From GT Solar to GT Advanced Technologies - Business Continues to Strengthen

Jun.20.11 | About: GT Advanced (GTATQ)

GT Solar (SOLR) is one of the few companies, and just about the only solar company, that has survived the May-June correction in the general market. The stock has managed to stay on an uptrend since the April (and 2011) lows although it has experienced some wild gyrations since reporting earnings on May 24th. The fight toward new all-time highs continues.

The fight toward new all-time highs continues
(Click to enlarge) *Chart created using TeleChart

Great order backlog news continues to roll in, and SOLR raised guidance for fiscal Q1 and its order backlog a mere three weeks after reporting earnings. I strongly suspect that if not for the on-going market correction, SOLR would be much higher right now.

GT Solar has maintained an incredible revenue and earnings history since 2007; the recession flattened out the trend for a year before surging again in the fiscal year just completed (includes at least one acquisition – Crystal Systems) {see p21 of the earnings presentation}:

Revenue stream (M): $60 (FY07), $244 (FY08), $541 (FY09), $544 (FY10), $899 (FY11)

EPS-Fully Diluted, Net Income: -$0.13 (FY07), $0.25 (FY08), $0.61 (FY09), $0.60 (FY10), $1.24 (FY11)

These numbers provide more confidence that SOLR can navigate the current slowdown. Moreover, SOLR's solar customers are planning for production 1-3 years out and looking past the current soft part of the cycle. From the prepared comments during the last earnings call:

"In general, bidding activity for new polysilicon business continues at a record pace and we expect several significant new orders to be signed in the balance of this fiscal year."

SOLR's guidance already accounts for the current solar slowdown and to the extent the slowdown is not as bad as feared, the company expects to report upside to its guidance. With respect to PV:

"To be clear, our guidance for this year is not dependent on a significant level of new PV business. In fact, we expect a slowing of growth in this sector during the balance of this fiscal year during the balance of the fiscal year …

… we are seeing evidence that some PV operators in the industry are starting to reduce utilization rates and are delaying new expansion projects as they respond to weaker near term end market demand. This is a very familiar pattern in the PV business and one that we've been talking about for quite some time. We believe that this slowdown in the PV sector is fully baked into our FY12 projections and into our FY13 expectations. To the extent that weakness in the PV sector in FY12 is short lived or is not as pronounced as we are anticipating, we would expect upside to our projections."

In parallel, the Sapphire business should provide a strong counter-cyclical foundation for GT Solar. The LED market should be growing rapidly in the coming years:

"Our opportunity in sapphire is underpinned by the fact that adoption of LEDs in the general illumination market is expected to drive substantial sapphire demand over the next several years. I would note that Canaccord Genuity's latest forecast calls for sapphire demand quadrupling by 2013 and again doubling by 2017." (prepared remarks, p20)

GT Solar's diversified base of revenues has compelled the company to change its name to GT Advanced Technologies. This transformation will become official in August along with a new stock ticker symbol.

I am finally posting my notes from SOLR's earnings conference call last month. Although so much time has past, I think there is plenty of commentary of interest for solar investors. I also include a few observations from the company's presentation. Here are the relevant links:

First, the new guidance. Note that revenues and profits were pulled forward from Q2 into Q1 thanks to a sooner than expected completion of DSS(NYSE:TM)650 upgrades.

Fiscal Q1
$225M revenue vs previous guidance of $140-150M
~$0.30 fully-diluted EPS vs previous guidance of $0.08 to $0.11
43-44% gross margin for vs previous guidance of 37%

$1.0-1.1B in revenue
$1.55-$1.85 EPS
42-44% gross margin
$1.6B in order backlog by end of fiscal 2012 vs previous guidance of greater than $1B

With this guidance I am significantly adjusting upward my previous price target range on SOLR from $8.75 - $11.50 to $14.00 - $18.50 before March, 2012 (end of fiscal year 2012). I am assuming SOLR can achieve a 9 to 10 forward P/E for the given earnings range. If the general market firms up, I think the market may be willing to pay as much as a 12 forward P/E, especially given the buy-out possibilities with SOLR. SOLR hit $14 briefly on June 3.

Now, my notes from the Q&A session for May 24th earnings conference call. Note that I was not able to capture the names of all the firms whose analysts asked questions. I put in bold a few highlights that I found particularly important and/or revealing. All answers are from CEO and President Tom Gutierrez unless indicated otherwise.

Piper Jaffray
Q: Sapphire guidance went up $100M for FY2012. Is this increased shipment or materials revenue?

A: We report the Sapphire business as a single unit. Not going to break out the two businesses. The materials business is also R&D business highly linked to the equipment side. We have more confidence in the materials side and will have reasonable revenue recognition on orders taken. The bulk of orders for Sapphire will be for 2013. We are taking orders to fill out the balance of 2013. Q4 was a very intensive quarter for build-out, giving us increased confidence for 2012 revenues.

Q: How should we think about cash conversion on the Sapphire business.

A: Initially it will take a little longer to recognize revenue. Once we are past the initial phase of getting acceptance criteria, it will start to look a lot like the DSS business.

Q: Regarding FY2012 sales guidance. 80% backlog coverage, where does the 20% remaining come from? Are you being conservative?

A: Once we have $722M of orders taken this quarter, pretty well booked up for FY2012. Variation of guidance from $1B to $1.1B is really driven by precise timing of revenue recognition of the ASS Sapphire orders delivered at tail end of year, and also the possibility of DSS orders at Q3 or Q4. Some of these units could move to 2013 if solar downturn turns out to be worse than expected. New Sapphire factories are being built, so factoring in potential slippage in guidance.

Q: ?
A: We are pretty much booked up until mid-fourth quarter. There is a strong pipeline of opportunities and all are being booked into FY2013. We can't accept any more orders for delivery in 2012.

Q: Question about mono-cache (?) products. Is it new product or retrofit for DSS. Is there a meaningful impact on expenses from Arc lawsuit?

A: Working with Georgia Tech to get crystal structures in DSS for efficiencies of upward of 18%. We generally won't take a product to market until we can ship hundreds of them in a reliable manner. Turns out it will be sold as a new furnace. Necessary retrofits are quite feasible so existing 3000 machines in the field can theoretically be upgraded to mono-cache performance levels. Helping bring efficiencies up helps brings costs down which will increasingly be the name of the game as subsidies come down. Will be both a stand-alone as well as a retro-fit product.

The Arc lawsuit is concerned…in the end…this is not about competitive losses in the near-term. We are basically handing our competition their proverbial tails in terms of taking orders off the street. This is not the issue. This is about principles. We see it as our responsibility to defend our shareholders' rights for the IP that the company has developed. We are spending more and more money on R&D. This is about defending IP. The complaint is in the public domain so I won't comment. Expenses won't be material but we will spend what we think is necessary to spend to defend the IP that has been developed.

Guilford Securities *important comments about market dynamics for polysilicon
Q: $15M orders of polysilicon in Q4. Delayed orders brings to $13.5M(?!). Explain what happened there? Every one of us is expecting over-capacity on the panel side, which the DSS side is reflecting, how is that going to play into the polysilicon side of the business.

A: Timing of the orders, orders in this industry are sort of lumpy. We have been negotiating $100M orders. It's a time-consuming process. So the timing is inconsequential. The fact that they've landed in the fourth quarter and the first month and a half of the new quarter is not meaningful in itself. I think what's meaningful is the nature of the customers who are ordering and increasing their capacity.

Obviously, OCI is committed for the long-term to be one of the leaders, if not the leader, in the polysilicon sector. And as I indicated on the call our order reflects completing Phase 4 and there's a Phase 5 coming that is of equal or larger size than Phase 4. So…and that leads into the discussion why the short-term PV environment does not substantially reflect what's happening in PV. Because unlike PV (I assume he meant LED?) where the industry can essentially shut down pretty quickly and then come back up very quickly, the build out of a polysilicon plant capacity can take years in some cases depending on whether or not you are building a new facility or adding to an existing facility. So the people who are in our customer base, are not folks focused on this year, they are focused on the capacities they believe they're going to need in fiscal 2014 and 2015 to match what the industry needs then.

And what's very typical in this industry then, is polysilicon goes into short supply or tight supply as it is right now, prices rise, it takes a few years for these investments to fall into place and then there's a period of over-supply, and we would expect that at some point, the supply of polysilicon, because not only the OCIs of the world are expanding, so are the Povacker's (?), and the rest of the incumbents, that the capacity will be such that it will drive the price down.

Perhaps below the ranges that are seen today for contact prices in the $50 range, that has a positive effect on the next cycle of PV because it brings the cost of polysilicon down and then we enter another cycle. But I think you have to look at polysilicon investments as polysilicon investments that are being made for the market that will exist two years out. Not for the market that exists today because of the time it takes to put them into place.

[Rick Gaynor, CFO]
You are right in Q4 we did about $15M of orders in the poly space, and in the first few weeks of this quarter we have done approximately $320M of orders and clearly people have been talking about a potential downshift in the PV sector for months now. I know we've been talking about it for 3 or 4 conference calls. I think the orders we've received…the polysilicon producers are well aware what's going on in the PV market and it has not deterred them from placing orders for
large capacity.

[Back to CEO]
I think I would cap it by saying this is an important area for our business, our pipeline is very robust. OK? Projects out in the Middle East are still moving. But the nature of the customers that we're dealing with are very well-capitalized customers that have the strength to basically make these investments over the next couple of years. So we're pretty positive on our ability to convert those orders into sales.

Credit Suisse **includes more PV cycle commentary
Q: On the strong orders in June, can you talk a little about the shipment timeline, give a little bit of color on poly and Sapphire. On the poly side in particular, are you receiving any customer deposits or LCs to go along with the orders?

A: I want to cap off something I should have said in the last conversation – we do expect the PV industry to repeat its normal cycle. And while…we view the balance of this year being somewhat soft or very soft, we would expect the PV industry to rebound in the second half of our FY2013 and rebound into another growth cycle. Having said that, almost all of the Sapphire orders we have taken are for FY2013. All of the polysilicon orders are for 2013 and 2014. And all the orders that are in the pipeline for Sapphire and polysilicon are for 2013 and 2014 as well. As I indicated earlier we are basically taking orders now to fill up 2013 and 2014 as we are pretty full on 2012.

We are receiving significant deposits. We received deposits in some cases with customers we have been in business with for a long time. In multiple steps in our backlog profile where we receive an initial deposit, a couple of months later, we receive a secondary deposit, and so we receive substantial deposits that make us believe that the business is firm. You want to think about it this way: you put in an order for a PV furnace, we're going to be shipping that to you in a matter of weeks. We take the order and say we're going to ship it to you in 3 months. We can secure materials right away so we need a substantial deposit right away, right in time to sign the contract.

The Sapphire orders we are taking now are for early next fiscal year, so we'll get a small deposit up front and a supplemental deposit at time of shipment. So you won't see all of that deposit reflected in the balance sheet, but it is part of our contractual arrangement in most cases.

Q: Quick follow-up. Margins. So f I take a look at what you said about margins in March and September, seems like for the second half of this year you will be closer to 44%. In the second half you are richer in Sapphire volumes. If the product mix …(?)

A: There are two things to look at. Our Sapphire business has higher than normal margins. And since Sapphire is going to feature strongly in the second half that drives that. And because we are taking a substantial number of orders for 2013, and PV tends to be the lower of the three businesses because of the nature of the large customers and the long-standing relationships we have with them. And so that would tend to actually balance out the highs and the lows.

In PV we get very, very good margins. And that's driven by the fact that we continue to drive our costs down, and we are able to maintain the premium pricing that we have and the technical lead.

Q: Shipment capacity on the Sapphire furnace. Can you "de-bottleneck" that more? Can you move any capacity from the DSS line to the Sapphire line?

A: If someone had asked me last year that we could ship 1500 DSS, I would have hesitated. I'll hesitate when I am giving the answer, you know to the extent we get pushed because we receive more orders and customers need them. We'll put massive effort in to try to do that. Apart from possible shifts we can go from DSS to Sapphire. But at the moment we are being cautious not to over-commit in this new business.

Q: Can you guys ship the Sapphire product; do you have visibility into … (?)

A: I think one of the beauties of our design of our ASS furnace architecture, is that you can grow a 85kg, 100kg, 130kg, and all that time continue to expand that within the same furnace. Our customers are not tracked into a single size. And certain sizes of (?) are more efficient depending on whether you are running 4 or 6 inch wafers, mostly 2 inch wafers. We are seeing the industry move more toward 4 and 6 and our belief is based on what we've seen with the downstream customers our customers are looking at, is that they are really aiming at a 4 or 6 inch type of application with their product line.

Q: I do understand that your product is actually scalable. (?)

A: No, I think what I said is that based on what they're telling us they're aiming at 4 and 6 inch type of applications more so than 2 inch. Because of the flexibility of the solution, what they produce will be based on their customers are demanding. They start out making a (batch?), because you'd be betting on how fast it moves from 2-inch to 4-inch to 6-inch. But most of our customers, given the timeline of when they're going to be up and running, are really more focused on 4 and 6-inch type applications.

Q: Can you tell me what the different segments …(?) Is it really going to be true that as the volume ramps we'll get the margin expansion?

A: During the March quarter, our Sapphire business was more of an R&D business. And we were really busy in the expansion. So I think the thing to focus on the Sapphire business is that we've said it's going to run at or above the high end of our range for fiscal 2012. Our fourth quarter is not a good measure on the Sapphire business because of all the disruption that's going on and our focus on the R&D side of it.

For the 4th quarter, gross margin by segment:
45.4% for PV
40.7% for polysilicon
3% for Sapphire

The previous quarter for Sapphire was 40.7%. In Q3 we had a significant amount of disruption associated with the new factory build out, we were moving furnaces, introducing new furnances into the line. We also had several end-of-year accounting entries we had to book against the business. We did the acquisition during the course of the year. We did our year-end true-ups. So the important thing to take away is that Q3 was more representative of the business and as we go forward, we expect that gross margin from Q3 to ramp…and we'll expect that to be at the high-end of our 42-44% range. for the fiscal year 2012.

Q: The increase in gross margin guidance for FY2012 Is that just due to mix as far as more Sapphire? What drove that increase?

A: It's a combination. It is mix because of the Sapphire business tends to carry a higher gross margin. On top of that, we continue to drive cost out of our gross margin. Basically driving manufacturing cost down. We're continuing to accelerate, becoming more Asia-centric. And when we talk about ourselves internally, we talk about ourselves as an Asian supplier with corporate headquarters in the U.S. And that's having a very significant impact on our cost structure as well.

(From the earnings presentation [p14]: 93% of revenue from Asia, 1 10% or greater customer accounting for 19% of revenue).

I have been with the company 4 or 5 quarters now and I continually hear that the Asian margin is going to come under pressure from low-cost copycat type of competitors from Asia. And the fact of the matter is we continue to innovate, we continue to develop new products into the marketplace and provide value to our customers and our gross margin reflects the fact that we are able to provide that kind of value.

Competition is out there, the competition is real. We continue to out-innovate and we get value for the products we put in the marketplace. And that's reflected in how our margins are not only holding up but to some degree strengthening.

From the prepared remarks (p7):

"We expect that competition, which is largely focused on copying our technology, will continue to try to close the technology gap that exists between them and GT. As such, we are increasing our overall R&D spend by more than 60% in the coming year, in order to accelerate our rate of innovation. This will make it much more difficult for competitors focused on copying our technology to succeed."

Q: One follow-up if I could…I'm just looking at the math which is the PV segment versus the DSS segment. I think you shipped about 480 units in fiscal Q3 and about 400 in Q4. So, if I just divide the revenue by the units sold, it looks like ASPs came down. I am just wondering if I'm doing that math correctly.

A: You actually can't do that because there [are] a couple of factors. One of them is in some cases you take 90% of the revenue and 10% of it goes into the next period. We've got revenues that ship that haven't hit the P&L yet because they're in deferred revenue because of revenue recognition issues associated with those. And there's auxiliaries, service revenue, and spare parts revenue. So you can't do that.

Without speaking to the pricing directly what I'll tell you is our strategy is to put incredible pressure on our competition. In other words, not to let the margins get out-of-control. And to the extent we take cost out, and we get more efficient, some of that gets passed on, some of that gets taken into the gross margin level. We're more in a position to put pressure on our competition than they are putting pressure on price.

Q: The production cost structure of your poly reactors. We've seen a lot of volatility in poly spot pricing in recent weeks. And I wanted to ask how low could in theory spot prices get before you might get to see your buyers begin to pullback in investment.

A: I think the world class players in the industry can produce in the $20-25 per kilogram cost range, "all-in," including depreciation. I think that the industry over time will become an industry of 5-6 Goliaths. Their ability to make money even at $40 is pretty substantial. That's my view.

Q: Relative to the competitive landscape, the other players you guys are playing against, especially on the poly side, how does that $20-25 range compare?

A: I won't speak to their position. I'd say that we believe we have the most productive, lower power consuming, lowest cost, in the industry by far. I think the commentary that we gave you is representative in the marketplace speaks to the capacity. These are installed units that are running in uwpards of 70%. And that sort of speaks to our technical position. So do the orders we're taking from some of these big players speak to our technical position.

Some people count number of units but that is sort of irrelevant if you're counting units that have half, a third or a fourth the capacity of others. Others count shipped units that are currently installed. We tend to count units that are operating and actually creating polysilicon.

And I think it is worth pointing out that the estimate of 70% market share is one of the factors that we just talked about is prior to the FCR600 (?), everyone in the marketplace is getting very material upgrades in performance.

Q: Just a quick question on your Sapphire orders that you've booked year-to-date. Have you been getting, how much deposits have you been getting from your customers. Is it the typical 30%?

A: Our deposits range from the Sapphire business is pretty typical across the rest of our business. There is not much difference in our policy from sector to sector. I'd rather not speak to individual orders because I think that puts us in a difficult situation with different customers. So, I'd rather not do that. On average it's the same as it is across our other business.

One slight difference you might to think about is … In terms of the DSS business. We receive an order, we actually start ordering materials straight away. We look at deposits right after the contract gets signed. Because of the leadtime on the Sapphire furnaces right now, it is hard to go to a customer and say if you want to place a $100M order, we want a $30M deposit now. Even though we won't be procuring the materials until past the back-end of the calendar year. So because of that we might have staggered deposit arrangements which give us something that will hold your place in line in the production plate. But as we get closer to actual production and delivery we will get a second deposit. So, in that case, when you look at the balance sheet, that secondary deposit does not appear at that point in time. But, as Tom said, our general philosophy and principle is to get the same sort of deposit structure overall for these furnaces.

Q: This year for fiscal 2012, you are estimating 25% of revenue from Sapphire. If I look at your statements on the fact that a majority of the new orders that you booked for Sapphire are going to be revenue until fiscal 2013. Plus your ? business. Am I correct in estimating that your ? revenue could be as high as 50% of your total revenue?

A: I wouldn't want to comment on that. I think the mix chart that I showed near my presentation intended to show our Sapphire business and our polysilicon business in 2013 to be very, very strong and in the second half of fiscal 2013 we would expect the PV business to come back in some meaningful fashion. Beyond that, I'd rather not say.

Other than that, we have said on the call that our confidence in our backlog exiting fiscal 2012 has gone up dramatically. A lot of these orders are falling straight in 2013 and perhaps even beyond that. And our confidence level for continued growth is increasing.

Q: Your new business initiatives, can you give us some more color on how we should be thinking about that? Is that going to be more close to the solar industry? More LED?

A: Our focus is continuing to diversify the business but staying close to home in terms of what we know how to do and what our skillset is. So we're looking at crystalline type of structures. Yes, there is some solar on the mono-side that we're looking at. And we're sort of looking at consumables. They sort of run the gamut. Our objective is to diversify the business even further and have more insulation(?) from any "cyclicality" on sectors that we serve. And we're in a fortunate position in having a considerable amount of cash on hand and flexibility to make those investments.

[End of notes]

Be careful out there!

Disclosure: I am long SOLR.