第一太陽能 (FSLR) 2008 Q1 法說會逐字稿

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 would now like to turn the call over to Mr. Larry Polizzotto, Vice President, Investor Relations for First Solar Incorporated. Mr Polizzotto, you may begin.

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 p.m. 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 a subscriber of FaxSet, you can obtain a written script within two hours. With me today are Mike Ahearn, Chief Executive Officer, Jens Meyerhoff, Chief Financial Officer, and Bruce Shon, 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 Principals. 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, use or disposition of solar modules, the demand for solar modules, the cost of capital available to our customers and end product users, the field performance and reliability of our products, the Company's ability to successfully replicate production at 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 its 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 5, 2008. Second, JPMorgan's 36th annual technology conference in Boston on May 20, 2008, and lastly, MainFirst Bank AG's solar conference during the Intersolar Trade Fair 2008 in Munich on June 12, 2008. It's now my pleasure to introduce Mike Ahearn, CEO of First Solar. Mike?

Thank you, Larry, and thank you for participating in today's first quarter 2008 earnings call. During the first quarter of 2008, we have 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 $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 one 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 qualifications processes. We anticipate being in full production in the third quarter of 2008. The initial results of our production runs 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 two, three, and four are in different stages of construction and are progressing inline with our previously announced capacity expansion plan.

Turning to the market, demand for our products remain robust during the quarter and we continue to experience market demand in excess of 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 incentive structures. In the first quarter we increased our contracted volume with EDFEN and also added a new contract with AES Solar Energy Limited, which is a joint venture between AES Corporation and River Stone Holdings, LLC. Those volumes under the AES contract will be shipped between 2008 and 2010. These new contracts bring our total volume to be shipped under long-term contracts to 3.4 gigawatts or $6.4 billion at 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 US 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 toward our objectives of securing these pilot projects and initial relationships. An example if the 7.5 megawatt AC ground mount pilot project with Southern California Edison in Blythe, California that is currently under review by the California Public Utility Commission. This project has an option for future expansion up to 21 megawatts AC and assuming CPUC approval would be First Solar's first PPA based turnkey system. Since we're still in various stages of securing initial projects, which ranges from discussions and negotiation 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 remains 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 over to Jens Meyerhoff, our CFO, who will discuss our first quarter 2008 financial results and provide an update to our guidance for 2008.

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 pretax income by $15.7 million. This decline was largely offset by an increase on watts 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 over 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 startup expense were reclassified to cost of goods sold in the second quarter.

In order to further reduce volatility around our euro exposure, we maintain a 37% hedge of our expected 2008 euro revenues at 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 startup 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 startup costs, 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 startup 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. Startup expenses will decline sequentially in the second quarter of 2008 and then increase again in the third and fourth quarter due to the pending startup of plants two, three, and four at our Malaysian manufacturing center.

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 startup costs, 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 pretax yield of 4%, compared to $7.2 million in the fourth 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 in 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 and upside in the second half of 2008 from the ramp of our Malaysian factories. We expect revenues of $975 million to $1.050 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 as 59% to 60% of the annual net sales are expected to occur in the second half of 2008. We expect plant startup costs to increase to $36 million to $39 million due to a possible pull-in of $8 million in plant startup costs for plants three and four 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, vesting schemes, and further expansion in our work force.

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 be to approximately 28% to 30% and will 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 four of our Malaysia manufacturing center and infrastructure related investment.

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

(OPERATOR INSTRUCTIONS) Our first question comes from Mark Heller.

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 material price changes?

Let me direct it over to Bruce Shon.

Yes, on the tellurium front, we are not saying any supply issues for tellurium. We have got a couple of sources and we've 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 make decisions for out plants, we always review the capability to source the raw materials and base our plant investments on that.

Great. And I was wondering if you could provide some thoughts on fab expansion beyond Malaysia.

Yeah, we -- we looked at the expansion periodically and we're thinking about that in terms of supply matched to demand. So there's a couple of variables, there's a few variables. One is the level of demand. The other is the level of production we're 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've got a couple of factors there and we don't have a set time schedule. We've got our hands full now 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 about all I can say. We continue to look at it.

Thank you.

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

Hi. Thank you very much for taking my question. Can you talk about your strategy of allocating your capacity between Europe and the U.S. markets? If you look at your (inaudible) capacity at the end of this year, you would have sufficient capacity to go out and sell -- enter more contracts in the European market in 2009.

Yes. Vishal, we look at this on a segment by segment basis and we would like to open up this U.S. 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 trajectory, some growth trajectory off of that. So we'll give that some priority on a reserve basis and then fill in around it with additional volume in Europe. If markets develop differently than we currently anticipate, we 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. There are also some beyond just the U.S. utility market that we're exploring and reserving a bit of product for.

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 are you not looking at it at all?

Well, 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's a set of strategic and financial considerations that go into that thinking. If we were to carve it out and talk specific about tellurium, I think it would be -- it would disadvantage us competitively and otherwise, so we don't get that granular.

Great. Thank you very much.

Thank you. Our next question comes from Stephen Chin of UBS.

Thank you, good morning, and congratulations on the good Malaysia ramp there. Jens, I wanted to know is -- 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 -- ?

No, the guidance was based on our current thoughts on allocation between the different markets, so it would include that.

Okay. And then in terms of 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 decline seen last year? Is that the message you're sending?

Yeah, I think you will see a lesser percentage decline, the percentage point decline in the gross margin coming out of Malaysia one when compared to Frankfurt Oder. The primary reason for that is actually the pure math on the scale, yeah. So you are calculating over much higher revenue and gross margin dollar base. And the upside coming from the Malaysia plant actually is a little bit more geared towards the second half of '08.

Okay. Thanks, that was helpful.

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

Hi, guys. You're doing extremely well on the rate of line throughput improvement. I think you previously talked about 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?

Yeah, Bruce, why don't you take that one?

Yeah, the -- yeah, Rob, the -- as you noted, we did have a particularly good quarter with about 3% improvement, up to about 45 megawatts per year run rate. Our long-term model has 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 really focus 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 yields that we get out of the line. And the third is the run rate at which the factory moves material. And we're making steady improvements on each of those. They tend to occur kind of inconsistently in the event driven over time. So we anticipate that we'll be able to continue to make progress on this.

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 a gigawatt of capacity. It sounds like that figure should be higher now. Can you add anything to that?

I think if you look at the last guidance we gave essentially is always based on the demonstrated run rate. So at this point in time, you would essentially take all 23 lines, multiply them by the 45 megawatt demonstrated run rate, which would get you about the gigawatt level.

Great. Thanks very much.

Thank you. Our next question comes from, excuse me if I pronounce this wrong, Jesse Pichel of Piper Jaffray.

Hi, congratulations on good quarter. Jens, regarding your Q2 guidance, I'm coming up with 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.

Yeah, I think what we gave you was not necessarily to intend to a quarter our remaining focus on annual guidance. So we wanted to give you a look, 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 the shipping that product completing final product qualifications in the quarter.

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

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

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

I'll have Bruce answer that.

Jesse, basically what you're 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 qualifications phases. So we're getting smarter and smarter and that basically enables us to startup the facilities more effectively.

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 rollout to the other plants a quarter or two after that?

Yes. Again consistent with our copy smart philosophy, what we do is we make improvements to efficiency and then those improvements are propagated out to all of our factories so that we maintain lockstep alignment in terms of the process in all of the factories. And so, yeah, as we make improvements, that will rollout 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.

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

Well, we've got a road map of efficiency improvements and as we've said in the past, those -- the implementation of those tend to be event driven. And as we factor those into the line and we qualify them, those will rollout appropriately to the other factories.

Thank you. Good luck.

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

Hi. 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 U.S., what balance of system cost is needed to achieve that? Thanks.

We don't -- we don't get that granular right now in terms of breaking out the system components. I think what we've -- the other thing is we don't really have projects, utility scale deployed if the U.S. yet to talk about and we try to stay at historical. But a data point I can provide that's helpful that we have talked about in the past is what have we 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 EUR1.55 or thereabouts. That doesn't mean it will necessarily translate into the U.S., but I think it's a data point anyway.

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 costs?

In terms of overall system costs?

Yeah.

I think it will be spread. I think it will be spread across the system components and installation, and -- I mine, if you think about what could a company, at a company level, afford to sell a system for, there's also an overhead absorption piece that's important. So some of this is business model related. How efficiently can you develop a business model to drive throughput and minimize the contribution margin, or maximize the absorption of overhead is a 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 to system cost components, a reduction in installation and labor as a result of primarily more rapid installation times, and then a business model that's scalable that allows you to drive high throughput of a system sales across a fairly lean fixed cost base.

Just one quick add to that. I think if you look at the cost reduction road map for balance of system that we published that indicate us coming from a $1.50 to $1.60, which we've seen in Europe, down to $1.00, and about one-third of that is efficiency driven, followed by bill of material savings, and then the scaling that Mike mentioned.

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 watts currently used in your panels on the tellurium side?

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

Thank you.

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

Sure. Hey, Jens, your hedging comments there, you said 37% was hedged at a rate of $1.45, but then you said 53%, I believe, was the combined with the natural hedge. Does that mean that 47% of your revenues are unhedged?

No, you have got to look at it on an income statement geographical basis. So 37% of the revenues are hedged. So on a pure revenue line basis, you have got 63% floating with the euro. However, since we've got euro denominated expenses in Frankfurt Oder, that translates into the 53% on an earnings basis being hedged naturally or by our derivatives.

Which would result, then, in 47% of your revenues throughout 2008 being unhedged then, is that correct?

Of our income, yes.

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

Yeah, 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 a number of utilities that have a demand to meet RPS requirements. So those are the discussions and under those programs there's typically, not always, but typically there's no breakout for PV, no separate set of quotas for PV, so PV is competing with other renewable energy sources under a set of criteria that, at least in California, is centered around least cost, best fit generation renewable resource under all the circumstances of their grid.

So the discussions have centered around that. How does our offering match up on a less cost best fit basis. What are the relevant price points, what's the appropriate path to market. What are the development cycles. There's a lot of learning involved here and quite a bit of difference from the feed in tariff markets that you see in Europe. That's basically how we're proceeding.

Okay. If I could just follow-up on that real quick. It would seem -- I'm surprised at your comments that you think that the RPS is the best in California. I mean the RPSs, quite frankly, are 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 need and you now have a RPS there that actually has penalties to go along with it. 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 and your installers here in the U.S. to worry about the commercial market?

Yeah. Well, I guess California versus New Jersey, we're -- we would welcome any RPS program that has bite it to, creates real demand. And we've looked at both of those RPS programs and others. And I don't mean to slight New Jersey. I think that's great, too. So we're looking at a variety of programs and we haven't really announced, other than the Blythe project, we haven't really announced this initial set of projects and even totally defined in our minds where will that initial traction be.

So I think everything is open for consideration. We're spending an awful lot of time in multiple states. So I didn't mean to imply just a California focus at this point. In terms of our customers, we do have the set of customers in Europe operating under these long-term take or pay agreements 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, in fact, making plans to do that and have started to do that. So I would expect that we would see some of our modules showing up on rooftops via our customer/integrators. That's a good point.

Thank you. Our next question comes from Al Kaschalk of Wedbush.

Good morning. Mike, I just wanted to follow up on -- I'll leave the margin questions alone, but on the utility side in the U.S., what is the, I won't say the timeline 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're touching on?

We would like to have by the end of the year several projects, let's call it two to four projects, approved, underway, being executed at various stages. These would be multi-megawatt, typically ground mounted projects, although wouldn't have to necessarily be ground mounted. It could also be large rooftop, working with the utility as an offtaker. We would like to have several of those underway. And we would 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 what we're working to now, and I think -- as I say, I think we're on plan to that. We haven't got a lot of these concluded yet, but I think we're making pretty good progress.

Would it be fair to say, I'm sorry if I appear to be pushing you on this, but let's go for it. Would it be fair to say that you're tracking towards your internal targets on this opportunity and there is maybe some frustration just at the speed in which maybe your potential end customer moves?

No, I don't think so. I think there's -- I think there's a fair amount of urgency on the end customer's side, but there are regulatory requirements here, there are permitting requirements. There's a more elaborate -- there's 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 elongated.

So I think we're seeing about what we expected, frankly, in terms of development cycles and approval processes, and I -- and we're observing a fairly high sense of urgency on the part of some of these utilities to procure renewable energy to meet the quotas. And I think that utility commissions, at least in some states, are putting a fair amount of pressure on utilities to comply. So I -- I really think we're about where we expected to be.

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 installations in the United States.

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

Yeah, hi, thanks for taking my question. Just a quick clarification on inventory. You produced about as much as you sold but days inventories were up a bit. Could you clarify what was driving that in Malaysia?

Yeah, every time we're bringing up a new manufacturing site, obviously, if you start producing, right, you take a step function involves raw materials and work in progress commensurate with that ramp bring up.

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 add a little bit more granularity. Is there any cost inflation from raw materials, like cadmium phalerate and also can you give -- remind us what Malaysia will give you once it is fully ramped in terms of cost reduction?

I think if you look at -- as a cost per watt we saw in the first quarter, actually if you compare quarter over quarter, there's 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 a quarter to quarter trend basis. With respect to Malaysia, I think we stated this before, that when compared to Harrisburg, we would expect about a $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, as the first plant gets to full production and we get full validation of that.

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

Hi. Thank you for taking my question. I was curious if you could maybe help us with what percentage of 2008's 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 feeding to accounts and maybe in 2009, how many would be affected by that 6.5% AST reduction that would hit January 1st. Is it the vast majority, is it 90%, something like that?

Yeah, Dan, on 2008, which is really what we've -- we sort of limit the discussion to '08, because '09, it's a dynamic process allocating products. It's hard to say where we'll 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 U.S., seed other opportunity. It's an ongoing process.

As I mentioned, demand continues to exceed supply and we have contractual put options in our customer agreements, so we feel like we can -- 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, so we manage it in that fashion.

Our next question comes from Michael Molnar of Goldman Sachs.

Good morning, everybody.

Good morning, Michael.

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?

That's our production -- that's a production cost. And so the way we calculate, you can't calculate it purely on a COGS basis because it includes the inventory component.

Got it. Okay, and --

It's also manufacturing costs in the period divided it by total watts produced.

And where were any sort of other costs related to Turner? I think there was a couple of million in the first quarter.

Well, I think really what we have seen 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 costs.

Okay. And second question is, given that PV large scale installations have not been done in the 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 levels?

Sure. I mean, what -- I guess if you start at the top and say the economics are more challenging here. If you think about that $0.12 to $0.15 a 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 rollup to a turnkey system cost, which then derives your cost per kilowatt hour, those assumptions have to -- they're finer with smaller ranges of error. And so part of this validation piece is really around before we start, we turn on the faucet, and really start running big volumes. 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.

Obviously, we don't want to be dramatically lower on price than we need to be to open up the market. So there's 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. To your point, if 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 of systems for projects installed, deployed or completed on time. I don't think that's an insurmountable issue, but it does require some development of the down stream 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 some time at the front to gather your partners, define 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 third piece is really fleshing 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 energy, as opposed to waiting on transmission projects to be built. But that takes some resource planning and some integration on the utilities side. So there's a set of discussions there that need to take place as well. But those are some of the issues, Michael, that we're working through now.

Our next question comes from Mehdi Hosseini of FBR.

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, the RPS programs, where your customers may be evaluating photovoltaic versus other means of solar options. How are those market dynamics are tracking, especially in regards to CSP?

And then outside of RPS, not knowing what the ITC -- when ITC is going to be extended or not, so not knowing what the [seat and tires] are going to look like in Europe, can you please elaborate on some of the market dynamics are you seeing that would impact some of your projects beyond '08? Thank you.

Okay. On the first question, there is no -- there is no ability to push out per quarter on the part of our customers under these contracts, so the quarters are locked down with respect to volume.

On the U.S. utility market, these regulated utilities our load serving entities are looking at, as I've mentioned, the whole range; solar, thermal, wind, geothermal, PV. Then a number of solar thermal contracts announced recently, or bids at least. So that's a competitor for us. So the way we think about that, what that means is initially we have to be in the 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 their other generation mix. And based on that, 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 -- we don't have a lot of moving parts. We don't have any moving parts. The operation, maintenance or variable expenses are minimal.

So there's 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 CSP and that's why I say when we -- what we're testing is this $0.12 to $0.15 a kilowatt hour range. That's, just anecdotally, where these CSP bids come in. And 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's see. On the ITC, I don't think we bring any special insight here. It's been pretty well chronicled publicly. The trials and tribulations of extending the 30% ITC, we just don't know. I mean, so in that situation, the best you can do is be robust in your business model against the various outcomes. We think if the ITC is not extended, which feels like less than a 50% outcome but it's a distinct possibility, if it is not extended, then that will hurt the U.S. market. There's no question about that. You can do the math and see that system costs go up somewhere between 25% and 30% if that ITC is not extended. Fortunately, we have other markets and that's where the optionality comes in to be able to redeploy and move where it makes economic sense. So we're long-term players in the U.S. utility market. I would say the short-term timing and we're watching it closely and just trying to be robust against the range of outcomes.

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

Good morning. I know that the efficiency gains you realize in your modules tend to be somewhat lumpy in realizing them; 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're finally beginning to approach some kind of [acentote] 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've actually seen in a lot of quarters over the last year?

Yeah, the performance this quarter, as you said, was up about 3% to about 45 megawatts per line per year. That's been something that has been steady over time for us to hit our long-term 2010 and 2012 cost targets. 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 three 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.

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

Yes, sir. Our final question comes from Jonathan Hoopes of ThinkEquity.

Thank you, I would like to better understand, generally speaking, if you're de-linking 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 your contracts or is all of the pricing fixed at time of signing?

I think we've, Jonathan, I think we answered that question earlier between contract and non-contract. We said about 80% to 85% of the production output was contracted, plus the underlying optionality and ability via put option to place more volume into a strong demand environment in Europe. With respect to the pricing, we really don't have -- we're not serving the spot market. Essentially those long-term contracts, when I do talk about customer mix, that 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.

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.