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Edited Transcript of VK.PA earnings conference call or presentation 24-Jul-19 4:30pm GMT

Half Year 2019 Vallourec SA Earnings Call

Boulogne-Billancourt Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Vallourec SA earnings conference call or presentation Wednesday, July 24, 2019 at 4:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Didier Maurice Francis Hornet

Vallourec S.A. - Former Director of Development & Innovation

* Edouard Frederic Guinotte

Vallourec S.A. - Former Director of Middle East/Asia

* Jean-Marc Agabriel

Vallourec S.A. - Director of IR

* Nicolas de Coignac

Vallourec S.A. - SVP of North America

* Olivier Bruno Benedict Mallet

Vallourec S.A. - CFO & Member of Management Board

* Philippe Crouzet

Vallourec S.A. - Chairman of the Management Board

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Conference Call Participants

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* Alan Henri Spence

Jefferies LLC, Research Division - Equity Analyst

* Guillaume Delaby

Societe Generale Cross Asset Research - Equity Analyst

* Hin Kin Wong

UBS Investment Bank, Research Division - Executive Director and Analyst

* Igor Levi

BTIG, LLC, Research Division - Director and Energy & Shipping Analyst

* Kevin Roger

Kepler Cheuvreux, Research Division - Research Analyst

* Lillian Starke

Morgan Stanley, Research Division - Research Associate

* Sahar Islam

Goldman Sachs Group Inc., Research Division - Analyst

* Vladimir Maximovich Sergievskii

BofA Merrill Lynch, Research Division - Research Analyst

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Presentation

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Operator [1]

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Hello and welcome to the Vallourec Q2 and H1 2019 Results. My name is Ralph, and I will be your coordinator for today's event. (Operator Instructions) I am now handing you over to Jean-Marc Agabriel to begin today's conference. Thank you.

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Jean-Marc Agabriel, Vallourec S.A. - Director of IR [2]

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Thank you, and thank you for joining us for Vallourec Q2 2019 Results Presentation. I am Jean-Marc Agabriel, Head of Investor Relations. With me today to comment these results we have Philippe Crouzet, Chairman of the Management Board; Olivier Mallet, member of the Management Board and Chief Financial Officer; Didier Hornet, Senior VP Development and Innovation; Nicolas de Coignac, Senior Vice President of North America; Edouard Guinotte, Senior Vice President of Middle East, Asia; Hubert Paris, Senior Vice President of Europe, Africa.

This conference is available via conference call, which will be recorded, and a replay will be available. It is also audio webcasted on our Investor Relations website, and the presentation slides are also presentable for download.

Before I hand over to Philippe Crouzet, I must warn you that today's conference call contain 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 documents filed with the French financial market regulator, the AMF. This presentation will be followed by a Q&A session.

Now I leave the floor to Philippe Crouzet.

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [3]

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Thank you, Jean-Marc. Good evening, everyone. I'm pleased to present our second quarter and first half results tonight as they, once again, bring evidence that we are well on track on our recovery path.

Let me start on Slide 5 with the usual overview of the key achievements of the quarter. Firstly, obviously, Q2 posted a strong performance, both at revenue and EBITDA levels. Revenues grew solid 8% at constant exchange rates driven by the rebound in oil and gas activity, commercial successes in the EA-MEA, as anticipated, and by the benefits of our transformation plan. As to EBITDA, Q2 jumped to EUR 102 million, bringing the first semester to total EBITDA of EUR 169 million, surpassing the full year 2018 EBITDA of EUR 150 million. This also demonstrates the solidity of our recovery.

Second, our free cash flow performance was another major achievement of the quarter. We generated a positive free cash flow of plus EUR 16 million in Q2 compared to an outflow of EUR 164 million in Q2 last year. This very good performance stems beautifully from the improved EBITDA I just talked about, which enabled us to generate a positive cash flow from operating activities, and from our relentless focus on cash discipline as showed by the strict management of our working capital. Consistent with our objectives, our net working capital requirement continued to decrease in Q2 in number of days. We achieved 6 days less than last year at the end of Q2 2019 at 108 days compared to 114 days at the end of Q2 2018.

Third takeaway, we keep a sound liquidity position at the end of June. We had around EUR 2.6 billion of available liquidity, including cash position in excess of EUR 720 million and EUR 1.8 billion of undrawn fully available banking lines. Our net debt was EUR 2.1 billion, slightly below that of end of March, a level obviously compatible with our banking covenant.

Lastly, about prospects, I will elaborate more on that in the last part of our presentation. For now, let me just highlight that based on our solid first half and on the current macroeconomic and market trends, we confirm our outlook for 2019, which remains unchanged over the full year. We continue to foresee a strong increase in EBITDA improvement in working capital requirements, both in terms of number of days on quarterly average and at the end of the year and of course, I repeat, the respect of our banking covenants.

The next slide, Page 6, just summarizes all the key figures of the second quarter.

So I will now hand over to Olivier to elaborate in more details on these financial results.

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [4]

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Thank you, Philippe. Good evening, everyone.

So let's move first to revenue on Slide 8. As you can see on this slide, our 2 main markets, segments, oil and gas and industry and other, we call it a strong growth in Q2 compared to last year. In oil and gas first, our largest activity with 2/3 of our revenue, in this segment, revenue increased by 18% or 14% at same exchange rates. This good performance was driven by EA-MEA. I remind you that this international markets do represent our largest oil and gas exposure with typically more than 50% of our oil and gas revenue. They are now recovering, after the U.S., about 1/3 of our oil and gas revenue in 2017 and '18. And we are, as expected, benefiting from this recovery associated, of course, with the competitiveness of our new Brazilian and Chinese routes. In oil and gas North America, we still benefited from the price increase passed through in Q3 last year, which enabled us to post a slide for the new increase. In South America, oil and gas revenue was down year-on-year, reflecting in temporary low point for offshore OCTG deliveries. A strong restart is expected there in the latter part of this year and in 2020.

Industry and other, which represents 23% of our total revenue, was also up strongly by 25% at same exchange rates. While industry Europe was slightly down with lower volumes but still benefiting from price increase of last year, mining activities in Brazil enjoyed significantly higher volumes sold and prices.

Lastly, petrochemicals and power generation, which represented 6% and 5% of the total revenue, respectively, were down, petrochemicals due to lower demand in North America and reallocation to higher-margin products in MEA and powergen due to a decline in demand as already well known.

Switching now to Slide 9 with, first, another view of the revenue growth in Q2 as presented by level. The increase of 10% was made of volume effect of 6% driven by EA-MEA oil and gas. We also had a slightly favorable price/mix effect of 2%, and ForEx contributed by another 2%. The industrial margin improved by a strong 64% to EUR 213 million, an increase of 6.4 percentage points in margin. Again, this was primarily fueled by the higher activity in EA-MEA oil and gas. SG&A was down in percentage of revenue, from 10.1% to 9.7%. And all these positive evolutions led us to a sharp increase in EBITDA by EUR 79 million, up 7.1 percentage points. We remind that IFRS 16 have there a small positive impact of EUR 8 million.

On the next slide, some comments on the rest of the P&L. The first point to highlight is this EUR 76 million progress of the operating result, which turned positive this quarter at EUR 1 million. This evolution was driven, of course, by the EBITDA improvement with other elements offsetting each other. On one hand, an impairment concerning an asset dedicated to nuclear activity was recorded for an amount of EUR 21 million, it was compensated compared to Q2 last year by reduction in restructuring and other charges. Financial charges remained broadly stable at EUR 61 million, including a EUR 2 million negative from IFRS 16. And finally, net loss group share was reduced by EUR 60 million.

Moving to Slide 11. Let me now comment on cash, starting with working capital management, which, of course, ranks among our top priority. This is a slide that we have been presenting for a few quarters now, which shows the evolution of our net working capital in days of sales by quarter since 2014. And as you can see, our Q2 performance does confirm our discipline and progress in this regard since net working capital requirement was at 108 days of sales at the end of Q2 '19, an improvement by 6 days year-on-year. This good performance came as a result of the action plan we launched early this year on this topic, which is now bearing fruit. What we have achieved goes actually beyond our initial expectations, and we, of course, target to confirm and continue this good performance in the second part of this year.

Let's look now Slide 12 on free cash flow, where the performance achieved in Q2 show the strong progress versus last year. First, our cash flow from operating activities turned positive, up EUR 39 million in Q2, a progress of EUR 100 million in this quarter year-on-year. The good performance in number of days of working capital relative in quite stability in million euros with an increase of EUR 4 million during Q2, which is, again, an improvement of EUR 80 million versus minus EUR 84 million of Q2 '18. And then our CapEx being similar to last year, these elements led to a positive free cash flow at EUR 16 million in Q2, which is, of course, a very nice improvement compared to Q2 '18, an improvement of EUR 180 million. Over 6 months, the progress is as well quite positive with an improvement of EUR 275 million.

Moving now to net debt on Slide 13. Since we had a positive free cash flow in Q2, our group net debt at the end of June, which was EUR 2.111 billion, was slightly down compared to the end of March, which was at EUR 2.125 billion. Our net debt was up EUR 112 million in the semester. This compared with an increase of EUR 392 million in H1 2018.

To conclude this financial part, a few words about liquidity on Slide 14. Vallourec's liquidity is, of course, very comparable to what we had at the end of Q1 and remains strong. We have total liquidity of EUR 2.6 billion made of the cash position of EUR 729 million at the end of June and of EUR 1.8 billion of undrawn committed bank facilities at the same date.

In terms of maturities, we will repay in a few days the almost EUR 400 million bond maturity. And then afterwards, no bond repayment until H2 2022. As far as bank lines are concerned, we have no major maturity until 2021. One word as well on our banking covenant, at the end of June, it is estimated at 79%, way below the threshold of 100%. That will be tested at the end of the year.

And with these words, I give back the floor to Philippe.

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [5]

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Thank you, Olivier. Let me now move to our outlook and begin with the review of our Transformation Plan on Page 16. Firstly, regarding gross savings, the new initiatives we are implementing to further accelerate the past recovery that were announced at the beginning of the year are progressing very well. We are confident that we will be able to deliver on the target of at least EUR 200 million of additional gross savings by 2020. And in H1 2019, EUR 48 million of gross savings were achieved. So this is perfectly in line with the 2-year objective. And of course, we have a specific focus on the German and Brazilian operations, and you see it on figures regarding the reduction in German headcounts.

Regarding the project to expand the production capacity of our iron ore mine, which we mentioned in our prior conferences, we've made substantial progress. And we have submitted to the Minas Gerais authorities this project, and it does include the construction of a new processing unit. And we've been granted the required license. So we should finalize the investment approval procedure in the coming months. As a reminder, the project aims at increasing the capacity of our iron ore mine to around 8.5 million tons per year as from 2022. From now on, in the meantime, we are already increasing the production volumes in 2019 through productivity improvements. And through these actions, we target to increase the production capacity of the mine from 4.7 million ton, which were -- tons produced in 2018 to between 4.5 million (sic) [5.5 million] and 6 million tons in 2019, obviously, to take advantage of the good market conditions.

Lastly, regarding the conventional powergen business, we were imposed a new import duty by the Chinese authorities on the specific segment of alloy-steel seamless tubes. This decision was announced in June. And therefore, the divestiture of that business, the process of divestiture which we had started in February, it obviously unlikely to come out positively. Therefore, discussions have already started with our German employees representatives to assess the future of the operations dedicated to this business segment in Germany.

Let me move on to the last slide or -- not the last slide, the one before on Page 17, and share with you our views on 2019 trends. Regarding our main markets, starting with oil and gas markets, what we see at the moment is the following. In North America, the market is slowing down as evidenced by the moderate decrease in the number of rigs in operations. And the market is expected -- obviously, this slowdown is expected to moderately weight on the second half results with operators maintaining strict CapEx discipline and distributors adjusting their inventories while in EA-MEA, tendering activity remains quite dynamic, and we should continue to benefit from the ongoing recovery of the various markets in the big area as well, of course, from our new competitive routes. Lastly, in South America, the pickup in deliveries in Brazil is expected to materialize in the latter part of this year. And this movement, as we already stated many times, should accelerate in 2020. We are confident that we will see in 2020 the restart of exploration in Brazil as a result of all the drilling commitments taken by the oil companies as a part of the bidding rounds, which took place over the last 2 years.

In other markets, non-oil and gas markets, the environment should stay broadly stable. For industry Europe, it's a challenging market. So it should remain so with demand and prices under pressure, particularly in Germany while the outlook for our mining operations in Brazil remains, obviously, positive. And we should continue to benefit from strong volumes and prices as in H1.

Overall, the moderate slowdown that we expect on the North American oil and gas market over the semester, second semester, should be counterbalanced by an overall good level of activity in our other markets, notably Brazil, and by the execution -- the continuing execution of our Transformation Plan. As a result, we target the -- a solid EBITDA generation achieved in the first semester to be confirmed in the second half of the year.

That leads me now to the last slide, Slide 18, where we strictly confirm our outlook for 2019. So I repeat the targets that we communicated last February, namely: strong increase in EBITDA, supported by both the market trends and by the additional cost savings that I commented earlier; the continued working capital improvement with a reduction in the number of days of working capital on both quarterly average and at year-end; and lastly, a CapEx envelope unchanged at around EUR 180 million. And based on all of those objectives, of course, we reiterate our confidence that the group would respect its banking covenant at the end of 2019.

Now the floor is yours.

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Jean-Marc Agabriel, Vallourec S.A. - Director of IR [6]

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We can now proceed to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the line of Lillian Starke, Morgan Stanley.

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Lillian Starke, Morgan Stanley, Research Division - Research Associate [2]

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The first question I have is with the rest of the working capital. You do (inaudible) on the improvement. But if you could walk us through in terms of any changes that you expect on the seasonality or more or less similar dynamics you're expecting just on the back of how your revenue mix might be changing for the second half.

And then the second question I had is if you could provide any color on any potential restructuring expenses that you might be anticipating on the German power business.

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [3]

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So with the [turn] on the first one, we basically don't expect a change in the fact that we should have a decrease in working capital in the latter part of the year in Q4, like it is typically the case, even if we have been much better-than-expected buyers and (inaudible) value as well at the end of the first semester. So this positive evolution of working capital in H2 should happen again, like always, knowing that we confirm our objective to reduce working capital in number of days at the end of Q4, like we are doing quarter-after-quarter. And all this is a result of the action plan we have launched at the very beginning of the year, the mixing our teams and some (inaudible) firms in order for us to make a diagnosis of the opportunities in this regard, which then have been translated into action plans in order, to some extent, to reduce seasonality in some regards. But still, we have seasonality, and we are currently expecting, again, early gain in working capital in Q4.

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Lillian Starke, Morgan Stanley, Research Division - Research Associate [4]

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Okay. Perfect.

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [5]

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On your second question about restructuring, so this takes place in the (inaudible) where the final outcome would be a closure of our German plant. The likelihood is that in this second (inaudible), there will be no other (inaudible) restructuring charges. You know that we have 3 other plants in the vicinity of the power plant in Germany, the rolling mill for our power generation plant. So that the askings that are quite usual in Germany, where we could offer jobs to the majority of the people working today in the rolling mill dedicated to powergen, but I don't want to comment further on this subject. It's the time to do so at the time being. And we are discussing with the tribunal in Germany about the future of this plant, and it's premature to give more elements about that.

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Operator [6]

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The next question comes from the line of Alan Spence from Jefferies.

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Alan Henri Spence, Jefferies LLC, Research Division - Equity Analyst [7]

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Firstly, on the iron ore mine, are you able to tell -- give us a bit of a sense of what the EBITDA contribution was from the mine, either in Q2 or, more specifically, the first half of 2018? And can you tell us what percentage of your production do you consume internally in your own blast furnaces or relative to third-party sales into the external market?

And then as a clarification on your guidance, to make sure I have it correct. Noting that the solid EBITDA generation achieved in the first semester confirmed into the second, do you think kind of the Q2 run rate is achievable? Or should we be thinking about an average of the first and second quarters?

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [8]

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So on the mine, unfortunately, since what you are asking us is not public information, I cannot give a lot much color. So the -- we don't provide the EBITDA by operation or by activity. It's -- though definitely a nicely profitable asset, which enjoys a very favorable production cost. So it's something that is really favorable to us and for which we contemplated investment to increase the capacity. We have the result about that. Definitely, be a very nice investment in terms of a payback and return once we have completed the internal [file] to finally give the green light to this investment, which would take place in the coming months.

In terms of what is the share sold externally, what I can tell you is that most -- the biggest part by far of the function of the mine is sold internally. One reason for that being that the -- externally, sorry. One reason for that being that the steel plant that we now operate in Brazil after the closure of the old steel plant in Barreiro Belo Horizonte that was using exclusively iron ore and charcoal. There are new steel plants in Jeceaba, is flexible and uses, to some extent, iron ore, but as well scrap or solid pig iron that we can buy on the market. So as a result of that, the vast majority of the function of the mine is sold to various local customers.

Then on your second question, we commented on the semester. So it's not about extending Q2 as being run rate. And you know, basically, that you have ups and downs quarter-by-quarter. So our comparison is vis-à-vis H1 2019, where we say that entering into H2 there is -- identify moderate decline in profitability to be expected in North America because the well-known slowdown in demand and in prices on the U.S. market due to the well-known as well cash discipline and to the fact that there are probably too much inventories on the world as of today in the U.S. It should still be moderate in terms of impact and offset in other activities of the group by Brazil.

One comment to explain that in the U.S., in fact, it's only moderate. It's the fact that raw material costs have gone down as well, which offsets a large part of what we have seen so far in terms of price pressure. And so in the second part ofthe year, the compensation, the offset will come from our other activities. We'll just give you one example of that, in Brazil, where our deliveries for OCTG for deep offshore in the first part of the year was relatively a low point. And as from the last part of the year, for in Q4, we will start increasing again our deliveries and our result for these very high-end products in deep offshore Brazil before the full restart of exploration drilling that is expected in 2020. And where the more we go, the more we are confident that it is happening.

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Alan Henri Spence, Jefferies LLC, Research Division - Equity Analyst [9]

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That's very helpful. Thank you very much. One just housekeeping question, a follow-up. The covenant ratio, I believe, declined to 75%. Was that -- correct me, if that's -- well, first correct? But then also is that in 2020 or 2021?

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [10]

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No. Sorry. What we said is that gearing ratio is at 79% at the end of H1. It's only an indication given to the market. Because as you know, it is tested once a year only at the end of December. It's just (inaudible) at the end of the semester. We have a lot of headroom vis-à-vis the 100% threshold, which, based on the objectives of our share review, makes us more than confident that we won't have an issue in this figure at the end of the year.

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Alan Henri Spence, Jefferies LLC, Research Division - Equity Analyst [11]

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Sorry, I was referring to that threshold. I believe I read that it -- that limit goes from 100 to 75 in future years, and I was just hoping you could clarify what year that changes.

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [12]

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It goes until December 2020. But since the very vast majority of our bank lines have a maturity in 2021 and (inaudible) will be extended, and this will be a new credit line in place after the end of 2020.

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Operator [13]

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The next question comes from the line of Vlad Sergievskii from Bank of America.

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Vladimir Maximovich Sergievskii, BofA Merrill Lynch, Research Division - Research Analyst [14]

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Very good to see this overall strong results, very well done on those.

Can I please continue on iron ore and ask a few questions here? [Just to all], how long does it take for spot iron ore price to be reflected in your realized prices? And the reason I'm asking you is that price has obviously spiked around mid-May. And then wondering whether you have been already able to benefit from the sales in spike in the second quarter or it should provide additional help in the third quarter.

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [15]

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Vlad, if I may, we have quite flexible contracts. So it doesn't take a lot of time before our -- we reflect in our revenues, the impact of all the fluctuations of the price of the iron ore.

This being said, we do recognize that the current spot price is pretty high. And as you certainly well known, some of this is due to temporary factors. And I'm referring specifically to weather conditions, very, very difficult weather conditions in Australia, which prevented the local producers to sell as much as iron ore as the market was looking for.

So we keep a certain caution regarding the price in the course of the year, the next part of the year. But definitely, the conditions are favorable to that business and for all the business which are more structural, like many, many events that happened in Brazil.

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Vladimir Maximovich Sergievskii, BofA Merrill Lynch, Research Division - Research Analyst [16]

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That's great. And my second question would be on the OCTG business in the Middle East. It looks like there are number of prospective offshore gas developments in the region, which, in theory, require high value-added OCTG, including chromium pipe. Do you see any pockets of supply tightness in any of high-end OCTG categories, like chrome, for example, out there in the market? And what are you generally seeing, pricewise, in the Middle East region?

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Didier Maurice Francis Hornet, Vallourec S.A. - Former Director of Development & Innovation [17]

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Yes. Maybe on the -- on your -- the first aspect of your question, the answer is yes. We see some tightness happening on some high-end material, typically, 13% chromium or duplex, super duplex. So this is happening right now.

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Vladimir Maximovich Sergievskii, BofA Merrill Lynch, Research Division - Research Analyst [18]

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Okay. That's great. And in terms of more general pricing dynamics in the Middle East, are prices stable, slow and then moving up? What are you seeing there?

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [19]

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Maybe we will try and let Edouard, our region manager for Middle East and Asia, answer the question. Edouard, are you on the line?

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Edouard Frederic Guinotte, Vallourec S.A. - Former Director of Middle East/Asia [20]

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Yes. Yes, Philippe. Can you hear me?

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [21]

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Yes. We do.

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Edouard Frederic Guinotte, Vallourec S.A. - Former Director of Middle East/Asia [22]

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Yes. Okay. So yes, I can only confirm what Didier just mentioned with regards to some pocket of tightness on the higher end of the product spectrum. Apart from that, I would say that the general recovery and the good activity, good tendering activity that we've seen in the Middle East, in particular, does not equally reflect on increased prices across-the-board. So it's a mixed bag of some niche products, which can be tight, and some more, let's say, standard products, which remain quite competitive.

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Operator [23]

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Your next question comes the line of Amy Wong from UBS.

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Hin Kin Wong, UBS Investment Bank, Research Division - Executive Director and Analyst [24]

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My question is just a follow-up, kind of broader on EA-MEA region. Typically, there's a longer kind of backlog for tenders there. So can you give us a sense of kind of where your bookings are tending this first half of the year? And how long that backlog stretches out into 2020? And then more general comment on pricing that's being booked into the tenders right now.

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [25]

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EA-MEA. And then I say Edouard wants to complement on the...

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Edouard Frederic Guinotte, Vallourec S.A. - Former Director of Middle East/Asia [26]

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Yes. Of course. So unfortunately, Amy, I won't be able to give you a lot of specifics with regards to our backlog and the length of our backlog. Because as you may realize, this is very sensitive information from our competitors, which I'm sure are listening. Let's just say that as mentioned in the press release, the tendering activity has been and continues to be quite high in Middle East and Southeast Asia combined, and we definitely expect to get our share with high tendering activity.

As far as prices are concerned, I can only repeat what was just commented. So [early call] price behaviors between standard segments and the higher end of the spectrum.

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [27]

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And if I may add a point. When we say the tendering activity is high in the Middle East, we refer both to the number of tenders and to the size of some of them. So it's really big, big, big volumes, which is ahead of us. And that may explain why on the most standard products, there is some competition, let's say. These are significant volumes and quite a high number of tenders ongoing. So quite a number of them are not yet beated.

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Hin Kin Wong, UBS Investment Bank, Research Division - Executive Director and Analyst [28]

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Okay. I have a follow-up question on the iron ore mine as well. Can you just give us a bit more thought -- elaborate iron ore decision, to expand on the iron ore mine, total CapEx involved, how long it's going to -- that CapEx is going to take you to achieve the expansion.

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [29]

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Yes. So the point that we are as of today is that we've got this quite news that the authorities of Minas Gerais gave the green light, the license for the expansion project. So what we will do in the coming few months is to finalize the CapEx file. We have very rigorous gates in our process, complete the engineerings studies, get to the quotations from the equipment suppliers before giving the green light, final green light, which I would say is very likely because it's undoubtedly a very positive operation. So expanding it is definitely very good for us.

For this reason, I cannot give you, at the time being, an exact figure in terms of CapEx. I'd say the broad range would be something slightly above EUR 50 million, EUR 60 million. But it will depend on the quotes to be received. And there may be quite an activity in the mining business in Brazil as of today due to what happened, so still to be confirmed. In any case, again, the payback should be really good, to some extent, whatever the final precise number in terms of CapEx will be.

From a timing point of view, as just said, the likelihood is to have the green light given in the coming next few months. Then we need time to order, to receive the equipment, to build the new plant. So that -- if everything goes as we expect, it would mean a start of operations in the course of H2 2021 and the full capacity of the new operations will be there in 2022.

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Operator [30]

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The next question comes from the line of Sahar Islam from Goldman Sachs.

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Sahar Islam, Goldman Sachs Group Inc., Research Division - Analyst [31]

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Can I ask about the U.S.? How should we think about pricing, the price erosion you've seen since Q3 last year? And should we then start to see that in the second half like you've talked about?

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [32]

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Yes. Nicolas, our Region Manager from North America.

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Nicolas de Coignac, Vallourec S.A. - SVP of North America [33]

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Yes. That's always, of course, a challenging one because I could do the same remark as Edouard, and we cannot disclose so much -- such precise information. But definitely, if you take a reference to some public information, which is the Pipelogix index that is known on the market, what I can tell you is that, so far, we've done better. We've contained our prices better than what Pipelogix can reflect.

So far, for -- since the last 9 months compared with the peak, as you were questioning compared to the peak, for the quarter to come, those prices are -- will see still some erosion, as Olivier mentioned earlier. And we will try to contain this within the improvement also of the inputs, so namely the scrap price evolution.

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Sahar Islam, Goldman Sachs Group Inc., Research Division - Analyst [34]

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And in terms of what you're seeing around inventory levels and your expectation towards the end of the year for those, please.

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Nicolas de Coignac, Vallourec S.A. - SVP of North America [35]

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Inventories in the U.S., you mean?

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Sahar Islam, Goldman Sachs Group Inc., Research Division - Analyst [36]

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In the U.S., exactly.

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Nicolas de Coignac, Vallourec S.A. - SVP of North America [37]

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Yes. So again, here, too, with this continuous small erosion of rig count, where we were thinking probably a quarter ago that we would see the end of the inventory adjustment by end of Q2. Since then, there has still been this more or less 4 rigs less per week since the beginning of the year. So this inventory is still adjusting. We expect to see it adjusting still in Q3, to some extent, although there's -- it has been reduced quite significantly already. And then what will be very important is to have the first guidance from the budget from the operating -- operators, that we start giving some flavor on probably around October about how 2020 will look like. And based on this, we'll probably see if this adjustment continues into Q4 or not.

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Operator [38]

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The next question comes from the line of Guillaume Delaby from Société Générale.

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Guillaume Delaby, Societe Generale Cross Asset Research - Equity Analyst [39]

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Yes. First, congratulations for your results. If we try to -- basically, to contrast your South American numbers in Q2 with the construction numbers, so basically, we arrive at the conclusion that Brazilian oil and gas revenue has been down very significantly in Q2. So could you explain us exactly what happened in Q2? Is this -- you mentioned it's probably quite specific. But what exactly happened?

And my second question is still in Brazil, and it is the mine. You have targets to improve production by circa 25% in 2019 to 5.7 million to 6 million ton. According to my back-on-the-envelope calculation, you already increased volume by probably 15% to 20% in Q2. Do you confirm? Or do you agree with that kind of thought process?

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [40]

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So on your first question, Guillaume, the various OCTG to Petrobras and operators, we are done, actually, as you see in Q2 this year and moderately in the first half of the year. This is really to the direct schedule to Petrobras. And I think they themselves commented a few weeks ago that they had, had some difficulties to fully achieve their goals. So in order -- in terms of ramping up the activity because of some lack of resources generated from the last few years. Keep in mind as well that in H1 last year, we had quite strong deliveries for the (inaudible), which were exceptional in nature and not [to be repeated] this year.

And of course, the last key comment on that is that we have in our order book the Petrobras orders for the balance of the year, which should lead to a significant pickup in Q4 in the last part of the year. And we are again very confident in the restart of the exploration drilling in 2020 from Petrobras and from the IOCs after the very successful (inaudible) in 2017 and '18. You know that when these companies acquire rights, first, they put billions of dollars on the table, and then they commit for exploration. It takes about 2 years to prepare that and is coming now in 2020. You can refer to [12] presentation of the full year last year where we give the figures specifically given by Petrobras on their increasing exploration activity for the next 3 years, which mean basically that their global drilling activity in terms of number of wells will increase by 55% to 40% on top of what the IOCs are doing. So these will be the third provider in the recovery on oil and gas activity in 2020. And we have no doubt, it will be there.

Moving to another part of Brazil, the mine, I think we commented in the press release that, yes, we are increasing volumes similar as to -- as in 2019, not waiting for the big expansion project that will take place later on. And we do that through various productivity improvements that allowed us to increase our volume produced in the mine by 35% in H1 as compared to H1 '18 and on the full year basis. I don't know to the -- exactly the 25% that you are mentioning, but not far off from this number. You're correct.

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Operator [41]

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The next question comes from the line of Igor Levi from BTIG.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [42]

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My first question is in regards to the U.S. market. You talked about customers being disciplined around inventories, and you expect that to adjust further. The latest data we've looked at show that inventories have actually crept up in the first half of this year. We have them up 5% year-to-date. So I was hoping maybe you can clarify. Are you seeing something different with the data you're looking at?

And my second question is in Q1. You talked about pricing improvement in the North Sea. Are you still seeing that? And are there any other notable regions outside of the U.S. where you can highlight any interesting moves in pricing?

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [43]

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Nicolas?

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Nicolas de Coignac, Vallourec S.A. - SVP of North America [44]

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Yes. So Igor, I'll take the part concerning U.S., so concerning 2 comments. Talking about customer discipline, this is about the operators on their CapEx. You know that they are very committed to their investors to keep the envelope of CapEx for the year. And today, they're ahead of time -- ahead of spent, sorry. At end of Q1, they were at about 28% of their CapEx spent. And we expect at end of H1, they're probably closer to 60%, which means that, of course, they'll be spending less on the second half of the year. So that's the first clarification.

The second one concerning inventory, we do have a survey that we do with our distributors where we have a monthly, let's say, data about work, to the extent about their global inventory. So we track this month after month. And our data clearly shows that there has been an improvement in their inventories. So here, I'm talking more specific probably about the distributors with whom we have this very close partnership. As you know, we're working with very few of them, and we're helping them to keep their inventories as much in control as possible. And if doing -- they have been doing an amazing job for the last months, and that's why I made that comment.

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [45]

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Regarding North sea, Didier, a bit of flavor there.

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Didier Maurice Francis Hornet, Vallourec S.A. - Former Director of Development & Innovation [46]

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Yes. A bit of flavor on the North Sea. So yes, we saw there a pickup of activity, like in a few other regions, namely Southeast Asia, North Africa. And Edouard was also commenting about the Middle East.

In term of price evolution, we see some -- only some moderate price increase specifically in the regions and in the North Sea and in the regions like the Middle East. I repeat what Edouard was mentioning, some of the very last tenders, which are on the table today, and keeping a softened price pressure on offers and tenders still to be awarded. So slightly positive trend, but moderate.

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Operator [47]

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The last question comes from the line of Kevin Roger from Kepler Cheuvreux.

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Kevin Roger, Kepler Cheuvreux, Research Division - Research Analyst [48]

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Yes. The first one, Olivier, is related to the operating cash flow. Q2 versus Q1, the EBITDA improved by around EUR 30 million, but the operating cash flow improved by almost EUR 70 million, so delta of EUR 40 million. Can you please explain me the delta between those 2 numbers?

And then I have a follow-up on the working cap. Basically, in the first half, you have improved the ratio in terms of sales by around 5 days. Should we assume that basically at the end of the year, you would be able to keep this number of days close to 5 days in terms of improvements?

And the last question is related to the iron ore mine, again. Can you provide us basically the average selling price that you have locally? Because if I were remember, basically, the selling pricing in Brazil is far different from watching the price that we can find on Bloomberg, et cetera, in terms of index?

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [49]

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So on your first question, it's more to do with the seasonality in terms of a tax outflow where we pay taxes, essentially in Q1. And this explain a sharp (inaudible) improvement in cash flow from operation activities as you mentioned in Q2.

Then in terms of the working capital improvement, we have improved the number of days by a certain number in Q1, slightly more, 6 days, in Q2. Honestly, I can just tell you that what we are doing is yielding very good. We are very happy about the action plans that have been put in place. We have been very happy with the results of the diagnosis that has been made, especially in terms of inventories, where we know that we have significant margins for improvement. This is why we definitely will confirm, we believe at least in the second part of the year, the good achievements all year later, in particular, in H2 in terms of working capital management.

As this being said, it's always very dangerous to give a precise figure in this regard. You know that if we were to book great orders to be delivered at the beginning of 2020, we would have to buy raw material to start having work in progress, and the turnover will be only in 2020, which would have an impact on the days of sales. So just assume that we were able to continue to post a good performance at the end of this year, but I can't give you, of course, a precise figure at this time.

In terms of the price for the iron ore we are selling, typically, the way it works is that from time to time, in many cases it's every year, we kept contracts with our various customers in Brazil for that. And the way usually it works, but you have different schemes, is that we start from the index of iron ore delivered to China. And we deduct from that logistics cost, for instance, and give (inaudible) the price at which we sell to the local customers in Brazil. And then we have, along the year, some indexation where we more or less follow the evolution of the Platts index, where in some cases. So a fix part of it, which smoothen the price evolution delivered to China but once again can differ from one customer to the other one.

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Kevin Roger, Kepler Cheuvreux, Research Division - Research Analyst [50]

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Okay. Understand very clear. And maybe one follow-up, please, on the operating cash flow. Just when -- tell me if there is something that I do not understand in that [trivia]. But I think you say that to be free cash flow positive, excluding any movement in the working cap, you need around EUR 550 million EBITDA. And if you assume basically that you will spend around EUR 150 million, maybe slightly plus in terms of CapEx, it gives you a breakeven to be operating cash flow breakeven close to EUR 400 million. So EUR 100 million per quarter. While this quarter, with EUR 100 million, you generate a positive operating cash flow of EUR 40 million. So is there something that I'm missing on that side, Olivier, please?

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Olivier Bruno Benedict Mallet, Vallourec S.A. - CFO & Member of Management Board [51]

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So it depends quite a lot on the seasonality in CapEx and working capital. I guess -- so the best is to look at that from a full year basis, where basically (inaudible) is at below EBITDA. There is roughly EUR 200 million or slightly more than EUR 200 million of cash out for financial charges. You have always some taxes, some restructuring charges, where you accumulate these 2 items. This year and maybe next year, it will be only slightly less than EUR 100 million, knowing that after that, there are certain charges will decrease because it will be done without restructuring plan of -- in Germany.

And then in terms of CapEx, an order of magnitude of EUR 12 million is probably more relevant when we go in the next year-on-years because of our existing (inaudible) net working at the same capacity acquisition as of today. And for this year, we've given an envelope of roughly EUR 180 million. So I hope I answer your question.

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Operator [52]

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We have no further questions in the queue. (Operator Instructions)

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Philippe Crouzet, Vallourec S.A. - Chairman of the Management Board [53]

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If there are no more questions, may be I can include a few words. Obviously, I'm very pleased with what we've done in Q2. We've made significant progress on the top line, first, and with the significant commercial successes pulling into our P&L. We've had good performance in most, if not all, our operations. And last, but not least, we've commented a plan, very good progress in working capital management. And this is good news. It is true that quite a number of our managers have been focused over the last years on restructuring. Now they can dedicate more of their time in managing the cash more efficiently, and that's what we achieved in Q2.

So that's exactly the scenario that we had designed with the successive recovery of North American market, then EA-MEA and Brazil now coming. Of course, there are ups and downs. And we've commented about the slowdown in North America. But now we have a very nice exposure, a very efficient footprint. We have quite a diversity of our geographies. North America is only 1/3 of our sales. So we have more exposure to more dynamic markets as we speak. And that's exactly the logic behind our Transformation Plan. So I hope and I'm convinced that we will continue to deliver along that plan.

Thank you for participating in that conference call.

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Jean-Marc Agabriel, Vallourec S.A. - Director of IR [54]

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Thank you, Philippe. This concludes our conference. Goodbye, everyone, and thank you again.

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Operator [55]

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Thank you for joining today's call. You may now disconnect your handsets. (inaudible), please stay on the line.