind of $0.60 to $0.70 advantage versus branded crystalline. So I am wondering how you think longer term as to what the cushion that you want to maintain for your pricing relative to branded crystalline once you normalize for the balance of system.
So are you willing to come down to $0.25? Is that where you want to keep the cushion? How do you think about that?
Maybe Mike wants to chime in here. I don't think there is such a magic formula where you just lock this in. You gauged the end market. You gauged the sell-through. As you know, we're going to use our cost reduction roadmap. We are firm believers in passing these cost reductions to some degree through and to the market for multiple reasons.
Number one, it helps us to grow our business and to drive overall sell-through. It strengthens the overall channel and our channel partners. We are a firm believer in demonstrating, especially to the government that have enabled feed-in tariffs that PV can scale. There is a logical and plausible task towards parity for this industry.
Your next question comes from the line of Al Kaschalk with Wed Morgan.
Al Kaschalk - Wed Morgan
I just wanted a follow-up on the sold out position that you have in terms of production and the next expansion project that we see from a capacity standpoint. The follow-up would be, could you comment a little bit further on the change in customer mix that you experienced in Q1?
Yes. This is Mike Ahearn. We didn't mean to imply that we were sold out in 2009. We are nearly sold out. I think our estimate is we have 90% of our volumes under contract at this point. So, we are about where we want to be in terms of having some flexibility to see some new relationships.
The factory expansion, we are thinking about that I guess the way we always have. When we can identify visible demand that we'll consume the output of incremental production over a time period that's sufficient to repay the investment. Then we'll make an expansion decision to go ahead and commit the expansion.
One of the advantages we have in the US from these long project timelines is that we think we can commence and build a factory faster than we can get through the utility scale project timeline right now, which means we have the advantage of preserving some optionality here in terms of when and where we commit to factory expansion.
So, we're looking at a number of sites. We are talking to a lot of people around the world about factory expansion. We're basically deferring decision on that and allowing demand to continue to crystallize and kind of look at our timelines in terms of when we must commit to serve demand that's been secured.
So, we don't have anything new to report today. Obviously, what we want to do is build more factories and expand, and we're eager to do it. So, we're working to put all those pieces together.
Yes, there was, I think, a question about customer mix. So obviously, I think as we mentioned, with respect to some of our revised pricing, the customers that committed to higher volumes that benefit from different terms compared to customers that essentially maintain certain volumes.
There is also differentiation with respect to markets served between feed-in-tariff based markets and markets that have less incentives. So, the US utility market would be one example, but also other emerging markets that are much closer towards grid parity requirements.
Al Kaschalk - Wed Morgan
Mike, a follow-up on the production and specifically on policy for the US. Can you give us a little update on tax incentives that the US government may be providing? I realized there is probably nothing specific, but maybe you could just comment on that. Thank you.
I think in general, at the federal government level, there is a real interest in trying to stimulate more solar manufacturing and technology development in the US. I think that the key issue there is to create a market opportunity in the US that will consume incremental manufacturing production, because absent a strong US market, I believe that manufacturing will continue to go where the markets exist. There are a number of other countries around the world that are working on market programs that try to stimulate manufacturing.
So, the first thrust I think in the US, at least what we've urged is, you ought to get the policies and programs to help stimulate a robust solar market. You can't leave this all to the States. Otherwise, it's going to be fragmented and under-funded. It's just a fact of life.
And so, there is a number of things, I think, to be done there. There is in the stimulus program an enhanced tax incentive for manufacturing, and it's something that I think will be useful. I don't believe it's been ruled out yet. I think they're working on the procedures and the logistics around it. That will be a useful sweetener, but I don't think it would substitute for creating a robust market in terms of really attracting manufacturing, you know certainly from First Solar's perspective.
Your next question comes from the line of [Collin Rush] with ThinkEquity.
Thanks. Mike can you talk a little bit more about the policy changes that you'd like to see mentioned a radical change? Can you just describe what would you like to see? How long do you think it's going to take and what sort of cooperative efforts across the industry do you see as necessary?
I think in the US, there are a few things I think would need to happen to create a real solar market in the US. One is that the incentive from the federal government, at least for large scale solar, needs to be higher than it is today, because with natural gas prices being at cyclical lows, these states are not in a position to fill subsidy gap. I just don't believe that's going to happen in size.
So, I think the incentive or the subsidy has to be higher. Providing that subsidy through the tax code in the form of an investment tax credit is extremely inefficient. It doesn't allow for capital to form around project finance in any kind of visible way or in a low cost way. It narrowly constricts the pool of available financers on these projects. So, I think once this grant program expires in 2011, we're kind of right back where we started. So that's a problem.
The transmission constrain needs to be addressed, in terms of renewable transmission. There are opportunities to do smaller volumes at solar, around exiting grids, about to get serious about this and really moves at multi gigawatt levels there, will need to be multi state transmission that is basically moving power out of the areas, where it's cheapest to make it, which is in the southwest and around the southwest and out of it. So, we have the transmission issue to be dealt with.
I think basically facilitating some kind of low cost project financing to put solar projects on parity with conventional power projects is going to be needed as well, at least for a while. We don't think, I don't think the loan guarantee program that's presently structured is going to be particularly useful, because it's a subjective program. It's not available to the market in general.
The rules and criteria aren't even developed let alone published and so when companies like us start thinking about how you put project finance in place to facilitate a large project, due late 2010 or beyond, we can't rely on that program. There's no visibility around it. No assurance, we will be entitled to participate.
So, I think there are a number of things here. I do think at the federal level people are asking questions and trying to figure it out. I hope that we can have some dialogue and I'll kind of get to the real issues. I think we speak for a number of companies on these points and would like to deploy big volumes here. We just need a few of these pieces to be in place.
Your next question comes from the line of Chris Blansett with JPMorgan.
Chris Blansett - JPMorgan
Question is kind for Jens here related to beneficial FX hedging, you've had. How do you expect this to roll off to the year, Jens, just to clarify?
Like I said, I mean, if you look right now how these hedges taper off. I think they are tapering towards the 130, 131 level. You may recall that the euro essentially traded up in the second half of last year from a high of about $1.61, down into the $1.20s. So, you see I think comparing us tapering off now from the $1.40 to the $1.30 level, that we essentially were quite successful in taking volatility out of the euro with respect to revenue recognition.
Your next question comes from the line of Jesse Pichel with Piper Jaffray.
Jesse Pichel - Piper Jaffray
Congratulations on the strong results. Of the 479 million of new volumes won in Q1, how much of that was a new win versus getting higher volumes in exchange for lower prices to your contract customers? And a follow-up to that would be; could you talk a little about glass, which I think is your largest cost. Some of the glass manufacturers indicated excess capacity, lowering prices. What type of TCO glass cost reductions are you looking at over the next year or two? Thanks.
I'll give you the breakdown Jesse on these contracts real quick. So, out of the 479 megawatts, you had 361 megawatts sold into existing customers in Europe. Then 23 megawatts is sold under contract into Ontario, Canada. That's a new market situation for us, and then 95 megawatts in the US that's new. Two projects, one with Sempra that will be installed in Copper Mountain, Nevada and other with Tri-State in New Mexico.
And then on the glass, maybe Bruce can talk to it?
Jesse, this is Bruce. On the glass fronts; so we deal with a number of suppliers for glass and we've had a long-term strategy that our global supply chain team works on to drive down the costs overall. Certainly that has been a key component to our cost reduction road map and is really required for us to address our bill of materials going forward over the next two to three years, so we get down to those $0.65 per watt cost range.
This has been an ongoing project that we have had, certainly the slow-up in the construction business and so forth has facilitated our access to glass, but of course we've been growing into that market over the last couple of years.
Your next question comes from the line of Mark Bachman with Pacific Crest.
Mark Bachman - Pacific Crest
Yes, gentlemen congratulations here on the solid execution and also the inclusion of the slide deck here and your thoughtful comments, I think are extremely helpful to your clients or your investors.
Jens, on page 25, you highlight the 53 megawatt project here. I know that you had set aside roughly 100 megawatts for the modules for First Solar owned projects, but you say you have only identified just 53.
So, I have a two-part question here. What's your appetite then for initiating projects for the remaining 47 so-called megawatts? And then two, how do we think about the revenue deferral for Q2?
Okay, I think, two questions. So again, as you see, our guidance remains unchanged around, that's right. So we're keeping the space over that allows us to do what I think. Slide 25 lays a low without why we're doing this right.
So, we're not doing this to be an independent power producer, right. We're doing this to mitigate risk around financing and to drive sell-through, right. It was a goal ultimately to sell these projects and so where we identified projects, these projects should be of a certain size. You shouldn't think of doing this like for a one megawatt project. That wouldn't make sense for larger projects. I think we remain open to that and preserve some optionality within the guidance to do this where we believe it makes sense.
With respect to the revenue recognition on this project, it was very specific to each project, Mark with respect to how they're structured and financed. So I think we'll give updates to this as we move through the quarter. Primarily it deals with closing financing and also with respect to final equity ownership are probably usually the triggers you want to look for.
Thank you for your participation. This concludes the presentation today. You may all disconnect. Have a great day.
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