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RBCN > SEC Filings for RBCN > Form 10-K on 14-Mar-2013All Recent SEC Filings

Show all filings for RUBICON TECHNOLOGY, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for RUBICON TECHNOLOGY, INC.


14-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. You should review the "Risk Factors" section of this annual report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements described in the following discussion and analysis.

OVERVIEW

We are an advanced electronic materials provider that develops, manufactures and sells monocrystalline sapphire and other innovative crystalline products for Light-Emitting Diodes ("LEDs"), radio frequency integrated circuits ("RFICs"), blue laser diodes, optoelectronics and other optical applications. The emergence of sapphire in commercial volumes at competitive prices has enabled the development of new technologies such as high-brightness ("HB") white, blue and green LEDs and highly-integrated RFICs. We apply our proprietary crystal growth technology to produce high-quality sapphire products efficiently to supply our end markets, and we work closely with our customers to meet their quality and delivery needs.

We are a vertically integrated manufacturer of high-quality sapphire substrates and optical windows that are used in a variety of high-growth, high-volume end-market applications. During 2012 and 2011, our largest product sales were six-inch polished sapphire wafers (substrates) for use in LED applications and in Silicon-on-Sapphire ("SoS") RFICs. Two through four-inch diameter sapphire cores were our second largest product sales category during 2012 and 2011, and comprised the majority of our sales prior to 2011. Cores are sold to sapphire polishers who make wafers for use in LEDs and blue laser diodes. We also sell sapphire products used for windows and lenses in military, aerospace, sensor and other applications. We have extended our technology, giving us the ability to produce cores and wafers of up to twelve inches in diameter to support next generation LED and RFIC production. In addition, we have developed the ability to produce large diameter circular and rectangular sapphire windows for use in various optical window applications.

Our revenue consists of sales of sapphire materials sold in core, as-cut, as-ground and polished wafer forms in two, three, four, six and eight inch diameters as well as optical materials sold as blanks or polished windows. Products are made to varying specifications, such as crystal planar orientations and thicknesses. We recognize research and development revenue in the period during which the related costs and fees are incurred.

We sell our products on a global basis. The Asian, North American and European markets accounted for 48%, 17% and 35%, respectively, of our revenue for the year ended December 31, 2012, 87%, 9% and 4%, respectively, of our revenue for the year ended December 31, 2011, and 90%, 8% and 2%, respectively, of our revenue for the year ended December 31, 2010. Demand from the LED market was very strong starting in 2010 continuing through mid-year 2011, particularly in Asia where there is a high concentration of customers that participate in the LED market. Demand for our products from the LED market slowed in the second half of 2011 due to a slowdown in LED chip sales which resulted in a build-up of inventory in the LED supply chain. The decrease in demand from the LED market was partially offset by the increased strength of the SoS market. The demand for sapphire substrates from the LED market is improving but excess sapphire capacity added in the marketplace has kept pricing low throughout 2012 and going into 2013. While we expect demand for LED chips to continue to strengthen throughout 2013 with increased adoption of LED lighting, it is difficult to predict how quickly the excess capacity will be absorbed and when the pricing environment will improve. Demand for our products from the SoS market increased considerably in 2012. However, there is some seasonality in that market which is centered around the introduction of new smartphone models so we expect orders to slow in the first half of 2013 with growth resuming in the second half of 2013.

We currently depend on a small number of suppliers for certain raw materials, components, services and equipment, including key materials such as aluminum oxide and certain furnace components. If the supply of


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these components were to be disrupted or terminated, or if these suppliers were unable to supply the quantities of raw materials required, we may have difficulty in finding, or may be unable to find, alternative sources for these items. As a result, we may be unable to meet the demand for our products, which could have a material adverse impact on our business.

We manage direct sales primarily from our Bensenville, Illinois offices. Substantially all of our revenue is generated by our direct sales force and we expect this to continue in the future.

We manufacture and ship our products from our facilities in the Chicago metropolitan area and from our facility in Penang, Malaysia. We have approximately 237,000 square feet of manufacturing and office space in Batavia, Franklin Park and Bensenville, Illinois and a 65,000 square foot facility in Penang, Malaysia, which processes sapphire grown by us in our Illinois facilities into finished cores and wafers. Our Malaysia facility currently finishes the majority of our core production and can produce production volumes of polished wafers. In March 2012, we acquired additional land in Batavia, Illinois to expand our crystal growth capacity. We have not yet determined when we will begin construction on this facility.

Financial operations

Revenue. Our revenue consists of sales of sapphire materials sold in core, as-cut, as-ground and polished forms in two, three, four, six and eight-inch diameters as well as optical materials sold as blanks or polished windows. Products are made to varying specifications, such as crystal planar orientations and thicknesses. We recognize research and development revenue in the period during which the related costs are incurred.

We have focused on increasing sales of larger diameter substrates, which we define as three inch or greater in diameter, as they generally yield higher gross margins. Sales increased significantly across most product lines and diameters for the year ended December 31, 2010, as demand for LED chips used for backlighting LED televisions and computer screens drove strong demand and price increases for our products. For the year ended December 31, 2011, we experienced a significant increase in revenue in large diameter polished product lines as one of our key customers was the first LED chip maker to move to a larger diameter (6") platform in high volume production. In addition, increased pricing for our core products resulted in higher revenue from these products for the year ended December 31, 2011. However, in the fourth quarter of 2011, the LED market began softening considerably with the maturing of the LED backlighting markets, and the demand and pricing experienced a significant decrease across most product lines. The weak market conditions continued throughout 2012 and for the year ended December 31, 2012 we experienced a significant decrease in revenue from our core products and large diameter polished product lines for the LED market. The decrease in our large diameter product lines for the LED market was partially offset by a strong SoS market. While we expect demand for the LED chips to continue to strengthen throughout 2013 with increased adoption of LED lighting, it is difficult to predict how quickly the excess capacity will be absorbed and when the pricing environment will improve. The SoS market is expected to grow in 2013; however, there is some seasonality in the market which is centered around the introduction of new smartphone models. We expect orders to slow in the first half of 2013 with growth resuming in the second half of 2013.

Historically, a significant portion of our revenue has been derived from sales to relatively few customers. For the year ended December 31, 2012, our top two customers accounted for approximately 67% of our revenue and for the years ended December 31, 2011 and 2010, our top three customers accounted for approximately 69% and 46% of our revenue, respectively. Other than as discussed above, none of our customers accounted for more than 10% of our revenue for such periods. Although we are attempting to diversify and expand our customer base, we expect our revenue to continue to be concentrated among a small number of customers. We expect that our significant customers may change from period to period.

We recognize revenue upon shipment to our customers and from our government contract as costs and fees are incurred. Delays in product orders or changes to the timing of shipments could cause our quarterly revenue to vary significantly. We derive a significant portion of our revenue from customers outside of the U.S. In most periods, the


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majority of our sales are to the Asian market and we expect that region to continue to be a major source of revenue for us. All of our revenue and corresponding accounts receivable are denominated in U.S. dollars.

Cost of goods sold. Our cost of goods sold consists primarily of manufacturing materials, labor, manufacturing-related overhead such as utilities, depreciation and rent, provisions for excess and obsolete inventory reserves, freight and warranties. We manufacture our products at our Illinois and Malaysia manufacturing facilities based on customer orders. We purchase materials and supplies to support such current and future demand. We are subject to variations in the cost of raw materials and consumables from period to period because we do not have long-term fixed-price agreements with most of our suppliers. We mitigate the potential impact of fluctuations in energy costs by entering into long-term purchase agreements. Once our current agreements expire, if electricity prices increase significantly, we may not be able to pass these price increases through to our customers on a timely basis, if at all, which could adversely affect our gross margins and results of operations.

Gross profit. Our gross profit has been and will continue to be affected by a variety of factors, including average sales prices of our products, product mix, our ability to reduce manufacturing costs and fluctuations in the cost of electricity, raw materials and other supplies.

General and administrative expenses. General and administrative expenses ("G&A") consist primarily of salaries and associated costs for employees in finance, human resources, information technology and administrative activities, as well as charges for outside accounting, legal and insurance fees and stock-based compensation.

Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and associated costs for employees engaged in sales activities, product samples, charges for participation in trade shows and travel.

Research and development expenses. Research and development ("R&D") expenses include costs related to engineering personnel, materials and other product development related costs. R&D is expensed as incurred. We believe our R&D expenses will generally increase as we continue to develop new products.

Other income (expense). Other income (expense) consists of interest income and expense and gains and losses on investments and currency translation.

Provision for income tax. We account for income taxes under the asset and liability method whereby the expected future tax consequences of temporary differences between the book value and the tax basis of assets and liabilities are recognized as deferred tax assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to be recognized. Our updated analysis of ownership changes that limit the utilization of the NOLs shows no ownership change. Our previous analysis of ownership changes that limit the utilization of the NOLs shows an ownership change but we believe that we are not restricted in our ability to use the full amount of the NOLs. A full valuation allowance was provided and no tax benefit was recorded until we could conclude that it is more likely than not that our deferred tax assets will be realized. During the twelve months ended December 31, 2011, we concluded that based on the current level of sustainable profitability that generates taxable income, it is more likely than not that our deferred tax assets will be realizable. We recognized a tax benefit of $3.3 million to record current and long-term deferred tax assets during the twelve months ended December 31, 2011. With the release of the valuation allowance, we began recording federal and certain state and non-U.S. income taxes attributable to the fiscal year's pre-tax income. The reversal of the valuation allowance favorably impacts our effective tax rate in 2011. The Illinois State Legislature has suspended the use of NOLs for taxable years ending after December 31, 2010 and before December 31, 2011, and has limited the net operation loss deduction to $100,000 for the years ending December 31, 2012 through December 31, 2014. In addition, Illinois has increased the corporate income tax rate which unfavorably impacts our effective tax rate. Our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the


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extent earnings are lower than anticipated. Our effective tax rate could also fluctuate due to changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations or accounting principles, as well as certain discrete items.

Stock-based compensation. The majority of our stock-based compensation relates primarily to administrative personnel and is accounted for as a G&A expense. For the years ended December 31, 2012, 2011 and 2010, our stock-based compensation expense was $2.0 million, $2.5 million and $2.3 million, respectively.

RESULTS OF OPERATIONS

The following table sets forth our statements of operations for the periods indicated:

                                                          Year ended
                                                         December 31,
                                                2012         2011         2010
                                                        (in millions)
           Revenue                             $  67.2      $ 134.0      $ 77.4
           Cost of goods sold                     67.3         64.4        36.2

           Gross profit (loss)                    (0.1 )       69.6        41.2

           Operating expenses:
           General and administrative              9.0         11.3         9.9
           Sales and marketing                     1.7          1.7         1.3
           Research and development                2.3          1.8         1.1
           Loss on disposal of assets               -           0.1         0.2

           Total operating expenses               13.0         14.9        12.5

           Income (loss) from operations         (13.1 )       54.7        28.7
           Other income (expense)                  0.5         (0.1 )       0.3

           Income (loss) before income taxes     (12.6 )       54.6        29.0
           Income tax benefit (expense)            7.1        (16.5 )       0.1

           Net income (loss)                   $  (5.5 )    $  38.1      $ 29.1

The following table sets forth our statements of operations as a percentage of revenue for the periods indicated:

                                                         Year ended
                                                        December 31,
                                                 2012        2011       2010
                                                   (percentage of total)
           Revenue                                  100 %      100 %      100 %
           Cost of goods sold                       100         48         47

           Gross profit (loss)                       -          52         53

           Operating expenses:
           General and administrative                13          8         13
           Sales and marketing                        3          1          2
           Research and development                   3          2          1
           Loss on disposal of assets                -          -          -

           Total operating expenses                  19         11         16

           Income (loss) from operations            (19 )       41         37
           Other income (expense)                    -          -           1

           Income (loss) before income taxes        (19 )       41         38
           Income tax benefit (expense)              11        (13 )       -

           Net income (loss)                        (8% )       28 %       38 %


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Comparison of years ended December 31, 2012 and 2011

Revenue. Revenue was $67.2 million for the year ended December 31, 2012 and $134.0 million for the year ended December 31, 2011, a decrease of $66.8 million. We experienced a decrease in revenue from our products sold to the LED market. Revenue from the sale of sapphire cores, which are sold into the LED market, for the year ended December 31, 2012 decreased by $52.6 million, of which $42.3 million was attributed to lower pricing and $10.3 million was attributed to lower volume. We also experienced lower revenue from sales of our polished wafers by $14.4 million, which was the result of $36.9 million lower sales of polished wafers to the LED market offset in part by a $22.5 million increase in polished wafers sold to the SoS market. Of the $14.4 million reduction in revenue from polished wafers, $16.9 million was attributable to lower prices offset in part by an increase in volume of $2.5 million. We experienced an increase in research and development revenue of $1.2 million as we were awarded a contract with the Air Force Research Laboratory in July 2012 to produce large area sapphire slabs. Revenue with respect to this contract was recorded as costs were incurred as well as a portion of the fixed fee for the year ended December 31, 2012. The contract will continue for duration of three years and the total value of the contract is $4.7 million. We also experienced lower optical revenue of $1.0 million due to the decrease in sales for sensor and instrumentation applications. While demand for polished wafers was strong for the year ended December 31, 2012, prices were lower. We believe pricing will slowly recover for sapphire cores as the excess capacity at sapphire producers is gradually absorbed by increasing demand from the LED and SoS markets, but it is difficult to predict exactly when and how quickly pricing will improve. Our wafer sales are almost exclusively six-inch wafers which have not yet been broadly adopted by the LED industry. Because the usage of six-inch wafers is limited and competitors are eager to participate in this promising market, we expect pricing of six-inch wafers to decline in the near term.

Gross profit. Gross loss was $40,000 for the year ended December 31, 2012 as compared to a gross profit of $69.6 million for the year ended December 31, 2011, a decrease of $69.6 million. The decrease in gross profit is primarily due to the reduction in revenue, which in turn is attributable to decreased pricing for our products as well as lower utilization of our production facilities attributable to the reduced demand from the LED market due to the buildup of excess inventory in the supply chain. Due to changes in customers' product specifications an excess and obsolete inventory reserve adjustment of $719,000 was recorded for the year ended December 31, 2012, which reduced inventory and increased cost of goods sold as various items in stock were no longer in demand. In addition, pricing for our small diameter core products declined throughout 2012 and in the fourth quarter of 2012 market prices fell below our carrying cost in inventory. As a result we recorded a lower of cost or market adjustment which reduced inventory and increased cost of goods sold by a net of $1.5 million for the year ended December 31, 2012. In addition, given the relative strength of the six-inch market, we wanted to make sure our boule inventory was capable of producing high-yield six-inch material. Consequently, we decided to recycle some boules from inventory that might have produced lower than normal six-inch yield. This added approximately $927,000 to cost of goods sold for the year ended December 31, 2012.

General and administrative expenses. G&A expenses were $9.0 million for the year ended December 31, 2012 and $11.3 million for the year ended December 31, 2011, a decrease of $2.3 million. Our bad debt expense decreased by $1.9 million as we made accommodations for the year ended December 31, 2011 to certain key customers of our small diameter cores by agreeing to write off a portion of their accounts receivable balances that did not re-occur in 2012. We also experienced a decrease of employee compensation costs of $385,000, resulting from a lower performance based bonus expense. In 2012, we also experienced higher legal expenses of $488,000, offset partially by lower consulting expenses of $268,000 and lower recruiting expenses of $102,000.

Sales and marketing expenses. Sales and marketing expenses were $1.7 million for each of the years ended December 31, 2012 and, 2011. A slight increase of $27,000 in sales and marketing expenses is attributable to additional employee compensation costs primarily due to annual salary increases and employee stock options expense.

Research and development expenses. R&D expenses were $2.3 million for the year ended December 31, 2012 and $1.8 million for the year ended December 31, 2011, an increase of $468,000. The increase is


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attributable to higher employee compensation costs of $204,000 related to increased headcount and salary increases, an increase in spending on research projects of $186,000 and an increase in travel of $77,000.

Other income (expense). Other income was $450,000 for the year ended December 31, 2012 and other expense was $118,000 for the year ended December 31, 2011, an increase in other income of $568,000. The increase was primarily due to an increase of $719,000 from realized gains on foreign currency translation partially offset by a $159,000 decrease in interest income on lower investment balances.

Income tax benefit (expense). Income tax benefit was $7.1 million for the year ended December 31, 2012 as compared to an income tax expense of $16.5 million for the year ended December 31, 2011. Our projected effective tax rate, while in a profit operating mode, is 30% to 35%; however, the rate of tax benefit accrued while in a loss mode will typically be higher and will vary based on the distribution of activity between our U.S. and Malaysia operations.

Comparison of years ended December 31, 2011 and 2010

Revenue. Revenue was $134.0 million for the year ended December 31, 2011 and $77.4 million for the year ended December 31, 2010, an increase of $56.6 million. We experienced a significant increase in revenue across most product lines and diameters in 2011 due to increased demand for our products, which led to a large price increase in the first half of 2011. We directed most of our additional crystal growth production capacity to support the growing demand for six-inch polished wafers. As a result, we increased our sales of polished wafers by $45.7 million primarily on higher volume of $55.1 million partially offset by lower pricing of $9.4 million, as demand for these products increased in both the LED and SoS RFIC markets. Revenue from the sale of core products for the year ended December 31, 2011 increased by $8.0 million, of which $23.0 million was due to an increase in pricing partially offset by a decrease of $15.0 million due to lower volume. We also had higher revenue of $3.1 million from optical products due to increased sales of sapphire for sensor and instrumentation applications.

During the second half of 2011, demand from the LED market weakened due to excess inventory in the supply chain. As a result, prices for our products declined. While demand for large diameter polished wafers was strong throughout 2011, the prolonged weakness in the LED market impacted pricing for this product in the fourth quarter as customers for this product accumulated excess inventory as well.

Gross profit. Gross profit was $69.6 million for the year ended December 31, 2011 and $41.2 million for the year ended December 31, 2010, an increase of $28.4 million. The increase in gross profit is primarily attributable to higher revenue due to increased core pricing in the first half of 2011 and higher volume sales of polished wafers.

General and administrative expenses. G&A expenses were $11.3 million for the year ended December 31, 2011 and $9.9 million for the year ended December 31, 2010, an increase of $1.4 million. Our bad debt expense increased by $1.7 million as we made accommodations to certain key customers of our small diameter cores by agreeing to write off a portion of their accounts receivable balances. Also, investor relations expense increased $728,000, primarily due to increased outside support services and investor relations consulting, audit fees increased $84,000, tax consulting expense increased $102,000 and executive travel expenses increased $111,000, primarily due to increased frequency in travel outside the U.S. G&A expenses for the Malaysia facility were also $202,000 higher as the facility began to incur G&A expenses starting in the third quarter of 2010. The G&A increases noted above were partially offset by a decrease of employee compensation costs of $1.8 million, resulting from a lower performance based bonus of $2.1 million, offset by an increase of $143,000 from annual salary increases and expenses associated with issuance and exercise of employee stock options and $158,000 of recruiting expenses.

Sales and marketing expenses. Sales and marketing expenses were $1.7 million for the year ended December 31, 2011 and $1.3 million for the year ended December 31, 2010, an increase of $391,000. The


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increase in sales and marketing expenses is attributable to additional employee compensation costs primarily due to annual salary increases, employee stock options expense and additional sales hires to support expansion as well as increased travel expense.

Research and development expenses. R&D expenses were $1.8 million for the year ended December 31, 2011 and $1.1 million for the year ended December 31, 2010, an increase of $727,000. The increase is attributable to higher employee compensation costs of $246,000 and an increase in spending on research projects of $458,000.

Other income (expense). Other expense was $118,000 for the year ended December 31, 2011 and other income $346,000 for the year ended December 31, 2010, a decrease in other income of $464,000. The decrease was primarily due to a $106,000 decrease in interest income on lower investment balances as well as a . . .

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