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Rubicon Technology, Inc. (NASDAQ:RBCN)

Q1 2010 Earnings Call Transcript

April 29, 2010 5:00 pm ET

Executives

Bill Weissman – CFO, Treasurer and Secretary

Raja Parvez – President & CEO

Analysts

Jed Dorsheimer – Canaccord Adams

Stephen Chin – UBS

Brian Neujip – William Blair

Joseph Foresi – Janney Montgomery Scott

Avinash Kant – D.A. Davidson

Jiwon Lee – Sidoti

Michael [ph] – Oppenheimer

Daniel Amir – Lazard

Operator

Good day, ladies and gentlemen, and welcome to the Rubicon Technology Incorporated first quarter 2010 earnings conference call. My name is Jane 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 today’s conference. (Operator instructions) As a reminder this conference is being recorded for replay purposes.

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

Bill Weissman

Thank you, Jane, and good afternoon everyone. We are pleased you could join us today for Rubicon’s first quarter 2010 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 one hour for our call this afternoon. Raja will provide an overview of our first quarter results of operations and discuss the current market environment and then I will review our financial results in detail as well as discuss our outlook for the second quarter of 2010. We will then be happy to take your questions.

Today's call is being simulcast on our Investor Relations website 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 website. As a reminder, our press release and preliminary financial statements are also available on 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 CEO, Raja Parvez.

Raja Parvez

Thank you, Bill. Good morning, everyone, and thank you for joining us today. We had a strong first quarter with revenue increasing 35% sequentially to $11.5 million and gross margin rising to 36%. Demand from the LED market was very strong, which resulted in a 20% sequential increase in our average selling prices. In addition, demand began to strengthen from the silicon-on-sapphire market and volumes sold into that market doubled the prior quarter volume.

With the increase in revenue and improved gross margins our diluted EPS increased to $0.07 as compared to loss of $0.04 in the fourth quarter of 2009. Demand is very strong from the LED market as the rate of adoption of LED backlighting for medium-to-large displays such as LED, LCD televisions, desktop monitors, notebook, and Netbooks computers continued to accelerate.

While adoption is accelerating, most of these applications, particularly LED televisions and monitors are in the early stages of adoption and are expected to continue to contribute significant growth over the next few years. In addition, LED used in general lighting, while still mainly used in niche applications, is also growing rapidly and reports are that it is expected to grow over 30% in 2010. With the expected growth in backlighting and general lighting, some analysts forecast that high brightness LED chip demand will more than quadruple between 2009 and 2014.This growth is attracting new entrants into the market with several major semiconductor and electronics manufacturers in Japan, Korea, Taiwan, and China now entering the LED chip production market, expanding our target customer base.

We continue to make progress in the qualification of our large diameter polished wafers at most of the major LED chip manufacturers while we are building our high-volume polishing operations in Asia to support our customers’ increasing production volumes. Customers clearly prefer to work with a supplier that is vertically integrated from raw material through a finished, polished wafer, as it gives them more confidence in the reliability of the supply and consistency in quality. This is becoming even more important as the sapphire supply continues to tighten.

The industry continues to migrate towards larger diameter substrates. While the majority of LED chips are still produced on two and three inch substrates, four inch substrates are now used in high volume production and there is significant development activity on six inch. Many of our customers are developing their six inch chip production capability using our six inch wafers so are qualifying Rubicon’s material at the same time they are optimizing their technology platforms for larger diameter wafer production.

We are therefore playing an important part in supporting their development efforts and they are counting on us to be able to support their operations once they move six inch into production. In fact, we expect some production orders for six inch wafers to begin in the second half of this year.

We are in the process of bringing on line additional capacity by the end of the year and in the mean time will be fully operationalizing our existing polishing operations to support anticipated additional demand for six inch polished wafers in the second half of this year. As I mentioned, revenue from the silicon-on-sapphire for the first quarter doubled sequentially, going from approximately (inaudible) in Q4 ’09 to $1 million in the first quarter of this year. Revenue from the optical market increased 50% sequentially from $600,000 in the fourth quarter to over $900,000 as we saw a significant improvement in demand in this market as well.

Regarding our capacity expansion, our two projects remain on schedule. As I am sure you recall, we are adding two new high volume manufacturing facilities to significantly expand both our crystal growth and post crystal growth capacity. Our new crystal growth facility in Illinois will house larger furnaces, giving us even greater ability to serve the growing demand for large diameter substrates. Our Asia facility will significantly expand our capacity to process large diameter wafers and reduce our current post crystal growth cost. Both of these facilities are scheduled to open by year-end and we anticipate both to be fully operational by the end of 2011. Additional capacity should begin to come on line at the end of this year with capacity to be added throughout 2011.

I am pleased with how the year has started in terms of our financial performance, the progress we have made on our capacity expansion and in expanding our customer base. Given the strong demand and progress made by our customers in shifting to larger diameter substrates, I expect 2010 to be a very productive year for Rubicon.

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 guidance for the second quarter of 2010. Bill?

Bill Weissman

Thank you, Raja. Revenue for the first quarter was $11.5 million as compared to $8.5 million in the previous quarter and $2.3 million in the same period last year. Revenue growth has been primarily driven by strong demand in the LED market, as Raja described. However, sale into the SOS and optical markets increased as well in the quarter.

Revenue from the LED market in the first quarter was $9.6 million, up 29% from fourth quarter 2009 LED revenue of $7.5 million. Given that we have been operating at full capacity in our crystal growth operation, the sequential increase came from increased ASPs and shift in product mix.

ASPs for substrates increased approximately 20% sequentially. Prices increased for all diameters with the largest increase at two inch, which had the largest drop during the recession. Revenue from large diameter material greater than two inch represented 64% of our substrate revenue in the first quarter as compared to 58% in the previous quarter. Sales increased in each of the larger diameters, three, four, and six inch.

Our revenue from the SOS market in the first quarter was $1 million, up from $486,000 in the previous quarter. As expected, orders from our key customer in this market increased significantly over the fourth quarter levels.

Our Optical revenue for the first quarter was $900,000 as compared to $600,000 in the fourth quarter. We saw an improvement in general in the market, and more specifically orders for wafer carriers increased in the quarter.

Our gross margin increased 24 percentage points sequentially to 36%. This increase is primarily attributable to the increases selling prices for our substrates and the change in product mix.

Operating expenses in the first quarter totaled $2.6 million, up from $2 million in the prior quarter. The sequential increase in operating expenses was primarily the result of the addition of some additional support staff, bonus accruals, and license expense and franchise taxes.

Diluted EPS in the first quarter was $0.07, up $0.11 per share over the previous quarter.

Turning to the balance sheet and cash flow, our cash position remains strong with $41 million in cash and short term investments at March 31st. Cash used in the period was approximately $3 million. Cash generated from operations in the quarter was $724,000, and capital expenditures totaled $3.9 million.

Our accounts receivable remained of high quality. DSO at the end of the first quarter was 58 days as compared to 53 days at the end of the previous quarter and 60 days at the end of the first quarter of 2009. Inventory remained unchanged compared to the prior quarter-end at $6.6 million. Inventory at the end of the first quarter 2009 was $8.1 million.

Regarding our outlook for the second quarter of 2010, we expect continued strong demand in the LED market and another significant increase in earnings. We are expecting revenues to be up approximately 22% sequentially to $14 million in the second quarter driven by an additional increase in selling prices of at least 10% and continued shift in product mix to large diameters.

We anticipate gross margin in the second quarter to be approximately 40% with diluted earnings per share of approximately $0.14 based on a projected diluted share count of 21.5 million shares.

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. In summary, the markets we serve are growing rapidly and large diameter substrates are becoming increasingly important in the LED market. Our expansion plans continue to progress on schedule and these new facilities will further increase our advantage in large diameter production. The industry is also evolving rapidly with more companies entering in the LED chip production market and we continue to expand our customer base by qualifying with Tier 1 LED manufacturers. This is an exciting time in the adoption of LED technology and I believe Rubicon is extremely well-positioned to capitalize on this market as it evolves.

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jed Dorsheimer with Canaccord Adams.

Jed Dorsheimer – Canaccord Adams

Hi, thanks, and congratulations on the quarter and outlook, guys.

Raja Parvez

Thank you.

Bill Weissman

Thank you.

Jed Dorsheimer – Canaccord Adams

A few questions for you, if you don’t mind. The first, have you already started to procure the parts for the furnaces in terms of the capacity expansion in the U.S.?

Raja Parvez

Yes, we, as you know that one of Rubicon’s technologies biggest, the IP position is both on the crystal growth, both on the equipment as well as on the process side. So we have already begun the process of designing, constructing those – the furnaces in house, yes.

Jed Dorsheimer – Canaccord Adams

And so, Raja, you’ve – presumably you’ve already secured the lease for the bricks and mortar there and you are starting on the electricity and the water there. As these furnaces start going in the Q4 timeframe, I am curious, what is the limiting factor in terms of bringing on faster, is it more of a human capital issue in terms of having the crystal growers, or is it just making sure that you don’t bring on too much too soon to affect yield, how should we look at that?

Raja Parvez

Well, very good question. First of all, we actually purchased the buildings, so that’s one thing we did. Now, I think the – one of the biggest limping [ph] factor here is this actually since we manufacture these equipment, assemble them, operationalize, integrate internally, it takes some time to have a – to do this one. (Inaudible) human factors, personnel bringing on time. As far as bringing on these furnaces, we have a very pretty significant experience in bringing on these furnaces very – in a very shortened – in a very short period of time, especially bringing on a with a pretty good stable high yield. But it’s just a matter of having the right resources to assemble those correctly to make sure we are eliminating any potential pitfalls that you will have in manufacturing.

But we are adding more resources. We are doing everything to – because the market is really demanding from us, our customers are asking for us. So, we are moving as fast as we can, but with a lot care, so that we are making sure that these things are on time and with very high yields.

Jed Dorsheimer – Canaccord Adams

So do you think that – I guess what is the variable in terms the – (inaudible) coming on sooner and is there an ability for you get this complete by say mid-year next year or because I know you’ve said it takes about a year. Is there any chance of speeding that up and what is the risk that it gets pushed out?

Bill Weissman

Well, the challenge is that you can only operationalize so many furnaces per month. So there really the guiding factor is how soon the facility will be ready for you to start installing furnaces. So it would be difficult to push it up that for. But we are hopeful we can get the facility opened and start installing furnaces certainly in the fourth quarter and get as much of a heads tart as we can.

Raja Parvez

Yes, also, Jed, remember that new facility that we purchased is about 130,000 square feet. You have seen our Bensenville facilities like five, six times larger in physical space. So, what we are trying to do is this, put the infrastructure, which is a pretty significant electrical and water system already in place and that will take some time. But when that infrastructure is complete, then we add as a phased approach equipment then the phase two is actually – it depends on how fast we can assemble them, integrate them and operationalize them.

Jed Dorsheimer – Canaccord Adams

All right. Just shifting to the – I may missed this, did you mention what the mix was in terms of two and greater than two inch?

Bill Weissman

Yes, it was 64% greater than two inch.

Jed Dorsheimer – Canaccord Adams

Great. And how do you see that trending over the rest of this year?

Bill Weissman

I think we’ll see a continued increase.

Raja Parvez

To the larger diameter, yes.

Bill Weissman

Yes.

Jed Dorsheimer – Canaccord Adams

And if we look at the silicon-on-sapphire, I think it’s – the history of that – if memory serves me correctly has been that the margin profile has actually been a little bit lower than for the LED industry. So as things tighten up, you used to see that business staying relatively flat and then allocating the capacity over to the say four inch or six inch on the LED side.

Raja Parvez

Well, you know it’s a good question because we are focusing on the larger diameter and we are focusing on the LED. We will continue to serve that SOS market, but I think that focus is especially on the LED market, because it is a massive market and currently we have a limited finished wafer capacity, so we are allocating most of that capacity to LED. But with the increase in our crystal growth and post crystal growth in Asia, I believe that we will be able to focus on that market as well, but LED will be highest one.

Jed Dorsheimer – Canaccord Adams

Alright, last question, then I will jump back in the queue. Gross margins obviously trending upwards, 40%. I presume as ASPs all of that increase is simply it flows into the profitability, which is driving a lot of the margin upside. So, my question is this, Bill, if you look at the capacity expansion plans, I think you bracketed some numbers in the past and they benched upwards 130 plus, 140 plus, 150 plus million. If you look at the price increases that you’ve seen, any update to that and how does what you are seeing in terms of near term pricing affect the business model here in the EBITDA and gross margin profile?

Bill Weissman

Well, when we originally gave the guidance of what the capacity would be when such facilities were completed, we gave in the 130 to 140 range and that’s when pricing was about 30% lower than it is today. So, yes, you can factor in those price increases and ramping up that new capacity. Our model has always been, our long term model has been high 30s gross margin or low 20s in operating. Obviously, we are going to be over the gross margin here we expect to be anyway. And the short term based on pricing. Long term I think that’s probably – what we are seeing today we are still comfortable with high 30s and low 20s, but if pricing continues to just go up and continues to hold at those level then it could be better than that.

Jed Dorsheimer – Canaccord Adams

So, Bill, sorry, if you look at the supply-demand in the marketplace for sapphire though, do you see coming back into parity in the next two years?

Bill Weissman

I don’t see – you know pricing is still not up to where it was pre-recession and I think we’ll still see some pricing increase and given what we know about the macro demand environment for LEDs and sapphire substrates, I don’t see a lot of pressure in the short term, and short term meaning the next year or two. So, no, we don’t really see that really going back much.

Jed Dorsheimer – Canaccord Adams

All right. Thanks.

Operator

The next question is from Stephen Chin with UBS.

Stephen Chin – UBS

Great. Thanks. Hi, Raja, Bill. Just a followup question on the tightness in supply that’s out there in the industry. As we talked got to some of the LED chipmakers, we are hearing about the delaying of adoption of the larger substrates as a possibility. How will that impact blended [ph] pricing and gross margins if that were (inaudible)?

Raja Parvez

Well, Stephen, as you saw our results, our larger diameter portion was 64% and we expect it will continue to grow. We are seeing exactly opposite what you have mentioned. Our demand for the larger substrates continues to increase from all of major electronics, semiconductor companies. I think that the efficiencies our customers gain from the larger sapphire in addition some of – as you know, many of these LED chip manufacturers are major either semiconductor or optoelectronics companies, and they have a massive infrastructure, which is focused on the large diameter because of the silicon or other material usage. So, they are also re-utilizing or retooling that investing in the front-end of the technology, which MOCVD reactors, and retooling the back-end of it. So there are multiple factors, which are fuelling and are reasons that they are moving to larger diameter. So, we are seeing exactly a very strong growth in the larger diameter continues to be as evidenced by the purchase orders we get and the demand forecast we get from our customers.

Stephen Chin – UBS

Okay, thanks. That was helpful, Raja. And then just a followup on the SOS wafer question. First, congrats on resuming those shipments. How should we think about SOS revenues throughout the year, continue to see a steady improvement through the year or it’s just kind of a lumpy order still?

Raja Parvez

Well, I believe that our customer is doing good in terms of their forecast and demand. But as I said that we will continue to support SOS market, but frankly it will depend on – we are – our major focus is on the LED. So right now because of a – our – from Chicago facilities, we have a well-defined six inch and eight inch polish capacity, which we are, majority of that we are providing to the LED companies and once new capacity comes on line, both in the crystal growth and post crystal growth, which will be end of this year, then hopefully we will be able to support that business more than we are supporting now. But we will continue to support them, but focus is on the LED.

Stephen Chin – UBS

Okay, thanks, and then one last question on the competitive landscape for sapphire wafers. The series shortages will likely entice new entrants to come into the market, but can you share your view, Raja, on what you are seeing on the competitive landscape?

Raja Parvez

I think the overall competitive landscape still remains the same. There is just a handful crystal growers are trying to improve and trying to expand their capacity. But I do agree with you, you will see that because of the massive growth of the LED technology one will expect that people will try to enter into this market. And that is why Rubicon Technology’s fundamental business model is continuing to focus on the larger diameter because even if there are some entrants into that market, the barrier to entry in larger diameter is much, much, much higher than the smaller diameter given the technology or maturity that we have. So – and I think as you know that in LED supply chain people are entering into the market wherever their strong points are. If you are chip company, they are entering in the chip level. But, fortunately for us, as far the sapphire growth is concerned there is a limited knowledge base and I believe still it is a handful of the people who are trying to operationalize.

Stephen Chin – UBS

Okay. Thanks for that Raja. Congrats on the results.

Raja Parvez

Thank you.

Operator

The next question is from the line Anil Doradla with William Blair.

Brian Neujip – William Blair

Hi, it’s Brian Neujipj, in for Anil. I wanted to ask about the price declines that you have seen, but also as it relates to the cost reductions from the peak quarter until now. So, first of all, do you have a number on the peak to trough to now sort of price reduction and have you actually reduced cost? I guess if your gross margins are higher you’ve reduced cost at a commensurate rate with those price reductions, so I am just wondering what’s driving that, first of all.

Bill Weissman

Are you talking about price increases or–?

Brian Neujip – William Blair

Well, just relative to the peak, how far is the price down right now–?

Bill Weissman

Okay. So, from the peak it went down 40% and now it’s up about 45%. Of course you need to get about 60% to get back to where you were since the – the math works. But – so we are still about 15%, 20% off the peak.

Brian Neujip – William Blair

Okay. And then what have you done to reduce cost that enabled you to get the gross margins that are above that peak level?

Raja Parvez

I think we – look, we’ve continued to increase our operation efficiencies by streamlining our processes and that’s why I mentioned earlier that Rubicon Technology has a significant advantage because we have an IP position especially in the crystal growth, both on the equipment as well as on the process side and that has enabled us to continue to focus on streamlining the processes and producing very large crystals, okay, very efficiently and very predicted balance sustain higher yields. So, those are things you continue to do. As you already know that we are building a factory, post crystal growth factory in Asia, and that will be one of the reason we are doing there also is this to reduce the cost and also be closer to our customers.

Brian Neujip – William Blair

Great. So, there are more leverage to pull there as we go over the next couple of years?

Raja Parvez

Yes.

Brian Neujip – William Blair

And in the past you talked about the premium that you could get on six inch wafers. I know my numbers are from a couple of years ago, but still, I am just wondering what – has that premiums narrowed, just kind of the price differential between a six inch wafer and a two or three inch wafer?

Bill Weissman

Well, we don’t generally give price by product because it’s very sensitive, but – and prices are moving around quite a bit recently, so it changes almost monthly. But there is still a significant premium over smaller diameter for sure.

Brian Neujip – William Blair

Okay. And then you still have a pretty high percentage of two inch wafers in the mix right now. Are you able to shift all that sales I mean to larger wafers or is there some kind of – is there not demand to support that move or is it more a matter of just trying to support your customers that are still buying two inch wafers?

Bill Weissman

Well, there is still significant demand in the marketplace for two inch, firstly, and there will always be, I believe. And with our technology, when you have a bow, you have – you take out large diameter first, you have a certain amount of material that you want to use for two inch to maximize the real estate of the bow. So, two inch will always be a part of our product offering and I believe there will always be a strong demand for it.

Raja Parvez

And also, we have a very long term core customers for the two inch area and then most of the diameter production is more based on which area, for example, Taiwan and China are a majority are the two inch, whereas if you look at Japan, Korea, North America and Europe, majority off them larger diameter. So – but we will continue to produce two inch material to support our customers as well.

Brian Neujip – William Blair

Okay. Thanks.

Operator

The next question is from Joseph Foresi with Janney Montgomery Scott.

Joseph Foresi – Janney Montgomery Scott

Hi, gentleman, and congratulations.

Raja Parvez

Thank you.

Joseph Foresi – Janney Montgomery Scott

My first question here is, are we at 100% capacity now based on the revenue run rate?

Bill Weissman

We have still some idle capacity in slicing and polishing, which we are ramping up, because we expect that to be fully utilized in the second half of the year as we do more six inch wafers.

Joseph Foresi – Janney Montgomery Scott

Okay. And just could you give us some idea what level of idle capacity?

Bill Weissman

That operation is probably running around 60%, 65% right now.

Joseph Foresi – Janney Montgomery Scott

65%. And you should be at probably 100% by the end of the year, is that about accurate?

Bill Weissman

Yes.

Raja Parvez

Yes.

Joseph Foresi – Janney Montgomery Scott

Okay. And then just returning to kind of you meaning demand, is it – is there a chance that you see I mean within the next couple of months that will – as you begin to ramp, will the backlog start to accrue you think as far as orders are concerned? I mean I know initially you guys gave a backlog number. Do you foresee a scenario where that returns are if we just change the just-in-time model?

Bill Weissman

Well, we are in a just-in-time model and that’s intentional because pricing is increasing.

Joseph Foresi – Janney Montgomery Scott

Right.

Bill Weissman

We don’t want to commit any further out than we have to. Will that change someday if things stabilize? Perhaps. But we also learned the lesson in 2008 that people really didn’t honor contracts when things got difficult. So, we are conscious of that and for right now with pricing increasing we are still keeping orders to a minimum. But, clearly, we could sell all of our capacity this time and more, but we are choosing not to.

Raja Parvez

Also, Joe, in addition to – because of the expected massive growth in the LED market, more and more traditionally semiconductor and optoelectronics, especially well capitalized and also which have a more richness in their chip technology are entering into this market, thus giving us the opportunity to even expand our customer base. So, that is another factor that we continue to have this capacity available and so that we can respond to those new major customers in a more efficient way.

Joseph Foresi – Janney Montgomery Scott

I guess what I am wondering is if you reach capacity ahead of schedule, does the backlog then form?

Bill Weissman

A backlog forms when you book orders for the future right?

Joseph Foresi – Janney Montgomery Scott

Sure.

Bill Weissman

Again, we’re – at the time-being we are not willing to do that. We don’t think it’s the right thing to do for the business, but that may change in time as things stabilize.

Joseph Foresi – Janney Montgomery Scott

Got you.

Raja Parvez

I mean you know that, Joe, look, penetration level of LEDs still is in – if you collapse minus the small handle devices, everything is still in single digits. So, this growth is expected more and more so I believe that the model we are working right now is most productive for us at this moment.

Joseph Foresi – Janney Montgomery Scott

And just I guess you touched on it a little bit in your comments. Could you just talk a little bit more about your customer base, may be walk us through what client concentration is like and if you’ve – how many customers you’ve added, just to get some color on how that’s changing for you?

Raja Parvez

Well, we are, as I said, more and more major electronics companies, and semiconductor and optoelectronics have decided to enter into LED chip manufacturing. Several years ago you will see chip companies in the world, Japan, Taiwan, Korea, China, Europe, and North America, and they will procure – they are the one who are the major supplier of chips to many electronics companies who will make into the backlight units to displays or general illumination and fixing [ph]. because of the – right now the growth in the LED market and especially expected growth into general illumination, many of these companies have decided to be vertically integrated from chip level. So, even though many of them currently procuring the chips from outside, but there also, parallel to that manufacturing chip inside. So, our customer base is increasing both from the chip point of view and also electronics point of view.

And to answer you question completely, Rubicon Technology is working with all major LED chip companies, with all major electronics companies, semiconductor and optoelectronics companies around the globe. And so – and we are very vigilant in the market as all of you know our sales team and myself are constantly on the ground with the customers and we are finding more and more the people who are entering and we are reaching out to them, explaining our technology, explaining our capabilities, and we are getting a very good reception from the market.

Joseph Foresi – Janney Montgomery Scott

Okay. Just one last quick one. I think, and you might have already this, but just to be clear, it sounds like pricing, the pricing cuts on two inch wafers, has that subsided?

Bill Weissman

Well, it subsided a long time. They have been increasing dramatically over the past couple of quarters.

Joseph Foresi – Janney Montgomery Scott

Okay. Okay, great, thanks.

Operator

The next question is from Avinash Kant with D.A. Davidson.

Avinash Kant – D.A. Davidson

Good afternoon, Raja and Bill.

Raja Parvez

Good afternoon.

Avinash Kant – D.A. Davidson

Quick question, on the market share side, would you be able to comment a little bit about your market share in the two inch wafer side and how will that shift or how could that shift as people migrate to four inch?

Bill Weissman

Well, I would say our market share in general is – it may be going down a little just because we are at a period where we are building out infrastructure to be able to add capacity while some others have been in a position to add some furnaces. So – but I don’t think we are losing any significant position. Obviously, as the industry moves to larger diameter, our share of larger diameter is increasing because we have a dominant position there. So, it would only get even larger as the industry shifts to larger diameter.

Raja Parvez

I think that to add to this one, industry is moving especially the well-known chip electronics companies to larger diameter. That’s where we have a leadership position. That will continue to be. Whereas two inch we are trying to ration the product to our customers to support all of them. We cannot meet all of their requirements. We are meeting some of their requirements by focusing on the larger diameter. So, that is – I believe, will continue to have a – the larger market share in the larger diameters and that’s where the better economics is for our customers and for us.

Avinash Kant – D.A. Davidson

So the order could be may be if you have 20, 25% share in the two inch, may be could have 35%, 40% share or how high could that be?

Bill Weissman

Well, it’s difficult to say, it’s difficult to know how quickly capacity is going to come on around the globe with our competitors, how quickly people are going to be shifting to larger diameter. So, it’s very difficult to say. But all we can say directionally, clearly with larger diameter, we have a larger market share and as the industry moves in that direction, our market share should increase.

Avinash Kant – D.A. Davidson

Right. And, Bill, also you have been moving into the polishing side of the business, and in the past you have had some comments that margins there may not be as high as the bow side of the business, of course. So, given the maximize capacity projections that you are talking about, could you just give us some idea about how would the mix be at that time and how would that margins turn out to be compared to what they are now?

Bill Weissman

Well in the slicing and polishing operations they have lower gross margin, but it’s still good margins in that business. So, as you probably recall, the plan here is to expand dramatically into large diameter polished substrates. So, we’ll be adding a significant amount of revenue and incremental gross profit. And to Jed’s earlier question, do we see pricing pullback, no we don’t. I think we are still targeting in the high 30s because again that blend of selling it in core form and polished substrate form we think will probably eventually settle out in there. Right now, the vast majority, 70-75% odd of revenue is coming from core sales and that’s going to shift dramatically over the next couple of year as we move to large diameter polished substrates. But again, it’s very good profit in that piece of the business. It’s just that it’s a little lower slightly than blended average gross margin.

Avinash Kant – D.A. Davidson

And operating side, there will be comparable use on an operating margin basis?

Bill Weissman

Well, yes, again, the target there is in the low 20s, long term. And could be better if the gross margins are higher.

Avinash Kant – D.A. Davidson

No, I am saying the polishing business versus the bow.

Bill Weissman

The operating margins?

Avinash Kant – D.A. Davidson

Yes.

Bill Weissman

Yes, they – well, again, they are – they will be slightly lower than selling it in core form.

Avinash Kant – D.A. Davidson

Right. And of course have you given out – you may have to (inaudible) what’s the CapEx reduction [ph] for the year, this year?

Bill Weissman

This year, about $35 million to $40 million.

Avinash Kant – D.A. Davidson

$35 million to $40 million?

Bill Weissman

Right.

Avinash Kant – D.A. Davidson

Okay. And have you talked about given the current cash position that you have how would you get the funding for that CapEx.

Bill Weissman

Well we have $41 million in cash. We should expect to have good cash flow this year. We do continue to look at options for bringing in some additional capital, but there has been no decision made at this point on that.

Avinash Kant – D.A. Davidson

Perfect. Thank you so much.

Raja Parvez

Thank you.

Operator

The next question is from Jiwon Lee with Sidoti.

Jiwon Lee – Sidoti

Good afternoon. I wonder whether you could talk a little bit more back to your revenue mix. What your expectation is in terms of dollar wise from the six inch by the year-end. Whether or not you think that could be bigger than your four inch sales?

Bill Weissman

Well we don’t give much granularity within that large diameter category. There is some sensitive information. There is some sensitive information there. And I don’t expect six inch revenue probably will not surpass four inch or – it could, it’s difficult to say. But generally don’t give that kind of specifics on the split between the large diameters.

Jiwon Lee – Sidoti

Okay, well that’s helpful enough. And then just kind of going back to your sales mix, if you can talk a little bit more about the geographic sales mix and whether or not there was any top ten customers during the quarter please.

Bill Weissman

Sure, geographical sales mix is 79% Asia, 18% North America, and the rest is Europe. And we had about 85% of revenue from top 10 customers.

Jiwon Lee – Sidoti

Okay, but nobody exceeded top ten–?

Bill Weissman

Yes, there were a couple.

Jiwon Lee – Sidoti

Okay, that’s helpful. Thank you very much.

Operator

(Operator instructions) The next question is from Yair Reiner with Oppenheimer.

Michael – Oppenheimer

Hi, congratulations on the results. This is Michael [ph] sir in for Yair Reiner.

Raja Parvez

Thank you.

Michael – Oppenheimer

So I guess you’d kind of answered this question, but I was wondering if you might be able to answer a more general kind of version of this question. Do you have kind of an estimate of the sapphire capacity will grow 2010 by area or–?

Raja Parvez

I think that the sapphire capacity growth in 2000 by area is still very limited and we are the market leader there. It’s highly dependent on the technology and I believe Rubicon Technology, our technology is the one which yields a very high – a large diameter sapphire. And – but people are trying to enter it, but as soon as you go to the larger diameter, especially four inch and six inch, it becomes technology barrier, it becomes more and more evident. So, people are trying to enter our, competitors are. As you know, some of our competitors, especially in Russia have their technology similar to us and they are – but other technologies like CG and EFG have certain limitations of going to larger diameter at least at a high volume and high yield. So, I believe that there will be a modest increase.

Michael – Oppenheimer

Okay.

Raja Parvez

Whereas we are significantly increasing the large diameter capacity because of our technology know-how and skill set.

Michael – Oppenheimer

I see.

Raja Parvez

That is why the new crystal growth facility will house all larger diameter furnaces, thus producing much larger crystals, giving us ability to core and cut and polish larger diameter, especially six and eight inches.

Michael – Oppenheimer

Not so much four inch.

Raja Parvez

We do also four inches, but in terms of the finish, the focus is on the larger, the six inch and eight inch, but it depends on the market.

Bill Weissman

Again, our crystal growth is really product neutral. We can take whatever diameter out of the bows that we would like. We are growing larger crystals just to give us the flexibility over larger diameter. But if the market is predominantly four inch, we’ll be able to serve that business easily.

Michael – Oppenheimer

Right, right, thanks. That was helpful. So – I mean you are saying that you were not willing to commit to long term agreements just yet, which is of course very – that makes a lot of sense given the pricing environment. But when things start to stabilize, would it make sense for you guys to – I mean I know you guys have been burnt [ph] in the past when pricing just kind of fell through the floor. But as you start to deal directly with the chip makers rather than some other intermediaries, I mean would it make sense to try and develop relationships there and get some good, solid, long term agreements with long term share, long term pricing?

Raja Parvez

Well, I believe that – look, we are open to this one, but at this point the business model supports that, we think current business model is more productive, but yes we are open to it and as I mentioned that we are constantly on the ground with our customers and we are very well tuned into this one. And we have and we continue to develop very strong relationships with them and if there are any opportunities, which is, we believe that there is a stability and there is a – it may – it is productive for us, we will consider that. We may consider that.

Michael – Oppenheimer

Okay. And last question from me. Do you guys have any kind of long term – actually may be this is long term projects in terms of reducing or increasing your cost efficiencies without having to simply use scale?

Raja Parvez

Oh, yes, we continue to have, we are continuing to focus on the evaluation of our technology platform. That’s why as you know we make 32 kilogram, 85 kilogram, and the world’s largest 200 kilogram crystal. So we continue to expand our technology platform both in the crystal growth side and the post crystal growth side to continue to focus on streamlining the processes, improving the yields, reducing the cycle times, and manufacturing intervals, and utilizing very innovative and highly automated approaches in manufacturing and design to reduce the cost. In addition to—we are relocating our post crystal growth operations in Asia, which further helps us to reduce cost and also closer to the customer, yes.

Michael – Oppenheimer

Okay. Thanks very much.

Operator

The next question is from Daniel Amir with Lazard.

Daniel Amir – Lazard

Thanks a lot and congratulations on a good quarter. Couple of questions here. First of all, in terms of your larger diameter mix, how much of the large diameter is related to the increase in the SOS portion, which is usually higher diameter and how much is related to LED?

Bill Weissman

Well, the – well, I’ll give you the percentage just for LED. It went from 55% large diameter in the previous quarter to 60%. And again I gave you the total, which is 58% and 64%, so the delta is really the impact of the SOS substrate.

Daniel Amir – Lazard

Okay. And now in terms of your gross margins, you talk about product mix and ASPs impacting the margins. I mean was it equally impacting, was ASPs more than product mix, I mean can you give us an idea what had a little more emphasis?

Bill Weissman

Sure, well, clearly the ASPs, they did well, 20%. So, that had a significant impact. But also the mix shift and some of the other factors also had a significant impact. But the ASPs would have had the biggest impact.

Daniel Amir – Lazard

And going forward, you said ASPs will be up I guess north of 10%, so would that be fair that the 40% margin impact is still largely ASPs or is it next quarter might be a little bit different.

Bill Weissman

No, it will be largely ASPs next quarter as well.

Daniel Amir – Lazard

Okay. Now the – my final question related to – about your current competition and their expansion plans, I mean what’s kind of your best sense in what year the plans are over the next 12 months in terms of capacities that is coming into the industry. Just like yourselves, your competitors are ramping up as well. In terms of kind of the outlook, how should we look at the sapphire market into next year?

Raja Parvez

Well, look, as I mentioned that it is very difficult to predict and know. But one would think that because of the significant growth in the LED market other competitors have and are adding capacity. But, again, our focus is on the larger diameter, and the larger diameter barrier to entry is significant because of the technology limitations that most of our competitors have. But I think that this growth and demand and the customers are demanding everybody to add capacity. So, I believe that they are adding it too, but it’s hard to tell how much is adding, because some of the companies even though are major companies, but their LED and sapphire portions are very small relative to their major business. So, it’s hard to tell separate from their small departments of major company how much they are adding.

Daniel Amir – Lazard

Okay, great, thanks a lot.

Raja Parvez

Thank you.

Operator

Ladies and gentlemen, this does conclude our question-and-answer session. I would like to turn the call back to management for any closing remarks.

Bill Weissman

Well, thank you. Thank you again for joining us today. We appreciate your interest in Rubicon and we look forward to speaking with you again next quarter.

Raja Parvez

Thank you.

Operator

Ladies and gentlemen, we thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a good day.

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Source: Rubicon Technology, Inc. Q1 2010 Earnings Call Transcript
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