SunPower Corporation (SPWR) 2006 Q3 法說會逐字稿

Good morning, and welcome to SunPower Corporation's third-quarter 2006 earnings release conference call. Your lines have been placed on a listen-only mode until the question-and-answer segment of today's call. This call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Tom Werner, CEO of SunPower Corporation. Thank you, sir. You may begin.

Welcome to SunPower's third-quarter 2006 earnings call. We had another very strong quarter with excellent execution across the board that resulted in another quarter of operational results that exceeded our guidance. Our first fab now has three lines fully ramped. The total capacity of these three lines is over 75 megawatts. Our move to thinner wafers in quarter one continues to pay off. We now run 190 Micron wafers on all of our lines, and we have a polysilicon utilization of less than 7.5 grams per watt.

We're on schedule and on budget for beginning our Q4 ramp of our Generation 2 technology on Line 4, and we're on schedule and on budget ramping our first automated panel line. Lastly, we're on schedule and on budget for installing our lines 5 and 6 that go into our new fab towards the middle of next year, and we more than doubled our installer network footprint in the United States.

Since the beginning of Q4, we have announced 2007 silicon contract with REC SiTech, solidifying our 2007 silicon supply, and we launched our new groundbreaking 315 watt solar panel. Compared to conventional solar panels, our new SPR 315 offers up to 50% higher power per square foot and 50% fewer panels to install.

During the remainder of this call, we will discuss our business strategy, view highlights of our business, report Q3 financial results and provide guidance for Q4 and confirm our guidance for 2007.

Let's first look at business strategy. Our goal as a Company is to drive down installed system cost to achieve economic parity with retail electric rates. When we accomplish this, we will then be able to participate in the global electricity market, which is measured in the form of $1 trillion. We have direct control over the solar cell and solar panel portions of the value chain, the technology core of the value chain that represents 50% to 75% of total installed costs. In these areas, we are increasing cell and panel efficiencies, improving silicon utilization, continuing to improve operating efficiencies, rapidly expanding our Company to achieve scaled economies, and establishing a scaleable, low-cost silicon supply portfolio.

We have or expect to achieve in the near future substantial influence on the downstream channel in key regions. We plan to scale outbound marketing and lead generation; provide innovative and scale efficient solutions for systems engineering, logistics, financing, and after sale service; develop comprehensive product solutions that integrate improvements across the value chain in silicon ingot to site installation; and we will diversify our customer base by application and geography.

All of these strategies taken together will allow us -- we expect these to allow us to drive installed solar system costs to be competitive with retail electric rates.

Let's now talk about technology. SunPower makes the highest efficiency solar cells commercially available. We are the only company shipping solar cells at a minimum rating of 20% efficiency. This compares to a market average of 14% age 16% according to third-party industry analysts. We are leveraging this technology advantage across the entire value chain. This advantage, or that advantage, stems from innovation by our founder, Dick Swanson and his team. And we are thrilled that Dick has been recognized twice in the last few months for this success. First, in Dresden, he was recognized with the Becquerel Prize by the European Commission. Last Tuesday, two days ago, Dick received a Wall Street Journal Technology Innovation Award.

We continue to invest in research and development, and we will substantially extend our lead in terms of efficiency. By the end of this year, we will be shipping our Generation 2 solar cells with a rated efficiency of 22%. In fact, we're already manufacturing pre-production volumes of our Generation 2 solar cells.

On the operating front, our R&D team works closely with our manufacturing operations on equipment and process design among other things. The evidence of this partnership can be seen in our operating results. We are meeting or exceeding our operating metrics. We've ramped three lines on plan or better, and those three lines compete against each other in terms of performance against operating metrics.

We have also successfully converted all three lines to 190 Micron wafers. And we continue to improve polysilicon utilization. In Q3, our polysilicon utilization was a little less than 7.5 grams per watt. On Line 4, which will produce our Generation 2 technology, we will reach approximately 7 grams per watt. And as silicon eases in the future, we expect significant leverage because of our excellent utilization of polysilicon.

And in the operations section, we are on schedule and on budget for completing buildout of Fab 1, beginning construction -- we've begun construction -- at Fab 2, the building that we bought in quarter two, and we are ramping our automated panel line, and I will speak more of that in a few minutes.

In terms of expansion, we had strong operational results that allow us to have better visibility into our expansion plans. By the end of this year, we expect to be at 108 megawatts of capacity and our first fab will be completely full. By the end of next year, we will have almost 100 more megawatts. We will be at 207 megawatts. That will be because we have implemented three new lines that utilize our Generation 2 technology, and that will be in the new fab that we bought in quarter two.

At the end of 2008, we expect to have about 375 megawatts, which is five more generation two lines that will fit within our new fab. Note that this new fab has capacity of 10 lines so that there will be two more lines that we can add some time beyond 2008, is the current plan.

Let me say a few things about our automated panel line. We manufactured our first production panels in the last few weeks. That plant that we are manufacturing has a 90 megawatt footprint. The first line has a 30 megawatt capacity. The reason why we're doing this is so that we can lower costs through advanced automated production. By being automated, we can replicate these lines close to end market so that we can reduce supply chain costs sometime in the future.

Now let me make a few comments about silicon. As you all probably know, silicon supply remains a gating factor in most of the solar industry. We expect silicon supply constraints to continue through sometime in 2007. Our Company is positioned very well for rapid expansion with existing deals 2008 and beyond. We expect to continue to work on polysilicon procurement in support of our ingot suppliers in 2007 and 2008.

Let me remind you that we take a portfolio approach to silicon supply, in that we diversify on three dimensions -- the first is length of term. We have short, intermediate and long-term contracts, the longest being ten years. We also diversify along the lines of suppliers. We have agreements with both incumbents and emerging suppliers. And lastly, we would diversify along technology lines. We have partnerships with established players as well as investments with emerging players.

Now let's talk about polysilicon supply a little bit more. First, we do business with the top three incumbents. We signed agreements to support market entry of two new entrants, the first being M. Setek, and they are on track for supply in 2008. The second is DC Chemical. And they are also on track to begin supply in 2008.

Let me just say a few words about DC Chemical. DC Chemical is a $1.7 billion company in terms of revenue. They are strongly profitable, and they produce a broad range of chemicals, including some of those used in polysilicon manufacture.

Now let's talk about ingot supply. Today we do business with leading ingot suppliers, including M. Setek, REC SiTech and Siltronic, among others. M. Setek has been a partner with us since our inception and we are very pleased with this partnership and we expect this to be a very long-term partnership.

We also announced a joint venture with Woongjin Coway. The idea of this joint venture is that they will produce ingot, utilizing EC chemical poly. Let me just say something about Woongjin.

Woongjin is a leading environmental products company. They have $1 billion of profitable revenue and a $2 billion market cap. Now the purpose of this JV is to reduce supply chain cost because we produce polysilicon in the region and then we will turn it into ingot in the region. We'll also be able to utilize advanced technology that will allow us to have very competitive costs.

Let me end the silicon comments with the cash pre-payments that we will incur over the next two years. First in the fourth quarter of 2006, we will have $47.6 million of pre-payments. In 2007, we will have $48.3 million and in 2008, $18.3 million. Our silicon contracts support both our expansion and our cost reduction plans for 2007 and 2008.

Now let me talk about marketing. As I mentioned earlier, we introduced ground-breaking SPR-315 product this past Monday at the San Jose Solar Conference. This is the highest efficiency, highest power mass marketed solar panel available. It is designed to enhance installation efficiency to drive system cost down. In fact, it requires half the panels, produces 50% more watts per rooftop compared with conventional solar panels.

We're also on track with our plans for geographic and customer diversification. We are expanding in Europe and Asia. We have an incredibly strong focus on our home market. In fact, in Q3, we captured 14% share in the California residential retrofit market.

We also have continued to invest in the outbound channels, and specifically in the domestic outbound channel. That investment is starting to bear fruit. During this quarter, we'll start to rollout an increasingly broad array of products and services, beginning with a new inverter line, customer financing, centralized lead generation, innovative logistics solutions, and finally, driving all of these things lead to improved scale economies and efficiency in a fragmented outbound channel.

On the international side, we have received lots of questions in Germany and Spain. And I will defer broad comments on that until the Q&A section. What I will say is how SunPower is doing.

And I would say that SunPower has strong demand continuing in all regions. We have strong momentum in the U.W. market, and we're rapidly expanding our dealer network. We have doubled our installer network in the past three months. We now have 56 dealers in 13 states. And our market share has increased seven times over the past four quarters. The signing of the California Solar Initiative reinforces the importance of the California market.

We also have sales ramping in Korea. We continue to expand our presence in Japan. And we have a broad base of customer demand throughout Europe, including Germany, Italy, Spain, Portugal, France and Greece.

Let me end with guidance. We will provide top-line gross margin and EPS guidance for next quarter and revenue guidance for this year and next year.

We expect Q4 revenue in the range of $70 to $72 million. We expect Q4 non-GAAP net income in the range of $0.16 to $0.17 per share and Q3 non-GAAP gross margins of 25% to 26%.

In terms of 2007, we will confirm our guidance from last quarter of full-year revenues of greater than $360 million.

Now I would like to turn the call over to Manny Hernandez, who will provide details of our Q3 financial results.

Thanks, Tom. Good morning, everyone, and thank you for joining our third-quarter conference, which ended -- for the quarter which ended September 30.

Before I go over the financial results, I would like to remind everyone that during this conference, management already made and will continue to make comments that are not historical in nature. Please consider these statements as forward-looking pursuant to the Private Securities Litigation Reform Act of 1995. Those statements are based on our current expectations and are subject to certain risks. Please refer to our press release and our SEC filings for a more detailed discussion of those risks.

Let me now give you a summary of our 2006 third-quarter financial results. Revenue for the third quarter was $65.3 million, a 19% increase from our prior-quarter revenue of $54.7 million and almost 3 times the year ago third-quarter revenue of $21.9 million. As Tom mentioned, demand for our products continues to be strong across all regions at relatively stable average selling prices.

On a GAAP basis, we posted a net income of $9.6 million or 14.7% of sales or $0.13 per diluted shares. And that compares to last quarter's net income of $5.4 million, or $0.08 per share and the year-ago quarter net loss of $1.6 million.

On a non-GAAP basis, which is adjusted to exclude non-cash charges for amortization of intangible assets, and stock-based compensation, our third-quarter net income was $12.1 million or 18.5% of sales. This resulted in a diluted earnings per share of $0.16, a 61% improvement from the prior quarter's net income of $7.5 million or $0.11 per share. Our year-ago third quarter was a net loss of $0.1 million.

Our third-quarter net income benefited from $3.9 million of other income, mostly interest from cash that we have on hand. Absent that interest benefit, our operating income also improved to $8.8 million or 14% of sales compared to last quarter's operating income of $6.2 million.

Our gross margin for the third quarter was 25.3% compared to last quarter's 23.5%, a 180 basis points improvement benefiting from our 19% increase in revenue, slightly higher ASPs, and continued benefits from our manufacturing cost reductions, most notably our thin wafer initiative. We still expect to exit this year with gross margin of 25% to 26% while we commence the ramp of our fourth line and also the ramp of our automated module factory.

Briefly on the balance sheet, we ended the third quarter with cash and short-term investments of approximately $274 million. The Company continues to have no debt. Our DSO was 65 days while our net inventory closed at 49 days.

Our capital expenditure for the quarter was $31.6 million and depreciation was $4.2 million. The total capital for the year is still estimated at $95 to $100 million and full year's depreciation of approximately $60 million.

Let me you now turn it over back to Tom to lead us through the Q&A session.

Thanks, Manny. I will open the call to questions in just a minute. A couple of housekeeping items first.

I have with me Peter Aschenbrenner, our VP of Sales and marketing, and Julie Blunden, our VP of External Affairs so they can provide answers as well. And one other housekeeping item.

I would like to have the questioner ask one question and perhaps a follow-up. And if you have more beyond that, then maybe you can come back into the queue later. But that way, we can make sure we get to everybody and the call has a reasonable period of time that we can get through it.

So with that, I will turn it to questions.

(OPERATOR INSTRUCTIONS). Sanjay Shrestha.

First Albany. First of all, congratulations on a great quarter here. Just a couple of quick questions. First one, Tom, you kind of mentioned in here passing about a lot of talk about the pricing pressure, the administrative issues in Spain and things of that nature. But seems like ASP did go up again for you guys here on a sequential basis. So I was wondering, if you can kind of go into some more details as it relates to -- not necessarily the supply side of the raw material but the demand side of the equation -- how that is playing out for you guys in a variety of different markets? And sort of like internal planning that you have in place for 2007. How are you looking at it internally? Are you sort of modeling a price decline curve about 5 to 7%? Or given your premium sort of commanding ability, are you sort of saying that the price sort of stays flat for you guys? Despite the potential decline for some of the other players in the industry, and hence, margin with all the benefit of the technology ramp-up and stuff like that.

Thanks, Sanjay, that was a heck of a single question. A good one to start with.

We get asked a lot about what is happening in the overall market, and we find ourselves opining on that. And then we usually end up saying, but let's talk about what is happening in SunPower specifically. So we want to be a little cautious about trying to talk too much about the overall market because we don't pretend to be a third-party analyst. And with that as just a characterization, I will turn it over to Peter and let him go through the details.

Sanjay, I think I will start with what our expectations are for next year in terms of our pricing. As we said on the past few calls, we have a target blended ASP of about $3.50 a watt and we expect that to continue stable at that level into 2007.

I think you touched on some of the reasons that support that in what is and should be in the future a declining price industry as we drive things down to grid parity costs. So in the near-term, there are a few elements that support our ability to maintain stable pricing. The first of which is that we have I think developed a strong brand presence in the market in a relatively short period of time, and there's a significant amount of latent demand for our product that we haven't been able to service as yet as we have been growing our capacity. So we've got a lot of customers in the queue, waiting for product from SunPower. And as we broaden our customer base, we will be able to get higher incremental ASPs to those customers.

Secondly, as we expand capacity, we can direct incremental product to higher ASP markets that -- where we are able to charge a premium for our product. And some of these markets include Korea and southern Europe, among other regions.

And finally, there will be a gradual shift in our product mix going forward, whereby we will see shift to higher value products such as the new SPR-315, which provides cost reduction potential for installers by virtue of its greater efficiency and size. And also, I think we will see relatively flat solar cell sales in absolute megawatt terms with growing module volumes with their higher relative ASPs. So all of these factors together among other things allow us to forecast a stable ASP outlook.

Got it, got it. That's great. And if I could, just a quick follow-up question. Tom, you mentioned in your prepared remarks that you think that the polysilicon situation could start to ease some time in 2007. Just wanted to clarify that. Is that more specific to you guys and your level of comfort with your new JV partners and their ability to deliver polysilicon? Or are you seeing some of the new entrants making a dramatic technological progress giving you a level off comfort that even on an industry basis going into 2008, the whole polysilicon situation should actually be much better than the way it might be even by the first half of '07?

I will just comment briefly on the macro environment and then spend most of my time on SunPower. Macro environment, in terms of the macro environment, we think the incumbents are minimally being successful with their expansion plans and we're optimistic as they are increasingly, I believe, that their expansion plans will actually be beaten a little bit. So I think that the incumbents will -- we are planning, to a degree anyway, that they will be able to exceed their expansion plans.

We also know that the semiconductor market is softening to a degree. And I think that that will start to play out during the first half of '07, if there will be some supply that will move over to solar. It is sort of an obvious thing for people that do both. Those are really the only two comments I would make on the overall macro environment.

In terms of SunPower, which I think is far more relevant, because frankly, it is what we spend all our time on, is can we get enough silicon? And I would say that you should think of our silicon situation really in three phases. And this has a lot to do with what I said about getting to electric power grid parity. And we kind of look at three phases of getting there. First is the first half of next year is a continuation of '06. And that is that we have contracts for the silicon we need to hit our expected revenue.

In the second half of '06, we have new supply coming online that both allows us to hit our expected revenue but also starts to improve the economics. And of course, while both of those things are happening, we are expanding our business, so we have scale advantages as well.

And then in 2008, we have a substantial change in supply with the new players coming on as well as an improvement of the economics of that supply. And both of those things, as well as our ability to ramp lines gives us a big scale advantage. So if you think of those as three phases in 2008, we really accelerate. The back half of '07, we start to accelerate. And the first half of '07, we are setting the table. And all of that big picture leads to us driving towards electric grid parity.

The last comment I am going to make, just briefly, is, yes, we also have increasing confidence in the new entrants. As I mentioned, some of the statistics on those companies -- they are big companies. They have most of the technology needed. And in collaboration, we believe that they have the pieces they need that they didn't have when they started. And the progress that both companies have had since the last time we had this call is at least on plan if not better.

That is great. Once again, thank you, and congratulations on a great execution here, guys.

Jesse Pichel.

Jesse Pichel from Piper Jaffray. First question is, could you give us some housecleaning items with ASPs, megawatts shipped and percentage of module versus cell?

And secondly, for Manny -- Manny, how do reach 30% gross profit, 5 more points of margin specifically? Could you break that out for us between polysilicon savings if any? Two, efficiency increases? Or three, some type of other efficiencies? And what ASP percent decline do you assume in reaching that 30%?

We will have Peter take the first question and then Manny will take the second one.

Jesse, our shipments for Q3 were just a hair over 17 megawatts. Our ASP was $3.57 a watt. As you know, I think we don't break that out into cell and module percentage for reasons of confidentiality agreements we have with our cell customers. So I guess that is my part of the answer. Manny?

On the 30% gross margin target that we have set for ourselves and are still aspiring to achieve by the second half of 2007, let me start with the last part of the question, what the ASP assumption or decline did we assume there. Keying off what Peter just went through, we're actually staying with our assumption that we could hold ASP stable in the 350 per watt range for the year.

So most of the improvements are going to come from both scale -- but more notably on the polysilicon side, Jesse, because we continue to reduce our grams per watt.

And the efficiency -- think about it this way, from an efficiency standpoint, Gen 2 is really going to come from Line 4. So our first three lines are still going to be producing the 1 Gen 1 product, line if you will. That will give you a sense of what ratio will come from efficiency, but mostly from polysilicon and scale is what is going to get us to the 30%.

Do you go back and upgrade lines 1 and 2 or 3?

Yes, Jesse, this is Tom. Yes, we will upgrade those lines. We are still determining what the schedule will be for the first three lines conversion. So for planning purposes, we currently don't have those lines shipping 22% cells.

Solid quarter, thanks.

Tim Luke.

Congratulations on your execution. I was just wondering just to follow up on your offer of some commentary with respect to the trends that you have seen in some of those key regions and how you have seen particularly the trend in both Northern Europe and then the opportunity as it is developing in southern Europe and how you see the mix and the outlook in North America as you alluded to this California set or initiative.

We will let Peter answer that. But I do have to comment, Tim, you get the iron man award for consecutive earnings calls (multiple speakers).

That was quite a call, that one.

Peter?

Tim, let's start in Northern Europe, which of course is dominated by the German market. So the policy environment in Germany has been relatively stable for a period of time, and I think reflects something of the gold standard, certainly on the policy side. The current feed-in tariff law is structured so that there is a built in reduction each year of between 5 and 6.5% of the feed-in tariff, depending on the specific application type. So that will kick into place again in January of 2007. And customers will receive a 5 to 6.5% lower price for the electricity they generate.

But I think we can expect in Germany -- or we should expect logically at least that type of price reduction in the installed system price. Exactly what percentage that comes in the solar panel versus the downstream piece, of course [there is real] dynamic tension.

The current EEG law, the feed-in tariff law, is scheduled for a review in 2007. And so I think we can expect to hear a lot about the German market on an ongoing basis for the next year or so.

What is the timeline for that change to really be coming into effect? (multiple speakers) because of the review and --?

Excuse me?

They are going to take a year to review --?

Yes, it's going to be a long process, I think.

In southern Europe, as you mentioned, there's a number of markets, a growing number of markets, that are establishing the infrastructure and the platform that is necessary if we look back in markets like Germany for the sort of second explosive growth phase. And I would say that both Spain and Italy are certainly in that stage of infrastructure building and policy firming. And arguably, Greece and France are slightly behind that but still in the pipeline.

There has been a minor change in the Spanish feed-in tariff as well in that the rate that customers receive for electricity generated by solar systems was pegged as a multiple of retail electricity rates, standard retail electricity rates. And as those rates went up, the policy makers decided to de-couple those two so that the solar rates weren't continuing to be pushed up by increasing retail rates.

And we believe that there will be also a review in Spain and potentially a change in the feed-in tariff sometime late in 2007, according to what we hear from our customers. So what we are seeing I think is a very natural evolution in a variety of policy-driven markets. They go through phases.

As the markets mature, rules get adjusted. I think the important thing is that these are generally being driven still by popular opinion, which is strongly in favor of renewable energy. And we think they key for a company like ours is to have a long-term strategy that rides through these things, strong partnerships locally, and a diversified base both in terms of application and geography. (multiple speakers.)

Could you just as an (multiple speakers) to that just comment on, there has been this -- maybe it's somewhat dated -- but there was this concern about inventory levels. And then also if you perhaps just allude to any changes that you may have perceived in the competitive positioning of players in those different markets?

I can talk to inventory levels directly since we have been meeting with most of our European customers here in the last few days. So what we have heard is that they do see inventory, in Germany in particular, but not of our product, was the exact quote that we heard.

So how do you see expect that to impact you guys or do you not?

Well, as I said earlier, we don't expect that to impact us in terms of our average ASP, at least for the foreseeable future.

Tim, this is Tom. A comment on both. The efficiency advantage or the power density advantage we have and the esthetic advantage are two things that have real benefits in the marketplace. And there has been an adequate supply to satisfy the demand for those benefits. So what we experience in the market may be a little bit different. And we are also, in terms of size, you have to take that into consideration as well.

In terms of relative to competition, I would just say that you can kind of -- we see the landscape group by efficiency or power output in a form factor. And there is one or two that have the high power density. Only one that has the aesthetics as well, that being us. And then there's a group of other folks that have materially similar output. And then in terms of power density I would put things like [syntel] on a lower tier. So I would group it like that. And there's different advantages. But we are feeling pretty good about both of our advantages.

Just as we model, we should think about the geographic mix doing what sort of things for '07?

Well, historically, our product has been about 50 to 60% varying by quarter in Europe. We would expect to see that continue next year. We would see a gradual ongoing shift from Germany to rest of Europe. And then the North American market growing from 20% to 30% say and the balance in Asia and other regions.

Rob Stone.

Cowen & Company. I wonder, Tom, if you could just put a little more color on your comments about downstream expansion, how that is to be implemented, whether that involves bringing in, in some formal way, some partnerships with folks who are already active downstream or if this is essentially a startup activity for SunPower?

I will make a couple of broad comments briefly and hand it to Peter, and he can cover any details on this.

We have talked about making both an organic investment, i.e., adding headcount and expertise and looking opportunistically at potential mergers and acquisitions or partnerships. And we continue to work on both of those; I will speak to the latter first.

Everybody knows that we haven't announced any M&A activity. And I would just tell you that we continue to look at options there. On the organic side, we have been investing for 18 months at least. And we have added expertise in the areas that I mentioned during my earlier remarks in terms of financing programs and logistics programs, marketing and things of that nature. And so what we are doing is we are partnering with dealer/installers, primarily in new markets and helping them scale. And that's why I say broadly. Do you want to add anything? I think that basically covers it.

A follow-up question, in your press release, you comment about gaining significant market share in the North American market. And some may interpret the absence of commentary about market share in other markets as having some hidden meaning. I suspect it may be that it's more difficult to measure share in other markets; can you put some color on that?

That is exactly right, Rob. One of the attributes of the California market is that there is a very detailed and open and transparent tracking mechanism, where you can go in on the California Energy Commission website and sort by a variety of filters and really get a good real-time view of market share, pricing and a variety of other market dynamics.

Many of the other markets lack that kind of tracking mechanism. So we think we are gaining share in all of the major markets where we are active. But numerically, it is most directly provable in California.

Shannon Mikus.

Credit Suisse. My question is on SG&A. It looks like it was higher than what you had anticipated. I think you said $4.5 million during the Q2 call. Can you talk about why that was? And was that $4.5 million a GAAP or a non-GAAP number?

Manny Hernandez will take that question.

The third quarter's SG&A expenses were abnormally high due to some non-recurring legal expenses related to transactions that we processed or completed during the quarter, including finalization of the DC Chemical contract, the Woongjin contract and other similar transactions. We have also increased our base spending on sales and marketing in pursuit of the downstream strategy that Tom just went over.

So our guidance for Q4 '06 is actually lower SG&A spending to around $5 million, down from the $5.5 that you know see there on the non-GAAP statement, Shannon. And the $5 million spending for SG&A in the fourth quarter will also include continued investment in the downstream channel.

So what do you expect that to go to in '07?

Our target or model for SG&A combined is 6% of sales. We are higher than that now, so consistent with our outlook of achieving our model by the second half, we should get to around 6% by the second half.

And that is non-GAAP?

That is non-GAAP, yes.

David Edwards.

Dave Edwards from ThinkEquity. Wanted to continue on the downstream side. You talked a little bit about the customer financing and I know there's some talk about that at the conference this week. Can you talk a little about the partnerships there and also how the customer will access the product?

So we have just announced a customer financing package that we just rolled out actually in the last week at our installer partner conference here in San Jose. This'll be accessed through the installer. There will be a standardized application, an approval process. And it will allow customers to finance their systems and improve the cash flow carrying capacity of the dealers, which is typically one of the bottlenecks in growing a network like this.

And just one other question if I could. You talked a bit about the expansion of the automated panel manufacturing in terms of megawatts. How should we think about that capacity in comparison to your overall cell manufacturing capacity?

This is Tom. So our automated panel line started production units over the last few weeks. And I want to mentioned as well that we have a partner in China and we will continue to have a partner in China. So they will continue to run at the rate that they essentially were all of our capacity in Q3. So going forward, we will expand with the automated lines and it will become an increasing percentage of the mix between our partner in China and our internal capability.

Throughout '07, we'll probably add and it's depending on how fast the lines ramp and the overall capacity of those lines, but we will probably ramp at least one more if not two more. So that you could roughly think of it as Q3 run rate for our partner in China and the balance increasing through our automated line.

David Smith.

Citigroup. On the price per kilowatt, can you give us a sense of what you are paying today and where you kind of see that moving going forward, on silicon?

Let me just address that in terms of how we think of cost of silicon. Just broadly speaking, we buy ingot, but what I would talk to is trends.

And it is materially consistent with what we've said on previous earnings calls. We are seeing the cost of silicon to us go up by single digits within the 10% that we previously talked about. And that is through the 2007 timeframe.

I should also, before someone asks, I will comment that in 2007, we now have contracts for the number of megawatts that we have communicated that we would ship -- the 110. And that those contracts have pricing in them as well for all of 2007.

Can you give us maybe a sense -- I know you are probably reluctant to talk about an actual dollar value per kilogram, but maybe on an index basis if today is say $100 in '07, would be like $70 '08, would it be like 50? Just an idea of where silicon price is going?

Yes, why don't I do an educated guess -- just a rough index, and then Manny will be calculating away -- if I got it off too badly.

So if you said '06 is $100, '07 would be $110, maybe $115, I don't have the exact number, but $110 to $115. And '08, now this is an educated guess, I will call it -- '08 would be less than $100. '08 is probably going to be on $80 to $90. And again, if I am off by much, we will re-answer that question later.

That is helpful. Can you maybe talk about -- in Europe, we've talked a bit about Spain, Italy, France, and Greece coming on but if we do see a bit of a slowdown, that's natural to expect in Germany given the growth that we've seen there. But how long do you think it takes for the rest of Europe to maybe absorb some of that fall-off in terms of market growth that we see in Germany?

Let me just say a couple things broadly and then I will turn it over to Peter if he wants to add. The German dynamic is something that is very consistent with what we, SunPower, have been communicating really since we went, public, and it is simply because the feed-in tariff reduces by 5% a year and next year will be 0.95 raised to the power of 3. It will be the third 5% reduction.

So the point is, is that in order for the economics to work, eventually the price of the product has to come down. So the dynamic we are seeing is, is the ability of manufacturers or the choice of manufacturers to lower price that will cause that market to either stabilize or continue to grow, but perhaps at a less of a rate.

So from a big picture, I'm not quite sure Germany -- it will slow in terms of growth, but maybe not flatten. The country that certainly has the capacity to start expanding fairly rapidly is Spain. And Peter mentioned earlier that there is some modifications going on there. But among those is the system that Spain uses is starting to get mature and get more effective for people to get the feed-in tariff -- or the feed-in rebate. So Spain specifically -- and then Peter, if you want to add a little bit?

David, this is Peter. I think what we are seeing in Europe on a pan-European basis is supply and demand that have come roughly back into balance from a situation six to 12 months ago when they were -- I guess I would characterize it as wildly out of balance in terms of not having anywhere near enough supply. So we see -- as I said, some inventory in Germany that can easily or more quickly get absorbed as the southern European markets come onstream a little bit more rapidly. And that is something that I think most people are expecting to happen in the next couple quarters.

Stuart Bush.

RBC Capital Markets. You talked about how bringing the panel production in house will eventually provide some supply chain benefits. Can you give us some more color on how large that incremental impact will be to gross margins and when we should expect to see some of those benefits?

Let me just talk a little bit about the strategy and then maybe, Manny, you could comment on the impact.

On the automated line -- we will have in two steps. The first step is what we call islands of automation, where the entire panel assembly is done in say two or three steps. Maybe some of you will see that when you go see our factory.

And then the second phase would be that there are no steps; it's just cells in and panels out. And it is when we accomplish that that we will start materially moving panel assembly to end markets. And that is either outside of '07 or at the very end of '07. It is really scheduled for the first part of '08 that we will actually start to be able to do that.

So the impact of '07 is going to be minimal. But in terms of the potential impact, I will turn that to Manny.

I want to give you a couple of data points that might help you get there. Just for reference, the conversion cost of a typical module represents about 25% to 30% of the cost of the product. And going to internal, fully automated manufacturing, we expect to realize 25% to 30% cost reduction from that piece. So the impact is fairly significant, particularly as that percentage of our business gets bigger from a module standpoint compared to the two today, where we have a certain mix of cells in modules, the module content is going to get higher. So as we do more ourselves in an automated way, expect a 25% to 30% cost reduction on that piece.

So we are talking about 7% or so incremental gross margin possibly in the '08 timeframe?

Yes.

Pearce Hammond.

This is Brian Gamble sitting in for Pearce from Simmons & Co. Just a couple of quick follows-up on some previously asked questions.

Number one, I know you guys talked about some of the shorter-term issues to keeping your prices up. I was wondering if you could provide any detail around the variants that you're seeing in the higher ASP versus the lower ASP markets -- as far as the pricing goes? Is there any percentage you can put on those as far as what the range is?

Sure, this is Peter Aschenbrenner. In rough terms, you would be looking at something in the neighborhood of $1.00 a watt delta between the highest and lowest solar panel ASP opportunities with roughly equivalent scale and conditions worldwide. So there's a very large difference.

And then secondly, what types of policy reviews are being looked at for the German market? Are they giving any specifics on what they plan to do on a cost feed-in decline? Or are they going to change out the policy completely?

And then how do you see that influencing any change that Spain might make towards the later half of '07 or beginning of '08?

Hi, Brian, Julie Blunden. In Germany, there is actually a requirement for a review report, an actual physical report delivered by the end of next year that reviews the entire EEG, not just the solar portion of it. So the components or the elements that they would consider changing, should they find any issues that require adjustment, will be developed in the course of the review of that document.

What we know today is that the solar program in Germany is very popular. It is popular with customers. It is popular politically. It has created a lot of investment in eastern Germany. It is certainly one of the bright spots in new industrial development in the country.

So we don't see the report as a major threat to the overall German market. We do think that there is a decent chance that there will be some fine-tuning of the program. But the scale of the German market, which is twice the size of any other market in the world is such that it is now created its own political momentum. And we feel good about the prospects for the German market going forward.

With regard to the Spanish market, we definitely see the Spanish market going through the same kind of process that we've seen in many other markets that are scaling up rapidly, where policy makers take a look at the kind of market dynamics that have developed as a result of the policies put in place and consider whether or not all the market segments are being adequately addressed etc., and make adjustments to those. It's part of the natural evolution of market development and we expect that we'll end up with constructive outcome in Spain as well.

Steve O'Rourke.

This is Steve O'Rourke from Deutsche Bank. Can you comment on how thin will production wafers go over the next couple of quarters? And at what wafer thickness is factory automation necessary due to yield loss from breakage? That is, could a manual operation handle say 190 Micron thick wafers?

Steve, this is Tom. So let me deal with manual versus automation. I think it is a really good question.

There's really two dynamics there, manual versus automated and then there's really architecture -- ours being a [back] contact cell. And so I think it is clearly more challenging to go thin with manual operation, simply because you have variability between operators. And as we scale companies, they get pretty significant so you can have quite a few operators. So I think you start transitioning as you get below 190.

There is also another dynamic, and that is multicrystalline wafers versus monocrystalline wafers. So I think as you get below 190, or maybe 180, it gets very difficult to handle multicrystalline wafers manually, and I think you need to automate.

For us, we are actually doing some trial runs on wafers that are thinner than that. And I should mention as well that our subsequent lines 5 and 6 and beyond that are Gen 2 lines, they are actually more automated Gen 2 lines. So we are being on lines in that timeframe that can handle thinner wafers, and we are already starting to run trials for those thinner wafers.

I don't want to speculate as to where that is going to land. We have built modules with those thinner wafers and we have them in qual. And so you have to get adequate yield and you have to also pass qual. But suffice it to say that it would be significantly south of 190, assuming that works, and that will be done via automation.

And one other question, what will it cost to upgrade a line to Gen 2?

I don't have the exact CapEx number for you. But it is less than -- significantly less than 20% of the cost of the line.

Tom Astle.

National Bank Financial. First question, just Tom, you made some comment about ASPs eventually being to a level that would support grid parity. Just sort talk about what level you think that is for your product maybe versus the peers? And what you are you seeing as grid parity?

Sure, and Julie may want to add to my question. This is Tom answering. We spent quite a bit of time on this for various reasons. It is what the market -- solar market needs to get to eventually, is to not needing incentives. And that varies by market because the electricity rates, the rates that people pay, the retail electricity rates, vary by market. Not surprisingly, some of those markets are the biggest solar power markets, that being Germany, Japan and California.

So the target cost per kilowatt hour varies by market. And what you have to do is convert a capital cost for a solar system to kilowatt hour cost. So it also varies by how much sunlight you have. And so to answer your question, I would say we think we start addressing incentives-less markets, the top tier of those markets when we get to a 4 to 450 installed solar product. And then of course as you go down further to say 2 to 250, then you are almost addressing the entire retail electric market.

And we have the things that I talked about that we're driving to get to that number. As we have subsequent earnings calls, we will talk about progress on those fronts and how that gets us first to 4 to 450 and then eventually to 2 to 250.

Julie, do you want anything or is that okay?

That is good.

Would you care to throw out a number where you think you will get your wafer thickness down to over the next couple of years?

I will say to you it is certainly probable we will get below 170. And much below that would be educated speculation.

And that drives better grams per watt, obviously.

Absolutely. And we are also, by the way, improving the curve loss. And the sum of curve loss and wafer thickness is called pitch. And both numbers are improving and both of those drive polygrams per watt.

Al Kaschalk.

Wedbush Morgan. Tom, my first 15 questions have been answered, so I will throw a softball out here for you. In terms of other income, if I heard earlier from Manny correctly, we should be trending towards $5 million non-GAAP SG&A?

Al Kaschalk.

Yes -- so your question is SG&A trend?

Well, the previous question was, it was much higher than commented, and I think there was some fees involved there. So just in terms of a run rate, I just wanted to make sure that I heard correctly. 6% of sales is long-term and 5.5 would be kind of the non-GAAP member number moving forward?

That's correct, Al. The guidance, the 5.5 that I mentioned earlier is the actual non-GAAP Q3 that included those extraordinary charges. The guidance for Q4 for SG&A is $5 million.

Okay. And then just on the tax rate, given the NOL they assume, we should be looking at provisions in the 8% to 10% range for some time, and what about on the cash flow?

Tax rate, that's for the year 2006, we're still good at 5%, which is what we have been using all year for non-GAAP. And for 2007, our new guidance now is 15%. We have been straddling 10% to 20%. We now know, or at least have a better sense, that it's going to be 15% for us in 2007.

Is that a function of getting better certainty on where the face of revenue is going to be, or income, in terms of country?

Exactly, Al. We have a better sense of the North American mix, which is really what is driving the tax rate for us, considering how we are structured. So that's already factored in the growth that we expect in North America in 2007.

Okay, thanks.

Laurence Alexander.

Jeffries & Co. Just one question on the polysilicon supply. Is the DC chemical supply on track for the first quarter of 2008?

The team here is going to attempt to answer questions quickly, and we will target, say, one question or so from the balance of questioners and try to get you guys out of here in a reasonable period of time.

The short answer to your question is, absolutely yes. And the indicators, we just had a review with them, the indicators are that the land is being prepped, that the equipment is being bought. You can imagine that they have expanded previously, so they have people that know how to do the project management, and they have a whole project management spreadsheet and they are on plan.

Perfect, thank you.

Michael Horwitz.

Pacific Growth. Wow, these calls are a lot longer. Can you describe how your relationships with PowerLite and any other sales relationships you have might allow you to have a more smooth transition when some of the markets might be -- have some bumps in the road over the next few quarters, and how much comfort level it gives you and visibility it gives you into 2007, 2008 revenue numbers because of some of these arrangements? And what risks may be involved in those contracts or relationships if markets truly do slow, or if subsidy programs change dramatically?

Let me just say a couple of real quick things. There are at least three people that on the outbound side that we have agreement -- long-term agreements with and close cooperation; PowerLite is one of those companies. Of course, we try to match up the product attributes of high-efficiency and superior aesthetics to companies that can exploit those most effectively. In PowerLite's case, they can exploit high efficiency as effectively as anybody in the world. And with that, I will turn it to Peter and see if you want to comment.

One of the things I mentioned earlier is that, as you look at this shifting pattern of regional policies going forward. One of the things you would like to have is strong global partnerships, and I think we have that in -- with our current customer base, and PowerLite is an important part of that. As you may know, they're active not only in North America, but increasingly in Europe and also in Korea. So I think all of our major partners have footprints around the world and are able to access most of the emerging markets, and so I think we are well diversified currently through this customer base.

And, Michael, to your point, our customers do change mix. I would say it takes the better part of a year for that mix to change significantly, but the incentive environment does change the mix of products that they offer, but the amount of time for the to go through the system is long enough for us to adjust.

Okay, great. Thanks.

Steve Wilbur.

Avis Capital. I just wanted to ask on respect to -- if we assume Germany is maybe a bit slower in the next two or three quarters for some of the reasons you noted, how large is the Spanish market relative to Germany and Canada absorb the inventory that might be building in the German market?

Sure, I will answer that question. The Spanish market we believe based on conversations with our customers this year can come in something in the neighborhood of 100 megawatts, maybe a little bit less, and certainly has the potential we believe to be twice that big next year. A lot of it hinges on -- I guess I would say bureaucratic debottlenecking, which we believe is proceeding reasonably well. These markets tend to be, when the rules get worked out properly, the resistance level goes way down and product kind of floods in. There are a variety of -- a large number of projects queued up and even undergoing installation which are subject to this debottlenecking process.

But also, I think it's important to note that there are a number of smaller but also very rapidly growing markets in other countries in southern Europe, as I mentioned, Greece, Portugal, France now and Italy. And another major factor of course is the California market. One of the things that we saw at the show here in San Jose this week is a large presence from many of the important German players who are setting up shop and see the California market as a highly attractive future growth market.

So I guess my answer would be, I think there is a good chance that over a multi-quarter time scale that the emerging growth markets are able to balance -- I don't see it as a weakness in Germany, but more of a kind of a flat spot in the growth of that market.

And then, I just wanted to ask if -- just so I'm clear on the comment you made earlier. I know you've had stable ASPs. Should we assume for this price changes, downward price movements that need to occur in a market late Germany to accept the feed-in tariff, et cetera, are you suggesting or were you inferring that it will be the distributors, sort of people at the end of the food chain, who are going to have to shoulder that burden, or will it also potentially pass up the supply chain?

I didn't mean to infer one way or another. I guess the bottom line is that system prices, we should all model system price reductions of 5% to 6.5% per year in Germany going forward, and I think all parts of the value chain need to get more efficient.

Okay, thank you very much.

Pierre Maccagno.

Needham. Congratulations on the quarter. I have a question regarding your competitor that use polycrystalline wafers. They're migrating to larger wafers to reduce cost. And are you planning to do similar?

Sure, let me say a couple of housekeeping things. After this caller, there's two more that we show, and then we'll wrap up the call. The question was -- multicrystalline wafer companies, companies that use multicrystalline wafers are going to larger diameters, and are we going to do that with our monocrystalline wafers? And answer is, yes. During the first of a next year, we will go to a larger diameter.

Starting in '07?

Right.

The product that we just announced this week has a slightly larger wafer size than our current product.

Okay. A quick follow-up, if you let me do this. In terms of your joint venture where you're fabricating the ingots, long-term, what percentage of your wafer do you expect to come from this joint venture?

The question was, in case people can't hear it, the question was -- what percentage of our longer-term would come out of our joint venture. And it's significantly south of the half, so that our current partners would continue to grow with us substantially. It -- I'll give you the exact number here in a minute, but it's substantially less than half.

Okay, thanks.

Rob Stone.

Cowen & Company. Tom, in the past, there really hasn't been any evidence of seasonality for solar module makers because the market has been growing so fast and supply constrained. Given the commentary about Germany, and I know you guys haven't given Q1 guidance, but should we be thinking about a seasonal pattern potentially for 2007, given these market conditions within the context of your full year revenue figure?

I will take the question. I don't think, because of the things that Peter said earlier in terms of we're still in the early stages of bringing our product to market, and there's preferential demand for our product, and we are changing the product mix. We're adding products that have a great deal of appeal to our installer partners. We're not really going to see something that we can attribute to seasonality. What we will see is a back-end loaded year, because both our line capacity and our silicon availability is back-end loaded to a degree.

And as long as I have the microphone, I wanted to correct myself on Pierre's question. The joint venture will be less than -- I said substantially less than 20%. It's really more like -- I'm sorry, I said substantially less than 50%. It's in the 20% or below range.

So with respect to the seasonal -- my question on seasonality, that implies not a sequential down Q4 to Q1, but sequentially up quarters through the year as capacity grows?

That's correct, Rob. And bear in mind that there are countercyclical markets. Even as the inherent seasonality of the market starts to show up, I think over time, particularly in Germany where it's difficult to install modules in Q1 because of snow in certain regions. There are other markets that are countercyclical. Japan has always been one of those with kind of a strong finish to their fiscal year in Q1. So it really depends also on your geographic diversification.

Great, thank you very much.

[Michael Carboy].

Signal Hill Capital. You folks are pushing the edge here on the efficiency front, and you're also driving some innovations in manufacturing. I was hoping you might elaborate a little bit about how you think about your R&D spend and what proportion of your R&D spend going forward here you think is going to be more process-based, rather than tied to specific targeted advances in cell efficiencies? Thank you.

Sure. I will say a few words, and Manny could maybe put numbers to it, or at least attempt to. The way it works organizationally, is we are increasing our engineering work force in the Philippines, and they mix of what they do is predominantly process work, process improvement, equipment improvements, and then there is some degree of research that we do in the Philippines. I'll just -- it's about 90/10 -- 90% process in manufacturing improvements and equipment. Of course in the states, we do more of the research and development, and it's probably 50-50 because we still do quite a bit of equipment development. So in terms of resource loading on -- that's what it looks like in terms of spend. Manny, can you take a pass and it?

Hi, Michael. R&D for us, just as a baseline in the quarter just ended, was 3.4% of sales. In our financial model, we've budgeted R&D to be 4% of sales, so we're obviously below that right now. We see the percentage of R&D easing towards the 4% next year. There is a possibility we'll be still a little short of 4% by 2007, but our budget is 4%.

Alright, thank you very much.

Jesse, we will wrap up with you.

Jesse, you may go ahead.

Is you ASP up 4% sequentially due to a higher mix of modules or price? And, are you going to follow the price increases taken by Kyocera and Sharp on October 1st? And then, lastly, could you talk a little bit about the shift to performance-based incentives next year and how you see your market positioning changing based on the different payout structure? Thanks.

Okay, Jesse, we'll start with Peter, and then Julie will answer the second question, and then I will wrap up the call.

So, Jesse, the ASP questions, our sequential improvement in ASP in Q3 was not the product of any significant mix shift. We don't plan on near-term price changes to match anything that's going on. I think you may have been referring to changes in the North American market. Our prices have been going up fairly steadily over the course of the year, and we try not to do anything dramatic, in terms of price changes. So we've implemented a policy of relatively gradual price increases continuously over the course of this year, and our prices were already significantly higher than other prices in the market products in the market.

We don't necessarily see that when we're looking at your average ASP, compared to the other public companies.

Bear in mind that the average ASP takes into account all regions and cell module mix. If you go do research on the CEC web site, for instance, you can see the type of price premium that SunPower systems are commanding at the system level, certainly.

Sure, at the system level, okay.

And the short answer to your question was -- are we going to respond to those price changes, and the answer was no -- essentially, that we have a plan that we're sticking to. Julie, you want to take the second one?

Sure. With regard to the question of how California has moved to a performance-based incentive would affect SunPower's positioning, I think what I would point out is that the majority of SunPower's products have historically gone to the European markets, which are performance-based, given the policy framework being a feed-in tariff. So I don't think that the change in the California market has any substantial impact on SunPower's positioning. Clearly, we are in an excellent position to start out with because of our high-efficiency situation, and also the benefit that we have from an overall performance perspective, kilowatts per kilowatt, which was discussed in the technical paper in Hawaii in May.

So just to cap off that question and cap the call, Julie is an expert in that area because she works on policy and has been a significant contributor to California policy. And as SunPower exploits its efficiency advantage, we'll also do that in combination with where the markets are heading and we think we'll have an advantage as performance-based incentives go in place. And thanks for the question, Jesse.

So let me wrap up the call. I would like to reiterate that SunPower's executing on our plan and meeting or exceeding our operating expansion goals. We guided revenue for Q4 of 2006 from $70 to $72 million for full-year 2007 revenue to greater than $360 million. We really appreciate you joining us. We appreciate the support of our stockholders and we're pleased to report our success in a rapidly-growing -- turning SunPower into a rapidly-growing market leader. Thank you very much.

Thank you. This does include today's SunPower conference call, have a nice day.