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Edited Transcript of GISSAA.MX earnings conference call or presentation 30-Jul-20 2:00pm GMT

Q2 2020 Grupo Industrial Saltillo SAB de CV Earnings Call

Saltillo, Coahuila, Jul 31, 2020 (Thomson StreetEvents) -- Edited Transcript of Grupo Industrial Saltillo SAB de CV earnings conference call or presentation Thursday, July 30, 2020 at 2:00:00pm 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

* Manuel Rivera Garza

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

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Conference Call Participants

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* Alejandro Azar Wabi

GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst

* Jose Vazquez

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Presentation

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Unidentified Participant, [1]

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Good day, everyone, and welcome to Grupo Industrial Saltillo Second Quarter 2020 Earnings Conference Call. Joining us today is Mr. Manuel Rivera, Chief Executive Officer; Mr. Jorge Rada, Chief Operating Officer; Mr. Jorge Mercado, Chief Financial Officer; and Mr. David Sandoval, Investor Relations Manager. Please be advised that this call is for investors and analysts only.

During this call, we will be discussing Grupo Industrial Saltillo's performance as per the earnings release issued on Tuesday. If you did not receive the report, it is available at www.gis.com.mx in Investor Relations section. We encourage you to follow along with the presentation slides that are now available on the live webcast.

Let me remind you that forward-looking statements may be made during this conference call. These are based on information that is currently available and is subject to change due to a variety of factors. For more details and a complete disclaimer, please refer to the earnings release. Also, all figures discussed are in U.S. dollars, unless otherwise stated.

It is now my pleasure to introduce the GIS team, starting with Mr. Manuel Rivera, to begin with our conference call. Please go ahead.

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [2]

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Thank you very much, Tenya, and thank you all for joining us today. I sincerely hope that you and your families are in good health in the midst of this unprecedented pandemic. It is my pleasure to share with you in these difficult times my vision of current events as well as the issue of our business. I believe it is important for me to join Jorge Rada and Jorge Mercado on this call so that we can all be available for your questions.

Our priority at GIS has been to protect all of our employees by implementing protocols to prevent infections. These measures have been designed based on best practices in the automotive industry, and they have been reinforced with communication and training for our personnel.

We have been successful in our operations in China and Europe where we have had no cases reported. In Mexico, we have been able to participate even in a (inaudible). Through the GIS Foundation, we reinforced our commitment to the communities where we operate. We have donated PCR testing equipment, ventilators and personal protective equipment. We have also financed consulting services for state government in order to help them develop strategies to contain the pandemic. As a result of this support and many other actions, the state of Coahuila has achieved testing levels and hospital bed capacity similar to those in South Korea. We will continue to monitor the pandemic and take all necessary actions to keep our employments safe.

Countries where we operate are implementing different strategies to contain the spread of the virus. The effectiveness of these actions is reflected in the (inaudible) of the completion product in those locations. China has effectively controlled the pandemic. In the main European countries where Draxton sells and operates, daily new cases are below the earlier peaks. And in the U.S., although the curve has been increasing recently, the monthly rates -- the mortality rates are lower.

Talking about -- now about markets, we expect that they will recover most of the losses towards the end of the year. As we expected, second quarter was very challenging in the regions where we operate. After the slump in growth experienced in China at the beginning of 2020, its economy has rebounded, and China is now leading global economic recovery. And Europe has shown a faster recent recovery than expected. And although June was slightly more impacted by the pandemic, we expect a slower pace. However, they have issued guidelines to ensure its economic recovery. We are, therefore, cautiously optimistic that the recovery process may be strong in all regions where we operate, as it has already been in China.

Before I turn the presentation to Jorge Rada and Jorge Mercado, let me emphasize the relative strength and position of GIS. First, as I previously mentioned, our results were severely impacted by the corona pandemic. Second, we have accelerated our rightsizing programs that began last year, adapting our cost structure, working capital and CapEx for the current situation without compromising our visioned growth.

During the second quarter, as part of our step to handle any economic difficulties, we registered extraordinary expenses of USD 3.5 million, mainly related to organizational restructuring and rightsizing, which we needed to implement in order to align our cost structure to the new market levels as the economy and industry recover.

Third, GIS has maintained a strong financial position with a net debt-to-EBITDA of 2.9x and a healthy cash level of USD 78 million.

Fourth, our clients have resumed operation. And even during this tough time, our divisions have brought in new business opportunities. Draxton received new machining orders from China. And we are proud to say that following our interest in entering into the electric vehicle business, we closed our first deal for brake components for Tesla. Vitromex also won an important Home Depot tender in Mexico. And China's export and IT firm exports increased, thanks to the new Graniteware line.

Finally, if there are no major COVID outbreaks in U.S. or Europe, we expect that by the fourth quarter, we will be in a range of 80% to 90% our pre-COVID revenue levels and, thanks to our rightsizing initiatives, very close to our initially planned EBITDA margin.

I will now pass the presentation 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 [3]

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Thank you, Manuel, and good morning to everyone. Let me turn now to Draxton. Regarding the automotive industry, I will share some trends in the market where we sell and operate. In North America, Draxton's main market, compared to April data, during May and June, we saw a recovery in light vehicle sales due to the reopening of activities, especially at car dealerships. Sales outpaced production, causing inventories to tighten. In order to recover inventory levels at dealerships, OEMs are expected to drop planned summer shutdowns and keep manufacturing cars. This is even more evident for trucks and SUVs where Draxton has an important share of its North American business.

Similarly, in Europe, light vehicle sales are starting to show slight improvements. The reopening of the economy, better control of the pandemic, government stimulus measures, production restarts and OEM's promotions, hoping for the positive outlook for the rest of the year.

In China, OEMs returned to pre-COVID production levels starting in late April. During the quarter, light vehicle sales and production remained strong due to government infrastructure investment, automotive loan incentives and subsidies for the application of new vehicles.

We are positive about recovery levels at the end of the year in both North America and Europe as OEMs and governments are taking steps to accelerate the auto industry, given its importance to economy. Some types of incentives are: easy credit terms, such as no interest and long payment terms; price discounts; unemployment insurance; tax incentives; and scrappage scheme.

Now I'm going to talk about Draxton's quarterly performance. During the second quarter, foundry volume decreased 65% year-over-year mainly due to the global crisis of COVID-19. The volume of our North American operations suffered a 70% drop, while the Draxton Europe and Asia, the volume decreased by 60% due to the stoppage in vehicle production in Europe since March.

Lower sales affected our EBITDA with a result of negative $6 million, which includes rightsizing provisions and extraordinary charges for $2.3 million. For the next 2 quarters, we expect a gradual recovery in the automotive market, and we estimate that our volumes would return to 85% to 90% of pre-COVID levels. With our organizational adjustments and efficiency programs, we estimate that we will return to a similar pre-COVID EBITDA to sales margin towards the end of the year.

I would also like to share with you that despite this very challenging environment, Draxton has obtained new significant orders. One of the most important new projects is the brake components order for Tesla, which Manuel already mentioned. With these new orders, Draxton has obtained contracts for 105,000 tons in the last 12 months. Additionally, we are currently developing more than 200 new projects that will represent a volume of 140,000 tons per year.

In Mexico, demand for brake components continues to grow due to the installation of new facilities from our brake customers. So even though it may take time for the automotive industry to recover its pre-COVID levels, we estimate demand will exceed our installed capacity by 2022.

Furthermore, Draxton has implemented organizational changes to boost its research and development activities. This will enable us to offer innovative solutions to our current and potential customers regarding new high-performance materials.

Let me now turn to -- the presentation to Jorge Mercado, who will talk about our other business units and consolidated figures.

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [4]

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Thank you, Jorge, and good morning, everybody. Now let's move on to Vitromex. Vitromex has been working according to its restructuring and profitability plan. We have been implementing some measures across the business, like restructuring the portfolio to adapt to its market need. We have also rationalized the capacities in our plant. And so far this year, our leaner cost structure has led to a 7% cost decrease versus last year. As a result of these actions, we have improved our working capital by almost 40%, making both inventory and service levels much more efficient.

Due to the effects of the pandemic in the second quarter of 2020, Vitromex revenues contracted 25% compared to the same period of last year, with April being the month with the largest decrease as all plants were shut down. The full impact of the pandemic was felt in the months of April and May. In June, we experienced a significant recovery compared to April and May, revenues were almost 60% higher, while EBITDA was positive.

Reported EBITDA for the quarter was negative MXN 45 million, which is 64% better on a reported basis than last year. Now excluding extraordinary effects of the slow-moving inventory liquidation and restructuring charges for the quarter, EBITDA would have been MXN 9 million.

Now going out to the month of June alone and excluding previously mentioned effects, EBITDA margin for the month of June of 2020 would have been 12% on a run rate basis versus reported 9%.

Now let me just walk you through some of the consolidated figures. GIS has faced the current situation by accelerating the rightsizing program that we initiated in the second quarter of 2019. All businesses have undergone structural changes, and working capital investments have been adapted to handle the current price. Even though the second quarter results were impacted by the pandemic, figures in June reflected the benefits of rightsizing and the gradual recovery of volume, which led us to believe that by the end of the year, we will be able to recover pre-COVID EBITDA margin.

As Manuel and Jorge mentioned, GIS has continued to have a very disciplined and responsible approach regarding debt quality. We made use of our credit line in order to close the second quarter with a healthy cash level of $78 million, net debt-to-EBITDA of 2.9x and committed a credit line of $50 million. We have assured financial flexibility through both the refinancing carried out last year, which exempted us from significant payments for this year and next, and the realization of our leverage ratio covenant for the next quarter. We have an excellent and close relationship with our lenders, and they are helping us remain flexible.

We will continue implementing our profitable growth strategy, and we are sure that the measures we have taken in all our businesses will improve our competitive position for the next quarters, even in this challenging environment.

This concludes my remarks for today. Thank you for your attention. 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 our first question comes from the line of Jose Vazquez with GBM.

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Jose Vazquez, [2]

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It is related to Vitromex. You said that June, it showed a very positive performance given the current situation. And taking out all the restructuring charges and some inventory charges, it would have been the first in several quarters to post a positive EBITDA. So looking ahead, seeing this trend, do you believe that we could see positive EBITDA in the remainder of the year?

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [3]

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Jorge?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [4]

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Thank you, Manuel, and thank you, Jose. Well, as you recall, Jose, we have been reporting the improving performance of Vitromex since last year. Vitromex results have all with -- been affected in the last quarter of last year and this -- the quarters of this year by the actions that we took last year in the restructuring. First was the charges regarding the close of the (inaudible) plant, and then the strategy to decrease the levels of inventory that we have carried for a long time. And those -- these are basically the numbers that we take out to understand the run rate of Vitromex. And consistently, if we take out the months of the pandemic in the last quarter and the first 2 months of this year, we were seeing run rates for Vitromex which were on the positive side. And we do think that if we continue that trend and we have volume growth, we will be able to see improvements in the margins of Vitro.

Certainly, at the end of the day, what needs to happen is that the volume comes back. From our side, we are focusing on the things that we can control, like the rightsizing process and taking the costs out and remain flexible. So if volumes does come back at reasonable levels, yes, we will see improvements in the margins and have positive EBITDA. But it has to be both a combination of things that we're doing, which are in the right direction, and how the market evolves as we come along in the future.

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Operator [5]

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(Operator Instructions) Our next question comes from Alejandro Azar with GBM.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [6]

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And I'll just follow up first on Vitromex, and then I'll move on to the Draxton. Jorge, you mentioned a margin in June, and Manuel mentioned also new contracts, I believe, in Vitromex. Could you give us more color on this? Because you -- in the question before this one, you mentioned about volume coming back. So is this volume significant to move that -- to move the needle and to have margins positive from the third quarter and forward?

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [7]

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The -- yes, basically, and it has been discussed in previous calls, Vitromex has developed a fast (inaudible) to recovery and profitability. First step was to (inaudible) organization, that has already been done. Second, putting systems in place. And I would say we now have about 70%, 80%. And for the (inaudible) for pricing issues, those have been significantly reduced.

When we talk about inventory effects that -- some are linked to products but were produced several months ago, some of them even a year ago at higher costs. So we are talking about excluding those inventory effects. It is the (inaudible) selling all the products. You see at current costs, we were -- we will be obtaining EBITDA margins close to a 2-digit figure, very close.

So that has been mainly the result of, first, adapting better our product mix to adjust to the market mix and very significant cost reduction from the manufacturing side. So we were very encouraged. As you know, April was very (inaudible). May was slightly better. For June, even though we still were lower than our original planned volumes, 1-digit figure, the company crossed the first time positive EBITDA in the -- with the margins of the EBIT (inaudible).

Now the situation is a little bit different. We feel relatively comfortable for the months of June, July, August, September. There is some pent-up demand. We still need to be cautious going forward in terms of our forecast. But I think what you see, companies -- we are talking about rightsizing. But our plan is that we wouldn't be adjusting all of our cost structure in the volumes. So yes, we maybe have been forecasting our volumes plus 10, minus 10 or a relative number, but we see at a certain level, we will certainly -- and the company is committed to adjust its cost structure to be -- to those levels. So the company commitment is to maintain EBITDA margins.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [8]

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A follow-on, on that is you mentioned inventories, do you have an estimate on when can we see those inventories gone, the higher cost one?

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [9]

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Yes. It's been higher for a very few months. Actually, it has been reduced almost to half. Especially during this quarter, we will reduce 2 -- about 2 million square meters of inventory in Vitromex. And the most important point is that while we'll reduce, the sales will improve because now the company has much better S&OP system. So the quality of that inventory in fulfilling the market's needs are much better. But from the accounting point of view, I think, in a couple of months, that will be in half.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [10]

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And if I can move on to Draxton, the obvious one on the Tesla contract, could you tell us more about it in terms of technology? Are you using (inaudible)? You are more value-added in these ones than the ones you have in North America? And I understand that Tesla has a different supplier in North America. Would you say this also is related to Tesla increasing its supplier base? Or...

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [11]

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Jorge, why don't you answer this questions?

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [12]

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Yes. Sure. Alejandro, thank you for your question. Well, Tesla is -- as you know, we are producing brake components for the auto industry through tier 1 suppliers. So this is -- what we produce is brackets and calipers for the brakes. That are the main 2 components of the brakes, and they are going to be assembled in a brake system for Tesla. In our case, we will produce an iron bracket, which is one to be delivered as cast, without any additional machining. And for the aluminum caliper, we will do the caliper, and we will do also the machining for that, okay? And that will be assembled by a tier 1 supplier, delivered to Tesla in Europe for the new models, Y and 3, okay?

So that's -- what we have said several times in other meetings is that electric vehicles, the technology for the brake is going to be very, very similar, like actually, the same as internal combustion vehicles because they have to stop anyway. And so what we are very optimistic about is that even though the trend for hybridization and electrification, in general, is there, and eventually, those numbers will grow, our technologies, our components are suitable very well for hybrids and electrics. So we see a very promising future as this trend goes on.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [13]

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And would you say you are working on other auto parts besides brake for electric vehicles? Even you mentioned, I think, products under production or R&D.

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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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Yes, sure. There is especially one component that is very, I would say, suitable for e-drives for the electric drives, and this is a differential case. The differential case is an iron component that needs to be iron, ductile iron. And normally, the new businesses are coming additionally with machining, which is additional value-added for our business. And we see that this trend continues, the cars have 1 or 2 and sometimes even 4 differential cases. So it means that even with electric depots, there is, I would say, a potential market growth for us as these components have to be in ductile iron. And we are developing the skills to produce those. We are already making them in Europe, and we already won a business for differential cases machines in China for Volkswagen for the plant they have in Dalian.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [15]

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Excellent. And one more, if I may. You guys also mentioned that you are optimistic on the demand exceeding your capacity by 2022, especially in brakes in North America. Do you have an estimate of how much -- percentage in terms of your products is sourced regionally? Because a lot of the growth, I understand, comes from a relocation from China to North America.

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [16]

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Correct. Actually, there are components -- I'm going to go a little bit back. When the companies, the automakers come to Mexico and they install facilities to produce cars, at the beginning, normally, they import their main components. I'm talking about Japanese, Korean, European. And then they start the relocation of components. And we are seeing a big relocation trend for brake components. So almost all the brake suppliers -- producers are growing or installing facilities in Mexico, or growing their existing facilities in Mexico. So there is actually only 1 manufacturer that doesn't have a plant in Mexico, all of the others are already installed in Mexico, and they are growing. And based on this, we see that from about 40% of our portfolio in Mexico now -- or 3 years ago was brakes, and 3 years from now, it will be close to 60% of our portfolio. So we are already obtaining new businesses, and we are negotiating with all these customers additional business. So we are very confident to say that in 2022, the demand in the market will exceed our capacity that we have installed right now.

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Operator [17]

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And now I would like to turn the program to [Tenya Vargas] for the webcast questions.

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Unidentified Participant, [18]

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Thank you, Nicky. We have one question via webcast, and it is regarding dividend. And it says which has been the Board's position in this regard given the current environment? This is the medium-term view on dividend.

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Jorge Alberto Rada Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - COO and Head of Draxton & Auto Parts [19]

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Tenya, thank you very much for the question. Regarding dividends, the Board of GIS decided this year to suspend dividend, aligned with the strategy to face the pandemic across all the businesses. And regarding next year, it will depend on the economy and how are we able to go back to the financial flexibility that we had previously to the COVID and then puts us back to a trend that is aligned with the original agreements that we have with our lenders. We want to be in a position in which we can continue to grow profitably.

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [20]

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And in complementing what Jorge has just mentioned, we feel comfortable in terms of our forecasted EBITDA generation for the following quarters. However, by the way leverage is computed, we use the last 12 months. We would have been (inaudible) the third quarter -- excuse me, the results of the second quarter. There have been instances, I (inaudible) coverage ratio the traditional way by just excluding the results of the second quarter. So that certainly causes distortion in our valuation, and it would be there until we release the results of the second (sic) [third] quarter of this year. But the company expects by then to resume the previous dividend policy. I hope that answers your question.

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Unidentified Participant, [21]

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Okay. We have another question, and it is from (inaudible) with BBVA. And it says, "Hi, good morning, everyone. Thanks for taking my question and I hope you're okay. Going back to the volume recovery in Vitromex, how are you seeing the demand dynamics on the construction sector in both Mexico and in the U.S.? Do you think the better pricing levels are sustainable in the coming months?"

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [22]

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Could you repeat the question slowly? This condition is not optimal.

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Unidentified Participant, [23]

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Sure. I'm sorry. It says, "Going back to the volume recovery in Vitromex, how are you seeing the demand dynamics on the construction sector in both Mexico and in the U.S.? Do you think the better pricing levels are sustainable in the coming months?"

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Manuel Rivera Garza, Grupo Industrial Saltillo, S.A.B. de C.V. - CEO [24]

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Yes. I think it's -- the construction in Mexico certainly is significantly better. Though it is important to point out that about 2/3 of the demand for Vitromex in Mexico is driven by remodeling. And remodeling has not been typically used for the (inaudible) somehow countercyclically to construction. New construction certainly has been affected, it's about 1/3 of the volume. Of course, there were new construction, but that's already growing -- ongoing previously. So that mix continues. So that will maintain the market. So -- but we are forecasting Mexico's demand (inaudible) will be around 10% lower than the pre-COVID levels. The business, as you probably know, has maintained very good levels of new houses, selling of new houses with some remodeling. I don't know if that answered the question.

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [25]

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To complement Manuel and regarding the pricing, as Manuel pointed out, we still see a tougher environment going forward, certainly with some recovery. That might put some pressure on pricing at the end of the year. The Vitromex team has been working a lot, and as we mentioned, in production on improving service levels, and also been very active in understanding what is the right product mix for each segment. And that has helped Vitromex being able to gain pricing through mix management and revenue management. We'll continue to do that, but we do expect an environment which will be demanding and competitive as there will be a lot of capacity out there that we'll try to place in production.

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Operator [26]

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(Operator Instructions) And it appears that we have no further questions. Jorge Mercado, do you have any closing remarks?

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Jorge Armando Mercado Pérez, Grupo Industrial Saltillo, S.A.B. de C.V. - CFO [27]

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Thank you very much all for attending the call, and we wish you all to be safe.