Rubicon Technology, Inc.
Q3 2014 Earnings Call Transcript

Published: 7 Nov 2014

[Operator:]

Good day and welcome to the Rubicon Technology Third Quarter 2014 Results Conference Call and Webcast. All participants will be in a 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 over to Dee Johnson, Vice President, Investor Relations. Please go ahead.

[Dee Johnson:]

Thank you, Amy. Good afternoon everyone. We are pleased you could join us today for Rubicon's third quarter 2014 earnings conference call. With me today is Bill Weissman, Rubicon's Interim CEO and Chief Financial Officer. We have allotted one hour for our call this afternoon. Bill will discuss third quarter results of operations and our outlook for the fourth 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 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 today, we will discuss among other financial performance measures. Non-GAAP loss per share; which is a non-GAAP financial 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.

[Bill Weissman:]

Thank you, Dee. Good afternoon, everyone and thank you for joining us today. Well significant in the sapphire industry in the third quarter were in the mobile device segment. The adoption sapphire in mobile devices continued to expand with the introduction of new products and the announcements of others soon to come. The home button in the latest version of the iPad has sapphire just like iPhones. An Apple watch coming out early next year has sapphire contents, [indiscernible] two at least smart watches already in the market. In addition, Kyocera has already introduced a new smartphone with a sapphire face plate and a Chinese smartphone manufacturer has announced plans to do the same. However, most people who follow the industry expect that at least one version of the iPhone 6 would have a sapphire face plate, but obviously did not happen and with subsequent bankruptcy filing by GTAT has raised considerable speculation, on how the mobile device segment of the sapphire market will evolve. Well we do not know, if Apple has changed their overall strategy around sapphire. Apple and other mobile device manufacturers continue to expand their use of sapphire, in more of their products. We expect this trend to continue and this segment of the market has potential to be the largest consumer of sapphire in a relatively short period of time. But it's difficult to say at this point, what the impact in the market will be as a result of GTAT bankruptcy. There are number of scenarios, well we do not want to speculate at this time. What we do know, is Kyropoulos which is the basis of our technology and EFG have become the defacto standards in sapphire crystal growth for the LED industry. And as other technologies have not been successful thus far, in gaining market share in the LED industry. Rubicon has been participating in the mobile device market, and we will continue to participate in the market in a significant way. However, our primary focus remains the LED market. There is considerable growth ahead of us in the LED market, with LED use in general lighting, still in the early stage of adoption. In addition, the shift to large diameter substrate should compound the growth opportunity for Rubicon. In our view, selling a higher value add product like PSS wafers into the LED market, which requires high quality crystal and advance polishing and patterning capability, will result in greater customer loyalty and higher margins than selling bulk sapphire or products with loose polishing and crystal specifications. In the mobile device market, the majority of applications are supported with two-inch diameter sapphire. This is mainly because the finished pieces need to be thin. And large diameters crack in processing to that thickness. While usage of two-inch material for these applications remained strong in the third quarter, that demand was largely met by the considerable inventory of two-inch material in the supply chain. We know, one competitor that had a six month supply of double side polish two-inch wafers used in the mobile device market going into the quarter. In addition, there is obviously been capacity added in the marketplace this year, to serve the mobile device market. As a result, there were limited opportunities to sell two-inch material in the quarter. Consequently, a revenue decline sequentially from $14.5 million in the second quarter to $8 million in the third quarter. Of the $6.5 million sequential decrease $5.5 million was attributable due to the lower two-inch core sales in the period. Our understanding is that, inventory levels of two-inch material in the supply chain have now been significantly been reduced and we are seeing increased demand in Q4, for two-inch material. We have included a table, as a full breakdown of revenue, by product in our press release for your convenience. While wafer revenue was also somewhat lower in the third quarter. We continue to make progress on developing our PSS product offering. Our strategy has not changed. We continue to focus on vertical integration and we view PSS product as an important part of our growth strategy. While the progress in PSS is not yet meaningfully reflected in our revenue. We are now qualifying with nearly all of the world's top tier LED chip manufacturers. The size of the orders from certain customers will begin to increase over the next six months, as we progress from initial qualification, to our full qualification with those customers. We expect production orders by mid next year and based on the progress we are making, we believe that our PSS capacity, will be fully utilized by the end of next year. The LED market continues to expand driven by strong growth in the general lighting segment. With increasing our MOCVD utilization rates, chip manufacturers are migrating to larger substrates as a way to increase throughput. The shift from two-inch to four-inch this past year has been dramatic and we are now seeing more interest in six-inch wafers and are providing six-inch polished and six-inch PSS wafers, to several different chip manufacturers that currently do not use six-inch wafers in production. While current low cost performance wafers could delay six-inch adoption for some of these customers. We expect one or two to move into production on six-inch next year. We also have received new order for sample volumes of eight-inch wafers from one top tier LED chip manufacturer in this month. To our knowledge, we remain the only vertically integrated sapphire producer with volume six-inch PSS capability, and volume six-inch polished wafer capability. And we also continue to make progress on our R&D projects. Our LANCE project to produce large two-inch thick rectangular windows continues on schedule and as we mention last quarter, we have two projects underway to address the smartphone face plate opportunities, by developing alternative approaches to producing large pieces for the mobile device market without, the need to fabricate these pieces from bulk crystal. If successful, this will provide a significant cost advantage, since the majority of the cost of these pieces is not the crystal, but rather in the fabrication of the crystal into the right form. We have patents pending on both technologies and we continue to product samples from one of these technologies and are currently testing samples with a major consumer electronics manufacturer. We also have request for samples from several other leading consumer electronics manufacturers. We continue to focus on reducing product cost at each step of the production process. In crystal growth, we are in the process of slightly modifying the geometry of our boules which is increasing yield and thereby reducing our crystal cost. This modification will be implemented in all of our furnaces over the next 12 months to 18 months. We also continue to lower our raw material cost in crystal growth. I think it's important to point out, that the current low cost of our raw material production is not yet fully reflected in our statement of operations. Back at the prior market peak, we were concerned about potential bottleneck in the raw material part of the supply chain, and we accumulated a significant inventory of the material that we used at that time, known as crackle, that material continues to flow through our production. As a result, the cost of raw material and our cost of goods sold is nearly doubled that of our current raw material production cost. Well the time, those cost, as well as our raw material inventory balance, will come down. We made progress in the quarter in reducing polished wafer cost, through some changes in the consumable formula and upgrading some equipment. We are also working on some more significant changes to our polishing platform, which if successful, would significantly reduce wafer cost and require minimal, additional capital expenditure. Polishing is the area, where we have the greatest opportunity to reduce cost, and an area where we must reduce cost, in order to fully realize the benefit of our vertical integration strategy. We continue to carry, a high idle plant cost associated with low utilization of our wafer operations. As I mentioned, we expect to see considerable improvement in this next year, particularly in the back half. Items like idle plant and the raw material situation, result in operating losses much greater than our cash burn. Cash used in operations totaled $4.5 million in the third quarter and $11.5 million for the nine months ended September 30, 2014. Regarding EPS despite coming in at the low-end of our revenue guidance range, our non-GAAP per share loss, which excludes non-cash charges was $0.36 in the third quarter, as compared with our guidance of a per share loss between $0.39 and $0.44, due to a combination of reduced product cost and product mix. GAAP loss per share were $0.53. We recorded $4.4 million, a non-cash charges in the quarter. Of the $4.4 million, $2.6 million was related to writing down consumables and equipment which became obsolete with changes made for the polishing platform in the quarter to reduce wafer cost. We expect to recover that amount through the reduction of wafer cost by the end of next year. In addition, $1.8 million of finished goods inventory was written as changes in customer specification, made it unlikely to be able to realize the full value of that inventory. Our balance sheet remains strong, with cash and investments balance of $53.2 million at September 30, with no debt. DSO was 66 days at September 30, up from the prior quarter and DSO of 54 days due to sequential decrease in revenue. Inventory balances with the exception of raw materials remains low. Regarding our outlook for the fourth quarter, we expect continued progress in growing the wafer business particularly with the PSS wafers. We are seeing improvement in the two-inch market. However pricing remains very challenging. Although the pricing environment was improved in the first half of this year, the excess supply of two-inch material in the third quarter drove pricing for two-inch core 30% lower than the previous quarter. With inventory levels of two-inch material in the supply chain declining, we hope to see improvement in two-inch pricing in the first quarter of 2015. While we were seeing increasing interest in two-inch material in the fourth quarter, four-inch demand is very weak due to seasonality in the LED market. While general lighting segment is growing steadily. The backlighting market continues to represent a large portion of overall LED demand and that segment continues to experience seasonality with the fourth quarter, typically being the weakest quarter. Which year, the seasonality is more impactful because of the level of inventory in the supply chain. As a result, we expect fourth quarter revenue to be similar to that for Q3, but then begin improving in the first quarter with the recovery in the four-inch market, along with continued growth in our wafer business. We expect our GAAP loss per share in the fourth quarter to be between $0.38 and $0.42. While we expect continue reduction in product cost, the quarter will be impacted by the reduced core pricing and product mix. The outlook for commercial sapphire remains very strong. Is clear that LED is the light source of the future. With the LED general lighting market expected to grow over 30% per year for the next several years. And we also believe, that we are in the very early days of the use of sapphire and the exterior of mobile devices. However, the sapphire market remains relatively young industry with new applications, seasonality and changes in the competitive landscape. Like other advanced material industries, as the industry matures the industry leaders, well the companies with skills, but more importantly the strongest capability in terms of vertical integration. Controlling cost and manufacturing quality at each step of the product process is key. While the build out of our vertical integration model is costlier in the near term, we believe that will position us well, to continue to innovate, and capture significant market share in the evolving LED market. Our margins will improve with increasing volume and experience in our new product lines and as customer specifications become better defined. We will also reduce our idle plan cost and our wafer product cost. Furthermore, while pricing is in certain product groups, may take a step back from time-to-time for various reasons. We believe, the general pricing trend for sapphire will continue to improve for some time. We also believe that our investments in R&D projects like LANCE and tentative approaches to larger sapphire pieces, the mobile devices in other markets will yield advanced products that will open up new markets for sapphire. I want to thank you for hearing [ph] us today and thank you for your continued support and now Amy, we will take our first question.

[Operator:]

Thank you. (Operator Instructions) our first question comes from Pierre Maccagno at Dougherty

[Pierre Maccagno:]

Hi, Bill. So I wanted to touch on the two R&D projects for the smartphone face plates. Well I've seen that, you recently put up two patents regarding the position of aluminum oxides on various substrates and I guess, that leaves one of our R&D projects and the other one, I believe is the horizontal directional solidification crystal growth method that you use for the LANCE and well you could, talk a little bit more those two, how are they progressing?

[Bill Weissman:]

Yes, there were two patents associated with one of the two face plate related projects that have been made public, those two are the first project, which is more of an aluminum oxide coating process. The second project is of pure single crystal sapphire solution, which is the real elegant solution of producing the single crystal sapphire in the near net-shape to the face plate. So that's what those two are, the second group of patents have not been made public yet. And then of course, the other one you were referring to is the LANCE project which is a, dipping both methodologies then moreover anybody uses today. It's significantly modified version of an older technology called [indiscernible], but we this week, we've got some very good results from that project and have a very high quality slab that's come out of that furnace and so that's very much on schedule.

[Pierre Maccagno:]

So when do you think these R&D projects could be prioritized and talk a little bit about your conversations with customers. How is that coming along? How could this grow in terms of revenues next year or the following?

[Bill Weissman:]

The coding-related projects could certainly generate significant revenue for us next year, if successful. We are still working with one customer, as we mention to kind of refine specifications in the process, but that is the greatest near-term potential. The second single crystal face plate solution is always away yet, it's at least the end of the next year, best case, but that one has the certainly the largest potential obviously and the LANCE project, we believe by the end of next year also, that will be ready for commercialization. So I think, we are getting close to having some real revenue from two of these three projects.

[Pierre Maccagno:]

And then regarding the closure of the GTAT plant, the impact it has on your business would you say, that it's only on the two-inch core or any other impact that you see there?

[Bill Weissman:]

It's really hard to know, you know what the impact has been to-date and what it will be in the future. I think, if there has been an impact, yes it's been primarily on the two-inch market for the mobile device segment to my knowledge. They've not been selling any sapphire in to the LED supply chain.

[Pierre Maccagno:]

Okay and then finally, ISP [ph] how are those trending for the six-inch?

[Bill Weissman:]

They're stable, the six-inch pricing has been low for some period of time, but they're stable. They're not dropping anymore and as the adoption of six-inch increases. We expect pricing to improve for that product.

[Pierre Maccagno:]

Okay, will come later for more questions in minutes [ph].

[Bill Weissman:]

Okay.

[Pierre Maccagno:]

Thanks.

[Bill Weissman:]

Thank you.

[Operator:]

Our next question comes from Brian Lee of Goldman Sachs

[Hank Elder:]

Hi, there guys. Thanks for taking my question, this is Hank Elder on for Brian Lee. I just wanted to ask with the PSS product seeing some qualifications at some OEM's. What are the volumes compared to this quarter and into the fourth quarter and in the first half of next year, that we might expect to see going forward?

[Bill Weissman:]

Well, the volumes are still being low because we are in qualification sampling for a number of customers. We do expect to be shipping PSS wafers to 12 different customers in the fourth quarter, and we will have some increase in volume that will still be below $1 million of revenue in the fourth quarter. And I think steadily you see that rise, in first half of next year and as I mentioned in my prepared remarks, we expect to see some real production level orders, kind of mid-next year and then really ramping to the end of next year, where we expect to have the infrastructure fully utilized by then.

[Hank Elder:]

Alright. Thank you.

[Operator:]

(Operator Instructions) and this time I'd like to turn the conference back over to Dee Johnson for closing remarks.

[Dee Johnson:]

Okay, thanks Amy and thanks everyone for joining us today and we appreciate your interest and we look forward to speaking with you again soon and this concludes the Rubicon third quarter conference call.