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AIXTRON AG (NASDAQ:AIXG)

Q2 2011 Earnings Conference Call

July 28, 2011 09:00 ET

Executives

Guido Pickert – Director of Investor Relations

Paul Hyland – President and Chief Executive Officer

Wolfgang Breme – Executive Vice President and Chief Financial Officer

Analysts

Timothy Arcuri – Citi

David Mulholland – UBS

Bill Ong – Condoroga Securities

Andrew Abrams – Avian Securities

Günther Hollfelder – UniCredit

Andrew Huang – Sterne Agee

Janardan Meron – Liberum Capital

Jed Dorsheimer – Canaccord

Maxime Mallet – Natixis Securities

Ali Khwaja – Berenberg Bank

David O’Connor – Royal Bank of Scotland

Operator

Good afternoon, ladies and gentlemen, and welcome to AIXTRON’s First Half 2011 Results Conference Call. Today’s call is being recorded. And I would now like to hand you over to Mr. Guido Pickert, Director of Investor Relations at AIXTRON for opening remarks and introductions.

Guido Pickert – Director of Investor Relations

Thank you. Good afternoon, and good morning everyone, thank you for attending today’s call. With us today are as always 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 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 all 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 includes additional information as most of you know on markets and technologies. This call is not being immediately presented via webcast or any other medium; however, we will place an audio file of the recording or a 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 – President and Chief Executive Officer

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 our presentation of AIXTRON’s first half 2011 results. In line with our usual practice, I am going to start the presentation by giving you an overview of the key developments in our market and some highlights of our financial and operational performance.

Given the current market volatility, I am going to pick out some specific points worth comparing from a sequential quarterly development perspective. Wolfgang, our CFO, will then take you through some detailed aspects of our financial and business performance. And after that I am going to close the presentation by running through our 2011 guidance model.

Let’s now look at key developments over recent months, which you can see on slide three. I’d like to start by talking first about the market developments we have observed during the quarter. What has been preoccupying the industry and its observers, above and beyond the backlighting cycle was and is the question of the timing and intensity of the onset of general lighting.

From where we stand, we continue to see steady and positive proliferation of LED lighting products, and we are very encouraged by the evident progress that’s being made. You will have heard us expressed the opinion before, that we believe that the key price tipping points, where the price of a 60 watts equivalent LED could trigger real commercial demand is somewhere between $20 and $15.

If that figure is right, then in Korea, we are within that tipping point range. Both Samsung and LG are offering to their domestic market an increasingly broad range of LED lighting products and are now pursuing highly competitive pricing strategies. Samsung for example is already offering a 60-watt equivalent LED light bulb at circa US$17. This represents a 50% year-on-year market reduction from Samsung, which is a good measure of that focus on this market and their technical and cost of ownership progress over the last 12 months.

Couple this commercial momentum with the evidence from around the globe of government commitment to energy efficiency programs, particularly in Asia, then you got a sense of our rising confidence that the adoption and conversion over to LED lightings is getting much closer. If I stay with South Korea on this theme, the South Korean government has launched a new LED lighting adoption program last month as part of their national energy-saving program.

The program aims at achieving 100% adoption rate for LED lighting in the Korean public sector and 60% penetration of all lighting applications nationwide by 2020. This is arguably the most ambitious national implementation plan seen so far globally. Currently, LED’s account for only 2.5% of all lighting in South Korea. And to achieve their objective, the government has undertaken to provide substantial subsidies to promote this technology to industry and their general population.

Korea will fund around $185 million in 2012 and in 2013 to facilitate energy-efficiency rebates and to support the switch from conventional lights to LEDs in industry and in the public sector, as well as government facilities, offices and in residential buildings. Although not fully defined at this point in time, the Korean Government has indicated that they expect to commit to similar levels of investment beyond 2013 to support this national energy efficiency initiative.

In our opinion, this combined commitment by both South Korean government and industry to initiatives promoting energy-efficient LED lighting applications, will not only create a momentum within the domestic Korean LED market, but is also likely to act as a positive catalyst to the earlier than forecast general adoption of LED lighting in other regions as well, potentially leading to wider demand for LED production equipment from AIXTRON.

In Japan, where consumer subsidies had been available for sometime already, we are not only seeing specific government targets, we are also seeing strong societal pressure to achieve greater energy efficiency. The Japanese public has responded very strongly to the direct call to dramatically reduce the energy they consume as private individuals. You can say that the Fukushima disaster in March and the realization that nuclear power is no longer an acceptable option in light of their recent experience have changed that society’s view on energy.

For the last four months, Japanese consumption of energy has sequentially fallen every month. Consequently the nation’s appetite and enthusiasm for energy efficient technology is increasing, and can only help the rates of LED lighting adoption in Japan going forward. A recently published study has shown that in sales volume LED light bulbs have already reached an adoption rate of more than 40% and are expected to exceed 50% in the second half of 2011.

And of course, needless to say China, too, is continuing to intensify its efforts to develop its own position in this market, not only to serve a significant domestic need, but also to address their ambition to become a global LED player in the years to come. Our Chinese business has been growing rapidly over the last two years, and will continue to do so. China is now, without a doubt, our strongest market and currently, AIXTRON’s biggest revenue driver.

Reflecting the increasing importance of China for AIXTRON, we have embarked on a program of strengthening our support infrastructure to meet the needs of this rapidly growing market. We have already announced the first results of this initiative, the upgrade of our representative office in Shanghai into a fully-fledged subsidiary and the establishment of our first Research and Customer Training lab in Suzhou. Wolfgang will expand on this program later on.

If I now move away from AIXTRON’s long-term commitment to China and turn to the short-term market issues, that I believe we are all trying to understand, namely the continuation of Chinese subsidies; I would like to give you my perspective. A lot has been written about the almost digital availability of subsidies, i.e. now you see them, now you don’t. But of course there is much more to the flow of subsidies than meets the eye.

The champion of these subsidies is the Central Chinese Government, who is very clear in its desire to make a step change in China’s investment policy in the sector. Remember that the Central Government’s objective is to end up with five to six major Chinese players, who can compete globally. But it is the regional governments and cities that are implementing this policy and managing the funding and execution of the subsidies.

Incidentally many regions already had subsidy programs in place before the Government initiative, motivated by a desire to attract LED investment to their specific area. The multitude of subsidies available in China since 2009, has created the Chinese investment environment from which we are now seeing the development of a second phase of investment. The first phase saw a stampede of companies eager to take advantage of these subsidies, and I am afraid to say some of those companies are unlikely to be there at the end of the race. Subsidies are now more difficult to obtain especially by smaller, less credible companies as the funding authorities become more selective as to who gets their money.

Today I would say we are already in the second phase, where larger and much more prominent players are beginning to emerge, amongst which will be the five or six major companies the government hopes to see becoming global players in the LED industry. I don’t worry about the subsidies, because they will continue to a greater or lesser degree, depending on which region or city you are talking about and their motivation to catch a departing train.

What we are focusing on is the emergence and development of a far more substantial and sustainable Chinese market, that is eventually less dependent on subsidies and more driven by end-market demand. The by-product of these two developments, namely subsidy uncertainty and emerging larger players has been the choppy waters we predicted would occur in Q2. And that is precisely what we have experienced in Q2 and expect to continue to experience in Q3. It does not change our optimism on how this market is developing. We remain very positive that there will be little or no substantial gap between the end of backlighting demand and the development of LED lighting.

Choppy waters effect is a transitional issue that we will have to contend with, but one that I expect to pass. Whilst we are in this period, although we continue to enjoy very healthy order intake, we have less precision in our visibility of revenue timing. If you do the maths on our guidance slide, I think that you will see that the risk of us not getting enough orders to achieve our guidance has diminished substantially.

But the risk to the conversion timing of our existing backlog will remain if customers do not finish their fabs on time, or don’t get their funds in place on time or can’t find the necessary engineers. And of course; with a far greater percentage of outstanding system orders being dominated by a smaller number of customers, any consequential delays would delay revenue recognition. We don’t predict that that will be the case, or we would have revisited our year-end guidance, but it’s not impossible. I stress again this is a revenue timing risk, not a revenue risk per se. We are talking about a transitional issue in a market that is actually developing more positively than many, if not all, of us predicted.

If I can move from market issues to AIXTRON’s operational performance, as you will have read, our order intake continues to be very healthy. And as you have just heard me say; our 2011 guidance remains unchanged, despite the short-term volatility in the market. I am also pleased to be able to report that the percentage of orders received for our latest generation products went up again from 65% in Q1 to 70% in Q2, which is a very strong indication of customer adoption.

I can also now talk about a new addition to the AIXTRON product portfolio. Three weeks ago, I attended the LED Forum in Shanghai, where we received a very positive response to our announcement of the next generation to the CRIUS II MOCVD systems: The CRIUS II-L, and you can see an image of this new system on slide four of our presentation.

The CRIUS II-L is the largest capacity MOCVD reactor available anywhere today, and is based on the proven CRIUS II platform. So process migration should be seamless and enables customers to process 69 2-inch wafers or 16 4-inch wafers at a time. This system can of course be configured for 6-inch and 8-inches as well, but in markets like China, where the wafer usage is dominated by 2-inch and 4-inch wafers, this new system delivers a distinct throughput per footprint competitive advantage, a substantial cost of ownership benefit and has already attracted a lot of customer interest.

We are in the process of shipping the first system to a lead customer as I speak. We have other interesting developments also in the pipeline, but we are very encouraged by the customer response to this particular new product. A combination of rising order intake and the shipment delays I spoke of have contributed to a rise in our work in progress figure, but also a sequential rise in customer deposits. Perhaps to some degree hidden within the result, is some considerable success we have had in reducing our operational costs year-on-year, which along with the strong liquidity position that we command means, so we continue to enjoy the operational flexibility we believe is essential in such growth markets.

Let me now make just a few comments on our financial performance in the quarter before I hand you over to Wolfgang. There are two main factors influencing the profitability recorded in Q2. The most obvious one is the weaker dollar, the less obvious one, ironically results from the success we have had in growing our business in China. A greater percentage of our Chinese customers have a preference for our CRIUS Showerhead systems, which carry a lower ticket price than our Planetary Reactor systems. Moreover, the shift away from single orders towards large multiple orders, especially from China, means that customers are able to negotiate lower average selling price. China is a very competitive market and we fully intend to compete for all of that business.

At the EBIT level, the reduced gross margin effect was less pronounced because of the improved operating cost base I spoke of earlier. Wolfgang will explain this in more detail later. I have already spoken about the reasons behind the rise in inventories, so I won’t repeat myself on that point, but will repeat that the issue is one of revenue timing, not revenue risk per se. Cash levels continue to be healthy, even after the $61 million dividend payout after our AGM in May.

I would now like to go past slide five of the presentation, which gives you the six month year-on-year comparison; because I suspect that you will be more interested in the sequential developments between Q1 and Q2 shown on slide six. We will of course be happy to take any questions later on that you might have concerning the year-on-year comparison on slide five.

On slide six, you can see that Q2 revenues came in at $175.6 million and as such are about 15% down on the first quarter of 2011. The principal reasons for the decline were a combination of later than originally scheduled Chinese LED fab completions causing shipment delays and delays caused by our customers not having the required funds in the right place at the time. Albeit at the timing issue only, you will appreciate we will not ship a system without the required level of confidence that we can claim the monies due.

Moreover, the average US dollar exchange rate against the euro in Q2 has weakened by more than 5% in comparison to Q1, which had a knock on effect on our euro-denominated revenues, despite the gains we made through expedient currency hedging operations and positive translation effects.

Without going through each line on this slide, order intake up sequentially, backlog up, book-to-bill up, customer deposits up, even the cash performance can be viewed positively, if you net off the €61 million dividend payment in Q2, however the margin mix and revenue timing effects are the areas we will be focusing on throughout the second half of 2011.

Let me now hand you over to Wolfgang to drill into the detail. I will then talk to you again at the end of the presentation. Wolfgang?

Wolfgang Breme – Executive Vice President and Chief Financial Officer

Thank you, Paul, and hello to you all ladies and gentlemen. As usual, I will pick out a few numbers in our financial statements which I think warrant some explanation and comment. On the following slides, these numbers are circled in red. Let’s look at our P&L first, on slide seven.

Paul talked about the impact of pricing on our Q2 Revenues, but let me expand on that from two angles; currency and the situation in China. In the course of the last 12 months, the U.S. dollar has depreciated considerably against the euro. The average exchange rate during Q2 2010 was $1.31 per euro. During Q1 2011, it was $1.36 and during Q2, it was $1.44. In other words, the U.S. dollar depreciation in Q2 amounts to 10% against the same quarter last year, and to a sizable 6% against Q1 2011.

At the same time, more than 90% of our Q2 revenues were generated in U.S. dollars. This presents a significant challenge to us, especially if you take into account our order visibility, which does not extend beyond three to six months as you know. However, on the plus side, when we do receive the order, they have trended towards bigger volume orders with delivery schedules beyond the more commonly requested four to six months delivery. This led us to the assumption, that €50 million out of our current backlog of €374 million will not be shipped this year, which you can see on our guidance slide. But on the question of the exchange rate issue, we meet this challenge, of course, by setting up appropriate, options-based currency hedges. But we still have to contend with an average exchange rate of only $1.40 per euro this year, against the $1.35 per euro we were able to use during the first half last year.

Of course, we are only hedging cash inflows forecasts, which have high degree of certainty. We do not enter into hedging contracts without underlying business visibility. In the current dynamic environment driven by larger orders, which come to a big extent from China, also the treasurer’s job has become difficult. But nevertheless we were able to generate a fixed income of €4.6 million in the second quarter. This equals nearly 3% of revenues, but was not enough to recover the reduction of our revenues due to currency effects completely.

Paul already mentioned the growing AIXTRON footprint in China. Over the last two years, China has rapidly become our most dynamic growth region and our most important source of revenue. I think it is therefore appropriate for me to spend a few minutes talking about our organizational built-up in that region. As you know, in 2010 our China business grew by a factor of eight compared to 2009. China became the second largest regional market for AIXTRON.

The dynamic development in China in this year will make China the biggest region for AIXTRON in terms of revenue. After the establishment of AIXTRON China Ltd. in Q1, we are on track to execute on our long-term strategy for China. We are currently recruiting additional service staff to support our growing installed base in China and support our customers during installation and start-up. For this staff, we will start to open branch offices with local spare parts stocks later in the year.

A very important step was completed in Q2. On June 22, we signed a cooperation agreement with the Suzhou Institute for Nanotechnology and Bionics, short SINANO. Within the next few months, we will open in their premises, MOCVD training center to address the training and qualification needs of our customers and to support their own research work. This center will be equipped with our latest production proven G5 and CRIUS II systems. This facility will represent a low double-digit million euro investment by AIXTRON. The cooperation with SINANO, who are part of the extensive Chinese Academy of Science network, is a continuation of the excellent cooperation with this community AIXTRON has built up over more than 10 years.

Let me now come back to the numbers. Paul has already commented on cost of sales and gross margin, but let me add a little bit of detail. We have consistently said that, as the market develops, our customer base will shift towards bigger players, who will be reluctant to pay large deposits. There is an additional element to that, as individual orders get bigger, pressure on selling prices increases.

Typically a customer ordering 50 machines expects a better price than one ordering only a single machine. This is part of the cost enabling process to reach the tipping price point for general lighting and this together with the FX effect, what we are seeing in the Q2 margins. It also reflects our determination to maintain a strong market share, position at this pivotal time in the development of this industry. It is essential for us to make sure that we drive our equipment into those larger companies that are going to champion the future development of the industry, particularly in China. While margins are reduced in the short-term, the effects of increased volumes will, to some extent mitigate the effects of lower unit prices as indicated by our guidance.

Moving on to discuss the composition of our operating cost, the components of which, show significant variation. This variation gives you an interesting perspective on the dynamics of our business. First of all, total operating costs in the quarter were down by almost half year-on-year, amounting to €22.5 million overall for Q2 2011.

Let’s look inside that number. Selling expenses fell by almost half as well, compared with the same period last year. This was the result of the quarterly revenue shift away from Taiwan towards China, where generally no sales commissions are paid. At 4.1% of revenues in Q2, selling expenses were almost three percentage points less than the 6.9% recorded in Q2 2010. In contrast, general and admin expenses rose significantly against the same period last year, principally due to higher management, IT and consultancy costs. This is an indication of the inevitable infrastructure growth of the administrative backbone of AIXTRON.

R&D expenses continued to rise as planned year-on-year. We have taken on additional personnel and now employ more than 250 staffs at our new Research and Development Center in Germany. This running cost for the new facility, an increasing number of engineers and of course, the growing need for research materials and other resources led to this budgeted cost increase. As said before, R&D is an essential investment necessary to secure the future of our company.

Net other operating expenses and income shows the biggest variation compared with last year, which is another symptom of the significant weakening of the U.S. dollar. While in Q2 2010, we were faced with a rapidly appreciating U.S. dollar and commensurate losses on our dollar hedges, reflected in net other operating expense. This year the U.S. dollar is depreciating and our hedges are yielding profits to set against currency losses.

In addition, we received just over €1 million of research and development grants in Q2, which are also recorded here. Our reduced revenue visibility and the uncertain macro environment make currency hedging an extremely difficult decision making process these days. We do, however, have a few elements in our favor. First, we have already hedged up to 70% of our anticipated H2 dollar cash flows. Second, delayed for first half revenues and high work in progress investments for second half revenues are likely to continue to be beneficial in terms of operating cost to revenue ratio. Third, it’s also fair to say that if the situation in China clears up in the second half, it’s likely that we will see a higher percentage of more profitable final acceptance transactions being completed. These three factors, together with the expectation of a higher level of revenues in H2, leads to a challenging, but achievable EBIT target of around 35%, which puts AIXTRON amongst the top performing businesses of our industry.

Let me now move to slide eight and our balance sheet slide. I only have three numbers to talk about here, inventories, cash, and advance payments. First, inventories are up in comparison to the figure recorded at the end of last year and in comparison to the end of Q1 2011. Our order book is healthy, and our engineers are preparing a large number of systems for shipment later in the year. The delay in revenue timing risk and the choppy waters that Paul and I have already talked about is also reflected in this high number, but it’s only a smaller component.

Second, cash and cash equivalents are down on the figure recorded at the end of last year and also in comparison to the end of Q1. This is due in very large part to the €60.7 million of dividends we paid out in May. Third, advance payments from customers are down on the end of last year, but actually up on the end of Q1. There is nothing of significance to read into that. These fluctuations are a function of the timing of inflowing funds and outgoing shipments. They also reflect regional and customer-specific terms and practices. We continue to expect that as lot sizes grow, the financial strength and reliability of our customers improves, and our risk therefore diminishes, advance payments will decrease accordingly.

I would now like to take a quick look at our statement of cash flows on slide nine. The operational cash flow shown here on slide nine amounted to €32.1 million in the first half of this year. The difference to the net income for the period of €90.4 million is the result of the growing working capital needs of the business. The cash flow from investing activities is positive at €49.6 million due to the reduction of short-term bank deposits, which are now in the cash line. The investment in property plant and equipment was around €11.7 million in the reporting period and therefore back to normal. The cash flow from financing activities contains the €60.7 million cash dividend paid out in May. This is also the main driver for the reduction of our free cash flow in the first half of 2011. In general, AIXTRON’s financial position remains excellent.

Slide 10 gives you an overview of our business development for the last quarter. You can see on the top chart of our order intake had continues to rise. In fact, the incremental increase from Q2 on Q1 is actually higher than the incremental increase from Q1 on Q4 last year, both in absolute and in relative terms. We have been seeing this high level of demand for almost four quarters now.

Given the book-to-bill ratio of greater than one, our backlog reached an all time high of €373.5 and gives us sufficient volume for our guidance, which Paul will elaborate on in a minute. But of course, looking at our revenue numbers, we see the impact of the revenue timing risks Paul mentioned at the beginning. But overall, it’s also clear that order activity is flattening out, which is not surprising given the business environment Paul has described to you and the base effect caused by the extremely strong year 2010. It is true that revenues are down 15% on the previous quarter, but again we are discussing here the revenue timing risk, not a revenue risk per se.

We feel comfortable that we will see a stronger second half of the year. Before I hand back to Paul, allow me to take a quick look at the composition of our revenues on slide 11. Equipment generated 92% of our revenues during the first half of the year. The remaining 8% came from spare parts and services. We used to assume that spare parts and services would contribute about 10% to total revenues, but this has changed slightly in the context of surging demand for our systems in the last two years.

Almost 90% of our revenues are contributed by systems that will be used for the production of LED applications, therefore, no change there. What hides behind the red section of the regional pie chart of course is the emergence of China as AIXTRON’s most dynamic demand driver. There is no doubt in our mind that this is set to continue.

With this, I would like to hand you back to Paul for our guidance model and his final observations. Thank you for your attention.

Paul Hyland – President and Chief Executive Officer

Thank you, Wolfgang. Let me now turn to slide 12 and pretty briefly talk about our guidance before I wrap up and open up the session for questions. We have already delivered €381 million of revenues in the first six months of this year, that’s the figure shown in the light blue area on the right of this pie chart. Our order backlog stands at €374 million, of which around €50 million is due for delivery in 2012. So that’s €324 million of second half revenues to add to the €381 million of already recorded revenues, taking us to €705 million for the year.

Let’s also assume that we will sell spares and services worth around anther €30 million into the second half of the year. This is broadly in line with the run rate in the first half of the year. This leaves us we needing another €65 million to €165 million of order intake before the end of the year that can be delivered and recorded as revenue this year, €65 million in order to get to €800 million revenues for 2011 and €165 million to reach €900 million. Albeit challenging, we believe our 2011 guidance is achievable and therefore we see no reason to change it.

Ladies and gentlemen, I would like to leave you with three main messages before I open up the floor for questions. First, the momentum for general lighting is gathering strength. We can see this in the escalating efforts of both commerce and governments to encourage the adoption of this technology. We can also see it more clearly in our own order book. We believe at least half of the systems we are delivering today will be used for the production of general lighting applications.

Moreover pricing for some of these new devices has reached what we believe to be a price tipping point. While backlighting investments are slowing, LED lighting investments, the so-called third investment cycle have started. We are increasingly of the opinion there will be little or no substantial gap between the end of backlighting demand and the development of LED lighting.

My second point is, China continues to be an extremely dynamic market, offering great opportunities for us, but also carrying some transitional timing risks. China and Taiwan are already a large source of revenue for us and demand from the region will continue to grow, especially on the basis of the increasing prevalence of general lighting. We have been predicting this development for some time, and have now started to put in place the necessary corporate infrastructure to support that market development. There is a downside on this substantial opportunity, bigger volumes, bigger customer concentration demanding lower priced systems will have an effect on margin in the short-term as we compete for market share in the aggressive marketplace. We started that battle with industry leading margins and an exceptionally flexible business model.

The reduced revenue visibility that I have spoken of will improve as the second demand phase of the investments in China settles down. And when, as we expect, we start to see the next investment cycle in Taiwan and Korea driven by increased traction in lighting replacing that of backlighting. In fact, you could say we are at the crossroads of two important investment phases. One road runs from west to east and is an end-market product investment phase, namely from backlighting to lighting. And the other road runs from south to north and is market participant investment phase i.e. from small to medium enterprises to substantial corporate investors. This is certainly true in the case of China.

My third and final point is that our order intake and new product development output continues to be strong. This combined with the strict assessment procedure we have in place before we accept orders as valid, gives us the confidence that we can achieve our guidance for this year and in 2012 and beyond, we will continue to complete the market leadership in all of those markets we address.

Ladies and gentlemen, I will thank you for your attention. And after a short comment from Guido, I would like to start the Q&A session. Guido?

Guido Pickert – Director of Investor Relations

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 again expect to have a long list of people wanted to ask questions, could you please limit your questions to maximum of two each time. 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 always and 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) The first question comes from Timothy Arcuri from Citi. Please go ahead with your question now.

Timothy Arcuri – Citi

Hi. I had two questions. First of all, on China, can you give us the percentage of your backlog that is China? You were talking about the tighter financing potentially impacting some of the second tier Chinese players and I'm wondering how much of your backlog is exposed to that. And then my second question is on orders. You were saying that you would need between €65 million and €165 million to hit the low end and the high end of your guidance for the year. That's significantly below what you just booked. You just booked €220 million. So that would sort of suggest that bookings are going to be down pretty significantly in Q3. But I am sort of wondering whether I am not reading that right. Thanks.

Wolfgang Breme

Tim, the backlog designated for China customers is exceeding two thirds of our backlog roughly at this stage. So it’s growing towards China, but it’s always important to note that systems designated to be installed in China can also to be part of joint ventures, which are headed by Taiwan needs and Korean players. So it’s a mix of real Chinese orders plus Korean and Taiwanese-managed joint venture investments. So, coming to orders, maybe I can just pick up on that point as well. Just to make sure we’re clear on this. It is I think true then that we’re seeing with the arrival of the bigger players into the market and competing against the smaller players in the market. Some of the smaller players are having more difficulty in securing the funding in the phase of competition from big corporate customers in China. And some of the new people -- recently have sometimes perhaps underestimated how long it takes to get the right money in the right price at the right time.

Paul Hyland

Only issue of the orders what we are saying is, I mean, typically we’re still delivering on four to six months is typically the sort of lead time. What we’re saying is in order to hit the range we’ve given we are not implying we get a lesser order intake. We’re simply saying, in order to hit the guidance we gave at the very beginning of the year, if we think $65 million of orders, we’re in a position to be able to deliver 865 to 900. It’s not a reflection of the order intake it’s simply a reflection of that portion of the reminder of this year, which orders will come first since the revenue customers may not want them. I think one characteristic that we’ve seen during the course of this last couple of quarters is, we’ve seen – this is probably the first time I remember where we have already 15 million order backlog not being requested by customers until the beginning of next year. It reflects bigger orders in the longer schedules. That would mean we got more order visibility, it just mean, those orders we are receiving are bigger and are phase-out longer. So it’s not right to assume that we’re talking about a drop. Remember we can’t ship every order that arise in Q3 and many customers may not require them. It’s just a reflection of what’s necessary to hit the objective.

Timothy Arcuri – Citi

Right. I was just asking because you were saying that even to get there would be challenging. So even to get to that?

Paul Hyland

You could do it. We talked about that the environment is challenging and indeed it is. I think if you look at it another way, you could say, if you look back on the same position in years gone prost. And I don’t think many people would be concerned about whether or not will enough holders to hit our guidance. I mean, that is less of an issue. I think this year then it’s being in pretty good shape.

Timothy Arcuri – Citi

Sure, great.

Paul Hyland

65 is not a huge account. 165 million is not a huge amount if orders to be looking for at the half-year. And that of course become great order intake coming since….

Timothy Arcuri – Citi

Thanks a lot.

Operator

The next question comes from David Mulholland from UBS. Please, may we have your question now?

David Mulholland – UBS

Hi. Thanks for taking my question. Firstly, just when you talk about the five to six companies that you view as being likely to succeed in China in the long term, could you possibly talk specifically about how you are positioning with those customers? And just secondly, in terms of the outlook for the market as we move beyond 2011 and with your guidance being intent, how do you expect this market to develop over the next few years? Do you still see it being growth beyond where we are today as lighting comes through?

Paul Hyland

First of all, in the five to six companies, the value is actually powerful, the state of objective to of the Chinese five-year plan. And I don’t think it’s pretty much in line with what you expect. And I don’t think they are looking to hundreds of companies. They are looking for substantial companies that cannot turn the -- meet their own domestic needs, but can compete internationally. I mean, that’s the objective. And of course it does make sense given the choice you want critical mass to be able to compete in the bigger market.

We have in the last 12 months seeing if you like bigger balance sheet, customers coming into the space. If you were to look at it back in 2009, very few the names of people talk about now who actually saw the placing orders. It’s only really in the last 12 to 18 months we’ve seen in your (indiscernible). So I wouldn’t want to state which of the companies. Certainly we have already orders from a couple of companies at least, that I would say are going to be, I believe amongst the five to six companies. And it maybe -- there are still more companies that will end to this space.

I don’t think it -- the year. If you look at the names of -- if I talk about ones that has been spoken about before, people like GCL, they’ve come in relatively recently into the space from a very successful history (indiscernible). I’m sure they’ve been encouraged over by the central Chinese government to participate in what is a very focused area of the Chinese. There may be others still to talk. We certainly got several very promising dialog with several customers of that sort of scale, that we think could still emerge in this market. But I wouldn’t want to name them. I’m sure probably we will be abused just to who they will be.

David Mulholland – UBS

And just secondly, on the outlook for the market over the next couple of years, lighting comes through?

Paul Hyland

I think it’s all a question of the adoption speed. We are – I mean, we are seeing also numbers for 1000, 2000, 3000 systems. I don’t know what the number is, because it depends obviously on the state of which the market grows. And I think it also is determined by the speed at which new products have developed and efficiency. I mean, certainly we are looking at several generations of products. We’ve just launched the net – situation in our current CRIUS II product, which is increasing sort of capacity substantially. I don’t know the number, but I think certainly we’re talking over the next three to five years of having very healthy business beyond that I’m just guessing.

David Mulholland – UBS

I appreciate it very much.

Paul Hyland

Okay.

Operator

The next question comes from Bill Ong with Condoroga Securities. Bill, your line is open now.

Bill Ong – Condoroga Securities

Good afternoon, gentlemen.

Paul Hyland

Good morning, Bill.

Bill Ong – Condoroga Securities

Since the beginning of 2008, AIXTRON shipped nearly 1,000 MOCVD tools in the past three-and-a-half years. And if you look prior to 2008, I submit that you have probably an install base about 400 to 500 new tools at that time. So how many of these four years or older tools have been decommissioned and what’s the remaining sort of legacy tools that you have a replacement opportunity for the company?

Paul Hyland

Very good question. I don’t think – I mean, I don’t think we have seen the replenishment cycle. I think -- a lot of those tools are still out there. What we believe happens is not the tools I’ve replaced because they run out. They tend to continue to operate on perhaps lowest spec devices. What initiates a spend is more likely to be a better cost of ownership or higher throughput. So it’s a different -- it’s a difficult thing to identify. We don’t often get customers coming back to us saying look, this is beyond its work we like, we do not like now the next generation. You are more likely to come back if we can give you a system that -- a higher throughput will consume less material. Because it tends to be the target application that dictates the sort of performance criteria at the stronger factor. I’m afraid we – I don’t know, but we certainly have a lot of those systems, we’ve shipped a lot of those systems as you saw over the years. And I’d say many of them are still out there, but they may not be delivering cutting-edge lighting product to – or the future markets.

Bill Ong – Condoroga Securities

Yeah, it’s a tough one. Thank you very much.

Paul Hyland

Welcome.

Operator

The next question comes from Andrew Abrams from Avian Securities. Please, may we have your question now?

Andrew Abrams – Avian Securities

Thank you. Paul, can you just talk a little bit about whether there were any trainees pull-ins. I know this is hard to isolate. But if there were any of your customers that sort of pulled in their orders thinking that it was going to be more difficult for them to get the financing that they might have gotten in the first half of the year? Have you seen any of that at all?

Paul Hyland

No, no, I don’t think we’ve yet, we haven’t seen people saying, I’m not having for the (indiscernible). We actually have had a conversation this week with the customers who said, you won’t get them earlier. But that wasn’t related to funding the tool. I think the new guys coming in here, they are saying, there I’ll say, they don’t need the subsidies. But they are unlikely to leave at the moment – that they are available. And I think that’s become a little bit disruptive for some of the small to medium-sized enterprises who perhaps do need the subsidies.

But no, we haven’t seen – we haven’t seen that yet. We do see – I think the question of available engineers to drive these is to be an issue. And we’re seeing quite an extensive amounts of – should we say recruitments from Taiwan into China. And that does have a knock-on effect that we have seen quite a rapid improvement in output from some Chinese facilities, where they’ve been able should we say capitalize on that Taiwanese expertise is going over. And that’s having an effect on LED pricing in Taiwan. I think if this market progresses, they are increasingly interlinked. But I’m afraid, what we haven’t seen what you’ve described yet, it could be, but we haven’t seen it come through yet.

Andrew Abrams – Avian Securities

And so a follow up, have you seen other than your standard competitor detail? Have you seen anyone else presents devices that are -- what you would consider even marginally competitive in the market yet?

Wolfgang Breme

You chose your words very carefully. I think certainly we haven’t seen anyone who is yet producing devices. We are of course seeing a number of people who are trying to quantify the technology. And I am sure that -- me saying, we know obviously -- from the time to do something we know that material has continued to be out there somewhere we know in (indiscernible) etcetera. But there are one or two new ones popping up in China. I think in anticipation, the subsidies will also be available for MOCVD equipment, because the cost of Chinese will want to compete throughout the whole food chain not just on (indiscernible). So that’s a fact of life and I’m sure, we will have to contend with that. But there have been many people that are trying to compete in this space and then found it difficult to qualify certainly through a device level. And I don’t think we’re making it easier. As you know, we are substantially increasing our R&D. We will be spending about $60 million on this new facility. And we’ll be upping out R&D head count about 50% by the time we finish. So I think competition gets tough and not easier going forward.

Andrew Abrams – Avian Securities

Got it. Thank you very much.

Paul Hyland

You’re welcome.

Operator

The next question comes from Günther Hollfelder from UniCredit. Please, it’s your turn now.

Günther Hollfelder – UniCredit

So just a follow-up on the price, yeah, let’s say the price impact from the CRIUS systems. And you also – you mentioned your new higher capacity system here. I understand there is like a 25% increase into wafer capacity system. So if this system is helping you to let’s say stabilize or is it having a positive impact here? And should we assume like -- half of the productivity gains of your customers you include in the price or like a 10% premium? And the second question would be about the current situation in China. I mean, I understand that right now there is no impact on the global supply and demand balance you’re coming from Chinese (indiscernible) installed. So what is your forecast? Do you think it will remain a closed market just producing in future when the systems are installed for Chinese demand? What’s your view here? Thanks.

Paul Hyland

First of all, we literally have just launched this. As I say, it was just a few weeks ago. So we’re not talking price here today. It is true that, it does have a fairly substantial increase. It may help me the last, but anyway this one, the previous version could handle 55 by 2-inch, that’s been increased to 69 or 13 4-inch, and that’s been increased to 16. So it does have quite a significant benefit in terms of -- both in terms of the output per wafer, cost per wafer that’s been fairly substantially improved. And indeed throughput per footprint has also gone up fairly substantially. So we’ve shift that, we’re just in the process of shifting the first system. We have a lot of customers who are wanting to try and get their head around it, we won’t be talking about I think price at this stage. But it is true that this is going to also help us to address especially for areas that are still dominated by two and 4 inch. The effect of -- the effects on China, I think China is effectively compressing what would have taken otherwise five years that in just over two or three-year period, I would expect at the end of that, you will definitely see a substantial and sustainable Chinese LED industry at the end of the last period.

There may be issues for them as to how long it takes them to produce products and devices to a competitively global spec, and they will still have to address some of the issues of IP if they were to achieve their objective of 60% export. But already I think you are beginning to see an effect. You can see that the impact its having on general LED pricing cost, because they’ve made such quick progress because of the expertise that is migrating to China.

So I think back if it has an indirect effect, it may well drive some of the other markets to look at other higher spec devices by perhaps lighting perhaps power electronics. So I think you can’t disconnect it. I think they are making very quick progress, but there will be a pools until they can get to a certain global standard. And then a further pools where they are able to achieve IP integrity that enables them to export.

Günther Hollfelder – UniCredit

Thanks.

Paul Hyland

Okay.

Operator

The next question comes from Andrew Huang from Sterne Agee. Please, may we have your question now?

Andrew Huang – Sterne Agee

Thank you. Just two quick questions, first, can you give us a sense of how much of the backlog is from some of these larger well-funded Chinese companies like TCL that you’ve been alluding to?

Paul Hyland

Yes, we do have all this for GCL and then it is not all of the order that we have received from GCL and in line with our booking policy. Beyond that, I don’t have any comment to make.

Andrew Huang – Sterne Agee

I guess, I wasn’t looking for specific customer need but more other customers like GCL in the backlog today?

Paul Hyland

Yes. There are several.

Andrew Huang – Sterne Agee

Okay. And then secondly, maybe you can comment a little bit on the order momentum for the second half of this year, how was it looking in terms of visibility?

Paul Hyland

I’m afraid we could but wouldn’t. We’ve done that as you know. We -- I was honest to give any forward-looking year ahead, which thankfully we have always been to be pretty close in the last five or six years, but we don’t give quarterly outlook. And -- but we continue to have number of dynamic customers. We continue to have a number of orders we have already received that haven’t yet take two of those boxes deposits, etc cetera. So we still continue to see, but then ask me to put a conservative measure on it.

Andrew Huang – Sterne Agee

Okay. And then just a real quick on the semi business, I was at semi kind of few weeks ago and your blues looked pretty busy there, give any comments on that?

Paul Hyland

We are very pleased with the progress we have made over the last couple of years. You will know, if you know the history of it that the CVD business that we acquired through (indiscernible) has always disappeared in the last few years. We have been working over the last, at least the last two years on focusing on a re-entry point for high throughput LED at sub 32-nanometer memory and sub 22-nanometer logic. We are very pleased with the technical progress we have made both internally and also at customers labs. The semi (indiscernible) have to get the R&D, JDO in place, then you have to do preproduction and production qualification. It’s true we are not making a lot of noise, as indeed, we are not making a lot of noise about our OVPD in large area organic semiconductor business. But nevertheless on both of those fronts, I shouldn’t exclude the sort of (indiscernible) business. We are very pleased to how that’s progressing but we’re not making noises about immediate revenues, but we are pleased with the progress.

Andrew Huang – Sterne Agee

Okay. Thanks a lot, Paul.

Paul Hyland

You’re welcome.

Operator

The next question comes from Janardan Meron from Liberum Capital. Please, it’s your turn now.

Janardan Meron – Liberum Capital

Yeah, thanks for taking the question.

Paul Hyland

Hi.

Janardan Meron – Liberum Capital

I was just – two small questions if I can. One is, just you saw some shipment delays from Q2 to Q3. Was there any order delays of which -- orders which you thought you would have got in Q2, but potentially you guys slipped into the second half of the year because of that construction delays or funding delays etcetera? And the second part of the question is -- the €65 million to €165 million of orders that you need to get to the low-end and the high-end of your guidance, that’s actually quite a small number. So I was just wondering what are the chances that you see that you will actually hit the high end of the guidance or could you even exceed the high end of that guidance or is that not possible because of capacity restraints or because you want to get that many shippable order even if your orders are flattish quarter-on-quarter?

Paul Hyland

Yeah, we haven’t seen any order delays. That doesn’t tend to be how it is. I mean it tends to be the orders will be placed. It’s more likely to be, it’s taking longer than I thought to either get the fast bill to get the money in the right place, R&D, to get engineers. So I don’t think it really is an issue on order delay. On the 165, I mean we’re just delivering on four to six months. We can’t do it less than that. If we know you, we know what the configuration is. But generally speaking, people are asking for much less than that because it takes that own figure along facilities in place. Of course, the third quarter starts quietly with holidays, etcetera, etcetera. But if we got more orders, yes, add capacity, we are not capacity limited. We already made 150 across, so we know we can do that. We know we can do 200 systems a quarter. We’re even looking at whether or not we can do 250 across. But at first, we don’t think we will have to see that sort of number. The world will run out of engineers before we are requiring to push out 250. We don’t have initiative and we outsourced 90%. We’ve got infrastructure in place and got to support at least 200 and probably more. So it is not capacity limited. It’s really a question of what customers want and when they received deliver -- when they want to receive delivering. Yes, we can do more and more of them.

Janardan Meron – Liberum Capital

All right. Thank you very much.

Paul Hyland

And I think just one last comment on that. Given the very modular nature of that product, it means that we’ve got the flexibility to build it, reduce the lead terms because of the commonality price to most of these systems.

Janardan Meron – Liberum Capital

Thanks.

Paul Hyland

Okay.

Operator

The next question comes from Jed Dorsheimer from Canaccord. Please, it’s your turn now.

Jed Dorsheimer – Canaccord

Hi, thanks for taking the question, guys.

Paul Hyland

Hi, Jed.

Jed Dorsheimer – Canaccord

Just two. I guess -- you guys have done a masterful job as far back as I kind of remember in terms of introducing new products on the cost of ownership to create a market where you actually have sort of flat to up ASPs. Is this the first time that we’re starting to see competing on pricing in the market. I know you mentioned that it’s a function of some of the larger customers, but it would seem that its cost of ownership of the new products is introduced. We shouldn’t see that. Any further comments and then I will follow-up.

Paul Hyland

I mean, this is a very pivotal moment in the growth of the industry. The arrival of a substantial market like China and the effectiveness. And indeed the history of China, which have the preference for the vertical deposition that China had thought of application. Although I will add there that we are seeing increasing inquiries from China’s Planetary possibly arriving from three sites, some of the teams have been being recruited from Taiwan, which had a very substantial planetary experienced base. But no, we don’t intend to give up market share without a fight. We will compete and I think probably given the driving of the cost base down, operating cost, but I’m the first to acknowledge that if you’re trying to complete the market share on price, once prices go down to my knowledge, they don’t come back up again. We think the most sensible way is to remain commercially competitive but to step up the rate at which we are delivering new, more cost-effective and more profitable products. That’s the way it has to be. I want you to outline most equipment companies is to enable customers to produce more at a lower production costs and higher performance. We can take some additional benefit on the top line from the ticket price, which is what we’ve done before. But also you have to drive some of the profitability into the business through better-quality design. I don’t think that policy, that’s what we are pursuing but we recognized this is a very competitive market and we intend to compete very resistant.

But we put our money where our amount is. We raised the money in 2009 because we wanted to substantially increase our R&D such that we could step up the price of product development. And I think what we have just launched is just the first of a number of products, I’m sure you will see from us. And that’s where $60 million has gone in the last 12 months and building a brand new facility that will enable us to increase R&D buying 50%. So profitability has to come from more than price, more than just top line, it has to come from more effective designs. Customers, everyone don’t get the cost of ownership benefits.

Jed Dorsheimer – Canaccord

That’s good to hear. The second question may be just sort of a higher level, Paul. If you look at your -- as you plan your business, I mean you have done a -- it looks like you have increased your capacity and increased head count by a decent amount. And I know you’ve got the five well-funded customers in China. But sort of beyond that, if you look at the health of the industry categorized by sort of utilization rates some 60% and a lot of the Korean and Taiwanese companies that have single or low double-digit margins down 50% from where they were a year ago. Is your model still as flexible as it was that if we look into 2012, if we see some of these markets not come back, we won’t see a drastic -- I mean, you would be able to turn things off pretty quickly and sort of tighten up the P&L.

Paul Hyland

I’m looking at (indiscernible), but I think probably breakeven is somewhere around about 260 million.

Jed Dorsheimer – Canaccord

Okay.

Paul Hyland

So, I mean, it’s true. But I mean you raised an interesting point. I did make this comment earlier, these markets that we serve particularly in Asia becoming much more interlinked than we have seen before. I mean we have seen the utilization rates shift. We have seen Korea began to buy a little bit more for backlighting from Taiwan. Now, we’re beginning to see the prices in Taiwan to be beginning to be affected by competitive prices from China, etcetera, etcetera. And through the comparison of these crossroads, (indiscernible) product migration from backlighting to lighting. And indeed, our actual comparison between this, there is some change in market participant process. We are moving quite definitely from small to medium enterprises to big one. I think if they also say there’s something similar happening also with the structure of the lighting industry. If we look back five or six years, the practical lighting companies, one wouldn’t have mentioned for example Samsung or LG. And now, we’ve got the prospects if China can’t achieve its objectives, we can’t be looking at China perhaps being a lighting source supplier maybe three to five years out. So I could easily see the development in our foundry industry, no one wants to complete with the (indiscernible) on the wafer industry. I think there is a positively disruptive effect in the lighting as well. This is very interesting times and you need to have an R&D investment and a flexible operation to do and meet what would be a very solid interesting periods ahead of us.

Jed Dorsheimer – Canaccord

That’s great. Thanks for the comments, Paul. It’s helpful. Bye bye.

Operator

The next question comes from Maxime Mallet from Natixis Securities. Please, may we have your question now.

Maxime Mallet – Natixis Securities

Yeah, good afternoon. Thanks for taking my question. Two questions actually. The first one will be regarding Korea, you’ve talked about the government and initiatives to promote the lighting. I was wondering, if you have already had an investment talking to pick up or get in this region or it really could have been later in the year? And the second one will be regarding the last MOCVD systems you have bought recently. I think it is based on the CRIUS II platform, do you expect it to have a faster input than the former reduction.

Paul Hyland

Right. Korea, yes, I do expect. I think Korea will be first. We must remember that Korea took us into this extraordinary cycle back at the beginning of 2009. Taiwan followed them and then China followed Taiwan and of course, the China investment phase is being extended by this extraordinary government investment or regional investment. If we follow that cycle, it would seem logical that Korea probably would start the next cycle and I think it will be more focused on lighting. I mean backlighting is little bit finished. If we assume that retail penetration is 55% to 60% this year and 80% next year, then we should assume that this year would represent 80% of the equipment requirement. So the next cycle will come from early positioning on lighting and of course, Korea has the most accelerated lighting program commercially. If you look at Samsung and LG have been doing quietly but very extensively. And now, they have some government so therefore I think you would comment, then I think it’s Taiwan again.

Maxime Mallet – Natixis Securities

Okay.

Paul Hyland

But I don’t want it for Taiwan, it is very difficult. We still we can see some signals at the beginning of the year, but I think that the green market is being affected by the current slowdown in OCVDs. And that seems to have put a force in the Japanese situation, also very difficult, but I do think it will come from there. But it’s not impossible to believe it could happen in the second half, but we are not predicting it.

Maxime Mallet – Natixis Securities

Okay.

Paul Hyland

On the MOCVD that you asked about, well, we certainly have the last product we launched that has had a faster adoption rate than the G5 and CRIUS II had a faster adoption in the previous generation. Given that the process migration is built on exactly the same platform, I think it has some considerable attraction to customers and are relatively short adoption cycles. So we’ll see but we have always had typically -- I think we said on a G4, it was 60% adoption out to 12 months. It’s probably being a bit better than that on the G4 and CRIUS II. This is common platform thing, has benefit of that design structure. So we have that thing to cross sell.

Maxime Mallet – Natixis Securities

Okay. Thanks, guys.

Paul Hyland

Okay.

Operator

And the next question comes from Ali Khwaja from Berenberg Bank. May we have your question?

Ali Khwaja – Berenberg Bank

Just one question, the other one have been answered. How secure is the backlog? Is there any risk of calculation or do you think that’s very secure?

Paul Hyland

I don’t think there is a risk of calculation because of this policy that we have and those that (indiscernible) about for the recognition, hope to pick up, we have been even more explicit than what it is. What we’re looking for is a fantastic order. We don’t want NOIs. We are also looking for what we consider to be shipment limiting documentation, we don’t want to build in time we don’t it. We are looking for deposits on the order. It’s another returnable deposit and we’re looking for thermal (indiscernible) shipments. And we have – probably that’s the last nine months have it on additional things, which means even if you tickle those boxes, we still will apply some management -- judgment, we should still record it or is there any doubt. So it’s an additional fantastic job. Given the VATs order backlog, I would say it’s pretty same. I don’t remember. I think I remember one cancellation probably about three years ago. And that was a business that -- I think that was a business that went past, but this was a settlement now.

Ali Khwaja – Berenberg Bank

All right. Thank you.

Paul Hyland

You’re welcome.

Operator

And the next question comes from David O’Connor from the Royal Bank of Scotland. Please, it’s your turn now.

David O’Connor – Royal Bank of Scotland

Thank you and good afternoon, gentlemen.

Paul Hyland

Hi.

David O’Connor – Royal Bank of Scotland

Question on, it was first the same level going forward…

[Call Ends Abruptly]

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