Rubicon Technology, Inc. - Quarter Report: 2010 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark one)

for the quarterly period ended September 30, 2010

or

for the transition period from              to             

Commission file number 001-33834

RUBICON TECHNOLOGY, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code: (847) 295-7000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of November 5, 2010 the Registrant had 22,937,049 shares of common stock, par value $0.001 per share, outstanding.

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RUBICON TECHNOLOGY, INC.

Quarterly Report on Form 10-Q

For the quarterly period ended September 30, 2010

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PART I FINANCIAL INFORMATION

Rubicon Technology, Inc.

Consolidated balance sheets

The accompanying notes are an integral part of these consolidated statements.

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Rubicon Technology, Inc.

Consolidated statements of operations

The accompanying notes are an integral part of these consolidated statements.

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Rubicon Technology, Inc.

Consolidated statements of cash flows

The accompanying notes are an integral part of these consolidated statements.

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Rubicon Technology, Inc.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2010

1. BASIS OF PRESENTATION

Interim financial data

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the US (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the US for complete consolidated financial statements and should be read in conjunction with the annual report filed on Form 10-K for the fiscal year ended December 31, 2009 for Rubicon Technology, Inc. (the “Company”). In the opinion of management, all adjustments (consisting only of adjustments of a normal and recurring nature) considered necessary for a fair presentation of the results of operations have been included. Consolidated operating results for the three and nine month periods ended September 30, 2010 are not necessarily indicative of results that may be expected for the year ending December 31, 2010.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Rubicon Worldwide LLC and Rubicon Sapphire Technology (Malaysia) SDN BHD. All intercompany transactions and balances have been eliminated in consolidation.

Foreign currency translation and transactions

Rubicon Worldwide LLC’s assets and liabilities are translated into US dollars at exchange rates existing at the respective balance sheet dates and capital accounts at historical exchange rates. The results of operations are translated into US dollars at the average exchange rates during the respective period. Translation adjustments resulting from fluctuations in exchange rates for Rubicon Worldwide LLC are recorded as a separate component of accumulated other comprehensive income (loss) within stockholders’ equity.

The Company has determined that the functional currency of Rubicon Sapphire Technology (Malaysia) SDN BHD is the US dollar. Rubicon Sapphire Technology (Malaysia) SDN BHD’s assets and liabilities are translated into US dollars using the remeasurement method. Non-monetary assets are translated at historical exchange rates and monetary assets are translated at exchange rates existing at the respective balance sheet dates. Translation adjustments for Rubicon Sapphire Technology (Malaysia) SDN BHD are included in determining net income (loss) for the period. The results of operations are translated into US dollars at the average exchange rates during the respective period. The Company records these gains and losses in other income (expense).

Foreign currency transaction gains and losses are generated from the effects of exchange rate changes on transactions denominated in a currency other than the functional currency of the Company, which is the US dollar. Gains and losses on foreign currency transactions are generally required to be recognized in the determination of net income (loss) for the period. The Company records these gains and losses in other income (expense).

Investments

The Company invests available cash primarily in investment grade commercial paper, corporate notes and government securities. Investments classified as available-for-sale securities are carried at fair market value with unrealized gains and losses recorded in accumulated other comprehensive income (loss). Investments in trading securities are reported at fair value, with both realized and unrealized gains and losses recorded in other income (expense), in the Consolidated Statement of Operations. Investments in which the Company has the ability and intent, if necessary, to liquidate in order to support its current operations, are classified as short-term.

The Company reviews its available-for-sale securities investments at the end of each quarter for other-than-temporary declines in fair value based on the specific identification method. The Company considers various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, changes in underlying credit ratings, forecasted recovery, its ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value and the probability that the scheduled cash payments will continue to be made. When the Company concludes that an other-than-temporary impairment has resulted, the difference between the fair value and carrying value is written off and recorded as a charge on the Consolidated Statement of Operations. As of September 30, 2010 and September 20, 2009, no impairment was recorded.

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Auction-rate securities put options (“ARS Put Options”)

In October 2008, the Company entered into an agreement that provided the Company with the right, but not the obligation, to sell all its auction-rate securities to UBS, AG for par value during the period from June 30, 2010 to July 2, 2012. The ARS Put Options provided the Company with the opportunity to recover the estimated unrealized loss on its ARS investments. The Company recorded the fair value of the ARS Put Options upon receipt and valued the ARS Put Options using a discounted cash flow model. Unrealized gains and losses related to the ARS Put Options are recognized in earnings. The Company exercised these put options on June 30, 2010. At September 30, 2010 the Company has no auction rate security or auction rate security put options in investments. The Company’s investment policy no longer includes auction rate securities as an approved investment. See Note 4—Investments for additional information regarding the ARS Put Options.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out method, and includes materials, labor and overhead. The Company reduces the carrying value of its inventories for differences between the cost and the estimated net realizable value, taking into account usage, expected demand, technological obsolescence and other information. Inventories are composed of the following:

The change in inventory reserves is comprised of the disposal of obsolete inventory and a change in standard cost to net realizable value and charges to costs and expenses. The table below details such changes (in thousands):

Property and equipment

Property and equipment consisted of the following:

Revenue recognition

The Company recognizes revenue from product sales when earned. Revenue is recognized when, and if, evidence of an arrangement is obtained and the other criteria to support revenue recognition are met, including:

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The Company does not provide maintenance or other services and it does not have sales that involve multiple elements or deliverables.

Net income (loss) per common share

Net income (loss) per share of common stock is as follows for the three and nine months ended September 30, 2010 and 2009:

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of diluted common shares outstanding during the period. Diluted shares outstanding are calculated by adding to the weighted-average shares outstanding any outstanding stock options and warrants based on the treasury stock method.

Diluted net loss per share is the same as basic net loss per share for the three and nine months ended September 30, 2009 because the effects of potentially dilutive securities are anti-dilutive.

At September 30, 2009, the Company had the following anti-dilutive securities outstanding which were excluded from the calculation of diluted net loss per share:

Recent accounting pronouncement

On January 21, 2010 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, amending Accounting Standards Codification (ASC) 820 (formerly Statement of Financial Accounting Standards No. 157). New disclosures related to transfers in and out of Level 1 and Level 2 measurements and separate disclosures about purchases, shares, issuances, and settlements relating to Level 3 measurements are required. ASU 2010-06 clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the Level 3 measurements disclosures about purchases, shares, issuances, and settlements which is effective for fiscal years beginning after December 15, 2010. The adoption of ASU 2010-06 did not have a material impact on the Company’s financial condition or results of operations.

On February 24, 2010 the FASB issued ASU 2010-09, which amends ASC 855 to address certain implementation issues related to an entity’s requirement to perform and disclose subsequent events procedures. ASU 2010-09 requires entities to evaluate subsequent events through the date the financial statements are issued. ASU 210-09 is effective immediately for financial statements that are issued or available to be issued. The adoption of ASU 2010-09 did not have a material impact on the Company’s financial condition or results of operations.

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In April 2010, the FASB issued ASU No. 2010 -17 – Revenue Recognition - Milestone Method (Topic 605): Milestone Method of Revenue Recognition. This standard provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for certain research and development transactions. Under this new standard, a company can recognize as revenue consideration that is contingent upon achievement of a milestone in the period in which it is achieved, only if the milestone meets all criteria to be considered substantive. ASU No. 2010 - 17 is effective for fiscal years beginning on or after June 15, 2010. ASU No. 2010 - 17 is not expected to have a material impact on the Company’s financial statements.

3. SEGMENT INFORMATION

The Company evaluates operations as one reportable segment, as it only reports profit and loss information on an aggregate basis to its chief operating decision maker.

Revenue is attributed by geographic region based on ship-to location of the Company’s customers. The following table summarizes revenue by geographic region:

The following table summarizes assets by geographic region:

4. INVESTMENTS

The Company invests available cash primarily in investment grade commercial paper, corporate notes and government securities. The Company’s short-term investments balance of $71.1 million as of September 30, 2010, is comprised of US Treasury securities of $7.5 million, corporate notes and bonds of $46.4 million, commercial paper of $17.0 million and FDIC guaranteed certificates of deposit of $200,000. The Company’s investments are classified as available-for-sale securities and are carried at fair market value with unrealized gains and losses recorded in accumulated other comprehensive income (loss).

In February 2008, the Company began experiencing failed auctions of its entire auction-rate securities portfolio, resulting in its inability to sell these securities in the short term. The Company held put options associated with an agreement with UBS, AG related to the auction-rate securities purchased through them. The Company exercised these put options on June 30, 2010 with a settlement date of July 1, 2010. The auction-rate securities were trading securities recorded at fair value and unrealized gains and losses were reported as part of gain on investments in the Consolidated Statements of Operations. The Company’s long-term investments at September 30, 2010, consist of a $2.0 million investment in Peregrine Semiconductor, Corp. (a customer) Series D-1 Preferred shares.

As noted above, in October 2008 the Company entered into an agreement with UBS, AG, which provided the Company certain rights to sell to UBS, AG the auction-rate securities that were purchased through them. The Company had the option to sell these securities to UBS, AG at par value from June 30, 2010 through July 2, 2012. The Company exercised the put option on June 30, 2010 with a settlement date of July 1, 2010. The ARS Put Options provided the Company with the opportunity to recover the estimated unrealized loss on its ARS investments. The Company recorded the fair value of the ARS Put Options upon receipt and valued the put options at their estimated fair value using a discounted cash flow model that weighs various factors, including interest rates and expected holding period. Unrealized gains and losses related to the ARS Put Options were recognized in earnings. During the nine months ended September 30, 2010, the Company recorded a gain of $63,466 representing the changes in fair value of the auction-rate securities. The Company also recorded during the nine months ended September 30, 2010, a loss of $55,279 representing the changes in fair value of the put options. During the three and nine months ended September 30, 2009, the Company recorded a gain (loss) of $9,628 and ($463,644), representing the changes in fair value of the put options. The Company also recorded during the three and nine months ended September 30, 2009, a gain (loss) of ($23,402) and $499,519, representing the changes in fair value of the auction-rate securities. Both the gain and loss from recording the change in fair value of the put options and auction-rate securities were recorded in gain on investments in the Consolidated Statements of Operations. The Company’s investment policy no longer includes auction-rate securities as an approved investment.

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The investment in Peregrine Semiconductor Corp. (Peregrine) is accounted for as a cost method investment.

The following table presents the amortized cost, gross unrealized gains and losses and fair value on all securities at September 30, 2010:

The Company values its investments at fair value, defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard below describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

The following table summarizes the Company’s financial assets measured at fair value on a recurring basis as of September 30, 2010:

The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets as of September 30, 2010:

In addition to the debt securities noted above, the Company had approximately $1.9 million of time deposits included in cash and cash equivalents as of September 30, 2010.

5. RELATED PARTY TRANSACTIONS

In November 2008, the Company purchased 1,345,444 shares of Peregrine Semiconductor, Corp. Series D-1 Preferred shares for a total of $2.0 million, which represents less than 1% of Peregrine’s shares outstanding. The terms and stock price of the purchase were

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the same as for the other investors who participated. Peregrine is a customer of the Company. For the three and nine months ended September 30, 2010, revenue from Peregrine was $218,750 and $2,113,250. As of September 30, 2010 and December 31, 2009, accounts receivable from Peregrine was $638,740 and $162,000. The pricing terms and conditions of the sales to Peregrine are similar to those available to the Company’s other non-related customers.

6. SIGNIFICANT CUSTOMERS

For the three months ended September 30, 2010, the Company had four customers that accounted for approximately 17%, 16%, 15% and 11% of its revenue and for the three months ended September 30, 2009, the Company had two customers that accounted for approximately 28% and 24% of its revenue. For the nine months ended September 30, 2010, the Company had four customers that accounted for approximately 19%, 14%, 12% and 10% of its revenue and for the nine months ended September 30, 2009, the Company had four customers that accounted for approximately 23%, 20%, 13% and 11% of its revenue.

Customers individually representing more than 10% of trade receivables accounted for approximately 76% and 68% of accounts receivable as of September 30, 2010 and December 31, 2009, respectively. The Company grants credit to customers based on an evaluation of their financial condition. Losses from credit sales are provided for in the financial statements.

7. STOCKHOLDERS’ EQUITY

Common Stock

As of September 30, 2010, the Company had 85,000,000 shares of common stock authorized with a par value of $0.001 and the Company had reserved 1,821,518 shares of common stock for issuance upon the exercise of outstanding common stock options. Also, 676,349 shares of the Company’s common stock were reserved for future grants of stock options (or other similar equity instruments) under the Company’s 2001 Equity Plan (the “2001 Plan”) and 2007 Stock Incentive Plan (the “2007 Plan”) as of September 30, 2010. In addition, 281,561 shares of the Company’s common stock were reserved for future exercise of outstanding warrants as of September 30, 2010.

On June 21, 2010, the Company completed a public offering of common stock in which a total of 3,029,100 shares were sold at a price of $30.00 per share. The Company sold 2,195,100 shares of common stock, including 395,100 shares pursuant to the full exercise of the underwriter’s over-allotment option, and 834,000 shares of common stock were sold by certain stockholders of the Company. The Company raised a total of $65.9 million in gross proceeds from the offering, or approximately $61.7 million in net proceeds after deducting the underwriting discount and commissions of $3.5 million and estimated other offering costs of approximately $712,000. The Company did not receive any of the proceeds from the sale of common stock by the selling stockholders.

Warrants

For the three and nine months ended September 30, 2010, no common stock warrants were exercised. At September 30, 2010 and December 31, 2009, there were 281,561 common stock warrants outstanding.

8. STOCK INCENTIVE PLANS

The Company sponsors a stock option plan, the 2001 Plan, which allows for the grant of incentive and nonqualified stock options for the purchase of common stock. Each option entitles the holder to purchase one share of common stock at the specified option exercise price. The exercise price of each incentive stock option granted must not be less than the fair market value on the grant date. At the discretion of management and with the approval of the Board of Directors, the Company may grant options under the 2001 Plan. Management and the Board of Directors determine vesting periods and expiration dates at the time of the grant.

In August 2007, the Company adopted the 2007 Plan, which allows for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards and bonus shares. The maximum number of shares which may be awarded or sold under the 2007 Plan is 2,307,692 shares. The Board of Directors has appointed a committee to administer the plan. The plan committee determines the type of award to be granted, the fair market value, the number of shares covered by the award, and the time when the award vests and may be exercised.

The Company uses the Black-Scholes option pricing model to value stock options issued after January 1, 2006. The Company uses historical stock prices of companies which it considers as a peer group as the basis for its volatility assumptions. The assumed risk-free rates were based on US Treasury rates in effect at the time of grant with a term consistent with the expected option lives. The expected term is based upon the vesting term of the Company’s options, a review of a peer group of companies, and expected exercise behavior. The forfeiture rate is based on past history of forfeited options. The expense is being allocated using the straight-line method. For the three and nine months ended September 30, 2010, the Company recorded $533,161 and $1,473,797, respectively, of stock compensation expense. For the three and nine months ended September 30, 2009, the Company recorded $200,251 and $560,744, respectively, of stock compensation expense. As of September 30, 2010, the Company has $5,910,254 of total unrecognized compensation cost related to non-vested awards granted under the Company’s stock-based plans that it expects to recognize over a weighted-average period of 3.05 years. The Company accounts for options issued prior to January 1, 2006 under the intrinsic value method.

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The following table summarizes the activity of the stock incentive and equity plans as of September 30, 2010 and changes during the nine months then ended:

The weighted average fair value per share of options granted for the three and nine months ended September 30, 2010 was $27.20 and $28.37, respectively, and the fair value of each option grant was estimated at the date of grant using the Black-Scholes option-pricing model using an expected term of 5.2 years, risk-free interest rates of 0.23% - 0.75%, expected volatility of 60% and no dividend yield. The Company used an expected forfeiture rate of 27.54%.

For the three and nine months ended September 30, 2010, the Company recorded $19,563 and $92,260, respectively, of stock compensation expense related to restricted stock. For the three and nine months ended September 30, 2009, the Company recorded $28,499 and $85,498, respectively, of stock compensation expense related to restricted stock.

A summary of the Company’s non-vested options during the nine month period ended September 30, 2010 is presented below:

An analysis of restricted stock issued is as follows:

9. COMMITMENTS AND CONTINGENCIES

Purchase Commitments

The Company has entered into agreements to purchase equipment and components to construct furnaces and to complete building construction. These agreements will result in the Company purchasing equipment, components and land for a total cost of approximately $10.1 million, with deliveries occurring through April 2011.

Litigation

From time to time, the Company experiences routine litigation in the normal course of its business. The management of the Company does not believe any pending litigation will have a material adverse effect on the financial condition or results of operations of the Company.

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All statements, other than statements of historical facts, included in this Quarterly Report on Form 10-Q regarding our estimates, expectations, beliefs, intentions, projections or strategies for the future, results of operations, financial position, net sales, projected costs, prospects and plans and objectives of management for future operations may be “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. We have based these forward-looking statements on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. These forward looking statements can be identified by the use of terms and phrases such as “believe,” “plan,” “intend,” “anticipate,” “target,” “estimate,” “expect,” and the like, and/or future-tense or conditional constructions such as “will,” “may,” “could,” “should,” etc. (or the negative thereof). Items contemplating or making assumptions about actual or potential future sales, market size and trends or operating results also constitute forward-looking statements.

Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Before investing in our common stock, investors should be aware that the occurrence of the risks, uncertainties and events described in the section entitled “Risk factors” in our Annual Report on Form 10-K and elsewhere in this Quarterly Report could have a material adverse effect on our business, results of operations and financial condition.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, forward-looking statements are inherently subject to known and unknown business, economic and other risks and uncertainties that may cause actual results to be materially different from those discussed in these forward-looking statements. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We assume no obligation to update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report, other than as may be required by applicable law or regulation. If one or more of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect, our actual results may vary materially from those expected or projected.

You should read this Quarterly Report, the documents that we reference in this Quarterly Report and have filed with the SEC as exhibits and our Annual Report on Form 10-K for the year ended December 31, 2009 with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

Unless otherwise indicated, the terms “Rubicon,” the “Company,” “we,” “us,” and “our” refer to Rubicon Technology, Inc.

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. Our largest product line is two inch to six inch sapphire cores and wafers for use in LEDs and blue laser diodes for solid state lighting and electronic applications. For the LED market we sell two inch 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 research and development efforts at this time. In addition, we sell six inch sapphire wafers that are used for Silicon-on-Sapphire (“SOS”) RFICs, as well as products for military, aerospace, sensor and other applications. We have also extended our technology, which gives us the ability to produce cores and wafers of up to twelve inches in diameter to support next-generation LED and SOS RFIC production. We have also 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. In 2010, our sales have been focused on core and large diameter polished wafers where our profit margins are higher. Products are made to varying specifications, such as crystal planar orientations and thicknesses.

Historically, a significant portion of our revenue has been derived from sales to relatively few customers. For the three months ended September 30, 2010, we had four customers that accounted for approximately 17%, 16%, 15% and 11% of our revenue and for the three months ended September 30, 2009, we had two customers that accounted for approximately 28% and 24% of our revenue. For the nine months ended September 30, 2010, we had four customers that accounted for approximately 19%, 14%, 12% and 10% of our revenue and for the nine months ended September 30, 2009, we had four customers that accounted for approximately 23%, 20%, 13% and 11% 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 continuing 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.

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We recognize revenue upon shipment to our customers. We derive a significant portion of our revenue from customers outside of the US. 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 is denominated in US dollars.

Our revenue for the three and nine months ended September 30, 2009 was significantly impacted by the global recession. Much of the sapphire we sell into the marketplace goes into LED lighting for consumer electronics. Consumer spending on these products declined during the recession, which decreased demand for our products. Toward the end of 2009, demand for sapphire began to strengthen as consumers resumed spending on consumer electronics, driven, in part, by the introduction of new products such as LED backlit LCD televisions. In addition to the increased demand, we experienced higher average selling prices for our products in the three and nine months ended September 30, 2010.

We manufacture and ship our products from our facilities in the Chicago metropolitan area. We have approximately 102,600 square feet of manufacturing and office space. We have completed construction of a 65,000 square foot facility in Penang, Malaysia, which will process sapphire grown by us in our Illinois facilities into finished cores and wafers. This facility is now processing cores. We expect some wafer production will come on line at the end of the fourth quarter of 2010. We also acquired in April 2010 a 134,400 square foot building in Batavia, Illinois to expand our crystal growth operations. This facility will also begin operations in the fourth quarter of 2010.

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 manufacturing facilities based on customer orders. We purchase materials and supplies to support such 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 our suppliers.

Our operating expenses are comprised of sales and marketing, research and development (“R&D”), and general and administrative (“G&A”) expenses. G&A expenses consist primarily of salaries and associated costs for employees in finance, human resources, information technology and administrative activities, charges for accounting, legal, and insurance fees, and stock-based compensation. The majority of our stock-based compensation relates to administrative personnel and is accounted for as a G&A expense.

Other income (expense) consists of interest income and expense, gains and losses on investments and currency translation. For the three and nine months ended September 30, 2010, interest income was $43,000 and $196,000, partially offset by a realized loss on currency translation of $13,000 and $72,000. For the three and nine months ended September 30, 2009, other income was $133,000 and $590,000 and consisted mainly of interest income.

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. A full valuation allowance is provided as management cannot conclude that it is more likely than not that our deferred tax assets will be realized. At December 31, 2009, we had approximately $55.6 million in net operating loss carryforwards (“NOLs”). We believe that we are not restricted in our ability to use the full amount of the NOLs, nor is there a limit to the amount of NOLs that may be used in any given year, however, we will update our analysis in 2010 and the results of that analysis may indicate an ownership change. If an ownership change is determined, the utilization of the NOLs may be limited. As of September 30, 2010, no tax benefit has been recognized for these NOLs.

We anticipate our capital expenditures will be approximately $45 million in 2010. These expenditures will be primarily focused on expansion projects in Illinois and Malaysia. Our capital expenditures in the three and nine months ended September 30, 2010 were $15.2 million and $34.9 million.

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RESULTS OF CONSOLIDATED OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

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

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

Revenue. Revenue was $20.5 million for the three months ended September 30, 2010 and $5.7 million for the three months ended September 30, 2009, an increase of $14.8 million. We experienced a significant increase in revenue across most product lines and diameters due to increased demand for our products due to an improved market and pricing environment. Revenue from the sale of core products for the three months ended September 30, 2010 increased by $10.7 million, of which $2.2 million was attributed to volume and $8.5 million was due to an increase in pricing. This increase was partially offset by a decrease in as-cut and as-ground sales of $283,000 attributable to focusing production on higher margin core products. We also increased our sales of polished wafers by $4.2 million attributable to increased demand for these products from the LED markets. We also had higher revenue of $168,000 from optical products due to increased sales of sapphire for military, sensor and instrumentation applications. While we have seen some softening of demand in the television backlighting segment of the LED market, overall demand for sapphire substrates remains strong and we expect additional increase in pricing for the remainder of 2010. However, the rate of increase will likely be slower than what we experienced in recent months.

Gross profit (loss). Gross profit was $11.1 million for the three months ended September 30, 2010 compared to a gross loss of $406,000 for the three months ended September 30, 2009, an increase of $11.5 million. The increase in gross profit is primarily

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attributable to higher revenue of $14.8 million and better utilization of equipment and staff, which led to improved operating leverage and higher throughput. In addition, sales of larger diameter products, which have a higher gross profit margin, increased by $8.6 million. In 2009, with the decrease in orders due to poor market and economic conditions, we experienced lower utilization of equipment and staff which resulted in under-absorbed manufacturing costs of approximately $702,000.

General and administrative expenses. G&A expenses were $2.4 million for the three months ended September 30, 2010 and $1.3 million for the three months ended September 30, 2009, an increase of $1.1 million. The increase was due in part to increased employee compensation costs of $921,000, of which $556,000 was from increased bonus accrual as no bonus was earned in 2009. We also experienced increased costs of $169,000 from additional training and other information technology expenses related to the startup of the Malaysian facility. Bad debt expense also increased $40,000 due to an overall increase in the accounts receivable balance.

Sales and marketing expenses. Sales and marketing expenses were $329,000 for the three months ended September 30, 2010 and $310,000 for the three months ended September 30, 2009, an increase of $19,000. The increase in sales and marketing expenses is attributable to additional employee compensation costs partially offset by a decrease in travel and commission expense.

Research and development expenses. R&D expenses were $260,000 for the three months ended September 30, 2010 and $216,000 for the three months ended September 30, 2009, an increase of $44,000. The increase was primarily attributable to an increase in employee compensation costs of $15,000 and additional spending on various projects of $32,000.

Other income (expense). Other income (expense) was $30,000 for the three months ended September 30, 2010 and $134,000 for the three months ended September 30, 2009, a decrease in net other income of $104,000. The decrease was primarily due to lower interest income of $106,000 largely a result of lower interest rates on our investment portfolio.

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RESULTS OF CONSOLIDATED OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

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

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

Revenue. Revenue was $47.8 million for the nine months ended September 30, 2010 and $11.3 million for the nine months ended September 30, 2009, an increase of $36.5 million. We experienced a significant increase in revenue across most product lines and diameters due to increased demand for our products as the market rebounded significantly. Revenue from the sale of core products for the nine months ended September 30, 2010 increased by $27.6 million, of which $14.2 million was attributable to volume and $13.4 million was due to an increase in pricing. We also increased our sales of polished wafers by $9.6 million as demand for these products increased in both the LED and SOS RFIC markets. We also had higher revenue of $947,000 from optical products due to increased sales of sapphire for military, sensor and instrumentation applications. This increase was partially offset by a decrease in as-cut sales of $1.6 million attributed to focusing production on higher margin core products.

Gross profit (loss). Gross profit was $22.5 million for the nine months ended September 30, 2010 and gross loss was $4.7 million for the nine months ended September 30, 2009, an increase of $27.2 million. The increase in gross profit is primarily attributable to higher revenue of $36.5 million and better utilization of equipment and staff, which led to improved operating leverage and higher throughput. In addition, sales of larger diameter products, which have a higher gross profit margin, increased by $23.6 million. In 2009, with the decrease in orders, we experienced lower utilization of equipment and staff which resulted in under-absorbed manufacturing costs of approximately $5.2 million.

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General and administrative expenses. G&A expenses were $6.9 million for the nine months ended September 30, 2010 and $3.4 million for the nine months ended September 30, 2009, an increase of $3.5 million. The increase was due to an increase in employee compensation costs of $2.4 million, of which $1.3 million was from increased bonus costs as no bonus was earned in 2009 and $1.1 million was from annual salary increases and expenses associated with the issuance and exercise of employee stock options. Bad debt expense increased $467,000 as 2009 included a reduction of our reserve on collection of an over 90 days past due receivable as well as an increase in the accounts receivables balance. Directors’ costs increased $151,000 due in part to $65,000 of costs associated with accelerating the last year of vesting of certain restricted shares for a director who resigned from our board and an increase in compensation in 2010. We also experienced an increase in expenses of $319,000 from additional recruiting, training, travel, information technology and other miscellaneous expenses related to the startup of the Malaysian facility.

Sales and marketing expenses. Sales and marketing expenses were $892,000 for the nine months ended September 30, 2010 and $799,000 for the nine months ended September 30, 2009, an increase of $93,000. The increase in sales and marketing expenses is attributable to increased employee compensation costs primarily due to annual salary increases and employee stock options expense and increased travel expense.

Research and development expenses. R&D expenses were $706,000 for the nine months ended September 30, 2010 and $566,000 for the nine months ended September 30, 2009, an increase of $140,000. The increase is attributable to higher employee compensation costs of $71,000 and an increase in spending on projects.

Other income (expense). Other income (expense) was $132,000 for the nine months ended September 30, 2010 and $590,000 for the nine months ended September 30, 2009, a decrease in net other income of $458,000. The decrease was primarily due to lower interest income of $360,000 as a result of lower interest rates as well as a $72,000 loss on currency translation not incurred in 2009.

LIQUIDITY AND CAPITAL RESOURCES

We historically funded our operations using a combination of issuances of common stock and preferred stock, a working capital line of credit, term loans and cash generated from our operations.

As of September 30, 2010, we had cash and short term investments totaling $83.1 million, including cash of $1.9 million held in deposits at major banks, $10.1 million invested in money market funds and short term investments in certificates of deposit, commercial paper, state and local bonds, and US treasury securities of $71.1 million. Our long term investment consists of a $2.0 million investment in Peregrine Semiconductor, Corp. (one of our customers) Series D1 preferred stock. In February 2008, we began experiencing failed auctions of our entire auction-rate securities portfolio, resulting in our inability to sell these securities in the short term. We held put options associated with an agreement with UBS, AG related to the auction-rate securities purchased through them. We exercised these put options on June 30, 2010 with settlement on July 1, 2010.

As noted above, we entered into an agreement with UBS, AG, which provided us with certain rights to sell to UBS, AG all of our auction-rate securities that were purchased through them. We had the option to sell these securities to UBS, AG at par value from June 30, 2010 through July 2, 2012.

Our right to sell the auction-rate securities to UBS, AG commencing on June 30, 2010, represented put options for a payment equal to the par value of the auction-rate securities. We exercised the put options on June 30, 2010 with a settlement date of July 1, 2010 for a payment equal to the par value of the auction-rate securities. During the nine months ended September 30, 2010 and 2009, we recorded a realized loss of $55,279 and $463,644, respectively, representing the changes in fair value of the put options. We also recorded during the nine months ended September 30, 2010 and 2009, a gain of $63,466 and $499,520, respectively, representing the changes in fair value of the auction-rate securities. Both the gain and loss from recording the change in fair value of the put options and auction-rate securities were recorded in gain (loss) on investments in the Consolidated Statements of Operations. The Company’s investment policy no longer includes auction-rate securities as an approved investment.

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Cash flows from operating activities

The following table represents the major components of our cash flows from operating activities for the nine months ended September 30, 2010 and 2009: