GT Advanced Tech Exec Insights: Sapphire Sales Guidance, R&D

On Thursday, GT Advanced Technologies Inc (NASDAQ:GTAT) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite revealed.

Sapphire Sales Guidance

Stephen Chin – UBS: Thanks for sharing the 2012 sales growth. Just a follow-up on the sapphire sales guidance for 2012? Tom, how much do you think sapphire pricing needs to rise to make it economical for customers to keep taking sapphire tools, and are you seeing customers convert some of their orders to your larger 120 kilogram furnaces to try to deliver better economics?

Tom Gutierrez – President, CEO and Director: We’re definitely seeing people upgrade, but I think there’s a couple of things in play that you have to consider. I mean, it is ours very strong belief that waiting around for recovery in prices is not a wise thing to do and in fact we’re targeting to bring our cost per millimeter by this summer or by July down by close to 40% from where our customers are right now, and we’re targeting to be below $2 per millimeter on a cost basis as we finish this excursion. Now, these are not pie in the sky targets. We’ve turned our Salem operation into almost a full time R&D operation over the last quarter and we’ve actually accomplished some of these levels at our Salem facility. Most of the cost comes out of the crucible cost and the consumable cost. They are very high yield, the size of the boules that we’re producing, and so our view is that we’re going to strengthen our backlog position and our customers’ ability to take those tools, not by waiting for the market pricing to go up, which is think is poly, but instead by putting them in a cost position that allows them to make money at the current prices and below. The second thing to consider, Steven, and I can’t emphasize this enough, as the prices have come down into the range that they’re in and as the costs drive into the area that we’re in, we’re working on some applications with some 30 well-known players here that could just blow the door off the backend of this thing in terms of the volume requirements in the industrial segment that our customers have. So, we’re putting massive amount of energy and effort into making sure that those applications take root. And in fact, I mean, I mentioned ShangCheng as one example; there’s several others, but I mean their follow-on orders are all in the industrial sector, okay. They are not for the LED business. In some cases they can get better pricing in some of the industrial applications that we’re working on. And so, we’re pretty bullish on driving the cost down, making our customers much more competitive; and two, amplifying the size of the market well beyond the LED sector.

Stephen Chin – UBS: And then a follow-up question, Tom, on your comments on the silicon carbide furnaces. When do you think you might be able to see orders for those silicon carbide furnaces, and can the substrates coming out of those silicon carbide furnaces also be used for the LED industry?

Tom Gutierrez – President, CEO and Director: Well, on the silicon carbide, you know, low-defect silicon carbide can be used in the LED industry. Our focus is – have been mostly aimed at the power semiconductor market where you can get some higher poly densities, and actually important for even the PV inverter market as well as the hybrid car industry. But our view is that we’ll introduce a product early in calendar year ’13 and at that point is when orders will start to take place. I can tell you, as is our normal pattern, we do a lot of market research before we enter a sector, we’ve talked to a lot of customers and nearly everybody that we talk to says when can I have it. So we’re pretty bullish about the opportunity, but we don’t expect to really introduce the product until calendar year ’13.

R&D

Ahmar Zaman – Piper Jaffray: Thanks for the guidance for the year as well. My first question is about your R&D spend increase, can you tell us – can you break it down by the 50% increase, which segment will that be focused on?

Tom Gutierrez – President, CEO and Director: I’d say it’s pretty evenly spread between completing the HiCz initiatives in St. Louis and getting that product introduce also in early calendar year ’13, completing the work on silicon carbide and a very significant amount of work that we’re doing in the sapphire area to drive the cost well below – for the crystal growth phase, well below $2 per millimeter. And so it’s pretty broad expenditure. I mean, while most of our peers in the industry are busy restructuring and spending money that doesn’t create future value. I mean, we are going to spend a lot of money building the future of the business.

Ahmar Zaman – Piper Jaffray: Then as a follow-up, LED – your sapphire customers that are pushing out – some of them are pushing out deliveries, others potentially are a little hesitant it seems like to take delivery. Given the improvement in the LED industry’s fundamentals and the stabilization of sapphire prices, can you talk a little bit about the competitive nature out there on the sapphire equipment side? I mean are there potential threats from competitors?

Tom Gutierrez – President, CEO and Director: At the moment and I can speak at the moment. Obviously I’m not going to name any competitors, mostly because there are none at the moment that we see posing a threat to our performance and as we bring our yields and our performance down to less than $2 per millimeter, we expect to maintain our first-mover advantage for quite some time. None of our customers are even looking any place else and we’ve had customers that moved in other directions that are starting to come back to talk to us about our ability to support them, and so I feel pretty good about the competitive environment. I’m mostly focused and lose most sleep about how fast we’re going to drive the cost down because that’s critical. I think the speed with which prices came down in the industry really surprised everybody. Our customers are in ramp-up mode, and as you know during ramp-up you don’t achieve the cost structure that you need until you’re in full high-volume production and so that’s a double whammy and so our focus is on cost, cost, cost, cost, cost, continue to improve yields and drive our customers’ success in the marketplace. Some of the delays in delivery are, as you stated, people being somewhat cautious, but I’d say there’s also a build out of facilities. We’ve had a couple of in the fourth quarter as you’ll note. I mean, our target originally been to ship closer to 400 units in the quarter. We have the one customer that we think will probably end up terminating the agreement with that impacted the fourth quarter. They’ve not taken units. We have a good 15% deposit that we’ll probably take, and so that had an impact. But I think we also had some facility issues with power and water that are going to be resolved through the first quarter and that’s what I think is going to drive the third quarter and fourth quarter pickup in deliveries.

Ahmar Zaman – Piper Jaffray: If I may squeeze in one last one, just on your gross margin guidance, can you dig a little bit deeper for us and help understand the gross margin, how we should think about gross margins for the ASF shipments as we go through the remainder of calendar year ’12, given gross margins for ASF shipments last quarter were pretty high around 48% (indiscernible)?

Tom Gutierrez – President, CEO and Director: Well, I think a couple things. We’ve traditionally said that our strategic targeted gross margin is in the 40-ish percentile range, and we said that for a couple of reasons. That is that I don’t want to create space for any potential competition, and obviously I also want to not stress the depreciation lines of some of my customers as they sort of seek to bring their cost structures down, and so first-mover first year of ASF sapphire (margins) were quite high, because actually we ended up spending less money than we actually thought in some of the rollout in commissioning of the furnaces, but it will normalize in calendar year ’12 and beyond to a level that’s more sustainable in the long-term. On the DSS side, that business is just under such incredible stress, and with the situation with multi and potential tariffs and all of that that we’re taking a strategic view of pricing as well as we – as we view the balance of the year. The fact of the matter is, we have a high mix of poly, particularly early in the year that’s going to impact our margins. But we don’t see a particular problem with being able to reach into the 40%-ish (out), that’s our strategic gross margin target.

Rick Gaynor – VP and CFO: Mark, just a little color on that. If you breakdown the 43% gross margin we had in the last quarter, sapphire segment was at 41.6%, so not tremendously higher than the guidance we’d given of 40%. Polysilicon was at 42.5%, which was a strong quarter for it. If you look at the same quarter of the prior year, it was 40.7%. So, that sort of 40%, 41% range is not atypical for polysilicon as well. PV was higher in Q4, but a small base could make (sense), but we’re not counting on PV helping us going forward anyway. So, if you look at the performance of the two primary segments that are driving the business now, they have been in the low 40s in Q4.

Tom Gutierrez – President, CEO and Director: I think the last thing to comment is we carry a lot of what we call flex headcount, and so, I believe that the flex or headcount on is pretty significant, which is why we don’t incur a lot of re – or any, restructuring charges per se, and during this next – this quarter that we’re in right now, we’ve sort of chosen to keep our headcount up slightly in preparation for what we see ahead in calendar year – in quarter three and quarter four in terms of our needs.