First Solar: Cfra's Accounting Quality Concerns

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1. In continuation to the discussion in the class, identify the areas of concern regarding the following:

1. Warranty Provisions:

First Solar offered product defect/ workmanship warranty for 5 years and power generation warranty of 90% for 10 years & 80% for 25 years. The main concern with this provision was that the Cadmium Telluride technology was relatively new and had not undergone any real world testing. Adding to this, cadmium telluride is much cheaper and less efficient than its silicon counterpart. These factors combined could hamper product quality for First Solar in the long run.

In this case, providing a long term warranty could lead to unexpectedly increased number of warranty claims. However, the claims that would arise as a result of this warranty provision were not accounted for anywhere in the balance sheet. This could result in inflated profits initially but would affect the overall margin when product defects appear in future.

1. Co-investing in Solar Projects with Customers

If First Solar decides to Co-invest in projects with its customers, this would mean that it would need to change its business model from being an entirely upstream company to being a mix of both, upstream and downstream. This would result in making them the competitors of their own customers, the ones with whom they are not investing. Also these left out customers would try to seek some other player in order to supply them the solar cells. As per Exhibit 13, First Solar has very high customer concentration. Just 5 of its top consumers account for more than 64% of its sales, each accounting for over 10% of the total sales at individual level. This means that losing even a single customer would drastically affect the revenue for this company, in turn affecting the profits, thereby reducing the market valuation.

Also entering into downstream business would mean getting into a more competitive and government dependent business category. First Solar is a company which is used to getting margins of over 50% out of its products. The downstream business is a highly capital intensive category and requires quite high Balance of Systems (BoS), the financing for which is getting difficult day by day. Even if they are able to arrange for the capital, the margins for this category are quite low while the operations are even more complex. These low margins would overall hurt the profits of the company and affect the ratios which govern the valuation of the firm.

1. Renegotiated contracts

As per First Solar’s 10-K, the company amended contracts with two of its customers by getting into long term obligations of providing the modules at lower cost, should they increase the volumes of their order. They also pledged to decrease the cost per watt by 6.5% annually. The very first impact of this contract would be on the Income Statement of the company, which would see declining profits, as this contract would result in lower margins for the company. Moreover, an annual reduction in the cost of modules may hurt the firm if the spot prices goes below the level mentioned in the contract.