Ladies and gentlemen, welcome to the VAT half-year results 2019 conference call and live webcast. I'm Sandra, the Chorus Call operator. I would like to remind you that all participants will be in listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star and one on your telephone. For operator assistance, please press star and zero. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mike Allison, CEO of VAT Group. You will now be joined to the conference room.
Good morning, everybody here in the room. Also welcome those joining us today on the conference call or the webcast. Welcome to the half-year results presentation of VAT. We issued our media release this morning, 7:00 A.M. I'm sure you have seen that. Otherwise, you can download all the presentation materials from our website to be well aware. Today, we have with us Mike Allison, CEO, and Stephan Bergamin, CFO. We will go as usual through a shorter presentation of the results followed by Q&A. As usual for the Q&A, we will switch between questions here from the room and from the conference line. With that, I would like to hand over to Mike.
Thank you, Michel. Good morning, everybody here in the room and on the phone. The agenda this morning is, I'll start with some of the highlights from the first half. I'll then pass on to Stephan to cover the second quarter and financial results in detail. Then I'll finish off with some of the outlook and priorities for the second half of the year. It's always a challenge at the middle of a downturn to talk about highlights of the business. I think what you'll see this morning is a pretty solid set of results. You'll also see a company extremely focused on technology and innovation and driving high-value solutions for our customers. What you'll also see is a company who's very focused on improving their operating model, and I think we're demonstrating the flexible and resilient operating model through this downturn.
I think also more importantly, we're going to be in a great position as we come out of this low market situation, and we'll attempt to show you that this morning. Looking at some of the key points, our sales were up about 6%, so we were towards the top end of our guidance. We were up in our valve segment as expected, but also in our service segment. I'll talk a little bit more about that. The industry segment was down, but we're kind of planning that because we had some low profitability business, legacy business in there that we're trying to reduce over time to give us more capacity in our facility in Romania. During this downturn, we focused on the things we can control, so a lot of focus on cost, and you'll see that from our margins and EBITDA margin.
You'll also see a huge focus on technology and innovation. One of our values at VAT is reliability and trust. When you're a technology leader in a segment like semiconductor, getting that customer trust is really important to continue to build market share. The executive team and I, we spend a lot of time building that, and I will show you later our market share results, which really verify that level of technology focus and trust our key customers are placing in VAT. One of our focuses in the last 12 months has been growing our service business, and I'm happy to show that that's growing about 11% year-on-year. That's down to having a great leadership team. It's down to having a great service strategy, the team have worked very hard in expanding the product portfolio.
Also having simpler options and more options for our customers, and you see that's growing 11%. We've been doing all that, investing in the service infrastructure, investing in innovation and R&D, yet still delivering an EBITDA margin of 25%, which I think is quite remarkable, and way above the levels we've seen in previous downturns. I think what we've also delivered during this period is a brand new facility in Malaysia that's fully up to speed, qualified in close to 30 products and really ready to ramp when we come out of this semicon downturn that we're experiencing at the moment. I think that puts VAT in a great position. The markets remain pretty mixed. I'll talk more about that as we look at future visibility. The visibility is very low at the moment, and we expect it to stay that way for the next couple of quarters.
You'll see that also within our guidance. Turning to the results for the first half, you'll see our valves make up about 75% of the business with a reasonable EBITDA margin. Service is up at 22%, which I'd love to keep it that way. That's kind of the long-term targets we're setting ourselves in the 20%, obviously, that's higher because of the lower valve sales. Still good performance and good EBITDA margin. Industry, lower as expected. You can see from the EBITDA margin the reasons why I'm trying to restructure that area and get out of some of the unprofitable businesses. Again, that is mostly third-party components and some of our automotive components. It doesn't reflect the overall industrial segment which is in our valves business. Looking at the market trends, I'd say, I think it's well-publicized that the memory market's still struggling.
We are, however, seeing some signs of stability there, especially in the NAND market. When it comes to things like hyperscale servers, we're seeing in July some positive signs there and positive comments from some of the big memory companies. Advanced logic is going well, as is microprocessors. We're seeing pretty strong activity in the semi sector there. I think overall, at this part of the cycle, there's probably a bias of spending in CapEx towards litho and metrology as customers focus on improving yield. As capacity comes back, you'll see more spending in the vacuum-based applications. Within display, down as expected again year-on-year. Current investments are mostly in the Gen 10.5 area of display for large-scale TVs.
We are seeing some OLED projects around mobile in China, and that's driving a fairly strong business in the second half of the year for us in the OLED sector. Again, TV size is still dominated by Gen 10.5. Solar was a reasonably strong area in 2018, and that's continuing into 2019. Mostly this time around the PERC technology. We'd probably see the thin-film stuff improving in the latter part of 2019 as well. Again, most of the demand here is in China. Industry and research is going along reasonably well. A fair amount of spending in large government projects, CERN, ITER, et cetera. We are also penetrating with new products into areas like scientific instruments and so on. Talking about our growth dimensions, and we've talked a lot about this in the past.
The first dimension is the end market growth. I think the digitalization of the planet continues. I think you read about that every day. 5G is starting to make a bit of an impact as I expected. I expect in 2020 we'll see improvement in smartphone growth. I think the important thing for 5G is the applications that will enable longer-term on machine-to-machine communication. I think as we get into 2022, 2023, things like autonomous vehicles and smart factories will pick up the pace there. That's certainly a positive trend. Second dimension is equipment growth. At the moment, that's muted, obviously, because of the capacity adjustments. We'll see that improve in 2020. It's still a bit early yet to say how 2020 is going to play out.
The market commentators are talking about 10%-15% growth in CapEx, but we'll see how that develops as we get towards the end of this year. A lot of technology advances in logic and foundry. 5 nanometer in foundry is accelerating, and we're seeing some activity in the second half of the year around there. As I mentioned before, the memory slowdown is bottoming out. There's also, I think, a general business impact at the moment from the ongoing conflicts, not just with U.S. and China, but also recently with Japan and Korea. That certainly isn't helping the business confidence around making major CapEx investments. Hopefully, we'll see that resolve itself also through 2019. The third dimension is a vacuum valve growth.
I think in this part, the bottom of the cycle is hard to see, but as you look at five nanometers and beyond, there is a huge amount of new platforms getting developed in the semi area to deal with the new device structures and more complicated processes happening at five nanometers, and also on advanced memory. I think that bodes very well for vacuum valve growth. EUV is now established as a production technology, mostly around the seven nanometer, five nanometers, but it likely going to come into DRAM at some point as well. I think what's interesting as that starts to proliferate, we're seeing opportunities across the EUV ecosystem. Not just on the EUV platform, but also on things like inspection and metrology associated with EUV.
I think there's a little bit more growth in that whole ecosystem than we expected. I think more importantly is heading towards this zero particle environment, which I've talked about in the past. One of VAT's core strengths is our ability to make products with extremely low particle levels. As you proliferate into 7 nanometers, 5 nanometers, that really is a key strength for our company and is allowing us to win more and more market share, in terms of spec wins on these new platforms. This whole growth in high-end nodes is good for VAT, and you can see that in our share gain, and you will see that next year in share gain also. Last slide in this section is the latest half year update from VLSI on market share.
They do a full in-depth analysis every year, where they analyze a company's results and try to break it down into backend component sales. The half year is an estimate. Nevertheless, it shows our overall market up 1 point, but in display, solar up 2 points, and in semiconductor up 2 points. That's actually a pretty good achievement in the middle of a downturn because in this type of environment, okay, we're spec-ed in on many of the advanced nodes, but there's a lot of generic sales that happen, and typically our small competitors try to target the business with price reductions. We're still able to repel that and grow market share at this point. I think it shows that our overall platform development, and the spec wins that we've talked about in 2018 are following through with solid market share gains for the half year.
We expect that to continue as we go into the second half of the year and into 2020. A very positive trend. This is not just our technology, it's the scale we have. It's the ability to produce in two parts of the world. Our neutrality as a Swiss/Malaysia manufacturer right now is also playing well with a lot of the global conflicts. The investments that we've made during the downturn in putting stronger key account teams and applications engineers closer to our key customers is also allowing us to flow these new products to our customers across the world very quickly. I'd say that the market share is not just one specific region. We're also gaining share heavily in Asia, which is good overall for our business. I'm very happy with this. A big thank you to our global team.
They work very hard on this, and it's another reason why we manage to keep our gross margin high with new technologies coming to market quickly. As we come out of this downturn, the market share we're gaining here is going to stand us in very strong stead for solid growth at a strong profit margin. That's the end of the first session. I'll pass you on now to Stephan, who'll look a little bit more detail with the first half results.
Good morning. I would like to summarize year-to-date financial situation. Revenues of CHF 263 million are at the top of the end of our guidance, and we see a positive trend comparing revenues Q1 with revenues Q2. EBITDA margin amounts to 25%. That's 2% higher compared to previous down cycles. It's a result of strict cost management as well as it shows the strength of our flexible operating model. Free cash flow is only marginally below free cash flow 12 months ago. We had low CapEx, and we were able to reduce net working capital. As a consequence, free cash flow conversion amounts to 69%. That's 30% higher compared to previous year. Order intake for the six months in 2019 amount to CHF 262 million. That represents a decline of 31% compared to previous year. Order backlog at the end of June was CHF 112 million.
That's only slightly below the backlog situation end of 2018. Looking at the sales pitch, comparing revenues end of June 2018 with revenues end of June 2019, you see significant impact of the volume reduction on the sales side. We were able to add positive elements with product mix, and very impressively, pricing remained stable despite significant lower volumes. EBITDA for the first half year decreased 36% to CHF 66 million, and EBITDA margin is at 25% versus 31.6%, reflecting the under absorption of fixed costs, investments into operational improvements, and higher level of research and development. EBITDA was impacted negatively by 1.3 percentage points from FX and IFRS 16 adoption. IFRS 16 adoption means that we have to report operating leasing costs below EBITDA. The EBITDA margin is at 25%. As mentioned, it's 2% higher compared to previous cycles.
This is a result of continued operational improvements in areas such as global supply chain optimization and more flexible labor cost structures. Summing up, half year results demonstrates strengths of VAT's flexible operating structure. Personnel cost as well as operating expenses are below plan and reflect the strict cost management. Q2 net sales were steady to higher in all business units compared with the first quarter of 2019. The development Q1 to versus Q2 indicates bottoming out of the down cycle. Regarding net sales by market segment, the valve segment represents 75% of group revenues. The service business grew compared to previous years to 22% of total revenues, and industry at 3%. From a regional perspective, Asia is contributing with 47% to total revenues, followed by North America, 34%, and Europe with 19%. Moving on to the segment results.
In the valve segment, sales declined 39% to CHF 198 million. Both the semiconductor and display and solar business units reported significantly lower sales as a result of the cyclical decline in their markets that started in the second half of 2018. The book-to-bill ratio in display and solar business reached a multiple of 1.2. It's a strong indicator for improving revenues in the quarters to come. The market for solar photovoltaic equipment remains steady as increasing energy efficiency levels continue to improve the competitive position of solar energy. First-half sales increased in general vacuum business unit, supported by technology innovations such as the first order for a vacuum furnace application in China. This order reflects the success of VAT's strategy to apply its proven technologies in semiconductors and displays to a broad range of industrial customers.
The Global Service Segment reported 11% net sales growth in the first six months to CHF 56 million, led by its valve repair and spare parts activities. The segment also released new service products, including upgrades for a wide range of transfer, control, and isolation valves. Net sales in the Industry Segment were down. This was mainly a result of moving the bellows activities from the Industry Segment to the Valves Segment, effective January 1st, 2019. First-half sales declined related to a temporary reduction in demand for dampers used in high-efficiency automotive fuel injection systems, reflecting the introduction of new emission regulations in several markets. Below EBIT, there is a negative impact due to the new Swiss tax regime. Higher tax rate in the holding company, as well as lower tax rate in the operational company, caused changes regarding deferred tax assets.
The final assessment of the new tax regime is still underway. We are evaluating implications of the patent box as well as of research and development treatment on the final tax planning. The effective tax rate for the first 6 months of 2019 was 35%, a temporary result of timing of new tax regulation in Switzerland. For year-end, we expect normalizing tax rate going towards the long-term level of 18%-20%. The combination of lower sales, lower EBITDA, and higher tax rate leads to a net income of CHF 25 million, which is significantly below previous year's situation. Free cash flow generation is well on track. Free cash flow in the first 6 months amounted to CHF 45 million, 4% below previous year. CapEx are lower than plan, lower than previous year, without compromising on investments in future projects.
It reflects also the successful completion of our infrastructure build-up in Malaysia, which had a negative impact in 2018. The company was able to reduce net working capital by CHF 8 million over the last six months. In percentage of net sales, net working capital increased to around 26%. The aim for end of year is to improve this ratio further and to go versus the midterm guidance of about 20% of sales. Summing up, free cash flow conversion rate was 69%, significant improvement compared to 12 months ago. On June 2019, net debt amounted to CHF 237 million, the leverage ratio is at 1.5 times. Year-end net debt to EBITDA ratio is unchanged at 0.7 times. Coming to the summary, key achievements for 2019. We deliver in a tough environment.
We are reaching an EBITDA margin of 25%, higher compared to previous down cycles. We cope also with negative impacts from volume-driven higher investments into building the infrastructure, and also negative implications from the F side. On free cash flow generation, we are acting well within the plan. That's a key focus. The net income, it's temporarily negatively impacted by the Swiss tax situation. Priorities for the end of the year are to focus on EBITDA margin, execute on cost improvement programs, making sure that we can improve EBITDA margin. Secondly, to further reduce net working capital with a clear task force in place. Finally, we are very prudent when it comes to CapEx, without compromising on future projects. That's the end of section two. I'm giving now the word back to Mike.
Okay. Looking now at the priorities, conclusion, and guidance for the third quarter. The end market, as I said, semiconductor continues to be very low visibility. We believe we're at the bottom of the cycle. Signs that we're gradually coming out of that. As I mentioned, memory inventories seem to be reducing and ASP is stabilizing. The logic and foundry business is improving, we see that coming in a little bit in the second half. If you look at the third-party forecast for the market, you'll see overall decline in the IC market around about -12%. That's further decline from -5% in February, it does seem to be stabilizing. Semiconductor CapEx, overall CapEx down about 16%, slightly down from the February number of -12%.
You see a big reduction still in memory CapEx, and as I've mentioned in previous results, that change in memory will really indicate when VAT sees the volume coming back. Wafer fab equipment, specifically, again, -19% to 22%, a little bit down again from the February estimate. Seems to be stabilizing at that level. Specifically in our market, vacuum processing equipment, a little bit lower than the overall CapEx, again, because the vacuum-related equipment tends to be more capacity driven than shrink or design rule driven. That's the outlook on semiconductor. Moving to display. Smartphone sales still moderating. A lot of new technology being trialed and coming to market. I think we'll see in 2020 further developments in the foldable smartphone area. There'll be a lot of new technology coming to market around 5G.
There's quite a few 5G phones already within the market, but 2020, we'll see a new portfolio from Apple, and we expect that will generate a fairly substantial refresh in smartphones. The current investments all around Gen 10.5, and Stephan mentioned the book-to-bill ratio in the display business of 1.2, and that gives us a bit of confidence in the second half. There's still overall overcapacity in LCD, so we don't expect to see further major LCD capacity expansions going into 2020. We think the capacity situation in 2020 will favor more large-scale OLED, but also continued investment in mobile. The display equipment market has actually improved from March. In March, we talked about a -38%. That has moderated to -23%, again, based on the improved OLED sales. Solar, we expect to continue. There's a lot of activity in China around solar.
The silicon-based solar technologies seem to be dominating at present, about 75% of revenues, but we expect thin-film also to improve in the near term. The majority of the end-user projects are happening in China at this point. Our priorities in the near term, we've got to be ready for any change in business conditions, especially in semiconductor. We're spending a lot of time ensuring that our supply chain, our facilities are ready to react very quickly to changes in semiconductor demand. We really have to be on the pulse. On top of that, the main internal priorities are continuing our focus on innovation and market share. A lot of activities there. Close to 100 development projects from small to large across VAT, targeting all different technologies, not just our core valve market, but also into our motion components and modules business.
Cost management remains a huge focus. That isn't going to change. Being in the high-tech market, delivering cost performance for our customers as well as for our shareholders is a critical item, and we continue to strengthen our supply chain into Asia and Eastern Europe. We continue to make strong productivity gains in our manufacturing operations, and overall improve the processes and efficiency of our company. Putting in a new ERP system during 2019 and 2020 is also a key focus. That will simplify how we run our business. Again, give us more operational visibility into running the company. Cost management will remain a big focus for us. Working capital, as Stephan mentioned, key focus. We still have quite a bit of inventory in the network that we built up during 2018.
A lot of that is for the semiconductor sector, to see real improvements in that, it will depend a little bit on the semicon recovery, but we're working hard on it. We're also being very prudent in our CapEx spending during the year. There are our key internal priorities. Looking at the conclusion, I think the overall market long term still looks positive. We don't change any of our view long term on the digitalization impact to VAT and how that's going to grow our end markets. Industry commentators are still talking positively about a long-term growth of semiconductors and the increasing capital intensity of equipment as you go to smaller design rules. At this point, we believe we are seeing the bottom of the market, I would caution that by saying there's still not much visibility out there.
I'd say it's steady as you go at this point. We're ready for a quick change in the market when it comes. Independent researchers are talking about an improvement towards the end of 2019, and then a further improvement into 2020. I think for us, we move a little bit before the capital equipment. That's why the end of 2019 may see a little bit of improvement, but it's too hard to tell at this point due to that lack of visibility. I mentioned the trade disputes. I don't think that's impacting our business dramatically other than overall business confidence. Certainly, if that gets resolved, it will give, I think, a boost of confidence to the overall business. We'll continue a focus on service. I think that's a great opportunity for us. Work hard during 2019 and 2020.
I think in 2020, we'll see there a good opportunity with our upgrades. We've been spending 2019 developing a lot of new upgrades for the installed base. That takes some time to get traction, and also reduced operating expenses within the IC market makes that quite difficult to penetrate in the short term. As capital frees up a little bit in 2020 and 2021, we see the upgrades as a great opportunity in our service business. Looking at the qualitative and guidance for the third quarter, obviously, we expect net sales to be lower compared to last year as with EBITDA and EBITDA margin. I hope you've seen today a very strong focus from us on keeping those EBITDA margins at a pretty high level.
That's going to put us in a very good position to deliver a 33% target as the market recovers. We're pretty confident we can achieve that based on the infrastructure improvements and operational improvements that we've made. Net income will be lower. CapEx, as you saw in the first half, we're managing that very prudently. We will have to make a few investments towards the end of 2019 to ensure we have the right equipment in place for new technologies coming to market. We have plenty of latitude still in the second half to ensure we hit a low CapEx number, but still prepare VAT for the future. Free cash flow is expected to be higher based on the working capital reduction to Stephan talk about. For the third quarter, we are guiding net sales to be between CHF 130 million and CHF 140 million. Again, limited visibility out there.
I think, from some of the markets like display, we're seeing certainly an improvement in order intake, and we're confident in that. Confident in the service business, the industrial business. The main questions remain over the semiconductor business. That concludes the end of the presentation, and I'll now open to questions. Thank you.
Okay. The first question is here from Michael. Please, if you all could state your name and company, because all the calls are transcripted, and for those who are following it later, it would be nice to know who asked what question.
Thank you. Michael from Vontobel. Three questions. The first one, regarding your cost run rate and your EBITDA margin, assuming that your sales would stay flat in the second half of the year, similar to the Q3 guidance, what sort of EBITDA margin level would you expect in the second half, considering where your cost run rate is now? That would be the first question. The second question is, on those vacuum furnaces for battery production, what sort of total market potential do you see for VAT in there? The third question would be, on the memory market, if we hear comments from Micron and Hynix talking about further deterioration of CapEx into 2020, my question would be how you reconciliate that with the statement that you see market researchers expecting 10%-15% growth in wafer fab equipment in 2020? Those would be my three questions, thanks.
Okay. I'll do the battery and the memory, Stephan, the cost run rate. The battery potential. The general vacuum segment, it's not like semiconductor. It's not one large market that is easy to get your hands around with a small number of OEMs. The general vacuum segment is literally 20, 30 different vacuum segments. It's a little bit harder to gauge exactly how big they are. Typically, though, we see these individual sectors in somewhere between CHF 10 million and CHF 30 million. Lithium ion battery is emerging fast. It's mostly China, but it's also expanding outside of China. I would certainly put it in that sort of range, CHF 10 million-CHF 30 million. It is a lower cost type environment. It's not as high tech as, say, our semiconductor and display. We think we can offer products within that at a reasonable margin.
I would gauge maybe half of that number, so maybe on average about CHF 15 million there. In memory, the CapEx for next year definitely will see continued growth in foundry and in Logic, and probably also in some of the smaller sectors. The CapEx in memory, you've got to bring new products to market at some point. Capacity utilization is still low in memory, and you've seen the large players are actually idling some of the capacity. It's certainly a question when they'll make those next capital investments. I would expect them to start in 2020 around new technologies, new DRAM technologies and new flash technologies. That's kind of what adds to the uncertainty of predicting a memory return. It's not just capacity. It's an intersection of new technologies plus capacity.
In all downturns, you're faced with this, where all logic tells you that the market's going to stay low forever, it rebounds pretty quickly as the major players come in and make new capacity investments around about new technology. That's what makes it so difficult, the commentators try to balance that view of new technology and existing capacity challenges. That's the best visibility we have at this point. You want to, Stephan, talk about the EBITDA run rate?
We expect the margin in the second half to be above the first half, but to be below the second half 2018. Why do we believe we will see an improvement in the second half? We have a performance improvement program in place
Where we had a slow start beginning of the year, and where we expect significant additional improvements in the second half.
Okay. Thank you. Next question here from [Bjorn].
Thanks. [Bjorn] from UBS. Two distinct questions. The first one is, please can you give us an update on your current capacity utilization, and what is the potential to capture new revenues in 2020? Would you, for example, be able, with your current fixed cost base, to deal with another CHF 51 million revenues in 2020 or would you need to have more fixed cost investment? Second question would be, please, on your design wins you had and your product launches for 2020, what % of revenues is this roughly? Is this coming at significantly higher gross margins? The last question on the OLED and solar sales going into the second half, making the mass, is it roughly around CHF 10 million-CHF 15 million higher sales in the second half versus the first half? Many thanks.
Okay. Capacity utilization, still at a low level. In Switzerland, it's certainly higher than it is in our factory in Malaysia. The factory in Malaysia is still, let's say, around a 25% utilization level. That's expected. In our business, it's very hard to move existing products from factory to factory because of the very tight qualification requirements by our customers. We tend to bias new products into our new facility in Malaysia. We do have a lot of products qualified there, as I mentioned, and that should ramp pretty quickly when the market comes back. Obviously, that's a drag on the results right now, but at some point you have to have that business continuity plan in place of having two factories. That's the situation we're in right now with that. I'd say the capacity utilization in Haag is somewhere between 50%-60%.
Opportunities and expansion, I think the fixed cost structure is pretty well in place now for Haag and for Malaysia. We shouldn't need much additional investment as the capacity ramps, in fixed costs. We will have a few spot requirements on latest technology tooling. We also want to make sure we continually upgrade our machine tool base to have the highest productivity, the highest speed machine tools. There's an ongoing replacement cycle required there. We expect the CapEx to be significantly lower and more around about the 4% level that we've talked about. New products tend to make up about 25% of sales in a given year. Very much depends on the adoption cycle of our key customers and where we are in the overall semicon cycle. Obviously, at the moment, things are slower in adoption because the overall CapEx is lower.
I think as we come out of this downturn, we'll see a fast pickup in adoption of new products. I think new product margins depend which market, depend which type of valves. We have different margin performance across different types of our control valves, transfer valves, and so on. It's difficult to put a finite number on that, but typically they would be in the higher range, the higher side. The OLED question for the second half. With a book-to-bill ratio of 1.2, we do expect an improvement in sales in the second half. I think, the sort of CHF 10 million range you talked about is reasonable.
Thank you very much.
Next question is from Philippe.
Philippe Rey from La GFF. You continue to invest in your service infrastructure. What are your new initiatives? What is the position today?
Our service business really breaks into three distinct areas. One is repair of our valves, the second one is spare parts, and the third part is upgrades and retrofits of existing products. On the repair side, what we're doing there is expanding the available network of repair centers. We're ensuring that we have a wide installed base of repair centers close to all our customers across the world, in every geography that has semiconductor or display manufacturing. We're having to expand some of those repair centers also because they tend to be pretty small operations, we'll have some CapEx investment in expanding. The return on that investment is very high, obviously. Specifically what we're doing in repair is making it simpler for our customers. We had a fairly primitive model around repair.
We're giving our customers a lot more options, from very high quality, almost replacement type service, down to a very basic refurb to compete with some of the lower priced third parties. We plan to take some of that business back from the third parties that we lost over the years. It's really a wider range in repair.
In spare parts, it's in just ensuring we have better availability of parts around the world, that we deliver quickly at very high quality, and we don't have any delays in execution. I think a big area is the third one, the retrofits and upgrades. We have a huge installed base of VAT valves in the market, and we want to use the latest technology we've got to offer all those customers the ability to upgrade to valves that are better productivity, and also lower particle levels. That has an impact on yield for them, and they can be pretty lucrative from a return on investment for those end users. It takes a lot of engineering effort to get these upgrades completed and ready for market, and that's what the team's been working on. We've introduced five upgrades during this year.
They're starting to come into the market, and we saw some of that happen in the first half of this year. I mentioned the uptake of them is a little bit muted because of the lower spending environment that exists in silicon today. I would expect that to accelerate as those budgets start to loosen up, as the industry grows again. Those three dimensions in service, I think will be pretty good for us. At the capital markets day we're going to have in November, we'll give you a more detailed view of the service business. I think it's a key one for us and give you more examples on how we plan to grow that business.
Okay. There seems to be no question from the room. There is one here in the front, Remo. After that one, we will turn to the callers.
Alexander Kohler, Zürcher Kantonalbank. If I do cross-read to other market participants, we see that there is certain pricing pressure in China, especially to get orders there. If I look at your gross margin, I see that this is not the case for you. What are the main reasons that you're, in a way, more resistant in this respect?
Today, most of the equipment going into China comes from U.S., Japanese, Korean-based OEMs. We're not actually competing directly in China. There are a few OEMs that we're heavily involved with, but typically our equipment goes into the OEMs from those different geographies. We work very closely with the customers around the world to get them very cost-competitive products to allow them to compete in the Chinese market. I think we offer a range of products to satisfy our customers' demands from the very high-end to the medium-end to low-end, where price competition is high. I think it's as simple as that. I would say our China business, we have very high market share in China. Not just with the Chinese OEMs, but also in selling directly to the fabs with our fab products, which are things like valves for the sub-fab. Okay.
Okay. There's one from Remo here in the front.
Remo Rosenau, Helvetische Bank. On a side remark, you mentioned the introduction of the new ERP system, this and next year. Could you just remind us what this exactly entails, including the timeline and the costs?
Mm-hmm. Stephan, you want to.
It's Microsoft Dynamics. We will introduce Microsoft Dynamics, will cover the finance part, but also manufacturing and all other key core disciplines within VAT. We are now in the implementation phase. It's expected to do the first launch mid of next year. We did a readiness check over the last two months, which confirmed to us that we are in line with plan costs, and also timing-wise, that we are confident to deliver according to the plan.
On timeline and costs in figures.
We will invest into an ERP system, more than CHF 15 million for the whole project over the next three years. To start with, the first pilot will be mid of next year.
I would add one comment to that, however. Today we're running different ERP systems across our different manufacturing facilities. There's a big consolidation got to happen. What that allows us to do is roll out the systems incrementally. We're rolling it out to our first manufacturing site in Romania, which is our lowest risk, smallest facility. We will not proceed with the second one, Malaysia, until we're absolutely sure that we wring this thing out strongly in Romania. Malaysia is our high volume product. That's a simpler environment compared to Haag. We'll further test it with Malaysia. The final implementation will be in Haag, where we have a pretty high mix, more complex environment. I think we've got a pretty solid plan on rollout, which will take us into 2021 for full rollout.
I hear you that you take the whole thing serious and going forward, prudent, because when we hear new ERP systems, always alarm bells start to sound, because we had many problems.
Absolutely
with many, many companies in doing that. It always takes double the time and sometimes triple the costs.
Well, I've gone through two major ERP implementations in my life, and I know the upside, I know the downside. Stephan also comes from an environment of having done a few. We're taking a very cautious approach. We cannot risk our business. We've got such a dominant position in the semiconductor market that I mentioned customer trust. Customer trust is the one thing that we cannot lose, either in product reliability, product quality, or disruption of supply chain. We cannot let that happen. It is not just a small focus, it's enormous focus. I would say the governance also from our board of directors is extremely high in that area.
To add on, we are supported by top consultants. Microsoft is involved. It's a key project for them in Switzerland. PwC is supporting us in order to make sure that we have the project under control.
Okay. Thank you.
Okay. Thank you. With that, we would go to the callers on the phone.
The first question comes from Deshpande Sandeep , from JPMorgan. Please go ahead.
Yeah. Hi. Thanks for letting me on. I'm not sure I heard all the questions, but I have one question on your valves business. Firstly, regarding the modules, when you are talking about the next generation product being designed, are these customers now designing standalone valves, or is this module based? How do you see that progression, and does that have an impact on your margin going forward? Secondly, just regarding what is happening in the market at the moment, you have said in the past that things remain uncertain, but you were hoping that by the fourth quarter things would begin to pick up because there would be a rollout at some of your end customers of your customers early next year. Do you still see that, or the visibility is not there at this point? Thank you.
Okay. First question around about the valve business. We have a solid plan to offer not just the different types of valves we produce, but also modules and also different types of components, like motion components. When it comes to dealing with our key customers, we do offer them a range of options of not just designing a custom valve for them, but integrating that more into their platform. That depends entirely on the architecture of the platform, and also the complexity of the platform. I would say on some of the latest platforms in the industry, we're seeing more motion component sales, and I'd say that's at a higher level than our modules. Our modules is improving, definitely. I think the motion components is a slightly higher uptake. They are much lower ASP than modules or valves.
Typically, they're in the same margin level as our valves. The module business, depending on complexity, they can be similar to valves or a little bit lower than valves. Obviously, we don't want to compete with things like the large contract manufacturers that make chambers. That's not attractive for us. Unless we can offer a very strong value proposition around integration of our valve with the chamber, or very, very advanced particle performance, then we would not take that business. We're very picky in the type of business that we want to offer there. There's no point offering chambers for the sake of it. When it is the right conditions, it certainly leverages our ability as a turnkey supplier around the whole vacuum transfer trend. That was the first question.
Second question, I mentioned visibility right now is still very low for the second half of the year. The information I'm conveying is more what external commentators are saying about the business. If they say a Q1, Q2 recovery, then we may see some of that into Q4, but I don't think I'm gonna have visibility on that until really towards the end of this quarter. It's too hard to tell at this point.
Thank you.
Yeah.
Okay. We have another question from the phone.
The next question comes from Sebastian Kuenne, RBC. Please go ahead.
Hi. Sebastian Kuenne, RBC. A couple of questions. First of all, IFRS 16, could you give us the impact in the first half of the year on EBITDA? I assume it's a helpful number for EBITDA, although in your statement you write a net negative impact, which I don't quite understand. What is the positive impact on EBITDA in the first half? When you speak of the year-over-year change, lower EBITDA that you expect for the second half, is this adjusted for IFRS already, or do we then have to be a bit more careful when it comes to comparable numbers? That's the first question. I would just like to know what the current shares of memory business as part of your valve sales.
I would expect last year or the last two years was around maybe 40% of valve sales. Do you have an indication of how much of your business currently goes into memory? Next question would be market share gains. You mentioned that earlier that you expect more gains in 2020. Was there any exits from the valve market? Any competitor that dropped a product line, or did you make any wins of specifications where you are more confident to gain share? Finally, on the 400 staff that you have or had on short time, they are now back in full employment. Is this really because the improved order level or does it have to do with Swiss regulation that the government doesn't pay the fifth day for these people anymore, and therefore you have to take them back?
What impact would that have on second half costs? Thank you very much.
Okay. Thank you. I'll do these in reverse order then. First, the short-term work. Yes, one reason is the slightly improved business levels. The second reason is we've been making productivity gains in our manufacturing. We've had some attrition of the workforce over the last one year, and that's allowing us to stop the short-term work. In the second quarter of the year, we weren't too far off the requirements of full-time employment for the production staff in Haag. It was a pretty easy decision to come out of the short-term work. The improved business in Q2 and then further into Q3 gives us confidence that we could bring or stop the short-term work. The other factor was the holiday season in the third quarter, it gives us a drop of productivity. We needed the full staff to get through Q3.
We even need a few temps as we'll now start to build up a temp workforce as we go through Q3 and into Q4, as we expect the market to come back. Being ready with trained employees is a really critical thing. We could have continued short-term work through till the end of October, but there was really no point at the level we were running at. The question before that was share gains. Yeah, we follow spec wins very closely. We basically chart all the new platforms and products coming to market across semiconductor and display. We have very good visibility of what we're winning. Obviously, a lot of the platforms are at the high end, focused on next generation products. That lends itself very much to VAT's strengths on low particle performance, high productivity, and very strong total cost of ownership.
We see we're gaining at that level, which gives us very strong confidence of future market share gains. I'd say, pretty confident we'll continue that trend over 2019 and into 2020. Memory, very hard to say exactly the impact of memory. Even if I knew, we have NDAs with our key customers, I wouldn't give that exact number. I think it's fair to say, though, it flows pretty well with the overall CapEx going into logic, foundry, and memory, and obviously memory is down at this point. When it comes back, it's high volume, and we'll see the benefits of that. The questions before that, Stephan, do you want to comment on them?
Regarding IFRS 16, the positive impact amounts to CHF 1.4 million for the first six months. That means EBITDA is positively impacted by CHF 1.4 million. On year-on-year basis, adjustments are already reflected.
Thank you very much.
Okay. At this point, I'm looking back here in the room. There are further questions. We have one here from Mark.
Mark Pulsar with VAT Group. Just a short question concerning the forecast ability of cycles. Have you done an analysis, back-tested how accurate the forecasts were in the past concerning cycle developments? As I remember, your predecessor basically said that there was no cycles anymore due to different reasons, and shortly after that, we came into a downturn. How valuable are these forecasts? Isn't it like garbage in, garbage out a bit?
I don't know how to answer that question. I think cyclicality, to me, is really a function of the growth rates of an industry. The more mature the industry, typically the lower the growth rates. The lower the growth rates, typically the lower the cyclicality. Semiconductor participates in a lot of new markets with very high growth rates, that means you get massive fluctuations in demand and the CapEx requirements around that. I don't think until semiconductor really becomes a trillion-dollar industry, maybe by the end of the next decade, that you'll see a type of stability that would say there's no cycles. I think the key thing for us is we know we can't forecast it. We have, I think, as strong a sensing network as anybody in our industry.
I think you've seen from our forecasting in the last couple of quarters, we've been pretty accurate. I think it's really impossible to nail it on a long-term basis. Short-term basis, we're getting better. Key thing is to have the most flexible operating structure that can deal quickly with those changes, both up and down, and the down is just as important as up.
In taking these 100 projects that you're involved in, that you mentioned.
Yeah
Weighting them by the size, the potential. Can you describe how that evolved over time, looking back maybe two, three years?
The engineering projects we got go from sizable ones down to smaller customizations, but because of the complexity, even the small customizations, we have to treat with a full project mentality with high-quality standards. We track every major project. I'd say, overall, it's growing because of the complexity of semicon. Semicon used to be pretty straightforward with litho, etch, and deposition. These days, you've probably got 10 to 15 different types of deposition, ALD, many types of different processes. The market's changed dramatically. The transistor structures today are very different in logic compared to memory or other types of chips. That means we need different technology to support them. Overall, there's more projects. That puts the strain on our engineering teams because we customize everything. Again, it's one of our strengths.
We have 150 or so engineers working across Switzerland, we've also expanded our engineering team into Malaysia. We've now got around, I think, 20 people in engineering in Malaysia, we'll continue to grow that team so we can have a lower cost structure across our engineering. It's one of VAT's core strength and our ability to rapidly customize for our key customers.
Okay, we have one more question here in the room.
Thank you. Ronald Hinteregger, Raiffeisen, Switzerland. I have a more general question. The capital market environment is heavily affected by the trade wars at the moment. My question would be, were you affected so far, and how do you see the developments in the future for your company?
I mentioned earlier that our neutrality as a Swiss company is a great calling card when I visit customers. We're not manufacturing in China, so that doesn't impact imports into the U.S. Also now having the fab in Malaysia, again, that's also neutral with respect to the semiconductor-producing countries. I think we really have very little impact directly, but indirectly, it reduces overall business confidence. If you're about to make a CHF 10 billion-CHF 15 billion investment in a next-generation memory fab, that business confidence, I think, plays into the timing. I think it's more of a confidence issue than it is direct impact to VAT. Our position now of having manufacturing here in Europe and in Malaysia, I think is a really optimal footprint that will support our growth into the future.
Any more questions? This does not seem to be the case. Before I hand back to Mike for short closing remarks, I'd like to remind you on our next dates. It is October 24th with our trading update for the third quarter, on November 11, VAT will host its first capital markets day here in Zurich. Invitations will be sent out in due course. Thank you for joining us here. With that, I would hand back to Mike for short closing remarks.
Yeah. Thank you very much. I hope today we've demonstrated through this cycle that we have a very flexible company, a very resilient company, a company that's very focused on technology. We're also continuing to upgrade our capability as a company, and that's in our people, that's in our facilities, that's in our cost structure. We're adding a lot of strong talent to the business. I didn't mention that in the presentation. I've just added a new head of our general vacuum business. She comes from very strong industrial background. She will help me in the general vacuum business do, hopefully, what we've done in the service business, is really reinvigorate that area. We're also upgrading talent across many other parts of the company, as well as giving our current talent a chance to grow with the business.
I think it's a very valuable time for us now during this downturn to really optimize our performance and really get ready for outperforming the market when the market returns. Thank you very much, and I'll see you at the third quarter midterm results. Thank you.
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