ABB Ltd. (ADR) (ABB)
Q4 2009 Earnings Call
February 18, 2010 8:00 am ET
Joseph M. Hogan - Chief Executive Officer
Michel Demare - Chief Financial Officer, Head - Global Markets
Brice Koch Ph.D. - Executive Committee Member, Head of Marketing and Customer Solutions
Ulrich Spiesshofer - Head - Corporate Development
Thomas Diamond (ph) - NJB (ph)
Axel Quinhog (ph) - ING
Mark Troman - Banc of America/Merrill Lynch
Lisa Randall - Nomura
Frederick Stahl - UBS
Alex Muerine (ph) - Halver (ph)
Julian Bure (ph) - SCBN Skilda (ph)
Simon Fuchs - Credit Suisse
Andreas Willi - JPMorgan
Martin Prozesky - Sanford Bernstein
Martin Wicke - Deutsche Bank
Olivier Esnou – Exane
Andrew Carter - Macquarie
Gabriel DeBre - Société Générale
Timothy Roger – Goldman Sachs
Good morning or good afternoon. I'm Stephanie, the conference call operator for this conference. Welcome to the ABB fourth quarter and full year 2009 results analysts and investors conference call hosted by Mr. Joe Hogan, CEO of ABB. (Operator's Instructions).
Okay, ladies and gentlemen, welcome to this year's ABB Q4 results analyst and investor meeting. Again, like every year, just a little security advice. There are a few exit doors to the left and the right and over there in the back. We are actually not expecting any emergencies today, but in case there is a siren or something going on it is real, not a training, so please exit quietly through these doors and follow instructions given by the various ABB people around you.
We also have, as usual, people following this conference here on the phone via conference call or over the web. We have a webcast as well. So if we later on come to the Q&A session we, like every year, will use microphones. Please wait until you have the microphone, state your name, and who you work for, so people on the phone or the webcast can hear your questions. Otherwise we will always have to repeat the questions. Okay, so without any further delay I would pass it to Joe to give you an overview of ABB's Q4 and full year results 2009. Joe?
Joseph M. Hogan
Good afternoon and thanks for coming. Michel and I will walk you through the initial part of this presentation and then we'll have Brice come up and talk about new parts of growth for ABB.
Safe harbor statement, any questions out there? Okay.
I think everyone in this room knows the kind of economy that the hold world faced last year. GDP down pretty substantially back to numbers that we have never really seen in our careers before, and well really the lifeblood of ABB is CapEx and when you look at CapEx, it dropped off a cliff really beginning later on in 2007 and 2008 and really dropped off faster than any recession we've been able to see, at least in our careers or even back to the 1930s. And since CapEx is such a leading indicator of ABB, we obviously were pretty concerned in the sense of what that would mean for our business, not just in 2009, but also 2010.
As we look at where we ended the year up, and I'm sure everyone has read the statistics so far, we're proud that we've been able to pull this company through as a team through the year and I think fairly good shape.
We left last year our strongest quarter and the strongest year that we've ever had at ABB at 15.5% operating profit, and you can see, I think everyone knows the kind of headwind pressures that we've faced as a business as lower revenue and price pressure and underutilization and obviously in the sense of how that would work on the portfolio.
But on the right-hand side you can see we've been able to maintain our 13% operating EBIT margin I'd emphasize, is right in the middle of the range that we've communicated to you over the last several years as where we want to steer the business to. And I'd say the main thing has been good operational execution around the backlog that we did have of about $25 billion coming into the year, but more importantly this team getting their hands around a cost takeout as quickly as we could and getting good traction around that initially, and also driving even stronger momentum with that cost out program through the year. And so we end up with an operational EBIT margin of about 13% and finished on a strong note in the fourth quarter. And then Michel will go over the walk of that in more detail in a second.
There are some really substantial aspects of a portfolio change this year as part of the business, and I think this emphasizes some real strength that ABB has in the sense of our footprint and the overall culture of the business. First of all, you could see on the left-hand side that from an emerging market standpoint in the fourth quarter of '08, about 43% of our orders in the fourth quarter of '08 were comprised of emerging economies, and as we closed out the fourth quarter of '09, that increased to 51% which is substantial. So you could see in the fourth quarter of '09 our emerging markets growth was up 15% in orders, but in developed countries, down almost 20%. And so that historical strength that ABB has had from an emerging markets standpoint and the footprint standpoint and really an association and understanding of emerging markets does really help us out because that's where predominantly most of the growth was in 2009.
On the right-hand side, again this is fourth quarter 2008 to 2009 data, everyone knows our overall portfolio here is being split between power and automation. We're pretty much an even 50-50 split in the fourth quarter of '08, but you can see a substantial decline on the automation side of which the most was robotics, and we'll get into more details on that, but power continued to expand in the fourth quarter of '09, up 5%. Now this has to do with an industry piece versus utility piece and we're not citing this as a long-term trend, but it does reflect the macroeconomics over the CapEx hitting industry pretty hard and are seeing some resiliency in emerging markets around infrastructure spend, and also in the developed economies around infrastructure spend around power too and it's reflected in these figures.
So overall, again, the infrastructure portfolio that we have been power and automation in the emerging market footprint actually came into being and so I'd say, honestly, if you try to really distill what happened with ABB in 2009 and how we're able to generate the cash and drive the margins that we did, there'd be two overall variables, okay? One would be that we found growth in emerging markets and we took advantage of what we have there, and secondly our cost out program actually generated more cost out than we initially — those are two of the overriding variables that contributed to the financial performance.
If you look at again, where the orders came from last year, and this is the chart that we often show you. Starting with the Americas it's down 24% overall. We look at the United States, it was down over 30%. South America was a little bit stronger throughout the year than the United States, but the US, we really didn't see much of a rebound at all through the four quarters in the US. And then Europe down 10%, but kind of a mix there in the sense of power infrastructure investment really helped us support some orders growth that we had in the business overall and we saw it through power systems and also power products, but that was really counterbalanced by some weakness in the industrial CapEx side of the business. Down below in Asia you can see we're up about 4% and this is fourth quarter 2009 data too, with India being up almost 70% in the quarter and we'll show you those specific figures. And then Middle East and Asia having an extremely strong quarter up 43%. So again, this represents that really the difference between the growth we saw in the emerging markets and then what we found in the developing markets side. It was even more extenuated in the fourth quarter than what we saw throughout the entire year.
China's been a big question raised in the (inaudible) community forced over the last couple of quarters and we just wanted to take one chart and walk you through where we are in China. I think the best place to start in this chart is on the top right-hand side. When you look at our portfolio we have about 40% of our business over there is in the automation side and about 60% in the power piece. And look, their growth drivers in China continue to remain positive for us. There's power infrastructure that Chinese are building an electrical infrastructure like no other country in the world. They demand the highest technology in some of these grids with the highest quality and ABB is well positioned there in the sense of being able to supply that kind of capability.
Look, local content rules and some emphasis on those over the last several quarters has heard us and so there has been increased competition there and our share has swung from quarter to quarter, but overall we've been able to remain competitive and across several different segments. And we haven't talked about this much, but we have a very strong mid-segment strategy that was really pushed hard by Brice within China.
And the mid-segment strategy is what we call in country for country which means we put as much capability as we can on the ground in China to compete with Chinese competitors in their home markets with their core technology. And so whether it be on the power side or be on the automation side, it's to make sure we're just not playing in the upper end of where we're comfortable from a high-voltage standpoint or a high end from an automation standpoint to make sure that we're really on the ground face to face meeting Chinese competition with our own Chinese resources and being able to compete on that level. We've been extremely successful in that sense and we'll continue to do that and we think to be a very competitive company to continue to be successful in these kind of geographies you have to be able to do that.
Down below the outlook for 2010 is we think we'll see some sustained investments. There are some questions that have been going on about state grids investment in the grids next year or whatever, but it looks like in the lower voltages the investment might be down, but in the higher voltages it might actually be up and so we're still waiting to see exactly how that settles out.
The bar graph on the bottom right-hand side, you can see in the fourth quarter of 2009 versus '08, power products is actually up 8%. You can see that automation products had a terrific year overall in China and it was really reflected well in the fourth quarter being up 31% and again, our mid-market segment has been very strong in that business also. So overall you can see that ABB in China up about 2% in the fourth quarter and so we continue to see growth in that geography. And we're not saying it's not competitive, but it has been a strong aspect of our portfolio. We feel good about our capability to compete in China and we continue to be optimistic about our ability to grow in that marketplace and to win share.
This is a chart that shows you the dark blue bars or orders, and the lighter ones are revenues, and it starts in Q1 2007 and moves to Q4 2009. I think really the most important thing to take from this chart is one is the most concerning thing I think if you look at all of our statistics in the fourth quarter was our revenues were down 13%. But when you look at that, and that's the far bar on the right-hand side, that was actually the second strongest quarter in revenues we've ever had in the history of ABB. It just happened to be against the comparison of the fourth quarter 2008 which was by far the highest revenue quarter we've ever had.
The other real key takeaway on this chart has to do with the orders bars. You can see somewhat of a flattening of those over the last three quarters of the business and what Michel and I have seen, and increasingly the AC team, is that our shorter cycle businesses we feel have pretty much bottomed out in the sense of what we've seen in the marketplace. But you have to remember that shorter cycle part of our business is about 20% of our portfolio, the other 80% is driven really by CapEx and we still remain somewhat cautious in this sense of what the investment tolerance is going to be or willingness to invest, particularly in industry or some governments over the upcoming quarters in 2010. But again, an outstanding again revenue quarter and it looks like at least the short cycle orders piece has stabilized on us.
We talk about emerging markets again and this is Q4 2009 data up on top. We talk about emerging markets. I just wanted to highlight some of those countries. I talked about China being up 2%, India up 72%, really power infrastructure and industrial equipment. Russia was actually up 81%. Actually, Russia was much stronger, I think, than any of us really anticipated, and in fact Eastern Europe overall, what we've termed old Eastern Europe, was actually pretty strong for us. United Arab Emirates up over 100%, incredible investments being made in sub stations there and in electrical infrastructure overall. Saudi Arabia up 52% and Brazil was down in the fourth quarter, but overall we had a good year in Brazil in orders, particularly because of the hydro project that we landed earlier in the year.
Down below is full year 2009 data. You could see that these are big countries for us, over $1 billion; China, India, Brazil, Algeria. Between $500 million, $0.5-$1 billion, it might surprise some of you in here, but countries like Saudi Arabia and Kuwait, Russia, even Mexico. These are, when we talk about BRIC countries you don't have Mexico in the BRIC side, but Mexico's been an unbelievable country for us this year in the sense of order. And it just shows you the emerging markets investments have been going on electrical infrastructure which are reflected in these figures.
And then on the far right-hand side between $200 million and $0.5 billion, Bahrain, Poland, Chile, South Africa, South Korea — so it shows you again the extent of ABB's footprint to be able to compete and offer opportunities in those areas, but secondly it shows what the emerging economies have done in the sense of continuing investment in the face of a very difficult downturn in 2009.
Look, we are very proud of our cash generation in the year. We had a very strong fourth quarter cash generation for the business and actually our net working capital dropped through that sequence. I think everybody in this room appreciates that the quality of earnings is always reflected in what your cash piece is and that's how the entire EC feels here, so we're really pleased to see over $4 billion in cash from operations and free cash flow of over $3 billion. So again, it shows the quality of the earnings and the operational execution that ABB I think showed throughout 2009, but it came together extremely well in the last quarter.
We declared a dividend. We're offering a dividend now of $0.03, up 6%, but the thing I want again to emphasize here is this is part of our dividend policy which is a steadily rising sustainable annual dividend throughout the business cycle. So when we offer this it's not just opportunistic based on what we've seen in this year or this specific quarter, it's because we have confidence in this business, its ability to generate cash and continue to compete, and we wanted that reflected as an indication of the confidence that we have in the business going forward. This obviously has to be approved by the AGM that will come up here in the spring, but we're confident that it will, and this will be delivered in the same way that it had in the past to help from a tax standpoint with Swiss citizens in particular. I'm not a Swiss citizen yet, so I don't think it's going to help.
So entering 2010 in a stronger position — look, 2009 revenues I talked about is near the record 2008. I think, again, one of the most surprising statistics if you would've asked me this time last year if we would've entered 2010 with relatively the same size backlog that we came into 2009, I would've said no. But we did. On a local currency basis this is within one or two points. Now the composition of this backlog is much different. There's a lot less automation in it, there's a lot more power systems in it, but look, backlog is good and it's great to have to see that not deteriorate significantly. That helps us with our projections and what we know we have to execute on as we enter 2010.
The pace of order decline, as I mentioned, slow in the fourth quarter. Remember, our base order rates when you look at Q4 '09 versus Q3 '09 we're up about 2% so it's a pretty good indication at least quarter to quarter, not year to year, we saw some stability in our base order side. Fast cost takeout that I talked about, we're increasing our cost takeout program from $2 billion to $3 billion. After Michel talks about the financials I'll come back up and explain in detail that other part of the $1 billion cost savings, where we expect to get it, how much we'll spend in getting it, and then we can address your questions after that's all over in the sense of what you might have there.
Record cash flow; one of the things we're very proud of is we ended up with all the costs we took out this year. We continued to invest in R&D over and above what we invested in 2008, anywhere between 5%-7%, and we'll show you some of the fruits of that investment and why it's so important to maintain that momentum to maintain our competitiveness overall. And the organization is better aligned with the evolution now that we've had with low-voltage products and also discrete manufacturing and also the new position we've put on staff with marketing and customer solutions and we'll go into detail on that so you understand it. So we're well positioned and we're confident about the future.
And we're always asked about our targets that were committed back in 2007 for the business, and we're basically saying is we look at EBIT margin and cash conversion and we feel that's in our hands in the sense of our operational execution and so we're reiterating our guidance on that that we feel that we can continue to be able to meet those expectations. On the right-hand side we think these are more recovery dependent on the revenue EPS and return on capital, and we'll still continue to shoot for those goals, but we're not quite sure based on the uncertain economic environment that's in front of us. But we have a strong track record. We think we've earned on operational execution so the EBIT side and the cash side stays firmly in focus and committed to.
And with that I'll ask Michel to come up and give you the gory details on the finances.
Thank you, Joe. Actually it will be very succinct. I'm very happy nowadays that I don't have to spend 20 slides anymore to explain to you what happens below the EBIT lines and the discontinued operations. There we have a pretty clean income statement and so it's much easier to read. We decided to try to have a little bit better explanations on the pricing trends after the questions that came after the third quarter, so what we are showing you here is basically an EBIT or operational EBIT walkthrough first for the fourth quarter, the next slide will be on the full year, and I think that can illustrate a bit better the different challenges we have been facing throughout the year. So you take this slide to start with which is a comparison of operation and EBIT in fourth quarter this year versus fourth quarter last year. You can see that overall we have lost 3.5% of EBIT margin on price and another 3% on volume while the mix of what we have offered to our customers during this quarter has in fact got into our favor. So we got a little bit more service, a little bit more powers, a little bit less systems.
You put these three elements together and we are talking about a 5.5% headwind, if I could say, that if you apply that on an operating margin of 14.7%, it would mean that we would end up with a single digit margin if we hadn't reacted to that. And that's why it was either cost savings programs which was needed and was also accelerated and generated in the quarter about 4.5% savings at EBIT margin level and thanks to that we could basically reduce the damage to 1.5% decline to 13.2 which is still well within the ranges of 11%-16% that we have committed to.
If you look at the full year the picture is not very different, so I think that first of all the good message is that the pricing loss is not accelerated. It is pretty constant from quarter to quarter. You see for the full year the pricing loss was as well about 3.5% of EBIT margin. The volume was an impact of 2%. And for the full year, the mix was slightly negative.
The best example to give there is we have sold less automation products which have a high contribution margin and we have involved, for instance, more power System projects that carry a lower EBIT margin and that has as well an impact on the total. Again, you put those three together and the impact is almost 6% would have again brought the full year EBIT margin below 10% and hence the cost savings program was here a very important tool to lend the EBIT margin at 13%. And obviously with that kind of charge you can already understand why we have decided to accelerate even further and increase the size of the program because we know as well that the pricing pressures remain, there will be pressures on our revenues next year, and so we need to continue anticipating the trend and deliver these additional cost savings.
Joe mentioned that already before, it has not just been about cost saving. We have also been reinvesting part of this savings and I think the most interesting, for instance, is to look at SG&A. SG&A overall adjusted for currency was down 2% this year compared to last year, but in fact it has mainly been an effort on the G&As or on the overhead parts which were down 8% with capital selling expense flat. We have reinvested also the savings we have done in G&A into new technology by increasing R&D spending by 5%. So it has been more a redistribution of the money to go towards growth and innovation, rather than just taking cost out of the system.
We have also not stopped investing, but we have tried to do it in a smart way. So in fact, this year we had about $1 billion of CapEx, that is 12% less than the year before, but it is still more than 150% of depreciation and to keep going with our capital discipline that we have now applied for many years, we have mainly financed this investment in CapEx, the part above depreciation, by being able to reduce a net working capital which has been down 8% compared to the year before, and so basically this decline in net working capital has more or less set the increase in fixed-asset investments. And as a result of that, our net capital employed on which we calculate our return has in fact only increased by 1% despite the high challenges of the lack of liquidity we have in this market which has given our customers much more incentive to try to delay payment while on the other side, no surprise, especially the smaller ones have the highest need for cash and are asking for accelerated payments whenever possible.
So because of this discipline on capital and because of the fact that at the end we have managed through the cost saving program to still reduce the impact on EBIT quite a lot, yes we have reduction in ROCE, return on capital employed after tax, but it's a reduction of only 4% and at 27% after tax compared to a cost of capital of about 9% so you see the value creation is still quite obvious. And I have here an illustration of that which is basically a benchmark of ABB return on capital employed after tax compared to our peers, and as you can see it is conservative usage of cash over the years which has obviously put us in a very strong position to look at the future with the ROCE which is about 2.5 times the average of the industry.
And when you have this strength of balance sheet and this cash flow as we have generated throughout the year, the good thing is that you have free hands to do what is right. So first of all, already commented on CapEx — we have invested now two years in more than 150% of depreciation into CapEx. That is to invest in technology like for instance the new plan that we are expanding here in Switzerland in Landsberg. This is our semiconductor plant, but as well to continue expanding our footprint we have built a lot of new factories in emerging markets like Poland, like Czech Republic, like Vietnam, like India, and China. We have as well, paid some money into M&A, still small — we'll talk about that a bit later as well.
The good thing as well, if you have the cash, if you have the balance sheets, you can really do the restructuring that you need to do. We have committed more than $1 billion to support this cost savings plan and that is also a big advantage when you can do that because not only protects your EBIT margin short term, but obviously the day the markets will fully recover, ABB will be very lean and perfectly positioned to jump on these opportunities and deliver very strong performance EBIT margins. And finally, obviously we keep yielding to our shareholders. Joe already emphasized the importance of our dividend policy. We are really sticking to that one, and we see this year with a confidence in our balance sheet and our financial strength we have even decided to slightly increase this dividend and pay $0.03 more than we did last year.
So we are ready. We have a very strong balance sheet, more than $7 billion of net cash, more than $14 billion of equity, gives you already a very good base to operate from, and on top of that we have also ample leveraging opportunity even if we are still committed there to leverage or push our balance sheets to a limit which would put at risk our investment grade rating. But as you can see, the credit part of ABB is also very well perceived in the market. Our CDS should be the lowest levels we have seen in the last two years. It's constantly been trading below the iTRAXX Europe index, and if you combine that to the fact that interest rates as well have been lower as we have never been before, actually if we would need to fund those sales tomorrow we could do it at a rate that we have never seen before in terms of potential borrowing rates.
And finally, the most important too is not only do we have good access to the markets, we have also a very solid and loyal banking pool behind us. We have decided this year to renew a little bit in advance our $2 billion credit facility. We have done that under very good conditions. It was actually the best conditions post crisis that we could reach there. We have therefore put together a pool of 30 relationship banks which are the ones that have been behind us for all the years, including the difficult years, but as well a few new players which are the orange spots that you see on this map in order to make sure we continue getting the support into the new markets that we are penetrating like China, like India, and like Brazil. So with that, the balance sheet, the wide access to the markets, as well as the wide banking support so that we can support from a financial point of view our ambitions for the future.
And back to Joe.
Joseph M. Hogan
So I just want to fuel down into our cost out program because we thought we might have several questions on that that we can maybe head off. As you know, first of all, last year we announced a $2 billion cost out program which extends from 2008 through 2010 in total of $2 billion of savings. And we reported each quarter to everyone in this audience in the sense of how well we were doing. When you look at the four buckets we've stayed with that we originally communicated which is overall footprint, sourcing standpoint, how we do on sourcing, operational excellence, and also G&A expenses.
And so really you can see in savings in 2009, you can see how that overall we're more than $1.5 billion of savings as we close out the year, and predominantly $800 million of that happened to be in the sourcing side. About $300 million you could see was in the footprint piece. Actually, operational excellence was much higher than what I thought and we'll show you later on a series of projects we've had in operational excellence because it literally takes thousands of these projects to make it happen, but the team really had gained great momentum over the year to help to push that.
And then really with Gary Steel's leadership and Michel's leadership in this room, and the rest of the help from the EC, we're able to attack G&A expenses in a big way also and be able to hit our targets. So look, as we just announced we're going to extend this cost savings program to another $1 billion so it'll be $3 billion in total, again, between 2008 and 2010. Now you can see the original targets, listed three from the left, and then the new targets. And I think it's really interesting to look at those and say well, what's the real difference here, Joe? It's really 90% of these savings are made up in two buckets is going to be another $0.5 billion in savings will occur from a sourcing standpoint, and then we're going to spend roughly $1 billion in restructuring. A lot of that goes in the footprint. And we're going to save another $400 million on the footprint piece. And those things are not just cost. The footprint piece is not just cost associated for ABB. It's strategically related too.
We're very long in the sense of what we export out of Europe still and we have to make sure that we balance our capabilities and different geographies so we can serve geographies from as nearby as possible and these kind of changes in footprint help us to do that too. You see also from operating excellence another $100 million and another $30 million of G&A just to maintain the momentum there. Again, we have good visibility on these. We did mention when we did the third quarter review that we were considering this, so obviously we're already looking at what we could do and where it would be done and so as we go into this year we have very strong targets, exactly where this would come from, and we just need to execute on those targets and be able to deliver these savings.
Now you look at the footprint and majors. If you go back to 2003, about 30% of our share of employees by regions were in emerging areas and in 2009 it's 45% and this is quickly moving towards the 55% range over the next few years as we make these footprint changes. And here are just some pictures. You can tell these are really garden spots if you want to live in Bulgaria or different places in Vietnam, but these are facilities we've put together recently and a lot of what we've done with these facilities is to try to combine like we've done in Mexico, the strength of ABB, both power and automation, in one site. So we try to get as much scale as we can in those investments as possible. So these are some examples of newer capacity and we'll continue to add and expand in those areas too.
We look at optimizing supply at both global and local levels and so what we wanted to show you here is exactly how we go about the cost savings piece. And not to bore you too long, but honestly, these things have to do with a lot of projects that people put together and track and follow and make sure that we deliver on them. I think extreme amount of best practice is sharing, the (inaudible) coordinated from a central standpoint is to point out if someone's savings a certain amount of money here with low cost sourcing in some way, why isn't that being duplicated in another part of the world by a similar part and being able to leverage the scale?
Remember, ABB for years is an extremely decentralized organization and what we try to do is I love the independence of the decentralized organization, the creativity of it, the capability of it, what it can do to drive growth, but we have to lever the centralization capabilities of the company and you see that a lot in the sourcing piece of what we're doing here is being able to share best practices and move a certain amount of centralization and commonality among the different business units of ABB. So in this case you can see pipe pumps, valves, and fittings, a $5 million savings in that sense. Engineering and erection services, a $10 million savings — different cluster kind of projects where you bring different suppliers together for $5 million, contracted services.
It's all over the world, it's all different kinds of programs, and the next page you can see here medium voltage drive and power electronics right here in Switzerland, programs that cut inventory by 82% again reflected in the cash that we showed you recently, units per employee which is really a great measure of productivity up 2X, reduced cost by $2 million, dead tank breakers in the US $10 million savings and reduced $10 million decrease and reduced cost. Low-voltage drives in China, power transformers in Columbia — so it's a thousand different programs in a hundred different locations that helps to bring this home, but I think the team's shown that they can execute on that and want to make sure that we maintain that momentum as we go through 2010.
When you look at our savings and just try to give you an idea of how it's spread out, our two product businesses; power Products and also automation Products, make up close to 50% of what those savings are. And then our Systems businesses, power Systems and Process automation, 19 and 17 respectively robotics at 7%, and then administrative is given almost 10% of this also. So this has been pervasive across the entire company. As you would expect, a lot of the sourcing side is going to come from the products division and that's why you see almost 50% of the savings come from those areas. So I think it's very logical when you follow the cost savings and the numbers that we showed to you is actually how these distill out.
So from a growth standpoint we made two major structural changes last year to help promote growth. So we said we invested in R&D last year 5% more than we did in 2008 and we do that because ABB has such a history of innovation and you want to maintain that momentum, but also structurally I wanted to make sure that we aligned these businesses properly around growth. And so I'll start from the right-hand side. We took our automation Products business and Tom Sjoekvist is here who's run this business extremely well for a number of years, but we collectively thought it was the right thing to do to split this up because there's really two businesses that are buried inside of automation Products, and that's a low voltage business and a discrete automation. And part of discrete automation means robotics fits in there too because that's a composite of true motion control and logic that fits in that business.
And so we combine those businesses together and Ulrich will come up here in a little while and explain to you how putting these parts together allows us to be able to share more, to be able to bring solution steps to customers, and actually I think gives you a better external benchmark against other discrete automation and manufacturing companies out there, and also better low-voltage companies. So it gives you better transparency in the sense of how ABB's portfolio is doing in that sense and allows management to see that too and to be able to hold ourselves accountable for that performance also.
On the left-hand side is last year at capital markets day we announced the creation of a new EC position that would basically be customer solutions and marketing and we asked Brice to come back from China and run that for us. And the idea there is to have at the EC level a position that's truly dedicated to growth. And the goal of this business is not to step on the division's toes. The division's shown that they know how to organically grow and to execute going forward, but we have never really brought the solutions power to ABB going forward.
So if you take something like Smart Grid and you look across Smart Grid, it falls across four divisions of ABB, but customers don't care about the little divisional solutions of Smart Grid. They want to know how Smart Grid comes together to solve a problem and that can be different in Europe than it is in the United States than it is in Asia. And by having us focused as a one ABB look and how you bring that solution step together — I also at capital markets day talked about convergence and how automation and power is coming into convergence to solve solutions, and I gave you the example of wind and rail and how that works. But again, it falls across several different divisions, and if you're going to get a solution set and have these parts actually talk and communicate together, they have to make sure that they work together and that's going to be Brice's role to help to drive that.
So with that said I'll ask Brice to come up and really expand on his position and then after that Uli will talk about discrete and motion.
Brice Koch Ph.D.
Thank you. Good afternoon, ladies and gentlemen. What about growth in ABB? I mean, going forward, as Joe mentioned, there are a number of sectors where we are working around. First of all, we are in a very lucky position today that having developed over the last decades a number of products which are highly efficient and really driving productivity, we have the market today which is moving to us. So we talk about climate change, we talk about environmental concerns, and in order to address those concerns we need more efficient and more productive products or solutions or systems, and therefore a market coming to the company or at least to the strength of the portfolio.
Now what does that mean more specifically? We talk about these key growth areas like rail, like wind, like water, and I will comment a little bit about (inaudible). We talk about energy efficiency. I mentioned that. We talk about solutions; how to make the world and the economy, and especially the industry and the utilities more energy efficient. I'll come also back on that. And also the business around service. We today have in ABB an estimation of something like $170 billion of installed base in the world. That means a lot of products will be maintained, retrofitted, upgraded, improved, but also systems and solutions around them. So these opportunities, we need to tackle it as one ABB more than BU (ph) by BUY (ph) because on the same side you don't have only one BU product. You have the whole ABB portfolio most of the time present so how can we leverage that together?
And finally, last but not least, innovation will be a very important part of addressing these solutions because a lot of them might not exist today so we need to bring that together, we need to innovate to do research, to improve that, and as Michel said we are investing more in that to make sure that we come with new solutions and really new systems and products.
Now, coming to these sectors which are growing today more visibly. Starting with wind, we know today that something like 2% of the energy in the world is wind energy, the rest being coal, nuclear, and others. Now, looking at these improvements, we need to go through for the environment, that means a huge potential to grow these kind of energy sources and availability, meaning 2% why not 4%, why not 6%? Those are figures which might be relevant and for sure will generate a lot of business around them.
Now going further and to take the advantage of Joe from before, wind today is served in ABB by 13 BUs 13. So 13 organizations in ABB are delivering products for wind, talking about transformers, switch gears, motors, drives, and I forgot some. So how do you make that package, that solution, more appealing and easier to deal with from a customer point of view? That is definitely an opportunity.
Furthermore, rail. Why is rail so important? Because again, driven by these energy efficient concerns and environmental concerns, rail is one of the best solutions, first of all to produce less CO2. Rail today produces something like 50-70 times less CO2 per kilometer and passenger than cars and planes. On the other side, rail, or additionally, rail alone to transport something like 25 times more passengers in an urban area than cars and 10 times more than busses. So rail is really a key solution going forward in order to address these energy efficiencies or environmental concerns we have.
Now why is that relevant for ABB? Yes, we don't produce locomotives, but 60%-70% of the electrical components of a railway of a locomotive are ABB's. We talk again about transformers, we talk again about motors, and drives, and switch gears, and so on. So why is rail so important? Because a lot of these electrical components in rail are coming from ABB today already. And you see here about the size of the business, we talk already today about something like $1.2 billion, and that is a business which will for sure continue to grow double digits in terms of percentage.
Water, I don't need to tell you about water scarcity and the problem we have in the world around water. What probably people know a little bit less is that one of the most efficient ways to get water scarcity partially solved is to reduce the leakages of the water systems. And again here, ABB with control products, with systems, with software, can help to improve these leakages in the networks which is again, a big opportunity.
Now, Joe mentioned before one of the strengths of ABB is not only the power system or the power business itself or the automation, but the combination of both. We are one of the rare companies, if not the only one, having really this full portfolio of automation and power to be able to be combined together. And here we have an example of a solution for an iron plant producing iron pellets in Oman where you see the combination of the two. You see on the one side the power side which is about linking this plant to the grid — so we talk power systems, we talk power products, we talk transformers, but you see also on the other side the control systems in order to integrate the whole plan. You see the drives, you see the motors, so more the automation part of it. And that combined heads the customer towards one solution which works together instead of having different partners, instead of having problems to have the two solutions fitting together, they have a one-stop shop basically with ABB, solving the two things together.
Now, Smart Grid. It's almost becoming a buzzword these days. Smart Grid, we are not so sure what's all in it. What we are sure about is that Smart Grid will change, or at least will refine the way the electricity flow is happening in the world. Now depending in which region you are, Smart Grid might be a solution to integrate renewables. In other regions of the world it is a better solution to strengthen the grid. In any case, we see around Smart Grid these integration functions and these intelligence coming into the grid where again, having a few pilots now mentioned here, but having a number of pilots worldwide, we try to understand better what would be the product, what would be the solution, what would be the value proposition around these Smart Grids?
And we speak about a project in Germany where it is about minimum emission, integrating distributor generation storage, but also customer billing or spending. We talk about another project in Stockholm which is building a small city and integrating all the aspects of a city in a Smart Grid kind of consideration. We talk about energy efficiency, alternate generation, storage, and immobility or electrical vehicles. So, really simulating what the world can look like in order to have a zero carbon footprint.
I mentioned also service, and here $179 billion of install base. It's a big base. Now we have different aspects we can address here. Again, we can address it from servicing that base, from replacing it, but what we can also do much more is develop service products and that is a benefit having the different views and division together because instead of fixing only one switch gear I can maybe at the same fix also the transformer next to it. Instead of fixing only a drive I can also fix a motor together with it because they are anyhow linked to each other. So having this one ABB approach will allow us to develop products which are much more simple to handle for the customers, and as such, we will head the market.
Furthermore, we have also over time developed a certain knowledge around energy efficiency, productivity, and that is something that we can also propose more and more to the market today, these kinds of brands, these kind of experiences to help industries, and also to partially utilities to get more products even more efficient. So all that package of service is driving us to become a better one company and leveraging the strength of the one BU to support the other one or vice versa.
So in all, as I said before, we are in a lucky position having developed over the last decade a number of very energy efficient product solutions having an embedded knowledge and DNA in the company around that, that the market is now heavily moving through that playing field. It is a lucky position to be in. I don't know how many times companies can enjoy such a position, but at least that's what we enjoy these days and going forward. So I'm rather strong about growth going forward definitely.
With that, thank you very much and I will give the floor to Ulrich Spiesshofer.
Thanks, Brice. Good afternoon. The new division that created automation and motion was formed not only for logical reasons, but also to serve a $100 billion market out there. Three reasons that Joe already laid out; on the one hand, combining everything that ABB has to serve these markets under one umbrella, secondly to have a tailored service offering and more service activities in a focused way, and thirdly, to have a sharper focus on the very specific requirements of the different industry segments that are active within that space.
You see on the slide here how it all comes together; power, the drives, controls, motors, and robots. And just to give you one simple example how we benefit already from it, on the drives, motors, and robots side we had three different remote service platforms bringing them together and operating in a more efficient way will not only yield more market penetration, but also a cost advantage and we are very happy with the progress that we have made already in the first couple of weeks.
The focus will be on industrial productivity, on energy efficiency, and renewables. Now let me walk through examples for each of them, what it means for our business. I'll start with industrial productivity. Purposefully we picked here an example out of one of the toughest hit industries in the world, automotive, which really faced a very, very traumatic downturn in 2009. However, if you look at the structure of the automotive industry, there's a proliferation of models coming that will fight for volumes in a very, very slow growing market. That proliferation of model means more parts, and more parts need to be produced more cheap. If you take, for example, different body parts that you need to produce for an automotive layer, press (ph) line is extremely important.
And the press line in the automotive plant historically is operated by a human being and involves them coming up and down, up and down, and he puts it in, puts his hands on some safety pads, took it off again, had to (inaudible) down and took it out. By putting a robot in there instead of the human operator, it means we have increased first of all the safety standard significantly because it's very often a very dangerous environment, secondly we have increased productivity by up to 50% having a much faster cycle time using a robot. In addition to that, we put a drive solution on top of the (inaudible) on the press line, and it means that basically we can connect the type of the place with the type of the robot and that gives us an additional productivity gain which is very significant. So this is how we can help the layers in automotive to compete in a very difficult environment.
So that was industrial productivity, second example on energy efficiency. Energy efficiency is a theme that goes throughout ABB. Brice has elaborated on it, Joe and Michel have talked about it, what can we do in this division to really work on it? I will give you a couple of examples. One is if you take a cement plant and look at the amount of conveyers that you have to transport the stuff around bringing coordinated drive systems, drives that speak to each other, and they're all synchronized in terms of speed, in terms of torque, in terms of movement that they create, is already the first advantage and of significant savings. The second one is a conveyer belt doesn't always go up, it also goes down, and taking the breaking energy and putting that back into the system is another contribution to energy efficiency.
In a recent example that you have up here, we saved quite significant amounts of energy and CO2 exhaust. So that's the reactive way of addressing it, but we have also developed some very proactive ways. We have launched an energy audit program that is tailored to specific industry domain needs where we go in together with the customer and assess the energy consumption of his plant and then we work through with him the right setup, the interchange, the investments that he should take in that environment. Recently we have done this in the UK for a company that produces plastic films, and the result was a very significant reduction in energy consumption of 37%. So we are not only following the demand of the customers, we are creating it through these tailored energy audits, and we plan to do more than 1,000 of them in the year 2010 out of the discrete automation and motion division.
Thirdly I would like to use the example of rolling stock. Brice has very nicely laid out already how important the railway sector for us is. It is a very fast growing infrastructure sector mainly also in emerging economies, and there we have a tailored offering, and just recently we were successful when we had the test run last week to put more energy efficient converters on a high-speed train saving more than 10%, in fact, close to 15% energy consumption, off the total drain for the total operating life cycle. So we think really we have something to offer on the energy efficiency side and believe therefore this is the second key driver for the division.
The third driver is around renewables. Now, you have already heard today about water, you have heard about solar, you have heard about wind. In wind, discrete automation and motion has a very balanced footprint already with plants in India, in China, and in Europe, that allow us to be the leading provider of wind generators and wind converters. In that area we will now bring more and more together the different parts and package them up to make sure that we take as much value added to our customers and make their life easier in terms of setting up wind turbines and wind plants. On the solar side you have here an example out of Spain where we have provided total systems and the division discrete automation and motion has provided the tracking, the POC, the control, the drive, and the motor that rotates the solar equipment out there.
And last but not least, water. Water is not only something that we consume, it's also a source of renewable energy. It's also very important for energy storage and just recently we got the order for the largest ever installed converter for a pump storage plant which will be installed now over the next couple of years. This is an area where we also will benefit from stimulus money. Talking to some of the CEOs in the wind industries who are our customers most recently, they all expect the market to pick up significantly in the second half of 2010 and hopefully that means also for us significant growth.
So if we bring this all together, what does this all mean? To summarize the challenges and there are numerous challenges around, I would like to state here four. Number one, there is an increasing demand for optimized packages. It means domain specific engineered applications of our products, solutions where we bring a drive and a motor together in a tailored way where we bring a POC and a motor or a drive together, and that is a key challenge for us. The second challenge is communication. It will be absolutely crucial to make sure that all the devices, the products, can talk to each other. Whether it will be (inaudible) or Ethernet based is something that depends on the level of complexity of communication needs, but it's definitely something that we need to address.
The third challenge is our customers expect us to be with them everywhere around the world, and the fourth is a lifecycle support and a lifecycle partnership where we do more than just shipping the naked product. We believe we have a very strong base to serve the customers. We have a strong market presence in all of the key product lines. We have a very strong technology position. We have a worldwide local presence meaning we have not only the global reach, but also local arms and legs that can work with the customers. The large install base helps us and the global service capability nicely compliments what we are doing on the product and solutions side.
So there are huge growth opportunities and we will try to work hard on them, finding solutions across the full ABB portfolio and across the ABB discrete automation and motion portfolio, working strong on the market channels for our products, penetrate high growth regional markets. I mentioned from a regional perspective there's definitely a lot of opportunity for us in emerging markets, and from a high growth perspective, the rail example, the renewable example are good ones where we can participate more. We will definitely leverage our technology strength to get there and focus more and more on advanced services to cover up the install base. We are aiming to bypass 20% of service orders of our total orders this year so hopefully we're going to reach that and can add more value to our customers.
So if I sum it up, the focus on industrial productivity, energy efficiency, and renewables, allows us to be cautiously optimistic for this division and the growth that we can expect. With that, over to Joe.
Joseph M. Hogan
So we talked about, again the increase in R&D that we had last year and I just wanted to share with you some of the innovations that we launched in 2009 and we think will help for us to grow not just in 2010, but in the future. On the left-hand side is 1,100 kV ultra high-voltage AC alternating current gas insulated switchgear. This goes into China. This is actually the highest voltage that's eve really been done in GIS and it shows you one, what China's actually putting in from an infrastructure standpoint, it's really incredible in that sense, but it also shows ABB's ability to meet a customer need in a sense and take the GIS to a level it's never been before.
In the middle, those are valve sets. Those are IGBTs that are used in HVDC light and this is a new product we've launched that actually has a lot more energy efficiency in the sense of the transmission of the energy than what we've had in the past and this is really critical when you start to look at offshore wind and often this is HVDC light that connects offshore wind ashore, in that sense underwater. And having one that has a higher wattage to it, but actually at the same time being able to save energy on that is really critical from a customer standpoint going forward for that specific market.
On the right-hand side is a transformer and transformers are probably one of the oldest components in our whole portfolio, over 100 years old. But typical of ABB is the continuing innovation around that. In this sense there are two clear innovations here. One is a biodegradeable oil that's more eco-friendly in this sense. Petroleum based oils are what's always been used in the past and it's always a concern from a fire hazard standpoint and also from a standpoint of contamination over time. In this sense, using a biodegradable oil actually raised the performance of the transformer overall, but it gives you a much more environmentally friendly approach and often these transformers are in neighborhoods or in light industrial areas that you have to be concerned about this.
Also as part of this was an amorphous core transformer. Remember, electrical steel was one of the main components inside of a transformer. It really dictates the efficiency of how well a transformer operates. The more amorphous, and this refers to the grain of the steel where it's more of a random pattern in the sense of how it goes together, changes the magnetic field, and makes the transformer much more efficient. The trick there is it's harder to work with and it's very difficult material to make at the same time, but we've been able to work at this over the years and be able to offer this product. And we think there's more and more scrutiny going forward in the sense of transformers themselves sand how much energy they actually use if they aren't efficiently designed. These kind of things; the environmentally friendly aspect of this, from the standpoint of the BIOTEMP, but also the energy savings aspect with the amorphous core is going to become even more important.
And then next we showed you last year this 800 kV HVDC transformer that's used in China to help to transport energy from about 2,000 km away. There will be 48 of these transformers and two converter stations. Remember, the converter stations are what actually convert the power back on both ends of the equation here. On the right-hand side, that's a beautiful transformer believe it or not. That's for New York City and New York City needed a low decibel transformer. For some reason, in New York they wanted it quiet, at least in some part of that city, and they required a transformer with 20-25 decibel level, and we were able to deliver that to Con Edison to do it, and again it just shows you, I think again, oldest product that ABB has, but continuing to innovate, continuing to differentiate, and this is a key component for us to be able to, in a very difficult economy in a sense from a pricing standpoint, is be able to differentiate ourselves and we continue to grow and to maintain margin in these businesses.
It was touched on briefly when Brice talked about and Uli talked about it too, about the power of being able to work cross portfolio with ABB. One of the things that we've had for years obviously is our process automation business or 800XA. Most recently what we launched is, instead of just process automation or monitoring the closed loop control that would exist in a refinery or a different area, there's also a power section in those plants too that are underneath a completely separate control. And with ABB being a power and automation company, we've brought those two together where you can monitor and control the power usage and distribution in your plant, along with the automation side and be able to optimize both of those when power is expensive or not available you reduce production, or you can change that on the other end of the equation if it is. And so it really shows the power of thinking about what a customer needs and making a more simple solution being able to embed that in our code and being able to offer that to our customer base.
And then this is just a series of products that came out. These are mainly discrete automation and motion products, just to go through a few. The BORDLINE CC150 is a high powered propulsion converter for locomotives. So Uli talked about how important it looks like electrical rail transportation is going to be in the future. We have several innovations going on in those areas about energy efficiency and energy savings and the way the propulsion goes, it's a key part of how you drive these systems. Low voltage AC drives for water and wastewater applications. We have a world class drives business, but it's so important that we continue to segment in those marketplaces, we segment by region, we segment by application, and we continue to innovate around how these drives work.
Solar inverters, we talked about us missing the solar inverter market last year and the year before that. Now we've launched our first solar inverters and we'll be launching several of these next year also to help fulfil different market niches and we feel great about our position in that marketplace.
Down below, Anders and his team in robots did a great job last year in taking our controller and reducing it. This doesn't give it justice, this picture, by taking a controller that was like this big, and a controller is pretty much what it sounds like. It just controls the motion and the signaling that goes into a robot from a controller about this size to a controller about this size, and consequently taking a huge amount, but keeping the performance at about the same level too. So more drives on the bottom, new generation 3 kg robot, and we see robots going a lot this way. Automotive will continue to stay as a large market for robotics, but robotic technology is getting simpler to use, it's getting smaller and cheaper, and you'll see through that that it starts to penetrate different markets. As Uli described, taking that capability and mirroring that with our drives business, our motion control business, to offer a total solution for companies and for industries we think is a huge opportunity, and then another photovoltaic application below with the V DCs.
So this is summary and outlook. So 2009, I think you could tell from the comments up here that we feel we had a strong 2009 despite the market turmoil and I think some questions out there that we all had about how businesses would perform through the cycle — solid emerging market growth as I mentioned in the opening. I think really the two key areas when you look at the leverage of the business overall, it was our ability to execute on cost and do it quickly, and really to leverage our emerging markets position to find a growth that was out there and to help to build our order base. Profitability well within that target quarter or the 13% EBIT and you can see Michel's walk as you go through both the fourth quarter walk EBIT and the total year you could see how important it was for us to drive that cost savings in order to mitigate the volume loss and also to mitigate what we saw from a pricing standpoint.
And then cash generation again shows the quality of the earnings, so it's a very strong year for ABB and it's really our thanks to the team, not just the EC team, but the teams around the world that helped execute this all this year.
Looking to the chart that I think several of you have seen in the past that starts with the merger of Brown Boveri and also Asea back in 1988. And if you remember, the portfolio of our business was really different back then. We had rail, we had big oil and gas businesses, a financial services business, power generation, and then when ABB had difficult years back in the early 2000s and we streamlined the portfolio around specifically power and the distribution of power, not the generation anymore, and also the automation side, and then the solid growth platform, and now we're at a point now where you look at the blue bars which are the revenue side, which are just about the size of what we were at the peak years with that much expanded portfolio, but much more enhanced EBIT margin which you can see on that line too. And again, we're committed to try to stay within that and we feel that we have the capability and portfolio to be able to do that.
So look, beyond the cycle of opportunities and uncertainties, I think from a market standpoint on opportunities it's been talked about a lot today and again it's what we emphasized at capital markets day. It's about sustainable energy. It's about emerging markets growth. And it's also about energy savings. And that's in any geography you want to talk about. We feel that we have a good position and also a good portfolio to address that. From an ABB standpoint you can see that from a technology standpoint, the geographical balance is again what we do with the footprint of investments that we're making that make sure that our resources are aligned properly. And that technology lead is so important at times. These are just iterative technologies that if you break them and you don't invest in them and you lose a few years, you can lose a market over time.
So I think what's been terrific is even though we pull $1.5 billion and more of cost out this year, but continue to invest in R&D to ensure the future of the business. There's always uncertainty in business, bu there's more uncertainty in these times I think than any other time we've been in business, and the amplitude and timing of the macro rebound I think that you all think about that or are concerned with it too so as governments remove stimulus, as they reduce monetary stimulus and fiscal stimulus, we're going to see how much private demand's really out there and we have to be cognizant of that. That's why when Michel and I say that we're mixed in the sense of what we think about the future in the sense of the future being uncertain, this is a really important year in the sense of those economic stimulus packages being muted somewhat and letting private demand take over again and we'll have to see how that works out.
Increasing protectionism; we can say we've seen that in different parts of the world. It affects us at times, but again I would say our footprint and our experience in those geographies and really in-depth knowledge of how to be able to compete in those geographies have helped us through this. Competitor pricing is always something that's unknown, but we'll have to face it, and that's why our cost out programs' so important. And then the developed market rebound. When you think of Western Europe and the United States I think we're all not quite certain exactly what that rebounds going to look like and how sustaining it'll be and that's why this cost out program and us staying on our toes operationally is so important so we're not surprised in the marketplace.
So outlook and beyond, as I mentioned, 2010 remains mixed. We're pleased about having about the same sized backlog as we go into 2010 as we had in 2009. We continue to see good demand and power transmission and also oil and gas and anything around energy savings is critical for us. Emerging markets we think will continue to be the real engine of growth in the near future. Look, our short-cycle demand we feel has bottomed. Remember, about 20% of our business we think is short cycle, but in that part at least quarter to quarter and what we've seen so far we think we've seen the bottom of that piece and we hope it stays that way. We confirm our 2011 EBIT targets and also cash pieces.
Our long-term market outlook remains optimistic. I'm very confident about our portfolio that we have in both automation and power. Our continued ability to invest in that and be able to innovate around that and be able to channel that through the right markets I feel very good about. Macro trends of climate change and energy efficiency continue and the organization alignments that were highlighted by Brice and Uli are specifically geared to putting more of a growth mindset of ABB which will balance good operational execution with an aggressive look forward on how we grow.
So with that Michel and me and the EC team is here today, everyone would be happy to take any questions that you might have.
Okay. Thank you, Joe. We're now going to the Q&A session and as usual I will start taking a couple of questions from the room here and then we turn over to people on the phone asking questions and maybe there are also questions coming in from the webcast. So who would volunteer first question in the room? Thomas? And again, please wait for the microphone.
Thomas Diamond - NJB
Hi. My name's Thomas Diamond (ph) from NJB (ph) and I have two questions. Actually, I got more, but I think you'll limit it to two, right?
Yeah. It depends how good they are, Tom.
Thomas Diamond - NJB
Thank you very much. Well, first of all goes to price pressure. You showed us very nicely in your slide what price pressure impact was in Q4 and full year it was 350 basis points. Now I suppose that in the order intake it was more than that. Can you give us some information what the price pressure in order intake was? And you said that going forward it's going to be a higher impact? And my second question really goes to service. I think we've heard that initiative before to drive service, and to drive service and in revenues in absolute terms irrespective of what the cycle will be, and obviously service revenues were down as well in 2009. I can understand that, but maybe you can share with us what you think you might have done suboptimally in the past or maybe you made mistakes in the past not to get that potential and what do you intend to do differently this time around?
Okay. Let me address the pricing pressure. Obviously it's always a matter of time. What you have seen this year in our income statement is really the pricing impact on the products that have a short cycle so strictly going from all this into revenue so it mainly reflects the pricing pressure that we've seen in the automation products and in power products, that is true. They are both between 3%-4%. It's very difficult for us to tell you exactly what it represents in the backlog because I think the reason like power systems for instance, it is clear that in power systems we are taking today substation orders in the Middle East at prices that are 20% below last year. But on the other side, the civil works, which is a big part of the cost to execute these projects are down 50%. So it's just a matter of making sure that yes, you have to cope with the lower prices, but that you also align your cost base, get all the sub contractors aligned to that as well, and deliver the engineer of your part from a cheaper location.
So what you can see next year is probably a bit more pricing pressure once some of these projects start getting into the revenue stream, but against that will come as well much lower costs. So what is important for us is to control the margins that we have in all the intake and in our backlog and most of them are still showing some very satisfactory trends.
Joseph M. Hogan
And Thomas, on the services side, I'd say you're right, guilty as charged in the sense that you've heard about this initiative in services before and what's really different from a team standpoint going forward, I'd say one of the things outside of our turbocharger business, this isn't a break and fix business. It's not one that has a normal supply of maintenance parts that are really associated with something breaking down in the field. And so there's a certain part of that kind of attrition that occurs with our products, but it's not like having a gas turbine or something like that where it's predictive. So what we're going to have to do and we're increasingly learning is we have to be more proactive in the sense of how we go after our services.
In other words, being able to do predictive maintenance. In other words, when a transformer fails, being able to predict when it will go down. Being able to change that transformed on site rather than having to move that transformer back to a plant and take it out of circulation. You heard Brice talk about our energy audit capability and what we could do from that standpoint and Uli did also is we are really experts in the sense of energy usage, particularly energy usage in different facilities, but you don't necessarily sell that to the facility's engineer. You usually go to a general manager and there's a different channel that you go to and so we're going to have to be able to explore those channels and to modify our channel approach.
We call these solution sets, and this is a lot what Brice is going to do in his role is we have to arm our sales force to be able to be comfortable to talk to a general manager and be able to explain why ABB can actually save money and the experience that we have. It's kind of a consulting service that way that pulls through our business.
And so look, this is going to be a long road and I won't deny that, but I say it's the right goal for the business. When you look at 16%-17% of our revenue base being services and what the opportunity is for that, it is and we won't give up. We think we know the path here. It's one that we're going to have to modify our channel practices, be able to be better sellers of solutions to do that, but I'm confident the team understands that now and that we'll be able to get at it.
So if I can add, looking a bit more behind the thing, indeed the organization setup did not always allow us to get the maximum potential out of it and that's why getting with the external view that Joe had when he came here, is I think, going to be very helpful to get more entitlement or maturities we should get out of revenues in total.
And just to correct one thing you said, on a currency adjusted basis, service revenues were flat last year, not declining.
Okay, another question here from the room? Maybe at the back?
Axel Quinhog (ph) - ING
Thank you. I'm Axel Quinhog from ING. Yeah, I have two questions as well. First of all — well, typically what you notice is when you go through restructuring projects and cost savings projects is that the incremental costs of taking costs out of increasing over time — you're now guiding for an additional $1 billion cost cut at actually a decreased incremental cost to the organization which is strange, but very interesting. Can you comment and elaborate on where you basically found that it became easier to save costs in the process? And secondly and directly connected to that, could there be more maybe to come in terms of additional cost savings beyond this $1 billion?
And the second question is, just about pricing pressure, I think the additional $1 billion cost that you want to take out could more or less coincide with an expected underlying pricing pressure of around 3, 3.1, 3 point something percent. Is that your expectation for this year's pricing pressure?
Let me try on the restructuring cost. I think what we've seen as we have gone through that is that in a way we have found a lot of cost savings that could be done without having to invest restructuring costs, resourcing is a major one and I think the pace that we have got has come at an accelerated speed compared to what we had forecasted. Joe also mentioned a lot of OpEx projects. These are also ones that it's a lot of work that people do in order to get these savings, but this is part of the normal work so we're not adding people to do that, nor do we have to take people out to realize these savings.
This is more getting productivity out of the tools so we have seen with that, that in fact the first $2 billion that we're committed to we could deliver them at a cheaper cost than what we had initially anticipated because of the composition of these savings, and I would say as well, with these restructuring programs it's always the same. It's very difficult to get them started, but once you have them going they start having a life of their own, and in fact they're seeing all the initiatives that we have taken already now would have taken us way beyond the $2 billion that we targeted with the investment we have done. So now we are just adding a few to get to the $3 billion, but that's why you have a bit of difficulty to reconcile the incremental costs. But we are now, I think, have much more experience in judging these incremental costs so we feel quite comfortable with the estimate we are giving to you today.
Joseph M. Hogan
Yeah. I think to add to part of that too, I think when you look at restructuring the footprint pieces, the question is always do you close the facility or are you just reducing employment to a new level and then you'll be able to pick up employment maybe in an emerging economy somewhere else and so fortunately as part of this we haven' had to close down as many facilities and we had to reduce employment in those areas and so that's the underlying reason Michel said that it didn't quite cost as much on the front end as what we thought of.
I understand your questions. I had exactly the same questions as these guys when they came with their friends, but it makes sense.
Joseph M. Hogan
And the pricing question too, Axel, I can see you're expecting it. Look, we're not quite certain what the pricing environment's going to be next year, but I think you have to think it's going to be at least in line with what we've seen this year and completely competitive. So this billion dollar cost out is again an insurance policy that we can possibly have against an economy that we say is mixed right now and that mix is both on demand and price.
Yeah. Let's not also forget that all these cost savings are independent of the fluctuation of the commodity raw material prices which obviously have also an impact on our final price so that makes it also quite difficult for us to really calculate exactly what this pricing pressure could be, but I think we are ready with enough initiatives now in terms of hedging for the commodity price and in terms of cost takeout for the non-commodity prices to be ready to react to whatever the market pressure will be.
Before we go to the phone, maybe a question that we received from Chris at DG Capital Management in Boston and it's to you Joe and it's going a little bit in the same direction. Chris would like to know what keeps you up at night more, is it the pricing or the macro concerns into 2010?
Joseph M. Hogan
Well actually, Chris, I actually think those two are related. I think the longer the macro concerns go on in the sense of demand suppression the more price pressure that you have in the marketplace and so I'd say these two things aren't discrete, they're actually interrelated and as I mentioned before, I think if you read economics right now and you're interested in it, there's going to be a massive withdrawal of different stimulus packages throughout the world over the next several months, probably most of it in the second half of 2010 and we're not quite sure, as anyone's not quite sure out there, what that's going to mean to the economy from a growth standpoint.
So if that moves fine and private demand picks up and we're starting to see CapEx investment, that's going to help from a pricing standpoint. If it doesn't, we'll see more pressure so it's very uncertain and the best way to deal with uncertainty is to plan for it, and again that's why we're so focused on the cost out piece, but we're also focused on innovation here too. And hopefully you saw that through the presentation and through the organization structure that we're trying to balance both so we can help to guarantee the future of the company.
Okay. And then we got another question this time from David Jacobson (ph) at Uman (ph) and he would like to know whether we can shed some more light on the weak power systems result in Q4? I think Jacob is referring to the EBIT margin, and specifically whether there were budget overruns or write downs in this business.
Joseph M. Hogan
Yeah. I think, David, on the power systems piece, (Inaudible) and Michel knows, I think there are about $76-$80 million of restructuring charges that were part of that whole piece.
Yeah. The adjusted EBIT margin was 7.6% which was actually was a 2% reduction compared to the fourth quarter last year. So that was the major one which was the restructuring. There's always a couple of one-off charges that are linked to project execution, but I would say that still, 7.6% for power systems is what we would call a good margin within the target ranges that we have.
Joseph M. Hogan
That's right, in the quarter we expressed for that business.
So now I guess we would turn to questions from the phone. Operator, please?
The first question from the line of Mr. Mark Troman with Banc of America/Merrill Lynch.
Mark Troman - Banc of America/Merrill Lynch
Yes, thank you. Thank you very much. Good afternoon, Joe and Michel. I just want to follow along on this pricing, it looks like 3.5% affecting Q4 and if I remember correctly, Q1 didn't have that much of a pricing impact. So is it fair to say that Q3 was the real low point of the year in terms of price down? That was the first question. And when we look forward with price, I take it from the earlier question that this is more about products than systems in terms of systems you can get an offset. I mean, basically, are you confident that the cost savings can fully cover any likely product deflation in 2010, and if so does that mean that we're thinking about volume now in terms of your profit outlook?
Joseph M. Hogan
Mark, those are tough questions. We'll do our best to answer them. First of all, Q3 you asked as being a low point on price in the sense of the year, I'd ask Michel in the sense of the quantification of that, but it doesn't feel that way to me. We still see continuing pricing pressure in the marketplace depending on where you're looking by geography. There's a certain mix in our business in the sense of what we see in automation products versus what we see in power systems or power products, but there's a lot of price competition out there and I wouldn't say that it decreased between, at least from what I've seen and felt, between the third and the fourth quarters.
Yeah. I think Q3 it was pretty low in terms of headwinds. It was a combination of prices and volume, probably more volume at this stage as it was a pretty soft quarter in terms of overall supply. So the combination of the two have indeed give us a margin compression. And it's true that the first half was a little bit slow in terms of price decline so I might agree although I don't think it's a huge difference, pricing normally Q3 compared to Q4.
And in regards to the future, yeah I agree, it's a difficult question. I think the only thing I can answer is that we don't have a crystal ball so it's very difficult to see when the market really turns, but we have demonstrated a signal or agility to react to market conditions and we might remember that we started the cost cutting programs with a $1.3 billion target, we raised it to $2 billion, now we are raising it to $3 billion and we can deliver on it actually in advance of what we committed so I can only ask you for your trust that we'll keep moving as we see the market get tougher.
Mark Troman - Banc of America/Merrill Lynch
Thank you. And just one quick one, your inventory performance looked very good in cash flow, particularly in the products divisions, is there a degree of underproduction going on relative to your sales?
Joseph M. Hogan
You mean less payables than the whole thing, Mark?
Mark Troman - Banc of America/Merrill Lynch
No. I meant just under absorption of fixed costs because you're producing less than you're selling?
No. I think if you really look into the cash flow, the two major elements that have contributed to great cash flow in Q4 has been on one side the reduction of over dues that has been quiet important in Q4, about 20% less, and the second part, and especially that one, a strong reduction of inventories which had been quite high for awhile. So in a way, indirectly your question is right. The way we look at it, inventories have been the biggest driver, yeah.
Mark Troman - Banc of America/Merrill Lynch
Okay. Thank you very much.
Next question, Mrs. Lisa Randall, Nomura. Please go ahead, madame.
Lisa Randall - Nomura
Good afternoon, gentlemen. Lisa Randall from Nomura, two questions please. Just firstly on robotics which is supposed to be under pressure again this year, Joe, you said the robotics technology is getting smaller and cheaper, so the question is, is this still a technology driven market that ABB continues to feel it has a competitive strength in?
And then secondly just on the dividend, you say on, I think it's Slide 12 of the presentation, that the dividend of $0.51 demonstrates a confidence in the outlook and the financial strength. Well, financial strength of (inaudible) is obviously clearly visibile. My question is really how you came to that sort of 6% increase year on year given the scale of the financial strength that the group has?
Okay. Let me answer the dividend first. It will be a shorter one. We have this policy of distributing steadily rising, but sustainable, dividends. So when we talk about outlook we always think about if we raise it to the next level we want to make sure that whatever happens in the coming years we will never have to cut it back to a lower level. So it's not just a short-term outlook, it's also a bit longer term looking at cycles and trying to see (inaudible). Obviously because of that you will not see from us a sudden 50% increase.
We did that in the beginning when we started from nothing, but now that we have the yield that we have, we have a dividend yield of about 2.5%, you should more expect these kind of incremental improvements always to a level that we are comfortable to sustain rather than a bigger one. Obviously if you compare it to our cash pile, again it is clear that $0.05 more or less doesn't make a big difference to the cash pile, but we look at it as well as a long-term commitment and as a result of that we need to still have a conservative approach and also keep the yield in mind at the same time. So that is the reason that we chose to go for a $0.03 increase.
Joseph M. Hogan
And, Lisa, on your robotics question I think it should be clear to everyone by what we did with robotics is taking it and making it part of the discrete automation and motion business is that we believe in this business and we believe in an integrated solution and how this is going to be used in the future. If we would've thought that this wasn't a valuable piece of our asset base and it wasn’t really worth hanging onto we would've kept it as a separate division and looked to sell it. But I truly believe in this technology.
Again, I spent a lot of my career from a GE standpoint in the GE automation business and I had a lot of association with the robotics side and as I went from medical, I came back to medical back in this automation business, I was amazed at how much change had gone on in robotics and really in three major areas. One was four sensor technology which means the ability to tactile feel of a robot. Because the robots before had no feel at all. If you grabbed a cup it would just crush it and you had to control that. Now you can actually control it physically.
Secondly, it used to be that any kind of eyesight on robots was extremely expensive and very slow, and today if you ever watch one of our flex pickers, in a fraction of a second it sees something, the orientation of it, and it picks it up and it move sit. And third is I couldn't believe the amount of costs that came down in robotics since my time at GE too. And so there's a natural progress that says as these more intelligent robotics with four sensor technology with eyesight capability, and with the costs coming down, you're going to see much better penetration into not just automotive, but industries it didn't hit before.
And look at the same time you have to say it won't be alone. It's going to have to be in conjunction with other types of automation equipment if you're really going to get the effectiveness out of it and that's why it belongs so well in the discrete automation and motion business. So I do believe in it, we'll continue to invest in it, and I'm certain we're going to be right over a period of time.
Yeah. And if I can add one point, about 20% of our total restructuring investment of the $1 billion we invest is basically in robotics so it is a mega change for that division. We get out of that a brand new range of products, new technology, and a cost structure which I think is really not comparable with any of our competitors. So what we just did there is a market picking up and I think then we are really ready to show everyone the strength of the business for the future.
Lisa Randall - Nomura
Okay. Thank you.
Next question, Mr. Frederick Stahl of UBS.
Frederick Stahl - UBS
Good afternoon, gentlemen. It's Frederick here from UBS. Two questions please, one on the cost cutting. You're obviously doing a lot better than you initially expected, can you maybe tell us a bit about how this came about? Has been top driven by you in management saying that well, $2 billion is not enough and you need to increase that or is it something that's come through the organization organically as you've gone through the initial programs? Or is it maybe just the fact that you underestimated the impact of the programs that you started with?
The second question is regarding to price. Is it really a coincidence that you're able to take out more costs than your price declined or is it may be fair to say that your pricing power and the industry price discipline is still strong enough to limit price erosion to what you actually can afford?
Joseph M. Hogan
Fredrick, on the first part, on the cost out side this is — when we initiated this cost out program it was from a management level. I mean, from an EC standpoint we could see a difficult market in front of us and we knew we had to set certain cost out goals and to drive it. I would say after that, as Michel explained, there's a certain amount of momentum that actually started to occur with this in the sense of new ideas and new opportunities that came up and I'd say as we saw that momentum and we saw a very good return on that investment according to Axel's question, we said we should accelerate this and have it move forward.
So it's a combination of everything that you talked about. There's a certain amount of topdown to begin with, there's a certain amount of momentum that we had in the program, and then lastly I'd say did we underestimate? Yeah, you never want to necessarily overestimate what you can do on cost as we're relatively conservative and through being conservative in that sense as we gained the momentum we could see it.
On the price versus more cost, it's always very difficult for us to answer those kinds of questions because you have to remember this portfolio of ABB is extremely extensive. It extends 35 different Bus or 40 different BUs across 180 different geographies, and there's actually different pricing pressures and different norms and different demands in each one of those areas. So we can only answer your question in general and I'd say certain segments of our portfolio, we see increasing price (inaudible). There's other segments of our portfolio, whether it be in low voltage or whatever that really we're in the initial part of the cycle and headed down.
We've seen better pricing discipline in the last couple of quarters and so I could answer your question in a mix sense as there's continuing pressure in some parts of our portfolio, but some stability that could be more around the alignment and the overall demographics of those marketplaces, but necessarily we have seen some good price discipline in those areas.
Frederick Stahl - UBS
Okay. Thank you very much.
Question here in the room. Yeah, Alex, you have a question here?
Alex Muerini - Halver
Hi. This is Alex Muerini (ph) from Halver (ph). A question on compliance; you've had yet another investigation now into your fax (ph) operations in Sweden and this is something that you clearly wanted to tighten the screws on, but it seems like there continues to be a steady stream, if you like, of new investigations, and I'm wondering whether you feel that this is not really fair and warranted alternative source of taxation, if you like, or whether there is still unresolved issues within the firm and as a consequence whether this could result in an erosion of your long-term pricing power?
Joseph M. Hogan
It's a thoughtful question. First of all I can't comment on the fax piece because it's under investigation and obviously we'd compromise ourselves, but I can tell you that everyone is sitting here and the people that work for them understand that compliance is not a legal issue, that it's an operational issue and it's a management issue, and that we take full responsibility for the culture that we set and how we try that kind of zero tolerance program down through the organization. And it's a big change in this organization over the last 18 months where the operations people really take that on, understand it, communicate it, and know they're held responsible for it. But I think anyone who's been in business over a period of time, we all understand cultural change takes a while.
And look, there's a lot of legacy issues in this business that we know we have to deal with and we won't make any excuses about that. We'll take it and stay responsible for it and we'll deal with it. I will say this is not about overzealous commissioner antitrust or FCPA or whatever. The issues that are presented to us, we investigate each one of them to see what the relevancy is, but I'd say could there be a driving force at some point in time about another kind of taxation? Maybe, but that's not what we see right now. We see that this is about compliance and how we have to deal with it.
And so, Michel and me talk about does that chance our pricing power going forward? I'd say no. I don't think it does at all. I think that we can be competitive and that those kinds of practices actually make companies sloppy. They don't make them competitive. They don't force you to look at cost out. They don't force you to change your footprint. Over time it erodes the competitiveness of a company. So I think there's a couple of reasons why you never want to cross that compliance line. One is it's immoral, both antitrust and bribery hurts countries, hurts people, and secondly it hurts a company over a period of time. It's just a lot of different dimensions as to why you don't want to do it.
So this leadership team is committed to making sure we run a compliant culture and we go forward. We'll clean up any issues we have and we'll drive as fast as we can forward into that new kind of competitive benchmark.
Okay, another question here from the room. Thomas maybe? Thomas I have still quite a number of people lined up still on the phone. You had your first chance, but if we dry out on the phone I'll come back to you. So then, operator, we go back to the phone.
Next question from the phone from Mr. Julian Bure (ph) of SCBN Skilda (ph).
Julian Bure - SCBN Skilda
Yes, good afternoon, Joe and Michel. Firstly, in terms of months of invoicing, your backlog looks to be in similar shape to as it was at the end of 2008, not least because of the help from power systems. And also, you're saying that the base order trends seem to be stabilizing (inaudible) chance that you could achieve flat or even positive organic invoicing trend in 2010?
Joseph M. Hogan
Julian, you kind of had a little static in between that. Thank goodness, it sounded like a tough question (laughter). We'll answer it the way we want to. First of all, when you look at the backlog, and Michel can correct me on this, but I think historically when we come into a year we look at about 60%-65% of our backlog actually converting within that year and that's what we actually see in the backlog that we have now. It's between those two areas and so like we mentioned before, the composition of the backlog is different. There's a lot of it around power systems and power products, but it's a good backlog in that sense.
And the rest of your question —
Yeah. It's a good backlog, but still, the composition of the backlog has changed quite a lot. The amount is the same, but if you compare division by division, for instance the backlog of power systems is up 20% compared to last year. The backlog of automation products is down 12%. So it's a different backlog in terms of EBIT mix composition and it's also a backlog that because of that, it extends a little bit more beyond 2010 than I think we had last year too. So we will need to ask your question about invoicing, and we will need more book and bill business to be able to get towards black numbers in there so it depends a little bit on the shorter-cycle businesses we have.
We see some encouraging signs this quarter if we take the typical short-cycle businesses of automation products, units like (inaudible) accessories, enclosures, or wakens (ph) and switches actually have shown a very nice order intake development and we've seen the same trend in some emerging countries like India and China where these businesses were also doing very well so it is encouraging from that part.
So that is the first part a lot of book and bill, and then for the rest we'll see how we can execute on the large projects because some of these are really large and will really extend over time.
Joseph M. Hogan
And Julian I think also, and in fact the analysts in the room to, when we think about orders and your invoicing is a question on how you're going to look on orders next year too and not just revenues. Remember, our first quarter orders last year were impressive and we had about $9.1-$9.2 billion of orders in the first quarter of 2009. That's a really tough mark for us from an order standpoint quarter to quarter and so as you talk about this positive invoicing piece I think you have to look at that quarter as really an anomaly in the sense of the size that it was. And we've averaged every quarter this quarter somewhere between $7-$7.5 billion of orders.
Yeah, and this quarter was especially strong in larger orders. That was a direct (inaudible) with $2.5 billion of large orders so that is really the more challenging. We'll see (inaudible). Operator, next question please.
Next question from Mr. Simon Fuchs, Credit Suisse.
Simon Fuchs - Credit Suisse
Hi, guys. Thanks a lot for taking the question. I just wondered if I could get a little bit more clarity on the factors that are bridging profit into next year. And the cost takeout program, I just wondered how much of that do you think will fall into 2010 profit of the sort of the remaining 1.5 cost savings? And also, in terms of mix, I guess it follows on from that last question of the difference between maybe a greater bias towards some of the later cycle project businesses in the backlog and the faster pick up of the short-cycle businesses. And then are you able to give us a sort of a steer as to how you think the impact of mix will be in 2010 versus '09?
Joseph M. Hogan
Yes, Simon. From a mix standpoint, obviously we've said that our short cycle part of our business we think we've seen a bottoming and actually some increase in parts of those businesses. Those tend to carry pretty good margins, but they're not a huge part of our portfolio so from a mix standpoint it can be positive, but it's not necessarily hugely positive when you look at it in the extent of across the whole portfolio.
So mix is always a — I tease the team, if you want to hide behind something just yell exchange and mix and you can get someone confused, but this is truly a business of a lot of different mix from a geography standpoint and a product standpoint. But it is safe to say that in some of the products we've seen a rebound in the short-cycle side and they tend to carry a little higher margin than some of the other longer-cycle businesses.
Yeah. And adding to that service, for instance, which was more resilient than the product business this year, but for sure we've seen, for instance, pretty weak business development in the spare parts business which is a high-margin business. So if you believe, Simon, that this recovery is there that we will start seeing a little bit more spending, clearly we should see from pickup from there too that could help the mix. As far as your first question is concerned, we have always talked our cost savings is 2010 versus 2008 base so we have $1.5 billion book so far so we will deliver another $1.5 billion in 2010.
Simon Fuchs - Credit Suisse
I mean just following up on that last point, so to get to achieve $1.5 billion given that you still have further work to do now, the actual scope of the program is actually beyond $3 billion?
Joseph M. Hogan
No, our target, Simon, is $3 billion. We're not going to dump anything that's really above that if that's your question. Could momentum take it to a different level? I think we'd talk to you about that in 2011 really. Right now the target's $3 billion in that 2008 to 2010 comparative period.
Simon Fuchs - Credit Suisse
Next question Mr. Andreas Willi of JPMorgan.
Andreas Willi - JPMorgan
Good afternoon, thanks for taking the questions. The first question I have is on the outlook for large orders. You had a very good 2009. If you look into the pipeline, what you see for 2010, to what degree did 2009 benefit from some large orders that slipped into the year due to the problems in the market in the second half of 2008, particularly with power systems? And on power systems as well in terms of the revenue recognition, revenues were a bit weaker in Q4, but you have an excellent backlog. What should we expect for 2010 in terms of conversion of that backlog into revenues?
Joseph M. Hogan
Well, first of all, the conversion of 2010 backlog as we move in we talked about of that $25 billion, think about a 60%-65% conversion rate if that's your question, Andreas. That's what we've historically had and as we analyze that backlog it looks like it won't change this year.
As far as the outlook for large orders in 2010, as you indicated, most of those do surround power systems. That's where we saw predominance of large orders outside of what we took in Algeria in the earlier part of oil and gas on our PA division. And I would say that we still have a very healthy tender backlog in that place. Particularly on the HVDC on the transmission side and also for distribution sub spaces.
There is a competitive environment obviously out there, and so we have to make sure that we pick the right projects to quote on in the sense that we utilize our resources well, because it costs a lot of money to quote on these projects too. But Peter's actually added extra resources this year that allow us to be more — actually, to entertain more projects and to be able to scope those out and so it's hard for us to say, but there are good projects out there in 2010 and we have a number of targets and we'll just have to see as we go quarter to quarter how well we do in converting that tender backlog.
Andreas Willi - JPMorgan
I mean, the question I had on power systems on the conversion of 2010 is just that we've seen kind of revenues trailing off into the end of '09 despite a more or less consistent positive book to bill for the last few years which indicates either kind of some temporary gap in revenue recognition or a push out by customers. So I'm just trying to better understand whether power systems should have positive sales growth, but it didn't have in Q4?
Joseph M. Hogan
Yeah, that's a good question. Remember, these projects we have in place, this isn't about project execution. They're supposed to execute and deliver around certain timeframes and we can't really affect that, and what happened in the fourth quarter we didn't have necessarily that demand pattern that said that we had to close those out in that quarter. And so this isn't about project execution, it's not about customers moving projects out on dates, it's just the way these things fall in place and the way they're executed upon.
Andreas Willi - JPMorgan
Thank you very much.
Next question Mr. Martin Prozesky of Sanford Bernstein.
Martin Prozesky - Sanford Bernstein
Good afternoon, gentlemen. Two questions please; the first one on your base order growth. The organic order growth was I think up to -13% compared to -23% in Q3. How much of that was the comp effect versus last year as well as the short cycle businesses improving versus kind of the midcycle businesses? Could you just give us some more color on that? And the second one, in terms of the realignment of the business units into the new divisions in automation, you've laid out the logic for either shifting the business unit, what else are you doing in terms of changing the way those divisions will operate? Are you changing R&D agendas the way you do in customer segmentation in terms of going to market product development? Just how would you realize the benefit from this realignment?
Joseph M. Hogan
Yeah. I'll start with that while Michel's looking up the base orders piece to give you more specifics on it. First of all, the realignment of the business units is of course we're going to have to realign when you look at R&D in different parts of those business. When we talk about solution sets, common protocol systems, and how things communicate between each other — actually how that's aligned. And so I know Uli and the team is in process of doing that and Tom's in the same look in low voltage.
If you look at when we separated those businesses too, they're very distinct in the sense of the services model. The discrete motion business that we have has much more of a services channel to it, more predictability, more uptime, more spare parts and those kinds of things. The low voltage business is really replacements parts at times.
It's relatively small and a lot of that business is channeled. There we had channel partners and distributors that work through that business much more than discrete automation and so as we separated those businesses we did that because they were so different in the sense of how you go to market and the R&D commitments and those pieces and of course what we'll do is it's not necessarily a rationalization, but it's a realignment of those resources around what makes more sense to drive from a productivity standpoint and an innovation standpoint in those businesses.
And on the base orders?
Yeah. On the base orders not too easy an answer to give there. I think indeed we see there that the pace of decline is clearly slowing down. We were year to date after three quarters something like 23% in base orders, the fourth quarter was 13% down so we see a marked improvement from that part. It's obviously quite influenced by some of the examples I gave before like (inaudible) accessories and breakers and switches that were up about 10% for the quarter so that helps a lot, but we can also have base orders in other divisions like power systems, for instance, or power products, and so you would have to go market by market to do that, but for sure the way we look at it, it is encouraging to see that the pace of decline is slowing down, it requires confirmation, but that seems to confirm what some other companies saw as well at least as this fast rotating business keeps improving.
Martin Prozesky - Sanford Bernstein
Great, thank you very much.
Next question, Mr. Martin Wicke (ph) of Deutsche Bank.
Martin Wicke - Deutsche Bank
Hi, good afternoon. This is Martin Wicke of Deutsche Bank. Just a question on some of the margin benefits you could see going into 2010. You mentioned that cost under absorption will decline in 2010 as the footprint efforts take hold. If you could just outline how much of that under absorption was really focused on the short cycle businesses which obviously declined the fastest and the earliest? And had the bulk of that footprint effort been focused on those areas and therefore we see an early benefit as the short cycle improves, or has that under absorption really been more widely spread across the portfolio? Thanks.
Joseph M. Hogan
Yeah. I'd say first of all it has been spread across the portfolio depending on where you look at it. The demand patterns haven't been the same across the board but when you look at the automation products division in general and that's where I think your question would center upon, I'd say the short cycle part of our business went into this downturn a lot sooner than other ones so we actually saw some under absorption – actually in 2008, you know. And so we absorbed some of that under-absorption in 2008 and then again in 2009.
So if I'm answering your question properly Martin I'd say as you go into 2010 we have reduced some of those footprints, we've reduced employment in those areas. As it comes back our plan is to not add employment back in the developed countries where we've streamlined it well, we'll bring it back up into the low cost countries and that's our strategy. So you will see some hopefully margin leverage in that sense. How big it will be and how soon it will come I can't say, but that's certainly in our plans.
Martin Wilkie - Deutsche Bank
Okay, thank you. Maybe I just have a second question on the tender back log. I don't know if you do give us a chart on the tender back log. Would you say that new tenders coming in to the power systems business is continuing at the same rate that you saw last year, or has there been any change in inquiry levels in terms of large contracts in power systems?
No, it is really continuing at the same trend, and we keep adding people to work on all these trends, I think especially the great systems as we see in fax really a lot of tender that are being worked on now, and so I would say the future from that side really looks promising as well. Obviously you sort of see the backlog coming down that is the result of the high success we have had in the last two quarters in bagging new orders, but there is still a lot of demand in a lot of products out there.
Martin Wilkie - Deutsche Bank
Okay, thank you.
Next question, Mr. Andrew Carter McRae (ph). Please go ahead sir.
Andrew Carter - Macquarie
Good Afternoon, it's Andrew from Macquarie. I had just a question on the transformer side again, which I didn't think of until a minute earlier. A number of comments from the electrical steel suppliers suggests that electrical steel selling prices fell quite substantially very late in 2009. And I wondered what that really meant in the market from your perspective. Does it mean that the market has moved from a supply position to an under supply position one? And do the smaller players that were previously shut down to the market, do they still exist and are they more able now to come back in?
Joseph M. Hogan
You know Andrew, we saw – I mean obviously there's more capacities that have come online transformers in the marketplace over time and so we've seen more competitive pressures there and we did see a significant fall in electrical steel prices in 2009. You know that equated – we didn't count that as part of our cost savings as Michel talked about before, it's more in the commodity end, because most of that just falls through to the back of the customer in that sense so you don't really realize it from a price standpoint, it just moves through.
As far as – you know I think your question is about an enhanced competition here – you know we do – there is more access to electrical steel than there was before because obviously the demand has gone down. You know I wasn't here to talk about if it initiated new competitors or not, but in the competitors that we do have, we have seen capacity expansion and it's available out there. So overall I'd say what you're doing is you're digging around our transformer business because it's a great place to dig around. We've been able to through that portfolio both – and the differences of kinds of products that we make and also the diversity that we have from a geography standpoint balance that business pretty well this year even in a competitive environment.
Our goal is to try to do the same thing next year but we do see a lot of competitive pressure out there. We have significant cost out programs to help address that so that we can remain competitive. Bernhard, any other thoughts? Makes sense? Okay, Andrew?
Next question Mr. Olivier Esnou – Exane
Olivier Esnou - Exane
Yes, good afternoon. I have two questions please. The first relates to the savings. If you look at the $1.5 billion this year – I mean in 2009 and 2010 would you say there is a portion of it that should normally come back as demand picks up which would be – I don't know consulting or marketing relating which is a sort of short term adaptation and that as normally the GDP comes back quickly or you know it's pure fixed cross cat for the long term? Second question, I'd like to come back on 2010 guidance because some competitors with shorter backlog are giving guidance for the sales growth in 2010 and I would like to know why you are somewhat reluctant to do it – is it that there are just more concerns on your side regarding the economy or is there something ABB specific that makes you reluctant to guide on the sales for 2010. Thank you.
Joseph M. Hogan
Yeah, starting with your second question, I'd say – you know we obviously watch our competitors guidance pretty closely and if you do watch it closely it seems to swing all over the place, sometimes in a manner of two week differences of a robust bullish type of an outlook and then kind of retracing their steps over a period of time. What Michel and I try to do is remain as consistent an (inaudible) as we possibly can. And so what we do is – we don't try to pretend to be economists. We look at our order patterns, we try to look at the historical piece, and we try to give you the most accurate representation as we can in the sense of what we see. Remember again that having 20% of our portfolio as a short cycle business, it helps to temper what we say about it is that we said – we feel that it's bottomed out. We've actually seen an increase in some parts of that portfolio but to have you think that's really going to drive an incremental margin increase across the business with that being a small part of our portfolio, we want to make sure we're very cautious in the sense of how we push that through. The other 80% of our business is driven strongly, well largely by CapEx.
And I think we all know that it takes as GDP comes back it takes a while before the CapEx fills in again. And if any part of our portfolio that we see has been hit hard it's been the industrial side. It's been hit extremely hard and it's going to be a while before we think we see the kind of robustness we saw in 2008 and that kind of expansion. So what we try to do is we're not pessimistic and we're not optimistic. We're cautious. And quarter to quarter we're going to try to report to you as cleanly as we can what we see.
We are a later cycle company than most of our competitors are that's for sure. On the first question, you know if you really look at the kind of savings we have here, I think if you talk about G&A it is sustainable. If you talk about OpEx savings which is mainly working at cost of poor quality, that should be sustainable as well and obviously a footprint saving, you know producing in a cheap country versus producing in a high cost country that is how you will stay as well. The only one you could be right is the resourcing savings can always be a challenge if the market shifts and suddenly becomes a suppliers market. Again. Now if that is the case that it's a suppliers market for steel then we will also be able to increase our own prices. So I think the margin that you start shifting from costs (inaudible) margin I think the ability for us to sustain the margin should still stay ahead because of that.
Olivier Esnou - Exane
Okay, thank you.
Next question Gabriel DeBre (ph), Société Générale. Please go ahead.
Gabriel DeBre - Société Générale
Yes hello, thank you for taking my questions. The first one is – actually if I look at the bridge on the chart page 17, there is a 100 bps and negative impact on the margin in 2009 which has not been properly explained. I was just curious to know what the different items within this other line and how this could develop in 2010. Second question related to China. You indicated at the beginning of the call that you expected orders to be still up in the higher voltages even if it could be down in lower voltages, following instead greets (ph) announcement that would cut CapEx by 25%. So does that mean that you still expect UN markets to grow over in China in 2010 and maybe can you give us some color on the breakdown of your power sales in China between high voltages and the lower voltages. Thank you.
Joseph M. Hogan
I think I'm a waterfall, Michel. Do you want to attack the other one while I think about what I'm saying?
Okay, you know the waterfall, obviously you still have the business like (inaudible) as diversified as it is a waste of a special charges that come. So what you have in disorder can be for instance adjustments of one vision, it can be some buy back write-offs that have come or some – one of course that we have on specific project execution so it is all the things that are not really characterized or categorized as a pure prize volume analysis. And that's why we've bundled them all together from that part. But nothing really exceptional, it's just linked to the nature of the business.
Joseph M. Hogan
On China – look China is obviously an extremely important market for ABB and we watch it extremely closely. I think the best way for me to convey China to you is in the chart that we showed that 40% of that business is automation and we saw some substantial expansion in our automation piece that was mainly automation products last year. And then our power business which is about 60% and the state grid is our largest customer over there. But obviously our power products division over there is spread
across a lot of different opportunities.
As we look at next year – you know we have not modified our forecast for China – you know with the recent announcements from our state grids standpoint. It's still quite uncertain in the sense of what our high voltage demand is going to be. We have several projects in our tender backlog that we're going to be quoting on that we'll see – you know when that actually comes due by quarter. But look, China is a very dynamic environment, it is extremely competitive, there is domestic competitors there and international competitors and it's difficult for us to say exactly how it will pan out.
But all I can do is convey confidence in the sense of our structure in China, our technology in China, our customer relationships we've had in place over the number of years and as we've showed in 2009, we've shown that we can be extremely competitive in that sense. And so we are again cautiously optimistic about China but we will have to see quarter by quarter exactly what those demand patterns look like. \
Gabriel DeBre - Société Générale
Okay, thank you.
So we are looking at hard stop for four o'clock today, I suggest we take the last question for today's conference call and conference here, and given that we still have a couple of people on the line I think that we take the last questions from the phone.
The last question for today is from Mr. Timothy Roger with Goldman Sachs. Please go ahead sir.
Timothy Roger – Goldman Sachs
Good afternoon, it's Tim here from Goldman Sachs. Just two quick questions please. Firstly, in relation to your sales in China, would you be able to break out what share of them are in the middle market where you're competing with local players versus those in the high end. And then secondly in relation to your solutions strategy in discrete automation. Could you just elaborate on that – how do you share the economics of improved productivity and energy savings with your customers? How does that translate – does it come through in terms of better pricing on components, or is it part of the overall contract price when you agree something with them?
Joseph M. Hogan
First of all, in the middle market side of China. You know I don't have those figures at the tip of my hand and – I don't think we share those with people in general, but it's a small section right now but it goes across each one of our divisions, whether you're in low voltage or you're in discrete or you're in power products, if you're in robotics. You know, we all have strategies and each one of those middle market segments we know that we have to compete against and we've invested in those over the last several years.
Great question on the discrete automation in motion. You know you're really asking how do we obtain value from the solutions sets. And I can tell you that the natural reflex of ABB is to get the pricing through better componentry. But increasingly we know that we have to become a partner in that sense and to be able to move in and to maybe share some of that savings and to help guarantee those savings for customers. As we develop these solution sets we obviously have different value propositions we'll put together for customers that could be enhanced you know from a product standpoint or also enhanced from a solutions standpoint and we'll remain flexible in that sense depending on how customers want to handle it.
Timothy Roger – Goldman Sachs
Joseph M. Hogan
Again, first of all thank you for coming and thanks for your support. Again we thought you know 2009 is team executed well and we're proud of that. We take nothing for granted and hope you can tell from our comments that we're optimistic about the future, we have confidence about the future but we are going to take 2010 in the sense of being cautious and work very hard on the operations side through this cost out effort but also continue to invest in growth. So with that we would like to thank you and we'll call an adjournment to the meeting. Thank you.
Thank you very much for those who actually came here to the world trade center in Zurich and the rest of the EC and Joe and Michel will stick around for a few more minutes. We have an employee briefing later in the afternoon so they don't have all the time in the world but they are still around and you can also get your well deserved beer outside or (inaudible).
Thank you ladies and gentlemen. This does conclude today's call. You may now disconnect your line.
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