First Solar - The Devil Is In the Details

First Solar beats the Street on earnings and revenue, and ups its full year earnings guidance, but reading between the lines yields concerns.
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(First Solar earnings story updated for with analyst commentary)



) -- First Solar easily beat Street expectations for the second consecutive quarter, reporting earnings per share of $1.84 and revenue of $587.9 million for the second quarter 2010, yet the reaction from investors was anything but a round of applause. First Solar shares were down more than 6% early on Friday, mirroring performance in the after-hours session on Thursday when the results were released. Last quarter, after a big beat, First Solar shares gained $22 on the morning after its after-market earnings report.

One big issue that First Solar bears had expected, and which showed up in the earnings and conference call, was a spate of settlement charges related to problems with solar modules manufactured between June 2008 and June 2009. First Solar referred to the issue with warranty settlements as a "manufacturing excursion" that impacted 4% of its volume produced during that one-year period.

The Street consensus was for First Solar earnings of $1.60 on revenue of $543 million. Yet the whisper number was closer to $2, as earnings estimates had become stale, according to one analyst. With demand for modules in Europe high, some First Solar watchers expected straight module sales to lead to an easy beat of the Street.

First Solar upped its full year earning guidance from a range of $6.80 to $7.30, to a range of $7 to $7.40.

First Solar revenue guidance for the full year was taken down a notch, from a high-end range of $2.7 billion last quarter, to a high-end of $2.6 billion in the second quarter. First Solar said in its earnings release that the revenue revision reflected pushing more solar module capacity from its systems business to Europe, to meet stronger module demand from European customers.

First Solar gross margin narrowed to 48.3% from 56.7%, the fourth consecutive decline in First Solar's consolidated margin rate. First Solar guided to a full year gross margin decline to a range of 44% to 45%.

First Solar was guiding prices, as well as gross margins, down for the remainder of the year. Yet First Solar shaved 5 cents off its PV module manufacturing cost to 76 cents per watt in the quarter.

With the big feed-in tariff reductions in the German ground-mounted solar market, First Solar long-term contracts in Germany will lead to lower pricing with German partners. First Solar told Wedbush analyst Christine Hersey that whereas previously there was an automatic step-down in contract rates based on feed-in tariffs, now the rates are being re-negotiated actively.

Solar analysts had concerns going into the First Solar earnings about potential warranty-related expenses, given that in its last earnings there appeared a much higher-than-typical rate of warranty-related settlements, but there was no detail provided at that time. First Solar noted in the earnings release additional charges that will be explained in its 10-Q filing related to non-recurring module replacement program and post-sales expenses.

Settlement charges jumped to $27.2 million in the quarter, according to one analyst on the First Solar call, and First Solar management said that these settlement impacts will continue to be an issue for six months.

The biggest change overall from last quarter was in First Solar's operating cash-flow guidance, down from the $725 million to $775 million projected last quarter, to $575 million to $625 million of operating cash flow. First Solar attributed the change to its acquisition of NextLight.

Total capital spending is projected to be $575 to $625 million, a change from last quarter guidance of $625 million to $650 million in spending.

There had been some analysts expecting First Solar to reserve more of its modules for its systems business as that pipeline, primarily in North America, becomes more critical to its future. A key issue for analysts is the timing of the projects in the pipeline.

Dan Ries, analyst at Collins Stewart, had projected a First Solar miss this quarter based on the idea that it would be holding back more modules for the systems business. However, the First Solar commentary in the earnings release suggests that's not the case, but doesn't provide a read on whether the systems business is slower to ramp than the Street had been expecting of it.

The Street was, as usual, divided in its First Solar outlook, with the earnings not really changing the opinions of the First Solar bulls and bears.

Needham & Co., downplayed the earnings beat, saying it was expected, and said that, if anything, the lowering of revenue guidance was probably a hit to high expectations for First Solar. The bigger issue, though, in the opinion of Needham analyst Edwin Mok, is that cost reductions made by First Solar won't be keeping up with pricing pressure.

"We believe the outlook suggests FSLR will further cut price in 2H10, which we believe is below expectations given that crystalline silicon spot prices are stable in 2Q/3Q10. We continue to believe FSLR will face further pressure on gross margins going into 2011," the Needham analyst wrote.

Oppenheimer & Co. hit on another big fear, the European austerity measures in place to tackle debt and deficits, noting that First Solar hinted in its earnings call that a sizeable digression to 2010 feed-in tariff rates in the EU are still potential negatives for solar -- and, for this reason, the Oppenheimer analyst thinks the solar sector is range-bound.

The same cost reduction of five cents in the quarter that First Solar bears don't think will be good enough to keep margins up was cited by more bullish analysts as a major positive from the latest earnings.

Collins Stewart referred to the module production cost as being of "paramount importance," and argued that the 6% sequential decline has long-term ramifications for First Solar. "First Solar has widened its lead versus its peers," Collins Stewart analyst Dan Ries wrote.

Auriga Securities more or less agreed, saying that the Street has been underestimating First Solar's ability to drive down costs while increasing productivity. "First Solar has widened the gap between itself and the industry-leading cSi competitors in terms of cost... This was a major surprise because improvement has been stagnant since 3Q09."

The bears continue to see the subsidy reductions as a threat to pricing and margins, while the bulls see the First Solar cost reduction as key during the period of time when the major European solar markets are all reducing their subsidy programs, arguing that First Solar will remain "significantly profitable while facing pressure on module pricing," in the words of Auriga Securities analyst Mark Bachman.

Jefferies analyst Jesse Pichel continues to believe there will be a better price to enter First Solar shares, and expressed disappointment in a lack of outlook on First Solar's project business. "We believe a modest guide up was priced into the stock, and FSLR did not accelerate its capacity or provide clarity around its projects in 2011 -- we looked for all three."

-- Written by Eric Rosenbaum from New York.


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