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Edited Transcript of VK.PA earnings conference call or presentation 22-Feb-17 5:30pm GMT

Thomson Reuters StreetEvents

Full Year 2016 Vallourec SA Earnings Presentation

Boulogne-Billancourt Feb 22, 2017 (Thomson StreetEvents) -- Edited Transcript of Vallourec SA earnings conference call or presentation Wednesday, February 22, 2017 at 5:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Etienne Bertrand

Vallourec SA - VP IR

* Philippe Crouzet

Vallourec SA - Chairman of the Management Board

* Olivier Mallet

Vallourec SA - CFO

* Nicolas de Coignac

Vallourec SA - SVP North America

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Conference Call Participants

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* Alessandro Abate

Berenberg Bank - Analyst

* Nick Green

Bernstein - Analyst

* Guillaume Delaby

Societe Generale - Analyst

* Raphael Veverka

Exane BNP Paribas - Analyst

* David Farrell

Macquarie Research - Analyst

* Amy Wong

UBS - Analyst

* Rob Pulleyn

Morgan Stanley - Analyst

* Maria-Laura Adurno

Goldman Sachs - Analyst

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Presentation

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Operator [1]

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Etienne Bertrand, Vallourec SA - VP IR [2]

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Good evening. You know me, Etienne Bertrand. I'm the head of IR at Vallourec. Tonight, we will present you the full-year 2016 results. With me, Philippe Crouzet, CEO, Olivier Mallet, CFO, Jean-Pierre Michel, COO, Didier Hornet, Senior Vice President Eastern Hemisphere, and on the phone from the US, Nicolas de Coignac, Senior Vice President North America.

I would like to inform you that this conference will be available on -- the conference call on the Web. This conference will be recorded and the replay will be available. It's audio webcasted on our Investor Relations website at www.Vallourec.com, and the slides will be commented by the management during the presentation, which will be also available for download on our website, both on the homepage and on the Investor Relations section in the financial results page.

Before I hand over to Philippe, I must warn you that today's conference contains forward-looking statements and that future results may differ materially from statements or projections made on today's call. For your convenience, the forward-looking statements and risk factors that could affect those statements are referenced at the beginning of our slide presentation and are included in our annual registration document filed with the AMF. This presentation will be followed by a Q&A session and we'll get alternatively questions from this room in Paris and from the people who are logged on the web or on the call, especially for (inaudible).

Now I would like to leave the floor to Philippe.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [3]

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Thank you. Good evening to you all. I'll start by providing you an overview of the achievements of the year before leaving the floor to Olivier for some more comments on the financials.

Let me quickly remind you how the year 2016 was. It was a tough year for the oil and gas sector as a whole. It's the second year in a row of massive CapEx decrease in exploration and production, which is a key driver for our oil and gas business. You see a 23% all-in CapEx following a 25% in 2015. This has never been seen before and, more importantly, it's impacted all the regions except the Middle East. Of course, this resulted in a lot of pressure on all of the supply chain and you see on the right-hand side of the slide some indication. We use the US index on our OCTG prices fell during the period, so we were exposed to a significant drop in our volumes and simultaneously in our prices.

Thirdly, we start to see some signs of recoveries in the US OCTG market in the second half -- you see the blue curve on the charts in the middle -- after hitting a low of ultimately 500 weeks operating in North America. By the end of May, we ended the year with 658 end of December. So this is the first sign of recovery, but only in North America so far because, in the rest of the world, we yet have to see this kind of trend materializing either in the oil and gas business or in other businesses of the group. The consequences of that environment are shown here, and I think it's good to take a longer-term view.

You see that our sales in 2015 were down 9%, but more importantly, down to approximately half of what we were shipping two years ago in 2014. What this graph says is that we probably reached the trough in 2016, in fact in the first half of 2016. You see that the second half of the year is up compared to the second half of 2015, up exactly by 11%. This change in trend is of course due to all of the efficiencies implemented by the industry, which made profitable drilling -- which were not profitable before, notably for the unconventional drilling as the result of the successful implementation of the OPEC agreement in November. But we think it's also reflective of the fundamentals driving our business, which should lead to a recovery of the drilling activity, which is of course driving our oil and gas business. And here is a reminder of those fundamentals.

Of course, the sustained growth in oil demand is one, but it is not the most important factor. Field depletion is the key factor. There is a need to put in production approximately 5 million barrels per day every year to just maintain the current ForEx supply. And we certainly see some of that behind the progressive rebalancing of the oil supply and demand expected in 2017, and this is shown in the graph below from the International Energy Agency. So all of this is going to happen this year, supporting the price of the barrel of course, and supporting the recovery of the drilling activity.

So, looking at a more short-term approach or period, it is clear that we have signs, effective signs, of this recovery taking place in North America. Hopefully other regions will join. And anyway, this is necessary; this recovery of the global E&P and drilling activity is necessary to avoid a new oil counter short.

So in the meantime, while all these events were taking place, we decided to of course focus on what we could do internally, and we decided to implement a transforming process in order to prepare the Company to benefit from the recovery.

And here is what we have achieved in 2016. The transformation plan we announced in 2016 is probably familiar to you. And I am pleased to say that we have been successfully executing all the key initiatives of that transformation plan. We are in the time frame on all initiatives, as we announced, and this is very encouraging. I remind you that this is planned, was designed to reposition the Group for more competitiveness and long-term profitable growth of course when global market conditions improve.

Starting with Europe, we have completed the reshaping of our European operations. We've closed two rolling mills and France at Deville-Les-Rouen and Saint-Saulve. We closed a threading line at Muelheim in Germany. In Scotland, a heat treatment line located in Bellshill near Aberdeen was closed in Q4 as announced. And we've also signed in the first weeks of 2017 a final agreement with Apco Metal for the sale of the majority stake in the steel mill in France, and we have completed as well the disposal of our heat exchanger tube activity.

So, the reduction in our -- the resizing, I should say, in our European operations, is mostly done in terms of equipment and installations. Of course, the impact on the job positions is going to show up in the coming months.

The other side of the transformation plan is to create new production hubs, and both are in place. First, in Brazil, we finalized, October 1, the merger of our Brazilian operations into the new Vallourec Tubos do Brasil, which will enable significant industrial and administrative synergies, especially in the area of steel production.

And the second production hub in China is well in place. We finalized the acquisition of Tianda Oil Pipe by the end of November last year. This is a major transaction for the Group as it will allow us to develop the highly competitive offer, combining our valve technology and competitive production, very competitive production costs.

On the financial side of the equation, as you know, we successfully raised close to EUR1 billion. We kept an increase in each one, and we've reinforced as well our partnership with Nippon Steel and Sumitomo Metals Corporation. I will come back to this later on.

Lastly, we've announced the organization of the group back in mid-January aiming at strengthening our customer focus in each of the four new regions created at optimizing the use of our global resources and are boosting our development in the organization will be effective early April 2017. As a result of these various initiatives, we have rebalanced our global capacities and we now have a much more competitive product with Europe's share in the Group's total production capacities decreasing by half between 2014 and 2017 and representing now 23% of our total capacity to be compared with 65% just seven years ago. And Asia now is expected to present 18% of our total production capacity by now, by 2017.

So, we now benefit from a unique position with leading and up-to-date state-of-the-art rolling and finishing capacities in our four regions, and this is what will allow us to serve better our oil and gas customers, and of course enabling us to leverage the expected recovery of our market for the future.

Now, back to 2016, a few words on our cost adaptation. We of course have been very focused on that. In line with our targets, we've continued to reduce our SG&A costs and we've achieved EUR150 million of savings in 2016 after EUR130 million in 2015. This is in line with our balanced plan target. We've continued to adapt our headcount to the low level of activity and of course consistent with the reshaping of our industrial footprint. The total headcount is down 12% versus end of 2015 and 24% versus end of 2014, of course excluding the recent acquisition of Tianda, but excluding as well the divestiture of the steel mill of (technical difficulty).

And lastly, we've been very strict in our CapEx use. Our CapEx were below EUR200 million in 2016 at EUR175 million, and this is of course very, very strict.

If we take a longer-term perspective, we confirm our targets of EBITDA improvement for the part of course which is within our control, costs and optimization of our network. Costs, firstly, the balance original target was EUR350 million of savings for full-year 2017. We've already achieved EUR130 million in 2015, EUR150 million in 2016, so the EUR350 million will be overachieved in 2017, no doubt.

In February of 2016, we've increased the target to an additional EUR400 million, but over the period 2016 to 2020. We started that with a nice EUR150 million of savings in 2016, which means that the remaining EUR250 million should be overachieved as well over the four-year period. And on top of that, we confirm the EUR350 million of additional contribution to EBITDA coming from our change in scope, the acquisition of Tianda, for example, and from the new routes. We stated that part of the total EUR750 million of additional contribution to EBITDA is related to increase of activity. And you will note that this increase of activity we have already gotten it in North America as I already mentioned.

Lastly -- and that was the financial side, part, of our transformation plan -- we have considerably reinforced our balance sheet and liquidity profile during the year through firstly a successful capital increase in April which allowed the Group to raise close to EUR1 billion, and second, through the commitment of new bank facilities in May. So at the end of the year, our medium and long-term undrawn committed credit facilities amounted to EUR2.3 billion. And all this of course provides the Group with the flexibility to implement its strategy and the ability to fully benefit from the market recovery.

I now leave the floor to Olivier.

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Olivier Mallet, Vallourec SA - CFO [4]

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Thank you Philippe. Good afternoon to those I didn't see before.

So, let's move to some figures, starting with the key objectives we had provided the market back a year ago on February 1, 2016. There were two objectives, free cash flow and net debt. The first one was to be at about [EUR960] million at stable working capital. This has been achieved minus EUR574 million at stable working cap. And under of that, we have significantly reduced again our working capital by EUR179 million, leading to a free cash flow of minus EUR195 million. On the debt side, the objective was to stay at a maximum net debt of EUR1.5 billion by year-end, and we ended up at right below EUR1.3 billion.

Let's have a first look on the key figures, starting from the revenue, which highlights the difficult environment still in 2016. Since our full-year revenue was down 22% due to both volume and prices, we will come back on that, it's interesting to notice that Q4 was on a significantly better trend with Q4 revenues down only 3% compared to Q4 2015. And this is due to what you see on the left-hand side of the slide with volume down 9% on a full-year basis, but up 18% on the last quarter year-on-year. And this is fully due to the very strong rebound we are experiencing in the US as of today still with a very difficult price depreciation in 2016.

EBITDA was negative EUR219 million in 2016 with as well for the first time since many quarters, Q4 2016 slightly better than Q4 2015 at minus EUR63 million.

I already commented the full-year free cash flow. Again, on the fourth quarter, it almost at breakeven. This is due to the very good Q4 performance in terms of working capital.

Quickly on this slide which shows a bridge for the full-year 2016 revenue, highlighting the fact that volume was again down in 2016 compared to 2015 with on top of that the quite significant negative price mix impact, mostly of prices of course, and almost no currency impact in 2016.

Having a look on the breakdown in our revenue by market and by region, no big change by market. Oil and gas is still of course our largest segment by far at 60% of our total revenue in 2016. More interestingly, the evolution by region where you see the quite large drop in North America revenue within our total revenue from close to 30% in 2015 to below 20% in 2016, due of course to the decrease in the oil and gas activity in the USA and despite the nice rebound that we have started to experience in this part of the world in the latter part of 2016.

A few words on the P&L from revenue to EBITDA, with revenues down 22%, and despite very good monitoring of our costs with a very good adaptation of overall variable costs and to a large extent of our fixed cost as well, the industrial margin was impacted by this working activity volume and pricewise and was down by EUR213 million compared to 2015.

We continued to decrease our SG&A by almost 13% in 2016, leading to a total decrease of 21% over two years. And we have already commented the EBITDA figure.

Below the EBITDA, the operating income was impacted by some restructuring charges or impairment charges taken mostly in H1 at the time when we announced our restructuring plan in Europe, although these charges were lower than the ones taken in 2015, especially the impairment charges taken in 2015.

Material to other comments on this part of the P&L, a strong increase in our financial charges largely due to a lower ForEx result than in 2015, leading to negative net income slightly reduced compared to the one of 2015.

Let's move now to some cash flow items, starting with free cash flow. The first line is the cash flow from operating activities, minus EUR199 million in 2016, slightly lower than 2015, due mostly of course to the decrease in the EBITDA. Again, a good performance in terms of working capital, down by EUR179 million. It's actually even more than that because you should not forget that, at the end of the year, we integrated all of the working capital the Tianda acquisition and from the VSB a full consolidation. There was as well some negative ForEx effect. That performance in terms of reducing our working capital is really quite good in 2016. CapEx was down to EUR175 million, slightly below the objective we had given you at the end of the year, which was about EUR200 million.

What does it mean in terms of net debt evolution? I won't comment the free cash flow. We have already done that. On the right-hand side of this slide, you see the effect of Tianda acquisition and VSB debt full consolidation which are exactly in line with the figures we had given you in February last year. So that, at the end of 2016, the net debt was EUR1.287 billion, which is leading to a quite satisfying year-end ratio at the end of 2016 of 34%.

From a liquidity and financing point of view, the key elements at the end of the year are that we have on our balance sheet EUR1.3 billion of cash in front of EUR1.5 billion of short-term debt, and, on top of that, EUR2.3 billion of long-term undrawn committed bank facilities. And as a reminder, we have extended EUR1.5 billion of these bank facilities back in July so that most of it, more than EUR2 billion, will be available until 2020.

And I will give the floor back to Philippe for the outlook.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [5]

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So, let me give you our thoughts on where we currently stand and the way we foresee 2017. We expect, clearly, continued volume growth in OCTG in the US all along the year. The demand is very strong as I speak, and it's driven partly by restructuring of distributors, but now clearly by your high final demand, final consumption for OCGT on the market. And this is really we think pretty sustainable.

In the meantime, we have experienced a significant surge in scrap prices starting at the end of 2016. It's pretty consistent with the change in many end markets using scrap. And so we've matched this by price increases that we announced in December and January, but of course they should mostly impact the second half of the year.

During the first half, we expect the surge in scrap price to largely offset the positive volume effect of the rebound in drilling activity. So this is for the US, and really this is the major factor in terms of activity regarding our outlook for the year and the rest of the world.

What we see is that the sanctioning of new, large projects, especially offshore projects, by IOCs has not yet restarted. And so the deliveries for the year, for the year 2017, should mostly rely on the backlog contracts that were awarded last year mostly by NOCs and at pretty low prices, and lower than the ones we -- of our deliveries at the beginning of 2016, which were based on higher prices coming from 2017 orders.

As far as Petrobras is concerned, Petrobras issued a new five-year business and management plan. And we, therefore, on the basis of that plan, expect their drilling activity to remain broadly stable in 2017 compared to 2016.

As far as other group businesses are concerned, we expect to experience still a low demand in a competitive pricing environment. We especially expect some slowdown, a progressive slowdown, in the conventional power generation activity in China due to recent government decisions.

For our industry activity, we do not expect significant change on these particular market segments with the exception of the subsegment of iron ore, where prices are clearly rebounding. So this is a positive.

And of course, we expect to benefit -- to continue to benefit from the impact of our transformation plan, especially in Europe. So therefore, based on current ForEx and market conditions, we target full-year EBITDA to improve by EUR50 million EUR100 million compared to the full-year 2016.

So thank you for your attention. We will now answer your questions.

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Questions and Answers

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Operator [1]

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Alessandro Abate, Berenberg.

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Alessandro Abate, Berenberg Bank - Analyst [2]

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Good afternoon guys. Just a couple of questions. If you can give a little bit more color on the recovery of OCTG in the ex-US market. And the second question is related to the momentum of demand in the US, which seems to be very, very strong at the moment. What kind of risk do you see from potential capacity that's going to come on stream if, let's say, the OCTG price exceeds a certain threshold to justify increase of capacity. This is clearly also including well the OCTG producer. Thank you very much.

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Etienne Bertrand, Vallourec SA - VP IR [3]

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This is Etienne. Could you just repeat the first question because there's been a missed connection between here and Paris (multiple speakers)

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Alessandro Abate, Berenberg Bank - Analyst [4]

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Sure. The question is if you can give a bit more color on the timing of the recovery of OCTG momentum in the ex-US market. Usually there is always a lag of three or four months, five months. I was wondering whether you see things strengthening in terms of potential order intake in terms of your utilization rates relative to the US, or if not, when do you think this will positively affect your underlying utilization rates and profitability?

And the second one, the momentum in the US OCTG is quite strong. So, what is the risk that you see that if the OCTG price keeps going up also on the boost of raw material cost, there might be an expansion of margin that may actually tweak further utilization rates at facilities now are not really working at full speed. Or do you think that momentum for rig count is so strong that you basically see very little risk coming from this potential increase from the supply side? Thank you.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [5]

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Maybe on the first one, ex-US, you mentioned a pretty short delivery time between recovery in North America and ex-US if I understand well. In fact, today, they are not correlated. I think we are really faced with two completely different situations, and in fact three if I want to be more specific. North America, you know the situation, and Olivier or Nicolas will comment. This is a clear rebound, a clear recovery in all the areas, and there are more than in the past where the breakeven is lower than the $55 per ton. And you know that each project is a relatively small amount of CapEx, so easy to start, easy to finance.

Outside the US, most of the projects which are being delayed at the moment are big projects, billionaire projects. And so it's logical that it takes more time to get to a positive decision, a final investment decision. On the other hand, in many cases, there is still a lot of engineering work to develop to lower the breakeven point. And so I think there, at best we expect some positive final investment decisions to be taken in the course of the second half, according to what the major oil companies are stating, and not all of them, and anyway, with absolutely no impact in terms of delivery given the delivery time over 2017. So that's what we really think, that this universe of IOCs, and mostly geared at offshore projects will not significantly impact our activity in 2017.

The third group of customers of course are at the NOCs, and they are continuing with their drilling activity. As you know, they were the ones not to slow down as much as the others and they will not of course rebound as much as North America. In between are the independents. It's theoretically a smaller category. Today, it's probably a more relatively bigger category. But they are faced with the same challenges as the IOCs in the offshore operations.

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Olivier Mallet, Vallourec SA - CFO [6]

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Maybe a few additional comments on what we see in the US market as of today, both in terms of demand and supply. First, on the demand side, very clearly there is a strong rebound that has taken place since June of last year, and that we believe is very healthy. It's driven by three levers. The first one is of course the increase of the rig count, and therefore the final consumption. As you know, the average rig count number in 2016 was 510 active rigs. Already as of today, as of the end of last week, we are at 751 rigs, so definitely a very nice rebound sustained by the WTI price increase.

The second factor is destocking/restocking moves that have taken place. Until early Q3 2016, there was a destocking phase where all of the distributors in the USA and the end-users very likely were trying to cut their inventories as much as possible, and this was impacting of course demand addressed to us. As of today, they are all restocking and they have to increase their inventories in order to follow the (inaudible) final demand and to keep what they typically like to keep, which is about five months of consumption in inventories.

The third element which is specific to us, to Vallourec, is that we have regained market share all over 2016 and we are benefiting from the full-year effect of that in 2017. So with that, frankly speaking, our issue as of today in the US is not about the demand. It's about rehiring as quickly as possible newer shifts in order to be able to follow with the demand without having to extend our delivery time to our customers. (multiple speakers) side for what we know which is a seamless supply environment, it's quite stable, I would say. Just two elements. One, U.S. Steel, which is one of the biggest if not the biggest producer in the US, has announced a few weeks ago that they were shutting down permanently two mills, including one seamless mill in Lorraine. So this is a definitive cut of capacity in the US market. On the other hand, but this is not new, Tenaris has announced that they will start somewhere in 2017 a new rolling mill in Bay City, knowing, which will be interesting to follow, that the production costs they will have from regional would certainly be higher than the ones they had from export from Mexico, so this will be an interesting piece to follow up.

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Alessandro Abate, Berenberg Bank - Analyst [7]

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Thank you very much. Thank you.

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Etienne Bertrand, Vallourec SA - VP IR [8]

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We will take the next question from Paris now.

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Unidentified Audience Member [9]

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I have two questions, if I may, regarding 2017 guidance and how you give guidance. Could you please give us more color on the assumption for the US? When you say current market conditions, what US (inaudible) are you taking into account to build the guidance? And also in terms of price, what is the assumption? You say that it is going to be in H2, but is it less than 10%, more than 10%?

Regarding the restructuring, what would be the impact for 2017? You say that, in 2016, it's EUR150 million. Can we expect more than that in 2017?

And then the final question, if we understood that, in 2017, the EBITDA would be negative, can we assume that clearly the 2020 objective that you announced at the time of the capital increase are not any more valid, meaning the EUR1.2 billion, EUR1.4 billion EBITDA guidance is dead, if I can say that? Thank you.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [10]

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So, on the first one, some more color on the US again. From a rig count assumption, it's difficult to follow. Actually, to be very transparent, we had a first assumption in our budget that was an average rig count for 2017 which was below what we see as of today on the market. So we are from time to time as of today revising up our assumption for the activity for the rig count in the US.

In terms of prices and raw material costs, the situation is as follows. On the raw materials side, in the US, we use scrap, essentially. And as you know, the cost of scrap has increased quite significantly since October/November 2016 by a good $100 per ton. We have announced two price increases, one of $75 per ton for deliveries in Q2, and the second one of $125 per ton for deliveries starting in Q3 with the caveat that this price increase do apply to what we call spot orders, but not what is called program customers, which are the customers with whom we renegotiate typically every six months, and in some cases every year their prices. So that there is a sort of a lag effect in the price increase, knowing that the program customers probably represent about 80% of our sales on the US market.

In other terms, in H1, we'll definitely benefit from the favorable volume impact in the US sequentially compared to the end of last year, to H2 2016. But this will be to a large extent offset by a negative squeeze between the current raw material cost increase and prices that we will see impact H2. Of course, the situation will change in H2 where we will continue to benefit from favorable volumes, and on top of that, we will benefit from these price increases which would be at least as high as the increase in the raw material. So this is the situation for the US, which means that all in all, 2017 compared to 2016, there will definitely be a plus in the EBITDA we'll generate on the US market.

As far as the savings are concerned, as you said, we have generated before inflation EUR130 million in 2015, EUR150 million in 2016. We don't give the precise number for 2017, but it will be, again, a very good year in terms of savings with three main elements in that -- one, the continuation of all the action plans that have been launched everywhere in the world to cut costs progressively. The second one, which is that the PSE, the (inaudible) phase in France is taking place, is being executed as of today, people that were working in the (inaudible) ratcheting down are leaving now, so this will be a strong saving year in France and in Europe.

And the third one is that the number one objective of the merger in Brazil between VBR and VSB was to generate savings which were really two different entities managed with different people, different organizations, so there is a lot of room for rationalization. This is true for many support functions, quality, maintenance, and so on and so forth. It's true as well, by the way, for inventories and working capital management. So all this will lead again to a quite nice 2017 year in terms of savings, and more generally implementation of our transformation plan.

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Unidentified Company Representative [11]

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The third question, your third question, was about the midterm perspective that we provided in last February, I guess. There were two components. One was what I would call the self-help, the homework. These are the EUR750 million of additional contribution, both from savings and from the new roads and extended scope that I referred to in my presentation. We do confirm that figure.

The other part was the market conditions. And what we said at that time is that, if, in [2020], we come back to the same volumes and prices that was experienced in 2014, we would be much higher of course than EUR750 million. Just as a reminder, the bridge between 2014 and 2015 from the top of my mind showed that the collapse in volume and price was equivalent to EUR900 million EBITDA.

So now the story is of course if we come back to the volumes and prices of 2014, I have no doubt that some significant chunk of that EUR900 million we will get back. Now, whether we come back and how fast we come back to those volumes and price is really a matter of opinions. What strikes me is that, over the last month, as we've read very different opinions regarding where the oil markets is going, none of these opinions -- and I am referring to oil companies, to consulting firms, etc. -- says that we will not -- we will stay where we are today. Part of the road back to 2014 we get -- a few people honestly say we will get back to those levels exactly, but the majority saying we may stay slightly below volume-wise, maybe more price-wise. And there is one scenario, which is the scenario of contrarian scenario, if I may call it, it's a complete disruption, supply being unable to follow demand and then triggering a very significant price increase in the oil, of course figuring much more drilling activity.

So what we are saying today is on what we control, what is under our control. We are confident. I even mentioned that we (inaudible) a bit the EUR750 million self-help, if I may say, savings or contribution, additional contribution, by saying that part of it is depending on activity recovery, which is true. When you make savings (inaudible) for example, it is partly related to volumes. I am more confident now to say that part of this we will have already engrained and will keep. What comes from activity volume-wise and price is probably more unpredictable, given the differences I referred to between the various segments of the oil and gas. Part of the road we are getting, part of the gap we are filling in North America and probably will come pretty close to where we were in the rest of the world, honestly, it is still too early to say.

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Etienne Bertrand, Vallourec SA - VP IR [12]

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We'll take a question from the platform. Tracy?

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Operator [13]

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Nick Green, Bernstein.

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Nick Green, Bernstein - Analyst [14]

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Good evening. Thank you for taking my call. Two questions please. Are you able to give a free cash flow guidance for the year 2017 on a closing net debt balance for the end of the year? Because if I understood right, you're guiding to EBITDAR of somewhere between minus EUR102 million to minus EUR150 million, CapEx maybe around EUR200 million if you can keep it low again. And under those numbers, you're posting, unless you think there's large working capital benefit, a very large free cash flow outflow, which would mean net debt could be rising back to the pre rights issue level. Are you comfortable guiding to those kind of numbers? Do you feel you have shareholder support if your net debt does go back up there? And can you just discuss as part of this question how you will handle the December 2017 bond refinancing, the EUR650 million that's due, if you're free cash flow is negative again? That's the first question. Thank you.

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Olivier Mallet, Vallourec SA - CFO [15]

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So on this question, we gave guidance (technical difficulty) on the EBITDA for 2017. The other parts of the puzzle are quite easy together. From the CapEx point of view, we are starting 2017 with the same kind of envelope that the one we started 2016 with, so something around EUR200 million. Of course, at the beginning of the year, it's much more difficult assess what will be the working capital level at the end of the year.

So, looking forward to the end of 2017, if the activity was to boom completely everywhere, there would be an increase in working capital. If it's less the case, we have demonstrated in particular in 2016 that all the efforts we are doing internally to improve our performance in terms of working capital is giving us the means to offset what is triggered by the increase of productivity.

Just two additional comments on what we are doing on this working capital side. One, it's on inventories. We have a plan called a rate invent for reduced inventories, which is very much lean management related. You know that fee management does allow to cut costs, but as well for reorganization of the flows in the plans to cut inventories. Our objective in 2016 was to cut inventories at the given activity level by about 10%, and we have achieved slightly more than that, and this will continue of course.

Second topic, when we have made a lot of progress and we can continue to make progress is about receivables where we have significantly reduced the amount of bad debt of overdues in 2016.

About the broader financing question, as you have seen, we have a lot of cash on our balance sheet, so no issue of course for the bond that is maturing now. And we have, which is another element that some of you look at legitimately, a very nice gearing situation at the end of 2016, 34% which is probably better than most of you had in mind. That gives us very larger headroom, even if we generate a negative free cash flow, which will be the case again in 2017. So no reason for being concerned in this regard.

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Nick Green, Bernstein - Analyst [16]

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Okay. So just to confirm that, you'll probably intend to refund that -- to fund that bond with cash as opposed to issuing a new bond, and you do expect to be free cash flow negative for the year, but it's not a big concern. Is that what you said?

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Olivier Mallet, Vallourec SA - CFO [17]

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We have cash. On top of that, of course, we permanently monitor the bond markets. So I'm not telling you that we will never issue a bond. We are monitoring that and will be ready one day when we feel it's a good time to do it, to ensure a bond on the market.

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Nick Green, Bernstein - Analyst [18]

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Okay. Thank you. And then the second question was on Slide 20 from your presentation. You showed that you added EUR300 million of net debt went from the consolidation of Tianda and VSB. Can you talk through, please, the revenue tonnage and EBITDA consolidation impact of those two? It seems slightly odd to us that the average selling price of the Group revenue divided by tons has seen such a marked increase on Q3. I'm wondering if that's partly influenced by some of the consolidation treatment around Q4. Thank you.

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Olivier Mallet, Vallourec SA - CFO [19]

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The EUR300 million are twofold, EUR158 million for Tianda acquisition, exactly the price that was announced a year ago, and the other part is for the full consolidation of VSB debt. It of course generating your EBITDA, it has started in Q4 already in Brazil, and Tianda will generate a positive EBITDA in 2017 as well. So, that's part of the transformation plan which is related to the change of (inaudible) is confirmed.

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Nick Green, Bernstein - Analyst [20]

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Sorry, I just meant, of your Q4 results, are you able to tell us, of the tonnage, how much of that is being benefited by a consolidation adjustment, the perimeter adjustment? The same for the revenue, same for the EBITDA?

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Unidentified Company Representative [21]

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In terms of Tianda, I guess it was zero.

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Olivier Mallet, Vallourec SA - CFO [22]

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Yes, Tianda it was end of December, so it was a consolidation in terms of tonnage and revenue for Tianda, it will be in 2017 only. And you know the figures for Brazil where the capacity of VSB is 600,000 tons. We were consolidating that on a proportional basis at 56%, and it's now consolidated to 100%. The same story for all the figures (inaudible)

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Nick Green, Bernstein - Analyst [23]

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Is that from October forward, is it?

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Etienne Bertrand, Vallourec SA - VP IR [24]

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We'll take a call now from the room.

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Unidentified Audience Member [25]

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Out of the more or less EUR150 million, out of EUR150 million of cost reductions you achieved last year, how much did inflation eat up?

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Olivier Mallet, Vallourec SA - CFO [26]

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Slightly us than EUR50 million, mostly in Brazil.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [27]

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Most of the inflation in Brazil, yes.

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Etienne Bertrand, Vallourec SA - VP IR [28]

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We'll take another question from the room.

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Guillaume Delaby, Societe Generale - Analyst [29]

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Yes, Guillaume Delaby, Societe Generale. One question. I understand what you mean regarding pricing in 2017, so H1 is likely to remain weak, H2 is likely to be better. However, I know you don't like when we talk about average selling price, but average selling price in Q4 is much better than Q3. So my question is, excluding Tianda, which of course brings some further complexity, but excluding Tianda, could we take average selling price in Q4 2016 as a good, let's say, proxy for Q1 and Q2?

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Unidentified Company Representative [30]

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As you rightly stated, I hate when you speak about selling price, because it's not that meaningful. It will be impacted like every quarter and every year by the mix evolution in our sales. Just keep in mind that the average selling price in the US market is significantly lower for oil and gas than in all other geographies. So the more the share of US sales increase in (inaudible) sales, the lower the average selling price is, which doesn't mean that the profitability is lower because it is good on the US market, but be very careful with this average selling price (inaudible).

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Operator [31]

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Raphael Veverka, Exane.

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Raphael Veverka, Exane BNP Paribas - Analyst [32]

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Good evening. Thank you for taking my questions. First, on pricing, and more specifically pricing in the rest of the world, I'm wondering if you could give us some color on the expected negative price impact we can expect in 2017 because of lag effect from a tender issued last year at weaker prices. And where there are incoming tenders with the NOCs, do you see today's (inaudible) to raise pricing in this rising raw material cost environment?

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Unidentified Company Representative [33]

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Maybe to give you some color on the tendering activity, so we secured some 2017 volumes following large tenders in 2016 and price concessions at typically double digits decrease. That's what I can indicate. Now, it is clear that we are making all attempts, sometimes with success, to increase our prices in the coming tenders, so typically this is happening in Saudi, which run bookings on a quarterly basis, so we are making some attempts under successfully some cases to start increasing prices.

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Raphael Veverka, Exane BNP Paribas - Analyst [34]

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Okay. And then the second question is on the US market, coming back there, whether you could give us approximately your current capacity utilization -- sorry, your operating rates, and how you see the industry operating today, at least for the seamless part.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [35]

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Nicolas, can you hear us?

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Nicolas de Coignac, Vallourec SA - SVP North America [36]

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Yes, I do hear you. Do on me to answer this, Philippe? So, currently, in the US, we are running at approximately 75% of our max capacity in all our facilities, and still ramping up. So, it's definitely a much better spot to be for our assets.

The way we see the rest of the industry, we see that this is now the case for the majority of our competitors too. But we don't see yet a lot of ERW being restarted, although this may eventually happen in the coming months. As you know, the first plants to be idled has been ERW, some will not restart, but at a point in time, we may see some of them restarting if there is a scarcity of offer on the market for seamless.

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Raphael Veverka, Exane BNP Paribas - Analyst [37]

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Okay, very clear, thank you. And my last question was just to come back on inflation, so you talked about EUR50 million impact in 2016 within Brazil. Is that -- do you expect a similar roughly impact in 2017, or are there any changes in that? If you could give us any guidance, that would be great.

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Unidentified Company Representative [38]

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I would say relatively similar about inflation is slightly getting reduced in Brazil, but on the other hand, it is getting slightly higher in Europe or in the USA. So same order of magnitude, maybe slightly more in 2017 than in 2016.

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Raphael Veverka, Exane BNP Paribas - Analyst [39]

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Okay, thank you very much.

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Etienne Bertrand, Vallourec SA - VP IR [40]

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Any questions here in Paris?

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Unidentified Audience Member [41]

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(inaudible) Kepler Chevreux. Just one question on the refinery. We understand that there is some lag effect in terms of pricing that will negatively impact steel H1. International market have not yet started to rebound. You will still have negative pricing effect in the Middle East. So, I wanted just to understand whether we will have very different two semesters in 2017, namely having a very negative H1. And could we expect a positive H2 EBITDA, or this is, in your view, much too optimistic? Thank you.

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Unidentified Company Representative [42]

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So, I'd say it's way too early to say. If we go by big region, in Brazil, we don't expect massive changes except if the iron ore is continuing to go up and up, which actually goes behind our general assumptions, which is good news.

On the Middle East market, and this backlog question, what is happening as of today when you compare 2017 versus 2016 is that the deliveries that have taken place in H1 2016 were based on orders, they can meet 2015 at still relatively good prices and margins. The orders that have been taken mid-2016 for deliveries in H1 or Q3 2017 has been taken in many cases at much lower prices. And this is the origin of this negative price backlog effect that will be the negative in the bridge between 2016 and 2017 global EBITDA.

Then what will be the situation in H2 2017? There is typically eight, nine months delivery time effect, so a significant part of the year is already booked. And then what will happen at the end of 2017 and beginning of 2018 will depend on the new orders to be taken in the coming weeks and months. As Didier was starting to mention, we have at least the feeling in this part of the world that prices will not go lower. They have been stable for a while now, and for each tender Didier is making with all my support his best efforts to start raising prices again, but this is more the market sentiment we have. We think that volumes themselves are like in the US are not restarting as of today. So that is still difficult to increase prices in this part of the world.

The second element of which we lack visibility is the second part of the Europe or the US market. So far, although I have been telling you analysts for two years that you would be surprised by the rebound in the market in the US, we have been also surprised as well, and we continue to be surprised by the rapid trend of increasing demand in the US. So what will be the situation H2, it's of course difficult to predict. Here the backlog is very short. We deliver in less than two months typically, so that any change in the volumes, in the prices, can have a quick impact on our P&L.

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Etienne Bertrand, Vallourec SA - VP IR [43]

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Tracy, your next question?

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Operator [44]

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David Farrell, Macquarie.

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David Farrell, Macquarie Research - Analyst [45]

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Good evening. I've got two questions please. Firstly, if I look at the geographic revenue breakdown, North America was up EUR65 million quarter-on-quarter. That's understandable. But Middle East and Asia was up EUR134 million. Can you just talk to that very large increase please?

And then I was hoping you could explain a bit more the leverage to iron ore prices. How much you are selling into the local market in Brazil? And what kind of pricing do you get relative to China? And kind of follow on from that, what pricing, iron ore pricing, are you assuming in your updated guidance?

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Unidentified Company Representative [46]

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Do you want to answer that?

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Unidentified Company Representative [47]

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Yes. On the Middle East, I think this is what Olivier was commenting a bit before. We benefited in 2016 from a very good backlog in the first semester, both in volume and in price. This is explaining the growth of revenue in Asia and Middle East region.

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David Farrell, Macquarie Research - Analyst [48]

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I'm specifically talking fourth quarter versus third quarter. Is it a volume thing into the Middle East that we saw much larger volumes?

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Unidentified Company Representative [49]

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In the fourth quarter compared to the third quarter, this may have been some specific large orders that we had to deliver in that case in North Africa.

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David Farrell, Macquarie Research - Analyst [50]

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Okay, thanks.

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Olivier Mallet, Vallourec SA - CFO [51]

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To your question about the iron ore price, the key parameters to have an mind is that our mine in Brazil, that's produced about 4 million tons of iron ore per year, and we sell to third parties because we don't need it about 3 million tons per year. So that, while directly exposed to the variations of international prices, we are benefiting from that as of today. I won't comment on our assumption as of today, but I don't think that we are too aggressive in regarding this regard.

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Unidentified Company Representative [52]

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Maybe, Olivier, I will add something that I've explained already to analysts is the price that you referred to is the (inaudible) 62% CIF China where you follow that every day. It's right now about $95. What we take into account for internal sales, it's local price, so you need to deduct the cost of freight, the cost of FOB, so it's just from a mine to another mine. So this is largely different from this. But the reference is the variation in terms of percentage that we see internationally. So don't take 3 million tons, multiply it by $95, you will be a little bit disappointed.

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Etienne Bertrand, Vallourec SA - VP IR [53]

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Maybe we'll take the next question also, Tracy.

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Operator [54]

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Amy Wong, UBS.

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Amy Wong, UBS - Analyst [55]

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Hi there. Most of my questions have been answered. Actually, one more left. Pricing increases, I just wanted to revisit that. You said you announced two pricing increases, $75 each. Can you comment on whether this is actually sticking with your customers, and how they -- what's the attitude in terms of responding to those pricing increases? And what's the -- will you also be able to pass it on to your program customers as well, the full extent of the pricing increases that you've announced?

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Unidentified Company Representative [56]

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Nicolas, maybe you answer?

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Nicolas de Coignac, Vallourec SA - SVP North America [57]

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Sure. It was not two times $75. It was it was $175 and $110 -- $125, so making it $200 a ton. So definitely as explained by Olivier previously, it is sticking but maybe more to the spot orders and mainly for Q2. Part of this has been as commented already offset by the evolution of scrap. And for what is concerning the program, customers, we are entering currently into the negotiation for H2, and we are putting this very firmly in front of them. So it's too early to state, but we definitely do expect this to stick.

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Amy Wong, UBS - Analyst [58]

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Got you. Just also a question, just to revisit some of the guidance that was given at the third quarter about the first half of 2017 looking very similar to the second half of 2016. Does that still hold, and is that the shape of the 2017 we should be expecting?

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Olivier Mallet, Vallourec SA - CFO [59]

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You know, I am always cautious when it's about what will be H1, what will be H2? It depends on so many factors that I have to be cautious there. It may be slightly better than what was the overall comment in the business environment for H1 we made a few months ago. But no very large variance either, and that's, again, (inaudible) H1 versus H2, many elements can impact that. I don't want to make you too optimistic on H1 either.

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Amy Wong, UBS - Analyst [60]

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Okay, thank you very much.

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Etienne Bertrand, Vallourec SA - VP IR [61]

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Turning now to Paris because we are running out of time. A quick question in Paris. No. To London? Tracy?

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Operator [62]

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Rob Pulleyn, Morgan Stanley.

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Rob Pulleyn, Morgan Stanley - Analyst [63]

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Good afternoon, or good afternoon, good evening gentlemen. So just two more questions for myself, please. So, firstly, just looking at the language in the outlook statement, it says "based on current market conditions". Could I just probe as to what exactly that refers to in light of the guidance for 2017? Is that conditions right now? Does that imply that the guidance assumes zero improvement in your markets, including the US, through 2017? I'd just like a little bit of clarity around the exact wording there.

And secondly, a housekeeping question. You were kind enough to give the utilization of your US mills at 75% currently. Would you also be willing to provide that for the other regions as that would be very helpful? Thank you.

If I may, a comment, although it's probably -- the one who wrote that sentence is Olivier. But my understanding of what market conditions refer to is the dynamics we are seeing as we speak. We see very strong, positive dynamics in North America, and we do not see similar movement elsewhere. So what we assume, what's behind our target for the year is clearly no significant recovery outside the US, not that we think the mines are not changing; they are changing. When we talk with customers, they are all reopening a number of projects. They are confident they can lower their breakeven quite significantly. But our statement is that the time between their decision to our deliveries is beyond the end of 2017. That's what we mean.

In terms of North America, today, as we speak, and as mentioned by Olivier, the number of rigs in operation is already 50% above the average of 2016. So, let's take that as a basis for assumption for the whole year. And of course, on top of that, some will have to be added regarding inventory rebuilds. So, this is basically, when we referred to current market conditions, is it's what we are experiencing today. It means by the way as far as North America is concerned that we do not foresee any collapse of that dynamics. We think it sustainable, as we mentioned, and so this is what it means. On top of that, of course, we referred to current ForEx conditions, and this may change quite significantly along the year.

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Rob Pulleyn, Morgan Stanley - Analyst [64]

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Thank you.

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Olivier Mallet, Vallourec SA - CFO [65]

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On your second question, in Brazil, the activity level is lower than the US, definitely, for two reasons -- because the local market for (inaudible) is about automotive, trucks, stadiums is still impacted by the depressed macro environment in Brazil. This being said, this is not fully that matters so much. What matters to us more, because it is very high-end stuff, is what we sell to Petrobras, and as we said, it's stable compared to 2016.

As far as export is concerned from VSB, it is depending on the Africa and Middle East market, which is not clearly restarting as of today, as already stated.

In Europe, a big change of course because the all-in capacity has been divided by two, so that the utilization rate that was pretty low is now at a quite good level, as expected, since we have eliminated some duplications in terms of rolling mills and in terms of steel as well with the divestiture of a majority stake in the south Seoul steel plant.

And finally, in China, the business model of Tianda is to run always at a very high level of activity, to sell to the very large Chinese market where is more let's say commodities and then to make a little bit more money, although it makes money in China as well by exporting OCTG tubes, so far mostly API, and we are starting to sell the very first premium tubes for -- and heat-treated in Tianda, and (inaudible) with premium connections in our other facilities in China, in Indonesia or elsewhere in the world.

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Rob Pulleyn, Morgan Stanley - Analyst [66]

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Okay, thanks for the color.

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Etienne Bertrand, Vallourec SA - VP IR [67]

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Tracy, just to finish, I think will take the very last question, and then we will end the conference call.

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Operator [68]

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Maria-Laura Adurno, Goldman Sachs.

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Maria-Laura Adurno, Goldman Sachs - Analyst [69]

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All my questions have been answered. So thank you.

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Philippe Crouzet, Vallourec SA - Chairman of the Management Board [70]

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Maybe if I may, as an answer to the non question, a short additional comment on the way I perceive the oil companies' state of mind. It's clear that they've done a lot of homework ,as we are doing, to reduce their costs and lower the breakeven on many of their projects. It's clear as well that confidence is building up, of course in relation with the way the oil prices is kept above $50 per barrel. But now, this being said, from this perception to pushing the button and triggering major projects, I don't think the level of confidence is yet there. And there is a big uncertainty of course about what the OPEC will do at the end of June when the agreement, the November 2016 agreement, comes to an end, and this is weighting above everything we can say outside the US. The US is driven by very specific market conditions, big demand, a lot of confidence based on recent -- including some recent political changes. The confidence is very strong, very high. And the rest of the world, I think we are not yet there. We are progressing in that direction, but we are not yet there. So sorry not to be more specific about the rest of the world for 2017, but there is a real special context.

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Etienne Bertrand, Vallourec SA - VP IR [71]

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Thank you very much. This is ending the conference call of tonight. Thank you and bye-bye.