First Solar (FSLR) reported Q3 earnings last Thursday night and surprisingly, it seemed many were shocked by the results if you look at the price movement on Friday. The stock tanked nearly 10% during the trading day. While volume didn't appear stellarly high, the move was significant. Having worked with a big 4 public accounting firm and large project based companies in my career, it is easy to see how project accounting can fly in the face of investor logic when it comes to impacting earnings results. First Solar's transition into a company that provides entire solar farms instead of merely selling modules has changed the way revenue is now recognized. This change has thrown a wrench into the standard logic of revenue recognition for investors and analysts alike.
United States generally accepted accounting principles dictate certain times for which companies are allowed to recognize revenue for the sale of a product or service. The sales process must be "substantially complete" in order to recognize such revenue. When First Solar makes 100 solar modules and ships them to a customer and issues an invoice, the revenue is booked along with the cost of the goods sold. The timing between the shipment, the invoice to the customer, and the revenue and related costs are typically booked on the same day. This type of sales process is the standard logic that most investors and analysts are accustomed to.
First Solar's new strategy and its related sales process is changing. The company now sells solar farms, not just modules. There has been mention in recent conference calls about meeting "contract milestones". This is where some investors and analysts may not be fully understanding the significance of the impact on revenue and profit. Contract milestones are agreed upon triggers within the sales agreement that usually causes customer cash payments to be released to First Solar and sometimes, revenue to be booked (along with the related costs). In my experience, the "contract milestones" can very significantly from contract to contract. It all depends on how the agreement is written, including clawback clauses, right to return or file a complaint against the work just completed, and the acceptance procedure around the milestone. A milestone could be defined in a contract in many different ways. For instance, it could be every 25% completion stage of the total project or it could be defined as every 50MW of power being consistently generated after 30 days output. The impact of meeting a milestone and customer acceptance sign-off the day before versus the day after the quarter ends can be significant to revenue recognized in one quarter versus the next. It can cause large swings of revenue between quarters. Much larger than when a company is merely shipping modules one at a time.
First Solar's management warned of these impacts in the Q2 conference call when they said that revenue is "lumpy" from quarter to quarter due to the projects' milestones. Even more surprising was that they even alluded to Q3 revenue being lighter and Q4 being stronger due to project accounting and the timing of milestones being met. After seeing analysts' revenue forecasts for Q3 near or ahead of Q2 revenue just prior to the Q3 earnings release, I thought it prudent to explain the potential implications of project accounting to First Solar's revenue numbers. Only management knows what each of the specific milestones is and when it will be reached and accepted by the customer. To the investors' and analysts' dismay, we may need to rely more on management's revenue indications than we would like.