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Executives

Ryan Blair

Thomas Gutierrez - Chief Executive Officer, President and Director

Richard J. Gaynor - Chief Financial Officer and Vice President

Analysts

Ahmar M. Zaman - Piper Jaffray Companies, Research Division

Nimal Vallipuram - Gilford Securities Inc., Research Division

Stephen Chin - UBS Investment Bank, Research Division

Josh Baribeau - Canaccord Genuity, Research Division

Jesse Pichel - Jefferies & Company, Inc., Research Division

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Amir Rozwadowski - Barclays Capital, Research Division

Weston Twigg - Pacific Crest Securities, Inc., Research Division

Pavel Molchanov - Raymond James & Associates, Inc., Research Division

Satya Kumar - Crédit Suisse AG, Research Division

Krish Sankar - BofA Merrill Lynch, Research Division

Colin W. Rusch - ThinkEquity LLC, Research Division

GT Advanced Technologies (GTAT) Q2 2012 Earnings Call August 2, 2012 8:00 AM ET

Operator

Good morning and thank you for standing by. Welcome to GT Advanced Technologies June Quarter Financial Results. [Operator Instructions] As a reminder, this call is being recorded. Now I will turn the call over to Ryan Blair of GT Advanced Technologies Investor Relations. You may begin.

Ryan Blair

Thank you. As we begin, I would like to remind everyone that certain statements made during this call maybe forward looking for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. We may discuss our expectations regarding future events. In particular, these may be forward-looking statements regarding estimated future financial results for calendar 2012 and beyond, factors likely to affect financial results and other forward-looking statements regarding market conditions and factors, which may affect the performance of each of our business segments. In this connection, we direct your attention to the slide entitled Forward-looking Statements, which is at the end of the presentation accompanying this call today.

Important factors that could cause actual results to be different than our expectations are discussed in GT Advanced Technologies filings with the Securities and Exchange Commission, including the statements under the heading Risk Factors in the company's quarterly report, or annual report, on Form 10-K for fiscal 2012 filed on May 25, 2012. Statements made during this call should be evaluated in light of these important factors.

GT Advanced Technologies is under no obligation to, and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

During this call, management will address non-GAAP financial measures. Information regarding such non-GAAP financial measures, including reconciliation to GAAP measures and performance, is available in our earnings release as well as the investor presentation accompanying this call, both of which are available on our website, www.gtat.com.

In addition, I'd like to remind you that the company has changed its fiscal year end from March to December in order to align our quarterly reporting cycle with the calendar year, and more closely with our industry peers. A webcast replay of today's presentation will be available for 90 days beginning today at approximately 10:00 a.m. Eastern and can be accessed on the IR section of our website. An audio replay will also be available. Please refer to our website for additional details. In addition, following today's call we will be posting a copy of our prepared remarks to our website. [Operator Instructions] With that, I would like to turn the call over to Tom Gutierrez, President and CEO of GT Advanced Technologies.

Thomas Gutierrez

Good morning. With me today is Rick Gaynor, our Chief Financial Officer. I'll start with an overview of our performance in the second quarter, which ended June 30. Rick will review financial details, and provide an update of -- on calendar year '12 guidance, and before opening it up for questions, I'll provide an update on our long-term outlook. Given the continued headwinds in our served markets, we were pleased with our performance in the second quarter, which builds on our long track record of performing at or above our guidance. Our polysilicon business had a very strong quarter and our Sapphire and PV businesses performed in line with our expectations.

Revenue for the June quarter was $167 million, and EPS came in at $0.12 on a GAAP basis and $0.16 on a non-GAAP basis. We achieved a gross margin of 36%, in line with our guidance and well above the performance of most of our industry peers. Our backlog, which largely underpins our revenue forecast, remains solid, at $1.6 billion, and our assessment of risk is unchanged from what we described a quarter ago. We remain on track to achieve our top and bottom line guidance for calendar year '12, and continue to target growth in calendar year '13 as well.

In our Sapphire business, as expected, ASF shipments moderated as our customers focused on commissioning their factories, training their teams and getting the material qualified. To some of these buildouts continued at a good pace, and it is our expectation that ASF shipments will start to build again later this quarter, and become very significant by year end as our customers resume their ramp into high-volume production.

As anticipated, we terminated a $32 million ASF order during the quarter with a customer in China that had not yet taken delivery. For terms of the contract, the customer forfeited its deposit and we're in the process of pursuing damages for breach of contract. Consistent with our commentary last quarter, we believe that an additional $40 million of ASF backlog could be at risk.

These relevantly modest adjustments aside, we've been very encouraged by recent developments in the LED industry, including reports of improved utilization, the Chinese government's increasing commitment to stimulate its domestic LED lighting market and reports that sapphire prices have stabilized and, in fact, have slightly increased.

Driving down the cost of sapphire remains one of GT's most important initiatives so as to strengthen our customer's competitive position, further secure our existing backlog, and develop new markets for Sapphire. We've made very good progress along these lines. Last month, we provided our customers with process enhancements that once installed will enable them to achieve a 30% cost reduction from the baseline of approximately $5 per millimeter we established when we initiated shipments of our sapphire growth solution last fall.

By year end of 2012, our objective is to enable accumulative cost structure reduction of approximately 60% from the baseline. Our goal in 2013 is to offer customers a combination of additional product and supply-chain improvements that if implemented could enable them to achieve a crystal growth cost profile of less than $2 per millimeter, a level that would enhance their ability to grow and expand market share.

As we enable a reliable supply of low-cost, high-quality sapphire to come online, we continue to see new applications developing in consumer electronics, retail, medical and industrial markets. In addition, we've seen expanded opportunity for our own materials business in the U.S. for military applications.

One of the most promising opportunities in the consumer market is the broader adoption of Sapphire and handheld mobile devices. GT's ASF grown Sapphire is particularly well suited for these applications, and we're actively working with several of our customers and major end market players that have approached us to qualify and certify sapphire produced on our ASF systems as a more cost-effective, scratch-resistant and optically superior alternative to other materials currently in use.

We believe that GT is the only sapphire equipment company capable of quickly scaling to support the quick ramp of quality, cost and sizable volumes that the mobile device market could require as sapphire gains wider market adoption.

In our Solar business, as expected, conditions remain challenging as the industry faces the effects of overcapacity, declining subsidies, low prices, and import tariffs in the U.S. and, potentially, in the EU. As a result, the entire solar value chain remains under pressure with a very high level of demand volatility.

In the short term, our PV exposure is limited, with less than 10% of our backlog in this segment, and a stated assumption that up to 1/2 of the existing backlog in this business is at risk and not considered in our revenue forecast going forward.

Solarbuzz and our Green Tech scenario published this July projects that PV demand will grow at a 16% CAGR over the next 5 years. These projections do not fully take into account China's recent announcement that it is targeting to more than double its solar power capacity to 50 gigawatts by 2020. While we subscribe to this view of future growth, we believe that full recovery in the PV market is not purely demand driven. It is our view that the solar industry's key challenge at this point is cost, and that in order to realize the growth that is projected and restore profitability in the face of diminishing subsidies and counterproductive trade barriers, the industry must accelerate the development of technologies that will allow for profitability at significantly reduced total systems cost of $2 per watt at the system level or below.

We believe that our proprietary HiCz end-type product, which is targeted to enable cost-effective cell designs that can achieve efficiencies of 22% or higher, will be a key enabler in achieving these cost targets. We expect to be the first to market with the reliable HiCz production tool that meets the industry's needs, and are already seeing strong interest from prospective customers. We will remain on schedule to release our HiCz tool for commercial sale on the first half of 2013.

Lower polysilicon costs are also critical to the evolution of the solar industry. We continue to make very good progress in advancing our polysilicon technology to help our customers lower their production costs and improve their competitive position. As shown here, our latest generation polysilicon technologies can enable cash cost production for polysilicon facilities below $14 per kilogram. This assumes the best-in-class facility operating at greater than 10,000 metric tons per year, using our latest generation 600-metric ton reactor and single-line hydrochlorination technology. As prices come down and the focus on cost sharpens, we're well positioned to continue to be the leading provider of low-cost, high-quality solutions to polysilicon industry players throughout the world.

Overall, our polysilicon business remains quite healthy, and we expect this segment to contribute significantly to our top line this year and next. We're comfortable with the composition of our polysilicon backlog and believe that only $60 million of our $759 million poly backlog is at risk, mostly associated with one new entrant in China that is having difficulty raising funds and starting up.

I'd like to note that our current forecast assumed that we will begin shipping reactors to OCI in support of their Phase 4 expansion in the second half of calendar year '13, and that we will start to recognize revenue from these shipments in calendar year '14. While we believe that the recent news of China proceeding with an anti-dumping investigation of U.S. and South Korean poly imports has already been factored into this timing, we are following this development closely.

Based on our first-hand understanding of the cost structures, selling prices and profitability of many of the world's leading polysilicon producers, it's difficult for us to see how the Chinese could have a viable case. Having said that, given our technical leadership in this sector, GT's opportunities in China could expand if China moved to become more self-reliant as a producer polysilicon.

Our polysilicon order pipeline remains active as well and we are competing for several projects in the Middle East and Southeast Asia that could represent an additional $400 million to $500 million in potential sales. One of our primarily competitors in these markets recently filed for insolvency protection, which we believe enhances our chances to prevail should these deals move forward.

Before turning the call over to Rick, I'd like to briefly comment on our view of recent solar tariff developments in the PV segment. As we've indicated before, GT remains adamantly opposed to the imposition of solar tariffs, as we believe that they are counterproductive to the goal of reducing the cost of solar to make it a mainstream energy solution. In fact, protecting high-cost manufacturers is the last thing the industry should be doing. We see no direct impact to our business as a result of the preliminary U.S. tariff ruling that came out this May. As expected, some Chinese customers have started sourcing cell supply outside of China.

The EU case that was recently filed could have a much more significant impact on our Chinese customers. However, it may prove to be an opportunity for GT, as it could result in PV capacity additions in Europe. We believe we would be very well suited to compete for such business given our technology leadership and experience with PV installations in Europe. With that, I'll turn the call to Rick to review the quarter's financial results and an update on our calendar year '12 outlook. Rick?

Richard J. Gaynor

Thanks, Tom, and good morning, everyone. Before I provide details our performance in the June quarter, I would like to remind you that we are now reporting on a December year end. We have added non-GAAP measures to our normal reporting package to provide additional perspective on our core operating results. A full reconciliation of GAAP to non-GAAP financial measures can be found in our press release, as well as the presentation accompanying this call, both of which can be found at www.gtat.com. Also, in keeping with our usual practice, we have published an investor financial summary on the IR section of our website.

Moving onto our results for the second quarter of calendar '12, which ended June 30, 2012. Revenue was $167 million, significantly above our quarterly guidance range due primarily to our ability to recognize approximately $53 million of incremental polysilicon revenue. As a result, we recognize the total of $121.5 million of polysilicon revenue in the quarter.

In line with our expectations, sapphire revenue for the June quarter was $36.3 million. Also as expected, the PV segment contribution this quarter was light at $9.4 million.

Our business is often subject to quarterly variations. Looking at our performance over a 6-month basis, the revenue for the first half of calendar year '12 came in at $521.1 million, an increase over the same period last year.

Our gross margin for the June quarter was 36%, at the low end of our guidance. The gross margin was impacted by low absorption rates in our ASF and PV businesses, customer mix, and also other onetime charges related to our support of ASF customer startups and supply of consumable kits to ASF customers at cost. While we are not in the business of supplying consumables, the supply chain for sapphire is still immature, and we felt providing startup kits would accelerate our customers' path to high-volume production.

In addition, we are being very competitive with respect to the limited number of the DSS opportunities that do exist. Consistent with the strategy we outlined earlier this year, we have continued to make significant investments in our R&D. In the June quarter, we spent $13.9 million, bringing calendar year '12 R&D spending to $29.2 million to date, a 52% increase over the same period last year. The June quarter R&D was largely targeted at further advancing our ASF in HiCz products. Our tax rate in the second quarter of calendar year '12 was 36.2%, up from the March quarter due to the higher portion of U.S. earned income from polysilicon contracts.

Fully diluted EPS in the June quarter was $0.12, compared to $0.65 in the prior quarter and $0.41 for the year-ago quarter. Non-GAAP fully diluted EPS in the June quarter was $0.16, compared to $0.69 in the prior quarter and $0.44 for the year-ago quarter. June quarter EPS came in above our guidance range, primarily due to the increase in polysilicon revenue, as well as favorable OpEx management across all functions.

During the June quarter, we invested over $14 million of CapEx, primarily to support the continued buildout of our HiCz pilot facility in St. Louis. This buildout is now in its final stages and is scheduled to be completed by the end of August. As Tom noted, we borrowed $70 million against our term loan facility in order to provide us with additional strategic flexibility. In line with our expectations, we ended the June quarter with $332.4 million of cash and cash equivalents and $145 million in borrowing. This is down from $350.9 million of cash and cash equivalents, and $75 million of borrowing at of the end of last quarter.

Given our commitment to continued investment in growth initiatives, we expect our Q3 cash position to drop from these Q2 levels before improving in Q4. We now expect our year-end cash position to be approximately $268 million to $270 million. This does not reflect any potential investments in M&A.

Moving on to our backlog. We entered the June quarter with a backlog of nearly $1.8 billion. During the quarter, we received orders totaling approximately $14 million, in line with our modest expectations going into the quarter. As noted earlier, we recognized $167 million in revenue, we had approximately $32 million of negative adjustments to our backlog related to the sapphire ASF contract that we terminated.

We ended the June quarter with a backlog of $1.6 billion, which included $759 million in polysilicon, $138 million in PV, and $697 million for the sapphire segment.

Our backlog security remained over 30%, with approximately $149 million in deferred revenue, $74 million in letters of credit and $272 million in nonrefundable customer deposits. Our assessment to backlog risk remains very much in line with our remarks last quarter. At that time, we said we had approximately $200 million of backlog at risk, and approximately $170 million remains at risk today. To be clear, this assessment does not imply a definite de-booking. It is intended to indicate that for a variety of reasons, such as a customer's financing and end market dynamics, we assess that these orders could be at risk, and there is also a possibility that they could very well translate into revenue.

While in the past, we have provided a backlog roll-off number. We believe this number is not the most accurate way to assess the future performer business. While backlog roll-off is a factor in determining future revenues, there are many additional things that have to be taken into account, including, but not limited to, revenue recognition timing, the rate of projected book and ship business and delivery timing.

Given the limitations of the backlog roll-off number, we will not be focusing on this number going forward. Instead, we believe that the combination of our current year revenue forecast, our projected year-end backlog number and our expectations for growth in calendar year '13 provides the best understanding of our future performance. All of these measures take into account our view of backlog security, backlog roll-off and new order rates.

On that note, I will now discuss an updated view of our outlook for calendar year '12, which ends on December 31, 2012. We continue to take a cautious view of the market through the balance of the calendar year. Nevertheless, we remain committed to invest in R&D and M&A in order to advance our competitive leadership position and continue to diversify our business, while being prudent with our overall OpEx spending.

We continue to expect calendar year '12 revenue to be in the range of $925 million to $975 million, which would represent the approximately 6% to 12% growth compared to the previous year. We now expect the revenue split by business for calendar year '12 to be approximately 45% from sapphire, 45% to 50% from polysilicon and the remaining 5% to 10% from PV.

Our gross margin for calendar year '12 is now expected to be approximately 38% to 39%. Both our polysilicon and sapphire segments are on track to achieve a 40% gross margin for the year, but PV margins are expected to be down due to our competitive pricing strategy on DSS through the balance of the year. Once we have commercially established our HiCz products, we expect that our PV margins will begin to rebound to their normal levels.

We continue to expect R&D to be in the range of $65 million to $70 million, which would represent a more than 50% year-over-year increase. While we are holding our R&D guidance, we are reducing overall OpEx guidance by $5 million, to a new range of $155 million to $160 million, a reflection of the fact that we have carefully scrutinized in spending in the current environment. We have also decided to reduce the amount of additional capital investment we were planning on making in China through the balance of the year. And as a result, we are reducing our CapEx range to $55 million to $60 million from the previous range of $60 million to $70 million.

Our effective tax rate guidance for the full calendar year has increased to 34% due to the higher portion of U.S. earned income from polysilicon contracts. We expect an estimated weighted-average diluted outstanding share count of approximately 121 million shares for the calendar year. Calendar year '12 non-GAAP EPS is still expected to be in the range of $1.30 to $1.40.

As we previously indicated, and as noted on this slide, the year-over-year increase in R&D, which is reflected in -- has been -- which has been factored into our earnings guidance, is expected to impact our EPS by approximately $0.14 per share. In regards to the shape of the second half of the year, we expect Q3 revenue to be in the range of $150 million to $180 million. The biggest swing factor are shipments currently scheduled for the end of the quarter that are dependent on timing of supply chain deliveries. We expect the Q3 EPS to be down slightly from Q2 levels primarily due to an increase in R&D. As this implies, we expect to have a very strong fourth quarter. We expect that we will exit calendar year '12 with a backlog of approximately $1.1 billion, and as Tom indicated earlier, we continue to target calendar year '13 to be a growth year when compared to calendar year '12. With that, I'll turn the call back to Tom to wrap up.

Thomas Gutierrez

Thanks, Rick. Despite the near-term turbulence that exists in our served markets, you'll note from my tone that we remain very bullish about GT's strength, competitive position and growth prospects going forward. We continue to explore ways to further diversify the company's portfolio into new high-growth areas while also assuring that we remain at the forefront of the industries that we currently serve. Our strategic objective is to double the company's revenue potential over the next 4 to 5 years.

As Rick noted earlier, we added $70 million in debt to our balance sheet to potentially fund several investments that are under consideration. These include: opportunities in silicon carbide, gallium nitride and next-generation solar technologies. As the company continues to evolve towards a diversified multibillion dollar equipment technology company, we have taken steps to add additional depth and experience to our executive leadership team.

As announced yesterday, Dan Squiller has joined the GT team as our new President of PV and worldwide operations. I've had the pleasure of working previously with Dan, and feel very fortunate to have such a seasoned executive on my team. He will be based out of our global operations headquarters in Hong Kong, and will be responsible for our DSS and HiCz PV businesses as well as our worldwide manufacturing and field service operations.

Dan has extensive experience in growing global businesses and will be a key team member, along with the strong team that is already in place, as the company implements its strategic vision. With that, we'll now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Ahmar Zaman with Piper Jaffray.

Ahmar M. Zaman - Piper Jaffray Companies, Research Division

I've got a couple of quick ones. On your poly order pipeline, you mentioned about $400 million to $500 million in opportunity there. Can you talk about the regions and maybe the mix between incumbent and merchant opportunities?

Thomas Gutierrez

Well, I think, the region, or at least, if you sort of look at our strategic vision of the future is -- for quite some time, I've been talking about the solar industry as a strategic area for investment. Now the projects in the Middle East, as we've come to really understand them, takes some time to develop because I think this is an area where the people that we're dealing with are technically competent. They have very deep pockets, but they're also very careful about who they invest with and the nature of the technology that we put in place. And so, I mean, our rationale for actually mentioning at this time and mentioning the size of it, is because our confidence has increased, that the opportunities are not only real but that our opportunity to win them, particularly in view of the fact that our only competitor in that part of the world has basically gone into insolvency. We feel that it's a pretty good opportunity. But these are new strategic investments, they're not incumbent, per se, that we're dealing with. Now having said that, as you know, we penetrated several incumbents and continue to believe as we develop our technology further and demonstrate the performance of our technology that more of those opportunities will come our way. So I think, a lot of people have said for some time that the poly industry is dead. On the other side of it, we see it as our pipeline is as strong as it's ever been. And our opportunity for new bookings to fuel fiscal '14 and '15 and beyond is quite good. And we already have a backlog as we said is pretty solid, with sort of a who's who of the polysilicon industry in the backlog.

Ahmar M. Zaman - Piper Jaffray Companies, Research Division

And then if I may ask a question on your sapphire business. Have you already recognized revenues on the majority or all of the furnaces that were shipped to date?

Thomas Gutierrez

Pretty much. I'd say in some cases there's the last 10% that is awaiting recognition. That's just a timing over quarter-end type thing. But I'd say, the vast proportion of everything that we shipped has been recognized into revenue.

Ahmar M. Zaman - Piper Jaffray Companies, Research Division

And then, Rick, if I may, a final quick one on the balance sheet. Looks like you added about $70 million in debt in the quarter, yet your cash balance declined, I'm calculating, around $70 million to $80 million. Can you walk me through, just where that cash went, especially since there was no major M&A in the quarter?

Richard J. Gaynor

Yes, it's -- the way to look at it is, obviously, this is an extremely light bookings quarter for us, so this was more an issue of -- there was no significant cash inflows in the quarter as opposed to anything different materially on the cash outflows. So we continue to invest in the business. We continue to see ramp in R&D in OpEx. We obviously have tax payments in the quarter. We continue to make CapEx investments in our St. Louis facility. So there's nothing particularly out of the normal in terms of cash outflows in the quarter. The real issue for cash -- free cash flow in the quarter was the fact that we didn't have any real new heavy deposit rate in the quarter.

Ahmar M. Zaman - Piper Jaffray Companies, Research Division

Did you generate positive cash from operations in the quarter?

Richard J. Gaynor

We did not.

Thomas Gutierrez

And I would say that this was expected. This is not an unexpected. And we remain committed to -- we have a flexible cost structure, as you know, but we will remain committed to keeping that cost structure in place. Because as we've seen in the past, this industry has a habit of turning quickly and we don't want to be caught flat-footed and we have some opportunities that we think could lead to us needing to have that infrastructure in place as we move into the fourth quarter. With that method developed, we would obviously change our cost structure down.

Richard J. Gaynor

We did indicate on the call that -- on the last earnings call, I might add, that we did expect to see our cash balance decline in Q2, as well as Q3, and we reiterated that today. And we did say we expect then to see an improvement in the fourth quarter into that $260 million to $270 million cash balance range.

Operator

And our next question will come from the line of Nimal Vallipuram with Gilford Securities.

Nimal Vallipuram - Gilford Securities Inc., Research Division

Tom, I have one question, and, Rick, also just one question. Tom, when you look at the cyclical nature of both your industries, solar and LED, can you contrast that with your experience in what happened in the semiconductor industries? Give us some similarities and also some disimilarities in terms of how the sales are stacking up year-over-year?

Thomas Gutierrez

Well, I think there are a couple of things to think about, Nimal, is that it's 3 segments, okay? We think of poly as being somewhat differently driven than the PV segment. And so we look at it as 3 different cycles that we're dealing with in our current construct of the business. And the other thing to consider is that the solar industry is nowhere near at the maturity level and the curve of development that the semiconductor industry is at. So you can't take your clues from today's semiconductor industry. I think you have to set a step back in time and see that in the semiconductor industry, there were many more technology inflection points than there've been in the solar industry. The solar industry's been more of an evolutionary world. What we're sort of saying today is that the solar industry is about to see its first really significant technology inflection, where a lot of the capacity that's installed may find itself no longer viable as we move to the next step. And so our focus in the solar part of our business is taking advantage of that technology inflection going forward. But I think as the -- if indeed the Solarbuzz numbers are anywhere near correct and China follows through with a 50 gigawatts by 2020, there's plenty of growth. But our point today was that, that growth won't happen without a technology inflection that enables much lower cost per watt at the system level than today's world. And so similarities or not, but I think it's too early in the solar cycle to sort of equate it to the semiconductor world, other than to consider the fact that this is the first of probably several technology inflection points that are going to occur in this industry, as happened in the semiconductor world.

Nimal Vallipuram - Gilford Securities Inc., Research Division

Just on the second point, Tom or Rick, can you give us some more color on -- with the new industries or the new areas you have invested or what you can talk about in -- you have said strategically other areas, can you discuss any one of them?

Thomas Gutierrez

Certainly. I mean, we started the conversation and you're talking about our 3 cyclical growth industries that we're sort of serving. For quite some time I said that our strategic vision is to have 4 or 5 legs to the stool. And our efforts in silicon carbide and in gallium nitride and a couple of other areas that we are looking to invest in expand into areas that we have know-how in, but sort of invite us into new verticals, in the power semiconductor industry, which we think has a growth rate of 10x over the next 5 to 7 years in terms of power semiconductors. But an industry that could have even more growth is the cost of the silicon carbide wafers, for example, and other technology we're to develop. And so we remain committed to obviously having a protected and strong position in the markets that we're already in today, but at the same time, expanding into new verticals. And power semiconductors is the one that we've identified as our next area of significant focus.

Operator

And our next question will come from the line of Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank, Research Division

A question on the sapphire business, Tom. I think you talked about providing some of your customers with some consumable materials. How much longer do you think you'll need to continue to supply them with these consumables, given your ability to quickly lower the crystal growth costs?

Thomas Gutierrez

That's a superb question, Stephen, because I think what you have to step back and think of is that we're not just an equipment supplier here. We're actually creating an industry in a place where there wasn't one a year ago. And so we're focusing on creating a supply chain for alumina, supply chain for molybdenum crucible, supply chain for a lot of the different consumables that are used by our customers. And so over the last quarter or so, we've qualified suppliers of alumina inside of China, so that avoids the import duties in some cases and all that. And so we're rapidly making progress at putting that supply chain in place, but our forecast for the year, sort of contemplate that we'll probably be in the business of supporting some of our customers through the end of the year probably as part of it. But this is the task that we take on as industry builder and just an equipment supplier, and we're making great progress.

Stephen Chin - UBS Investment Bank, Research Division

And then for Rick, just a thought on the potential sapphire backlog risk of $170 million. Is that risk mostly from potential lack of payment to GT? Or is it the lack of experience using the ASF furnace? Or is it just weak industry prices?

Thomas Gutierrez

Stephen, this is Tom. The $170 million is across our entire $1.6 billion backlog. What we indicated is that we thought we had about a $40 million exposure in sapphire in our sapphire business. And that's not allocated to a particular customer. It's more of a general feeling on our part if there's going to be some adjustment and shipment numbers from one customer to the other, et cetera. But payment, as a matter of fact, this sort of has killed one of our polysilicon competitors, is payment terms for us are we ship it. We get paid before we ship it. So we don't generally have payment exposure sitting out there as some of our competitors do. And as a result of that, we tend to end up with Tier 1 players that have the cash to be able to play in that manner. And so it's really more of a generic risk, $40 million out of the $700 million or $800 million we have left of sapphire. By and large, we're actually quite pleased with how our sapphire customers are doing. Fuyuan, that's received a lot of attention, okay, has actually progressed to building what they call an LED city. And they have now 4 or 5 facilities out there bringing in capability to make luminaires, as well as crystal growth and their filling in between. And so these guys have gone well beyond just being a crystal growth house. And so we're pretty pleased with that type of development on their part.

Operator

And our next question will come from the line of Jed Dorsheimer with Cannacord Adams.

Josh Baribeau - Canaccord Genuity, Research Division

It's Josh Baribeau for Jed. Tom, you talk about 2013. You're hopeful that it's going to be a growth year. And just doing the math, you can exit this year with $1.1 billion in backlog, but a lot of that is for the OCI Phase 4, which you said is 2014, as well as some other polysilicon potential pipeline is 2014. So where are you expecting a lot of this growth to come from? Do you see that -- obviously, you expect a lot of the sapphire backlog to work itself through. PV probably remains influx. So are you expecting significant contributions from new opportunities, whether that's elsewhere in LED or power electronics?

Thomas Gutierrez

Not really. I think the -- if we look at our backlog composition, we're going to have a good strong year in poly next year, not driven by Phase 4 because Phase 4 is really a fiscal '14 revenue opportunity for us. I think we have -- I think it's close to $700 million or $600 million and something of backlog in sapphire. A good piece of that will work its way through in calendar year '13. We anticipate that some of the effort that we're putting in to the mobile handset market will come to fruition in calendar year '13, and so we expect to have an add-on order, set of orders, associated with our sapphire growth technologies in that area. And confidence comes from the fact that we're not just hoping for the business, we're working with the key suppliers of those kind of devices, and so we feel pretty comfortable. And then the PV segment, it's not the existing product line that's going to support our growth in calendar year '13. It's really the initiation of our HiCz product line. And we speak from the confidence of we have some very good customers in our pipeline that we're talking to that are interested in becoming the flagship customers for our initial entry point. And we continue to maintain that we're introducing our HiCz product by midyear, not backed up off from that. And there'll be a little bit of contribution from some of the energies that we're putting into silicon carbide and some of the other things, but they'll also be minor and won't grow really until calendar year '14.

Richard J. Gaynor

Josh, while we don't breakout our backlog by customer, because you mentioned OCI Phase 4, I think we can throw out the data point to you that OCI Phase 4 actually constitutes well less than 20% of our total backlog. So it's not as though our entire calendar year '13, '14 is riding on that one opportunity.

Josh Baribeau - Canaccord Genuity, Research Division

Okay. And then switching gears a little bit. You talked a lot about the LED opportunity, maybe something in mobile for sapphire. But are any of your existing customers or probably, at least, new people talking to you about non-LED application such as silicon insulator for sapphire?

Thomas Gutierrez

We've got one customer. And for customer confidentiality, I won't tell you who it is, who is added to their capacity already. We always have a follow-on orders from them that is running flat out on non-LED type production. I just revisited them just last month and I was just blown away by the variety of non-LED opportunities that they've been able to find and so -- and tap into. A lot of that is driven by the fact that if the cost comes down, new doors open, because the properties of sapphire are superior to some of the low-cost things that were being used, but we're quite encouraged by what we're seeing as developing areas beyond just the mobile handset area. And in the U.S., we have an interesting set of opportunities associated with military applications that only we can serve because of the rules on military contracts. And so, hopefully, that's responsive to your question.

Operator

And our next question will come from the line of Jesse Pichel with Jefferies.

Jesse Pichel - Jefferies & Company, Inc., Research Division

Poly plants that don't use hydrochlorination are going to have a tough time getting costs down in this environment, and I'm wondering how big that opportunity is for GT?

Thomas Gutierrez

I think we have about 25, is it, 25 different projects ongoing as we speak that are in our backlog. And some of these engineering services and all that represent probably 10% of our current backlog today. And so that's definitely an opportunity here. They're not $100 million and $200 million orders, but they're nice $25 million, $30 million orders. And I think as the industry moves to some of the higher efficiency areas that they need to move to, it's not just capacity that's important, it's going to be quality of the poly. And a lot of the quality of the poly is derived from the quality of the PCS that's being fed into the reactors. And so we see that as an opportunity area that -- and when I commented on the China versus the rest of the world, I'm terrified that's going on. China could become an interesting market for us if they chose to really double down and become more self-reliant in the poly area.

Jesse Pichel - Jefferies & Company, Inc., Research Division

When you say that 10% of the backlog is in hydrochlorination, are you including the front-end xylene package that you're offering? Was that an additional?

Thomas Gutierrez

That's in total.

Jesse Pichel - Jefferies & Company, Inc., Research Division

Total. And this quarter, you've had some cancellations there. And I'm wondering how much customer deposit unit you kept and what the margin impact of that was. It looks like customer deposit came down $60 million?

Thomas Gutierrez

We kept around just shy of $6 million worth of the deposit, around $5 million, $5.5 million or thereabout from the sapphire customer that we terminated. And obviously, there's a larger sum associated with the actions that we're taking for breach of contract that's not included in that.

Jesse Pichel - Jefferies & Company, Inc., Research Division

And the cost down is very helpful, from $5 a millimeter. And I'm wondering what is the number today? It's a little hard to see from the chart. And can you confirm that a 2-inch core is around $4 a millimeter today, price?

Thomas Gutierrez

No, what I can tell you is that we introduced our ASF85 last fall our initial price or cost and, as you know, every manufacturer has different competencies and efficiencies, but our cost target was a little bit over $5. We've just introduced what amounts to 30% cost reductions. That would bring that $5 -- approximately $5 down to a new level. But every customer's -- that's what can be achieved with the technology. But you know I like car analogies. Everybody that has a Ferrari can't drive it at 150 miles an hour. So the capability to get 30% below $5 is there today with what we've done. We expect by year end to have that capability down another 30%, for a total of 60%, which gets us -- starts to get us pretty close to our target. But every manufacturer is different in terms of where they -- how they've implemented and what they're able to achieve.

Operator

And our next question will come from the line of Jeff Osborne with Stifel, Nicolaus.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Just a couple for me. On the mobile front for sapphire, can you talk about what the cost advantage is expected to be versus the current glass solution?

Thomas Gutierrez

I don't think it's a cost advantage discussion, Jeff. I think it's really a -- if you're in the box of cost, it's performance, okay? The performance of the sapphire relative to scratch resistance, relative to breakage resistance, relative to optical qualities as such and it also carries a pizzazz with it, okay, that makes it a somewhat different solution than the existing solutions are. But what I can confirm to you is that we're in the cost box. We're in the cost box, it's now about performance. Can we demonstrate and can our customers demonstrate as they're piloting our capability whether or not it's something that they want to do. There is a cellphone out there already that uses sapphire. The Vertu cellphone uses sapphire, and, as you know, all high-end watches use sapphire for the same reasons: scratch resistance, optical qualities, et cetera. And so it's not a cost down, it's a performance upgrade.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

And then just 2 quick ones here. Can you talk about -- to your best of your knowledge, do you think the 2 new incumbents that you've talked about in the past as having customers on the poly side? In your view, are those fully funded projects at this point? And then another just second qualitative question. Can you just kind of discuss on the sapphire side what your view of the 4-inch qualification processes is from your customers?

Thomas Gutierrez

The first question -- can you repeat the first question? I'm not sure I understood it.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

So on the 2 incumbent poly customers that you talked about in the past, I think you press released the MEMC-Samsung joint venture, and then another one was undisclosed. In your view, are those fully funded projects at this point?

Thomas Gutierrez

Yes.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then on the 4-inch side. What's the update there in terms of the Chinese and Taiwanese customers, in terms of the production mix that you're seeing?

Thomas Gutierrez

Well, I think the path to 6-inch is definitely a lot slower than most anticipated, because the technical challenges have proven to be quite substantial. But the other factor that I think has emerged is that the cost of sapphire and the cost of the substrate at the 2-inch level have decreased. Some of the -- what we're seeing is that the push to 4-inch and 6-inch has slowed down, that -- we're seeing our -- we're seeing the Chinese value chain putting a lot of emphasis on 2-inch and 4-inch, but almost no emphasis on the 6-inch side.

Richard J. Gaynor

Remember, Jeff, we have said that we are in 6-inch production today ourselves out of our facility in Salem. So we're sort of agnostic as how quick that moves, because we're well positioned in all diameters, it's just -- this is the way the market's moving, so.

Operator

And our next question will come from the line of Amir Rozwadowski with Barclays Capital.

Amir Rozwadowski - Barclays Capital, Research Division

Tom, looking at your outlook for 2013, it does seem as though a lot of it is dependent on a sort of strong traction or improved traction on the polysilicon business. The one question I had was in terms of potential share gains opportunities, we had heard chatter that your technology has been -- the folks who haven't traditionally haven't used your technology have them looking at it from a lower cost opportunity perspective. I was wondering if you could give us a little bit of color there, that would be helpful.

Thomas Gutierrez

Well, I think, I'll go back to the beginning of your statement. I mean, our poly business for next year is essentially in backlog. It's not go off and get it, and go off and win it, it's delivering, okay? It's execution and delivery. And I made a point today of pointing to the fact that Phase 4 in Korea is not in our revenue projections for calendar year '13, it's in calendar year '14, to give you some sense of what the volatility may or may not be. And I think, we pretty well disclosed the nature of a lot of our Tier 1 top-notch customers in poly. And Rick commented that OCI was less than 20%, or Phase 4 was less than 20%. And so our poly view for next year and our growth for next year is not really dependent on going off and grabbing a bunch of share and all that. I think our growth in '14 and '15 and '16, that really requires us to continue to win some of these poly contracts and all that. And so I think the -- to your technology question, our SDR 600, 600 metric tons, very low energy consumption per kilogram, is several generations ahead of anybody's merchant equipment that's out there. And to a large extent, I think that's what sort of chased our European competitor that's in difficulty right now into some of the more risky markets for their business. And that sort of played out the way that we expected it to play out, but the performance of our technology is far ahead. Now having said that, we've also indicated to the marketplace that we will introduce in the next year or so a product that will be significantly more productive than the SDR 600 or the 600 metric ton machine that we are now implementing in the marketplace. And so the technology train has not slowed down, it's actually accelerating towards what we think is going to be a pretty breakthrough series of products next year.

Amir Rozwadowski - Barclays Capital, Research Division

And then, Rick, if I may. If you look at your 2012 guidance, obviously, a touch lower in terms of the gross margin expectations. I was wondering if you could give a little bit of color there. Is that sort of just a mix shift that we should think about, no real change in terms of structurally the gross margins for the individual businesses?

Richard J. Gaynor

The gross margin is purely a reflection of the fact that we're a dogfight DSS environment right now. So we are willing to be very aggressive on pricing in the DSS side, where opportunities exist, as well as the fact that we have absorption issues in the DSS business, given the low volumes that it's running at. So what we try to indicate on the call is that -- so structurally long term, our poly margins and our sapphire segment margins are holding where we expect them to be, at that sort of 40% range. The drag that we're getting on gross margin this year is entirely due to the DSS business.

Thomas Gutierrez

Sure. And I think when you think of the DSS business, the other thing to think about is, we're holding ground with customers that we want to maintain very good relationships with as we move into our HiCz product, which is truly differentiated going forward, and so that's part of our game right now. And then on the structure and the absorption, we've made a decision to maintain our structure in view of our vision that this, too, shall come to an end and there'll be a ramp-up. Now where we come to the conclusion that, that wasn't the case, we'd take that overhead out, and we're in a good position to do that.

Operator

Our next question will come from the line of Weston Twigg with Pacific Crest.

Weston Twigg - Pacific Crest Securities, Inc., Research Division

Just 2 quick questions, actually. Just on the order side, I'm wondering -- you talked about the poly orders this year, but what are your expectations for when the HiCz orders, and maybe more orders for the industrial sapphire could come in, and when would those start meaningfully adding to the backlog?

Thomas Gutierrez

I'd say in 2013. I feel -- our view has been and our projection for $1.1 billion at year end doesn't take a lot of math to figure out that we're assuming very low order intake through the balance of the year. We'll see some orders in the sapphire side of it because we're in negotiation on follow-on orders with several customers. Poly orders, the big ones in particular, are probably into 2013. And we're going to introduce our HiCz midyear 2013. And that's really when the order rates really start to crank back up. But starting the year with essentially $1.1 billion or more, which is what we're projecting, puts us in a pretty good position.

Weston Twigg - Pacific Crest Securities, Inc., Research Division

And then also just wondering, Rubicon yesterday announced that technology patent for in-situ crystal orientation. I'm just wondering if that has any impact on your sapphire business?

Thomas Gutierrez

It sounds interesting, but it doesn't have any impact.

Operator

And our next question will come from the line of Pavel Molchanov with Raymond James.

Pavel Molchanov - Raymond James & Associates, Inc., Research Division

On the -- of the deals you're currently contemplating, are they pre-revenue, revenue generating or is it a combination of both?

Thomas Gutierrez

Generally, I don't comment on individual deals, but I'd say it's a combination of both. We tend to orient our M&A activities towards bolt-ons that bring technology into the -- and market opportunity versus buying things that have to be restructured in a lot of revenue. The other thing that I'll say just for being completely transparent in giving clarity is, we have 0 interest in doubling down in the solar value chain that exists today. Any solar investments that we make are aimed at next-generation technology that drives the cost down towards that, less than $2 per watt at the system level. But you're not going to see us doubling down in the value chain that exist today.

Pavel Molchanov - Raymond James & Associates, Inc., Research Division

Okay. You used the term solid in relation to the backlog as it currently stands. Is there a level of backlog where you would begin to get concerned?

Thomas Gutierrez

Well, rather than sort of giving you a specific number and such, what we've said is that the normalized backlog that this company should aim to have, given its book-and-ship profile and the new technologies and all that, is circa $1 billion. I think the company has been at $500 million or $600 million of backlog back when I first joined the company 3 years ago, and you've seen our growth since then. So I would start to get nervous if it got down to those kind of levels, but a normalized level in and around $1 billion is what you'd normally expect of a book-and-ship type structure like what we have.

Richard J. Gaynor

Now Pavel, I mean, sapphire backlog itself is kind of a difficult health indicator to use just because of the nature of our business. So, for instance, we have said that we had very high sapphire ASF backlog that will come down because that's moving more and more to a book-ship type business. So you would not expect to see hundreds of millions of dollars in backlog for sapphire furnaces. Once we get that to be a full book-ship type business, we're only -- it stays in your backlog for a matter of weeks as opposed to months or quarters. On the other hand, as HiCz comes online, we would expect to see backlog starting to build for that in the early stages. So you're always going to have some ebb and flows dependent on what products you've just brought to market. So that's why that's a difficult health barometer to use. And you really have to look at the individual mix of businesses and where we are in the product life cycles.

Operator

Your next question will come from the line of Satya Kumar with Crédit Suisse.

Satya Kumar - Crédit Suisse AG, Research Division

I just have one question. Most of my questions have been answered. The cash balance that you mentioned, Rick or Tom, $260 million to $270 million at the end of the year, is that a gross or a net cash balance? Do you expect to increase the debt levels in the $145 million to year end? And can you clarify how much drawdown you still have left on the credit facility?

Thomas Gutierrez

Yes, Satya, I think we look at cash from 2 perspectives; one of them is what does it take to run the business on a day-in and day-out basis. And we can run the business well below a couple of hundred million dollars in cash balance. The other factor that we take into account as to whether or not we're going to take on debt or not take on debt relates to opportunities that are on the table that allow us to reach towards our doubling of revenue in 4 or 5 years. And at the moment, what we've said is we took in what we thought we needed to execute on the opportunities that we've got in front of us. Where -- a new opportunity that come across the bow that was very, very substantial, we might consider it. But at the moment, we all feel reasonably comfortable with where we're sitting. And we're pretty comfortable with where we expect to end the year as well.

Operator

And our next question will come from the line of Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch, Research Division

I have 2 of them, either for Rick or for Tom. The PV backlog that is at risk about $70 million, is that at risk because of the financial condition of your customer or is it due to competition? And I also had a follow-up.

Thomas Gutierrez

It's the financial condition of our customers. By and large, our customers have been pretty loyal to us, because we've been able to continue to give them new technology and protect their base investment and the technology. And so the reason we're being aggressive is a little bit of payback to some of those customers to help them through these very difficult times. But it's all about their profitability, health and cash availability. It's not about competition.

Krish Sankar - BofA Merrill Lynch, Research Division

And then just a follow-up. The OCI Phase 4 reactors, would they be what they're using too like the SDR 300 or would it be like the 400 or 600s?

Thomas Gutierrez

I'm sorry, say that again?

Krish Sankar - BofA Merrill Lynch, Research Division

The OCI Phase 4, are they SDR 300 reactors or are they higher?

Thomas Gutierrez

I would rather not divulge exactly what OCI has, but I would say they're one of the most technically advanced producers in the industry. And so that would lead you into the direction of what kind of technology they're implementing and they have.

Operator

And our next question will come from the line of Colin Rusch with Think Equity.

Colin W. Rusch - ThinkEquity LLC, Research Division

Could you talk about your expectations for where the CapEx funding is going to come from for this next generation of the solar industry? Are you seeing significant interest from new players that have more substantial, sizable balance sheets and better cash flow than the existing folks or do you see additional funding coming from local lenders in China?

Thomas Gutierrez

I've commented for some time that the nature of the pipeline for HiCz, for example, is not the traditional players that you're seeing today. We're seeing some pretty well-funded Japanese, Korean and even Western European players, and Middle East as well. And so we're seeing new players that are interested in walking through this door that's suddenly opened and being able to be competitive, because nobody in their right mind is going to go off and try to take on the massive value chain that exists in China today. Now the other thing that we've noticed is that the Chinese incumbents tend to be focused on figuring out how to protect this massive infrastructure that they've built over the last year and so we actually see them coming to the party on the new technology side somewhat slower than some of the players that we're talking to on HiCz. And so this could not only be a technology inflection point in the industry. There's a potential for there to be a geographic inflection under way as well. Now the Tier 1 top-level guys in China, they're all with it. I mean, they all understand what's about to happen and they all are in the game. But I think that there's a potential that the geography and the players are going to shift here, because the existing players don't have the cash.

Colin W. Rusch - ThinkEquity LLC, Research Division

And then just changing gears into the fixed in short that you guys are doing. Can you talk a little bit about how much variability in thickness you've been able to work with and reliably run through different processes both on the industrial side as well as on the LED side?

Thomas Gutierrez

You're talking about the sapphire itself?

Colin W. Rusch - ThinkEquity LLC, Research Division

Yes.

Thomas Gutierrez

Well, we're not polishing, okay? We're selling basically cores and boules, or that's what our customers are generally selling. And the ones that are polishing, which is actually more than 1/2 of them, okay, have put in polishing operations and wafering operations, I couldn't tell you what their process tolerances are.

Colin W. Rusch - ThinkEquity LLC, Research Division

Okay. But you're not doing any of that work yourself in the R&D?

Thomas Gutierrez

It's not a function of the boules or of the cores, it's a function of the downstream wafering and polishing. The quality of the sapphire counts, and, obviously, we produce very high quality sapphire, but it's not a function of what we do.

Okay. That concludes our call for today. Thank you again for joining us this morning and for your questions. We look forward to seeing many of you during our upcoming investor relations activity. We'll be at the Canaccord Genuity growth conference in Boston later this month and at the Barclays Clean Tech event in Zurich in September. Have a great day.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may all disconnect. Good day, everyone.

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