Rubicon Technology, Inc.
Q3 2015 Earnings Call Transcript

Published: 10 Nov 2015

[Operator:]

Good day and welcome to the Rubicon Technology Third Quarter 2015 Results Conference Call. All participants will be in a listen only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Dee Johnson, Vice President of Investor Relations. Please go ahead, ma’am.

[Dee Johnson:]

Thank you, Dan, and good afternoon everyone. We're pleased you would join us today for Rubicon Technology’s third 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 will provide an overview of third quarter results of operations and Mardel will review our financial results in detail and discuss our outlook for the fourth 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 one 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 could 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. On this call we will mention among other performance measures non-GAAP loss per share, which is a non-GAAP performance measure. Please refer to the company’s earnings release issued earlier today for a reconciliation of non-GAAP loss per share to GAAP loss per share. And now I would like to turn the call over to Bill Weissman.

[Bill Weissman:]

Thank you, Dee. Good afternoon everyone and thank you for joining us today. The sapphire market remained very challenging in the third quarter as excess capacity in the market and fluctuations in inventory levels in the supply chain added additional downward pressure on pricing and volumes for the industry. The current excess capacity has been driven by the prospect of sapphire cover glass in mobile devices, and if that application becomes a reality, it has the potential to quickly change the market supply situation. We are taking steps to assure that Rubicon is positioned to participate in the sapphire cover glass market if that application is adopted but we are also making sure that we implement a model that offers less volatility and greater margins over time regardless of the outcome of sapphire cover glass. We are focused on higher value add products and new product development, while aggressively working on cost reductions. Today we will provide an update on these initiatives in addition to reporting on results of the third quarter and outlook for the fourth quarter. The third quarter was impacted by high inventory levels of two-inch double side polished wafers for the mobile device market at our customers, which resulted in minimal two-inch core demand in the period. As a result, revenue from two-inch core sales declined sequentially by $2.1 million. This was partially offset by an increase in PSS wafer revenue which increased sequentially by approximately $500,000 in the quarter. In total, revenue for the third quarter was $5.3 million, a sequential decrease of $1.8 million. Revenue from four-inch core sales in the LED market was similar to the prior quarter. However that market was also weaker and pricing declined further in this period. We believe this is also likely to be related to excess inventory in the LED supply chain due to reduced demand from the backlighting market. While the LED general lighting market continues to grow, demand for LCD TVs has declined to their lowest levels since the global recession according to industry analysts at IHS. This has resulted in excess supply of LEDs for the backlighting display market. However there are fluctuations in demand, 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 that there will be further adoption of sapphire for use in mobile devices. While the sapphire industry remains in the state of excess supply, we believe capacity should be gradually absorbed by these growing markets. However it is difficult to predict how long it will take for the excess capacity to be fully absorbed. The current oversupply in the sapphire industry has been driven by the anticipation of mobile device market potentially converting to the use of sapphire for cover glass in smartphones. While we believe there's a good chance for the use of sapphire in that application, the timing for adoption and scale of that adoption if it occurs is uncertain. If sapphire cover glass is adopted on a large-scale, industry analysts suggest that the current excess sapphire capacity will be rapidly absorbed and significant capacity increases will be needed to support that application. While we are positioning the company to take advantage of the potential adoption of sapphire cover glass, we are working toward diversifying our product offerings and making the company less susceptible to the pricing swings in the bulk sapphire market. Our key initiatives toward that aim include aggressively pursuing our PSS potential, targeting high margin optical applications and developing new products. Our goal is to focus on products that require more intellectual property to produce, like large diameter PSS wafers produced entirely in-house and optical products. While the PSS and optical markets are still impacted by swings in sapphire pricing, they tend to be less volatile. With PSS we believe there’s significant process now as in being able to produce PSS wafers starting from powdered aluminum oxide, particularly in large diameters. Few competitors have that capability and for customers that are very sensitive to potential disruptions in the supply chain and consistency of quality that vertical integration is very important. This was a significant factor in our qualification at an important sections six-inch PSS customer and we believe it will become increasingly important to other LED chip manufacturers over time. The customer qualification process for these wafers can be quite lengthy which can lead to greater customer loyalty and intimacy. In the optical market which consists largely of sapphire windows and lenses for defense and commercial applications, we expect increasing opportunities, particularly in large diameter windows and optics requiring high-quality sapphire. Rubicon is known for high-quality sapphire crystal and the market where crystal quality matters most is the optical market. This along with our ability to grow very large crystals positions us well for this market. 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 large windows currently for semiconductor and defense applications from our large bulls and we have begun qualification of very large windows from our lens technology projects for both 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 bull sizes and commercializing our lens and other new technologies. We are dedicating more sales resources to expand our customer base and we are also expanding our finish capabilities in order to sell higher value products. Developing new products is essential to diversifying our revenue. We continue to make progress on our R&D projects aimed at providing a more affordable solution for the use of sapphire in smartphones, tablets and many other mobile devices and displays. We continue to work with several major consumer electronics manufacturers interested in testing our samples of sapphire coated glass and are also preparing samples of coating on certain metals, a broader range of glass as well as plastics for a variety of products beyond the mobile device market. We will be producing more samples in the coming months to test the limits of the process and better define the target markets. While we're still in process development, we are at a stage where we are selecting a production tool 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. 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 the consumer electronics market. If successful, we will be able to produce a single crystal sapphire faceplate for mobile devices that will require 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 full development will take longer, we hope to finish proof-of-concept stage by the end of this year or early next year. Paramount among our objectives this year is to drive to reduce the use of cash and become cash flow positive as soon as possible. While declining prices have posed additional challenges we remain focused on that objective and are aggressively working on reducing product costs. As we discussed on our last call we entered into a resource sharing agreement with a leading sapphire polisher to expedite the cost-reduction of our polishing operation so that we can optimize the potential of our vertical integration model particularly as they relate to PSS opportunities. We had kicked up offset [ph] projects that have made good progress in the quarter. We are targeting -- implementing most of the adjustments to our process by the end of the year with the goal of going into next year with a meaningfully lower wafer cost. We continue to work on process improvements and design changes to our crystal growth technology as well to continue to drive those costs lower. The fourth quarter will present some additional challenges which we will discuss soon but I expect efforts to begin --our efforts to begin to show results in the first quarter of 2016. For the third quarter, our GAAP loss per share was $1.84 which included a non-cash charge of $39.6 million for impairment of long-lived assets which Mardel will discuss further. Mardel will also comment further on our outlook for the fourth quarter. The fourth quarter will be particularly difficult. Given the current pricing for two-inch, four-inch core we have decided to limit sales of those products in the core to allow time for the inventory and the supply chain to clear and see how the market develops in coming months. In response to this, we have scaled-back crystal growth operations further to avoid building excess inventory. Also, while a relationship with our key PSS customer is progressing nicely, they have delayed the start of their purchase order from October 1 to January 1 which will impact fourth quarter wafer revenue. As a result, we will be in the low – revenue will be low in the fourth quarter but it is expected to pick up again in the first quarter. In summary, the sapphire market is very challenging at the moment with weakness in all markets. The first quarter should certainly be better based on our visibility for PSS wafer sales along with our belief that we should see improved demand for two-inch, four-inch core. We are taking actions necessary to diversify the business to reduce volatility and drive stronger margins over the long term while putting intense focus on cost reduction to reduce cash usage in the short term. With the sapphire cover glass application becomes a reality, it has the potential to rapidly change the market. Our focus on developing technology and customer relationships should result in growth and greater margin opportunity even if that application does not develop. We believe we are making good progress on these fronts and that results of our efforts will show throughout the course of next year. I’d like to turn the call over to Mardel who will provide you with greater details on results of operations for the third quarter and our outlook for the fourth quarter.

[Mardel Graffy:]

Thank you, Bill. Revenue for the third quarter was $5.3 million, down $1.8 million from the prior quarter. Core revenue decreased $4 million in the prior quarter to $1.8 million due to lower revenue for two-inch core as Bill explained. Wafer sales increased to $2.1 million from $1.7 million in the prior quarter on stronger PSS wafer sales. Our optical and R&D revenue was similar to the prior quarter at $1.4 million. This market has also been relatively weak in recent quarters but we are beginning to see some improvement. We continue to focus on this business and expect revenue from this market to grow in coming years. Given the lower demand for two-inch, four-inch core, we’ve scaled-back crystal growth production further and are currently operating at 40% of capacity. While we expect the market to improve, it is difficult to predict the timing and want to avoid building excess inventory. Utilization at our wafering operations in Malaysia increased in the third quarter with the additional PSS volume. As Bill noted, we continue to work on implementing the changes associated with the resource sharing agreement that we announced last quarter. Once the other party begins using a portion of Malaysia facility, our utilization will increase further. However some of the depreciation that is currently reflected in idled plant will continue on but will be classified differently. Given the current market conditions, the timing of their use of our facility is uncertain. We continue to benefit from the knowledge transfer of their lower cost polishing process which will be the main driver -- which was the main driver for entering into this agreement. Idled plant costs in the third quarter totaled $1.8 million as compared with $1.6 million in the prior quarter. Operating expenses, excluding the impairment charge and accrual for settlement of litigation in the third quarter totaled $3 million as compared with $3.2 million in the prior quarter. The decrease was due to lower spending on reporting compliance which the second quarter included annual report costs. Due to the protracted weakness in sapphire pricing, it was determined in the period that our long-lived assets such as machinery, equipment and facilities should be written down to current fair market value of both assets in accordance with generally accepted accounting principles. Total amount of that non-cash charge was $39.6 million and additional information can be found in our third-quarter 10-Q. Excluding the impairment charge and the accrual for settlement of litigation, our operating loss in the third quarter was $6.9 million as compared with $8.3 million in the prior quarter. For the third quarter, our GAAP loss per share was $1.84 which includes the non-cash impairment charge of $39.6 million and $900,000 accrual for settlement of litigation. Our non-GAAP loss per share, excluding those charges, was $0.29 as compared with our prior quarter GAAP loss per share of $0.33. Turning to the balance sheet and cash flow. We maintained a strong cash position with our cash and short-term investments balance of $34 million at September 30 with no debt. We used $1.9 million of cash in the quarter as compared with $5 million in the prior quarter. Our DSO at September 30 decreased to 56 days, down from the prior quarter end DSO of 102 days. Inventory levels in total increased by $1 million primarily the result of increased work in process consisting primarily of bulls and cores due to lower core sales. Regarding our outlook for the fourth quarter, we expect it to be a very challenging quarter. As we mentioned demand for two-inch, four-inch core is weak given high inventory levels and the supply chain, we plan to limit sales of those products in the quarter at current pricing. We will reevaluate throughout the remainder of the quarter and look for improvement in demand going into the new year. In addition, as Bill mentioned, the start of our purchase order for volume PSS sales has been pushed out by a quarter reducing the revenue opportunity for the fourth quarter. The relationship with our customer is strong and we've agreed to produce PSS wafers for their consignment inventory, so they will be available as needed. As a result four quarter revenue will be very limited, we will be incurring the cost of producing PSS wafers in advance of recognizing revenue. However we expect improvement in the first quarter based on visibility of wafer sales and we also believe LED and mobile device supply chain inventory should come down and anticipate some improvement in demand for two-inch, four-inch core in the first quarter as well. Fourth quarter revenue will likely be limited to $2 million to $3 million with GAAP loss per share of around $0.30. As I mentioned, we used $1.9 million cash in the third quarter. Reducing the level of cash usage is a top priority and we believe we will show sustainable improvements in cash flow starting early next year as wafer costs decline and we reduce inventory levels. Additional improvement is expected later in the year by increasing optical revenue. However given the expected inventory build in the current quarter for the wafer consignment inventory and limited core sales, cash used will be higher in the fourth quarter. I would now like to turn the call back over to Bill for some closing comments and then we will be happy to take your questions.

[Bill Weissman:]

The long-term outlook for commercial sapphire remains strong. And general LED lighting adoption continues to gain momentum and the use of sapphire in mobile and consumer electronics applications is also growing, with potential for significant upside in sapphire cover plates for smartphones. However there remains significant excess supply of sapphire in the market and fluctuations in demand continue to create additional challenges. We continue to aggressively reduce product costs while focusing development and marketing efforts on products that should diversify the business and drive stronger margins. Our goal is to drive growth that is more balanced between large diameter PSS, optical products, bulk crystal like cores and rectangular blocks and new products. The bulk crystal will likely continue to be volatile but has significant potential upside if the cover glass application is adopted. The rest of the business should offer good growth opportunities with less volatility and with good margins. If we are successful in developing our new technologies such as Net Shape growth, there’s significant upside. I believe that the actions we are taking this year in cost reduction, technology development and new product development will position the company to reduce volatility and drive stronger margins while still positioning us to capture opportunities that arise in the bulk sapphire market as they develop. I want 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:]

[Operator Instructions] Our first question comes from Colin Rusch of Oppenheimer.

[Colin Rusch:]

Thanks so much. Can you talk a little bit about the competitive environment for the PSS products? Are you seeing anyone else really be a significant competitor and how many folks?

[Bill Weissman:]

Yes, there are actually quite a few. There are several firms that just focus only on putting the pattern on. But they have to purchase the polished wafers from people that often purchase the crystal to make the way for -- so the difference in our positioning is that we are vertically integrated, we start with powdered aluminum oxide to produce pattern substrates and our main focus is on the larger substrates. So the combination of being able to do larger substrates and the vertical integration we expect to be a real differentiator and it certainly has been for this first major customer, that was a major consideration for them is selecting a supplier that was truly vertically integrated, so that they didn’t have to worry about bottlenecks in the supply chain or valuations and quality.

[Colin Rusch:]

And then can you talk a little bit about your ability to mine the inventory line for cash, and how much is that inventory is finished goods inventory?

[Bill Weissman:]

Well most of it currently is in core form or even more so in bull form, and those bulls can be converted into any product we want. So they are available as soon as the market picks up and convert into whatever product we need. In the fourth quarter we will be building wafers for consignment as we mentioned in our prepared remarks and those the customer is obligated to buy, so there’s little risk in the inventory there and we expect them to be converted to sales in the first quarter.

[Colin Rusch:]

And then your expectation for cash consumption in the fourth quarter.

[Bill Weissman:]

Well, Mardel said it’s going to be high, it’s going to be high because of the inventory build, so it’s mostly working capital which obviously will be converted to cash hopefully soon after. But it could be in the $5 million range but obviously we expect cash burn to be significantly lower than that going into next year.

[Operator:]

Our next question comes from Andrew Abrams of Supply Chain Market Research.

[Andrew Abrams:]

Hi thanks guys. A question on your PSS sharing partner. Is there a time set where you know the partner will be using the facilities or are we at the point right now where the technology is the key changer for you guys?

[Bill Weissman:]

Well firstly, that arrangement is focused on polishing the pattern and the knowledge transfer has happened to a great degree and now it’s a matter of implementing some of those changes. The other party like everybody else in the sapphire market is struggling and really do not need the capacity right now. So when they start to use it remains to be seen. But clearly we are getting what we wanted out of the relationship. We’ve learned a lot in terms of the process and we’re now implementing a lot of those changes and expect to see cost improvement as a result of those changes. So don't really know when or if they will use that capacity but of course it’s available to them.

[Andrew Abrams:]

And on the crystal growth side for fourth quarter, I think Mardel said that you were running at 40% now. Is that going to be where you expect to be for the entire quarter?

[Bill Weissman:]

Yes and we will reassess and see how the market develops over the next quarter. If we have to go lower we will go lower but we are hopeful that the inventory will start to clear out of the supply chain but things will start to pick up.

[Andrew Abrams:]

And once you're in the first quarter how much of a difference will we see in utilization rate in terms of your PSS polishing? Will we see the utilization rate go up in the fourth quarter because you’re actually producing or would you expect it to stay that way in first quarter as the material is sold and you get reorders from that customer?

[Bill Weissman:]

It will likely be a little higher in the first quarter, because we are producing wafers in the fourth quarter for consignment, that it won't be significantly higher. End of Q&A

[Operator:]

Showing no further questions I would like to turn the conference back over to management for any closing remarks.

[Dee Johnson:]

Okay, thanks everyone for joining us today. We appreciate your interest and we look forward to speaking with you again soon. This concludes the Rubicon Technology’s third-quarter conference call.

[Bill Weissman:]

Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.