Cemex SAB de CV (CX) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Cemex second quarter conference call. At this time all participants are in the listen-only mode. Later there will be an opportunity for questions and instructions will be given at that time. If you should need any assistance during the call, please press star then zero and an operator will assist you offline. As a reminder, this today's call is being recorded. Now I'd like to turn the call over to the Executive Vice President of Planning and Finance, Mr. Hector Medina. Please go ahead, sir.

Thank you. Good morning and thank you for joining us for the second quarter conference call. Let me start the call by reiterating three key points that we have shared with you throughout this year, and more recently in our analysts meeting that we held a couple of weeks ago.

First we will continue the strategy to enhance our customer relationships and value propositions in order to engender greater ground loyalty and increased cement market penetration. Second, we will continue with our initiatives of improving our operating efficiencies, with an emphasis on cost containment and expense reduction, while maximizing the return in our investments and efficiency program. Third, we will continue to strengthen our capital structure.

Despite a challenging operating environment we are pleased with the performance of Cemex in what we believe is the downside of the cycle of many of our markets. For the first six months of the year we delivered net sales growth of 7% on the back on the 5% system wide volume growth, generating close to $0.5b of free cash flow during the period.

We remain optimistic about our major markets leaning to long-term economic outlook. However, we continue to approach the coming months with caution. We don't expect a meaningful upturn to develop before the fourth quarter of the years, as signs for recovery continue to be weak and mixed. But, we expect moderate GDP growth for 2003 in the majority of our markets.

We are confident that our balanced portfolio will continue to allow us to weather today's challenging global environment, as well as individual market volatility. Weaknesses in markets such as the United States, who we believe are at the bottom of their economic cycle, are being offset by strengths in Mexico and Spain.

Looking ahead our year-to-date results reinforce our original full-year guidance. Specifically, we are now more comfortable with our ability to achieve our original guidance of $2b in consolidated EBITDA. We now expect our free cash flow for the year to be above $900m in 2003. While we are not making specific changes to our company forecast, we expect that the consolidated EBITDA will exceed the $2b mark.

This year offers us the opportunity to continue to deliver shareholder value, by further strengthening our capital structure with better leveraging, as we continue to target using at least two-thirds of our free cash flow with net debt reduction. We also expect to do some selective accretive bolt-on acquisitions and investments to enhance our portfolio.

We are pleased with the results of our business model and its ability to perform in challenging times. In better times the convenience of the Cemex model will return to a mid to low teens rate of growth. This could be achieved with the combination of organic and acquisition growth, with continued strength in free cash flow generation.

Now let me go to the outlook of our major markets for the rest of the year.

Mexico, we continue to expect moderate GDP growth of 2%, due to global market economic weakness, mainly in the United States. However, lower interest rates, lower than expected inflation and positive real wage growth has [indiscernible] to provide an encouraging backdrop of healthier economic growth in the second half of the year.

Also unemployment is expected to further improve towards the end of the year. Of course all of these is highly dependent on the possibility of higher economic activity in the United States, as the impact of a fiscal package begins to help.

Despite the current economic environment in the first half of the year, demand for cement and readymix in Mexico grew at a very health pace of 6% and 11% respectively. Construction activity has benefited from a robust low income home building activity, as well strong infrastructure construction. The main demand from the self construction segment continues to be stable with moderate growth. We are encouraged by the better than expected performance year-to-date. And while we do not see any reason for a slowdown in the coming months, we are cautious about the continued strength of cement demand for the remainder of the year.

Pricing continues to be in line with first quarter trends. Going forward we will continue to aim to maintain pricing stable in constant peso terms. We have stressed how we have been focusing on enhancing the value proposition for the customer. In Mexico the results of [indiscernible] and multi product initiatives have exceeded our expectations. The number of this division points that related to the [indiscernible] concept now stands at 2,050.

This year we have been focusing on consolidating the network, and ensuring that all the division points work under a consistent operational and service standard. And on strengthening our relationships with networks initiatives.

Our multi-product initiative is on track to deliver revenue in excess of $180m this year, with a positive EBITDA margin contribution of 4.5%, well above our expectations. These two initiatives are win/win propositions that translate into increased customer loyalty for Cemex, while providing our customers the benefit of higher economies of scale in procurement. This should translate into higher profitability and/or better market share for our customers.

Mortgage lending, sponsored by government agencies are expected to continue growing [indiscernible]. Mortgages are also becoming more available and affordable to consumers due to lower interest rates, as well as the tax deductibility of the real portion of interest. In this context we have been making significant strides to ensure that we provide the best value proposition to home builders. Both large scale and regional players.

Our infrastructure of project backlog remains robust, and we expect next year's fiscal budget to include a sustainable and growing infrastructure component. We believe that our nationwide presence, together with our expertise and technical capabilities make us the partner of choice for construction companies and large government projects.

Finally, as general economic activity stabilizes and begins to improve in the US, we should experience a recovery in employment in the manufacturing sector in Mexico. This will bode well for consumption activity, construction activity and thus positively impact our self construction sector.

Turning to the United States, we continue to remain cautious about the outlook cement demand for the remainder of the year. Construction activity remains mixed. The total value of construction put in place in current dollars is up 1.6% year-to-date as of May. The [indiscernible] construction sector continue to show strength. We saw from yesterday it's better than expected housing starts and building permits data. This sector has been driven mainly by the very favorable interest rates environment, as well as favorable demographics and house formation, especially in our market. Total residential construction is up 9% year-to-date, with single family units up 11%.

Industrial and commercial activity remains weak. This has been driven by high office space vacancy rates, lower corporate capital expenditure and general weak economic activity. Industrial and commercial construction put in place has declined by 11% year-to-date. Weather it continues to be a factor with significant influence over cement demand [indiscernible] all of our sectors. Heavy rainfall throughout most of our markets had an impact on our cement sales volumes during the quarter. On average the states where we operate experienced twice as many inches of rain during the second quarter of this year compared to the same period last year.

Public construction activity has remained somewhat stable year-to-date, with value of construction put in place up 0.6%. Highways and streets the most cement intensive within the public work segment, has shown a moderate decline of 1.6% year-to-date. This is explained mostly by the tight fiscal conditions of the state, coupled with delays experienced in the 2003 transportation budget profit.

The [CA21] reorganization process will definitely influence cement demand activity in the short and the long run. Also from the cement demand and the house transportation infrastructure [indiscernible] the percent [standing] increases of 35% and 63% respectively. A Bill proposed by the Bush administration [indiscernible] a 7% improvement in spending over [CA21]. The end result will most likely fall somewhere within that range.

I will first briefly comment on the company's performance during the fourth quarter of 2002, and our outlook for 2003 on the different markets in which we operate. Our CFO, Rodrigo Trevino will follow with a discussion of our financial results. The tight fiscal condition of the states in the US is another key element driving cement growth expectations. An estimated 50% of all highways and street construction activity is performed with the state funds. This represents about 17% of total cement demand from the US. The value of highway contracts awarded year-to-date to May, have declined 14% versus last year, partly due to weak fiscal state conditions. Expected fiscal aid package at the state level has [indiscernible] the currency of the [indiscernible] by some of the states where we operate.

For the US our full year guidance is 1% decline in cement sales volume. This is in [indiscernible], continuing the first half performance of 3% decline in volume. Of course this target is contingent on improving weather conditions during the second half, as well as the recovery of the some of the decline in the industry sales we experience last year.

In Spain our cement sales grew at the healthy pace of 6% for the first six months of the year, almost three times the rate of expected GDP growth for 2003. We are confident the total cement demand in Spain for the year will reach about 45m tons.

Public works spending continues to fuel domestic cement demands. The sectors main growth drivers continue to be the government infrastructure plan - this is expected to continue until 2007 - and electoral [indiscernible].

The housing sector also remains very strong, driven mainly by lower interest rates and migration. We now expect it to stay above 500,000 starts for the fifth year in a row.

As there are very few reasons, if any, to expect a slowdown in consumption growth in the second half, we are now expecting to substantially increase our current guidance for volume growth of 1% in 2003. On a macro level we expect GDP growth of about 2.3%, one of the healthiest growth rates in Europe. For the rest of the year we expect prices to be higher in dollar terms than 2002, as we expect the euro dollar exchange rate to be stronger than our original assumptions.

In Venezuela we continue to face a very challenging operating environment, where demand remains depressed and with a very difficult social and political situation. To better face declining demand in the coming months, we will remain focused on reducing costs and expenses. We would also maintain a total cement production flat from last year, by increasing our exports and selling Venezuelan cement elsewhere in the Cemex system.

As a result of this effort, a stable pricing environment and an improvement in the foreign exchange market due to a very strong accumulation of foreign exchange reserves, we expect EBITDA for Venezuela to be roughly flat versus 2002.

In Columbia, despite of a somewhat challenging environment with cement volumes declining by about 2%, we expect stable cash flow generation and margins. This is a result of ongoing cost cutting and a very strong trend in readymix sales.

In Caribbean we recently acquired Porto Rican operation, and the associated port members integration benefits. This translates into more stability in the regions and higher EBITDA.

So now I will turn the call over to Rodrigo.

Thank you, Hector. Good morning everyone, and again, thank you for joining us today.

Despite the continuing challenging economic environment Cemex has delivered a solid performance during the second quarter. EBITDA for the quarter declined by only 1% versus the same period a year ago. EBITDA margin declined by 2 percentage points. This margin contraction is a result of a change in our product mix, higher multi-product sales, as well as higher energy costs.

SG&A as a percentage of sales declined by 150 bps for the first six months. We expect the trend that we will lower SG&A as a percentage of sales to accelerate during the second half of this year, as we reap the benefits of our cost-cutting efforts and efficiency programs put in place during 2002, 2001, as well as the benefits from the actions taken during the first half of this year.

For the first six months of the year we have achieved an EBITDA in excess of $1b. More than half of our full-year guidance of $2b. Given that the second half of the year is typically stronger due to seasonality of our three major markets, we expect to exceed our current $2b guidance. Additionally, our operations in Venezuela suffer from the significantly low utilization rates during the first quarter of this year. We expect the benefits in Venezuela, due to higher exports, will run at higher utilization levels during the second half. We also expect the benefits from our cost-cutting efforts for the full second half of this year and beyond.

Finally, after suffering the negative impact of the war in the Middle East, and from oil supply disruptions, we expect energy costs to decline relative to the levels we saw in the first half of the year. We are increasingly confident in our ability to exceed our EBITDA guidance of $2b for the full year. And given our concerted effort to optimize capital expenditures and working capital investments, we are also confident that we will exceed our free cash flow target by more comfortable margins.

This translates into double-digit growth in free cash flow versus last year levels, if we adjust for last year's extraordinary account review [indiscernible] transaction. In fact, despite higher interest expense and flat EBITDA our free cash flow for the first six months of the year is 10% higher relative to the same period a year ago.

Our intention continues to be to apply at least two-thirds of our free cash during 2003 to pay down debt. We are below our leverage target of net debt to EBITDA of 2.7 times. In the second quarter we dedicated close to 100% of our $390m of free cash flow to reduce net debt. However, net debt decreased by only $350m due to the strengthening of the euro versus the dollar. As we pay down debt and refinance our short term maturities, we continue diversifying our borrowing sources and lengthening the duration of our debt.

In the second quarter the actions the domestic capital markets in Mexico, the US [indiscernible] market, and the European capital markets through our [MTN] program in Cemex Espana. This March we raised around $700m equivalent in three to twelve-year [indiscernible] at an average cost equivalent to of 135 bps.

From December 2002 to June 2003 the percentage of our total debt stores from commercial banks decreased from 57% to 50%. We maintained banks lines available, and this translates into increased flexibility. Raising long-term debt at fixed rates will also allow us to achieve our desired funding strategy mix of fixed rate and floating rate, without the need to use derivatives.

Looking at our capital structure, our interest average for the 24 months was 4.9 times, well above our target of 4.5 times for 2003. Our leverage ratio improved from 3.2 times to three times as measured by net debt to EBITDA during the second quarter, due mainly to lower net debt. But also as a result of higher grading to our EBITDA. We remain committed to our stated capital structure target of net debt to EBITDA of lower than 2.7 times. Given our expectation for free cash flow generation and net debt pay downs, we believe that we will achieve our target ratio ahead of schedule.

Continued favorable performance in the in the key variables, the impact of derivatives instrument [indiscernible], such as the Mexican peso/dollar exchange rate, our share price, US dollar fixed interest rates, the aggregate fair market value of our derivative position has improved by $347m during the second quarter. Reaching a negative $122m as of June 30. Since then and until yesterday the fair market valuation has further improved by an additional $100m.

These favorable trends in the markets translated into a 350% increase in our net income for the second quarter of this year versus last. Although we are taking steps to reduce the volatility in our income statements, we want to emphasize that the use of financial derivatives is an integral part of our funding strategy. It is designed to align our assets and our operating business cycles with our funding strategy. It has also allowed us to significantly reduce our borrowing costs, enhance our free cash flow generation, and made it more stable and predictable. And it has helped us to minimize the potential dilution to our shareholders.

We have been operating under a challenging macro economic environment during the last couple of years. This has also coincided with strategic initiatives that have important long-term benefits such as the design and implementation of the Cemex [indiscernible], our company-wide IT platform, our commercial programs and our energy optimization investments. These investments are strengthening our business model, increasing efficiencies and preparing us to reap the benefits of the next upturn in the business cycle. Throughout this difficult period we have achieved returns in excess of our cost of capital. As the business cycle improves, as we reduce our cost base and operate with a more efficient IT platform, and as we begin to reap the benefits of our marketing and commercial initiatives, the thread between our return on capital and our weighted average cost of capital should improve and thus enhance value creation for our shareholders.

Before taking your question, I would like to emphasize the following two ideas. One, with the substantial completion of our investment designed to achieve greater efficiencies, cheaper and more predictable energy sources, and great customer loyalty, more of our free cash flow is expected to be dedicated to net debt reductions and/or elective [accretions] also in acquisitions. Two, we intent to use at least two-thirds of our free cash flow towards net debt reduction until we reach our stated capital structured target of net debt lower than 2.7 times [indiscernible] on EBITDA.

As always, I've been asked to tell you that any forward-looking statements we make today are based on our current knowledge of the markets in which we operate, and could change in the future due to a variety of factors beyond our control.

Thank you for your attention. Now we will be happy to take your questions. Operator?

Thank you. Ladies and gentlemen, if you would like to ask a question, please press star then one on your touchtone phone. You will hear a tone indicating you've been placed in queue. If your question is answered and you just wish to remove yourself from the queue please press the pound key. And we ask if you are using a speakerphone if you would please pick up your handset before pressing any numbers. Once again, if you do have a question, please press start then one. One moment please for our first question.

Our first question is from Everardo Camacho with DBM. Please go ahead.

Hello Hector and Rodrigo. My first question is for you Rodrigo. You comment you plan to extend the average length of your debt maturities. Do you have an idea of short term/long term debt mix for year end? I think the question arises since in this quarters mix short term debt seems to be considerably above last year. So what are your comments regarding this?

Well yes we have extended the average life of our debt from 3.2 years on average. As you know we are targeting a net debt to EBITDA, a ratio of 2.7 times. And we generate close to 50% of free cash flow from the 50% of EBITDA and free cash flow. So a target ratio of 2.7 times translates into between 5 and 6 years net debt to free cash flow. That means that in order to fully service our debt obligations with our free cash flow, we would need to have an average life of around three years, which we do have. But we do have a portion of our debt exposure with banks, and banks prefer to have shorter maturities. But so long as we maintain a strong capital structure and our ability to generate strong free cash flow, we feel confident that we will maintain the bank support that we've had in the past.

In the meantime we have strong free cash flow generation but we also maintain committed lines of credit available. As an example, as of June 30 we had close to $1b in committed lines available that we could draw upon to meet short term obligations. And so we feel comfortable with the average life of our debt. However we are taking steps to lengthen it further as we address some of the maturities of 2004 well ahead of schedule, and extend the maturities perhaps during the second half of this year, 2003.

You're currently on a 66% long-term and 34% short term, right - of total debt?

Yes, that is likely to increase as we address, as I mentioned, some of the maturities of 2004 ahead of schedule. But we don't have a target for the end of the year. The question that we have is to lower the net debt to EBITDA, strengthen our capital structure and maintain available committed lines in place. To give us financial flexibility that we have and strengthen that even further.

Thank you very much, Rodrigo, it was very helpful. And I have two questions for Hector. Would you remind us, Hector, why profits in the US declined considerably more than sales did?

Is that the question?

Could you just remind us why profits in the US are declined year-over-year considerably more than sales decline?

[indiscernible] component is of course energy. The first quarter was significantly higher than last year. And we have also lower cement volume and lower cement prices. In addition to that we have in the SG&A higher pensions expenses. Pension funds declined in values. And in addition to that the insurance cost is very significant. The position but still looking at the margins, although this of course translate more sales and more EBITDA. And the margin decreases as the readymix increased over cement sales - it was the largest - and therefore mixed effect decreased our margins.

Perfect, Hector. And if I may make a second question. You commented that you expect to make small accretive acquisitions. Is that for this year? Should we expect that in 2003?

That is always a possibility. But again the priority for us is the use of the free cash flow to reduce net debt, and to use at least two-thirds of free cash flow to reach as soon as we can our 2.7 target of net debt to EBITDA.

so those acquisitions would certainly not compromise that 2.7 times leverage target, right?

That's it, yes.

Okay, Thank you, Hector.

Thank you.

Our next question is from the line of Daniel Altman with Bear Stearns. Please go ahead.

Hi, it's Daniel from Bear Stearns. Two questions. First of all your Capex number, it's looking like on an annualized level somewhere around 330m. I just wonder if you can give us an update where your target is for the year; will we see an increase in the second half? And secondly, the percentage of your debt in euro declined during the second quarter. I wonder if you can give us some insight into that? I'm sorry, a third question would be, your cash position. A lot of the improvement in net debt resulted from higher cash position. I wonder if you have plans to use that cash to retire debt? Thanks.

The first one, in terms of the Capex, as you mentioned we are at around 330m to 350m annualized target. That more or less would be our target for the year. It might be a little bit over 350m, but it's around 350m.

Now Rodrigo can take the debt question.

Yes, we did end the quarter with an unusually high level of cash. And that is important because we raised funds towards the end of the month. And we raised them in the Mexican domestic capital markets [indiscernible]. $10m equivalent. We have built up our cash position in anticipation of the $500m bond maturity we had in July. In fact today we're paying that three-year bond that matured as of today. The debt in euros is close to 13% or slightly below that, as of the end of the quarter. And that is as a result of using some of our free cash flow in Spain to pay down debt. But we have not changed our intent to continue to borrow in euros, and we have cash flows and assets in Europe.

Did you say 13, because in the press release --?

I think it went down slightly below that to maybe 11%.

Yes, it shows 11%

[indiscernible] using free cash flow to pay down debt.

Okay, thanks very much.

Thank you.

Our next question is from the line of Steve Trent with Smith Barney. Please go ahead.

Good morning, gentlemen. Steve Trent from Smith Barney.

Good morning.

One of my questions is actually a follow-up on what Dan Altman just asked you. On the currency side on your debt, there's been some talk that maybe your euro exposure is still a little bit high on your leverage side, vis-à-vis the cash flows you receive from Spain. Do you have a target as to -- as I saw also the euro portion decreased. Do you have a target as to what the currency mix might be going forward? And then my second question is, with respect to the strong reductions in net debt and leverage, have you changed your Q1 '04 target for reaching 2.7 times? Have you shifted it forward at all, or are you sticking with that?

Well going to your first question, we actually believe that the amount of debt we have in euros is significantly below the assets we have invested in Spain. And so there is a possibility of our debt in euros increasing and still having a natural hedge that we have as a result of the more than $2b investment we made in assets in the euro regions. Regarding your second question, can you repeat that again? Your question is --?

Sure, Rodrigo. I believe you recently said in terms of getting back your long-term leverage target of 2.7 times that you'd probably reach it by the end of Q1 '04. I was wondering if you are changing that as you've signaled that you're going to exceed $2b in EBITDA this year, and comfortably achieve $900m in free cash flow.

Well that's a good question, yes. We have indicated that we expect to exceed our original guidance of $2b. We've also indicated that we feel more comfortable that we will be able to exceed the $900m of free cash flow original target that we had. We are committed to using at least two-thirds of our free cash flow to pay down debt. And so you can very easily play with the numbers to find our under which combination we would achieve our 2.7 times targeted net debt to EBITDA ratio ahead of schedule. We are increasingly confident that we will get there ahead of schedule and our original target was to get there by March of '04. So yes there is a possibility that under different combinations we will get there much sooner than that.

Okay, that's great. Thank you very much.

Our next question is from the line of Gordon Lee with UBS. Please go ahead.

Hi, good morning, gentlemen. Two quick questions. The first just on SG&A reduction. I noticed that the pace of reduction declined during the second quarter, I think it was only down 1% year-on-year, relative to I think 7% or 8% in the first quarter. And SG&A was actually up 10% from the first quarter. Was there any particular reason for that, and what can we expect for the second half of the year?

And the second question is just on the expansion in the Dominican Republic that you make reference to in your press release. I'm actually a bit surprised at your timing for that, given the significant excess capacity you still have in Venezuela. And also some excess capacity you recently acquired in Porto Rico. Are you seeing demand conditions in the Caribbean strong enough to justify that, or is it particularly just the Dominican Republic sort of demand scenario you are seeing strengthening there?

Thank you, Gordon. First question, SG&A. We do include the division costs in our SG& figures and so as volume increases they are likely to have higher distribution costs. And that means an increase in SG&A in absolute terms. In terms of [indiscernible] to our sales [indiscernible] our SG&A for the year has decreased by 110 bps year-on-year. So the components of SG&A that is related to our corporate expenses and our general administrative expense in all of our operations is going down. It's not enough to compensate the increase in these division costs, but that is a [indiscernible] related to volume [indiscernible] volume that we're selling.

There are, as you mentioned, the case of the US some additional expenses in terms of pensions, and insurance. But in terms of -- well again the consolidation of Porto Rico brings some additional SG&A [indiscernible] the figures.

In terms of the Dominican Republic, our business expansion that has been planned for quite a long term. We think as we make those decisions we don't make them in isolation in particular markets. Of course we have to consider what is the situation of our different markets and the trading situation around the world. And we have to consider also that this expansion is not going to happen today, it's going to take about two years to come in line. So what we expect is that the excess capacity in the regions, and in other parts of the world will by that time have diminished.

And therefore because of the increased [indiscernible] increased [indiscernible] costs of the [indiscernible] capacity that comes on line, these are timing for this expansion results of profit at this particular time in the Dominican Republic. Where we, as you input significant volumes of [indiscernible] 600,000 tons per year. So the [indiscernible] figure [indiscernible] image of this does not [indiscernible] only the situation in the Dominican Republic but in the rest of the region, the Caribbean region. And as I said, other regions of the world.

As an example we see for example the imports into the US from Asia, Korea, and some other places diminishing adds to the [indiscernible] this market is starting to grow. So yes there is excess capacity, but three years from now we think that will be a different case.

Thanks. If I could just have one quick follow up on that. Does the expansion then in any way modify your appetite for [indiscernible]?

What, I'm sorry?

Does the expansion in any way modify your appetite for your [indiscernible] cement company that you were considering, and you made an offer to buy last year?

We have a 20% minority [indiscernible] in Trinidad Cement. The tender offer we made of the intent to change the [indiscernible] to the companies who have the 75% [indiscernible]. That is a 20% ownership invitation to remove sales, [indiscernible] for 6% to 7% of the shareholders. That's the story there. Our [indiscernible] in Trinidad Cement is still a very positive one [indiscernible] agreement with the company in terms of markets [indiscernible] and tradings. And so we think that will continue, [indiscernible].

Thank you very much.

Thank you.

Our next question is from the line of Carlos Pereylongue with Merrill Lynch. Please go ahead.

Thank you. First congratulations on a solid quarter. Free cash flow numbers were quite encouraging.

Thank you.

My question relates to your derivative instruments. The notional amount on your FX derivatives increased by about 440m versus the first quarter of the year. Can you explain why this happened, and can you elaborate on what is your strategy going forward on this one?

Yes. As you know we have decided that we need to borrow primarily in US dollars, because we have the assets in dollars in the US and Porto Rico and elsewhere. And also because our businesses in the Americas tend to be fairly dollar-wise in the medium to long term, as evidenced by the stability in prices that we've been able to achieve. Even during the last seven years with major disruptions in FX rates in the region.

We did borrow in pesos close to $230m as of the end of the fourth quarter, and as of the end of the first quarter. But early in the second quarter in April we decided that we did not want to continue to borrow in pesos and again we used derivatives, stock related derivatives, to go back to dollar funding strategy. Of course the peso has strengthened since then, and that explains about $230m of the increase in the notional about of cross currency derivatives.

The rest is explained by the tapping of the Mexican domestic capital markets, and we raised to the end of June $210m equivalent in [indiscernible] for [indiscernible] of up to close to 6 years. But we did not want to borrow in pesos. What we intended to do was to achieve the lowest cost of funding available to us, and that was by tapping the Mexican domestic capital market in pesos and then using cross currency derivatives to swap into the dollar funding [indiscernible] that we had. Achieving an all-in cost of close to [indiscernible] 1.25, much tighter than we would have been able to had we issued directly in dollars in the US international capital market. That's the reason why the notional amount of cross currency derivatives has increased during the quarter.

Thank you very much.

Our next question is from the line of Eric Ullman will ING. Please go ahead.

Hi, gentlemen, and congratulations on the results. Rodrigo, could you expand a little bit on the improved performance in the derivative book? Give us an indication of what part of the book the improvement came from. And can you also just comment on where Moody stands in their long awaited upgrade on your credit rating?

The most dramatic improvement in the mark to market of derivative has to do with the improvement in the price of our stock during the quarter. We did suffer during the quarter a further drop in interest rates in the five-year treasury. And so that did not help in the fact that that partially offset the improvement shown in the other parts of the derivatives, cross currency as well as stocks. We maintain our funding strategy of borrowing close to 70% of our funding needs at a fixed rate. We were able to get there through the use of derivatives. And we intend to maintain that position. We understand that with the passage of time that negative mark to market on the interest rate derivatives will improve. As the interest rates swaps reach their maturity the mark to market will [indiscernible] zero. And of course as US treasury five-year rates move higher the mark to market on that position improves.

And that is part of the explanation why the mark to market has improved further from June 30 through yesterday by an additional $100m, primarily as a result of the US treasury five-year rates moving up again from the levels reached on June 30. And also partially because of the continued trend towards stronger stock price.

Okay. So we should continue to see -- if we continue to see bond markets sell off, we should see this ultimately decline even more?

Well yes. As US treasury rates move up, the mark to market on the interest rate derivatives will tend to improve. And also with the passage of time they will tend to improve.

Okay. And where does your discussion with Moody's stand?

Well we maintain a close dialogue with all rating agencies. We update them regularly of our performance, of our financial plans and strategies. We update them of our strategic initiatives. And we maintain a close dialogue with them. We think the fact that we have performed as strongly as we have through the cycle maintaining strong free cash flow generating abilities, is something that definitely makes a strong case for an upgrade when we eventually deserve it. We have consistently been upgraded over the last five year. We are one of the few companies in our industry that has been able to achieve that. Most of our peers have suffered downgrades. And so we feel that speaks very strongly about our business model and the fact that the portfolio of assets that we put in place has the ability to regain financial flexibility quickly. Without the need to either dispose of assets or dilute shareholdings. We think that's very valuable.

And without the [indiscernible] the fact that we are where we are today, and our [indiscernible] in these difficult times. I think [indiscernible].

Okay. Thank you.

Our next question is from the line of Gonzalo Fernández with Santander. Please go ahead.

Gonzalo Fernández: Hi, good morning. I have two questions. First on the free cash flow statement. Can you share with us your expectations in terms of working capital? It was negative this quarter, is that sustainable going forward? And the second is on electricity prices in Mexico. Other companies have been talking about very important increase. I don't know if you can share how much electricity price -- the electricity costs increased for you? And how much of your electricity needs do you have covered by hedges if this is the case?

Let me break up the first one. Prices [indiscernible] Capex. [indiscernible] increases, significant increases in the electric prices for us. Now we have here a different perspective. [indiscernible] over the last year have been 39% and we still [indiscernible] dollar per unit [indiscernible] at 15% of [indiscernible]. Now the important fact here is the fact that we expect the [indiscernible] power plant to be in line, generating the savings as of November this year. We also always do -- are thinking of new ways to save energy in our operations through better management of our operations.

So all in all for the year our electricity costs will be around 24% [indiscernible] increase year-over-year. And that's on a [indiscernible] basis. Yes, there's a significant increase [indiscernible]. As I said once our generating unit is [indiscernible] that should bring savings and lower our costs of energy [indiscernible].

Regarding the other question on working capital. You know the first quarter of every year is a quarter during which we made the greatest investments in working capital. We intend to recover as much of that during the second, third and fourth quarter. This year, as you know we are very focused on regaining financial stability, getting back below our 2.7 times net debt to EBITDA ratio. And we have sensitized the whole organization to the importance of this objective. And so we did work hard during the second quarter to minimize the investments in working capital. And so some of the expected working capital improvement that are targeted for the third quarter we were able to achieve during the second quarter.

And that has led partially to the stronger than expected free cash flow generation during the second quarter. Nevertheless we feel that we are on track to exceed our original guidance of $900m. As I mentioned the second half of the year tends to be stronger for us because of the seasonality in the US of some of our other major markets, where operating cash flow tends to be significantly stronger in the second half of the year versus the first half. This year, to the extent that there is an economic recovery that does take place over the second half of the year in the US, so that is a consensus estimate, we expect this to be the case as well. And that will contribute. So not only greater operating cash flow, but also stronger free cash flow.

And so we remain on target for our full-year forecast in terms of investment in working capital, and we're doing everything we can top recover the investments of the first quarter as quickly as possible.

Gonzalo Fernández: Okay. If I may ask one last question. Your tax provision in the income statement doubled, and the taxes paid in the free cash flow decreased significantly. Is there any particular reason for this?

Well yes, you are right to highlight that. Our cash taxes during the second quarter were significantly lower than expected. That also explains part of the reason why our free cash flow during the second quarter is stronger than expected. The other taxes come out of the accounting calculations. They don't necessarily reflect the taxes that we expect to pay. We are obligated to calculate taxes according to the generally accepted accounting principles. And so the number you see there for total taxes, both cash and non cash come from that formula that we have to apply to our income statement.

Gonzalo Fernández: Okay, thank you, Hector and Rodrigo and congratulations on the results.

Thank you Gonzalo. I think we have time for one more question.

And that will be from the line of Mike Betts with JP Morgan. Please go ahead.

Good morning, gentlemen. I wanted to follow on actually on the question on energy costs - broaden it a little bit. I mean we talked about electricity in Mexico. When I look at the cash cost numbers in the press release you've mentioned already the US, but also taking out currency, there seems to have been a cost increase in Spain as well. Which I presume is on the energy side. Is most of that firstly on solid fuel or on electricity? And then I've got a follow-up question depending on the answer on that.

In the case of Spain the cash cost increase is the other components other than energy. There are transportation costs that have increased due to the [indiscernible] demographic mix has changed. But it's also increases in energy given the fact that [indiscernible] coke prices have increased a little bit. But I can follow up with you in more detail later in the case of [indiscernible] energy prices in Spain.

Okay, that would be useful. Then just as a follow-up, maybe just for the major kiln fuels in terms of fuel oil, [PET] coke and coal. Could you just indicate how you do the purchasing there and whether you hedge against? Whether you're buying on annual contracts, and whether you are hedging or not?

I'm sorry I lost the last part of the question.

Sorry. In terms of your kiln fuels, coal, PET coke, fuel oil, I'm just interested in whether you are buying on an annual basis or a shorter term basis? And also what hedging you do to protect yourself against any increasing costs?

Well of course our energy strategy has several components. One very important is that all our plants should be able to [indiscernible] to maybe use other fuels. And when I say major it's off course fuel oil, coal, Pet coke or natural gas. And then of course there are [indiscernible] fuels that are also part of our strategy. But of course they are they minority component of that. And in the case of those fuels that can be acquired on a long-term basis, we think that -- we try to [indiscernible] the longest term contracts in our purchasing of these types of fuels. Hedging as much as we can. Now in terms of that the case of the [indiscernible] contract with Cemex is a 20-year contract, it's a very long term contract. But will fuel both our kilns and the power generating units in Northern Mexico.

Very seldom are the use of derivatives in the energy field for the hedging, because we think that our strategy around the world allows us to optimize this sourcing of energy.

I suppose just to --

With the component of the possibility of burning different fuels in our kilns at any particular moment.

Okay. I suppose the main aim of my question, to cut to the chase is that your major competitors [Holsome and Lafarge] seem to be indicating that their fuel costs would be lower this year than last year. I mean you've indicated that they're going to come down in your case in the second half? Is this just a time issue, or are yours higher maybe because you use more fuel oil given the importance of that in some of the emerging markets? Do you have a view on that?

Well it is true that in the beginning of the year [indiscernible] Venezuelan situation, there was an impact on fuel costs around the world. Of course the price of oil with the situation in Iraq also had an impact. So as the energy markets around the world stabilized we all expect energy prices to go down. That's essentially the trend. That doesn't take into account the specific long-term petroleum costs at contract.

Okay, last question. How much would you expect approximately decline in energy costs in the second half if the oil price remains where it is now?

I don't have specific number, but I can follow up later on with this.

That would be great. Thank you.

Well thank you very much. In closing I would like to thank everyone for your time and attention. We would like to remind you that the presentations of our analysts meeting that we held this month in Connecticut as well as the transcript of our Chairman's remarks, are available for downloading on our web site. We look forward to your continued participation in Cemex. Please feel free top contact us directly, or visit our web site at any time. Thank you again, and a very good day to everyone.

And, ladies and gentlemen, this conference is available for replay. It starts today, July 18th at 1:30 pm eastern. It will last until July 25th at midnight. You may access the AT&T Executive Playback Service at any time by dialing 320 365 3844. And the access code is 690970. that number again, 320 365 3844, and the access code, 690970. That does conclude your conference for today, we do thank for your participation. You may now disconnect.