Evergreen Solar: The Worst Is Behind

| About: Evergreen Solar (ESLRQ)

alternative energy investing logoFrom James LoGerfo, Michael Riedinger and Joe Berwind (Alternative Energy Investing): Evergreen Solar's (ESLR) Third Quarter 2006 revenue of $36.2 million beat consensus estimates of $31.25 (+16%) and also beat management’'s guidance of $26 to $34 million. Revenue generated from its EverQ product was $25.4 million in the third quarter which was above $16 to $22 million quarterly guidance as capacity ramped faster than anticipated. Unfortunately, completing the ramp a quarter ahead of schedule meant embarking on the next facility upgrade earlier then expected causing the company to drop EverQ’s gross margin guidance from 30% to 35% in the fourth quarter to 22%. Despite the change in timing, the company is progressing well and profitability on greater scale is an optimal decision despite the headline.

Completing EverQ-1’s ramp a quarter ahead of schedule meant embarking on the next facility upgrade earlier then expected which will result in a gross margin of 22%, flat q/q and down from 30% to 35% guidance. Despite the change in timing, the company is progressing well and profitability on greater scale is an optimal decision despite the headline.

Guidance for EverQ’s 4Q’06 revenue was given to be in the $20 to $25 million range slightly lower than previous guidance of $23 to $25 million due to conversion issues that create downtime and pressuring margins (formerly expected to be 30% to 35%). Marlboro continues to contribute at $10 to $12 per quarter for the foreseeable future as expected although gross margin guidance for Marlboro was guided to 5% to 15%, down from 7% to 15%.

2007 Guidance for marketing (approximately 2% EverQ revenue), licensing fees and technology development fees coming out of EverQ to Evergreen is expected to be $10 to $15 million. Therefore, total 2007 sales are expected to be $50 million to $63 million for ESLR. Management put more emphasis on the low end of the range by stating that it expected total Evergreen and EverQ revenues to be $200 to $250 million. This is marginally lower than we had expected after the October 3, 2006 announcement that the company would only recognize marketing, license and technology development fees from its EverQ partnership.

EverQ: EverQ-1 fully ramped, a quarter ahead of schedule (15 months) proving that string-ribbon can be scaled and potentially opening opportunities to partner outside the EverQ joint-venture. In our judgment the speed at which string-ribbon is ramping is opening possibilities for the company to partner with the silicon endowed sooner than we had expected. We also advocate the decision to sacrifice near-term gross margins at EverQ-1 in order to accelerate the introduction of thin-wafer technology given the temporary high-priced poly silicon that must be processed for part of 2007.

EverQ-2 a $145 million investment ($50 million from ESLR) in 60 megawatts will begin production in Q2 of 07 and fully capacity should be achieved by around the end of the year. At approximately $200 per kilogram for mid 2007 to mid 2008 when REC will supply at long term prices for all of EverQ – margins will suffer. Interim poly silicon supply agreements will be signed guaranteeing EverQ-2 reached full production capacity prior to 2008.

EverQ revenue is expected to be $160 million to $200 million in 2007 (EverQ-1 $100 to $125 million, and EverQ-2 $60 to $75 million) with gross margins of 30%-35% delayed until the second half of the year due to heady raw material costs. REC (OSEAX: REC.OL) will supply poly silicon $200 kg. Evergreen Solar’s thin ribbon technology utilizes poly silicon sparingly. This technology lies at the hart of the company’s joint-venture. Evergreen Solar’s ability to grow its share beyond the current plan effectively requires it to open manufacturing facilities independently of Q-Cells which it can not do as new partners with access to poly silicon simply do not exist and are not likely to appear until the end of 2008 at the earliest. That said, the speed at which string-ribbon scaled bodes very well for the prospect of attracting new partners. Furthermore, the possibility that quad furnace technology could be commercialized as early at June of 2007 creates a very optimistic scenario for Evergreen as this technology will be sought after by a wide variety of industry players watching its development with great interest. More specifically, management stated that EverQ-3 should begin construction within nine months in order for the joint-venture to reach its 300 MW goal by 2010 and that it believed EverQ-3 will be designed around the quad-furnace.

Evergreen introduced a new metallization process in the quarter at the Marlboro fab achieving about 15% cell efficiency and opening the door to achieve 16% to 18% cell efficiency in the next couple of years. Cell efficiencies averaged 13% to 13.5% in 3Q’05 and increased to 13.5% to 14% in 4Q’05. Achieving 15% cell efficiency is critical to the launch of a 180 watt module. Replacing the 120 module with the 180 watt module will push average selling prices up improving margins along the way. Recall ESLR produced its 120 watt panels with the same physical dimensions of the existing 110 and 115 watt panels and drove higher revenues and margins as a result. Note that cell efficiency gains are an imperative and Evergreen had hit a bump in the road in the second quarter of this year reporting no gains in cell efficiency in that period. The company continued to stress the need to achieve 15% cell efficiency before year-end as has been the plan from the beginning of the year.

The Bottom Line:

On October 2nd, Evergreen Solar announced that it would recognize marketing fees from its Ever-Q joint-venture in lieu of recognizing revenue based on the gross sales of modules. The company had up until this point guided analysts to expect that it would book gross sales and accept an agreed upon margin. As a result of Evergreen's changed revenue recognition policy AEI let investors know the Street's sales estimates needed to come down dramatically. This process has essentially been completed with the conclusion of the conference call.

AEI thinks ESLR shares have endured the worst. We think the company's quad-furnace is a significant catalyst for the company and "others" that have a desire to access the technology. AEI is recommending subscribers begin looking at ESLR on the long side as the worst is behind it and better times lie ahead keeping in mind the fair value calculation for ESLR.

ESLR FAIR VALUE = 1/3 EVER-Q ([$160*5]/.33) OR APPROX $240MM + 100% OF MARLBORO'S MID-POINT ($57*4.75) OR APPROX $270 FOR A TOTAL EQUITY VALUE OF $510.75 OR $7.61

Evergreen's balance of cash, cash equivalents, marketable securities and investments stood at $90.9 million at September 30, 2006, down from $95.8 million at July 1, 2006.

Perhaps the most critical take-away from the call is the importance of the development of Evergreen’s Quad-Furnace which must be commercialized in short order if EverQ’s next facility (EverQ-3) is to be designed around the technology. Quad ribbon is the next technology hurdle for the company. Quad ribbon is a reference to a new furnace design based on proprietary technology for pulling four ribbons instead of two. Quad ribbon represents the next doubling of capacity per furnace, offering the promise of additional cost savings and moving the company to 35% to 40% margins --quad ribbon also offers the potential for virtually lights-out processing (i.e. fully-automated). Previously, management had set expectations that the quad ribbon furnace would be ready to roll-out commercially at the end of 2007. Therefore, should the company succeed in its bid to engineer EverQ-3 with quad ribbon technology this would mark a significant catalyst for Evergreen Solar with diverse and positive implications for investors in ESLR stock.

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