SunPower Corporation (SPWR) 2010 Q1 法說會逐字稿

Good afternoon, and welcome to the SunPower Corporation as first quarter 2010 earnings conference call.

Today's conference 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.

Bob Okunski, Senior Director Investor Relations at SunPower Corporation.

Sir, you may begin.

Thank you, Ed.

I would like to welcome everyone to our first quarter 2010 earnings conference call.

On the call today we will start out with a first quarter overview and strategy discussion from Tom Werner, SunPower's CEO, followed by Dennis Arriola, our CFO, who will go into greater financial details on the quarter.

Tom will then discuss our outlook for 2010 before opening up the call for questions.

We have allotted 60 minutes for today's call, and a replay will be available later today on the investor relations page of our website.

During today's call, we will make forward-looking statements subject to various risk and uncertainties that are described in our 2009 10-K as well as today's press release.

Please see those documents for additional information regarding those factors that may impact these forward-looking statements.

To enhance this call, we have also posted a set of PowerPoint slides which we'll reference during this call on the investors presentations page of our investor relations website.

In the same location, we have also posted a supplemental data sheet related to our historical performance.

On slide two of our PowerPoint presentation you will find our Safe Harbor statement.

With that, I would like to turn the call over to Tom Werner, CEO of SunPower, who will begin on slide three.

Thanks, Bob.

Thank you all for joining us today.

I'll start by giving a brief overview of the quarter and then provide detail on our expectations for the balance of 2010.

I will focus on demand visibility and our competitive cost position.

Our prepared remarks will run approximately 25 minutes which will allow plenty of time for questions.

SunPower continues to experience very strong demand in all geographies and market segments.

We were sold out in Q1, remain sold out in Q2 and our production of approximately 550 megawatts fully allocated based on participated bookings for the rest of this year.

Our SunPower panel supply will increase as Fab 3 begins to manufacture significant volumes in 2011.

In the meantime, as we indicated in March, we are also capitalizing on third party solar cell supplies to meet demand and provide revenue upside in 2010.

We are marketing this third party solar cell supply as SunPower's Serengeti brand and managing panel manufacturing to ensure our high standard of quality.

Our strong downstream position in key global rooftop markets in the utility and power plant business provides clear revenue visibility into the second half of 2010 and 2011.

I'll elaborate on this point later in my remarks.

Turning to cost, our panel cost reduction initiatives are on track, and we forecast continued cost improvements throughout 2010 commensurate with our expectations for ASP reduction.

SunPower's superior high efficiency technology and value added services provide clear advantages in the downstream value chain and create a sustainable proven ASP premium.

In addition, this morning we announced our new Oasis modular power plant.

Oasis draws on SunPower's unparalleled solar power plant experience for the past decade and provides our customers with the standardized fully integrated approach to distributed in central station power plants that can reduce balance system costs by up to 25%.

Finally, we were pleased to announce in April our first US panel manufacturing facility in Silicon Valley together with our partner, Flextronics .

This facility will bring 100 manufacturing jobs back to Silicon Valley and will provide SunPower with 75 megawatts of local panel manufacturing capacity.

We would like to thank the US Department of Energy, the city of Milpitas and Governor Schwarzenegger's team for all of their help in making this happen.

Our financial performance in the first quarter reflects continued strength of our vertically integrated business model and diversified channel strategy.

Revenues were the quarter were $347 million, up 64% year on year.

We continue to gain share in our most important markets and segments.

we finished the quarter with a gross margin of 22.5% and non-GAAP EPS for the quarter was $0.05 a share, in line with our previous guidance.

Our results include projects under construction that will not have revenue recognized until Q4.

SunPower's balance sheet remains strong as we ended the quarter with $877 million in cash and investments.

Now I would like to explain the basis for our revenue outlook for the second half of 2010 and into 2011.

Please turn to slide four.

This chart shows a high level view of our current utility and power plant pipeline.

Our UPP group is well positioned for strong future growth with a multi-gigawatt pipeline in EMEA and North America.

We expect to install more than 155 megawatts in our UPP business for 2010, including a 19 megawatt power plant under a PPA with Xcel in Colorado, more than 100 megawatts of power plants in Europe, including more than 60 megawatts power plants through SunRay in Italy for which we will recognize revenue in the fourth quarter or earlier.

We will deliver 12 megawatts of T5 solar roof tiles for Southern California Edison under our five year supply agreement.

In addition, we plan on more than 25 megawatts delivered to other UPP customers worldwide.

In California, we expect to prevent our 250 megawatt CVSR project for PG&E in 2010, which now includes an incremental 40 megawatts that we announced last week.

Now moving on to slide five.

I would like to provide a better understanding of our expected 2010 UPP revenue recognition signing.

Our SunRay acquisition established SunPower as a major project developer in EMEA complimenting our existing North America development position.

As I will explain shortly, the advantage of our involvement in the project development business is higher gross profit per megawatt and visible demand in 2010, 2011 and beyond.

When we act as project developer, we will not recognize revenue on a percentage of completion basis.

Instead, we defer revenue recognition until the power plant is fully financed and sold to a third party investor.

This slide illustrates that although we will be constructing more than 60 megawatts of projects in Q2 and Q3, we won't recognize this substantial portion of our UPP revenue related to our development activities until Q4 2010.

We are, as Dennis will explain shortly, working diligently to monetize these power plants as quickly as possible.

2011 we expect more balanced UPP revenue.

Slide six illustrates how our fully integrated position in the downstream power plant value chain allows SunPower to maximize absolute gross profit per lot.

Using the example of a typical Italian power plant, this chart illustrates how we add value from panel through engineering procurement construction, or EPC, through project developments in order to generate, in this example, absolute gross profit of $1.70 per watt.

This corresponds to a gross margin of 24% on a vertically integrated basis, higher than the gross margin of any of the individual value chain steps.

By building additional margin across the value chain, we expect to realize gross margins at or above 20% for many of our large scale UPP projects.

In summary, with respect to our global UPP business, we have a large growing pipeline and power plants that provides us with clear demand visibility through the second half of 2010 and beyond with improved margins.

We are confident in the demand for SunPower's high performance products in our residential and commercial business, or R&C.

Slide seven shows the expansion history of our residential and light commercial dealer base and the strong correlation to revenue growth.

Over the past five years, we have built what we believe to be the industry's preeminent dealer network with more than a thousand dealers worldwide.

During 2010, we expect to further grow our dealer network to more than 1,500 dealers.

This larger base of dealers will be the primary revenue growth driver for our R&C business.

The reason we can consistently attract high quality new dealers to our network is straightforward.

SunPower sells a better product that delivers a superior customer value proposition.

Slide eight shows a comparison between a typical SunPower residential rooftop system and a conventional crystalline silicon system.

As you can see, our dealers are willing to pay a fair ASP premium for our panel in value added services.

Higher efficiency panels allow for cost savings on balances systems cost and installation labor.

Customers are willing to pay more for a SunPower system because our system generates more kilowatt hours from their roof and thus, increase their system in TV.

Slide nine includes a quote from Mark Nelson at Southern California Edison specifically addressing this benefit with respect to our five year 200 megawatt DC T5 supply agreement.

Sophisticated customers like Southern California Edison recognize that system return is not solely defined by panel cost per watt but rather, by the total installed system cost and its performance over time.

If MPV benefit accrues to most rooftop system owners but is particularly powerful with feed-in-tariff structures and incentive regimes including net metering or self consumption rules such as those in the US, Japan, Italy and Germany.

Now let me move to our cost reduction initiatives shown on Slide ten.

We are working across the entire value chain to accelerate cost reduction in all facets of our business system performance and reliability.

Our R&D group continues to drive higher cell efficiencies for next gen technologies, as well as delivering yield and productivity improvements on our 15 Fab lines.

For 2010, we expect overall panel cost reduction to be in line with our forecasted ASP decrease of up to 20%.

We continue to increase conversion efficiencies at Fab 1 And Fab 2 and we will be shipping a majority of our panels as E19s by the end of this year.

2011, our Gen 3 cell technology with conversion efficiencies greater than 23% will ship in sufficient volumes to contribute to our cost reduction program.

In our supply chain, we are leveraging our scale as we expect our material costs to decline by more than 10% this year.

In addition, our regional panels manufacturing strategy will begin to reduce logistic costs and working capital needs by the end of 2010.

Our R&D team is investing in several major initiatives to reduce capital expenditures per watt, improve return on invested capital and increase overall equipment effectiveness.

Our cost reduction strategy focuses on both our existing fabs in the Philippines as well as our new Fab 3 in Malaysia.

For example, we see significant opportunity to improve triplet yield as line productivity is expected to increase by 15% this year.

Importantly, cost improvements are not limited to manufacturing.

Turning to slide eleven, you'll see the results of our investment system cost reduction.

This morning we announced our new Oasis modular standardized power plant that reduces balance of system cost by up to 25%.

Each Oasis power block integrates SunPower T0 trackers with high efficiency SunPower 400 watts utility solar panels.

Premanufactured system cabling and a dedicated converter and operating control system.

This configuration offers project flexibility, rapid installation times and easily scales from a 1 megawatt distributed power plant to a larger central station power plant.

Oasis demonstrates SunPower's ability to combine leading edge solar cell technology with low cost balance of system design and implementation to create a highly competitive solar power plant product offering.

We expect revenues from Oasis beginning in early 2011.

These are the demand creation and cost reduction strategies we are implementing that will help us meet our 2010, 2011 goals.

With that, I would like to turn the call over to Dennis to go over our financials in greater

Thanks, Tom.

Let me remind you that when we issue our second quarter results in August, we will begin using our new business segments which are residential and commercial, or R&C and utility and power plants, or UPP.

We will also report prior periods using these new segment definitions so the investors may analyze our financial results on comparable days.

Now, please turn to slide 12.

Revenue in the first quarter of 2010 was $347 million, a 64% increase from the first quarter of 2009.

Improvement in our revenue base was driven by our strong performance in all of our major residential and components markets.

In the US, megawatts sold nearly doubled over the first quarter of 2009 and were up over four-fold in Germany.

Our components business was up more than 160% from Q1 2009 with revenues of $283 million.

We experienced strong year-over-year growth in all of our major markets with the US, Germany and Italy being the largest contributors.

In our systems business, we recorded revenues of $65 million in the first quarter of 2010 compared to $104 million in the same quarter of 2009.

The first quarter was impacted by typical seasonality, some delayed projects as well as deferred revenue as a result of our acquisition of SunRay.

Consolidated gross margin on a non-GAAP basis for the quarter improved 22.5% from 17.2% for the same quarter in 2009 and from 21.7% for the fourth quarter of 2009.

For our components group, non-GAAP gross margin for the quarter was nearly 26% as we continued to grow our market share in Italy, Germany and France and we maintained our leading position in North America.

As Tom mentioned, the growth in our global dealer base will continue to pay dividends as more and more customers get access to SunPower's products around the world.

Let me spend a moment on our systems gross margin.

In Q1 of 2002, we recorded a non-GAAP gross margin of 8.3%.

Now let's dive into that number a little more.

You can basically break down our system's cost of revenue into two buckets.

The costs directly associated with projects that generated revenue in the quarter and unabsorbed costs and labor in the quarter.

For those projects that recognized revenue in Q1 of 2010, the corresponding gross margin was approximately 18.3%.

However, there was about $6 million of unabsorbed overhead associated with projects that have shifted in timing and are scheduled to be completed later this year.

As part of our cost optimization strategy, we're evaluating ways to reduce the proportion of fixed cost in our system's business which will allow us to leverage more often variable cost so we can scale up or down, depending upon the overall level of business in that quarter.

Given the projected level of systems business for the remainder of the year and our bookings year-to-date, we expect the gross margin for the business segment to be over 20% in all of 2010.

Operating expenses in Q1 of 2010 were $64.6 million on a non-GAAP basis compared to $58.4 million in the fourth quarter of 2009.

The increase in operating expenses for the quarter included approximately $11 million pre-tax related to the accounting investigation and our acquisition of SunRay.

For full year 2010, we expect our operating expenses as a percentage of revenue to be in the 10% to 11% range, excluding the $11 million in costs just mentioned.

Other income and expenses on a non-GAAP basis was a $10.8 million expense compared to $6.3 million expense in the fourth quarter of 2009.

The increase was primarily related to the cost of our foreign exchange hedging program.

For the remainder of 2010, we have about 72% of our euro exposure hedged at a US rate of $1.38 for Europe.

Our non-GAAP defective tax rate for the quarter was 26% compared to 20% in the fourth quarter of 2009.

The increase in the quarter's tax rate was driven by a one time foreign tax payment.

For the full year, we still expect our non-GAAP tax rate to be in the 19% to 22% range.

Our GAAP tax rate needs a little more explaining.

First, like most companies, we estimate our 2010 tax rate based on our projected profit before taxes for the full year.

Since the majority of our profit before tax will be generated in the second half of the year, and we incurred a GAAP loss before taxes in the first quarter, we actually recorded a tax benefit for Q1 2010.

As a result of the tax benefit, our GAAP earnings for share for the quarter were a positive $0.13 per diluted share.

With the deferred timing of our expected profits into the second half of 2010, it makes sense to provide investors with a forecasted full year GAAP tax provision rather than quarterly tax rate estimates since there can be a wide range in the actual quarterly GAAP tax rate results as well as the reported GAAP earnings per rate results.

We expect the full year GAAP tax provision to be in the range of $40 million to $50 million.

Depending upon the quarterly allocation of that provision, GAAP quarterly tax rates may fluctuate significantly.

Having completed the SunRay purchase price allocation and with higher non-cash expense related to our new convertible bonds, we now expect our GAAP earnings per share for the year to be in the range of a loss of $0.20 a share to a positive $0.25 per share, including the GAAP tax provision just mentioned.

Net income on a non-GAAP basis for Q1 was $5.2 million, $0.05 per diluted share, consistent with the guidance we provided on our fourth quarter conference call.

Once again, this includes the $11 million in expenses related to the accounting investigation and SunRay acquisition which is approximately $0.08 per share after tax.

So overall, it was a solid quarter and consistent with the expectations we laid out earlier in year.

Let me turn to the balance sheet and our liquidity update on slide 13.

Our balance sheet remains strong as we completed the acquisition of SunRay prior to the end of the quarter, and we took further steps to improve our overall liquidity.

We ended the quarter with $877 million in cash and investments which includes nearly $500 million that is available to help fund our operations and capital expenditure program.

We completed a $250 million convertible debt issuance and also closed a new $350 million letter of credit facility with a syndicate of major international banks.

This new letter of credit facility provides us with additional flexibility since it requires 50% cash collateral compared to our former letter of credit facility which required 100% cash collateral.

In addition, we announced on Monday that we are registering new $75 million term loan with the International Finance Corporation for our operations in the Philippines.

We believe that maintaining our strong balance sheet and improving our financial flexibility are prudent, especially given the events in the financial markets over the last couple weeks.

Let me spend a moment now on our European financing program at SunRay.

One of the many benefits of acquiring SunRay is its successful project finance team.

This team led the financing of the Montalto project last year and has been actively coordinating the debt and equity financing for an additional 60 megawatts this year.

We expect to monetize the Montalto 24 megawatt project before the end of the third quarter and use the cash proceeds to finance the working capital requirements related to the other Italian projects this year.

I'm pleased with the progress we've made in negotiating the debt financing and the sale of project equity to different investors, and I'm confident that we will be making some announcements soon.

As we debt finance these projects and monetize the equity, we will begin recognizing the revenue related to those projects.

The Italian portfolio of SunRay projects consisting of more than 60 megawatts are on schedule to be constructed and hooked up to the grid by year end 2010.

Based on our advanced discussions with bank and project equity investors, we are confident that we will recognize the revenue and earnings from these assets in 2010.

In total, we expect to recognize revenue from more than 100 megawatts of power plant projects in Europe this year.

Overall, we're on track with our 2010 financial plan.

With that, I would like to turn it back to Tom for our 2010 outlook and guidance.

Thanks, Dennis.

Now I would like to turn to our guidance beginning on slide 14.

This slide shows our expected revenues using our new business segmentation.

As I mentioned in my opening remarks, our manufacturing capacity is fully allocated for 2010, and we have clear demand visibility in our rapidly growing UPP business in 2011.

We have a high degree of confidence in our 2010 revenue guidance of $2 to $2.25 billion, representing in excess of 33% growth versus 2009.

As we laid out on slide five, our UPP business under construction in the second and third quarters will lead to a strong fourth quarter in terms of realized revenue from SunRay, as well as completed EPC business.

We are confident that we will finance, monetize and execute on more than 155 megawatts UPP business in 2010.

On slide 15, you'll see our guidance summarized.

Over the past year, we expect gross margins -- over the year, we expect gross margins in the 20% to 22% range.

This range is ASP declines of 20% year-on-year on our R&C business.

We reaffirm non-GAAP earnings per share in the range of $1.25 to $1.65 from last quarter.

As we've mentioned, 72% of our euro exposure for the remainder of the year is hedged at a US dollar rate of $1.38 to 1 euro.

Our guidance also assumes a non-GAAP tax rate of 19% to 22% in 2010.

Our production plan remains at approximately 550 megawatts with an additional 50 to 100 megawatts coming from third party solar cell supply.

Fab 3 which will begin initial cell production in late 2010 will be the driver of the majority of our $375 million to $475 million capital expenditure program this year.

With that, I'll open the call to questions now.

In addition to Dennis, I also have with me Howard Wenger, President of our Utility and Power Plants group, Jim Pape, President of our Residential and Commercial segment, Julie Blunden, our EVP of Public Policy and Corporate Communications, Navneet Govil, our Vice President and Treasurer and Bob Okunski, our Senior Director of Investor Relations so that they may provide some of our answers.

With that, let's take questions.

Thank you.

(Operator Instructions) Our first one comes from Satya Kumar from Credit Suisse.

Your line is open.

Mr.

Kumar?

Hi.

Can you hear me?

Yes, Satya, we can now.

Sorry about that.

A couple of questions.

Firstly on the euro, what is the assumption on the unhedged portion for the currency exchange rate?

Can you give us an estimate of how every penny (inaudible) can affect the total income in 2010?

Satya, do you have two parts of your question that involve the finance team --

The other is on Italy, so I can ask you after this if you want.

Yes, why don't you go ahead with Italy while they --

Okay, on Italy, you had a really good slide talking about $1 70 gross profit at a system level which is about 27% gross profits.

A couple of questions that follow from that.

Can you help me how to think about what the operating margins at the EPC and product development portions of that?

And as we look in 2011, Italy is considering to lower the tiles by 25% on ground mounted systems.

Giving that that's about the gross margin percentage that you have in 2010, how would the stack for profits look like in 2011 for the Italian projects?

Thanks.

Okay.

So I've got FX for the unhedged portions and I've got Italy, and I think Howard captured the couple questions you had on Italy.

So why don't I turn first to Dennis on FX, and then we'll go to Howard.

Sure.

Satya, based upon our unhedged position and recognizing that it's over a three quarter period, a $0.01 change in the exchange rate is equivalent to about $4.5 million on a revenue basis and roughly $2 million on an operating profit basis.

Satya, this is Howard Wenger.

On Italy you had a couple of questions.

The first one had to do with margin and how that stacks up.

What we do is we bifurcated the panel from the EPC portion of the system, and we're at about 20% gross margin on both those pieces.

We do not include the panel in the EPC buildup on that.

And then we add on top of that the project development margin, and that's how we get 24% for the full stack.

And the full stack is based on the sale price to the equity and the debt.

With regard to 2011, our prospects in Italy with the feed-in-tariff going down, we are in really great position in Italy.

As you know, we purchased a company called SunRay, which is a premier developer in Europe.

They have got 80 people who are on the ground, and we're putting in place land positions in Italy 4-20-11 built, and our analysis shows with the feed-in-tariff a reduction, which we are anticipating will be between 20% and 30%.

We will still be plenty profitable for those projects in combination with our cost reduction program and other product rollouts, such as Oasis.

So Satya, just to recap Howard's last piece, new product roll outs and cost reductions on the existing cell and model.

Thanks.

Our next question will come from Vishal Shah from Barclays.

Your line is open, sir.

Yes, thanks for taking my question.

So on the systems business, you showed that slide 100 megawatts plus to the European UPP business at $7 a watt and 24% gross margins, and your total margin guidance for the systems business is 20%.

So I'm trying to understand whether the gross margins in the systems business outside of Europe is going to be below 20%.

Is that your assumption to begin with?

And then secondly, your component gross margins in the quarter were really good at 25%, yet seems to me that your total margins for that business also for the full year is around 20%.

Can you help me reconcile that, especially when you are talking of costs coming down in line with ASPs during the year?

Yes, sure Vishal, thanks for the question .

So we'll split this into two.

I'll first go to Howard on the mix involved with the systems map that you were doing, and then we'll go to Jim Pape on the margin question

We anticipate -- this is Howard.

We anticipate margins in excess of 20% for the projects in the European portion of our utility business and margins below 20% in 2010 for the North America portion of our utility business.

Okay.

Let's go to the components question which was, if you're 25 now, how do you end at 20?

Jim?

Yes.

So there is pressure, Vishal, on pricing post German fit.

So we are expecting to see some pressure there as built into our plan and into our structure.

We think the north of 20 plan going through the end of the year is absolutely achievable, and we're highly confident that we can continue to deliver in that north of 20 range given, even with all of the variables in the mix.

Yes, so Vishal, on the component side, there is a timing element.

So you assume an instantaneous price decrease consistent with the feed-in-tariff.

However, your cost reductions aren't instantaneous, so you have to integrate the area under the curve over the second half of the year.

Why don't we go to the next question and Vishal can jump back in if we didn't quite get it.

Our next question comes from Rob Stone with Cowen and Company.

Your line is open, sir.

Hi.

First of all, follow up to the euro sensitivity.

You mentioned what the delta was on a one penny change, but you didn't say what you were assuming for an average unhedged rate underlying your guidance for the rest of the year.

Okay, Rob.

They're verifying that.

Did you have a second part for the question?

Yes.

So my second question has to do with having a lot of revenue that is going to be recognized on monetizing these projects in the fourth quarter.

What are the factors that could lead to potentially earlier or later possibility of slipping out recognized revenue into Q1 of next year?

Okay, sure.

Let me put a little bit of color to your second question and Dennis, if you could add to euro assumption for the 27% or 28% that's unhedged.

So, Rob, in terms of timing, there would be what SunPower would choose to do.

And that is there's a rate of return that both the debt and equity acquirers would require.

And the less risk and the more certainty the project i.e., the later in the built stages the project is, the lower the return that they would require, so risk offset by return.

So that would be our decision of when to sell and as Dennis can elaborate, we are in active discussions on everything that we showed.

The flip side would be, of course is if the environment changed and those people that we're talking to chose to make decisions differently than what they're currently projecting, which would be a change -- something external would have to change their posture that what we're currently being told and working with them in terms of timing.

So go ahead, Dennis, on both of those, please.

Yes, the -- let me just answer the FX one and then I'll come back to what Tom was talking about as well.

On the FX, if you look at our unhedged positions at this point in time on a weighted average basis, we're assuming 127.

So we're looking at what's going on currently in the market and incorporating that into our outlook and maintaining our guidance.

As far as where we stand with the financing and the equities though, we're very encouraged by the response both of the bank as well as the equity investors.

And I think one of the things that we found is that Europe is actually a much more mature market and seasoned when it comes both to the project finance bank and equity investors.

And what we found is that the equity -- excuse me, the project finance bank, given their experience both on the win side as well as all of the projects they've done in Spain on the solar side, they're very familiar with structures and in general, they're willing to provide leverage of more than 80% for technologies that they're comfortable with and companies that they're comfortable with.

And I think that is one of the competitive advantages that we have right now in the market is that there are a lot of banks that have done their homework.

No more technology, and want to work with us in order to make money for themselves.

So we're excited about that.

So you're not seeing, especially in the last couple of weeks, chaos over there, any inclination towards stretching out financing schedules?

No, we really haven't.

If anything, I think banks that have started the credit approval process are trying to accelerate it so they can avoid any delays down the road.

Great, thank you.

Our next question comes from Stephen O'Rourke from Deutsche Bank.

Your line is open, sir.

Yes, hi.

This is Peter Kim for Stephen O'Rourke.

I had a quick question about your example for the Italy installation, the 24% gross margin example.

Does that include the use of the Oasis that you guys just released?

I'll comment on that briefly and if Howard, you want to add to it, you can.

The answer in the example is, no, that Oasis is the 2011, and that will offset the earlier question of any further feed-in-tariff drops.

I have nothing further, Tom.

Okay.

And then a quick follow-up.

It looks like your Q3 gross margin estimates, the revenue breakout looks like that your smaller systems, I forget what you call it now, O&R -- O&C, excuse me, commercial and real estate portion was larger in terms of revenue.

So I was wondering, is the R&C gross margins lower than your UPP margins?

Yes.

So I think the profile that you're looking at is -- includes R&C would have up to a 20% price decrease in the second half of the year.

And so what that -- what you can conclude is is that like the question earlier that the combined first half and second half performance will end up in the 20% to 22% range.

Anything that Dennis or Jim want to add?

Okay.

So -- and the system business is materially similar.

So I think you can assume that we exit the year with it (inaudible) have very similar gross margins.

Thank you.

Our next question will come from Michael Horwitz from Baird.

Your line is open, sir.

Great.

Thanks for taking my question.

Quickly, can you walk through what the economics are going to look like on some of the third party cells that you'll be using?

And I think that in your prepared remarks, you mentioned something about that allowing for some upside in revenue.

And I don't know if I was mistaken when I heard that.

Yes.

You heard the upside revenue correctly Michael, and that would explain the range in our guidance.

We also had a very broad range in terms of third party utilization.

So of course, if we're at the extreme positive end of that we could be pushing the positive end of our guidance for sure, perhaps even slightly north of that because of the variable large range of third party supply.

The economics of third party supply varies significantly over time, just almost directly correlated to pricing that you see for a -- call it a core commodity type module that which you can buy from China.

And so the pricing on those modules has changed.

It was lower earlier in the year, perhaps at the end of last year, than it is today, but not by a lot.

Frankly, we expect that pricing to decrease.

So the economics on third party supply is in fact a lower gross margin today, but we expect that gross margin to improve throughout the year.

Okay, great.

That was helpful.

And then quickly on slide eight, when we look at conventional versus SunPower and you walk through panel balance systems, installation dealer margin, what I always find interesting about these kind of charts is I never really see much change going on in dealer margin or installation in terms of any benefits that may occur or any margin decrease that those parts of the value chain may need to accept to maintain their position in the market.

So can you just walk through that downstream part and why those people are still getting that kind of margin?

Yes.

Fair enough, Michael.

I'll comment and, Jim , if you want to add something, you can.

Of course, our dealer partners would not react favorably if we forecasted for them what their margins are going to do.

And so frankly, Michael, on both, as you correctly point out, on both of those we held those specs, which as those being equal to compare clearly on installation we are full out of salt on those, the cost to install a system.

As you can see with the pictures, it's a substantial part of the costs.

And obviously, a higher efficiency panel is one of the ways of doing that, and of course, we're increasing the efficiency of both our cell and our panel to accomplish that.

But things like Oasis for utility will be doing similar things in the other parts of our business where we'll be standardizing and pulling costs out for sure.

The more dealers you have, the more competitive the environment is, and that probably will influence margins, is the last thing I would say about dealer margins.

Jim, would you want to

Yes.

Just to build on that, to say that as markets mature, you see that margin expectation by deal or by job compressed.

And that is kind of the maturity path across the planet.

And so the question you asked was dynamic, the picture we showed you is kind of static.

But that's -- there is a difference there.

Okay.

Thank you.

I would say that materially, it's similar to what Jim experienced in training.

Yes.

Our next question, please.

Next question comes from Timothy Arcuri from Citigroup.

Your line is open, sir.

Hi.

A couple of things.

First a module question, second a guidance question.

First on modules, can you give us some sense of ASPs relative to Q4 and the percentage of modules that were captive in the traditional systems revenue that you reported for the quarter.

So I'm wondering whether you can give some guidance in our current revenue breakout.

So can you guide components systems as you currently report?

Thanks.

Okay.

So Tim, I'm going to ask the finance team to answer both of those.

The second question sounded like, can you forecast the way you currently report the next three quarters?.

And the first question is ASP for module and percent captive, meaning that which is consumed in the system's business.

Dennis, can you take those?

Yes.

As far as the -- if you look at the -- our current segmentation and our new segmentation going forward, this year they're not going to change substantially.

There's actually going to be about 50/50 under the old version and under the new segments as well.

So don't expect very much there.

Going forward with what is going on in our UPP business, we will see more growth out of UPP in the future.

As far as the -- I'm sorry.

On the second question --

ASP for modules and percentage of modules going to the systems business.

On the -- remember that we talked about a blended ASP for our residential and commercial business and from quarter-to-quarter, they were down about 10%.

Okay.

I think we may have to look up the --

Yes, we'll get back to you on the other question, Tim.

Give us a second.

Okay.

Thanks.

The next question, please.

Next question comes from Pavel Molchanov from Raymond James.

Your line is open, sir.

Hi, guys.

First just a housekeeping item on taxes.

When you said $40 million to $50 million tax provision, given the benefit of $30 million in Q1, does that mean $70 million of provision in the latter three-quarters of the year?

Well, the way that you need to think about it is, once again, we look at what are expected profit before taxes going to be for the full year, and then we have to go back and depending upon what the quarterly numbers are.

So the $40 million to $50 million is for the full year on an expense base.

We had a benefit in the first quarter.

So what you could expect when we do book a substantial amount of revenue in the fourth quarter, there will be a larger than expected tax expense to offset the benefit in the first quarter.

Understood.

And then on SG&A with SunRay close, can you tell us how much that line item should move up, given the extra headcount?

We haven't spoken that out specifically.

What I can tell you is that the overall -- the operating expense range that I gave you, 10% to 11% for the year, excluding the $11 million for the acquisition and the accounting investigation, includes the SunRay OpEx, or SG&A.

Okay.

Thanks, guys.

So it will be in line with what we've had previously.

Okay.

Next question will come from John Hardy from Broadpoint.

Your line is open, sir.

Yes, thanks for taking my questions.

One quick one.

What was the third party component revenue in the quarter?

Okay.

So we'll add that to the percent of modules that went to systems with the third party component revenue.

Yes.

Let me answer Tim's question first.

Out of the slightly under 100 megawatts about just under a quarter of them went to the systems business.

Okay?

Then on third party revenue, it was less than 5%.

Okay.

Thanks.

And then a quick follow-up on the very interesting slide six.

If I look at that 24% gross margin number, it's on a pretty rich ASP, consistent with what's going on in Italy right now.

But as you move forward you have more of your UPP business in the US in 2011 at say, a 30% lower number than that $7 number on slide six, what are some of the differences on the cost side, moving to the US, to even get you close to that 20% target?

So lower ASP in America versus Italy, how do you hold margin?

Howard?

So several ways.

Number one is scale.

The scale of the projects that we're developing and building in the US that are much larger.

Number two the type of sites that we have.

In Europe, they tend to be somewhat more challenging, more hilly, not big, square, flat sites.

We have better sites in the US.

And then when you couple our work on this Oasis project, which I can take a minute to go through that.

What we're doing with Oasis, what that is is a standardized power plant, we call it internally power plant in a box, if you will.

What we are doing is we are productizing the power system.

We're taking our 15 years in the systems business and as a vertically integrated company, and we're shifting the product from being one of panels to one of being systems, which is what our customers want.

Sort of like a car.

They don't want an engine -- they don't want to buy an engine, they don't want to buy the tires, they want to buy the whole vehicle, and that's what we're providing.

And so we're designing from A to Z the entire system, we're standardizing it.

And what that does is it lowers the cost in three ways.

We're able to decrease installation time, we're able to design out certain elements of customized systems such as fewer connections, better wiring layout, better power block configuration.

And then we're also, because we're standardizing on a one-by-one power block, we're able to realize some economies of procurement.

So with those three elements, we're able to drive to a 20%, 25% higher cost reduction with our Oasis power blocks.

So all of those things in combination get us to a better gross margin -- or a sustainable gross margin profile in the US.

We will add one thing, which is the Oasis product is being rolled out first in the US, so we are really targeting that market first.

In 2011.

The last thing I would say is if you look at the profile of our new PT revenue, it is materially skewed towards Europe in the near term, and the US revenue is out a few years, 2010 and beyond.

So you benefit from the significant cost reduction curve that we have in the Company.

Thank you.

Our next question comes from Chris Blansett from JPMorgan, your line is open.

Thanks, guys.

I had a couple, almost housekeeping questions.

One is, wondering if you can give us an idea of free cash flow quarterly throughout the year.

And then he other one, I wasn't sure if you could talk about your regional revenue breakout during the quarter.

And Chris, do you want regional breakout for Q1?

Yes, please.

And maybe you can give some color on how you expect that to shift throughout the year, as well.

Okay, so regional breakout Q1, Dennis?

Sure.

Let's start with the cash flow.

We haven't broken out free cash flow before on a quarterly basis.

What I can tell you is that with the acquisition of SunRay in the first quarter, we were obviously free cash flow negative.

Given that we're building up the -- and developing the projects, especially with the SunRay acquisition in Europe, we'll continue to be a cash user in quarters two and three, and we'll be free cash flow positive in the fourth quarter.

But on an overall year basis, primarily because of our CapEx program and because of the SunRay acquisition, we will be free cash flow negative for the full year.

As far as, if you look at revenue and/or megawatts by country, the United States continues to be our most important market with nearly a quarter of our overall megawatts and roughly 30% of revenues.

Over the quarter, Germany and Italy were very close second, and France, we had a substantial improvement in growth in France.

So those are the four main countries that continue to be great contributors for us.

Going forward into the rest of the year, you will see -- once again, because of the SunRay portfolio, you'll see Italy contributed substantial amounts of our revenues and megawatts allocated to it in the third and fourth quarter.

But you'll see also in North America throughout the year, our R&C business and especially the residential business will remain strong in the United States.

So expect to see the US continue on a -- for the overall year, be our main market.

Strong presence in German and Italy coming on strong in the second half of the year.

And then I had just one quick question about your Oasis product.

Is this something that is going to pretty much be assembled at an off-site factory somewhere, maybe in the Philippines and then shipped in large assemblies to wherever the systems go?

Or is this still assembled largely on site, just from components?

It's be largely assembled near the site in strategically located assembly areas.

Not necessarily on site, but near the locus of project activity.

And of course, there will be minimal on site assembly because it will be prepackaged, so to speak, in a separate location.

And as you point out, that will be a low cost location.

So this is kind of a ways of bringing the system integration up one more step before you actually ship to the site?

Yes, but I think there's a predesign element to it that allows you to standardize components that give you scale of purchasing as well as less or lower cost components.

But yes to your question with those other two things.

Alright, thank you very much.

You bet.

Next question will come from Colin Rusch from ThinkEquity, you line is open.

Thanks.

Can you guys give us an update on Australia sales, into Japan as well as Ontario for this year into next year?

Sure, Colin.

Your question was on Ontario, Japan and Australia?

Correct.

I'll comment overall, and Jim or How -- Jim or Dennis, you can qualify.

Let me start with Australia.

Australia market is doing fine.

Again, we are supply constrained, so our problem is where to allocate product, and we've got a good presence in Australia, and I think that we'll see it picking up the rest of the year.

Japan, our Toshiba agreement is going great.

They're seeing great sell-through of our product, and as we sit here, we can't make it fast enough for the Japanese market.

And in the third market, Ontario is not a market that we've participated in yet.

Dennis or Jim, anything you want to add?

No, Australia is coming great, exceeding all of our expectations.

Great, and just a quick follow-up.

Have you considered adding any module based capacity, or is Flextronics looking at other areas in Asia for finishing the modules for you?

The answer to your question is yes.

We do -- we are looking for more regional modco capacity.

And you'll see us do other things with module assembly in region.

I wouldn't necessarily point to any certain contract manufacturer or any certain region because we're going to be modifying the way we make modules over the next five quarters, and it will include both of those things.

Different manufacturers from different regions.

Thanks so much.

You bet.

Our next question comes from Stephen Chin from UBS.

Your line is open, sir.

Stephen?

Mr.

Chin, check your headset or mute button, please.

Yes, hi.

Can you hear me now?

Yes, we can.

Sorry about that.

Just a follow-up question on slide 14, Tom.

If I eyeball the residential and commercial sales, it looks like that business can be up about 30% to 40% in the second half of this year versus the first half of the year.

What gives you that confidence?

Is it the number of dealers you're signing up or new products?

And then I had a separate question.

Sure.

Yes, this is Jim Pape.

So most businesses are accelerating, right?

The North American system of business is building backlog and growing throughout the year finishing strong.

And then you answered the question correctly on the residential side.

The dealer additions, the slide -- the other slide was intended to show the correlation in dealer additions to revenue growth, and we continue to expect that obviously to continue.

That's a very, very strong play for us and is going to continue to drive us into the end of the year.

Yes, so both the R&C business includes residential and all the commercial business.

Both of those businesses will see substantial growth.

I think the systems business may be slightly higher growth.

Our east coast team based out of New Jersey is doing a wonderful job and having a great start to the year.

And I think that that is going to pay significant dividends in the back half of the year.

You probably are aware that New Jersey is a very strong market in general and extremely strong market for SunPower.

So number of dealers, yes, new product with Serengeti to complement our existing supply and Jim is on allocation.

So the more he can get, the more he can sell and an accelerated systems business.

Okay, thanks Tom, for that.

And the second question I had was just on the inventory build that might be need to support the big UPP sales in the fourth quarter.

Is there going to be a quarter where we'll see a big step function increase in inventory?

Is there going to be a quarter where we'll see a big step function increase in inventory?

And if so, what quarter will that be and any magnitude what to expect on the balance sheet going forward?

Yes.

So I'll let Dennis and Navneet will give us inventory guidance.

We are increasing inventory velocity in the Company and working capital velocity, so at same time you see -- rightfully point out that you will see a work in process build up for systems business, you're seeing better inventory velocity -- I'm sorry -- better working capital management in the rest of the Company.

Dennis, how does that net out?

Yes, if you look at where we ended the quarter with roughly $252 million in inventory, you're going to see a slight increase in the second and third quarter, but it's not going to be anything material.

It's generally going to be within 5% of that, and then you'll see it come down a little bit in the fourth quarter.

But remember that our business profile beyond the fourth quarter is strong as well.

So we're going to need to make sure that we maintain a sufficient level of inventory.

We're also able to actually bring it down.

It's actually lower than it has been at peak periods in the past, and that is really through our regional (inaudible) strategy.

So that is helping us optimize our working capital as well.

Any follow-up?

If not, we'll go to the next question.

I think we're going to take two more, two or three more.

Our next one comes from Edward Mok from Needham & Company.

Your line is open, sir .

Hey, thanks for taking my question.

Tom, you mentioned several times that you guys are sold out, so how do you buy between a panel that you produce for a dealer versus your own UPP product government project business?

Yes, thanks for the question, Edwin and I think that is a really, really important question as you look at SunPower.

Because if we would take all of our panels and sell them as components, then obviously, our gross margins would have been north of 25% or 30% as a Company.

So we're making a tradeoff decision to prepare ourselves for a long-term Company, and we're supporting our UPP business, both in Europe and North America.

And we make that decision -- the way we make that decision is we believe over the next few years, it's going to be more of a demand driven market.

And as we said over the last five years, we believe that owning the outbound channel allows us to control own our own destiny.

So, in fact, you see us preparing for the future in our current profile.

And if we weren't doing that, then the financial performance of the Company would be markedly different in Q1 and Q2.

So it is investment in the future that we're consciously making.

Okay.

And then my follow-up will be on regarding the slide four, you show us that your EM -- your UPP business at 1.2 gigawatt, and it shows that there is three yellow boxes.

Does that imply that you expect to finish the whole 1.2 pipeline within the next three years, give or take?

Yes.

Why don't I let Howard take that question.

Yes, that's right.

Over the next three years is just about right.

Okay.

So what that would tell you is that the pipeline that we acquired, yes, now those 80 people are acquiring new land, as Howard alluded to, and so that pipeline will increase, obviously, over that time.

Great, thanks.

That's all I have.

Okay .

Next

Next question comes from Gary Hsueh from Oppenheimer.

Your line is open, sir.

Great, thanks for taking my question.

Just looking at your near term guidance here for 2010 with gross margin dipping down to 18% and 20% in Q3, am I to understand that that is because of the mix kind of going more towards the more R&C side of the house?

And then to follow that, if you look at Q4, if you use that same logic that R&C is somewhat depressing kind of growth margin expansion in Q3, isn't there a possibility you can see much a better kind of gross margin range in Q4 than the 20% to 22% maybe north of 22%, 22% to 24% in Q4 if it's more UPP rich there?

And I have got another follow-up.

Sure.

Your question -- your general hypothesis of your question is fair, and we are mix dependent.

And in Q4, if there were more systems business, then that mix would push us to the high end of our gross margin range.

And I also think that there is more of an opportunity for cost reduction in that business.

What you're seeing in Q3, of course, is that we've built into our Company the ASP decrease into the early part of Q3.

And of course, cost reductions don't happen instantaneously, so you're seeing that disconnect in the way we've guided or the way we've built the back half of the year.

Okay.

Just a quick follow-up here on Oasis.

I think if you look at slide six, are we to look at that slide and say that basically, if you kind of point that slide outside of Italy and lower IR regions, that Oasis is probably one of the key mechanisms in how SunPower is going to be able to sustain 24% project gross margins outside of Italy?

Is Oasis the key mechanism for that, and are there any other levers to maintaining that kind of margin structure outside of Italy besides Oasis?

Sure.

Let me make two comments, largely drawn off of what Howard said earlier.

Outside Italy you tend to have, particularly in the United States, you tend to have larger scale projects, tend to be on easier sites, so easier to install.

And, yes, we can exploit Oasis particularly well and plan to in that market.

So that would be a yes.

But I would add to that that make no mistake, we are all over cost reduction in our solar cell and module business, and I can assure you that there is quite a few people that have stack bar charts and three W plans that support the slide that we showed with the cost reductions from that part of the business as well.

We're very capable of tracking the best in cost -- module cost in the industry, and I can assure you we're focused on the keeping pace.

Alright, great.

Thanks a lot.

Our last question will come from Dan Ries from Collins Stewart.

Your line is open, sir .

Thank you for taking my question.

The questions regarding the target for increase dealers, is there any difference in the approach to residential versus commercial installers with that target?

The question is really that it seems like the market share in California has been sustained in the residential space, but maybe slipped a bit in the commercial space.

I'm wondering if there's anything in the plan to address that.

I thing Serengeti might -- Serengeti may also address that.

Is there anything to that ?

Yes.

So let me -- Dan, let me have Jim comment, and then I'll comment and wrap it up.

Jim?

Yes, Dan, you did my work for me.

Yes, still holding on to number one share in California, have seen some pressure there.

The commercial piece where we would call it neck-and-neck with the competitors and a strong first place through Q1 in residential all combined, we call that a strong first place and feel good about that.

Your question started with, is there a difference in how you approach them?

The answer is yes.

We have a light commercial only dealers.

We have residential only dealers and we have combination dealers, and we do recruit them in a slightly different way.

Dan, I'll let you follow up.

I would just say that don't forget for large scale commercial, we do the EPC ourselves, and we don't go through a dealer,r and sometimes that line is a little gray.

The mix of our business, Jim has suffered from inability to get SunPower product, so we starve that business.

We will not starve it as much in the back half of the year and have a great product, or great pipeline of projects in the back half of the year in that commercial business, both small and large.

I guess the allocation issue is what I was getting at.

When would that have started where the allocation made it tough to feed all of those markets?

And is that what led to Serengeti?

Because Serengeti, you could have done years ago, but you're doing it now.

Was that tied that the allocation issue arose?

Yes, Dan, I'm going to have to answer that and then wrap it up.

We do appreciate the question and we'd be happy for you to call back.

We have -- recall, we acquired PowerLight in January 2007.

PowerLight did not make modules to speak of, so we're exclusively third party.

And when we acquired PowerLight, we continued that strategy, so it is actually in our history to acquire used third party modules.

What is unique about Serengeti is we're acquiring a solar cell and we're managing the -- both the quality and the manufacturing of the product.

And it's going through quite a bit of quality and reliability testing.

So the shift is the way we're managing the supply chain.

It just happens that there was a depreciating period where there wasn't a lot of third party used, although we did use third party in every quarter of last year.

So I hope that helps.

It turns out it takes a long time to build a billion dollar fab, and that fab is coming online at the end of the year.

So our plan would be to have Serengeti help us get to our fab and then we would continue to capitalize on what we believe is going to be a very competitive module market, and we think we can capitalize on it with our great outbound channel.

Great.

So Dan, I'm going to have to wrap there.

Thank you very much for your time.

We appreciate everybody joining our call.

We look forward to reporting our results in Q3 and Q4 and to complete the story of our transition to a utility scale project developer.

Thank you very much.

At this time, that will conclude today's conference.

You may disconnect.

Thank you for your attendance.