Last September, I asked whether First Solar (Nasdaq: FSLR) was becoming obsolete, and we may be getting our answer sooner than expected. My theory was that as overall solar system costs fell, the balance of system costs (land, inverters, etc.) would begin taking up more of the cost and therefore put an emphasis on more efficient modules. Since your big limitation in a solar installation is land, I thought falling costs would play into the hands of high-efficiency companies like SunPower (Nasdaq: SPWR) and away from First Solar. The day I wrote the article, shares ended the day at $64.75.

Since then there's been nothing but bad news for First Solar. The company announced a change in management, a shift in strategy, and lower earnings guidance.

Yesterday, when full-year 2011 earnings came out, they were worse than even the lowered guidance had anticipated. Fourth-quarter net sales were down $345 million from the third quarter to $660 million, and the company lost $4.78 per share. Earnings were negatively affected by a goodwill impairment charge for the components business, warranty expenses, and restructuring. We'll get to the red flag that brought up in a minute.

The cost lead evaporates
First Solar used to be the lowest-cost manufacturer by a wide margin. Now, Chinese manufacturers are starting to catch up, and it's showing in First Solar's financials.

First Solar said the cost per watt was $0.73, comparable to the $0.76 cost per watt Canadian Solar (Nasdaq: CSIQ) said it has achieved and close to the $0.94 Trina Solar (NYSE: TSL) is making modules at. But even though First Solar increased efficiency to an average of 12.2%, Canadian Solar and Trina Solar are still producing more efficient modules, so First Solar's modules aren't as attractive at the same cost.

Not every manufacturer can match First Solar's costs, but they're quickly catching up. When they do, First Solar is going to need to unleash higher-efficiency modules or risk losing out on even more module sales.

Warranty worry
Between June 2008 and June 2009, First Solar made modules that experienced premature power loss in the field, and the company is paying for the mistakes right now. It posted a $125.8 million loss to add to warranty reserves to pay for replacement of modules and other costs. It doesn't appear that these costs will continue, but it's worth keeping a close eye on.

The sad solar player
Compared with SunPower, which was excited about new products and opportunities in new markets, First Solar's management sounded like a sad puppy on the conference call. Michael Ahearn referenced "draconian measures" when referencing feed-in tariff changes in Germany. Tone isn't always indicative of performance, but in this case it's just another red flag for me.

Lowered expectations
First Solar is planning to idle part of its plant in Germany for up to six months; it's going to delay commissioning its Mesa, Ariz., plant; and it's discontinuing work in Vietnam. Read between the lines, and First Solar doesn't think its manufacturing facilities have much of a future.

Revenue expectations were also revised down to a range of $3.5 billion to $3.8 billion from previous estimates. Profit is still expected to be $3.75 to $4.25 per share in 2012.

What keeps me in the game
As much as I realize the strategic weakness, I can't ignore that First Solar is one of the only profitable solar manufacturers, despite this quarter. First Solar also has a 2.7 GW systems pipeline, which will maintain earnings at a profitable level for the near future and for big-name systems backers such as NRG Energy (NYSE: NRG) and MidAmerican Energy. These buyers show the confidence utilities have in First Solar's large-scale plant developments.

If First Solar wanted to make a strategic change to becoming a power-plant developer instead of a module manufacturer, it probably could and still generate a decent profit. But in the meantime, the company will keep bumping along.

If the stock jumps in the coming weeks I may cash out, but I view the downside risk as small enough to hang on to my shares. My much bigger solar bet is on SunPower, but First Solar will stay in the game despite this disappointing quarter.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.