OSRAM Licht AG

OSRAM Licht AG

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Q2 2017 · Earnings Call Transcript

May 6, 2017

Executives

Andreas Spitzauer - Head of Investor Relations Olaf Berlien - Chief Executive Officer Ingo Bank - Chief Financial Officer Stefan Kampmann - Chief Technology Officer

Analysts

Sebastian Growe - Commerzbank Alok Katre - Societe Generale James Moore - Redburn Sven Weier - UBS Lucie Carrier - Morgan Stanley James Fetler - Barclays John Quealy - Canaccord Genuity Guenther Hollfelder - Baader Bank Andreas Willi - JP Morgan

Operator

Dear ladies and gentlemen, welcome to the analyst call of OSRAM. At our customers request this conference will be recorded.

As a remainder all participants will be in a listen only mode. After the presentation there will be an opportunity to ask questions.

[Operator Instructions] I now hand you over to Andreas Spitzauer, who will lead you through this conference. Please go ahead, sir.

Andreas Spitzauer

Good afternoon, as well as good morning, ladies and gentlemen. My name is Andreas Spitzauer, the new Head of Investor Relations of OSRAM and I want to welcome you to OSRAM's conference call for our second quarter financial results 2017.

As a reminder, the conference call will be recorded and is available on our homepage www.osram-group/investorrelations .com. You can find today's presentation there as well.

It is now my pleasure to turn over the call to the CEO, Dr. Olaf Berlien; the CFO, Ingo Bank; and the CTO, Dr.

Stefan Kampmann.

Olaf Berlien

Thank you, Andreas. Ladies and gentlemen also from my side a warm welcome to our analyst call.

Let me start by giving you a brief overview. Looking at the second quarter we can see that our Diamond initiative has gained further momentum.

We are well-positioned to profit from a high-tech market. This is reflected by our figures on Slide 4.

We increased sales by around 10% on a comparable basis. In doing so we almost doubled the pace of our growth compared to year earlier.

If we are setting aside the one-time effects on the carve-out, the last time OSRAM grew at such a strong pace was in 2011, and we achieved the same excellent EBITDA as last year. This translates into a margin of 17.4%.

Please keep in your mind that last year's results benefit from the significant currency effects. Doing to the strong developments in the first 2 quarters we have raised the outlook for fiscal year 2017.

Now we expect the revenue growth on a comparable basis of 7% to 9%. The adjusted EBITDA margin should be in the range of 16.5% to 17.5%.

And EPS is expected to be in the range of EUR2.70 to EUR2.90. Ingo will provide you more details later.

So let me switch Slide 5. An important milestone of transforming OSRAM into an high-tech company was the sale of Ledvance.

We successfully completed the transaction in early March. Depending on the licensee income, the total transaction value is about EUR500 million to EUR550 million.

We are very satisfied with the selling price, and we delivered on our promises. So let's turn to the next slide.

Today we provide a broad range of innovative products, which create illumination of new ways of seeing or sensing the world. They also enable new applications for improving our life, for example in the field of healthcare.

This is why we are able to benefit from attractive growth markets; one of them is automotive, as you can see on Slide 7. The latest market figures for global car production show a growth on a global scale.

In the last quarter again we have been able to outpace these figures therefore we were gaining market share. As the semiconductor content per car is growing rapidly the relevant market shows clear growth.

This development is driven by the trend towards driving assistance today and self-driving cars in the future. Our semiconductor products are key technologies for supporting these trends.

The relevant sensor market for our infrared laser is expected to grow by 25% per year. With this technology cars are able to detect their surroundings.

Today a new car includes many components from OSRAM that go beyond pure lighting functions. As you can see on Slide 7, there are LED-based functions such as rain sensors, lane detection or pre-crush sensing.

These applications are related to invisible lights. They are made possible by our products which help to improve safety.

Looking on Slide 8, you can see that these sensors also support the development of new business opportunities in smart cities. Integrated sensors enable us to offer complete lighting networks in the future, especially in cities such networks are creating value that goes way beyond basic lighting.

I warmly invite you to meet us on our booth at the Light Fair Conference in Philadelphia next week. There you can see some of the products I just mentioned.

Of course, there are other fascinating examples and they are making one thing quite clear, with a broad range of technologies and applications we are setting standards for mobility, safety and communication. These high-tech segments strongly support our business units.

The order books of Opto Semiconductor continue to be fully loaded and we are happy to operate on a high capacity utilization. As I mentioned, there is a strong demand for our products.

Consequently, we are now expanding capacities in order to further meet such strong demand. The ground-breaking ceremony for our ramp up in Regensburg here in Germany took place in March.

The expansion of our backend factory in Wuxi, China will begin in August. In Kulim, we are well on track to begin the machinery installation this month.

Production will start in November. Our Specialty Lighting segment also saw clear growth in the second quarter especially driven by a strong automotive business.

Also below the line the division delivered great results with an EBITDA margin of 16%. Our third pillar, the business with Lighting Solutions & Systems was impacted by weaker markets in U.S.

However, we expect an improved business development in the second half of the current fiscal year. The focus is still on improving the cost base on our luminaires business.

These steps are a part of a program designed by - to successfully lead our business into the future. We are working hard to rapidly make our luminaires business competitive again.

So let me summarize briefly. We had a strong performance in the second quarter.

We expanded our technology leadership position based on our 17,000 patents. Therefore we are able to serve the growth market of today and tomorrow.

We are betting on the right trends and technologies proved by high demand from our customers. So in this case I would like to hand over to Ingo and maybe you'll run through the figures.

Ingo Bank

Yes. Thank you, Olaf and good morning, good afternoon to all of you.

Thank you for joining the second quarter fiscal year '17 earnings call. With the conclusion of the Ledvance divestment we are now clearly emerging as a technology company with a strong growth profile, which we believe further evidenced by the revenue and profitability performance in our second quarter.

Being half way through 2017 and having delivered a strong performance thus far we upped our guidance for this fiscal year, as Olaf pointed out. I will come back to the specifics of that update later in my remarks.

For now, let me start by going through the key financials for OSRAM in the second quarter of fiscal year '17. I am on Slide 9 now.

Revenue for the second quarter was EUR1.05 billion, representing a strong comparable growth of 9.7% relative to the same period of fiscal year '16. This top line acceleration was particularly driven by Opto followed by SP.

Comparable growth for LSS in the quarter was basically flat. When looking at revenue from a geographical perspective, APAC stayed strong even a notch higher than what we already saw in the first quarter of '17, driven mainly by demand for Opto and SP.

EMEA picked up strong momentum in the second quarter with a comparable growth of 9%, whereas growth in the Americas turned negative with a challenging quarter for our LSS segment. Moving on to profitability, the company's adjusted EBITDA margin for the quarter was a solid 17.4%, in line with expectations, and was EUR183 million at about the same absolute level as the second quarter of '16.

Compared to prior year's quarter, profitability was lower by 190 basis points due to ongoing investments into our Diamond growth program, cost dissynergies as a result of the Ledvance deconsolidation, as well as unfavorable results in LSS. I will provide some more color on the profitability drivers in Q2 '17 for the segments later on.

Adjusted EBITA, earnings before interest, tax and amortization, was EUR134 million, representing a profitability of around 12.8%. Corporate items came in at EUR29 million as expected.

We anticipate a similar run rate for the remaining quarters of our fiscal year '17. Special items in this quarter amounted to EUR14 million and were related to post-merger integration costs as well as ongoing transformation expenses.

For the full year we expect special items to be between EUR75 million to EUR85 million, slightly lower than previously communicated. Underlying this expectation are costs for activity projects in various and different parts of our businesses as well as post-merger integration costs.

Moving on to net income and earnings per share on Slide 11, diluted EPS from continued operations in the quarter reached EUR0.81. This is EUR0.09 below the same quarter a year ago, given increased levels of special items in the quarter as well as a higher corporate income tax rate in the second quarter of fiscal year '17.

Last year's tax rate benefited from some tax exemption of the FELCO sale. Corporate income tax this quarter at approximately 30% was in line with expectations.

In the table below the graph we have provided the net income for continued as well as discontinued operations. The net income from discontinued operations reflects the change of control for Ledvance as of March 3.

The vast majority of the loss for discontinued operations in the quarter relates to balance sheet related foreign exchange effects triggered by the final deconsolidation. This is in line with what we communicated ever since the sale agreement was signed in 2016.

Further details can be found in the appendix to the second quarter '17 presentation. Let's now move to the reporting segments and take a closer look at the financial performance in our second quarter of fiscal year '17.

Opto accelerated growth to 24% on a comparable basis and came in at EUR430 million in the second quarter of fiscal year '17. LED demand from our automotive customer base in Asia remained strong in the quarter.

EMEA showed good momentum as well. At the same time, we also saw significant growth in our infrared business driven by demands for mobile consumer devices.

Admittedly, the strong growth rate for OS in the quarter was helped by somewhat favorable comps relative to Q2 '16. We expect Opto to continue to grow in the double-digit range for the balance of the year but not as pronounced as this quarter.

Our SSL business continued to build momentum also in the second quarter of this year. Book-to-bill rates were again substantially above 1 preparing the grounds for our SSL future growth plans.

Adjusted EBITDA came in with EUR124 million, representing a robust margin of 29%, up sequentially, with high levels of demands driving capacity utilization levels further up in Opto's industrial base. Compared to the same period a year ago, profitability was lower as Opto absorbed SSL-related ramp-up costs and continued to invest into future growth opportunities.

We expect these investments to continue for the balance of the year, in addition to the costs we anticipate for commissioning Kulim in the second half of this fiscal year. Moving on to Specialty Lighting, SP delivered EUR610 million in revenue with LED products continuing to be a very strong driver of the underlying growth.

LED now makes up for roughly half the total revenue base of SP, including both LED components and modules. SP carried its growth momentum from the start of the new fiscal year well into the second quarter, delivering a comparable growth of 8.1%, albeit with somewhat different underlying geographical growth dynamics.

Growth continued to be strong in APAC driven by LED demand, while revenue for traditional light sources saw a small decline compared to the same period a year ago. In EMEA demand for LED-based lighting was strong supported by low double-digit growth in the automotive aftermarket business.

In the Americas we experienced a slowdown in growth driven by our aftermarket customers who were working through elevated inventory levels in the quarter. Demand for LED modules in that region continues to be a strong driver of growth, supported also by the Novita Tech acquisition.

Adjusted EBITDA came in at EUR99 million, EUR13 million ahead of the same period last year at 16.2% of revenue, 40 basis points above last year's profitability in the same quarter. Looking ahead, we expect growth to slow down in the second half of the current fiscal year.

Next to the typical seasonal patterns in this business, we have to remember that growth comparisons in Q3 as well as Q4 of fiscal '17 will be distorted by the pre-buying effects that took place a year ago. These were linked to the IT changes OSRAM put in place back then in connection with the Ledvance carve-outs.

For the full fiscal year 2017, we expect SP to deliver an adjusted EBITDA profitability of between 13% to 14%.Moving on to LSS, I'm now on Slide 14. Lighting Solutions & Systems delivered a disappointing quarter.

Revenue at EUR243 million was flat, when compared to the prior-year quarter, with negative growth in Lighting Solutions offset by low single-digit growth in our Digital Solutions business or DS. LS revenue performance continues to be impacted by delays in a few larger projects in the U.S.

service business. These delays were customer and project specific.

Elsewhere growth for LS was sound, particularly in EMEA driven by strong outdoor lighting business in that region. For DS, revenue growth slowed down markedly in comparison to the first quarter of '17 driven by a challenging U.S.

market, with subdued demand from large OEM customers, as well as softness in the short cycle, smaller project market. Overall, adjusted EBITDA was negative with EUR11 million for LSS driven by the performance in Lighting Solutions where the shortfall in the U.S.

in addition to an overall unfavorable channel mix impacted gross margins. In addition, we continued to increase our innovation spend into smart lighting solutions for the DS business as part of the Diamond initiative.

During the course of the second quarter of '17 we announced our intention to reduce up to 290 employees in our LS business in Traunreut, Germany over the next 2 years. This is in line with earlier communications highlighting that a substantial part of the midterm target achievement for this business has to come through structural cost measures.

The related restructuring charge is expected to be taken during the course of the second half of fiscal year '17. The related expenses were already anticipated in the overall guidance given for special items provided at the beginning of our fiscal year.

Our objective to turn LSS to a breakeven performance for the year remains unchanged for now. It has, however, certainly become more challenging given the weak first half year performance combined with a slowing U.S.

market environment. We continue to drive the business towards this goal.

However, it will require a pickup of the growth momentum in the United States in the second half of our fiscal year 2017. Moving on to free cash flow in the quarter, free cash flow came in at EUR5 million for the quarter, unchanged compared to prior year, despite an increased level of capital expenditures largely related to Opto.

Working capital continues to be managed well with overall days outstanding reduced compared to the same period a year ago. We anticipate a substantial pick up in capital expenditures in the second half of fiscal year '17, particularly in the third quarter as we begin the commissioning of the equipment in Kulim, Malaysia.

Furthermore, we expect to continue to expand capacity elsewhere in Opto to respond to the higher levels of demand for our premium products. Moving on to net liquidity on Slide 13, sorry Slide 16 that is, we closed the quarter with a strong level of net liquidity of EUR570 million, next to the operational performance and the movements in assets, which I just explained, we had a few special items worth noting.

With the divestment of Ledvance concluded during the quarter, we received the proceeds related to the sale of Ledvance amounting to approximately EUR486 million. We closed the acquisition of Maneri-Agraz in the United States, strengthening our LSS service business further.

Please also refer to the related press releases we issued. We continued our share repurchase program for which we had cash outflows of approximately EUR67 million in the second quarter of fiscal '17.

The total cumulative amount of this program since its inception now amounts to approximately EUR399 million. This represents more than 8% of our total outstanding share counts.

We expect our share repurchase program to conclude around the middle of calendar year 2017. And in the quarter we also paid the dividends related to fiscal year '16 amounting to approximately EUR100 million.

Let's change perspective and look forward. Based on the performance in the first 6 months of fiscal year 2017 and the current outlook of our businesses we've changed our guidance for the full fiscal year 2017 as published yesterday.

We expect comparable revenue growth for fiscal year '17 now to be in a range of 7% to 9%, up from the range of 5% to 7% given earlier in the year. Adjusted EBITDA is expected to come in at a range between 16.5% and 17.5% for the year, up a notch from earlier guidance.

Cash flow is expected to be around the breakeven level, unchanged from prior guidance. This continues to reflect a substantially higher CapEx spending level for our Opto business when compared to fiscal year '16, as we continue to invest into the future growth of this business, not limited to Kulim, Malaysia only.

From an EPS perspective, we now expect a range of between EUR2.70 to EUR2.90, which will represent a year-over-year growth of approximately 12%, when taking the midpoint of the range. And with this, operator, we can now start the Q&A session.

Operator

We'll now begin our question-and-answer session. [Operator Instructions] The first question is from Sebastian Growe of Commerzbank.

Please go ahead.

Sebastian Growe

Yes, good afternoon gentlemen and thanks for taking my questions, it's three actually, two on Opto and one on LSS. To start with Opto then, IR has emerged as a very strong growth engine within the Opto division, I would be interested in whether you could give us a sense how much infrared products currently contribute to the total Opto sales and how quickly the new capacity in Regensburg will phase in, i.e., should we be expecting decent growth in the second half of the year, as you indicated before moving eventually sideways only in the say first half of 2018 or so, that is before Regensburg comes online, so that would be interesting to hear your thoughts on this one.

And then secondly, can you also provide indication where you stand regarding the general illumination business within Opto Semiconductors? Are you at a run rate of around 15% or so of the total segment sales as you alluded to in the Capital Market Day 2015, or are things going a bit slower than you might have been planning in the past?

And then moving on to LSS, again, you missed both, I think your own and also external expectations in the segment, irrespective if you will deliver on your breakeven target for the full year? And for me the question is if you are really the best owner for the assets, not the least the synergies with other divisions look comparatively limited.

So to cut a long story short, can you comment on the strategic outlook for the segment and explain the rationale from your end to hold on to that very division?

Ingo Bank

I will take the questions on Opto and then I will hand over to Olaf for LSS. So if you think about Opto, infrared right now is experiencing substantial growth, predominantly driven by demand for mobile consumer devices.

So I think it's also fair to say in the quarter we were experiencing very high demand also because the related customers were sort of building up inventory for the launch of the product, and I cannot refer to who that customer is and what the product is, obviously. So from that perspective it was very strong and we believe that we can handle that demand for the balance of the year by the capacity that we have in place.

The new capacity that Olaf was referring to will only come online sometime early next calendar year and not earlier that that because it takes a while before we get production capacity ramped up even in Regensburg. So I don't expect any contribution from that, certainly not in the current fiscal year and probably only sort of in the second quarter of the next fiscal year or the second half of fiscal year.

As far as SSL is concerned, we are very happy with the growth we see in the order book right now. So the last two quarters we've seen book-to-bill ratios well above 1, so that is in line with what we've planned.

However, given the fact that the LED components business as well as infrared business is going so fast right now, the relative share SSL in the total is a bit lower than that. But we are on track as far as the book-to-bill is concerned, so no changes in that regard.

And then, on LSS, I will hand it over to Olaf.

Olaf Berlien

Coming to your question to LSS, if you remind, in November 2015 I clearly said we're running a three-pillar strategy with expand in OS, with some expand in SP and clear with the signal monitoring restructuring in LSS. So if you compare what's happened between November '15 and today, the group LSS or the segment LSS is performing year-over-year in the right direction.

So we made heavily losses in '15, we reduced the losses dramatically in '16 and we are on the right track to reach the breakeven. I'm coming to this, when it will happen.

So the question was [indiscernible] in November '15, it's on a watch list, so they have to show if they reduce losses, if they are on the way to an 8% asset [ph] target. So we clearly said, if you compare to the competition in Europe and take a look to the profit pool they had to achieve, in the end 8%.

If they cannot achieve it, then they - clearly we have to think about if they are - if we are the right owner, just owner for this business. So far they are good on track.

What happened in the first half year, I think the US market, it was really an issue of the US market, and we have to be fair to the business, if you see what happened with Acuity or with Eaton or the other ones, they all have the same slowdown in order entry in the US, and we have it as well. So it was not the fault of LS, it's the market.

And in this case they're clearly on track and I think we clearly are the right owner for the LSS business. Because the market potential is huge, I remind you that the market potential for the LSS business over 100 billion worldwide a year, so it's a huge market, growth is usually stable and we had - as I said, we only had in the first two quarters the US market.

So I hope that gives you a clear answer what we're doing with LSS.

Sebastian Growe

Yes, to the most extent at least, but in any case I think you will never really have the same competitive position in the LSS business, I believe, as you have it with Opto and SP, so in any case I think it will require some additional M&A investment, et cetera, eventually to grow the business further up, et cetera, et cetera. So question then is couldn't you really spend the money in a more attractive way when putting more money on the table for OS and SP where you currently enjoy obviously very, very strong market demand, and that's I think what the whole question is around.

Olaf Berlien

Yes, you are right, but put in your - I think that's one argument. The other argument is I think to run a group it is good to have it well-balanced.

You have, of course you have a higher EBITDA margin in Opto but you have higher CapEx. So the investment in LSS is less than EUR30 million a year, so it is well-balanced.

And I have, as I said, I have a huge market, I have usually healthy growth, and so to see it, of course, the profitability is less but the investment is less. So in this case I don't think it's the right time to think about a strategic move of LSS.

Sebastian Growe

Okay, fair enough. Thank you.

Operator

The next question is from Alok Katre of Societe Generale. Please go ahead.

Alok Katre

Just wanted to comment, ask a couple of questions really. One is just you have an interesting chart outlining the rising sensor content per vehicle.

You highlight that you see a 25% growth rate on the automotive sensor market as such. One is of course, is that the 2016-2020 timeframe, the CAGR that you outline over there?

And then could you quantify for us where we stand today in terms of the OSRAM's LED chip content per car, especially on the infrared side? I mean are we sort of talking $10 per car going to $30 or $50 going to $150, or just to give us a sense of how large the market now is, because clearly it seems it's probably a larger market than what you envisaged back in January 2016, when you laid this out for us.

The second bit perhaps is just on the Opto Semi, could you just clarify how we should think about - and you mentioned the investment should continue in the second half of the year, but I just wonder how we should think about the margin impact of those investments and personnel related costs and so on? I mean because if you look at the underlying margins in the second quarter, you are probably well north of 30%.

So is that what we should be thinking, going into the next sort of 12 months as and when the effect of some of these investments start to fade?

Olaf Berlien

Maybe I'll start and then Ingo will do the rest, that's good, lot of question. I think what I did for this analyst call is to give you a little bit the chart about the applications of OSRAM.

So really moving a little bit ahead from the product, maybe you saw on this chart was a car that how many applications we do have today in a car with more and more driver systems? And in these driver systems you need always LED chips from OSRAM.

And so the demand, is it a raining sensor, is a lane detection, is it a LIDAR system, is this whatever, you see it [indiscernible] system. There is a huge demand and all these applications are not anymore only in premium cars, they are moving more and more in midsize and small cars as well.

Rain - raining sensors, parking sensors. So the demand - and that's what I said was a 25%; there is a huge increase in demand, and we expect for the next years that more and more applications coming in the cars.

But nevertheless, it's not only cars it's in mobile phones, it's in wearables and so whatever wearables you need an infrared chip, it is in horticulture. So I see or we see, let me say, we see huge demand in so many - for so many applications, so that I expect the minimum, the 25%.

Second one - yes?

Alok Katre

Yes, maybe you could just quantify for us. I mean how much is infrared as percentage of your total sales?

I mean, I come to something like low-single digit as an estimate, as a percentage of group sales, is that a fair assumption, and then where do we see this over the next - let's say by 2020 within the business plan?

Olaf Berlien

Yes, we don't like to go too deeper because then my competitors know what I am doing in infrared but Ingo maybe you are better for this than me.

Ingo Bank

Yes, so - your estimate on group level is approximately correct. So from that perspective there is nothing wrong.

As Olaf said, what we see is a significant expansion of applications in which our chips go, including infrared, so we expect that the amount of semiconductor content in a car will increase, and given that we are either 1 or 2 in these respective areas, and we still have a [indiscernible] a lot of the value is increasing we should grow proportionally more than the normal growth you would expect from OSRAM. So from that [indiscernible] that's all I can tell you, basically at least those are the plans.

As far as Opto is concerned, you asked a question around the margins for the second half. Basically we said at the beginning of the year that we expected the adjusted EBITDA for Opto to be somewhere between 26% and 28%; that hasn't changed.

If you would ask me where to look, I would probably look more to the right part of the range than to the left part of the range. Obviously with the growth we should see also something drop back to the bottom end, but at the same time, we obviously want to absolutely make sure that not just commissioning Kulim in Malaysia is done properly but that we also build the organization around it, including R&D, marketing and sales so that we can run the business when it's advertised in a proper way.

And currently the growth and the results we produced in Opto help us and therefore we are reinvesting part of that growth into the future of that business.

Olaf Berlien

And to make clear that this benchmark with the 28% - 26% to 28%, we are absolutely benched that nobody in the world had these EBITDA margin.

Alok Katre

All right. Fair enough, fair enough.

Can I then just follow up as well a separate topic on terms of the pricing? Clearly I mean, some of these products that you talk about are on the infrared side, particularly on the auto sensors, et cetera, I mean so the pricing probably is much better than what you see elsewhere.

I mean in the past you talked about 10% price decline for the LED and chip market but maybe you could give us a sense of what's happening especially on these products in particular the infrared and auto side of things?

Olaf Berlien

I think as I've tried to explain in the past, price decline you have to compare really from two sides. If you compare the chip generation from the last chip generation to today, of course you have the price decline by 10%, 10% to 11%.

But again, you have the new development and the new chip is coming up with the same price. So the price is the same but if you sell a chip from the last generation, you would have a decline up to 10% to 11%.

Alok Katre

Okay. So there's no change.

Olaf Berlien

There's no change, there's no - that's the opposite, so the prices in comparison to last year, very stable.

Ingo Bank

And just to make sure that Olaf is referring to the SSL business, the price erosion in the other areas is far less than that and is stable.

Alok Katre

Sure. Great, thanks.

Operator

The next question is from James Moore of Redburn. Please go ahead.

James Moore

Yeah, good afternoon everyone, Olaf and Ingo. Thanks for taking my questions.

Perhaps I will go one at a time, if I can. I see on the Opto growth that it's well above SP; there used to be more in line.

It sounds like that is reflective of the non-automotive growth, and you talk about some of the devices I guess, iPhones and other things. Could you perhaps say a little bit more about the rate of organic sales growth and the differential between the auto, which is like a half of that business, and the other pieces, communication, industrial GI, and does that change drive some negative mix?

That's the first one, if we could address that, please.

Ingo Bank

So, as I said in my prepared remarks, we saw still a solid growth in LED components, and as it's driving obviously Opto and SP at this point in time in the same way, that's because the revenue base of SP is lower - higher than that of Opto. Relatively speaking, the extra boost certainly for Opto was this quarter the infrared business that I was referring to related to mobile, consumer devices that obviously doesn't go through as SP as well, and it can be expected that that part of the business will drive so much faster some of the other business we have in Opto, and therefore the mix could somewhat change.

But overall I think what we see is that particularly coming out of APAC the demand for LED components going into lighting to car lighting is still very, very strong. And that means both SP as well as Opto should benefit from that.

I think, I would like to point out the interesting thing was, if you look at the numbers that considering that roughly 50% of the revenue of SP in the quarter was LED related, not all components but some of it also modules, the margins for SP was very resilient. And the reason for that was, amongst others, that some of the other innovations that we started to invest into in the last two years have become somewhat more profitable than in prior years.

So overall despite the high share of LED products in the SP revenue base, SP managed a pretty good margin for the quarter. And I think that's important to mention as well.

James Moore

Okay good, just to clarify, and can I assume that Opto's auto piece grows broadly in line with SP or is that not a good way to think about that?

Ingo Bank

Yes, but again the relative space if you look at the sensors is different because the SP business is bigger in total than the Opto business. So you can't just compare percentages obviously but yet what we sell in LED components also flows to into SP with a distributor margin of 3%.

James Moore

And my second question is just on the loading of Kulim. We're a little bit further forward in time.

Is the mix of premium versus GI still the same or have you changed your thinking on that? And have you won any more orders to fill Kulim, and if so could you quantify what sort of annual revenue in Kulim is filled?

Olaf Berlien

Kulim was never 100% GI. As I said on the last call it was a what-if kind of question as well.

If you have the EBITDA [indiscernible] there's no change, is it a general lighting or is it maybe in specialty lighting. So that means Kulim will be a mixture of premium products and GI products.

And as Ingo said, we have a huge demand these days from premium products. So today my answer is we have a well-balanced mixture of both product lines running through Kulim, but nevertheless for the economy of scale, for the economy of scale you need the GI product to bring the product costs down as much as we can.

James Moore

I understand that. I just wonder whether the 35% is now 40% because of the better premium growth.

Ingo Bank

Well, I think we should first see to start Kulim because we haven't even started producing in Kulim. And I think what Olaf is saying is important.

So Kulim was, in the plans we presented 2 or 3 years ago so was there was always the idea that one day we would introduce also the capability to produce, if you like, premium products in that facility. Given the demand we now see for the premium product range we decided that actually Kulim right from the get go will be able to do both, premium and the GI business.

Olaf Berlien

And it will be automotive certified.

Ingo Bank

Correct. And then on that basis we will have the flexibility that we need.

So from that perspective Kulim is still on track. We're happy that we're able to respond also to the higher demands we have of premium products from the other segments we are in.

We are happy to see that the book-to-bill in the SSL business is picking up so that we can also start filling Kulim. And I want to underline what Olaf said.

Kulim, as a factory itself, will never be filled solely by premium products. That's going to be impossible given the capacity we put there.

So that means that the Kulim factory and the scale effect will depend also to a large extend on our ability to make inroads in general illumination, which is what we are seeing at this point of time. So overall, if you look at the strategy, we are on track.

But again Kulim hasn't even started to produce.

James Moore

And the last one on Opto, is the investment costs that you talk about in the quarter and in the second half, I just don't understand, these costs that you are pulling forward such that they won't be in '18 or '19, or are you finding cost inflation or costs in general are proving higher than expected?

Ingo Bank

So first of all we haven't changed our accounting principles. And secondly, because of the demand that we see we're trying to accelerate certain things.

But we are expensing them according with our accounting principles. We're not sort of doing anything strange here.

So we're just puling forward as much effort as we can to get Kulim up and running. At the same time we also communicated that we are getting ready in Regensburg.

We're preparing also the ramp up somewhat in August-September timeframe starting with Bosch, so that's plenty of construction sites at this point in time, if you like, at Opto. And of course we continue to spend money on the R&D side in Opto for SSL to make sure that we have the complete product portfolio we need to be successful in that segment.

But we also see future innovations on the premium side of the house. That won't be in cars maybe next year or the year after but after that, and therefore we're also making sure that we are innovating right now so that we can get the returns on that investment in two years from now.

James Moore

Very helpful, thanks. Just lastly on SP, you talk about the sensor growth, the 25%.

Can you help us with how much of SP is really car lighting versus other sensor products? And is that spilt the same, LED, halogen, xenon?

Ingo Bank

I don't think we ever broke this down this way. I mean SP is roughly 80% related to, if you like, car, automotives and then 20% to other specialty lighting applications that we have and that split really hasn't changed.

James Moore

But I was thinking within auto, I guess lighting remains the bulk. I'm just trying to scale what the sensor 25% means?

Ingo Bank

Well, I think early on the call a colleague of yours did a guess on what the total revenue level is for the company in ForEx so that maybe a good pointer for you.

James Moore

Thank you very much.

Operator

The next question is from Sven Weier of UBS. Please go ahead.

Sven Weier

Good afternoon, thanks for taking my questions. Three questions, please.

The first one is coming back to Opto. I was just wondering, I think in Q1 you said that despite the capacity bottlenecks you didn't have to turn down any customer order so you can still handle those?

Is it still the same in Q2? And what kind of additional CapEx are you spending on de-bottlenecking in total this year?

And the second question goes back to your share buyback program. You said you are going to finish soon on this.

Is that also an option at the end of the year if you haven't done any big M&A that you simply come up with a new buyback program? And then on LS, I guess, if you breakeven, even if you were to breakeven for the division as a whole this year, I guess LS would probably still be loss-making.

So how do you see the trajectory to the 8%? And is the kind of decision to keep it or leave it or something you would only take then in 2020 or if you already missed some milestones in between?

Olaf Berlien

You are right, I explained in the first quieter that we really had bottlenecks in the capacity. We had progress in the bottleneck on one hand, on the other hand the demand increased.

So to be honest we still have absolutely full order books and it is not easy to handle the bottleneck in these days. I really have letters from customers asking to get products.

It's a luxury problem but usually it's not good. So that's one of the reasons that we invested in 2016 in the current factories in Regensburg and in Penang.

This is helpful. And I expect that we have a better situation in the fourth quarter with infrared.

But nevertheless one question is how successful is the new product of these mobile phone, which the iris scan, if there will be a high demand as we see it today it could be that we have a bottleneck as well. The second question, share buyback is Ingo asking, but I'm coming to the third one and then I hand over to Ingo.

As I said, it was original plan to have breakeven for LSS for this year. And - but I have to be fair, the U.S.

market is weak and for this reason it will be tough to reach a breakeven for this year. So what we see in our forecast is really to do it.

But to be honest, nobody knows what will happen in the U.S. market in the next 6 months.

So it will be something around breakeven. But as I said, I think LS is on a right track.

They made two years ago, EUR50 million losses. So really they are going step ahead.

They reduced losses and they have performance programs, so I see milestones month-by-month and Ingo and me we are watching the milestones from the financial point of view, Stefan is looking what kind of R&D is in the pipeline, new products are coming up. So overall, I'm not so unhappy.

Of course, I know it would be better to have a profitable business, but I think if you think it forward from the turnaround 24 months ago, I had EUR50 million losses, I think we are on a good way. And in this way there is a clear pass for 8% that means if they reach then in the beginning of the next year or the last quarter of this year, the breakeven then they have to show to come to 2%, 4%.

And I see till 2020 the 8% and EUR800 million for the turnover. So in this case there is no question for leave it or keep it, it's clear that it's leave it and we would like to make a turnaround because I think we create more value if we make the turnaround and then we are thinking about the strategic option.

Ingo Bank

Coming back to the share buyback, I suggest you first wait to complete the first share buyback before we even talk about next share buyback from a capital deployment perspective. Clearly the focus right now is for us to strengthen the three segments that we operate in through possible attractive acquisitions, that's the key focus at this point in time, and then we will see how that works.

And then of course always other capital deployment decisions are on the table, but for now let's complete what we have and then concentrate on M&A to start with.

Sven Weier

And maybe if I may, maybe a follow-up questions from Mr. Kampmann on LIDAR, I was just wondering, I think you said on one of the previous calls that this is kind of a market-ready in two years, I mean see - are you seeing a lot of pressure from the OEMs to finish earlier than that because it is gaining more traction for autonomous driving and you see possibility of a stronger up-tick within the next one or two years already.?

Stefan Kampmann

Yes, what we see currently is indeed a high interest in our light sources or LIDAR applications. The good thing is that we also basically see innovations which are coming not only from the established company, especially new ideas also for low-cost systems coming from startups because obviously our capability in LIDAR, hence in light source for LIDAR is so unique that each and everybody is attracting OSRAM.

You're right, there is clearly from the automotive OEM there is a clear pressure on the systems, but if you look into especially electronic and electronics for autonomous driving systems you know that we have a kind of development time to do the validation for the systems. So indeed we feel the pressure but we think that the expected time of two years to get more and more the system, especially also in an affordable price range, is probably more than realistic view of this topic.

Sven Weier

Okay, thank you very much all.

Operator

The next question is from Lucie Carrier of Morgan Stanley. Please go ahead.

Lucie Carrier

Hi, good afternoon gentlemen. Thanks for taking my questions.

I will have three questions. Maybe as a start, I was wondering if you could give us a bit more color on why the gross margin seems to have deteriorated quite a lot initially, I thought maybe all of the investments had gone in SG&A and I can see the ratio there has increased but the gross margin seems to have deteriorated quite significantly.

So that would be question one please.

Ingo Bank

Yes, so I think overall with the results I think we are still happy to have an EBITDA about 70%, so I believe that's also what we expected it to be. As I said, we of course incur some ramp up costs at this point in time in our SSL business and we have also basically have started to sell a couple of new products into the market around SSL and some of that is reflected simply in the margins because obviously as you know the SSL margins are not as high as the premium products that we are selling.

So that's one part. The other reason why the gross margin at the company level was a bit lower is also because we had, as I said, in my prepared remarks, a lower gross margin for the LSS business, and that had to do more with a somewhat more or less favorable channel mix where we were selling less into trade and more into projects and sometimes that can cause margin differences and that's something we saw also in the second quarter.

So those are the two major reasons, if you like, for a decline on the gross margin.

Lucie Carrier

Maybe just before I move to the second question, a quick follow up on that, when you say you had some new product launches in SSL, are you suggesting that maybe there was some kind of offer prices as you kind of ramping up on new segments so a bit of a incentivizing your potential customer with the prices?

Olaf Berlien

No. It's not a question of price discrepancy, we don't sell via prices, we are selling about chip size and chip performance.

The question is not the price gain, chip size and chip performance gives you the advantage to make profitability. And take a look to Nichia, they do it chip size and chip performance.

Smaller size, higher performance then you make it.

Ingo Bank

Yes, the lower -

Lucie Carrier

I understand that. Sorry, I just wanted to get clarification on when Ingo mentioned that there were some ramp up costs in new product launches in SSL having impacted the gross margin I just kind of want to try and understand what was behind that?

Ingo Bank

Lower yield in production, that's the reason. So when you talk about ramp up - yes, ramp up expenses because you commission equipment and other expenses that you can capitalize obviously and then you also - once you run you also have initially lower yields and that's what we are seeing in the gross margin right now.

It's not pricing as Olaf said, but it is more on the typical curve you have when you ramp up new products your yields are not necessarily those that you aspire to have on the longer term.

Lucie Carrier

Okay, understood. My second question was follow up on the schematic you showed on your slide around the opportunity in automotive.

I was wondering if you could give us a bit more color on how advanced you are already are on the non-visible application because we know you are very advanced on the visible one and market leader, so how advanced you are on the non-visible one. And whether it would change to some extent some of the competitive environment you're having, i.e.

whether instead of just maybe competing with Nichia or Lumileds maybe you are going to be facing competition from guys like Lumentum or OMF maybe?

Stefan Kampmann

Yes, Lucie you're right. It is an interesting question because our competitive landscape is obviously increasing due to the applications which we see and the slide which Olaf has shown with the different application on the visible side but especially also in the invisible light applications where we are tracing these applications with our infrared component, show that the competitive landscape is increasing and obviously within this applications also in new players.

So you're absolutely right that we will see in the future not only the established competitors. But on the other hand these new players in this field are focusing more on a system level.

And what I said as an example with LIDAR, we see that we as a innovation partner, as a technology company are very, very requested from these new players to deliver basically the appropriate components because in all these applications it's a question of the number of photons, means intensity of the light sources and the quality of light. And I think with these applications we have a huge opportunity to increase our market on the infrared side.

But we have also the opportunity to establish ourselves as a technology company and especially as innovation partner for these new applications and that's very promising for us.

Lucie Carrier

Okay, so if understand well, what you are also saying is, you might not be providing the entire system but you might be tying into some of this kind of system providers on some of the application you have shown.

Stefan Kampmann

Yes, it is - think a little bit deeper, it is clear we provide components here as the light source, but we are doing also the backend, the packaging and the questions what are the other components which we can in the future put as a kind of system on packaging level into this package, and that's something what we are doing in evaluating in our advanced development projects. So there is more opportunity out there than only in purely being a component provider in the future.

Lucie Carrier

And just my last question was around CapEx, if you could I mean year-to-date you have done about EUR200 million of CapEx, roughly a bit less than 10% of sales for the first half. I was wondering if you could give us a bit more guidance for either the full year or the second half.

I mean, you said it would be kind of stepping up, but considering you also now doing Regensburg and continuing on Kulim could we have a bit more guidance on what could be the overall number for the year?

Olaf Berlien

So we expect that, as I said in the prepared remarks, a step up in the third quarter but also a somewhat higher level in the fourth quarter. So we could imagine that you would see something like EUR300 million of CapEx in the second half of this fiscal year.

Lucie Carrier

And just as a follow-up to that, how should we think about normalized CapEx levels I would say from 2020 when you kind of pretty much finished with Kulim and Regensburg as percentage of sales?

Olaf Berlien

Lucie, that's a fairly tough question right now because first of all we are focusing first to get to 2020, and if I may say, we are - I mean this quarter is encouraging in that perspective. We have to see how demand develops there.

By then we should have then sort of completing the SSL part, which means - and as you know, we are building it in a way that we can upgrade from 6 to 8 inch capabilities in Kulim, which would not necessitate a complete new factory after that. So I would argue that most likely from 2020 onwards we would face a CapEx percentage of Opto, which is more closely to what you would expect from a normal semiconductor company probably.

Whereas, in the time between now and 2020 certainly this year and most likely also next year, we assume that somewhat of a higher percentage given that we are again entering into a new segment SLL and we are also seeing more demand in a segment like infrared that was a bit of a sleeping beauty, if you like, in the last couple of years, where we are now building up the capacity, which is I think, outside of the normal cycle of the investment.

Lucie Carrier

Thank you.

Operator

The next question is from David Vos of Barclays. Please go ahead.

James Fetler

Hi, it's actually James Fetler here on behalf of David Vos. Two questions here, the Nichia margin in 2016 halved from 25% to 12%, which they blame on backlighting and historically excess backlighting should capacities gone into general lighting do you see this happening now and if not what is different this time?

That's the first question. And then the second one, you provide a chart at the Analyst Day on how margins would develop as Kulim ramps up.

On that basis the margin corresponded to a range of 20% to 24%, you are now guiding for 26% to 28%, clearly a much higher level, what has really changed to get there?

Olaf Berlien

So in terms of backlighting capacity, most of the backlighting capacity is now going into, I would say in the more commoditized market for general illumination, which is an area that we don't, right now, don't really focus on. The general illumination market is a market that also has a strong professional lighting segment, which we are addressing in that backlighting capacity, not necessarily helps you to be successful in the market.

So we are not really suffering from that capacity over there, but it clearly shorter in the commoditized part of the business here and there. In certain markets you see somewhat stronger price erosion but again we are not playing in that area right now.

As far as the margins are concerned, I believe what was shown at the Capital Markets Day was a kind of a longer-term outlook for Opto. What I am guiding for now is the outlook for this year.

So in that sense I don't think you can really compare. You will see the impact of Kulim also only in the results of our fiscal year '18, where we start the ramp and the sale of the products that come out of that factory.

And then when the time has come we will also tell you what the expectation is for '18 and how that's going to play out. But I think it's a bit too early to talk about that already today.

James Fetler

Great, thank you.

Operator

The next question is from John Quealy of Canaccord Genuity. Your line is now open.

John Quealy

Hi, good afternoon. Thanks for taking my question.

Two questions, first, on the consolidated group I believe EUR90 million in R&D, can you talk about how that's spread across the businesses if you don't mind? And then the second question on lighting solutions and all of the sort of stagnant demand we have here in the US at present.

Can I ask you to speculate, it seems like calendar 2017 is the lost year for demand in lighting, can you talk about is that cyclicality, is that over-saturation, what do you think is going on? And I will take my answer offline.

Ingo Bank

Let me start with the US lighting first and then let's go back to the R&D question later that can be handled by Stefan, Olaf. On the US lighting business, I think what we are seeing right now is that two things, first of all there is uncertainty, particularly with smaller projects, smaller installers related to some of the potential implications of the tax reform both in terms of what it means but also in terms of when it will be applied and whether there will be some retroactive impact or not.

And for a lot of these installers that's a fairly important consideration and hence some of those projects are being pushed out. Secondly, what I think we're also seeing on the general lighting this is all with respect to our - if you like the DS business in the United States that there has been some buildup of inventory at large OEM manufacturers or OEM lighting customers of ours.

And obviously, they will - are working through that right now a little bit, and hence we also have somewhat of a more softer outlook for the US market as far as the second half of our fiscal year is concerned. Overall, if you look at the underlying drivers for general lighting markets in the United States, I would say that [indiscernible] forget about the inventory and you would assume that the uncertainty goes away.

I think the fundamentals are still very much intact. The underlying economy is growing, house prices in the US are increasing, construction days are improving.

So from that perspective over the longer I think the lighting industry in the United States should be doing okay. So I think it's just a temporary situation that we are working through and for this reason we see a strong order book for the second half that was as I said.

So we had some projects, they moved from first half year to the second half. But again from what we have in our - what we get on feedback from the market and in our order books we see a strong second half for LSS.

Olaf Berlien

And on R&D maybe the EUR90 million what you asked for is 50% of this EUR90 million is more or less for OS and EUR25 million is for SP and EUR25 million is for LSS. So this is 50% OS and the other 50% is between LSS and SP and a case of 25%, 25%.

Ingo Bank

And also Stefan has a little pocket here where he invests into future topics that are let's say beyond the scope of the views, where - which is more the art if you like of the R&D and that's I think important as well to point out. Right Stefan?

Stefan Kampmann

Yes, but Ingo as we agreed upon we not talk about certain topics here in this meeting.

Ingo Bank

That is right.

John Quealy

Great, thank you guys.

Operator

The next question is from Guenther Hollfelder of Baader Bank. Please go ahead.

Guenther Hollfelder

Many thanks. First a follow-up on Kulim, the automotive qualification that you mentioned for when are you expect this qualification?

Olaf Berlien

First of all, as Ingo said, first of all please we have to look at it in time and we installed all the machines, ramp up is in November, and then if we have the ramp up we are moving and start the certification, and this will be in the end of '18 something, beginning of '19, that's minimum because it takes time to get all the approvals. Again you need approvals from every single OEM.

So you need the approval of Toyota like you need the approval of BMW or Mercedes. So I think it will be a step-by-step and it will run '18 to '19.

Guenther Hollfelder

And the second module in Kulim, what are your thoughts here right now?

Olaf Berlien

Good question, if I think about and if I see the demand and if you see the growth in OS I think you see that we made the right decision to say that we expand at the OS and SP I think it was a right decision. In this case I really believe in module 2 and 3 but we will do it as we agreed step-by-step.

So first of all the ramp up must be finished, let's take a look how it works and then we come to the next phase. But I strongly believe in our program, module 1, module 2, and module 3.

Guenther Hollfelder

And then I had a question regarding the visibility for the iris you are selling right now into high-volume smartphones. Do you have visibility already for next generation modules so that there is visibility for growth, let's say, in 12 months or what's the range of your visibility there?

Olaf Berlien

What I think is clearly is good, I think in 5 years from now every single mobile phone will have iris scan that's what I really believe. The finger print scan is not safe or not safe as the iris scan as a gesture recognition.

So I clearly believe in 5 years you have clearly everybody will have it, in the iPhone, in your other products it will be in. Banking automation, cash machines you will have.

So that is some demand. And as we are getting it better, performance will increase.

Guenther Hollfelder

As a last related question on here, regarding your strategy for VCSEL technology what are you confident that you can establish a business here organically or are you looking at all options right now?

Olaf Berlien

Yes, we are looking at all options so we have certain studies in the advanced development I think from the basic physics if you go in on VCSEL at a component level let's say it's not so far off as the technologies which we are using for our components. In the application that's currency basically the topic of our investigations and analysis the question is what is the intensity of light you need for the time of light evaluation and here is the clear question win a laser or close to a laser VCSEL system with all the limitations you have and the high-performing infrared diode and that's what we are evaluating.

But, as I said, there is a clear view on the market that VCSEL is basically the next big thing, we have basic capabilities also to do it in-house and go with the growth potential which we see in this application.

Guenther Hollfelder

Okay, many thanks.

Operator

The next question is from Andreas Willi of JP Morgan. Please go ahead.

Andreas Willi

I just wanted to follow-up on LSS and your earlier comments in terms of you said you have basically the backlog for the higher turnover in the second half from the orders. Are these new orders that you have or are these the delayed orders that you now expect to come through in the second half?

And then kind of what indications and what are you watching to kind of monitor whether these projects go ahead? And still on the whole topic of slowdown in the lighting market in the US we have seen 3, 4 years where lighting clearly outgrew construction and now we're seeing lighting growing slower or declining relative to construction how do you explain this beyond the uncertainty.

Because the uncertainty is not really impacting other parts of the non-residential construction market if you look at the companies that have reported results so far it's only really the lighting companies that fear negative trends, which indicates that it's something more structural rather than something related to uncertainty on tax reform or the agenda of the new administration.

Olaf Berlien

Okay, let me start with the second question, so if you look at the numbers we get from NIMA in the U.S. we see that, again as I said the inventory levels were the most - so called lighting equipment manufacturers has increased somewhat in the last couple of months or so and that they are working through that right now.

We've also seen, for us at least, in the last few quarters a very, very strong growth for the reason being that we took market share in the United States and also that we now see fairly high penetration level already of LED-based controls in lighting installations in the United States. If you look at where we are seeing shortfalls in our business right now it's really because you've never been in the residential areas in the non-residential markets.

And it's really related to smaller customers because we don't really see in that business as different to LS and I come to that in a minute maybe. We don't really see bigger projects being delayed for the larger ones, it's really the small ones that are telling us that they are at this point in time waiting to see what is happening and given our business structure at least for OSRAM that is affecting us at this point in time.

If you look at the order book, the order book is both - is of course new orders that we were able to secure in the quarter - the second quarter and also includes, to your point, the orders that were delayed from the second and in the third quarter. And although the order book is full, as I said in my prepared remarks, there is of course still a risk that some of the customers will delay that order execution even further into the fourth quarter or maybe into the next fiscal year.

And that's where some of the uncertainty for us comes into play that we, I think, expressed in the call. And we are monitoring that very closely we have a number of larger projects that we are monitoring by almost on a weekly now together with the business that we have in the US to see how that is progressing.

But again, it's something that is going to, sort of, be more clear I believe when we are closer to the summer periods. So we expect quite a bit in the third quarter to happen in order to then say something more meaningfully to the fourth quarter.

Andreas Willi

Thank you.

Andreas Spitzauer

Thank you very for your participation, if you have further questions, please feel free to call the IR team of OSRAM. And have a great afternoon and morning.

Olaf Berlien

And see some of you next week in Philadelphia. Thank you.

Bye-bye.

Operator

Ladies and gentlemen, thank you for your attendance. This call has been concluded, you may disconnect now.