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Edited Transcript of VACN.S earnings conference call or presentation 8-Aug-19 8:00am GMT

Half Year 2019 VAT Group AG Earnings Call

Haag Aug 20, 2019 (Thomson StreetEvents) -- Edited Transcript of VAT Group AG earnings conference call or presentation Thursday, August 8, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Allison

VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing

* Michel R. Gerber

VAT Group AG - Head of Corporate Communications & IR

* Stephan Bergamin

VAT Group AG - CFO

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Conference Call Participants

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* Alexander Koller

Zürcher Kantonalbank, Research Division - Research Analyst

* Jörn Iffert

UBS Investment Bank, Research Division - Director and Analyst

* Michael Foeth

Bank Vontobel AG, Research Division - Head of Industrials Team

* Remo Rosenau

Helvetische Bank AG, Research Division - Head of Research

* Sandeep Sudhir Deshpande

JP Morgan Chase & Co, Research Division - Research Analyst

* Sebastian Kuenne

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [1]

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Good morning, everybody, here in the room, and 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. 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. And as usual, for the Q&A, we will switch between questions here from the room and from the conference line.

So with that, I would like to hand over to Mike.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [2]

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Thank you, Michelle. 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, and then I'll finish off with some of the outlook and priorities for the second half of the year.

So it's always a challenge, the middle of a downturn to talk about highlights of the business, but I think what you'll see this morning is a pretty solid set of results, and you'll also see a company extremely focused on technology and innovation, and driving high-value solutions for our customers. What you will also see is a company who is 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 will 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 get us more capacity and our facility in Romania.

During this downturn, we focused on the things we can control. So a lot of focus on cost, and you will see that from our margins and EBITDA margin. You'll also see a huge focus on technology and innovation. One of our values of VAT is reliability and trust, and when you are a technology leader in a segment like semiconductor, getting that customer trust is really important to continue to build market share, and the Executive Team and I, we spend a lot of time building that, and I'll 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 and the team have worked very hard and expanding the product portfolio. And 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 and close to 30 products, and really ready to ramp when we come out of this semicon downturn that we are experiencing at the moment. So I think that puts VAT in a great position.

The markets remain pretty, 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. And 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%, but obviously that's higher because of the lower valve sales, but still good performance and good EBITDA margin. An industry, lower as expected, and 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 which is in our valves business. Looking at the market trends, I'd say, I think it's well publicized that the memory market is still struggling. We are however seeing some signs of stability there, especially in the NAND market, and when it comes to things like hyperscale servers, we're seeing in July, some positive signs there and win positive comments from some of the big memory companies.

Advanced logic is going well as is microprocessors, so we're seeing pretty strong activity in the semi sector there. I think overall, there is a lot -- 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. And 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, but 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, but we probably see the thin film stuff improving in the latter part of '19 as well. And again, most of the demand tiers in China.

Industry and research is going along reasonably well, fair amount of spending in large government projects, CERN, ITER et cetera. And we're also penetrating with new products into areas like scientific instruments and so on.

Okay, about our growth dimensions and we've talked a lot about this in the past. The first dimension is the end market growth and 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 and I expect that 2020 will see improvement in smartphone growth, but I think the important thing for 5G is the applications that will enable longer-term machine-to-machine communication.

So I think as we get into '22, '23, things like autonomous vehicles and smart factories will pick up the pace there. So 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% to 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 and foundry is accelerating, and we're seeing some activity in the second half of the year around there. And as I mentioned before, the memory slowdown is bottoming out. There is 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 and Korea and that certainly is hurting the business confidence around making major CapEx investments. So hopefully, we'll see that resolve itself, also through '19.

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 5-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 process is happening at 5-nanometers, and also on advanced memory. So I think that bodes very well for vacuum valve growth.

EUV is now established as a production technology, mostly around the 7-nanometer, 5-nanometers, but it likely going to come into DRAM at some point as well. I think what's interesting is that starts to proliferate, we're seeing opportunities across the EUV ecosystem, so not just on the EUV platform, but also in things like inspection and metrology associated with EUV. So I think there's a little bit more growth in that whole ecosystem than we expected.

I think more importantly is heading towards the Zero particle environment which I've talked about in the past. One of VAT core strengths is our ability to make products with extremely low particle levels. And 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. So 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.

The 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 companies’ results and try to break it down into vacuum component sales, so 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 are [expecting] 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. So we're still able to repel that and grow market share at this point.

So I think it shows that our overall platform development and the spec wins that we've talked about in '18 are following through with solid market share gains for the half year. And we expect that to continue as we go into the second half of the year and into 2020. So a very positive trend.

I think this is not just our technology, it's the scale we have, it's the ability to produce in 2 parts of the world. I think our neutrality as a Swiss/Malaysia manufacturer right now is also playing well with a lot of the global conflicts. And also 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.

And 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. So I'm very happy with this, a big thank you to our global team, they worked very hard on this. And it's another reason why we managed to keep our gross margin high with new technologies coming to market quickly. And as we come out of this downturn, the market share we're gaining here is going to stand as a very strong stat for solid growth and a strong profit margin.

So that's the end of the first session, I'll pass you now to Stephan, who will look a little bit more detail for the first half results.

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Stephan Bergamin, VAT Group AG - CFO [3]

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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 the positive trend comparing revenues, Q1 with revenues Q2. EBITDA margin amounts to 25%, that's 2% higher compared to previous down cycles, and 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 6 months in 2019 amount to CHF 262 million, a 3% 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 bridge comparing revenues end of June 2018 with revenues end of June 2019, you see significant impact of the volume reduction on the sales side. But we were able to add positive elements with product mix and very impressingly 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 the strength 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 downcycle.

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.

However, the book-to-bill ratio in display and solar business reached a multiple of 1.2x, it's a strong indicator for improving revenues in the quarters to come. The market for solar photovoltaic equipment remain 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 our vacuum furnace application in China. This order reflects the success of VAT's strategy to apply its proven technologies in the semiconductors and displays to a broad range of industrial customers.

The Global Service segment reported 11% net sales growth in the first 6 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 1, 2019. Additionally, 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 cause 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.

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% to 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 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 6 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 mid-term 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 and at -- leverage ratio is at 1.5x. Year-end net debt to EBITDA ratio is unchanged at 0.7x.

And coming to the summary, key achievements for '19, we deliver in a tough environment. We are reaching an EBITDA margin of 25%, higher compared to previous down cycles and we cope also with a negative impacts from volume-driven, higher investments into building the infrastructure. And also negative implications from the FX side.

On free cash flow generation, we are acting well within the plan, that's is the key focus. And 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 clear task force in place. And finally, we are very prudent when it comes to CapEx without compromising on future projects.

That's the end of section 2. I'm giving now the word back to Mike.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [4]

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Okay. Looking now at the priorities, conclusion and then 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 inventory seem to be reducing and ASP is stabilizing. The logic and foundry business is improving, and we see that coming in a little bit in the second half. If you look at the third-party forecast for the market, you will see overall decline in the IC market around about minus 12%, so that's further declined from minus 5% in February, but it does seem to be stabilizing.

Semiconductor CapEx, overall CapEx down about 16%, slightly down from the February number of minus 12%. But 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 volume coming back.

Wafer Fab Equipment, specifically again minus 19% to 22% a little bit down again from the February estimate, again seems to be stabilizing at that level, and 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 '20 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, will see a new portfolio from Apple, and we expect that will generate a fairly substantial refresh in smartphones. The current investments is all around Gen 10.5, and as Stephan mentioned, the book-to-bill ratio in the Display business of 1.2x, 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 OLED, large scale OLED, but also continued investment in mobile.

And the display equipment market has actually improved from March. In March, we talked about a minus 38%, that has moderated to minus 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 technology seem to be dominating at present about 75% of revenues, but we expect thin film also to improve in the near term. And the majority of the end user projects are happening in China at this point.

So our priorities in the near term, we are -- we've got to be ready for any change in business conditions, especially in semiconductor. So 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. You really have to be on the pulse.

On top of that, the main internal priorities are continuing our focus and innovation on 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 a 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 continuing 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 '19 and '20 is also a key focus that will simplify how we run our business. Again, give us more operational visibility into running the company. So 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, so to see real improvements in that, it will depend a little bit in the semicon recovery, but we're working hard on it. We're also being very prudent in our CapEx spending during the year. So that are 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. We are -- at this point, we believe we are seeing the bottom of the market, but I would caution that by saying, there's still not much visibility out there. So I'd say, it's steady as you go at this point, and we are ready for a quick change in the market when it comes.

Independent researchers are talking about a -- an improvement towards the end of '19 and then a further improvement into 2020. I think for us, we move a little bit before the capital equipment, that's why '19 may see a -- end of '19 may see a little bit of improvement, but is 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. If certainly, if that gets resolved, it will give, I think, a boost of confidence to the overall business, and we'll continue a focus on service. I think that's a great opportunity for us, work hard during ' 19 and '20. I think in 2020, we'll see there a good opportunity with our upgrades, we've been spending '19 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, but as capital frees up a little bit in 2020 and 2021, we see the upgrades is a great opportunity in our service business.

So 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. But I hope, you've seen today, a very strong focus from us and keeping those EBITDA margins at a pretty high level. That's going to put us in a very good position to deliver 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 and CapEx, as you saw in the first half, we're managing that very prudently, but we will have to make a few investments towards the end of '19 to ensure we have the right equipment in place for new technologies coming come to market. So 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. And free cash flow expected to be higher, based on the working capital reductions as Stephan talked 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, but 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.

So that concludes the end of the presentation, and I'll now open to questions. Thank you.

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Questions and Answers

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [1]

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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 will be nice to know who asked what question.

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Michael Foeth, Bank Vontobel AG, Research Division - Head of Industrials Team [2]

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Michael Foeth, 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? And it will be the first question.

The second question is on the -- on those vacuum furnaces for battery production, what sort of total market potential do you see for VAT in there?

And 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 re-conciliate that with the statement that you see market researchers expecting 10% to 15% growth in wafer fab equipment in 2020? Yes. Those would be my 3 questions.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [3]

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Okay. I'll do the battery and the memory [and] Stephan, the cost run rate. So 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 the somewhere between 10 million and 30 million.

Lithium-ion batteries emerging fast, it's mostly China, but it's also expanding outside of China. But I would certainly put it in that sort of range 10 million to 30 million. It is a lower-cost type environment, it's not as high tech as they are semiconductor and display. But we think, we can offer products within that at a reasonable margin. So I would gauge maybe half of that number, so maybe an average about [50 million entity] there. In memory, the CapEx for next year definitely, we 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. So it's certainly a question when they will make those next capital investments, but I would expect them to start in 2020 around new technologies, new DRAM technologies, and new flash technologies, but that's kind of what adds to the uncertainty of predicting the memory return, it's not just capacity, it's an intersection of new technologies, plus capacity.

So in all downturns, you are faced with this what, all logic tells you that the market is going to stay low forever, but then it rebounds pretty quickly, as the major players come in and make new capacity investments around about new technology. So that's what makes it so difficult, and the commentators try to balance our view of new technology and existing capacity challenges. So that's the best visibility we have at this point. You want to, Stephan, talk about the EBITDA run rate?

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Stephan Bergamin, VAT Group AG - CFO [4]

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We expect the margin in the second half to be above the first half, but to be below at the second half 2018. Why do we believe it will -- we will see an improvement in the second half. We have performance improvement program in place, where we had a slow start beginning of the year. And there we expect significant additional improvements in the second half.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [5]

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Next question here from Jörn.

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Jörn Iffert, UBS Investment Bank, Research Division - Director and Analyst [6]

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Jörn from UBS. Two to three 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 to [recur any] fixed cost base to deal with another CHF 51 million revenues in 2020 or would you need to have more fixed cost investments.

And the second question would be, please on your design wins, you had a new product launches for 2020. What percentage of revenues is this roughly? And is this coming at significantly higher gross margins?

And the last question on the OLED and solar sales going into the second half. Making the math, is it roughly around CHF 10 million, [CHF 50 million] higher sales in the second half versus the first half?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [7]

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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, when you -- 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. So 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. So 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 2 factories and 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 on expansion, I think the cost, 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 cost. 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 higher-speed machine tools. So there's an ongoing replacement cycle required there. But 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. And 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 and adoption of new products. And I think new product margins depend, depend which market, depend which types of valves. We have different margin performance across different types of our control valves, transfer valves, and so. So it's difficult to put out a finite number on that. But typically, they would be on a higher range, the higher side. And the OLED question for the second half, yes, with a book-to-bill ratio of 1.2x, we do expect an improvement in sales in the second half. I think the sort of 10 million range, you talked about is reasonable.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [8]

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Next question is from [Philippe].

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Unidentified Analyst, [9]

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[Philippe Ray from Reg FE] You continue to invest in your service infrastructure. What are your new initiatives to and what is the position today?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [10]

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Okay. Our service business really breaks into 3 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, so 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 operation.

So we will have some CapEx investment in expanding. But the return on that investment is very high, obviously. And 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 price third parties. So we plan to take some of that business back from the third parties that we lost over the years. So it's really a wider range in repair.

In spare parts, it's -- and 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 practical 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 efforts to get these upgrades completed and ready for market and that's what the team has been working on. We've introduced 5 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 uptick of [them] is a little bit muted because of the lower spending environment that exist in silicon today, but I would expect that to accelerate as those budget start to loosen up as the industry grows again.

So those 3 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.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [11]

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Okay. There seems to be no questions from the room. There is one here in the front, Remo and after that one, we will turn to the callers.

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Alexander Koller, Zürcher Kantonalbank, Research Division - Research Analyst [12]

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Alexander Koller, Zurcher Kantonalbank. And 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?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [13]

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Today, most of the equipment going into China, it comes from U.S., Japanese, Korean-based OEMs. So 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. So that we work very closely with our customers around the world to get them very cost-competitive products to allow them to compete in the Chinese market.

So I think we offer a range of products to satisfy the -- our customers' demands from the very high end to medium end, to low-end, where price competition is high. So I think it's as simple as that. But 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 subfab. Okay.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [14]

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Yes. There is one from Remo here in the front.

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Remo Rosenau, Helvetische Bank AG, Research Division - Head of Research [15]

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Remo Rosenau, Helvetische Bank. On the site remark, you mentioned the introduction of the new ERP system recent next year. Could you just remind us what this exactly entails including the time line and the costs?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [16]

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Stephan, do you want to?

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Stephan Bergamin, VAT Group AG - CFO [17]

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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, is expected to do the first launch mid of next year. And we did our readiness check over the last 2 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.

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Remo Rosenau, Helvetische Bank AG, Research Division - Head of Research [18]

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Then on time line and cost in figures?

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Stephan Bergamin, VAT Group AG - CFO [19]

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We will invest into an ERP system, more than CHF 15 million for the whole project over the next 3 years, and the start with the first pilot will be mid of next year.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [20]

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I would add 1 comment to that. However is, we are covered -- at today, we are running different ERP systems across our different manufacturing facilities. So there's a big consolidation got to happen. But what that allows us to do is roll out the systems incrementally, so we're rolling it out to our first manufacturing site in Romania, which is our lowest risk, smallest facility. So we will not proceed with the second one in Malaysia, until we are absolutely sure that we ring this thing out strongly in Romania. Then, Malaysia is our high volume product, so that's a simpler environment compared to Haag, and we will further test it with Malaysia, and then the final implementation will be in Haag, where we have a pretty high mix, more complex environment. So I think we've got a pretty solid plan on rollout, which will take us into 2021 for full rollout.

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Remo Rosenau, Helvetische Bank AG, Research Division - Head of Research [21]

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So I hear you that you take the whole thing serious and up going forward prudent, because when we hear new ERP systems, always alarm bells start to sound because we had many, many problems of some -- with many, many companies in doing that, though these takes double the time and sometimes triple the costs.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [22]

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Well, I've gone through 2 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. I mean we are -- 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.

And it's not just small focus, it's enormous focus. And I would say the governance also from our Board of Directors is extremely high in that area.

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Stephan Bergamin, VAT Group AG - CFO [23]

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And to add on, we are supported by top consultants. Microsoft is involved, it's key project for them in Switzerland. [PDMWC] supporting us, in order to make sure that we have the project under control.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [24]

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Okay. Thank you. So with that, we would go to the callers on the phone.

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Operator [25]

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The first question comes from Deshpande Sandeep from JPMorgan.

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Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [26]

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I'm not sure, I heard all the questions, but I have 1 question on your valves business. Firstly, regarding the modules. I mean when you're talking about the next generation product being designed, are these customers now designing standalone valves or exist module-based or/and will then -- how do you see that progression, and does that have an impact on your margin going forward?

And then secondly, just regarding, what's happening in the market, at the moment, you've 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 rollout at some of your end to end customers of your customers early next year. And do you still see that or you -- the visibility is not there at this point. Thank you.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [27]

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Okay. First question around about the valve business. We have a solid plan to offer not just the different types of valves, we produced, but also modules and also different types of components like motion components. So 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.

Now 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. So our modules is improving definitely, but I think the motion components is slightly higher uptake. There are much lower ASP than modules or valves, but typically, they're in the same margin level as our valves. The module business depending in complexity, they can be similar to valves or a little bit lower than valves.

But obviously, we don't want to compete in with things like the large contract manufacturers that make chambers. That's not attractive for us. So unless we can offer a very strong value proposition around integration of our valve with the chamber or very, very advance particle performance, then we would not take that business. So we're very picky in the type of business that we want to offer there.

There is no point offering chambers for the sake of it. But 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 going to have visibility in that until really towards the end of this quarter. So it's too hard to tell at this point.

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Operator [28]

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The next question comes from Sebastian Kuenne, RBC.

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Sebastian Kuenne, RBC Capital Markets, LLC, Research Division - Analyst [29]

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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, it's, I assume it's a helpful number for EBITDA although in your statement, you [write in] net negative impact, which I don't quite understand. So what is the positive impact on EBITDA in the first half? And then when you speak of the year-on-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.

Then I would just like to know what the current shares of memory business as part of your valve sales, I would expect last year, well last 3 years was around 40%, maybe 40% of valve sales. Do you have an indication of how much of your business currently goes into memory? And then 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 or any competitor that dropped a product line or did you make any wins specifications, where you are more confident to gain share? And then finally, on the 400 staff that you have or had on short time, they are now back in full employment. Is this really because an improved order level or does it have to do with Swiss regulation that you pay -- that the government doesn't pay the [5th day] for these people anymore and therefore, you have to take them back. And what impact would that have on the second half costs?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [30]

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Okay. Thank you. I'll do these in reverse order, then so is, first to 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, and we've had some attrition of the workforce over the last 1 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. So it was a pretty easy decision to come out of the short-term work, but the improved business in Q2 and then further into Q3 give us this 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. So we needed the full staff to get through Q3, and we even needed a few temps, as we will 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. And we could have continued short-term work through to the end of October, but there was really no point, at the level we were running out.

And the question before that was share gains. Yes, I mean, we follow spec-wins very closely. So we basically chart all the new platforms and products coming to market across semiconductor and display. So 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, so that lends itself very much to VAT strengths on low particle performance, high productivity and very strong total cost of ownership. So we see we're gaining at that level, which gives us very strong confidence of future market share gains. And so I'd say, pretty confident, we'll continue that trend over '19 and into 2020.

Memory, very hard to say exactly the impact of memory, I mean 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's fairly, 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?

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Stephan Bergamin, VAT Group AG - CFO [31]

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Regarding IFRS 16, the positive impact amounts to CHF 1.4 million for the first 6 months. That means EBITDA is positively impacted by CHF 1.4 million. But on a year-on-year basis, adjusted -- adjustments are already reflected.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [32]

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Okay. At this point, I'm looking back here in the room, if there are further questions? Yes. We have one here from [Mark].

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Unidentified Analyst, [33]

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[Mark Poscha, VVAG.] Just a short question concerning the forecastability of cycles, have you done analysis, back tested how accurate the forecast were in the past, concerning cycle developments and, 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. So how valuable are these forecasts? Isn't it like garbage in, garbage out a bit?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [34]

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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. We are participating -- semiconductor participates in a lot of new markets with very high growth rates. And that means you get massive fluctuations in demand and the CapEx requirements around that.

I don't think until semiconductor really becomes of a trillion-dollar industry, maybe by the end of the decade or the next decade that you'll see a type of stability that let's say there is no cycles. I think the key thing for us as we know we can't forecast it, we have, as I think a strong, a sensing network as anybody in our industry and I think you've seen from our forecasting in the last couple of quarters, we've been pretty accurate. But I think it's really impossible to nil it on a long-term basis, short-term basis, we're getting better. Key thing is to have the flexible, most flexible operating structure that can deal quickly with those changes. Both up and down and the down is just as important as up, so.

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Unidentified Analyst, [35]

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And taking these 100 projects that you're involved in that you mentioned, and weighting them by the size, the potential. I mean can you describe, how that evolved over time looking back maybe 2 years, 3 years?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [36]

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Yes, I mean, the engineering projects we got -- go from sizable ones down to smaller customizations. But we -- because of the complexity, even the small customizations, we have to treat with a full project mentality with high quality standards. So 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 probably got 10 to 15 different types of deposition, ALD, many types of different processes, and also the markets changed dramatically. The transistor structures today are very different in logic compared to memory or other types of chips. So that means we need different technology to support them.

So overall, there's more projects and that puts a strain on our engineering teams because we customize everything. But again, it's one of our strengths, we have a 150 or so engineers working across Switzerland. But we've also expanded our engineering team into Malaysia, we've now got around, I think 20 people in engineering in Malaysia, and we'll continue to grow that team, so we can have a lower cost structure across our engineering, but it's one of VAT's core strength and our ability to rapidly customize for our key customers.

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Unidentified Analyst, [37]

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[Ronald Winter here for Bright Sights] Switzerland. I have a more general questions. The capital market environment is heavily affected by the trade wars at the moment. My question will be, were you affected so far? And how do you see the developments in the future for your company?

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [38]

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I think I mentioned earlier that our neutrality as a Swiss company is a great calling card when I visit customers, we are not manufacturing in China. So that doesn't impact imports into the U.S. And also now having the fab in Malaysia, again that's also neutral with respect to the semiconductor producing countries. So I think we really have very little impact directly, but indirectly, it reduces overall business confidence. And if you are about to make a CHF 10 billion, CHF 15 billion investment in the next generation memory fab, that business confidence I think plays into the timing. So I think it's more of a confidence issue than it is direct impact of VAT. But our position of having manufacturing here in Europe, and in Malaysia, I think is a really optimal footprint that will support our growth into the future.

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Michel R. Gerber, VAT Group AG - Head of Corporate Communications & IR [39]

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Great. Any more questions? This does not seem to be the case. So before I hand back to Mike for short closing remarks, I'd like to remind you on our next date. It's October 24, with our Trading Update for the Third Quarter; and then 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.

And with that, I would hand back to Mike for short closing remarks.

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Michael Allison, VAT Group AG - CEO, Member of Group Management Board and Head of Sales & Marketing [40]

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Yes. So thank you very much. I hope today, we've demonstrated through the cycle that we have a very flexible company, a very resilient company, our company is very focused on technology. We are 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 out in the presentation, but I've just added a new Head of our General Vacuum business. She comes from very strong industrial background, and 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. So 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.

So thank you very much and I'll see you at the third quarter mid-term results. Thank you.