First Solar, Inc. Q3 FY2021 Earnings Call

Good afternoon everyone and welcome to First Solar's Third Quarter 2021 Earnings Call. This call is being webcast live on the Investors Section of First Solar's website at investor.firstsolar.com. At this time, all participants are in a listen-only mode. As a reminder, today's call is being recorded. I would now like to turn the call over to Mitch Ennis from First Solar Investor Relations. Mr. Ennis, you may begin.

Thank you. Good afternoon everyone and thank you for joining us. Today the company issued a press release announcing its third quarter 2021 financial results. A copy of the press release and associated presentation are available on First Solar's website at investor.firstsolar.com. With me today are Mark Widmar, Chief Executive Officer; and Alex Bradley, Chief Financial Officer. Mark will begin by providing a business and technology update. Alex will then discuss our financial results for the quarter and provide updated guidance for 2021. Following their remarks, we will open the call for questions. Please note this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management's current expectations including among other risks and uncertainties the severity and duration of the effects of the COVID-19 pandemic. We encourage you to review the safe harbor statements contained in today's press release and presentation for a more complete description. It is now my pleasure to introduce Mark Widmar Chief Executive Officer. Mark?

Thank you, Mitch. Good afternoon and thank you for joining us today. Beginning on slide three, I would like to start by thanking the First Solar team for their dedication and continuing execution. Operationally, despite the challenging freight and COVID-19 environment, our associates continue to deliver on their commitments. In the third quarter, we produced over two gigawatts of modules and in October, we increased our top production bin to 465 watts, which represents a 19% glass area efficiency. In parallel, we started construction of the building of our third Ohio factory and began ordering equipment for our first factory in India. Commercially, we had a good quarter increasing our record year-to-date bookings to 10.5 gigawatts. From a financial perspective, while Q3 freight costs were higher than anticipated, our full year sales freight expectation is unchanged. Shipments, which we generally define as when the delivery process to a customer commences and the module leaves one of our factories, totaled 2.1 gigawatts in Q3, which was only modestly below our expectations. Despite this total shipment result, the global freight market continues to experience record levels of scheduled delays and reliability issues. As a result, approximately 820 megawatts of modules shipped remained in transit at quarter end, nearly double that of the preceding four quarters and were therefore not recognized as revenue in the quarter. While we expect extended transit times to continue, we anticipate our in-transit volumes to improve in Q4 as a high percentage of our shipments are expected to come from our Perrysburg factory and US distribution centers. As a result, we reiterate our full year 2021 EPS guidance. Turning now to slide four, I'll provide an update on our expansion plans. As it relates to our US expansion, we started construction in mid-August after a successful groundbreaking ceremony, which included bipartisan representation from state and federal government including Secretary of Labor, Marty Walsh. As we continue this expansion journey, we're proud to be at the forefront of America's solar manufacturing, supporting domestic energy independence and creating good-paying middle-class jobs that will be here for years to come. Looking forward with a vertically integrated manufacturing process and a differentiated CadTel technology, we are uniquely positioned to expand our leadership role as the largest PV module manufacturer in the United States and support the nation's climate objectives. With construction underway and our schedule on target, we expect to commence initial production at the 3.3 gigawatt factory in the first half of 2023. In September, I had the privilege of meeting Prime Minister Modi in Washington D.C. to discuss India's long-term climate objectives and focus on energy independence and security, as well as opportunities for technology leadership in India. Through an ambitious target of 300 gigawatts of installed solar capacity by the end of this decade, paired with a holistic industrial and trade policy, India has created a supportive environment for companies seeking to manufacture renewable energy in the country. We commend the Indian government for its leadership and believe that if every country were to take bold steps like India, our collective ability to achieve the targets within the Paris Agreement would be well within reach. With this backdrop in mind, we are excited to be expanding our manufacturing footprint into India. Overall, the site preparation is complete and we started to order equipment and the schedule is on track with the 3.3 gigawatt factory expected to commence initial production by the end of 2023. Turning to Slide 5. I'll now provide COVID-19, manufacturing, supply chain and cost updates. As a global company, we have demonstrated disciplined execution, agility and a steadfast commitment to health and safety throughout the pandemic. Reflective of this approach, we have been able to maintain capacity utilization, excluding planned downtime of over 100%. Despite the challenging COVID-19 environment in Vietnam and Malaysia, our Vietnam-based manufacturing associates have been essential in the success by electing to remain on site in order to ensure manufacturing continuity. While this very challenging period of on-site quarantine ended in late October, we acknowledged our team's resiliency, ingenuity and incredible dedication to the company's mission. Through the strength of our global associates, we continue to execute our bill of material strategically and navigate the current environment as reflected by the manufacturing performance metrics on Slide 5. While we've delivered against our near-term production commitments, travel and other COVID-19 restrictions have added constraints on getting third-party equipment installers as well as our US-based associates into Malaysia and Vietnam to perform the planned product throughput and efficiency upgrades. We have continued to work with relevant agencies to support this essential travel in a safe manner. However, the timing of upgrading our last factory in Vietnam to Series 6 Plus is now expected to be completed in Q2 of next year. While I will provide a holistic update on our CuRe program later in the call, the aforementioned factors have contributed to impact the implementation timing in Malaysia and Vietnam. Consistent with our expectation from a prior earnings call, the ocean freight market globally has remained challenging due to ongoing port congestion, limited container availability, historically poor schedule reliability, higher fuel costs and other events. While shipping rates have increased since the July call, we had accounted for this expectation in our previous full year sales rate guidance which remains unchanged. As highlighted in our prior earnings call, we continue to partially mitigate the effects of higher sales rates per watt through implementation and improvements in module efficiency, utilization of our US distribution network and freight-sharing contractual arrangements with our customers which cover a portion of expected 2022 deliveries. Despite these mitigating factors, the challenging freight environment has adversely impacted our financial results. And while we have been able to maintain our global module gross margin guidance for 2021, we expect freight costs to remain at current elevated levels into 2022. I would next like to provide an update on our variable bill of material spend. Although spot prices for aluminum have continued to rise since the July earnings call, we have had a commodity swap contract in place which covers the majority of our US consumption through Q4. Going forward and for our domestic and international manufacturing sites, we have several strategies and processes to reduce framing costs in the near to mid-term. Firstly, by differentiating the frame design and reducing the cost of modules installed in the interior versus exterior of the array; secondly by optimizing the mounting interface of our next-generation module; and finally evaluating alternative materials for the construction of our frame. From a glass perspective, we have largely hedged this cost through long-term fixed price agreements with domestic suppliers that have volumetric pricing benefits as we achieve higher levels of production. While cost uncertainty remains for certain bill of material items, our targeted 3% cost per watt sold reduction including sales rate between where we ended 2020 and expect to end 2021 is unchanged from the prior earnings call. As we mentioned, while sales rates remain elevated in excess of pre-pandemic levels, we have accounted for this in our guidance update during the previous earnings call. Regarding our end-of-year cost per watt produced target, we expect to face challenges primarily due to COVID-related delays impacting the start-up of a new glass cover factory to support our Malaysia and Vietnam factories. Additionally, we expect higher adhesive costs due to supply chain disruptions in China and a mix shift of production to higher-cost exterior modules to support projects in high wind zones. As a result of these factors, our revised year-end cost per watt produced reduction target is 5% when compared to the prior year. Given the majority of modules produced during the fourth quarter are expected to be recognized as revenue next year, this cost per watt produced headwind is not expected to impact our 2021 P&L. In aggregate, despite these near-term cost pressures, our multi-year midterm targets to reduce Series 6 bill material costs by 20% to 25% remain on track. In the United States, there are a number of items in the mix as it relates to industrial policy, trade policy, and importation. While the outcome of these items remains uncertain, we continue to believe the Biden/Harris administration has a unique opportunity to produce a comprehensive strategy for solar that could include a mix of manufacturing tax credits, an extension of the investment tax credit with the domestic content requirement and enforcement of responsible solar among other strategies. Through a long-term strategic approach to policy, the administration has the opportunity to create an environment that not only helps secure America's sustainable energy future in a manner that reflects our country's values and principles, but also fosters innovation for the next generation of PV to be developed and manufactured in the United States. As it relates to trade policy, we continue to monitor developments related to the petition to extend Section 201 tariffs and to investigate whether certain solar manufacturers have circumvented antidumping and countervailing duties. As it relates to importation, we have repeatedly and unequivocally condemned the reported use of forced labor in the crystalline silicon PV supply chain. We continue to do so, as long as it remains an issue. During the previous earnings call, we indicated that this issue necessitates swift and resolute action, but also emphasized that it should present an impetus for the United States and like-minded nations to separate their climate goals from the over-reliance on one country and one PV technology. No country should be forced to choose between fighting climate change and standing up for its principles such as safeguarding human rights and securing energy independence. While we acknowledge the challenges presented by the withhold release order issued by the U.S. Customs and Border Protection in June of this year, there are practical commercial solutions to reduce the risk of purchasing modules associated with forced labor and uncertain trade policy outcomes. For example, one of our peers has recently established a vertically integrated supply chain from polysilicon to module assembly outside of China without direct or indirect ties to Xinjiang. While this is a small step and only impacts a portion of the overall operation, we believe it is a meaningful step in the right direction. Two essential attributes of PV power plants are their environmental benefits and their zero ongoing fuel consumption as compared to thermal generation. While the economic competitiveness of solar continues to drive an acceleration of global adoption, many international markets including China rely on coal-fired power for the majority of their electricity generation. Due to supply chain challenges and geopolitical factors, China is experiencing a coal shortage that has resulted in higher energy prices and government-mandated power restrictions against parts of the manufacturing sector. Given the majority of global polysilicon capacity is located in Mainland China, higher coal costs, mandated reductions in energy consumption, and reduced operating capacity have further exacerbated the supply and demand imbalance in the polysilicon market, contributing to an ongoing increase in pricing for both polysilicon and solar modules. This coupled with the challenging freight environment has caused many Chinese-based manufacturers to prioritize availability of solar module supply to the local market, where the major investors in utility-scale solar are the country's state-owned enterprises. This is yet another potent reminder of the risk of having climate goals tethered to supply chains that lead to a single nation in PV technology, and demonstrates the irony of America's clean energy transition currently being hindered by reliance on coal to produce crystalline silicon solar modules. Turning to slide 6, I'll next discuss our most recent bookings in greater detail. We had a good quarter with bookings of 1.5 gigawatts since the previous earnings call. After accounting for shipments of approximately 2.1 gigawatts during the third quarter, our future expected shipments which extend into 2024 are 16.5 gigawatts. Including our year-to-date bookings, we are sold out for 2022 at 4.2 gigawatts of planned deliveries in 2023 and 0.3 gigawatts in 2024. While our energy quality and environmental advantages are all key differentiators, customers have been placing a premium on our vertically integrated manufacturing process, supply chain transparency, and zero tolerance for the use of forced labor in our supply chain. We are seeing our value proposition drive interest in multiyear framework agreements. With a robust and several active negotiations with customers in the United States and India for multiyear and multi-gigawatt agreements, we are pleased with the robust demand for our CadTel technology. At the time of our previous earnings call, we had indicated the ASP across our volume for potential deliveries in 2023 was 1% lower than the volume to be shipped in 2022. Including our incremental bookings since the previous earnings call, our 2023 ASP is largely unchanged. In summary, we have seen a significant increase in the desire to work with First Solar due to our differentiated value proposition of more value with less work. While many of our crystalline silicon competitors have reportedly canceled deliveries, prioritized shipments into the domestic Chinese market, and have openly requested price increases and delayed shipments, we however continue to stand behind our contractual commitments. With this backdrop in mind, we are seeing bookings momentum with customers who value our technology advantages, the benefits of domestically produced products, and our responsible solar principles. Additionally, as reflected on slide 7, our pipeline of future opportunities also remains robust. Our total bookings opportunities is 45 gigawatts with 21 gigawatts in mid to late-stage customer engagement. Note our capacity expansion in India and the related increase in available supply to meet projected domestic demand has increased our bookings opportunity in India to over 17 gigawatts, a 10 gigawatt increase since our Q2 earnings call. Before turning the call over to Alex, I would like to provide an update on our technology road map. Looking forward, CuRe represents an anticipated enhancement to our module performance, which is expected to increase efficiency and reduce long-term degradation. On the April earnings call, we indicated the CuRe lead line implementation was anticipated by Q4 of 2021 and fleet-wide by the end of Q1 2022. On the July call, we indicated CuRe implementation in Vietnam required international travel from third-party equipment installers as well as our US-based associates. Regarding Malaysia, we were in the process of implementing the required CuRe upgrades, but not all have been completed as of the end of the July call. In July through September COVID-19 cases began to significantly increase as the Delta variant spread and government restrictions were put in place in parts of Southeast Asia. As it relates to our CuRe development program, we have demonstrated the product's full performance entitlement in a lab setting and are currently working to translate this potential into high-volume production in Ohio. While this trend for improving module wattage and degradation appears favorable, we are still working to realize the full performance entitlement in high-volume manufacturing conditions. We are continuing to refine our production parameters in order to bridge this gap relative to the program objectives for CuRe. As a result of the aforementioned challenges, our integration schedule is delayed and we have revised our integration schedule to the lead line implementation by the end of Q1 2022. Fleet-wide replication timing will be determined upon completion of the implementation of the lead line and factory equipment upgrades required for CuRe. While CuRe has been delayed, this presents a window of opportunity to leverage the optionality in our technology road map and demonstrate the resiliency of our vertically integrated manufacturing process. Through product enhancements to our current Series 6 technology, we have increased our top production bin to 465 watts which represents a 19% glass area efficiency and produced over 125 megawatts with 460-watt modules during October. In addition to improved efficiency in module wattage, Series 6 is expected to have a significantly improved long-term degradation rate. Using improved metrology to measure degradation at our test sites and further validated by third-party analytical methods and customer site data, the current Series 6 platform is expected to have a 30-year degradation rate of 0.3% per year, which is 40% below our previous expectation. While the improved Series 6 nameplate wattage is in line with our target to exit 2021 with a top production bin of 460 to 465 watts, its energy performance including a slightly higher long-term degradation rate and higher temperature coefficient is below the expected performance of CuRe. In connection with our CuRe obligation starting in Q1 of next year, we have either amended or will endeavor to amend certain customer contracts utilizing CuRe technology by substituting our Enhanced Series 6 product. In connection with these customer contract amendments we may make certain price concessions. We currently estimate that the price concessions that we will potentially make across the impact of customer contracts will not exceed approximately $100 million of 2022 revenue. Despite these challenges, we are encouraged by the promise of CuRe technology. Through the relentless focus and persistence of our manufacturing technology teams, we believe CuRe's performance on the manufacturing line will continue to improve. We will discuss the full year 2022 impacts during our fourth quarter earnings call. I'll now turn the call over to Alex, who will discuss our third quarter financial and 2021 guidance.

Thanks, Mark. Starting on Slide 8, I'll cover the income statement highlights for the third quarter. Net sales in Q3 were $584 million, a decrease of $46 million compared to the prior quarter. The decrease in net sales was primarily due to lower systems segment revenue, which was partially offset by an increase in module segment revenue. On a segment basis, our module segment revenue in Q3 was $563 million compared to $543 million in the prior quarter. Systems segment gross margin in Q3 was $6 million, which was largely driven by a favorable settlement related to a legacy systems project. Module segment gross margin was 21% in Q3 compared to 20% in Q2. There are several positive and negative factors that impacted this Q3 result. Firstly, we recorded a reduction in our product warranty liability, which was primarily due to lower claims than previously estimated for our Series 2 and Series 6 modules. This resulted in a $33 million reduction of our warranty liability, a corresponding benefit to cost of sales. Secondly, certain of our legacy module sale agreements are covered by a collection and recycling program, where a corresponding expense to the estimated future cost of our obligation was recognized at the time of sale. During Q3, we recognized an $11 million increase in our module collection and recycling liability due to changes in the expected value of certain recycling byproducts. Thirdly, as mentioned, we're in the process of implementing factory upgrades in 2021, which requires downtime resulting in lower production and underutilization. In Q3, our module segment gross margin was impacted by $6 million of underutilization. On a net basis, these factors increased module segment gross margin dollars and percent by $16 million and three percentage points respectively. Separately, while we continue to navigate and partially mitigate the effects of the dislocated shipping market, higher freight costs impacted our financial results for the quarter. In Q3, sales rate totaled approximately $67 million. Along with module warranty expense of approximately $1 million, sales rate and warranty reduced our module segment gross margin by approximately 12 percentage points. As a reminder, many of our module peers report freight costs as a separate operating expense. For comparison purposes, we encourage you to consider this factor when benchmarking our module gross margin relative to our peers. SG&A and R&D expenses totaled $69 million in the third quarter, an increase of approximately $9 million compared to the prior quarter. This increase was primarily driven by a $3 million impairment charge related to a certain project development in Japan, a $2 million increase in R&D expense predominantly related to CuRe testing and a lower net benefit of $2 million from reductions to our expected credit losses in Q3 as compared to Q2. Production startup, which is included in operating expenses, totaled $3 million in Q3 compared to $2 million in the prior quarter. Q3 operating income was $51 million, which included depreciation and amortization of $66 million, $9 million related to underutilization and production start-up expense and share-based compensation of $6 million. Recorded tax expense of $1 million in the third quarter compared to $20 million in Q2. The decrease in tax expense for Q3 is driven largely by lower pre-tax income, a shift in our jurisdictional mix of income, and lower estimated taxes in certain jurisdictions. The combination of the aforementioned items led to third quarter earnings per share of $0.42 and $3.16 for the first three quarters of 2021 on a diluted basis. Next, turn to Slide 9, to discuss balance sheet items and summary cash flow information. Our cash and cash equivalents marketable securities and restricted cash balance ended the quarter at $1.9 billion, a decrease of $111 million compared to the prior quarter. There are several factors impacting our quarter-end cash balance. Firstly, in Q1, we sold certain marketable securities associated with our module collection and recycling program for total proceeds of $259 million, which were presented as restricted cash on our balance sheet and were therefore included in our measure of total cash at the end of Q1 and Q2. During Q3, these proceeds were reinvested and are now represented on our balance sheet as restricted marketable securities which are not included in our measure of total cash. Secondly, net cash generated by operating activities was $305 million, which included collection of proceeds from a $65 million settlement agreement related to a legacy systems project that was reached in Q2. Finally, this was offset by capital expenditures of $165 million during Q3. Total debt at the end of the third quarter was $279 million, which was consistent with the prior quarter. As a reminder, all of our outstanding debt continues to be project-related and will come off our balance sheet when the corresponding project is sold. Our net cash position, which includes cash, cash equivalents, restricted cash and marketable securities less debt decreased by $111 million to $1.7 billion as a result of the aforementioned factors. Net working capital in Q3, which includes noncurrent project assets and excludes cash, cash equivalents, and marketable securities, decreased by $296 million compared to the prior quarter. This decrease was primarily driven by a reduction in accounts receivable related to the aforementioned settlement agreement collection of receivables related to prior project sales. Net cash generated by operating activities of $305 million in the third quarter compared to $177 million in the prior quarter, and capital expenditures were $165 million in the third quarter compared to $91 million in the prior quarter. Continuing on Slide 10, I'll discuss 2021 guidance. In comparison to our initial expectations coming into 2021, our year-to-date performance reflects the strength of the business model but also tremendous execution during the course of the year. While the effects of higher freight costs were partially offset by the aforementioned settlement related to our legacy systems project, our current earnings per share guidance is largely within the range we provided during the February earnings call. Relative to year-to-date EPS of $3.16 to $4.30 midpoint of our current full-year guidance implies fourth quarter EPS of $1.14 compared to $0.42 in the third quarter. There are several factors driving this quarter-over-quarter increase in earnings per share and our ability to reiterate our full-year 2021 EPS guidance. Firstly, approximately 820 megawatts of modules remained in transit at quarter end and were not recognized as revenue during Q3. While extended transit times impacted our Q3 results, we anticipate a significant portion of these modules will be recognized as revenue in early Q4. Driven by a strong start to the fourth quarter, we anticipate an increase in module volume sold during Q4. Secondly, while freight costs in Q4 are expected to remain above pre-pandemic levels, we had accounted for this expectation in the guidance we provided on the July earnings call. As a result, our sales rate guidance for full-year 2021 of 10 to 11 percentage points of gross margin remains unchanged. Thirdly, we remain on track to complete the sale of certain Japanese systems projects in Q4 contributing to an expected increase in Systems segment revenue and gross margin compared to Q3. So with that context, I'll next discuss the updated guidance ranges in some more detail. Our revenue gross margin guidance remains unchanged. And note that our gross margin continues to include the impact of $61 million to $66 million of ramp and utilization and reduced throughput costs. SG&A and R&D expenses of $265 million to $275 million, production start-up expense of $20 million to $25 million, and operating expenses of $285 million to $300 million are unchanged. Our operating income guidance range of $545 million to $625 million is unchanged and includes anticipated depreciation and amortization of $258 million, share-based compensation of $21 million, $61 million to $66 million related to ramp and utilization reduced throughput and production start-up expense, and a gain on the sale of our US project development in North American O&M businesses of approximately $150 million. Our full year 2021 EPS guidance also remains unchanged. Our capital expenditure guidance is $675 million to $725 million, which represents a $150 million decrease relative to our previous expectations. This is primarily related to the expected timing of certain factory upgrades. Our year-end 2021 net cash balance is anticipated to be between $1.45 billion and $1.55 billion. This $100 million increase relative to our previous expectations is primarily due to the reduction in our CapEx guidance. Lastly, our shipment guidance of 7.6 to eight gigawatts is unchanged. Turning to slide 11, I'll summarize key messages from the call. From a financial perspective, we delivered year-to-date EPS of $3.16. Our full year 2021 EPS guidance is unchanged and our net cash position of $1.7 billion remains strong. From a manufacturing perspective, we produced over two gigawatts despite the challenging COVID-19 environment, increased our top production bin to 465 watts, and have revised our CuRe implementation schedule. Finally, Series 6 demand remains at record levels with 10.5 gigawatts of year-to-date net bookings, which includes 1.5 gigawatts since the previous earnings call. With that we conclude our prepared remarks and open the call for questions.

Your first question comes from Philip Shen with ROTH Capital Partners.

Hi, everyone. Thank you for my questions. I have three groups of questions. The first one is about bookings and pricing. Could you provide more insight on that? Looking ahead, do you expect to accelerate or possibly slow down bookings to optimize pricing? Additionally, are you considering any changes to how you structure your contracts to maximize pricing? The second question pertains to the reconciliation bill. You mentioned the $0.04 per watt thin film cell credit and the $0.07 module credit for the manufacturing production tax credit. Can you discuss whether you think you’ll receive both credits combined or just one of them? Lastly, regarding capacity expansion, could you share your thoughts? Do you believe you’ll need the reconciliation bill before considering the next phase of capacity in Ohio or elsewhere in the U.S., and what conditions do you think would be necessary to announce another capacity expansion? Thank you.

Thank you, Phil. I'll address all three points. First, regarding bookings, our pipeline has significantly expanded. Our mid to late stage opportunities have more than doubled from nine gigawatts last quarter to 21 gigawatts now. Additionally, our opportunities in the U.S. have nearly tripled, increasing from just over six gigawatts to more than 18. This gives me confidence in our strong position moving forward. Encouragingly, many of these opportunities involve multiyear, multi-gigawatt agreements, which provide us with flexibility in our strategy to ensure we can capitalize on them. For instance, we discussed on the last call our plans to enable bifaciality for CadTel, which presents a set value that could enhance our average selling price. We are also considering how domestic content requirements might evolve with the ITC and the associated value implications. I'm pleased with the engagement we're experiencing, both in the U.S. and in India. We have 17 gigawatts of opportunities in India just a little over a quarter after announcing our factory expansion, showcasing strong involvement and potential there. I must note that the sales cycle for customer engagements is taking a bit longer as we look at long-term horizons and work to create flexibility while ensuring we understand all factors that may impact these contracts. We're optimistic about pricing stability in the U.S. and India, especially as it shifts towards domestic manufacturing. The reconciliation bill, particularly the manufacturing tax credit, is designed to be additive. Recent clarifying language suggests that it should indeed be additive at least at the cell and module levels and may extend further. We are hopeful that this bill, if passed, will strengthen our domestic capabilities and contribute to our energy independence. On capacity expansion, we are already collaborating with our suppliers to align on a six-month timeline. After the Perrysburg expansion, we plan to follow with the India expansion and are also discussing the possibility of an additional factory within six months afterward, which could align with early 2024. We're focusing on ensuring we have clear visibility for potential expansions beyond our current capacity commitments.

So the only other thing I'd add is that we talked about the potential for putting some debt on the balance sheet associated with the additional factories we're looking at right now. Given the policy environment we're seeing and the ASP environment we're seeing, if we added additional capacity, that would obviously be very cash-generative, but there may be a bridge where that would be helpful in terms of the timing of CapEx, let's say, with those new factories before they came online. So as we think about the balance sheet and how we look at funding the amount of capacity already, that might impact how we look at it, depending on whether we see the possibility for additional capacity beyond currently in our factories.

Your next question comes from the line of Julien Dumoulin-Smith with Bank of America.

Good afternoon, everyone. Thank you for your time. I’d like to follow up on Phil's questions. First, regarding the year and guidance, how confident are you about shipments in the fourth quarter? I know some are already slipping from the third quarter to the fourth. What are you experiencing with port congestion and your overall delivery capability? I understand this involves various factors, but it seems you have some visibility and confidence. Additionally, I’ll combine my questions for convenience. What is your perspective on qualifying for certain subsidies, particularly the PLI in India, in relation to your expansion? Lastly, could you provide insights on pricing trends for 2023? I realize you've touched on maximizing pricing, but at a broader level, what trends are emerging for 2023 and into 2024, especially as we see some backfilling and consider the ITC?

Hey, Julien. I’ll start with the shipment fee. We’re experiencing port congestion and general shipping market issues that are currently at their peak. I don’t anticipate any improvements. The cost of sales rate we indicated for the quarter remains elevated. That said, we still encounter challenges with blank sailings. Overall, I have strong confidence in our shipment numbers for the year. The variability lies in how much will be reflected in the P&L concerning recognized revenue. In Q3, we achieved our expected shipment numbers, but we fell short by about 300 to 400 megawatts regarding the expected revenue recognized, primarily due to transit times. Historically, from factory gate to revenue recognition, it has taken about two months. This duration has increased by roughly 50%, meaning we now observe around 90 days for products shipped from Asia to the US. In terms of volume shifts, I remain very confident. Currently, for products coming from Asia, if they haven’t left the factory yet, they won’t reach their US destination by year-end. So, we have a reasonable understanding of that situation. However, the timing for revenue recognition differs. We do expect to make some progress on the revenue recognition front in Q4, partly due to shifts in the product mix. We foresee more expected volumes being recognized as revenue from either Perrysburg or our US distribution center. There are also slight variations in terms of income in this mix. Therefore, I have good confidence in shipments, though there’s still some uncertainty regarding revenue recognition.

I appreciate the opportunity to discuss the PLI with you. It was a pleasure meeting with Prime Minister Modi in D.C., where we discussed our commitment to India. He is encouraged by First Solar's investment, which aligns with India's goal for diversification away from the Chinese supply chain. Our factory is fully integrated, allowing us to support India's concerns about energy independence and security. The Prime Minister assured me that he would ensure we receive our fair share of the PLI. Although the PLI details are still being finalized, our initial scoring does not guarantee an allocation, but we're navigating that process. His administration is considering expanding PLI funding due to high demand, and we may also find alternative avenues for equivalent benefits. While our business case did not rely on PLI funding, any support would be advantageous. We have secured other incentives, such as a 24% credit for our factory CapEx and a 20% rebate on labor costs for ten years, all of which are progressing positively. We are optimistic about reaching a favorable conclusion regarding PLI and remain confident in our business model and product competitiveness in India. Current pricing trends for 2023 look promising, and we believe we will maintain attractive pricing through 2024 and into 2025 as we establish long-term agreements.

Yeah. The other thing I'd add just on that is its pricing and also risk terms. So there is a view of changing risk profile around the sales rate for instance that we're looking at in 2023 relative to historical contracts. So may not necessarily influence the overall ASP but does change the risk shift especially in the market we're seeing sales rates being a higher cost today.

You said you're getting a premium ASP for your risk or you're not recognizing a premium for your risk factors?

We are adjusting how we allocate risk in contracts to enable the sharing or transfer of certain costs to customers due to the uncertainty surrounding shipments.

So, if you think of it this way. I mean look freight cost right now is up 70%, 80%, 90%. And so we've kind of created a level of which we're willing to accept but a high percentage of that will now be passed through directly to our customers versus us sharing or carrying that entire risk on our ledger.

Your next question comes from the line of J.B. Lowe with Citi. Mr. Lowe, your line is open.

Good afternoon. How are you doing?

Well, thank you.

My question was on given all the moving parts we have between what you have booked for 2022, the ASPs that you have already locked in and kind of the moving pieces of costs that we have flowing through at this point shipping and otherwise, how do you think gross margin per watt should trend in 2022 versus 2021?

So, if you look through the various moving pieces across the year, so Mark in his prepared remarks mentioned that there'll be some impact from our timing around CuRe. There'll be some specific impact related to that timing. We also will see some impact from overall cost per watt. So, the factory upgrades not only impact CuRe, but impact overall cost per watt. Without them we have less watts. Therefore, we have less amortization of fixed costs going across the capacity we have. We've seen commodity price pressures. So, I think in the prepared remarks, we talked about our year-over-year cost of watt produced being down about 5% versus our previous expectation of 9%. That's mostly bill of materials issues. On the long-term, we believe that gets resolved but we do see short-term pressure especially on the aluminum side. From a sales rate perspective, I would say that you're going to see the run rate you're seeing in the second half of this year most likely carry forward into next year. So, no sequential increase forecast today, but higher relative to pre-pandemic levels. If you look in 2022 overall as well, it's going to be the first year we don't have the US Systems business, although we will have some contribution from Japan on a company-wide gross margin level you're going to see some impact of that. And then I'd say the other piece you're going to see is the flip side of not having that US Systems business the strategic decision we made to exit was accompanied by a growth decision and you're going to see that come through later. But in 2022, we haven't yet got additional capacity in the US or in India online, but you are going to see the costs associated with that in terms of startup and ramp costs coming through. We talked on the last call about that being somewhere in the range of $60 million to $70 million per factory combined start-up and ramp and you'd see I think a little bit more than half of that total coming through in 2022 with the remainder coming in 2023. So, you're going to see some pressure across the board in 2022. What I would say is if you then look forward and take that through into 2023, most of those short-term challenges don't tell the longer-term story. So, the CuRe delay that we talked about that impact will be felt from 2022 not in 2023. By 2023, you'll have over half of the ramp and start-up for the India and the US factory, which will have been spent sequentially year-on-year. Going 2022 to 2023, you're going to see a decrease in startup and ramp. As we talked about in the prepared remarks, ASPs right now we're seeing 2022 to 2023 are essentially flat in the backlog. At the time when we have strong macro tailwinds right now on the bookings. We would expect sea cost per watt to come down over the two years. From a volume produced and sold perspective, you're going to see volume come up as the factories come online in 2023. You're also going to see Series 7 come through. Right now we're not booking for that. As we mentioned on our last call, we expect to see about a $0.01 to $0.03 gross margin entitlement advantage associated with Series 7 relative to Series 6 and that's a benefit split across ASP cost per watt in sales rate. Lastly, on the sales rate side, you're going to see a benefit again in 2023 relative to 2022. I just talked about the contractual shift that we're making whereby we are capping effectively the amount of sales risk we take and the passing remainder through to customers. So, you are going to see that by virtue of a lot of those things an impact to gross margin in 2022 a lot of which will reverse out in 2023 and we'll give you more clarity and visibility into that when we give guidance in February.

Thanks. My other question was about the impact of recent pricing and cost challenges on our outlook for capital expenditures needed to build the new facilities and the timing of those developments.

Yeah. So look, there's a lot of moving pieces in the CapEx right now for both of the factories and some positive and some challenging, right? And one of the unfortunate realities of sales rate or freight in general I should say, carries itself all the way through our tool set and delivering of those tool sets to our factories, right? So we are seeing some higher costs there. We've seen some other benefits relative to our original assumptions around the equipment cost that are more favorable. So, as we review, which we do every month the status of those two expansions and then the relative CapEx relative to the goals and also what we committed externally. The numbers are still lining up. The thing that could impact schedule per se would be long delayed in transit delivery schedule of the equipment set. And so we are trying to get ahead of that and we're trying to move that forward. And we've accommodated for some longer in-transit delivery times. But everything we see as of right now, we're still on target basically within the budget which we've communicated externally as well as the schedule when those factories will be up and operational.

Your next question comes from the line of Ben Kallo with Baird.

Thank you. If we had the manufacturing credit, how do you monetize that? Can you use it yourself, or do you need a tax equity partner? How does that work? Additionally, how significant do we think that is?

So first off, the way it's been structured right now, it's a refundable tax credit. We don't need to have enough tax capacity to make use of it. If we have a tax liability, the credit will offset that portion. If the credit exceeds our tax liability, the excess will be refundable from the US government. You can do the math, and the numbers can be quite significant at $0.11 per watt. If you multiply $0.11 per watt by our US capacity, roughly three gigawatts without considering the expansion, and with the expansion adding another 3.3 gigawatts, we exceed 6 gigawatts in total. With how it works now, including module and cell production being additive, we stand to receive $0.11 for every watt that we ship and produce after January 1, 2022. Therefore, anything produced now won't qualify, even if it potentially ships next year. However, anything produced next year and shipped will qualify for a credit that is currently set at a minimum of $0.11 per watt.

Got it. With the uncertainty around shipping costs, financing costs, and other factors, I'm often asked how much gets delayed until next year as customers wait to see what happens. Thank you, everyone.

We are currently facing some challenges as we are not seeing much movement. Unfortunately, not all of our customers are fully engaged. While I am grateful to those who are completely committed to First Solar's technology, some are not and are being tempted by our competitors. In certain cases, customers who have commitments with us might try to redirect volumes to other projects due to supply issues. For us, this isn't significantly affecting our operations because most customers don't want to relinquish their secured opportunities with us. Instead, they are taking deliveries of modules and using them for other projects. Although I know other companies are experiencing delays, we haven't felt much of that impact yet.

Your next question comes from the line of Maheep Mandloi with Credit Suisse.

Hi. Thanks for taking my questions. Just on the Japan project could you just talk about how much of EPS sensitivity do you expect from that? And just in terms of certainty what are you thinking about it? And could you just also talk more about the CuRe delay and improvements and how much the impact there is? I think you spoke about $100 million previously. Just wanted to clarify that for 2022. Thanks.

Yes, this is Alex. We'll estimate a gross margin of about $55 million to $70 million for Q4 related to the Japan assets.

Yes. Regarding CuRe, we are currently facing two main challenges. One is our ability and timing to replicate. We are in the process of upgrading our factories in Malaysia and Vietnam to support CuRe production, which requires certain tools to be improved, particularly the oven. Unfortunately, the COVID pandemic and the spread of the Delta variant have restricted our efforts, but conditions are improving. This has been a significant constraint, delaying our rollout. At this stage, even in the solution development phase, we are not where we want to be. If we consider CuRe's attributes, its primary value lies in the improved long-term degradation rate, higher efficiency, and better temperature coefficient. We've managed to close the gap between our existing product and CuRe's degradation rate, which is now at a 0.3 annual degradation rate, based on our studies and third-party validation. While this is an improvement from our previous 0.2, it still falls short of the levels CuRe is expected to reach. In terms of efficiency, we've recovered about two bins with our existing products as we progress through the year, but we're still slightly off from our efficiency goals. The temperature coefficient also isn't as favorable with our current product as we aim for with CuRe. We have validated the attributes through lab work and our pilot line. However, transitioning to high-volume manufacturing presents challenges, particularly in handling the product, as the film isn't yet as resilient as our current device, making handling more concerning. We need to improve how we manage the product during production and enhance film resilience. Additionally, the atmosphere, particularly humidity, poses challenges that we need to address. We are confident that we can resolve each of these issues; the challenge lies in doing so in high-volume manufacturing. We've been conducting runs and experiments for validation, and we must finalize these efforts. The technology's viability is not in question, as demonstrated through our laboratory results and pilot line validation of the necessary attributes to achieve CuRe's program objectives. We expect to have our lead lineup ready by the end of Q1 2022. After that, we can decide on replication across the fleet, and we hope to see positive progress in our ability to travel to Vietnam and Malaysia to begin the upgrade process. However, the need to upgrade the toolsets remains a constraint. If we encounter a new variant this winter that prevents travel, it could lead to further delays. We are currently negotiating with customers regarding potential impacts related to the rollout delays. While some negotiations have been positive, others have not, and we deemed it necessary to communicate the potential revenue impact next year due to these delays, estimating around $0.01. When applied across eight to nine gigawatts of shipments, this could have a significant impact, so we wanted to ensure clarity on this matter.

Thanks.

And this does conclude our allotted time for questions-and-answers. And this does conclude today's conference call. Thank you for participating. You may now disconnect.