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Aixtron Aktiengesellschaft (NASDAQ:AIXG)

Q2 2012 Earnings Conference Call

July 26, 2012 09:00 ET

Executives

Guido Pickert – Director, Investor Relations

Paul Hyland – President and Chief Executive Officer

Wolfgang Breme – Executive Vice President and Chief Financial Officer

Analysts

David Mulholland – UBS

Olga Levinzon – Barclays Capital

Edwin Mok – Needham & Company

Sandeep Deshpande – JPMorgan

Bill Arnold – B. Riley

Andrew Huang – Sterne Agee

Andrew Schenker – Morgan Stanley

David O’Connor – Exane BNP Paribas

Operator

Good afternoon, ladies and gentlemen, and welcome to the AIXTRON’s First Half 2012 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, Investor Relations

Good afternoon and good morning everyone. Thank you for attending today’s call. With us today as always are Paul Hyland, President and Chief Executive Officer of AIXTRON, as well as 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 re-broadcast 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 loud, but would like to point out that it applies throughout this conference call. You may also wish to have a look at our latest IR presentation, which includes additional information on markets and its 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.

I would now like to 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 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 2012 first half year results.

I’m going to open the presentation by giving you an overview on the current market environment as well as some of the key financial elements in the last quarter. Wolfgang will then elaborate on some aspects of our half year financial and business performance, before I close the presentation by discussing our prospects for the rest of the year and beyond.

Let me start by making some general comments. During our Q1 call on April 26, we shared with you our expectation that Q2 would not be any better than Q1 and so it has proved to be. We also shared with you our expectation of a potentially better second half. At this stage, quotation levels suggest that we will see a gradual increase in demand in the second six months, and we continued to believe that we will see significant increased demand in 2013 providing the macroeconomic environment doesn’t deteriorate further.

So, let me set to the macro scene first. The current economic data suggest a much more moderate development of the global economy in the short-term, also evidenced by the latest news that China’s growth rate slowed to 7.6% year-on-year in Q2, the slowest since 2009. Potentially serious implications of this specific economic growth slowdown signal in the biggest end market for LED equipment, is emphasized by China’s recent announcements of a reduced bank interest rate and foreign dividend tax reduction measures clearly taken to encourage investments within China.

There is however some good news. Some of our customers, especially in Taiwan, have been reporting very high utilization rates which is an essential precursor indicator of any capacity driven equipment demand pick up. Unfortunately many of these same customers remain cautious on adding new capacity at this time, principally because of their doubts on the sustainability of the currently high LED backlighting demand. This understandable customer caution makes the magnitude and timing of any system demand pick up still difficult to forecast with any real precision. Nevertheless, we are still of the opinion that next year will be a much stronger year, based on the predicted increased penetration of LEDs and in general LED lighting market, for which AIXTRON is well positioned to capitalize on this opportunity.

Let me now move on to slide three to pick out some of our key financials from the last quarter. As you can see on this slide there are some positive developments to report from the second quarter results. Revenues were up by 10% sequentially to €46 million compared to the €42 million achieved in Q1 2012. The gross margin improved over the prior quarter by 7 percentage points to 32%. Although still in negative territory, the EBIT achieved in Q2 was a 10% improvement sequentially with the operating loss for the quarter amounting to €16.5 million.

Order intake remained broadly in line with the prior quarter at €30 million, leaving us with an order backlog of around €138 million. I’d also like to point out that after a few years in the wilderness in the silicon world. It’s good to be able to report the return on production orders for our silicon semiconductor equipment business. A large part of these orders, placed by a leading Korean DRAM manufacturer with AIXTRON’s next generation QXP-8300 ALD deposition tool. My colleagues and I continued to believe that AIXTRON has a significant growth opportunity with this tool, given the projected growth in sub-30 nanometer DRAM production.

Now let me hand you over to Wolfgang for a more detailed overview of the first half of 2012 numbers. Wolfgang?

Wolfgang Breme – Executive Vice President and Chief Financial Officer

Thank you Paul and welcome also from my side. Let’s move on to slide four, the consolidated income statement. I would now like to elaborate further on a few key financial figures. I will start with the year-on-year comparison H1 2012 versus H1 2011. During the first six months of 2012, AIXTRON reported total revenues of €88.1 million, a decrease of €292.9 million or 77%, compared to €381 million in the same period last year. The most significant factor in this development was the year-on-year decrease in demand for MOCVD deposition equipment for LED applications in line with the current cyclical downturn of the industry.

In the first half of this year, some 71% of revenues, namely €62.4 million were generated from equipment sales with the remaining 29% or €25.7 million coming from the sales of spare parts and services. This high level of spare parts and services revenues is a reflection of the previously mentioned increased utilization rates at our customers, which has resulted in higher demand for production consumables. As you all know, the equipment bought by AIXTRON’s customers is predominantly used for the production of LEDs, which in turn are primarily employed as backlighting devices for LCD displays and emerging lighting applications.

We would like to highlight, that the second largest market demand driver for AIXTRON equipment in the second quarter was for power electronics recorded as Display and Others. On a regional basis, 77% of total revenues in the first six months of 2012 were generated by sales to customers in Asia, around 13 percentage points lower than reported in H1 2011. Europe accounted for 7% of H1 2012 sales with the remaining 16% in the United States. Cost of sales decreased 68% year-on-year from €200 million in H1 2011 to €63.1 million in H1 2012, due to the reduced business volume.

Cost of sales equaled 71.6% of revenues for the period compared to 52% in the prior year period. This is due to the effect of fixed costs related to facilities and service activities. The impact of the revenue slowdown combined with the fixed cost effects on cost of sales resulted in the gross margin of 28% for the first half 2012, down from 48% in the same period last year. Operating costs increased year-on-year in absolute terms by 15% to €59.9 million in H1 2012 mainly due to increased research and development investments.

Consequently, operating costs were 68% of sales in H1 compared to 14% of sales in H1 of last year. This development was influenced by the following factors. First and foremost, selling expenses decreased year-on-year by 26% to €13.3 million, largely due to lower regional sales commissions and provisional standard warranty expenses links to lower sales volumes. Secondly, general and admin expenses decreased by 39% year-on-year to €10.8 million in the first half of 2012 principally due to reduced numbers of temporary staff, lower consultancy costs, and lower IT infrastructure costs.

In Q2, 2012, general and administrative costs were down by 13% compared to the previous quarter amounting to €5 million or 11% of revenues. This sequential decrease was mainly due to the impact of our ongoing cost optimization measures. And thirdly, R&D costs increased 42% year-on-year from €24 million in first half of last year to €34 million in the first half of this year, reflecting AIXTRON’s continuing high level of strategic investments in research and development, which Paul will address in his closing remarks.

Let me now comment on the development of the net other operating income and expenses. Net other operating income and expenses in the first six months of 2012 resulted in an expense of €1.7 million, as opposed to an income of €7.5 million in the same period last year. This was mainly due to the weak euro resulting in the following currency related effects. In H1 2012, a net currency expense of €3 million, whereas in H1 2011 an income of €7.8 million was reported.

The currency related result is coupled principally to US dollar Euro hedging contracts, which resulted in an expense of €2.4 million in the first half of this year and a currency transactional and translation difference related expense of €0.6 million in the first half of 2012. €1.9 million in R&D grants received in the first half of the year as well as €1.1 million of grants received in H1 2011 were as usual reported as other operating income. The absolute operating results decreased 127% year-on-year from €129.2 million in the first half of last year to an operating loss of €34.7 million in H1 of 2012. This development is largely attributed to the fall in gross profit, coupled with the increased absolute operating cost base due to the higher investments into R&D for future products as well the already described currency effects.

On a quarterly basis, the operating loss improved by 10% from €18.3 million in Q1 2012 to €16.5 million in Q2 2012 in line with the sequential revenue development. The net financial result in the first half of the year was €1.6 million compared to €0.3 million last year leading to a pre-tax profit of €33.1 million, pre-tax result of €33.1 million compared to €129.5 million in H1 of 2011 equal to 126% year-on-year decline. In H1 2012, AIXTRON reported a tax credit from the capitalization of deferred tax assets of €9.2 million, which splits into €4.8 million for Q1 and €4.4 million for Q2 2012.

The net result in the first half of the year was down 126% year-on-year from €90.4 million or 24% of revenues to a loss of €23.9 million, which equates to 27% of revenues. The net loss for Q2 improved to €11.6 million compared to €12.3 million loss in Q1 of 2012. Let me now come again to a sequential quarter-on-quarter comparison. As Paul already mentioned, the revenues in Q2 were up 10% sequentially to €46 million, also we saw a sequential gross margin improvement in Q2 to 32% from 25% in the first quarter due to a favorable product mix and some tailwinds from currency.

Our ongoing cost reduction activities brought the administrative expenses further down whereas R&D expenses went up in line with our high level of strategic investment in that field. On a quarterly basis, the operating loss again improved by 10% from €18.3 million in Q1 to €16.4 million in Q2 in line with the sequential revenue development. Therefore, the net loss of Q2 improved to €11.6 million compared to €12.3 million in Q1 2012.

Let me now move on to slide five, consolidated income statement of financial position. Just as at the year-end December 2011, AIXTRON continued to report no bank borrowings as of June 30. Due to 9% lower balance sheet total, the equity ratio increased to 84% as of June 30, 2012, compared to 81% as of December last year. Inventories including raw materials, work in process and finished goods, increased from €184.6 million as of December 31, 2011 by 17% to €215.8 million as of June 30, 2012. This is principally explained the increased non-standard, prototype and laboratory tools work in progress.

Advance payments from customers increased slightly by €3.6 million to €68.5 million as of June 30. Trade receivables decreased from €78.6 million as of year-end 2011 to €30.6 million as of June 30 reflecting the reduced business volume in the first half.

Cash and cash equivalents decreased to €234.9 million as of June 30th compared to €295.2 million as of December 31. The decrease was mainly driven by the incurred losses, the dividend payment and the increase of work in progress within the first six months. Despite these effects, we take pride in the fact that we are free of debt and have a strong cash position, which will serve the company well in meeting the opportunities ahead.

Next slide shows our consolidated statement of cash flows, the increase in operating losses had the major impact on cash flow from operating activities, which fell from €32.1 million in the first half of 2011 to minus €28.4 million in the first six months of this year. Cash flow from investing activities also fell from €49.6 million in H1 2011 to €7.5 million growth in the same period this year. Included in these figures are a drop in cash deposits of €16.6 million as well as a reduction in capital expenditures for the first half of 2012 to €9.9 million, down from €11.7 million in the same period last year.

The outflow in cash from financing activities of €24.6 million in the first half of the year is lower than the outflow of €57.6 million last year mainly due to a lower dividend payment to our shareholders this year. Finally, AIXTRON finished the first half of the year with €234.9 million of total cash. This figure includes €129.1 million in cash and cash equivalents, and €105.8 million invested in other financial assets, which is cash on deposits with a maturity of more than 90 days. By the end of December, the cash position amounted to €295.2 million in comparison. It is worth mentioning that the dividend payment in May of about €25 million accounted for a significant part of the reduction in our cash balances.

Our final slide is our 25 months business development slide this puts the scale of the reduction order and volumes into sharp focus. On the one hand, the figures for Equipment order intake, equipment order backlog and total revenues are reflective of the business cycle.

In detail, the Q2, 2012 equipment order intake decreased from the all time record level order intake of €222 million in Q2 2011 to a trough level order intake of €30 million in Q2 of 2012. This figure was virtually flat compared to the prior quarter number of €31.5 million. These amounts were valued according to internal policy at the current 2012 budget exchange rate of AIXTRON of $1.40 to the euro. The total equipment order backlog of €138 million as of June 30, 2012 was 50% lower than the €274 million reported a year ago. The backlog has edged slightly higher from the backlog figure of €136.2 million we recorded at the end of March.

Ladies and gentlemen, thank you for your attention. Let me now hand you back to Paul for his concluding remarks before we will open the floor for your questions. Paul?

Paul Hyland – President and Chief Executive Officer

Okay, thank you, Wolfgang. Let’s move straight on now to slide eight. As I said earlier, I would now like to talk to you about our business prospects for the rest of the year and beyond. Let me start by talking about the MOCVD market how we see potential market developments over the next 18 to24 months and why we believe AIXTRON is well-positioned for the expected upturn in the order cycle.

Starting with our core MOCVD end-user market, the LED market, LED chip demand has been steadily increasing since the beginning of the year and capacity utilization rates today remain at a very high level. Additionally, we are seeing increasingly positive LED adoption signals coming out of the LED general lighting sector. However, we have not yet seen a clear turning point in our customers’ buying behavior and we believe that there are a number of reasons for this. First this is the second year in which LED chip manufacturers have had to contend with substantial price erosion, resulting in considerable margin pressures.

Secondly, there is customer concern about the potential for growth slowdown in LED backlighting demand, which has been the major growth driver for the LED industry over the last three years. And thirdly, there is growing concern I suspect that this applies to all of us on this call about the fragility of the global economy and its impact on consumer spending. The net effect of these factors is that our customers are understandably cautious about new investments and wherever possible are focusing on measures to fine tune their manufacturing processes to maximize output with their existing assets.

Our view is that eventually our customers will come to a point at which they will have to invest in new cost efficient and highly productive systems as global LED demand continues to increase ultimately driven by increasing adoption of LED lighting applications. As perhaps recently evidenced by Philips reporting 20% of their luminaire business in Q2 already being LED based. The momentum in general lighting is growing in strength, thanks to the increasingly competitive pricing of LED lighting products, particularly in Asia, but also in the U.S. where the relevant players focused on the commercial and industrial segments are making encouraging noises about the adoption of LED products.

This is also true in the U.S. consumer household sector, where the average price for a 60 watt equivalent LED light bulb has decreased from $24 to $22 since the last quarter, getting closer to the commercial tipping point range of $20 to $15 which we have speculated about before. Not forgetting that there are, in the U.S., additional point of sale utility rebates offered lowering the purchase price further. The general lighting market today is served by relatively few comparative LED lights. This will change profoundly in the coming years. According to the most recent study conducted by McKinsey, the general lighting market will be worth about $60 billion by the end of this year, of which the LED market penetration can be measured in single digits.

It won’t surprise you perhaps to hear that China’s stated ambition is to achieve 100% penetration of LED lighting by 2020. As I’ve mentioned before, the exact timing of that inflection point leading to the third major LED investment cycle, namely for LED general lighting is difficult to predict accurately in current climate. But whatever the timing was uncertain is that the volume growth being predicted following LED adoption in the general lighting market, will require a very substantial build up of LED capacity.

And our view is that this will translates into an incremental need for somewhere between 2,500 and 3,500 systems, the exact number depending on a number of factors including the speed of adoption and the pace at which pricing becomes commoditized. We believe we understand what the key differentiators will be in this next market up cycle and our R&D investments, our technology track record, our strong local footprint and customer relationships mean we are well positioned to respond to this opportunity.

On a longer term view, we remain committed to building on our leadership position over the last 30 years, not only in LEDs, but also in other growth markets. The accumulated expertise within AIXTRON’s traditionally strong R&D group has been the key to the company’s past success, and we see that same strong R&D culture as an essential future growth driver for AIXTRON supporting our ambitions for the new markets we are developing products for.

For all of the end markets we are working on in R&D, we are very focused on helping our customers achieve their own development roadmaps and will continue to deliver systems which raise their performance and further reduce their cost of ownership in an increasingly performance and cost competitive environment. The areas in which we are concentrating our deposition development expertise include a number of different technologies. But I'd like to pick out two especially interesting areas of interest for us namely organic material applications, including OLEDs and power electronics applications.

But first, Organic Semiconductors is an emerging and technically challenging technology, which is at a very early stage of commercialization and ideally suited to the expertise we have in-house. There are a number of highly relevant short-term applications, such as displays for mobile phones and small displays. There are also some very substantial mid-term applications which can take advantage of the OLED particular strengths of picture quality and low power consumption. Televisions and larger displays being more obvious candidates for general adoption in the next 3 to 4 years. Although we are already seeing some early examples of OLED lighting, the development of OLEDs as a competitor to conventional LED lighting is still in a relatively early stage of developments, with real commercial traction probably being more mid to long-term. When fully developed, we expect to see these two LED technologies, namely conventional inorganic LEDs and organic LEDs becoming more complementary rather than competitive lighting technologies.

Our R&D investments into MOCVD, OVPD and PVPD technologies over the last few years, means we are well positioned to provide manufacturing solutions for both technology markets. In fact, we have just shipped this month a Gen 3.5 OLED system to an Asian production customer. The revenue recognition for this system will kick in next year. In the power electronics equipment field, we’ve recently announced the expansion of our MOCVD platform with a particular focus on next generation energy efficient power applications.

According to IMS Research; the end market for power semiconductor devices, modules and power management ICs is estimated to double over the next decade from $33 billion last year to $70 billion by 2021. With the projected growth in these three addressable end-user markets, we believe we have a very real opportunity to significantly increase equipment sales in this area, and are targeting an equipment TAM of approximately $500 million over the next 5 years.

The new G5+ planetary 5 by 200 mm deposition system we announced this week, not only offers best-in-class uniformity and yield on standard 200 millimeter silicon wafers, but also gives LED customers an equipment platform for Gallium Nitride on Silicon LED applications and enables power electronics customers to produce highly cost efficient devices, such as high electron mobility transistors, with an upgrade option from 6-inch to 8-inch wafers. In summary, you can see that we are not only focused on the LED markets, but also on a number of other areas that are providing future growth opportunities for the company.

Let’s move on finally to our outlook for the remainder of 2012 on slide 9. We continue to believe that orders and revenues in the second half of 2012 will increase compared to the first six months of the year. The recently perceived increase in short-term macroeconomic risks in the end markets we address has increased the timing risks on the predicted orders and shipments in the second half of the year and consequently the company’s ambition to be EBIT profitable in 2012. Order intake and shipment commitments in Q3 and early Q4 will determine the full extent of the year end performance.

To be clear, we can still see a customer-specific route to the breakeven revenue target we have talked about on previous calls, but the risks along that routes have increased considerably. Nevertheless, we expect to return to profitability within the second half of this year. In the meantime, we will continue to review and implement appropriate cost-saving measures to deliver the best possible year-end results.

Finally, let me assure you, we have seen challenging times in the past and have deliberately set out to build a business with the kind of flexibility and resilience that will enable AIXTRON to succeed in the current climate of subdued demand as well as in the future. We are focused on delivering cutting-edge production technology solutions to markets with great growth potential, which we are fully confident will deliver significant shareholder value in the coming years.

Okay, thank you. And with that, I’ll pass you back to Guido.

Guido Pickert – Director, Investor Relations

Thank you, Paul. Let me make my remark before we hand the call over to the operator for the following Q&A session. Since we are bound to have a long list of people wanting to ask questions, could you please limit your questions to a 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. I will now pass it 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 David Mulholland from UBS.

David Mulholland – UBS

Hi. Thanks for taking the question. Just one and then come on follow-up, firstly, in terms of the (indiscernible) in the market being 2.5 to 3.5 dozen tools for LED lighting still and just wanted to ask you the delay we are seeing in the ramp in the potential for higher capacity tools going forward. It’s already considered within this guidance and already seeing people Philips in the 20% of their business on LED. Could you still see that 2.5 to 3.5 dozen tools opportunity and what drives it?

Paul Hyland

I think, there is the number of issues to this. Obviously, the state at which the investment comes, actually, the faster the ramp the more the tools that we needed, because you don’t have the same natural opportunity to get the incremental efficiencies building in. So, that’s the reason the range is so wide, but certainly what is going to be pretty clear is the need for actually very cost competitive high-volume lower cost is going to be a key driver over the next three to four years.

It’s the speed at which the investment goes in, I think, determines the quantity. So, I think that’s a really strong evidence. That was very interesting, because I think it was the 20% increase was very much on the end product, Philips luminaire business rather than actually at the chip level. That sort of reflects a lot of what we are seeing a lot in the big investments made in Asia over last two to three years, that’s what’s driving a lot of the competitive pricing. So, I think we are going to see quite a wide range of ramp up on this. I can’t be any more precise than that.

David Mulholland – UBS

That’s okay. Just default in terms of your backlog obviously quite encouraging on the silicon side, could you also give us some details to whether these orders from (indiscernible) are already in your backlog and if still how much and also is that Chinese player that drives which are breakeven, just kind of customer specific?

Paul Hyland

Because there are three pieces, second part, first of all our costs in semiconductor in the backlog, but I didn’t get the second part of the question with the Chinese player.

David Mulholland – UBS

First you said how much of your backlog is now for the Silicon business?

Paul Hyland

I’m afraid we can not disclose that.

David Mulholland – UBS

Okay. And then just in the customer specific groups, so you’re getting some breakeven is that driven by the Chinese player if you can possibly comment?

Paul Hyland

Well I would say it’s driven of course generally by a pick up in the market, but the Chinese customers play of course a very prominent role in our whole revenue scenario, that’s the case.

David Mulholland – UBS

Thanks very much.

Operator

The next question comes from Olga Levinzon from Barclays Capital.

Olga Levinzon – Barclays Capital

Thank you for taking the question. I guess the question is based on your commentary for an order and shipments to customers in the second half of the year. You found a bit more confidence there this time around and you are seeing a bit of pick up in customer deposits. So, just wondered if you can get a sense for which region that you’re seeing the most increased level of confidence form your customers that you feel more confident in your 2013 outlook. And how broadly is that based, is this a couple of customers or are you seeing increase in confidence across more broader (indiscernible) customers?

Paul Hyland

Yes, I mean, what we have seen obviously if you compare it sort of 9 to 12 months ago where a very large percentage of business was coming out of Asia, out of China, and consequently there were less customers with bigger volumes. What we are not saying yet is the return to those sort of very high volume Chinese customers being committing to all this. But we are seeing pickup more broadly, we are seeing in – we are now seeing demand coming in from most regions, some of them of course helped by the fact that there are other non-pure LED applications which are increasing older intake. But at this current level, I don’t think we can point to a specific pattern. I think I will just come back to the comments I made in the call. We are getting far most sort of interests and enquiries, but understandably customers are still very reluctant to commit. And I think that maybe probably understandable as we haven’t seen the big plan yet in general lighting. But most of the increased demand that’s coming in the last 6 months is being because of increased back lighting capacity that’s where the client know me typically in the past in the markets like Taiwan and elsewhere. If you get to around 70%-80% utilization that would normally be a trigger point for the next capacity, but we haven’t seen that this time. And I think it’s because people are wondering how sustainable the back lighting is. But coming to the original question the demand is very broad and not so China centric, but that’s still a major part of our current business.

Olga Levinzon – Barclays Capital

And then touching on your ALV and the outlook for your silicon business, very helpful to see us around how you seen the power electronics market. Could you help us think about what sort of revenue opportunity you could see in the sub-20 nanometer DRAM I guess shrink from here quantifying the ALV opportunity for let’s say 30,000 wafer starts of DRAM conversion to sort of high teens or low 2X nodes?

Paul Hyland

Well I guess over the next sort of five years, the sector that we are looking at could be worth anything up to $400 million to $500 million of the total market. Obviously, we are not comprised enough to think that all the business will take. But the point is actually after a very long time (indiscernible) and now being able to qualifying in energy platform and certainly for one of the major DRAM manufacturers we are much confident that we have been able to compete through all of that business over the next five years. So, the guys that who worked extremely harder over the last four or five years to move from what was the originally declining CVD base to the point where that R&D is now pulled exactly into the game. So, it’s a substantial market and a very important progress for us given how much resource and efforts we put into developing this new platform. I mean suppose a very competitive market I don’t have to tell you that ALD was a very hot space and very big names, so we are very pleased to found approve the technology.

Olga Levinzon – Barclays Capital

Okay, thank you.

Paul Hyland

You’re welcome.

Operator

You have another question form Edwin Mok from Needham & Company

Edwin Mok – Needham & Company

Hi, thanks for including my question. So, first question relate to kind of power electronics opportunity or the market there. I think last quarter you guys booked on how much was non-LED versus LEDs and can you provide that number and within that how much was power electronics versus silicon?

Paul Hyland

So, as I said in my presentation, there is of course a significant part of non-LED business currently. First of all, in silicon, unfortunately, contractually I cannot disclose the silicon number, which was in the order intake. The display and other, I would say just to give you a number, you know that we always – almost certain what the customers are doing with, I would say, maybe 20% to 30% of the order intake comes from the power electronics.

Wolfgang Breme

This is not a new market for us, but it’s a market which we’ve been selling both R&D and production systems for long time, but which is now quite clearly getting traction as the manufacturers begin to produce very competitive device product. So, it’s a lot of hard to say, but we are beginning to see now some traction on it. I think I did mention in the call, the total addressable market size just for that sector is probably in the region of about roughly statement of $500 million over the next five years. That’s how do with it.

Edwin Mok – Needham & Company

Great, that’s a helpful color. And then just going back to the guidance for second half right half right, if I look at your backlog right now, you feel $137 million stock right, how much of that confident on the second half comes from customer just taking equipment on the back half of the backlog versus (indiscernible) customer to come back with new orders. And just call around that, I know since your backlog actually increasing and the order was below – the equipment order intake was below revenue, I was wondering what was the adjustment there?

Wolfgang Breme

So, you answered the second question simply Edwin, you saw the dollar increasing against the euro. So, the revenues are inflated a little bit by the strong dollar in the second half or the second quarter of 2012. So, it’s more revenues actually booked in revenues as revenues compared to what we picked out of the backlog, which is at 140, so that it’s more – this was a little bit shifted to the number and makes it hard to explain, but totally slightly, so there only mathematical adjustments in the backlog. If we look at in the second half of the year, of course, we will have certain percentage of orders, which will come out of the backlog. The majority will come out of the backlog, but if you look at the numbers we definitely meet more orders in Q3 and early Q4 to go and achieve our target, which you said in the beginning of the year which we still have, which is not losing money in the whole of 2012. So, but there is clearly under the assumption we meet significant orders in the rest of the year that we can ship and turn into revenue.

Paul Hyland

And taking up on the first part of your question, you will recall I said at one point during the quarter, we haven’t – we still see a customer-specific route of sort of breakeven revenue points that we have talked about earlier on this year. I think if I am right in saying that we’ve talked about $275 million is being an annualized breakeven figure. But you can also – you probably also recall I said in the call that obviously the great to which purchase orders and delivery commitments come through in Q3 and Q4 will actually determine the final result.

And that comment really links in with what I was saying earlier about the very – the nervousness of customers to commit. And maybe one more point, which joins us up with Wolfgang’s comment whereas normally in previous years we would have said to you, that we really need to see those orders by perhaps the end of Q3, at the very beginning of Q4. This year is a little bit different, because, of course, we got less with systems in inventory as a result of particular customers backing out in the course of the end of last year and that means that actually we do have some flexibility in terms of converting existing stock or working purposes assembled into converting into shipments later than perhaps we would normally do. It’s not something of choice, but nevertheless it’s a fact that we have a little bit more flexibility in shorter term lead times than we have had in previous years.

Edwin Mok – Needham & Company

Great, thank you.

Paul Hyland

You’re welcome.

Operator

The next question comes from Sandeep Deshpande from JPMorgan.

Sandeep Deshpande – JPMorgan

Yeah, hi. Thanks for taking the last question. Just a quick question on your – I mean the models of tools that you have shipping at this point. Paul do you think that what you'll have in terms of shipping today is what is going to be – are going to be higher volume LED tools for the lighting market. I mean vis-à-vis our competition who has gained strength in the last couple of years. Do you need to have a revamp model line up to be able to complete in the lighting market. And then secondly I have one more follow-up?

Paul Hyland

Well, I think us I'm sure I said on many occasions we have typically at least one or two generations of follow-up work in progress. Actually if you think about it and agencies with no demand in the market this is no perfect time to launch a new feature equipment. But clearly what will happen going forward is I think we will see an acceleration of pressure in terms of both performance and cost of ownership. Internally we often look quite closely at this LED is we have an internal like tax cost roadmap in which we try to calculate what the effect is of the target we're going have to achieve for our customers. And it’s not just about number of wafers, it takes into account capital cost MO gas costs, labor, etcetera, etcetera.

I think I recognized on pretty sure from compared from 2011 to 2016 our costs it will have to come down by have actual five. So, we know that we're going into a period with very aggressive cost reduction, need to cost competitions, because that’s the only way that this will actually maintain the adoption of LED general lighting going forward. So, we having these products going through as you've seen from (indiscernible) we first launched our G5+. We have products there we’ll bring them out as and when it's appropriate and as and when the market needs them. But I'm sure both older players in this market will be looking for increasingly cost effective and product solutions (indiscernible).

Sandeep Deshpande – JPMorgan

Alright. Thanks Paul. I mean again one question for you on regarding the inventory I mean I don’t know whether you make prepared remarks on this aspect. Inventory is quite high with respect to your current sales level, are you quite confident at this point that inventory will sell through without any write down given that I mean there is a lot of inventory on the book?

Paul Hyland

I’m absolutely confident that we can now – scenarios that we can use all of this inventory I mean we had as you know we had some backlog in the course of last year. But we are fully confident that we can use this inventory and if you see all of – let’s say our statement also our sales expectations so to say for next year we are very confident that we’ll use this inventory. And by the way this is also an important cornerstone in AIXTRON because this will significantly rebound our cash flow to form up strength when we use this inventory.

Wolfgang Breme

Sandeep if I can just add to that is well if you look I mentioned on – answer to one of the earlier questions it isn’t just as we saw in 2010 or 2011 very focused on China and Taiwan. The orders are getting broader and with that comes its not just surely standard products as we currently have inventories. So, we are building in the course of this first six months more non-stand if you like non-FDS type products and of course the R&D as you’ll see from the headcount has also grown substantially and we get a lot of work material getting both into R&D projects.

Sandeep Deshpande – JPMorgan

Thank you and all the best.

Wolfgang Breme

Welcome.

Operator

Your next question reaches us from Bill Arnold from B. Riley.

Bill Arnold – B. Riley

Yes, good afternoon gentlemen. My question is regarding – yeah how are you doing. So my question is regarding the deployment of R&D during the past three versus Vecco. So if we look at Vecco they’ve already spent about $190 million in R&D from mid-2009 to now. Just taking out the non-LED business and that’s comparable to AIXTRON about $190 million. So, if you look at Vecco’s deployment this roll out do we make a new product in the last two years and increase market share and it looks have tuned up to get out of the metrology and solar business. If we can trap that with AIXTRON we only rolled out two major products I know you saw that silicon drag but congratulations on getting that silicon tools. So, my question is do you believe that you R&D's more affected than Vecco and what type of strategies do you have to outpace Vecco going forward?

Paul Hyland

Well and occasions I’ve met John they are always trying to be very hopeful and forth coming I'm sure he preferred to answer that question himself on the R&D. But I'll tell you I think the companies have similar end market targets, but there is a lot of difference between the two. There are different end markets that the two companies address and a lot of common brands we acquire. Once again the focus if you like of our business is being not only on MOCVD and the multiple varieties of that, but we’ve also with the interest just can’t spend quite a lot of money developing both next generation silicon product and also clearly been spending a lot of work and effort going into the OLED market which causes a - which is organic semiconductor market which is a huge market and has that’s a different cost metrics to anything you had seen before.

So, I wouldn’t like to – I certainly wouldn’t judge what the percentage I think that’s always – I’ve always wondered about that question about the R&D percentage as a percentage of sales as R&D should really be related to the amount of future sales not the ones you call it amount. I think we believe if we have retained the focus within the business on complex material applications and we haven’t been drawn out into areas where we don’t believe we have a particular expertise. And I think we are comfortable, we’re maintaining that focus. It is expensive, but that comes to the territory the markets we’re driving for we think a very attractive and growth markets.

Bill Arnold – B. Riley

Thank you so much gentlemen. It’s very helpful.

Paul Hyland

You’re welcome Bill.

Operator

The next question comes from Andrew Schenker from Morgan Stanley.

Andrew Schenker – Morgan Stanley

Hi its Andrew Schenker, just one question on the competition again. I think you’ve said previously for 2012 you will expect order patterns in the industry as a whole to be in line with previous years which would suggest you’d have maybe 50% of orders this year and is that something you’re comfortable with those?

Wolfgang Breme

I think we can’t compare 2012 to – and if we need to really probably separate out what the market impact is on MOCVD in particular LED and the rest of the sector. We know the entire technology sector is suffering from the economic and macroeconomic issues, but you add to that with the LED what clearly was fairly substantial over investment being supported by state subsidies. So, we went into a difficult global economic period we had already considerable over capacity. I think my comment which maybe taken slightly on the complex this if we’re talking about – if we not consist on comparison both there are really two major players in the MOCVD market that sells and Vecco we know there are other Japanese and Korean players. But we’ve over the last 30 years been the major players, both companies are very capable. And then of course market shares have fluctuated over the years in line with where we’re each in different parts of the cycle. I think that’s (indiscernible) this change. I think both companies continued to invest heavily in this, both companies are very capable and I’m sure we’ll be competing on equal level over the next five to ten years.

Andrew Schenker – Morgan Stanley

Okay. Thank you.

Wolfgang Breme

You’re welcome.

Operator

We would now like to hear the question from Andrew Huang from Sterne Agee.

Andrew Huang – Sterne Agee

Hi guys.

Paul Hyland

Hello Andrew.

Andrew Huang – Sterne Agee

So, first can you give us an update on your strategy for multi-reactor tool?

Paul Hyland

I wouldn’t – we wouldn’t share with you any breakdown of our internal R&D programs. Andrew I think you probably understand that there is very obvious reasons why that would be the case. But if you want to talk about standalone compared to automated systems, there is the numbers different avenues that can be excluded in this region. It’s a question of what’s appropriate and what’s the right timing. Clearly we have considerable large wafer and automation expertise within the business, otherwise we wouldn’t be selling systems to the Korean companies nor it would be in the business of offering very comfort system. In fact we’ve already sold custom systems today you can buy from us and customers have G5 systems for production. Its – but what we’re developing in our own research plants we wouldn’t talk to about obviously on a public call. But there are a number of avenues that can be taken and the obvious isn’t always necessarily the best route.

Andrew Huang – Sterne Agee

Okay. And then can you give us an update on what you’re seeing on the transition to 6 inch wafers for LED?

Paul Hyland

I think its fair to say that we saw a steady rise of 4 inch and some 6 inch over the last 18 months. Then we saw that fairly dramatically slow as many of the new players particularly in China were coming in at 2 inch level. There is some some progression there. There are some Chinese customers are beginning now to make the migration to 4-inch. But the balance is also going back to 2 and 4-inch whereas 18 months ago, the total we’ve seen to be on the root, 4 to 6 inch.

And that of course is different from other MOCVD recursions and obviously the things like that power electronics, people already sort of the progressing from the 6 to 8-inch, which is why we have launched this the new G5+, which is optimized for 6 and 8-inch specifically from standard silicon product and because we see increase and correctly I said we see increasing convergence – the opportunities to convergence between compound and semiconductor tools and in fact we have a G5 is one of very early examples of something that equally applicable to LED and going to silicon or indeed power electronics, so the trend will be more difficult to talk about generally. But on early days, I think we are very much back into 2 to 4-inch is being the prominent wafer assignment.

Andrew Huang – Sterne Agee

Thanks, Paul. I just have one quick follow-up if you don’t mind.

Paul Hyland

Okay.

Andrew Huang – Sterne Agee

Have you been hearing that there are still some subsidies for MOCVD and China, do you have any commentary on that?

Paul Hyland

Of course that then we have a word government subsidy they were always local regional subsides and China is very much sort of essentially guided, but originally managed so, the big subsidies were coming from the regions rather than central government. And there is increased encouragement from central government and some new initiatives. But certainly other regional level, there are some small subsidy residues both as I say residue commitments, customers who already have made agreements and with a local government. But I personally would not expect to see a return of substantial subsidies and in China, I think we reached the stage now with a Chinese government expects may be some consolidation. But the Chinese companies are able to found on the (indiscernible), which is why some of the – I expressed the concern on things like increased change in the interest rate and such they are definitely trying to further encourage local investment as well as (indiscernible) investments trying to help some of the early successful Chinese companies.

Andrew Huang – Sterne Agee

Okay, thanks for your time.

Paul Hyland

You’re welcome.

Operator

The next question comes from David O’Connor from Exane BNP Paribas.

David O'Connor – Exane BNP Paribas

Thanks for taking my question. Firstly on the quotation – the increased quotation activity I recall from the Q1 call you talk there both increased quotation level as well, but is more focus on true performance in upgrades and this time we are on the – how was conversation evolved versus Q1 that’s my first question. And then second question just comeback to may be one of the comment Paul mentioned earlier in the shorter lead time given the inventory and so far understand the orders already Q4 into Q4 can still be delivered revenue in the 2012, and I mean, this depend those orders are standard tools or non-standard tools, I mean can you still, I mean, worked the inventory to non-standard tools, understanding there is such a lot of the inventory is standard tools?

Paul Hyland

Well, of course the later get in the year were closed to the fit to the systems or the modules, we have installed from the (indiscernible) is to do it. But if we do get to we say configuration is exactly the same and what we generally we like to work hard. I’m sure we find the ways to trying tune this as possible as we can, and you also asked about the upgrade. We don’t see, what we do, we have seen an increased numbers. I think I made a comment on the call, which was that we are seeing customers who are reluctant to perhaps make a capital investment on doing whatever they can’t trying to improve the performance for the throughput the systems I go, which is not the optimal solution for. The prices are dropping too fast that’s one of the key issues, but we say we are in the second year now and which and prices are dropping by 20 to 30%. So in those many cases, family step change and without the margins are suffering and we are seeing those – we are seeing some customers were looking for upgrades to try to continually improve their outlook, but one sense is that if we saw definite signals from lighting that would probably convert into greater likelihood of more efficient systems.

David O'Connor – Exane BNP Paribas

Got it. Thank you.

Paul Hyland

Okay

Operator

Next question comes from (indiscernible).

Unidentified Analyst

Yes, hi gentlemen. How are you doing? Actually three questions, first of all to come back on customer behavior that you would start with every moment in R&D is that like comments you were saying okay look we have the utilization rates are up but we’re still somewhat reluctant on the macro topics, do they provide you some forecasts, if it that eases let’s say then everybody wants to order again in Q4 or is there some kind of behavior like that. And may be you could also elaborate a bit on are there differences in the regions i.e. do the Taiwanese see the market currently somewhat different compared to the Chinese and probably we have to take into account if they may progress on LED quality then we should also probably differentiate here between the (indiscernible) I guess so if you could just elaborate on that a bit. And then a quick one in fact on you were saying you expect return to profitability in the second half. I would assume that you are probably not referring to third quarter. So, is it correct to assume that we should model in still some losses in Q3 as R&D scales up and is it correct to assume that R&D for expenses will be above 70 million probably in the P&L. And the very last question is on obviously the topic that’s always been asked on new products and if I remember this correctly you made some small remarks last time about new products on all that, I was just wondering whether all this R&D money brought some success here and you could be a bit more open about potential will that product hitting the markets probably in the second-half?

Paul Hyland

Okay let me try and start with the beginning of that like we were talking about customer behavior and response I mean what is – it’s driving. I think we should just take a step back probably two or three quarters I think which – when we first started to say actually in our view the majority of backlighting was done. And we were certainly on schedule for probably at least 60% and penetration back into our 2012 which means 80% investment typically just provided for one year. So, our view going for at least three quarters was actually the majority of backlighting was done. It was really about how quickly does lighting (indiscernible).

Now we have seen in last six months very considerable increase in capacity utilization particularly in Taiwan. And that was being driven not necessarily by greater penetration but it is – there was a particular demand pull-through coming from backlight as apposed to HD products and principally out of china. There are very few if you like three in Japanese main line OEMs there are pushing out back as apposed to HD. So, the question I think many of the companies who have seen a significant growth in that utilization rates was well before we invest in new equipment, how sustainable is this, is this likely to continue now and will it continue to be growth demand going forward. And I understand why customers would be a bit reluctant and hence the reason far more focus on can we get more out of this and can we slightly upgrade it etcetera, etcetera. Everyone is looking for more positive signals coming out of other markets.

You are also right to pick out on the differences in the markets of course traditionally Taiwan, Korea and China are very different. Korea was very much a corporate culture very much dominated by the big corporate companies Samsung, LG, etcetera, etcetera, so semi. Taiwan is perhaps formal entrepreneurial and always was a mystery I mean where the money comes from. And it can come very quickly and Taiwan’s capacity has certainly gone up helped by the fact that Korea probably has outsourced more early days in the last year. Having been the first invested in R&D.

And china I would say is still very much in the technical digestion phase. And but the quality I’d say is definitely improving. I mean they have been helped by inward investments from Taiwanese plus Taiwanese teams coming over. But now they are improving helped by factors, they’ve got the equipment, it’s a lot easier than when you don’t have the equipment. So, then it’s a question of time. I think I said a year ago, I felt we had to be kind and give the Chinese probably two years to really absorb and start to get the performance as well as the – up as well as the price down. But I am still confident these guys would be big players. I mean, they already manufacture more than 70% of the world’s levels and you can guess our ambition is for LED light. And helped by our safe subsidies, it’s a very competition to being.

OLEDs, well, probably worth just spacing again, our first production system that we ship in 2003 which we shipped to Taiwan and we also shipped systems to big like plastic logic we were producing or aiming to produce a Kindle light products. And I think the last two years we have seen a much bigger increase in interest from customers perhaps spurred on by the investments, by the big display manufacturers. And so actually we had far more inquiries since the (indiscernible) then I am able to tell you that we’ve actually shipped the system – production system to Asia this month.

Revenues, no, I think I make the points on the call. This is the next generation production system. So, this is like in next year, I think before we see revenue recognition. But we do we have a lot more activity and more interest, but the scalability is bigger, it’s very technical challenging technology. Anyone who has tried it, will know this. And what we have at the moment is still relatively early development although you converted it, I think still the generation adoption is probably maybe two, three years out despite what one might think.

Oh, they are liking probably a much bigger market, it even further, but the recent serious money going into this area and we are seeing it being reflected in some of the approaches we are getting, but we are not getting revenues within the short-term. Now, I think you had one last question on profitability, which I think, Wolfgang you want to kind of comment?

Wolfgang Breme

Yeah, can you just repeat it once more please?

Unidentified Analyst

Yes, just wondering whether we should factor in still some you losses in Q3 and on R&D spending this year?

Wolfgang Breme

Definitely back end loaded here, that’s for sure. And you ask also about the R&D, with the $70 million many less, but that’s depending on project related expenses.

Unidentified Analyst

Okay.

Wolfgang Breme

Well, 70 would be on the consolidated side.

Unidentified Analyst

Okay.

Wolfgang Breme

Okay. We will see our Q2 figures as Paul said in his remarks you also need your orders in early Q4 to achieve the goal.

Unidentified Analyst

Okay, perfect. Thank you gentlemen.

Paul Hyland

Let me jump in for a second. I am afraid we only have time for one more question, but I will try to get back to any if you are still waiting on the line after the question – after we close this call. So, please as per your understanding? Operator?

Operator

Alright, the next question comes from Simon Schafer from Goldman Sachs.

Simon Schafer – Goldman Sachs

Yes, thanks so much. Paul, I actually want to go back to your comment about rising utilization rates among the customers. What about the question of deals, we all know just for the very wide range in terms of accomplished deals among your customers, any sort of indication as to how that’s progressing in the last quarter or so would be helpful?

Paul Hyland

Although, last quarter is tough, I’d say the general comment is obviously as you would expect performance in yields vary according to the market they are in, markets like Taiwan have got huge amount of experience in this area and (indiscernible) is growing very fast in this area. We continue to see steady yield improvement, I can’t put a figure on it. I would say actually the strong margin pressure is probably added momentum into the efforts to try to improve yields. And hence the reason I said earlier in the call, our view is in between 2011, 2016, we probably will see something like a five-fold reduction in cost per wafer going forward. So, but I can’t give you a figure on the last quarter. And the Chinese generally are coming from a lower yield level, but are learning quickly. It may take a bit more time to get to sort of Taiwan and Korean standards, but they are learning very quickly indeed.

Simon Schafer – Goldman Sachs

Got it. And my last question will be just going back to those inventory points, with 250 in an inventory on the books, what (indiscernible) cycle, I mean, I suspect that certainly not achieved for the second half of the year. But how long – how quick you do what is the pick up an order for that (indiscernible). Thank you very much.

Paul Hyland

The projected orders, which we have we need to achieve our breakeven target in this year would consume a significant part of it, it’s not always work is in progress, it’s I would say maybe one-fourth or one-third of it spare parts and the regions consumed, etcetera. And the work in process if things go in the right direction should be flushed by the middle of next year, so I don’t really expect a significant write off despite normal write offs because of long stories titled for (indiscernible). But the major portion is work in progress which will be out of books hopefully by the middle of next year.

Simon Schafer – Goldman Sachs

Okay, thank you so much.

Paul Hyland – President and Chief Executive Officer

Okay. Bye-bye. I am afraid we have run out of time. Thank you all very much for listening and for your questions. Please feel free to call myself or my colleagues in the U.S. we’re always available for your question from you and have a good. Thank you. Bye.

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