Rubicon's Revenue Falls 20% in Q2, as 2-Inch Sapphire Core Sales and Pricing Hit by Weak Mobile Market

For second-quarter 2015, Rubicon Technology Inc of Bensenville, IL, USA (which makes monocrystalline sapphire substrates and products for the LED, semiconductor and optical industries) has reported revenue of $7.1m, down 51% on $14.5m a year ago and down 20% on $8.9m last quarter due to weaker sapphire demand (most likely resulting from increased TV inventory levels and some seasonality in the LED light bulb market) and lower pricing.

"While sapphire pricing rose in the first half of last year, pricing has declined over the past several quarters and the current pricing environment is particularly tough," says president & CEO Bill Weissman. "The continued oversupply in the market along with weak currencies in Russia and Japan have been compounded by the current softness in the market."

Specifically, demand from the mobile market was weaker, resulting particularly in lower 2-inch core volumes and additional pressure on pricing (which is down 18% on last quarter and almost halved from a year ago). Revenue from 2-inch cores has hence fallen further, from $6.4m a year ago and $4m last quarter to just $2.6m. Revenue from 4-inch cores rose from $1m to $1.2m, although that is still down on $3.2m a year ago. Revenue from 6-inch cores rose from just $23,000 last quarter to $171,000. Total revenue for cores fell further, from $9.6m a year ago and $5.1m last quarter to $4m.

Overall wafer revenue was roughly unchanged sequentially. However, polished wafer sales have fallen further, from $2.6m a year ago and $1.43m last quarter to $0.84m because the firm's focus on wafer sales has shifted exclusively to patterned wafers, where it believe there is greater margin opportunity. Patterned sapphire substrate (PSS) wafer sales have hence begun to accelerate, from $0.26m a year ago then nearly doubling from $0.46m last quarter to $0.9m.

Optical revenue fell by $578,000 from $1.77m last quarter to $1.19m due to lower sales volume.

Crystal growth operations continued to run at full capacity, but wafer polishing and patterning operations remained under-utilized. However, idled plant costs fell from $2.2m to $1.6m as PSS production was increased at Rubicon's facility in Penang, Malaysia.

Operating expenses were $3.17m, up from $2.84m last quarter due mainly to R&D spending (on personnel and projects) rising from $0.43m to $0.6m, as well as an increase in legal fees.

Raw material inventory balance was lowered further, by $1.4m from $12.9m to $11.5m. "In addition to reducing our per-unit costs through our internal raw material process, we have also reduced the total quantities in inventory," says Weissman. However, total inventory levels increased by $320,000, as working process inventory rose by $1.2m because Rubicon built in advance some inventory for third-quarter shipments.

Given the lower 2-inch demand, Rubicon has also temporarily scaled back some of its crystal growth operations from full production to about two-thirds capacity, as well as limiting its raw material production. "While we expect the market to improve, it is difficult to predict the timing, and we want to avoid building inventory," says chief financial officer Mardel Graffy. "The reduced throughput will still give us sufficient crystals to support our growing PSS business and support our key core customers, while allowing us to reduce inventory levels, particularly in raw materials," he adds. "Reducing raw material and crystal inventory will improve cash flow in the near-term, and we are retaining key personnel to ensure we can scale back up to full production quickly as market conditions improve."

While the sequential price decline put additional pressure on operating results, net loss was $8.6m ($0.33 per share), up only slightly from $8.3m ($0.32 per share) last quarter and still better than $10m ($0.39 per share) a year ago.

Net cash used in operating activities has risen from $3.9m last quarter to $5.1m (doubling from $2.5m a year ago). During the quarter, cash and short-term investments hence fell from $41m to $36m (with no debt).

"One of the objectives this year is to become cash-flow positive by the end of this year," says Weissman. "While it will be difficult to hit that target this year without some pricing increases, we remain focused on that objective," he adds. "The time it will take for the excess capacity in the marketplace to be absorbed is difficult to predict. At this time, we are placing intense focus on reducing product costs and introducing new products, while tightly managing cash flow."

"Through yield improvement and raw material cost reductions, we have reduced our crystal growth costs by about 15% in the past year," Weissman says. "We continue to work on process improvement and design changes to continue to drive crystal costs lower. One such change is the conversion of our 83kg furnaces to 93kg, which will allow us to increase throughput for a nominal incremental cost, and also increase yield. The conversion is being done gradually according to our maintenance schedule to avoid premature replacing expensive parts," he adds.

"We have also made progress in reducing wafer costs. Our original polishing operation was focused only on 6-inch wafers and we subsequently added 4-inch polishing to support our entry into 4- as well as 6-inch PSS," says Weissman. "A key to optimizing the potential of our PSS capacity is to further reduce our polishing costs, and this has been a top priority for us this year, but reducing polishing costs has progressed more slowly than we have expected."

Resource sharing agreement

To expedite polishing cost reductions, Rubicon has hence also recently signed a resource sharing agreement with a leading sapphire polisher, under which it will receive a 4-inch polishing process that should halve its polishing costs, Rubicon believes, in exchange for making available to the other party the use of about half of Rubicon's under-utilized slicing and polishing capacity in Malaysia. Despite relinquishing about half of its existing installed capacity, the new lower-cost process is also higher throughput, so Rubicon's polishing capacity will only shrink to about 70%.

"The capacity we retain should be ample to meet our full PSS capacity needs and will allow us to spread some of our manufacturing overhead to further reduce costs," says Weissman. Rubicon will continue to use its existing 6-inch polishing process but believes that some of the process modifications made for 4-inch will be transferrable to 6-inch and result in reduced cost for that product as well. The process improvement is not expected to require any additional capital expenditure.

"The industry got too much capacity and there needs to be consolidation in one form or another," believes Weissman. "We need to make sure that the capacity that's out there is being used efficiently. This agreement works very well for both parties and makes us more cost-efficient and provides them with what they need, which is some additional capacity," he adds.

"During the current down cycle in the market, we have been focusing on a number of key initiatives: aggressively pursuing our PSS potential; targeting high-margin optical applications; driving down product costs; and developing new products… we are making progress on each of these fronts," says Weissman. "Our goal is to focus on products that require more intellectual property to produce like PSS wafers, particularly in larger diameters, and optical products."

Rubicon recently received a $9m purchase order from a new user of 6-inch PSS wafers (to be delivered over 12 months starting this October). Another major LED maker was moving to 6-inch PSS this year, but they are going at a slower pace than expected so far, says Weissman, while the other major 6-inch user in Asia is also a bit slower (both slowdowns resulting from weakness in general market conditions)."Overall, we are still seeing more interest in 6-inch," he adds. Rubicon hence expects PSS wafer sales to continue to ramp towards meaningful volumes through the rest of 2015. "We are focusing on PSS wafer sales because we believe this product has greater margin potential than polished wafers; however, we must reduce slicing and polishing costs in order to realize the potential… The resource sharing agreement will allow us to reduce those costs faster than internal development, especially for 4-inch wafers," Weissman adds. Due to the new resource sharing agreement plus the continuing increase in PSS wafer orders, Rubicon expects utilization of its Malaysia factory to increase significantly.

Rubicon expects the challenging market to continue in the third quarter. While PSS wafer sales are expected to increase, visibility on 2- and 4-inch core sales is limited, so Q3 revenue should be at or below Q2 levels. PSS revenue is expected to continue to grow in the fourth quarter, when demand for 2- and 4-inch core should also strengthen, the firm believes.

Process changes associated with the resource sharing agreement will be made over the remainder of 2015. "The extent and timing of cost reductions from these changes will be better understood as the changes are implemented," says Graffy. However, for Q3, loss per share is expected to be at or higher than Q2.

"While the timing is uncertain, we believe that the pricing environment will improve. This improvement, along with the actions we are taking this year in cost reduction, technology development and new product introductions will position the company to generate strong margins once again," concludes Weissman.