Ladies and gentlemen, good morning. Welcome to the VAT half-year results 2018 conference call and live webcast. I am Alice, the Conference Call Operator. I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded. After the presentation, there will be a Q&A session. You can register for questions at any time by pressing star and 1 on your telephone. Should you need assistance, please press star and 0 to call an operator. The conference must not be recorded for publication or broadcast. At this time, it is my pleasure to hand over to Michael Allison, CEO of VAT Group, and Andreas Leutenegger, CFO. You will now be joined into the conference room. Ladies and gentlemen, please hold the line. The conference will begin shortly. Thank you.
Good morning, everybody, to the Q2 and half-year results presentation of VAT. I am glad you, despite the heat, you were able to join us here, but probably that is because the room is air-conditioned, so it is certainly a benefit for you being here. We have today as speakers, Michael Allison, our CEO, and Andreas Leutenegger, CFO. As usual, we will do a formal presentation followed by Q&A. The Q&A, again, as usual, we take questions here from the room, but also from the people who join us via the conference call. Without much further ado, I would like to hand over to Mike.
Good morning, everybody, and thank you for joining. I am going to kick off with some highlights for the first half and Q2, then I will pass you on to Andreas for a detailed look, and then I will round up with some short-term guidance on the market. Let us get started. In Q2, we delivered a near record net sales and continued a strong performance of nine consecutive quarters of year-to-year growth. As I mentioned back in the April call, we were seeing some moderation in the market. It was not really until the June timeframe that we saw significant impact in order intake and also some major revisions from the key equipment makers that pushed us to change our guidance for the year. We think that June was the low point of our order intake. It is still quite difficult to fully characterize Q4.
We have got a better picture of Q3, but there is still quite a bit of volatility in Q3. I think the key thing is, this is we call it a correction, but it is probably the smallest correction I have seen in the semiconductor market, and we are still on track to have positive growth for the year. VAT has a outstanding and very experienced executive team, and we reacted very quickly to the changes that we were seeing in the market. It shows our operational agility and flexibility that we will be able to still achieve outstanding results for the full year. The market remains strong. I was talking to some people outside. I have never seen a position where the key chip makers are delivering such outstanding results. Almost all of them have recorded record profits and exceeded guidance.
I think that the long-term view that we've been talking about in the various meetings with you in the investment community, I think is still intact. It seems very strong. My story is, I think, pretty consistent. The customers are managing the supply-demand dynamics very well, and that means they're not putting in excess capacity, which is good for the long-term health of the industry, but it does mean that we see these short-term changes. I think for us, leadership is important at this time, and I've been very focused with our teams in continuing to drive market share, and trying to get spec wins for next-generation technologies, and also continuing our spend in R&D and bringing products to the market. We're really relentless in our planning for share gains.
When we look at the design wins we've had in the first half of this year versus last year, there's about 50% more. That speaks well to our future market share and the opportunities. We've also been investing in our modules and motion components business. That really leverages the knowledge we have in machining, particle management, contamination, and we had four big spec wins in the modules business that will come into play in 2019 and beyond. We've also got our facility in Malaysia almost finished. It looks fantastic. We've got tremendous operational capability there. We now have a lot of volume. That's really helping with our General Vacuum business. In the past, we had some challenging lead time problems as we ramped semiconductor, and you'll see our business there grew pretty nicely.
I think the other benefit we're seeing in Malaysia is in a neutral location, and that's very interesting for the key OEMs right now, especially with the U.S.-China trade issues. We've had a lot of customers visit, and they're very impressed and we've qualified a lot of products, and we're ready to really ramp our production there. Let's look at the numbers, for first half. I think net sales of CHF 387, with growth of 18%, on profitability, EBITDA margin on track, 31.6%, it's up 150 basis points from a year ago. More significantly, the EBIT margin was up 330 basis points. Valves had a steady growth. Our service business, also performing well, up 17%, and the industry business, General Vacuum business up 20%, again, showing the benefit of the shrinking lead times there and ability to eat into the backlog that we had.
We're really focusing on those customers in the second half to continue to drive our business. We recently, in the General Vacuum business, recently picked up a very substantial automotive contract, that's a multi-year one, which is going to help our industrial business. Looking at market share, I mentioned huge focus from the teams on market share. This is preliminary data. I just want to point that out. It's first quarter actual and second quarter preliminary. Again, it shows strong performance across the board. Semiconductor, as expected, it's a fairly flat market at the moment. There's not so many of the new platforms coming to market, so flat market share there. Our design wins that we're working on should help us in 2019. You'll see in the semi and related area up 1%. That's mostly due to solar and a little display.
Overall, the General Vacuum position comes in. You see we're taking some share in the General Vacuum area. I think positive outlook. Really the number one focus at times like this, when there's a correction in the market, it's important for us as a leadership team to really keep the teams focused on market share and winning the future slots, and also continuing with product development. That's the big focus. At this point, I'll pass you on to Andreas, and he can cover the financials in more detail.
Thanks, Mike. I'm happy to lead you through some of the financials in more details. Same, KPI set we used since the IPO. I haven't changed anything here. We stick to the numbers we report, and we don't change them even in bad times or more difficult times. Third party net sales, top left, we have started, and again, we grew about 18%. Let's not forget that is on the back of a significant growth last year of around 35% in the first half and as well as a very strong number in the second half of 2017. EBITDA, we grew 24%, over proportionally, and we have no adjustments on EBITDA. I think that's also important. We have made the last IPO-related adjustment a year ago in the first half year, 2017. That was the IPO-related bonus, or share allocation to the employees of CHF 2.9 million.
Since June 2017, we have not made any further adjustments. That's why we took the word adjustments out. I always said, clearly, I'm not in favor of making adjustments unless there are really anything extraordinary which comes up. EBITDA margin as a result of the overproportional EBITDA growth, grew by 150 basis points, as mentioned by Mike. We are certainly proud of that market and profitability expansion. I think also what we definitely should mention is EBIT margin improvement is 330 basis points. We should always look at both numbers. As you know, we outsource more, and we should not forget that the outsourcing portion hurts us on EBITDA margin. Please also be reminded that when you outsource more, we have the policy that we want to outsource more than two-third of the supply chain.
We move not only depreciation cost into EBITDA, but we also move cost of capital, the margin of any suppliers, again, cost of capital, profit, everything a supplier has, is actually you move up into EBITDA. Financing cost, and as I said, even cost of capital, you move up. The profit and the gain, and that hurts us on EBITDA margin. You actually see that EBIT margin, that's the result of the higher economics of scale profitability. All the internal hard work actually grows 330 basis points. Now, seeing the difference of the two improvements here, 150 versus 330, is all related to outsourcing. That's probably not right. Again, you have also an economy of scale effect and the base effect, because we have a slightly lower number. You can assume, as I reported last year, 2017, the outsourcing effect was 140 basis points year-on-year.
Of course, we continued to outsource additionally in the first half of 2018. You can assume the outsourcing cost, or let's say, negative effect on EBITDA margin, is between 150 to 180 basis points. Net income and earnings per share, we both grew by 41%, and that's certainly also a good figure year-on-year. Free cash flow, CHF 47 million, -13%, and I will show you later on a slide what the reasons are for that lower figure. Free cash flow margin is 12%, and free cash flow conversion 39%, both numbers a bit low. But again, that's related to the free cash flow generation in the blue box. I will explain all three KPIs, why they are a bit lower. They are, again, here, just upfront, there are no major concerns, and we will pick up by year-end. Net debt is one time EBITDA.
Right now, this is around our target leverage. Let's not forget, we just paid the dividend on the 24th of May, so then the leverage usually goes up, and then start to decline over the next 12-month period. The ratio was 1.1% a year ago, so we are almost identical or even slightly better despite the dividend payment in May. Order intake, you have seen the press release and also what Mike just said. We see near-term delays in semiconductor memory spend, which mostly occurred in June. Order intake was -13% in the second quarter, while the first quarter was still +18%. But again, that happened mostly towards the end of May and mostly in June. That dropped.
We also have an effect, I also have to mention that, but that's not the main cause, that one of the OEMs moves more orders into consignment stock. That actually means there's no pre-order, no order intake with a delivery time with two to three months. When he pulls out of the consignment stock, then we book it as order intake, but only then when he really consumes the product. That also has a bit an effect on the absolute order intake. But again, we don't want to blame all that the low order intake. It's just we see some push-outs, as we mentioned. Order book is around CHF 159 million. In Q1, at the end of Q1, it was CHF 184 million, so about CHF 25 million lower. I always say the order book is a good indication of around three-month sales.
It's a bit lower from the history, 2.8, 2.9-month sales, and that gives you usually a good indication going forward. Oops, I'm too fast here. On the next one, EBITDA margin, net sales trend, we have talked a lot. EBIT margin, again, EBITDA margin was up 150 basis points. We have made big steps in terms of costs optimization. You also know that we said last year, the first half year was actually lower in terms of EBITDA margin due to the significant ramp-up costs we had in Switzerland. These costs fell partly away, and that's why we have an improvement. However, we also said we have some ramp-up costs now in Malaysia. Mike also mentioned the factory expansion is near completion. But of course, we had hiring costs in Malaysia.
You saw that we have additional headcount. That's also mostly related to Malaysia, there, we incurred some costs. I think I mentioned that at the year-end press conference, that 2017 was under the light of ramp-up in Switzerland. 2018, we will have some additional costs for ramp-up in Malaysia for the new factory or the factory expansion. The margin rise, we were at 31.8% in the first quarter and 31.4% in the second quarter, so almost similar growth here. I also mentioned that EBIT margin, 330 basis points up to 27.2% EBIT margin. That's certainly a good and nice figure going forward. To be reminded, we manage profitability with the three, I call it golden rules or internal guidance to sell variable cost.
We want to outsource at least two-thirds up to 70%. We still want to deliver 23% EBITDA margin in a 30% downturn scenario. That's why profitability certainly has a very high priority. Whatever happens in the market, we want to deliver EBITDA margin, but also EBIT margin in terms of return on invested capital and returns to the shareholders. The net sales bridge, same as at year-end. You see that actually interesting here also the product mix, that also includes any new product or newly, let's say, further developed product. Also here, product mix, we call anything which has a new serial number or product number. That means that can be a change or can be a complete new product. You see that innovation, then working together with our customers, drives our business. That means also spec wins.
Mike mentioned as well how many spec wins. That's the future, actually, revenue generation. That's very important that we continue to develop and work together with our customers. Also you see actually here, they contributed nicely, around 12% in terms of growth. In terms of price, we have almost nil impact, about minus one percentage point. We have a small effect on volume rebates. Again, that's related to the second box of the product mix. If we do the right thing there, if we are faster in innovation, then our customers ask for price rebates. I would say a customer ask for price rebates is if products get boring or become boring, then they probably ask for price declines. That's why we need to continuously innovate and bring some value added to our customers. The price discussions are usually not that difficult.
Almost nil effect on the foreign exchange. The first half year was rather quiet at the FX front. You will have in your documentation, you will have one slide where we show the foreign exchange exposure, net cash flow exposure. I will not comment on that one in the presentation, but if you want to refer to, you will find it in the back-up, one page, where we show you the foreign exchange exposure. In terms of mix here and segment reporting, you will realize on the left-hand side, net sales by segment, that is unchanged. 81% valves, global service and industry. The figures here have not changed versus year-end 2017. On the right-hand side, by region, there you will observe a shift more to Asia, where we gained about two percentage points. North America, negative four percentage points, then EMEA, plus two.
That actually confirms we see a shift from a bit more out of North America directly to Asia, as some of our top OEMs move more also their sales and production to Asia. In EMEA, we are good in bellows, industrial products, and General Vacuum, and that's why there the contribution is also slightly higher. If we go to the financing below EBIT, actually, as I mentioned, EBIT margin up 330 basis points. to 27.2%. We could reduce a bit the finance cost by 24%. You have probably followed that we issued a debut bond, the first bond ever for the company, a CHF-based bond in May, CHF 200 million. We issued at the coupon rate of 1.5%. That, of course, puts the financing on, I would call it, on two legs and not only one.
We had the RCF, and now we have more flexibility and more potential also. With the money from the bond, we actually repaid part of the RCF. That's why, interest-wise, we could decline it a bit, also year-over-year reduce it. EBIT margin, I mentioned 40%. EBT, earnings before tax, is 40% up, and net income 41%, in line with earnings per share, also 41% up here. Working capital, I mentioned at the colorful slide, I will come back to that. Actually, you see cash flow from operations increased by 13%, from CHF 72 million to CHF 81 million. We spent more on capital expenditures, which increased around 50%, from CHF 18 million to CHF 34 million. That's actually the plant expansion in Malaysia.
I repeat myself, we always said the CHF 40 million plant expansion overall, the big part will be in 2018, and that's now you see the spend in that figure. That means free cash flow declined by 13% to CHF 47 million. That means also free cash flow conversion, of course, declined to 39%, how much EBITDA we convert into free cash flow. We did here, we can easily explain, actually, the CapEx, the capital expenditures effect is about 13 percentage points. Then we have trade working capital. It's higher right now at half year, around CHF 35 million, negative on the cash flow. If we adjust both in a way of like for like, or let's say adjusted basis, then actually the conversion rate will be at 80%. You remember we said trade working capital should be about 20% of sales.
Right now it's about almost 24% of sales, and that four percentage points around this makes you about CHF 35 million effect. That has 29 percentage points. 29 on trade working capital and 30 on CapEx plus the 39, then you end up at 80%. We always said conversion rate, free cash flow conversion rate should be around 70%-80% in that range. What I want to say is we are in that range, but we have spent more on CapEx, and we have right now a bit higher trade working capital balance at half year, but we will move back to our target by year end. That's why we said also in the outlook, in the guidance, we expect to deliver free cash flow higher than in 2017. Here we have no concerns. We have no issues. Our customers pay on time.
We pay on time. We just have also the supply chain. You remember we said we have some bottlenecks we communicated earlier, which will be mostly resolved by mid-year. Now actually these bottlenecks are almost gone. That actually means now we have a good, very healthy flow of materials. That's why we have a bit higher. Also stock up the consignment stocks of our OEMs. That we will reduce in the second half of 2018. I think I commented on that one here. We have the new debit bond, and the one-time EBITDA. In terms of leverage, it was 1.1 and at half year 2017 and 0.7 at the year end. Again, that's always the effect of the famous Toblerone effect. When we pay dividends, it jumps up, and then the next 12 months, it goes down.
We stick to our target of around one times EBITDA in terms of leverage. We actually now have a financing potential of around CHF 500 million, which is CHF 300 million is the RCF and CHF 200 million is the bond. We have financing potential again. Also that's a security of CHF 500 million at very reasonable or low interest rates. We are actually safe and stand firm on two legs, as I call it, going into the future. That leads me to the summary of the financial results. It has been commented on that we had the ninth consecutive quarter of higher net sales year-over-year since the IPO. We reacted very swiftly to a certain moderation. We delivered a nice EBITDA and certainly EBIT margin.
We had a cost reduction thanks to our very flexible cost structure, to react here, which means we demonstrate that we are able to adjust quickly. I think that's one of the utmost if you're a company like us. We optimized the financing structure, reduced the finance expenses also going forward. One can also expect substantially higher net income and earnings per share going forward, also in the second half, as we improve profitability. You remember in last year, 2017, we had this one-time hit in terms of financial expenses. We recycled some foreign exchange losses in the last quarter 2017, which had a negative effect on net income and earnings per share. That CHF 35 million, you probably remember, hit, that will also help us this year. We were upgraded by both rating agencies, Standard & Poor's and Moody's, by one notch.
For Standard & Poor's, we are now at BB, and for Moody's, we are at Ba2. That means we are two notches, two steps below investment grade. That actually means we are up since the IPO, we are three steps up in terms of Standard & Poor's and two levels up in terms of Moody's. It also demonstrates our track record. We gradually want to move up. You remember at the beginning, we always said we want to be investment grade. We want to move up to that group and join the group of being investment grade. You also know with rating agencies, it takes a bit time. You have to prove first. I think it also shows the track record now, three steps up Standard & Poor's and two level up Moody's.
two more steps to go, we can join the investment grade club. Outlook, again, as we said, we have higher working capital as a percentage of sales. We are almost 24%, we said we want to move towards back to the target of around 20% of sales, that should free up significant amount of free cash flows in the second half of 2018. Also CapEx level should ease back to the number we mentioned, the 4% over the cycle. Free cash flow, I said that's the result of both actually above the full year of 2018. Free cash flow is expected to exceed 2017 levels, which was CHF 108.5 million, to be reminded here. We are fully committed, we will work hard to reach what I just said before.
That's all from my side, I can hand back to you, Mike.
I'm going to talk a little bit about the industry drivers, short term and long term. First of all, long term. We've talked a lot in previous presentations about the industry and what's driving the industry. First of all, I think the CapEx that we're seeing today, around about CHF 50 billion in wafer fab process equipment, seems to have stabilized at that level. We've talked about things like the data economy, Internet of Things, autonomous driving our business. For me, it's always important to look at what signals we see in the market, that this is actually coming. I think, as I look at the quarterly results from the key IC manufacturers, there's quite significant changes. Intel's data centric businesses grew 25% quarter-on-quarter. That's very substantial. Compare that to 6% in their PC business.
You're starting to see more data centers, and also a much higher percentage of solid state drives within PCs and also within the data centers. Also looking at Intel's results, their Internet of Things group had huge gains, as did their Mobileye business, which was up 37% year-on-year. Those guys are number 1 in the autonomous driving chipsets and software. I think, there's a lot of evidence to show that other drivers other than the usual PC, mobile, are starting to drive the business. The memory sector is looking pretty strong. Samsung, as you saw the day before yesterday, had very strong results. Their memory sales were up 33% year-on-year, 7% quarter-on-quarter. I think also significant in the memory space, I saw that Hynix reported 4% ASP growth.
Historically in our industry, you very rarely see quarter-on-quarter ASP improvements. Even in the NAND market, which is the flash memory market, which has been under a bit of pressure, the ASP performance there has been quite robust. Micron reported some pretty good results there. I think again, those long-term trends, the trends for more data centers, more flash memory, still seem pretty intact. Looking at some of the other sectors, display. I think display is fairly neutral. We're seeing very solid business from the large LCD panel makers, the Gen 10 makers. OLED is still a little bit soft at present, but I think there's a lot of optimism that things like flexible displays will drive that into second half of 2019. That's a possible opportunity there.
Solar was going along quite nicely for us until June, when the Chinese government unexpectedly announced the changes in the incentive schemes, tariff schemes, and that's hit quite a lot of people. I think the business we have with one of the largest solar makers in China, it's a temporarily hold there. I think we'll see that improving into 2019. There still is a strong demand for panels. I think the industry there just has to digest the recent news from the Chinese government. We're still optimistic there. I think the IC makers, overall strong, robust outlook. The demand for high-end valves and modules is still increasing. We see strong demand across all the next generation platforms, as we do in the modules area, as I mentioned earlier. Services and General Vacuum showing strong growth. I'm increasing the infrastructure in both of those groups.
I recently hired a new head of services, a very strong operations expert. He's an American that's lived about 17 years in Switzerland. He came from Balzers, but was also CEO of Ionbond for a while. Very robust operations specialist that will help me put the scale into that service business, and also gives me some executive strength as well. The General Vacuum business is going along well. We've talked about the improved lead time, we expect to see that strong in the second half. I think we're in a great market position. There's nobody better positioned to take advantage of growth in the following year. We have the technology solutions, we've got the operational scale. As you'll see in our results, we have the agility as well to weather any small correction or moderation in the market.
Even through this period, we're maintaining the 300 people that we put into Malaysia. We think that's important. We want to be able to ramp that. There's benefits for us in doing that. We've had meetings during, there's a big trade show in the U.S. called SEMICON West. That's where we heard on some of the major corrections OEMs were making. We also had a chance to meet with the key executives there and show them the capability we put in for future volume expansion in Malaysia. That raised a lot of interest, especially since the OEMs are looking at putting more of their manufacturing capacity into Singapore and Malaysia. We think that will be a competitive advantage for us going forward. Let's talk a little bit about the short term. I think that's the area of a lot of discussion right now.
The semiconductor industry CapEx still growing in the first half of the year. We expect single-digit growth for the whole year. I think it's quite hard still to really predict fully what Q4 is going to look like. I think there's growing evidence that it could be slightly up. If you look at Tokyo Electron's announcement, their fiscal year ends 1st of April, and they announced a stronger second half, which we believe telegraphs a stronger performance in Q1, which generally means we normally ship product ahead of that ramp. In our numbers, we're looking at a slightly weaker Q3, but then an improving Q4. I think industry CapEx has stabilized at this level, which is good news. I know it's a correction, but in terms of semiconductor cycles, this is very mild. The customers are focused on these sustainable business models.
They're managing very much the CapEx to revenue ratios, and they're driving pricing very tough. I think there's been quite a lot of announcements around about push-outs. Intel, TSMC have both announced slight delays in the 7-nanometer processes. Not cancellations, just push-outs or slower ramps. I've mentioned also in previous calls about customers are getting better at how they ramp up their fabs. They used to do it in large lumps. They're now doing it in much smaller lumps. That gives them, again, a much better ability to manage the business. The bigger thing for us is memory, and as you probably all read, Samsung pushed out a major project out of Q4. Again, there's rumors that they may bring that back in again. The situation there is quite dynamic.
I think as you'll see in our guidance, we're saying mid-single digit growth overall for the year. I think looking at the CapEx outlook for future years is pretty strong. There is still a drive for more layers in NAND. There's still a lot more layers in high-end logic in DRAM. If you look at the CapEx per square inch of silicon, that's grown by 50% in the last 3 years, and we expect that type of ratio to continue. With the shrinking design rules, it means more process equipment per waiver out, which means more vacuum valves, modules, and components. That still looks very strong for us. I think another factor that's hindered a bit of investment in the second half is the trade wars at the moment. It doesn't impact VAT at present.
The only thing is the, I think, level of uncertainty that it brings to our key end users. We're hoping that calms down a little bit in the future. I think wafer fab equipment, as you know, has been pushed down for the year, but the good news is that we were expecting more of a decline in 2019. Now I think 2019 is looking more positive. Still too early to tell, but if I was guessing right now, I'd say flat to positive for next year rather than maybe flat to negative. The delays in 2018, I think, will create a better potential for 2019. Moving on to the summary, I think we are the technology leader. We've explained that to you. We've shown you the products we're bringing to market, the share gains we make.
We've also got a class-leading, sustainable, and agile business model that will deliver very strong results over the year. We also will not reduce our R&D spending over this small correction. In fact, we're focusing even more on it. We're also focused very heavily on the partnerships with the key customers. Our business model will allow us to generate strong profits and cash, which is good. We're investing in people and processes. This quarter, we start the implementation of our new ERP system, which is based on the Microsoft platform. I think that will add a lot of capability and productivity for us in coming years. A fairly major project. It should take a 2 years, but we're all very excited about that. We're investing heavily in people. I told you about our new head of service.
I've also put in a new head of Asia sales. There's a growing % of our sales in Asia, so I put in a very experienced semiconductor executive to run that. We've also added a new head of supply chain. Again, very experienced guy from the automotive industry. At this time we're choosing our adds very carefully. We've been very prudent in cost. We'll make sure we're putting in the infrastructure that will allow us to grow fast, cut costs in future, manage the supply chain better, and be more intimate with our key customers. The new factory is up and running and ready to go. I just wish I had more business right now. We're ready to take it. Hopefully, into 2019, as I mentioned, that will increase. Services refocusing. I think we've a great opportunity there, as I've said in the past.
That will be one of my major focuses in working with Joe in the second half of the year to ramp that up. I think organically in our business, we've got fantastic opportunities. You saw we made some gains in share, even in the first half. Into 2019, that will continue in our core products. When you look at things like multi-valve modules, multi-valve modules we only have 10% market share at the moment. Pretty small. If we can put a lot of our knowledge, precision, and solutions into multi-valve modules and motion components, there's areas there we can drive pretty quickly. Again, that's all organically at this point. I'm very optimistic about the future. I think as the market comes back in 2019, we're in a great position. We're maintaining our infrastructure, and we've got, I think, the operation model to make that happen.
Looking at the outlook, as I mentioned, it was quite a difficult year to call. A strong first half. We were optimistic in the April call that we were on track for a 15%-20% year. Things deteriorated fast in June, and we saw the push-outs from the OEMs, especially at the beginning of July. At this point, looking at the third quarter, slightly down. Fourth quarter, coming back up again. We expect to achieve mid single-digit growth. Full year EBITDA, we say we're gonna maintain that around current levels, and we're still on track to deliver the 33% by 2020. Full year net income expected to grow substantially. CapEx around 8%, as Andreas said, with the lower revenue base. That's a little bit higher than we wanted. That will come down in 2019. Free cash flow expected to be around the 2017 amount.
Thank you very much. That concludes our presentation. At this point, I would open for any questions.
Okay. Thank you very much, Mike and Andreas. We now open the Q&A session. As usual, I like to remind you that we have people following this conference on the phone or over the webcast. If you have a question, please wait before you receive the microphone so that the people on the phone and on the web can hear the question as well. As usual, we take first a couple of questions from the room before turning to the operator for questions from the conference call. First question here in the room. Yeah, maybe there, Dominic.
Thank you. Dominic Feltrus from NZZ. Could you please maybe elaborate a bit on the cost reductions you did lately? I would also be interested in whether you still might reckon with growing pricing pressure, especially for your established products. I think you mentioned innovation, how important innovation is. Maybe I would like to know from you, Michael Allison, how satisfied you are with the innovation power of the company as it stands at the moment.
I'll address the latter part, then maybe Andreas, you can talk about some of the cost reductions. I've been obviously in my first six months, digging deeply into our innovation process. I'm looking at some small changes there. I think we spend a lot of time customizing our products, and a lot of our design wins are customizing existing products to be more cost effective and to hit the exact requirements for our key customers. That makes up about 50%-75% of our R&D. I'd like to focus a little bit more on the longer term projects. We have four or five major ones that I'll be focusing on in the second half and into 2019. That's also very important to keep up with the productivity requirements of the OEMs. Pricing is always gonna be tough. Pricing pressure never goes away.
As our key customers get bigger, there is a constant focus on cost down. What we try to do, though, is we try to look at design changes with them. How can we work together to optimize our designs that's a win-win for both of us? Having engineering teams stationed next to our key customers in California and in Asia allows us to do those designs in smart ways. Nevertheless, we expect more pressure to come. We're cutting our own costs. We're driving cost changes in our supply chain. The move to Malaysia helps that as well. You can't run a semiconductor business and not expect cost down. On the other hand, innovation helps us with that. Our latest products are class-leading. What we're doing in building more of our valves into load locks to offer modules instead of singular valves.
That's been quite successful for us, and we'll continue to do that. Complexity is good for us. Our expertise is in design and dealing with complex mechanical systems, and as design rules shrink, we'll continue to gain from that. Andreas, do you want to talk about cost?
Yeah. The first part, you probably remember last year we ramped quite significantly and also had some inefficiencies and a big chaos. For example, if I can give some examples. In supply chain, we use mostly air freight shipping mode, and hardly any sea freight. A big part of the growth last year, our additional capacity came from suppliers. In the outsourcing proportion, as I mentioned earlier, the ramp-up on the supplier side, and the outsourcing, we had to give them a hand and, let's say, reorganized the entire supply chain. Internally, we had ramp-up costs, hiring, recruiting costs last year. We hired, you remember, about 500 people in the first half year. If you compare half year on half year.
We had to relocate part of our inventory or, let's say, stock to an outside office in Rüti, for example, and we relocated our lab to Haag, and that also incurred some costs last year. In overall, actually, I would say we regained our efficiency we had before the significant ramp in terms of, for example, if we measure output per head. That's a very important KPI for us, how much actually we sell per head employed, in terms of productivity efficiency. What we lost last year due to the chaos, I would say we regained more or less back to more or less normal levels. It also means we have further opportunities to gain further productivity gains going forward into the future. That's why we stick to the midterm target of 33%.
Okay. Next question here from the room. This seems not to be the case, we already turn to the callers on the phone. Operator, please.
The first question from the phone comes from Sandeep Deshpande from JPMorgan. Please go ahead, sir.
Yeah. Hi, thanks for letting me on. My question is regarding your guidance for the second half. Some of your peers and competitors have guided for the full year overall, and they are indicating that sales will be up in the semi-CapEx environment overall about 5%-10%, whereas you are at the mid-single digits. Is there something different about your exposure, which makes your guidance different? Or is it just that you're being cautious at this point? I have one follow. Thanks.
That is the million-dollar question. As I mentioned, I think the second half has been quite difficult to call. A lot of the players have not guided the fourth quarter. If you look at it, MKS and Advanced Energy, who are very similar in sector size and proportion to VAT, have only guided the third quarter. I think they're doing that for a reason, because it's quite challenging to really predict the fourth quarter. Also, there is a delay in the component suppliers to the OEMs. We tend to supply our components sometimes three to six months before the OEMs take revenue. Not till they ship, but till they take revenue. Trying to work out the exact relationship between when we ship compared to when they revenue is complicated.
Our best guess right now is that Q3 is down and Q4 is going to be up, resulting in a mid-single digit.
Secondly, regarding, you talked a little bit in your opening remarks about display. At the moment, at least, the indications from the Asian supply chain are that OLED will be down even in 2019. Is that what you're continuing to see, or do you think that OLED will actually recover into 2019?
Again, another good question. I mentioned LCD is pretty strong. OLED, we started seeing quite a bit of investment coming from Chinese players, and they were telegraphing they were going to spend in 2019. We've seen some of that pushed out to late 2019. I think the key question there is the product proliferation in 2019. Which new products are going to come to market that drives the OLED business? I think it's a little bit too early to say for OLED in 2019. I think by, say, the fourth quarter, we'll get a much better view on that. At the moment, we're planning that display business to be roughly flat. There's still some very attractive projects in the LCD area
Thanks. Then my last question, you've made some important hires, as you mentioned in your opening remarks. Is there any particular intention behind those hires? Is it just replacing existing people because they moved on, or is it because you want to make some particular changes in those businesses or in those areas?
Yeah. VAT has some outstanding talent. Let me be clear. Our number one goal is to develop and use the people we have, and we spend a lot of time developing our key people. However, VAT's grown extremely fast over the last 3 years. There are unique skill sets we need that we don't have today. That's really what we're doing. As we go through our strategic planning process, we're looking at where we have capabilities, where we need to improve or enhance them. This is a progression I think you'll see over the next year. The ones I talked about, the Asian one is a replacement, but it's certainly a very strong hire I've made in that area. Services, again, the operational requirements of our service business are increasing with more and more repair centers across the world. That was a very strategic hire.
Someone with a lot of operations knowledge that can really put in place the right structure and efficient structure and give me the capability to be a partner for the OEMs and the IC makers. That was a strategic hire, and I think you'll see more of that over the future.
Understood. Thank you.
Operator, next question, please.
The next question from the phone comes from Joern Iffert from UBS. Please go ahead.
Yes. Hi, gentlemen, and thank you for taking my questions. These are also some follow-ups from the questions you just get. I have to say, I'm a little bit surprised on the spot on guidance for the second half 2018, given all the uncertainties you are highlighting. Also you're indicating a quite sharp recovery at the end of the day in Q4 versus Q3 of +15% quarter-on-quarter, if I read your comments correctly. Can you please give us some more color what your customers are indicating you for Q4? Is this across the board? Is this coming from one customer? This would be helpful. Second question would be please on 2019. When wafer equipment is flattish, maybe mildly up, as you have indicated, and display is also flattish.
This can be a quite dry year for VAT in 2019, or are you confident that market share gains are the key driver and you still can reach your medium-term guidance of 7%-9% for 2019? The last question would be, please, it's a technical one. Other income was CHF 7 million in H1 2018 versus CHF 1 million in the first half 2017. Can you give us some more details? What was the driver here? Thank you.
Do you want to do the last one first?
Mm-hmm. Shall I start with the last one, Joern? Other income, in this year, we had some foreign exchange gain on the balance sheet, accounts receivable. Probably remember last year, the exchange rates regained towards the year-end. The reevaluation of the accounts receivable, that had an impact into the P&L going into 2018. It's mostly, it's not only, let's also not forget, a year ago, we had negative effects as well, the IPO related cost. Mostly it's FX related.
Okay. On your other two questions. Yeah, we still have quite a bit of backlog in the industrial area that we're working through. As you saw, the growth rates there have been quite strong, as they have been in service. Looking at a mix of what we're hearing from the OEMs in Q3 and Q4, we felt comfortable at this point, to come out with a 5%. We are kind of expecting that Q1 will be a strong quarter. That's the only real indication we've had from the OEMs, that they expect more robustness in Q1. Again, we haven't had any direct forecast, just like we didn't have any direct forecast for the second half of the year when I spoke to you back in April. The situation is dynamic.
I think, where we are today is, we'll make the assumption Q1 is going to look good, which means we should see some business coming back in Q4. Regarding 2019, I mentioned flat to up. Again, difficult to make a direct forecast for 2019. We're working on a lot of fronts. I mentioned share gain. That's our number one priority right now. Again, the GV industrial market and the service market, we're very optimistic in those areas. Also the modules and motion components area. I think with the drive of the OEMs to outsource more modules, as they move their operations to Asia, gives us a good opportunity. We'll be focused on all those three elements to ensure we keep growing the company.
All right. Thanks very much.
Next question please, operator.
The next question comes from Sebastian Kuenne from Berenberg. Please go ahead.
Yeah. Hi, gentlemen. A few questions from my side. First of all, I would like to understand the current business.
I think semi is about 60% of your valve business, I have OLED, sorry, I have display at 25, PV at five, industry at 10. Can you maybe give us a bit more indication of what the split actually is? Also within semi, what the split is between logic and memory. Second question would be on Samsung. Can you tell us what your indirect exposure is to Samsung? They are a big client in OLED, a big client in logic, and a big client in memory. What is your feeling that Samsung contributes to your business per year or maybe in 2018? I have a question on global services. I was a bit surprised that order intake was down year-over-year, given that the production of IC is going up so strongly.
I would have thought that this is much more stable and also shows good growth year-on-year in Q2. Maybe you can give some light on this. I have a few more questions after that. Thank you.
First one we do.
Maybe I start with the first one. We do not disclose sales by memory and the kind of chips. We have never done that. It is also not always easy to know where our machines, our valves go to, or the machines go to, including our valves. What we can disclose is that about half of the valves business is semi-related, around 20% is display and solar, and the other quarter is General Vacuum and modules, which includes the motion components. This is the split of the valves segment.
I think a separate story on Samsung
For your feeling in terms of-
Our customers don't disclose to us what % is going into exact Samsung memory, because even in memory, you've got NAND, you've got DRAM, then logic. We don't get that split, so we've got to try to extrapolate that, which is not always easy. It's hard to comment exactly what %. On service, I think there's two elements there. Last year, we had a lot of major upgrades that happened, which haven't happened this year. Our general repair business is up, but we're still working hard to have more upgrade offerings for the market. We expect that to continue growing. The other thing is, the first thing the OEMs do when they see a market correction is really put a stop on everything. We've seen a reduction in the number of spares they're buying for consumables.
Again, we think that's a temporary thing, and as the market comes back, we expect the order intake and service to come back to more reasonable levels. Again, our outlook in service is positive.
Samsung, the indirect exposure, what's your feeling there?
I think the only thing I would say is, one of the large OEMs is very exposed to flash memory, and therefore, Samsung. We certainly see a bigger decline on that OEM. Again, it's almost impossible for us to extrapolate from direct valve sales back to end users, because we have similar valves, exact same valve series that go into a, say, a Lam etcher or an Applied etcher that goes to different customers. We don't know always where the valves end up. I can't really comment exactly on the % from Samsung.
It's not about exact, it's just 20 to 30, maybe?
I really don't have a number. Sorry.
Okay. The next question regarding Malaysia ramp up. You mentioned the cost that you have in 2018. Can you quantify those costs and where you think they will be in 2019, given that the construction is done, is finished? Will those costs come down by, what, CHF 10 million? What's the scale there?
We are not disclosing that. I don't expect it to be CHF 10 million. That's certainly too high. I don't think that will be very significant, except we are hiring there and construction costs, which partly will be capitalized. We are not disclosing that separately.
I have two more remaining questions, that's all then. On the PV project from China, you mentioned again, it's a scale or a sizable project. Usually, PV, I think is roughly 2%-3% of your valve sales. Is this now changing the split of the business? Is it more than 5%? What is the margin, implied margin in PV? The final question would be on working capital. I noticed a CHF 35 million increase in inventory, which is substantially more than your increased sales would justify, let's say. Are you creating some buffer stock for later of the year, or what is the reason here for that strong increase?
I don't think the ratio on solar has changed dramatically because we also had quite strong solar business in other territories. Also, the margin performance in that area is, I'd say, on a par with the rest of our valve business, is pretty healthy. The inventory is just a factor of the sort of shift in balance we've seen. We were expecting a faster ramp-up in the second quarter from the OEMs. We saw improvements in the solar and industrial markets. We probably have a little bit too much inventory in the semiconductor area that we've got to burn off in the second half. That was why we're pretty confident that our net working capital will come down in the second half.
Yeah. As I said, the ratio is up. You're right. It has grown faster than the sales because the ratio is almost 24% of sales. A year ago, it was actually 19.1 working capital in percentage of sales. I think Mike has given you the reason, and that's also the explanation why we can drive it down in the second half to normal level.
We're not keeping any buffer other than consignment agreements we have with our key OEMs.
The inventory also to add, if you actually look, for example, finished products inventory is, compared to other industries, still very low. Our finished product inventory is around one month sales. We are not having inventory, and there's no major concern of having inventory for years. Our finished product inventory, again, is around one month sales. Of course, then we have semi-finished and raw materials. Altogether, the ratio is higher, we will drive that down towards the year-end.
Okay. Understood. Thank you very much.
Okay. Thank you, Sebastian. Maybe in the meantime, we have another question here from the room. Just looking around. This still is not the case, operator, we can go back to callers.
The next question from the phone comes from Paul Moran from Northern Trust. Please go ahead.
Good morning. Thanks for having me on. I have just two questions. I will take one at a time. The first one is on product mix with respect to revenue growth. I think my memory serves me correctly, we talked about in Q1, volume being two-thirds of the growth and product mix being a third. I see on the slide in the presentation that mix is actually stronger than volume. My question really is, if we have got the second half of the year, say down eight year-on-year is what is implied, would product mix end up reversing? Is that going to be a drag on revenue growth, or is this really a function of the innovation and it might end up being much stronger than volume again? That is my first question.
The mix effect won't be significant year-on-year. Due to the low order intake, and we talked about the semi segment, we have a little bit lower contribution proportionally from the semi. We have a bit more in General Vacuum than a year ago. Everything else is the same. I am just looking at the numbers in front of me, and we do not expect a major shift here. Again, 81% is the valves, of which a bit more than half is the semiconductor business. Display has almost unchanged. We do not expect, let's say, a visible change in mix. Of course, it can change, but right now our models do not expect a major shift here.
Sorry, just to clarify, when you say you don't expect a major change, are you talking about for the full year-on-year, or are you talking about H2 year-on-year?
H2 year-on-year.
Oh, okay. That is great. That being the case then, just my second question is with respect to the drivers of margin, because I guess I am kind of surprised that given the downtick in the revenue growth, that effectively is going to come through, that EBITDA margins are going to be down. Obviously, it sounds like your variable costs will be lower, so that should be EBITDA margin positive. It sounds like mix is also helping in the second half. There will be a drag from fixed costs, and then I guess you have got Malaysia being a negative. Directionally, is that right? Mix positive, variable cost positive, Malaysia negative, fixed cost negative in the second half for EBITDA margin.
I think you did the math already. I do not need to comment on it anymore.
No. Okay. All right. Thank you.
Okay. If there's another question on the phone?
The last question from the phone is a follow-up from Mr. Deshpande with JPMorgan. Please go ahead, sir.
Yeah. Hi. Sorry to come back. Mike, I did not understand exactly what you're saying about the second half. Did you say that things are difficult in the third quarter, but coming back in the fourth quarter, or did you say that the fourth quarter still remains uncertain because you mentioned in response to my question that MKS and others have not actually guided to the fourth quarter. I'm trying to figure out whether the order environment has actually improved significantly in the third quarter or actually you do not exactly have the visibility as such into the fourth quarter at this point.
I mentioned our best estimate at this case is Q3 will be down slightly and then Q4 improving. Again, the reason Q4, I think, will improve for us is if the OEMs are expecting a stronger Q1, which there is some evidence to suggest, then we would see some of that happening in Q4. It's what we based our forecast on at this point.
Do you see that in your orders, or you are expecting that to happen based on your indications from customers?
Based on our indications from customers and what we see in things like consignment forecasts for the second half of the year.
Understood. Thank you.
This is quarter-on-quarter, what you say, not year-on-year.
Yeah. This is quarter-on-quarter I'm discussing here.
Yeah
Not year-on-year.
Quarter-on-quarter, you're going to see improvement from Q3 to Q4. Understood. Okay. Thank you.
Okay. If there are no further question, I thank you all very much for joining us today in this conference call and webcast. We will report the next set of numbers, trading update Q3 2018 on October 25, 2018. Thank you very much. That concludes the call.
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