SunPower Corporation (SPWR) 2007 Q1 法說會逐字稿

Good morning, and good afternoon, and welcome to SunPower Corporation's first quarter 2007 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.

Thank you for joining us today.

Today we will report our first quarter 2007 financial and operational results. We will report our tremendous progress on the combination with PowerLight and we will provide guidance for our combined company for Q2 and full-year.

First let me start with our first quarter financial performance. With the integration of our PowerLight subsidiary, we had an excellent quarter.

Let me preface my comments on the quarter by talking about how we're going to report this quarter and subsequent quarters. We're going to report the way we run the business and that is by systems and components.

The systems business generally represents product and services sold directly to the systems owner, components business represents the balance of our business which generally is products and services sold to dealers to resellers.

Let me highlight some of the financials in Q1 2007, our non-GAAP revenue was $143.2 million, up 92% from our Q4 2006 revenue of $74.5 million. Our systems revenue was very strong with non-GAAP revenue of $79.3 million. Our components revenue was strong as well at $63.9 million in revenue.

You should note when you look at these numbers that SunPower panels used by PowerLight are accounted for within the systems financial results. Compared to Q4 2006 our blended cell and [modules] fees were up by 3%. And our gross margin and EPS soundly beat our guidance, as Manny will describe in detail.

Now, me talk about our selling channels or our downstream business. After closing our acquisition of PowerLight Corporation on January 10th, we moved rapidly to merge the two businesses. Let me give you a few of the highlights of what we've accomplished.

First, we've moved manufacturing of some of PowerLight's system components to SunPower manufacturing operations in the Philippines. Next, we've combined sourcing of key components of both companies. An example of that is inverters.

Next, we've leveraged our Philippine operations to support PowerLight's manufacturing and service support groups. We've also introduced PowerLight systems products into our SunPower legacy dealer network. Lastly, we've integrated key functions, like research and development and marketing and sales.

As you know, our Company's plan is to drive down install costs to compete with retail electric rates. We've combined the great talent from both companies to drive solar system cost reduction by 50% within five years and as we do that, that increases the available market to us substantially because the total available market, electricity market, is a trillion-dollar market.

With PowerLight, with the acquisition of PowerLight, we have acquired technology, product innovation competency and project development expertise that will accelerate our progress towards this 50% cost reduction in taking solar to the extreme. It will allow us to have direct control over the downstream portion of the value chain through a world-class sales force for large-scale solar systems as well as the new production home segment. I'd also like to note that we have maintained strong third party panel support for this business.

Now, let's talk about the two business segments. The systems business segment continues to thrive. In Q1 we dedicated an 11-megawatt power plant that was at Serpa in Portugal. We partnered to deliver 61 megawatts to Spanish systems that is happening during this quarter.

And we signed North America's largest solar photovoltaic power plant, a 15-megawatt installation at Nellis Air Force Base. We've signed over a dozen new home communities with three builders.

On the components side of our business, we have been organically growing our dealer network to improve control over downstream cost and customer experience through that channel. We've expanded our dealer network and it's now over 75 dealers and 15 states.

We've launched our premiere dealer program that offers additional services and brand alignment, the best dealers who implement our customer service velocity when they join our network. We've had great response from our dealers for the value-added services that we offer that include logistics, warehousing, training, marketing and lead generation.

Let me move on to manufacturing and technology. Our first three solar cell manufacturing lines continue to benefit from cycles of (inaudible] leading to significant performance improvements.

Our fourth line, manufacturing second generation technology is fully qualified with a nameplate capacity of 33 megawatts. In the first quarter, we have used this line, line four, at times for advanced cell and thinner wafer development. This completes the build-out of our first cell manufacturing facility. That facility has a total capacity of 108 megawatts.

Let me give you a quick update on our second generation technology. Second generation technology is a 22% conversion efficiency technology.

It is a full 2 percentage points better than our first generation technology, the A-300 cell, which still is a market-leading cell with the competition, most of the competition at 15% to 17% in terms of conversion efficiency. When we integrate this technology into our panel, into a panel, our second generation cell technology will allow our panels to achieve industry breakthrough efficiencies of 19% to 20%.

A quick comment on wafer thickness. All four lines are moving to 165 micron wafers. We have qualified 165 micron wafers both at TUV and UL. Combined with Gen2, our generation two cell technology, our silicon efficiency will now be between 7 and 7.5 grams.

On to our second cell fab. Construction continues on time and on budget. This facility will house, or it will start running two new lines, lines five and six, and those lines will begin ramping in Q3. We'll begin ramping line seven in Q4 and in 2008, we expect to ramp five more lines on top of those three.

All of those lines will had run our second generation technology and each of those lines will have a nameplate capacity of 33 megawatts each. That will bring our total capacity at the end of 2007 to 200, our total nameplate capacity to 207 megawatts at the end of 2007.

In terms of our first solar panel manufacturing facility, it is now in full commercial operation. The first line is producing panels. That is a 30-megawatt nameplate rated line.

Also a semiautomated line that will give us learning as we continue on our road map to design a fully automated line. And we expect that line to ramp to full capacity during Q2 and we've ordered two more lines of that same configuration.

Just a few more comments. Let me comment on silicon. Our near-term situation is positive. We have 110 megawatts of silicon coverage for 2007, 250 megawatts in 2008 and 400 megawatts in 2009.

As you know, we're buying silicon from two new entrants as well as three of the top silicon incumbent top silicon providers. The two new entrants are M. Setek, they're currently the world's largest solar ingot producer and they're our ingot supplier.

They are integrating upstream to begin polysilicon production and their polysilicon plant is on schedule to deliver silicon based on this new capacity in Q3 of 2007. The other new entrant is DCC, the leading Korean chemical company and they are on schedule, as well, to begin delivery of polysilicon to us in Q1 of 2008.

Quick comment on silicon pricing. Consistent with what we said on previous calls, we expect pricing to be up relative to 2006 approximately 10%. We work to mitigate this painful additional price increase through better silicon utilization, greater scale and manufacturing process improvement.

With that, I'd like to turn the call over to Manny Hernandez who will report details of our tremendous Q1 results, provide details on each of the segments and provide guidance for Q2 2007 and some thoughts on 2008. Manny?

Thanks, Tom, and good morning, everyone and thank you for joining our conference call for the first quarter of 2007. This is our first quarterly report as a combined company with the acquisition of PowerLight being effective January 10th of this year.

Before that, I'd like to remind everyone that during this conference management made and will continue to make statements that are not historical in nature. Please consider these statements as forward-looking pursuant to the Private Securities Litigation 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.

Before I go over more detailed financial results, let me highlight a few points. We executed well and exceeded the first quarter guidance of the combined company in all parameters, sales, margin, operating income and EPS.

And as we stated in the last quarterly earnings call, we expected PowerLight to have a favorable mix of high gross margin business that would benefit the quarter. That is largely what happened in the first quarter, particularly in the systems business segment, having transactions bearing higher than typical gross margins which contributed nicely to our first quarter results. The acquisition was highly accretive in the first quarter and we expect the accretion to continue going forward.

Let me now give you summary of our 2007 first quarter results for the combined company. On a GAAP basis revenue for the quarter was $142.3 million, gross margin was 22.8%. Operating loss was $2.5 million and net income, because of a tax benefit, was $1.2 million, resulting in a fully diluted income of $0.02 per share on a GAAP basis.

These numbers include acquired IP R&D expense of $9.6 million in the quarter, amortization of purchase accounting intangibles, of $6.9 million, and non-cash stock-based compensation of $10.6 million.

The next series of figures are results I'm about to enumerate are our non-GAAP results which exclude non-cash purchase accounting adjustments and revenue as well as non-cash charges for amortization of intangibles, purchase accounting and stock-based compensation.

The non-GAAP revenue for the first quarter was $143.2 million, a 92% increase from our prior quarter revenue of $74.5 million which represented SunPower's standalone business only in that quarter. We significantly exceeded our Q1 revenue estimates due to a very strong systems segment related revenue recognized during the quarter.

Our systems business segment accounted for $79.3 million of our first quarter revenue while our components business segment accounted for $63.9 million of the quarter's revenue. Our combined non-GAAP gross margin for the first quarter was 29% versus last quarter's gross margin of 26.2%.

Our systems business segment, which benefited from the higher than typical gross margin mix, posted gross margin of 30%, while our components business segment posted gross margin of 27.8%.

Also benefiting us this quarter was a nonrecurring net benefit of $1.1 million, emanating from material warranty-related credits and warranty provision. This one-time net benefit favorably impacted our margin by approximately 1 percentage point.

Our combined non-GAAP operating income for the first quarter was $25.5 million and a combined net income of $23.3 million resulting in a $0.29 fully diluted earnings per share. This compares with our prior quarter's net income of $13.6 million, or $0.18 fully diluted earnings per share and also compares with our year-ago first quarter net income of $2.8 million, or $0.04 per share.

The one-time warranty-related credit, or benefit, I mentioned earlier also favorably impacted our earnings by approximately $0.01per share. We also ended up with a lower tax rate for the year which is now estimated at 12.5% which also aided our EPS for this quarter by approximately $0.02 versus our regional guidance of 20% tax rate.

Briefly on the balance sheet, we ended the first quarter with cash and short-term investment of approximately $215 million. During the quarter, we completed a convertible debenture offering, we've infused approximately $195 million of cash.

Our combined DSO was approximately 64 days while net inventory closed at approximately 68 days, both metrics now inclusive of PowerLight information.

Our capital expenditure for the quarter was approximately $47 million with depreciation of approximately $6 million. Our 2007 capital expenditure is still estimated at 170 to $190 million and our full year's depreciation is estimated at $32 million.

Now, as far as reporting in the traditional SunPower standalone and PowerLight standalone results, this will be the last time that we will be able to share some information with you in this breakdown. Due to our early planning and relatively good execution so far, we are fast becoming a fully integrated company and our segmentation into systems and components is how we are managing the business.

So, based on this segment breakout, it is the component business segment that will be the closest parallel to the traditional SunPower standalone that you've gotten to know and understand. So, since we gave you guidance on the old SunPower and PowerLight standalone basis, I'd like to now share with you the results for the first quarter on that same reporting basis.

For the first quarter, the SunPower standalone revenue was approximately $73.2 million. That's slightly below our guidance of 75 to $77 million but we also ended the quarter with approximately $3 million more of finished goods and shippable inventory than the prior quarter.

Non-GAAP gross margin for the standalone SunPower business was approximately 28% but this also got benefited by this one-time warranty benefit, so excluding that benefit, the standalone SunPower margin was approximately 26.5% within our guidance of 26 to 27%.

PowerLight's standalone revenue was $81.3 million, exceeding our guidance of 75 to 77, largely due to higher system percent completion and higher activity than we forecasted. As we noted in the earnings call last quarter, PowerLight was expected to benefit from a favorable gross margin mix and did, posting a non-GAAP gross margin of 28.5%.

To help you better understand and model our financial results, we will continue to provide quarterly guidance for revenue, gross margin and earnings and we will also provide you annual guidance for revenue and earnings. As we noted in the last quarter's call, our business is now susceptible to mixed shift between the systems and components and even within the system segment, susceptible to mix and percent completion factors that would lead to non-sequential growth in either revenue, gross margin or earnings.

If we are faced with a non-sequential growth in any given quarter, we will give you appropriate guidance and also give you any changes to our annual estimates so that you can continue to measure us on an annual target.

So, let me -- almost wrapping up here, the next series of numbers I'm about to enumerate are now our guidance numbers for the second quarter and for fiscal year 2007. The second quarter is an example where the revenue mix of our business segments will cause us to have a sequential revenue growth but a decrease in gross margin percent and earnings per share.

So, for the second quarter 2007 for the combined company, our estimated non-GAAP results are revenue of 150 to $160 million, gross margin of 22 to 23%, and earnings per share of 18 to $0.22 per share.

On a segment basis for the second quarter we expect our systems business segment to have revenue of 86 to $94 million with a non-GAAP gross margin of 18 to 20%. The component business segment is expected to have revenue of 64 to $66 million and a non-GAAP gross margin of 26 to 27.5%.

For the fiscal year 2007, despite the decrease in our estimated gross margin and earnings in the second quarter, we are raising our annual combined company guidance to the following non-GAAP results: Revenue of 680 to $700 million, earnings per share of $1.09 to $1.18 per share. These earnings is based on tax rate of 12.5% for the year.

Just one last note. When you model the second half financials for the Company, please be cognizant that the third and fourth quarters will not grow linearly from Q2. Even the expected contribution of our new production lines, which Tom mentioned, we expect a stronger sequential growth in Q4. We will give you more detailed guidance accordingly next quarter.

Sorry this took longer than usual. Thank you for your patience. Let me now turn it over to Tom who's going to lead us through the Q&A session.

Thanks, Manny.

A couple of administrative items before we go to questions. First, let me tell you who is here to answer questions. We've got Manny and myself along with Howard Wenger, VP of Global Business Units, Peter Aschenbrenner, VP of Marketing, Julie Blunden, VP of Public Policy and Corporate Communications, Jay [Peer], VP and Treasurer, and Mike [Arms], VP of Finance.

And we'd like to try to do what we did on the last couple of calls and that is limit your questions to one, one question and a follow-up if we could, please. So we'll take the first question.

Thank you. (OPERATOR INSTRUCTIONS) One moment, please. Steve O'Rourke, you may ask your question and please state your company name.

Thank you. Steve O'Rourke with Deutsche Bank. A couple of quick ones first.

Megawatt sold in the quarter. And can you also comment on megawatts installed by PowerLight in the quarter?

We're not giving total megawatt sales numbers this quarter going forward since we have a mix of internally generated and externally generated megawatts.

Okay.

If I could ask a little different question here then. What are your plans, if any, to address the thin film solar PV approaches and does your relationship with Applied Materials extend beyond installing a system on the [Maydan] center?

Yes, this is Tom. I'll take that question.

We analyze thin films as well as all other solar technologies on an ongoing basis. We have an internal group that does that as a major part of their function. And so we stay abreast of not only thin film but other developing technologies.

As of now, we continue with our strategy of a focused technology strategy, that is because we believe we have technology that will allow us to continue to perform excellently. And as we do the analysis we see that the strategy sort of splits or bifurcates two different ways of getting the low installed costs our way to have moderate or low cost modules. Minimal balance of system because of our high efficiency modules which allows us to get to low installed costs.

Thin film, on the other hand would target low-cost modules but would have more balance a system. And they would try to offset that more balance a system with lower module cost. Two different approaches to the same challenge. We feel good about our approach and we're going to focus on that.

Second part of the question was --

The second part of the question was Applied Materials. Does your relationship extend beyond just your installing of a system? On the [Maydan] center?

Yes, so Applied Materials, we -- the person who runs the Applied Materials solar group actually has worked extensively with SunPower so we have a strong relationship with Applied Materials.

And you can imagine that we have a lot of dialogue about where the market's going and things that we might do working together. But I would characterize it as a strong dialogue and a good partnership on potential things but nothing specific to talk about.

Thank you.

Thank you. Sanjay Shrestha, you may ask your question and please state your company name.

Great. Thank you. Lazard Capital Markets. First of all, congratulations, guys. Quick question here.

You know, the silicon titan support 400-megawatt shipment in 2009. Two-part question on that. One, how much of that is coming from some of your existing established player and how much of that is coming from the new entrants like the M. Setek and the DC Chemical?

And two, if you guys have 400-megawatt of silicon available, what are some of the things we need to see here, guys, to see maybe the acceleration from the ramp- up schedule standpoint?

Okay. So, the second -- let me paraphrase the second question make sure I got it. If you have enough silicon, what else do you need to do and where are you getting the silicon?

That's right.

So, let me first talk about where we're getting silicon and I am looking at a relatively complex chart in front of me so it's going to take me just a second to sort it out and give you a percentage. I would say it's half the two-thirds from the new entrants and the balance from incumbents and that ratio changes as we go out beyond that.

Sure.

And in terms of what else we need to do for expansion to 400 megawatts, we can do that with the two existing facilities so we need to do, frankly, what we've shown we can do with the fourth line. And that is to replicate second generation technology bringing the people and bringing the lines on time and do that within the second facility and that, as we mentioned, is going well on lines five, six and seven.

Got it. And one quick follow-up then, guys.

When we talk about the ASPs here, we certainly saw some nice sequential jump for you guys. Wanted to understand how much of that was mix related or was the overall pricing power because of the high efficiency cells?

And two, second part question on that. You know the guidance for Q2 also reflects that the pricing dynamics is not going to change for you guys just on the component side despite the ramp up related cost. Is that because you see even continuous sequential growth in pricing, or two, just the incremental benefit coming from the thinner wafer and the full realization of that in Q2?

Sanjay, this is Peter Aschenbrenner. I'll answer that question.

With respect to the first part, the sequential ASP increase we saw in Q1 was due entirely to organic ASP growth not to mix issues.

Okay.

And as we've said in the past, we do have a structural long-term mix shift going on but we didn't recognize that in Q1.

In the second part of the question, we see stable pricing for our product currently going forward. As we've said in the past, there are several reasons for that.

As we said, there is a gradual shift in mix from sales to modules because of our flat -- our stable volume in absolute terms on a quarterly basis on the sales side and growing volumes on the module side. Our incremental capacity allows us to capture premium ASPs in some of the higher ASP regions around the world like Southern Europe. So that helps us on the ASP side.

And then finally, we're still unlocking latent demand for customers that want to buy our product but haven't been able to yet. And finally, in our dealer network, we're selling a little bit further down the channel than we had been previously so all those factors maintain pricing power for us.

Got it. That's great. Thanks a lot, guys.

Thank you. Tim Luke, you may ask your question and please state your company name.

Thanks.

Just following on from the pricing question. Maybe, Tom, if you could give any sort of updates on the core trends and sort of momentum in some of the different regional markets that might be helpful. It seems like you are seeing very strong traction in Southern Europe and premium ASPs therein. Thank you very much.

Sure, Tim, this is Tom.

You're right. And we do -- one of the interesting things about our mix is given the new structure of the Company, it will are change considerably quarter-to-quarter because we at times will book large projects in a region and so mix isn't necessarily an indicator.

SunPower mix isn't necessarily an indicator of the overall market. And we're having great success across Southern Europe as well as California and I think going forward, you'll see success in the Far East.

Having said that, I'll let Peter add a few more specifics.

Tim, we're not seeing any significant variation in pricing momentum for our products regionally. That is to say our pricing is relatively stable in each of the major regions where we participate which are, of course, North America, Germany, Southern Europe, and Korea.

And any comment on the mix shift, how it's going to trend for those different areas as we kind of get through to the end of the year?

And then just lastly, for Tom, it sounds like with M. Setek if that's going to start in the third quarter, if you have any incremental color on how you're proceeding their ramp. You said it was looking solid and on track [inaudible] fairly soon, but that would be very helpful. Otherwise, just congratulations on your numbers and execution.

Tim, I'm going to give you the regional breakdown first. For Q1, for the combined company, our revenues broke down approximately as follows. And these, a small caveat, these are our best attempt to map the end use of our components as opposed to maybe the first stop in a resale value chain.

So we believe that our regional breakdown is roughly 40% North America, 35% Spain, 10% Germany, 5% rest of Europe, and 10% in Asia which, for us, was dominated by Korea.

That's very helpful. Is that going to be very lumpy, that kind of regional trend or how should we think about that?

I think we can expect, what we said in the past is that, and really, there are small differences between the channels. But I think we can expect on an ongoing basis, roughly half of our business to be in Europe, 40% or so in North America and then the balance in Asia.

Thank you so much.

This is Tom. M. Setek, bear with me but I'll use an American football analogy.

M. Setek's first and goal on the one yard line, usually you get in the end zone in one play, sometimes it takes several plays. And I would say it's likely that they'll therefore have a grand opening in Q2 that would support silicon in Q3, but emphasis on likely. They haven't announced that yet. And I appreciate your comments on the quarter.

Thank you. Mark Heller, you may ask your question and please state your company name.

Hey, guys. This is [Sweeny].

Manny, just a clarification on the tax rate. Could you help us understand what's driving it lower? And maybe something about what's going to happen in 2008 and beyond.

Hi, [Sweeny].

Yes, the tax rate was favorable change for us and it really got flushed out when all of the purchase accounting with the acquisition of PowerLight got finalized. In short, SunPower had a, what you call deferred tax asset which was fully reserved. That's called valuation allowance. And that's been the case with our books before PowerLight.

The acquisition of the PowerLight balance sheet brought in what's called deferred tax liability which then does not necessitate the valuation allowance anymore, and it's, in short, the ability to use a deferred tax asset as a tax deduction. So there was a favorable change to 12.5% for the year.

As to 2008, we're still modeling changes to the legal structure of the Company. But I think I'm going to stay with the guidance I gave before which is 20 to 25% for 2008.

Okay. Fair enough. Then one question, Tom.

You said you moved to 165 micron, already moving there, and if I look at your megawatt forecast for the silicon supply, you have 110 and 250. As you move to the, you know, thinner wafers, should we expect some upside to that 110 and 250 megawatts or is it already kind of accounted for that?

Our forecast account for an offset in yield. First of all, our forecast always assumed a transition to 165. To the degree it's sooner, our forecast incorporate a yield offset.

And to the extent that our operating team can minimize the yield offset, meaning there is some penalty going to thinner wafers, yes, there could be an upside.

Thank you.

Thank you. Stuart Bush, you may ask your question and please state your company name.

Hi. It's Stuart at RBC. Congratulations on a good quarter, guys.

Thank you.

You guys are expecting PowerLight to standalone systems margins of 18 to 20%. How do you see this trending in 2008 and beyond?

And if you can offer any views on what you think the average industry margins will be for the installation segment going forward.

Stuart, let me take the first piece of that. 18 to 20% gross margin for the system segment side of the business is, in fact, the guidance for Q2. If you recall in the previous conference call last quarter, we characterized that piece of the business to be in the 15 to 20%. It's actually good that we're on the higher end of that range.

As far as how that might transition going forward into 2008, one of the bigger influences there is to the extent the systems business segment consumes or uses [10] power panels and if you recall, our margin stacking argument, that means we have the potential, even theoretically for that segment to be at 30% margin as well. So we're going to transition to that, obviously.

Well, I guess what I was aiming for is how you see PowerLight compared to the rest of the industry installation players?

Yes, Stuart, we'll have Howard Wenger take the question about overall industry and relative comparisons.

The short answer is we see that our gross margins relative to the rest of the industry should be growing faster as we integrate more and more SunPower material. The other thing, Stuart, is that we've integrated the design teams and so we're now optimizing designs from cell to system and we expect to see some advantage from that as well.

Stuart, this is Peter.

The last point I'll make is that PowerLight has got a lot of experience, of course, and have many cycles of learning under their belt. So we would expect that their cost structure and efficiency, particularly in implementing multiple projects and large projects, would be ahead of some of the newer competitors on an apples to apples basis.

Okay. Great.

You guys have also talked a lot about the pricing premium you're getting versus traditional panels. Are you seeing a premium per watt in every region and can you help us understand how we can quantify what sort of premium you might be getting?

Sure. We'll have Peter take that question.

Yes, we see a premium per watt in every region. And we typically have characterized it in the past for a panel, a solar panel, that premium being somewhere in the 10 to 20% region, depending on the market conditions.

Okay. Great. Thanks a lot, guys.

Thank you. Pearce Hammond, you may ask your question and please state your company name.

Yes, Pearce Hammond with Simmons & Company. Congrats on the quarter.

Thank you.

Manny, when you were talking earlier, you had mentioned SunPower standalone, the revenues were $73.2 million, which is slightly below, and you mentioned $3 million of shippable inventory. Did I hear that right?

Yes, you did.

And I'm just curious why did it come in a little bit lower just SunPower standalone?

It's nothing material or significant to really describe besides us trying to optimize logistics on the last two days of the quarter.

Okay. Great.

And what do you all see from the subsidy standpoint and public policy in Washington? Any changes that look intriguing there as far as changing the federal subsidies for solar?

Hi, Pearce, this is Julie.

We obviously have a whole set of very positive factors right now in the public policy environment globally and in the U.S. with the change in Congress and the intense focus on carbon mitigation this year. It certainly is a great opportunity for renewables generally and solar specifically because we're relatively a newer entrant to the energy business at a large scale.

So we feel confident that our trade association who we work with to move federal legislation, is doing an excellent job positioning solar to be part of a tax package this year. And anticipate that over the summer, as the energy discussion heats up, you'll see more and more discussion on solar and DC.

What do you think the probability of getting the changes if you had to handicap it?

You know, trying to handicap legislative environment is a tough one. I'd say that this is about as positive an environment as we've seen. It feels good but you never know until the game is done.

And have you all tried to quantify what the market impact would be to certain changes? I mean how big the market could be?

Of course. Obviously, there's dynamics between what happens at the federal level and the state. Right now, the specifics of the Bill would extend the tax credit for eight years at $3 a watt.

That's a substantial market impact but the actual piece of legislation that gets passed may end up looking different than that. So we've looked at a series of scenarios and thought about what the consequences would be for our moves into the market.

Pearce, I'll add something to that. This is Peter.

The most obvious impact in terms of the federal incentive would be to turn the market from what is now, in North America, a state by state focus into truly a national focus. So as Tom said earlier in our current dealer network, we're active in about 15 states, that would essentially triple the number of states which we could effectively address and we feel very good about our current capacity to scale quickly having been working on this network build-out for the past two years.

Great. Thank you very much. And again, good quarter.

Thank you.

Thank you. Pierre Maccagno, you may ask your question and please state your company name.

Needham. Congratulations on the quarter.

If you could talk a little bit about the geographical strengths or weaknesses during the quarter. And then next, is it possible to give a pro forma guidance in terms of the gross margins?

So we'll have Peter take the first part. Peter?

So Pierre, I'm going to answer in general terms in terms of how we see the various markets growing as opposed to our role in those markets. Will that answer your question?

Sure.

So in general, North America is growing very nicely. Total market size is something in the neighborhood of 175 megawatts last year. Growing quite quickly in California, in particular, which is the market we're most directly focused on.

Germany has been a market under significant discussion recently. Just last week we had the opportunity to talk with a number of our partners over in Europe. We did see according to Navigant, one of the leading third party market researchers, we did see growth from 2005 into 2006 in the mid teens. So that was good news.

It's a little bit difficult to get market data in Germany but I think most people agree that the market was growing slightly into 2006. And the reports we're getting is that at least for Q1, where we are today, as the market builds through the spring, that order backlogs and order rates are significantly higher than they were in 2006.

So it appears to us, in talking to our customers, that there is vitality in the German market that perhaps wasn't widely recognized last year.

Is that because lower pricing or --

Yes.

Okay.

Pierre, this is Manny.

You were asking about pro forma gross margin guidance. If you were asking from a business segment standpoint, we covered that early but I don't mind repeating. For the systems segment for Q2 the gross margin expectation is 18 to 20% and for the component business it's 26 to 27.5%.

Okay. Thanks.

Thank you. Rob Stone, you may ask your question and please state your company name.

It's Cowan and Company. Let me add my congrats to the list already mentioned.

Thank you, Rob.

Could you comment on the megawatts of output from your own production? I recognize you don't want to give total megawatts because that pulls in PowerLight but the megawatts produced and then how much was transferred internally and any comment on those two factors for Q2, please.

Okay, Rob, this is Peter.

I'm going to have to decline on that one. Since we're now sourcing product both from third parties as well as internally, we believe that for competitive reasons, it's better for us not to break out megawatt contribution in total or by channel. So that's a policy that we've adopted currently and we expect to follow going forward.

So how will investors then track the progress of the ramp of your factory? I mean I recognize the competitive issues, but it makes it quite difficult to follow either the ramp up of the factory or the impact of margins stacking on the consolidated results if we don't have some idea of those two numbers.

Rob, this is Tom.

18 to 19 megawatts. And we will talk about ramp up lines relative to the nameplate capacity and we'll work with all of you on the phone on how we'll characterize that or how best to do that going forward consistent with what Peter said. So that should get you through what we need to today anyway.

Okay.

With respect to nameplate capacity then, just a quick follow-up. With respect to 400 megawatts production in 2009, at some point between now and then are you going to be converting the first three lines to the Gen2 or have you made a decision about that?

We have not made a decision about that. We've done some work on that and in one or two of those lines it's going to be a bit of a tight fit. But you know, over the course of a couple of years, I'm guessing we're going to figure that out.

But we don't have a definitive plan because we're actually working on Gen3 technology and we're more focused on which lines that will phase in on.

So with a dozen lines though, the two facilities would be completely filled, is that correct?

There would be 14 lines between the two facilities, four and 10.

Okay. Thank you.

Thanks, Rob.

Thank you. David Edwards, you may ask your question and please state your company name.

Hi. It's Dave Edwards from ThinkEquity.

One question just going back to the intercompany transfers. In the past, you've talked about using about a third, having PowerLight's business be based on about a third of SunPower panels in 2007 and then half of the business in 2008. Is that still an accurate way to think about it?

Yes.

Okay. Great.

And Manny, can you talk a little bit about tax rates? I understand that you've got some, the near-term benefits you're seeing.

Have you -- has any of the stuff you've done changed your long-term projection of what you think the sustainable tax rate is for the Company? Is the 2008 guidance which you think is sort of a steady state for the business?

Hi, Dave.

Answer is yes to the 20, 20.5% tax rate '08 going forward. We're structuring a legal entity around the business activities around the tax rate from a sustainable standpoint.

Okay. Great. So we should just assume 20, 25% going forward?

Correct.

Great. Excellent. Thanks a lot, guys.

Thanks, Dave. Al Kaschalk, you may ask your question and please state your company name.

Wedbush Morgan. Just to follow-up on that.

Does that imply you're getting tax incentives in the various locations for the lower tax rate or is it just a benefit of perhaps earlier years operations?

It's a little bit of both but going forward, more of the former. We have structured the organization of the Company legally to benefit from a couple of things which are typical.

One, you locate your manufacturing locations in countries that give you tax holidays, that's certainly true in our case. And two, you structure intercompany organizations and agreements such that you pay little or no tax in certain territories in Europe. So really, the biggest sensitivity is the U.S. presence and that's what's driving our tax rate to 20, 25% in '08.

Great. Thanks for clarifying that.

Most of my other questions have been answered but just to follow-on on the policy and the balance here between dealer count and outlook. Could you just talk about maybe the trade-off on how aggressively you approach expansion on the dealer side relative to what certainly is going to be a changing policy environment?

Yes. This is Tom. I'll take a pass at that and of course we've got Julie and Peter who both could add on if needed.

We have a premium dealer network on purpose because we have great partners in the dealer channel. And it's because we can add value to them and help them scale faster so we think it's an inherently scalable model, or we know it's an inherently scalable model. So we tend to be very aggressive in terms of dealer network growth.

We've now got the infrastructure in that we can continue to be aggressive and nimble so as policy changes on a state by state level, we can deploy our dealer network approach in that new state rapidly. To the extent that there's a market across all of the states, I would say the same thing.

Anything to add? That would be our answer.

Okay. So, right now, just to refresh. 15 states here or is it 13?

15.

Great. Thanks, Tom.

Thank you. Jesse Pichel, you may ask your question and please state your company name It's Piper Jaffray and this is Colin Rush for Jesse.

Are you concerned at all about overcapacity in the industry?

Well, I would say that we're in Silicon Valley so I'd quote Andy Grove and say only the paranoid survive. And we're constantly evaluating the balance between expected supply and expected capacity. Frankly, I think the expected capacity is a little more straight -- I'm sorry, the expected supply and the expected demand, the expected supply is a little more easy to model for us. A little more straightforward than expected demand.

On the demand side, it's hard to predict elasticity as we reduce costs and eventually price and so that's sort of a wild card. And so, you know, our confidence in our (inaudible) on our estimate of when things might become more in balance are perhaps out of balance the other way as our confidence interval is quite large.

So that's a long-winded way of saying yes, we're concerned. We constantly evaluate that. And that's why we have invested in the outbound channels so that we can reduce the installed costs, improve system performance, improve brand and manage 80% of the value chain. So all of the things we're doing are consistent with preparation for that day whenever it hits.

Okay. Great.

And getting back to the German market, all our data points aren't suggesting much growth if any in Germany. And I'm wondering if you could comment on Photon's article that was published yesterday estimating the EEG costs to German taxpayers at $77 billion euros and how you think that discussion will proceed in Germany affecting the EEG review this year and next year?

Yes, Julie will take the majority of that question or perhaps all of the content.

I would say that it's a very good question. It's one that we watch closely. That math is relatively straightforward. We're doing that internally as well.

And that has a lot to do with, you know, trying to predict the demand environment. That is one of the variables, one of the significant variables that goes into that equation.

Julie has focused most of her time in the United States but is increasingly focused on Europe as well so I'll let her comment a bit.

Hi, Colin.

Hi.

With regard to Germany and really all of the [feed] and tariff states, there's always a question of how you bound the tariff, whether it's on megawatt dollars or if you keep it uncapped how you keep a check on it. In Germany, the way they do that is to re-evaluate every two years by taking a report back to Parliament.

In this case, you know, we've got a set of conditions in Germany where the solar market has created a lot of economic benefit to the state. One of the fastest growing employment generators for Germany. We certainly think that solar is a long-term component of the German energy strategy.

As they review their policy environment, they will certainly look at all of the dials that they have to ensure that it is a sustainable energy strategy and we're working with our trade associations in Europe and in Germany to ensure that we can contribute positively to that conversation. What we don't anticipate happening is to have Germany evaporate overnight.

One more comment here, Colin, from Peter.

I'll just add one thing.

One of the things we do very actively is to evaluate our portfolio of markets with respect to growth opportunity, incentive risk and other areas. And as we said earlier, we currently have about 10% of our revenue in Germany. So we feel we have a good footprint there but we're not overly exposed to any near-term or long-term risk in terms of incentives.

Great.

And just one final question on the downstream channel in terms of capacity to ramp that. We're hearing estimates of anywhere between six to 12 months to train staff to install systems. I'm just wondering how fast is that going to happen in terms of PowerLight building its business in the U.S.?

How fast can you scale up your capacity and what do you think you can reach in terms of actual potential to install if we see U.S. subsidies passed?

Sure, Colin. We would break that down by market segment. We look at residential retrofit separate of new production homes, separate of commercial and public/power plants.

You asked about PowerLights. They would be commercial, public and power plants and their approach is inherently scalable. I should say out approach is inherently scalable.

We don't actually typically don't have the labor that's installing the system. We typically manage project installation. I'll comment on the other two segments then I'll let Howard Wenger add any color on that.

In terms of new production homes, that is something we actually do turnkey for new homebuilders and so we manage the ramp ourselves. And the good news on the residential retrofit side of the business is it's fast growing and the model we've chosen is inherently scalable.

I can't give you an exact number but it's more like weeks, not months that we can train people that have relevant experience, for example, electrical contractors and the range is probably four to eight weeks. And we have training facilities on both coasts currently.

Howard, would you want to add anything to my comments on the projects and commercial and public sector?

Just a couple of comments which are that we've proven that we're able to scale up historically. We're doubling our growth every year roughly and the same holds true for 2006 over 2005 and quarter-to-quarter in Q1 2007 over Q1 of 2006. We're continuing to grow fast.

A big part of that is because we, as Tom alluded to, we do train local subcontractors so we have a built-in network of electrical and mechanical subcontractors. We employ in the Company, project managers, construction managers, and people that can quickly translate our knowledge to the local infrastructure which enables us to very quickly grow and one example of that is in Florida.

We don't have a big business there. We ended up selling a system there. We were able to very quickly find qualified subcontractors and install the very top-rated system.

Yes, if I could just throw ten more seconds on. That was one of the positive surprises as we worked with PowerLight that they have an experienced and very competent project and construction management team that can do what Howard just suggested.

Great. Thanks so much. I have a few more questions but I'll take those off line.

Thank you. Michael Carboy, you may ask your question and please state your company name.

Signal Hill. Good afternoon, ladies and gentlemen.

Manny, in your earlier remarks you had talked a little bit about the percentage of completion associated with some of the PowerLight contracts as being responsible for some of the margin shift. I'm wondering if you could kindly talk to us a little bit about the margin profile through the life of these contracts if you can think about it.

Then could you also elaborate on if you will or when will you begin to discuss backlog for the PowerLight business given the nature of the contract structures. And then lastly, how are you planning on managing balance sheet metrics as the business mix changes so dramatically? Thank you.

Okay. Michael, I'll take the first and the last.

Let me start with the margin question relative to percent completion or a profile of how these margins are recognized over the life of a project. Pursuant to certain accounting rules for construction or percent complete recognition, we, it's a true up of gross margin estimate through the life of the project.

So a certain percent of the project is recognized. You calibrate at that point what the potential margin is and you ratably recognize it. So on a perfect situation, the budgeted margin is what's realized over the life of the project even if it spans multiple quarters.

In reality though, you could be a little higher or lower than that and you always catch up on a cumulative basis is how the accounting is done. So fortunately we've got people in PowerLight who are good at this so the learning curve for the rest of the SunPower folks is getting pretty fast.

On the balance sheet metrics, we're obviously after only 91 days of being combined here, we're still developing those. But we would like our DSO, which is currently 64 days, to be lower than 60. We're actually six days more than theoretical right now so we're going to drive that more towards theoretical.

Inventory days, which we ended at 68, we would like to stay below 70 but it will take a few more initiatives on the logistics and supply chain side to improve upon that. But it's actually a pretty good metric right now and from a working capital standpoint, we're targeting a 15% of sales, an incremental working capital at 15% of sales as one of the benchmark and we'll continue to monitor that as we go.

I believe you asked about backlog. This is Tom. Let me comment on that.

Backlog is complicated by the fact that in each of our channels, it is -- the characteristics of backlog are quite a bit different. So it's something I think we'll evolve with you guys how we calibrate on backlog. Let me just say that Q2 is completely booked and that most of the balance of our business is actually on allocation.

So most of our time is spent allocating and so in terms of -- that's how we characterize things now and we'll work with you guys on looking at each of the segments in a better way perhaps in Q3 and Q4.

All right. Thanks very much.

Thank you. Michael Weisburg, you may ask your question. Please state your company name.

Yes, ING Investment Management. If I could hit you with a couple of quick things.

I think you commented briefly on the ideal mix for PowerLight between internal and external solar suppliers. If you could just reiterate that. That was the first thing.

Second, could you comment on the mix between residential and commercial installations in the U.S. and how you think that's going to change?

And third, you two-thirds answered the question in terms of the outlook of some of your major markets and you talked about North America and Germany. I wonder if you could talk about Spain and other of U.N. markets in terms of how they look in '07? Thanks a lot.

Sure. You've got a three-part question that will take three people to answer. Manny will take the first part, Howard the second, Peter the third. So, Manny.

Okay. Hi, Michael.

On the mix of products that PowerLight consumes, we have estimated that for 2007 we expect about a third of SunPower's output to be consumed in PowerLight by systems projects. That's still the goal for 2007 so that's unchanged.

There is a benefit to gross margin and profitability as the PowerLight project consumes more, or in fact, 100% of their PV come from SunPower. That is actually the ultimate model is you actually get to margins better than 30% when you do that.

Now, on the other hand, that it will have to transition towards that mix. For 2008, our stated objective was 50% and that's really unchanged at this point.

While we transition to Howard, let me just say that, you know, it's unclear what our mix of third party supply versus internal supply will be in time. And I would reiterate that we expect to continue to have third party supply over the long-term and I think Manny, in the previous call, had given a 70% plus or minus number that gets us to model of internal supply if that's what you were specifically getting to. And now we'll turn the second part to Howard.

Sure. This is regarding the relative mix, residential-commercial. So clearly, it varies by region. In certain regions such as Europe, we're very heavily oriented towards the commercial projects and power plant business. In North America, it's more balanced.

Now as a combined company, we address all of the segments to retrofit residential segment, the new home construction segment for builders. And then the commercial segment, rooftop and ground power plants and rooftop systems for end users.

As a combined company, we're approximately one-third, 35, 40% residential, 60% commercial. I expect that to even out as we go forward.

Michael, this is Peter Aschenbrenner. I'll take the question about Southern Europe.

So we were just at a show last week in Verona. The Italian market is growing, I guess, explosively would be not too overstated.

The market in Southern Europe, primarily led by Spain, and now Italy, Portugal and France, roughly doubled between 2005 and 2006. It's now becoming a major market.

We feel like we have very strong market share there. Their product plays particularly well with the balance of higher efficiency and great aesthetics. And so we're extremely bullish on southern Europe and very active.

Thank you, Michael.

Great. Thanks a lot.

Thank you. Pavel Molchanov, you may ask your question and please state your company name.

Sure. Pavel with Raymond James.

You guys have won some pretty significant marquis contracts in recent months including for instance, the Air Force base. Do you see your sales growth being driven primarily by those types of large-scale projects or do you think it's going to be sort of below the radar, smaller scale type customers?

Our strategy as a company is to have strengths in all market segments so as I mentioned before, we would split the market residential retrofit, new production homes, commercial public and we would actually separate power plants which you referenced as power plants.

We have strengths in each of those PowerLight, broad strengths and new production homes, commercial public and power plants and legacy SunPower and head strength and residential retrofit. We continue to invest in each of those segments. And to the degree that policy changes then markets move between the segments and we would expect to have competence in each of those so that we can move with the market.

So we wouldn't actually target any specific balance between those. Perhaps in time, we will. And I will also mention that we're developing new products that target each of those segments so we're not favoring any one over any of the others.

Great. Thanks very much.

Thank you. Jeff Osborne, you may ask your question and please state your company name.

Jeff Osborne at CIBC.

Just had a quick question, Tom, you gave an outlook for '07 poly pricing going up 10%. I was just wondering if you had any comments for 2008?

Yes. For SunPower 2008 is contracted and some of the contracts have substantially lower pricing. And that's because either we were in close partnership with the producer and/or provided some financing and/or provided longevity of the contract and those things all influence the price that we would get. So in 2008 we would expect silicon prices to go down.

In terms of a specific percentage of what that mix looked like, I would like to delay that a quarter because it's influenced by the new entrance ramp to a relatively significant degree and we'll have a lot more certainty in the next three months.

Very good. And just lastly on the same topic. Can you just talk about what silicon today makes up as a percentage of your cost of goods? For the classic SunPower business?

Yes. What I'm going to want to do on that one is answer it after someone else answers the question so I can make sure I do the math correctly because I want to do it at an installed level. Is that sufficient? At a systems level or would you prefer data module level?

Module level would be ideal but whatever works for you on the fly math there.

Yes, okay. I'll give you module level but let me look and see where our significant data books that are in the room and make sure I hone in on the right number.

So we'll take the next question. I'll just append it (inaudible).

Appreciate it.

Would you like to go to the next question, sir?

Yes.

Thank you. Paul Lemming, you may ask your question and please state your company name.

Soleil Securities. Good afternoon. Three questions.

One, what percent of your silicon supply do you see refined metallurgical grade silicon being in 2009?

Two, I was wondering if you'd ballpark the size of the four or five largest geographic markets in 2008, where do you see the size of the German, U.S., Spanish and Italian markets being next year?

And finally, Tom, you talked about the trillion-dollar per year electricity market. I was wondering if you had an estimate of rather than the electricity market, of how much total electricity generating capacity was installed globally last year solar, coal, oil, gas, the works? Thanks.

All right. So, there was -- I got the second and third questions. I apologize.

So the, oh, yes, metallurgical grade. Thank you. So I'll answer metallurgical grade, Peter will take the second question, Julie, the third. And I'll answer the previous question first.

The previous question was what percentage of silicon of a module, it's between 15 and 20%. 15 is poly, 20 is ingot.

In terms of metallurgical grade, that's a straightforward answer. We currently assume zero percent metallurgical. The actual may vary from that because we're certainly not going to exclude that as a possibility but as we sit here, the answer is zero. Peter?

Yes, so Paul, I believe your question was how do we see the major markets growing in the year 2008 or what is our projection for overall size in the year 2008?

Yes, I'm interested in kind of your take on how many megawatts installed in the four or five largest markets.

Okay. So, we see -- I'll give you a multi-part answer.

The total installed last year, and you get slightly different numbers depending on which source you go to. So the number last year that we use is close to 2,000 megawatts worldwide. And we believe that in 2008 that that will be somewhere between 3500 and 4,000 megawatts depending on what sort of growth scenario we end up actually seeing.

In individual markets we would expect North America in that time to approximately double. We would expect to see slower growth in Germany, somewhere in the high single digits or 10% per year. And we would expect to see the balance of Europe go up by a factor of several, somewhere between 2 and 3 in the same period.

Okay. Let's wrap up that question with Julie.

My guess, Paul, is that what you're looking for is to understand what the scale of solar insulation is relative to total installations globally? Is that a good--

That is absolutely it. The percent of installations that solar represented in '06.

Yes, so the answer is going to be less than a percent. So if you look at the total accumulative capacity going in globally, although I don't have a precise number, I can tell you it's going to be more than 500 gigawatts a year.

So, you know, hundreds of gigawatts a year so when you think about single gigawatts a year going into the solar industry, we're talking about, you know, kind of a 1% scale. So in the scheme of things, there's an opportunity to scale dramatically from where we are now before we hit any sort of a market penetration cap.

Okay. Thanks, Paul. We're actually rounding down to our last 10 or so minutes and it looks like we have four or five callers in queue so that will fit nicely. Next question, please?

Thank you. Jeff Bencik, you may ask your question and please state your company name.

Sure. This is Jeff Bencik from Jefferies & Company. I have a couple of questions.

Manny, first off, can you, I think you said there was a $0.02 impact from tax in the quarter but looking through it, it looks like there's a $0.07 impact. So if you can resolve that difference there.

Sure, Jeff. That $0.02 comment is with respect to the guidance that we gave you guys a quarter ago. So just replaying that, we guided the quarter to an 18 to $0.20 EPS so call it a mean of 19, but that was generated from a 20% tax rate assumption. So if you just reverse compute what that would have been, at 12.5%, that would be the $0.02.

Okay. So what's the $0.07 tax effect that's listed in the release?

That would be for the year because the tax benefit of the 12.5 impacts the rest of the year as well, Jeff.

Okay. Okay. We can take this off-line but it says for the three months ended but anyhow.

And then for the tax rate, on -- you listed it for non-GAAP. What is the expected tax rate on a GAAP basis?

I was hoping nobody would ask that question because that's actually hard to answer but we have the answer.

Just because of how the tax provision works on a GAAP basis, it cannot actually be expressed as a tax rate. It is instead expressed as an absolute dollar provision.

Okay.

For 2008, 7 GAAP, the tax provision is $14 million.

And I think I now know your $0.07 question. Jeff, we should definitely take that off line. Those are tax effect of $0.07 is on the intangible charges for the quarter which offset all those amortizations when you book purchase accounting. So call us after the meeting, please, and I'll walk you through that.

Okay. Very good. And then just one more question.

In terms of, you know, the solar is usually seasonal and the first quarter is usually the weakest quarter of the year. I'm just wondering why you're guiding to lower second quarter even than the first quarter sequentially EPS even on the higher revenues? And I just wonder if that's because of the ramp and the new lines that are coming up that are impacting the gross margins?

This is Tom. I'll take that.

So it is because of mix, the systems and components business. And in Q1, when we had our earnings call relevant to Q4, we suggested or stated that our Q2 systems business would be below 18% and it's actually, we're actually guiding up.

So relative to what we gave guidance for on our call in Q1, it's actually up and it's because the systems business is very mix sensitive. And so the mix that we had in Q1 was near optimal.

The second thing I'd say about Q2 is realize that we're at the high end of the range of what we expect the systems business to be and we're at the low end of the range in terms of SunPower modules being utilized. So as time goes on, of course, that margin will go up as we utilize more of SunPower modules.

Okay. Thank you.

Thank you. Paul Clegg, you may ask your question and please state your company name.

It's Natexis Bleichroeder. Thanks for the call, guys, and most of my questions have been answered at this point. Maybe one for Julie, though.

Are you seeing any traction on the solar legislation in Texas and are there any other new states out there where you're seeing activity at the state government level?

We do have a bunch of Bills going through state legislatures this year. Some are market development oriented where we're trying to create new funds for specifically pushing solar. Others are more optimization of market rules to make it faster, easier and a better customer experience to put solar on your roof.

In the case in Texas, we're looking at both of those and we have had some strong positive response, some good media, recent movement in committee. So, you know, positive view in Texas. You never know until it's over and in the case of Texas, we'll know in June.

Okay. Thanks.

And just one quick question on how much traction are you seeing with the SunTile product? Are the volumes still very small there or is that starting to pick up?

This is Tom.

The volumes are picking up considerably. And the SunTile product is on plan or ahead of plan and that's because, of course, it goes in new homes and there's less new homes being built so that's a very bullish signal. And that's because you amortize the cost of a SunTile into the mortgage and you're cash flow positive day one, the way the math works, and we have a market leading product because it's highest efficiency system.

Not only cell but the way PowerLight designed it, it performs better as a system and it's also the only one that replaces the roof. So we have strong advantages, therefore, our tax rate is very high despite a down housing market.

Okay. Thank you.

Okay. Just the last few questions then we'll wrap up.

Thank you. Mark Heller, you may ask your question. Please state your company name.

Thanks. Manny, this is [Sweeny] again.

Talked about Q3 being, you know, a little somewhat softer than Q4. I'm wondering, is this all project related or do you expect your component business to be kind of volatile in the second half?

Hi, [Sweeny].

We'll obviously give better guidance next quarter. We expect Q3 to be sequentially up from a combined company. The only caution I'm giving you guys is don't model Q3 and Q4 equal or linear because Q4's going to be bigger.

And that's just a consequence or result of the production lines that are being implemented in the second half which would have more contribution in the fourth than the third.

Does it have anything to do with the silicon availability or is it just the manufacturing ramp?

It does but we mapped the ramp of our lines to when we expected silicon and the plan is coming together as we thought it would. Silicon looks to be coming available when we have the capacity coming online.

Okay. Great. And then just one quick one, Manny. What's going to be the options expense for the full-year?

Option expense for the full-year. Actually, give me a second.

I got three accountants flipping through. I'll have the number here really soon.

I've got it here. About $7.5 million in the quarter is the best way to think about it.

Okay. Got it. Thank you.

Okay.

Last two callers please?

Thank you. Tom Astle, you may go ahead with your question. Please state your company name.

Yes, it's National Bank Financial. Thanks for taking my question. Just a high level one, Tom probably.

Looking at your R&D line it's now down to 1.7%, I think, of revenue in the quarter. Seems pretty low for a company that's based itself, its differentiation on its technology. I understand PowerLight impacted that in your growth rate in general but what's your long-term view for that?

Yes, it is. Well, PowerLight ran a lower model. That's one factor.

Second factor is both companies have projects that are partially funded by DoE and [Enrelm] and just a quick subpoint on that. We are working through DoE on the Solar America initiative. So that will influence that line.

So we'll actually put our foot on the accelerator for R&D in the next several years but that won't necessarily show up in terms of percentage of revenue. And you know, it's hard to predict when we'll finally, finalize the contract on the Solar America initiative and therefore, it's hard to predict exactly where we'll land.

But you're correct. We are increasing R&D investment and on a dollar basis and perhaps we could tell you with and without some of the support that we get in future quarters.

The third thing I'd say is we're increasing our R&D investment in the Philippines. Of course, that's more economical.

Okay. And just any kind of long-term modeling for R&D that you could help us with?

Yes. Our model is 4%.

4%.

Given the variables that I said. It will probably be a while before you see that.

Okay. Thanks.

Thank you. Our last question comes from James Bash. You may ask your question and please state your company name.

Yes, actually this is John [Fikdorn] for James Bash from [Dialect] Capital. I have a couple of questions.

The first question is, could you talk a little more specifically about the product revenue line? It seemed to be a little lighter than we expected and how we should expect that to trend going forward? Then I have two more follow-ups after that.

Sure. I think Manny will answer that question.

I think what you're going to see is that it's where the modules that we shipped to our systems business, how we accounted for those. It's marginally going to settle that math for you. And I think Manny will have that here in a second.

Yes, I'm assuming when you say product, it's the component business segment we're talking about?

Yes. And even after the sell in, it seemed to be a little light. Maybe if you could give us more specific guidance on that line specifically. That would be helpful.

Yes. If you did the eliminations and you added it back, you would find the growth, as I recall, to be in at least the 10% range which is actually slightly up from earlier guidance. If that gives you a reference point.

Okay.

I guess my second question is, there's been a lot of money raised by a lot of Japanese solar manufacturers both in the cell and the module arena. Could you talk about kind of if you're seeing any effects from all of these players and how you expect the additional capacity that they're adding to affect pricing in the market going forward and margins?

Yes. That would be presumably Chinese capacity. And there has been an investment on substantial fund-raising that that will play out in an indeterminate time frame because, of course, they need to get silicon and that goes back to price elasticity as prices go down in end markets which we've been saying all along that we expect to happen that the demand elasticity, the demand could perhaps increase rather dramatically.

Now having said that, our strategy has been to invest in downstream channel so that we differentiate ourselves in terms of brand and our brand is built on a technology platforms that we continue to invest in technology, both systems as well as cell efficiency and module efficiency. So we differentiate ourselves by having the highest system efficiency that includes our traditional cell technology.

So we differentiate ourselves on brand, technology, and the most effective channel that makes it easiest for our customers to do business with us. So as we look forward with all of this new your capacity coming on line, we're preparing for that capacity with those, primarily those three things.

It's really hard to predict if that capacity overshoots demand because if demand elasticity, and when that capacity actually comes on line, we think regardless of that date, the three things we're doing makes sense and we're driving those things aggressively.

So you don't see any effect from those players today as they seek to kind of put their increases in capacity to work?

Yes, I wouldn't say any effect. I'd say we definitely see their product in the market and that influences our strategy some. I would say that our -- the three things I said have been effective and we expect them to continue to be.

And finally, with regards to kind of demand sensitivity, as I understood it, a lot of the Southern European markets, which are growing explosively today, kind of have caps currently on their subsidies. And I know Spain has primarily maxed out its subsidy for the year at this point. It's going to continue building all year.

But could you talk about how you expect maybe these subsidy caps and even in California, Spain and Italy, you know, how do they grow year-over-year? Spain's is, I think, flat from 2007 to 2008. And how we can expect kind of the whole concept of demand elasticity to change if we're driven by subsidies that are currently capped?

Very good question. We'll have Julie take that and if we could, we'll end on that question.

Okay.

The caps on the feed-in tariffs in Europe are designed to create an opportunity to reassess the design of the market. So the concept is not that we have a plan for our energy resource mix and we want 371 megawatts of PV in Spain. The idea is they want to have a lot more PV in Spain but as they've set up their market design, they recognize that they don't fully understand what their market rules will create in terms of demand.

So Spain, pretty much the policy makers in every country have designed and explicitly stated that they want to create a fully functioning, fully competitive solar market and that they'll take steps along the way to adjust their policy design to get there as quickly as possible.

Every market does it just a little bit differently. That means that they set their caps differently, they organize their sign differently but at the end of the day, we found that the policy makers tend to be really excited when they see markets respond rapidly to the policy design that they've put in place and are enthusiastic to find ways to rapidly evolve policy to allow markets to grow as fast as possible.

I would just comment that you are correct. It's not as simple as saying, looking at the econ 101 and saying as prices come down how much does demand go up because demand is, as you point out, still policy-driven and therefore, the cap's irrelevant.

There are, of course, a number of other factors that are relevant to demand. On, you know, how quickly you can add the capacity to install and, of course, new policy in the United States would be the first one to talk about there.

And there are also specifics within each of the countries in terms of how the policy works, net metering would be an example of something that as you drill down on demand creation, that's one of the variables that we look at.

So you're correct. The essence of your question is right on. It's not just lowering prices it's a combination of those other things. And we take those things into account as we answer these questions.

Hopefully that's helpful. We are going to talk to folks after this call. We're going to end with one clarification from Manny and then we'll be done.

Thanks, Tom.

I forgot who asked the question now, but since we still have you all, James or Tom asked earlier what the stock compensation is every quarter. My answer was 7.5 a quarter. That's true but there's another piece that you should add to that.

The $7.5 million a quarter is deferred compensation from the PowerLight acquisition. When we built into the deal's retention features, so that's the 7.5 per quarter.

There's also the traditional FAS 123R stock-based comp and that's about 3 to $4 million incremental. So total of about 11 to 11.5 a quarter for stock compensation expense.

All righty. Thank you all for joining us on our Q1 earnings call.

We had a strong quarter. We think we're positioned well going forward. We look forward to reporting to you in three months on our second quarter. Thank you very much.

Thank you. This does conclude today's SunPower conference call. Have a nice day.