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Edited Transcript of GISSAA.MX earnings conference call or presentation 4-May-20 4:00pm GMT

Q1 2020 Grupo Industrial Saltillo SAB de CV Earnings Call

Saltillo, Coahuila, May 22, 2020 (Thomson StreetEvents) -- Edited Transcript of Grupo Industrial Saltillo SAB de CV earnings conference call or presentation Monday, May 4, 2020 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jorge Alberto Rada Garza

Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts

* Jorge Armando Mercado Pérez

Grupo Industrial Saltillo, S.A.B. de C.V. - CFO

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Conference Call Participants

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* Jose Vazquez;GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division

* Melanie Carpenter

i-advize Corporate Communications Inc. - Co-Founder & MD

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Presentation

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Operator [1]

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Good afternoon. My name is David, and I'll be your conference operator. At this time, I'd like to welcome everyone to the GIS Earnings Conference Call. (Operator Instructions) I will now turn the program over to Melanie Carpenter with i-advize.

Please go ahead.

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [2]

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Thank you, David. Good day, everyone, and welcome to the First Quarter 2020 Earnings Call for Grupo Industrial Saltillo. Joining us today is the Chief Financial Officer, Mr. Jorge Mercado; the Operating Officer, Jorge Rada; and the Investor Relations Manager, Mr. David Sandoval. Please be advised this call is for investors and analysts only. During the call, they're going to be discussing the company's performance as per the earnings release that we issued last week. If you didn't receive it, it's now available on the company's website at gis.com.mx in the Investor Relations section.

We also encourage you to follow along with the presentation slides that are now available on the live webcast, and we're actually going to take questions from the webcast at that point later on in the call.

So let's go to Slide 2, and here just some housekeeping items. We just remind you that any forward-looking statements are based on information that's currently available, they're subject to change due to a variety of factors, and we just ask that you refer to the disclaimer in the earnings release. The figures that they're going to discuss today in Mexican pesos unless otherwise stated.

So now turning to Slide 3. It's my pleasure to introduce Mr. Jorge Mercado, who's going to begin with the main highlights for the quarter.

So please go ahead, Jorge.

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [3]

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Thank you very much, Melanie and thank you all for joining us today. Just a small correction, we'll be reporting in dollars, it's our first quarter reporting in dollars. Said that, I think we at GIS hope that all of you and your families find yourself healthy and safe during these difficult times. Before we actually start with our Q1 financial and business performance, let me share some information about COVID-19 pandemic and different measures we have implemented in order to protect the health of our teams across the world. As you all know, we operate in 3 continents, Asia, Europe and North America. COVID-19 first appeared in China, where we started to experience social distancing measures and factory stoppages in our plant in Wuhu during the months of January and February.

Next as the virus epicenter moved to west, we were affected in Europe, first in Italy and then in Spain. In both countries, we had to significantly reduce our operating activity. A couple of weeks later, as the virus continued to spread to North America, we began to feel its impact in Mexico. The lockdown and social distancing measures taken around the globe to fight the virus have shown positive results, slowing down the infection rate of the disease. As seen in China, the economy and social activity are slowly returning to pre-COVID levels. There is light at the end of the tunnel.

Daily new cases are gradually decreasing in the countries affected the globe. Italy, Spain and the U.S.A. are all in the similar path. Although still under very restrictive conditions, all these countries are beginning to prepare for reactivation and reopening of the economy.

Thanks to the experience gained from our operations in China and Europe, we began sharing the relevant information between Draxton Mexico, [Vitromex]. We've enacted earlier than requested by the Mexican authorities. The planning of the measures started to take place in February and were implemented during March. So far, we have been able to successfully protect our team.

In addition to these efforts, the GIS foundation has donated ventilators and protective equipment such as masks, gloves and other items for medical staff at hospital in the community we are part of.

Now on the economic front, we are seeing a difficult environment. We expect the second and third quarters to be very challenging in the regions where we operate. Global GDP will have an important contraction during the second quarter.

Governments are implementing very significant stimulus packages to accelerate the economic and social recovery. Although we understand that it will be a new normal and social distancing will remain in some form. We are optimistic that the economic recovery process will start during the third quarter, first in Europe and the U.S. as it has already in China.

Now let's talk about our consolidated figures. As we announced last December, from the first quarter of '20 onwards, we'll be presenting our consolidated numbers in dollars.

This is another step aligned with our globalization strategy. Despite COVID-19 impact in first quarter, GIS was able to improve EBITDA margin from 14% to almost 15%. This is thanks to the

(technical difficulty)

which we began implementing last year as well as the continuous improvement trend of Vitromex, which gained 900 basis points versus last year. GIS has had a very disciplined and responsible approach to (inaudible) policy. This has resulted in a strong financial position at the closing in the first quarter. We have managed to reduce consolidated debt by almost 40% during the last 3 years. We have no significant maturity during 2020. In addition, we have short-term facilities as well as confirmed revolving lines of credit which should navigate the next quarters of economic weakness and volatility.

We are in close contact with all our key lenders working towards aligning all the scenarios. With that, let me now pass the presentation over to Jorge Rada to talk about Draxton.

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [4]

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Thank you Jorge, and thanks to everyone who is here today. Regarding the automotive industry, mainly due to the COVID-19 pandemic, vehicle production and sales in the regions where Draxton participates showed a decline in the first quarter 2020 versus first quarter 2019.

In China, which had the biggest decrease for this quarter, the automotive manufacturers have now resumed operations. However, the majority of them are still working at partial capacity. Europe was strongly affected since mid-February by COVID-19 with a decrease of 20% in production and 26% in sales versus last year. North America was the less affected of the regions, showing a decrease of around 420,000 units despite a 3% sales growth through February versus the same period of last year. The auto industry had an unprecedented drop in production due to the sharp reduction in demand and the measures that were taken to protect the employees and the population in general.

OEMs in Europe will be gradually restarting operations in early May, while North America's OEMs are expecting to restart by mid or the end of May.

We are expecting the greatest impact on vehicle sales to be in the second quarter 2020 with gradual recovery from third quarter onwards. Governments of China, Europe and the U.S.A. are supporting this recovery through fiscal stimuli and monetary policy. Meanwhile, in Mexico, we are waiting for the government's decision to allow the automotive industry to restart a few days before the U.S.A. We are working together with the INA, the National Association of Auto Part Suppliers in Mexico and the Mexican authorities on developing the protocols to ensure a safe restart to the operations.

Draxton has scheduled shutdowns in Europe and Mexico, following health measures established in each country. Five plants in Draxton Europe started operating on April 20. The reactivation plan for our Mexican facilities will be defined in the following days. It will be based on the OEMs restarting schedules in North America.

Regarding Draxton's quarterly performance, in the first quarter 2020, Draxton revenues reached $148 million, which is 15% below the previous year. This is mainly due to the volume reduction resulting from the COVID-19 pandemic, also due to the U.S.-Europe exchange rate going from 1.13 to 1.11 as well as the lower iron scrap prices, which are included in our product price formulas.

EBITDA for the quarter was a $32 million. It is important to emphasize that despite the 15% decline in revenues, EBITDA only decreased by 8% versus 2019. This is due to the rightsizing and productivity and efficiency programs we have been implementing since 2019.

Based on this, we were able to grow our EBITDA margin from 20% to 22%. In Draxton Europe and Asia, the effects of the COVID-19 pandemic have been greater since that is where the pandemic started and then spread. As a result, EBITDA reached $15 million, a 13% decrease compared to the same quarter last year. However, we improved the EBITDA margin from 18% in the first quarter '19 to 19% in the first quarter 2020. In North America, EBITDA for the quarter remained practically at the same level compared to the previous year despite a 3% reduction in volume. The margin for this region increased from -- to 24% from 22% in 2019.

In addition to the operational improvements that we have implemented globally, whose effects we can observe already in our results, we made very important steps in the launching of new facilities in Mexico and Spain.

In Evercast, in Mexico, we produced our referred samples using the new third line by February 15 as it was planned. The next step will be the validation process with the customer, expecting to start serious production during the second half of 2020, in line with the market's recovery. In Lleida, in Spain, we are ramping up production of machine components for electric vehicles and high silicon castings for heavy trucks, which is a growing market for us in Europe. This concludes my remarks about Draxton. Jorge?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [5]

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Thank you very much, Jorge. Now moving on to Vitromex. In Mexico, the total ceramic pouring volume market grew by almost 2% during the month of January and February, while Vitromex revenues increased 5%. We started to feel the effects of COVID-19 in the second half of March, with sales stop that offset the progress made in the previous 2 months, leading to a 3% decrease in the domestic volume for the first quarter. Vitromex confirmed a solid recovery trend in the first quarter of the year. Proof of basis is the EBITDA margin growth of 900 basis points, reaching MXN 7 million.

On a pro forma basis, that is excluding the costs related to inventory rationalization and portfolio simplification, the business showed significant improvement, with EBITDA margin of MXN 53 million, which would be a 6% EBITDAR margin.

And that concludes my remarks for today regarding the business performance. Operator, please begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question on the phone from José Vazquez with GBM Asset Management.

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Jose Vazquez;GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division, [2]

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I was wondering that given the current conditions, is there still room for going into second quarter, there's going to be a much difficult quarter than the first one for margin improvement, as we've seen in the past quarter, to support some of the results, mainly in Draxton.

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [3]

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Thank you very much for the question. I think we had a very solid first quarter. Regarding what we were facing out there in terms of market trends of the start of the economic impact of the pandemic, first in China and then in Europe. If you recall also, when we came out in Draxton out of the GM strike in the last quarter of the last year. So being able to move the needle in the EBITDA margin, I think it was quite significant, and it was a solid performance in terms of us being, delivering good results from the profitability side.

Now going forward, we will continue on the process of rightsizing and productivity. This is a program which we started at the end of the second quarter of last year. So I believe it got us in a good position in terms of Draxton, and we'll continue to do as much as we can in the next quarter and the following quarters. That should help offset a very massive market decline and economy shutdown. We are definitely very happy that we're doing that, and we end up, for sure, in a better position than we would have ended up if we hadn't done that. And it might certainly help us offset some of this massive impact. But I think the impacts are very real and very, very important.

I think the same goes for Vitromex. Vitromex, as you recall last year, we started our rightsizing program, which we announced on the third -- the second quarter of last year and we did significant reduction. We shut down one plant, we took out about 20% of the labor force, and we continued through the end of the year, reducing support staff. So also Vitromex was caught in a good situation even without (inaudible). So we'll continue to do that and rightsize the business as much as we can to offset this.

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Jose Vazquez;GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division, [4]

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Okay, perfect. Just on what we -- one of those -- a second question, regarding China. Do you see that -- I don't know, that your facilities are already operating over there? And what's your time line for a full recovery in the operations in China, at least in Europe?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [5]

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I'll turn that question to Jorge, which knows much better than me.

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [6]

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Sure, sure. Yes, sure. Our plant in China is running already. Actually, we have been running since March. Definitely, the pandemic started there. And during the Chinese New Year, people didn't return back to operations because it was requested by the government, because at that time, there was an epidemic, right? Now we are operating, and we are more or less at the level of pre-COVID-19 volumes. The market is going back to, I would say, the new normal. And we don't expect the market to grow, but we do expect the market to go back to the COVID -- to sorry, to pre-COVID forecast by the end of this year.

Our factory is already running. We can see the customers are asking for more. We just expect that the confidence from the consumer is there and people start again buying cars, okay? But definitely, the plant is running. And we are -- we feel that the volume is starting to grow. On the contrary, in North America and Europe, the facilities are not running. We are just starting in Europe. We started last week in some operations. And in North America, we are waiting for the OEMs to restart operations. So as you know, there are a lot of controversies in the U.S. on how to reopen. So we are not running at this moment. But we are already seeing the plans from the, all the OEMs to start in May. In Europe, we are already running.

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Operator [7]

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(Operator Instructions) We'll now take questions from the web line.

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [8]

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Excellent. Our first question came from [Luis Lida] from Armada Capital. He asks, if you could explain why the effective tax rate was so high, and what we should expect for the coming quarters?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [9]

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Sorry, Melanie, could you repeat the question, please?

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [10]

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Sure. Why was the effective tax rate so high this quarter? And what we -- what can we expect for the coming quarters with regard to that?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [11]

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Okay, just -- thank you. Yes, regarding the tax rate for the quarter, it was due to the movement in the exchange rate, mostly in our U.S.-denominated assets. It's a noncash charge that has to do what we call the deferred tax part of our profit tax. And if you call it in our balance sheet, goes to the P&L, but it's not a noncash, and it was mostly related to the movement of the peso, which we had a noncash gain, due to that a lot of our assets are denominated in dollars.

And going forward, the tax part which should normalize given that we have some level of -- or comparison level in terms of the asset base. And regarding the business, we, as Jorge explained very clearly, this is key. We do expect significant challenges in the next 2 quarters in terms of volumes in the market.

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [12]

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Okay. There is a second question from [Luis] regarding, he asked, if you've seen a disruption in the supply of raw materials within the supply chain that could affect the restart of operations, considering that the reopening times are still unclear? Do you have sufficient inventory levels? And how much would that translate into weeks of production?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [13]

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I'll -- we'll leave that question to Jorge Rada.

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [14]

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Sure. No, we don't see a problem regarding raw materials. We normally use for the production of the castings, in Draxton, we use basically scrap, and scrap is generated by some of our customers. So if the customers restart, then we will get the raw material from them in many of the cases, so. And also the steel industry is running in many countries, and they are also gaining some scrap, but the quantities they use are much higher than the quantity we use. So we don't expect problems in the supply chain of the main raw material that is scrap. In all the raw materials, we have enough material to restart. You need to remember that we will start gradually. We will not go back to 100% capacity immediately.

So we have enough inventory and the customers -- sorry, the suppliers that are providing us with these other materials are not showing any concern regarding the availability of the material. So we don't expect that, we just would like to have higher return on the operations and volumes, which will benefit a lot our numbers, but that doesn't depend on us. That depends on the COVID performance or behavior, and how fast the government can allow economies to reopen, and how fast the consumer is going to go back to the market and buy cars.

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [15]

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Excellent. We got another question, which is on CapEx. And they ask, your investment in Evercast, is it already done, the $45 million CapEx expectation, how much would that be of maintenance? And then I'll continue with the next after you answer that.

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [16]

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Yes. And Jorge can also do a much better job in terms of the overall CapEx for Draxton in America. But as Jorge mentioned, the third line in Evercast, it's pretty much done. There's still some payments that have to be made, and that's part of the $46 million. And the balance of that is -- about 80% would be maintenance and a small -- some other -- all other investments, which are not for growth so much apart from our regulatory and the CapEx. But most of it is the third line of Evercast, which there's some payments out there. And balance is mostly maintenance Capex. I don't know, Jorge, if you want to add something more particular.

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [17]

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I didn't get exactly the question. But the question is regarding the CapEx from Evercast, you are right. We are finalizing the investments of the third line. And what we have there, as CapEx this year is basically the amount that we have to pay to the suppliers that are working on this third line. We don't have much more CapEx in Mexico there. Some of the CapEx that we are planning to make in this year, in Mexico at least, is mostly based on compliance. There are some things that we have to do to comply with certain rules that are changing in the Mexican, let's say, environment, especially for energy, but it's not necessary CapEx growth, okay? And we are being very careful with the CapEx. And every project that was there in the plan that can be postponed is being postponed, because in this point in time, what we have to be careful is about cash. So -- and we don't know how fast the economy is going to come back. So that's why, at this moment, we are postponing or even canceling in some cases, projects that we had in our plans, but we don't see that we have to do them right now.

Only commitments to customers, in which for example, we are going to launch some new products next year in Europe, and they are confirming that these volumes are going to be there, then we need to invest in this, especially for machining, where every machining project makes additional capacity most of the time. In those cases, we are continuing with the projects. In other cases, where the Board, even the customers, are telling us, you know, let's postpone this a little bit until the situation gets more stable. Then we are postponing the CapEx together with the customers' agreement, so we don't spend money unnecessarily. So we -- I mean the message is, we are taking care of the CapEx, trying to minimize it and postpone it as much as possible to conserve cash.

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [18]

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Okay. Excellent. I'll switch over now to a question on Vitromex. The person asks, if you're planning to sell your outdated inventory this year? And then with the rightsizing and the plant closure that you did last year, what's your EBITDA margin target that you're aiming for?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [19]

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Thank you. We sold most of the inventory last year, and we still had about 1 million meters this year. And we made actually a lot of progress in the first quarter. So we don't have that much inventory. Still we have a few, but we'll probably be able -- depending how -- if the market comes back, how fast it comes back here in Mexico and the U.S., we should be able to sell off all the remaining excess inventory in the balance of the year. Our metrics of inventory are very good right now. We have above 80%, what we call service inventory. And last year, we had below 50%, service inventory was around 45%. That means that we had a large chunk of inventory, which was nonservice, which was no moving products, which right now is on a different path.

And to be honest, the first quarter performance was right on track of where we had planned. It's difficult to say right now what would be a reasonable number for the balance of the year, we don't provide guidance. But we were very happy with the performance of Vitromex at the end of last year, at the beginning of this year. And right now, given the economy, what we've seen out there, we have some impact regarding exchange rate in Vitromex, which was more challenging to the business.

So it's tough to call a number right now. Our aim is to continue the process of turnaround. We recover the U.S. market. We were able to get back a key executive in the U.S. market. We cover, we hire back the guy that grew Vitromex to almost 10 million meters a few years back. This person had left the company for a competitor, and we were able to bring him back. So we are quite happy with that. We believe that as things get back to normal in the next few months, we should be able to pick up the pace and continue to move in the right direction for Vitromex.

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Melanie Carpenter, i-advize Corporate Communications Inc. - Co-Founder & MD [20]

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Excellent. Well, I think that's everything from the webcast. So I will turn it back to you, gentlemen, if you want to make any closing remark.

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [21]

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Well, if there isn't any more questions, I'd like to thank you all for the call, for being here. We hope that you guys stay safe and healthy, and we wish you the best.

Thank you very much.

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Operator [22]

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This does conclude today's program. Thank you for your participation, and you may now disconnect.