Rubicon Technology, Inc.
Q2 2015 Earnings Call Transcript

Published: 7 Aug 2015

[Operator:]

Good afternoon and welcome to the Rubicon Technology Second Quarter 2015 Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Dee Johnson, Vice President, Investor Relations. Please go ahead.

[Dee Johnson:]

Thank you, Travis, and good afternoon everyone. We're pleased you would join us today for Rubicon's second quarter 2015 earnings conference call. With me today is Bill Weissman, Rubicon's CEO, and Mardel Graffy, Rubicon's Chief Financial Officer. We have allotted one hour for our call this afternoon. Bill provide an overview of second quarter results of operations and Mardel will review our financial results to detail and discuss our outlook for the third quarter of 2015. We will then be happy to take your questions. Today's call is being webcast through the Investor Relations section of our website. The webcast and press release can be found at ir.rubicontechnology.com. A replay of this call will be available for a week and the webcast will be archived in the Investor Relations section of our website. Before we begin, please be advised that certain statements in this presentation relate to future results that are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the accuracy of which are necessarily subject to risks, uncertainties and assumptions as to future events that may not prove to be accurate. Factors that can cause actual results to differ materially from those expressed or implied include general economic conditions, and the factors discussed in our most recent Form 10-K and other filings with the Securities and Exchange Commission. We undertake no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Now I'd like to turn the call over to Bill.

[Bill Weissman:]

Thank you, Dee. Good afternoon everyone and thank you for joining us today. The sapphire market continued to be very challenging in the second quarter as overall sapphire demand was weaker in the quarter. We believe this to be a result of a combination of factors, including increased TV inventory levels impacting the LED backlighting market and some seasonality in LED lightbulb sales. While there are quarterly fluctuations in the sapphire market, the main markets for sapphire, LED lighting and mobile device components, continue to grow. Sapphire unit sales into the LED market and the current mobile device applications are expected to grow 16% per year for the next several years, and we believe there will be further adoption of sapphire for use in mobile devices. While the sapphire industry remains in a state of excess supply, we believe capacity should be gradually absorbed by these growing markets. During the current down-cycle in the market, we have been focusing on a number of key initiatives, aggressively pursuing our PSS potential, targeting high-margin applications, driving down product costs, and developing new products. Our goal is to focus on products that require more intellectual property to produce like PSS wafers, particularly in larger diameters, and optical products. We also continue to leverage our vertical integration to keep our product costs low so we can compete in the more competitive markets like mobile device components and smaller substrates. And we believe that new product introductions will help diversify the business and drive stronger margins. So our product development efforts are a high priority. Our revenue in the second quarter was $7.1 million as compared to $8.9 million in the first quarter. The reduction in revenue was primarily due to lower volume and pricing, particularly for 2-inch core. Demand from the mobile market was weaker in the quarter, resulting in lower 2-inch core volumes and additional pricing pressure. 2-inch core pricing declined around 18% in the second quarter as compared to the prior quarter pricing. While pricing declined sequentially, loss per share was similar to the prior quarter at $0.33. Overall wafer revenue was unchanged sequentially; however, PSS wafer sales began to grow as expected. PSS sales in the second quarter totaled $900,000, nearly double the amount in the prior quarter. We expect PSS sales to grow throughout the year and we recently received a $9 million purchase order for 6-inch PSS wafers to be delivered over 12 months beginning this October. Polished wafers sales declined sequentially because our focus on wafer sales has shifted exclusively to patterned wafers where we believe there's greater margin opportunity. In the optical market, demand was softer in the second quarter, but we continue to build strong customer relationships in that market and expect steady growth over the next several years. We are focusing our customer relationship and technology development efforts on larger-size sapphire parts, 200 mm to 500 mm and greater dimensions for aerospace, semiconductor, defense and industrial markets. We are producing larger windows currently for semiconductor and defense applications from our large Biels [ph] and we have begun qualification of very large windows from our lens technology both in defense and commercial applications. We intend to be the dominant supplier of large-area sapphire optical products within the next one to two years by expanding our Biel [ph] sizes and commercializing our lens and other new technologies. We are also expanding our end-user and finishing customer bases in our target optical markets by enhancing our finishing capabilities and dedicating more sales resources to these markets. Mardel will provide a more detailed breakdown of second quarter revenue in a few minutes and we have provided a revenue table in our press release for your convenience. While sapphire demand from the mobile device market was soft in the second quarter, the market is expanding with the introduction of sapphire watches -- excuse me, smart watches, and broader use of camera lens covers. The current excess capacity of sapphire was largely driven by the unfit [ph] sales growth expectations for this segment, particularly as they relate to the use of sapphire and larger pieces such as faceplates for smartphones. While this application has not yet been adopted, we believe that it will be in time. While the focus of sapphire faceplates has primarily been on scratch and break resistance, some are considering ways to use the qualities of single crystal sapphire to add greater functionality. In the meantime, we expect global capacity to be gradually absorbed by the greater adoption of these smaller pieces in mobile devices. However, the market at the moment is very challenging. While sapphire pricing rose in the first half of last year, pricing has declined over the past several quarters and the current pricing environment is particularly tough. The continued oversupply in the market along with weak currencies in Russia and Japan have compounded -- have been compounded by the current softness in the market. Pricing for 2-inch core in the second quarter was close to 1/2 the price of what it was in the second quarter of last year. One of the objectives this year is to become cash flow positive by the end of this year. While it will be difficult to hit that target this year without some pricing increases, we remain focused on that objective and are aggressively working on reducing product costs. We have made good progress in reducing our crystal growth costs over the past 12 months. Through yield improvement and raw material cost reductions, we have reduced our crystal growth costs by approximately 15% in the past year. We continue to work on process improvement and design changes to continue to drive crystal costs lower. One such change is the conversion of our 83 kg furnaces to 93 kg, which will allow us to increase throughput for a nominal incremental cost, and also increase yield. The conversion is being done gradually according to our maintenance schedule to avoid premature replacing expensive parts. We have also made progress in reducing wafer costs. As most of you know, our original polishing operation was focused only on 6-inch wafers and we subsequently added 4-inch polishing to support our entry into 4 as well as 6-inch PSS. And as I mentioned, we are currently focused on PSS sales as we believe it represents a better margin opportunity for us than polished wafers. And we expect PSS volumes to continue to increase throughout this year. A key to optimizing the potential of our PSS capacity is to further reduce our polishing costs, and this has been a top priority for us this year. Reducing polishing costs has progressed more slowly than we have expected. In order to expedite the polishing cost reductions, we have recently signed a resource sharing agreement with a leading sapphire polisher. Under that agreement, we will receive what we believe to be a lower cost 4-inch polishing process in exchange for making available to the other party the use of a portion of our under-utilized slicing and polishing capacity in Malaysia. The capacity we retain should be ample to meet our full PSS capacity needs and will allow us to spread some of our manufacturing overhead to further reduce costs. We will continue to use our existing 6-inch polishing process but believe that some of the process modifications made for 4-inch will be transferable to 6-inch and would result in reduced costs for that product as well. This improvement in process is not expected to require any additional capital expenditures. We are also making progress on our R&D projects aimed at providing a more affordable solution for the use of sapphire and smartphones, tablets and many other mobile devices and displays. We are currently working with several major consumer electronics manufacturers interested in testing our samples of sapphire coated glass and are finding interest in a much broader application base than initially expected. We recently received requests for samples of coating on certain metals, a broader range of glass, as well as plastics for a variety of products. We will be producing those samples in the coming months to test the limits of the process and better define the target markets. We expect the order of production reactor this quarter to enable us to provide the higher volume samples and pilot production capacity which are required for customers to fully test and qualify the new products and processes. The lead time for this production reactor is expected to be four to six months. Additionally, we are moving forward with a proof-of-concept of our net shape growth technology to provide a low-cost single crystal solution for consumer electronics -- the consumer electronics market. If successful, we will be able to produce a single crystal sapphire faceplate for mobile devices that will require very minimal post growth processing. Today, making such products from the current bulk growth process is very costly, primarily due to the high costs for fabricating the bulk crystal into the finished form. While development will take longer, we hope to finish the proof-of-concept stage by the end of this year. In summary, the sapphire market continues to be challenging, but the actions we are taking during this difficult time in the market will position the Company to drive strong margins from a more diverse set of products once the market improves. We believe we will increase our PSS revenue over the course of this year. We are being very aggressive in our efforts to reduce product costs. And we're excited about the opportunity to commercialize new products in the consumer electronics, defense and aerospace markets, and to grow our current optical business. I'd like to turn the call over to Mardel who'll provide you with greater details on the financial results for the second quarter and our outlook for the third quarter of 2015.

[Mardel Graffy:]

Thank you, Bill. Revenue for second quarter was $7.1 million, down $1.8 million from the prior quarter. Core revenue decreased from $5.1 million in the prior quarter to $4 million. As Bill explained, core revenue was lower on decreased volumes and pricing, particularly for 2-inch core. Wafer sales were lower by $587,000 from the prior quarter as we shifted our focus to patterned wafers. PSS wafer sales almost doubled from the prior quarter and volumes are ramping towards a meaningful increase in the second half of the year. Optical revenue decreased from the prior quarter by $578,000 on lower sales volume. Optical revenue tends to fluctuate throughout the year, so there will be some volatility quarter to quarter. We continue to enhance our focus on this business and expect revenue from this market to grow in coming years. Our crystal growth operations continued to run at full capacity throughout the quarter, but our polishing and patterning operations remained under-utilized. Idled plant costs in the second quarter were $1.6 million, down from $2.2 million in the previous quarter as we increased PSS production in Malaysia. We expect utilization of our Malaysia factory to increase further as PSS wafer orders continue to increase and from the new resource sharing agreement. Operating expenses in the second quarter totaled $3.2 million as compared with $2.8 million in the prior quarter. The increase was due to increased spending on R&D personnel and projects and an increase in legal fees. The result was a loss per share in the second quarter of $0.33 as compared with the first quarter loss of $0.32 per share. Turning to the balance sheet and cash flow. We maintained a strong cash position with our cash and short-term investments balance of $36 million at June 30th, with no debt. We used $5.1 million in cash in the quarter. Our DSO at June 30th increased to 102 days, up from the prior quarter-end DSO of 77 days. This reflects timing on collection of certain accounts from which some payments were received then in July. Inventory levels in total increased by $320,000. We continue to lower our raw material inventory balance, which declined sequentially by $1.4 million from $12.9 million at the end of the first quarter to $11.5 million at the end of the second quarter. In addition to reducing our per unit costs through our internal raw material process, we've also reduced the total quantities in inventory. Working process inventory increased by $1.2 million in the quarter as we built in advance some inventory for the third quarter shipment. Given the lower 2-inch demand, we have begun scaling back some of our crystal growth from full production to about two-thirds capacity, as well as limiting our raw material production. While we expect the market to improve, it is difficult to predict the timing and we want to avoid building inventory. The reduced throughput will still give us sufficient crystals to support our growing PSS business and support our key core customers, while allowing us to reduce inventory levels, particularly in raw materials. With the new resource sharing agreement, we expect utilization of our Malaysia factory to increase significantly. However, some of the depreciation that is currently reflected in idled plant will continue on but will be classified differently. Regarding our outlook for the third quarter, we expect the challenging market continue. While PSS wafer sales are expected to increase, visibility on 2-inch and 4-inch core sales is limited, so third quarter revenue is expected to be at or below second quarter levels. Revenues from PSS sales is expected to continue to grow in the fourth quarter and we believe demand on 2-inch and 4-inch core should also strengthen in the fourth quarter. Process changes associated with the resource sharing agreement will be made over the course of the remainder of the year. The extent and timing of cost reductions from these changes will be better understood as the changes are implemented. For the third quarter, loss per share is also expected to be at or higher than the prior quarter. I would now like to turn the call back over to Bill for some closing comments and then we'll be happy to take your questions.

[Bill Weissman:]

Thank you, Mardel. The long-term outlook for commercial sapphire remains strong. General LED lighting adoption is ahead of projections and growing rapidly. Mobile and consumer electronics applications are also growing, with potential for significant upside in sapphire cover plates for smartphones. And there are many high-margin applications available and developing in optical markets for large-area high-quality sapphire and sapphire coating technologies. But the near term remains very challenging given the current pricing environment. The time it will take for the excess capacity in the marketplace to be absorbed is difficult to predict. At this time, we are placing intense focus on reducing product costs and introducing new products, while tightly managing cash flow. While the timing is uncertain, we believe that the pricing environment will improve. This improvement, along with the actions we are taking this year in cost reduction, technology development and new product introductions will position the Company to generate strong margins once again. I'd like to thank you all for joining us today and thank you for your continued support. And now, operator, may we take our first question?

[Operator:]

Thank you. [Operator Instructions] The first question today comes from Jed Dorsheimer from Canaccord.

[Jed Dorsheimer:]

Hi. Thanks. How much do you expect to take -- how much in terms of further cost could you remove from the core business per millimeter over the next six to 12 months, do you anticipate?

[Bill Weissman:]

Difficult to say. We think it's not unreasonable to expect another 15% plus. We're working on a number of things to significantly increase the yield and particularly in our Batavia plant. But my expectation, it would be at least that much.

[Jed Dorsheimer:]

Okay. And then in terms of demand coming back. Six-inch demand, is there a particular hotspot that you -- or I guess there's no hotspots in the sapphire market right now, but is there a particular region that you're seeing coating activity pick up at all? And then I have a similar question for 2-inch and 4-inch cores, as to whether or not that's largely China-based in terms of that demand.

[Bill Weissman:]

Sure. The 6-inch one, 6-inch order for PSS is kind of a new user of 6-inch, I'd prefer not to say what region that's from. There is another major LED manufacturer that was moving to 6-inch PSS this year. They're kind of going at a slower pace than expected so far. And the other major 6-inch user in Asia is also a bit slower. Those are really slowdowns resulting from kind of weakness in general market conditions. But I think overall we're still seeing more interest in 6-inch. But obviously it's still kind of a relatively small percentage of the total. I'm sorry, Jed, what was the other of your --

[Jed Dorsheimer:]

So in 2-inch and 4-inch, I recognize that most of your customers are polishers that are going to be in Taiwan and maybe some, to a lesser extent, in China. But do you have any indication in terms of demand? Is it all being driven out of China, or is it equally spread between Taiwan, China and Korea?

[Bill Weissman:]

Yes. Two-inch demand is almost exclusively in China right now. There's a little bit of 2-inch use in LED in Taiwan, but most of the 2-inch is used in Taiwan -- excuse me, in China, for both LEDs and the smartphone market. And 4-inch is -- there is some 4-inch in China but that's almost exclusively in Taiwan and Korea.

[Jed Dorsheimer:]

Okay. And then last question for me, in terms of the GT fallout, are you seeing any market implications with respect to the GT bankruptcy at this point, or what are your thoughts around that?

[Bill Weissman:]

No, we're really not hearing anything on that. We're not seeing any -- we're not hearing about any [on furnaces] really popping up anywhere. We do hear that smartphone manufacturers, certain smartphone manufacturers are still very keen on faceplates and are sampling bricks and so on and trying to evaluate how much is available in the open market and how much they would have to supplement. There was also some interesting new interest for 6-inch wafers from some non-traditional sources that are popping up. So there's a lot of buzz out there about new demand for larger dimensions on the horizon, but certainly nothing concrete enough to get excited about at this point, so.

[Jed Dorsheimer:]

Okay. I'll jump back into queue. Thank you.

[Bill Weissman:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] The next question comes from Andrew Abrams from Supply Chain Market Research. Please go ahead.

[Andrew Abrams:]

Hi. Thanks. Can you, I know it's a little early on the revenue share side, can you talk a little bit more about that in terms of, you mentioned, process changes that you were getting in exchange for the use of idle capacity, can you talk a little bit about that, what that actually entails? Is it really a change in process or is it different equipment that you're going to need to purchase? Is there anything associated with your side of it that's going to be cost related? And also you mentioned something about -- or I think Mardel mentioned something about the reclassification of some of the idle costs. If you could kind of be more specific on that.

[Bill Weissman:]

Sure. So the party that we're working with has done extensive development on 4-inch slicing and polishing. And I've been spending the past six months or so working with some of our competitors, exploring different scenarios, and I believe they've done a lot of unique things on 4-inch slicing and polishing side, and bringing that process in-house will dramatically reduce our 4-inch polishing costs once they're in place, would cut them at least in half. And also, should transfer -- a lot of those processes should transfer to 6-inch and reduce those costs as well. In exchange for that, they're getting the use of some of our equipment. We will not charge the for the equipment, we will not charge them for depreciation, but we will charge them for a lot of the manufacturing support, engineering support, maintenance and so on that is kind of some cost for us anyway. So we're spreading that cost over a larger number of wafers and billing this other company for a portion of that. They're also, based on the process we'll be adopting, we're expecting the throughput to increase quite a bit. So while, if we're basically allowing them to use essentially about half of the installed capacity, with an increased throughput, we're not expecting all our capacity to reduce by half, it should be something less than that. We expect to have something more like 70% of the existing capacity still available to us. So it really is, in my view, a win-win situation. The industry is -- got too much capacity and there needs to be consolidation in one form or another. We need to make sure that the capacity that's out there is being used efficiently. And I think this agreement works very well for both parties and makes us more cost-efficient and provides them with what they need, which is some additional capacity.

[Mardel Graffy:]

And in answer to your question too about the CapEx piece of it, they've already, as Bill mentioned, we were working with on this for several months that -- so they have come in and looked at our machinery and have not come through and said that needs to be replaced to fit their models. And in answer to your other question then, we haven't finished really completing the specifics in terms of research and the appropriate accounting treatment for this agreement. And once we do, then we'll be able to give more specifics on how that depreciation will be classified.

[Andrew Abrams:]

Got it. Okay. And is there any difference in what you guys are sensing in terms of your Russian competitors and their ability to price better at this point given the currency issues? Has that settled down at all or changed at all or is it still about the same as it was last quarter?

[Bill Weissman:]

Well, the currency situation really hasn't, you know, hasn't weakened at all, so that has not helped them any further. Of course it's giving them a significant advantage over where they were a year ago, and to a lesser degree some of our Japanese competitors. But I think the current weakness in the last quarter has been more a function of kind of a general weakness in demand rather than currency fluctuations.

[Andrew Abrams:]

Got it. Thanks very much.

[Bill Weissman:]

Thank you.

[Operator:]

Thank you. That does conclude our question-and-answer session. I would now like to turn the conference back to Dee Johnson for closing remarks.

[Dee Johnson:]

Thanks, Travis, and thanks everybody for joining us today. We appreciate your interest. And we look forward to speaking with you again soon. This concludes the Rubicon second quarter conference call.

[Bill Weissman:]

Thank you.