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Edited Transcript of TX earnings conference call or presentation 31-Oct-18 1:00pm GMT

Q3 2018 Ternium SA Earnings Call

LUXEMBOURG Oct 31, 2018 (Thomson StreetEvents) -- Edited Transcript of Ternium SA earnings conference call or presentation Wednesday, October 31, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Maximo Vedoya

Ternium S.A. - CEO

* Pablo Daniel Brizzio

Ternium S.A. - CFO

* Sebastián Martí

Ternium S.A. - IR Director

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Conference Call Participants

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* Alfonso Salazar

Scotiabank Global Banking and Markets, Research Division - Director of Metals and Mining

* Carlos De Alba

Morgan Stanley, Research Division - Equity Analyst

* Leonardo Correa

Banco BTG Pactual S.A., Research Division - Research Analyst

* Marcos Assumpção

Itaú Corretora de Valores S.A., Research Division - Sector Head

* Rafael Cunha

Crédit Suisse AG, Research Division - Research Analyst

* Thiago K. Lofiego

Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst

* Timna Beth Tanners

BofA Merrill Lynch, Research Division - MD

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Presentation

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Operator [1]

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Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Ternium Third Quarter 2018 Results Conference Call. (Operator Instructions) Thank you.

Sebastián Martí, you may begin your conference.

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Sebastián Martí, Ternium S.A. - IR Director [2]

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Good morning. Thank you for joining us today. My name is Sebastián Martí, and I'm Ternium's Investor Relations Director.

Ternium issued a press release yesterday detailing its results for the third quarter 2018. This call is complementary to that presentation.

Joining me today is Mr. Maximo Vedoya, Ternium's CEO; and Mr. Pablo Brizzio, Ternium's CFO, who will discuss Ternium's business environment and performance in the third quarter 2018. At the conclusion of our prepared remarks, we will open up the call to your questions.

Before we begin, I would like to remind you that this conference call contains forward-looking information and that actual results may vary from those expressed or implied. Factors that could affect results are contained in our filings with the Securities and Exchange Commission and on Page 2 in today's webcast presentation.

With that, I'll turn the call over to Mr. Vedoya.

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Maximo Vedoya, Ternium S.A. - CEO [3]

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Thank you, Sebastián. Good morning, and thanks all for participating in this call. As usually, I will make some brief comments about our performance and the current state of our main market, and then I'll ask Pablo to review our results in the third quarter of the year. Later, we'll go into a Q&A session.

Well, as you read, we reported a record EBITDA level in this third quarter. In the first 9 months of 2018, Ternium's EBITDA reached $2.1 billion, a 50% increase compared to the same period last year. So far, in 2018, we've had a 25% EBITDA margin, equivalent to an EBITDA per ton of $215. We expect to report happily EBITDA again in the fourth quarter of the year, although lower than the EBITDA levels we just reported for the third quarter, mainly as a result of sequential decrease in EBITDA margins.

The very strong operating performance Ternium showed in the first 9 months of the year translated into earnings per ADS of $5.79. On the other hand, even after the acquisition of CSA in September of last year, Ternium's balance sheet is solid -- is as solid as ever. Free cash flow generation has been strong so far in 2018, reaching $847 million in the first 9 months of the year, taking net debt just to $2.1 billion as of the end of September. This is just 0.8x last 12 months EBITDA.

Going to the develop of our main markets. Since our last call, Mexico, the U.S. and Canada successfully renegotiate NAFTA. Well, now, it's renamed USMCA, but let me just refer to it as new NAFTA in this conference call. For us, this is a very positive development. The new NAFTA changed some things in -- than from the original NAFTA agreement, makes some things a little tougher. But in generally, we see this as a positive for the industry. This agreement also significantly reduced the uncertainty that was preventing many investment decisions from going ahead during the last year. I will not go into the details of this new agreement. I'm sure that you already have gone through it, and we can expand in the Q&A session.

But I would like to point out that the introduction of several changes, particularly to the rule of origins, mainly in the auto industry, should ensure a much higher participation in the final product of regionally produced high-end steel. There were no rules on the original NAFTA related to the steel content in car. So these are very good news for us, for Ternium, as one of the main avenues of growth for our company over the last year has been the expansion and sophistication of our high-end steel production facilities targeting the auto industry. We built our Pesqueria facility in Mexico 5 years ago, then last year, we acquired a state-of-the-art slab mill in Brazil. And a couple of months -- a year ago, we announced the investment program to further expand the capacity of the Pesqueria facility and to integrate it with our new slab mill. This growth path will bring Ternium to a much competitive position as a provider of high-end steel products in the Mexican market.

As I said, we are very pleased with the new NAFTA, but I think there are still some issues of trade that are not yet solved, mainly the application of the Section 232 from the U.S. to Mexico. When the U.S. imposed a 25% tariff to imports of steel from most countries in the world, Mexico and Canada were not exempted. Now that the 3 countries have reached an agreement on this new NAFTA, it make no sense to maintain Section 232 tariff for Mexico and Canada, and this will probably change when the 3 countries formalize the agreement.

What remains to be seen is how this is going to change, if Mexico and Canada are going to be exempted from the current tariff or if there is going to be a quota system like the one negotiated between the U.S. and other countries like Brazil, South Korea and Argentina. Ternium doesn't export much steel to the U.S., but our position and the position of all the Mexicans in the industry is that Mexico should be exempted. At the end, the U.S. export more steel to Mexico than the other way around. So any tariff of quota imposed to Mexico should be mirrored by the Mexican government, and this would hurt more the U.S. than the Mexican steel producers.

Let me now turn to Argentina. So we mentioned in our last call, the economic situation in Argentina changed significantly during the last couple of quarters as international financial market lost confidence in the country, and there were less favorable financing conditions for emerging markets in the world. Following a 30% depreciation of the Argentinian peso in the second quarter of 2018, the currency depreciate another 30% in the third quarter. This prompt another increase of interest rate, taking them to an annual level of around 70%, which stabilize the local currency market at a cost of strongly affecting economic activity.

Everything points out to slow shipments in Argentina in the fourth quarter as well as in the first quarter of 2019, which is -- which, in Argentina, this first quarter is a seasonally weak quarter. After this, we have better prospects for the country, with the election uncertainty in Brazil over and ongoing process to stabilize the fiscal balance in Argentina, our recovery of the agribusiness activity and a continuous strength in the energy sector.

Finally, in the third quarter, we began applying IAS 29 to the financial reporting of our Argentine subsidiaries. This have several effects in the accounting mechanism from the third quarter 2018 and on. Also, we have to reexpress accordingly the first and second quarter of the year. Pablo will expand on this later.

Regarding Ternium's expansion project. The work at Pesqueria facility and Colombia are advancing on plan. The new galvanizing and pre-painting lines in Pesqueria should be up and running during the first half of next year.

So with all these, we are very excited with the changes Ternium is going through and the opportunities they will bring us to increase shareholder value.

All right. Please, Pablo, go ahead with the comments about our performance in the third quarter.

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Pablo Daniel Brizzio, Ternium S.A. - CFO [4]

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Thanks, Maximo. Good morning, and thank you all for participating in our call. As Maximo said, let's review now the performance of the third quarter and the first 9 months of the year.

As already anticipated, our performance in the third quarter was exceptional, with record EBITDA level of $833 -- $832 million, higher than the EBITDA in the second quarter and significantly higher compared to the same quarter last year.

Before we continue, let me remind you that starting in the third quarter, we have applied the International Accounting Standard 29 to the financial reporting of Ternium's Argentine subsidiary. This means that financial reporting of our subsidiary in Argentina has been adjusted to take into account the effect of inflation. Consequently, figures for the fourth -- for the first and the second quarter of the year have been reexpressed to reflect end-of-September constant value of the Argentine peso. This is why you will find that figures reported in yesterday press release for the first and the second quarter of the year differed from the original disclosed one.

Going now to Page 3 in the webcast presentation and looking at Ternium's EBITDA per ton on the lower left side and EBITDA margin on the higher right side. We reported a margin of $265 per ton in the third quarter or 29% of net sales as revenue per ton increased and operating cost per ton decreased.

As for net income, in the second (sic) [third] quarter, we reported $523 million, equivalent to earnings per ADS of $2.49. This means $0.93 sequential increase due mainly to higher operating income and lower effective tax rate, partially offset by higher net financial expenses.

We will now review in the next page our shipments performance. In the third quarter, finished steel shipments decreased in Mexico and Southern Region and remained relatively stable in other markets. The decrease in finished steel shipment was partially offset by higher shipments of slabs to third parties, mainly in the U.S. market. As you can see in the lower right chart, shipments of slabs to third parties fluctuated every quarter, and the balance of slabs production in Brazil is consumed internally. The combined effect of -- as I've mentioned, resulted in consolidated steel shipments decreasing 5%.

Looking forward to the fourth quarter, which is seasonally weak period, we expect slight sequential reduction of the steel shipments. Part of this decline will be related to lower slab shipments to third parties and, consequently, higher internal slab consumption. Industrial markets in Mexico continue growing steady demand, while commercial market, usually driven by construction activity, remained weak.

In Argentina, as Maximo anticipated, financial market volatility and high interest rate continue to have a negative impact in industrial sectors production rates and construction activity. This event, together with the destocking process in the value chain caused by high financial costs, will also affect the level of steel shipments in the country.

Please turn now to Page 5 to review the drivers of EBITDA and net results in the third quarter and the first 9 months of the year. The upper chart depicts sequential changes in EBITDA and net income in the third quarter, and the lower chart show year-over-year changes in the first 9 months of the year.

Looking at improvements in the third quarter. The upper-left chart, EBITDA per ton increased sequentially, reflecting a good level of steel prices in the U.S. and Mexican market as well as slightly lower consolidated cost per ton. On the other hand, shipments decreased 5%, as already mentioned.

In the fourth quarter, we expect to report strong EBITDA levels, although lower than record EBITDA we reported in the third quarter of the year, with lower EBITDA margin and slightly reduction in the steel shipments. We anticipate a sequential decrease in revenue per ton in Mexico, reflecting a decrease of steel prices over the last 3 months. We also expect cost per ton to raise at our Mexican subsidiary as higher prices of previously purchased slabs gradually flow through the cost of sales.

On the upper-right chart, we can see the increase in the third quarter net income. The main drivers of the improvement were higher operating income and slightly lower effective tax rate, partially offset by higher net financial expenses.

The decrease in the effective tax rate was mostly related to the Mexican peso fluctuation against the U.S. dollar. The Mexican peso 8% depreciation in the second quarter and 6% appreciation in the third quarter reduced significant noncash sequential changes on deferred taxes.

Let's review now the drivers of EBITDA improvement in the first 9 months of the year on the lower-left chart. On a year-over-year basis, EBITDA per ton increased with the help of an overall strong steel price environment in the world steel markets as well as lower purchase of third-party steel in 2018 due to the integration of Ternium Brasil. On top of that, shipments increased 1.8 million tons year-over-year, mainly due to the consolidation of Ternium Brasil slab sales to third parties.

Let's now review the increase in net income in the first 9 months. There was a $386 million year-over-year increase in net income on a strong operating income. This improvement was partially offset by higher net financial expenses, with effective tax rate remaining relatively stable. There were significant year-over-year increases in net financial expenses mostly related to currency fluctuation in Argentina and other markets that were partially offset by gains related to inflation accounting over the net short monetary position. There was also a slight increase in interest expenses, mainly reflecting higher net indebtedness following the acquisition of Ternium Brasil in September 2017.

To better understand these effects on our financial results, which were mainly noncash, let me remind you that the Argentine peso depreciated 55% against the U.S. dollar in the first 9 months of the year compared to the 8% depreciation in the prior year period. And the Ternium Argentine subsidiary used the Argentine peso as their functional currency.

Please turn now to Page 6. This is the last page in our presentation, where you can see the evolution of free cash flow, capital expenditure and net debt. As Maximo commented, free cash flow in the first 9 months reached a very strong $847 million. Capital expenditures were $345 million in this period, higher than in the same period of last year, mainly due to the consolidation of Ternium Brasil and the works being carried out in the Pesqueria facility.

Looking forward into the fourth quarter, we expect to continue showing a trend in cash flow generation in line with our strong EBITDA expectation. We expect capital expenditure to start picking up, specifically during 2019, due to the development of our new hot-rolling mill in Pesqueria.

Finally, Ternium's net debt decreased to $2.1 billion at the end of September, reflecting the strong free cash flow in the period, less the dividend paid, and represents a comfortable level of 0.8x to EBITDA.

So thank you very much for your attention. These were all my prepared remarks. So please let's start the Q&A. Operator, please let's proceed with it. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Leonardo Correa with BTG Pactual.

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Leonardo Correa, Banco BTG Pactual S.A., Research Division - Research Analyst [2]

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My first question is still regarding Argentina. I just wanted to explore some of the impacts, guys, going forward. Many parameter changes in Argentina. As you mentioned in the report, there is -- clearly, the domestic environment is quite challenging for steel operations. We've been seeing a dramatic currency move. Typically, when we observe past pass-throughs, right, in these environments, we note that the pass-through is quite incomplete. So I just wanted to get a sense of how profitability in Argentina should evolve going forward. And if you guys can comment on the outlook for volumes in 2019. I know that it could be a bit premature, but just to help us to try to map out what type of scenario for Argentina, given that this has been a main concern for some investors over the past couple of quarters. And the second point, regarding CSA. Clearly, the operational numbers from -- coming from CSA had been quite strong. Looking at the volumes in other markets, they also surprised on the positive side. If possible, guys, can you provide a bit more of clarity on the type of contribution on the profitability side and also on -- absolutely, did that come from CSA? Those will be my questions.

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Maximo Vedoya, Ternium S.A. - CEO [3]

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Thank you, Leonardo. I will start with Argentina, your first question, and there are several question that you made about that. Of course, Argentina, I mean, today, is in a very difficult position, and we all know what is going on. But it has been going on for the last 2 quarters. So regarding, first, price. Today, prices in Argentina of steel are stabilized, and they are in line with the Brazilian prices. Of course, they're not as high as the U.S., but they are in line with the Brazilian. So we don't expect many changes in the short term regarding that. Regarding volume, the World Steel just released how the volumes in Argentina are going to change, and we pretty much have the same that we are seeing. 2018 will be between 6% and 7% down, but we are seeing an increase compared to 2018 in 2019. This increase is of 2%, but it's a change in the current situation. In my initial remarks, I said that the Argentina situation was problematic, but I think also I mentioned that there were several things that are supporting an increasing demand beginning in the second Q of 2018 -- 2019, sorry. Commercial balance is reversing. For the first time in many months, last month, finally, there was a positive commercial balance, and that probably will continue. The peso has stabilized. The tourism is increasing. The energy flows are reversing, which also helps in the commercial balance. And agriculture business should be much higher than last year. So I think that the last thing that should happen is that interest rates start going down. And when that happened, I think, as I said, the volumes will start going up. Of course, it's still very early to say that all this is going to happen 100%. But the volumes in this quarter and next quarter are already very, very small for our usual business. So I think, again, 2019 will be a little bit better. Regarding CSA, Pablo?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [4]

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Yes, okay.

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Maximo Vedoya, Ternium S.A. - CEO [5]

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Or ex CSA.

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Pablo Daniel Brizzio, Ternium S.A. - CFO [6]

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Ex CSA, yes, Ternium Brasil now. So I understand the concern that you have, and we have been trying to give you or read the market in advance the situation in Brazil, which will cause some volatility in the volumes because, as you know, what we're reporting is the sales of slabs to third parties. Clearly, the slabs that we produce in Brazil and send to our operations are not reflected as sales. So in -- depending on the total trade that we have with third parties and the needs that we have internally, this is the -- what is reflected in the number of sales that can fluctuate quarter-over-quarter and can -- makes the total shipments happened during this quarter and what we are predicting in the coming quarter where we are expecting to see some production in shipments to third party, an increase in shipments to our own facilities to be reflected there. The margins that we are generating, and as you know, unfortunately, we are not disclosing specific numbers for our Brazil operation, clearly, have been better than initially expected because of the increase in volumes that we have achieved in our Brazilian operation and the reduction in costs that we were also able to achieve. And I guess, as you remember what you -- what was mentioned by Maximo, Marcelo Chara in our investment -- in our Investor Day. And also, we have, specifically in this quarter, the devaluation of the currency that helps in order to reduce the real input costs. So all in all, demands in Brazil are very good, and the fluctuation that you see in sales is basically related to that.

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Leonardo Correa, Banco BTG Pactual S.A., Research Division - Research Analyst [7]

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Perfect. Would it be possible to provide just the operating rate from CSA, Pablo?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [8]

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Yes, we will be -- as you know, we set the targets at the beginning of the year. And clearly, at the end of the year, we will be commenting on the operating performance of our facility. Clearly, we will be doing that.

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Operator [9]

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Your next question comes from Thiago Lofiego with Bradesco BBI.

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Thiago K. Lofiego, Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst [10]

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Two questions on my side. The first one, just on the recent development regarding the Mexico City Airport. Do you guys see any possible implications to Mexican steel demand given the more, at least, apparent uncertain environment for companies? Do you see the potential drove down in construction [bet] or any risks to your own growth plan in Mexico? And within that question, what's your outlook for Mexican steel demand growth for 2019? And second question, what could be the potential increase in slab capacity in CSA? Can you give us an update on that?

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Maximo Vedoya, Ternium S.A. - CEO [11]

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Thank you, Thiago. Let me start with the Mexican environment and, yes, the news -- or the new news of the cancellation of the new airport. I mean, on the short term, we don't have any business with the new airport, so we don't have any direct impact at Ternium because of this cancellation or not. But clearly, the cancellation is not a good news. I mean, the new office or the new government, it's still not yet in office. After the election, I think they made some very positive things. I mean, it was really positive, the attitude and the things that they were doing. One of them was the participation in the NAFTA negotiations. It would not have been possible to close the deal without the direct involvement of the new administration. So I think that was one of the positives. The decision of canceling the airport, clearly, is not a very good decision from a business perspective. I think it's a setback. But to be fair, Mr. Lopez Obrador has been very vocal about his opposition to this infrastructure project for the last 8 years. So although we didn't expect, it was something that could happen. If this is going to have a setback in our plans, so what we think of the Mexican growth for next year, not yet. I think -- on the contrary, I think this government, it's very outspoken in increasing infrastructure, as you know, and we have been talking about this for a lot of quarters. For the last 2 years, construction in Mexico -- the commercial market in Mexico has been almost the same because there was a huge decrease in spending of the government infrastructure, which was compensate by the increase in the private investment. Last quarter, both of them decreased. So that's what you've seen in our shipments in Mexico. But I think that this government wants to change that. So I don't think spending in infrastructure will decrease. On the contrary, I think it will increase. Private spending, on the other hand, it has to increase. I think -- again, the closure of NAFTA is something very good. The airport is not something very good. So I think we have to wait to see what will happen with the private one. As -- although I don't think it's going to be worse, I don't know if it's going to improve a lot because only of the NAFTA. I think with that, I -- yes, and the other one was?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [12]

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Relationship of the slab production...

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Thiago K. Lofiego, Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst [13]

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Mexican steel demand growth for 2019, actually.

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Maximo Vedoya, Ternium S.A. - CEO [14]

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The Mexican steel growth. World Steel, which are the only official numbers just released, and they said it is 1.2% the growth for 2019. I think that's correct. But remember that Mexico has a lot of imports. So for us, I mean, we are expecting to gain market share against imports. So the consumption is growing. It's not growing by a lot, but it is growing. And we have this upside of how able we are going to be to compete with these imports. The increase in slab production, today, we are producing at a rate of roughly 4.7 million, a little bit more than 4.7 million. When we took was 4.3 million, I think, the annual rate, I don't remember that. And the expectation is to reach 5 million tons in 2020. That's our expectation. And, of course, we will continue analyzing as we do in all our assets if that could increase a little bit more.

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Thiago K. Lofiego, Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst [15]

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Just to make it clear, Maximo, the increase to 5 million tons, that's when you go to your nominal capacity, right, installed capacity of 5 million tons?

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Maximo Vedoya, Ternium S.A. - CEO [16]

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Exactly.

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Thiago K. Lofiego, Bradesco S.A. Corretora de Títulos e Valores Mobiliários, Research Division - Research Analyst [17]

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But are you envisaging any potential capacity expansions at CSA?

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Maximo Vedoya, Ternium S.A. - CEO [18]

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No. Today, we are not seeing that. What we are looking at is what our -- the debottleneckings where we can have marginal increases, but not a huge expansion.

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Operator [19]

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Your next question comes from Carlos De Alba with Morgan Stanley.

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Carlos De Alba, Morgan Stanley, Research Division - Equity Analyst [20]

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I would like to understand how do you see the evolution of EBITDA per ton in Ternium Argentina or the southern region given the accounting effects that you have, given the functional currency in the country is local. And what can we expect? A contraction in EBITDA per ton, I think, is what we will see. But if you can quantify, give us a little bit of more color as to what you are seeing, that will be really useful. And then you've given the weak -- relatively weak shipments in Mexico in the third quarter. Can you tell us what -- how is your order book looking for the fourth quarter? Do you expect to see a recovery in volumes? I don't think that in the outlook that was provided on Page 3 of the release, there is any comments on volumes in Mexico. So any color there will also be useful.

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Maximo Vedoya, Ternium S.A. - CEO [21]

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Thank you, Carlos. I'll take the second one first, if you don't mind, and then, I think, Pablo is much better expert in accounting than myself to explain the first one. Shipment in Mexico, I mean, we expect today to be rather flat in the fourth quarter. The fourth quarter in the commercial market, usually, it's a slow quarter, but it's better in the industrial market. And we don't see any changes from the third quarter in our order book. So we expect something similarly in the next quarter. I don't know if that answered the question, Carlos.

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Carlos De Alba, Morgan Stanley, Research Division - Equity Analyst [22]

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Yes, that's good. Yes, that's good color.

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Maximo Vedoya, Ternium S.A. - CEO [23]

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So Pablo?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [24]

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Yes, okay. I understand that the issue of inflation accounting is causing some doubts on the number. But the big impact of inflation accounting was we had up to now because we needed to adjust our numbers since the last time that we did adjust the numbers, which was back in 2002. So there where we have the big impact. From now on, the impact will be reduced if we want -- to the difference between today inflation rate and the exit rate at the end of the quarter. So what you will see, for example, is during the fourth quarter, on our number, you have the same devaluation. As of inflation rate, there should be no impact because of that. But going exactly -- or related to your question, we are not seeing that any of these adjustments will have a negative impact in the margins in Argentina. In fact, the margins during the third quarter were reasonable margins. And we are expecting to see margins in the fourth quarter at the same or even a little higher levels than what we saw up to now.

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Carlos De Alba, Morgan Stanley, Research Division - Equity Analyst [25]

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And, Pablo, these margins we'll see -- sorry, EBITDA margin. Doesn't really matter if it's in pesos or in dollars. But my question was more than the application of IAS 29, was on the fact that the impact of the rapid moves in devaluation in the inventory and the cost once it flows into the P&L given that the currencies have devalued in the last 9 months and you have been purchasing raw material and put them in your inventory in pesos. So when do you expect to see -- and then, obviously, when it flows into the income statement, it has been providing a positive boost to EBITDA there. When do you expect to see a change in this trend? And how big of an impact do you expect that we will see?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [26]

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No, it's clear. Of course, probably the significant impact is not the inflation accounting but the devaluation, as you pointed. Since we have peso as our currency -- accounting currency in Argentina, clearly, the value in dollar terms after the devaluation of the currency of our inventories is lower. So the cost of the following quarter decreased. We are expecting this to continue in the fourth quarter and should start to normalize beginning of next year, most probably entering to the year or entering into the second quarter. But all in all, we are expecting to continue to see good levels of margins coming out of Argentina.

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Operator [27]

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Your next question comes from Rafael Cunha with Crédit Suisse.

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Rafael Cunha, Crédit Suisse AG, Research Division - Research Analyst [28]

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So my question is still in the line of prices. More specifically, could you update us on where we stand on the gap between prices in Mexico and the U.S. currently? And how do you see it behaving going forward given the developments in NAFTA and protection scenario on a global scale? And also, in your outlook section on the earnings release, you mentioned value chain destocking in Argentina. I was just wondering if you could expand on producers and currency stock by levels throughout the chain in both the (inaudible) markets in Mexico and also in Argentina. And what lines of products do you see as more like overstocked than others? If you could give us a color on that, that would be very helpful.

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Maximo Vedoya, Ternium S.A. - CEO [29]

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Thank you, Rafael. Prices. Prices in both Mexico and the U.S. trended down during the past 3 months. I think that although local Mexican price has been, I think, a little bit more affected as a result of the decrease in the commercial demand connection with the weakness in the construction industry that we talked a little bit before. If you remember our last conference call and the other one, I think the last 2 conference calls, we were talking about the gap between the U.S. and Mexico because after the -- in history, the prices were much more related and they were kind of similar. Today, there is a gap between both prices because of the 232. What will happen, we don't see -- I mean, I think current prices in Mexico are in a sustainable levels. I think that a positive outcome if the 232 is solved between the U.S. and Mexico, this could be a good news or would be a good news. But again, that depends if the 232 is solved somehow. If not, I think we are going to continue with the gap we had this quarter, and the following quarter, we'll continue with the same gap. Okay, Pablo?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [30]

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Okay. I'll take the second one, Rafael. Thank you. Clearly, when we see a situation like the one we saw in Argentina, we understand it's quite normal to see a destocking process because at the very end, the Argentine market was working at a level and it was quite high as of the end or at the beginning of the second quarter. And then we started to see a reduction on demand. So our customers, clearly, that were working with inventory levels that were related to the volumes or the level of the volumes that you saw previously clearly start to reduce this inventory because -- of course, also because of the interest rate that we see in Argentina is not a significant cost for them to maintain a level of inventory which is higher than what they really need for the new level of shipments. So for us, it's something that is normal when we have this type of situation. So you are seeing a reduction in demand because of the reduction in growth in the Argentine economy or the recession that we are seeing for this quarter. And the second one is the adjustment of our customers' inventories to the new reality. So in this case, it usually takes a couple of quarters for them to do that. And we are expecting to see a normalization of this again beginning of next year.

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Operator [31]

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Your next question comes from Marcos Assumpção with Itaú.

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Marcos Assumpção, Itaú Corretora de Valores S.A., Research Division - Sector Head [32]

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First question is on the outlook for the gap between HRC and slab prices and how do you think that could impact your EBITDA per ton going forward. Second question, on Argentina, just about prices. When do you expect to recover the prices that we were seeing 1 year ago? When we look at the southern region average revenue per ton, we see that, that number is still 20% below today of what was 1 year ago. If you could -- just last one on the new NAFTA. If you could -- if you believe that -- if you still have the same views on auto production growth in Mexico following the new agreement. That's it.

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Maximo Vedoya, Ternium S.A. - CEO [33]

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Thank you, Marcos. I start with the last one because I like the new NAFTA. I mean, I think, yes, Mexican automobile production this year will end up around 4 million units. And I think that with the new NAFTA, there's going to be an increase in that production. I think that there are going to be 2 effects. I think that more people, if they want to sell in NAFTA, are going to produce cars in the region, number one. And number two, the rule of origins or the rules to make what a car is NAFTA have changed. So I think that in the long term, there's going to be an increase in the consumption of steel because of this. I know, everybody knows. But the old NAFTA said that a car, in order to be Mexican -- sorry, in order to be NAFTA, of NAFTA origin, has to have 62.5% of local content. But that local content was calculated in a very particular way. And steel, for example, and many other products, were not taken into account, I mean, in that calculation. You can have steel from -- I don't know, from China or Japan and produce a door in Mexico, and that door will be NAFTA origin. The new rules have 3 sets of standards in order for a car to be NAFTA. The first one is also the local content and goes from 62.5% to 75% in 4 years. The second one is that 70% of the steel and aluminum has to be from -- coming from NAFTA. And the third one is that part of the production has to be made in places where workers earn $16 an hour or more. So all these 3 things, I think, put together a situation where more cars and more local content has to come from NAFTA. So I think that, yes, there is no yet -- I mean, there is not yet any publication of what is going to be these 4 million units in a couple of years, but I think it's going to be a little bit higher. I know, with that, I answered that question.

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Marcos Assumpção, Itaú Corretora de Valores S.A., Research Division - Sector Head [34]

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It did.

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Maximo Vedoya, Ternium S.A. - CEO [35]

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Second one, prices in Argentina. I mean, Pablo can explain it a little bit better. But the price you are seeing or the decrease you are seeing in prices is because of this inflation adjustment. And, Pablo, why don't you explain it very detailed?

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Pablo Daniel Brizzio, Ternium S.A. - CFO [36]

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Yes. It is -- you should not compare what you saw in the last conference call, in the last quarter results because that numbers were not adjusted. And as I mentioned at the beginning, by applying the new rules, we need to adjust every number to, basically, as of September 30 this year. So in order to see a comparison, you need to look at the numbers that we are publishing now in order to look at the comparison. Clearly, adjusting by inflation, what makes is for you to increase, in this case, the level of sales and then you divide that number by the exchange rate that applied at the end of the quarter. So that's the number that you need to look. And just to make things a little bit more complicated, next quarter, in the fourth quarter, we will be adjusting again all numbers in order to reflect the reality as of December 31. So you will see probably a further increase on that side. But I think that the important thing is what Maximo said, which was that -- when he was answering another question, which was that the prices in Argentina are reflected in international prices and are at the level of what we see in Brazil as steel prices.

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Maximo Vedoya, Ternium S.A. - CEO [37]

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And, Marcos, the first question regarding slab prices, I think, well, the prices have decreased a little bit over the last couple of months. But what will happen in the future, I think there are 2 -- 3 things. One, in the negative side is the U.S. is producing a little bit more steel, although I don't think that, that effect is going to be very high. But on the other side, raw materials are increasing, and that should put pressure on slab prices. The second one that is during 2019, there are going to be some disruption in slabs production in several facilities that produce slabs in Russia and in Brazil. So I think that it's going to more than compensate what happen in -- what is happening in the U.S. So I don't expect prices to be much different than what they are today.

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Marcos Assumpção, Itaú Corretora de Valores S.A., Research Division - Sector Head [38]

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Okay, Maximo. Just a follow-up here, why you are seeing the disruption in slab productions in Russia and Brazil. And actually, my question was more on the gap between HRC and slab prices. How do you see that evolving going forward?

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Maximo Vedoya, Ternium S.A. - CEO [39]

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No, the disruption comes from some industries that have to make huge or long maintenance in blast furnace and in the continued casting. So that's -- the gap -- you're referring to the gap in between the U.S. and the slab prices.

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Marcos Assumpção, Itaú Corretora de Valores S.A., Research Division - Sector Head [40]

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Or I would say global prices. The differences between -- HRC prices were very high, mainly in the U.S., and that impacted also Mexican prices and then slab prices. I think that for the part that you are nonintegrated, that impacts your margins, and that's why I want to see a little bit of an overview from you on how do you see the difference between those prices.

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Maximo Vedoya, Ternium S.A. - CEO [41]

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No, I understand, but when -- I mean, overall, we are integrated, remember, because although we are buying slabs, we are also selling almost the same amount of slabs. So it's not going to affect us very much that margin or that gap for Ternium's -- I mean, for Ternium's results. The gap today, it's clearly -- and again, the hot-roll prices are decreasing a little bit. But I don't see major changes, again, in this gap today. There are things -- again, I think that the prices in the market are going to continue -- or are set to continue in this space. And slab prices, although have come down a little bit, I don't see that they are going to come down much more.

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Operator [42]

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Your next question comes from Alfonso Salazar with Scotiabank.

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Alfonso Salazar, Scotiabank Global Banking and Markets, Research Division - Director of Metals and Mining [43]

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I have a couple of questions here. The first one is regarding NAFTA, the new NAFTA. You mentioned about these 3 new provisions. And my concern is with the new introduced one, the level of value content provision, which specifies that 40% of the auto value content must come from manufacturing sites with wages of least $16 an hour. Don't you think that, that could make production going back to the U.S. or Canada or at least slowing now the production in Mexico? That's my first question. The second one is if you can give us an overview of demand and profitability in other markets, I'm thinking about Colombia, in the coming years. And the third question, if you can give us or remind us what is the CapEx estimates as you expand in the coming years.

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Maximo Vedoya, Ternium S.A. - CEO [44]

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Perfect, Alfonso. Thank you very much. NAFTA. I think the 40% rule of labor that are above or equal to $16 an hour, I think it's going to increase production. I think it's going to increase production in the U.S. also. But I think it's going to increase production in other regions. Remember, the 40% has a way also of calculating how this 40% is done. And 15% -- at least 15% of that can come from things that are already paying more than 16 hours (sic) [$16 an hour], for example, research and development and other things. So it's hard, but we have been talking to several people or several of our customers, and it seems that they are going to get -- they are going to make it to this 40%. And so we are confident that they are going to stay in Mexico, in the country, and they probably will increase a little bit. In other markets, I think, Brazil -- I mean, Brazil is doing much better, to be honest. If you see -- if you saw the Usiminas numbers that came out a couple of weeks ago, I mean, the market is increasing. Volume are increasing. Again, World Steel is predicting that the steel consumption in Brazil is going to increase to almost by 6% next year. So I think the elections at least bring some confidence to the market, at least for what we are seeing in the market. So I think that Brazil is going to bring us good news. Colombia has -- I mean, Colombia is a market that is more focused on construction or commercial products. The last couple of quarters has not been very good for Colombia. Construction has decreased for almost 7 quarters in a row in Colombia. But I think that the new -- with the new government, things should start to improve in the beginning of next year. And Argentina and Mexico, they are our other main markets. I think we discussed it extensively. CapEx. CapEx would be around $800 million next year. This year will be a little bit less than $500 million; next year, $800 million; and 2020 will be probably around $1 billion because that will be the peak of our Pesqueria -- new Pesqueria investment. 2021 will probably come back to normals of $550 million.

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Operator [45]

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Your last question comes from Timna Tanners with Bank of America.

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Timna Beth Tanners, BofA Merrill Lynch, Research Division - MD [46]

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Wanted to ask -- I'll just ask 2. I know there's a multiple question thing here, but I wanted to ask about -- a little bit more detail about why you're so convinced to taking share from imports into coming years with new supply, just in light of the fact that there's also new supply coming on in the U.S., about 10 million-plus tons over the next several years. China is consuming fewer tons. And just wondering a little bit more about why you think that Mexico can be more self-sufficient. And then second question is just in light of the really strong results this last quarter in a rising price environment and a reversal a bit in next quarter, how do we think about more normalized profitability per ton? Do you think that we have out-earning in this quarter, under-earning in the next quarter and then maybe more normal if prices stabilize? Or am I missing something?

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Maximo Vedoya, Ternium S.A. - CEO [47]

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Thank you, Timna. I think the first question -- and I think there's a couple of things. I mean, China is not decreasing consumption. On the contrary, China is increasing consumption today. And supposedly -- and this is -- of course, supposedly, but is decreasing production. I mean, it's shutting down capacity, and there's a huge discussion because they have a lot of capacity that was not recognized but was producing anyway. So it's very difficult to compare numbers. But I think China will continue with some restriction, with some environmental restriction. And consumption is increasing. And if China will continue with this trying to put more investment as they are -- I mean, it seems that they are doing that, consumption will continue strong in China. I mean, in Mexico, there are almost -- in flat products, only 8 million imports. And so I think that Mexico is a little bit more -- a place more competitive to produce steel than the U.S. And that's why we think that we are much capable of getting that share than -- and competing with the U.S. I mean, there is a logistic much near. I mean, our customers are very near our facilities. And so we don't see a disadvantage. I don't know if this is answering the question, but I'm very confident that we will be able to gain share of imports with this new facility.

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Pablo Daniel Brizzio, Ternium S.A. - CFO [48]

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Okay, Timna, let me take the second question, which is not an easy one to answer because, clearly, we are running at EBITDA margins, which is how we look to see these numbers. And the consequence of that is the EBITDA per ton at very high level. Clearly, that's the case. This has been the case for the last, I would say, couple of years. Remember that we always said that we expect to run our facility at -- or our company at the level of above 15% to up to a 20% EBITDA margin. Clearly, we have been overpassing that level in the last years, in the last couple of years, especially in this year. The integration of CSA, now Ternium Brasil, is a key component of this increase in -- margins, of course, helped also by the increase in prices that we saw in the North American market. But even as we see, and we have been discussing, and Maximo gave a lot of details on the gap that we are seeing and it has been the case in the last quarter between the prices in Mexico and the prices in the U.S., signaling that, in fact, the prices in Mexico have been not that high or outperforming as we saw in the U.S. The -- what we are seeing is that we already, in our outlook, have said that we are expecting to sustain a healthy level, not only of EBITDA as a number but also EBITDA margin, clearly not at the levels that we saw during this quarter. So -- and also, as you know, and we have been describing this for years and especially in the last Investor Day, we will continue working as much as we can in order to control or reduce costs. And one question that was answered by Maximo in showing part of that is not that we only are expecting to reduce costs but increase the capacity utilization in our facility, especially the one in Brazil, to levels that will match the nominal capacity of that facility. So all in all, we are expecting to continue to show very strong EBITDA margin and EBITDA per ton. Clearly, we cannot tell you that we will sustain the one that we have just showed, but we understand that we will be able to sustain at healthy levels of EBITDA margins. Hope to answer your question, Timna.

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Operator [49]

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There are no further questions at this time. I'll turn the call back over to the CEO for closing remarks.

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Maximo Vedoya, Ternium S.A. - CEO [50]

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All right. Thank you, everyone, again for participating in our conference call. I hope you found the call useful. As always, feel free to contact us for any comments or additional questions. And we'll see you or talk with you in our next conference call in 3 months. Thank you very much.

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Operator [51]

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This concludes today's conference call. You may now disconnect.