The turnaround story at Evergreen Solar (Nasdaq: ESLR) took a few steps backward when the company announced third-quarter earnings yesterday.

The maker of String Ribbon panels shipped a record 42.6 MW during the quarter, but already razor-thin gross margins fell from 8.6% to 7.5% in the quarter. Total revenues increased 2.4% sequentially to $86.5 million, but a net loss of $27.2 million, or $0.13 per share, was worse than analysts expected.

What I'm watching at Evergreen is cost per watt, which is currently among the highest in solar. A drop to $1.88 at the Devens facility is $0.06 lower than last quarter, but not nearly fast enough to catch up with multicrystalline powerhouses Yingli Green Energy (NYSE: YGE) and Trina Solar (NYSE: TSL), which are around $1.10 per watt. Of course, cost leader First Solar (Nasdaq: FSLR) took a step backward last week, so if Chinese fabricators don't see big cost reductions in the third quarter Evergreen may have some time to catch up before we declare life support.

On the positive side, the Wuhan facility started making panels in September and shipped 3.4 MW by the end of the month. It's this facility that Evergreen predicts can reach $0.90 per watt by 2012. The small amount of production this quarter doesn't give us any clue if that cost is achievable, but the next quarter will be crucial.

I've touted Evergreen as my favorite high risk/high reward solar play and even though this quarter doesn't look great I'm not ready to jump off the bandwagon quite yet. Costs are falling and the company has $93.3 million in cash, enough to fund operations for a while. If the Wuhan facility can produce panels at $1.25 per watt in 2011, as predicted, there is a lot of upside potential.

This may not have met expectations, but it's too early to count Evergreen out of the solar game. When the Wuhan facility ramps up, the company's competitive position should change immensely.

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Fool contributor Travis Hoium is long shares of First Solar. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

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