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Edited Transcript of UPM1V.HE earnings conference call or presentation 23-Jul-19 10:15am GMT

Q2 2019 UPM-Kymmene Oyj Earnings Call

Helsinki Jul 25, 2019 (Thomson StreetEvents) -- Edited Transcript of UPM-Kymmene Oyj earnings conference call or presentation Tuesday, July 23, 2019 at 10:15:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Jussi Pesonen

UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director

* Tapio Juhani Korpeinen

UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy

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Conference Call Participants

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* Alexander Berglund

BofA Merrill Lynch, Research Division - Analyst

* Justin Joseph Jordan

Exane BNP Paribas, Research Division - Analyst

* Lars F. Kjellberg

Crédit Suisse AG, Research Division - Research Analyst

* Linus Larsson

SEB, Research Division - Analyst

* Markku Järvinen

Handelsbanken Capital Markets AB, Research Division - Analyst

* Mikael Doepel

UBS Investment Bank, Research Division - Executive Director & Analyst

* Robin Santavirta

Carnegie Investment Bank AB, Research Division - Financial Analyst

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Presentation

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [1]

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Ladies and gentlemen, the audience, welcome to UPM's webcast. My name is Jussi Pesonen here. I'm the CEO of UPM, and I'm here with our CFO, Tapio Korpeinen.

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [2]

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Hello to everyone.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [3]

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When I was walking down here to the conf call room, I sum it up that this is my 62nd quarterly report, and I have to be saying that there has been quite many big changes and forward-looking events in UPM, starting with the closure of Voikkaa Mill and then acquisitions of Fray Bentos and Myllykoski and the operating (inaudible) change, not even speaking about taking the balance sheet to a strong position. But today, I think that it is a kind of historical date and day for me and for the whole UPM.

We have 2 important topics to be discussed: first of all, the result of UPM of the second quarter, which was 25th consecutive quarter of increasing earnings, and Tapio, of course, will analyze that more in details in few seconds; secondly, UPM's Board of Directors has today made a decision to proceed with the new world-class pulp mill investment in Uruguay. It is my great pleasure to also describe this investment more in details later today.

But if we move to the Page 2. The 25th consecutive quarter of earnings is absolutely important for us, and I think that the keyword for the Q2 and for the remaining part of the year will be, "How do we manage and how we are managing the margin?" And we have been able to manage margins well in UPM on UPM level but also in different businesses.

So let's start with the Q2 performance. In Q2, our operating model continued to deliver good result. We succeeded in maintaining good margins, and our comparable EBIT continued to increase, reaching EUR 345 million in the quarter. The slowing economic growth particularly in Europe was having some impact in our product markets in Q2. However, at the same time, also the cost environment started to moderate. Our operating cash flow was strong, increased clearly from that of last year, totaling EUR 436 million in Q2. Our net debt at the end of Q2 was EUR 366 million or 0.19x EBITDA. So even after the adaptation (sic) [adoption] of the IFRS 16 standards for leases and paying out a dividend of EUR 693 million during Q2, our balance sheet is particularly -- or practically debt-free. This is absolutely great starting point as we are now being -- beginning the large investment project in Uruguay.

But ladies and gentlemen, at this point, I will hand over to Tapio for detailed analysis of the result. Tapio, please?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [4]

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Thank you, Jussi.

On this third slide, you will see, first of all, the moderation that is starting to take place in the cost environment and then the continued positive development in our margins in the second quarter.

So on the left-hand side of this slide, you can see the comparable EBIT development year-on-year compared to last year second quarter. And there still, sales prices continued to have a positive impact on our earnings year-on-year. And at that comparison, at that time -- at the same time, the increase in variable cost already had only a minor negative impact. Fixed costs decreased from last year mainly due to less maintenance than in the same period last year. Deliveries and production volumes had a small negative impact on the second quarter impact -- second quarter EBIT mainly coming from lower deliveries and also related to reducing paper stocks in Communication Papers.

On the right-hand side, you can see the same development sequentially as compared to the first quarter this year. And here, sales prices had a small negative impact on EBIT. This comes from lower pulp prices. However, variable costs decreased as well, having a larger positive impact on our EBIT. About half of this cost relief comes from pulp costs in our paper businesses. But as you can see in this slide also, other variable costs started to increase already in the second quarter -- started to decrease already in the second quarter. Fixed costs increased seasonally compared to the first quarter and also due to the maintenance shutdown at the UPM Kymi pulp mill. Deliveries and production volumes had a negative impact on our Q2 EBIT. This was partly due to seasonal reasons, also due to the maintenance shutdown at the Kymi pulp mill and due to the reducing of paper stocks in Communication Papers.

And here, we have the comparable EBIT development by business area. In Biorefining, EBIT increased from last year despite the fact that pulp prices were 6% lower. Solid customer demand from our customers continued for pulp, and therefore, our delivery volumes grew by about 5% compared to the first quarter last year. Also for advanced biofuels, demand continued to be strong, and our deliveries grew. Many of you remember that last year, we had scheduled maintenance shutdowns at 2 pulp mills and also at the Lappeenranta biorefinery where we had the so-called turnaround shutdown. And as compared to that, then now we only had one pulp mill down for maintenance. Sequentially, compared with the first quarter, Biorefining EBIT decreased due to the 5% lower pulp price and the maintenance shutdown at the Kymi pulp mill.

In Communication Papers, paper prices continued at a good, stable level during the second quarter. Comparable EBIT was held back by the combined impact of lower deliveries and reducing stocks during the quarter. On the positive side, this reduced our working capital during the quarter and, thus, contributed to the strong cash flow. Paper demand development in Europe has been somewhat weaker than last year, and part of it is related to the slow economic growth in the region. But then also thinking about the second quarter figures in particular, part of it is due to reducing safety stocks created ahead of the expected Brexit which did not take place in March and probably also related to postponing purchases to Q3 ahead of the moderate reduction in paper prices in July.

To ensure our competitiveness, we continue stringent cost control and asset optimization in Communication Papers. In July, we completed the closure of Plattling paper machine #10 in Germany, reducing our coated magazine paper capacity by 155,000 tonnes. And the conversion of Nordland paper machine #2 will reduce our fine paper capacity by about 200,000 tonnes later this year while enabling our Specialty Papers business to grow in a highly competitive way.

And speaking of Specialty Papers, we achieved a clear recovery in EBIT after 3 weaker quarters. Pulp costs started to decrease, or we started to feel the decrease also in the bottom line of the Specialty Paper business while fine paper prices in Asia actually slightly increased from the first quarter. Demand for our products continued to be solid. Our fixed cost reduction measures started to show results. To stay on this track, we continue our cost management and our product development initiatives as well. Also our growth projects in Germany and China are proceeding well and will support our growth and competitiveness next year.

Raflatac and Plywood showed stable EBIT development from the first quarter. In Raflatac, sales growth continued mainly due to higher sales prices and improved mix. Also, deliveries grew slightly from last year.

And then finally, Energy had an excellent quarter. Here, we had a perfect combination of higher hydropower and nuclear power generation volumes, higher electricity sales prices and lower costs. Even the annual maintenance shutdown at the Olkiluoto power plants proceeded smoothly, having a smaller negative impact than last year. In the second quarter, we received the update on fixed costs for nuclear power generation from TVO. Fixed costs decreased by EUR 12 million for the first half of the year which was all booked in the second quarter, so roughly about EUR 6 million of the Q2 EBIT in Energy is related to the first quarter.

Then looking at the cash flow. As Jussi already mentioned, operating cash flow was strong at EUR 436 million, increasing by EUR 108 million from last year. Working capital decreased by EUR 48 million during the quarter mainly due to reduction in stocks.

And here we have the updated outlook for 2019. We continue to see the same uncertainties in the global economy and business environment that we highlighted 6 months ago. The economic growth continues but at a slower pace especially in Europe. Nevertheless, we expect UPM's business performance to continue at a good level in 2019.

In the second half of 2019, we expect pulp prices to be lower than they were in the first half. Paper prices in Europe and in North America are expected to decrease moderately in the second half compared to the first half of 2019. On the positive side, we also expect input costs to be lower in the second half than they were in the first half. We will continue our measures to reduce both variable and fixed costs.

And finally, fair value increases of forest assets are not expected to contribute materially to our comparable EBIT this year.

And now back to Jussi. It's time to discuss our Uruguay investment.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [5]

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Thank you, Tapio. Yes, let's get ourselves into the details of the investment. But I would like to first start with somewhat a background material of, obviously, in last 3 years in UPM, we have been putting a strategy together which then came to a kind of picture that we see here, as I call it, a triple-tower growth initiative picture where the -- where we're presenting this also in our Capital Markets Day.

This slide reminds you of the spearhead of growth, the 3 focus areas where we see significant growth during the coming years. And these 3 are long term. The spearhead, all of them are actually attractive, long-term growth outlook having and supported by the global megatrends. And obviously, one of the topic that we have been always discussing here is that there needs to be a clear entry barrier for the business as well. So basically, that is the kind of background for that kind of information.

In specialty packaging materials, on the left tower, we are growing through the ongoing focused growth initiatives that are, as we speak, around EUR 200 million investments in Finland, in China and in Germany. Where -- the right-hand side is still in the development phase, i.e., the molecular bioproducts, biofuels and biochemicals. And those could provide a large, new growth platform for UPM for the coming years and decades. Preparation continue for the potential investments are proceeding as planned. But however, today, we will focus on the middle part of the picture, high-value fiber. The competitive new pulp mill in Uruguay will represent a large growth step in this area.

Page 9 is actually UPM's investment into a world-class pulp mill in Uruguay. As said already, we have made today investment decision to make a 2.1 million tonne eucalyptus pulp mill in Central Uruguay near the town of Paso de los Toros, as you can see it from the maps here. The total investment is about USD 2.7 billion, on top which we will invest $350 million on dedicated pulp terminal or port in Montevideo harbor and local facilities in Paso de los Toros as well. The new mill is scheduled to be starting up on the second half of 2022, and the major part of the capital expenditure will take place over the years 2020 to 2022.

Next page so is actually describing why it is a good investment. Firstly, it will provide a significant step for UPM future earnings. So earnings growth is something that we are always looking after. With competitive plantation operations, the scale and the best available technology at the mill and the efficient logistics systems, so it's a threefold, plantations, the mill itself and then the outbound/inbound logistics. The new mill is expected to be one of the most competitive pulp mills in the world both in terms of costs and in terms of safety and environmental performance of the whole value chain.

We expect its cash cost level to be about $280 per delivered tonne of pulp, and this means all fixed costs and variable costs of the plantation operations, mill and then logistics, inbound/outbound logistics and delivered to the customer. So it is including all of those costs.

We have carefully prepared the prerequisites for the investments. As I said earlier, 3 years in a very kind of intensive phase but more than 5 years or close to 9 years of preparation for the possible investments. So we have done that in a very careful way. For us, it has been important to ensure sustainable competitive operations long term and to minimize risks both in the project phase and during the continuous operations.

For Uruguay, the project and the infrastructure development offers significant opportunities for economic and social development. For UPM's Pulp business, the project represents a step change. It will grow our pulp capacity by almost 60% in a sustainable and high competitive way.

With our pulp mill -- pulp product mix, the share of the fast-growing eucalyptus pulp increases significantly, as does the share of the plantation-based production. The average production cost will decrease, and the average profitability increases both because of the new low-cost unit but also because of the synergies with the existing operations in Uruguay, i.e., the Fray Bentos mill.

So why is the pulp business interesting? To start with, we believe that the long-term market outlook for pulp is attractive.

Page 12. Global consumer megatrends such as middle-class growth in Asia, urbanization, changing demographic and digitalization are driving demand for tissue, hygiene packaging and specialties. This provides a robust base for pulp demand growth. Sustainability, for example, consumers' kind of view against plastics could drive further growth in specialties and new end uses. Recycled fiber scarcity worsened by declining graphic paper consumption is also positive long-term driver for the pulp demand. We estimate that the long-term demand growth for market pulp is about 3%.

In coming 3 years, only limited additional pulp capacity is expected to enter to the market, in the long term, creating a competitive and sustainable wood supply forms in -- an entry barrier, which limits the rate of the -- at which kind of scale the new capacity can enter into the market. Obviously, I think that when I said that UPM has been managing margin well during the last few years, I think that one part of the managing the market is a commercial success, how we are commercially operating. And I think that UPM does have a very solid commercial strategy for the pulp business as well.

First of all, we are aiming to grow with our growing customers. UPM is trusted pulp supplier with our own sales and marketing network throughout the whole globe, so we have a global kind of presence in all markets. Today, our existing external customer base is representing about 2.6 million tonnes of pulp annually in growing end uses in Asia, in Europe and globally. Pulp is not 1 or even 2 commodities. There are many different types of qualities of pulp, not to mention the different levels of sustainability performance as well. We offer a broad, multi-fiber product portfolio. Most of our pulp customers are buying 2, 3, even in some cases, 4 different pulp grades from us. We provide them with the R&D, and especially, I would like to underline a very good technical support to optimize the quality and the cost of their products. Our products and operations meet the highest sustainability standards in terms of forestry, biodiversity, environmental performance of the mills as well as our stakeholder engagement. We will build on all of this with the new mill in Uruguay. It will increase our offering in sustainable, high-quality and cost-competitive way in eucalyptus pulp.

So what makes our new pulp mill competitive? What are the key prerequisites that one needs to meet in order to be able to make an attractive investment on this business or to look into, from another perspective, what are the barriers of entry? As I already summarized, to be competitive and profitable and to achieve attractive returns for the investment, one needs to meet 3 hurdles: competitive and sustainable wood supply for the mill; state-of-art mill design; and then thirdly, efficient logistic value chain inbound and outbound to the world markets.

So let's shortly look at all of these topics. Wood supply, first of all, is one of the most important part of the competitiveness of the mill. We have secured eucalyptus availability for the current Fray Bentos mill years ago and new mill near Paso de los Toros through our own leased plantations and sourcing agreements -- long-term sourcing agreements with the private partners, so 3 sources of how we have been able to secure the kind of competitive wood supply. We started to develop our plantation base in Uruguay almost nearly 10 years ago, if I remember correctly, that was year 2010, with the aim of eventually supply the second mill with the sustainable raw material. Now our own and leased plantations in the country are covering 382,000 hectares. We have over 30 -- more than 30 years of experience in plantation operations in Uruguay which secures well managed and productive plantations without making compromises on sustainability. Also this optimizing the plantation operations for the 2 mills will provide synergies for the existing Fray Bentos mill.

Then the second one, part of the competitiveness comes from the state-of-art mill design. The new mill has been designed as an efficient, single-line operations with the best available technology in this globe. The design criteria have been to enable the highest -- high operating rate, maintainability and energy output. So we have been really putting a lot of emphasis onto the scope, to ensure also the low-cost operating costs, excellent safety and high environmental performance during the long life cycle of the mill. So all of these criteria we have been clearly putting a lot of emphasis and developing them to the phase that we would have the best available mill in this globe, most competitive one. The total investment cost is $2.7 billion. And it is also a competitive investment level if we compare with the previous projects.

Page 14 (sic) [Page 18] puts our investment level to the perspective. This is a comparison chart provided by Pöyry showing the capabilities and specific investment levels of the selected greenfield and brownfield projects with -- which on the axes is capacity and then the CapEx per tonne. The chart shows that our expected investment is below $1,300 per tonne of capacity. And that is clearly lower than the average cost of these major projects especially in the greenfield. Obviously, this chart only shows the level of investment, the attractiveness of the investment, i.e., the returns come from having a -- both efficient investment level and having the elements of the competitive operations in place.

Then moving to the logistics. The third major part of the competitiveness is obviously inbound and outbound logistics, how do we set up that. This, in our case, will be secured by the agreed road improvements in Uruguay, the agreed extensive rail modernization from Central Uruguay to Montevideo harbor as well as the dedicated pulp terminal at the Montevideo deep-sea port and harbor. We will construct the modern pulp terminal into the Montevideo port with an investment of $280 million. The direct rail access from the mill to the port creates a very efficient supply chain into the world markets. Once again, the new Montevideo deep-sea harbor also enables synergies with our existing UPM Fray Bentos mill. We will also make local investments outside of the mill fence totaling of $70 million. A large part of this is related to permanent and temporary housing in the area.

When this cost -- the status of our preparation 3 months ago in our Q1 call, several important prerequisites were still under preparation or pending. Now the necessary permits have been granted, and the material agreements with the government of Uruguay have been concluded to the satisfaction of both parties. The PPP agreement between the government and the railway construction company was signed in May 2019. Initial works on the central railway have been started, and the financing of the railway construction consortium is proceeding but not yet finalized. We will begin site works for the mill and dredging of the port immediately. And the tendering for the main equipments and the manning of the project is -- and are going. And as already mentioned, the mill is expected to start in the second half of 2022.

Ladies and gentlemen, I would like to summarize my presentation by stating that the Q2 was 25th consecutive quarter of increased earnings. We expect our business performance to continue at a good level in 2019. Our investment in -- on new highly competitive pulp mill in Uruguay will provide a step change in the scale of our pulp business and, of course, in the UPM's future earnings.

At this stage, I conclude the prepared part of the presentation. Dear operator, we are ready for Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Lars Kjellberg from Crédit Suisse.

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Lars F. Kjellberg, Crédit Suisse AG, Research Division - Research Analyst [2]

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Congratulations on this decision for the pulp mill. It's clearly an interesting project. Could you share with us how you think about the return on these investments given your different criteria with sort of what you expect and if the total investment also includes what you have invested in forest lands. If you can start there, please.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [3]

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Clearly, Lars, obviously, what we have been guiding is the cash cost level of $280 per tonne. And then what is the criteria for investment is in our capital markets material where the return on capital employed for the whole business to be over the cycle more than 14%, and this will meet those criteria.

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Lars F. Kjellberg, Crédit Suisse AG, Research Division - Research Analyst [4]

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All right. And then coming back to the results. Specifically, I'm -- interesting to hear what sort of costs you are seeing coming back aside from pulp as mentioned.

And also the Energy fixed cost reduction, is that something we should expect also in the second half, i.e. about EUR 6 million per year?

And then finally, if you think about your comments on pricing, pulp, paper prices, how do you see the spread between cost and price developing? Is that a net negative or neutral or whatever, how you see it?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [5]

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Yes. This is Tapio. Maybe I'll comment on those questions. So first, starting on the cost development. As again pointed out, it was already visible in the second quarter figures that this kind of a cost environment turned. And I said, obviously, lower pulp prices is negative for our pulp business but positive for our pulp-consuming paper businesses, and we were able to sort of capture that benefit as a lower cost.

But then other costs started to come down as well, and we would expect that to continue into the second half of the year, and let's say, going forward. What we have seen already also in other fiber costs, including particularly wood costs, that the market prices started to come down. And as the kind of inventory cycle or the cycle in the sort of value chain from purchase to harvest, to consuming the pulp -- or the mill -- wood in the pulp and paper mills and wood products mills is longer than that, takes some time to sort of flow to the bottom line. But we expect that to kind of happen and take place during the second half of the year. Also let's say in the logistics costs, we are starting to see some moderation as well. So on several fronts.

Then to your question in -- regarding the costs in the Energy business, maybe just as a background where this particular item is coming from. In the costs of nuclear power generation that is charged to us from TVO, is included a charge for the estimated future costs of dealing with the final depository for the spent fuel -- nuclear fuel. And Posiva, which is the company in Finland owned by TVO and Fortum, who will take care of the final placement of the spent fuels from Loviisa. And Olkiluoto today made a revised estimate of those future costs, as they do annually at this time, also related to the fact that Posiva made earlier this year, a decision to move into the implementation phase of that plan for the spent fuel. And therefore, there was a more significant revision downwards, therefore this EUR 12 million lower fixed cost for the first half. But there will be, let's say also as far as the fixed cost is concerned for the rest of the year, a benefit coming for our Energy business in the second half as well.

And then finally to your question in terms of pulp and paper prices. No sort of specific comment on the spread as such. But I would say that, as has been visible already in the first half of the year in this environment, we expect that we will keep our margins stable the same way in the second half as we have succeeded doing in the first half of the year as well.

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Lars F. Kjellberg, Crédit Suisse AG, Research Division - Research Analyst [6]

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Just one final question, if I may, just on CapEx. You raised this year's guidance by EUR 100 million. What sort of level of CapEx should we expect in 2020 and 2021? If you can give us any color on that, please.

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [7]

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That, we don't have as -- a figure to give yet. But as said, the sort of rest of the CapEx for this Uruguay project then is expected to take place during '20, '21 and '22.

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Operator [8]

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And our next question comes from the line of Justin Jordan from Exane.

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Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [9]

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And firstly, just want to say congratulations to the Board for finally reaching this decision. I know there's many, many years of preparation work gone into this decision.

Can I just focus -- firstly, just talk about the Communication business -- sorry, Communication Paper division. I'm just intrigued about your comment of impact of reducing stocks in Q1. Because, I guess conceptually, if I take a step back, you should be benefiting from lower pulp raw material costs in this division. And is that something that is yet to come through? Or is that something that has been masked by the impact of reducing stocks in Q2?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [10]

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Maybe if I'll comment on that. Perhaps it's a bit of both in a sense that there is some time lag, how quickly and at what pace, in a sense, the pulp cost/benefit shows in the bottom line. Of course, in the case of Communication Papers, that's most relevant for the fine paper part of the business, to some extent to the magazine papers, where we do consume some chemical pulp as well.

Then on the -- in the inventory reduction part, the way in a sense the accounting works is that, kind of the realization of the margins in our bottom line is somewhat less when you are selling from stock, more so than what you are adding to stock by producing paper. So it's a combination of the 2.

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Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [11]

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Okay, all right. And I fully accept what you're saying in terms of the long-term global pulp demand growth rate being circa 3% for market pulp. Can you give us some thoughts as to where you think short-term, i.e. for the remainder of 2019, pulp price outlook is? I know you talk about lower pulp prices in the second half overall. But do you believe, for example, Chinese pulp prices are at or near their trough? Or what's your view on this? Because clearly, there are -- if you ask 10 investors, there are 20 different views out there at the moment as to where we may or may not be. I'm just interested in your view.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [12]

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Maybe that is the reason that we do not actually put that kind of guidance for you. There is 20 different views on it. It remains to be seen how the balance of the market will move on as we have seen that now, the inventories are getting downwards even if they are still on the high level. But that is something that is now happening and most probably, those kind of delivery statistics are not representing the underlying demand. My opinion is that the underlying demand is somewhat better than what we have seen in the deliveries, for the reason that there's a kind of inventory correction as well.

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Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [13]

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Okay, Jussi. Just one final question from me. Can you just remind us -- I know this may seem like a really boringly anal question from me, but UPM, when you're declaring your dividend as a Board, I am right in thinking you based that off your operating cash flow? And the important thing I'm trying to check here is clearly, you're signaling a much reduced free cash flow period over the next 3 years, in 2020 to 2022. But am I right in thinking that should not influence future dividend payments?

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [14]

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That should not be the case.

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [15]

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Yes, maybe to sort of recap in a sense that we have been discussing earlier. First of all, the dividend policy is -- let's just say it's based on operating cash flows. So it's before investments, after obviously any finance cost, taxes or -- finance cash costs, taxes or change in working capital, but pre any CapEx. Then secondly, kind of the policy, we have the 30% to 40% range, which is the target where we want to be over time, meaning that it's not a hard ceiling or a floor. So obviously, the Board will consider, in a sense, let's say, the trajectory on which we have been as far as our dividend is concerned and kind of what the expectations are for the future and where we are in terms of our financial standing, in terms of our balance sheet and performance of the business. So obviously, we put great weight on sort of predictability and kind of a consistent track as far as dividends are concerned.

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Operator [16]

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And our next question comes from the line of Alexander Berglund from Bank of America.

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Alexander Berglund, BofA Merrill Lynch, Research Division - Analyst [17]

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I have 2 additional questions on Uruguay. So first of all, if you can comment anything on how long you think it will take to reach full capacity. Is it kind of in the range of 3 years or so?

And then the second question is just kind of a clarification on the ownership. So I think you said you will have 91% ownership in the project. Does that also mean that you're only going to pay 91% of the $3 billion CapEx? Or how does that partnership work? Those are my questions.

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [18]

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Yes, I'll take that. 3 years is probably a good estimate. Of course, let's say, accounting for the fact or kind of taking a note that it's not a linear curve in terms of 3 years. Let's say, the curve -- startup curve normally for an experienced operator such as ourselves is pretty quick in the beginning, and then there is a, let's say, a tail of getting to the full capacity for the full days of the year. That takes a couple of more years.

And then in terms of the ownership, as we have said, we have a local partner in Uruguay who has been also with us in the Fray Bentos project from the beginning. They hold the 9%, and in a sense, it's a partnership where they have, in a sense, responsibilities and benefit that mirror ours in that project.

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Operator [19]

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Our next question comes from the line of Mikael Doepel from UBS.

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Mikael Doepel, UBS Investment Bank, Research Division - Executive Director & Analyst [20]

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I have a couple of questions. First of all, on the paper markets. What we have seen recently in the European statistics is that the demand declines have been accelerating a bit recently. Do you see that as a new trend? Since we are coming down faster now compared to the 3% to 5% in the recent years, is that a new trend or is this mainly reflecting a weaker cyclical situation and some inventory adjustments? That would be my first question.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [21]

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First of all, I guess that we have not changed our view of the around 5% trend decline in Paper business. And as like Tapio said earlier, that there was inventories on Brexit -- inventory corrections. And then of course, paper business is also having a kind of link to the general economics, and the pace has been somewhat lower in Europe now. Our kind of view is very solid with that 5% -- around 5%. And I would not actually draw conclusions from one quarter, that would -- there would have been any kind of particular change.

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Mikael Doepel, UBS Investment Bank, Research Division - Executive Director & Analyst [22]

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Okay. And then in terms of pricing, you mentioned you expect somewhat lower pricing on paper in the second half. Would you care to give some more color on the magnitude of the declines?

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [23]

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Definitely, we are not giving any particular number. But if we did have the moderate increase in the beginning of the year, I think that this will be similar to that, going downwards.

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Mikael Doepel, UBS Investment Bank, Research Division - Executive Director & Analyst [24]

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Okay, and then just finally on costs and the maintenance costs that you have. How should we think about -- you talked about the underlying input cost. But if you think about the maintenance costs, H2 compared to H1, or Q3 compared to Q2, what kind of a delta should we expect to see there?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [25]

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I believe at the end of first quarter, we talked about roughly EUR 35 million impact of maintenance costs in the second quarter, including everything that has been mentioned here in the Biorefining business. And well, let's say, impact of maintenance, obviously, not the only costs but sort of lost margin in Biorefining, Energy and to some extent in the Communication Papers business as well. Third quarter, from that point of view, will be a clean quarter in terms of any major maintenance. And then in the fourth quarter, we will have the Fray Bentos maintenance shutdown.

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Operator [26]

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And the next question comes from the line of Linus Larsson from SEB.

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Linus Larsson, SEB, Research Division - Analyst [27]

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Again, congratulation on this very exciting go-ahead decision that you made today. I'd like to follow up a bit on Uruguay. The -- if you could talk a bit about the scope of the investment. Correct me if I'm wrong, I think the amount that you have talked about in rough terms before was somewhat lower, the $2.7 billion. I wonder if you could talk about the scope, if that has changed in any way. Also in this context, whether there is also an investment need in further plantation expansions, please.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [28]

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If I may actually start with -- and maybe Tapio continues. Obviously, when we are looking the kind of rough estimate that we gave, 2 million tonnes and EUR 2 billion, that was a rough estimate. As you can see, that it would have been very competitive on that level. Obviously, the scope has changed somewhat with the energy concept is something that we actually have been improving. There are -- in all of the areas, there have been some changes. And of course, the capacity is somewhat now bigger, so it is a bigger facility. But there are additional kind of facilities as well that -- to secure that $280 per tonne cost level. So basically, that's the reasoning that it is somewhat higher on that.

And obviously when it concerns the platform of the Uruguayan plantations, obviously, we have already secured through these 3 items, i.e., the owned forest and then the Fomento arrangements, leases and then the external long-term suppliers. But obviously, we are continuing with the development of the plantation platform as well. So that's something that will not stop here but will move on.

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Linus Larsson, SEB, Research Division - Analyst [29]

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But we shouldn't expect the step up in your investments in owned plantations from now on, given the go-ahead decision that you made today?

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [30]

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No. We have secured supply for the mill -- for the both mills actually, and that is the status at this point with this -- all these factors we are talking about, 90% self-sufficiency already on the kind of secured volumes. But obviously, hey, we will develop. When it is feasible to use CapEx for new plantations, we will do so.

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Linus Larsson, SEB, Research Division - Analyst [31]

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Makes sense. That's great. Also on the results and the outlook, I'd like to follow up on what you've talked about on variable costs. If I look in your graph in your presentation, it looks as if the tailwind, including pulp obviously, on variable cost in the second versus the first quarter was around EUR 50 million. Is that the sort of magnitude we should expect in the third quarter sequentially as well?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [32]

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No. No sort of figure to give on that at this point in time. But as said, we believe that this is a kind of the shift that now took place in the second quarter and we expect to sort of continue with that during the second half of the year. And I said, about half in a sense of the benefit was coming from pulp cost for the paper business. So that can be more or less during the second half of the year. But then also, let's say, there is the flip side of the coin. So then it's the sort of other items, in a sense, which we continue -- that we will continue to see a trend in the second half of the year in terms of input costs decreasing.

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Linus Larsson, SEB, Research Division - Analyst [33]

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Great. And specifically on wood costs, did you have a tailwind sequentially in the second quarter? And what kind of market outlook and a P&L effect -- sorry, are you seeing in the third and fourth quarters, please?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [34]

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Well, let's say, no sort of -- no more details on that than what I said earlier, that we have seen, let's say, the sort of market prices moderating, and that -- already earlier. And that is kind of flowing do -- flowing through to our bottom line as we are starting to consume but -- that wood.

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Operator [35]

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And our next question comes from the line of Robin Santavirta from Carnegie.

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Robin Santavirta, Carnegie Investment Bank AB, Research Division - Financial Analyst [36]

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So first, in terms of the Uruguay project, you have agreed with Uruguay on no tax or a tax-free zone for the new project. How long is that agreement? And does that also work for the Fray Bentos mill, the tax-free agreement?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [37]

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It's actually a free trade zone, where there is obviously a lower fixed annual tax that we pay, which is mentioned in our release. It is 30 years long, as we had for the Fray Bentos mill as well. And actually, that Fray Bentos free trade zone agreement has been agreed to be extended for 30 years starting from now.

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Robin Santavirta, Carnegie Investment Bank AB, Research Division - Financial Analyst [38]

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All right. Good. And in terms of the synergies that you several time talked about during the prepared presentation with the Fray Bentos operation. Can you sort of provide some kind of examples and what kind of magnitudes are we talking about in terms of earnings?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [39]

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We don't have a number. We don't sort of provide that. But obviously, if you think about our operations in Uruguay, we can utilize the platform that we have built there for the, let's say, whole business in terms of the plantation operations, the running of the pulp mill itself and all the sort of supporting functions that we have over there.

Obviously, let's say, the significant areas of synergy are in the plantation operations as a whole as we are developing and optimizing the whole plantation area for the 2 mills. And then as Jussi mentioned also, in the logistics, where the investments that are being made, particularly in the harbor terminal operations, will benefit our Fray Bentos mill as well.

And then in terms of sourcing and securing the main inputs for the operations in Uruguay, obviously, we will have scale benefits, like for instance in the area of chemicals, but other areas as well. So several areas and -- benefit for the existing operations as well. But no numbers to give on that.

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Robin Santavirta, Carnegie Investment Bank AB, Research Division - Financial Analyst [40]

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All right. And in terms of the -- you had 2 other sort of transformative investments you have been talking about. And you're planning the biofuel project and the biochemicals project. What is the status of those projects? And when should we expect an investment decision? Could it be already during 2020?

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [41]

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This is, Robin, great. 5 minutes after we have announced EUR 2.7 billion or EUR 3 billion investment, somebody's asking already the next step. This is a fair, good question. We are moving as we have planned to, to actually develop those projects. And like we have been guiding, that biochemicals are somewhat advanced, more advanced than the biofuels. But both are moving on into -- based on the plan. And when we -- when they are ready, obviously, we are making those decisions. But today, I have no more further information on those.

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Robin Santavirta, Carnegie Investment Bank AB, Research Division - Financial Analyst [42]

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I understand. And then finally, I don't know if I didn't catch the -- when do you expect sort of to reach design capacity? Is it already during 2024 in Uruguay?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [43]

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Well, what I was saying earlier to the earlier question that somebody asked, is 3 years a good assumption for the kind of start-up curve? And I said that, that's probably a good estimate. Again, sort of noting the fact that it's not a linear curve, but let's say, the ramp-up during the first year for us is pretty quick. But then it takes a couple of more years probably to get to the sort of full production throughout the year.

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Operator [44]

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And our next question comes from the line of Markku Järvinen from Handelsbanken.

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Markku Järvinen, Handelsbanken Capital Markets AB, Research Division - Analyst [45]

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Yes. I had a few more questions on the pulp mills still. You mentioned that your environmental permit allows more than 2.1 million tonnes and 2.1 million is sort of the initial capacity. Could you sort of specify how high can you go within the current permit? And what kind of -- does it require further investment to increase capacity? Or how should we interpret that?

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [46]

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That is something that we have not disclosed. The pulp mill is designed for 2.1 million tonnes. But typically, like in all of the size of the investments you have creep and creep is only needing some minor CapEx when actually doing so. So basically today, we do not have any more information around this.

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Markku Järvinen, Handelsbanken Capital Markets AB, Research Division - Analyst [47]

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Okay, very good. And do you at this stage have a view on what the annual depreciation will look like when you're up and running?

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Tapio Juhani Korpeinen, UPM-Kymmene Oyj - CFO & Executive VP of UPM Energy [48]

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Well basically, you can assume 20-year depreciation on the equipment of the mill.

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Markku Järvinen, Handelsbanken Capital Markets AB, Research Division - Analyst [49]

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Okay, very good. And then further on to your other investments that are in the plants, biochemicals, biofuels. Now that you know the timeline of this investment, does that have any impact on the timeline of those investments? Or can you run these concurrently? Or how does it work?

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [50]

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Basically, we have been from the beginning, resourcing these separately. So basically, this is not a resource question to UPM. It is more how these initiatives will develop and get to the stage that we are prepared to take the decision. So basically, it is more on that, at how we develop those.

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Operator [51]

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Okay, so that was the last question. So I'll hand the call back to you, speakers.

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Jussi Pesonen, UPM-Kymmene Oyj - President, CEO, Head of UPM Biorefining & Director [52]

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Yes. Thank you for joining us today. And like I said, this is a pretty historical moment to make a big investment, which is one of the largest, most competitive pulp mill in the whole globe.

With these words, thank you for joining us and have a very nice day. Thank you. Bye.