Rubicon Technology, Inc. (NASDAQ:RBCN)
UBS Global Technology Conference Call
November 14, 2012 3:00 pm ET
William F. Weissman – Chief Financial Officer, Treasurer and Secretary
Stephen Chin – UBS Securities, LLC (U.S.)
Stephen Chin – UBS Securities, LLC (U.S.)
Okay, good afternoon, everybody. Thanks for joining us in this afternoon session. My name is Stephen Chin. I’m the analyst here at UBS covering the alternative energy sector and it’s my pleasure to welcome Rubicon Technologies to give us a brief presentation. And then if we have questions, we have a break-out session right after this down in the Julliard room, which is just one floor below. So I’m going to hand it off to Bill Weissman, Rubicon’s Chief Financial Officer.
William F. Weissman
Thank you, Stephen. Good afternoon. Rubicon is the world’s leading provider of sapphire products. We’ve been in business for about 12 years now. And over those 12 years, we’ve developed our technology, both in terms of the production of crystals themselves and then processing crystals into large diameter windows and lenses and have taken a very significant leadership position, particularly in those larger diameter products.
Our business is focused on three main markets, which I’ll talk about each of those, as we get into the presentation further, but each of those three main markets have significant growth potential. We have very strong IP, as I mentioned earlier, in both the crystal growth and the processing of those crystals, particularly in producing very large diameter windows and lenses. And those windows, lenses, and wafers are all enabling the various customers we have to progress their technologies.
We have very long-standing relationships. As I mentioned, we’ve been in business for 12 years, which is actually quite a long time for sapphire, given the young markets we serve. And we have great relationships at the LED chip manufacturers, LED polishers, SoS, and optical customers.
The three main markets we serve are the LED market, the SoS market, and the optical market, the largest being the LED market. Sapphire is used as the substrate of choice to produce high brightness LEDs. It’s used to produce probably 80%, 90% of the world’s high brightness LEDs. We’ll talk about the LED market in a little bit greater detail.
The second market is the SoS RF market. Similar to the LED market, it’s used as a substrate to produce certain RF chips, most notably the chip that’s in your antenna switch of your smartphone. And the optical market, unlike the other two markets, is where sapphire is used for its physical properties. It’s a very strong, durable material. It has great optical qualities, so it’s used for lenses and windows in very harsh environments.
The LED market, I’m sure everybody’s familiar with. The main drivers for the LEDs in applications today are like TVs and displays have been the main driver, the backlighting market, it’s often referred to. That probably represents about 60%-plus of the world’s LED demand today.
But the greatest potential obviously is in the general lighting market. It’s kind of the Holy Grail for the LED market. We’re seeing significant growth there as well. We haven’t quite hit the inflection point that everybody’s waiting for on general lighting, but we are seeing growth rates of something in the neighborhood of 30% or 40% per year for general lighting applications.
And the auto applications are also growing nicely. You used to only see LEDs in the high-end autos, and now you’re starting to see them in all types of makes and models.
Rubicon’s greatest strength, however, is in producing large diameter sapphire. We’re the world’s leader in large diameter substrates, for example. Current sizes today used in the LED market are two, three and four-inch diameter for the most part. Six-inch is a new product that we’re beginning to see traction on, and we probably have about 70% market share of six-inch use in the LED market today.
Similarly, the LED market is not the only ones who use six-inch wafers. The SoS market also uses six-inch wafers. That market started at six-inch diameter, and we have a very significant majority position in that market as well. Really, six-inch and beyond is the future of LED, we believe, because just like you saw in the semiconductor world, larger diameter substrates allow the chip manufacturers to gain greater efficiencies in their production process.
The SoS market is fairly new. The SoS product is owned the IP is owned by a company called Peregrine Semiconductor in San Diego who recently went public. And their product is displacing certain gallium arsenide-based chips, most notably the antenna switch in your smartphone has some really great efficiency attributes to it. For example, a single SoS chip displaces several gallium arsenide-based chips. So it’s a smaller form factor. It uses significantly less power, and sapphire being a great insulator eliminates the crosstalk.
So that’s why you’re now seeing the SoS chip gain wins in most of the smartphones that you see in the marketplace today. Peregrine is also working on taking its SoS technology and deploying that in other gallium arsenide-based chips such as power amplifiers. I know they’re working on introducing a power amplifier sometime next year.
One of the other key strengths of Rubicon is we’re really the only true vertically-integrated sapphire producer in the marketplace today. There are a number of sapphire companies out there, but they all seem to focus on one part of the sapphire production process. There are companies that focus on crystal growth, others that focus on fabricating the crystals into windows, some that work on the raw materials.
But Rubicon really controls the entire process, starting at the very base raw material of powdered aluminum oxide, converting that into crystals and then formulating those crystals into large diameter windows and lenses. That allows us to do two things. It allows us to control the quality throughout the process and allows us to control the costs throughout the process.
The raw material process is something we developed internally within the past year and a half, and we’re just now rolling that out. That’s where we’re taking powdered aluminum oxide and converting it internally into the form we use in our crystal growth furnaces. Most companies that are in the sapphire space go out and buy raw material that is already preprocessed. We’re in the process of rolling that out today. About 10% of our internal need is produced internally. By the middle of next year, we’ll be doing about 100%, or close to 100% of our internal raw material process. And that’s very significant, because the raw materials is a very large part of the crystal cost, and we’ll be cutting that part of the crystal cost in half by the middle of next year.
Crystal growth is really where the heart of our technology is. Over the past 12 years, we’ve continually revised the design of our furnaces, and they’re very highly efficient and I’ll talk in a couple of slides about why we have a significant cost advantage on the crystal growth side of things as well. Then within the various fabrication steps, core fabrication, for example, is when we take the boule, the crystal boule and we take the various core sizes out of it. There too, we have very strong IP. Fairly recently, we’ve been awarded a patent for in-situ processing, meaning we can do all of our crystal orientation within the equipment themselves, so that we reduce the time of processing and reduce the cost.
Slicing and polishing is another key competency, core competency of Rubicon for larger diameters, very difficult to do. Sapphire is the second hardest material in nature behind the diamond. The only thing that really cuts and wears the stuff down is diamond slurries, diamond wires. And we’re seeing requirements for these wafers where the variation in thickness, a bow and warp can only be four or five microns across a surface of a wafer. Very difficult to do when you’re using diamond slurries and you’re wearing down your pads and your equipment at the same time as you’re wearing down the wafers themselves.
So our strategy going forward is to continue to vertically integrate. As I mentioned, that’s a key differentiator for us. The next step downstream for us is called patterning. What the LED chip manufacturers do when they get our polished wafers, before they put it into their MOCVD reactors, they typically etch a pattern into the surface of the sapphire. That does two things. It allows for a more uniform architectural growth on top of the sapphire substrate, and it also extracts more light.
And sapphire, once the device is created, is actually an impediment to light. So by etching a pattern into the surface of the sapphire, it changes how light is refracted through the sapphire and extracts more light.
While we’re working on developing this capability so that we can offer the customer a pre-patterned sapphire substrate, there are some providers out there that may offer this product today for smaller diameters. But really to our knowledge, there is no vendor out there that can provide a pre-patterned six-inch wafer, and we plan on introducing that product the middle of next year.
We believe that not only do we have a leading technology, but we have a leading cost structure, and people that know how we’re structured that our crystal growth in the U.S., say well, how can you do that, how can you compete with your Asian competitors with a lot of your manufacturing infrastructure here in the U.S. And this is some of the reasons. As I mentioned, raw material, we produce our own raw material. It’s a significant cost advantage to most of our competitors.
The crystal growth furnaces we build ourselves. That’s part of our core IP. We know how to construct these furnaces, and if you were to buy a crystal growth furnace on the open market, it would cost you twice what it costs us to build one of our furnaces. Over the past 12 years, we have developed a very high level of automation into our furnaces. We only have five operators running 100 furnaces. That’s the best in the industry, and that means our labor content for crystal growth is very low.
Believe it or not, in the area of Illinois where we’re located, we have some of the lowest power costs in the industry, pay $0.035 per kilowatt hour. And that’s a very important cost input, because these furnaces are operating at 3,800 degrees Fahrenheit, which is the melting point of aluminum oxide.
And all those inputs can be the lowest in the industry, unless you have a very high yield, it’s not going to help you. But in the case of Rubicon, our yields in crystal growth are extremely high. So that’s how we’re able to keep our crystal growth in the U.S. and keep a low cost structure. It’s important for us to keep it here, because this is our core IP, and we want to protect it. Now the processes of taking the sapphire and fabricating it into large windows and wafers or even smaller diameter cores, that is more labor intensive, and those processes we’ve now moved to our Malaysia processing plant.
So again, our strategy is crystal growth is kept in the U.S. We’re able to protect the IP and still maintain a low cost structure. All of our fabrication operations are now being done at our new world class operation in Penang, Malaysia.
In terms of our product mix, I mentioned that we have a leadership position in the large diameter wafers, and that’s illustrated in kind of our revenue break-up here. You can see 70% of our revenue this year is coming from six-inch wafers. We have a 70% plus market share of that business. That’s a function of two things, one is the six-inch business is quite good right now, and also we’ve decided not really to sell too many of the smaller diameter products into a very weak market at the moment.
So you could see, the markets we serve are young, but they’re also highly volatile, particularly the LED industry. We’ve gone through quite a ride here in the past couple of years. The LED market really started to take off in late 2009 and with the introduction of LED TVs. And as you could see from this chart, revenue and pricing and margins really grew very strongly through 2010 into 2011. That did attract a lot of competition, not so much from new entrants, but the five incumbent players, there’s five of us that really dominate the market. All of us added a lot of capacity during that time to make sure we’re capturing our share of that 60% gross margin business.
Well then the LED market slowed down. The backlighting market slowed down, and pretty quickly there became an imbalance in the supply/demand equation for sapphire. And so we’re starting to work our way back through that. You can see we’ve kind of bottomed out in the first quarter of this year, and revenues and margins have been ticking back up. I think going forward, it’s difficult to say exactly when we’ll see a better balance in the supply/demand side of sapphire, but demand is gradually improving. There is certainly not any more meaningful capacity coming on line, so we expect to see that improve pretty significantly in the near future.
The other thing that’s happened with the weak LED market is it has delayed some migration to six-inch, and we really only have one very large six-inch user on the LED side. We thought we would have more than that by now, but the down cycle has delayed that somewhat as people focus really on their underutilized current assets.
We are seeing some of our six-inch customers that are working on it in R&D re-engage in that process, and we do think we’ll see a couple of more move into production sometime later next year, so that will help with the six-inch demand as well. So really that’s the story.
Again to recap, we have very strong IP, both in crystal growth and in processing large diameter crystals. We’ve been doing this for 12 years, and it’s taken that long to really refine the process and the equipment. We build our own equipment, and gives us a real strong leadership position, particularly in the large diameter wafers and windows.
We serve very high growth markets. Yes, they’re volatile, and we’re going to have some ups and downs. But they are high growth markets with huge potential in those markets. Our vertical integration is a real advantage for us in terms of both containing costs and making sure we have leadership position in terms of quality, and we have very long-term relationships, both in the LED, SoS, and the optical side.
So thank you very much, and we’ll see you downstairs for Q&A.
[No Q&A session for this event]
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