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Executives

Guido Pickert – Director, IR

Paul Hyland – President and CEO

Wolfgang Breme – EVP and CFO

Analysts

Mark Miller – Noble Capital

David Mulholland – UBS

Steve Babureck – Exane

Tim Arcuri – Citi

Daniel Amir – Lazard

Andrew Abrams [ph] – AVI [ph]

Bill Ong – Merriman & Company

Andrew Huang – Sterne Agee

Olga Levinson – Barclays Capital

Peter Knox – SG

Janardan Menon – Liberum Capital

Adrian Hopkinson – WestLB

Jagadish Iyer – Arete Research

Simon Schafer – Goldman Sachs

Jeff Bencik – Kaufman Brothers

Sandeep Deshpande – JP Morgan

Malte Schaumann – Warburg Research

Aixtron AG (AIXG) Q4 2010 Earnings Conference Call March 1, 2011 9:00 AM ET

Operator

Good afternoon, ladies and gentlemen. And welcome to the Aixtron Full Year 2010 Results Conference Call.

Today's call is being recorded and I would like to hand you over to Mr. Guido Pickert, Director of Investor Relations at Aixtron for opening remarks and introductions.

Guido Pickert

Thank you very much. Good afternoon and good morning, everyone, and thank you for attending today's call. I should point out to you that this is the first public conference call that we have held since converting from an AG company structure into an SE registered company.

I would like to stress that the conversion, which formally took place on December 22nd of last year has no effect on – either has no effect on either the matured content or the presentation of our financial results, either now or in the future and as such you will not need to receive any other information beyond what has been published today.

With us again as always are Paul Hyland, President and Chief Executive Officer of Aixtron; and Wolfgang Breme, Executive Vice President and Chief Financial Officer of Aixtron.

As the operator indicated, this call is being recorded by Aixtron and is considered copyright material. As such it cannot be recorded or rebroadcast without express permission. Your participation in this call implies your consent to this recording.

As with previous results conference calls, I trust that all participants have our results presentation slides, page two of which contains the usual Safe Harbor statement. I will therefore not read it out but would like to point out to you that it applies throughout this conference call.

You may also wish to have a look at our latest IR presentation, which is also available on the internet, which includes additional information on markets and technology. This call is not being immediately presented via webcast or any other new medium. However, we will place an audio file of the recording or transcript on our website at some point after the call.

Let me now hand you over to Paul Hyland, Aixtron's President and CEO to start the actual presentation. Paul?

Paul Hyland

Thank you, Guido. Ladies and gentlemen, good afternoon to those of you calling in from Europe, good morning to those of you joining us from the U.S. and good evening to investors calling in from Asia. I'd like to welcome you on behalf of Aixtron's Executive Board to presentation of our full year 2010 results.

I should start by saying we have good reason to be proud of these results, not only because they represent another record performance of Aixtron, the third one in a row. But also, in addition, to absolute increase in volume, we've also been able a very high standard in the quality of our earnings growth as well.

I would start the presentation by giving you an overview of the financial highlights and some points on the general market environment which influenced our 2010 results. Wolfgang Breme, our CFO, will then take you through some important aspects of our financial and business performance. I will then close the presentation by coming back to some of the most prominent questions in the market and finish with a breakdown of our financial guidance for 2011.

Let's start by turning to slide three and look at some financial highlights for the year 2010. I'm not going to go through all the numbers on this slide but let me just touch on some of them. 2010 revenues ended up a little higher than our guidance at just under €784 million, which is more than $1 billion at the current exchange rate. This is 2.5 times more than the 2009 total revenue figure.

There are number of reasons for this extraordinary growth, not least of which was the early signs of the emergence of LED lighting applications. The U.S. dollar appreciated by about 5% against the euro last year, using annual exchange rate averages, which gave some additional impetus to our euro recorded revenues.

In terms of our customers' needs, systems demand for backlighting LEDs from LCD TV and monitor producers grew rapidly during the year and was significantly enhanced by early demand for LED lighting production equipment. I'll come back to these themes later.

Crucial to our 2010 success story was our operational setup, which was flexible enough to respond quickly and efficiently to the significant increase in demand we experienced during 2010. The outcome of that response is reflected in the quality of the result we are presenting to you today.

This result includes our gross margin increasing from 44% in 2009 to 50% last year and our EBIT more than quadrupling to over €275 million taking the operating margin to 35% in the process.

Our 2010 EBIT performance deserves special mention because it highlights how far we've come over recent years. The absolute 2010 EBIT figure alone is higher than the total revenues for 2008. Consequently, in comparison to 2009, our basic earnings per share nearly quadrupled to €1.93 during 2010.

Our orders steadily increased throughout the year, consolidating on a high level of €204 million in Q4, taking our systems order intake for 2010 to a record level of €748.3 million. Backlog stood at €274.8 million, which is the highest year-end backlog the company has ever recorded. Our opening backlog coming into 2011 stood at €302.3 million, revalued at our current budget rate of $1.35 to the euro.

While this performance could not have been achieved without the extraordinary commitment and responsiveness we got from the Aixtron team during 2010, equally we own much to the structural decisions we made several years ago, which have delivered the flexible platform we work with today.

I believe in the future we will be able to similarly reflect on the very substantial investment decisions we're making today in R&D, which we are convinced will be decisive factors in the long-term sustainability of our market leadership position. We spent close to $46 U.S. last year on R&D and will have spent a similar figure on building our new R&D center here in Germany, which will be completed by the beginning of 2012.

Moving now to slide four, our operational flexibility and leverage chart, which most of you will be familiar with. It provides clear evidence of my earlier claims on the flexibility and leverage in our business model. Comparable with the 102% growth in system order intake we've seen in 2010, our absolute SG&A costs have risen by 70% year-on-year, to just under €80 million, against nearly €47 million for 2009.

However, as a percentage of total revenues, they have dropped by a third from 15% in 2009 to 10% in 2010, which quantifies the operating leverage we've managed to build into our organization. The very positive leverage of our gross margin, EBIT margin and return on equity are equally impressive when seen here in the context of the developments over the last five years and compare very favorably with our peer group.

I'll now hand you over to Wolfgang, who will take you through a few slides to discuss our financial performance in more detail. Wolfgang?

Wolfgang Breme

Thank you, Paul, and hello to everyone on the call. Rather than rattling through all of the numbers on the financial statement, I would just like to pick out a few which I think are worth focusing at.

The first one of these is the gross margin on our income statement on slide five, Paul has already alluded to or rather I would like to talk about what's behind that figure, because the jump from 44% to just under 53% looks good, but what does not justice to what we needed to be achieved under – to deliver that increase. We had to ramp-up our capacity from under 200 systems in 2009 to significantly more than 400 systems in 2010. In other words, we were able to more than double our output.

Our suppliers had to increase their capacity repeatedly throughout the year and their superb response to that challenge reflects the strength of our supply strategy. All of this was achieved with very little additional investment.

The second figure on the income statement I want to have a closer look at are the selling expenses, which nearly doubled. This is largely volume-related, on the one hand for warranty provisions, but on the other hand, also for sales commissions. However, discretionary expenses fell in relative terms and enabled us once again to record a falling percentage of selling costs to revenues of 10% in 2008 to 8% in 2009 to 6% in 2010.

And the third figure on the income statement I would like to talk about is our R&D spend. With €46 million, we spent 40% more on research and development during 2010 than we did during 2009. Because this is a large increase, let me give you a few examples of what we did with this money and in this context, what we intend to do on the R&D front this year and beyond.

During 2010 we increased our research personnel by 20% compared to 2009. Our R&D team is now four times larger than our global sales team, which tells you a lot about the intensity of our effort in this area. This explains most of the incremental spend. The rest is material expenses and depreciation.

In terms of projects, much of the work done by our R&D team is in conjunction and collaboration with universities, research centers and industrial partners worldwide. For 2010 and beyond, we plan to further increase our R&D expenditures, which underlines our commitment to this area, enabling us to remain a recognized technology and market leader.

I think you will agree that investment into R&D is the foundation for future success. As Paul has written in his letter to our shareholders and as I'm sure he will repeat to you later, if you do not invest extensively today you will not compete tomorrow.

Finally, a quick look at our net result and especially what we will do with it. Aixtron generated a group net result of €192.5 million in 2010, which represents a net return on sales of 25%. As you know, according to our dividend policy, we will endeavor to pay out about one-third of our group net result as dividend to our shareholders.

This is unchanged for 2010. We intend to propose to our AGM, which will take place on May 19th in Aachen, to pay a per share dividend of €0.60 per share. If approved as proposed, the dividend will take €61 million out of our cash reserves mid-year, which has to be provided for when planning our cash flows for 2011.

Let's now move on to slide six and our balance sheet slide. There are three figures I would like to discuss in more detail, property, plant and equipment, our cash position and advanced customer payments.

First, PP&E, this value has more than doubled because of the investment into our new R&D center in Herzogenrath. Phase I of the building project was completed, as many of you know in October 2010 and approximately 250 staff has now moved in.

Phase Two is scheduled to be finished early 2012 and includes a new application lab, as well as a production facility for prototypes. This additional facility will house a further 150 personnel.

Upon completion of the first two phases of this project, we will have spent in excess of €40 million on this new facility. Additional, of course, we will have invested in new laboratory equipment for this facility.

The second and third figure I would like to look at is our total cash position and the advanced payments of customers. Our cash and cash equivalents, including cash deposits figure of almost €385 million still includes some of the proceeds from the capital increase we carried out in October 2009 and is 28% higher than at the end of 2009.

The growth is due mainly to two factors, first, our net profit of €192.5 million, second, advanced payments from customers, as one of my focal points of this slide increased by almost €30 million in comparison with 2009.

This is an important consideration for those of you who have commented on our cash levels in the past. Our response has always been and continues to be that, given the demand volatility our industry is subject to, it is prudent and rational to maintain safe cash balances.

Our cash position strategy is not dissimilar to our peer group and if you calculate a figure that I would call our net cash position or cash balances without customer prepayments, and relate this figure to total cash and cash equivalents and compare it with other companies in the semiconductor industry, you will find that Aixtron is actually well within the industry spectrum.

Needless to say that Aixtron is well funded at this point and fully able to finance all its operational and investment requirements. It also continues to have no restrictions on its use of cash resources, as well as full access to capital markets.

The cash flow statement on the following slide, slide seven, does not contain anything that should surprise you. So let's just take a brief look at it. As you would expect, most of the cash inflow from operating activities of just under €148 million comes from our substantially increased net result.

The difference between net profit and operating cash flow is largely explained as in previous year by increased working capital requirements resulting from our strong growing business. About two-thirds of the investing cash outflow are due to investments in money market deposits. You will find them again on the detailed balance sheet as other financial assets.

The rest of this CapEx, chiefly for the new R&D facilities in Herzogenrath, as you have heard before. Our cash outflow from financing activities of about €12 million in 2010 will be significantly higher this year, as it will include dividend payment of more than €60 million if the Annual General Meeting in May follows our proposal.

Slide eight shows you the familiar chart over eight quarters of equipment order intake and backlog valued in 2010 at our budgeted exchange rate of $1.50 U.S. per euro and total revenues at actual rate. You can see from the top chart that Q4 order intake has remained at a high level compared with the previous quarters and is within 2% of the prior quarter.

Looking at this development, we'd like to point out to you that we generated a new order intake record five quarters in a row and overall, our order intake more than doubled relative to the previous year.

More encouragingly still, we saw a growing component of orders intended for lighting applications rather than backlighting applications. Lighting is coming, ladies and gentlemen. It's still an emerging source of demand and still in its early stages of development but it's coming slowly but surely. Paul will tell you more about our expectations for 2011 later, so I will leave it at that.

In accordance with our order intake figures and bearing a relatively stable lead time of about four to six months, our order backlog grew as well. At an exchange of $1.50, we were able to record a firm backlog €275 million at the end of 2010, 35% higher than at the end of 2009, which supports our confidence regarding Aixtron's prospects for this year.

By firm I mean that our very strict conditions for the recognition of orders continues to apply, we will recognize orders only once we have received a firm purchase order and agreed financing arrangements such as deposits or letters of credit and have confirmed a delivery date with our customers.

As usual, we recalculate our year-end order backlog on the basis of the New Year's budgeted exchange rate of $1.35 U.S. per euro, which gives a year opening backlog worth €302.3 million.

Revenues increased in line with strong demand for the past seven quarters, which we consider a remarkable operational performance.

Let me now move on to the next slide without delay. There is not much news on the revenue composition front. 94% of revenues came from systems, the remaining 6% from spares and services. Spares and services are 3 percentage points lower than in 2009, suppressed in relative terms by the higher number of systems shipped during the year. As you will see later, we expect the contribution made by spares and other non-equipment revenues will be lower still in 2011, a trend, however that may well revert in future years.

The response of our customers to the new generation of production systems we introduced at the beginning of 2010 continues to be extremely positive and we have no reasons to doubt that we will achieve the targeted penetration rate of 60% of shipped systems within one year of launch.

A large majority of our systems namely 93% are used to manufacture LEDs, still primarily for backlighting purposes but increasingly also for general lighting applications. We will – while it continues to be very difficult to estimate how many of our systems are now used to make LEDs for general lighting purposes, we continue to believe that about one-third of the deliveries made during the year 2010 are now being used for this purpose in one form or another.

Regionally, 91% of revenues were generated by sales to Asia, an increase of 8 percentage points compared to 2009. The remaining 9% was split almost equally between Europe and the United States.

Ladies and gentlemen, thank you for your attention for now. Let me now hand you back to Paul for his strategic observations regarding 2011 and beyond. I will be, of course, available for questions later on. Paul?

Paul Hyland

Okay. Thank you, Wolfgang. Before we go to our guidance for 2011, I want to try to give you an insight into how we are managing the current environment. On slide 10, you can see what we believe are elements of our very positive prospects for 2011 and beyond.

It's important to say up front we remain confident in Aixtron's business positioning and our strategic prospects. Our consistent track record in the past and our increasing investments for the future underpin that confidence.

However, one very significant business condition remains. That is that our very detailed operational visibility continues to be limited to about two quarters ahead. There is little we can do about that at present. It simply reflects the market environment. But that said, the very high order backlog to revenue conversion rate, it was 78% in the fourth quarter of 2010, illustrates we've been able to adapt our business to accommodate such short horizon visibility.

Let me now talk to you about the three market-related questions that I get asked more than any others. Before I do, let me tell you in advance, we do not have full answers to these questions, but I will share with you our thoughts on the issues raised.

The first question is, how much longer will the demand for systems for LED backlighting cycle last? The second question is, when will the volume demand for systems for general lighting applications start? And implicit in both of these questions is the elephant in the room, is there a demand gap between these two investment cycles and if there is a gap, how wide and how deep is it?

The third question actually has many elements to it but it can be summarized by the question, what is happening in China. Let me try and answer those questions to the relatively limited extent I'm able to today.

First, the backlighting cycle. Let's start with what we think we know. According to a relatively recent report by market analysts from Display Search, they believe that of the 150 million LCD TVs sold in 2009, only 3.9 million or 2.6% were LED backlight.

Their estimates for 2010 and beyond are that LED TVs will have accounted for 25% of the 216 million LCDs sold in 2010, 50% of the 238 million in 2011 and 80% of the 262 million in 2012 and that the LCD industry will be completely LED backlit by 2013.

If I reflect on what I saw at the CES booths in January and heard at Strategies in Light Conference last week, I'm tempted to be more bullish than that. I could imagine that as a best case/worst case scenario, we could see a 100% penetration being achieved by the end of 2012 or mid-2013 at the latest.

Of course, it's not just TVs. The 200 million plus units a year monitor market is also very rapidly converting over to LEDs, but given that they are served by the same supplier base, it's likely to be on a similar timescale.

Just to try to keep this deliberately simple, if we assume that the procurement of MOCVD systems occurs typically 12 months before the effect is seen at retail level, then we could speculate that this year 2011, could as a worst case, be the last year in which significant MOCVD system demand comes from pure capacity buys for LED backlighting. And I'd stress this is the worst-case scenario. The best case would be 12 months later.

The second question of when LED lighting starts is more difficult, but no one is going to argue that it has not started. Not a month passes without more early positioning lighting products being launched and in many cases, by companies that in the past we might not have associated with lighting products. It's not just a question of technology replacement, of LEDs replacing incandescents. It's also a question of a likely change in market participation.

The list of players in the lighting market is almost certainly going to look very different in five years time and it could be that we're entering a structurally disruptive period for the lighting industry, which has the potential to increase the degree of aggressive investments by the principal participates. We'll have to wait and see to what degree that happens.

Where are we looking to measure the early momentum in this area, namely lighting products? In the case of municipal and street lighting, there is already clear evidence of intent in the form of top down state subsidies being used globally to both start energy-efficient programs and the same subsidies being used to encourage domestic LED industries.

In the area of commercial lighting, we're seeing considerable focus on the ubiquitous 60-watt equivalent light, which is by far the most commodity light output used in extended usage scenarios, where the monetary value of energy savings plays a more significant role in making the premium cost acceptable in a return on investment/cost of ownership calculation.

The average cost today of a 60-watt LED equivalent in the U.S. is about US$35. In Japan, it's already being sold in places at less than $25. My personal guess is that the volume tipping point for commercial traction will probably kick in when that price declines into the US$20 to US$15 range.

How long will that take? I don't know, but if I look at the efforts being put in globally and that the quality of the company names involved, old and new, I would not expect it to be so long. It may not even be how long will it take for someone to be able to make it at that price, but when will someone be willing to sell at that price.

Now, to address the elephant in the room question, will there be a gap between these two cycles, no one can give a guaranteed answer to that question, but I'm certain that the likelihood of a gap is diminishing each and every quarter, not the least because of the third question, what is happening in China?

What is happening in China and has been since mid-2009 is that the Chinese government has initiated a substantial investment program as indeed have many local government bodies in China, focused on accelerating the development of a sustainable LED industry. They're at the forefront of both using top down capital project subsidies and in parallel, bottom up industrial subsidies to create both critical mass and a platform for technology development.

Apart from their global commercial aspirations, they're also highly motivated by the high potential internal benefits that will arrive from having access to energy efficient lighting.

Much has been made of the rumors concerning the risk of Chinese subsidies being stopped in the short-term but very little has been made of the inclusion of LEDs as one of the target technologies in the 12th Five Year Plan the Chinese plan to roll out in detail later this month.

It may take China some time to overcome the technology and IP gap issues that exist between the average Chinese company and the rest of the world, but their track record in relentlessly pursuing their chosen strategy should tell you it's not a question of if, it's only a question of when and in partnership with whom.

You'll have to decide for yourself if a combination of these factors closes the gap between the two cycles or not, but in our opinion that gap is closing more rapidly than any of us would have thought even 12 months ago.

Although there can be no doubt we've already moved from being a small, technical niche market to the point where we're now serving two major end markets, namely consumer electronics and the energy utility market both of which have significantly more sustainable critical mass.

The longer term question is not dissimilar to that which faces the solar cell market, namely where is the transition point between the industry being subsidy-driven to when it becomes market-led? I certainly don't have a definitive answer to that question but the increased investments by established LED companies and the rush of new players into LED space suggests to me that it may come in a shorter time scale that in the solar cell industry.

You could now turn to slide 11, I'd like to consolidate those thoughts on the market environment and tell you what it could mean in terms of our guidance for 2011.

Despite the traditional lack of visibility beyond two quarters, we believe that 2011 and 2012 have the clear potential to be another growth period for Aixtron. You can see in the red segment on the right side of the 2011 guidance pie chart, that we already have more than €300 million of system orders in our order backlog, all of which are due for delivery in 2011.

As most of you already know, at Aixtron we only recognize orders as order intake and backlog when all of our internal conditions are met. Even signed contracts with paid deposits remain as firm prospects until we have received confirmed delivery dates for each system ordered.

We do not plan to change this long-term policy of prudent risk management, which has consistently protected us from having to report push-outs or cancellations. With this prudent approach, €302 million represents a very reliable and solid foundation for 2011.

As you can see in the lower green segment of the pie chart, we're expecting about €40 million to come from spares revenue in 2011. And finally, in the blue segment, on the left hand side of the pie chart, you can see that we need to receive about €458 million to €558 million of shippable orders to achieve our revenue guidance for 2011 of €800 to €900 million, from which we would expect to generate an EBIT margin of around 35%.

This concludes our 2010 year-end presentation and I'd like to hand you back – thank you for your attention and turn the call back to the operator to be able to start the Q&A session.

Guido Pickert

Thank you, Paul. Let me make one more remark before we hand the call over to the operator for the following Q&A session. Since we have a quite long list of people waiting to ask questions, we would ask you to limit your questions to a maximum of maybe two each time. If you can do that, this will, hopefully, allow everyone to ask their questions. You are, of course, welcome to join the queue again if you wish. Your cooperation on this is much appreciated as you can imagine.

I will now pass you back to the operator. Operator?

Question-and-Answer Session

Operator

Thank you, gentlemen. Let me now open the conference call for the Q&A session. (Operator Instructions) Okay, the first question comes from Mark Miller from Noble Capital.

Mark Miller – Noble Capital

On your success, just wondering if you could talk about the impact of multi-reactor cluster tools on your outlook. Is this a viable way for you to go and what effect does it have on the projections?

Paul Hyland

Well, the G5 is already designed as a clusterable tool. The question as to the point at which it becomes economically and technically viable is as much to do with what the market is doing and what customers are doing to be able to achieve that. There is still several questions on that. But it is already a tool that's been designed to be clustered as and when the market needs it. In fact, we have already shipped several G5 with robot attachments.

So it does have part of our projection for 2011, probably not, not a significant number, I don't think. We might see some, but I don't think the market is yet in a position to want to take that sort of system in the short term. That's just our view.

Mark Miller – Noble Capital

My last question, do you feel that people are selling these tools at a significant discount to what they can produce? In other words, if they can produce five times as many LEDs, they're selling it for three times the price, do you see that cannibalizing? Do you see that happening and do you see it cannibalizing future sales?

Paul Hyland

Well, I mean, I wouldn't want to comment on what other people are doing. I think our view is that, clearly, we are entering a phase – at the Structures [ph] in live conference last week. I was particularly struck by – we're used to people talking lumens per watt but certainly there was a considerable increase in the number of times I heard dollars per lumen.

So I think we are now, as we enter the phase where people are looking at how to product high-performance devices at increasingly more competitive prices. I expect more focus on the equipment capabilities and that's one very good reason why we're investing so much in our R&D at the moment. We can, I think, see now quite an exciting period in the next two to three years as the industry begins to prepare and tool up for the emergence of lighting.

Mark Miller – Noble Capital

Thank you.

Paul Hyland

Okay.

Operator

The next question comes from David Mulholland from UBS.

David Mulholland – UBS

Hi. Thanks for taking my questions. And just firstly, on the brief comment you made on the call and in the Annual Report, that you see growth potential in 2012. Can you just possibly give us some of the drivers of that and how much of that could be driven by China or is that your view on what happens in the market?

Paul Hyland

Well, I think what we're seeing in China, of course, at the moment is a catalyst effect, which is helping to bring forward lighting. But we should probably look at China almost as a separate entity for 2011. I think my comment on not only do we expect a good 2011, but I can see it continuing into 2012 is because I think we will see a speeding up of the process whereby we see more and more LED lighting devices appear in the market.

I think once the momentum starts to build up, certainly by some of the subsidies that China and many other areas are investing. And I think it will carry forward. I think we could be looking at several good years, but, of course – I can't guarantee it will always be the same every quarter. But I think if you step back and look in the longer-term view, I'd say the outlook looks as positive as at any time I can remember in the sort of nearly 10 years that I've been in this job.

David Mulholland – UBS

And then just a quick follow-up, just on the margin guidance you've given for 2011 after exiting 2010 at a 38% margin. Could you maybe give us some of the drivers of that and what potential growth you might see in your R&D budget this year?

Wolfgang Breme

Hi, David. This is Wolfgang. We basically looked at it from a perspective of the 35% we have reached for the total year and as you know, the major impact for that comes for us from the U.S. dollar development. Last year, the average rate for the year was around $1.32. Our current budget rate for this year, as I mentioned, is U.S. $1.35 to the euro, that is the major impact.

Of course, a few other impacts are the – especially the increased R&D expenses but they are in the context of significantly more than $1 billion revenues, not really material for the margin. The major impact is the uncertainty of the U.S. dollar development as we invoice 90% or more of our revenues directly in USD.

David Mulholland – UBS

Thanks very much.

Operator

The next question comes from Steve Babureck from Exane.

Steve Babureck – Exane

Hi. Good afternoon, everyone. Steve Babureck from Exane. Just two questions, please. The first question, in your view, Paul, what would it take for the industry to reach actually $10 a light bulb prices? What would be – where do you think the cost need to be cut?

And the second question on R&D, what are you exactly cooking? i.e., it seems that your main competitor has gained some share in 2010. How do you explain that and what's your key strategy to gain that share back? Thank you.

Paul Hyland

I think I said on the call that, I mean, my personal guess is that we're currently in the U.S. at about $35. And my guess is that when it comes down that curve to somewhere in between the $20 and $15, I wouldn't be at all surprised to see a significant pickup in volume uptake from people because I think the tipping point is not $10.

We know that an incandescent you can buy at under $2, but that's not that the point because certainly in the commercial, I don't see residential as being the catalyst. For commercial applications where you've got extended use, lights on for 12 to 24 hours and high maintenance costs, the return on investment when it gets down to that range, I've already heard people talking about return on investment of one year and a bit and less.

Okay, so now, so – we are not – still not even sure it's necessary the catalyst will come from someone can make it at that price. I wouldn't be at all surprised to see a catalyst come when someone decides to sell at that price.

Steve Babureck – Exane

But when you look at the upstream of the value chain, do you think that, for example, increasing the wafer size is the way to go or what would be the major technology breakthrough to actually reduce the cost structure?

Paul Hyland

Well, don't forget. I mean, the LED is just part of an LED bulb. We shouldn't lose sight of the fact that there is considerable science in making a good light bulb. The LED is the light source. What we're talking about is being able to buy a light bulb. So, there's a lot of work to be done. I think, it's not just about the work that's done on the wafer or indeed making a good LED. It's as much about being able to build the whole device.

Now we – we already, in terms of the efficiency of our process, we already have several customers that are getting in excess of 90%, 95% efficiency epi. Downstream, though, there are still some challenges and I'm sure, given the attention it's getting, as I say, by both established, well-known lighting companies and some of the new ones. I think the momentum will be able to carry that, I think, in the foreseeable future. Certainly, the evidence suggests that.

Steve Babureck – Exane

Okay.

Paul Hyland

Now you asked me about market share. Well, I think if we look back at our market share over the last 10 or so years, it's been pretty consistent. And, of course, we would typically, whenever we've launched new products, as we did in February 2009, we see a similar pattern that emerges afterwards. And to give you some indication of that, I mean with the G4, the previous generation, 12 months after we launched the G4, I think we had about 60% of the orders received were for G4.

The G5, which we – and the CRIUS II, which we launched in February of this year, I mean, of 2010, I think in Q4 we had about 55% of the order intake was for those new systems. So, I mean, that would suggest that probably the pattern is very similar to the previous new product introductions and it normally takes a little bit of time for customers to try the product, get their ahead around the proposition, come and kick the tires in our lab, et cetera, et cetera but we appear to be back in line with what we would expect in terms of the adoption and development of those products.

Steve Babureck – Exane

Okay. Thanks a lot.

Paul Hyland

Okay.

Operator

The next question comes from Tim Arcuri from Citi.

Tim Arcuri – Citi

Hi, guys. Two things, first of all, Paul, you just mentioned that 55% of the orders were for G5.

Paul Hyland

Yeah.

Tim Arcuri – Citi

I'm wondering what the percentage of revenue is from the G5 and then I had a second one, as well.

Paul Hyland

I think Wolfgang is just trying to reach for that detail and we'll tell you in a minute. I'll just correct, perhaps, an earlier point I made. I was talking earlier about the G5. I mean, it is true we've shipped some of the G5s. We have already shipped G5s in cluster format as well. It's probably important just to stress that. Okay. You've got a number there. Wolfgang.

Wolfgang Breme

Yeah, 13%. Tim, it's at 13%. I said 15 but good estimate. So 13%.

Tim Arcuri – Citi

For the full year.

Wolfgang Breme

For the full year and then very positive so that we're already at more than 35% in the fourth quarter.

Tim Arcuri – Citi

Got it. Thanks.

Wolfgang Breme

So, just on track, as I said, to achieve more than 60% within 2011.

Paul Hyland

I think, also important, in Q4, we had both repeat orders and multiple orders for G5. So I think when we – we can be never comfortable, but we can reasonably confident we're getting the sort of traction that we would hope and expect to get on the new products.

Tim Arcuri – Citi

Got it. Okay. Thanks. Just as a second question, just on customer deposits, orders were up about €4 million, but the deposits were down about €50 million and I'm sort of wondering why that was. Is it customer mix? Is the mix shifting toward customers that you don't require as much of a deposit from? Is that the issue? Thanks.

Wolfgang Breme

Let's just see, year-over-year, we were able to increase it, but you are correct quarter over quarter it went down and, as you said, it's mostly driven by customer mix. I mean, if you remember, if you go back to October of 2009 when we raised additional capital, we had two major reasons for that. Number one was the start of the building project for our new R&D facility and the second was an expected reduced volume of down payments. And if you look at our balance sheet today, we actually were able to finance our inventory in the last year, more or less, 100% through customer deposits.

This percentage has gone down as expected because there are some people coming into the LED business which are big and which have other financing conditions as the traditional players had.

Tim Arcuri – Citi

Okay. Thanks a lot.

Paul Hyland

I think, also – one last thing on that. It's also important to recognize that with the orders getting – individual orders getting bigger, it doesn't take a lot if the deposit comes in for a large order one week rather than the one before, it can have a difference, some of it is timing. There is no major issues in line with what we expected when we did the capital increase.

Operator

The next question comes from Daniel Amir from Lazard.

Daniel Amir – Lazard

Thank you. Congratulations on a good year. A couple of questions here. On the gross margins front, can you give us a bit of an idea, I mean, your gross margins have kind of seemed like plateaued here for a couple quarters at 52%. I mean, is this kind of the bar that you think we're looking at for 2011 or could we see it increasing back, maybe, kind of to the mid-50s that we saw a few quarters ago. And I have one follow up. Thanks.

Wolfgang Breme

Hi, Daniel. It's – as I said in my – one of the previous answers, it's driven by the dollar. If I would build up a model, I would go with like 50% to be on the safe side, but it's definitely depending on the U.S. dollar development and looking forward, if I model $1.35 U.S. to the euro, I end up with a slightly lower gross margin than the previous year and this is also the difference between the Q4 or the justification for the difference between the Q4 EBIT margin of 38% compared to the 35% of guidance we are currently giving. Of course, there is always an upside if the dollar moves to our favor.

Daniel Amir – Lazard

Okay. And, Paul, in terms of, kind of, the guidance, the annual guidance that you gave, I mean, I know your visibility is somewhat limited for the year, but how do you think we should be looking at the demand side here this year? Should we see it accelerating as the year progresses? Do you expect it to be staying at the current level and it relates to both backlighting and general lighting? Thanks.

Paul Hyland

Yes, well, the 800 to 900, I think, to some degree, echoes some of the uncertainty at the back end of the year. We don't know. It depends on precisely what happens there. But, I mean, we start from a very nice – if we just talk round numbers. I mean, we are starting with 300 already in the bag and we've been running the last few quarters at around about 200. I don't think we should get too fixed on 200, because, of course, 10% is 20 million and that's only probably six or seven systems.

So – but nevertheless, we still have, with our two quarter visibility, still some quite positive dialogue and, of course, we have those orders already in our pocket for which we're waiting for the final boxes to be ticked. So, I mean, we know – we've always been able to manufacture sort of two quarters. I mean, Q1 and Q2, clearly, can be converted. Q3, we've often converted a fair amount of Q3 and, of course, if they are customer orders and we're waiting for qualification, if we know, we might even go and do something sort of late Q3. And if we add all that up internally and look at the prospects, we think this is a reasonable projection of what we think the revenues would be this year.

Daniel Amir – Lazard

Okay. Thanks a lot.

Paul Hyland

You're welcome.

Operator

The next question comes from Andrew Abrams [ph] from AVI [ph].

Andrew Abrams – AVI

Hi, guys. First, congratulations.

Paul Hyland

Thank you.

Andrew Abrams – AVI

And maybe you could talk a bit about delivery lead times and your conversion rate. Can you kind of give us some guidance as to where that is right now?

Paul Hyland

Yes. I think the last quarter we were about 78%. I mean, this is a measure that one of – someone in the market has been watching. It's a very straightforward conversion of the value of order backlog in comparison to the revenues the following quarter. So, I mean, it's very high and I think we know that we're reasonable efficient at turning orders but it also, I think, reflects that we don't necessarily report all orders, even if we've got all the boxes ticked. If someone's asking us for a firm delivery date on an individual system 12, 11 months out, we might take a view on it.

But we are – I mean, we outsource 90%. We have now satellite units around the facility that can feed the main unit. We're turning units around quicker internally, doing more of the work elsewhere and we've got a considerable number of contractors that allow us to be very flexible. And we're not running on anything like full shifts at the moment. So, we've got more fuel in the tank, if we need to. We can make 150 systems a quarter now and we're already working on what would be necessary if we had to make more.

But I think we can get carried away with this number, because it is likely that the market would take the maximum number of systems we could produce, plus what Veeco? I think you run out of wafers and engineers before you get to that stage, but we're not limited, certainly, in the short term.

Andrew Abrams – AVI

And your lead times, currently, have they changed at all from kind of the mid-year levels?

Paul Hyland

Not really. I think we've kept them – in fact, our lead times are as much dictated by the lead times that customers have on their fabs.

Andrew Abrams – AVI

Okay.

Paul Hyland

Typically, they need time to be able to get their own fabs up and services in place. I mean, I suppose the average conversation starts sort of four to six months. We've got some customers that might come in and say they want something in three months, but we have to know them for us to be able to do that for them. And some customers, as I said earlier, are wanting to place sort of multiple – multi-quarter schedules on us. But all in all, you've got to take a view on those.

One of the reasons we were quite prudent in Q1, if you get a customer who says he's going to put a fab up in four months, then you should take the order but just be a little cautious about turning that into a predicted revenue. And we did have one or two cases like that, but we managed them accordingly.

Andrew Abrams – AVI

In that same regard, large, multi-year orders from either new or existing customers, how do you kind of – especially from the new customers, how do you look at that in terms of what you consider real and what you don't consider real? I know what your policy is, in terms of backlog, but I mean, how do you guide your business over a two- or three year-period based on kind of those super-large orders that we hear float around sometimes?

Paul Hyland

I think we've been helped here in that we've had people on the ground in all of the Asian markets now for, probably, a good seven or eight years. And over that period of time, progressively we've developed sort of the traditional ex-pat community you start with into very much a local staffed team. And I think that local presence and that relationship building over the last few years has been very good.

It has been, I admit, difficult in some parts of Asia where we've had a sudden rush of new people that's been brought in. But I think we've got sufficient people on the ground and maybe enough experience in this area to be able to make sort of reasonable value judgments. I still stick by my suspicion that not everyone going in the tunnel will come out. But nevertheless, I think we are now seeing in this last quarter – last two quarters, the arrival of a new, different breed of bigger, more recognizable balance sheet companies that clearly are beginning to lay down longer-term plans and with more track record and credibility.

So we are beginning to see the pattern emerge, certainly in some of those emerging Asian markets, which look encouraging that this current subsidy-driven environment can make the jump into a market-led environment. But it will need a bit of patience and time, perhaps over the next couple of years.

Andrew Abrams – AVI

Great. Thank you.

Paul Hyland

You're welcome.

Operator

The next question comes from Bill Ong from Merriman & Company.

Bill Ong – Merriman & Company

Yes, congratulations on a solid year.

Paul Hyland

Hi, Bill.

Bill Ong – Merriman & Company

Hi. As I segment your Q3 and Q4 bookings, it looks like G5 orders rose about 87% sequentially from €60 million to €112 million, and your non-G5 orders fell about 34%. So can you, perhaps, segment further, what percentage of that bookings drop came from the G3/G4 versus the CRIUS?

Paul Hyland

I'm not sure how to answer that. That's probably more detail than I can give you here. I mean, let me just give you some general comments. We have talked about – you've seen how the volume of orders that's reported has been rising and we've also told you what percentage in this last quarter of our order intake comes from new systems. We are still selling G4s. In fact, we're even selling G3s. I mean, there are customers out there who continue to buy G3 and are sort of happy with the spec and performance it gives them.

I can't give you a detailed breakdown of what you've asked for but I'm sure if we think about it, we can probably talk to you after the call. But generally, the comment is that we've still got what you'd call our legacy products doing good work, but the growth, certainly, is coming from G5 and CRIUS II. I should – I keep forgetting to talk about both. Both G5 and CRIUS, we're seeing orders for both and we're seeing repeat and multiple orders for both. So we're happy with the way it's developing.

Bill Ong – Merriman & Company

Okay. I guess the question was more, are you seeing the CRIUS, which is more legacy, going down at a greater rate versus the G3/G4. So I was just, basically, trying to see what the replacement is?

Paul Hyland

No, I think the growth potential for our CRIUS II is very positive because China is a more vertical deposition market than perhaps, many others. So I think the prospects for CRIUS and CRIUS II continue to be very positive, particularly in areas like China.

Bill Ong – Merriman & Company

Great. And then my last question, you mentioned the advance payments drop was customer mix. Could it be G5-tool-related, where customers evaluating their tools, therefore place a small deposit until it gets qualified?

Paul Hyland

No.

Wolfgang Breme

No, no the new products already have 35% order intake. That's not qualifying. They are all qualified, more or less since a year now, more than a year.

Bill Ong – Merriman & Company

Okay. That's helpful. Nice job, gentlemen.

Paul Hyland

Okay. Thank you.

Operator

Your next question comes from Andrew Huang from Sterne Agee.

Andrew Huang – Sterne Agee

Thank you. Congratulations on a good year.

Paul Hyland

Thank you.

Andrew Huang – Sterne Agee

The first question is, on the transition to six inch, can you share with us your view of the market for six-inch-capable tools in 2011 and then in 2012?

Paul Hyland

Yes. Well, I do. Let me just sort of go back to a comment I made on the last call. I'm afraid I don't have the number for Q4 but I do remember this number. I said, of the shipments we made in Q3 we had sort of a double-digit percentage of systems going out in six-inch configuration. Now, the significance of that, I think, is, clearly at the moment, six-inch wafers are not commercially viable over $450. But it does indicate that we've got a number of customers who are taking six-inch systems for a combination of both R&D and process qualification.

So, what I read into that is customers are preparing and modifying their processes in anticipate than when, eventually, we get the availability – volume availability and an appropriate price, six inch will deliver for many customers the sort of cost of ownership benefit that could make a difference, certainly make a difference, going forward. So we're getting the same development tools, bigger wafers. It's actually really in line with what we saw in Q3.

Andrew Huang – Sterne Agee

Okay. And then for your sales by geography, can you give us some color on the breakdown within Asia?

Paul Hyland

Can we give you some color on the breakdown in Asia? I can tell you that over 90%, I think 90% – did we say 93% of revenues into Asia? Of the Asian revenues, if I remember this right, 90% went into the top three segments, which is Taiwan remains the largest, then China and then what we could call Taiwanese-Chinese joint venture and probably Taiwan is still, in revenue terms, just above the combination of China and Taiwan, but you can see a rising revenue potential going into 2011 for the China and joint ventures.

Andrew Huang – Sterne Agee

Okay. And then just one last question, a very quick one. I think you mentioned that your tool capacity right now is 150 per quarter and can you share with us where you might be exiting 2011?

Paul Hyland

No. I mean, could we make, could we make 200. I mean, we're working on what would be necessary to do – could we do 250? Yeah. We could do 250. I mean, it's really a question of, if you think we outsource 90%, we have third parties supplying us assembled, tested modules. We have satellites doing some of the sub-assembly and preparation. The name of the game is to be able to do all of the test and process effectively and efficiently in site. Could we do more than we are doing now? Yes, we could.

And, of course, towards the end of this year, as we complete the new prototype and pre-production lab, then it creates even more space here to be able to put more systems on the floor but we don't have an internal capacity issue. If there is one, it's somewhere out in the supply base and our guys are constantly working their way backwards to identify and clear any of those blockages. I don't see a limitation on capacity in the short term.

Andrew Huang – Sterne Agee

Thanks very much, Paul.

Paul Hyland

You're very welcome.

Operator

The next question comes from Olga Levinson from Barclays Capital.

Olga Levinson – Barclays Capital

Hi. Thanks for taking my question. My last question is, with 35% of your revenues in the fourth quarter coming from G5 and CRIUS II, can you talk about what the blended ASP on your LED tool was in the fourth quarter and how you expect that to trend throughout the year?

Paul Hyland

I mean, for the G5 and CRIUS II, we're talking in the region of about $2.5 million to $3 million, but it very much depends on the configuration.

Olga Levinson – Barclays Capital

So what was the blended ASP, specifically, for the quarter?

Paul Hyland

I don't have that. I don't have that here.

Olga Levinson – Barclays Capital

Okay. And then, within your Korean customers and the Taiwan stand-alone customers, not the JVs, how have orders trended from the fourth quarter and heading into the first half of the year and when do you expect those orders to ramp up again?

Paul Hyland

Well, what did I say earlier? 90% of our orders, revenues, came from those top three countries in Q4, probably about 80% of the orders. We're beginning to see a little bit of a pickup now in early development of work in Korea. We'll watch that carefully. Clearly, Korea led us into this, into this cycle at the beginning of 2009, then Taiwan followed and now China is having an extended investment period. We'll watch carefully to see whether or not we get any more momentum but Korea's looking more promising than, perhaps, the previous quarter.

Olga Levinson – Barclays Capital

Okay. Thank you.

Paul Hyland

Welcome.

Operator

Next question comes from Peter Knox from SG.

Peter Knox – SG

The question's been answered.

Paul Hyland

Hello?

Guido Pickert

The question’s been answered.

Paul Hyland

Okay.

Guido Pickert

Operator? Next? Hello, operator, next please.

Operator

The next one comes from Janardan Menon from Liberum Capital.

Janardan Menon – Liberum Capital

Yeah, hi. Thanks for taking the question.

Paul Hyland

You're welcome.

Janardan Menon – Liberum Capital

I'm just wondering, what do you see the impact of some of the new entrants that are going into the market? Even if they may not take some share, would they be able to muddy the waters in terms of pricing and when do you think some of the new entrants would be able to make a credible impact on some of your customers, especially in China?

The second question is on TV backlighting. There has been a sort of mini-cycle of a period of (inaudible) digestion in that market. Can I assume that your comments in Korea can be construed to assume – to mean that that market is coming back? And, if so, at what stage of that cycle are we right now?

Paul Hyland

Well, let me answer that one first. You shouldn’t assume it’s necessarily just backlighting. In terms of the competitive position, I think you’re talking there about competitors to us, rather than customers. Well, at the moment, predominantly, this is a market which both Veeco and ourselves enjoy a particularly high market share, but there are other competitors, quite rightly, as you pointed out. Some established competitors over the years, albeit not terribly large, but people like Nippon Sanso and others. Some – a few customers build their own equipment. But there have been, for some time, people trying to develop products for this area. Probably the best known are, I think, we know that Applied Materials continues to work on a long-term project to develop technology for this area. Jusong is another company that has worked hard in this area and tried to qualify products for this area.

And I think in terms of what I think you are suggesting is rumors of Chinese competitors and, perhaps, some other regions of the area. Yes, we read the same reports. We haven’t seen any traction today. But clearly in the elements in the past, it’s fairly difficult technology to reproduce, otherwise we would have seen more generic engineering products in the past. We haven’t yet seen any significant, but we don’t dismiss the fact. I mean, people like Applied Materials and Jusong are very serious technology companies with considerable amounts of experience.

So we don’t make the assumption we continue to have such a large market share and should be prepared, maybe in one day in the future we will have to share this market with others.

Janardan Menon – Liberum Capital

And to an early answer on market share, you suggested that over the last 10 years you’ve had 60% market share and the orders and the new tools are moving up. Can I take that to assume that you would expect to return to 60% market share in the sort of medium term?

Paul Hyland

I think if you look at the charts in our IR presentation, you’ll see there is a chart in there that shows the history of market share over the last 10 or 12 years or whatever it is and you’ll see two red lines. And the two red lines represent, in our view, the absolute maximum zone beyond which I think it’s very difficult for any one company to get more than that. We’ve been very fortunate in previous years. We’ve had in that 60% to 70% market share and we continue to believe that we can compete for that sort of level of business in the future.

But it’s a very competitive market. But our investments tell you that we’re determined that we should continue to be a major player in that market.

Janardan Menon – Liberum Capital

Okay. Thank you very much.

Paul Hyland

Welcome.

Operator

The next question comes from Adrian Hopkinson from WestLB.

Adrian Hopkinson – WestLB

Good afternoon, everybody.

Paul Hyland

Good afternoon.

Adrian Hopkinson – WestLB

Just a follow up on the subject of the clusterable machines, will this – do these machines, when they are combined have a higher price point due to the additional equipment you supply? And will there be an element of service revenues in installing this extra equipment?

Paul Hyland

Well, that’s a very interesting two questions. I think, certainly, the service issue, I do expect, in future, that we will see a larger percentage of service revenues, but at the moment, it still remains a sensitive topic for many customers who are always somewhat concerned about access to their process and process recipe.

And I – I mean, I understand that in many companies, it is the very process which is determining their ability to make premium products. So, as processes become more standardized, so, I think, we will see the opportunity to deliver more added service revenues to our customers. But we may have to be a little bit more patient for that.

And your other question was? I’ve lost it.

Adrian Hopkinson – WestLB

Whether there was more equipment involved, the robots and so on?

Paul Hyland

Oh, yes, I’m sorry. Yes. Well, clearly, if you have multiple systems and you start putting in more robotics and automation, there is greater cost and I am sure they will have higher ticket prices. But it’s worth, maybe, just going back to my comment about G5 and G4, the G5, theoretically can give a customer up to a 100% increase in throughput. If he can take advantage of all the facilities that we’ve put in there, he can get up to 100% additional throughput.

However, probably the maximum price we’d expect is maybe a 30% pick up in price.

So, I think the – this sort of – whilst you might initially assume that must cannibalize as a market, I think what you have to realize, in order for us to be able to enable the market, to be able to access the larger volumes, we have to deliver better cost of ownership tools. We get part of the additional profitability coming from higher ticket price, but part of it has to come from better designs, more efficient designs.

And I think if you look at our results, you can see that despite offering these more competitive products, we’re still able to protect a fairly sustainable profitability and it comes from better quality, better designed products as well as higher ticket price.

Adrian Hopkinson – WestLB

Okay. Thank you very much.

Paul Hyland

You’re welcome.

Operator

Your next question comes from Jagadish Iyer from Arete Research.

Jagadish Iyer – Arete Research

Yes, thanks for taking my question. Two questions, Paul and Wolfgang. First one is that, Paul, you have talked about the worst case and the best case scenario, and if you just stepped back for example for 2012, can you give us some more color in terms of what would be the range there is in dollars on MOCVD units, that will be helpful?

Well, I’m just trying to get a sense of if there is going to be a step function increase in MOCVD uptake because of the lighting starting to accelerate much faster than expected?

Paul Hyland

Well, I tried to give as much colors to it, but let just talk briefly about it.

I did, deliberately, try to, because I was trying to answer the question that, obviously, a lot of people have in their mind, well, if I combine the worst case of both scenarios, will there be a gap in between.

So I offered what I thought was a fairly prudent view, albeit it’s not coming from us, but a third party. We’re talking about a market which is significantly growing organically, anyway, $150 million a year to $350 million a year in sort of a six-year period. My observation, really, is if we just take the simple math and assume that whatever the penetration is reflects the MOCVD deliveries 12 months earlier, and I think it’s not unreasonable, then worst case scenario would mean sort of maybe end of 2012 – midst of 2012, beginning mid 2013, would be the sort of an end of that cycle.

So the question, then, is when does lighting start? I think there’s good evidence to suggest that it is starting. You are seeing now, we’re all seeing, products that you can now buy and you’re seeing huge investments by governments and, indeed, regulatory influence, that is clearly accelerating the arrival of it. I mean, we are – if we’re sitting here, as I was in Q3 of last quarter, telling you that maybe up to 30% of our orders had some sort of lighting related end market behind them, I think we can say – I can’t give you a precise number, but clearly we’re beginning to see some growth towards lighting.

Probably, if I break down all LEDs, there’s probably three. There’s backlighting, there’s lighting and there’s probably an equal amount of LEDs which fall into neither category. It shouldn’t be underestimated the sheer volume of other lighting applications that other LED applications that require MOCVD tools.

Jagadish Iyer – Arete Research

Okay. I just had a follow-up question. Your competitor issued a press release very recently about their penetration into one of your biggest customers for power electronics applications. I just wanted to find out what is Aixtron doing in this segment? Thank you.

Paul Hyland

Well, we’re active in a couple of customer accounts, already, in that area and that particular account I think you’re talking about is Samsung Research. And, indeed, Samsung Research is the gateway portal into this – this is the area where they are able to do the evaluation, development, et cetera, and you will find already several of our systems in there and Samsung clearly is interested in evaluating all the different technologies.

And so I don’t think there was any great surprise in that.

Jagadish Iyer – Arete Research

Thank you.

Paul Hyland

Okay. You’re welcome.

Operator

The next question comes from Simon Schafer from Goldman Sachs.

Simon Schafer – Goldman Sachs

Yes, thanks very much.

Wolfgang Breme

Hi, Simon, how are you?

Simon Schafer – Goldman Sachs

Hi, there. Good, thank you.

Paul Hyland

Not so good, by the sound of it. What can we do for you?

Simon Schafer – Goldman Sachs

So just a quick question on what you called the elephant in the room. I mean, lots of noise has been made on the subsidy issue and as to where that may change and where it may not and, obviously, that is subject to what I would call, many regional flavors, if that makes sense, in terms of variation of local subsidy and so on. But, if you could just provide us with some of your own thoughts as to where that may be coming to an end and where it’s focused on and, perhaps, some other geographies where that’s, perhaps, more sustainable, that would be very helpful?

Paul Hyland

Well, certainly, the subsidies are not digital. I think you’ve got to remember there is two different types of subsidy. Of course, the subsidies arose in 2009 when China could see – and was frightened of falling behind.

So, it actually started out as a 2009 program, but continued through 2010 into 2011, and I would say that there’s been a certain urgency about – from parties that concerns when it was going to end. Clearly, it will end at some stage.

But what, effectively, the government has done has made central funds available and then mandated the seven different regions and includes some city authorities, so there’s probably maybe 10 or 12 different authorities mandated them to manage these subsidy programs, to which, I would add, some of them also have additional local funding programs, as well.

Now some of those or all of them have a very similar shape to their subsidies. It’s typically sort of a third of the money with the order and when the deposit’s required, a third when you get the system, and a third if you can prove the original business plan you submitted is also being achieved.

So you don’t get it if you’re producing by a kilo. Now those programs have been run by the different cities and provinces and they all have different – slightly different, (inaudible) some will end by the middle of this year and has been published as doing so for, probably, at least six or nine months.

I think, Wolfgang, you were in China recently and it was already well known there were some areas. But some of the regions have stated dates that go out to 2012. I think of one that’s actually still talking about three years. So, as always, it’s a slightly complicated picture with, but you shouldn’t simply think it’s purely digital.

There are different colors for different areas. I would add it’s also, perhaps, also, being influenced by the arrival, I won’t say late arrival, but later arrival of bigger, substantial Chinese companies who are probably currently doing the rounds asking these authorities, well, before I move on to the next province, are there any subsidies left in yours.

And I think that, probably, is also causing some of the designated authorities to even considering moving subsidies around. So it’s not as straightforward as it looks and it’s certainly not aggression that this all ends by the middle of this year, particularly bearing in mind we’re only days away from nearing the rollout of a detailed proposition of the 12th Five-Year Plan from China, of which one element is LED technology.

It would be very strange if we suddenly saw the heart stop at the very point at which they’re promoting – a five-year plan to establish themselves as a meaningful LED players. And right now with from the draft that we’ve seen, they clearly have a very focused view as to how they can achieve that.

So, I hope that’s an answer.

Simon Schafer – Goldman Sachs

Okay. Thanks so much, Paul.

Paul Hyland

Okay.

Operator

The next question comes from Jeff Bencik from Kaufman Brothers.

Jeff Bencik – Kaufman Brothers

Hi, guys. Can you give me some details on the actual tools shipments in the quarter and the year?

Wolfgang Breme

We shipped in excess of 450 systems, throughout the year it was a steadily increasing that production scheme. So, the capacity we currently have in the fourth quarter is for150 systems, but, of course, this does not mean that we invoiced 150 systems per quarter, but that’s our current capacity.

Shipments in the quarter were slightly below that.

Jeff Bencik – Kaufman Brothers

Okay. And then, can you talk a little bit about the pricing that you achieved in terms of the G5 unit? You talked about previously the 30%, upto 30% better. Are you achieving that?

And then I also want to talk about the cost to manufacture your G5 units versus your G4. Are those similar or is it more expensive to manufacture the G5?

Paul Hyland

Well for G5 and CRIUS II, the range is from around about $2.5 million to $3 million, depending on the configuration. In terms of the manufacturing cost, we don’t break it down, but I think our margins tell you clearly that this is still a profitable product, but we don’t break down manufacturing cost.

Jeff Bencik – Kaufman Brothers

So is the G5 a higher-margin product than the G4? And if so, then why were your margins sort of flattish? Was that all due to the negative FX impact sequentially in the quarter?

Wolfgang Breme

Well, I wouldn’t say that the margins are flattish. We have quite a common target to set out our margins. Of course, you see some of the US dollar/euro exchange rate impact, but in general terms, we are quite happy. If you compare the margins year-over-year, you can see the huge improvements. We have done and one contributor are the new generation systems. So we are quite pleased to announce those higher margins.

Paul Hyland

I think if you look at slide four of the presentation we’ve just given, and Wolfgang’s right, that you shouldn’t just look at it on a quarter-on-quarter basis. But if you look at, actually the margins, we’ve seen, I think, pretty consistently growing in the right direction.

And given that over 90% of our revenues are in dollars, you can appreciate and less than, probably 20% of that costs in dollars, you can appreciate there’s a fairly significant effect, just on the dollar effect.

Jeff Bencik – Kaufman Brothers

No, that’s exactly what I’m trying to understand, because you had a greater percentage of G5 sales in Q4 versus Q3 and, therefore, I would expect some benefit from it, but sequentially those gross margins were flattish and I was supposing that it was due to the FX impact and that’s what I was trying to clarify.

Wolfgang Breme

Okay. That’s great, but, of course, you can never compare this quarter over quarter. You have regional distributions in there. You have revenue recognition issues, which means we recognize 90% on shipment, 10% on final acceptance.

So, in general terms, G5s and CRIUS II were 16% or 15% of the quarter’s revenue, not really the majority of systems, but in total we are quite pleased with those margins.

Jeff Bencik – Kaufman Brothers

Okay. Well, thanks, guys. Nice quarter.

Paul Hyland

Okay, thank you.

Operator

The next question comes from Sandeep Deshpande from JP Morgan.

Sandeep Deshpande – JP Morgan

Yes, hi. A quick question, following up on your comments earlier, Paul, on efficiency. I mean, can you talk about where your customers in China or Taiwan are at this point on efficiency on the LED, given that, I mean, for lighting you need a certain efficiency to happen?

Paul Hyland

Well, I wouldn’t – no, I wouldn’t like to talk specifically about customers, but I think –

Sandeep Deshpande – JP Morgan

Not a particular customer. I don’t mean a particular customer.

Paul Hyland

I think I did say – I think I said on the call that there is clearly a gap between the capability or the device performance of the average Chinese company if we were to compare it to the average company elsewhere. But that’s sort of commitment going into this area and the partners who are being drawn into developing the market, I think you will see the quality steadily increase progressively, quite rapidly probably.

And we should also remember that many of the initial products that are not necessarily destined for PG&E approved spec applications, but they won’t necessarily have to be the best in the world, but they’ll have to be good enough. And certainly at the moment I don’t think there’s many Chinese LEDs in global brand LCDs, but the Chinese domestic LCD market is not inconsiderable and it’s growing. So I think we must be careful not to necessarily judge these early days of Chinese development in a sort of global perspective.

I did say to someone, I think for these investors who are focused in on this market, the next two years could be quite a sort of volatile period. You will see lots of steady stream of good news and bad news, companies failing, companies succeeding. But if you can have the patience to wait two years, I believe the Chinese will have a very sustainable LED industry. But it’s wrong to try and compare them with companies who have well established product specifications and expertise. It needs a bit of patience.

Sandeep Deshpande – JP Morgan

So is what you’re saying that because the Chinese are slightly behind the curve in terms of their LED technology, that despite the Chinese taking quite a large volume of orders or shipments over the last 12 months, that they are not contributing to the global supply, because of some of the issues with ramping up technology?

Paul Hyland

I would say not yet. I mean, part of the ambitions of the five-year plan is that they have aspirations to eventually, perhaps, have 60% of the business being exported. And that’s quite a significant ambition and, clearly, they have to get – around issues like IP and various others before they’ll be able to achieve that. But they have the rather nice situation is that the same people who are giving them subsidies to start their MOCVD business is the same customer who is distributing subsidies for capital projects. Their supplier is also their customer. And they put a huge amount of what I call capital project subsidies out.

I think last year they actually installed something like 350,000 street lights and something like 80,000 tunnel lights. And the Chinese have the benefit of having a very focused end market, because their own government is one of the major customers within China at the moment.

Sandeep Deshpande – JP Morgan

And then, quickly following up on one of the other questions, on the advanced payments, so there has been a step change in what you are charging in terms of advance payments from customers – or there is – it might change again in Q1, for instance?

Paul Hyland

Well we – part of the logic behind the capital raise back in 2009, one was working capital, which was we knew work-in-progress will rise considerably, it has. And two, the arrival of bigger corporate customers meant we almost certainly would see a reduced percentage of deposits being paid and that has also been the case.

The other side of it was shorter product cycles, which we are convinced will be the norm going forward, and the need for a significant, if you like, general-lighting specific product, which probably will look nothing like the systems that you see today. So, hence the $60 million plus investment we’re doing in R&D.

Sandeep Deshpande – JP Morgan

Thank you very much.

Paul Hyland

Okay. You’re welcome.

Operator

The next question comes from Steve Babureck from Exane.

Steve Babureck – Exane

Hi, good afternoon. Thanks for taking my follow-ups. Just two quick questions outside of the LED space, if I may? Regarding semiconductors, a large Korean semiconductor company has been one of your key partners in the last couple of years. Any update on the ALD product for transistor gate depositions?

And the second question with regards to organic LEDs, there’s also a strong push expected in Korea for the next few years. Could you please highlight any of your commercial prospects there?

Paul Hyland

Yes. We’ve got activities on both those different areas and – but we are not talking publicly about either of them, in both cases. I think to just qualify your comment on activities in Korea, certainly the impression I got when I was at CES in January is, the next couple of years is going to be about LED backlight Smart TV with a hope that 3D might kick in volume in consumer homes.

OLED, I doubt, will be a significant market even from Korea in the short term. They are doing a lot of work. They are doing a lot of R&D and they’re producing some very nice OLED televisions that are looking very attractive, but commercially, I don’t think that’s going to necessarily impinge in the short term.

We, however, are continuing to do work on organic – large area organic deposition, particularly R&D and with some customers and I’d say we’ve seen a pickup in customer interest and involvement in that work in the last, sort of, 12 months.

Steve Babureck – Exane

Could you get AG compatible tools in the next – 18-24 months or are you still far away from your core competency?

Paul Hyland

No, we already have production tools out there. We already have discussions with customers on next generation, shall we say, R&D systems, and we have – we certainly have a clear roadmap to next generation production. But we are not talking of organic, or indeed, semiconductors in the short term, although, as I said, we are having very – I think very encouraging success with the targeted ALD markets for sub- 32 nanometer memory and sub-22 nanometer logic, both of which we have systems in customers’ facilities both in our R&D and in evaluation.

So, I mean, although you are not seeing it in revenue, in both those areas, I would say we are very pleased at the progress we have made in the last 12 months.

Steve Babureck – Exane

Okay, thanks a lot.

Paul Hyland

You’re welcome.

Guido Pickert

We have time for one more question here and if you didn’t have a chance to ask questions, please get in touch with us. We’ll get your questions answered.

Operator

The last question comes from Malte Schaumann from Warburg Research.

Malte Schaumann – Warburg Research

Yes, good afternoon, gentlemen.

Paul Hyland

Hi, there.

Malte Schaumann – Warburg Research

The first question is regarding the yields of – compared from backlighting to lighting applications. Maybe you could comment on that and how do you expect yields to develop in 2011 and going forward, maybe in the year 2012 in both applications?

And the second question is regarding the risk of any of your Chinese customers gets bankrupt or do you see if we are going to see some insolvencies over the years? Do you see the risk of a larger amount of used systems coming into the markets?

Paul Hyland

You know, it’s probably a little unfair to identify Chinese customers as being at more risk, but it’s probably true, given it’s both a formative stage and a very compressed development of the Chinese LED. There is a risk. And, of course, the whole manner in which we manage our order intake and payments is geared to mitigating that risk.

So I don’t really see there being any major risk to our business of that, but it’s something, which I think, might be a part of this period of rapid development of LEDs. There are a number of new people coming in who don’t necessarily have the depth of experience and expertise, so it’s not without a risk. But it’s not a risk that we expect to impinge on ourselves.

I’m sorry Malte, your first question was?

Malte Schaumann – Warburg Research

The first question was on the yields, compared from backlighting and lighting applications and the improvement in yield per system over, let’s say, a 12-month period?

Paul Hyland

I don’t know the answer to that question. I think most of the challenge at the moment – well, if we talk about what’s necessary, I mean, I think people will generally accept a 110 or 120, even a 100 lumens, which the Chinese can do now. Many of our Chinese customers are already doing 100 lumens a watt, but it’s probably good enough for most lighting applications.

The challenge is now shifting to one of dollars per lumen and, indeed, the ability to turn a good LED light source into a good LED fixture. But certainly some of the comments I heard last week at Strategies in Light suggest there will be considerably more pressure, both on delivering cost-effective LED devices going forward. I think one of the big speakers I heard talked about they shouldn’t be surprised at 20% pricing pressure during the course of the year to be able to achieve the breakeven or cost of ownership target for lighting.

So I’m afraid I can’t give you a yield issue. I think I’ll only state what I said earlier, (inaudible) yields, we’ve got customers who are getting 95% plus, but many, many customers would be delighted at 50% yield on the LED. And, of course, there are further, perhaps, risks on the actual LED fixture.

Malte Schaumann – Warburg Research

Yes.

Paul Hyland

I am sorry, I can’t give you more than that. I think that’s as much as I can offer you now.

Malte Schaumann – Warburg Research

Fair enough. That’s fair enough. Okay, thanks.

Paul Hyland

Okay. Well, I think thank you very much, gentlemen, for all your calls. I mean, as Wolfgang and Guido said, if we can follow up, if anyone hasn’t asked a question, we’ll be delighted to take a call or email and we can follow up with a conference call if someone particularly wants to talk through any of the details we’ve offered here today. But otherwise, thank you very much for attending the call.

Wolfgang Breme

Thank you.

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