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Edited Transcript of TUPY3.SA earnings conference call or presentation 15-Aug-19 2:01pm GMT

Q2 2019 Tupy SA Earnings Call

Aug 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Tupy SA earnings conference call or presentation Thursday, August 15, 2019 at 2:01:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Fernando Cestar de Rizzo

Tupy S.A. - CEO & Member of the Board of Officers

* Thiago Fontoura Struminski

Tupy S.A. - CFO & VP of the Board of Officers

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Conference Call Participants

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* Catherine Kiselar

BB-Banco de Investimento S.A., Research Division - Analyst

* Lucas Marquiori

J. Safra Corretora de Valores e Cambio Ltda, Research Division - Former Research Analyst

* Marcelo Garaldi Motta

JP Morgan Chase & Co, Research Division - Research Analyst

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Presentation

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Operator [1]

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[Interpreted] Good morning. Thank you for waiting. We'd like to welcome you for the Conference Call for the Earnings of Q2 2019 for Tupy. (Operator Instructions).

This conference call is being recorded. The company would like to remind you that this event is also being transmitted on the web via webcast. You can access at www.tupy.com.br/ri, where you will find the deck of slides. The slides will be controlled by you. The company clarifies that any declarations made during the conference call, concerning business perspectives, projections, or operational goals and financial goals concerning Tupy's business are all forecast based on the administration's beliefs.

These expectations are highly dependent on international and national market conditions and the economic performance of the sector, therefore, subject to change.

With us, we have Mr. Fernando Cestar de Rizzo; Chairman of the company; and Thiago Struminski, Vice President of Finance, Administration and Controls. Mr. Fernando, you have the floor.

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [2]

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Good morning to all. I thank you all for your participation in our conference call for the earnings of Tupy. After first semester marked by many operational instabilities in the month of January and February, our team delivered excellent results reaching the highest adjusted EBITDA revenue of the company, and also the highest physical sales in the last 5 years, independent of the suspension of our activities in the foundry in Mauá.

Also we have been also able to execute our commercial strategy. We increased prices, we increased our share in high value added products and CGI from 14% to 21%. We expanded our machining operations from 21% to 25%. This new product mix together with internal initiatives involving cost reduction and increase in efficiency, contributed to increase significantly our margins in relation to Q1 '19. In relation to last year, we have a growth in gross margin and independent of the effects of the truck drivers' strike last year, we had an -- we had these good results, and also we had also the return of taxes on payroll, and also a reduction in benefits for companies that exports, and also the return of the freight's price-list adopted by the government, which totaled BRL 23 million, and had an impact on our margins circa 150 basis points.

In spite of these effects, it is important that the company was able to increase the volume and revenue on its asset base. So we saw significant growth and this superior to 23% higher net profit, and in terms of capital allocation, we had a reduction of 8 days in the cash conversion cycle, in relation to the same period last year. The results presented in Q2 '19 show that we are on the right track. But we are seeing also many other opportunities to grow revenue and increase margins due to a better product mix, new contracts and internal improvements, especially in the operations in Mexico.

This year, we were able to begin important projects with more CGI and we began to ramp up the delivery of finishing with a total of 50 machines and the 20 that we already had plus these 20. Now we would like to talk about the indicators, and I would like to invite Thiago.

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Thiago Fontoura Struminski, Tupy S.A. - CFO & VP of the Board of Officers [3]

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Thank you, Fernando. Slide #3. We had a volume of 154,000 tons, 1.7 higher than Q2 '18, a greater -- the highest value in the last 5 years, especially in the internal markets and also in terms of the volume of transportation infrastructure and agriculture, 25% more -- 25% of partially machined products and 21% CGI.

In both cases, we observed an increase in the participation, both in the comparison with Q2 '18 and also Q1 '19 with the launching and ramp-up of new products.

On Slide 4, we see the revenue increasing 15%, reaching BRL 1.405 billion, the highest in the company's history. In the domestic market, we saw an expressive growth of 27%. In the export market we grew 13%. It is important to highlight the recovery of the domestic market, many of our clients use our

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products. Commercial vehicles had a growth of 51%, machines that operate equipment had a drop of 2%.

On Slide 6, the revenues from the export market were impacted by the phase in and ramp-up of products, and increasing participation of high value-added products and CGI and machine products. An increase of 19% in passenger vehicles, 16% in commercial vehicles, expansion of 21% in medium and heavy commercial vehicles.

Here on Slide 3 (sic) [7], we see a volume of 154,000 tons, 1.7 higher than in Q2 '18, much higher than in the last 5 years, with a highlight to the domestic markets. Also here we see the volume of transportation, infrastructure and agriculture, 25% were totally or partially machines, on -- here on -- we have here, again, the numbers, we had a gross margin of 17.5%. In spite of the increase in margin, the comparison was also effected by the truck drivers' strike last year and also, higher taxes, higher taxes on payroll, with a negative impact of BRL 23 million in this quarter.

In this period, we highlight the increase of 14% in the cost per -- with raw materials, due to the price increase in relation to last year, including the minimum freight price list adopted by the government, also devaluation of our currency in Brazil, we have many expenses in our operations in Mexico, in U.S. dollars.

Also an increase in the consumption of high priced raw materials, a growth of 21% in the expenses with labor, also employees participation in profits and social benefits, new programs, and also, an impact of higher taxes on payroll. An increase of 15% in cost, with maintenance, materials and third-parties, due to, again, the new operations in Mexico, and also, maintenance that we had to in the Joinville plants.

Operational expenses increased by 26%, especially due to greater expenses with labor, freight and commissions on sales, due to the increase in volume and also the exchange rates. We also had an impact due to the freight price list -- minimum freight price list adopted by the government and also higher taxes on payrolls.

Slide #9. Adjusted EBITDA reached BRL 204 million, highest value in the company's history, an increase of 30% in relation to Q2 '18 with a margin of 14.6%, an increase, substantial increase, of 390 basis points in relation to the margin observed in the first quarter of 2019, and when we had also some stops in the plant to ramp up in Mexico, unplanned stops. On the bottom of the slide, we see the net profit, BRL 59 million, in comparison with BRL 48 million in Q2 '18.

On Slide 10, we see the variation of the main accounts of working capital, an increase of BRL 107 million in accounts receivable, with a reduction of 6-days in sales, an increase in inventory levels, BRL 55 million, with a reduction of 6-days coming from more efficiency in the operations, and an increment of BRL 93 million in accounts payable with a reduction of 4-days.

On next Slide #11, we see investments totaling BRL 74 million, 5.3% of the revenue. This increase is related to the new contracts that contributed for our growth, both in CGI and machining. Also we allocated new resources in productivity increase and automation, and also new projects for the environment and safety.

The investments made in the first 6 months of 2019 reached BRL 120 million and represent 4.5% of net revenue in the period. And this continues to be lower than our level of depreciation.

Slide 12. Operational cash generation, BRL 75.5 million, this was impacted by the increase in the consumption of working capital, and also in the cash conversion cycle in relation to Q1 '19, especially due to the strong growth in sales and non-receive -- and some -- also some clients that will pay in the next quarter, this is a seasonal effect.

On Slide #13, net debt BRL 921 million, corresponding to 1.34x adjusted EBITDA in the last 12 months. The obligation from foreign currency represent 98%, which is in line with our business profile. Most of this debt is represented by our bond with a maturity in 2024. In relation to cash, 36% are in local currency, reals. Now I'd like to pass the floor to Fernando. He will make his final comments on the quarter.

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [4]

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Thank you, Thiago. Well, since 2017, we carried out many initiatives to increase the return on capital invested. We began with a suspension of the operations of our foundry in Mauá. We sold another unit and also plots of lands, reducing our assets and also making our alliance more and more efficient. So in terms, we were able to have more new products that are more complex and our total volume grew since -- grew 10% since 2017, and the revenue, more than 52%, in spite of removing 15% of our capacity for the production of heads and blocks.

The strong sales also brought a lot of overtime and more expenses with energy and maintenance. In this sense, a slowdown will allow us, really, to decrease our cost. The result of this process, in 24 months, brought ROI to 11%. Historically, it was below this. Still we recognized that there are many opportunities for us to be more efficient, and speaking about contracts involving manufacturing and investments in our automation and technologies in Industry 4.0.

And also many improvements, as in purchasing. This happened also in other areas due to improvements in our organization end. We have also hired new talent that will help us in the challenges in all the areas in the company. Many of these initiatives we mentioned and they begin to deliver results now in Q2.

Well, as you have seen the demand for CGI and machines products have contributed a lot for the company's revenue. Soon this will also affect our margins, increasing our margins. So we have new products that we launched in 2019. Also in relation to margin, we have seen an increase in relation to the previous quarter, especially in our operations in Brazil. I must say, the great impact of BRL 23 million in EBIDTA in this semester due to the truck drivers' strike. If we were to compare our performance considering this loss, our growth would be even higher and the adjusted margin would reach 16%. In practice, this means that the company is much better, more efficient and has many opportunities to add value in our installations.

And to conclude, I reinforce that we continue with a diversified portfolio many -- with many new clients, products and new geographies, which have different cycles and different opportunities. This is helping us to navigate better, in case we have a fluctuation in the future.

Concerning geographies, the recovery of the domestic market is very positive for Tupy, considering the strong presence of our clients in agriculture, heavy vehicles, and also structural components that have high value-added for this second semester. We are expecting volumes to slow down a little, especially CGI and machine products.

In terms of operations this will contribute for a greater gain in efficiency with a better usage of the equipment and implementation of projects aiming at better productivity that we are carrying out. If necessary, we have many opportunities to defend ourselves. We are reducing fixed cost and preserving margins if we have a fluctuation in demand.

We have said this in previous calls, we are well prepared for new situations. We trust in the -- in this fundaments of our industry and global growth, and also especially great needs in sanitation; food; transportation; finally, a better quality of life.

We continue to look for new opportunities to generate value to our shareholders with special attention to capital allocation and continuous evaluation of our assets, monetization of credits and opportunities for strategic projects. I thank you all for your attention, and now we will begin the Q&A session. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question, Lucas Marquiori, BTG.

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Lucas Marquiori, J. Safra Corretora de Valores e Cambio Ltda, Research Division - Former Research Analyst [2]

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Two questions. The first, Fernando, we see 64% of the revenue coming from the U.S., we are concerned with -- in the markets with the increase in demand in the U.S. You mentioned that you expect slower volumes. How are you seeing demands? And do you expect the greater slowdown in other sectors? Please give us some details, where you expect more of a slowdown.

The second question's about the closing of the plant in Mauá. Will this continue? Do we have more accruals provisions?

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [3]

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Lucas, thank you for the questions. Let's begin with the market, what do we see in our portfolio? In the domestic market, we see a higher level of sales and maintaining this higher level of sales. So all the effects of Argentina which were felt in Q1, we had growth in Brazil and production had a slower growth due to less exports -- export of vehicles from Brazil. In the U.S, as you asked, in off-road, we saw a reduction in Q1 already. If you look at the data that we presented for Q2 and the number that is not there, we had a reduction in volume of 11%. This has been happening since Q1.

So this sector, we are looking at the demand, we're analyzing the demand, the availability in dealerships of construction equipment. There is an expectation to sell this equipment because the equipment in the market is getting older. And we believe that we should see this situation, which is lower than in 2018.

So another factor, pickup sector -- the pickup sector is still strong, very strong. So the sector is less affected, and we hope a strong volume with this. So we have a small share in the U.S. in terms of lights, trucks, sedans and smaller cars. These are less relevant in this context. That's why we believe that there will be a slowdown but what we believe, this has already happened.

We also -- we have many mechanisms ready to defend ourselves, for example, movement of products between plants, and we are working to sell more complex and more expensive products. We have been operating since 2018. We have been working on weekends with higher cost of energy and labor and maintenance. This is not good. This hurts the company's operation.

We are very capital-intensive and the equipment has to work with high efficiency. So in Brazil, we are improving efficiency, we had extraordinary results in our operations in Brazil, due to the transfer of products from Mauá, we are capturing value, and in Mexico, we have new products.

We have not received the results of this. We believe that now -- from now on we will be able to capture the benefit of this portfolio, which brings us a better revenue, more CGI, but we have not captured all the gains we can capture in margin.

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Thiago Fontoura Struminski, Tupy S.A. - CFO & VP of the Board of Officers [4]

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Concerning the second question, Thiago speaking, so we have provisions, we had accruals due to labor court actions, when we closed the plant in Mauá. We believe that the majority of the topics links to Mauá have already been solved. We have -- we still have labor court's processes involving employees in terms of Mauá. So we have been working on this.

What did we do? We adjusted the labor hours -- the work hours in trying, really, to avoid labor court actions, and this should reduce the labor contingencies in terms of 8% to 12% in the next few years.

These labor court actions, they -- we have many labor court actions now. This can impact results, BRL 8 million to BRL 11 million by quarter, lower than the concentration we had in this quarter due to some processes in -- from the plant of Mauá.

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Operator [5]

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(Operator Instructions) Our next question comes from Marcelo Motta, JPMorgan.

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Marcelo Garaldi Motta, JP Morgan Chase & Co, Research Division - Research Analyst [6]

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Two questions. Could you comment on working capital? We saw that there was an improvement in relation to Q2 last year. But we see that it was higher than in Q1. How can we improve the efficiency in working capital and M&A? You always talked about discipline and maybe, M&A becomes more attractive.

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [7]

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Marcelo, thank you for the question. In this quarter, we had a lower performance in relation to cash. We had an increase -- seasonal increase that will be solved in the next semester. We have delinquency problems, nonpayment problems in this quarter. But we believe that we will be able to have a better situation in Q3.

Inventory is in line, accounts payable also suffered due to some inventory issues. We believe we can capture more of the positive effects in the next quarters.

Now in terms of M&A, we continue searching for operations that are in-line with our strategy, growing in blocks, engine blocks and heads, in CGI and machining, and we have nothing to inform. We are looking for assets that are in line with our profile and our strategy.

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Operator [8]

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Our next question comes from Catherine Kiselar, Bank of Brazil.

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Catherine Kiselar, BB-Banco de Investimento S.A., Research Division - Analyst [9]

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Congratulations for the results. My question is on cost. We've seen an increase in the quarter, and due to -- with an impact from the operations in Mexico, could you talk about the cost during the first semester? Do we have anything different for this second semester? And a second question, a follow-up on the Mexican plants.

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [10]

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Could you repeat the 2 questions?

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Catherine Kiselar, BB-Banco de Investimento S.A., Research Division - Analyst [11]

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Yes. My first question on cost. This quarter we had a nonrecurring cost impact from Mexico. So cost in the first semester and for the next semesters, will we see changes?

And the second question the Mexican plants, the status of the operations. What we can expect in terms of margin from Mexico?

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [12]

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We have some difficulty in hearing. But we will try to answer. Mexico due to the complexity that was added both in terms of CGI and machining was more complex than we would like. It has -- it can deliver much more margin. Brazil is doing well. So we believe that for our standard of revenue, we see an important upside to be captured in the next semesters. I don't know if this is what you asked.

In terms of inputs, we -- there is a deflation. There is no pressure coming from commodities. This is good for us. We were able to -- so we were able to benefit from lower prices. Now we have to produce more efficiently all these products that we sent to this plant.

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Catherine Kiselar, BB-Banco de Investimento S.A., Research Division - Analyst [13]

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When will the Mexican operation run normally -- in a normal way?

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [14]

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Fernando. We -- it is running now in a much better way than when we bought it. Efficiency is higher than when we bought it but we have our standard in comparison with Brazil. So we have great opportunities to grow there in Mexico. What we expect in 2 to 3 semesters, we hope to have an improvement. At the same time as we are attracting new leaders for the operation, we're also producing new products with very high complexity. So the company has to become more mature.

This -- we have great changes in preparing the metal equipment, products are much more sophisticated than the ones that were produced in the Mexican plant in the past. Although, we had a good margin in the quarter, we understand that there is an enormous potential for more margin because we have this experience in the company.

So the operation delivered a lot of value. We have new products, we built a third machining plant. And this combination of sophisticated products and the new plant, we believe we have great opportunities there. So we believe that in 2, 3 semesters, gradually, we will see improvements in margin in the Mexican operation.

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Catherine Kiselar, BB-Banco de Investimento S.A., Research Division - Analyst [15]

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Could you comment cost in general -- the cost in general? And...

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [16]

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Well, we're observing in general a slowdown in the price of the main inputs, raw materials, this helps us. There is also the exchange rate that is helping, the exchange rate. So the trend is for better cost performance in the next semesters. There are opportunities with some -- we have some things that can benefit us in the next semesters. So we have good expectations for the next semesters. Thank you.

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Operator [17]

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Our next question comes from Lucas Marquiori, BTG.

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Lucas Marquiori, J. Safra Corretora de Valores e Cambio Ltda, Research Division - Former Research Analyst [18]

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Just a quick follow-up. Fernando, you mentioned that the ROIC is around 11% as a result of everything you did. Just to see -- where do you believe you can get by the end of next year, the range?

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [19]

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Well we have our internal goal in auto parts. We have a very superior performance in relation to any other foundry. We understand that the standard of the companies that supply to OEMs for off-roading trucks, we'd like to get to 13%.

We could have reached this going back to your previous question. We were running with a high-volume. We had expressive growth in volumes in some projects, and we had to activate some processes in Mauá to help with the operations in Joinville. We used some assets we had in Mauá. We could -- the foundry worked, really, but we couldn't finish the process. So we had some inefficiencies, until recently, using these things. Same thing happened in Mexico. We ran the operation with very high volumes as mentioned, and we had to work on Saturdays, and all of this results in maintenance costs with a -- and we saw that the higher volumes brought the marginal effect.

So now we have a more balanced situation, this should improve the company's numbers because these very high volumes, really, brought new costs. So especially in off-road, there was a drop. So now we will balance the production. We believe that with a balanced growth, we will be able to deliver a better ROIC.

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Operator [20]

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(Operator Instructions) We'd like to conclude the Q&A session. I'd like to pass the floor to Mr. Fernando for his final comments.

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Fernando Cestar de Rizzo, Tupy S.A. - CEO & Member of the Board of Officers [21]

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Well, once again I thank you for participating in our conference call, and also your trust as investors and analysts of the company. I would like to thank publicly our clients for the trust and partnership and opportunity to develop joint solutions that will be used in the next decades.

Finally, I'd like to thank all the team in Tupy for the excellent work done. I reinforce my commitment and the team's commitment to generate value to you, and we're available with our Investor Relations team to clarify points. Thank you. We wish you a good day.

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Operator [22]

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Tupy's conference call has concluded. Thank you for your participating, and we wish you a good day.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]