Rubicon Technology, Inc.
Q1 2014 Earnings Call Transcript

Published: 2 May 2014

[Operator:]

Good day, and welcome to the Rubicon First Quarter 2014 Results Conference call and webcast. All participants will be in listen-only mode. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference call over to Dee Johnson, Vice President, Investor Relations. Ms. Johnson, the floor is yours ma’am.

[Dee Johnson:]

Thank you, Mike. Good afternoon everyone. We are pleased you could join us today for Rubicon’s first quarter 2014 earnings conference call. With me today are Raja Parvez, Rubicon’s President and Chief Executive Officer; and Bill Weissman, Chief Financial Officer. We’ve allotted one hour for our call this afternoon. Raja will provide an overview of first quarter results of operations and discuss the current market environment, and then Bill will review our financial results in detail and discuss our outlook for the second quarter of 2014. We will then be happy to take your questions. Today’s call is being webcast through the Investors 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 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. Now, I would like to introduce our President and Chief Executive Officer, Raja Parvez.

[Raja Parvez:]

Thank you, Dee. Good afternoon, everyone, and thank you for joining us today. The general lighting segment of the LED market continue to strengthen in the first quarter, as adoption of this disruptive technology continues to gain momentum. Overall, LED growth in the quarter was tampered by seasonality associated with the backlighting market. Demand from this market is typically lower at the beginning of the year. As a result, overall demand in the first quarter was similar to the prior quarter. And sapphire pricing therefore remained fairly consistent with the previous quarter. Our revenue increased to $14.3 million in the first quarter from $11.5 million in the prior quarter. Most of the increase was due to an increase volume of 2 and 4-inch core sales. We operated at full utilization on our crystal growth operations for the entire quarter while continue to draw down our boule inventory. We also added some additional fabrication capacity which allowed us to increase core throughput in the quarter. Wafer revenue also increased by approximately $300,000 sequentially. We received our first production volume order of 4-inch polished wafers and began ramping up production at the end of the quarter. We had a sequential increase in 6-inch polished wafer orders from the LED market, which more than offset the lack of SoS wafers in the quarter. In recent months, we have seen an acceleration in the shift to 4-inch wafers from 2-inch wafers by chip manufacturers in the LED market. While we are yet to see a meaningful shift to 6-inch substrates, we view the shift to 4-inch a validation of the LED chip manufacturers desire to move to larger diameter for greater efficiency and for increased throughput without investing in new tools and facilities. We continue to believe as do many industry analysts that the 6-inch market will soon gain momentum, and that it will become the fastest growing segment of the LED sapphire substrate market in the future. There is also increasing interest among LED chip manufacturers in purchasing patterned wafers. A significant majority of LED chip manufacturers now use pattern as opposed to just polished wafers in their production. Most have internal patterning capability, but many are now looking to purchase patterned wafers. We introduced PSS products in October of last year, and last quarter we discussed having already received requests for samples from 16 different customers. We continue to ship sample volumes to these customers. There are usually seven iterations of samples of various patterns before specification alignment is complete. However, feedback has been positive and we just received our first production order for 2,000 4-inch PSS wafers for delivery in Q2. A potential next step in our vertical integration could be offering a gallium nitride template to the LED market. In order to more effectively evaluate this and other new market opportunity, we have recently added a recognized expert in the field of bulk GaN growth to our technology team. The use of sapphire in mobile devices is a relatively new application and has a normal potential for growth. Smartphone manufacturers are looking to incorporate sapphire on the exterior of their devices due to the strength and optical characteristics it provides. Thus far, most of the demand for these applications had come from one manufacturer. However, we believe we will begin to see greater adoption of sapphire in mobile devices. We participate in this market, primarily by selling a significant amount of smaller diameter core to our polishing partners. We are also well positioned to sell larger diameter bulk crystal in a variety of shades and dimension into the market as additional applications develop. In addition, we have two projects in R&D to develop solutions for these applications that would eliminate the need to fabricate pieces from bulk crystal, which if successful, would provide a significant cost advantage, since most of the cost of these pieces is not in the crystal but in the fabrication of crystal into the right form. We have patents pending on both technologies and we are now producing samples from one of these technologies, which we are testing with a major consumer electronics manufacturer. We also have requests for sample from several other leading consumer electronics manufacturers. We will provide more information on the progress of this product as we move forward. Regarding our margins. We believe our large diameter wafering and patterning capability position us well for the future. At the moment, however, the wafer operations are generating losses. The pricing environment continues to be challenging in general. As we explained on our last call, we decided to begin offering 4-inch polished wafers given that we are offering 4-inch PSS wafers and to move rapidly improve the utilization of our polishing operations. Since the supply chain for 4-inch wafers at most LED chip manufacturers is already established, we are offering attractive pricing and differentiated specification in order to gain market share for their products, which compounds the pricing challenge in the near-term. The challenging pricing environment along with the higher-than-normal cost due to the multiple iterations associated with the PSS qualification process and the establishment of a 4-inch polished production line are resulting in losses on wafer sales right now. However, we believe cost will come down over the course of this year, and we’ll begin to see meaningful price improvement in the back half of this year. Since we are currently selling wafers at a loss, we adjust our inventory to market prices. Given the build off wafer inventory in process at the end of the quarter, we recorded an additional $1.5 million in the first quarter. The outlook for the LED market remains very strong. Industry analyst Strategies Unlimited recently reported that they believe the LED general lighting market will grow even more steeply in the near-term. According to their analysts, revenue from the LED replacement lamps will grow from $4.8 billion in 2013 to $12.2 billion in 2018. We are also in the early days of migration to larger substrates, which provided an additional growth opportunity for Rubicon. We also believe that we are in the very early days of the use of sapphire in the exterior mobile devices for applications like camera lens covers and home buttons. Based on our knowledge of the marketplace with the exception of one competitor who is building out capacity for a specific customer, none of the existing sapphire producers are planning to add capacity in the current environment and some competition is now leaving the market. So with the expected accelerating demand from our key markets, we expect to begin seeing meaningful price increases for sapphire, which are long overdue. We will talk more about second quarter guidance in a few minutes, but regarding our expectations for pricing in the second quarter, we expect some pricing improvement, particularly for 4-inch materials. At the moment, we see some softness in the 2-inch market for the second quarter. However, we believe it is temporary and associated primarily with some fluctuation in demand from the mobile device market. There remains a lot of opportunity for leverage in our models as we begin selling more of our crystals in polished and patterned wafer form, because we generate significantly more revenue on the same amount of crystals. Based on the progress of our PSS product introduction, I remain confident in skewing additional production orders for PSS wafers in the second half of the year as planned. I also expect order for 4 and 6-inch polished wafers to increase throughout the year. The challenge in the near-term is securing production orders so that we can get our wafering and patterning production line running efficiently to further bring down the costs, which will allow us to show a significant improvement in operating results by the end of the year. I would now like to turn the call over to, Bill, who will provide you with greater details on the financial results for the first quarter and our outlook for the second quarter.

[Bill Weissman:]

Thank you, Raja. Revenue for the first quarter was $14.3 million, as compared to $11.5 million in the prior quarter. Revenue from 2 and 4-inch core sales increased 23% sequentially, a result of increased volume as Raja explained. Revenue from 2 and 4-inch cores in the quarter totaled $11.4 million, as compared to $9.2 million in the prior quarter. Revenue from wafer sales in the first quarter totaled approximately $1.1 million, as compared to $800,000 million in the prior quarter. All of our wafer revenue in the first quarter was from the LED market. Wafer revenue from the LED market increased by $800,000 sequentially while wafer revenue from the SoS market declined by $500,000 sequentially. The decline in the SoS revenue was expected for the reasons provided on our previous earnings calls. PSS revenue was minimal in the quarter as we are still shipping small volumes for qualification. Optical and R&D revenue totaled $1.8 million in the first quarter, as compared to $1.6 million in the prior quarter. We are on track with our lens project to produce large rectangular windows and dimensions not available in the market today and anticipate revenue from that product beginning in 2015. Our crystal growth operations ran at full capacity throughout the quarter. Our polishing and patterning operations continue to be underutilized. However, that will begin to improve towards the end of the quarter as we started ramping up 4-inch polished wafer production. Operating costs declined to $2.4 million in the first quarter, as a result of increased utilization of our crystal growth operations and the increased activity in the wafering operations. However, much of the additional wafering activity was dedicated to producing samples and getting the polishing line for 4-inch established. Operating expenses in the first quarter totaled $3.4 million, slightly higher than the prior quarter’s operating expense of $3.2 million. Our pre-tax loss in the quarter was $10.9 million, as compared to $9.1 million in the prior quarter. The additional loss was primarily the result of the mark-to-market adjustment, a work-in-progress in finished goods for the wafers and inventory at the end of the quarter. As Raja mentioned, the high cost of producing low volumes with PSS and polished wafers and the cost of getting a 4-inch polishing line running combined with the challenging pricing environment has resulted in losses on the wafer products. As a result, wafers inventory at the end of the period needed to be adjusted down to market value. Given we are ramping up the wafer operations at the end of the quarter, that amount was material. With the establishing of the tax valuation allowance in the fourth quarter, we do not currently record a tax expense or tax benefit with the exception of some miscellaneous items. Our loss per share in the first quarter totaled $0.43. Turning to the balance sheet and cash flow, we maintained a strong cash position with our cash in short-term investments balance of $63 million at March 31 with no debt. We raised an additional $35 million in the quarter through the sale of common stock in order to ensure we can expand capacity as the market strengthens and we could continue to develop new products. We used approximately $6 million in the quarter, $4 million in operations and $2 million in capital expenditures. Our DSO at March 31 remained low at 52 days, but was higher than the year-end DSO of 28 days, as we had a change in mix of prepay versus credit customers in the quarter. Inventory levels declined by $5.8 million as we continued to reduce our material, boule and core inventory levels in the period. Regarding our outlook for the second quarter, we expect to see some pricing improvement for cores primarily in 4-inch. Core volumes will decline somewhat due to our excess inventory – boule inventory being exhausted. We believe we will see meaningfully higher wafer revenue in the second quarter, which will improve the utilization. However, in the near-term will not improve margins. With reduced core revenue offsetting increased wafer revenue, we expect total revenue in the second quarter to be similar to the first quarter. We expect our loss per share in the second quarter to be between $0.38 and $0.46. This is a relatively wide range because the timing of orders and shipments will affect the size of our wafer inventory at the end of the quarter, which will impact the size of any mark-to-market adjustments. I’d like to turn the call back over to Raja for some closing comments. And then we’ll be happy to take your questions.

[Raja Parvez:]

Thank you, Bill. We are building momentum in the wafer business. We are currently shipping, both, 4-inch and 6-inch polished wafers. And we have orders to ship PSS wafers in the second quarter. With the increasing volume and experience and as customer specifications are defined, we will reduce our idle plant costs and our wafer product costs. Furthermore, we believe pricing will improve going forward. We also have a number of new product development initiatives underway in R&D that we are very excited about. We believe that the market opportunities ahead of us are substantial, and the work we are doing now will result in significant improvement in financial performance by the end of the year. I want to thank you all for joining us today and thank you for your continued support. Now may we take our first question?

[Operator:]

Thank you sir. We will now begin the question-and-answer session. (Operator Instructions) At this time, we will just pause momentarily to assemble our roster. The first question we have comes from Jed Dorsheimer of Canaccord.

[Jed Dorsheimer:]

Hi. Thanks for taking my question. I guess the first one, as we look at Q2, average core pricing between 2-inch and 4-inch for you, how much – can you provide a range of where that is priced at or contracted at, or would you mind providing a relative increase/decrease to Q1 please?

[Bill Weissman:]

Yes, we generally don’t give prices for products, but we – at this point in time we’re seeing some increase in the 4-inch, probably very little, if any, in 2-inch at the moment. On average, we’re expecting probably a 3% overall increase in core pricing in the second quarter.

[Jed Dorsheimer:]

And did that change recently? I thought pricing was actually up a little bit more in Q2.

[Bill Weissman:]

No. It hasn’t really changed recently. The 4-inch pricing has strengthened, but the 2-inch has been, as we said in our comments, a little bit weaker than expected in the second quarter.

[Raja Parvez:]

There is much more demand on the 4-inch and that’s why the pricing has somewhat improved on the 4-inch.

[Jed Dorsheimer:]

Okay. And then if we look at – so with utilization now at 100%, inventory coming down, we’re not seeing margins benefit in Q2. Could you help explain that a little bit more?

[Bill Weissman:]

Sure. Well, the volumes on core are coming down a bit as we mentioned, because we’ve used up our excess boule inventory. We will see some pricing improvement, as I said, about 3% but it’s not a big improvement. And then the wafer business will increase. And the challenges of cost structure around the wafer business right now, both PSS and polished, which will improve over the course of the year, but right now given the small volumes and the multiple iterations on the PSS side, the costs are quite high.

[Jed Dorsheimer:]

And so as we look at Q3, I guess, how much of Q2 margins are being affected by sample inventory on the wafer side of the business?

[Bill Weissman:]

Well, clearly the bulk of the loss right now is in idle plants and wafer costs. And over the course of the next several quarters, we expect both of those situations to improve.

[Jed Dorsheimer:]

Okay. And to achieve the $15 million, I think for the back half in wafer revenues, I think you had maybe talked about needing to have three high volume customers. It sounds as if you have one. So, it sounds like it – well, let me ask, is that still on track in terms of the $15 million?

[Raja Parvez:]

First of all, yes, it is on track. Second, as we mentioned in the previous quarter, that we have the request for samples from 16 different LED chip manufacturers and we are making very good progress with all of them. And because of the lengthy qualification cycle of PSS products, that several iterations of the samples going back and forth. And we have – as we mentioned, we have production order from one customer and we believe they will get production orders in second half, especially starting in Q2 and Q4 and still our original target is still intact at this moment.

[Jed Dorsheimer:]

And sorry, just to – I just want to clearly understand this. In terms of the sample cost, so providing you get your three customers and you ramp on the wafer side in terms of the utilization for that part of the business. The sample overhang, should that be fully absorbed in Q3 or will that linger in Q3 and Q4?

[Bill Weissman:]

It’s difficult to tell. It depends on the timing of orders obviously, but we’re hopeful that it will all be gone for the fourth quarter and we probably have some still remaining in the third quarter.

[Jed Dorsheimer:]

Okay. I’ll jump back in queue. Thank you.

[Operator:]

Next we have Avinash Kant of D.A. Davidson.

[Avinash Kant:]

Good afternoon, Raja, Bill and Dee.

[Raja Parvez:]

Hello.

[Avinash Kant:]

The first question I had was, you talked about multiple iterations in the wafer side. And I was just checking, is it only the iterations for the qualification of the wafers or it is also because the yields are not good?

[Raja Parvez:]

No, it is all because of qualifications. As you know that most of the LED chip manufacturers do have some internal capability of PSS. And this is part of their IP. So many times what we do is that they order samples of different densities, different dimensions and different configurations of the pattern. So we provide them a different variety of patterns that they can choose from there, so it is a very interesting process. It is not the function of the yield. It’s just we trying to optimize the process based on their requirements. And this was expected. This is normal qualification process that we are dealing with on the LED chip manufacturers. In addition to some of the LED chip manufacturers are also in a process of auditing or manufacturing lines to get ready for a production orders as well.

[Avinash Kant:]

I see. And also you said that you are kind of losing money on the 4-inch wafers that are non-PSS, right? So is it a strategy to get out of the 4-inch wafers once you start doing PSS in volume or you will still be doing both PSS and 4-inch polished?

[Bill Weissman:]

No. We’ll still be doing both. The reality at the moment is the 4-inch is an established market and the 6-inch is still developing. So we would likely continue to do polished and pattern 4-inch until we see a stronger adoption of 6-inch. If we have enough demand for the patterned, we’ll cut back on the polished, but obviously the wafers have to be polished before they’re patterned anyway.

[Raja Parvez:]

Well, look, the overall objective is still to provide 6-inch patterned wafers followed by 6-inch polished followed by 4-inch PSS and 4-inch polished. Now recently as we have mentioned that we have seen a shift from LED chip manufacturers migrating from 2-inch to 4-inch. And that is the first evidence we are seeing moving to larger device sizes. And we believe that if this trend will continue to migrate from 2 to 4-inch and 4 to 6-inch, obviously our main objective will be to focus on the larger and larger wafer sizes. But at the moment, to increase these utilization and as well as get more, because we are producing the 4-inch PSS, so it was important for us to do 4-inch polish as well, but overall objective is to really focus on the larger diameter, because the 6-inch where we have the most experience is of the polishing as a company.

[Avinash Kant:]

Okay. And the final question. If you could highlight a little bit about the two patented processes that you are talking about, are they some sort of chemical [ph] process or it’s still a bulk process or if you could give any color in terms of what kind of approach is being taken there?

[Raja Parvez:]

Well, first of all, let me give a broader answer to that question. We had been providing small diameter especially 2-inch core into the supply chain for applications to the mobile, especially home button and also camera lens and also flash lens cover. In addition to, we also have a internal capability to provide different dimensions and shape of sapphire material. As you know, in LED industry we supply a core which is round 2-inch and 4-inch. However, for the mobile applications, we have the capability to provide a form factor specific to the mobile device which could be rectangular. So we have that capability. And we have been providing into that application for quite some time, but we also started and we have been working on two R&D projects. Both of those projects are in the progress right now. But one of the projects we have been sampling our products to visit one of the major electronics manufacturer and we are currently waiting for their feedback. It is also as you know a process which we get the feedback and we resubmit the sample. But in addition to, we have requests from several electronics manufacturers to provide them samples. At this moment, that’s all we can share with you, but we will keep you updated as we move forward on both of these projects, but we are very excited on both of these approaches. Now, these approaches are obviously will be the approaches which will be much more cost effective than a pure sapphire solution which is a bulk solution. As you know most of the cost is not in the crystal but in the fabrication. So these projects are intended to focus on where we provided much more cost effective and innovative solutions.

[Avinash Kant:]

But the fill [ph] is still sapphire, not a mixture of something else, right?

[Raja Parvez:]

Avinash at this point that I cannot elaborate more on the details of it, but we will provide more color as we move forward.

[Avinash Kant:]

Thank you so much.

[Operator:]

The next question we have comes from Paul Coster at JPMorgan.

[Paul Coster:]

Yes. Thanks very much for taking my questions. So, first of all on the core business. The pricing is improving there and the inventory is down. Is that business profitable in its own right, are margin gross profitable in its own right, are the gross margins moving north now to core business while the spending has declined?

[Bill Weissman:]

For pricing, the first quarter was not – it was not profitable based on pricing, but the losses is relatively small going into the second quarter depending on the pricing increases forge could be at that point of time. So we’re getting close to breakeven, but we’re not quite there yet in the core business.

[Paul Coster:]

Right. And if we look at your cost – your COGS direct cost in total, what percentage of it is variable and what is fixed, if you can get to that?

[Bill Weissman:]

Well, it depends on various into the products obviously, but and what to including in there but about half of it is variable and half of it is fixed.

[Paul Coster:]

Thank you. As we look at the PSS businesses, it starts to ramp up, is there a level revenues or unit volumes that you can talk to that might represent breakeven?

[Bill Weissman:]

No. I mean product mix has such a big impact on – so it’s very difficult for us to give any kind of a target revenue. When I say product mix, that includes the diameters too. So it’s very difficult for us to give a target revenue at which we can say we’re likely to breakeven.

[Paul Coster:]

So looking at this from the outside, the work you’re doing with the 16 customers with polished wafer business, it feels like you’re almost doing on played R&D because you’re bringing, sort of really leading edge new capabilities to market, and kind of experiment with them. And you’re not getting paid for it. Is there anything to that argument?

[Bill Weissman:]

We’re not providing the technology to them. We’re offering them different samples of product that we can produce for them. So we’re not giving them the capability to do it.

[Raja Parvez:]

And this is a standard process when you introduce a very complex product. And it does require several different considerations. And when you supply to them samples, they review it, they test it. And many of them, they just don’t test the wafers, they test are in their device lab while they make the chips out of it, and either at a margin level or picture level or some at reliability level test before they give us a feedback. And that’s why this process is rather longer process and more involved process But keep that in mind, this is an investment on both sites, from us and from our customers as well. So for them to invest into it, this is their desire. So it goes both ways. So we are very excited that they are working with us too, because they are investing their time and the resources to qualify all our products just as if we are spending all the resources to provide the samples to them.

[Paul Coster:]

Sure, I get that. What I perhaps I am trying to get to aside from the fact that there is a lot of kind of risk being taken for you on their behalf at the moment is also I guess long-term once you pull this off and you’ve got volume, many customers on the PSS front, will the gross margins of that business be superior to that which you would have otherwise had, or is it all about gross profit on the higher revenue?

[Bill Weissman:]

Well, our strategy all along has been to try to have a certain base of revenue coming from more differentiated products. We’ll have sapphire as a commodity and the core – certainly too enforce, core as commodity. That’s why we focused on 6-inch polishing. As pointed out, that market is taking longer to progress than it has, but patterning is the next step in that and we obviously are focused on 6-inch patterning in particular but we’re offering 4-inch in the interim. So when the industry progresses, the 6-inch pattern wafers I think will have a significant differentiation in the marketplace and can significantly higher margins on that product and the industry will see to take more products.

[Raja Parvez:]

And also I might add at this moment, we are the only one providing and have the capability as the outside supplier rather than internal of a 6-inch PSS wafer. And since we are vertical integrated all the way from raw material to patterns, that is another attractive point for the major LED manufacturers that is stable supplier, known supplier and an existing company supplier. So that’s why they are investing more time with us to qualify our products. And once we have these design wins, we believe that it will be significant product moving forward.

[Paul Coster:]

All right. Thank you very much. I appreciate it.

[Bill Weissman:]

Thank you.

[Operator:]

The next question we have comes from Andrew Huang from Sterne Agee.

[Andrew Huang:]

Thanks for taking my questions. I think the good news here is that you made some good progress on both polished wafers and PSS wafers, which is ultimately going to get you back to profitability. But so we can better understand the benefit of going to PSS, can you give us a sense of the multiplier effect of selling a PSS wafer instead of the equivalent amount of core material that you would have used to make that PSS wafer?

[Bill Weissman:]

Yes, sure. Well, PSS wafer would generate something like six to eight times the amount of revenue you would get from the same amount of core. So that’s why our focus this year is we can take the existing amount of crystal we’re producing, sell it in a different form and show dramatic growth. In the near-term, we have to really focus on getting the volumes up, getting the efficiencies down, so we get the cost structure better in line, but the potential longer term is huge for converting the existing crystal and selling it into a pattern wafer form rather than selling it in core form.

[Andrew Huang:]

So just to be clear, like right now you’re sold out of capacity on the core side and you’re making a strategic decision to take some of that core that you could easily sell if you wanted to and basically transform that core to PSS with the hopes that longer term you’ll be able to generate or create a PSS business?

[Bill Weissman:]

Exactly, and that’s how we feel we can grow the top line and time the bottom line dramatically without adding lot of crystal growth infrastructure right now.

[Andrew Huang:]

Right. Okay. And then, can you give us a sense of exiting this year. Where you think your PSS wafer capacity will be on a TIE per month?

[Bill Weissman:]

Well, it depends on how the year progresses. We do expect to add capacity, and probably be in the 10,000 to 15,000 6-inch wafer equivalent per month range by the end of the year.

[Raja Parvez:]

And we are constantly – during the qualification process, we are also evaluating with our customers what their demand will be, what their volume will be. And when we established first, the production line back quarter and a half, two quarters ago, we had an X amount of capacity. And then we talked to the customers. They wanted us to have more capacity. So we are in the process of adding some of the capacity, but we are in consultation with customers what the capacity they will require. And as we said, we have the skill sets and we have the resources to add capacity in that production line as the demand will increase, but we will be very prudent in terms of adding back any capacity or any investments.

[Andrew Huang:]

Okay. Just to be clear on that – the answer to my previous question. Did you say 10,000 to 15,0000 6-inch wafers per month?

[Bill Weissman:]

Yes.

[Andrew Huang:]

Okay. And then I guess the other question I had is – so I understand the dynamics now, but when are we going to see the positive effects really affect the gross margin?

[Bill Weissman:]

Well again, we do expect the second half of this year to be significantly better. I mean we’re making some investments right now and pricing environment still is not great. So we expect bulk pricing and cost to improve in the back half of the year and volumes to pickup in the wafer side of thing which offset the idle plants. So we are still expecting a very significant improvement by the end of the year.

[Andrew Huang:]

When you talked about your PSS wafer customer that you expect to shipping for Q2. Can you give us a rough idea of how much revenue you’re expecting for Q2 for PSS?

[Bill Weissman:]

No. We don’t give the guidance broken down by products.

[Andrew Huang:]

Okay. Got it. Okay, thanks. And I’ll get back in the queue.

[Raja Parvez:]

Thank you.

[Operator:]

Next we have Andrew Abrams of JG Capital.

[Andrew Abrams:]

Hi guys. Just couple of questions. I think you mentioned that you had added a little bit of crystal growth capacity. Is that correct, and how much of that – how much capacity did you add? And I wonder if you could also talk about what you think your utilization rate will be at the polishing facility, what it was in first quarter and what you think it will be by the end of second quarter?

[Bill Weissman:]

No, we didn’t have any crystal growth capacity. We added some fabrication capacity. And we pulled – in addition to operating at full utilization in crystal growth, we also continue to use boules that we had in inventory which is why we’re able to sell more than our typical production. Utilization in wafering was around 20% to 25%. It will probably go up to maybe 35% in the second quarter.

[Andrew Abrams:]

Got it. And I’m not sure if you were mentioning the size of the 4-inch order that you had. I thought I heard you say 2,000 wafers, but I wasn’t sure of that.

[Raja Parvez:]

Yes, that is correct. It’s 2,000 wafer order. Yes.

[Andrew Abrams:]

Okay. And that was polished or is that PSS or – I’m assuming it’s polished.

[Raja Parvez:]

It is PSS.

[Andrew Abrams:]

PSS, okay. And lastly, you mentioned the potential for supplying GaN wafers. Have you done that before or is this kind of an R&D project?

[Raja Parvez:]

Look, this is a logical and technologically a right step, next potential step. We understand. We have lot of experts in-house who understand the technology. However, as we mentioned, we just recruited a very well recognized expert in the bulk GaN growth. We are currently evaluating that opportunity as part of the early marketing with our customers. And we are gauging the marketability of that product. We believe it will be an additional very innovative product beyond PSS, but we are currently in the process of evaluating the marketability with our customers and we will launch that project once we have that data collection and discussion with the customers.

[Andrew Abrams:]

Okay. And just one other, on 6-inch, I think you said you picked up a little bit of 6-inch business. Was that core business, or was that wafer business?

[Bill Weissman:]

We don’t sell 6-inch core. So that’s all wafer business.

[Andrew Abrams:]

I’m sorry, that’s right. So 6-inch was wafer. Is it a new customer or is it an existing customer or...?

[Bill Weissman:]

It’s one historical customer and one newer customer.

[Andrew Abrams:]

Got it. Okay. Thanks very much.

[Operator:]

(Operator Instructions) Next we have Steven Chin of UBS.

[Steven Chin:]

Hi everyone. Just a couple of questions. To start off, question on your Chinese sales. Our checks found you start shipping directly to one of the big partners of mobile handsets last month. Can you give some color on how sustainable you expect this business to be? Was it a one-time win or over-concerned on Russian supply or was this more competitive win based on quality of sapphire? Can you provide any?

[Bill Weissman:]

I’m sorry, could you ask that question again, we didn’t quite get it.

[Raja Parvez:]

I’m sorry, can you please repeat your question.

[Steven Chin:]

Sorry about that. The question was on your Chinese sales. Our channels saw that you had a fairly large shipment coming to a big partner of mobile handsets last month. We just want to get some color on how sustainable you expect this business to be going forward? Was it more or a one-time win on Russian supply or was this more of a competitive win on high quality sapphire?

[Raja Parvez:]

Well, we continue to supply, as we mentioned earlier we continue – we have been continue supplying product into their market. I cannot comment on a specific customer of what we do, but we have been supplying into that market for quite sometime and we will continue to do so.

[Bill Weissman:]

And we do have quite selling core to polishers that are serving both the LED and the mobile phone market. So we never really have great visibility on which they are directing the material into, but they’re not dedicated to that product. They also serve the LED market.

[Steven Chin:]

Got you. Second question is just a quick one on your Malaysian factory. Just wondering how flexible it is to on the 4-inch versus 2-inch production, whether it’d be reconfigured for more 4-inch, or for whatever reason you handle more 2-inch. Just wondering how we can better utilize your Malaysian factory to maybe, A, you address margin going forward based on...

[Bill Weissman:]

Well, we don’t polish 2-inch. We sell the 2-inch material in the core form to a polishing partner. In fact we probably have sold 4-inch in core form as well. The reason to polishing 4-inch, as Raja mentioned earlier was for two reasons. One is because we were going to be offering a PSS 4-inch product, but also that’s exactly the reason why we started polishing 4-inch is we want to increase the utilization in Malaysia faster. So, at this point we have no intention of doing 2-inch polishing. We think there is going to be ample work to get us to a higher utilization in Malaysia just focused on 4 and 6-inch.

[Steven Chin:]

Got you. Thank you.

[Operator:]

The next question we have comes from Brian Lee of Goldman Sachs.

[Brian Lee:]

Hi guys. Thanks for taking the questions. I guess the first one, on the PSS sales target of $50 million for 2014. Is it fair to assume that to come next quarter, you are going to have enough visibility whether or not that target is achievable or not, just given – I guess wondering what sort of lead time you’re requesting from your customers who are doing the qualifications and may ramp up in terms of the timeframe you need to get ready to ship higher volumes?

[Raja Parvez:]

Yes, obviously. And the Q3 will be a good indicator of that, but at this time we are – at this moment, we are confident that everything is on track based on the feedback we’re getting from our customers.

[Brian Lee:]

Okay, fair enough. Raja, how much of your, I don’t know if you guys still break this out but your core’s mix is 2-inch versus 4-inch today? And has your outlook for pricing changed a bit here for the rest of the year, especially given the 2-inch trend being a bit more flattish into the second quarter?

[Bill Weissman:]

Typically we do more 2-inch and 4-inch volume, which is especially when we’re doing 6-inch that’s just how the utilization of the crystal works out. Pricing outlook has always been kind of one quarter out. We still think at a high level, as based on Raja’s comments on what’s happening in the competitive landscape and what we’re seeing on the demand side that we fully expect pricing to increase meaningfully in the second half of this year, but actual visibility is still remains only about a quarter out.

[Brian Lee:]

Okay. Last one for me. The increased confidence in wafer sales for the second quarter. You have touched upon it a little bit, but can you elaborate on what specific products and markets and diameters as well that mix is going to be comprised of, and how the additional volume impact will trend or will flow through your gross margin trends here in the near-term? Thanks guys.

[Raja Parvez:]

Well, as we’ve said that we expect the second half of our business in the wafer business will growth, which will be – combination of this will be more 6-inch and 4-inch, both in the PSS and the polished side. So far we are making a good progress both on the polished side and also on the PSS side. So the bulk of the wafer business still be between those two products which is the patterned and the polished and then with the different diameters 4-inch and 6-inch. Obviously at this moment, there are more 4-inch users than the 6-inch, but we are making good progress on both of those product portfolios.

[Bill Weissman:]

And the margin structure on the wafer side is clearly challenge right now. We got to get the cost down by getting the volume up and getting spec alignment so that we’re making one version and not 10 versions. We’ll get those costs down over the course of the year and again expect to see some price improvements here. So the margin structure will improve, but at this moment, the margins on the wafer side of the business are very challenging. Operator, do we have any more questions?

[Operator:]

No sir. We will go ahead and now conclude the question-and-answer session. We’ll go ahead and turn it back to you sir for any closing remarks.

[Dee Johnson:]

Okay. Thank you very much everybody for joining us today. We appreciate your interest. We look forward to speaking with you again soon. This concludes Rubicon’s first quarter conference call.

[Raja Parvez:]

Thank you.

[Operator:]

And we would like to thank you management team today. The conference call is now concluded. We thank you all for attending today’s presentation. At this time, you may disconnect your lines. Thank you and take care everyone.