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Solarfun Power Holdings 2009 annual report & 2010 first quarter analysis

|Includes: Hanwha Q CELLS Co., Ltd. (HQCL)
Solarfun Power Holdings has endured two straight fiscal years of negative earnings; however, it has maintained positive operating cash flows for five of the past six quarters and has had substantial increases in solar module megawatts shipped. Furthermore, the company posted a strong gross margin and positive net income margin in the first quarter 2010, accompanied by increased module shipments. Forward earnings are still negative, but the company is trading at 7.4 times 2011 earnings estimates.
First quarter 2010 earnings and limited disclosure were released May 28, 2010. The company’s 2009 annual report was released May 25, 2010, 81 days after the 2009 fourth quarter earnings release on March 5, 2010.
The company has found itself in the middle of the pack relative to its peers on many of the metrics after two straight fiscal years of negative earnings. Despite negative earnings, the operating cash flows of the company have been strong, pushing the company to number one among its peers on this metric. Free cash flow has also been strong due to strong operating cash flows and decreasing capital expenditures over the last twelve months. The company also ranks 1st on the free cash flow metric. Significant debt relative to cash has dropped the company’s ranking on cash-to-debt to 33rd among its peers.
The company provides limited information in quarterly filings, but does provide more information than its fellow 6-K filers. It does not provide full footnote disclosures. It started providing a statement of cash flows in the fourth quarter 2009. The company provides total megawatts shipped in each quarterly and annual filing; however, many of the key performance indicators, such as conversion efficiencies, are only found in annual filings. Warranty and allowance for doubtful accounts data can only be found in annual filings; however, provisions and write-offs can be found in the quarterly cash flow statement should they exist for that period.
For the past three quarters, the company has been below the industry average in terms of cost per watt. The company provides its total solar modules shipped in megawatts on a quarterly and annual basis, but only provides revenues and costs associated with solar module production and solar module sales on an annual basis.
Based on our computations, we calculated an average cost per watt of ¥7.99 for the first quarter 2010, down from ¥9.18 for the fourth quarter 2009. Fiscal year 2009, we calculated an average cost per watt of ¥13.53, down substantially from ¥26.58 for fiscal year 2008. Annual cost per watt is based on solar modules sold and costs associated with solar module production, both of which provide a more accurate figure. Megawatts shipped by the company increased in all except the first quarter 2009. The first quarter of 2009 proved to be most difficult among many of the company’s peers as well. Year-over-year, photovoltaic module shipments increased by 81.4% from 172.8 megawatts in 2008 to 313.4 megawatts in 2009.
The company says its average selling price of solar modules was ¥15.27 per watt in 2009 and ¥26.77 per watt in 2008. We calculated identical revenue per watt figures using revenues derived from the solar module business and solar modules sold in each fiscal year. Average selling price and revenue per watt are synonymous. Revenue per watt on a quarterly basis is less accurate as the company does not provide revenues related to its solar module business and total solar modules sold. Quarterly, revenue per watt has been consistently decreasing, falling from an eight-quarter high of ¥31.37 in the second quarter 2008 to ¥9.80 in the first quarter 2010. Furthermore, revenue per watt has been significantly below the industry average for the past four quarters.
Revenue per employee has been impacted by a 23.7% decrease in revenue in 2009 compared to 2008 and a 33.1% increase in employees during the same time period. The company is considerably below the industry average, falling to ¥0.71 million per employee in 2009 compared to the industry average of ¥3.03 million per employee.
Conversion efficiency is the percentage of absorbed light converted to electrical energy. The company manufactures solar cells using both monocrystalline and multicrystalline wafers. As of Dec. 31, 2009, the company claims it achieved conversion efficiency rates of 16.5% to 17.8% for its monocrystalline cells and 15.3% to 16.3% for its multicrystalline cells.
Solarfun expects to expand solar module production capacity to 900 megawatts by Aug. 30, 2010, solar cell production capacity to 500 megawatts by July 1, 2010, ingot production capacity to 360 megawatts by May 31, 2010, and wire sawing capacity to 400 megawatts by May 31, 2010.
The company began including statements of cash flow in its quarterly Form 6-K reports in the fourth quarter of 2009. The quarterly Form 6-K’s provide very limited disclosure.
The company does not disclose a provision for inventories in any of its filings. The company made inventory write-downs totaling ¥37.8 million in the first quarter 2010, ¥282.6 million in 2009 and ¥413.8 million in 2008, primarily due to significant decreases in prices of silicon and silicon wafers that the company had already contracted to purchase in multi-year supply agreements at pre-determined prices. The first quarter 2010 write-down represented 3.1% of COGS, 2009 write-downs represented 8.5% of COGS and 2008 write-downs represented 8.4% of COGS.
Solarfun provides standard warranty coverage on its solar modules, which includes a two-to-five-year unlimited warranty against technical defects, a 10-year warranty against a decline from initial power generation capacity of more than 10% and a 20-to-25-year warranty against a decline from the initial power generation capacity of more than 20%. The company accrues for warranty costs for the two-to-five-year unlimited warranty based on 1% of revenue for solar modules. No warranty cost accrual has been recorded for the 10-year and 20-to-25-year warranties because the company determined the likelihood of claims arising from the warranties to be remote based on testing of the modules and strong quality control in the production process. This is unique in the solar industry; we do not believe any other company has made this claim.
Terry McCarthy is on the audit committee and was formerly the chairman of the audit committee and independent director from November 2006 to March 2009. He also served as a director and interim chief financial officer from March 2009 to November 2009.
A Nasdaq marketplace rule requires that each audit committee member must not have participated in the preparation of the financial statements of the company or any current subsidiary at any time during the past three years, but it does allow a foreign private issuer to follow its home country practice. Solarfun has received exemption from the Nasdaq rule with respect to McCarthy, who previously served as the company’s interim chief financial officer. 

Disclosure: No positions