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GT ADVANCED TECHNOLOGIES INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are identified by the use of words such as, but not limited to, "anticipate," "believe," "continue," "could," "estimate," "prospects," "forecasts," "expect," "intend," "may," "will," "plan," "target," and similar expressions or variations intended to identify forward-looking statements and include statements about our expectations of future periods with respect to, among other things, backlog, backlog conversions, gross margins, timing of when our business segments will recognize revenue and the amount that will be recognized, gross margins in our sapphire business to improve over time, continued investment in new product development and expansion of product base in each segment, increases in research and development spending, range of capital expenditures in fiscal 2012, material impact of accounting rules on financial position and results of operations, timing of revenue recognition, limited impact of change in market interest rates on our investment portfolio, all of the information under "-Factors Affecting the Results of Our Operations," timing of delivery of products, customers substantially performing their contractual obligations, customers renegotiating contracts, timing of recognizing deferred revenue as revenue, sufficiency of cash resources to satisfy working capital requirements, capital expenditures and other cash requirements, customer concentrations, demand for our products, effects of government tariffs, change in tax rates and the reasons therefore, growth of our business and product portfolio, fluctuation of polysilicon revenue, long term prospects for the solar industry and our PV segment, PV business accounting for a majority of our revenue for fiscal year 2011, outcome of litigation, tax rates, our plans to produce and sell crystal sapphire materials and our plans to produce, sell, deliver and install ASF systems. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to factors discussed under the heading titled "Risk Factors" included in this Quarterly Report on Form 10-Q. Forward-looking statements speak only as of the date of this report or, as of the date given if provided in another filing with the SEC. We undertake no obligation to publicly update or review any forward-looking statements to reflect events or circumstances after the date of such statements. Company Overview GT Solar International, Inc., through its subsidiaries (referred to collectively as "we," "us" and "our") is a global provider of polysilicon production technology, multicrystalline ingot growth systems and related photovoltaic manufacturing services for the solar industry, and sapphire growth systems and material for the LED and other specialty markets. Our customers include several of the world's largest solar companies as well as companies in the chemical industry. On July 29, 2010, we acquired privately-held Crystal Systems, Inc., which we refer to as Crystal Systems, a crystal growth technology company that produces sapphire material used for LED applications, as well as other industrial markets. We operate through three business segments: our polysilicon business, our photovoltaic, or PV, business and our sapphire business. Polysilicon Business Our polysilicon business manufactures and sells chemical vapor deposition, or CVD, reactors, used to react gases at high temperatures to produce polysilicon, the key raw material used in silicon-based solar wafers and cells, while also offerring engineering services and related equipment. 22 -------------------------------------------------------------------------------- Table of Contents Photovoltaic Business Our PV business manufactures and sells directional solidification, or DSS, crystallization furnaces and ancillary equipment used to cast multicrystalline silicon ingots by melting and cooling polysilicon in a precisely controlled process. These ingots are used to make photovoltaic wafers which are, in turn, used to make solar cells. Our PV business provided services related to the production of photovoltaic wafers, cells and modules, referred to as our turnkey business. During the three months ended July 3, 2010, we completed a review of our PV turnkey business and decided to no longer offer these services. This decision was based on our assessment of reduced market opportunities, as well as low gross margins compared to our other product lines. Our decision did not impact the recoverability of any tangible or intangible assets, and we did not incur any significant costs to eliminate this product offering. Sapphire Business Our sapphire business manufactures and sells sapphire materials and equipment. Our sapphire material is manufactured using our advanced sapphire crystal growth systems that incorporate the Heat Exchanger Method, or HEM, technology. We commercialized advanced sapphire crystal growth systems, or ASF systems and delivered the first system in May 2011 and expect to deliver additional systems throughout the fiscal year ending March 31, 2012 and beyond. We have limited experience installing and operating the ASF systems in customer facilities. If the ASF system does not operate properly in our customers' facilities, we will not be able to recognize revenue from the sale of ASF systems in a timely manner, or at all. In addition, our sapphire business, and our overall business, would be materially and adversely impacted. In addition to selling ASF systems, we intend to continue production and sale of sapphire materials in selected specialty markets. Factors Affecting the Results of Our Operations Demand for our polysilicon and PV products and services are driven by end-user demand for solar power. Key drivers of the demand for solar power include: volatile prices of conventional energy sources; the desire for energy independence to counter perceived geopolitical supply risks surrounding fossil fuels; environmental pollution from fossil fuels and the resulting tightening of emission controls; the competitive cost of energy from alternative renewable energy sources; and government incentive programs that make solar energy more cost competitive and changing consumer preferences towards renewable energy sources. In addition, our results of operations are affected by a number of other factors including the availability and market price of polysilicon and sapphire material, availability of raw materials, foreign exchange rates, interest rates, commodity prices (particularly molybdenum, steel and graphite prices) and macroeconomic factors, including the availability of capital that may be needed by our customers, as well as political, regulatory and legal conditions in the international markets in which we conduct business, including China. Our results of operations are affected by a number of other factors including, among other things, when we are able to recognize revenue under our PV, polysilicon and ASF system contracts. Our revenue recognition policies require us to defer revenue recognition in certain circumstances from shipped equipment and recognize revenue at a later date as more fully described under the caption "Note-2 Significant Accounting Policies-Revenue Recognition" in the notes to the condensed consolidated financial statements. Other factors affecting operations include delays in customer acceptances of our products, delays of deliveries of ordered products and our rate of progress in the fulfillment of our obligations under our contracts. A delay in deliveries or cancellations of orders would cause us to have inventories in excess of our short-term needs, and may delay our ability to recognize, or prevent us from recognizing, revenue on contracts in our order backlog. Changes in the global capital markets have resulted in a more stringent lending environment which in turn has, at times, caused decreased spending within the industries we serve. While we have experienced increased revenue in our PV business during the three months ended July 2, 2011 as compared to the same 23 -------------------------------------------------------------------------------- Table of Contents period in the last fiscal year, the international commercial lending environment has not stabilized and if the availability of capital or credit were to become even more limited than we are currently experiencing, we expect that the results of operations attributable to our PV business, and our other business segments, would be negatively impacted. We are required to make a significant upfront investment in order to fill orders for our PV, polysilicon and sapphire production equipment. In the past we have had customers for our DSS furnaces and CVD reactors place orders and fail to make payments (and while we did not complete these orders, we incurred certain expenses). In an attempt to mitigate such risks, we generally require customers to make non-refundable deposits and/or provide letters of credit on most polysilicon, PV and sapphire equipment orders. These advances, however, may not cover all of the expenses we incur in preparing to fill the applicable order. In addition, we have negotiated extensions of the delivery schedules and other modifications under some of our existing contracts and we expect similar negotiations to occur in the future. When customers fail to make a deposit when due under their contracts, we may terminate, and have terminated, those contracts. When we renegotiate terms of existing contracts with our customers, such negotiations may result in a change in the timing of deliveries and other terms, which may have an impact on our results of operations as more fully described under the heading "Order Backlog." During the early part of calendar 2010, market demand in the market for polysilicon increased and, in response, worldwide manufacturing capacity of polysilicon exhibited growth, due principally to expansion by existing manufacturers. However, as 2010 progressed, there was an excess of polysilicon manufacturing capacity and the market price for polysilicon experienced significant declines. Notwithstanding the total excess in polysilicon capacity, those market participants without the necessary cost structure will be unable to operate profitably in a lower polysilicon price environment. Accordingly, there will be an even greater focus on reducing production costs among polysilicon manufacturers. Since polysilicon production equipment is one of the principal factors that accounts for the costs of polysilicon production for manufacturers, we expect that for the immediate future there will be substantial pressure by our customers to lower the cost of equipment or they may delay or cancel their purchases of polysilicon production equipment. Even in the face of a consolidating market, we believe we are well positioned to capture a portion of the future demand for polysilicon equipment among the more limited number of manufacturers due to the higher throughput and lower power consumption, leading to greater efficiencies, generated by our reactor equipment. However, the timing of any future purchases is uncertain and it may be a significant amount of time before we see the benefits of any purchases of equipment, if it all. Much like our other business segments, our PV business is subject to cyclicality in demand for our PV products, particularly our DSS furnace. Revenues from our PV segment grew in fiscal year 2011 as compared to the prior year in large part due to the increased demand among solar manufacturers for our DSS products. We do not, however, expect that solar manufacturers will continue to purchase PV furnaces at the same rate in fiscal 2012, and such decreased demand may continue for a longer period. We believe that, due to consolidation within the solar industry and increasing cost pressures, some of our PV customers are starting to lower capacity utilization rates and delaying expansion projects as they respond to weaker near term end market demand. Due to efficiencies offered by monocrystal silicon and advances in monocrystal silicon production technology, we may experience a longer contraction in end user demand for multicrystalline silicon solar modules than in the past. This contraction has resulted in increased pressure on the margins for our PV products. It is not possible to determine when market demand for multicrystalline solar products will return with any certainty, but initial indications are that the market will exhibit increased demand in fiscal year 2013 or the first half of fiscal year 2014 compared to the same period in 2012. We have begun to develop monocrystal silicon production technology but have not yet commercialized such equipment. Demand for PV on-grid applications, which in turn impacts the demand for PV manufacturing equipment, has historically been dependent in part on the availability and size of government subsidies and economic incentives. The ability of governments to provide economic incentives may be significantly 24 -------------------------------------------------------------------------------- Table of Contents impacted by the recent economic downturn. For example, Germany, which has among the world's largest PV installed base, has implemented reductions in solar feed-in tariff rates for certain solar systems and further reductions in solar feed-in tariff rates may be made in the future. Spain, which has also been a major market for PV products, reduced availability of subsidies in 2009 from 2,400 MW per year to 500 MW per year for solar projects. Conversely, adoption of feed-in-tariffs in China could positively increase market demand. It is difficult to determine the impact that a changing incentive program has on solar module demand and our customers' ability to sell solar modules in a particular geographic market. We believe decreasing costs within the solar value chain will reduce the effect of tariffs on the investment returns for solar projects. In contrast to decreasing incentives in Europe, China continues to maintain policies designed to stimulate its renewable energy sector, including solar power. The changing environment for such government incentive programs creates uncertainty for the solar industry. We are a new entrant into the sapphire materials and sapphire equipment business. The results of our sapphire business will depend on the demand for sapphire-based materials and products, which will likely result in the majority of our revenue from the sapphire business in fiscal 2012 being attributable to the sale of ASF systems, and that the revenue from the sale of sapphire material will be comparatively smaller. However, we may not be able to recognize revenue pursuant to existing (or future) contracts to sell ASF systems in the expected time frame, in which case, a greater percentage of revenue from our sapphire business will be attributable to our materials business and beyond. We have limited experience installing and operating the ASF systems in customer facilities. During the three months ended July 2, 2011, we did not recognize revenue in connection with the sale of ASF systems. If the ASF system does not operate properly in our customers' facilities, we will not be able to recognize revenue from the sale of systems in a timely manner, or at all. In addition, our sapphire business, and our overall business, would be materially and adversely impacted. The sapphire materials industry has recently begun to show signs of slowing demand and decreased prices charged by sapphire manufacturers. We anticipate long-term demand for sapphire material will be driven, in large part, by general illumination manufacturers. However, in the short-term, the decreased demand for sapphire materials may impact demand for our supplied materials and ASF systems and the timing of which amounts attributable to supplied materials and ASF systems roll-off of backlog and into revenue. Our quarterly results have fluctuated significantly in the past due to, among other things, the factors cited above, and we expect that our quarterly results will continue to fluctuate significantly in the future for these and other reasons. Acquisition of Crystal Systems, Inc. On July 29, 2010, we acquired 100% of the outstanding shares of common stock of privately-held Crystal Systems, a crystalline growth technology company that manufactures sapphire materials used in LED applications and other specialty markets. The purchase consideration consisted of $24.8 million in cash, approximately 5.4 million shares of our common stock valued at $30.9 million (based on the closing market price of our common stock on the date of the acquisition) and a potential additional $18.7 million of contingent consideration based on the attainment of certain financial and technical targets through the period ending March 31, 2012. The fair value of the contingent consideration was $12.5 million at the date of acquisition. We recorded a purchase price adjustment resulting in a reduction in the fair value of consideration by $392 during the three months ended July 2, 2011. We have made contingent consideration payments of approximately $3.5 million through July 2, 2011. The transaction has been accounted for as a business combination and is included in our results of operations beginning on July 29, 2010, the date of acquisition. Order Backlog Our order backlog primarily consists of written contractual commitments and signed purchase orders, deferred revenue (which represents equipment that has been shipped to customers but not yet recognized 25 -------------------------------------------------------------------------------- Table of Contents as revenue) and short-term contracts or sales orders for sapphire materials. Substantially all of the contracts in our order backlog for PV, polysilicon and sapphire equipment require the customer to either post a standby letter of credit in our favor and/or make advance payment prior to shipment of equipment. From the date of a written commitment, we generally would expect to deliver PV and sapphire equipment products over a period ranging from three to nine months and polysilicon products over a period ranging from twelve to eighteen months, however, in certain cases revenue may be recognized over longer periods. Disregarding the effect of any contract terminations or modifications, we would expect to convert approximately 44% of our July 2, 2011 order backlog into revenue during the next twelve months and approximately 56% thereafter. Although most of our orders require substantial non-refundable deposits, our order backlog as of any particular date should not be relied upon as indicative of our revenues for any future period. We began tracking our backlog as a performance measure on a consistent basis during 2007. If a customer fails to perform its outstanding contractual obligations on a timely basis, and such failure continues after notice of breach and a cure period, we may terminate the contract. Our contracts generally do not contain cancellation provisions and in the event of a customer breach, the customer may be liable for contractual damages. During the three months ended July 2, 2011, we terminated or modified contracts resulting in a $10.4 million reduction in our order backlog (81% of the reduction was from 3 contracts). During the fiscal year ended April 2, 2011, we terminated or modified contracts resulting in a $10.7 million reduction in our order backlog (82% of the reduction was from 3 contracts). During the three months ended July 2, 2011, we did not record any revenue from terminated contracts and during the fiscal year ended April 2, 2011, we recorded revenues of $44.4 million from terminated contracts. Although we have a reasonable expectation that most of our customers will substantially perform on their contractual obligations, we attempt to monitor those contracts that we believe to be at risk, which include contracts with customers to whom we have sent notices of breach for failure to provide letters of credit or to make payments when due. We conduct negotiations with certain customers who have requested that we extend their delivery schedules or make other contract modifications, or who have not provided letters of credit or made payments in accordance with the terms of their contracts. We engage in a certain level of these negotiations in the ordinary course. We monitor the effect, if any, that these negotiations may have on our future revenue recognition. If we cannot come to an agreement with these customers, our order backlog could be reduced. Other customers with contracts in our order backlog that are not currently under negotiation may approach us with similar requests in the future, or may fail to provide letters of credit or to make payments when due. If we cannot come to an agreement with these customers, our order backlog could be further reduced. The table below sets forth our order backlog as of July 2, 2011 and April 2, 2011 by business segment: July 2, 2011 April 2, 2011 % of % of Product Category Amount Backlog Amount Backlog (dollars in millions) Photovoltaic business $ 370 16 % $ 468 39 % Polysilicon business 978 43 % 537 45 % Sapphire business 952 41 % 184 16 % Total $ 2,300 100 % $ 1,189 100 % Our order backlog attributable to our PV, polysilicon and sapphire businesses as of July 2, 2011, included deferred revenue of $395.7 million, of which $77.0 million related to our PV business, $317.2 million related to our polysilicon business and $1.5 million related to our sapphire business. Cash received in deposits related to our order backlog where deliveries have not yet occurred was $263.6 million as of July 2, 2011. 26 -------------------------------------------------------------------------------- Table of Contents As of July 2, 2011, our order backlog consisted of contracts with 29 PV customers, 16 of which have orders of $3 million or greater, contracts with 14 polysilicon customers, 13 of which have orders of $3 million or greater and contracts with several sapphire customers, 9 of which had orders of greater than $3 million. Our PV, polysilicon and sapphire order backlog as of July 2, 2011, included $554.0 million and $460.4 million attributed to two different customers, each of which individually represents 24% and 20%, respectively, of our order backlog. Results of Operations The following tables set forth the results of operations as a percentage of revenue for the three months ended July 2, 2011 and July 2, 2010: Three Months Ended July 2, 2011 July 3, 2010 Statement of Operations Data:* Revenue 100 % 100 % Cost of revenue 51 66 Gross profit 49 34 Research and development 5 3 Selling and marketing 3 3 General and administrative 7 8 Amortization of intangible assets - - Income from operations 34 20 Interest income - - Interest expense (1 ) - Other income (expense), net - - Income before income taxes 33 20 Provision for income taxes 10 8 Net income 23 % 12 % -------------------------------------------------------------------------------- º * º percentages subject to rounding. Three Months Ended July 2, 2011 compared to Three Months Ended July 3, 2010. Revenue. The following table sets forth total revenue for the three months ended July 2, 2011 and July 3, 2010: Three Months Ended Business Category July 2, 2011 July 3, 2010 Change % Change (dollars in thousands) Photovoltaic business $ 198,628 $ 111,441 $ 87,187 Polysilicon business 23,885 23,725 160 Sapphire business 8,583 - 8,583 Total revenue $ 231,096 $ 135,166 $ 95,930 71 % Revenue from our PV business increased 78% to $198.6 million for the three months ended July 2, 2011 as compared to $111.4 million for the three months ended July 3, 2010. PV revenue is comprised of sales of our DSS furnaces, other equipment, services and ancillary parts and spares. The increase in revenue attributable to the PV business is primarily due to an increase in the number of DSS units on which revenue was recognized during the period offset in part by a decrease in revenue related to our 27 -------------------------------------------------------------------------------- Table of Contents turnkey business, for which we no longer offer as an option to our customers. Revenue recognized during the three months ended July 3, 2010 from turnkey projects was $41.1 million and we did not recognize any revenue from turnkey projects in the three months ended July 2, 2011. Revenue from our polysilicon business for the three months ended July 2, 2011 was consistent with revenue recognized in our polysilicon business for the same period in the prior year. Polysilicon revenue for the three months ended July 2, 2011 substantially relates to contracts that were in our order backlog as of April 2, 2011. Revenue in our polysilicon business is generally recognized upon acceptance of product, whether existing or new, unless acceptance is considered perfunctory. As a result, our polysilicon business tends to have a higher level of deferred revenue than our PV and sapphire businesses. Approximately 80% and 73% of our deferred revenue balance at July 2, 2011 and July 3, 2010, respectively, relates to our polysilicon business. Included in our backlog are polysilicon contracts that grant contractual rights which require revenue to be recognized ratably over the contract period. Revenue is recognized when all other elements have been delivered and other contract criteria have been met. During the three months ended July 2, 2011 and July 3, 2010, we recognized revenue on a ratable basis from one of these contracts of $20.9 million in each of the respective periods. As of July 2, 2011 our deferred revenue balance included $52.1 million related to this contract which is expected to be recognized as revenue ratably through fiscal year 2012. Revenue from our sapphire business was $8.6 million for the three months ended July 2, 2011. Our sapphire business revenue during the period is attributed to the sale of sapphire material used in sapphire-based LED applications, as well as other specialty markets. Our sapphire business was acquired on July 29, 2010 and therefore, there is no prior year comparison. We did not recognize any equipment revenue from our sapphire business during the period. In both the three months ended July 2, 2011 and July 3, 2010, a substantial percentage of our revenue resulted from sales to a small number of customers. Two of our customers accounted for 29% of our revenue for the three months ended July 2, 2011 and three customers accounted for 56% of our revenue for the three months ended July 3, 2010. No other customer accounted for more than 10% of our revenue during the respective periods. Based on our results through July 2, 2011 and our order backlog as of that date, we believe our PV business will account for a majority of our revenue for fiscal year 2012. For the fiscal year ending March 31, 2012, we believe that no one customer will account for more than 25% of our total annual revenue. Gross Profit and Gross Margins. The following table sets forth total gross profit (in dollars) and gross margin percentage for the three months ended July 2, 2011 and July 3, 2010: Three Months Ended July 2, 2011 July 3, 2010 Change % Change (dollars in thousands) Gross profit Photovoltaic business $ 102,504 $ 36,692 $ 65,812 Polysilicon business 9,761 9,231 530 Sapphire business 1,124 - 1,124 Total $ 113,389 $ 45,923 $ 67,466 147 % 28 -------------------------------------------------------------------------------- Table of Contents Fiscal Year Three Months Ended Ended July 2, 2011 July 3, 2010 April 2, 2011 Gross margins Photovoltaic business 52 % 33 % 43 % Polysilicon business 41 % 39 % 42 % Sapphire business 13 % - 23 % Overall 49 % 34 % 42 % Overall gross profit as a percentage of revenue, or gross margin, increased to 49% for the three months ended July 2, 2011 from 34% for the three months ended July 3, 2010, primarily related to favorable product mix, improved factory utilization, timing of revenue recognition for certain contracts in our PV business and the maintenance of the prices we charge for our products. Our gross margins in our PV, polysilicon and sapphire businesses tend to vary depending on the volume, pricing and timing of revenue recognition. Our PV gross margins for the three months ended July 2, 2011 were 52% as compared to 33% for the three months ended July 3, 2010. The increase was primarily due to an overall increase in volume and a higher portion of revenue attributable to the timing of final acceptance under certain PV contracts. In addition, included in the gross margins for the three months ended July 3, 2010 was revenue of approximately $40.3 million from a terminated turnkey project that generated a gross margin of approximately 17%. Our polysilicon gross margins for the three months ended July 2, 2011 were 41% as compared to 39% for the three months ended July 3, 2010. The increase was primarily due to the timing of revenue recognition related to final acceptance on certain contracts during the three months ended July 2, 2011. Our sapphire business gross margins were 13% for the three months ended July 2, 2011.Our sapphire gross margins were impacted by unabsorbed manufacturing costs experienced during the three months ended July 2, 2011. We expect gross margins in our sapphire business to improve over time as we improve factory utilization. Operating Expenses. The following table sets forth total operating expenses for the three months ended July 2, 2011 and July 3, 2010: Three Months Ended July 2, 2011 July 3, 2010 Change % Change (dollars in thousands) Operating Expenses Research and development $ 11,272 $ 3,747 $ 7,525 201 % Selling and marketing 6,153 3,711 2,442 66 % General and administrative 16,208 10,588 5,620 53 % Amortization of intangible assets 1,070 791 279 35 % Total $ 34,703 $ 18,837 $ 15,866 84 % Operating expenses increased 84% to $34.7 million for the three months ended July 2, 2011, as compared to $18.8 million for the three months ended July 3, 2010. Research and development expenses consist primarily of payroll and related costs, including stock-based compensation expense, for research and development personnel who design, develop, test and deploy our PV, polysilicon and sapphire equipment, sapphire materials and our services. We expect to continue to invest in new product development and attempt to expand our product base in each of our segments. Research and development expenses increased 201% to $11.3 million for the three months 29 -------------------------------------------------------------------------------- Table of Contents ended July 2, 2011, as compared to $3.7 million for the three months ended July 3, 2010. The increase was primarily related to an increase in non-production materials of $3.1 million as we continue to incur such costs associated with our next generation DSS and polysilicon products. In addition, during the three months ended July 2, 2011 there was an increase in payroll and payroll related costs of $0.8 million. Further, the three months ended July 2, 2011 includes research and development costs of $2.2 related to our sapphire business which was acquired on July 29, 2010 and is not included in research and development expense for the three months ended July 3, 2010. Our spending on research and development activities is directly related to projects under development and the timing of the spending associated with each of the projects may vary from quarter to quarter. We expect our spending in research and development to increase over the remainder of the fiscal year ended March 31, 2012. Sales and marketing expenses consist primarily of payroll and related costs, stock-based compensation expense and commissions for personnel engaged in marketing, sales and support functions, as well as advertising and promotional expenses. Selling and marketing expenses increased 66% to $6.2 million for the three months ended July 2, 2011 from $3.7 million for the three months ended July 3, 2010. The increase in selling and marketing expenses was driven primarily by an increase of $0.3 million for payroll and payroll-related costs in our PV and polysilicon businesses and an increase of $0.8 million in trade show related expenses. In addition, the three months ended July 2, 2011 includes expenses of $1.1 million related to the sapphire business, which was acquired on July 29, 2010 and is not included in sales and marketing expense for the three months ended July 3, 2010. General and administrative expenses consist primarily of the following components: payroll, stock-based compensation expense and other related costs, including expenses for executive, finance, business applications, human resources and other administrative personnel; depreciation and amortization of property and equipment we use internally; fees for professional services; rent and other facility-related expenditures for leased properties; the provision for doubtful accounts; insurance costs; and non-income related taxes. General and administrative expenses increased 53% to $16.2 million for the three months ended July 2, 2011 from $10.6 million for the three months ended July 3, 2010. The increase was primarily due to an increase in payroll and payroll-related costs of $4.1 million; an increase of $1.1 million in facilities and office expenses primarily driven by increased activity at the facilities in our sapphire business that was acquired on July 29, 2011, and $0.7 million in earn-out accretion expense in connection with the acquisition of Crystal Systems. These increases were offset in part by a decrease of $0.7 million in legal expenses. Amortization expense attributed to intangible assets increased 35% to $1.1 million for the three months ended July 2, 2011 from $0.8 million for the three months ended July 3, 2010. The increase is due to the amortization of intangible assets related to the Crystal Systems acquisition, and is offset in part by a decrease in amortization expense attributed to the mix of intangibles being amortized, as certain intangibles related to our PV business became fully amortized during the fiscal 2011. Interest Income. Interest income decreased to $0.1 million for the three months ended July 2, 2011 as compared to $0.2 million for the three months ended July 3, 2010. The decrease was driven primarily by a decrease in the returns earned on our invested cash during the three months ended July 2, 2011. We invest our excess cash primarily in money market mutual funds. Interest Expense. Interest expense increased to $3.5 million for the three months ended July 2, 2011 from $0.2 million for the three months ended July 3, 2010 due primarily to interest expense and the amortization of deferred financing costs in connection with entering into our new credit facility during fiscal 2011. Included in interest expense for the three months ended July 2, 2011 was $2.2 million of non-cash charges for the amortization of deferred financing costs in connection with our credit facility. Interest expense also includes the interest component of forward foreign exchange contracts and represents the interest rate differential between the two currencies involved in our forward foreign exchange contracts for the specified period of time and can be either a premium or discount at the beginning of the contract and 30 -------------------------------------------------------------------------------- Table of Contents are adjusted to reflect interest rate market condition changes. The interest component of our forward foreign exchange contracts was not significant for the three months ended July 2, 2011 or July 3, 2010. Other, net. Other expense, net, was $0.1 million for the three months ended July 2, 2011 as compared to other income, net of $0.2 million for the three months ended July 3, 2010. The decrease was primarily due to an increase in foreign currency exchange losses incurred during the three months ended July 2, 2011. Provision for Income Taxes. Our effective tax rate is based on our expectation of annual earnings from operations in the U.S. and other tax jurisdictions world-wide. Our world-wide effective tax rate was 30.7% and 39.6% for the three months ended July 2, 2011 and July 3, 2010, respectively. The change in our reported tax rate for the three months ended July 2, 2011, as compared to the same period in 2010, relates to proportionally higher expected levels of income in lower tax jurisdictions as a result of our continued transition of our global operations center to Hong Kong. We review the expected annual effective income tax rates and make changes on a quarterly basis as necessary based on certain factors including changes in forecasted annual operating income by jurisdiction, changes to actual or forecasted permanent book to tax differences, impacts from future tax settlements with state, federal or foreign tax authorities, and impacts from tax law changes. Due to the volatility of these factors, our consolidated effective income tax rate can change significantly on a quarterly basis. Liquidity and Capital Resources Overview We fund our operations generally through cash generated from operations, proceeds from credit facilities and proceeds from exercises of stock awards. Our cash and cash equivalents balance increased by $110.6 million during the three months ended July 2, 2011, from $362.7 million as of April 2, 2011 to $473.4 million as of July 2, 2011 primarily resulting from increases in cash flow from operating activities. Net cash provided by operating activities in the three months ended July 2, 2011 allowed us to fund our working capital requirements during such period. We manage our cash inflows through the use of customer deposits and milestone billings intended to allow us in turn to meet our cash outflow requirements, which primarily consist of vendor payments and prepayments for contract related costs (raw material and components costs) as well as payroll and overhead costs as we perform on our customer contracts. The following discussion of the changes in our cash balance refers to the various sections of our Condensed Consolidated Statements of Cash Flows, which appears in Item 1 of this Quarterly Report on Form 10-Q. Our principal uses of cash are for raw materials and components, wages, salaries and investment activities, such as the purchase of property, plant and equipment. We outsource a significant portion of our manufacturing and therefore we require minimal capital expenditures to meet our production demands. The following table summarizes our primary cash flows in the periods presented: Three Months Ended July 2, 2011 July 3, 2010 (dollars in thousands) Cash provided by (used in): Operating activities $ 139,721 $ 25,613 Investing activities (8,854 ) (1,264 ) Financing activities (20,261 ) 1,294 Effect of foreign exchange rates on cash 36 61 Net increase in cash and cash equivalents $ 110,642 $ 25,704 31 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Operating Activities For the three months ended July 2, 2011, our cash provided by operations was $139.7 million. Our cash flow from operations was driven primarily by net income of $52.1 million, an increase in customer deposits of $119.1 million due to new orders in our polysilicon and sapphire equipment businesses and a decrease in accounts receivable of $31.7 million. These items were partially offset by a decrease in deferred revenue less deferred costs of $23.2 million, an increase in inventories of $35.6 million and a decrease in accounts payable and accrued expenses of $35.3 million. For the three months ended July 3, 2010, our cash provided by operations was $25.6 million which included $16.5 million of net income, $1.9 million of a net increase in deferred revenue less deferred costs and a decrease in accounts receivable of $15.2 million. We also experienced an increase in customer deposits of $19.5 million and increases in inventory and advance payments on inventory purchases of $24.7 million as a result of the increase in customer orders over the preceding six month period. Cash Flows from Investing Activities For the three months ended July 2, 2011, our cash used in investing activities was $8.9 million, consisting entirely of capital expenditures. These capital expenditures were primarily used for expanding our sapphire business and improving our business information systems. Our total capital expenditures in our fiscal year ending March 31, 2012 are expected to range from approximately $25 million to approximately $30 million, consisting primarily of improvements to our business information systems, manufacturing equipment, expansion of our facilities in New Hampshire and expected expansion of our facilities in Asia. However, our capital expenditures may exceed such range if we were to accelerate plans for the implementation of our growth strategy. Our capital expenditures for the three months ended July 3, 2010 were approximately $1.3 million. Our capital expenditures for the three months ended July 3, 2010 were primarily used for improving our business information systems and purchase of machinery and equipment to support our growth. Cash Flows from Financing Activities For the three months ended July 2, 2011, cash used in financing activities was $20.3 million, driven primarily by principal payments made under our Term Facility of $24.7 million. Of these principal payments, $4.7 million relates scheduled principal payments under the Term Facility. The remaining $20 million represents an additional voluntary principal prepayment made by us on June 15, 2011. This prepayment will be deducted from the payment due at the maturity of the debt in December 2013. These cash outflows were offset by proceeds and related tax benefits from the exercise of stock awards of $5.7 million. During the three months ended July 3, 2010 we received $1.3 million from financing activities, primarily related to the exercise of stock options. As of July 2, 2011, we had $41.6 million of outstanding standby letters of credit that were issued against the Revolving Facility. The majority of the standby letters of credit are related to customer deposits. As of July 2, 2011, there were no amounts available for borrowing under the Term Facility and $33.4 million available for borrowing under the Revolving Facility. We believe that cash generated from operations together with our existing cash, including cash received under the Term Facility, customer deposits and amounts available under our Revolving Facility will be sufficient to satisfy working capital requirements, commitments for capital expenditures, and other cash requirements for the foreseeable future, including at least the next twelve months. 32 -------------------------------------------------------------------------------- Table of Contents Long Term Debt and Revolving Credit Facility On December 13, 2010, we entered into the Credit Agreement, with Credit Suisse AG, Cayman Islands Branch, as administrative agent and collateral agent, and the lenders from time to time party to the Credit Agreement. The Credit Agreement consists of the Term Facility, in an aggregate principal amount of $125.0 million with a final maturity date of December 13, 2013 and the Revolving Facility, in an aggregate maximum principal amount of $75.0 million with a final maturity date of December 13, 2013. The Term Facility will be repaid in equal quarterly installments in an aggregate annual amount equal to 15% of the original principal amount of the Term Facility, with the balance payable on December 13, 2013. The full amount of the Term Facility was drawn by us on December 13, 2010 and no amounts have been drawn on the Revolving Facility as of July 2, 2011. We use the Revolving Facility in connection with the issuance of letters of credit. On December 13, 2010, we and the other parties to the Credit Agreement also entered into a Guarantee and Collateral Agreement, which we refer to as the Guarantee and Collateral Agreement. Pursuant to the Guarantee and Collateral Agreement, our obligations under the Credit Agreement are guaranteed by each of our wholly-owned domestic subsidiaries and secured by, among other things, a lien on substantially all of our wholly-owned domestic subsidiaries' tangible and intangible personal property (including but not limited to accounts receivable, inventory, equipment, general intangibles, certain investment property, certain deposit and securities accounts, certain owned real property and intellectual property), a pledge of the capital stock of each of our wholly-owned restricted domestic subsidiaries (limited in the case of pledges of capital stock of any foreign subsidiaries, to 65% of the capital stock of any first-tier foreign subsidiary), subject to certain exceptions and thresholds. Borrowings under the Credit Agreement bear interest, at our option, at either (i) an alternate base rate or an adjusted London Interbank Offered Rate, or LIBOR, rate plus, in each case, an applicable margin. Such applicable margin will be 3.25% in the case of alternate base rate loans and 4.25% in the case of LIBOR rate loans. Interest is payable (a) in the case of alternate base rate loans, quarterly in arrears, and (b) in the case of LIBOR rate loans, at the end of each interest period, but in no event less often than every three months. A commitment fee is payable quarterly in arrears at a rate per annum equal to 0.50% of the daily unused amount of the commitments in respect of the Revolving Facility. The Term Facility borrowing rate in effect at July 2, 2011 was 4.44%. Over the next three fiscal years, we will be required to repay the following principal amounts under the Term Facility (amounts in millions): Principal Fiscal Year Ending Payments 2012 (remaning nine months) $ 14.1 2013 18.7 2014 62.8 Total $ 95.6 In June 2011, we made a required principal payment in the amount of $4.7 million pursuant to the Term Facility in accordance with the payment schedule in the Credit Agreement. We may, at our option, prepay borrowings under the Credit Facility (in whole or in part), at anytime without penalty subject to conditions set forth in the Credit Facility. On June 15, 2011 we made a voluntary prepayment of $20.0 million against the Term Facility. This payment was applied against the payment due in December 2013. In connection with this prepayment, we recorded accelerated amortization of 33 -------------------------------------------------------------------------------- Table of Contents $0.9 million of outstanding deferred financing fees as interest expense as a result of the voluntary prepayment. We are required to make mandatory prepayments with: º • º 50% of excess cash flow (as defined in the Credit Agreement) in any fiscal year commencing with the fiscal year ending March 31, 2012 (as reduced by voluntary repayments of the Term Facility); and º • º 100% of the net cash proceeds (as defined in the Credit Agreement) of all asset sales or other dispositions of property by us and our subsidiaries, subject to certain exceptions. In addition, if the amount of all then outstanding letters of credit exceeds $75 million of the borrowing base, we will be obligated to pay the excess, subject to certain exceptions. The borrowing base will be determined from time to time as the sum of: (a) consolidated adjusted EBITDA (as defined in the Credit Agreement) for the four preceding fiscal quarters multiplied by 3; plus (b) the balance of unrestricted cash and cash equivalents as of the determination date. These mandatory prepayments are required to be applied pro rata to the remaining amortization payments under the Term Facility. The Credit Agreement imposes several financial covenants on us and our subsidiaries, including, but not limited to (i) maximum capital expenditures of $50 million during the two quarters ended April 2, 2011 and $40 million in any fiscal year thereafter, (ii) minimum ratio of consolidated adjusted EBITDA (as defined in the Credit Agreement) to consolidated fixed charges (as defined in the Credit Agreement) ranging from 1.0 to 1 to 2.0 to 1 at various times during the term of the Credit Agreement and (iii) maximum leverage ratio (as defined in the Credit Agreement) of 0.6 to 1.0 throughout the term of the Credit Agreement. As of July 2, 2011, we were in compliance with all covenants in the Credit Agreement. In addition, we have agreed to maintain all of our cash and permitted investments (as defined in the Credit Agreement) (which we collectively refer to as the Pledged Cash) in deposit or securities accounts in the United States that are subject to a lien in favor of the collateral agent for the benefit of the secured parties and perfected by control, provided that we shall be required to maintain Pledged Cash greater than 110% of the aggregate amount of the outstanding principal amount of the Term Facility and the revolving credit exposure (as defined in the Credit Agreement) on the last day of each fiscal quarter. The pledged cash is available to fund operations and is not restricted. The Credit Agreement requires that we and our subsidiaries comply with covenants relating to customary matters (in addition to the financial covenants described above), including with respect to incurring indebtedness and liens, using the proceeds received under the Credit Agreement, transactions with affiliates, making investments and acquisitions, effecting mergers and asset sales, prepaying indebtedness, and restrictions on paying dividends. The Credit Agreement includes events of default relating to customary matters, including, among other things, nonpayment of principal, interest or other amounts; violation of covenants; inaccuracies in the representations and warranties in any material respect; cross default and cross acceleration with respect to indebtedness in an aggregate principal amount of $10.0 million or more; bankruptcy or similar proceedings or events; judgments involving liability of $10.0 million or more that are not paid; ERISA events; actual or asserted invalidity of guarantees or security documents; and change of control. We use amounts available under the $75 million Revolving Facility in connection with standby letters of credit related to customer deposits. As of July 2, 2011, we had $41.6 million of outstanding letters of credit pursuant to the Revolving Facility resulting in $33.4 million of available credit under the Revolving Facility. On June 29, 2011, we entered into an amendment (the "Amendment") to the Credit Agreement, with Credit Suisse and the other lenders thereto. The Amendment made certain changes to the Credit Agreement, including (i) permitting us and our subsidiaries to cash collateralize letters of credit, and allowing liens to be placed on the cash and accounts utilized in connection with such cash collateralization, without any obligations in respect of such letters of credit being considered indebtedness for purposes of 34 -------------------------------------------------------------------------------- Table of Contents our financial ratios or available debt or lien capacity in the Credit Agreement and (ii) allowing our foreign subsidiaries to incur up to $100.0 million of indebtedness for working capital purposes (formerly this amount was $25.0 million) and permitting us to provide an unsecured guarantee in connection with such indebtedness. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. Standby Letters of Credit As of July 2, 2011, we had $41.6 million of standby letters of credit outstanding issued under the Credit Agreement representing performance guarantees issued against customer deposits. These standby letters of credit are scheduled to expire within the next twelve months and have not been included in the condensed consolidated financial statements included herein. Contractual Obligations and Commercial Commitments There have been no material changes to our "Contractual Obligations and Commercial Commitments" table in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Form 10-K for the year ended April 2, 2011, other than: º i) º as of July 2, 2011, purchase commitments under agreements totaled $352.9 million, substantially all of which are due within twelve months. As of July 2, 2011, prepayments under certain of these purchase commitments amounted to $263.6 million. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements On April 3, 2011, we prospectively adopted the provisions of Accounting Standards Update ("ASU") 2009-13, Revenue Recognition (Topic 605) -Multiple-Deliverable Revenue Arrangements, or ASU 2009-13, for new and materially modified arrangements originating on or after April 3, 2011. The adoption of ASU 2009-13 did not have a material effect on our financial results for the three months ended July 2, 2011, and is not expected to have a material impact on our financial position or results of operations in fiscal year 2012. Accounting Pronouncements Not Yet Adopted In June 2011, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income. This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The amendment requires that all nonowner changes in stockholders' equity be presented either in a single statement of comprehensive income or in two separate but consecutive statements. The standard is intended to enhance comparability between entities that report under U.S. GAAP and those that report under International Financial Reporting Standards, and to provide a more consistent method of presenting non-owner transactions that affect an entity's equity. The amendments in this update are to be applied retrospectively. The amendments are effective during interim and annual periods beginning after December 15, 2011, which for us would be the fiscal year beginning April 1, 2012. We have not yet determined which method we will elect to present comprehensive income under the new standard. 35 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates For the three months ended July 2, 2011, there were no significant changes to our critical accounting policies and estimates included in our Annual Report on Form 10-K for the fiscal year ended April 2, 2011, filed on May 25, 2011, with the exception of the changes to the Company's revenue recognition policy noted below. Revenue Recognition On April 3, 2011, we prospectively adopted the provisions of Accounting Standards Update, or ASU 2009-13, Revenue Recognition (Topic 605) -Multiple-Deliverable Revenue Arrangements, or ASU 2009-13, for new and materially modified arrangements originating on or after April 3, 2011. ASU 2009-13 amended the accounting standards for multiple-deliverable revenue arrangements to require an entity to allocate revenue in an arrangement on the basis of the relative selling price of deliverables. When applying the relative selling price method, the selling price for each deliverable is determined using vendor-specific objective evidence of selling price, or VSOE, if it exists, or third-party evidence of selling price, or TPE. If neither VSOE nor TPE exists, then the vendor uses its best estimate of the selling price or ESP, for that deliverable. The use of the residual method was eliminated by ASU 2009-13. The majority of our contracts involve the sale of equipment and services under multiple element arrangements. The multiple-deliverable revenue guidance requires that we evaluate each deliverable in an arrangement to determine whether such deliverable would represent a separate unit of accounting. The product or service constitute a separate unit of accounting when it fulfills the following criteria: (a) the delivered item(s) has value to the customer on a standalone basis and (b) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control. Our sales arrangements do not include a general right of return. For transactions entered into prior to the adoption of ASU 2009-13, we assess whether the deliverables specified in a multiple-element arrangement should be treated as separate units of accounting for revenue recognition purposes described above and whether objective and reliable evidence of fair value exists for these separate units of accounting. We apply the residual method when objective and reliable evidence of fair value exists for all of the undelivered elements in a multiple-element arrangement. If objective evidence does not exist for the undelivered elements of the arrangement, all revenue is deferred until such evidence does exist, or until all elements for which we do not have objective evidence of fair value are delivered, whichever is earlier assuming all other revenue recognition criteria are met. In certain circumstances we enter into contracts that grant contractual rights which are considered a separate element and require revenue to be recognized ratably over the period commencing when all other elements have been delivered and other contract criteria have been met and through the period when such rights expire. Upon the adoption of ASU 2009-13, management will allocate arrangement consideration based on the ESP of the contractual rights, which will be recognized ratably through the period when such rights expire. The adoption of ASU 2009-13 did not have a material effect on our financial results for the three months ended July 2, 2011, and is not expected to have a material impact on our financial position or results of operations in fiscal year 2012. Should we materially modify certain arrangements the amount of previously recorded deferred revenue could be materially impacted based on the application of ASU 2009-13 to the modified arrangement. The anticipated timing of revenue recognition for multiple element arrangements will generally not be significantly affected under ASU 2009-13 since we maintained objective evidence of fair value for the majority of the undelivered elements in its arrangements. For those arrangements where we have not historically had VSOE for the undelivered elements, such as certain contractual rights or ancillary products, revenue may be recognized earlier under ASU 2009-13. 36 -------------------------------------------------------------------------------- Table of Contents |