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Edited Transcript of SOLB.BR earnings conference call or presentation 31-Jul-19 11:30am GMT

Q2 2019 Solvay SA Earnings Call

Brussels Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Solvay SA earnings conference call or presentation Wednesday, July 31, 2019 at 11:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Geoffroy Raskin

Solvay SA - Head of IR

* Ilham Kadri

Solvay SA - Chairman of the Executive Committee, CEO & Director

* Karim Hajjar

Solvay SA - CFO & Member of the Executive Committee

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Conference Call Participants

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* Ben Gorman

UBS Investment Bank, Research Division - Associate Analyst

* Charles L. Webb

Morgan Stanley, Research Division - Equity Analyst

* Chetan Udeshi

JP Morgan Chase & Co, Research Division - Research Analyst

* Christopher Anthony Ryan

BofA Merrill Lynch, Research Division - Analyst

* Laurence Alexander

Jefferies LLC, Research Division - VP & Equity Research Analyst

* Markus Mayer

Baader-Helvea Equity Research - Lead Analyst of Chemicals

* Mubasher Ahmed Chaudhry

Citigroup Inc, Research Division - VP

* Mutlu Gundogan

ABN AMRO Bank N.V., Research Division - Analyst

* Nathalie Debruyne

Banque Degroof Petercam S.A., Research Division - Analyst

* Sebastian Christian Bray

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Wim Hoste

KBC Securities NV, Research Division - Executive Director Research

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Presentation

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Geoffroy Raskin, Solvay SA - Head of IR [1]

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Good afternoon. Welcome to our second quarter call. And I am Geoff Raskin, from Investor Relations, and I'm here with our CEO, Ilham Kadri; and our CFO, Karim Hajjar. Now before handing the call over to them, let me remind you that our results are compared to 2018 pro forma figures, which already includes the positive IFRS 16 impact. This makes that the corresponding 4.2% growth is excluded from the presented growth figures in H1. We've also added slides to today's broadcast. And with that, I'll turn the call over to our CEO, Ilhan.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [2]

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Thank you, Jeff. And hello, everyone. Thank you for joining our call today. I'll begin with the quick overview of the result. Turning to Slide 3. As anticipated and discussed with you at our last results call, the macro headwinds we experienced in quarter 1 in key end markets, including automotive, electronics and oil and gas remain challenging in quarter 2. Against this backdrop, we executed well by focusing on actions, such as cash management, cost discipline, and price increases to deliver operational performance in line with our expectations. As a result, net sales were up 2.6% in the first half, and the underlying EBIDTA was minus 0.5% as foreign exchange compensated for organic decrease of minus 3%.

 

In the second quarter, underlying EBITDA was 5% down organically, including a minus 2% net effect from onetime elements. Our diversified portfolio provided resilience for the group. In our advanced materials segment, composite materials for aircraft showed continued strong double-digit growth in volume. While in Specialty Polymers, despite the difficult macro environment, performed slightly better than the general auto market as we also benefited from higher sales in hybrid and electric vehicles. In our Advanced Formulations segment, mining, agro, coatings, and personal care markets were stable, while oil and gas remain challenged.

 

The Performance Chemicals segment continue to deliver solid results through strong pricing in soda ash and peroxide businesses. Last quarter, we discussed with you our near-term priority to increase focus on cost and cash as a means to help mitigate the current challenging environment. I am pleased to report that our effective cost control is already starting to bear fruit and that we were able to sustain a healthy EBITDA margin of 23% in the first half.

 

Moving to cash from continuing operations, I am pleased with the improvements we delivered. Free cash flow to shareholders reached EUR 33 million in the first half as our delivery in the second quarter more than compensated for a negative quarter 1. And while I am encouraged by our early progress, there is still more work to be done in this area. And we have a clear line of sight of the opportunities ahead. Turning to Slide 4. One of the first actions that I took it since joining the group was to simplify and align the roles, responsibilities and structure of the Executive Committee. We're already seeing this realignment leading to faster decision-making. This enables swift actions to reduce inventories where needed and to focus the businesses on improving cash generation. To complete the executive team, I am thrilled to welcome a new executive committee member in the role of a Chief People Officer, Hervé Tiberghien, will be joining us from PPG on September 1. He has the right competencies and experience to become a key partner and drive the performance culture in the company going forward. Now I would like to speak about what matters most, our customers. After my initial focus on meeting employees and listening to our investors, my recent focus has been on meeting customers. My take away from meeting more than 50 customers is that they believe we have the right relationship, the right technologies, and future breakthrough innovation to respond to their needs and their unmet needs. They're relying on us to make them win and share the value created. I am especially excited to meet with many of our key strategic customers at the Paris Air Show last month. The collaboration with our customers remain at a high-level, and we are accelerating the Composite Materials breakthrough innovation, both thermoset and thermoplastics for the next generation of aircraft. I would also like to congratulate Airbus for their prestigious engineering award for the composite wing on the A220 aircraft that reduces the environmental footprint of commercial jets. The wing is made using Solvay's proprietary resin transfer infusion. It's 10% lighter than metal, which reduces fuel consumption and CO2 emissions. We are very proud that our technologies helps our customers achieve this award. I would like to celebrate another one of our innovations. In Silica, it's all about clean mobility, and we're very proud to have a new premium technology being adopted by our -- one of our key customers. This solution features 25% less rolling resistance compared with the standard tires, thereby reducing fuel consumption and CO2 emissions by 7%. While we are helping our customers achieve their sustainability goals, we are also making progress on our own sustainability goals.

 

So let me address our key priorities around sustainability. This is central to the way we run our operations. I know you have all seen our 2025 targets we shared last year. I'd like to update you with the preliminary figures on 2 of those metrics, safety and greenhouse gas emissions.

 

On safety, our goal is to halt the rate of occupational health and safety incident. Year-to-date, we improved our accidents rates by 17% from an existing very strong performance, reflecting the continued commitment to safeguarding people and the environment. On greenhouse gas emissions, in the first half of this year, we made very good progress towards our objectives of 1 million tons absolute reduction targets by 2025. We're down by 0.3 million tons. We continue to take targeted actions, such as the investment in biomass, in our Rheinberg plant, which we announced earlier in the year and which will reduce our emissions further by some 0.2 million tons in the coming years. Before closing the sustainability chapter, I would like to address the questions we have received related to the New Jersey directive. There are some specific concerns about 2 type of PFAS, namely PFOA and PFNA. In the past, Solvay purchased processing aids from other companies that contain those substances and we used these in certain manufacturing operation. Let me be clear that Solvay didn't produce or sell this processing aids. The Environmental Protection Agency or EPA set up a voluntary program to phase out PFOA by 2015. Solvay joined the voluntary program and stopped using PFNA by 2010 and PFOA by 2013, years ahead of the program deadline. This, of course, happened in full transparency and together with the local and regional authority. Now I would like to provide an update on the strategy review. As I outlined last quarter, we are conducting a comprehensive strategy review with the ultimate goal to unleash and accelerate Solvay's value creation potential. We continue to make progress and we will conclude the review in the coming months. We look forward to sharing a detailed roadmap for value creation on our third quarter results webcast on November 7. We then plan to conduct several roadshows in the week following to meet with our investors and discuss our plans for value creation. With that, I'll hand it over to Karim, who will provide more granularity on each operating segment. Karim?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [3]

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Thank you, Ilham. Good afternoon, and good morning, everyone. I will now provide some comments on each of the 3 business segments, and I will start with Advanced Materials on Slide #7. In the first half, segment sales were up 1.2% on an organic basis driven mainly by price. In the second quarter, segment sales were up 2.5% organically. I will now focus my comments mainly on the second quarter results.

 

Conditions in our largest market, transportation, were mixed again. Automotive, which represents close to 30% of the Advanced Materials sales, and around 15% of group sales remained a challenging environment as vehicle production declined globally by 6% compounded again by inventory destocking. So the Specialty Polymers business did better than that with the sales down about 5% as the demand environment remained challenging and customers, of course, remained cautious. There was a modest sequential improvement over the first quarter as higher sales of products used in batteries for electric, for hybrid vehicles helped us to outperform the macro trends in automotive. While visibility into the second half is somewhat limited, we're not expecting a major pickup in demand in the second half. Turning to aerospace, which exceeds 20% of segment sales is about 10% of the group sales. We, again, delivered record sales in second quarter, up 12%, and that excludes the positive foreign exchange impact. Where did improvement comes from? Fundamentally, it came from build rate increases on commercial programs, including the Boeing 787, the LEAP engine, new programs like the Boeing 777X, the COMAC's C919 and in addition to that the rising demand for Lockheed's F-35 military program. In addition, we benefited from growth in business jets and in rotorcraft. Profits and composites also reached record levels in the quarter as we're starting to see the benefits from our operational focus that began last year. For example, a 20% increase compared to a historical production on our major line at our Greenville plant in Texas. If I look at the Piedmont, South Carolina plan we also saw significant increase in the carbon fiber unit. We're planning further improvements in these lines and are deploying similar improving programs at other major industrial sites and composites. Looking to the second half, growth is expected to moderate from current first half levels mainly because of the usual seasonality in destocking. Now for the latest update on our sales to this 737MAX program, to date, we've been operating and delivering at a rate of 52 aircraft per month. Boeing recently indicated that they will continue to operate at a 42 monthly build rate based on an assumption that regulatory approval will be forthcoming in the fourth quarter. We, therefore, expect orders for our materials to moderate towards a 42 build rate by year-end. We will continue to stay in very close communications with our customers and will align according to their changing needs. Turning to electronics, which is more than 10% of Advanced Materials sales, 5% of Solvay group sales, the market headwinds that we experienced in Q1 continued to pressure our business. Sales to smart devices were down by double digits with reduced consumer demand and with customers impacted by the trade war. In addition, we have not seen any improvement in the semiconductor market. Many producers continue to announce weak demand conditions and inventory corrections. In fact, we're seeing orders getting pushed from late 2019 into 2020. We, therefore, are not anticipating much of an improvement in the electronics markets going into the second half. Overall for the Advanced Materials segment, EBIDTA was down 12% in the first half organically. If we exclude the positive onetime impact of EUR 19 million related to pension synergies last year, the EBIDTA was down 9%. Now the decrease is primarily the results of higher costs. Fixed costs were up mainly to support growth in composite materials and due to the focused reduction of inventories in Specialty Polymers in Q2, particularly. Also, certain higher raw material prices could not be passed through in our special chem business. As a result, EBITDA margin in this segment were down 3.5 percentage points at 25.6% in the first half. I will now turn to the Advanced Formulations segment, which you can see on Slide 8. Sales in the first half were down almost 2% on an underlying basis. And organically, down 5% and that is mainly due to the lower volumes in oil and gas. In the second quarter, sales were down 6% organically, volumes were down 8% and prices were up 2%.

 

In the oil and gas market, which is our largest market -- largest business in this segment, and accounted for close to 20% of the sales in that segment or around 5% of group sales, volumes were down significantly in the second quarter. I explained -- as I explained in the first quarter, that although drilling and production levels have increased, there was limited activity in stimulation and that's where we operate. This continued to impact demand levels in the quarter versus a strong comparable quarter in 2018. The market environment is also intensifying, customers are being very focused on managing costs and it led by that kinds of attention to very lean budgets. This has created or exacerbated a technology shift, which is having a negative impact on our performance resulting in some lost business as some customers shifted to lower-priced competing products. We've got our work cut out to address these channels. And it does require some time. As we look forward, as a result of the market challenges and despite the new pipelines in the Permian basin that we expect to come on stream, we expect performance to weaken in the second half. And I have integrated that into our full year outlook. The mining market accounts for 10% of our segment sales or just under 5% of Solvay group sales. Our sales in technology solutions grew 8% in the second quarter related to both volume and price. Growth was driven by new business wins as the team secured 4 new mine projects in the second quarter, clearly as customers value our innovative solutions. We expect the mining market to remain robust in the second half and we are pursuing more new business opportunities. Turning to our Aroma Performance business, which represents 4% of group sales. It is performing well. Sales are up 2% in the second quarter driven by pricing initiatives. Demand for inhibitors used in monomers remains solid, and it was complemented by good demand for our natural vanillin ingredients which are used in flavors and fragrances. In fact, the business secured its first customer for our natural -- U.S.-based customer for our natural vanillin technology, which is a good sign for more business opportunities in the region. Overall, underlying EBITDA in the Advanced Formulations segment was down 5.8% in the first half organically or by 4% if we exclude the onetime pension benefit of EUR 4 million that was booked last year. The EBIDTA margin remained flat at 18%.

 

Turning to the Performance Chemicals segment, which you can see on Slide 9, it delivered a 5% organic sales growth in the first half mainly driven by price. In the second quarter, sales grew 3% organically. The soda ash business continued its robust performance with higher prices across regions in a balanced market environment. This was complemented by steady performance in the peroxides business, which serves a number of markets as well as supplying some large scale HPPO operations. Market conditions are expected to remain healthy in both soda ash and peroxides in the second half.

 

Performance Chemical's EBIDTA in the first half was up 11%, robust demand, high prices, operational excellence, all contributed to increase our margins to 30% against 20% last year. We also renegotiated an energy contract in our soda ash business and that resulted in a EUR 12 million gain, which contributed 3% to that growth. As usual, we flag such operational results whenever they are material. I'll now turn to cash generation and to the balance sheet, and I will highlight that information on Slide #10. Total free cash flow to shareholders of EUR 191 million was EUR 114 million better than the first half last year. With continuing businesses, accounting for nearly half of that improvement. Cash generation in Q2 of EUR 123 million overcame the weaker performance in Q1, as Ilham noted, we began to take a number of actions to improve our cash performance from the first quarter. All businesses are laser-focused on cash, teams are further incentivized by the changes that Ilham implemented to the bonus targets as one of her first actions as CEO on the 1st of March. We clearly see its bearing fruit. Well, we are also mindful that we have structural opportunities in the midterm and these relate to our supply chain infrastructure to drive more sustainable improvements in our end-to-end processes from order to cash. Turning to Slide 11, our strong free cash flow delivery in the second quarter allowed us to keep net debt stable at EUR 5.8 billion. That's after the payment of the final dividend of EUR 238 million on the 23rd of May this year. Year-to-date, net debt was up EUR 0.3 billion and that reflects the usual concentration of dividends in the first half. Our leverage ratio remains stable at 2.1x. Total provisions were EUR 4 billion at the end of June, up EUR 0.2 billion compared to start of the year. And that reflects 2 key points. One, continued operational deleveraging of EUR 45 million and $0.2 billion increase in provision that resulted directly from lowered discount rates. The environmental provisions were largely stable at EUR 0.7 billion, and for the avoidance of doubt in relation to the PFAS matters that Ilham mentioned based on all the information we have, we believe that we are adequately provisioned for such matters. Looking forward you'll find our full year outlook on Slide #12. And now as you'll appreciate the macro environment remains dynamic, there continues to be a high degree of uncertainty across key markets. We continue to monitor very closely these key end markets and now staying in with very close touch with our customers. We will remain focused on what we can control mainly cash, cost, but of course customers. As a result, we confirm our full year 2019 EBIDTA guidance of flat to modestly down, although as you'll understand, the comparison base will remain more challenged in Q3 than Q4. We also confirm our estimate for free cash to shareholders from continuing businesses of EUR 490 million for the full year. If you included the strong contribution of the discontinued operations thus far, this will allow us to deleverage the balance sheet by at least EUR 0.25 billion. And with that, we will now turn -- I will now turn you back to Michelle, our moderator to begin the Q&A. Michelle, over to you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Wim Hoste from KBC Securities.

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Wim Hoste, KBC Securities NV, Research Division - Executive Director Research [2]

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Wim Hoste from KBC Securities. I have 2 questions, please. First, on the Corporate & Business Services, there was a EUR 10 million improvement roughly in second quarter this year versus second quarter last year on EBIDTA level. Can you maybe provide us a new run rate going forward that it seems that your costs efficiency measures are bearing some fruit. So that's the first question. And the second question is on Specialty Polymers. On smart devices, revenue has been under pressure in the last couple of years, can you maybe talk a little bit about what the prospects are for that business? Is there any -- are there any new contracts or awards in the pipeline that will, at some point, start to turn the trends up again in that business? Any visibility on that or any clarity on that would be helpful for us?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [3]

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Let me take the first question to start off with. It's a very good spot, clearly, what you can see in Q2 is the impact of the cost measures that we have implemented but there is some phasing as well. There's also been a modest improvement in the contribution of our energy business. To your point around the full year expectations, what I would say is, you will remember that Corporate & Business Service costs are typically second half phased anyway. What I can confirm is that we continue to focus on cost discipline those measures will stay in vigor, but also we're looking to invest and we are investing in matters such as digitalization and the ramp-up in the operational improvement capabilities. As a result, what I would say is, you can expect the last year's outcomes on Corporate Business Services to be indicative of what the landing for this year will be. On the Specialty Polymers, Ilham?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [4]

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Yes, I can take it. Wim, so your question about the semiconductor for electronics, right? I mean, as we've seen semiconductors are still experiencing strong headwinds due to the slowing economy. You may have heard some of the OEMs and our clients with significant profit warning. Some customers are now pushing some orders into 2020, although some are speculating that the market hits bottom in H1 on semiconductors and smart devices from where we stand. The visibility remains very low, Apple was minus 12% on the devices yesterday. We, therefore, do not anticipate much of improvement so I don't like to speculate, you will get to know me. So we don't really anticipate any improvement and that's what we factor in our guidance.

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Operator [5]

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Your next question comes from Chris Ryan from Bank of America.

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Christopher Anthony Ryan, BofA Merrill Lynch, Research Division - Analyst [6]

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My first question just on the debt side. There is a EUR 700 million increase in the debt when you did the hybrids and then the repay -- or the repayment in May should have brought debt down but obviously, you just chose to keep liquidity what exactly -- what kind of facility was drawn upon for the repayment of the hybrids? Not including the deal of the hybrid issuance that was done in 2018.

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [7]

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Okay. Well, Chris, I think you personally answered the question because we anticipated the EUR 700 million hybrid call in May and in doing so, what was very, very encouraging for us, is we got the support of both credit rating agencies for the reduction in the hybrid portfolio that's why we issued EUR 300 million in December and we tried EUR 700 million and that will improve our free cash flow going forward. To your point, we financed the EUR 700 million redemption with the proceeds of a EUR 300 million issuance in December, so it was late November, and then with our liquid resources that we already have in place. And that to my man is a real example of how we trying to really keep the efficiency and the focus on our bottom line.

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Christopher Anthony Ryan, BofA Merrill Lynch, Research Division - Analyst [8]

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What was that some sort of a revolver draw or -- because obviously, the cash levels stayed the same?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [9]

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It's a combination of factors. Again, if you recall our cash flow was even stronger. We have more than EUR 3.5 billion of liquidity reserves. So we were always very cautious, so we draw on what is most effective internally. It's a combination of cash, available credit facilities and the proceeds from last November's issuance.

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Operator [10]

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The next question comes from Mubasher Chaudhry from Citi.

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Mubasher Ahmed Chaudhry, Citigroup Inc, Research Division - VP [11]

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Mubasher Chaudhry from Citi. Just 2 quick questions, please. You provide an update on the sale to BASF and how that's going and do we still expect it to close in, sometimes, 3Q? And just on the carbon credit sales that were mentioned in the press release, could you provide some color as to why those are being sold now, were they intended to generate -- just some color around those would be helpful?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [12]

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So I'll tackle with both questions. No news is good news. We're on track, we're confident, we are working very closely and very constructively with BASF to get to the outcome, and we stay on track towards the tail end of the second half. So I've certainly -- so we're looking forward on that. To your point on the carbon credits, one, preparing your business for sale, clearly we look at monetizing everything that we can to extract maximum value. And so given at the pricing conditions, the markets were very compelling, we didn't hesitate to monetize those credits. Now all of that cash is excluded from our continuing businesses, but it's still very welcome cash.

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Operator [13]

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The next question comes from Nathalie Debruyne from Degroof Petercam.

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Nathalie Debruyne, Banque Degroof Petercam S.A., Research Division - Analyst [14]

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Two actually, if I may. The first one would be on Advanced Formulations because Karim if I understand you correctly, you are saying that it's going to weaken in the second half of the year regarding oil and gas, I mean, but I see mining apparently improving. And if you're lucky or actually if you do a good job, first, you can win new contracts for new mines over there. So what can we expect in terms of development for the second part of the year for Advanced Formulations as a cluster both in terms of revenues, but also in terms of EBITDA margin. Is there some potential uplift that we can expect from 18% that we see today? That will be my first question. And then the next one that will be actually on Composite Materials. You also said that H1 was particularly strong and that you do not expect such high levels to continue into H2. So perhaps, you could help me understand what you mean with that? Like is it on a sequential basis or on a year-over-year basis?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [15]

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Thank you, Nathalie. Let me start with Advanced Formulations question. I think your question has a number of specific details that I'd rather not get into in that level of granularity but let me address and clarify one thing. When I said things were going to be tougher and deteriorates in second half, I was really confining my commentary to oil and gas for the reasons that we explained. We are taking what I believe is a very realistic outlook, what we're saying is whilst the market may well, volumes may come up, we have work to do to get back to where we need to that's really the point. Well, you are absolutely right, and you did hear me very well, which is, we have 1 new mine, we're very focused on repeating the successes and that really is what we're saying now. I'm not going to give a specific EBITDA margin or anything else for the second half. But I'm sure Ilham may want to add 1 or 2 things, Ilham?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [16]

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I mean the oil and gas story just to be clear, it's still very volatile, it represents 5% of the group sales and the volume is as we shared with you was down in quarter 2. We see few things, since that -- although drilling and production levels have somewhat increased. The activity is still limited in stimulation where we operate as we told you in quarter 1. So this is yet to come. Second, because of pressure on margin, customers are very focused on cost and they are turning to lower --, I would call them lower-cost commodities, so away from high-value products as they are managing, obviously, their costs and lowering their spending. So we are staying very closely to our customers to assess their needs, we will address any challenges going forward and we are looking closely at ways to do better. Mining, we are very pleased with, you know, copper prices in Q2 remained at the reinvestment levels supportive of production increases, we were experiencing healthy volume in mining. Our President of Technology Solution was with us yesterday, we are winning new mines, we are a technology leader in that space. So we will continue keeping our leadership position, actually, increasing share in the new mine space. So that's something we see it happening, and we have been awarded as we said the new business -- some new business in mining. So all in all, we see the H2 extremely stable now with the comparison with last year, it's probably, last year was a very strong quarter in formulation. So the comparison is probably strong and tough for the second half. However, all of this has been factored in our guidance.

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [17]

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Maybe to second point in Composite Materials, there is seasonality and remember the comments that I have highlighted around what we believe is expected moderation of the build rates of 52 to 42 and you do get some seasonality into the inventory reductions as our customers really focus on having a more efficient balance sheet towards year-end, so it is very customary.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [18]

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And on Composites again 737, obviously, and we knew that all of you will be interested by some feedback, so that's why we included it that this is one of the many programs we are serving, right? We are very, very pleased of our double-digit sales growth in Composites since 3 quarters in a row, we see the leverage between the top line and the bottom line because our teams are extremely focused on fixing the waste in the supply chain. And that's important. That's a big opportunity for composites. So definitely the Boeing story we told you about that, but we have many, many more opportunities, we are growing in other Boeing program, and obviously, the F-35 is also increasing pretty well.

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Operator [19]

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Next question comes from (inaudible) from Exane BNP Paribas.

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Unidentified Analyst, [20]

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To start with, I'd like to ask about Advanced Materials margins, and I know there's a lot of moving parts. But I'm just wondering if you could help us understand on one side, how much of the margin pressure is on mix, i.e., in the lower growth from the -- or lower sales from the higher-margin business in polymers against the other factor, which seems to be your management working capital and presumably lower production rates? So that's the first question. And then to be greedy I've got 2 quick ones. One is on soda ash. We don't have a lot of good data points, but it looks like Chinese spot prices have been under pressure are you seeing that in the rest of the export market? And the third one on formulations, can you tell us a little bit about volumes in the rest of Novecare so HPC and agro and seeds?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [21]

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Good. Shall I kickoff, perhaps, on Advanced Materials, Ilham?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [22]

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Yes, go ahead, Karim.

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [23]

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Okay. So how much of the margin compression was due to mix, I'll tell you there are 3 factors and I have alluded to them: one is the onetime, which is not recurring from the Cytec medical that's about 1% in its own right. And where the fixed cost, which I'd say, is good, it's an investment, we see the examples to the reduction in waste and efficiency that Ilham mentioned as well. And then finally, there is an element of mix, clearly. Smart devices such as -- all of these things have an impact. So these are the main components. So first soda ash and China. Do you want to take this? Do you want to it, Ilham? So on China and soda ash the fact of the matter is this we -- let me just think about that.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [24]

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Let me do it. Soda ash, I mean, I am very, very pleased with the pricing, right? You've seen it, the team is leading the way, supply and demand very tight and you're right, we've seen some decrease of soda ash prices in China was mainly linked to some strong production over there, but prices have moderated in recent years. So although we are not directly impacted by the Chinese market as we don't produce or sell there, historically, we have seen that some Chinese exports to the seaborne market, which we supply obviously, increased when Chinese domestic prices dropped. Overall, we have seen and we are not expecting any significant impacts on the seaborne market, and as you know, the U.S. and Europe, the market conditions are extremely balanced in terms of supply and demand and should remain balanced throughout this second half. We have yearly pricing so our pricing is pretty robust throughout the second half of the year. Is that clear?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [25]

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May be to quickly respond to that third question as well but formulation is doing really well, if you look out of the few -- look at the asset beyond oil and gas, there's strength, there's some growth in Agro, in coating, HPC is being very resilient, we are seeing some good pricing, some good mix and strong volumes. Unfortunately, when you look at the totality and what happens with oil and gas, you don't see it comes through to the bottom line.

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Operator [26]

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Next question comes from Ben Gorman from UBS.

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Ben Gorman, UBS Investment Bank, Research Division - Associate Analyst [27]

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I just have a few quick ones for me. First of all, in terms of your exit rate from June, can you just give a bit of an idea in terms of what you're seeing there? And in July as well particularly in obviously, autos and aerospace? And then secondly, just on the gross margin, if I'm looking at it correctly, it looks like not too much of a sequential down in Q2 versus Q1, but I just sort of wonder why that is and necessarily in terms of what we've seen with aerospace still very strong and et cetera. And pricing still very strong. So just those 2 for me.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [28]

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Maybe I start, Karim, on this. Well, first of all, I mean, like in quarter 1, I mean, you've seen what's happened in quarter 2. For us, growth in aerospace, mining, agro, aroma, performance specifically was offset by the headwinds auto, electronics and oil and gas. As you know, auto, electronics and oil and gas all combined represents approximately 25% of the group sales, and we remain challenging. We don't see much improvement there. Having said that, the -- for us, aerospace with double digits growth will remain very strong in quarter 3 and is expected to moderate from the level in the first half, mainly due to seasonality, right? And some destocking in quarter 4 but this is again factored in our guidance. We believe that the markets, as I just mentioned earlier, on soda ash but also peroxides in Performance Chemicals serve in mainly the building & construction, which has been extremely resilient will remain healthy with solid pricing throughout the year. We're happy with the mining market, is expected again to remain robust in the second half and we're pursuing as we shared with you some new business opportunities. So finally, I mean, diversified portfolio has demonstrated resilience, coupled with what I call our 3Cs of the focus; cost, cash, and customers. Pricing being part of it. Pricing doesn't mean only pricing for customers, but also as you've seen renegotiating our purchasing contracts with our suppliers, whenever it makes sense. So that gives us confidence in reaching 2019 guidance, Karim?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [29]

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To second question, I wanted to try to not particularly point to Ilham, but maybe on the second question that [Laurent] asked how come we don't see a bigger variation in margins Q2 versus Q1, I mean there are many moving parts. What I would say is that the mitigation the way that business is adapting, has to be what it is and we've seen the impact of that. And that's really aggressive, some of the headwinds we've seen head-on. It is worth noting that we also have, and we have mentioned it, that in Q2, there is the fixed cost impact on the targeted inventory reduction, particularly, Specialty Polymers. So that's one of the ways we've really driven strong cash but the outcome of that is you see an impact on fixed cost. You could say, I am not going to say it's a one-off, but it has an impact that's worth taking into account so the underlying margin in Q2 is even stronger if you took that into account, okay?

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Operator [30]

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Next question comes from Mutlu Gundogan from ABN AMRO.

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Mutlu Gundogan, ABN AMRO Bank N.V., Research Division - Analyst [31]

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The first question is on the outlook actually because if I compare to Q1 and also at the beginning of the year, you sound definitely a bit more cautious on certain important end markets within Advanced Materials and Advanced Formulations, but nevertheless, you reiterate your guidance. Can you tell us why that is? And just to be certain, are there any one-offs in the second half that you already know? Just to be clear about that. And then secondly, on the earnings from associates and joint ventures, this was EUR 23 million versus EUR 50 million last year, you indicated in press release that it was driven by your Russian PVC joint venture, can you give us a little bit background on what was driving that? Is this is a structural uplift in earnings or more a onetime event?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [32]

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Yes, Mutlu, I will take your question 1 and Karim question 2. I am not sure if you're cautious or realistic, right? I mean, in quarter 1, when we came in, we realistically shared with you our view of 2019 development. And as I mentioned, just assuming it's a go, at that time we didn't see much of the auto -- any major pick up in auto, electronics and oil and gas, unfortunately, it happened that we were, yes, realistic then others so I think that's what happened. We put the guidance there, our quarter 2 is in line with our expectations, we did exactly what we told you we were going to do. We mobilized the team as soon as the 1st of March. And again, on the 3Cs called the cash, cost and customers and pricing, and we will continue doing so because indeed there is still some volatility uncertainty out there and we will continue some measures, some of them are austerity measures, others will be more structural measures to really, you know, just raise the bar on execution, innovation, collaboration, and stay closer to our customers. So we have every confidence today in reaching our 2019 guidelines.

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [33]

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Absolutely, maybe just to add, we are not anticipating any significant one-off or anything like that, this is really around mitigating in an environment that we think, realistically, will be quite challenging. Onto second point around the equity earnings, I think, the only point to have note is that RusVinyl joint venture in Russia, on PVC, is doing really well. It's about EUR 10 million up year-on-year, majority of that is in Q2, and essentially, we're benefiting from high -- from very favorable spread in PVC and that's what you get, that's it.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [34]

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And maybe to close the loop on your question may be on the cash guidance because I gave you probably too high-level answer. You will notice our cash flow is always back-ended to the second half, as you know, the free cash flow guidance implies that we need to deliver a minimum of EUR 460 million in the second half, which compares -- if you remember, to EUR 580 million in the first half of 2018. So we will maintain, again the strong discipline on resources allocation, the CapEx allocation and on working capital, which is now centralized and in the hands of our executive committee. Though, again, we also anticipate some modest rebuilding inventory to make sure we can meet our customer's needs.

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Operator [35]

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Next question comes from Chetan Udeshi from JP Morgan.

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Chetan Udeshi, JP Morgan Chase & Co, Research Division - Research Analyst [36]

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I had a couple of questions. Firstly on at PFAS. Have you recognized any provisions already associated with any spending that you might have to do. That's number one question. Second question I had was just to understand the CO2 credit strategy of the company because at the moment, it seems that prices have been going up consistently over the last 18 months and maybe most companies would be wanting to preserve whatever they can preserve, just given that it seems the prices have more room to go up, then come down. So in that context, maybe can you probably discuss what is the current bank of credits that you have existing? And what is the strategy on making sure you have enough flexibility, in case, the prices go up in the future?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [37]

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Okay. Chetan, so I will start and Karim will address to the second question. On PFAS, as Karim mentioned previously, we believe we have adequately provision for existing methods related to PFAS given the information we have. Again, because we received some questions I wanted to ensure we address them. This is a highly technical and complex topic as I said in the past we purchased processing aid containing those 2 substances, we never manufactured or sold such processing aids ourselves like others in the market, and importantly, we voluntarily phased out of these substances ahead of this schedule, right? 2010, 2013 set by the EPA. So what I can tell you, I will leave you with, we hold ourselves to high standards of safety and sustainability, which I care passionately about, personally. Karim, on the second question?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [38]

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Let me just add one point, just actually, you remember that our provisions at the end of last year were EUR 691 million, now they are EUR 707 million. So A, we have not increased our provisions materially at all, in that period. And you heard me say that we are comfortable with the degree of our provisions based on everything we know today. Now, obviously, I'm not going to get into the specifics of what I've provided for or not but that will tell you a lot already. So for this year to credit strategy, leaving aside what I have described rather Polyamide business and this EUR 30 million of cash. Fundamentally our strategy is, what you asked, is that we hedge forward and we cover for our net exposures looking forward over time. And this is, sort of, around anticipating and having visibility on our landing. That's what we were talking about. Does that help Chetan?

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Chetan Udeshi, JP Morgan Chase & Co, Research Division - Research Analyst [39]

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Yes. Maybe just follow up, does the sale -- because you know, I think, the Q2 sale was recognized as part of the discontinued operations or does that have any impact on the deal value with BASF at all?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [40]

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No. Not at all.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [41]

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No. Not at all. It's from the past so not at all.

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Operator [42]

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Next question comes from Charlie Webb from Morgan Stanley.

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Charles L. Webb, Morgan Stanley, Research Division - Equity Analyst [43]

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Just a few for me, mostly quantification questions or clarification. So just on the PFAS have you been in discussion with EPA, has EPA given any sense to you how broad this investigation is? And as you think about the provisions that you've put in place that you think are suitable, so that does relate to the plants or the sites that in theory handle the process such materials, is that where it is now isolated to? First question. Second question in terms of Specialty Chemicals, you talk about, no improvement. As we look at the second half, is that given the comp effects, does that mean we should expect flattish development in the second half? Or you're still trending negative in Specialty Polymers in the second half? That's number 2. And then just on a soda ash, I understand of the, kind of, contracts structure implies that pricing is still very robust and through the second half of this year, but perhaps, typically when you see pricing come down in the seaborne market to a degree of price deflation in the next round of contract as we look into 2020, just maybe some kind of comment on that would be helpful.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [44]

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First starts, Charlie, with the PFAS and then Karim will address the 2 other questions. As I said, we are working in full transparency and together, first, with the local and regional authorities. The EPA, the Environmental Protection Agency, has set up a voluntary program to phase out PFOA by 2015, all right, as I mentioned. And we joined, actually, the voluntary program back half I think even before probably 2010 for sure. And we stopped using one substance called PFNA by 2010 and PFOA by 2013, so years ahead of the program's deadline which was 2015. But again, I think I would like to be very clear with all of you is that Solvay didn't produce or sell these processing aids and that's important to keep in mind. And today our provisions, as Karim said, are adequately in the books. Karim?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [45]

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To other 2 points, so what can you expect in H2, by definition if you know that first half, we're down 3.1% EBITDA and we reconfirmed our guidance. It would suggest because we also said modestly down means up to about minus 3% thereabout. It, kind of, means flattish. But remember, we also said Q3 would be somewhat more challenging, purely, because of the comp basis. Soda ash, fundamentally, we're not seeing any disruption in the seaborne market and we are solid and the market remains balanced. So we're very confident that we can work with our customers to get to a decent outcome and that's what our folks are working on right now.

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Operator [46]

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Next question comes from Laurence Alexander from Jefferies.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [47]

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I guess, couple of quantifications. Can you quantify the amount of inventory drag on EBIDTA this quarter? And how volumes did in electronics and automotive, so we can see the impact of destocking relative to the end market trends? And then secondly, on the PFOA, PFNA, PFOS questions, just to be clear does Solvay have any PFAS use in products, in your own processes, such that if European regulations change, or if there are phase-outs in the U.S. Solvay would need to find substitutes?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [48]

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Returning to your first question. I think the answer is inventory is down significantly. I think in the second quarter if you remember we talking, EUR 133 million and that you can see from a cash point of view. The fixed cost impact well, they're getting into overly precise numbers. We're talking low double digits EBITDA impact in Q2, I remember. That begins to compensate for the gain from having higher inventories in Q1. So far as PFOA, Ilham?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [49]

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Yes, I can take it. I'm can take it, Laurence. So, yes, I mean, as I said, PFAS are a very large family of literally, probably, thousands of substrates, they are used in a wide variety of consumer products and industrial application and have probably different physical and chemical properties and uses and that's why it's technically, extremely complex. As I said, we exited PFOA, PFNA through this voluntarily EPA request and to replace the processing aids containing PFOA and PFNA we developed and produced certain other processing aids that are PFOA and PFNA free and are proprietary. These are exclusively produced for our internal use. We don't, again, sell any processing aids, these replacements are using compliance with the existing laws and regulation. Now we are obviously, continue monitoring that and we have our own innovation, which is -- I don't want to get ahead of time to explain a bit our strategies, but we will tell you more after developing our roadmap for the future.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [50]

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Is there any way you could quantify just to, sort of, because, at some point, there is a kind of headline risk around this. Is there a way you can quantify the amount of your total sales that is touched by PFAS chemistries just so people can, at least, ring-fence it in their minds?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [51]

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That's not information we currently have to hand. Laurence what I do know is that, we have looked at that, theoretically, at that exposure and remember we just don't sell PFOA, it's a processing aid, so you use with sales so very difficult to answer that specific question, but again, we have looked at the exposures and we are very, very comfortable with everything that's been done.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [52]

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And Laurence, that's important, we're not selling any of these. So any processing aids being used is used internally, right? And again, they are PFOA and PFNA free. So that's important for you to remember.

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Operator [53]

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Your next question comes from Sebastian Bray from Berenberg.

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Sebastian Christian Bray, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [54]

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I would have 2, please. And just a quick one on the sale of the carbon credits from the business due to go to BASF. I know Chetan has asked this previously but is this just simply something not covered by the contract with EUR 60 million of the value is taken out of that business, but the purchase price remains unchanged? It just feels a bit strange. The second question is on Silica, how is pricing and -- how pricing and volumes developing in this division as we move into 2020? Do you see the capacity situation globally as broadly balanced?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [55]

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Okay. Sebastian to your first question, I think the sale of these carbon credits is, historically we have done at a very low value because they're free allocation of carbon credits so essentially it's not at all a feature that's unusual it's operational in nature. We just happen to have had them and decided when is the right time to monetize them. The conditions in Q2 motivated us, notice as simple as that. But it's not -- it's something we have accumulated over a couple of years that we have not monetized. As I said no impact on the contract.

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Sebastian Christian Bray, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [56]

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So would they have passed to BASF, had they not been sold?

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [57]

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It would've been a gift to any future acquirer and would not do that, we don't do that. And it was as given on our balance sheet which is why it goes straight to the bottom line in cash.

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [58]

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Okay. Clear? Yes. So on Silica. I can take it. Silica sales, as you know, we are flat with the resilient demand from the fuel-efficient tire market. Growth in specialties compensated for slightly lower price on other grades, we did better than the market. As you may know, surely you know, our Silica business is about 2/3 replacement tire business, which provides resilience during these times. You may have seen recent news with some of our international customers announcing certain plant closures because they're feeling the pressure from Chinese competition in the tire market. These announcements don't impact us given the structure of our contract. However, but it does point to the intense competitive pressures in these markets. So the way to do best is to innovate and be ahead, then have the lowest total cost of ownership. So as I mentioned and I was glad to share it with you in my prepared remark despite the challenging environment, we have been introducing our new premium technology for the tire market. This solution features 25% less rolling resistance, thereby, reducing the fuel consumption and the CO2 emission by 7%, normally, this cycle is, at least, 5 to 7 years for doing that and we're launching it after 18 months. So when our customers, they start putting money in industrial trials with our new premium technology, it tells me that we have something there and that's a good news for us.

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Operator [59]

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Your next question comes from Markus Mayer from Baader-Helvea.

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Markus Mayer, Baader-Helvea Equity Research - Lead Analyst of Chemicals [60]

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Two questions from my side. Markus Mayer from Baader-Helvea. Coming back to this corporate cost question, sorry for this, but I am still not absolutely clear, what you've meant before. You said year-over-year the holding cost should be flat or basically the full year -- holding cost of last year is a good guidance so this would mean that the holding cost in the second half would up -- would be up by roughly EUR 18 million to EUR 20 million. And maybe you can shed some more light on this where are those positive effects from cost savings are going to? And how much extra cost from this, kind of, digitalization measures are landing then in the second half? That's my first question. And the second question is on the peroxides business, how do you see demand evolving for the second half and also do you expect that the price increases they have to stick in the second half?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [61]

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So Karim.

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Karim Hajjar, Solvay SA - CFO & Member of the Executive Committee [62]

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Markus on the corporate cost, and I'm not going to start giving very granular, tiny information on things, like, how much we putting into digital, et cetera. The debt material counting us be very, very [openly says] with what we're doing. What am I saying? I'm saying that if you look at the phasing last year of our corporate cost and the year before you'll find that we typically have a back-ended phasing through our corporate cost and that's a fact. What I've also said is this year we expect that to be repeated. Last year Corporate & Business Services came to just under EUR 0.2 billion on a constant foreign exchange basis. And I've also explained that I expect to land at around that level by year-end and we have integrated that. What it means is that we're offsetting inflation, we are maintaining that discipline and we are choosing to reinvest for future value creation, Ilham?

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Ilham Kadri, Solvay SA - Chairman of the Executive Committee, CEO & Director [63]

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Yes, on the peroxide. As we know, peroxide is about 25% of the Performance Chemicals or 7% of the group sales. It continues to benefit from good momentum and stable environment. I am very pleased with the performance of this business. The higher price in Europe more than compensated for some decline in Asia we have seen. As you may know, almost 45% of our sales are using the certain seaborne market and building and construction markets combined, which basically have shown some resilience. On your question on how the prices are sustainable, so far, the conditions are stable, they're expected to continue, specifically in Europe and in the U.S. As I said, Asia is a bit more challenging as competition is putting some pressure, but we're up to it. As a reminder as well, HPPO supply to the mega PO producers are protected by contracts we have guaranteed return mechanism. So we have a long-term contract with the major worldwide player and Solvay enjoys more than 70% of the worldwide capacity with guaranteed returns, so it's an excellent business, and we see it stable throughout the second half of the year.

 

Okay. Shall we close? Yes. Okay. So thank you very much. Thank you for your questions and interest in our stock. In summary, we are taking actions to drive change and improvements across the group, and we're very excited about the opportunities ahead. Our main focus remains to focus on executing on our operational and financial goal. This is even more essential in these uncertain environments. I am asking our team to continue to raise the bar on 3 things, execution, innovation and collaboration. And we're also hard at work on our deep dive of the group strategy, and I look forward with Karim and the team to updating you on our third quarter conference call. So with that, I thank you all for your attention, and I wish you a good summer.

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Operator [64]

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Ladies and gentlemen, this concludes today's conference call. Thank you all for your participation, you may now disconnect.