Rubicon Technology's (RBCN) CEO Raja Parvez on Q2 2014 Results - Earnings Call Transcript

Aug. 7.14 | About: Rubicon Technology, (RBCN)

Rubicon Technology, Inc. (NASDAQ:RBCN)

Q2 2014 Results Earnings Conference Call

August 7, 2014, 05:00 PM ET

Executives

Dee Johnson – VP, IR

Raja Parvez – President and CEO

Bill Weissman – CFO, Treasurer and Secretary

Analysts

Jed Dorsheimer – Canaccord Genuity

Avinash Kant – D.A. Davidson

Andrew Huang – Sterne Agee

John Shen – Sterne, Agee & Leach

Paul Coster – JPMorgan

Pierre Maccagno – Dougherty

Operator

Good afternoon and welcome to the Rubicon Technology Second Quarter 2014, Results Conference Call. All participants will be in a listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Dee Johnson, Vice President of Investor Relations. Please go ahead.

Dee Johnson

Thank you, David. Good afternoon everyone. We are pleased you could join us today for Rubicon’s second quarter 2014 earnings conference call. With me today are Raja Parvez, Rubicon’s President and Chief Executive Officer and Bill Weissman, Chief Financial Officer.

We have allotted one hour for our call this afternoon. Raja will provide an overview of second quarter results of operations and discuss the current market environment, and then Bill will review our financial results in detail and discuss our outlook for the third quarter of 2014. We will then be happy to take your questions.

Today’s call is being webcast through the Investors Relations section of our website. The webcast and press release can be found at ir.rubicontechnology.com. A replay of this call will be available for one week and the webcast will be archived in the Investor Relations section of our website.

Before we begin, please be advised that certain statements in this presentation relate to future results that are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the accuracy of which are necessarily subject to risks, uncertainties and assumptions as to future events that may not prove to be accurate.

Factors that could cause actual results to differ materially from those expressed or implied include general economic conditions and the factors discussed in our most recent Form 10-K and other filings with the Securities and Exchange Commission. We undertake no obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

And now, I would like to introduce our President and CEO, Raja Parvez.

Raja Parvez

Thank you, Dee. Good afternoon, everyone, and thank you for joining us today. Our second quarter results reflects continued progress in developing our wafer business and strong demand in the quarter for 4-inch material, but also the beginning of some near-term challenges with the 2-inch market.

The LED market continues to strengthen in the second quarter, fuelled primarily by the general lighting segment which continues to gain momentum. We're also seeing a significant shift among LED chip manufactures to larger diameter substance, which drove strong demand for 4-inch material for in the quarter. Moving to a larger diameter substrate is a way for chip manufacturers to increase throughput at their existing fab which lifted additional capital expenditure.

MOCVD utilization rates have been steadily rising and chip manufacturers are looking ways to increase production without investing in new facilities. Shifting to larger substrate provides that opportunity, and in recent quarters we have seen a meaningful shift from the use of 2-inch substrate to 4-inch substrate. We view this as positive because we believe this is the validation of our view that the industry will eventually move to large diameters, such 6-inch and 8-inch, whereas Rubicon has extensive capabilities and market and production experience. Our revenue for the second quarter totaled $14.5 million as compared with $14.3 million in the prior quarter.

Wafer revenue was up sequentially by $1.8 million, which was offset by a reduction in revenue from core sales of $1.8 million. The majority of our wafer revenue in the quarter came from 4-inch polished wafers. We have recently decided to move into 4-inch wafer sale in addition to selling 4-inch core for two reasons. First, while our plan for offering patterned substrates was primarily focused on the developing 6-inch market, we decided to offer 4-inch PSS wafers to increase utilization of the flattening infrastructure until the 6-inch market extend.

Second, we will be polishing for these wafers to feed our internal PSS operations. We decided to offer 4-inch polished wafers in order to increase utilization at our polishing operations in Malaysia and develop a low cost polishing formula for 4-inch again until the 6-inch demand increases. This was the first quarter in which we had a volume production order for 4-inch polished wafers.

We also have sequential increase in PSS and 6-inch polished LED wafer sales and saw the redemption of orders from our 6-inch SoS customer in the quarter. Regarding our recently, recently introduced patterned wafer offering, we continue to make strong progress in the second quarter. As we reported last quarter, we received our first production order for 2000 4-inch patterned wafers, that order was delivered successfully and upsized to 4-inch wafers, 4000 wafers in the quarter.

A significant development in introduction of our PSS product came this quarter with the initial qualification of 4-inch and 6-inch PSS wafers at three additional customers. Two of which are major international LED chip manufactures. These customers plan to expand their use of patterned wafers in their production and they have chosen Rubicon, because of our vertical integration and our strong capability in both polishing and patterning large diameter wafers.

Orders will likely be limited in the second half of this year, as we continue to work on spec alignment and additional testing. But these accounts have the potential to generate significant revenue for us next year. Overall, on our PSS product introduction, we are a quarter two behind where we had hoped to be in terms of revenue generation, but I am very pleased with where we are in terms of the qualification process with high-quality customers.

As I mentioned, revenue from coal sales are core sales are lower sequentially by 1.8 million, volumes and pricing per 4-inch core increased sequentially, as 4-inch demand from the LED market continued to strengthen. 4-inch core pricing was up close to 10% sequentially in the second quarter as a result. However, 2-inch volumes and pricing were lower sequentially. As we mentioned on our last call, second quarter core volume would be lower because we had exhausted our excess boule inventory in the first quarter. Also we used more of our crystal for 4 and 6-inch wafers and 4-inch core thereby reducing the amount of crystal available for 2-inch.

2-inch pricing was around 2% lower than the prior quarter, as a result of the shift to larger substrate in the LED market, as well as American softness in the mobile device market. We expect demand for 2-inch to be very limited in the third quarter, as our polishing customers currently have excess inventory.

In addition, we believe that recent capacity additions in the Sapphire market which are primarily targeted on the development mobile device market are temporarily impact the 2-inch. However, we believe that this capacity will be soon be absorbed with the expected growth in the demand can be mobile market.

There is much speculation on the broader use of Sapphire in mobile devices. The significant majority of the Sapphire used today in the mobile devices is on the camera lens covers and home buttons. At a minimum expect broader adoption of these applications in the near future.

Rubicon has sold a significant amount of Sapphire into this market and will continue to do so. There is also significant interest among mobile device manufacturers and to use to up Sapphire pieces.

The current industry solution is to take bulk Sapphire and fabricate it into the required form. Rubicon is certainly prepared to participate in that market the same day there we have for the smaller pieces and with continue our dialogue with the number of electronics manufacturers regarding their interest in sapphire with this approach. But we also believe there need to be a more cost effective solution longer-term.

As I mentioned on our last call, we have two projects in R&D to develop solutions for these applications that would eliminate the need to fabricate pieces from bulk crystal. If successful, this would provide a significant cost advantage since the majority of the cost of these pieces is not in the crystal, but rather in the fabrication of crystal into the right form.

We are pattern spending on both technologies. We continue to produce samples from one of these technologies and are currently testing samples with the major consumer electronics manufacturers. We also have request for samples from several other leading consumer electronics manufacturers. We will provide more information on the progress of this product as we move forward.

Regarding our margins, our loss per share in the second quarter was $0.39 as compared with $0.43 in the prior quarter. We believe our large diameter wafering and patterning capability is key to the long-term sectors of Rubicon. At the moment however, the wafer operations are generating losses. The pricing environment continues to be challenging in general, and entering the four-inch polished wafer market required aggressive pricing.

In addition, polishing four-inch wafers while easier than six-inch is different and required some time to optimize the process. We believe we will make meaningful improvement in the process by the end of the year and we’ll continue to define our more established processes to cut the reduced cost, also producing multiple sample varieties for qualifying, our PSS products has been costly and once we lock-in a pattern for customers and begin evaluating production, our cost will come down.

Our fixed in positive cost should come down by an additional 10% by the end of this year based on current development efforts. Additionally, we are in the process of slightly modifying the geometry of our goods which is increasing heat and thereby reducing our crystal cost. This modification will be implemented in all of our policies over the next 12 months.

Finally, we’ll continue to reduce our raw material cost by increasing the throughout of our proprietary internal alumina preparation process. The outlook for the wafer market remains very strong. It is clear that LED is the light source of the future with reality general lighting market expected to grow over 30% per year for the next several years.

We also believe that we are in the very early days of use of sapphire in the exterior of the mobile devices. While the build out of our vertical integration and model is costly in the near term, we believe it will position us well to continue to innovate and capture significant market share in the evolving LED market.

The industry is rapidly adopting pattern substrate and LED chip manufacturers are increasingly open to outsourcing the paddling process. The LED market is also beginning to shift to larger diameter substrates and we are the only sapphire company in the world with the capability to produce high volume of 6-inch patterned wafers.

With the lead it will not be long before large diameter patterned wafers are the fastest growing segment of the LED substrates market and should become the highest margin product in the sapphire supply chain. Controlling production of the entire process from powder aluminum oxide through wafer patterning gives our customers comfort that we can deliver consistent quality on schedule.

We also believe that our investment in the R&D project like lens and alternative approaches to larger sapphire pieces for mobile devices and other markets will give advance product that will open up new markets for sapphire.

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 outlook for the third quarter. Bill?

Bill Weissman

Thank you, Raja. Revenue for the first quarter was $14.5 million as compared to $14.3 million in the prior quarter. Wafer revenue increased to $2.9 million from $1.1 million in the prior quarter, of the $1.8 million increase $1.1 million was from 4-inch polished wafers, 500,000 from 6-inch polished wafers and 200,000 from patterned wafers. The increase in 6-inch revenue was primarily from the LED market, although we resume shipment to the SoS market in the quarter as well.

Both 4-inch polished and 4-inch and 6-inch PSS are new product offerings for us. We had our first volume order of 4-inch polished wafers in the quarter and began producing 4-inch PSS wafers for our first qualified PSS customer in the quarter.

We expect a steady flow of orders from this customer. However, this will not likely be a high volume user. However, as Raja mentioned in quarter, we received initial qualification of our PSS product at several new accounts which do has a potential to be significant volumes through polishing and PSS operations next year.

We also continue to make good progress on qualification of PSS with other major LED chip manufacturers. While we are behind where we had hoped to be from a revenue perspective, we are pleased with the level of interest in the product and the qualification process.

Revenue from our 2-inch and 4-inch core sales decreased by $1.8 million sequentially, going from $11.4 million in the first quarter to $9.6 million in the second quarter. 4-inch revenue increased sequentially primarily from an increase in average selling price, driven by increased LED demand. That increase was more than offset by a reduction on 2-inch core revenue which was primarily the result of lower volumes sold for the reason Raja provided. Pricing for 2-inch core was slightly lower than it was in the prior quarter.

Optical and R&D revenue totaled $2 million in the second quarter as compared with $1.8 million in the prior quarter, with the increase coming primarily from increased R&D revenue from our LANCE project, which remains on track and is expected to begin generating revenue from product sales in 2015.

Our crystal growth operations continue to run at full capacity throughout the quarter. Our polishing and patterning operations remained low – utilization remained low, however, that began to improve some in the quarter with the increased wafer volumes. Idle plant cost declined by to $1.9 million in the second quarter from $2.4 million in the prior quarter.

Operating expenses in the second quarter totaled $2.9 million as compared to the $3.4 million in the prior quarter, primarily due to lower legal fees and reduced headcount. Our loss per share was reduced to $0.39 in the second quarter from $0.43 in the prior quarter.

Turning to the balance sheet and cash flow, we maintain the strong cash position with our cash and short term investments balance of $58 million at June 30, with no debt. We used approximately $5 million in cash in the quarter, $2 million from operations and $3 million in capital expenditures. Our DSO at June 30 remained low at 54 days up slightly from the prior quarter DSO at 52 days. Inventory level declined by $5.2 million as we continue to reduce raw material and core inventory levels in the period.

Regarding our outlook for the third quarter, we expect continued progress and growing the wafer business with additional volumes in both polished and PSS wafers. However, we are seeing very limited demand for two inch core in the third quarter for the reasons Raja provided. As a result, we expect third quarter revenue to be between $8 million and $12 million. This is relative wide range because of the uncertainty in the two inch market.

We expect two inch inventory that our polishing customers to be reduced over the course of the third quarter and for demand to improve in Q4. We expect our loss per share in the third quarter to be between $0.39 and $0.44.

While our wafer business has some profitable asset moment, we expect to continue to reduce cost in the wafer operations throughout the rest of the year. There remains a lot of leverage in our model as we bring down wafer cost and increase volumes, thereby reducing idle plant and increasing production efficiencies.

I would like to turn the call back over Raja for some closing comments and then we will be happy to take you questions.

Raja Parvez

Thank you, Will. We continue to build momentum in the wafer business. We are currently shipping both 4-inch and 6-inch polished wafers and PSS wafers with volumes steadily increasing.

The initial qualification of our PSS product has several new customers in the quarter, it's an important step in building a solid customer base for their product and qualification efforts continue with other major LED manufacturers. This increasing volume and experience in our new product line and as customers' specification becomes better defined, we'll reduce our idle plant cost and our wafer product cost.

Furthermore, while pricing in certain product groups may take a step back from time-to-time for various reasons, we believe the general pricing [indiscernible] will continue to improve for some time. We also have a number of new product development initiatives underway in R&D that we are very excited about.

We believe that the market opportunities ahead of us are substantial, and the work we are doing now will result in significant improvement in financial performance in the future.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answers session. [Operator Instructions] The first question comes from Jed Dorsheimer of Canaccord Genuity. Please go ahead.

Jed Dorsheimer – Canaccord Genuity

Hi, thanks. Just to maybe frame this, basically the pattern or the wafer business the post crystal is ramping slower than you expected and you are pulling potential revenue from the crystal business for that business to try and qualify. Is that what is occurring here?

Raja Parvez

Well, as we mentioned that this quarter we got initial qualification for three additional customers and both in 4-inch and 6-inch. Now initial – beyond initial qualifications, as you know, our qualification takes many aspects of it.

Starting from initial spec alignment to initial samples then increasing the volumes of those samples as part of qualifications many customers audited our quality and our manufacturing system. And we have passed with many of these customers.

Now we are in a process of supplying high volume to these customers. As we move forward, I believe that this volume will continue to increase and also the customers are in a process of ramping-up our wafer specific because especially in the 6-inch market, we’re searching the market in terms of PSS and if you are searching the market that they designed there processes around different categories.

Jed Dorsheimer – Canaccord Genuity

Okay. I was just trying to match the narrative to the results and there seems to be a significant delta there?

Raja Parvez

Our outlook for the PSS product still remains very strong. It has shifted by quarter to and it’s the function of customers helping up and our qualification process with customers because many customers perform the qualification, some at wafer level, some at a device level some at a module level and that our outlook will still remain very strong with PSS.

Bill Weissman

The results were consistent with that we are expecting. We’re seeing as an increase in wafer volume and as we said right now the wafer business is losing quite a bit because we’re getting the 4-inch wafer line up and running and more efficient. And we are still producing PSS samples rather than locking in on a particular pattern and becoming more efficient that way.

So really there is not – nothing here in the quarter that we did not expect, but the only thing – change we’re seeing is that the revenue expected in the back half of PSS is been delayed, but we’re extremely excited about the qualification went so far because of really high quality customers and we expect to generate significant amount of revenue from the next year.

Raja Parvez

And many of these customers are pulling in both products, polished PSS and 6-incha PSS.

Jed Dorsheimer – Canaccord Genuity

Guys, you are missing by 30 million in the back half of this year. I find it hard to believe that everything is as expected?

Raja Parvez

We just said it’s not as expected Jed, because back half PSS revenue significantly behind where we had hoped it to be.

Jed Dorsheimer – Canaccord Genuity

Got you. Thanks. I'll jump back in the queue.

Operator

Our next question comes from Avinash Kant from D.A. Davidson & Co. Please go ahead.

Avinash Kant – D.A. Davidson

Good afternoon. Raja and Bill.

Raja Parvez

Hello.

Bill Weissman

Hi, Avinash.

Avinash Kant – D.A. Davidson

Just some clarification. Did you give out your mix of LED and SoS you had some SoS revenues this quarter, right. Could you break that down?

Raja Parvez

Yes. The SoS shipments just resumed, so its fairly small, its only about $100,000 in the quarter, but we have orders for Q3 as well.

Avinash Kant – D.A. Davidson

But the rest everything was LED, right?

Raja Parvez

Correct.

Bill Weissman

Yes. Both polished and PSS.

Avinash Kant – D.A. Davidson

Okay. But then beyond the SoS have you tried to break down your revenues on the LED applications versus the cell phone applications?

Raja Parvez

Well the cell phone application for us is really coming from 2-inch core sales and we sell the 2-inch cores to polishers primarily that are servicing both markets. So it's difficult for us to have great visibility of how much is actually going into the mobile device market versus the LED market.

Bill Weissman

And as we have mentioned in previous calls, we have been and continue to sell significant material into the mobile products in terms of our core raw bulk materials.

Avinash Kant – D.A. Davidson

So your core sales were $9.6 million in the quarter, right. Could you give us how much was 2-inch core in that?

Bill Weissman

Yes. About two thirds of it -- about $6.5 million roughly the revenue is from 2-inch core.

Avinash Kant – D.A. Davidson

So $6.5 million from 2-inch and then rest everything was 4-inch right?

Bill Weissman

Right. And then of course looking at the kind of volume mix, all the wafer business was $4 million and $6 million.

Avinash Kant – D.A. Davidson

All the wafer was $4 million and $6 million, okay. And then 6 we already know that, only $0.1 million was 6-inch.

Bill Weissman

No, that for the SoS 6-inch.

Avinash Kant – D.A. Davidson

Okay. But you had LED 6-inch sales too?

Bill Weissman

Right.

Raja Parvez

Yeah.

Avinash Kant – D.A. Davidson

So, could you provide us how much was that?

Bill Weissman

It’s about $1 million.

Avinash Kant – D.A. Davidson

Okay. And the clearly to PSS opportunity it seems to be pushed out now here. So, what do you expect in the second half from PSS? You had strong expectations earlier, I think 15 million or higher, what do you expect in the second half now?

Raja Parvez

Look as I mentioned earlier, our outlook for PSS product still remains very strong. The revenue generation has shifted by a quarter or two, and the reason for that as I mentioned earlier is a qualification process, as well as our customers ramping up. So, in fact in this quarter, as we mentioned few times that we got really high quality customers which has a potential to generate a significant revenue for us beginning of next year.

Though, remaining part of this year, these customers have moved from a smaller sample from prototype to 100 wafers per months. So, the volume is progressively increasing and we believe they will continue increase.

But the later part of their internal qualification this is which requires them to do aging and also reliability testing is that needs to be validated. And we believe that will progressively increase starting from now because already started leading up to the beginning of the year especially in Q1.

And we should expect production orders from these customers and as well as other customers because we have been working with as many of the LED chip manufacturers. There are various stages of stack alignment and qualification. So we expect production orders starting in Q1 for several of these customers.

Avinash Kant – D.A. Davidson

Now the pricing that you having to give these customers, so the negotiations you are having in pricing, does it show – you expect signficant revenue, but would there be signficant profit?

Raja Parvez

Yes, based on the pricing we are talking about when we lock-in on giving pattern that the patterning steps of it alone would be profitable today even in a very difficult market when wafer margins are negative.

Overall, we do need to continue to lower the cost on the polishing side and see some additional price improvement on the wafer side force that the product as whole to be profitable. But we think the PSS product itself should generate signficant result, certainly better margins than the polished wafer business.

Avinash Kant – D.A. Davidson

So if the pricing go to not move up in the PSS that you are offering at this point, you would know – I know you will do cost reductions if would that become profitable without the pricing increases?

Raja Parvez

I mean reality is nothing in the sapphires space today is profitable for anybody. So the industry does need to see continued price improvement and we believe that’s going to happen as 2-inch phenomena is happening right now is that we believe as better than normally.

We talked little bit about being behind people’s expectations for revenue in the second half. I mean, most of the issue from Q3 is a lack of two-inch demand, not the lack of progress on the wafer side. Although, as we said, again, pattern revenue is behind schedule, but the process of qualification and the quality customers we’re talking to are very pleased with.

Avinash Kant – D.A. Davidson

Final question, what gives you the confidence that the inventory issue that is on two-inch wafers will go away most likely in the third quarter?

Raja Parvez

Well, part the reason that this happen in Q3 is a major portion is affected by the optical business. As you know we’ve been selling significant amount of two-inch core into the – which was for mobile application. And some portion, you can attribute to because LED chip manufacturers are migrated from two-inch to four-inch, but majority of the mobile devices.

Now we believe that the recent capacity added by others is now being directed to this market as opposed to the – which was targeted for the larger devices. So we believe that since, right now there is a inventory for the customers, during the Q3 that inventory should start depleting.

And again, with the introduction of more mobile devices with largest sapphire requirements, we believe – that's why we believe that we should see more improvement in the two-inch core market for us in the Q4.

Avinash Kant – D.A. Davidson

Do you have already seen some designs coming where cell phone guys are using larger sapphire?

Raja Parvez

Well, as you know there are lot of chapter, there are lot of rumors in the market, but I believe that there is significant focus by – and cell phone manufacturers to introduced those, but at this point, we don’t have any specific information when they will be introduced but considering the amount of capacity added one would think that was the reason that this capacity was to begin which created. Again, that has shifted because of probably various reasons and that's why it is impacting us in Q3.

As I mentioned, we have sold significant amount of 2-inch core in the prior quarters specifically for which went through the mobile applications. And we will continue to have very strong relationship with many of the supplier who are direct or in direct supplier through the cell phone manufacturers.

Avinash Kant – D.A. Davidson

Thank you so much.

Operator

Our next question comes from Andrew Huang of Sterne, Agee. Mr. Huang is your line mute? All right – let's go to the next question…

Andrew Huang – Sterne Agee

Yes, yeah…

Operator

…all right, you there go ahead.

Andrew Huang – Sterne Agee

Sorry. I think you answered this question earlier, but I just want to clarify so to better understand Q3 revenue guidance, I think it will be very helpful if you could give us the revenue for 2-inch core for both Q1 and Q2 just so we can see the progression?

Bill Weissman

The 2-two inch core in Q1 was 8.5 million and 6.5 million in Q2.

Andrew Huang – Sterne Agee

Okay. Thanks very much. And then based on our checks it's seems like you may have restarted your business with LG Innotek for 6-inch polished wafer, but I'm hearing that you did at a very aggressive price. My question is, is that true? And then secondly, is that potential for you to kind of accelerate that or migrate that business to 6-inch PSS?

Raja Parvez

Well Andrew as you know, we cannot specifically comment on a given company. But we have been working very aggressively to introduce more and more larger diameter wafers in to all naked LED chip manufacturer and we'll continue to make progress.

Yes, pricing is aggressive, not only for us, as Bill mentioned, entire supply chain is under a lot of pressure in terms of the pricing and especially in the 6-inch, because volumes are still limited, by few customers.

So as we have witnessed very recently that some of the LED chip manufacturer, who are using a large quantities of 2-inch polished wafers, has started about three or four quarters ago to migrate to the largest platform which is a 4-inch because of its efficiency and the same and efficiencies also applied to the 6-inch.

And we believe that now the trend is becoming to that point that we see the next logical and operational and efficient step for those companies to migrate to the larger diameter, which is a 6-inch and 8-inch especially more knowledge MOCBD growth, better equipments available. So I believe that, that will, that should help increase the demand thereby, it should improve the pricing moving forward.

Bill Weissman

There are still fairly limited number of competitors that can effectively compete to the fictions business. The challenge as Raja said was the volumes are just not there, so pricing is still very low. But as we see greater adoption that should – you can see a price correction on that eventually.

Raja Parvez

And we still have the largest experience both marketing their product, producing their product and vertical integration and customers value that as I mention this quarter that's one of the reason that the customer to qualified as initially in this quarter on the PSS product.

One of the value proposition was our vertical integration, our crystal capacity, crystal quality, polishing capacity, polishing quality and our PSS introduction into the market.

Andrew Huang – Sterne Agee

Okay. One thing that occurred to be I think in the last up cycle my sense is that you may have brunt some bridges in Taiwan specifically. I guess now that you are trying to reenter the polished wafer business and PSS wafer business. How the progress and trying to rebuilding those relationships?

Raja Parvez

While I can’t comment on what you are stating but we had we continue to have a very strong relationship with our customers as you know the supply chain has been under lot of pressure and the time to time you have relationship which will move up and down.

But I can assure you I just came back just day before yesterday from all of my customers we had very strong relations with customer, we depend on each other and we rely on each other.

So some time did market will dictate certain actions by certain companies but our long term relationship with customers still impact time to time we discuss different volume the pricing and those things.

Andrew Huang – Sterne Agee

Okay. And then I just have one last question if you don’t mind on PSS I understand that you are the only one in the supply chain its vertically integrated. But right now they give your PSS maker and you are buying core in the open market you actually are the cost advantage because pricing is below cost. So I guess my question is what about the competition on PSS aren't you worried about that at all?

Raja Parvez

Well of course, of course we recognized [ph] that all the competition and we are fully aware of that. But as far as the -- remember, we started our PSS product introduction for the 6-inch and 8-inch. While we are doing this one, we started introducing the 4-inch PSS market, which you already know that other suppliers have been offering the 4-inch PSS. And the reason we did was this is to feed our own PSS line to increase the utilization.

But -- and again 6-inch PSS and even 4-inch PSS and 8-inch PSS are very sophisticated products. It is very critical for high-value, high-end sophisticated LED chip manufacturers to really relay on those companies which have the ability to have a crystal as well as polishing, as well as PSK we build internally. And that's how -- remember many of the LED chip manufacturers currently have internal capability of the PSS, because they have been using for number of years.

For them to outsource there has to be a viable, reliable supply to do that and that's where our vertical integration and our quality and performance and our most experience producing the large diameter wafers both in LED side and SoS side has enabled us to engage with the customers early on as we said.

We had 16 customer started with PSS introduction and we continue to work with all of them out of which four of them have that initial qualification.

Bill Weissman

Certain times there will be bottleneck in excess of different points of the sapphire supply chain. I mean at sometimes it may look like it's better to be only in one segment and not in others, but I think over the long run these things can rationalize in time.

And in our view, there's no question that having control of the entire production process is going to be beneficial from not only a quality perspective, but a cost perspective.

Raja Parvez

And also, of the 6-inch PSS especially it’s a new product into the market. And as you know, first in the market has certain advantages. And that's why the stack alignment for major LED manufacturer have gone so well. So once our product is aligned with a given recipe and given manufacturing platform from LED chip manufacture, therefore by default that becomes a benchmark.

And we believe that that will continue. That gives us advantages, but of course, we continue to focus on providing more and more different varieties of patterns, different configurations of patterns, custom patterns, standardizing them and continue to aggressively reduce the cost so that we can introduce this product more efficiently which is more value added for us and our customers.

Andrew Huang – Sterne Agee

Okay. Thanks very much for taking the time.

Raja Parvez

Thank you.

Operator

Thank you. Our next question comes from John Shen of Sterne, Agee & Leach. Please go ahead.

John Shen – Sterne, Agee & Leach

My question has been asked. Thanks.

Operator

Thank you. We'll go to Paul Coster of JPMorgan.

Paul Coster – JPMorgan

Yes, thanks. Just want to go back to the expectations that the fourth quarter will be stronger. That's because of there's migration of 4-inch and 6-inch and recovery into inches, is that a fair statement?

Raja Parvez

Right that’s our expectation.

Paul Coster – JPMorgan

So the 2-inch recovery the thesis you are putting out there is as investment in additional capacity at the moment for the mobile market. The mobile market is not there and so you are suddenly seeing how slow people trying 2-inch into the market that’s why.

There is two things that we go right, one is that that capacity suddenly get sucked up by the mobile market and we don’t seem to have very good visibility into that. And the second is that those other suppliers are not continuously investing in more capacity and of course we just saw the GIC chip furnaces in the quarter.

So I think there is go to go right there on the 2-inch front. Just once again just can you back to what you see that gives you confidence that 2-inch will recover?

Raja Parvez

Part of the issue is polishing customer have inventory so the buying almost nothing but they are still shipping. So we believe that their inventory levels will be down by the end of the quarter and there will be some additional purchases.

So we believe fourth quarter will be better, how much better it’s difficult to say. And you are right lot of it is contingent on what happens in the mobile device market. So what we are saying is it should be better.

We don’t know if there will be a full rebound yet or not but our belief is just from the reduction in inventory level that should be better to a degree.

Paul Coster – JPMorgan

All right. So is the mobile if then doesn’t come through to benefit everyone. You will see that all of those other commodity supplies can not migrate to 4-inch and 6-inch quality product, is that correct?

Bill Weissman

That’s right, yeah.

Paul Coster – JPMorgan

Yeah, okay. Two other questions then, one is, at what level now do you think the revenue – the run rate in the core business – and I know it’s difficult because of the mix – what kind of revenue run rate do you think is breakeven and likewise for the polished and wafer business PSS business aggregate, what kind of run rate quarterly, that is about breakeven from a gross margin perspective?

Bill Weissman

Well from the wafer perspective, the part of the equation is volume because we’ve got debt to utilization of our polishing up higher. So, we need to have probably all these two active current volumes we have but we also need to continue to lower cost and see some price improvement.

On the core side, 4-inch pricing is actually at a point where it is slightly positive. 2-inch of course now we are taking a bit of a step back see where pricing shakes out on that, but obviously if there is only limited demand that’s not positive for short-term pricing but. The industry as a whole has been seeing price improvements over the past year, year and a half.

There’s been a period of step back here and there for various reasons and we are seeing that now for the 2-inch market. But, given the enormous potential of demand both for the LED and the mobile device markets, we think it’s going to continue to improve from quarter-to-quarter, we may see some fluctuation but.

We are convinced we will continue to see price improvements and our focus in on what we can control and that’s continuing to reduce cost and continue to increase volume with these recent qualifications.

Paul Coster – JPMorgan

Okay. My last question is, do you plan to invest in new capacity? And if so what you currently know, when do you think you would do that?

Raja Parvez

In the near term we only think we see adding capacity on would be the PSS operation and that would not be a major investment, most of the infrastructure is there, the clean room and some of the equipment is capable and are significantly more than we can produce right now.

We just need to add some additional pieces of equipment and we’ll add those as needed. And over the next couple of quarter, we would expect to need that additional equipment.

Paul Coster – JPMorgan

Okay. Thank you.

Operator

[Operator Instructions] Our next question comes from Pierre Maccagno of Dougherty. Please go ahead.

Pierre Maccagno – Dougherty

Oh, good afternoon, Raja and Bill.

Raja Parvez

Good afternoon, Pierre.

Pierre Maccagno – Dougherty

So looking at your capacity utilization for the polishing plant, can you give us an idea what is the utilization now probably lower than 20%, correct?

Bill Weissman

No. It’s around 30%, 35%, right now.

Pierre Maccagno – Dougherty

But you’ve seen some improvement, last quarter it was 20%, correct?

Bill Weissman

Yeah. That's right. That's why our idle plant cost went down in the quarter.

Pierre Maccagno – Dougherty

And you’re still expecting that to go to 50% by the end of the year?

Bill Weissman

Well, as we’ve said, we are little behind on the PSS revenue front. So we’re – we may not quite get there by the end of the year, but sooner after that we should be.

Pierre Maccagno – Dougherty

Regarding the wafer cost expected to decline as you go to production, can you give us an idea, once you are at full production level and 100% capacity utilization, but how much was the cost decline I don’t know maybe you have to go by different products that you have but I don't know if I mean, what can you tell us about that?

Raja Parvez

Yeah. It's difficult to say. It's depends on the diameter and whether its pattern and the type of pattern and so on. As we said, we expect the 6-inch polished wafer cost to come down by additional 10% by the end of the year. And the patter wafer products will come down considerably as we kind of moving into the volume production. 4-inch we're still making significant progress on.

We think that will come down much more than 10% by the end of the year. So there is a number of initiatives underway and as volume increase and the process get refined this cost will come down significantly.

Pierre Maccagno – Dougherty

Do you this regarding your sales operational what was the investments?

Raja Parvez

The investment?

Pierre Maccagno – Dougherty

Yes.

Bill Weissman

It was around $5 million.

Pierre Maccagno – Dougherty

Okay. And so regarding your customers, if I understand well, you now have four qualified customers for PSS products?

Raja Parvez

Yes. Yes. And they are infinite and initial qualification which is a significant milestone now – now we are shipping better volume higher volumes to them for them to collect more data to optimize their processes, yes.

Pierre Maccagno – Dougherty

And it's one of them that is the 6-inch correct? Or one of them has 6-inch and 4-inch PSS?

Raja Parvez

Yes.

Pierre Maccagno – Dougherty

Okay. To the last question you said, yes. Okay. Okay. I think that's answers most of my questions. Thanks.

Operator

This concludes our question-and-answer session. I would like to turn the conference back to Dee Johnson for any closing remarks.

Dee Johnson

Thank you. And thanks to everyone for joining us today. We appreciate your interest and we look forward to speaking with you again soon. This concludes the Rubicon's second quarter conference call.

Raja Parvez

Thank you.

Bill Weissman

Thank you.

Operator

Thank you. The conference is now concluded. Thank you for attending today's presentation. And you may now disconnect your lines.

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