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Canadian Solar is moving away from its many rivals by diversifying its product line and cutting expenses.

Canadian Solar Inc.

Shares of Canadian Solar Inc. soared Tuesday after the company said strong sales to Japan helped deliver a smaller first-quarter loss than had been expected.

But with rising inventories, higher interest costs and shrinking investment in research and development, the Guelph, Ont., company may be challenged to sustain market optimism.

The solar industry has been in the dumps, faced with a glut of panel production, a weak global economy and fewer government subsidies. Against that grim background, Canadian Solar has lit investor hopes with predictions that it will return to profitability this year.

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Executives said Canadian Solar is moving away from its many rivals by diversifying its product line and the markets into which it sells. As much as 40 per cent of Canadian Solar's capacity this quarter will go to Japan, where there is a new hunger for solar power following the Fukushima nuclear disaster in 2011.

The geographic shift is significant because two of the company's traditional markets have been posing problems. In China, a glut of solar panels has crushed much of the industry. Meanwhile, European officials charged Chinese manufacturers with selling below cost – or dumping – and have threatened to tax shipments from the country. Canadian Solar has significant manufacturing operations in China, but has added a factory in Ontario to try to circumvent the European threat.

Shares of Canadian Solar shot up by as much as 24 per cent on Tuesday in heavy trading on the Nasdaq, before closing with a 9-per-cent gain.

The small group of analysts following the company had estimated it would deliver a loss of 78 cents (U.S.) a share on sales of $236.5-million for the first three months of the year. Instead, the company reported a loss of just 10 cents a share or $4.4-million on sales of $263.6-million. A year earlier, the company had reported a loss of $21.3-million.

To get its losses under control, Canadian Solar has ratcheted back expenses rather than reaching for sales. Revenue tumbled 19 per cent year over year. Shawn Qu, chief executive officer, told analysts on a conference call that his focus for this year is on returning to profitability rather than increasing volume.

He pointed to an improvement in gross margin to 9.7 per cent last quarter, a figure ahead of expectations, as a sign of the company's success. He added that gross margin could come in as high as 11 per cent this quarter, reflecting in part greater profitability in the Japanese market than in China and elsewhere.

"We are on a clear path to be one of the first solar module suppliers to return to profitability," Mr. Qu said.

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Savvy investors will surely be looking at what happens once Canadian Solar returns to the black. One of the areas where the company has cut spending is in R&D, trimming the budget 19 per cent from a year earlier to $2.4-million in the first quarter. A news release described the decline as "due to better and more efficient management of product development activity."

Overall operating expenses tumbled in the first quarter, falling to $7.5-million from $106.4-million in the fourth quarter, and from $38.5-million in the comparable quarter a year earlier. At the same time, short-term borrowing surged by more than $100-million to $966.3-million. (Long-term debt declined marginally to $203.5-million).

Quizzed by analysts about the increase in short-term borrowing, Michael Potter, the chief financial officer, said "it is mainly due to the start of construction on our [power] projects," representing about 50 megawatts of output. To put that into context, the company expects to ship as much as 420 megawatts worth of equipment this quarter.

While the details on those projects were scarce, the company said in its earnings release that it is using a greater proportion of its short-term borrowings to finance its expansion in Ontario. That strategy appears to be pushing up interest expenses, which reached $14.6-million in the first quarter, up from $9.9-million in the fourth quarter. At the same time, inventories reached a value of $291.3-million last quarter, up 6 per cent in just three months.

Financials aside, investors should be asking themselves whether they think they know something about Canadian Solar that executives themselves are missing. That's because over the past 12 months, as the shares tripled in value, insiders never increased their own holdings and institutional shareholders reduced their holdings by about 5 per cent.

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