☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
or
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 001-33156
First Solar, Inc.
(Exact name of registrant as specified in its charter)
Delaware
20-4623678
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
350 West Washington Street, Suite 600
Tempe, Arizona85281
(Address of principal executive offices, including zip code)
(602) 414-9300
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common stock, $0.001 par value
FSLR
The NASDAQ Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
As of October 23, 2020, 105,976,169 shares of the registrant’s common stock, $0.001 par value per share, were outstanding.
FIRST SOLAR, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2020
Marketable securities (amortized cost of $353,413 and allowance for credit losses of $48 at September 30, 2020)
353,819
811,506
Accounts receivable trade
221,196
476,425
Less: allowance for credit losses
(2,413)
(1,386)
Accounts receivable trade, net
218,783
475,039
Accounts receivable, unbilled and retainage
89,368
183,473
Less: allowance for credit losses
(919)
—
Accounts receivable, unbilled and retainage, net
88,449
183,473
Inventories
567,785
443,513
Balance of systems parts
34,280
53,583
Project assets
1,222
3,524
Assets held for sale
35,009
—
Prepaid expenses and other current assets
224,092
276,455
Total current assets
2,800,493
3,599,834
Property, plant and equipment, net
2,386,591
2,181,149
PV solar power systems, net
257,400
476,977
Project assets
362,777
333,596
Deferred tax assets, net
210,340
130,771
Restricted marketable securities (amortized cost of $245,351 and allowance for credit losses of $0 at September 30, 2020)
261,507
223,785
Goodwill
14,462
14,462
Intangible assets, net
58,469
64,543
Inventories
197,520
160,646
Other assets
435,658
329,926
Total assets
$
6,985,217
$
7,515,689
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$
153,925
$
218,081
Income taxes payable
32,172
17,010
Accrued expenses
298,133
351,260
Current portion of long-term debt
40,412
17,510
Deferred revenue
115,592
323,217
Accrued litigation
—
363,000
Liabilities held for sale
12,721
—
Other current liabilities
78,136
28,130
Total current liabilities
731,091
1,318,208
Accrued solar module collection and recycling liability
125,594
137,761
Long-term debt
220,456
454,187
Other liabilities
511,963
508,766
Total liabilities
1,589,104
2,418,922
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.001 par value per share; 500,000,000 shares authorized; 105,974,984 and 105,448,921 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively
106
105
Additional paid-in capital
2,855,645
2,849,376
Accumulated earnings
2,600,059
2,326,620
Accumulated other comprehensive loss
(59,697)
(79,334)
Total stockholders’ equity
5,396,113
5,096,767
Total liabilities and stockholders’ equity
$
6,985,217
$
7,515,689
See accompanying notes to these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of First Solar, Inc. and its subsidiaries in this Quarterly Report have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, these interim financial statements do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. In the opinion of First Solar management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement have been included. Certain prior period balances have been reclassified to conform to the current period presentation.
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Despite our intention to establish accurate estimates and reasonable assumptions, actual results could differ materially from such estimates and assumptions. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or for any other period. The condensed consolidated balance sheet at December 31, 2019 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These interim financial statements and notes should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2019 included in our Annual Report on Form 10-K, which has been filed with the SEC.
Unless expressly stated or the context otherwise requires, the terms “the Company,” “we,” “us,” “our,” and “First Solar” refer to First Solar, Inc. and its consolidated subsidiaries, and the term “condensed consolidated financial statements” refers to the accompanying unaudited condensed consolidated financial statements contained in this Quarterly Report.
2. Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326),to provide financial statement users with more useful information about expected credit losses. ASU 2016-13 replaces the historical incurred loss model with a model that reflects current expected credit losses (“CECL”), which requires consideration of a broader range of information to measure credit losses and determine the timing of when such losses are recorded. The CECL model is applicable to certain financial assets measured at amortized cost that subject us to credit risk, including cash equivalents, trade accounts receivable, unbilled accounts receivable and retainage, and notes receivable. In addition, ASU 2016-13 amended certain aspects of the accounting for available-for-sale debt securities, including the presentation of credit losses as an allowance against, rather than a write-down of, the fair value of such securities. Furthermore, a credit loss is only considered when a security is in an unrealized loss position, is limited to the difference between such security’s fair value and amortized cost basis, and is recorded directly to “Other expense, net.” Any remaining unrealized loss is recorded to “Accumulated other comprehensive loss” until realized.
We adopted ASU 2016-13 in the first quarter of 2020 using the modified-retrospective approach, which resulted in the recognition of an initial allowance for credit losses for our various financial assets through a cumulative-effect adjustment that decreased retained earnings by $9.2 million, net of tax, as of January 1, 2020.
The allowance for credit losses is a valuation account that is deducted from a financial asset’s amortized cost to present the net amount we expect to collect from such asset. We estimate allowances for credit losses using relevant available information from both internal and external sources. We monitor the estimated credit losses associated with our trade accounts receivable and unbilled accounts receivable based primarily on our collection history and the delinquency status of amounts owed to us, which we determine based on the aging of such receivables. For our notes receivable, we determine estimated credit losses through an assessment of the borrower’s credit quality based primarily on quarterly reviews of certain financial information, including financial statements and forecasts. We estimate credit losses associated with our marketable securities and restricted marketable securities based on the external credit rating for such investments and the historical loss rates associated with such credit ratings, which we obtain from third parties. Such methods and estimates are adjusted, as appropriate, for relevant past events, current conditions, such as the COVID-19 pandemic and related containment measures, and reasonable and supportable forecasts. We recognize writeoffs within the allowance for credit losses when cash receipts associated with our financial assets are deemed uncollectible.
See Note 3. “Cash, Cash Equivalents, and Marketable Securities,” Note 4. “Restricted Marketable Securities,” and Note 5. “Consolidated Balance Sheet Details” to our condensed consolidated financial statements for further information about the allowance for credit losses associated with our various financial assets.
3. Cash, Cash Equivalents, and Marketable Securities
Cash, cash equivalents, and marketable securities consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Cash and cash equivalents:
Cash
$
1,276,662
$
1,345,419
Money market funds
392
7,322
Total cash and cash equivalents
1,277,054
1,352,741
Marketable securities:
Foreign debt
214,436
387,820
Foreign government obligations
—
22,011
U.S. debt
14,561
66,134
Time deposits
124,822
335,541
Total marketable securities
353,819
811,506
Total cash, cash equivalents, and marketable securities
$
1,630,873
$
2,164,247
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within our condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019 to the total of such amounts as presented in the condensed consolidated statement of cash flows (in thousands):
During the three and nine months ended September 30, 2020, we sold marketable securities for proceeds of $27.6 million and $188.1 million, respectively, and realized gains of less than $0.1 million and $0.2 million, respectively, on such sales. During the three and nine months ended September 30, 2019, we sold marketable securities for proceeds of $32.0 million and $52.0 million, respectively, and realized no gain or loss on the sale. See Note 8. “Fair Value Measurements” to our condensed consolidated financial statements for information about the fair value of our marketable securities.
The following tables summarize the unrealized gains and losses related to our available-for-sale marketable securities, by major security type, as of September 30, 2020 and December 31, 2019 (in thousands):
As of September 30, 2020
Amortized Cost
Unrealized Gains
Unrealized Losses
Allowance for Credit Losses
Fair Value
Foreign debt
$
214,045
$
467
$
66
$
10
$
214,436
U.S. debt
14,508
53
—
—
14,561
Time deposits
124,860
—
—
38
124,822
Total
$
353,413
$
520
$
66
$
48
$
353,819
As of December 31, 2019
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Foreign debt
$
387,775
$
551
$
506
$
387,820
Foreign government obligations
21,991
20
—
22,011
U.S. debt
65,970
176
12
66,134
Time deposits
335,541
—
—
335,541
Total
$
811,277
$
747
$
518
$
811,506
The following table presents the change in the allowance for credit losses related to our available-for-sale marketable securities for the nine months ended September 30, 2020 (in thousands):
Marketable Securities
Balance as of December 31, 2019
$
—
Cumulative-effect adjustment for the adoption of ASU 2016-13
207
Provision for credit losses, net
215
Sales and maturities of marketable securities
(374)
Balance as of September 30, 2020
$
48
The contractual maturities of our marketable securities as of September 30, 2020 were as follows (in thousands):
Restricted marketable securities consisted of the following as of September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Foreign government obligations
$
141,728
$
126,066
U.S. government obligations
119,779
97,719
Total restricted marketable securities
$
261,507
$
223,785
Our restricted marketable securities represent long-term marketable securities held in custodial accounts to fund the estimated future costs of collecting and recycling modules covered under our solar module collection and recycling program. As of September 30, 2020 and December 31, 2019, such custodial accounts also included noncurrent restricted cash balances of $0.7 million and less than $0.1 million, respectively, which were reported within “Other assets.” As necessary, we fund any incremental amounts for our estimated collection and recycling obligations on an annual basis based on the estimated costs of collecting and recycling covered modules, estimated rates of return on our restricted marketable securities, and an estimated solar module life of 25 years, less amounts already funded in prior years. To ensure that amounts previously funded will be available in the future regardless of potential adverse changes in our financial condition (even in the case of our own insolvency), we have established a trust under which estimated funds are put into custodial accounts with an established and reputable bank, for which First Solar, Inc.; First Solar Malaysia Sdn. Bhd.; and First Solar Manufacturing GmbH are grantors. Trust funds may be disbursed for qualified module collection and recycling costs (including capital and facility related recycling costs), payments to customers for assuming collection and recycling obligations, and reimbursements of any overfunded amounts. Investments in the trust must meet certain investment quality criteria comparable to highly rated government or agency bonds.
During the nine months ended September 30, 2020, we sold certain restricted marketable securities for proceeds of $115.2 million, realized gains of $15.1 million on such sales, and repurchased $114.5 million of restricted marketable securities as part of our ongoing management of the custodial accounts. During the nine months ended September 30, 2019, we sold certain restricted marketable securities for proceeds of $47.9 million and realized gains of $15.0 million on such sales as part of efforts to align the currencies of the investments with those of the corresponding collection and recycling liabilities and disbursed $14.9 million of overfunded amounts. See Note 8. “Fair Value Measurements” to our condensed consolidated financial statements for information about the fair value of our restricted marketable securities.
The following tables summarize the unrealized gains and losses related to our restricted marketable securities, by major security type, as of September 30, 2020 and December 31, 2019 (in thousands):
The following table presents the change in the allowance for credit losses related to our restricted marketable securities for the nine months ended September 30, 2020 (in thousands):
Restricted Marketable Securities
Balance as of December 31, 2019
$
—
Cumulative-effect adjustment for the adoption of ASU 2016-13
54
Provision for credit losses, net
(29)
Sales of restricted marketable securities
(25)
Balance as of September 30, 2020
$
—
As of September 30, 2020, the contractual maturities of our restricted marketable securities were between 9 years and 21 years.
5. Consolidated Balance Sheet Details
Accounts receivable trade, net
Accounts receivable trade, net consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Accounts receivable trade, gross
$
221,196
$
476,425
Allowance for credit losses
(2,413)
(1,386)
Accounts receivable trade, net
$
218,783
$
475,039
At September 30, 2020 and December 31, 2019, $25.0 million and $44.9 million, respectively, of our trade accounts receivable were secured by letters of credit, bank guarantees, surety bonds, or other forms of financial security issued by creditworthy financial institutions.
Accounts receivable, unbilled and retainage, net
Accounts receivable, unbilled and retainage, net consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
The following table presents the change in the allowances for credit losses related to our accounts receivable for the nine months ended September 30, 2020 (in thousands):
Accounts Receivable Trade
Accounts Receivable, Unbilled and Retainage
Balance as of December 31, 2019
$
(1,386)
$
—
Cumulative-effect adjustment for the adoption of ASU 2016-13
(171)
(459)
Provision for credit losses, net (1)
(1,421)
(635)
Writeoffs
565
175
Balance as of September 30, 2020
$
(2,413)
$
(919)
——————————
(1)Includes credit losses for trade accounts receivable and unbilled accounts receivable of $1.8 million and $0.7 million, respectively, to reflect our estimate of expected credit losses attributable to the current economic conditions resulting from the ongoing COVID-19 pandemic.
Inventories
Inventories consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Raw materials
$
275,309
$
248,756
Work in process
67,273
59,924
Finished goods
422,723
295,479
Inventories
$
765,305
$
604,159
Inventories – current
$
567,785
$
443,513
Inventories – noncurrent
$
197,520
$
160,646
Prepaid expenses and other current assets
Prepaid expenses and other current assets consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Prepaid expenses
$
153,772
$
137,927
Prepaid income taxes
50,173
47,811
Indirect tax receivables
3,238
29,908
Restricted cash
1,516
13,697
Derivative instruments (1)
1,320
1,199
Notes receivable, net (2)
—
23,873
Other current assets
14,073
22,040
Prepaid expenses and other current assets
$
224,092
$
276,455
——————————
(1)See Note 6. “Derivative Financial Instruments” to our condensed consolidated financial statements for discussion of our derivative instruments.
(2)In November 2014 and February 2016, we entered into a term loan agreement and a convertible loan agreement, respectively, with Clean Energy Collective, LLC (“CEC”). Our term loan bears interest at 16% per annum, and our convertible loan bears interest at 10% per annum. In November 2018, we amended the terms of the loan agreements to (i) extend their maturity to June 2020, (ii) waive the conversion features on our convertible loan, and (iii) increase the frequency of interest payments, subject to certain conditions.
We assess CEC’s credit quality based primarily on certain quarterly financial information, which was last provided during the three months ended September 30, 2020. As of December 31, 2019, the aggregate balance outstanding on the loans was $23.9 million. Upon the adoption of ASU 2016-13, we evaluated the estimated credit losses over the remaining contractual term of the loan agreements based on a discounted cash flow model. As a result of this evaluation, we recorded an allowance for credit losses of $10.8 million as of January 1, 2020. During the nine months ended September 30, 2020, we recorded incremental credit losses of $13.1 million due to CEC’s inability to repay the loans by their contractual maturity date. In September 2020, we wrote off the aggregate outstanding loan balance against the associated allowance for credit losses based on our determination that the loans are uncollectible.
Property, plant and equipment, net
Property, plant and equipment, net consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Land
$
14,363
$
14,241
Buildings and improvements
666,637
664,266
Machinery and equipment
2,101,726
2,436,997
Office equipment and furniture
143,242
159,848
Leasehold improvements
43,795
48,772
Construction in progress
467,513
243,107
Property, plant and equipment, gross
3,437,276
3,567,231
Accumulated depreciation
(1,050,685)
(1,386,082)
Property, plant and equipment, net
$
2,386,591
$
2,181,149
We assess our property, plant and equipment for impairment whenever events or changes in circumstances arise that may indicate that the carrying amount of such assets may not be recoverable. We consider a long-lived asset to be abandoned after we have ceased use of the asset and we have no intent to use or repurpose it in the future, and such abandoned assets are recorded at their salvage value, if any. During the three months ended September 30, 2020, we recorded an impairment loss of $17.4 million in “Cost of sales” for certain abandoned module manufacturing equipment, including framing and assembly tools, as such equipment was no longer compatible with our long-term module technology roadmap.
Depreciation of property, plant and equipment was $49.7 million and $145.5 million for the three and nine months ended September 30, 2020, respectively, and $42.8 million and $129.4 million for the three and nine months ended September 30, 2019, respectively.
Photovoltaic (“PV”) solar power systems, net consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
PV solar power systems, gross
$
313,048
$
530,004
Accumulated depreciation
(55,648)
(53,027)
PV solar power systems, net
$
257,400
$
476,977
Depreciation of PV solar power systems was $4.8 million and $16.4 million for the three and nine months ended September 30, 2020, respectively, and $5.9 million and $12.9 million for the three and nine months ended September 30, 2019, respectively.
Project assets
Project assets consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Project assets – development costs, including project acquisition and land costs
$
232,116
$
254,466
Project assets – construction costs
131,883
82,654
Project assets
$
363,999
$
337,120
Project assets – current
$
1,222
$
3,524
Project assets – noncurrent
$
362,777
$
333,596
Capitalized interest
The components of interest expense and capitalized interest were as follows during the three and nine months ended September 30, 2020 and 2019 (in thousands):
Other assets consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Operating lease assets (1)
$
223,554
$
145,711
Advanced payments for raw materials
98,733
59,806
Restricted cash
38,119
80,072
Indirect tax receivables
12,154
9,446
Notes receivable (2)
8,556
8,194
Income taxes receivable
4,132
4,106
Equity method investments
3,013
2,812
Other
47,397
19,779
Other assets
$
435,658
$
329,926
——————————
(1)See Note 7. “Leases” to our condensed consolidated financial statements for discussion of our lease arrangements.
(2)In April 2009, we entered into a credit facility agreement with a solar power project entity of one of our customers for an available amount of €17.5 million to provide financing for a PV solar power system. The credit facility bears interest at 8.0% per annum, payable quarterly, with the full amount due in December 2026. As of September 30, 2020 and December 31, 2019, the balance outstanding on the credit facility was €7.0 million ($8.2 million and $7.8 million, respectively). In October 2020, the project entity repaid the outstanding balance of the credit facility.
Goodwill
Goodwill for the relevant reporting unit consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
The following tables summarize our intangible assets at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
Gross Amount
Accumulated Amortization
Net Amount
Developed technology
$
99,964
$
(49,647)
$
50,317
Power purchase agreements
6,486
(1,216)
5,270
Patents
7,780
(4,898)
2,882
Intangible assets, net
$
114,230
$
(55,761)
$
58,469
December 31, 2019
Gross Amount
Accumulated Amortization
Net Amount
Developed technology
$
97,964
$
(42,344)
$
55,620
Power purchase agreements
6,486
(972)
5,514
Patents
7,780
(4,371)
3,409
Intangible assets, net
$
112,230
$
(47,687)
$
64,543
Amortization of intangible assets was $2.7 million and $8.1 million for the three and nine months ended September 30, 2020, respectively, and $2.6 million and $7.6 million for the three and nine months ended September 30, 2019, respectively.
Assets and liabilities held for sale
We classify long-lived assets we plan to sell, excluding project assets and PV solar power systems, as held for sale on our condensed consolidated balance sheets only after certain criteria have been met, including: (i) management has the authority and commits to a plan to sell the asset, (ii) the asset is available for immediate sale in its present condition, (iii) an active program to locate a buyer and the plan to sell the asset have been initiated, (iv) the sale of the asset is probable within 12 months, (v) the asset is being actively marketed at a reasonable sales price relative to its current fair value, and (vi) it is unlikely that the plan to sell will be withdrawn or that significant changes to the plan will be made. We record assets held for sale at the lower of their carrying value or fair value less costs to sell.
Following an evaluation of the long-term cost structure, competitiveness, and risk-adjusted returns of our operations and maintenance (“O&M”) business, we received an offer to purchase certain portions of the business and determined it is in the best interest of our stockholders to pursue this transaction. As a result, in August 2020 we entered into an agreement with a subsidiary of Clairvest Group, Inc. (“Clairvest”), pursuant to which Clairvest will acquire our North American O&M operations. Accordingly, we classified the assets and liabilities we expect to transfer to Clairvest as assets held for sale and liabilities held for sale on our condensed consolidated balance sheet as of September 30, 2020. The completion of the transaction is contingent on a number of closing conditions, including the receipt of certain third-party consents, a review of the transaction by the Committee on Foreign Investment in the United States, and other customary closing conditions. Assuming satisfaction of such closing conditions, we expect the sale to be completed in late 2020.
Other current liabilities consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Other taxes payable
$
31,715
$
994
Operating lease liabilities (1)
14,506
11,102
Derivative instruments (2)
3,120
2,582
Contingent consideration (3)
2,082
2,395
Other
26,713
11,057
Other current liabilities
$
78,136
$
28,130
——————————
(1)See Note 7. “Leases” to our condensed consolidated financial statements for discussion of our lease arrangements.
(2)See Note 6. “Derivative Financial Instruments” to our condensed consolidated financial statements for discussion of our derivative instruments.
(3)See Note 10. “Commitments and Contingencies” to our condensed consolidated financial statements for discussion of our “Contingent Consideration” arrangements
Other liabilities
Other liabilities consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
December 31, 2019
Operating lease liabilities (1)
$
184,887
$
112,515
Other taxes payable
95,536
90,201
Product warranty liability (2)
75,028
109,506
Transition tax liability
62,385
70,047
Deferred revenue
45,990
71,438
Contingent consideration (2)
4,500
4,500
Derivative instruments (3)
107
7,439
Other
43,530
43,120
Other liabilities
$
511,963
$
508,766
——————————
(1)See Note 7. “Leases” to our condensed consolidated financial statements for discussion of our lease arrangements.
(2)See Note 10. “Commitments and Contingencies” to our condensed consolidated financial statements for discussion of our “Product Warranties” and “Contingent Consideration” arrangements.
(3)See Note 6. “Derivative Financial Instruments” to our condensed consolidated financial statements for discussion of our derivative instruments.
As a global company, we are exposed in the normal course of business to interest rate, foreign currency, and commodity price risks that could affect our financial position, results of operations, and cash flows. We use derivative instruments to hedge against these risks and only hold such instruments for hedging purposes, not for speculative or trading purposes.
Depending on the terms of the specific derivative instruments and market conditions, some of our derivative instruments may be assets and others liabilities at any particular balance sheet date. We report all of our derivative instruments at fair value and account for changes in the fair value of derivative instruments within “Accumulated other comprehensive loss” if the derivative instruments qualify for hedge accounting. For those derivative instruments that do not qualify for hedge accounting (i.e., “economic hedges”), we record the changes in fair value directly to earnings. See Note 8. “Fair Value Measurements” to our condensed consolidated financial statements for information about the techniques we use to measure the fair value of our derivative instruments.
The following tables present the fair values of derivative instruments included in our condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019 (in thousands):
September 30, 2020
Prepaid Expenses and Other Current Assets
Other Current Liabilities
Other Liabilities
Derivatives designated as hedging instruments:
Foreign exchange forward contracts
$
—
$
1,152
$
107
Commodity swap contracts
—
228
—
Total derivatives designated as hedging instruments
$
—
$
1,380
$
107
Derivatives not designated as hedging instruments:
Foreign exchange forward contracts
$
1,320
$
1,740
$
—
Total derivatives not designated as hedging instruments
$
1,320
$
1,740
$
—
Total derivative instruments
$
1,320
$
3,120
$
107
December 31, 2019
Prepaid Expenses and Other Current Assets
Other Assets
Other Current Liabilities
Other Liabilities
Derivatives designated as hedging instruments:
Foreign exchange forward contracts
$
226
$
139
$
369
$
230
Total derivatives designated as hedging instruments
$
226
$
139
$
369
$
230
Derivatives not designated as hedging instruments:
Foreign exchange forward contracts
$
973
$
—
$
1,807
$
—
Interest rate swap contracts
—
—
406
7,209
Total derivatives not designated as hedging instruments
The following table presents the pretax amounts related to derivative instruments designated as cash flow hedges affecting accumulated other comprehensive income (loss) and our condensed consolidated statements of operations for the nine months ended September 30, 2020 and 2019 (in thousands):
Foreign Exchange Forward Contracts
Commodity Swap Contracts
Total
Balance as of December 31, 2019
$
(962)
$
—
$
(962)
Amounts recognized in other comprehensive income (loss)
(2,129)
(228)
(2,357)
Amounts reclassified to earnings impacting:
Cost of sales
647
—
647
Balance as of September 30, 2020
$
(2,444)
$
(228)
$
(2,672)
Balance as of December 31, 2018
$
1,329
$
—
$
1,329
Amounts recognized in other comprehensive income (loss)
153
—
153
Amounts reclassified to earnings impacting:
Net sales
(124)
—
(124)
Cost of sales
(1,081)
—
(1,081)
Balance as of September 30, 2019
$
277
$
—
$
277
During the three and nine months ended September 30, 2020, we recognized unrealized gains of $0.1 million and $1.2 million, respectively, within “Cost of sales” for amounts excluded from effectiveness testing for our foreign exchange forward contracts designated as cash flow hedges. During the three and nine months ended September 30, 2019, we recognized unrealized gains of $0.2 million and $0.3 million, respectively, within “Cost of sales” for amounts excluded from effectiveness testing for our foreign exchange forward contracts designated as cash flow hedges.
The following table presents gains and losses related to derivative instruments not designated as hedges affecting our condensed consolidated statements of operations for the three and nine months ended September 30, 2020 and 2019 (in thousands):
Amount of Gain (Loss) Recognized in Income
Three Months Ended September 30,
Nine Months Ended September 30,
Income Statement Line Item
2020
2019
2020
2019
Interest rate swap contracts
Cost of sales
$
—
$
—
$
—
$
(1,656)
Foreign exchange forward contracts
Cost of sales
(195)
—
(73)
—
Foreign exchange forward contracts
Foreign currency (loss) income, net
(2,598)
3,635
(2,405)
883
Interest rate swap contracts
Interest expense, net
(5,878)
(357)
(7,259)
(10,089)
Interest Rate Risk
We primarily use interest rate swap contracts to mitigate our exposure to interest rate fluctuations associated with certain of our debt instruments. We do not use such swap contracts for speculative or trading purposes. During the nine months ended September 30, 2020 and 2019, the majority of our interest rate swap contracts related to project specific debt facilities. Such swap contracts did not qualify for accounting as cash flow hedges in accordance with Accounting Standards Codification (“ASC”) 815 due to our expectation to sell the associated projects before the maturity of their project specific debt financings and corresponding swap contracts. Accordingly, changes in the fair values of these swap contracts were recorded directly to “Interest expense, net.”
In December 2019, FS Japan Project 31 GK, our indirectly wholly-owned subsidiary and project company, entered into an interest rate swap contract to hedge a portion of the floating rate term loan facility under the project’s Anamizu Credit Agreement (as defined in Note 9. “Debt” to our consolidated financial statements). Such swap had an initial notional value of ¥0.9 billion and entitled the project to receive a six-month floating Tokyo Interbank Offered Rate (“TIBOR”) plus 0.70% interest rate while requiring the project to pay a fixed rate of 1.1925%. In September 2020, we completed the sale of our Anamizu project, and its interest rate swap contract and outstanding loan balance were assumed by the customer. As of December 31, 2019, the notional value of the interest rate swap contract was ¥0.9 billion ($8.0 million).
In January 2017, FS Japan Project 12 GK, our indirect wholly-owned subsidiary and project company, entered into an interest rate swap contract to hedge a portion of the floating rate senior loan facility under the project’s Ishikawa Credit Agreement (as defined in Note 9. “Debt” to our condensed consolidated financial statements). Such swap had an initial notional value of ¥5.7 billion and entitled the project to receive a six-month floating TIBOR plus 0.75% interest rate while requiring the project to pay a fixed rate of 1.482%. In September 2020, we repaid the remaining loan balance and settled the swap contract prior to completing the sale of our Ishikawa project. As of December 31, 2019, the notional value of the interest rate swap contract was ¥18.7 billion ($171.7 million).
Foreign Currency Risk
Cash Flow Exposure
We expect certain of our subsidiaries to have future cash flows that will be denominated in currencies other than the subsidiaries’ functional currencies. Changes in the exchange rates between the functional currencies of our subsidiaries and the other currencies in which they transact will cause fluctuations in the cash flows we expect to receive or pay when these cash flows are realized or settled. Accordingly, we enter into foreign exchange forward contracts to hedge a portion of these forecasted cash flows. As of September 30, 2020 and December 31, 2019, these foreign exchange forward contracts hedged our forecasted cash flows for periods up to 18 months and 22 months, respectively. These foreign exchange forward contracts qualify for accounting as cash flow hedges in accordance with ASC 815, and we designated them as such. We report unrealized gains or losses on such contracts in “Accumulated other comprehensive loss” and subsequently reclassify applicable amounts into earnings when the hedged transaction occurs and impacts earnings. We determined that these derivative financial instruments were highly effective as cash flow hedges as of September 30, 2020 and December 31, 2019.
As of September 30, 2020 and December 31, 2019, the notional values associated with our foreign exchange forward contracts qualifying as cash flow hedges were as follows (notional amounts and U.S. dollar equivalents in millions):
September 30, 2020
Currency
Notional Amount
USD Equivalent
U.S. dollar (1)
$44.5
$44.5
December 31, 2019
Currency
Notional Amount
USD Equivalent
U.S. dollar (1)
$69.9
$69.9
——————————
(1)These derivative instruments represent hedges of outstanding payables denominated in U.S. dollars at certain of our foreign subsidiaries whose functional currencies are other than the U.S. dollar.
In the following 12 months, we expect to reclassify to earnings $2.3 million of net unrealized loss related to foreign exchange forward contracts that are included in “Accumulated other comprehensive loss” at September 30, 2020 as we realize the earnings effects of the related forecasted transactions. The amount we ultimately record to earnings will depend on the actual exchange rates when we realize the related forecasted transactions.
Transaction Exposure and Economic Hedging
Many of our subsidiaries have assets and liabilities (primarily cash, receivables, deferred taxes, payables, accrued expenses, and solar module collection and recycling liabilities) that are denominated in currencies other than the subsidiaries’ functional currencies. Changes in the exchange rates between the functional currencies of our subsidiaries and the other currencies in which these assets and liabilities are denominated will create fluctuations in our reported condensed consolidated statements of operations and cash flows. We may enter into foreign exchange forward contracts or other financial instruments to economically hedge assets and liabilities against the effects of currency exchange rate fluctuations. The gains and losses on such foreign exchange forward contracts will economically offset all or part of the transaction gains and losses that we recognize in earnings on the related foreign currency denominated assets and liabilities.
We also enter into foreign exchange forward contracts to economically hedge balance sheet and other exposures related to transactions between certain of our subsidiaries and transactions with third parties. Such contracts are considered economic hedges and do not qualify for hedge accounting. Accordingly, we recognize gains or losses from the fluctuations in foreign exchange rates and the fair value of these derivative contracts in “Foreign currency (loss) income, net” on our condensed consolidated statements of operations.
As of September 30, 2020 and December 31, 2019, the notional values of our foreign exchange forward contracts that do not qualify for hedge accounting were as follows (notional amounts and U.S. dollar equivalents in millions):
We use commodity swap contracts to mitigate our exposure to commodity price fluctuations for certain raw materials used in the production of our modules. In August 2020, we entered into a commodity swap contract to hedge a portion of our forecasted cash flows for purchases of aluminum frames for a one-year period. Such swap had an initial notional value based on metric tons of forecasted aluminum purchases, equivalent to $24.9 million, and entitled us to receive a three-month average London Metals Exchange price for aluminum while requiring us to pay certain fixed prices. The notional amount of the commodity swap contract proportionately adjusts with forecasted purchases of aluminum frames. As of September 30, 2020, the notional value associated with this contract was $18.5 million.
This commodity swap contract qualifies for accounting as a cash flow hedge in accordance with ASC 815, and we designated it as such. We report unrealized gains or losses on such contract in “Accumulated other comprehensive loss” and subsequently reclassify applicable amounts into earnings when the hedged transaction occurs and impacts earnings. We determined that this derivative financial instrument was highly effective as a cash flow hedge as of September 30, 2020. In the following 12 months, we expect to reclassify into earnings $0.2 million of net unrealized losses related to this commodity swap contract that are included in “Accumulated other comprehensive loss” at September 30, 2020 as we realize the earnings effects of the related forecasted transactions. The amount we ultimately record to earnings will depend on the actual commodity pricing when we realize the related forecasted transactions.
Our lease arrangements include land associated with our systems projects, our corporate and administrative offices, land for our international manufacturing facilities, and certain of our manufacturing equipment. Such leases primarily relate to assets located in the United States, Japan, Malaysia, and Vietnam.
The following table presents certain quantitative information related to our lease arrangements for the three and nine months ended September 30, 2020 and 2019, and as of September 30, 2020 and December 31, 2019 (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Operating lease cost
$
4,798
$
5,788
$
13,694
$
16,607
Variable lease cost
628
904
1,919
2,592
Short-term lease cost
1,112
1,118
2,817
6,818
Total lease cost
$
6,538
$
7,810
$
18,430
$
26,017
Payments of amounts included in the measurement of operating lease liabilities
$
15,756
$
15,995
Lease assets obtained in exchange for operating lease liabilities
$
93,992
$
172,760
September 30, 2020
December 31, 2019
Operating lease assets
$
223,554
$
145,711
Operating lease liabilities – current
14,506
11,102
Operating lease liabilities – noncurrent
184,887
112,515
Weighted-average remaining lease term
20 years
15 years
Weighted-average discount rate
3.0
%
4.3
%
As of September 30, 2020, the future payments associated with our lease liabilities were as follows (in thousands):
The following is a description of the valuation techniques that we use to measure the fair value of assets and liabilities that we measure and report at fair value on a recurring basis:
•Cash Equivalents. At September 30, 2020 and December 31, 2019, our cash equivalents consisted of money market funds. We value our cash equivalents using observable inputs that reflect quoted prices for securities with identical characteristics and classify the valuation techniques that use these inputs as Level 1.
•Marketable Securities and Restricted Marketable Securities. At September 30, 2020 and December 31, 2019, our marketable securities consisted of foreign debt, foreign government obligations, U.S. debt, and time deposits, and our restricted marketable securities consisted of foreign and U.S. government obligations. We value our marketable securities and restricted marketable securities using observable inputs that reflect quoted prices for securities with identical characteristics or quoted prices for securities with similar characteristics and other observable inputs (such as interest rates that are observable at commonly quoted intervals). Accordingly, we classify the valuation techniques that use these inputs as either Level 1 or Level 2 depending on the inputs used. We also consider the effect of our counterparties’ credit standing in these fair value measurements.
•Derivative Assets and Liabilities. At September 30, 2020 and December 31, 2019, our derivative assets and liabilities consisted of foreign exchange forward contracts involving major currencies, interest rate swap contracts involving major interest rates, and commodity swap contracts involving major commodity prices. Since our derivative assets and liabilities are not traded on an exchange, we value them using standard industry valuation models. As applicable, these models project future cash flows and discount the amounts to a present value using market-based observable inputs, including interest rate curves, credit risk, foreign exchange rates, forward and spot prices for currencies, and forward prices for commodities. These inputs are observable in active markets over the contract term of the derivative instruments we hold, and accordingly, we classify the valuation techniques as Level 2. In evaluating credit risk, we consider the effect of our counterparties’ and our own credit standing in the fair value measurements of our derivative assets and liabilities, respectively.
At September 30, 2020 and December 31, 2019, the fair value measurements of our assets and liabilities measured on a recurring basis were as follows (in thousands):
Fair Value Measurements at Reporting Date Using
September 30, 2020
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant
Unobservable
Inputs
(Level 3)
Assets:
Cash equivalents:
Money market funds
$
392
$
392
$
—
$
—
Marketable securities:
Foreign debt
214,436
—
214,436
—
U.S. debt
14,561
—
14,561
—
Time deposits
124,822
124,822
—
—
Restricted marketable securities
261,507
—
261,507
—
Derivative assets
1,320
—
1,320
—
Total assets
$
617,038
$
125,214
$
491,824
$
—
Liabilities:
Derivative liabilities
$
3,227
$
—
$
3,227
$
—
Fair Value Measurements at Reporting Date Using
December 31, 2019
Quoted Prices in Active Markets for Identical Assets (Level 1)
At September 30, 2020 and December 31, 2019, the carrying values and fair values of our financial instruments not measured at fair value were as follows (in thousands):
September 30, 2020
December 31, 2019
Carrying Value
Fair Value
Carrying Value
Fair Value
Assets:
Notes receivable – current (1)
$
—
$
—
$
23,873
$
24,929
Notes receivable – noncurrent (1)
8,556
9,872
8,194
10,276
Liabilities:
Long-term debt, including current maturities (2)
$
269,097
$
265,022
$
482,892
$
504,213
——————————
(1)See Note 5. “Consolidated Balance Sheet Details” for further information about the allowance for credit losses for our notes receivable.
(2)Excludes unamortized discounts and issuance costs.
The carrying values in our condensed consolidated balance sheets of our trade accounts receivable, unbilled accounts receivable and retainage, restricted cash, accounts payable, and accrued expenses approximated their fair values due to their nature and relatively short maturities; therefore, we excluded them from the foregoing table. The fair value measurements for our notes receivable and long-term debt are considered Level 2 measurements under the fair value hierarchy.
Credit Risk
We have certain financial and derivative instruments that subject us to credit risk. These consist primarily of cash, cash equivalents, marketable securities, accounts receivable, restricted cash, restricted marketable securities, notes receivable, foreign exchange forward contracts, and commodity swap contracts. We are exposed to credit losses in the event of nonperformance by the counterparties to our financial and derivative instruments. We place cash, cash equivalents, marketable securities, restricted cash and marketable securities, and foreign exchange forward contracts with various high-quality financial institutions and limit the amount of credit risk from any one counterparty. We continuously evaluate the credit standing of our counterparty financial institutions. Our net sales are primarily concentrated among a limited number of customers. We monitor the financial condition of our customers and perform credit evaluations whenever considered necessary. Depending upon the sales arrangement, we may require some form of payment security from our customers, including advance payments, parent guarantees, letters of credit, bank guarantees, or surety bonds. We also have power purchase agreements (“PPAs”) that subject us to credit risk in the event our off-take counterparties are unable to fulfill their contractual obligations, which may adversely affect our project assets and certain receivables. Accordingly, we closely monitor the credit standing of existing and potential off-take counterparties to limit such risks.
Our long-term debt consisted of the following at September 30, 2020 and December 31, 2019 (in thousands):
Balance (USD)
Loan Agreement
Currency
September 30, 2020
December 31, 2019
Revolving Credit Facility
USD
$
—
$
—
Luz del Norte Credit Facilities
USD
186,931
188,017
Ishikawa Credit Agreement
JPY
—
215,879
Japan Credit Facility
JPY
13,481
1,678
Tochigi Credit Facility
JPY
38,452
37,304
Anamizu Credit Agreement
JPY
—
12,138
Kyoto Credit Facility
JPY
30,233
—
Anantapur Credit Facility
INR
—
15,123
Tungabhadra Credit Facility
INR
—
12,753
Long-term debt principal
269,097
482,892
Less: unamortized discounts and issuance costs
(8,229)
(11,195)
Total long-term debt
260,868
471,697
Less: current portion
(40,412)
(17,510)
Noncurrent portion
$
220,456
$
454,187
Revolving Credit Facility
Our amended and restated credit agreement with several financial institutions as lenders and JPMorgan Chase Bank, N.A. as administrative agent provides us with a senior secured credit facility (the “Revolving Credit Facility”) with an aggregate borrowing capacity of $500.0 million, which we may increase to $750.0 million, subject to certain conditions. Borrowings under the credit facility bear interest at (i) London Interbank Offered Rate (“LIBOR”), adjusted for Eurocurrency reserve requirements, plus a margin of 2.00% or (ii) a base rate as defined in the credit agreement plus a margin of 1.00% depending on the type of borrowing requested. These margins are also subject to adjustment depending on our consolidated leverage ratio. We had no borrowings under our Revolving Credit Facility as of September 30, 2020 and December 31, 2019 and had issued $4.2 million and $39.3 million, respectively, of letters of credit using availability under the facility. Loans and letters of credit issued under the Revolving Credit Facility are jointly and severally guaranteed by First Solar, Inc.; First Solar Electric, LLC; First Solar Electric (California), Inc.; and First Solar Development, LLC and are secured by interests in substantially all of the guarantors’ tangible and intangible assets other than certain excluded assets.
In addition to paying interest on outstanding principal under the Revolving Credit Facility, we are required to pay a commitment fee at a rate of 0.30% per annum, based on the average daily unused commitments under the facility, which may also be adjusted due to changes in our consolidated leverage ratio. We also pay a letter of credit fee based on the applicable margin for Eurocurrency revolving loans on the face amount of each letter of credit and a fronting fee of 0.125%. Our Revolving Credit Facility matures in July 2022.
In August 2014, Parque Solar Fotovoltaico Luz del Norte SpA (“Luz del Norte”), our indirect wholly-owned subsidiary and project company, entered into credit facilities (the “Luz del Norte Credit Facilities”) with the U.S. International Development Finance Corporation (“DFC”) and the International Finance Corporation (“IFC”) to provide limited-recourse senior secured debt financing for the design, development, financing, construction, testing, commissioning, operation, and maintenance of a 141 MWAC PV solar power plant located near Copiapó, Chile.
In March 2017, we amended the terms of the DFC and IFC credit facilities. Such amendments (i) allowed for the capitalization of accrued and unpaid interest through March 15, 2017, along with the capitalization of certain future interest payments as variable rate loans under the credit facilities, (ii) allowed for the conversion of certain fixed rate loans to variable rate loans upon scheduled repayment, (iii) extended the maturity of the DFC and IFC loans until June 2037, and (iv) canceled the remaining borrowing capacity under the DFC and IFC credit facilities with the exception of the capitalization of certain future interest payments. As of September 30, 2020 and December 31, 2019, the balance outstanding on the DFC loans was $139.9 million and $140.8 million, respectively. As of September 30, 2020 and December 31, 2019, the balance outstanding on the IFC loans was $47.0 million and $47.2 million, respectively. The DFC and IFC loans are secured by liens over all of Luz del Norte’s assets and by a pledge of all of the equity interests in the entity.
Ishikawa Credit Agreement
In December 2016, FS Japan Project 12 GK (“Ishikawa”), our indirect wholly-owned subsidiary and project company, entered into a credit agreement (the “Ishikawa Credit Agreement”) with Mizuho Bank, Ltd. for aggregate borrowings up to ¥27.3 billion ($233.9 million) for the development and construction of a 59 MWAC PV solar power plant located in Ishikawa, Japan. The credit agreement consists of a ¥24.0 billion ($205.6 million) senior loan facility, a ¥2.1 billion ($18.0 million) consumption tax facility, and a ¥1.2 billion ($10.3 million) letter of credit facility. In September 2020, we repaid the remaining $215.5 million principal balance on the credit agreement prior to completing the sale of the project.
Japan Credit Facility
In September 2015, First Solar Japan GK, our wholly-owned subsidiary, entered into a construction loan facility with Mizuho Bank, Ltd. for borrowings up to ¥4.0 billion ($33.4 million) for the development and construction of utility-scale PV solar power plants in Japan (the “Japan Credit Facility”). Borrowings under the facility generally mature within 12 months following the completion of construction activities for each financed project. The facility is guaranteed by First Solar, Inc. and secured by pledges of certain projects’ cash accounts and other rights in the projects.
Tochigi Credit Facility
In June 2017, First Solar Japan GK, our wholly-owned subsidiary, entered into a term loan facility with Mizuho Bank, Ltd. for borrowings up to ¥7.0 billion ($62.2 million) for the development of utility-scale PV solar power plants in Japan (the “Tochigi Credit Facility”). The term loan facility matures in March 2021. The facility is guaranteed by First Solar, Inc. and secured by pledges of certain of First Solar Japan GK’s accounts.
In December 2019, FS Japan Project 31 GK (“Anamizu”), our indirect wholly-owned subsidiary and project company, entered into a credit agreement (the “Anamizu Credit Agreement”) with MUFG Bank, Ltd.; The Iyo Bank, Ltd.; The Hachijuni Bank, Ltd.; The Hyakugo Bank, Ltd.; and The Yamagata Bank, Ltd. for aggregate borrowings up to ¥7.7 billion ($70.8 million) for the development and construction of a 17 MWAC PV solar power plant located in Ishikawa, Japan. The credit agreement consisted of a ¥6.6 billion ($61.0 million) term loan facility, a ¥0.7 billion ($6.5 million) consumption tax facility, and a ¥0.4 billion ($3.3 million) debt service reserve facility. In September 2020, we completed the sale of our Anamizu project, and the outstanding balance of the Anamizu Credit Agreement of $31.3 million was assumed by the customer.
Miyagi Credit Facility
In July 2020, GK Marumori Hatsudensho (“Miyagi”), our indirectly wholly-owned subsidiary and project company, entered into a credit agreement (the “Miyagi Credit Facility”) with Shinsei Bank, Ltd. for aggregate borrowings up to ¥17.2 billion ($164.2 million) for the development and construction of a 40 MWAC PV solar power plant located in Miyagi, Japan. The credit facility consisted of a ¥15.2 billion ($145.1 million) term loan facility, a ¥1.5 billion ($14.4 million) consumption tax facility, and a ¥0.5 billion ($4.7 million) debt service reserve facility. In September 2020, we completed the sale of our Miyagi project, and the outstanding balance of the Miyagi Credit Facility of $79.4 million was assumed by the customer.
Kyoto Credit Facility
In July 2020, First Solar Japan GK, our wholly-owned subsidiary, entered into a construction loan facility with Mizuho Bank, Ltd. for borrowings up to ¥15.0 billion ($142.8 million), which are intended to be used for the construction of a 38 MWAC PV solar power plant located in Kyoto, Japan (the “Kyoto Credit Facility”). Borrowings under the facility generally mature within 12 months following the completion of construction activities at the project. The facility is guaranteed by First Solar, Inc. and First Solar Japan GK, our wholly-owned subsidiary, and secured by pledges of the project’s cash accounts and certain other assets.
Anantapur Credit Facility
In March 2018, Anantapur Solar Parks Private Limited, our indirect wholly-owned subsidiary and project company, entered into a term loan facility (the “Anantapur Credit Facility”) with J.P. Morgan Securities India Private Limited for borrowings up to INR 1.2 billion ($18.4 million) for costs related to a 20 MWAC PV solar power plant located in Karnataka, India. In July 2020, we completed the sale of our Anantapur project, and the outstanding balance of the Anantapur Credit Facility of $14.0 million was assumed by the customer.
Tungabhadra Credit Facility
In March 2018, Tungabhadra Solar Parks Private Limited, our indirect wholly-owned subsidiary and project company, entered into a term loan facility (the “Tungabhadra Credit Facility”) with J.P. Morgan Securities India Private Limited for borrowings up to INR 1.0 billion ($15.3 million) for costs related to a 20 MWAC PV solar power plant located in Karnataka, India. In July 2020, we completed the sale of our Tungabhadra project, and the outstanding balance of the Tungabhadra Credit Facility of $12.0 million was assumed by the customer.
Certain of our long-term debt agreements bear interest at prime, LIBOR, TIBOR, BBSY, or equivalent variable rates. An increase in these variable rates would increase the cost of borrowing under our Revolving Credit Facility and certain project specific debt financings. Our long-term debt borrowing rates as of September 30, 2020 were as follows:
Loan Agreement
September 30, 2020
Revolving Credit Facility
2.15%
Luz del Norte Credit Facilities (1)
Fixed rate loans at bank rate plus 3.50%
Variable rate loans at 91-Day U.S. Treasury Bill Yield or LIBOR plus 3.50%
Japan Credit Facility
1-month TIBOR plus 0.55%
Tochigi Credit Facility
3-month TIBOR plus 1.00%
Kyoto Credit Facility
1-month TIBOR plus 0.60%
——————————
(1)Outstanding balance comprised of $146.4 million of fixed rate loans and $40.5 million of variable rate loans as of September 30, 2020.
Future Principal Payments
At September 30, 2020, the future principal payments on our long-term debt were due as follows (in thousands):
Total Debt
Remainder of 2020
$
701
2021
40,853
2022
17,516
2023
36,318
2024
7,020
2025
7,560
Thereafter
159,129
Total long-term debt future principal payments
$
269,097
10. Commitments and Contingencies
Commercial Commitments
During the normal course of business, we enter into commercial commitments in the form of letters of credit, bank guarantees, and surety bonds to provide financial and performance assurance to third parties. Our amended and restated Revolving Credit Facility provides us with a sub-limit of $400.0 million to issue letters of credit, subject to certain additional limits depending on the currencies of the letters of credit, at a fee based on the applicable margin for Eurocurrency revolving loans and a fronting fee. As of September 30, 2020, we had $4.2 million in letters of credit issued under our Revolving Credit Facility, leaving $395.8 million of availability for the issuance of additional letters of credit. As of September 30, 2020, we also had $10.1 million of letters of credit under separate agreements that were posted by certain of our foreign subsidiaries and $124.4 million of letters of credit issued under a bilateral facility, of which $1.2 million was secured with cash, leaving $434.2 million of aggregate available capacity under such agreements and facilities. We also had $97.0 million of surety bonds outstanding, leaving $619.3 million of available bonding capacity under our surety lines as of September 30, 2020. The majority of these letters of credit and surety bonds supported our systems projects.
When we recognize revenue for module or system sales, we accrue liabilities for the estimated future costs of meeting our limited warranty obligations for both modules and the balance of the systems. We make and revise these estimates based primarily on the number of solar modules under warranty installed at customer locations, our historical experience with and projections of warranty claims, and our estimated per-module replacement costs. We also monitor our expected future module performance through certain quality and reliability testing and actual performance in certain field installation sites. From time to time, we have taken remediation actions with respect to affected modules beyond our limited warranties and may elect to do so in the future, in which case we would incur additional expenses. Such potential voluntary future remediation actions beyond our limited warranty obligations may be material to our condensed consolidated statements of operations if we commit to any such remediation actions.
Product warranty activities during the three and nine months ended September 30, 2020 and 2019 were as follows (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Product warranty liability, beginning of period
$
123,194
$
217,991
$
129,797
$
220,692
Accruals for new warranties issued
3,435
1,723
7,903
11,636
Settlements
(9,289)
(4,211)
(18,772)
(10,233)
Changes in estimate of product warranty liability
(19,987)
(77,598)
(21,575)
(84,190)
Product warranty liability, end of period
$
97,353
$
137,905
$
97,353
$
137,905
Current portion of warranty liability
$
22,325
$
19,526
$
22,325
$
19,526
Noncurrent portion of warranty liability
$
75,028
$
118,379
$
75,028
$
118,379
We estimate our limited product warranty liability for power output and defects in materials and workmanship under normal use and service conditions based on return rates for each series of module technology. During the three months ended September 30, 2020, we revised this estimate downward based on updated information regarding our warranty claims, which reduced our product warranty liability by $19.7 million. This updated information reflected lower-than-expected settlements for our older series of module technology and revisions to projected settlements, resulting in a lower projected return rate. During the three months ended September 30, 2019, we revised this estimate downward based on updated information regarding our warranty claims, which reduced our product warranty liability by $80.0 million. This updated information reflected lower-than-expected return rates for our newer series of module technology, the evolving claims profile of each series, and certain changes to our warranty programs.
In general, we expect the return rates for our newer series of module technology to be lower than our older series. We estimate that the return rate for such newer series of module technology will be less than 1%. As of September 30, 2020, a 1% increase in the return rate across all series of module technology would increase our product warranty liability by $101.1 million, and a 1% increase in the return rate for balance of systems (“BoS”) parts would not have a material impact on the associated warranty liability.
Performance Guarantees
As part of our systems business, we conduct performance testing of a system prior to substantial completion to confirm the system meets its operational and capacity expectations noted in the engineering, procurement, and construction (“EPC”) agreement. In addition, we may provide an energy performance test during the first or second year of a system’s operation to demonstrate that the actual energy generation for the applicable period meets or exceeds the modeled energy expectation, after certain adjustments. If there is an underperformance event with regard to these tests, we may incur liquidated damages as specified in the applicable EPC agreement. In certain instances, a
bonus payment may be received at the end of the applicable test period if the system performs above a specified level. As of September 30, 2020 and December 31, 2019, we accrued $19.3 million and $4.6 million, respectively, for our estimated obligations under such arrangements, which were classified as “Other current liabilities” in our condensed consolidated balance sheets.
As part of our O&M service offerings, we typically offer an effective availability guarantee, which stipulates that a system will be available to generate a certain percentage of total possible energy during a specific period after adjusting for factors outside our control as the service provider, such as weather, curtailment, outages, force majeure, and other conditions that may affect system availability. Effective availability guarantees are only offered as part of our O&M services and terminate at the end of an O&M arrangement. If we fail to meet the contractual threshold for these guarantees, we may incur liquidated damages for certain lost energy. Our O&M agreements typically contain provisions limiting our total potential losses under an agreement, including amounts paid for liquidated damages, to a percentage of O&M fees. Many of our O&M agreements also contain provisions whereby we may receive a bonus payment if system availability exceeds a separate threshold. As of September 30, 2020, we accrued $0.9 million of liquidated damages under our effective availability guarantees, which was classified as “Liabilities held for sale” in our condensed consolidated balance sheets. As of December 31, 2019, we accrued $0.6 million of liquidated damages under our effective availability guarantees, which was classified as “Other current liabilities” in our condensed consolidated balance sheets.
Indemnifications
In certain limited circumstances, we have provided indemnifications to customers, including project tax equity investors, under which we are contractually obligated to compensate such parties for losses they suffer resulting from a breach of a representation, warranty, or covenant; a reduction in tax benefits received, including investment tax credits; or the resolution of specific matters associated with a project’s development or construction. Project related tax benefits are, in part, based on guidance provided by the Internal Revenue Service and U.S. Treasury Department, which includes assumptions regarding the fair value of qualifying PV solar power systems. For any sales contracts that have such indemnification provisions, we initially recognize a liability under ASC 460 for the estimated premium that would be required by a guarantor to issue the same indemnity in a standalone arm’s-length transaction with an unrelated party. We typically base these estimates on the cost of insurance policies that cover the underlying risks being indemnified and may purchase such policies to mitigate our exposure to potential indemnification payments. We subsequently measure such liabilities at the greater of the initially estimated premium or the contingent liability required to be recognized under ASC 450. We recognize any indemnification liabilities as a reduction of revenue in the related transaction.
After an indemnification liability is recorded, we derecognize such amount pursuant to ASC 460-10-35-2 depending on the nature of the indemnity, which derecognition typically occurs upon expiration or settlement of the arrangement, and any contingent aspects of the indemnity are accounted for in accordance with ASC 450. As of September 30, 2020 and December 31, 2019, we accrued $5.2 million and $0.8 million of current indemnification liabilities, respectively, and $2.0 million and $4.2 million of noncurrent indemnification liabilities, respectively. As of September 30, 2020, the maximum potential amount of future payments under our tax related and other indemnifications was $202.9 million, and we held insurance policies allowing us to recover up to $43.8 million of potential amounts paid under the indemnifications covered by the policies.
Contingent Consideration
We may seek to make additions to our advanced-stage project pipeline by actively developing our early-to-mid-stage project pipeline and by pursuing opportunities to acquire projects at various stages of development. In connection with such project acquisitions, we may agree to pay additional amounts to project sellers upon the achievement of certain milestones, such as obtaining a PPA, obtaining financing, or selling the project to a new owner. We recognize a project acquisition contingent liability when we determine that such a liability is both probable and reasonably estimable, and the carrying amount of the related project asset is correspondingly increased.
As of September 30, 2020 and December 31, 2019, we accrued $2.1 million and $2.4 million of current liabilities, respectively, and $4.5 million of long-term liabilities, for project related contingent obligations. Any future differences between the acquisition-date contingent obligation estimate and the ultimate settlement of the obligation are recognized as an adjustment to the project asset, as contingent payments are considered direct and incremental to the underlying value of the related project.
Solar Module Collection and Recycling Liability
We previously established a module collection and recycling program, which has since been discontinued, to collect and recycle modules sold and covered under such program once the modules reach the end of their service lives. For legacy customer sales contracts that were covered under this program, we agreed to pay the costs for the collection and recycling of qualifying solar modules, and the end-users agreed to notify us, disassemble their solar power systems, package the solar modules for shipment, and revert ownership rights over the modules back to us at the end of the modules’ service lives. Accordingly, we recorded any collection and recycling obligations within “Cost of sales” at the time of sale based on the estimated cost to collect and recycle the covered solar modules.
We estimate the cost of our collection and recycling obligations based on the present value of the expected future cost of collecting and recycling the solar modules, which includes estimates for the cost of packaging materials; the cost of freight from the solar module installation sites to a recycling center; material, labor, and capital costs; and by-product credits for certain materials recovered during the recycling process. We base these estimates on our experience collecting and recycling solar modules and certain assumptions regarding costs at the time the solar modules will be collected and recycled. In the periods between the time of sale and the related settlement of the collection and recycling obligation, we accrete the carrying amount of the associated liability and classify the corresponding expense within “Selling, general and administrative” expense on our condensed consolidated statements of operations.
We periodically review our estimates of expected future recycling costs and may adjust our liability accordingly. During the three months ended September 30, 2020, we completed our annual cost study of obligations under our module collection and recycling program and reduced the associated liability by $18.9 million primarily due to changes to the estimated timing of cash flows associated with capital, labor, and maintenance costs and updates to certain valuation assumptions.
Our module collection and recycling liability was $125.6 million and $137.8 million as of September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020, a 1% increase in the annualized inflation rate used in our estimated future collection and recycling cost per module would increase the liability by $20.8 million, and a 1% decrease in that rate would decrease the liability by $18.0 million. See Note 4. “Restricted Marketable Securities” to our condensed consolidated financial statements for more information about our arrangements for funding this liability.
Legal Proceedings
Class Action
On March 15, 2012, a purported class action lawsuit titled Smilovits v. First Solar, Inc., et al., Case No. 2:12-cv-00555-DGC, was filed in the United States District Court for the District of Arizona (hereafter “Arizona District Court”) against the Company and certain of our current and former directors and officers. The complaint was filed on behalf of persons who purchased or otherwise acquired the Company’s publicly traded securities between April 30, 2008 and February 28, 2012 (the “Class Action”). The complaint generally alleged that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by making false and misleading statements regarding the Company’s financial performance and prospects. The action included claims for damages, including interest, and an award of reasonable costs and attorneys’ fees to the putative class.
On July 23, 2012, the Arizona District Court issued an order appointing as lead plaintiffs in the Class Action the Mineworkers’ Pension Scheme and British Coal Staff Superannuation Scheme (collectively, the “Pension Schemes”). The Pension Schemes filed an amended complaint on August 17, 2012, which contains similar allegations and seeks similar relief as the original complaint. Defendants filed a motion to dismiss on September 14, 2012. On December 17, 2012, the court denied defendants’ motion to dismiss. On October 8, 2013, the Arizona District Court granted the Pension Schemes’ motion for class certification and certified a class comprised of all persons who purchased or otherwise acquired publicly traded securities of the Company between April 30, 2008 and February 28, 2012 and were damaged thereby, excluding defendants and certain related parties. Merits discovery closed on February 27, 2015.
Defendants filed a motion for summary judgment on March 27, 2015. On August 11, 2015, the Arizona District Court granted defendants’ motion in part and denied it in part, and certified an issue for immediate appeal to the Ninth Circuit Court of Appeals (the “Ninth Circuit”). First Solar filed a petition for interlocutory appeal with the Ninth Circuit, and that petition was granted on November 18, 2015. On May 20, 2016, the Pension Schemes moved to vacate the order granting the petition, dismiss the appeal, and stay the merits briefing schedule. On December 13, 2016, the Ninth Circuit denied the Pension Schemes’ motion. On January 31, 2018, the Ninth Circuit issued an opinion affirming the Arizona District Court’s order denying in part defendants’ motion for summary judgment. On March 16, 2018, First Solar filed a petition for panel rehearing or rehearing en banc with the Ninth Circuit. On May 7, 2018, the Ninth Circuit denied defendants’ petition. On August 6, 2018, defendants filed a petition for writ of certiorari to the U.S. Supreme Court. Meanwhile, in the Arizona District Court, expert discovery was completed on February 5, 2019. On June 24, 2019, the U.S. Supreme Court denied the petition. Following the denial of the petition, the Arizona District Court ordered that the trial begin on January 7, 2020.
On January 5, 2020, First Solar entered into a Memorandum of Understanding (“MOU”) to settle the Class Action. First Solar agreed to pay a total of $350 million to settle the claims in the Class Action brought on behalf of all persons who purchased or otherwise acquired the Company’s shares between April 30, 2008 and February 28, 2012, in exchange for mutual releases and a dismissal with prejudice of the complaint upon court approval of the settlement. The proposed settlement contains no admission of liability, wrongdoing, or responsibility by any of the parties. As a result of the entry into the MOU, we accrued a loss for the above-referenced settlement in our results of operations for the year ended December 31, 2019. On January 24, 2020, First Solar paid $350 million to the settlement escrow agent. On February 13, 2020, First Solar entered into a stipulation of settlement with certain named plaintiffs on terms and conditions that are consistent with the MOU. On February 14, 2020, the lead plaintiffs filed a motion for preliminary approval of the settlement. Following a February 27, 2020 hearing, the Arizona District Court entered an order on March 2, 2020 that granted preliminary approval of the settlement and permitted notice to the class. Following a June 30, 2020 hearing, the Arizona District Court entered an order on June 30, 2020 that granted final approval of the settlement and dismissed the Class Action with prejudice.
Opt-Out Action
On June 23, 2015, a suit titled Maverick Fund, L.D.C. v. First Solar, Inc., et al., Case No. 2:15-cv-01156-ROS, was filed in Arizona District Court by putative stockholders that opted out of the Class Action (the “Opt-Out Action”). The complaint names the Company and certain of our current and former directors and officers as defendants, and alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and violated state law, by making false and misleading statements regarding the Company’s financial performance and prospects. The action includes claims for rescissory and actual damages, interest, punitive damages, and an award of reasonable attorneys’ fees, expert fees, and costs.
First Solar and the individual defendants filed a motion to dismiss the Opt-Out Action on July 16, 2018. On November 27, 2018, the Court granted defendants’ motion to dismiss the plaintiffs’ negligent misrepresentation claim under state law, but otherwise denied defendants’ motion. On June 3, 2020, First Solar and the plaintiffs in the Opt-Out Action entered into an agreement in principle to settle the claims in the Opt-Out Action. On July 17, 2020, the parties executed a definitive settlement agreement pursuant to which First Solar agreed to pay a total of
$19 million in exchange for mutual releases and a dismissal with prejudice of the Opt-Out Action. The agreement contains no admission of liability, wrongdoing, or responsibility by any of the defendants. On July 30, 2020, First Solar funded the settlement, and on July 31, 2020, the parties filed a joint stipulation of dismissal. On September 10, 2020, the Arizona District Court entered an order dismissing the case with prejudice. As of December 31, 2019, we accrued $13 million of estimated losses for this action. As a result of the settlement, we accrued an incremental $6 million litigation loss during the nine months ended September 30, 2020.
Derivative Actions
On July 16, 2013, a derivative complaint was filed in the Superior Court of Arizona, Maricopa County, formerly titled Bargar, et al. v. Ahearn, et al., and now titled Kaufold v. Ahearn, et. al., Case No. CV2013-009938, by a putative stockholder against certain current and former directors and officers of the Company (“Kaufold”). The complaint generally alleges that the defendants caused or allowed false and misleading statements to be made concerning the Company’s financial performance and prospects. The action includes claims for, among other things, breach of fiduciary duties, insider trading, unjust enrichment, and waste of corporate assets. By court order on October 3, 2013, the Superior Court of Arizona, Maricopa County granted the parties’ stipulation to defer defendants’ response to the complaint pending resolution of the Class Action or expiration of a stay issued in certain consolidated derivative actions in the Arizona District Court. On November 5, 2013, the matter was placed on the court’s inactive calendar. The parties jointly sought and obtained multiple requests to continue the stay in this action. On June 30, 2020, the parties jointly requested that the stay be lifted. On July 1, 2020, the Superior Court of Arizona, Maricopa County ordered that the stay be lifted. On July 14, 2020, defendants filed a motion to dismiss the complaint with prejudice. On September 14, 2020, First Solar and the plaintiff entered into an agreement in principle to settle the claims in the Kaufold action, providing for, among other things, payment of the plaintiff’s attorney’s fees in an immaterial sum, subject to the execution of a stipulation of settlement and approval by the Arizona District Court.
Other Matters and Claims
We are party to other legal matters and claims in the normal course of our operations. While we believe the ultimate outcome of such other matters and claims will not have a material adverse effect on our financial position, results of operations, or cash flows, the outcome of such matters and claims is not determinable with certainty, and negative outcomes may adversely affect us.
11. Revenue from Contracts with Customers
The following table represents a disaggregation of revenue from contracts with customers for the three and nine months ended September 30, 2020 and 2019 along with the reportable segment for each category (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
Category
Segment
2020
2019
2020
2019
Solar modules
Modules
$
422,480
$
371,184
$
1,187,679
$
798,744
Solar power systems
Systems
471,174
79,792
776,724
454,841
O&M services
Systems
28,061
28,245
89,237
82,397
Energy generation (1)
Systems
14,335
20,366
54,884
40,488
EPC services (2)
Systems
(8,485)
47,219
(6,424)
287,270
Net sales
$
927,565
$
546,806
$
2,102,100
$
1,663,740
——————————
(1)During the three and nine months ended September 30, 2020, the majority of energy generated and sold by our PV solar power systems was accounted for under ASC 840 consistent with the classification of the associated PPAs.
(2)For certain of our EPC agreements, we provide an energy performance test during the first or second year of a system’s operation to demonstrate that the actual energy generation for the applicable period meets or exceeds the modeled energy expectation, after certain adjustments. If there is an underperformance event with regard to these tests, we may incur liquidated damages as specified in the applicable EPC agreement. During the three months ended September 30, 2020, we accrued liquidated damages for certain of these arrangements, which we recognized as a reduction to revenue. See Note 10. “Commitments and Contingencies” to our condensed consolidated financial statements for discussion of our performance guarantee arrangements.
We recognize revenue for module sales at a point in time following the transfer of control of the modules to the customer, which typically occurs upon shipment or delivery depending on the terms of the underlying contracts. Such contracts may contain provisions that require us to make liquidated damage payments to the customer if we fail to ship or deliver modules by scheduled dates. We recognize these liquidated damages as a reduction of revenue in the period we transfer control of the modules to the customer.
For certain sales of solar power systems and/or EPC services, we recognize revenue over time using cost based input methods, in which significant judgment is required to evaluate assumptions including the amount of net contract revenues and the total estimated costs to determine our progress toward contract completion. If the estimated total costs on any contract are greater than the net contract revenues, we recognize the entire estimated loss in the period the loss becomes known. The cumulative effect of revisions to estimates related to net contract revenues or costs to complete contracts are recorded in the period in which the revisions to estimates are identified and the amounts can be reasonably estimated.
Changes in estimates for sales of systems and EPC services occur for a variety of reasons, including but not limited to (i) construction plan accelerations or delays, (ii) module cost forecast changes, (iii) cost related change orders, or (iv) changes in other information used to estimate costs. Changes in estimates may have a material effect on our condensed consolidated statements of operations.
The following table outlines the impact on revenue of net changes in estimated transaction prices and input costs for systems related sales contracts (both increases and decreases) for the three and nine months ended September 30, 2020 and 2019 as well as the number of projects that comprise such changes. For purposes of the table, we only include projects with changes in estimates that have a net impact on revenue of at least $1.0 million during the periods presented. Also included in the table is the net change in estimate as a percentage of the aggregate revenue for such projects.
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Number of projects
6
4
12
4
(Decrease) increase in revenue from net changes in transaction prices (in thousands)
$
(16,319)
$
(2,435)
$
(25,470)
$
3,649
Increase (decrease) in revenue from net changes in input cost estimates (in thousands)
24
(6,676)
(2,483)
(15,645)
Net decrease in revenue from net changes in estimates (in thousands)
$
(16,295)
$
(9,111)
$
(27,953)
$
(11,996)
Net change in estimate as a percentage of aggregate revenue
The following table reflects the changes in our contract assets, which we classify as “Accounts receivable, unbilled” or “Retainage,” and our contract liabilities, which we classify as “Deferred revenue,” for the nine months ended September 30, 2020, excluding any assets or liabilities classified as held for sale as of September 30, 2020 (in thousands):
September 30, 2020
December 31, 2019
Nine Month Change
Accounts receivable, unbilled (1)
$
97,281
$
162,057
Retainage
11,367
21,416
Allowance for credit losses
(919)
—
Accounts receivable, unbilled and retainage, net
$
107,729
$
183,473
$
(75,744)
(41)
%
Deferred revenue (2)
$
161,582
$
394,655
$
(233,073)
(59)
%
——————————
(1)Includes $19.3 million of long-term accounts receivable, unbilled classified as “Other assets” on our condensed consolidated balance sheet as of September 30, 2020.
(2)Includes $46.0 million and $71.4 million of long-term deferred revenue classified as “Other liabilities” on our condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019, respectively.
During the nine months ended September 30, 2020, our contract assets decreased by $75.7 million primarily due to billings associated with ongoing construction activities at the GA Solar 4, Sun Streams, and Sunshine Valley projects, partially offset by certain unbilled receivables associated with the sale of the Anamizu and Miyagi projects. During the nine months ended September 30, 2020, our contract liabilities decreased by $233.1 million primarily due to the recognition of revenue for sales of solar modules for which payment was received in 2019 prior to the step down in the U.S. investment tax credit, partially offset by advance payments received for sales of solar modules in the current period. During the nine months ended September 30, 2020 and 2019, we recognized revenue of $296.7 million and $123.2 million, respectively, that was included in the corresponding contract liability balance at the beginning of the periods.
The following table represents our remaining performance obligations as of September 30, 2020 for sales of solar power systems, including uncompleted sold projects and projects under contracts subject to conditions precedent. Such table excludes remaining performance obligations for sales arrangements that had not fully satisfied the criteria to be considered a contract with a customer pursuant to the requirements of ASC 606. We expect to recognize $11.7 million of revenue for such contracts through the substantial completion dates of the projects.
Project/Location
Project Size in MWAC
Revenue Category
Customer
Expected Year Revenue Recognition Will Be Completed
As of September 30, 2020, we had entered into contracts with customers for the future sale of 10.8 GWDC of solar modules for an aggregate transaction price of $3.4 billion. We expect to recognize such amounts as revenue through 2023 as we transfer control of the modules to the customers. While our contracts with customers typically represent firm purchase commitments, these contracts may be subject to amendments made by us or requested by our customers. These amendments may increase or decrease the volume of modules to be sold under the contract, change delivery schedules, or otherwise adjust the expected revenue under these contracts. As of September 30, 2020, we had entered into O&M contracts covering approximately 14 GWDC of utility-scale PV solar power systems. We expect to recognize $0.5 billion of revenue during the noncancelable term of these O&M contracts over a weighted-average period of 10.8 years, including contracts expected to be transferred to Clairvest in connection with the sale of our North American O&M operations. See Note 5. “Consolidated Balance Sheet Details” to our condensed consolidated financial statements for further information.
12. Share-Based Compensation
The following table presents share-based compensation expense recognized in our condensed consolidated statements of operations for the three and nine months ended September 30, 2020 and 2019 (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Cost of sales
$
1,099
$
1,719
$
2,554
$
5,520
Selling, general and administrative
5,562
6,243
13,323
15,627
Research and development
548
1,525
2,312
4,067
Production start-up
—
139
—
194
Total share-based compensation expense
$
7,209
$
9,626
$
18,189
$
25,408
Share-based compensation expense capitalized in inventory, project assets, and PV solar power systems was $1.0 million as of September 30, 2020 and $1.2 million as of December 31, 2019. As of September 30, 2020, we had $33.3 million of unrecognized share-based compensation expense related to unvested restricted and performance stock units, which we expect to recognize over a weighted-average period of approximately 1.4 years.
In February 2017, the compensation committee of our board of directors approved a long-term incentive program for key executive officers and associates. The program is intended to incentivize retention of our key executive talent, provide a smooth transition from our former key senior talent equity performance program, and align the interests of executive management and stockholders. Specifically, the program consists of (i) performance stock units to be earned over an approximately three-year performance period, which ended in December 2019, and (ii) stub-year grants of separate performance stock units to be earned over an approximately two-year performance period, which ended in December 2018. In February 2019, the compensation committee of our board of directors certified the achievement of the maximum vesting conditions applicable for the stub-year grants. Accordingly, each participant received one share of common stock for each vested performance unit, net of any tax withholdings. In February 2020, the compensation committee of our board of directors certified the achievement of the threshold vesting conditions applicable to the remaining 2017 grants of performance stock units. Accordingly, each participant received one share of common stock for each vested performance unit, net of any tax withholdings.
In April 2018, in continuation of our long-term incentive program for key executive officers and associates, the compensation committee of our board of directors approved additional grants of performance stock units to be earned over an approximately three-year performance period ending in December 2020. Vesting of the 2018 grants of performance stock units is contingent upon the relative attainment of target gross margin, operating expense, and contracted revenue metrics.
In July 2019, the compensation committee of our board of directors approved additional grants of performance stock units for key executive officers. Such grants are expected to be earned over a multi-year performance period ending in December 2021. Vesting of the 2019 grants of performance stock units is contingent upon the relative attainment of target cost per watt, module wattage, gross profit, and operating income metrics.
In March 2020, the compensation committee of our board of directors approved additional grants of performance stock units for key executive officers. Such grants are expected to be earned over a multi-year performance period ending in December 2022. Vesting of the 2020 grants of performance stock units is contingent upon the relative attainment of contracted revenue, module wattage, and return on capital metrics.
Vesting of performance stock units is also contingent upon the employment of program participants through the applicable vesting dates, with limited exceptions in case of death, disability, a qualifying retirement, or a change-in-control of First Solar. Outstanding performance stock units are included in the computation of diluted net income per share based on the number of shares that would be issuable if the end of the reporting period were the end of the contingency period.
13. Income Taxes
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act (the “CARES Act”) was signed into law. The CARES Act includes a number of federal corporate tax relief provisions that are intended to support the ongoing liquidity of U.S. corporations. Among other provisions, the CARES Act allows net operating losses incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years. Because changes in tax law are accounted for in the period of enactment, the retroactive effects of such changes are accounted for as a discrete item in our tax provision.
Our effective tax rate was (16.9)% and (84.8)% for the nine months ended September 30, 2020 and 2019, respectively. The increase in our effective tax rate was primarily driven by the relative size of our pretax income in the current period and higher losses in the prior period in certain jurisdictions for which no tax benefit could be recorded, partially offset by a discrete tax benefit associated with the net operating loss carryback provisions of the CARES Act described above. Our provision for income taxes differed from the amount computed by applying the U.S. statutory federal income tax rate of 21% primarily due to the effect of tax law changes associated with the CARES Act.
Our Malaysian subsidiary has been granted a long-term tax holiday that expires in 2027. The tax holiday, which generally provides for a full exemption from Malaysian income tax, is conditional upon our continued compliance with certain employment and investment thresholds, which we are currently in compliance with and expect to continue to comply with through the expiration of the tax holiday in 2027.
Our Vietnamese subsidiary qualifies for certain tax incentives, which generally provide a two-year tax exemption and reduced tax rates for the subsequent four-year period. These incentives are available in the period an entity first generates taxable profit or, if earlier, four years after an entity’s first taxable sale. Given our anticipated earnings in Vietnam, we expect to receive such benefits in the current year.
In the normal course of business, we establish valuation allowances for our deferred tax assets when the realization of the assets is not more likely than not. We intend to maintain such valuation allowances on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of the allowances. Given our anticipated future earnings in Vietnam, it is reasonably possible that, within the next 12 months, sufficient positive evidence may become available to allow us to reverse the valuation allowance in that jurisdiction. However, the exact timing and amount of such reversal is subject to change depending on our future earnings in Vietnam and other factors.
We account for uncertain tax positions pursuant to the recognition and measurement criteria under ASC 740. It is reasonably possible that $63.3 million of uncertain tax positions will be recognized within the next 12 months due to the expiration of the statute of limitations associated with such positions.
We are subject to audit by federal, state, local, and foreign tax authorities. We are currently under examination in Chile, India, Malaysia, and the state of California. We believe that adequate provisions have been made for any adjustments that may result from tax examinations. However, the outcome of tax examinations cannot be predicted with certainty. If any issues addressed by our tax examinations are not resolved in a manner consistent with our expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs.
14. Net Income (Loss) per Share
The calculation of basic and diluted net income (loss) per share for the three and nine months ended September 30, 2020 and 2019 was as follows (in thousands, except per share amounts):
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Basic net income (loss) per share
Numerator:
Net income (loss)
$
155,037
$
30,622
$
282,652
$
(55,525)
Denominator:
Weighted-average common shares outstanding
105,967
105,397
105,830
105,272
Diluted net income (loss) per share
Denominator:
Weighted-average common shares outstanding
105,967
105,397
105,830
105,272
Effect of restricted and performance stock units and stock purchase plan shares
784
830
707
—
Weighted-average shares used in computing diluted net income (loss) per share
106,751
106,227
106,537
105,272
Net income (loss) per share:
Basic
$
1.46
$
0.29
$
2.67
$
(0.53)
Diluted
$
1.45
$
0.29
$
2.65
$
(0.53)
The following table summarizes the shares of common stock that were excluded from the computation of diluted net income (loss) per share for the three and nine months ended September 30, 2020 and 2019 as such shares would have had an anti-dilutive effect (in thousands):
The following table presents the changes in accumulated other comprehensive loss, net of tax, for the nine months ended September 30, 2020 (in thousands):
Foreign Currency Translation Adjustment
Unrealized Gain (Loss) on Marketable Securities and Restricted Marketable Securities
Unrealized Gain (Loss) on Derivative Instruments
Total
Balance as of December 31, 2019
$
(73,429)
$
(5,029)
$
(876)
$
(79,334)
Other comprehensive income (loss) before reclassifications
922
36,994
(2,357)
35,559
Amounts reclassified from accumulated other comprehensive loss
(370)
(15,346)
647
(15,069)
Net tax effect
—
(822)
(31)
(853)
Net other comprehensive income (loss)
552
20,826
(1,741)
19,637
Balance as of September 30, 2020
$
(72,877)
$
15,797
$
(2,617)
$
(59,697)
The following table presents the pretax amounts reclassified from accumulated other comprehensive loss into our condensed consolidated statements of operations for the three and nine months ended September 30, 2020 and 2019 (in thousands):
Comprehensive Income Components
Income Statement Line Item
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Foreign currency translation adjustment
Cost of sales
$
370
$
—
$
370
$
1,190
Unrealized gain on marketable securities and restricted marketable securities
Other expense, net
9
—
15,346
15,016
Unrealized (loss) gain on derivative contracts:
Foreign exchange forward contracts
Net sales
—
—
—
124
Foreign exchange forward contracts
Cost of sales
(334)
—
(647)
1,081
Total unrealized (loss) gain on derivative contracts
We operate our business in two segments. Our modules segment involves the design, manufacture, and sale of cadmium telluride (“CdTe”) solar modules, which convert sunlight into electricity. Third-party customers of our modules segment include integrators and operators of PV solar power systems. Our second segment is our systems segment, through which we provide power plant solutions, which include (i) project development, (ii) EPC services, and (iii) O&M services. We may provide any combination of individual products and services within such capabilities (including, with respect to EPC services, by contracting with third parties) depending upon the customer and market opportunity. Our systems segment customers include utilities, independent power producers, commercial and industrial companies, and other system owners. As part of our systems segment, we may also temporarily own and operate certain of our systems for a period of time based on strategic opportunities or market factors. See Note 21. “Segment and Geographical Information” in our Annual Report on Form 10-K for the year ended December 31, 2019 for additional discussion of our segment reporting.
The following tables present certain financial information for our reportable segments for the three and nine months ended September 30, 2020 and 2019 and as of September 30, 2020 and December 31, 2019 (in thousands):
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Securities Act of 1933, as amended (the “Securities Act”), 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 concerning, among other things: the length and severity of the ongoing COVID-19 (novel coronavirus) outbreak, including its impacts across our businesses on demand, manufacturing, project development, construction, O&M, financing, and our global supply chains, actions that may be taken by governmental authorities to contain the COVID-19 outbreak or to treat its impacts, and the ability of our customers, suppliers, equipment vendors, and other counterparties to fulfill their contractual obligations to us; effects resulting from certain module manufacturing changes and associated restructuring activities; 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 (including estimated future module collection and recycling costs), warranties, solar module technology and cost reduction roadmaps, restructuring, product reliability, investments, and capital expenditures; our ability to continue to reduce the cost per watt of our solar modules; the impact of public policies, such as tariffs or other trade remedies imposed on solar cells and modules; effects resulting from pending litigation; our ability to expand manufacturing capacity worldwide; our ability to reduce the costs to develop and construct PV solar power systems; research and development (“R&D”) programs and our ability to improve the wattage 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,” “seek,” “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 and therefore speak only as of the filing date. 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, whether as a result of new information, future developments, or otherwise. 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 severity and duration of the COVID-19 pandemic, including its potential impact on the Company’s business, financial condition, and results of operations; structural imbalances in global supply and demand for PV solar modules; the market for renewable energy, including solar energy; our competitive position and other key competitive factors; reduction, elimination, or expiration of government subsidies, policies, and support programs for solar energy projects; the impact of public policies, such as tariffs or other trade remedies imposed on solar cells and modules; our ability to execute on our long-term strategic plans; our ability to execute on our solar module technology and cost reduction roadmaps; our ability to improve the wattage of our solar modules; interest rate fluctuations and both our and our customers’ ability to secure financing; the creditworthiness of our off-take counterparties and the ability of our off-take counterparties to fulfill their contractual obligations to us; the ability of our customers and counterparties to perform under their contracts with us; the satisfaction of conditions precedent in our sales agreements; our ability to attract new customers and to develop and maintain existing customer and supplier relationships; our ability to successfully develop and complete our systems business projects; our ability to convert existing production facilities to support new product lines, such as Series 6 module manufacturing; general economic and business conditions, including those influenced by U.S., international, and geopolitical events; environmental responsibility, including with respect to CdTe and other semiconductor materials; claims under our limited warranty obligations; changes in, or the failure to comply with, government regulations and environmental, health, and safety requirements; effects
resulting from pending litigation; future collection and recycling costs for solar modules covered by our module collection and recycling program; our ability to protect our intellectual property; our ability to prevent and/or minimize the impact of cyber-attacks or other breaches of our information systems; our continued investment in research and development; the supply and price of components and raw materials, including CdTe; our ability to attract and retain key executive officers and associates; and the matters discussed in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019, elsewhere in this Quarterly Report on Form 10-Q, and our other reports filed with the SEC. You should carefully consider the risks and uncertainties described in these reports.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto included in this Quarterly Report on Form 10-Q. When referring to our manufacturing capacity, total sales, and solar module sales, the unit of electricity in watts for megawatts (“MW”) and gigawatts (“GW”) is direct current (“DC” or “DC”) unless otherwise noted. When referring to our projects or systems, the unit of electricity in watts for MW and GW is alternating current (“AC” or “AC”) unless otherwise noted.
Executive Overview
We are a leading global provider of comprehensive PV solar energy solutions. We design, manufacture, and sell PV solar modules with an advanced thin film semiconductor technology and also develop and sell PV solar power systems that primarily use the modules we manufacture. Additionally, we provide O&M services to system owners. We have substantial, ongoing R&D efforts focused on various technology innovations. We are the world’s largest thin film PV solar module manufacturer and one of the world’s largest PV solar module manufacturers.
Certain of our financial results and other key operational developments for the three months ended September 30, 2020 include the following:
•Net sales for the three months ended September 30, 2020 increased by 70% to $927.6 million compared to $546.8 million for the same period in 2019. The increase was primarily due to the sale of the Ishikawa, Miyagi, Anamizu, Tungabhadra, and Anantapur projects and an increase in the volume of modules sold to third parties, partially offset by the completion of substantially all construction activities at the Phoebe and Seabrook projects in 2019.
•Gross profit for the three months ended September 30, 2020 increased 6.3 percentage points to 31.6% from 25.3% for the same period in 2019. The increase in gross profit was primarily due to the volume and mix of higher gross profit projects sold during the period; a reduction in our module collection and recycling liability due to changes to the estimated timing of cash flows associated with capital, labor, and maintenance costs; and higher throughput at our manufacturing facilities from the successful ramp of various Series 6 manufacturing lines; partially offset by a higher benefit from reductions to our product warranty liability in the prior period; an impairment loss for certain module manufacturing equipment, and manufacturing related charges associated with the ongoing COVID-19 pandemic.
•As of September 30, 2020, we had 5.5 GWDC of total installed Series 6 nameplate production capacity across all our facilities. We produced 1.5 GWDC of solar modules during the three months ended September 30, 2020, which represented a 55% increase in Series 6 module production from the same period in 2019. The increase in Series 6 production was primarily driven by the production capacity added in 2019 at our second facility in Ho Chi Minh City, Vietnam and our facility in Lake Township, Ohio as well as higher throughput at various facilities. We expect to produce approximately 6 GWDC of solar modules during 2020, substantially all of which will be Series 6 modules.
•In response to the COVID-19 pandemic, governmental authorities have recommended or ordered the limitation or cessation of certain business or commercial activities in jurisdictions in which we operate, including the United States, Malaysia, and Vietnam. At this time, such limitations have had a limited effect on our Series 6 manufacturing facilities. However, these orders are subject to continuous revision, and our understanding of the applicability of these orders and any potential exemptions may change at any time. To enable the continuity of our operations, we have implemented a wide range of safety measures intended to inhibit the spread of COVID-19 at our manufacturing, administrative, and other sites and facilities.
•In August 2020 we entered into an agreement with a subsidiary of Clairvest, pursuant to which Clairvest will acquire our North American O&M operations. The completion of the transaction is contingent on a number of closing conditions, including the receipt of certain third-party consents, a review of the transaction by the Committee on Foreign Investment in the United States, and other customary closing conditions. Assuming satisfaction of such closing conditions, we expect the sale to be completed in late 2020.
Market Overview
The solar industry continues to be characterized by intense pricing competition, both at the module and system levels. In particular, module average selling prices in many global markets have declined in recent years and are expected to continue to decline in the future. Furthermore, the COVID-19 pandemic has adversely affected certain purchasers of modules and systems, which may result in additional pressure on demand and average selling prices. In the aggregate, we believe manufacturers of solar cells and modules have significant installed production capacity, relative to global demand, and the ability for additional capacity expansion. Accordingly, we believe the solar industry may from time to time experience periods of structural imbalance between supply and demand (i.e., where production capacity exceeds global demand), and that such periods will also put pressure on pricing, which may be exacerbated by the current COVID-19 disruption in the global economy. Additionally, intense competition at the system level may result in an environment in which pricing falls rapidly, thereby potentially increasing demand for solar energy solutions but constraining the ability for project developers and diversified module manufacturers to sustain meaningful and consistent profitability. In light of such market realities, we continue to focus on our strategies and points of differentiation, which include our advanced module technology, our manufacturing process, our financial viability, and the sustainability advantage of our modules and systems.
Global solar markets continue to expand and develop, in part aided by demand elasticity resulting from declining average selling prices, both at the module and system levels, which have promoted the widespread adoption of solar energy. As a result of such market opportunities, we are expanding our manufacturing capacity while also developing and operating multiple solar projects around the world as we execute on our utility-scale project pipeline. See the tables under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Systems Project Pipeline” for additional information about projects within our advanced-stage pipeline. Although we expect a meaningful portion of our future consolidated net sales, operating income, and cash flows to be derived from such projects, we expect third-party module sales to continue to have a more significant impact on our operating results as we expand capacity and leverage the benefits of our Series 6 module technology.
Lower industry module and system pricing is expected to contribute to diversification in global electricity generation and further demand for solar energy. Over time, however, declining average selling prices may adversely affect our results of operations to the extent we have not already entered into contracts for future module or system sales. Our results of operations could also be adversely affected if competitors reduce pricing to levels below their costs, bid aggressively low prices for module sale agreements or PPAs, or are able to operate at minimal or negative operating margins for sustained periods of time. For certain of our competitors, such actions may be enabled by their direct or indirect access to sovereign capital or other forms of state-owned support. In certain markets in California and elsewhere, an oversupply imbalance at the grid level may reduce short-to-medium term demand for new solar installations relative to prior years, lower PPA pricing, and lower margins on module and system sales to such markets. However, we believe the effects of such imbalance can be mitigated by modern solar power plants and
energy storage solutions that offer a flexible operating profile, thereby promoting greater grid stability and enabling a higher penetration of solar energy. We continue to address these uncertainties, in part, by executing on our module technology improvements, partnering with grid operators and utility companies, and implementing certain other cost reduction initiatives.
We face intense competition from manufacturers of crystalline silicon solar modules and developers of solar power projects. Solar module manufacturers compete with one another on price and on several module value attributes, including wattage (or conversion efficiency), energy yield, and reliability, and developers of systems compete on various factors such as net present value, return on equity, and levelized cost of electricity (“LCOE”), meaning the net present value of a system’s total life cycle costs divided by the quantity of energy that is expected to be produced over the system’s life. Many crystalline silicon cell and wafer manufacturers have transitioned from lower efficiency Back Surface Field multi-crystalline cells (the legacy technology against which we have generally competed) to higher efficiency Passivated Emitter Rear Contact (“PERC”) mono-crystalline cells at competitive cost structures. Additionally, while conventional solar modules, including the solar modules we produce, are monofacial, meaning their ability to produce energy is a function of direct and diffuse irradiance on their front side, certain manufacturers of mono-crystalline PERC modules are promoting bifacial modules that also capture diffuse irradiance on the back side of a module. The cost effective manufacture of bifacial PERC modules has been enabled, in part, by the expansion of inexpensive crystal growth and diamond wire saw capacity in China. Bifaciality compromises nameplate efficiency, but by converting both front and rear side irradiance, such technology may improve the overall energy production of a module relative to nameplate efficiency when applied in certain applications, which, after considering the incremental BoS and other costs, could potentially lower the overall LCOE of a system when compared to systems using conventional solar modules, including the modules we produce.
We believe we are among the lowest cost module manufacturers in the solar industry on a module cost per watt basis, based on publicly available information. This cost competitiveness allows us to compete favorably in markets where pricing for modules and systems is highly competitive. Our cost competitiveness is based in large part on our advanced thin film semiconductor technology, module wattage (or conversion efficiency), proprietary manufacturing process (which enables us to produce a CdTe module in a matter of hours using a continuous and highly automated industrial manufacturing process, as opposed to a batch process), and our focus on operational excellence. In addition, our CdTe modules use approximately 1-2% of the amount of semiconductor material that is used to manufacture conventional 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. In recent years, polysilicon consumption per cell has been reduced through various initiatives, such as the adoption of diamond wire saw technology, which have contributed to declines in our relative manufacturing cost competitiveness over conventional crystalline silicon module manufacturers.
In terms of energy yield, in many climates our CdTe solar modules provide an energy production advantage over most monofacial crystalline silicon solar modules of equivalent efficiency rating. For example, our CdTe solar modules provide a superior temperature coefficient, which results in stronger system performance in typical high insolation climates as the majority of a system’s generation, on average, occurs when module temperatures are well above 25°C (standard test conditions). In addition, our CdTe solar modules provide a superior spectral response in humid environments where atmospheric moisture alters the solar spectrum relative to laboratory standards. Our CdTe solar modules also provide a better shading response than conventional crystalline silicon solar modules, which may experience significantly lower energy generation than CdTe solar modules when shading occurs. As a result of these and other factors, our PV solar modules typically produce more annual energy in real world field conditions than conventional modules with the same nameplate capacity. Furthermore, our thin-film CdTe semiconductor technology is immune to cell cracking and its resulting power output loss, a common failure often observed in crystalline silicon modules caused by adverse manufacturing, handling, weather, or other conditions.
While our modules and systems are generally competitive in cost, reliability, 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 of our products could result in further declines in the average selling prices of our modules and systems and additional margin compression. We continue to focus on enhancing the competitiveness of our solar modules and systems by accelerating progress along our module technology and cost reduction roadmaps.
Certain Trends and Uncertainties
We believe that our business, financial condition, and results of operations may be favorably or unfavorably impacted by the following trends and uncertainties. See Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019 and Item 1A. of this Quarterly Report on Form 10-Q for discussions of other risks (the “Risk Factors”) that may affect us.
Our long-term strategic plans are focused on our goal to create long-term shareholder value through a balance of growth, profitability, and liquidity. In executing such plans, we are focusing on providing utility-scale PV solar energy solutions in key geographic markets that we believe have a compelling need for mass-scale PV solar electricity, including markets throughout the Americas, the Asia-Pacific region, Europe, and certain other strategic markets. While these markets are expected to exhibit strong long-term demand for solar energy, the economic disruption caused by the COVID-19 pandemic has adversely affected near-term demand for electricity at the grid level. As a result, such temporary decline in load may adversely affect demand for specific forms of generation, such as our PV solar energy solutions, depending on the severity and duration of the economic disruption. Given these market dynamics, we continue to focus on opportunities in which our PV solar energy solutions compete directly with traditional forms of energy generation on an LCOE or similar basis, or complement such generation offerings. These opportunities include the retirement and replacement of aging fossil fuel-based generation resources with utility-scale PV solar energy solutions. For example, cumulative global retirements of coal generation plants are expected to approximate 900 GWDC by 2040, representing a significant increase in the potential market for solar energy.
This focus on our core module and utility-scale offerings exists within a current market environment that includes rooftop and distributed generation solar, particularly in the United States. While it is unclear how rooftop and distributed generation solar might impact our core utility-scale based offerings over the next several years, we believe that utility-scale solar will continue to be a compelling offering for companies with technology and cost leadership and will continue to represent an increasing portion of the overall electricity generation mix. However, our module offerings in certain international markets may be driven, in part, by future demand for rooftop and distributed generation solar solutions.
Our ability to provide utility-scale offerings on economically attractive terms depends, in part, on market factors outside our control, such as the availability of debt and/or equity financing (including, in the United States, tax equity financing), interest rate fluctuations, domestic or international trade policies, and government support programs. Adverse changes in these factors could increase the cost of utility-scale systems, which could reduce demand for such systems and limit the number of potential buyers. For example, we generally sell projects we have developed within our systems business, including projects in the United States, Japan, and elsewhere, to purchasers that depend on financing to fund the initial capital expenditures required to develop, build, and/or purchase a system. Although governments and central banks around the world have implemented significant measures to support capital markets, the economic disruption caused by the COVID-19 pandemic may result in a long-term tightening of the supply of capital in global financial markets (including, in the United States, a reduction in total tax equity availability). A reduction in the supply of project debt or equity financing (including, in the United States, tax equity financing) caused by the COVID-19 pandemic could make it difficult for our customers to secure the financing necessary to develop, build, purchase, or install systems. Similarly, purchasers of modules may cease or significantly reduce business operations, cease or delay module procurement, encounter an inability to obtain financing, including due to a reduction in the supply of project debt financing or equity investments (including, in the United States, tax
equity financing), conserve capital resources, or take other actions in response to the COVID-19 pandemic, which may reduce demand and average selling prices for our modules.
In certain markets, demand for our utility-scale offerings may be affected by specific regulations or policies of governmental bodies or utility regulators. For example, in June 2020, the Japanese legislature enacted an amendment to the Electricity Business Law Enforcement Order for the Ministry of Economy, Trade and Industry (“METI”) of Japan which, among other things, is expected to invalidate the feed-in-tariff certificates for projects that fail to achieve construction plan acceptance and/or commercial operation within a set period of time following dates specified in their respective certificates. The amendment, which becomes effective in April 2022, applies to all projects regardless of generation type and is intended to release grid capacity reserved for delayed projects to enable other newly developed projects to utilize such capacity at a lower cost of electricity to consumers. The deadline period by which a project must achieve construction plan acceptance and/or commercial operation will be proposed at a later date by METI. Any deadlines that precede the expected construction plan acceptance and/or commercial operation dates of our various projects in Japan could adversely affect the value of such projects and our ability to secure any related project financing.
We intend to focus 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 significant current or projected electricity demand, relatively high existing electricity prices, strong demand for renewable energy generation, and high solar resources. As a result, we closely evaluate and monitor the appropriate level of resources required to support such markets and their associated sales opportunities. We have dedicated, and intend to continue to dedicate, significant capital and human resources to reduce the total installed cost of PV solar energy and to ensure that our solutions integrate well into the overall electricity ecosystem of each specific market.
Creating or maintaining a market position in certain strategically targeted markets and energy applications also requires us to adapt to new and changing market conditions. For example, we continue to monitor and adapt to the dynamics of emerging technologies, such as commercially viable energy storage solutions, which are expected to further enable PV solar power systems to compete with traditional forms of energy generation by shifting the delivery of energy generated by such systems to periods of greater demand. Storage solutions continue to evolve in terms of technology and cost, and cumulative global deployments of storage capacity are expected to exceed 900 GWDC by 2040, representing a significant increase in the potential market for renewable energy. We also continue to monitor and adapt to changing dynamics in the market set of potential buyers of solar projects. Market environments with few potential project buyers and a higher cost of capital would generally exert downward pressure on the potential revenue from the solar projects we are developing, whereas, conversely, market environments with many potential project buyers and a lower cost of capital would likely have a favorable impact on the potential revenue from such solar projects. For example, the emergence of utility-owned generation has increased the number of potential project buyers as such utility customers benefit from a potentially low cost of capital available through rate-based utility investments. Given their long-term ownership profile, utility-owned generation customers typically seek to partner with diversified and stable companies that can provide a broad spectrum of utility-scale generation solutions, including reliable PV solar technology, thereby mitigating their long-term ownership risks.
On occasion, we may also elect to develop partially contracted or uncontracted systems for which there is a partial or no PPA with an off-taker, such as a utility, but rather an intent to sell some portion of the electricity produced by the system on an open contract basis until the system is sold. Expected revenue from projects without a PPA for the full off-take of the system is subject to greater variability and uncertainty based on market factors and is typically lower than projects with a PPA for the full off-take of the system. Furthermore, all system pricing is affected by the pricing of energy to be sold on an open contract basis following the termination of the PPA (i.e., merchant pricing curves), and changes in market assumptions regarding future open contract sales, including potential changes in energy demand caused by the COVID-19 pandemic, may also result in significant variability and uncertainty in the value of our systems projects.
As previously disclosed, following an evaluation of the long-term sustainable cost structure, competitiveness, and risk-adjusted returns of our U.S. project development business, we have determined it is in the best interest of our stockholders to explore options for this business line. This exploration may result in, among other possibilities, a partnership with a third-party who possesses complimentary competencies or a sale of all or a portion of our U.S. project development business. These potential third-party partners or purchasers of interests in our U.S. project development business may now, or in the future, be impacted by the global business disruption caused by the COVID-19 pandemic, and may consequently focus on their own operations and/or delay considering potential partnerships or other arrangements with respect to our U.S. project development business. While we have previously disclosed that the exploration of options for our U.S. project development business is not subject to any definitive timetable and there can be no assurances that this process will result in any transaction, the COVID-19 pandemic may have the effect of delaying or preventing the consummation of any such transaction.
We continually evaluate forecasted global demand, competition, and our addressable market and seek to effectively balance manufacturing capacity with market demand and the nature and extent of our competition. During 2019, we commenced commercial production of Series 6 modules at our second manufacturing facility in Ho Chi Minh City, Vietnam and our manufacturing facility in Lake Township, Ohio. We are currently in the process of transitioning our legacy Series 4 manufacturing facilities in Kulim, Malaysia to our Series 6 module technology and continue to expand capacity and throughput at our other existing manufacturing facilities. Such additional capacity, and any other potential investments to add or otherwise modify our existing manufacturing capacity in response to market demand and competition, may require significant internal and possibly external sources of capital, and may be subject to certain risks and uncertainties described in the Risk Factors.
In response to the COVID-19 pandemic, governmental authorities have recommended or ordered the limitation or cessation of certain business or commercial activities in jurisdictions in which we do business or have operations. While some of these orders permit the continuation of essential business operations, or permit the performance of minimum business activities, these orders are subject to continuous revision or may be revoked or superseded, or our understanding of the applicability of these orders and exemptions, may change at any time. In addition, due to contraction of the virus, or concerns about becoming ill from the virus, we may experience reductions in the availability of our operational workforce, such as our manufacturing personnel. As a result, we may at any time be ordered by governmental authorities, or we may determine, based on our understanding of the recommendations or orders of governmental authorities or the availability of our personnel, that we have to curtail or cease business operations or activities altogether, including manufacturing, fulfillment, project development, construction, operating or maintenance operations, or research and development activities. At this time, such limitations have had a limited effect on our manufacturing facilities and certain project construction activities, and we have implemented a wide range of safety measures intended to enable the continuity of our operations and inhibit the spread of COVID-19 at our manufacturing, administrative, and other sites and facilities, including those in the United States, Malaysia, and Vietnam.
To address the near-term business disruption caused by the COVID-19 pandemic, many governments have proposed policies or support programs intended to stimulate their respective economies. Such support programs may include additional incentives for renewable energy projects, including PV solar power systems, over several years. While we compete in many markets that do not require solar-specific government subsidies or support programs, our net sales and profits remain subject to variability based on the availability and size of government subsidies and economic incentives.
The following tables summarize, as of October 27, 2020, our approximately 1.4 GWAC advanced-stage project pipeline. The actual volume of modules installed in our projects will be greater than the project size in MWAC as module volumes required for a project are based upon MWDC, which will be greater than the MWAC size pursuant to a DC-AC ratio typically ranging from 1.1 to 1.4. Such ratio varies across different projects due to many factors, including PPA pricing and the location, design, and costs of the system. Projects are typically removed from our advanced-stage project pipeline tables below once we substantially complete construction of the project and after substantially all of the associated project revenue is recognized. A project, or a portion of a project, may also be removed from the tables below in the event the project is not able to be sold due to the changing economics of the project or other factors or we decide to temporarily own and operate the project based on strategic opportunities or market factors.
Projects under Sales Agreements
The following table includes uncompleted sold projects and projects under contracts subject to conditions precedent:
Project/Location
Project Size in MWAC
PPA Contracted Partner
Customer
Expected Year Revenue Recognition Will Be Completed
% of Revenue Recognized as of September 30, 2020
GA Solar 4, Georgia
200
Georgia Power Company
Origis Energy USA
2020
96%
Seabrook, South Carolina
72
South Carolina Electric and Gas Company
Dominion Energy
2020
98%
Total
272
Projects with Executed PPAs Not under Sales Agreements
Project/Location
Project Size in MWAC
PPA Contracted Partner
Fully Permitted
Expected or Actual Substantial Completion Year
% Complete as of September 30, 2020
Horizon, Texas
200
(1)
Yes
2023
—%
Big Plain Solar, Ohio
196
Verizon Communications
No
2023
—%
Ridgely, Tennessee
177
Tennessee Valley Authority
No
2023
1%
Sun Streams 2, Arizona
150
Microsoft Corporation
Yes
2021
22%
Luz del Norte, Chile
141
(2)
Yes
2016
100%
Rabbitbrush, California
100
(3)
No
2022
5%
Oak Trail, North Carolina
100
Verizon Communications
No
2023
—%
Sun Streams PVS, Arizona
65
APS
Yes
2022
8%
Kyoto, Japan
38
Chubu Electric Power Company
Yes
2022
33%
Total
1,167
——————————
(1)150 MWAC of the plant’s capacity is contracted with Dow Pipeline Company; remaining capacity to be sold on an open contract basis
(2)Approximately 70 MWAC of the plant’s capacity is contracted under various PPAs; remaining capacity to be sold on an open contract basis
(3)Central Coast Community Energy – 60 MWAC and Silicon Valley Clean Energy – 40 MWAC
The following table sets forth our condensed consolidated statements of operations as a percentage of net sales for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Net sales
100.0
%
100.0
%
100.0
%
100.0
%
Cost of sales
68.4
%
74.7
%
75.2
%
87.0
%
Gross profit
31.6
%
25.3
%
24.8
%
13.0
%
Selling, general and administrative
5.4
%
9.8
%
7.6
%
9.0
%
Research and development
2.5
%
4.6
%
3.4
%
4.3
%
Production start-up
1.4
%
3.4
%
1.1
%
2.3
%
Litigation loss
—
%
—
%
0.3
%
—
%
Operating income (loss)
22.3
%
7.6
%
12.4
%
(2.6)
%
Foreign currency (loss) income, net
(0.2)
%
0.2
%
(0.2)
%
0.2
%
Interest income
0.2
%
2.1
%
0.7
%
2.4
%
Interest expense, net
(1.2)
%
(0.9)
%
(1.0)
%
(1.4)
%
Other expense, net
(0.3)
%
(0.6)
%
(0.4)
%
(0.3)
%
Income tax (expense) benefit
(4.1)
%
(2.7)
%
1.9
%
(1.5)
%
Equity in earnings, net of tax
—
%
—
%
—
%
—
%
Net income (loss)
16.7
%
5.6
%
13.4
%
(3.3)
%
Segment Overview
We operate our business in two segments. Our modules segment involves the design, manufacture, and sale of CdTe solar modules to third parties, and our systems segment includes the development, construction, operation, maintenance, and sale of PV solar power systems, including any modules installed in such systems and any revenue from energy generated by such systems.
Net sales
Modules Business
We generally price and sell our solar modules on a per watt basis. During the three and nine months ended September 30, 2020, we sold the majority of our solar modules to integrators and operators of systems in the United States, and substantially all of our modules business net sales were denominated in U.S. dollars. We recognize revenue for module sales at a point in time following the transfer of control of the modules to the customer, which typically occurs upon shipment or delivery depending on the terms of the underlying contracts.
Systems Business
During the three and nine months ended September 30, 2020, the majority of our systems business net sales were in Japan, the United States, and India, and were denominated in Japanese yen, U.S. dollars, and Indian rupee. We recognize revenue for the sale of a development project, which excludes EPC services, or for the sale of a completed system when we enter into the associated sales contract with the customer. For other sales of solar power systems and/or EPC services, we generally recognize revenue over time as our performance creates or enhances an energy generation asset controlled by the customer. Furthermore, the sale of a solar power system combined with EPC services represents a single performance obligation for the development and construction of a single generation asset. For such arrangements, we recognize revenue as work is performed using cost based input methods, which
result in revenue being recognized as work is performed based on the relationship between actual costs incurred compared to the total estimated costs for a given contract.
The following table shows net sales by reportable segment for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Modules
$
422,480
$
371,184
$
51,296
14
%
$
1,187,679
$
798,744
$
388,935
49
%
Systems
505,085
175,622
329,463
188
%
914,421
864,996
49,425
6
%
Net sales
$
927,565
$
546,806
$
380,759
70
%
$
2,102,100
$
1,663,740
$
438,360
26
%
Net sales from our modules segment increased $51.3 million for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 primarily due to a 15% increase in the volume of watts sold, partially offset by a 1% decrease in the average selling price per watt. Net sales from our systems segment increased $329.5 million for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 primarily due to the sale of the Ishikawa, Miyagi, Anamizu, Tungabhadra, and Anantapur projects, partially offset by the completion of substantially all construction activities at the Phoebe and Seabrook projects in 2019 and lower construction activities at the GA Solar 4 project in the current period.
Net sales from our modules segment increased $388.9 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 primarily due to a 48% increase in the volume of watts sold. Net sales from our systems segment increased $49.4 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 primarily due to the sale of the Ishikawa, American Kings, Miyagi, Anamizu, Tungabhadra, and Anantapur projects, partially offset by the completion of substantially all construction activities at the Phoebe, Rosamond, Lake Hancock, and Seabrook projects in 2019, the sale of the Beryl, Cove Mountain, and Muscle Shoals projects in 2019, and lower construction activities at the GA Solar 4 project in the current period.
Cost of sales
Modules Business
Our modules business cost of sales includes the cost of raw materials and components for manufacturing solar modules, such as glass, transparent conductive coatings, CdTe, and other thin film semiconductors, laminate materials, connector assemblies, edge seal materials, and frames. In addition, our cost of sales includes direct labor for the manufacturing of solar modules and manufacturing overhead, such as engineering, equipment maintenance, quality and production control, and information technology. Our cost of sales also includes depreciation of manufacturing plant and equipment, facility-related expenses, environmental health and safety costs, and costs associated with shipping, warranties, and solar module collection and recycling (excluding accretion).
Systems Business
For our systems business, project-related costs include development costs (legal, consulting, transmission upgrade, interconnection, permitting, and other similar costs), EPC costs (consisting primarily of solar modules, inverters, electrical and mounting hardware, project management and engineering, and construction labor), and site specific costs.
The following table shows cost of salesby reportable segment for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Modules
$
297,658
$
223,378
$
74,280
33
%
$
907,564
$
664,451
$
243,113
37
%
Systems
336,892
185,065
151,827
82
%
673,723
783,632
(109,909)
(14)
%
Total cost of sales
$
634,550
$
408,443
$
226,107
55
%
$
1,581,287
$
1,448,083
$
133,204
9
%
% of net sales
68.4
%
74.7
%
75.2
%
87.0
%
Our cost of sales increased $226.1 million, or 55%, and decreased 6.3 percentage points as a percent of net sales for the three months ended September 30, 2020 compared to the three months ended September 30, 2019. The increase in cost of sales was driven by a $151.8 million increase in our systems segment cost of sales primarily due to the timing of when revenue recognition criteria were met for project sales, partially offset by the lower volume of projects under construction during the period. The increase in cost of sales was also driven by a $74.3 million increase in our modules segment cost of sales primarily as a result of the following:
•higher costs of $45.2 million from an increase in the volume of modules sold;
•an impairment loss of $17.4 million for certain module manufacturing equipment, including framing and assembly tools, which were no longer compatible with our long-term module technology roadmap;
•manufacturing related charges of $3.5 million associated with the ongoing COVID-19 pandemic; and
•a reduction to our product warranty liability of $80.0 million in 2019 due to revised module return rates; partially offset by
•a reduction to our product warranty liability of $19.7 million in 2020 due to lower-than-expected settlements for our older series of module technology and revisions to projected settlements;
•a reduction in our module collection and recycling liability of $18.9 million primarily due to changes to the estimated timing of cash flows associated with capital, labor, and maintenance costs and updates to certain valuation assumptions; and
•continued module cost reductions, which decreased cost of sales by $38.8 million.
Our cost of sales increased $133.2 million, or 9%, and decreased 11.8 percentage points as a percent of net sales for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. The increase in cost of sales was primarily driven by a $243.1 million increase in our modules segment cost of sales primarily as a result of the following:
•higher costs of $327.0 million from an increase in the volume of modules sold;
•the aforementioned impairment loss of $17.4 million for certain module manufacturing equipment;
•manufacturing related charges of $12.3 million associated with the ongoing COVID-19 pandemic; and
•the reduction to our product warranty liability of $80.0 million in 2019 described above; partially offset by
•the reduction to our product warranty liability of $19.7 million described above;
•lower under-utilization and certain other charges associated with the initial ramp of certain Series 6 manufacturing lines, which decreased cost of sales by $48.9 million compared to 2019;
•the reduction in our module collection and recycling liability of $18.9 million described above; and
•continued module cost reductions, which decreased cost of sales by $137.2 million.
Such increase in our modules segment cost of sales was partially offset by a $109.9 million decrease in our systems segment cost of sales primarily due to the lower volume of projects under construction during the period, partially offset by the size of projects sold and the timing of when revenue recognition criteria were met.
Gross profit may be affected by numerous factors, including the selling prices of our modules and systems, our manufacturing costs, project development costs, BoS costs, the capacity utilization of our manufacturing facilities, and foreign exchange rates. Gross profit may also be affected by the mix of net sales from our modules and systems businesses.
The following table shows gross profit for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Gross profit
$
293,015
$
138,363
$
154,652
112
%
$
520,813
$
215,657
$
305,156
142
%
% of net sales
31.6
%
25.3
%
24.8
%
13.0
%
Gross profit increased 6.3 percentage points to 31.6% during the three months ended September 30, 2020 from 25.3% during the three months ended September 30, 2019 primarily due to the volume and mix of higher gross profit projects sold during the period, the reduction in our module collection and recycling liability described above, and improved throughput at our manufacturing facilities from the successful ramp of various Series 6 manufacturing lines. These increases were partially offset by the lower benefit from reductions to our product warranty liability described above, the impairment loss for certain module manufacturing equipment described above, and manufacturing related charges associated with the ongoing COVID-19 pandemic.
Gross profit increased 11.8 percentage points to 24.8% during the nine months ended September 30, 2020 from 13.0% during the nine months ended September 30, 2019 primarily due to a mix of higher gross profit projects sold during the period, higher gross profit on third-party module sales, and improved throughput of our manufacturing facilities from the successful ramp of various Series 6 manufacturing lines, partially offset by the lower benefit from reductions to our product warranty liability and the impairment loss for certain module manufacturing equipment described above.
Selling, general and administrative
Selling, general and administrative expense consists primarily of salaries and other personnel-related costs, professional fees, insurance costs, and other business development and selling expenses.
The following table shows selling, general and administrative expense for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Selling, general and administrative
$
49,861
$
53,542
$
(3,681)
(7)
%
$
160,218
$
149,828
$
10,390
7
%
% of net sales
5.4
%
9.8
%
7.6
%
9.0
%
Selling, general and administrative expense for the three months ended September 30, 2020 decreased compared to the three months ended September 30, 2019 primarily due to lower project development, travel, and employee compensation expenses, partially offset by an increase in professional fees.
Selling, general and administrative expense for the nine months ended September 30, 2020 increased compared to the nine months ended September 30, 2019 primarily due to an increase in professional fees; higher charges for impairments of certain project assets; and higher expected credit losses for our accounts receivable due to the current economic conditions resulting from the COVID-19 pandemic. See Note 5. “Consolidated Balance Sheet Details” for further information about the allowance for credit losses associated with our accounts receivable.
Research and development expense consists primarily of salaries and other personnel-related costs; the cost of products, materials, and outside services used in our R&D activities; and depreciation and amortization expense associated with R&D specific facilities and equipment. 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.
The following table shows research and development expense for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Research and development
$
22,972
$
24,912
$
(1,940)
(8)
%
$
71,068
$
71,184
$
(116)
—
%
% of net sales
2.5
%
4.6
%
3.4
%
4.3
%
Research and development expense for the three months ended September 30, 2020 decreased compared to the three months ended September 30, 2019 primarily as a result of lower employee compensation expense due to reductions in R&D headcount for our systems business. Research and development expense for the nine months ended September 30, 2020 was consistent with the nine months ended September 30, 2019.
Production start-up
Production start-up expense consists primarily of employee compensation and other costs associated with operating a production line before it is qualified for full production, including the cost of raw materials for solar modules run through the production line during the qualification phase and applicable facility related costs. Costs related to equipment upgrades and implementation of manufacturing process improvements are also included in production start-up expense as well as costs related to the selection of a new site, related legal and regulatory costs, and 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 or replacement of production lines at an existing manufacturing facility, primarily due to the additional infrastructure investment required when building an entirely new facility.
The following table shows production start-up expense for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Production start-up
$
13,019
$
18,605
$
(5,586)
(30)
%
$
23,812
$
38,564
$
(14,752)
(38)
%
% of net sales
1.4
%
3.4
%
1.1
%
2.3
%
During the three and nine months ended September 30, 2020, we incurred production start-up expense for the transition to Series 6 module manufacturing at our second facility in Kulim, Malaysia and the capacity expansion of our manufacturing facility in Perrysburg, Ohio. During the three and nine months ended September 30, 2019, we incurred production start-up expense at our facility in Lake Township, Ohio, and our second facility in Ho Chi Minh City, Vietnam, which commenced commercial production in early 2019.
The following table shows litigation loss for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Litigation loss
$
—
$
—
$
—
—
%
$
6,000
$
—
$
6,000
100
%
% of net sales
—
%
—
%
0.3
%
—
%
In June 2020, we entered into an agreement in principle to settle the claims in the Opt-Out Action filed in 2015 in the Arizona District Court by putative stockholders that opted out of the Class Action. On July 17, 2020, the parties executed a definitive settlement agreement pursuant to which we agreed to pay a total of $19 million in exchange for mutual releases and a dismissal with prejudice of the Opt-Out Action. The agreement contains no admission of liability, wrongdoing, or responsibility by any of the parties. On July 30, 2020, First Solar funded the settlement, and on July 31, 2020, the parties filed a joint stipulation of dismissal. On September 10, 2020, the Arizona District Court entered an order dismissing the case with prejudice.
As of December 31, 2019, we had accrued $13 million of estimated losses for this action. As a result of the settlement, we accrued an incremental $6 million litigation loss during the nine months ended September 30, 2020. See Note 10. “Commitments and Contingencies” for further information about the Opt-Out Action.
Foreign currency (loss) income, net
Foreign currency (loss) income, net consists of the net effect of gains and losses resulting from holding assets and liabilities and conducting transactions denominated in currencies other than our subsidiaries’ functional currencies.
The following table shows foreign currency (loss) income, net for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Foreign currency (loss) income, net
$
(1,852)
$
1,209
$
(3,061)
253
%
$
(3,549)
$
3,107
$
(6,656)
214
%
Foreign currency loss for the three and nine months ended September 30, 2020 increased compared to the three and nine months ended September 30, 2019 primarily due to higher costs associated with hedging activities related to our subsidiaries in Europe and Japan and differences between our economic hedge positions and the underlying exposures.
Interest income
Interest income is earned on our cash, cash equivalents, marketable securities, restricted cash, and restricted marketable securities. Interest income also includes interest earned from notes receivable and late customer payments.
The following table shows interest income for the three and nine months ended September 30, 2020 and 2019:
Interest income for the three and nine months ended September 30, 2020 decreased compared to the three and nine months ended September 30, 2019 primarily due to lower interest rates on cash and cash equivalents and lower average balances and interest rates associated with time deposits and marketable securities.
Interest expense, net
Interest expense, netis primarily comprised of interest incurred on long-term debt, settlements of interest rate swap contracts, and changes in the fair value of interest rate swap contracts that do not qualify for hedge accounting in accordance with ASC 815. We may capitalize interest expense to our project assets or property, plant and equipment when such costs qualify for interest capitalization, which reduces the amount of net interest expense reported in any given period.
The following table shows interest expense, netfor the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Interest expense, net
$
(10,975)
$
(4,976)
$
(5,999)
121
%
$
(21,018)
$
(24,018)
$
3,000
(12)
%
Interest expense, net for the three months ended September 30, 2020 increased compared to the three months ended September 30, 2019 primarily due to changes in the fair value of interest rate swap contracts, which do not qualify for hedge accounting. Interest expense, net for the nine months ended September 30, 2020 decreased compared to the nine months ended September 30, 2019 primarily due to lower interest expense associated with project debt and changes in the fair value of interest rate swap contracts, which do not qualify for hedge accounting, partially offset by higher amortization of debt discounts and issuance costs and a decrease in capitalized interest.
Other expense, net
Other expense, net is primarily comprised of miscellaneous items and realized gains and losses on the sale of marketable securities and restricted marketable securities.
The following table shows other expense, net for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Other expense, net
$
(3,236)
$
(3,399)
$
163
(5)
%
$
(8,653)
$
(4,328)
$
(4,325)
100
%
Other expense, net for the three months ended September 30, 2020 was consistent with the three months ended September 30, 2019. Other expense, net for the nine months ended September 30, 2020 increased compared to the nine months ended September 30, 2019 primarily due to expected credit losses associated with certain notes receivable, partially offset by prior period charges associated with certain letter of credit arrangements and the impairment of a strategic investment. See Note 5. “Consolidated Balance Sheet Details” for further information about the allowance for credit losses for our notes receivable.
Income tax (expense) benefit
Income tax expense or benefit, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid. We are subject to income taxes in both the United States and numerous foreign jurisdictions in which we operate, principally Australia, Japan, and Malaysia. Significant judgments and estimates are required to determine our consolidated income tax expense. The statutory federal corporate income tax rate in the United States is 21%, and the tax rates in Australia, Japan, and Malaysia are 30%, 30.6%, and 24%, 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, conditional upon our continued compliance with certain employment and investment thresholds.
The following table shows income tax benefit for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Income tax (expense) benefit
$
(38,107)
$
(15,035)
$
(23,072)
153
%
$
40,894
$
(25,385)
$
66,279
(261)
%
Effective tax rate
19.7
%
33.0
%
(16.9)
%
(84.8)
%
Our tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amounts of income we earn in those jurisdictions. The rate is also affected by discrete items that may occur in any given period, but are not consistent from period to period. Income tax expense increased by $23.1 million during the three months ended September 30, 2020 compared to the three months ended September 30, 2019 primarily due to higher pretax income. Income tax benefit increased by $66.3 million during the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 primarily due to a discrete tax benefit from the effect of tax law changes associated with the CARES Act and lower discrete tax expenses associated with filing a return in a foreign jurisdiction, partially offset by higher pretax income.
Equity in earnings, net of tax
Equity in earnings, net of tax represents our proportionate share of the earnings or losses from equity method investments as well as any gains or losses on the sale or disposal of such investments.
The following table shows equity in earnings, net of tax for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2020
2019
Three Month Change
2020
2019
Nine Month Change
Equity in earnings, net of tax
$
(65)
$
65
$
(130)
(200)
%
$
150
$
(205)
$
355
173
%
Equity in earnings, net of tax for the three and nine months ended September 30, 2020 was consistent with the three and nine months ended September 30, 2019.
Critical Accounting Policies and Estimates
In preparing our condensed consolidated financial statements in conformity with U.S. GAAP, we make estimates and assumptions that affect the amounts of reported assets, liabilities, revenues, and expenses, as well as the disclosure of contingent liabilities. Some of our accounting policies require the application of significant judgment in the selection of the appropriate assumptions for making these estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. We base our judgments and estimates on our historical experience, our forecasts, and other available information as appropriate. We believe the judgments and estimates involved in over time revenue recognition, accrued solar module collection and recycling, product warranties, accounting for income taxes, and long-lived asset impairments have the greatest potential impact on our condensed consolidated financial statements. The actual results experienced by us may differ 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 description of the accounting policies that require the most significant judgment and estimates in the preparation of our condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2019. There have been no material changes to our accounting policies during the nine months ended September 30, 2020 with the exception of certain changes to our allowance for credit losses
accounting policies as part of the adoption of ASU 2016-13 as described in Note 2. “Recent Accounting Pronouncements” to our condensed consolidated financial statements.
Recent Accounting Pronouncements
See Note 2. “Recent Accounting Pronouncements” to our condensed consolidated financial statements for a summary of recent accounting pronouncements.
Liquidity and Capital Resources
As of September 30, 2020, we believe that our cash, cash equivalents, marketable securities, cash flows from operating activities, contracts with customers for the future sale of solar modules, and advanced-stage project pipeline will be sufficient to meet our working capital, systems project investment, and capital expenditure needs for at least the next 12 months. As needed, we also believe we will have adequate access to the capital markets. We monitor our working capital to ensure we have adequate liquidity, both domestically and internationally.
We intend to maintain appropriate debt levels based upon cash flow expectations, our overall cost of capital, and expected cash requirements for our operations, such as systems project development activities in certain international regions. However, our ability to raise capital on terms commercially acceptable to us could be constrained if there is insufficient lender or investor interest due to company-specific, industry-wide, or broader market concerns, such as a tightening of the supply of capital due to the COVID-19 pandemic and related containment measures. Any incremental debt financings could result in increased debt service expenses and/or restrictive covenants, which could limit our ability to pursue our strategic plans.
As of September 30, 2020, we had $1.6 billion of cash, cash equivalents, and marketable securities compared to $2.2 billion as of December 31, 2019. The decrease in cash, cash equivalents, and marketable securities was primarily driven by the $350 million settlement payment associated with our prior class action lawsuit; purchases of property, plant and equipment; the timing of cash receipts from certain third-party module sales, for which proceeds were received in late 2019 prior to the step down in the U.S. investment tax credit; and other operating expenditures; partially offset by cash proceeds from the sale and construction of systems projects. As of September 30, 2020, $1.0 billion of our cash, cash equivalents, and marketable securities was held by our foreign subsidiaries and was primarily based in U.S. dollar, Japanese yen, and Indian rupee 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. If certain international funds were needed for our operations in the United States, we may be required to accrue and pay certain U.S. and foreign taxes to repatriate such funds. We maintain the intent and ability to permanently reinvest our accumulated earnings outside the United States, with the exception of our subsidiaries in Australia, Canada, and Germany. In addition, changes to foreign government banking regulations may restrict our ability to move funds among various jurisdictions under certain circumstances, which could negatively impact our liquidity and capital resources.
Our systems business requires significant liquidity and is expected to continue to have significant liquidity requirements in the future. The net amount of our project assets and related portion of deferred revenue, which approximates our net capital investment in the development and construction of systems projects, was $359.6 million as of September 30, 2020. Solar power project development cycles, which span the time between the identification of a site location and the commercial operation of a system, vary substantially and can take many years to mature. As a result of these long project cycles and strategic decisions to finance the development of certain projects using our working capital, we may need to make significant up-front investments of resources in advance of the receipt of any cash from the sale of such projects. Delays in construction or in completing the sale of our systems projects that we are self-financing may also impact our liquidity. In certain circumstances, we may need to finance construction costs exclusively using working capital, if project financing becomes unavailable due to regional, market-wide, or other concerns.
From time to time, we may develop projects in certain markets around the world where we may hold all or a significant portion of the equity in a project for several years. Given the duration of these investments and the currency risk relative to the U.S. dollar in some of these markets, we continue to explore local financing alternatives. Should these financing alternatives be unavailable or too cost prohibitive, we could be exposed to significant currency risk and our liquidity could be adversely impacted.
Additionally, we may elect to retain an ownership interest in certain systems projects after they become operational if we determine it would be of economic and strategic benefit to do so. If, for example, we cannot sell a system at economics that are attractive to us or potential customers are unwilling to assume the risks and rewards typical of system ownership, we may instead elect to temporarily own and operate such system until we can sell it on economically attractive terms. The decision to retain ownership of a system impacts our liquidity depending upon the size and cost of the project. As of September 30, 2020, we had $257.4 million of net PV solar power systems that had been placed in service, primarily in international markets. We have elected, and may in the future elect, to enter into temporary or long-term project financing to reduce the impact on our liquidity and working capital with regard to such systems.
The following additional considerations have impacted or may impact our liquidity for 2020 and beyond:
•We expect to spend $450 million to $550 million for capital expenditures, including amounts related to the transition of our second manufacturing facility in Kulim, Malaysia from Series 4 to Series 6 module technology and upgrades to other machinery and equipment, which we believe will further increase our module wattage and expand capacity and throughput at our other manufacturing facilities.
•In January 2020, we entered into an MOU to settle a class action lawsuit filed in the Arizona District Court. Pursuant to the MOU, among other things, we agreed to pay a total of $350 million to settle the claims in the lawsuit in exchange for mutual releases and dismissal with prejudice of the complaint upon court approval of the settlement. In February 2020, we subsequently entered into a Stipulation and Agreement of Settlement (the “Settlement Agreement”) with certain named plaintiffs on terms and conditions that were consistent with the MOU. Pursuant to the Settlement Agreement, among other things, (i) we contributed $350 million in cash to a settlement fund that will be used to pay all settlement fees and expenses, attorneys’ fees and expenses, and cash payments to members of the settlement class and (ii) the settlement class has agreed to release us, the other defendants named in the class action, and certain of their respective related parties from any and all claims concerning, based on, arising out of, or in connection with the class action. The Settlement Agreement contained no admission of liability, wrongdoing, or responsibility by any of the parties. On June 30, 2020, the Arizona District Court entered an order granting final approval of the settlement and dismissed the Class Action with prejudice.
•Our failure to obtain raw materials and components that meet our quality, quantity, and cost requirements in a timely manner could interrupt or impair our ability to manufacture our solar modules or increase our manufacturing costs. Accordingly, we may enter into long-term supply agreements to mitigate potential risks related to the procurement of key raw materials and components, and such agreements may be noncancelable or cancelable with a significant penalty. For example, we have entered into long-term supply agreements for the purchase of certain specified minimum volumes of substrate glass and cover glass for our PV solar modules. Our actual purchases under these supply agreements are expected to be approximately $2.4 billion of substrate glass and $500 million of cover glass. We have the right to terminate these agreements upon payment of specified termination penalties (which are up to $430 million in the aggregate and decline over time during the respective supply periods).
•The balance of our solar module inventories and BoS parts was $457.0 million as of September 30, 2020. As we continue to develop our advanced-stage project pipeline, we must produce solar modules in volumes sufficient to support our planned construction schedules. As part of this development and construction cycle, we typically produce these inventories in advance of receiving payment for such materials, which
may temporarily reduce our liquidity. Once solar modules and BoS parts are installed in a project, they are classified as either project assets, PV solar power systems, or cost of sales depending on whether the project is subject to a definitive sales contract and whether other revenue recognition criteria have been met. We also produce significant volumes of modules for sale directly to third-parties, which requires us to carry inventories at levels sufficient to satisfy the demand of our customers and the needs of their projects, which may also temporarily reduce our liquidity.
•We may commit significant working capital over the next several years to advance the construction of various U.S. systems projects or procure the associated modules or BoS parts, by specified dates, for such projects to qualify for certain federal investment tax credits (“ITC”). Among other requirements, such credits require projects to have commenced construction in 2020, which may be achieved by certain qualifying procurement activities, to receive a 26% investment tax credit. The credit will step down to 22% for projects that commence construction in 2021, and will further step down to 10% for projects that commence construction thereafter.
Cash Flows
The following table summarizes key cash flow activity for the nine months ended September 30, 2020 and 2019 (in thousands):
Nine Months Ended September 30,
2020
2019
Net cash used in operating activities
$
(149,198)
$
(607,492)
Net cash provided by (used in) investing activities
116,322
(54,635)
Net cash (used in) provided by financing activities
(98,196)
81,742
Effect of exchange rate changes on cash, cash equivalents and restricted cash
1,251
(6,732)
Net decrease in cash, cash equivalents and restricted cash
$
(129,821)
$
(587,117)
Operating Activities
The decrease in net cash used in operating activities was primarily driven by higher cash proceeds from the sale of systems projects in Japan and the United States, partially offset by the $350 million settlement payment associated with our prior class action lawsuit as described above and the timing of cash receipts from certain third-party module sales, for which proceeds were received in late 2019 prior to the step down in the U.S. investment tax credit.
Investing Activities
The increase in net cash provided by investing activities was primarily due to lower purchases of property, plant and equipment.
Financing Activities
The increase in net cash used in financing activities was primarily due to the repayment of the Ishikawa Credit Agreement, partially offset by proceeds from borrowings under project specific debt financings associated with the construction of certain projects in Japan.
Our contractual obligations have not materially changed since December 31, 2019 with the exception of borrowings under project specific debt financings and other changes in the ordinary course of business. See Note 9. “Debt” to our condensed consolidated financial statements for more information related to the changes in our long-term debt. See also our Annual Report on Form 10-K for the year ended December 31, 2019 for additional information regarding our contractual obligations.
Off-Balance Sheet Arrangements
As of September 30, 2020, we had no off-balance sheet debt or similar obligations, other than financial assurance related instruments, which are not classified as debt. We do not guarantee any third-party debt. See Note 10. “Commitments and Contingencies” to our condensed consolidated financial statements for further information about our financial assurance related instruments.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes to the information previously provided under Item 7A. of our Annual Report on Form 10-K for the year ended December 31, 2019.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our “disclosure controls and procedures” as defined in Exchange Act Rule 13a-15(e) and 15d-15(e). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2020 our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
We also carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of our “internal control over financial reporting” as defined in Exchange Act Rule 13a-15(f) and 15d-15(f) to determine whether any changes in our internal control over financial reporting occurred during the three months ended September 30, 2020 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there were no such changes in our internal control over financial reporting that occurred during the three months ended September 30, 2020 despite the fact that many of our associates are working remotely due to the COVID-19 pandemic. We continue to monitor and assess the COVID-19 situation on our internal controls to minimize potential impacts on their design and operating effectiveness.
CEO and CFO Certifications
We have attached as exhibits to this Quarterly Report on Form 10-Q the certifications of our Chief Executive Officer and Chief Financial Officer, which are required in accordance with the Exchange Act. We recommend that this Item 4. be read in conjunction with those certifications for a more complete understanding of the subject matter presented.
Control systems, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems’ objectives are being met. Further, the design of any system of controls must reflect the fact that there are resource constraints, and the benefits of all controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of error or mistake. Control systems can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Note 10. “Commitments and Contingencies” under the heading “Legal Proceedings” of our condensed consolidated financial statements for legal proceedings and related matters.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019, which could materially affect our business, financial condition, results of operations, or cash flows. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently consider immaterial may also materially adversely affect our business, financial condition, results of operations, or cash flows. Except for the risk factors set forth below, there have been no material changes in the risk factors contained in our Annual Report on Form 10-K.
COVID-19 and other public health crises could materially impact our business, financial condition, and results of operations.
The COVID-19 pandemic has continued to have an unprecedented impact on the United States, Malaysia, and other countries throughout the world, including those in which we do business or have operations. Although as of the date of this filing, we have not been materially impacted by COVID-19, the pandemic could materially impact our business, financial condition, and results of operations in the future. The extent to which the pandemic could impact us continues to be highly uncertain and cannot be predicted, and will depend largely on subsequent developments, including the severity and duration of the pandemic, measures taken to contain the spread of the virus, such as restrictions on travel and gatherings of people and temporary closures of or limitations on businesses and other commercial activities, and policies implemented by governmental authorities to ease restrictions in a phased manner.
As a result of the COVID-19 pandemic and these related containment measures and reopening policies, we may be subject to significant risks, which have the potential to materially and adversely impact our business, financial condition, and results of operations, including the following:
•The continued economic disruption caused by the COVID-19 pandemic may result in a long-term tightening of the supply of capital in global financial markets (including, in the United States, a reduction in total tax equity availability), which could make it difficult for purchasers of our modules or our
development projects to secure the debt or equity capital necessary to finance a PV solar power system, thereby delaying or reducing demand for our modules or these projects;
•Purchasers of PV modules may delay module procurement in response to the COVID-19 pandemic, which may result in additional pressure on global demand and average selling prices for modules, and may exacerbate structural imbalances between global PV module supply and demand;
•We may at any time be ordered by governmental authorities, or we may determine, based on our understanding of the recommendations or orders of governmental authorities, that we have to curtail or cease business operations or activities, including manufacturing;
•The failure of our suppliers or vendors to supply materials or equipment, or the failure of our vendors to install, repair, or replace our specialized equipment, due to the COVID-19 pandemic, related containment measures, or limitations on logistics providers’ ability to operate, may idle, slowdown, shutdown, or otherwise cause us to adjust our manufacturing capacity. We have incurred manufacturing charges associated with the ongoing COVID-19 pandemic;
•The COVID-19 pandemic and related containment measures may result in us incurring delays in obtaining, or failing to obtain, the approvals or rights that are required for our development projects to proceed, such as permitting, interconnection, or land usage approvals or rights, and the COVID-19 pandemic and related containment measures may delay or prevent the performance by third parties of activities related to the development of these projects, such as interconnection, engineering, procurement, construction, and other activities;
•We perform substantial R&D to continue to improve our module wattage (or conversion efficiency), lower our module cost per watt, lower the LCOE of our PV solar power systems, and otherwise keep pace with technological advances in the solar industry. The COVID-19 pandemic and related containment measures, including the unavailability of our personnel and third-party partners who are engaged in R&D activities, may inhibit our R&D efforts or our ability to timely advance or commercialize these efforts; and
•In response to the COVID-19 pandemic, the vast majority of our associates who are capable of performing their function remotely are telecommuting (i.e., working from home). While we have instituted security measures to minimize the likelihood and impact of a cybersecurity incident with respect to associates utilizing technological communications tools, these measures may be inadequate to prevent a cybersecurity breach because of the unprecedented number of associates continuously using these tools. Recently, there have been reports of a surge in widespread cyber-attacks during the COVID-19 pandemic. Any increase in the frequency or scope of cyber-attacks during the COVID-19 pandemic may exacerbate the aforementioned cybersecurity risks.
If the severity and duration of the COVID-19 pandemic does not abate and related containment measures are not lifted, are eased more slowly than anticipated, or are reinstituted, many of the other risks described in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019 may have a significant impact on our business, financial condition, and results of operations.
The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or other adverse public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar modules and systems and limit our growth or lead to a reduction in our net sales, thereby adversely impacting our operating results.
Although we believe that solar energy will experience widespread adoption in those applications where it competes economically with traditional forms of energy without any support programs, in certain markets our net sales and profits remain subject to variability based on the availability and size of government subsidies and economic incentives. Federal, state, and local governmental bodies in many countries have provided subsidies in the form of feed-in-tariffs, rebates, tax incentives, and other incentives to end users, distributors, system integrators, and manufacturers of PV solar products. Many of these support programs expire, phase out over time, require renewal by the applicable authority, or may be amended. A summary of certain recent developments in the major government support programs that may impact our business appears under Item 1. “Business – Support Programs” of our Annual Report on Form 10-K. To the extent these support programs are reduced earlier than previously expected or are changed retroactively, such changes could negatively impact demand and/or price levels for our solar modules and systems, lead to a reduction in our net sales, and adversely impact our operating results. Another consideration in the U.S. market, and to a lesser extent in other global markets, is the effect of governmental land-use planning policies and environmental policies on utility-scale PV solar development. The adoption of restrictive land-use designations or environmental regulations that proscribe or restrict the siting of utility-scale solar facilities could adversely affect the marginal cost of such development.
In addition, policies of the U.S. presidential administration may create regulatory uncertainty in the renewable energy industry, including the solar industry, and our business, financial condition, and results of operations could be adversely affected. Members of the U.S. presidential administration, including representatives of the U.S. Department of Energy, have made public statements that indicate that the administration may not be supportive of various clean energy programs and initiatives designed to curtail climate change. For example, in June 2017, the U.S. President announced that the United States would withdraw from participation in the 2015 Paris Agreement on climate change mitigation. In addition, the administration has indicated that it may be supportive of overturning or modifying policies of or regulations enacted by the prior administration that placed limitations on gas and coal electricity generation, mining, and/or exploration. Additionally, in October 2017, the United States Environmental Protection Agency (“U.S. EPA”) issued a Notice of Proposed Rulemaking, proposing to repeal the previous U.S. presidential administration’s Clean Power Plan (“CPP”), which established standards to limit carbon dioxide emissions from existing power generation facilities. In June 2019, the U.S. EPA issued the final Affordable Clean Energy (“ACE”) rule and repealed the CPP. Under the ACE rule, emissions from electric utility generation facilities would be regulated only through the use of various “inside the fence” or onsite efficiency improvements and emission control technologies. In contrast, the CPP would have allowed facility owners to reduce emissions with “outside the fence” measures, including those associated with renewable energy projects. While the ACE rule is currently subject to legal challenges and may be subject to future challenges, the ultimate resolution of such challenges, and the ultimate impact of the ACE rule, is uncertain. As a result of the new ACE rule and other policies or actions of the current U.S. administration and/or the U.S. Congress, we may be subject to significant risks, including the following:
•a reduction or removal of clean energy programs and initiatives and the incentives they provide may diminish the market for future solar energy off-take agreements, slow the retirement of aging fossil fuel plants, including the retirements of coal generation plants, and reduce the ability for solar project developers to compete for future solar energy off-take agreements, which may reduce incentives for such parties to develop solar projects and purchase PV solar modules;
•any limitations on the value or availability to potential investors of tax incentives that benefit solar energy projects such as the ITC and accelerated depreciation deductions could result in such investors generating reduced revenues and economic returns and facing a reduction in the availability of affordable financing,
thereby reducing demand for PV solar modules. The ITC is a U.S. federal incentive that provides an income tax credit to the owner of the project after the project is placed in service. Among other requirements, such credits require projects to have commenced construction by a certain date, which may be achieved by certain qualifying procurement activities. Accordingly, projects that commenced construction in 2019 were eligible for a 30% ITC. The credit will step down to 26% for projects that commence construction in 2020, 22% for projects that commence construction in 2021, and 10% for projects that commence construction thereafter. Under the Modified Accelerated Cost-Recovery System, owners of equipment used in a solar project may claim all of their depreciation deductions with respect to such equipment over five years, even though the useful life of such equipment is generally greater than five years. In addition, in December 2017, the U.S. government enacted comprehensive tax reform legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). Under the Tax Act, qualified property placed in service after September 22, 2017 and before January 1, 2023 is generally eligible for 100% expensing, and such property placed in service after December 31, 2022 and before January 1, 2027 is generally eligible for expensing at lower percentages. However, the Tax Act also reduced the U.S. corporate income tax rate to 21% effective January 1, 2018, which could diminish the capacity of potential investors to benefit from incentives such as the ITC and reduce the value of accelerated depreciation deductions and expensing, thereby reducing the relative attractiveness of solar projects as an investment; and
•any effort to overturn federal and state laws, regulations, or policies that are supportive of solar energy generation or that remove costs or other limitations on other types of electricity generation that compete with solar energy projects could negatively impact our ability to compete with traditional forms of electricity generation and materially and adversely affect our business.
Application of U.S. trade laws, or trade laws of other countries, may also impact, either directly or indirectly, our operating results. For example, in January 2018, following a petition filed by a U.S.-based manufacturer of solar cells under Sections 201 and 202 of the Trade Act of 1974 for global safeguard relief with the U.S. International Trade Commission (the “USITC”), requesting, among other things, the imposition of certain tariffs on crystalline silicon solar cells imported into the United States and the establishment of a minimum price per watt on imported crystalline silicon solar modules, the U.S. President proclaimed tariffs on imported crystalline silicon modules, and a tariff-rate quota on imported crystalline silicon cells, over a four-year period, with the tariff on modules, and the tariff on cells above the first 2.5 GWDC of imports, starting at 30% for the February 2018 to February 2019 period and declining by five percentage points in each subsequent 12-month period. Thin film solar cell products, such as our CdTe technology, are expressly excluded from the tariffs. The Office of the United States Trade Representative (the “USTR”) has also granted certain requests that particular types of solar products be excluded from the tariffs. Among these was an exclusion for bifacial solar modules that was issued in June 2019. In October 2019, the USTR announced that it would withdraw the exclusion for bifacial solar modules. However, in December 2019, the United States Court of International Trade (the “Trade Court”) overturned the announcement by issuing a preliminary injunction ordering the exclusion of bifacial solar modules from the tariffs. In January 2020, the USTR announced a public comment process regarding the possible retention or withdrawal of the exclusion for bifacial solar modules, and the USTR received public comments in February 2020. In April 2020, the U.S. Government informed the Trade Court that the USTR issued a determination for publication in the U.S. Federal Register that the USTR would withdraw the exclusion for bifacial solar modules if the court lifts the preliminary injunction, but in no case earlier than 30 days from the determination’s publication in the Federal Register. In May 2020, the Trade Court denied the U.S. Government’s motions to dismiss the action challenging the October 2019 withdrawal of the exclusion for bifacial solar modules and to dissolve the preliminary injunction. In a Federal Register notice published in June 2020, the USTR announced that the October 2019 withdrawal had been rescinded and superseded by the USTR’s April 2020 determination to withdraw the exclusion for bifacial solar modules. On October 15, 2020, the Trade Court denied the U.S. Government’s renewed motion to dissolve the preliminary injunction, modified the preliminary injunction to cover the USTR’s April 2020 determination, and vacated the USTR’s October 2019 withdrawal. In addition, on October 10, 2020, the U.S. President issued a proclamation entitled “Proclamation to Further Facilitate Positive Adjustment to Competition From Imports of Certain Crystalline Silicon Photovoltaic
Cells” (the “October 10 Proclamation”). In the October 10 Proclamation, the U.S. President stated, among other things, that the exclusion for bifacial solar modules would be revoked, effective October 25, 2020; that the tariff rate on imports covered by the solar safeguard action would be increased from 15% to 18% for the fourth year of the safeguard measure; and that the USTR is authorized to request that the USITC conduct an investigation under Section 204(c) of the Trade Act of 1974. A USITC investigation under Section 204(c) is one of the steps that would be required to extend the solar safeguard action beyond its current four-year term. On October 24, 2020, the Trade Court issued an order temporarily restraining the U.S. Government from enforcing the October 10 Proclamation’s revocation of the exclusion for bifacial solar modules, and the court is considering motions to modify the existing preliminary injunction to cover the October 10 Proclamation. It is unknown whether, or when, the U.S. Government would be permitted to enforce the October 10 Proclamation.
The United States has also imposed import tariffs in connection with other proceedings during 2018, 2019, and 2020. In March 2018, the U.S. President proclaimed tariffs on certain imported aluminum and steel articles, generally at rates of 10% and 25%, respectively, under Section 232 of the Trade Expansion Act of 1962. Currently, all countries except Argentina, Australia, Canada, and Mexico are covered by the aluminum tariff, and all countries except Argentina, Australia, Brazil, Canada, Mexico, and South Korea are covered by the steel tariff. In addition, in May 2018, the U.S. President proclaimed absolute quotas for the import of aluminum articles from Argentina and the import of steel articles from Argentina, Brazil, and South Korea. In January 2020, the U.S. President announced the expansion of tariffs under Section 232 to cover certain derivative steel and aluminum articles. Separately, in a series of actions during 2018 and 2019 that followed an investigation under Section 301 of the Trade Act of 1974, the United States imposed tariffs on various articles imported from China at a rate of 25%, including crystalline silicon solar cells and modules and various other articles. In August 2019, the U.S. President announced that the Section 301 tariff on various products, including crystalline silicon solar cells and modules, would increase to 30%, but such increase was later postponed in connection with U.S.-China negotiations. In December 2019, the United States and China announced a “Phase One” economic and trade agreement, whereby the U.S. Section 301 tariffs on various products, including crystalline silicon solar cells and modules, remained at 25%, while Section 301 tariffs on certain other products were lowered from 15% to 7.5%. In March 2020, the USTR granted Section 301 tariff exclusions for certain medical-care products related to the U.S. response to COVID-19, and it has requested public comments on possible exclusions for additional medical-care products. Since then, the USTR has announced additional Section 301 tariff exclusions, including for non-medical care products, although most exclusions are set to expire by the end of 2020.
On October 2, 2020, the USTR initiated two new investigations under Section 301 of the Trade Act of 1974 concerning Vietnam’s acts, policies, and practices related to currency valuation and illegal timber, respectively, and it has requested public comments by November 12, 2020. It is unknown whether these investigations will result in U.S. import tariffs on Vietnamese goods, but tariffs on our solar modules imported from Vietnam could negatively impact our business. We will continue to closely monitor these investigations.
In May 2020, the United States undertook new initiatives relating to trade and commerce in the energy sector. On May 1, 2020, the U.S. President issued an executive order prohibiting various types of transactions (including acquisition, importation, and transfer) that are initiated after May 1, 2020 and involve bulk-power system electric equipment and any property in which any foreign country or a national thereof has any interest. The prohibition applies where the U.S. Secretary of Energy, in consultation with other officials, has determined that a transaction (i) involves bulk-power system electric equipment designed, developed, manufactured, or supplied by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary, and (ii) poses certain types of risks to U.S. interests. The May 1, 2020 executive order instructs the U.S. Secretary of Energy to publish implementing rules or regulations, which are expected to be issued in late 2020. We are evaluating the potential impact on our business of the May 1, 2020 executive order and the U.S. government actions it contemplates, and our evaluation will be informed by the implementing rules or regulations to be published by the U.S. Secretary of Energy. In addition, on May 4, 2020, the U.S. Secretary of Commerce announced the initiation of an investigation, under Section 232 of the Trade Expansion Act of 1962, into whether laminations for stacked cores for incorporation into transformers, stacked and wound cores for incorporation into transformers, electrical transformers, and
transformer regulators are being imported into the United States so as to threaten to impair U.S. national security. The U.S. Secretary of Commerce has 270 days from the initiation of the investigation to report findings and any recommendations to the U.S. President, and if a threat to national security is found, the U.S. President then has 90 days to decide whether to take action, such as the imposition of tariffs, to adjust imports of the products at issue. We are evaluating the potential impact on our business of U.S. government action that could result from this U.S. Secretary of Commerce investigation.
Internationally, in July 2018, the Indian government imposed a safeguard duty regime on solar cells and modules imported from various countries, including member countries of the Organisation for Economic Co-operation and Development (“OECD”), China, and Malaysia, for a two-year period, starting at 25% through July 2019 and declining by five percentage points in each subsequent six-month period. In July 2020, the Indian government announced an extension to the safeguard duty regime at a revised rate of 14.9% through December 2020 and declining to 14.5% through July 2021. These duties are applicable to imports from member countries of the OECD, China, Vietnam, and Thailand, but imports from Malaysia have been exempted from the revised safeguard duty regime. In addition, in March 2019, the Indian government issued technical guidelines related to the enlistment of approved models and manufacturers of PV solar modules, pursuant to which all projects owned by the Indian government or from which energy would be supplied to the government would be required to procure eligible components from such enlisted manufacturers. The enlistment procedures have certain distinguishing criteria depending on whether a manufacturer is located inside or outside of India, which may inhibit or restrict our ability to access the Indian market. While the effective date of this regulation was due to take effect in March 2020, in response to the COVID-19 pandemic, the effective date of this regulation has been deferred and a new effective date is expected to be announced in late 2020. Such tariffs and policies, or any other U.S. or global trade remedies or other trade barriers, may directly or indirectly affect U.S. or global markets for solar energy and our business, financial condition, and results of operations.
These examples show that established markets for PV solar development face uncertainties arising from policy, regulatory, and governmental constraints. While the expected potential of the markets we are targeting is significant, policy promulgation and market development are especially vulnerable to governmental inertia, political instability, the imposition of trade remedies and other trade barriers, geopolitical risk, fossil fuel subsidization, potentially stringent localization requirements, and limited available infrastructure.
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*This exhibit shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in such filings.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
