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RBCN > SEC Filings for RBCN > Form 10-K on 13-Mar-2014All Recent SEC Filings

Show all filings for RUBICON TECHNOLOGY, INC.

Form 10-K for RUBICON TECHNOLOGY, INC.


13-Mar-2014

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 a vertically integrated, advanced electronic materials provider specializing in monocrystalline sapphire for applications in light-emitting diodes ("LEDs"), optical systems and specialty electronic devices. 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 radio frequency integrated circuits ("RFICs"). Recently, sapphire has been adopted for use in several new applications in mobile devices specifically camera lens covers, dual flashes and home buttons on certain newer model smartphones. The reason sapphire was adopted for use on the home button on certain smartphones is because of the scratch resistance and increased touch capacitance offered by sapphire, which are important characteristics to ensure the effectiveness of the fingerprint recognition security built into the device. We believe that the use of fingerprint recognition security and other biometrics could become more prevalent in the future, which could become a strong growth driver for sapphire. 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. Our largest product lines are:

sapphire cores, two to six inches in diameter, which our customers further process into wafers for use in LED applications and into components such as lens covers for mobile devices;

six-inch sapphire wafers that are used as substrates for the manufacture of LED chips and to a lesser extent for other semiconductor applications such as Silicon-on-Sapphire ("SoS") RFICs; and

Optical sapphire components in various shapes and sizes, including round and rectangular windows and blanks, domes, tubes and rods. These optical sapphire products are used in equipment for a wide variety of end markets, including defense and aerospace, medical devices, oil and gas drilling, semiconductor manufacturing and other markets.

For the LED market, we sell two to four-inch material primarily in core form and six and eight-inch material primarily in polished wafer form. Eight-inch wafers are sold primarily for customers' research and development efforts at this time. We have the ability to produce cores and wafers of up to twelve inches in diameter to support production of chips for next-generation LED and other electronic applications. Larger sapphire also has current applications in the optical markets. In other semiconductor markets, we sell primarily six-inch wafers; our major customer in that market, however, is modifying its technology to produce its higher volume RFIC products on a substrate other than sapphire, a development which will likely significantly reduce the amount of sapphire demand from that market beginning in early 2014. Other non-LED semiconductor customers are using sapphire in research and development at this time.

We recently introduced a new product offering, patterned sapphire substrates or "PSS". HB LED chip manufacturers etch a pattern onto the surface of the sapphire wafer in the early stages of their production process in order to improve light output. We have leveraged our capability in producing larger diameter sapphire wafers to offer pre-patterned, larger diameter (four-inch and six-inch) wafers to the LED market.


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We sell our products on a global basis. The Asian, Australian, North American and European markets accounted for 60%, 25%, 11% and 4%, respectively, of our revenue for the year ended December 31, 2013 and 48%, 19%, 17% and 16%, respectively, of our revenue for the year ended December 31, 2012. The Asian, North American and European markets accounted for and 87%, 9% and 4%, respectively, of our revenue for the year ended December 31, 2011. Demand from the LED market was strong though mid-year 2011, particularly in Asia where there is a high concentration of LED customers. Demand for our products from the LED market slowed in the second half of 2011 due to a slowdown in LED chip sales that resulted in a build-up of inventory in the LED supply chain, which continued throughout 2012. We experienced increased demand for our core products throughout 2013 with stronger demand from the LED general lighting market and the adoption of sapphire in newer applications like the lens cover, dual flash and home button on certain smartphones, however, improvements in pricing has been gradual. Demand for our six-inch polished wafers sold into the SoS market increased significantly in 2012, partially offsetting the decrease in sales of polished wafers sold into the LED market. However, the manufacturer of the majority of SoS chips will be introducing new products that will be produced on a substrate other than sapphire which reduced demand in the second half of 2013 and will likely significantly reduce the amount of sapphire demand from that market beginning in early 2014. We expect pricing for sapphire cores to continue to increase gradually as excess sapphire capacity in the market is absorbed by growing demand from the LED and other markets. However, we believe six-inch polished wafer prices may decline further in the near-term. We experienced limited demand for LED polished wafers in 2013, but expect increased adoption of six-inch wafers in the LED market. While we expect demand for LED chips to continue to strengthen throughout 2014 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.

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 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. 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


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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 on decreasing pricing as well as decreased demand for our 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. Throughout 2013, we experienced limited demand for our large diameter substrates and gradually improved pricing for our smaller diameter core products. While we expect demand for the LED chips to continue to strengthen throughout 2014 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.

Historically, a substantial portion of our revenue has been derived from sales to a small number of customers. For the year ended December 31, 2013, our top two customers accounted for approximately 44% of our revenue. For the year ended December 31, 2012 our top two customers accounted for approximately 67% of our revenue and for the year ended December 31, 2011, our top three customers accounted for approximately 69% of our revenue. 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 based upon shipping terms with 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 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, idle plant, 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. We determine our normal operating capacity and, if necessary, record as idle plant expense costs attributable to lower utilization of equipment and staff.

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, idle plant charges 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.


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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 most recent analysis of ownership changes that limit the utilization of the NOLs shows no ownership change. We believe that an updated analysis will not likely indicate an ownership change that would limit the utilization of our net operating losses and tax credits as of December 31, 2013. We will be updating our analysis in 2014 and the results of that analysis may, because of the primary stock offering in January 2014 indicate an ownership change. If an ownership change is determined, the utilization of the net operating losses and the tax credits may be limited.

A full valuation allowance is provided and no tax benefit is recorded until we can conclude that it is "more likely than not" that our deferred tax assets will be realized. Due to the losses in the fourth quarter of 2013, we are in a cumulative loss position for the past three years, which is considered significant negative evidence by the accounting standards that is difficult to overcome on a "more likely than not" standard through objectively verifiable data. As of December 31, 2013, a valuation allowance of $9.5 million has been recorded against the net U.S. deferred tax assets in order to measure only the portion of the deferred tax assets that are more likely than not to be realized based on the weight of all the available evidence. Until an appropriate level of profitability is attained, we expect to maintain a valuation allowance on net deferred tax assets related to future U.S. tax benefits and will no longer accrue tax benefits or tax expense. During the twelve months ended December 31, 2011, we concluded at that time that based on the then current level of sustainable profitability that generates taxable income, it was 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.

The Illinois State Legislature has suspended the full use of net operating loss carryforwards for taxable years ended after December 31, 2010 and before December 31, 2011, and has limited the net operation loss deduction to $100,000 for the years ended December 31, 2012 through December 31, 2013. Our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated.

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, 2013, 2012 and 2011, our stock-based compensation expense was $1.6 million, $2.0 million and $2.5 million, respectively.


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RESULTS OF OPERATIONS

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

                                                         Year ended
                                                        December 31,
                                               2013         2012         2011
                                                        (in millions)
          Revenue                             $  41.5      $  67.2      $ 134.0
          Cost of goods sold                     63.4         67.3         64.4

          Gross (loss) profit                   (21.9 )       (0.1 )       69.6

          Operating expenses:
          General and administrative              8.6          9.0         11.3
          Sales and marketing                     1.5          1.7          1.7
          Research and development                2.3          2.3          1.8
          Loss on disposal of assets              0.6           -           0.1

          Total operating expenses               13.0         13.0         14.9

          Income (loss) from operations         (34.9 )      (13.1 )       54.7
          Other (expense) income                 (0.6 )        0.5         (0.1 )

          Income (loss) before income taxes     (35.5 )      (12.6 )       54.6
          Income tax benefit (expense)            5.1          7.1        (16.5 )

          Net (loss) income                   $ (30.4 )    $  (5.5 )    $  38.1

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

                                                         Year ended
                                                        December 31,
                                                2013         2012       2011
                                                   (percentage of total)
           Revenue                                 100 %       100 %      100 %
           Cost of goods sold                      153         100         48

           Gross (loss) profit                     (53 )        -          52

           Operating expenses:
           General and administrative               21          13          8
           Sales and marketing                       4           3          1
           Research and development                  5           3          2
           Loss on disposal of assets                1          -          -

           Total operating expenses                 31          19         11

           Income (loss) from operations           (84 )       (19 )       41
           Other (expense) income                   (1 )        -          -

           Income (loss) before income taxes       (85 )       (19 )       41
           Income tax benefit (expense)             12          11        (13 )

           Net (loss) income                     (73%)        (8%)         28 %


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Comparison of years ended December 31, 2013 and 2012

Revenue. Revenue was $41.5 million for the year ended December 31, 2013 and $67.2 million for the year ended December 31, 2012, a decrease of $25.7 million. In 2013, we experienced higher revenue from the sale of sapphire cores, which are sold into the LED market, of $13.5 million, of which $16.3 million was attributed to higher volume partially offset by a decrease of $2.8 million that was attributed to lower pricing. We experienced a decrease in revenue from our wafer products sold to the LED and SoS markets. Revenue from sales of our polished wafers decreased by $38.3 million, which was the result of $21.7 million lower sales of polished wafers to the LED market as well as a $16.6 million decrease in polished wafers sold to the SoS market. Of the $38.3 million reduction in revenue from polished wafers, $1.0 million was attributable to lower prices and $37.2 million was attributable to lower volume. We also experienced lower optical revenue of $1.2 million due to the decrease in sales for sensor and instrumentation applications. We experienced an increase in research and development revenue of $234,000 on our contract with the Air Force Research Laboratory. 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, 2013 and 2012. The contract will continue for a duration of three years and the total value of the contract is $4.7 million.

Demand for our core products increased throughout 2013 with stronger demand from the LED general lighting market and the adoption of sapphire in newer applications like the lens cover, dual flash and home button on certain smartphones. As a result, pricing gradually increased for our core products in the second half of 2013. We expect pricing for sapphire cores to remain steady in the first quarter of 2014 and then begin to slowly increase as excess sapphire capacity in the market continues to be absorbed by growing demand from the LED and other markets. We continued to experience limited demand for LED polished wafers during 2013 but expect increased adoption of six-inch wafers in the LED market. We have also recently begun offering four-inch polished wafers and four and six-inch patterned wafers which we expect to generate additional wafer revenue in 2014. The manufacturer of the majority of SoS chips will be introducing new products that will be produced on a substrate other than sapphire starting early 2014, therefore the amount of wafers sold into that market will be significantly reduced beginning in 2014. We operate in an extremely volatile market, so the amount of price or volume change is difficult to predict.

Gross loss. Gross loss was $21.9 million and $40,000 for the years ended December 31, 2013 and 2012, respectively, an increased loss of $21.9 million. The increase in gross loss is primarily due to a reduction in revenue, which in turn is attributable to decreased demand of our higher margin wafer sales as well as lower utilization of our production facilities. For the years ended December 31, 2013 and 2012, we determined we were not operating at capacity and recorded costs associated with the lower utilization of equipment and staff of $13.2 million and $1.9 million, respectively.

General and administrative expenses. G&A expenses were $8.6 million for the year ended December 31, 2013 and $9.0 million for the year ended December 31, 2012, a decrease of $389,000. In 2013, we experienced lower consulting fees of $430,000 and lower travel expenses of $93,000, partially offset by an increase in legal expenses of $103,000.

Sales and marketing expenses. Sales and marketing expenses were $1.5 million and $1.7 million for the years ended December 31, 2013 and 2012, a decrease of $164,000. The decrease is attributable to a decrease in employee compensation.

Research and development expenses. R&D expenses were $2.3 million for the years ended December 31, 2013 and 2012, a decrease of $11,000. We experienced a decrease in employee compensation costs offset by an increase in spending on certain R&D projects.

Other income (expense). Other expense was $627,000 for the year ended December 31, 2013 and other income was $450,000 for the year ended December 31, 2012, an increase in other expense of $1.1 million. The increase was primarily due to an increase of $932,000 from realized losses on foreign currency translation and an increase in interest expense of $95,000.


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Income tax benefit. Income tax benefit was $5.1 million and $7.1 million for the year ended December 31, 2013 and 2012, respectively. In accordance with ASC740 "Accounting for Income Taxes" ("ASC740"), we evaluate our deferred income tax assets quarterly to determine if valuation allowances are required or should be adjusted. ASC740 requires that companies assess whether valuation allowances should be established against their deferred tax assets based on consideration of all available evidence, both positive and negative, using a "more likely than not" standard. Due to the losses in the fourth quarter of 2013, we are in a cumulative loss position for the past three years which is considered significant negative evidence by the accounting standards that is difficult to overcome on a "more likely than not" standard through objectively verifiable data. While our financial outlook remains positive, the accounting standards attribute greater weight to objective negative evidence than to subjective positive evidence, such as our projections for future growth. Based on this evaluation, as of December 31, 2013, a valuation allowance of $9.5 million has been recorded against the net U.S. deferred tax assets in order to measure only the portion of the deferred tax assets that are more likely than not to be realized based on the weight of all the available evidence. Until an appropriate level of profitability is attained, we expect to maintain a valuation allowance on net deferred tax assets related to future U.S. tax benefits and will no longer accrue tax benefits or tax expense on our Consolidated Statement of Operations. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

We are evaluating the impact of the recent regulations concerning amounts paid to acquire, produce, or improve tangible property and recovery of basis upon disposition. Given that Revenue Procedures were issued in late January 2014, we are determining whether or not any changes in an accounting method are required. Presently, we do not anticipate a material impact to our financial statements.

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. In 2012, 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 . . .

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