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Rubicon Technology, Inc. (NASDAQ:RBCN)

Q2 2009 Earnings Call Transcript

July 29, 2009 8:30 am ET

Executives

Bill Weissman -- CFO, Treasurer and Secretary

Raja Parvez -- President and CEO

Analysts

Jed Dorsheimer -- Canaccord Adams

Steven Chan -- UBS

Brian Neujip -- William Blair & Company

Joseph Foresi -- Janney Montgomery Scott

Jiwon Lee -- Sidoti & Company

Yair Reiner -- Oppenheimer & Company

Avinash Kant -- D.A. Davidson & Company

Operator

Good day ladies and gentlemen and welcome to the second quarter 2009 of Rubicon Technology Inc. earnings conference call. My name is Becky and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions).

I would now like to turn the presentation over to your host for today's call Mr. William Weissman, Chief Financial Officer. Please proceed.

Bill Weissman

Thank you, Becky and good morning everyone. We are pleased you could join us today for Rubicon second quarter 2009 earnings conference call. My name is Bill Weissman, and I'm Rubicon's Chief Financial Officer. With me today is Raja Parvez, Rubicon's President and CEO.

We have allotted 45 minutes for our call this morning. Raja will provide an overview of our second quarter results of operations and discuss the current market environment and then I will review our financial results in detail. We will discuss our current outlook for the third quarter and provide additional market information based on Raja's recent customer visits. We'll then be happy to take your questions.

Today's call is simulcast on our Investor Relations Web site located at www.rubicon-es2.com. A replay of this call will be available for eight days and the webcast will be archived in the Investor Relations section of our Web site. As a reminder, our press release and preliminary financial statements are also available on our Web site.

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 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 CEO, Raja Parvez.

Raja Parvez

Thank you, Bill. Good morning, everyone, and thank you for joining us today. The results of operations in the second quarter exceeded our guidance for the quarter as we saw the LED market begin to rebound in the quarter with the solid recovery in certain geographic markets. Revenue for the quarter was 3.2 million versus guidance of 2.3 million and our net loss in the quarter was 2.9 million compared to the projected loss of 3.9 million.

In the quarter we saw a significant improvement in the LED market particularly in Taiwan and Korea; in Taiwan leading LED chip makers ramped up factory utilization in Q2 and depleted their substrate inventories as a result we began receiving new orders from polishers in Taiwan.

The improvement in the Taiwan and Korean markets is being driven primarily by the increase rate of adoption of LED backlighting for notebook and netbook computers as well as rush to bring LED-backlit, LCD televisions to market by some of the large consumer electronics companies.

As we reported in our last call the rate of penetration for LED in these applications has accelerated. With notebook manufacturers launching ultra thin green model, the overall penetration rate of LED backlit units in the notebooks and netbooks may now reach as high as 70% to 80% in Q4 of this year compared to earlier estimates of approximately 30%. The key drivers for this acceleration are reduced LED-backlit unit cost and proven performance.

In addition, leading consumer electronics manufacturers are actively bringing to market large screen LED-backlit LCD Televisions. Production costs continue to decrease and these companies anticipate that these eco-friendly, ultra-thin, light weight televisions with exceptional picture quality will stimulate LCD TV demand.

As these new televisions gain in popularity, this category may become one of the leading drivers of LED demand in 2010 and 2011. For example, each large screen television requires approximately 1,000 LEDs where as the average laptop has approximately 50 LEDs.

Currently, the resurgence of activity is centered in Taiwan and Korea. Several high volume providers of cost effective LED chips, LED-backlit units and LCD panels are located in Taiwan. Many of the world's leading consumer electronics manufacturers source a significant portion of their LED chips and LCD panels from these companies.

Demand from Mainland China is also contributing to growth in the Taiwan LED business, consumers and rural China can receive significant rebates when they purchase electronics and other goods that contain LEDs. China is now one of the fastest growing markets for LCD TVs, notebook computers and higher end smartphones. Additionally, many cities are installing LED street light as part of a major initiative across China to reduce electricity usage.

In Korea, the leading consumer electronics manufacturers are actively increasing their internal production of capacity for LED chips and LED backlight units to keep with an increasing demand for green lighting, notebooks and new LED TVs that use much less energy.

LED demand is slowly picking up in the Japan, North America and Europe markets as chip inventories are finally dropping due to increasing demand for LEDs in general illumination and display signage. Demand for some LED applications such as automotive and mobile devices remains sluggish. We do not expect dramatic improvement in demand for these products until the worldwide economic environment improvements.

LED manufacturers in these regions are also beginning to benefit some increased penetration of LEDs backlight units into consumer electronics, display applications. Several key Japanese consumer electronics companies have also recently introduced LED-backlit televisions. We expect demand to continue to improve throughout this year.

Q3 revenue should be approximately 4.5 million, the sequential growth continues in Q4. However, visibility while improving is still limited to a few months so we are not giving specific revenue guidance for Q4 at this time. We believe that demand for sapphire wafers and LED chips should continue to increase in 2010 as polishing companies and LED manufacturers add capacity to keep up a numerous general illumination and consumer electronics applications for LEDs.

Based on the improving market environment we are working on bringing manufacturing capacity back on line where we will provide more specifics on Q3 guidance in a few minutes.

Since we are still early in the recovery of LED demand pricing has been a significant challenge. Sapphire producers, polishers and LED chip manufacturers have been pricing very aggressively in order to spread their fixed cost while improving utilization.

Compounding the situation is the fact that the Taiwan LED market is driving much of the renewed activity at the moment. This market remains almost exclusively focused on two-inch wafers which is a market that all current sapphire producers can address. However, it is clear that sapphire capacity is tightening significantly and we expect to see some pricing improvement starting in the fourth quarter.

The LED industry continues to make progress in utilizing large diameters substrates. Several LED chip manufacturers are currently investing in 4-inch wafer production capacity while several others are actively working on 4-inch development.

In addition, we are working with several customers on their development efforts using 6-inch sapphire substrates and we have also begun some initial work with Bartend [ph] on outage LED wafer R&D initiatives.

This next generation development can provide the longer term road map for the LED industry to continue to increase throughput and drive down costs as is needed for widespread adoption of LEDs to replace incandescent and fluorescent lights worldwide.

We expect to see 4-inch demand increasing throughout 2010 and production orders for 6-inch wafers to begin in late 2010.

The SoS substrate business remains unchanged. Our key customers in this market continues to work through its substrate inventory based on our agreement with them once they begin purchasing substrates again above the current base level Rubicon will receive orders for at least half of the volume purchase through 2011. I believe we will begin to see additional orders from the SoS market in the first half of next year.

Our optical revenue for the second quarter was down sequentially by 100,000 to 500,000 orders per windows and other optical products with commercial applications continue to be impacted by the overall economic environment we have several defense related programs and qualification stages as we become qualified in some of these programs and as the economy improves orders for optical products should begin to increase in 2010.

In summary, LED substrate demand has come back significantly in the Taiwan and Korean markets with signs of improvement in the other geographies as well. Indications are that demand should continue to improve throughout the rest of the year and should be stronger yet in 2010.

Based on current activity in the marketplace I expect to see large diameter capacity continue to be added next year. We are very excited about the activity in the LED market right now and believe this is a long-term trend driven by applications such as backlighting for laptops and televisions as well as general illumination applications such as street lighting and other commercial lighting.

In addition, SoS technology continues to gain adoption in the marketplace and I believe this market as well as optical markets hold considerable long-term opportunity for Rubicon. While we have experienced a pause in demand over the past three fiscal quarters the markets we serve have tremendous growth potential and I believe Rubicon's proven scalable technology, platform, high volume production capacity, large diameter capabilities, and high quality material will be key to the advancement of these markets.

I would now like to turn the call over to Bill who will provide you with greater details on the financial results for the second quarter and our guidance for the third quarter.

Bill Weissman

Thank you, Raja. Revenue for the second quarter was $3.2 million as compared to $2.3 million in the previous quarter and $11.5 million in the same period last year. The lower year over year revenue is primarily a function of 3.5 million lower SoS related revenue and lower volume, lower ASPs and product mix in the LED market.

Revenue from the LED market was up 1.3 million sequentially to 2.5 million in the second quarter as the LED market improves in the quarter for the reasons Raja provided.

LED revenue in the second quarter of 2008 was 6.9 million. As Raja mentioned the recovery thus far has been driven primarily by markets purchasing LED chips from the Taiwanese manufacturers which use almost exclusively to its substrates.

In the second quarter 76% of LED revenue came from 2 inch material and 24% from large diameter. This compares to 20% from 2 inch material in the previous quarter due primarily to the resurgence of orders for 2 inch material. The LED diameter mix in the second quarter of last year was 60% 2 inch and 40% larger diameter. We are still early in the recovery. The pricing environment has been very difficult. However, sapphire capacities beginning to tighten and we expect to see some improvement in pricing in the fourth quarter. Our revenue from the SoS market in the second quarter is 300,000.

As we mentioned on our last call, revenues are expected to remain in the 400,000 to 500,000 per quarter range this year. Second quarter revenue was below that range based on shipping schedules, so we should see above the range in Q3. SoS revenues in Q2 of last year were 3.5 million. As Raja mentioned we anticipate an increase in volume in this market in the first half of next year.

Our optical revenue for the second quarter was $500,000 as compared to $600,000 in the prior quarter and $900,000 in the second quarter of 2008 as this market continues to be impacted by the weak economy.

Operating expenses in the second quarter totaled $1.5 million, consistent with the previous quarter and $1 million lower than the second quarter of last year. Operating expenses in the second quarter of last year included $500,000 in cost associated with the secondary offering done at that time. Diluted EPS in the second quarter was a loss of $0.15 per share as compared to a loss of $0.19 per share in the previous quarter, an income of $0.10 per share in the second quarter of last year.

Turning to the balance sheet and cash flow, our cash position remains strong at $48 million in cash and short-term investments. Our auction rate securities are now classified as short-term since we have the right to put those securities back to UBS as face values starting next June.

Cash used from operations in the quarter was 1.5 million and capital expenditures totaled 1.1 million where total cash used in the period of 2.6 million. Our accounts receivable remained of high quality. DSO at the second quarter was 65 days, up five days from the prior DSO of 60 days.

There has been some slowing of payments from customers in Asia as a result of the market challenges. However, now that demand is resuming. We expect to see some improvement in DSO as well.

Inventory decreased slightly to $8 million from $8.1 million in the first quarter and continues to consist primarily of raw material and bull inventory.

I would like to turn now to our expectations for the third quarter. We expect revenue for the third quarter to be approximately $4.5 million. The utilization will continue to improve and the volume of materials sold in for the LED market in the third quarter should begin to approach the levels we were at last summer. However pricing and mix will continue to be challenging for us in the third quarter.

As we mentioned we expect both pricing and mix to begin to improve in the fourth quarter. Based on the expected pricing and mix the net loss in the third quarter is expected to be approximately 2.5 million.

I want to thank you all for joining us today and thank you for your continued support and now Becky, may we take our first question.

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from Jed Dorsheimer of Canaccord Adams. Please proceed.

Jed Dorsheimer -- Canaccord Adams

Hi, thanks guys. I wanted to maybe just dig in to this pricing a little bit further and try and understand I guess the comments about how Q4 will bounce back in yet the profitability for next quarter is coming down. So could you provide a little bit more color maybe quantify what you're expecting in terms of pricing pressure because it would appear that both with revenues and utilization increasing you're expecting a pretty big drop in pricing next year, is that the correct way to categorize that?

Bill Weissman

Couple clarifications, Jed. We're not forecasting lower earnings. We're forecasting improved earnings. It's not a dramatic improvement, obviously because of the pricing. Secondly, we didn't say that the pricing would snap back in the fourth quarter, we say we start to see some improvement. Basically pricing is bottomed out. Pricing will be slightly lower on average in the third quarter than it was in the second quarter. But already we're seeing orders for the fourth quarter that are up some and we expect probably around a 10% increase on average in the fourth quarter pricing and hopefully that will continue going into the next year, but that's obviously largely that depends on how the demand continues to improve going into next year.

Jed Dorsheimer -- Canaccord Adams

Alright. And do you see that is it mainly I guess the impact in terms of pricing, is this mainly due to competitive or is it mainly due to mix shift and then with respect to mix shift in terms of wafer size, I think you provided last year the 60% and 40% I didn't see the, could you just update me on what it was this particular quarter?

Bill Weissman

Yeah, Raja can comment on the competitive landscape in a minute, but pricing and all is really based on demand, right though, we had an unprecedented drop off in demand over the past several quarters and now things are beginning to improve and it’s going to take a while for the pricing to improve as the demand catches up with the supply. In terms of the mix we were at 24% large diameter LED in this quarter, 76% 2 inch, we're at 80% large diameter last quarter and that's really a function of the resurgence again of the 2 inch business out of the Taiwan market.

Raja Parvez

Jed, adding to that I think the pricing pressure is mainly focus on the 2 inch material which is currently being hold in the Taiwan market, however, there is some pricing pressure, now the diameter is also, but as you know that in the 2 inch market almost all of the current substrate providers can compete and this is somewhat of a competitive environment plus also the large amount of 2 inch consumes currently into the market.

Jed Dorsheimer -- Canaccord Adams

And so, Raja, with respect to that is we look at the 3 and the 4 inch market, what is pricing doing in those particular markets?

Bill Weissman

It down as well because even though there is limited sources for that material in the marketplace the couple of sources that exist been very aggressive on pricing in this downtime and but we would expect the pricing on the large diameter obviously to return quicker than the 2 inch since there are limited number of providers in the large diameter.

Jed Dorsheimer -- Canaccord Adams

And as you see a pickup in North America, Europe and Japan, I would assume that your mix shift should see an improvement, is that really what has driven the shift from that 80% to the 24% was geographical mix?

Bill Weissman

That's correct, yes.

Jed Dorsheimer -- Canaccord Adams

Alright. And then just another question and then I will jump back in the queue. But in terms of backlog you are starting to see things tighten a little bit in terms of supply/demand, last year you were fortunate as you were in the beginning of the year to have a healthy backlog I believe in, I was wondering is you do see things tightened, one, do you expect to sign orders for next year, are you starting to see that is maybe you could just update on what you are seeing in terms of backlog and then if you built any backlog at this point for longer term contracts?

Bill Weissman

Sure. With the learning experience really went through a last year, right? We have tremendous backlog going into 2008 and what we saw was when things got tough the backlog didn't mean a lot because customers couldn't take the material. We all kind of know the history. So the lesson there was be careful on how you lock in. Now we had customers approaching us now, going to lock in to long-term agreements again. But today's pricing doesn't make any sense at all for lock in to long-term agreements. In fact, just the opposite, we had, we could take quite a few orders for Q4 if we wanted to right now, but we need to see how the pricing is going to evolve, because we know that it's not sustainable all of the sapphire providers out there are in the same boat and I think anybody can make money at these prices so we're waiting to see how the pricing environment evolves, but certainly there is a lot of inches right now and locking in sapphire supply and, Raja can provide more color on that, he has visited with our customers and there seems to be a lot more anxiety in the marketplace right now around sapphire supply than there was before.

Raja Parvez

Jed, adding to that I just came from all the Asian customers and it is clear to us that the sapphire supplies again tightening up and especially I believe that this will continue especially starting Q4 and beginning of next year and many of our customers are concerned and they want to make sure that we are there for them to support them which we will, but I believe directionally these things are very positive for us and as we continue all the things that we've just talked about should improve for us.

Jed Dorsheimer -- Canaccord Adams

So just as a follow-up and then I will jump back in the queue. Have any customers come to you and like in the solar market and are willing to help pay for some of your capacity expansion and where are you in terms of expanding capacity seeing thing tighten a little bit? Thanks.

Raja Parvez

I think so far the answer is no. I think most of the customers as Bill mentioned at the current pricing they will some of them have showed an interest of locking up for the longer term but we are not really at this time encourage because of the current pricing, but in terms of paying for expansion that is not the model which is currently probably practice in the LED area yet.

Operator

And your next question comes from the line of Steven Chan of UBS. Please proceed.

Steven Chan – UBS

Hi, thanks. Hi, Raja, hi, Bill. Nice execution in the quarter. Just a couple of follow-up questions on the last question, when you talk about improved pricing in the fourth quarter is that also include improved pricing on the 2 inch sapphire wafer?

Bill Weissman

Yes.

Steven Chan – UBS

Okay. And then you are thinking about the third quarter in terms of LED product mix should be still model 2 inch to be the majority of the LED sales in the third quarter, Bill?

Bill Weissman

Yes, they will be in the third quarter.

Steven Chan – UBS

And then you talked about capacity tightening up I think in this fourth quarter, what do you estimate your factory utilization rates were in the second quarter and where do you think this would end up by the end of the year?

Bill Weissman

Well, it varies across the production line, the furnace, the crystal growth in the fabrication where we take the cores out of the bulls have been quite busy and will be close to 100% we believe with the installed capacity by the end of the year based on what we are seeing right now although again it's the visibility on orders is still somewhat limited. Now we're looking at timing around purchasing remaining furnaces to populate the remainder of our available floor space for furnaces and will make decisions on that although the course of the next quarter around the timing and the rate of which we install those.

Steven Chan – UBS

Okay. And then lastly with (inaudible) Precision Group gone as a beneficiary as the shift to these larger diameters continue when do you think will see that that inflexion point back to these larger diameter wafer. Do you think you will see a big shift anything in that fourth quarter with customers into these larger diameter wafer?

Raja Parvez

Well, Steven, it will start beginning in Q4, yes, and it should continue to improve into 2011. As a matter of fact other than Taiwan and China, majority of the other companies are already moved to more than 2 inches and 3 and 4 inches. There is significant amount of activity going on in the 4 inch market currently and I believe that will continue for us in the Q4 and especially in 2011.

Steven Chan – UBS

And just lastly on the guidance the third quarter, Bill, how should we think about the operating expenses in the third quarter as you see more capacity back on line, should we begin the model SG&A and R&D up sequentially in the third quarter?

Bill Weissman

Not materially, no. It should be relatively constant at some point when we move back into profitability we will start accruing bonuses again and that will increase some as a result of that, but other than that there aren't any major additions right now.

Steven Chan – UBS

Okay, thank you. That's helpful.

Operator

And your next question comes from the line of Brian Neujip of William Blair & Company. Please proceed.

Brian Neujip -- William Blair & Company

Good morning.

Bill Weissman

Morning.

Brian Neujip -- William Blair & Company

Are you able to update us more specifically on the price erosion that you're seeing, last time you gave some good color at 25%, 40%, is that kind of the same levels we should be thinking about this last quarter?

Bill Weissman

Yeah the 40% was two inch and was year-over-year and are still slightly on average lower than that, not materially, larger diameter because again the demand being so low is probably 25%, 30% lower than it was last year. So those numbers still apply and we've again seen we believe that will be the bottom of the price erosion here as a result of the demand weakening and the other things are taking back up we should see gradual improvement. Again it's not going to be a snap back in pricing, never goes up as fast as it comes down, right, but we think the tide has turned and we will start to see some momentum going the other way.

Brian Neujip -- William Blair & Company

Sure. Then how does that figure enter your break even level so how much pricing power do you need to get to break even at a 100% capacity or is it more dependent on make shifting the larger way pursue?

Bill Weissman

Yeah, dependent on lot of things, mix being a key to it.

Brian Neujip -- William Blair & Company

Okay, so you guys back to I guess a little bit from the repurchases this quarter, is that the way we should be thinking about it going forward at these levels that you're likely to shy away from repurchases and maybe you can talk about what other options you've explored in terms of making use for cash?

Bill Weissman

Yeah, we did not buyback any shares in the quarter. The plan is still authorized and exist and we review that with the board periodically and we may or may not buy back shares in the future, so we don't have any specific program in place as far as the timing or the prices, which we will be buying back shares. In terms of use of cash, obviously, the other things the demand is coming back as I mentioned we will sort to relook at timing of furnace purchases and installations and capacity expansion, we are in the process of planning out both crystal growth and post crystal growth expansion plans for next year and will get back to everybody with specific information on that probably next quarter.

Brian Neujip -- William Blair & Company

Okay. And then shifting gears a little bit can you just talk about the competitive environment that four inches and versus six inches obviously, we are kind of lumping in large diameter to gather in your commentary but just curious how that looks as people transition in four inches, how much larger is your competitive advantage versus two inches and then or is it really worse at six inches where we get the biggest advantage?

Raja Parvez

Well, in general, two inches market where almost all of the current sapphire producers can participate and they do participate and that's why we have been seeing significant price crashes in the two inch market. Now as soon as you move beyond two inches for us that situation starts improving especially four inch, four inch is the area where less and less competitors are there because of our technology advantage. So I believe that four inches is starting point for us and obviously six inches and much more less competitive than four inch versus two inch so I think the four and six inch are the areas where we have the technology advantage, production capacity advantages and as we mentioned that we are currently working with several companies on four inch as well as next generation six inch and some even on eight inch LED development so those are the areas that where we have the most advantage competitively and also from our quality production and also the performance.

Brian Neujip -- William Blair & Company

Right. Along those lines, can you may be just provide a little bit more color on what you are seeing in terms of the qualification process for six inches, are there more companies every quarter that are looking at it, or the existing ones that are already in the qualification process or how well are they progressing?

Raja Parvez

I think it's a mix of the companies, those companies which have more technology advantage and where more technology resources are obviously focusing on the larger diameter and are already beginning initial qualification of the six inch product those companies which are in the technology are not that rate so they are working mostly on the four inch side of it. So it's a mix of it but however I believe that in 2010 four inch will be really in production for 2010 and the six inch qualification process will continue until middle of 2010 and we expect to see production volume order for six inch late 2010 and beginning of 2011.

Brian Neujip -- William Blair & Company

And then six inch I mean other than the obvious incremental equipment needed to get the six inches are there significant technology hurdles that you are seeing, I mean do you think, do you feel like your customers are going to be able to get the kind of yields that they require to get the optimal advantage for moving to six inches?

Bill Weissman

I believe that they will be of course, there are ramp up issues that there are technology challenges they have to come across especially at the front end of the technology which is the (inaudible) growth and some back end, but I think in the last about year and a half as I mentioned the companies which have more technology resources have progressed significantly over the years and I believe that based on what I see in the market and what I worked with several companies I believe that they will be able to do that what in the time period that I mentioned.

Brian Neujip -- William Blair & Company

Okay, one more thing on the guidance are you expecting that inventory has in fact bottomed this quarter or are you baking in any further reductions in your outlook?

Bill Weissman

The customer inventories you are talking about?

Brian Neujip -- William Blair & Company

Yeah. No just the channel inventory really.

Bill Weissman

Yeah, I think the two inch inventories certainly gone and large diameters largely gone as well.

Brian Neujip -- William Blair & Company

Okay. Great, thanks.

Operator

And your next question is a follow up question from the line of Jed Dorsheimer, Canaccord Adams. Please proceed.

Jed Dorsheimer -- Canaccord Adams

Hey, Bill, did you give what your utilization rates was at?

Bill Weissman

No, because it varies by area production probably on average its probably 60%

Jed Dorsheimer -- Canaccord Adams

60%, 6-0?

Bill Weissman

Obviously higher in crystal growth and fabrication and obviously that what the slicing and polishing is quite low still.

Jed Dorsheimer -- Canaccord Adams

Alright and then, Raja, I was just wondering it is a follow up to one of the previous questions, as we talk about the larger the competitive landscape in the larger area market has anything changed in your view, are that you costly in the EFG producers able to address that market, what is that your view that only Criyabilis [ph] suppliers are able to address the four inch and above market?

Raja Parvez

To have a respectable throughput, Jees, okay, I believe still the ES2 method is the most preferred and most reliable and highly profitable model, (inaudible) technologies may be in a R&D level or low volume level you could go potentially up to four inch but its still a I believe that technologically is a significant barrier and has been for many, many years.

Jed Dorsheimer -- Canaccord Adams

So I guess to ask the point a little bit more bluntly, in the competitive landscape, do you only see two suppliers they can serve the four inch and above market, do you think that will limit the market or do you see more competitors supplying in that market place?

Raja Parvez

I think in the four inch you may have a few suppliers who can supply, but

the six inch you have a much more limited choice.

Jed Dorsheimer -- Canaccord Adams

Got you. Alright, thank you.

Operator

And your next question comes from the line of Joseph Foresi of Janney Montgomery Scott. Please proceed.

Joseph Foresi -- Janney Montgomery Scott

Hi, gentlemen. My question here is just a couple of different ones. First starting with it sounds like you feel like demand is going to start to pick up towards back off for the year, but yet visibility is low, maybe you can just help me reconcile those two statements with a lack of visibility what gives you confidence that demand is going to pick up?

Raja Parvez

Yeah, Joe, the reason is it because of the current applications which have a margin last two to three months especially the BLUs for LED TVs, major electronics companies have already introduced many different models and also the penetration rate for the notebooks and netbooks now are nearing 70% 80% compared to last year projections of only 30% and going into the next year also the focus in the China and other markets and the street lights and general illumination. I think all of these factors are contributing our confidence that the market will continue to improve on this area. But yes, still, we are still cautious about it and we are saying that with till another quarter that remains to be seen to see a much longer visibility, but we are seeing the signs of it that visibility will get better and better as the time improves

Joseph Foresi -- Janney Montgomery Scott

Okay, and then just you talked about two inch and the pricing I wonder if you could just give some idea, is the demand pick up in two inch attributed to the depletion of inventory or is that new demand?

Raja Parvez

No, this is a new demand specially attributed to the more adoption of the back light units for display market and that's the main reason.

Joseph Foresi -- Janney Montgomery Scott

Okay, and then also on the two inch it sounds like you are expecting pricing to get a little bit better, as I understood sort of the model in general is in there typically over time pricing pressure in the smaller inch wafers I mean that sort of the whole idea moving to the higher inch wafers, as we understand that rebound in pricing is that in a fact of it being the price cuts being overdone or do you expect them to return to some sort of normal, in other words, are we returning to a normal level or how should we think about that because I would think over time pricing in two inch wafers would continue to come down?

Raja Parvez: I think its all of the above and yes, it was overdone because of people were desperate and they have a lot of inventory in the system and they just kept on dumping and that artificially reduce it and now as you know and the bar has been set by all our customers like that. However, we believe that moving forward two inch pricing which somewhat improves slightly, but I do not believe that two inch pricing will go further down based on the current view that we have and especially for the larger diameter, I think it will stabilize and improve better than two inch.

Joseph Foresi -- Janney Montgomery Scott

Okay, alright. And then just lastly I think you talked about Taiwan and Korea, maybe you can talk about just the general timeframe for I know you sort of roughly put it out there but the general timeframe for improvement in North American and European markets and why they have been sort of slower to rebound here?

Bill Weissman

I think the first we are seeing the signs that starting Q4 we should see some sign improvements in North America, Europe and Japan markets and we are seeing that. Why they have been slower, I think traditionally some of those markets need to collect more data before they jump into especially as you know the current market surge for last about two and a half months has been primarily driven from BLUs coming from Korea and Taiwan markets, specially for the LED TVs, as you know an LED TV on the average depending on the size it requires about 1,000 LEDs versus laptop of 50 LEDs so that has increased the demand. But I think traditionally other markets do see some collects more longer term data and as you know some companies are more aggressive than the other, it plays in that area as well.

Bill Weissman

The other markets were less focused on backlighting units and then they're more focused on other applications like auto and signage mobile devices and the Japanese market is a little late getting into the LED TV market especially compared to how aggressive the Koreans have been.

Raja Parvez

And very recently several Japanese consumer electronics company have already introduced the LED backlight as you know television into the market as well.

Joseph Foresi -- Janney Montgomery Scott

Okay, alright, thank you.

Operator

Okay. And your next question comes from the line of Jiwon Lee of Sidoti & Company. Please proceed.

Jiwon Lee -- Sidoti & Company

Yes, good morning, I am just kind of going back and try to reconcile the pricing as well. What do you think that three inch and the four inch pricing will come back? I am asking because when the two inch demand did come back the pricing kept falling. So if your expectations towards the larger diameter because of a little more favorable capacity out there or you think when the demand comes back it will be much better than the two inch demand pick up or you think the pricing can just falling?

Bill Weissman

Well, I don’t think its true that the price for the two inch fell as demand picked up, I mean the demand started picking up this past quarter and the orders that we were taking in the quarter stabilized in terms of pricing and now we are looking at pricing for Q4 we are seeing that we will start to get some modest increases so that the dynamic is shifted. That the confidence in the larger diameter pricing improving is not only a function of the pricing cuts being overdone, but also again based on the competitive landscape this is not that many providers of larger diameter material out there, there is a lot of investment going in, in production larger diameter producing LEDs are larger diameter substrates and will start to see more of that happening next year, so that's where our confidence in the improvement in the larger diameter pricing comes from.

Jiwon Lee -- Sidoti & Company

Okay, fair enough. And what was the customer concentration like for the second quarter?

Bill Weissman

Our top ten customers accounted for about 90% of revenue.

Jiwon Lee -- Sidoti & Company

Okay, 90%? And what was the quarter ago, Bill?

Bill Weissman

It was roughly the same.

Jiwon Lee -- Sidoti & Company

Okay, so then if the customers who were supposed to move over to larger diameters sometime next year if they are waiting for sort of a similar pricing dynamics as you are, are you seeing a little more proactive dialogue from your key customers about 2009 contract?

Bill Weissman

Yeah, well as I mentioned earlier there is a number of customers that would love the lock in long term right now in today’s pricing but that doesn’t make sense for us.

Jiwon Lee -- Sidoti & Company

Okay, I think I got it, thank you.

Operator

And your next question comes from the line of Yair Reiner of Oppenheimer & Company. Please proceed.

Yair Reiner -- Oppenheimer & Company

Great, thank you, Just a couple of housekeeping questions first. CapEx for next quarter in the full year can you give that guidance for us?

Bill Weissman

I still think it will be around $10 million for the year which means it will be around $7 million for the second half.

Yair Reiner -- Oppenheimer & Company

Great. And then if you can give us the geographical split and typically you can lump Asia together if you can give us a little more granularity on Taiwan versus Korea and Japan that would be very helpful?

Bill Weissman

Sure. Taiwan was about 57% of revenue, I remember Taiwan is serving Korea largely, so our sales directly into Korea are quite small, but again the Korean market place is being served largely by Taiwan, about 10% of Japan and the rest is Europe and North America.

Yair Reiner -- Oppenheimer & Company

Okay. In terms of Korea kind of the very fast growing customer there potential customer is obviously Samsung LED you have a long-term agreement with them for six inch when that comes to past, do you have any relationship now with them for four inch and could that be something potentially develops over the coming year?

Raja Parvez

Well first of all we don’t comment on any specific company and we do not have long-term contracts and agreements with those companies, but yes we are working with several companies on the four inch and six inch development and also on the R&D activities.

Yair Reiner -- Oppenheimer & Company

Okay, very good. In terms of industry capacity obviously lot of plans of have been put aside over the last year but the capacity has been added, when you do your analysis of the market as a whole where do you see industry capacity now versus last year and what do you think industry wide utilization is on the crystal growth part?

Raja Parvez

I think on the crystal growth size I think the competitive landscape and the capacity has not significantly changed over the last two three quarters then I believe moving forward people who have the capability they might add some capacity, but still I think this pace is actually managed by few of us and just because of the technology barrier. However this industry, LED industry is moving to a much larger industry and companies like us especially us we have the capability and also the resources to continue to respond to the market and we are carefully considering right now our options of any further what actions we take in order to and we are going to make sure that we continue to focus on our customers and have enough product of different sizes to provide them in a timely fashion.

Yair Reiner -- Oppenheimer & Company

Very good. Last question is on inventories, your own inventories remained relatively elevated in the quarter, where do you want them to be exiting next quarter and also from P&L point of view what is the impact of potentially selling material as inventory rather than out of production in the third quarter?

Bill Weissman

Inventories stay relatively constant and again its largely made up of raw material and bull inventory about $6 million of the $8 million is raw material and bull inventory. Raw material we have cut back our suppliers during that slow period and now we are staring to use more material than we are bringing in, obviously, we wanted to retain those relationships and continue to take some material, but we are now in a position where we are using more than we are taking in so that should start to gradually come down. The bull inventory is a good thing something we always wanted to have and never had the production capacity to build a bull inventory that could support us in the case of spike in demand or things like power outage so bull inventory is a positive thing but yeah we would like to get the raw material inventory down significantly obviously over time but there is no shelf life associated with that so its not really a major concern.

Yair Reiner -- Oppenheimer & Company

So there is really no impact positive or negative of selling out of the inventory?

Bill Weissman

Yeah.

Yair Reiner -- Oppenheimer & Company

Okay, thank you very much.

Operator

And your next question comes to the line of Avinash Kant of D.A. Davidson & Company, please proceed.

Avinash Kant -- D.A. Davidson & Company

Good morning, Raja and Bill.

Raja Parvez

Good morning.

Bill Weissman

Good morning.

Avinash Kant -- D.A. Davidson & Company

The question I had was some of the equipment manufacturers have been talking about very strong sales lately and a strong booking given what you see in the field, do you think these tools are being supplied for more in the four inch or six inch applications, are they going for into two inch applications?

Raja Parvez

I think majority of the tools for last about a year so the equipment manufacturer have been designing and supplying are actually capable of doing four inch and some of them are now six inch. There is no tool which is specifically designed for only two inch, most of them are interchangeable between two and four inch, but the many tools are now also being supplied in the six inch area and the majority of the companies are currently focusing on the tools which can go all the way up to six inch and some companies also look in if the tools which can go up to the eight inch so there is somewhat diameter independent in that case.

Avinash Kant -- D.A. Davidson & Company

Now understanding it from the technology point of view, clearly, there is an advantage if you move to larger wafers, and what I am not able to understand is what is holding people from going there, is it the tool or is the price of the wafer, what is holding them or the process is not mature enough?

Raja Parvez

I think it is, the key reason is the process is not mature enough of the technology barriers are manufacturing especially in the front and the AP [ph] textual growth yields still are, they have to be improved significantly in order to get to that point. So that's of course the other factors also play into this one. But majority is the technology barrier and ramp up challenges that people have.

Avinash Kant -- D.A. Davidson & Company

Now as people see problems in the AP growth area do you think they can look for some other material or another wafer or some other material could be more helpful than sapphire, could it be possible?

Raja Parvez

I do not, well, practically it is possible, I do not see for next many, many, many, many years to come if there is any other material other than R&D level, but I believe that sapphire is an optimal substrate for the LED growth at least that's what the all the industry and all the applications and all the investment have been carried out to support their material.

Avinash Kant -- D.A. Davidson & Company

The next question was with Bill, at this point, Bill, in compared to what your revenues are, could you give us what percentage of your sales are coming from finished wafers and what percentage are going into pre coat wafers?

Bill Weissman

Sure, well, since it is a largely two inch market right now and the Taiwan market place the polishers have fairly large installed capacity for slicing significantly more about sales right now in the form of core versus wafers so about 60% in the second quarter were core.

Avinash Kant -- D.A. Davidson & Company

And does that, I believe that could be another factor that impacts your margin?

Bill Weissman

Well generally I mean in a normal pricing environment where the margins are stronger in core because you do add incremental value with slicing, but it's at a lower rate but obviously since core pricing is about 60% of what wafer pricing is yet lower revenue so that's another function as to why our revenues are a little bit lower than they were last year also was the mix between core and wafer.

Avinash Kant -- D.A. Davidson & Company

Okay, and the final question is in terms of pricing, when you talk about pricing and pricing improving in the fourth quarter, is it based on conversations that you are having with your customers right now, when you are talking about pricing increase, are they willing to do some pricing increases on the two inch side also or is solely on the four inch side?

Bill Weissman

No, it's on the two inch side also. That is based on conversations we are currently having with customers.

Avinash Kant -- D.A. Davidson & Company

And did you give out any backlog numbers at this point or you are kind of?

Bill Weissman

No, we said we have minimal orders for Q4 booked right now but that’s by design we could book a lot more, we could have booked a lot more at existing pricing but we don’t want to do that we wanted to see how the pricing environment evolves, we think that demand will be there and we think that's the best approach to take right now.

Avinash Kant -- D.A. Davidson & Company

And a little bit of longer term question, historically, you have said that with the current capital that you had invested you could get to roughly $50 million in revenues on an annual basis, now given pricing has been coming down, where do you think you would need to add further capacity what's the run rate at which…?

Bill Weissman

Well that 50 with the pricing decline comes down obviously to 35 or something like that but we still have room for expansion and get that back up to 40, 45 even on today’s pricing environment so but again with the pricing and mix we think sure to improve so that dollar capacity will improve in addition to that. And of course we will be adding new facilities in addition to (inaudible) existing facilities.

Avinash Kant -- D.A. Davidson & Company

Now if I would think of the two inch market share do you think there has been a shift in the market share as far as the two inch wafers are concerned over the last year or so?

Raja Parvez

Well overall I think that the last year, last two quarter has been pretty volatile market in terms of so, but I think that in the areas where we still have a significant market share and based on that there have been minimal impact because of the changes in and we are still consistent, but I mean we look at these things on a yearly basis, not on a quarterly basis so I think we are still consistent in terms of our key customers that we have.

Avinash Kant -- D.A. Davidson & Company

Okay, perfect, thank you so much.

Bill Weissman

Okay, sorry operator, I believe our time is about up. Thank you all for joining us this morning and we look forward to speaking with you again soon.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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