[May 07, 2013] FIRST SOLAR, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 (the "Exchange Act") and the Securities Act of 1933, which are subject to risks, uncertainties, and assumptions that are difficult to predict. All statements in this Quarterly Report on Form 10-Q, other than statements of historical fact, are forward-looking statements. These forward-looking statements are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include statements, among other things, concerning: our business strategy, including anticipated trends and developments in and management plans for our business and the markets in which we operate; future financial results, operating results, revenues, gross margin, operating expenses, products, projected costs, warranties, balance of systems ("BoS") roadmap, restructuring, product reliability and capital expenditures; our ability to continue to reduce the cost per watt of our solar modules; research and development programs and our ability to improve the conversion efficiency of our solar modules; sales and marketing initiatives; and competition. In some cases, you can identify these statements by forward-looking words, such as "estimate," "expect," "anticipate," "project," "plan," "intend," "believe," "forecast," "foresee," "likely," "may," "should," "goal," "target," "might," "will," "could," "predict," "continue" and the negative or plural of these words and other comparable terminology. Forward-looking statements are only predictions based on our current expectations and our projections about future events. All forward-looking statements included in this Quarterly Report on Form 10-Q are based upon information available to us as of the filing date of this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements. We undertake no obligation to update any of these forward-looking statements for any reason. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to differ materially from those expressed or implied by these statements. These factors include, but are not limited to, the matters discussed in Item 1A: "Risk Factors," of our Annual Report on Form 10-K for the year ended December 31, 2012 and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K and other factors. You should carefully consider the risks and uncertainties described under this section. The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the accompanying notes contained in this Quarterly Report on Form 10-Q. Unless expressly stated or the context otherwise requires, the terms "we," "our," "us," and "First Solar" refer to First Solar, Inc. and its subsidiaries. 37 --------------------------------------------------------------------------------Executive Overview We are a premier global provider of solar energy solutions. We manufacture and sell photovoltaic ("PV") solar modules with an advanced thin-film semiconductor technology, and we design, construct, and sell PV solar power systems that use the solar modules we manufacture. We are the world's largest thin-film PV solar module manufacturer and one of the world's largest PV solar module manufacturers. In addressing overall global demand for PV solar electricity, we have developed a differentiated, fully integrated systems business that can provide a competitively priced turn-key utility-scale PV system solution for system owners and competitively priced electricity to utility end-users. Our fully integrated systems business, which uses the solar modules we manufacture, has enabled us to increase module throughput, drive cost reduction across the value chain, identify and break constraints to sustainable markets, and deliver compelling solutions to our customers and end-users. With our fully integrated systems business, we believe we are in a position to expand our business in economically sustainable markets (in which support programs are minimal), which are developing in areas with abundant solar resources and sizable electricity demand. We are committed to continually lowering the cost of solar electricity, and in the long-term, we plan to compete on an economic basis with conventional fossil-fuel-based peaking power generation. In furtherance of our goal of delivering affordable solar electricity, we are continually focused on reducing PV solar system costs in five primary areas: module manufacturing, BoS costs (consisting of the costs of the components of a solar power system other than the solar modules that we produced, such as inverters, mounting hardware, trackers, grid interconnection equipment, wiring and other devices, and installation labor costs), project development costs, the cost of capital, and the operating expenses of a PV solar system. First, with respect to our module manufacturing costs, our advanced technology has allowed us to reduce our average module manufacturing costs to among the lowest in the world for modules produced on a commercial scale, based on publicly available information. In the three months ended March 31, 2013, our total average manufacturing costs were $0.69 per watt, which is competitive on a comparable basis with those of traditional crystalline silicon solar module manufacturers, based on publicly available information. By continuing to improve conversion efficiency, production line throughput, and lower material costs, we believe that we can further reduce our manufacturing costs per watt and maintain cost competitiveness with traditional crystalline silicon solar module manufacturers. Second, with respect to our BoS cost reduction roadmap, we have aggressive programs which target key improvements in components and system design, which, when combined with continued improvements in conversion efficiency, volume procurement around standardized hardware platforms, use of innovative installation techniques and know how, and accelerated installation times, are expected to result in substantial reductions in our BoS costs resulting in a lower system levelized cost of energy. Third, with respect to our project development costs, we seek optimal site locations in an effort to minimize transmission and permitting costs, and to accelerate lead times to electricity generation. Fourth, with respect to the cost of capital, by continuing to demonstrate the financial viability and operational performance of our utility-scale PV solar power plants and increasing our PV solar power system operating experience, we believe we can continue to lower the cost of capital associated with our PV solar power systems, thereby further enhancing the economic viability of our projects and lowering the cost of electricity generated by PV solar power systems that incorporate our modules and technology. The remaining primary PV solar system cost relates to the actual operating expenses of a solar power plant, which includes the operations and maintenance costs of the plant. We believe that our operations and maintenance services are an important aspect to the overall future reduction expected in the levelized cost of electricity ("LCOE") of a solar power plant through seamless grid integration, increased reliability and maximization of availability of the solar power plants we operate and maintain for our customers. We believe that combining our reliable, low-cost module manufacturing capability with our systems business enables us to more rapidly reduce the price of solar electricity, accelerate the adoption of our technology in utility-scale PV solar power systems, and identify and remove constraints to the successful migration to sustainable solar markets around the world. Our vertically integrated capabilities enable us to maximize value and mitigate risk for our customers and thereby deliver meaningful PV energy solutions to varied energy problems worldwide. We offer leadership across the entire solar value chain, resulting in more reliable and cost effective PV energy solutions for our customers, and furthering our mission to create enduring value by enabling a world powered by clean, affordable solar electricity. Business Segments We operate our business in two segments. Our components segment involves the design, manufacture, and sale of solar modules which convert sunlight into electricity. Third-party customers of our components segment include project developers, system integrators, and operators of renewable energy projects. Our second segment is our fully integrated systems business ("systems segment"), through which we provide complete turn-key PV solar power systems, or solar solutions that draw upon our capabilities, which include (i) project development, (ii) engineering, procurement, and construction ("EPC") services, (iii) operating and maintenance ("O&M") services, and (iv) 38 -------------------------------------------------------------------------------- project finance expertise, all as described in more detail below. We may provide our full EPC services or any combination of individual products and services within our EPC capabilities depending upon the customer and market opportunity. All of our systems segment products and services are for PV solar power systems which use our solar modules, and such products and services are sold directly to investor owned utilities, independent power developers and producers, commercial and industrial companies, and other system owners. • During project development, we obtain land and land rights for the development of solar power plants incorporating our modules, negotiate long-term power purchase agreements ("PPA") with potential purchasers of the electricity to be generated by those plants or develop plants in regulated markets where feed-in-tariff ("FiT") structures are in place, manage the interconnection and transmission process, negotiate agreements to interconnect the plants to the electric grid, and obtain the permits which are required prior to the construction of the plants, including applicable environmental and land use permits. We also buy projects in various stages of development and continue developing those projects with system designs incorporating our own modules. We sell developed projects to system operators who wish to own generating facilities, such as utilities, or to investors who are looking for long-term investment vehicles that are expected to generate consistent returns. • We provide EPC services to projects developed by us, to projects developed by independent solar power project developers, and directly to system owners such as utilities. EPC products and services include engineering design and related services, module and BoS procurement, advanced development of grid integration solutions, and construction contracting and management. Depending on the customer and market need, we may provide our full EPC services or any combination of individual products and services within our EPC capabilities. An example of such combination of individual services would be providing engineering design and procurement of BoS parts and modules (EP services) for a third party constructing a PV solar power system. • We have a comprehensive O&M service offering with multiple plants in operation. Utilizing a state of the art Global Operations Center, located in Mesa, Arizona, our team of O&M experts provide comprehensive plant services including North America Electric Reliability Corporation ("NERC") compliance, energy forecasting, 24/7 monitoring and control, PPA and Large Generator Interconnection Agreement ("LGIA") compliance, performance engineering analysis, turn-key maintenance services including spare parts and breakdown repair, and environmental services. • Our project finance group is primarily responsible for negotiating and executing the sale of utility-scale power plant systems incorporating our modules which allows us to optimize the value of our project development portfolio. This group is experienced in arranging for and structuring financing for projects incorporating our modules including non-recourse project debt financing in the bank loan market and debt capital markets and project equity capital from tax oriented and strategic industry equity investors. See Note 18. "Segment Reporting," to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Market Overview The solar industry continues to experience a challenging environment, categorized by intense pricing competition, both at the PV module and system level, with many solar companies generating operating losses or little to no operating income. In the aggregate, manufacturers of solar modules and cells have installed production capacity that significantly exceeds global demand. We believe this structural imbalance between supply and demand (i.e., where production capacity significantly exceeds current global demand) may continue for the foreseeable future, and we expect it will continue to put pressure on pricing and our results of operations through the remainder of 2013 and into 2014. We further believe that this structural imbalance will remain unfavorable for solar companies that are primarily module manufacturers, but that companies with established expertise and meaningful PV generation solutions in other areas of the solar value chain, such as project development, EPC capabilities, and O&M services, are more likely to develop economically sustainable businesses. In light of such market realities, we continue to execute our Long Term Strategic Plan described below under which we are focusing on our competitive strengths. A key core strength is our differentiated, vertically integrated business model that enables us to provide utility-scale PV generation solutions to sustainable geographic markets that have an immediate need for mass-scale PV electricity. Solar markets worldwide continue to develop, in part aided by demand elasticity resulting from declining industry average selling prices, both at the PV module and system level, which make solar power more affordable to new markets, and we have continued to develop our localized presence and expertise in these markets. For instance, in Chile, we announced in January 2013 our acquisition of Solar Chile, a Santiago-based solar development company with a portfolio of early- to mid-stage utility-scale 39 -------------------------------------------------------------------------------- PV power projects totaling approximately 1.5 GW in northern Chile, including the Atacama Desert region, which offers among the highest solar irradiance in the world. In North America, we continue to execute on our advanced-stage utility-scale project pipeline. We continue to make construction progress on what are currently or will be among the world's four largest solar PV power plants: the 550 MW AC Topaz Solar Farm, located in San Luis Obispo County, California; the 550 MW AC Desert Sunlight Solar Farm, located west of Blythe, California; the 290 MW AC Agua Caliente project in Yuma County, Arizona; and the 230 MW AC Antelope Valley Solar Ranch One project ("AVSR"), located just north of Los Angeles, California. The Agua Caliente project is currently the largest operating PV power plant in the world and has achieved a peak generating capacity of more than 250 MW AC while connected to the electrical grid. We expect a substantial portion of our consolidated net sales, operating income and cash flows through the end of 2014 to be derived from these four projects. We continue to advance the development and selling efforts for the other projects included in our advanced-stage utility-scale project pipeline, and we continue to develop our early-to-mid stage project pipeline and evaluate acquisitions of projects to continue to add to our advanced-stage utility-scale project pipeline. In January 2013, we announced that we started to construct the 139 MW AC Campo Verde Solar Project, located near El Centro in Imperial County, California, which we sold in April 2013. We also announced in January 2013 our acquisition of the 50 MW AC Macho Springs Solar project in Luna County, New Mexico, which will be the state's largest solar power project when completed. In March 2013, we acquired the 150 MC AC Solar Gen 2 power project, located near El Centro in Imperial County, California. In April 2013, we announced our acquisition of the 60 MW AC North Star solar project in Fresno County, California. Industry average module pricing continues to experience downward pressure, although the rate of average selling price declines experienced in some markets over the last two years has begun to lessen. Lower industry module pricing, while currently challenging for solar manufacturers (particularly manufacturers with high cost structures), is expected to continue to contribute to global market diversification and volume elasticity. Over time, declining average selling prices are consistent with the erosion of one of the primary historical constraints to widespread solar market penetration, its affordability. In the near term, however, in light of industry-wide manufacturing capacity that exceeds demand, it is uncertain whether growing worldwide demand can absorb industry wide module supply without further inventory build-up and/or price reductions, which could adversely affect our results of operations. If competitors reduce module pricing to levels below their manufacturing costs, or are able to operate at negative or minimal operating margins for sustained periods of time, our results of operations could be further adversely affected. We continue to mitigate this uncertainty in part by executing on and building our advance stage utility-scale systems pipeline as a buffer against demand fluctuations, accelerating our module efficiency improvements and cost reduction roadmaps to maintain and increase our competitiveness, profitability and capital efficiency, adjusting our production plans and capacity utilization to match our expected demand, and continuing the development of worldwide geographic markets, including those in India, Australia, the Middle East, Latin America, and China. In the components business, we continue to face intense competition from manufacturers of crystalline silicon solar modules and other types of solar modules and PV systems. Solar module manufacturers compete with one another in several product performance attributes, including reliability and selling price per watt, and, with respect to solar power systems, return on equity ("ROE") and LCOE, meaning the net present value of total life cycle costs of the solar power project divided by the quantity of energy which is expected to be produced over the system's life. We are among the lowest cost PV module manufacturers in the solar industry, based on publicly available information. This cost competitiveness is reflected in the price at which we sell our modules and fully integrated PV systems and enables our systems to compete favorably in respect of their ROE or LCOE. Our cost competitiveness is based in large part on our proprietary technology (which enables conversion efficiency improvements and enables us to produce a module in less than 2.5 hours using a continuous and highly automated industrial manufacturing process, as opposed to a batch process), our scale, and our operational excellence. In addition, our modules use approximately 1-2% of the amount of semiconductor material (i.e., silicon) that is used to manufacture traditional crystalline silicon solar modules. The cost of polysilicon is a significant driver of the manufacturing cost of crystalline silicon solar modules, and the timing and rate of change in the cost of silicon feedstock and polysilicon could lead to changes in solar module pricing levels. Polysilicon costs have declined over the past several years, contributing to a decline in our manufacturing cost competitiveness over crystalline silicon module manufacturers. Given the lower conversion efficiency of our modules compared to many types of crystalline silicon modules, there may be higher BoS costs associated with systems using our modules. Thus, to compete effectively on the basis of LCOE, our modules need to maintain a certain cost advantage per watt compared to crystalline silicon-based modules with higher conversion efficiencies. We continue to reduce BoS costs associated with PV systems using our modules. We believe we can continue to reduce BoS costs by improving conversion efficiency, leveraging volume procurement around standardized hardware platforms, using innovative installation techniques and know how, and accelerating installation times. BoS costs can represent a significant portion of the costs associated with the construction of a typical utility-scale PV solar power system. While our modules and PV systems are currently competitive in these product cost and performance attributes, there can be no guarantee such competitiveness will continue to exist in the future to the same extent or at all. Any declines in the competitiveness 40 -------------------------------------------------------------------------------- of our products could result in additional margin compression, further declines in the average selling prices of our solar modules, erosion in our market share for modules and PV systems, decreases in the rate of net sales growth, and/or declines in overall net sales. We have taken, and continue to take, various actions to mitigate the potential impact resulting from competitive pressures, including adjusting our pricing policies as necessary, accelerating progress along our module and BoS cost reduction roadmaps, and focusing our research and development on increasing the conversion efficiency of our solar modules. As we continue to expand our systems business into sustainable markets, we can offer value beyond the solar module, reduce our exposure to module-only competition, provide differentiated product offerings to minimize the impact of solar module commoditization, and provide comprehensive utility-scale PV systems solutions that significantly reduce solar electricity costs. Thus, our systems business allows us to play a more active role than many of our competitors in managing the demand for our solar modules. Finally, we continue to form and develop strong partner relationships with our customers around the world and continue to develop our range of product offerings, including EPC capabilities and O&M services, in order to enhance the competitiveness of systems using our solar modules. TetraSun Acquisition In April 2013, we completed the acquisition of TetraSun, Inc., a start-up company that is in the advanced stages of developing a novel, high-efficiency, low-cost crystalline silicon technology. We believe that when the technology is successfully transitioned to commercial manufacturing scale, the innovative cell architecture developed by TetraSun is capable of conversion efficiencies exceeding 21 percent with commercial-scale manufacturing costs comparable to conventional multicrystalline silicon solar modules. We expect modules incorporating this technology to complement our current CdTe module and systems offerings by allowing us to expand our leadership position and effectively address markets beyond the utility-scale solar sector, notably in space constrained commercial and residential applications, including rooftop applications. In such applications, we expect our high-efficiency modules based on the TetraSun technology to be competitively differentiated by enabling solar systems with high energy density in constrained spaces at competitive pricing. We are in the process of evaluating and developing distribution channels for PV modules incorporating this technology in Japan and other target markets. We are currently targeting commencement of commercial-scale manufacturing of PV cells incorporating this technology, and third-party assembly of such cells into modules, in the second half of 2014. Certain Trends and Uncertainties We believe that our continuing operations may be favorably or unfavorably impacted by the following trends and uncertainties that may affect our financial condition and results of operations. See "Risk Factors" in Part I, Item 1A of the Company's Annual Report on Form 10-K filed with the SEC on February 27, 2013 ("Form 10-K Risk Factors") and elsewhere in this report for a discussion of other risks that may affect our financial condition and results of operations. Long Term Strategic Plan In May 2012, we provided information regarding our long term strategic plan ("Long Term Strategic Plan" or "LTSP") to transition our business to primarily sustainable opportunities by the end of 2016. In executing the LTSP we are focusing on providing solar PV generation solutions using our modules to sustainable geographic markets that we believe have a compelling need for mass-scale PV electricity, including markets throughout the Americas, Asia, the Middle East, and Africa. As part of our LTSP, we are focusing on opportunities in which our solar PV generation solutions will compete directly with fossil fuel offerings on a levelized cost of energy basis. Execution of the LTSP entails a reallocation of resources around the globe, in particular dedicating resources to regions such as Latin America, Asia, the Middle East, and Africa where we have not traditionally conducted significant business to date. We are evaluating and managing closely the appropriate level of resources required as we transition into and penetrate these specific markets. We have and intend to continue to dedicate significant capital and human resources to reduce the total installed cost of solar PV generation, to optimize the design and logistics around our solar PV generation solutions, and to ensure that our solutions integrate well into the overall electricity ecosystem of each specific region. We expect that, over time, an increasing portion of our consolidated net sales, operating income and cash flows will come from solar offerings in the sustainable markets described above as we execute on our Long Term Strategic Plan, and that, over time, larger relative contributions to our overall financial performance will continue to come from systems offerings in comparison to module only sales. The timing, execution and financial impacts of our Long Term Strategic Plan are subject to risks and uncertainties, as described in the Form 10-K Risk Factors. We are focusing our resources in those markets and energy applications in which solar power can be a least-cost, best-fit energy solution, particularly in regions with high solar resources, significant current or projected electricity demand and/or relatively high existing electricity prices. As part of these efforts, we continue to expand resources globally, including by appointing country 41 -------------------------------------------------------------------------------- heads and supporting professional, sales and other staff in target markets. Accordingly we are shifting current costs and expect to incur additional costs over time as we establish a localized business presence in these regions. We expect joint ventures or other business arrangements with strategic partners to be a key part of our strategy, and we have begun initiatives in several markets using such arrangements to expedite our penetration of those markets and establish relationships with potential customers and policymakers. Some of these business arrangements are expected to involve significant investments or other allocations of capital on our part. We are in the process of developing relationships with policymakers, regulators, and especially end customers in each of these markets with a view to creating markets for utility scale PV solar power systems. We sell solar power solutions that include our modules directly to end customers, including independent power producers, utilities, retail electricity providers and commercial and industrial customers. Depending on the market opportunity, our sales offerings range from third party module only sales, to module sales with a range of engineering, procurement and construction products and solutions, to full turn-key solar power system sales. We expect these sales offerings to continue to evolve over time as we work with our customers to optimize how our PV solar power solutions can best meet our customers' energy and economic needs. In order to create or maintain a market position in certain strategically targeted markets our offerings from time to time may need to be competitively priced at levels associated with minimal gross profit margins, which may adversely affect our results of operations. We expect the profitability associated with our various sales offerings to vary from one another over time, and possibly vary from our internal long-range profitability expectations and targets, depending on the market opportunity and the relative competitiveness of our offering compared with other energy solutions, fossil fuel based or otherwise, that are available to potential customers. Construction of Some of the World's Largest Solar PV Power Plants We expect a substantial portion of our consolidated net sales, operating income and cash flows through the end of 2014 to be derived from the following four projects in North America, which are currently or will be among the world's four largest solar PV power plants: the 550 MW AC Topaz Solar Farm, located in San Luis Obispo County, California; the 550 MW AC Desert Sunlight Solar Farm, located west of Blythe, California; the 290 MW AC Agua Caliente project located in Yuma County, Arizona; and the 230 MW AC AVSR project, located just north of Los Angeles, California. Please see the tables under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Financial Operations Overview-Net Sales-Systems Project Pipeline" for additional information about these and other projects within our utility systems advanced-stage project pipeline. Construction progress of these projects is subject to risks and delays as described in the Form 10-K Risk Factors. Revenue recognition for these projects is in many cases not linear in nature due to the timing of when all revenue recognition criteria have been or are expected to be met, and consequently period over period comparisons of results of operations may not be meaningful. As we progress towards substantial completion of our four largest PV power plants under construction, which is expected to occur in late 2013 through 2014, we expect to have a larger portion of our net sales, operating income and cash flows come from future sales of solar offerings outside of North America, pursuant to our Long Term Strategic Plan described above. North America however, will continue to represent a significant portion of our net sales, operating income and cash flows as a significant portion of our advance-stage project pipeline, after excluding the four projects above, is comprised of projects in North America. Manufacturing Capacity As of March 31, 2013, we had 28 installed production lines with an annual global manufacturing capacity of approximately 2.0 GW at our manufacturing plants in Perrysburg, Ohio, and Kulim, Malaysia. Production at one or more of our manufacturing plants has and may in the future be idled temporarily to better align production with expected market demand and to allow us to implement upgraded process technologies as part of our conversion efficiency improvement initiatives. The Company expects to produce between 1.5GW to 1.7GW of solar modules in 2013. Restructuring We have undertaken a series of restructuring initiatives as further described in Note 4. "Restructuring," to our condensed consolidated financial statements included in this Form 10-Q. In February 2012 and April 2012, respectively, we announced material restructuring initiatives intended to (i) align the organization with our Long Term Strategic Plan, including expected sustainable market opportunities, (ii) accelerate operating cost reductions and improve overall operating efficiency, and (iii) better align production capacity and geographic location of such capacity with expected geographic market requirements and demand. Such restructuring initiatives resulted in charges to restructuring expense of $2.3 million and $401.1 million in the three months ended March 31, 2013 and March 31, 2012, respectively. The most significant actions taken as part of these restructuring activities were the decisions to close our manufacturing operations in Frankfurt (Oder), Germany at the end of 2012 due to the lack of policy support for utility-scale solar projects in Europe and to not proceed with our 4-line manufacturing plant in Vietnam 42 -------------------------------------------------------------------------------- or a 2-line manufacturing plant in France, based upon expected future market demand and our focus on providing utility-scale PV generation solutions primarily to sustainable geographic markets. Financial Operations Overview The following describes certain line items in our condensed consolidated statements of operations and some of the factors that affect our operating results. Net sales Components Business We generally price and sell our solar modules per watt of name plate power. During the three months ended March 31, 2013, a significant portion of net sales from the components business was related to modules included in our solar systems described below under "Net Sales - Systems Business." Other than the modules included in our solar power systems, we sold the majority of our solar modules to solar power system project developers, system integrators, and operators headquartered in the United States, Germany, India, and France, which either integrate them into power plants that they own, operate, or sell or resell our modules to end-users. We have entered into module sales agreements with customers worldwide for specific projects or volumes of modules through the remainder of 2013 and thereafter. During the three months ended March 31, 2013 and March 31, 2012, 52% and 33%, respectively of our components business net sales, excluding modules included in our solar power systems, were denominated in Euro and were subject to fluctuations in the exchange rate between the Euro and U.S. dollar. Under our typical customer sales contracts for solar modules, we transfer title and risk of loss to the customer and recognize revenue upon shipment. Pricing is typically fixed at the time of shipment, and our customers do not typically have extended payment terms. Customers do not have rights of return under these contracts. Our revenue recognition policies for the components business are described further in Note 2. "Summary of Significant Accounting Policies," to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Systems Business Through our fully integrated systems business, we provide complete turn-key solar power system solutions using our solar modules, which may include project development, EPC services, O&M services, and project finance expertise. Net sales from our systems business are impacted by numerous factors, including the cost competitiveness of our systems offerings in comparison to our competitors' solar systems and other forms of electricity generation, the magnitude and effectiveness of support programs, and other solar power system demand drivers. Revenue Recognition - Systems Business. Revenue recognition for our systems projects are in many cases not linear in nature due to the timing of when all revenue recognition criteria have been met, and consequently period over period comparisons of results of operations may not be meaningful. We typically use the percentage-of-completion method using actual costs incurred over total estimated costs to construct a project (including module costs) as our standard accounting policy, but we only apply this method after all revenue recognition criteria have been met. There are also many instances in which we recognize revenue only after a project has been completed, primarily due to a project not being sold prior to completion or because all revenue recognition criteria are not met until the project is completed. Our revenue recognition policies for the systems business is described in further detail in Note 2. "Summary of Significant Accounting Policies," to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Systems Project Pipeline The following tables summarize, as of May 6, 2013, our approximately 3.1 GW AC ("alternating current") systems business advanced-stage project pipeline. As of March 31, 2013, for the Projects Sold/ Under Contract in our advanced-stage project pipeline of approximately 2.0 GW AC, we have recognized revenue with respect to the equivalent of approximately 787 MW AC. Such MW AC equivalent amount refers to the ratio of revenue recognized for the Projects Sold/ Under Contract in our advanced-stage project pipeline compared to total contracted revenue for such projects, multiplied by the total MW AC for such projects. The remaining revenue to be recognized subsequent to March 31, 2013 for the Projects Sold/Under Contract in our advanced-stage project pipeline is expected to be approximately $4.4 billion. The substantial majority of such amount is expected to be recognized as revenue through the later of the substantial completion or project sale dates of the Projects Sold/ Under Contract. The remaining 43 -------------------------------------------------------------------------------- revenue to be recognized does not have a direct correlation to expected remaining module shipments for such Projects Sold/Under Contract as expected module shipments do not represent total systems revenue and do not consider the timing of when all revenue recognition criteria are met including timing of module installation. The actual volume of modules installed in our Projects Sold/ Under Contract will be greater than the Project Size in MW AC as module volumes required for a project are based upon MW DC ("direct current"), which will be greater than the MW AC size pursuant to a DC-AC ratio typically ranging from 1.2-1.4. Such ratio varies across different projects due to various system design factors. Projects are removed from our advanced-stage project pipeline tables below once we have completed construction and after substantially all revenue has been recognized. As we continue to execute against our LTSP, we continually seek to make additions to our advance stage project pipeline. We are actively developing our mid to early stage project pipeline in order to secure PPAs and we are also pursuing opportunities to acquire advance stage projects, which already have PPAs in place. In 2013, we have acquired 260MW AC of advance stage projects through May 6, 2013 and we expect to acquire additional advance stage projects when such acquisitions meet our strategic and return on investment requirements. Projects Sold/Under Contract (includes uncompleted sold projects, projects under sales contracts subject to conditions precedent, and EPC agreements including partner developed projects that we are constructing) Expected Year Revenue Power Purchase Recognition Project Size Agreement Third Party Will Be Project/Location in MW AC (1) ("PPA") Owner/Purchaser Completed By Topaz, California 550 PG&E MidAmerican 2014 Desert Sunlight, California 550 PG&E / SCE NextEra/GE/Sumitomo 2014 Agua Caliente, Arizona 290 PG&E NRG / MidAmerican 2014 AV Solar Ranch One, California 230 PG&E Exelon 2013 Campo Verde, California 139 SDG&E Southern 2013 Imperial Energy Center South, California 130 SDG&E Tenaska (2) 2013 Copper Mountain 2, Nevada 58 PG&E Sempra (2) 2015(3) PNM2, New Mexico 22 UOG(4) PNM(2) 2013 Amherstburg 1, Belmont, and Walpole ("ABW"), Ontario, Canada 50 OPA (5) GE/Alterra 2013 DEWA, UAE 13 DEWA DEWA(2) 2013 Total 2,032 Projects Permitted with Executed PPA - Not Sold/Contracted Expected Year Revenue Project Size in Power Purchase Recognition Will Project/Location MW AC (1) Agreement (PPA) Be Completed By Solar Gen 2, California 150 SDG&E 2014 Macho Springs, New Mexico 50 El Paso Electric 2014 Maryland Solar, Maryland 20 FE Solutions 2013 Lost Hills, California 32 PG&E 2015/2016(7) Total 252 Projects in Development with Executed PPA or Awarded Projects- Not Sold/ Contracted 44 -------------------------------------------------------------------------------- Expected Year Power Purchase Revenue Project Size in Agreement Recognition Will Project/Location MW AC (1) ("PPA") Be Completed By Stateline, California 300 SCE 2016 Silver State South, Nevada 250 SCE 2016 AGL, Australia (6) 159 AGL (2) 2015 North Star, California 60 PG&E 2015 Cuyama, California 40 PG&E 2015/2016(7) Total 809 Key:(1) The volume of modules installed in MW DC ("direct current") will be higher than the MW AC ("alternating current") size pursuant to a DC-AC ratio typically ranging from 1.2-1.4. Such ratio varies across different projects due to various system design factors (2) EPC contract or partner developed project (3) First 92 MW AC phase was completed in 2012. Remaining phase is 58 MW AC for which substantial completion is expected in 2015 (4) UOG = Utility Owned Generation (5) OPA = Ontario Power Authority RESOP program (6) Subject to financial close and execution of EPC contracts (7) PPA term does not begin until 2019 Cost of sales Components Business Our cost of sales includes the cost of raw materials and components for manufacturing solar modules, such as tempered back glass, transparent conductive oxide coated front glass, cadmium telluride, laminate, connector assemblies, laminate edge seal, and other items. Our cost of sales also includes direct labor for the manufacturing of solar modules and manufacturing overhead such as engineering, equipment maintenance, environmental health and safety, quality and production control, and procurement costs. Cost of sales also includes depreciation of manufacturing plant and equipment and facility-related expenses. In addition, we accrue shipping, warranty and any obligation for solar module collection and recycling costs within cost of sales. Our manufacturing cost per watt, which is an operating metric we use as an indicator of manufacturing cost competitiveness, represents the current manufacturing and associated costs incurred to produce and sell solar modules during a period divided by the number of salable watts produced in the same period. Beginning in 2013, our cost per watt excludes any costs associated with our manufacturing plants in Frankfurt (Oder), Germany, which closed manufacturing operations at the end of 2012. Overall, we expect our cost per watt to decrease over the next several years due to an increase in watts per solar module, an increase in unit output per production line, and ongoing reductions in variable and fixed costs. This expected decrease in cost per watt would be partially offset during periods in which we have underutilized manufacturing capacity. Systems Business Within our systems business, project-related costs include standard EPC costs (consisting primarily of BoS costs for inverters, electrical and mounting hardware, project management and engineering costs, and installation labor costs), site specific costs, and development costs (including transmission upgrade costs, interconnection fees, and permitting costs). As further described in Note 18. "Segment Reporting," to our condensed consolidated financial statements included within this Quarterly Report on Form 10-Q, at the time when all revenue recognition criteria are met, we include the sale of our solar modules manufactured by our components business and used by our systems business within net sales of our components business. Therefore, the related cost of sales are also included within our components business at that time. The cost of solar modules is comprised of the manufactured inventory cost incurred by our components segment. Gross profit 45 -------------------------------------------------------------------------------- Gross profit is affected by numerous factors, including our module and system average selling prices, market demand, market mix, our manufacturing costs, BoS costs, project development costs, the effective utilization of our production facilities, and foreign exchange rates. Gross profit is also affected by the mix of net sales generated by our components and systems businesses. Gross profit for our systems business excludes the sales and cost of sales for solar modules, used in our systems projects which we include in the gross profit of our components business. Research and development Research and development expense consists primarily of salaries and personnel-related costs, the cost of products, materials, and outside services used in our process and product research and development activities for both the components and systems businesses. We acquire equipment for general use in our process and product development and record the depreciation of this equipment as research and development expense. Currently, the substantial majority of our research and development expenses are attributable to our components segment. We maintain a number of programs and activities to improve our technology and processes in order to enhance the performance and reduce the costs of our solar modules and PV systems using our modules. Selling, general and administrative Selling, general and administrative expense consists primarily of salaries and other personnel-related costs, professional fees, insurance costs, travel expenses, and other business development and selling expenses. We expect selling, general and administrative expense to decline over time as we reduce costs in connection with our restructuring activities, which is a component of our Long Term Strategic Plan. Our systems segment has certain of its own dedicated administrative key functions, such as accounting, legal, finance, project finance, human resources, procurement, and marketing. Costs for these functions are recorded and included within selling, general and administrative costs for our systems segment. Our corporate key functions consist primarily of company-wide corporate tax, corporate treasury, corporate accounting/finance, corporate legal, investor relations, corporate communications, and executive management functions. These corporate functions and the assets supporting such functions benefit both the components and systems segments. We allocate corporate costs to the components and systems segments as part of selling, general and administrative costs, based upon the estimated benefits provided to each segment from these corporate functions. We determine the estimated benefits provided to each segment for these corporate costs based upon a combination of the estimated time spent by corporate employees supporting each segment and the average relative selling, general and administrative costs incurred by each segment before such corporate allocations. Production start-up Production start-up expense consists primarily of salaries and personnel-related costs and the cost of operating a production line before it has been qualified for full production, including the cost of raw materials for solar modules run through the production line during the qualification phase. It also includes all expenses related to the selection of a new site and the related legal and regulatory costs, and the costs to maintain our plant replication program, to the extent we cannot capitalize these expenditures. In general, we expect production start-up expense per production line to be higher when we build an entirely new manufacturing facility compared with the addition of new production lines at an existing manufacturing facility, primarily due to the additional infrastructure investment required when building an entirely new facility. Production start-up expense is attributable to our components segment. Restructuring Restructuring expenses include those expenses incurred related to material restructuring initiatives and include severance and employee termination costs, asset impairment and asset impairment related costs that are directly related to our restructuring initiatives, costs associated with contract terminations and other restructuring related costs. See Note 4. "Restructuring" to our condensed consolidated financial statements included with this Quarterly Report on Form 10-Q for more information. Expenses recognized for restructuring activities are discussed further above under "Executive Overview -Restructuring." Foreign currency gain (loss) Foreign currency gain (loss) consists of gains and losses resulting from holding assets and liabilities and conducting transactions denominated in currencies other than our subsidiaries' functional currencies. 46 --------------------------------------------------------------------------------Interest income Interest income is earned on our cash, cash equivalents, marketable securities, and restricted cash and investments. Interest income also includes interest received from notes receivable and interest collected for late customer payments. Interest expense, net Interest expense is incurred on various debt financings. We capitalize interest expense into our property, plant and equipment or project assets when such costs qualify for interest capitalization, reducing the amount of interest expense reported in any given reporting period. Other expense, net Other expense, net is primarily comprised of changes in fair value of foreign exchange contracts and realized gains/losses on the sale of fixed income investments. Income tax expense (benefit) Income taxes are imposed on our income by taxing authorities in the various jurisdictions in which we operate, principally the United States, Germany, and Malaysia. The statutory federal corporate income tax rate in the United States is 35.0%, while the tax rates in Germany and Malaysia are approximately 29.3% and 25.0%, respectively. In Malaysia, we have been granted a long-term tax holiday, scheduled to expire in 2027, pursuant to which substantially all of our income earned in Malaysia is exempt from income tax. Use of estimates Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP for interim financial information. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales, and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to percentage-of-completion revenue recognition, estimates of future cash flows from and the economic useful lives of long-lived assets, certain accrued liabilities, income taxes and tax valuation allowances, reportable segment allocations, product warranties and manufacturing excursions, accrued collection and recycling expense, and goodwill. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Results of Operations The following table sets forth our condensed consolidated statements of operations as a percentage of net sales for the periods indicated: 47 -------------------------------------------------------------------------------- Three Months Ended March 31, March 31, 2013 2012 Net sales 100.0 % 100.0 % Cost of sales 77.6 % 84.6 % Gross profit 22.4 % 15.4 % Research and development 4.0 % 7.3 % Selling, general and administrative 9.9 % 18.5 % Production start-up 0.2 % 0.8 % Restructuring 0.3 % 80.7 % Operating income (loss) 8.1 % (91.8 )% Foreign currency gain (loss) 0.2 % (0.2 )% Interest income 0.7 % 0.6 % Interest expense, net (0.1 )% (0.2 )% Other expense, net (0.1 )% (0.2 )% Income tax expense (benefit) 0.9 % (1.4 )% Net income (loss) 7.8 % (90.4 )% Segment Overview We operate our business in two segments. Our components segment involves the design, manufacture, and sale of solar modules which convert sunlight into electricity. Third-party customers of our components segment include project developers, system integrators, and operators of renewable energy projects. Our second segment is our fully integrated systems business ("systems segment"), through which we provide complete turn-key PV solar power systems, or solar solutions that draw upon our capabilities, which include (i) project development, (ii) EPC services, (iii) O&M services, and (iv) project finance expertise. We may provide our full EPC services or any combination of individual products and services within our EPC capabilities depending upon the customer and market opportunity. All of our systems segment products and services are for PV solar power systems which use our solar modules, and such products and services are sold directly to investor owned utilities, independent power developers and producers, commercial and industrial companies, and other system owners. In our operating segment financial disclosures, we include an allocation of net sales value for all solar modules manufactured by our components segment and installed in projects sold or built by our systems segment in the net sales of our components segment. In the gross profit of our operating segment disclosures, we include the corresponding cost of sales value for the solar modules installed in projects sold or built by our systems segment in the components segment. The cost of solar modules is comprised of the manufactured cost incurred by our components segment. See Note 18. "Segment Reporting," to our condensed consolidated financial statements included with this Quarterly Report on Form 10-Q for more information. See also Item 2: "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Operations Overview - Net Sales - Systems Project Pipeline" for a description of the projects in our advanced-stage project pipeline. Due to the distinct size and terms of the underlying sales arrangements for each project under construction, timing of meeting all revenue recognition criteria may create uneven net sales patterns, making year over year comparisons less meaningful. Product Revenue The following table sets forth the total amounts of solar modules and solar power systems net sales for the three months ended March 31, 2013 and March 31, 2012. For the purpose of the following table, (a) "solar module revenue" is composed of total net sales from the sale of solar modules to third parties, and (b) "solar power system revenue" is composed of total net sales from the sale of complete solar power systems and related services including the solar modules installed in the solar power systems. 48 -------------------------------------------------------------------------------- Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Solar module revenue $ 193,250 $ 67,409 Solar power system revenue 561,955 429,646 Net sales $ 755,205 $ 497,055 Three Months Ended March 31, 2013 and March 31, 2012 The explanations below includes discussion of the results of operations for both our components and systems segments for net sales, costs of sales, and income (loss) before income taxes. Net sales Three Months Ended March 31, (Dollars in thousands) March 31, 2013 2012 Three Month Period Change Net Sales Components $ 356,596 $ 168,130 $ 188,466 112 % Systems $ 398,609 $ 328,925 69,684 21 % Total Net sales $ 755,205 $ 497,055 $ 258,150 52 % The 52% increase in net sales during the three months ended March 31, 2013 compared with the three months ended March 31, 2012 was primarily due to a 112% increase in net sales from our components segment, combined with a 21% increase in net sales from our systems segment. Net sales from our components segment, which includes modules used in our systems projects, increased $188.5 million primarily due to a 197% increase in the volume of watts sold, partially offset by a 29% decrease in module average selling prices. Net sales from our systems segment, which excludes solar modules used in our systems projects, increased by $69.7 million, primarily due to increases in net sales from our Topaz, Imperial Energy Center South and AV Solar Ranch One projects, partially offset by decreases in net sales from our St. Clair and Agua Caliente projects. The increase in net sales is primarily due to the number and size of projects under construction between the periods as well as the timing of when all revenue recognition criteria have been met. Cost of sales Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Cost of Sales Components $ 344,987 $ 190,589 $ 154,398 81 % Systems 240,892 229,721 11,171 5 % Total Cost of Sales $ 585,879 $ 420,310 $ 165,569 39 % % of net sales 77.6 % 84.6 % The 39% increase in cost of sales during the three months ended March 31, 2013 compared with the three months ended March 31, 2012 was primarily due to a $154 million increase in our components segment cost of sales. These increases related primarily to a 197% increase in the volume of solar modules in terms of watts sold and $14 million for an increase in underutilization of our manufacturing capacity primarily related to the idling of manufacturing lines in Malaysia, partially offset by a $27 million decrease in expense for costs associated with voluntary remediation efforts for our 2008-2009 manufacturing excursion, an $11 million decrease related to accelerated depreciation for certain manufacturing equipment that was replaced as part of our planned equipment upgrade program in the first quarter of 2012 and a $24 million decrease for certain lower of cost or market inventory write-downs primarily as a result of declines in market pricing during the first quarter of 2012. The remaining partially offsetting decrease was primarily due to continued cost reductions between the periods. Additionally, cost of sales increased by $11 million 49 -------------------------------------------------------------------------------- in our systems segment primarily for BoS and other construction costs related to an increase in the number and size of various utility-scale solar power systems under construction between the periods. Our average manufacturing cost per watt decreased by $0.04, or 5%, from $0.73 in the three months ended March 31, 2012 to $0.69 in the three months ended March 31, 2013. The decrease is the result of increased module efficiencies realized and the closure of our German manufacturing plants, partially offset by increased underutilization during the three months ended March 31, 2013. Gross profit Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Gross profit $ 169,326 $ 76,745 $ 92,581 121 % % of net sales 22.4 % 15.4 % Gross profit as a percentage of net sales increased by 7.0 percentage points in the three months ended March 31, 2013 compared with the three months ended March 31, 2012. This increase was primarily attributable to a 5.4 percentage point increase related to reduced costs associated with voluntary remediation efforts for our June 2008 to June 2009 manufacturing excursion, a 2.4 percentage point increase related to a reduction in lower of cost or market inventory write-downs between the periods, a 0.9 percentage point increase in systems segment gross profit due to the mix of projects under construction between the periods and a 0.8 percentage point increase due to reductions in accelerated depreciation on certain manufacturing equipment that had been replaced as part of our planned equipment upgrade programs, partially offset by a 2.5 percentage point decrease due to lower gross profit for modules sold in our components segment primarily due to lower average selling prices between the periods. Research and development Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Research and development $ 29,931 $ 36,084 $ (6,153 ) (17 )% % of net sales 4.0 % 7.3 % The decrease in research and development expense of $6.2 million was partially due to a $3.3 million decrease in personnel-related expenses. Additionally, testing and qualification materials expense decreased by approximately $3.4 million. These decreases were partially offset by increases of approximately $0.5 million in other expenses. During the three months ended March 31, 2013, we continued the development of solar modules with increased efficiencies at converting sunlight into electricity and increased the average conversion efficiency of our solar modules from 12.4% for the three months ended March 31, 2012 to 12.9% for the three months ended March 31, 2013. Selling, general and administrative Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Selling, general and administrative $ 74,465 $ 91,820 $ (17,355 ) (19 )% % of net sales 9.9 % 18.5 % The decrease in selling, general and administrative expense of $17.4 million between the periods was primarily due to a $16.0 million decrease in expense related to the June 2008 to June 2009 manufacturing excursion and a $5.5 million decrease in salaries and personnel-related expenses. These decreases were partially offset by increases of $1.0 million in infrastructure expenses and $3.1 million in professional service costs. Production start-up 50 -------------------------------------------------------------------------------- Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Production start-up $ 1,376 $ 4,058 $ (2,682 ) (66 )% % of net sales 0.2 % 0.8 % During the three months ended March 31, 2013 and March 31, 2012, we incurred $1.4 million and $4.1 million, respectively, of production start-up expenses primarily for our global manufacturing personnel dedicated to the installation and implementation of new equipment, equipment upgrades and process improvements for existing plants. Restructuring Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Restructuring $ 2,347 $ 401,065 $ (398,718 ) (99 )% % of net sales 0.3 % 80.7 % During the three months ended March 31, 2013 and March 31, 2012, we incurred $2.3 million and $401.1 million, respectively, of restructuring expenses due to charges relating to the previously announced February 2012 manufacturing restructuring and April 2012 European restructuring initiatives, which included charges associated with the closure of our German manufacturing plants at the end of 2012. See Note 4. "Restructuring," to our condensed consolidated financial statements included with this Quarterly Report on Form 10-Q for additional information. Foreign currency gain (loss) Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Foreign currency gain (loss) $ 1,618 $ (984 ) $ 2,602 264 % Foreign currency gain during the three months ended March 31, 2013 increased compared to a foreign currency loss in the three months ended March 31, 2012, primarily due to differences between our economically hedged positions and the underlying exposure, and changes in the associated exchange rates between the periods. Interest income Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Interest income $ 4,947 $ 2,911 $ 2,036 70 % Interest income increased $2.0 million during the three months ended March 31, 2013 compared with the three months ended March 31, 2012, primarily due to interest received from notes receivable, affiliate of $1.4 million, combined with increased interest received from marketable securities. Interest expense, net Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Interest expense, net $ (750 ) $ (920 ) $ 170 (18 )% Interest expense, net of amounts capitalized, decreased during the three months ended March 31, 2013 compared with the three months ended March 31, 2012, primarily as a result of a decrease in long-term debt between the periods. Other expense, net 51 -------------------------------------------------------------------------------- Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Other expense, net $ (833 ) $ (1,211 ) $ 378 31 % Other expense, net, decreased during the three months ended March 31, 2013 compared with the three months ended March 31, 2012, primarily as a result of timing differences of various immaterial miscellaneous items. Income (Loss) Before Income Taxes Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Income (loss) before income taxes Components $ (49,538 ) $ (513,454 ) $ 463,916 (90 )% Systems 115,727 56,968 58,759 103 % Total income (loss) before income taxes $ 66,189 $ (456,486 ) $ 522,675 (114 )% Components segment loss before income taxes decreased by $463.9 million, during the three months ended March 31, 2013 compared with the three months ended March 31, 2012, primarily from an increase in sales volumes, a reduction in expenses relating to a series of restructuring initiatives, and a decrease in expense associated with our voluntary remediation efforts from our June 2008 - June 2009 manufacturing excursion, partially offset by a decrease in average selling prices between the periods. Systems segment income before income taxes increased $58.8 million, during the three months ended March 31, 2013 compared with the three months ended March 31, 2012, primarily due to increased systems segment net sales during the three months ended March 31, 2013 compared with the three months ended March 31, 2012, due to an increase in the number and size of projects under construction for which all revenue recognition criteria were met. Income tax expense (benefit) Three Months Ended (Dollars in thousands) March 31, 2013 March 31, 2012 Three Month Period Change Income tax expense (benefit) $ 7,047 $ (7,070 ) $ 14,117 (200 )% Effective tax rate 10.6 % (1.5 )% Income tax expense increased by $14.1 million during the three months ended March 31, 2013 compared with the three months ended March 31, 2012. The increase in income tax expense was primarily attributable to the generation of a profit from operations during the three month ended March 31, 2013 as compared to having generated an operating loss during the three months ended March 31, 2012. The income tax benefit during the three months ended March 31, 2012 was partially offset by an increase in tax expense related to the establishment of valuation allowances of $12.3 million against previously established deferred tax assets. See Note 15. "Income Taxes," to our condensed consolidated financial statements included with this Quarterly Report on Form 10-Q for additional information. Critical Accounting Policies and Estimates In preparing our financial statements in conformity with U.S. GAAP, we make estimates and assumptions about future events that affect the amounts of reported assets, liabilities, revenues, and expenses, as well as the disclosure of contingent liabilities in our condensed consolidated financial statements and the related notes thereto. Some of our accounting policies require the application of significant judgment by management in the selection of the appropriate assumptions for making these estimates. We base our judgments and estimates on our historical experience, our forecasts, available market information and other available information as appropriate. We believe that the assumptions, judgments, and estimates involved in the accounting for percentage-of completion revenue recognition, accrued solar module collection and recycling liability, product warranties and manufacturing excursions, accounting for income taxes, reportable segment allocations, long-lived asset impairments, and goodwill have the greatest potential impact on our condensed consolidated financial statements. The actual results experienced by us may differ 52 -------------------------------------------------------------------------------- materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. For a complete description of our critical accounting policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission. There have been no material changes in any of our critical accounting policies during the three months ended March 31, 2013. Recent Accounting Pronouncements See Note 3. "Recent Accounting Pronouncements," to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a summary of recent accounting pronouncements. Liquidity and Capital Resources As of March 31, 2013, we believe that our cash, cash equivalents, marketable securities, cash flows from operating activities including the contracted portion of our advanced-stage project pipeline, availability under our Revolving Credit Facility considering minimum liquidity covenant requirements, and access to the capital markets will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. We intend to continue to carefully execute our Long Term Strategic Plan and manage credit and market risk. However, if our financial results or operating plans change from our current assumptions, we may not have sufficient resources to support the execution of our Long Term Strategic Plan. Cash generated from operations including the contracted portion of our advanced-stage project pipeline is our primary source of operating liquidity and we believe that internally generated cash flows combined with our existing cash and cash equivalents, marketable securities, and availability under our Revolving Credit Facility considering minimum liquidity covenant requirements, are sufficient to support day-to-day business operations. We monitor our working capital to ensure we have adequate liquidity, both domestically and internationally, to support the execution of our Long Term Strategic Plan. We intend to maintain appropriate debt levels based upon cash flow expectations, the overall cost of capital, cash requirements for operations, capital expenditures, and discretionary strategic spending. In the future, we may also engage in one or more debt or equity financings potentially including project specific non-recourse debt financings. We believe that when necessary, we will have adequate access to the capital markets, although our ability to raise capital on terms commercially acceptable to us could be constrained if there is insufficient lender or investor interest due to industry-wide or company-specific concerns. Such financings could result in increased debt service expenses or dilution to our existing stockholders. If we are unable to obtain debt or equity financing on reasonable terms, we may be unable to execute our Long Term Strategic Plan. As of March 31, 2013, we had $1,011.7 million in cash, cash equivalents, and marketable securities compared with $1,003.9 million as of December 31, 2012. Cash, cash equivalents, and marketable securities as of March 31, 2013 remained consistent with December 31, 2012. As of March 31, 2013 and December 31, 2012, $762.1 million and $548.5 million, respectively, of our cash, cash equivalents, and marketable securities were held by foreign subsidiaries and are generally based in U.S. dollar and Euro denominated holdings. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed. Our expanding systems business requires liquidity and is expected to continue to have significant liquidity requirements in the future. Solar power project development and construction cycles, which span the time between the identification of a site location to the commercial operation of a PV power plant, vary substantially and can take many years to mature. As a result of these long project cycles, we may need to make significant up-front investments of resources in advance of the receipt of any cash from the sale of such systems projects. These amounts include payment of interconnection and other deposits (some of which are non-refundable), posting of letters of credit, and incurring engineering, permitting, legal, and other expenses. Additionally, we may have to use our working capital, the availability under our Revolving Credit Facility, or enter into non-recourse project financing to finance the construction of our systems projects, if such projects cannot be sold before construction begins. Depending upon the size and number of projects that we are developing and self-financing the construction of, the systems business has and is expected in the future to require significant liquidity. For example, we may have to substantially complete the construction of a systems project before such project is sold. Delays in construction or in completing the sale of our systems projects which we are self-financing may also impact our liquidity. We have historically financed these up-front investments for project development and when necessary, construction, primarily using working capital. Additionally, we may in the future decide to retain ownership of one or more of our systems projects for a period of time up to the useful life of the project if we determine it would be of economic and strategic benefit to do so. If, for example, we cannot 53 -------------------------------------------------------------------------------- sell a systems project at economics that are attractive to us or potential customers are unwilling to assume the risks and rewards typical of project ownership, we may instead elect to own and operate such systems project. Any such decision to own and operate a systems project is expected to impact liquidity depending upon the size and cost of the project. If such decision is made, we may elect to enter into temporary or long-term non-recourse project financing to reduce the impact on our liquidity and working capital. The following considerations have impacted or are expected to impact our liquidity in the remainder of 2013 and beyond: • The amount of accounts receivable, unbilled as of March 31, 2013 was $257.6 million and primarily represented revenues recognized on the construction work performed on systems projects in advance of billing the customer under the terms of the underlying construction contracts. Such construction costs have been funded with working capital and the unbilled amounts are expected to be billed and collected from customers during the next twelve months. Additionally, we had $222.5 million of current and $188.7 million of noncurrent retainage, which represents the portion of a systems project contract price earned by us for work performed, but held for payment by our customer as a form of security until we reach certain construction milestones. Such retainage amounts relate to construction work already performed. • The amount of finished goods inventory ("solar module inventory") and BoS parts as of March 31, 2013 was $462.4 million. As we continue with the construction of our advanced-stage project pipeline we must produce solar modules and procure BoS parts in the required volumes to support our planned construction schedules. As part of the normal construction cycle, we typically must produce or acquire the necessary materials for construction activities in advance of receiving payment for such materials. Once solar modules and BoS parts are installed in a project, such installed amounts are classified as either project assets, deferred project costs, or cost of sales depending upon whether the project is subject to a definitive sales contract and whether all revenue recognition criteria have been met. Accordingly, as of any balance sheet date, our solar module inventory represents solar modules that will be installed in our advanced-stage project pipeline or that we expect to sell to third parties. • There may be a delay in when our solar module inventory and BoS parts can be converted into cash compared to a typical third-party module sale. Such timing differences temporarily reduce our liquidity to the extent that we have already paid for our BoS parts or the underlying costs to produce our solar module inventories. As previously announced, we have adjusted, and will in the future adjust, our manufacturing capacity and planned solar module production levels, to match expected market demand. Any decrease in planned production reduces our risk and the impact on liquidity of having excess solar module inventories that we must sell to third parties as we execute our Long Term Strategic Plan and respond to market pricing uncertainties for solar modules. Our solar module inventory as of March 31, 2013, is expected to primarily support our systems business, including our advanced-stage project pipeline, with the remaining amounts being used to support expected near term demand for third-party module sales. As of March 31, 2013, approximately $210 million or 64% of our solar module inventory was either on-site or in-transit to our systems projects. Of this amount, approximately $43 million of solar module inventories or 13% of the total solar module inventory balance was physically segregated for the purpose of qualifying a project for the Department of Treasury's Section 1603 cash grant program prior to the program's expiration in December 2011. Such segregated solar module inventories are expected to be installed in the underlying systems project in the normal course of our construction, which has not yet begun. All BoS parts are for our systems business projects. • We expect to commit working capital during the remainder of 2013 and beyond to acquire solar power projects in various stages of development including advance-stage projects with PPAs and continue developing those projects as necessary. Depending upon the size and stage of development, costs to acquire such solar power projects could be significant. When evaluating project acquisition opportunities, we consider both the strategic and financial benefits of any such acquisitions. • In connection with the execution of our Long Term Strategic Plan, we expect joint ventures or other business arrangements with strategic partners to be a key part of our strategy. We have begun initiatives in several markets to expedite our penetration of those markets and establish relationships with potential strategic partners, customers, and policymakers. Many of these business arrangements are expected to involve a significant cash investment or other allocation of working capital that could reduce our liquidity or require us to pursue additional sources of financing, assuming such sources are available to us. Additionally, in order to execute our Long Term Strategic Plan in such markets, we have elected, and may in the future elect or be required to temporarily retain an ownership interest in the underlying systems projects we develop, supply modules to, or construct. Any such retained ownership interest is expected to impact our liquidity to the extent we do not obtain new sources of capital to fund such investments. 54--------------------------------------------------------------------------------• Our restructuring charges are expected to result in total future remaining cash payments of between $30 million and $40 million. Such cash payments are primarily related to severance costs for reductions in force as a result of such restructuring initiatives. • In connection with our Long Term Strategic Plan, we expect additional future restructuring actions as we continue to align our manufacturing production capacity with market demand, evaluate our cost structure and identify potential cost savings opportunities, and focus our resources on developing target sustainable markets. We may in the future to incur additional restructuring costs, which may be significant (including potentially the repayment of debt facilities and other amounts, the payment of severance to terminated employees, and other restructuring related costs) that could reduce our liquidity position to the point where we need to pursue additional sources of financing, assuming such sources are available to us. See Note 4. "Restructuring," to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. • During the remainder of 2013, we expect to spend up to $330 million for capital expenditures, primarily related to expenditures for upgrades to existing machinery and equipment, which we believe will increase our solar module efficiencies. A majority of our remaining capital expenditures for 2013 will be incurred in foreign currencies and are therefore subject to fluctuations in currency exchange rates. • Under the sales agreements for a limited number of our solar power projects, we may be required to repurchase such projects if certain events occur, such as not achieving commercial operation of the project within a certain time frame. Although we consider the possibility that we would be required to repurchase any of our solar power projects to be remote, our current working capital and other available sources of liquidity may not be sufficient to make any required repurchase. If we are required to repurchase a solar power project, we would have the ability to market and sell such project at then current market pricing, which could be at a lower than expected price to the extent the event requiring a repurchase impacts the project's marketability or related tax benefits. Our liquidity may also be impacted as the time between the repurchase of a project and the potential sale of such repurchased project could take several months. Alternatively, we may determine that the most economically attractive solution for a repurchased project is for us to own and operate such project, which would have a longer term impact on our liquidity compared to a resale of a repurchased project. The unprecedented disruption in the credit markets that began in 2008 and the current instability in Europe have had a significant adverse impact on a number of financial institutions. The ongoing sovereign debt problems in Europe and its impact on the balance sheets and lending practices of European banks in particular could negatively impact our access to, and cost of, capital, and therefore could have an adverse effect on our business, results of operations, financial condition and competitive position. It could also similarly affect our customers and therefore limit the demand for our systems projects or solar modules. As of March 31, 2013 our liquidity and marketable securities and restricted investments have not been materially adversely impacted by the current credit environment, and we believe that they will not be materially adversely impacted in the near future. We will continue to closely monitor our liquidity and the credit markets. However, we cannot predict with any certainty the impact to us of any further disruption in the current credit environment. Cash Flows Descriptions The following table summarizes the key cash flow metrics for the three months ended March 31, 2013 and March 31, 2012 (in thousands): Three Months Ended March 31, 2013 March 31, 2012 Net cash provided by (used in) operating activities $ 66,455 $ (16,136 ) Net cash used in investing activities (141,600 ) (182,320 ) Net cash provided by financing activities 21,355 195,778 Effect of exchange rate changes on cash and cash equivalents (4,751 ) 7,539 Net (decrease) increase in cash and cash equivalents $ (58,541 ) $ 4,861 Operating Activities Cash provided by operating activities was $66.5 million during the three months ended March 31, 2013 compared with cash used in operating activities of $16.1 million during the three months ended March 31, 2012. The increase in net cash provided by operating activities during the three months ended March 31, 2013 was primarily due to an increase in cash received from customers, 55 -------------------------------------------------------------------------------- which was partially offset by an increase in cash paid to suppliers and associates. Interest received also increased from $1.2 million to $3.4 million during the three months ended March 31, 2013, primarily as the result of the re-payment of our note receivable, affiliate. Such amounts were offset by an increase in the excess tax benefits related to share-based compensation arrangements, which decreased our first quarter of 2013 operating cash flow by $24.9 million compared to a $9.5 million decrease during the first quarter of 2012. In addition, income taxes paid, net increased from net payments of $2.5 million during the three months ended March 31, 2012 to net payments of $5.7 million during the three months ended March 31, 2013. Investing Activities Cash used in investing activities was $141.6 million during the three months ended March 31, 2013, compared with $182.3 million during the three months ended March 31, 2012. Cash used in investing activities during the three months ended March 31, 2013 included capital expenditures of $71.7 million, which decreased from $124.5 million during the three months ended March 31, 2012. The decrease in capital expenditures was in accordance with our Long Term Strategic Plan. Also, we increased our net investment in marketable securities by $66.8 million during the three months ended March 31, 2013 compared with a decrease in our net investment in marketable securities of $43.4 million during the three months ended March 31, 2012. We also increased our investment in equity and cost method investments by $14.9 million in accordance with our Long Term Strategic Plan during the first quarter of 2013. Acquisitions, net of cash acquired, resulted in payments of $7.9 million in the three months ended March 31, 2013 compared to $2.4 million in the three months ended March 31, 2012. Based upon reductions in our estimated future end-of-life collection and recycling costs we determined no incremental funding was needed for the purchase of restricted investments during the three months ended March 31, 2013, compared to $80.7 million in purchases of restricted investments during the three months ended March 31, 2012. The remaining change in cash used in investing activities was primarily driven by a decrease of $5.1 million in restricted cash and a payment received on our note receivable, affiliate of $17.1 million in the three months ended March 31, 2013. Financing Activities Cash provided by financing activities was $21.4 million during the three months ended March 31, 2013 compared with $195.8 million during the three months ended March 31, 2012. Cash provided by financing activities during the three months ended March 31, 2013 resulted primarily from the proceeds of borrowings under long-term debt of $335.0 million and excess tax benefit from share-based compensation arrangements of $24.9 million, partially offset by the repayment of long-term debt of $330.2 million and the repayment of economic development funding of $8.3 million. Cash provided by financing activities during the three months ended March 31, 2012 resulted primarily from the proceeds of borrowings under long-term debt of $200.0 million and excess tax benefits from share-based compensation arrangements of $9.5 million, partially offset by the repayments of long-term debt of $13.1 million. Contractual Obligations Our contractual obligations have not materially changed since the end of 2012 other than in the ordinary course of business. See also our Annual Report on Form 10-K for the year ended December 31, 2012 for additional information regarding our contractual obligations. Off-Balance Sheet Arrangements We had no off-balance sheet arrangements as of March 31, 2013. [ Back To TMCnet.com's Homepage ]