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ABB (NYSE:ABB)

Analyst Conference Call

January 22, 2014 1:30 am ET

Executives

Ulrich Spiesshofer - Chief Executive Officer

Eric Elzvik - Chief Financial Officer and Executive Vice President

Analysts

Andreas P. Willi - JP Morgan Chase & Co, Research Division

Ben Uglow - Morgan Stanley, Research Division

Mark Troman - BofA Merrill Lynch, Research Division

Andreas Brock - Nordea Markets, Research Division

Operator

Ladies and gentlemen, good morning. Welcome to the ABB Media, Analysts and Investors Conference Call. I'm Stephanie, the Chorus Call operator.

At this time, it's my pleasure to hand over to Mr. Ulrich Spiesshofer, CEO of ABB; and Mr. Eric Elzvik, CFO of ABB. Please go ahead, gentlemen.

Ulrich Spiesshofer

Thank you, Stephanie. Good morning, ladies and gentlemen, and thank you for joining the call. With me is our CFO, Eric Elzvik.

We expect you have seen this morning's press release. We are disappointed we have to come to you with such news. But I committed at my start as new CEO to be as open and transparent as possible, and today's press conference is demonstrating that we live as promised. While 4 out of 5 divisions performed in line with our expectations in the fourth quarter, our results were adversely impacted mainly by charges and some operational issues in the Power Systems division.

The main part of the charges are for the cost of delays to offshore wind projects, following severe winter storms in the North Sea throughout the fall and in December. You may remember that winds of more than 220 kilometers an hour were recorded as Storm Xaver swept across the North Sea. A storm like this slows down installation processes and operations, which has costly knock-on impacts and delays on related activities and project time schedules. This reflects, once again, that offshore wind power is a relatively young business with new technology and business solutions that require us and our partners to manage new risks. These storm-related charges and some other operational issues mean that our original guidance for PS operational EBITDA margin in Q4 2013 is no longer achievable.

Since we announced the strategic realignment in late 2012, the team has made progress in regard to improving project execution and operations in the PS division, but we need to invest more time in the realignment to complete this process. Additional restructuring-related charges were taken in response to the division's soft order intake in 2013. As you remember, one important element of the reset is to be more selective about new orders, which means that we aim at booking new projects at more attractive commercial conditions. Our newer offshore wind project now better reflects what we have learned since we started in this business.

At the same time, we are addressing some operational issues in the division unrelated to offshore wind power with a high sense of urgency. Claudio Facchin, the new head of PS, and his team are taking a fresh look at the business and its operations. We will present an update on the business, its direction and key actions when we announce the fourth quarter and full year results in mid-February. I'm very confident that with Claudio we have the right leader to bring PS back to profitable growth. Claudio has successfully led a profitable global systems business in PS that draws from a deep understanding of the global market needs.

While we are facing these serious issues in some parts of the PS portfolio, we have many businesses within PS that are performing well. And I would like to say that PS overall has great potential given today's energy challenges. We are a technology and market leader in most of our PS businesses. This is a business we like, and we're going to be in it with the right approach and scope, serving our customers in a reliable and competitive way. The actions we are taking to address the defects in some parts of the PS portfolio are very well defined. I'm confident that we will bring this business back to meet our ambitious expectations.

The charges we are taking for legacy group issues are primarily related to historic legal issues, losses on some small divestitures and discontinued operations. If I look at the overall ABB portfolio, we are satisfied with the performance of 4 out of the 5 divisions in these uncertain times. We are pleased about our strong free cash flow outside of PS, which leads to an overall expectation for ABB's free cash flow, in line with 2012, for the full year 2013. This reflects the health of most of our businesses and a strong focus on cash we announced when I took charge in September last year.

Earnings per share was impacted by the PS operational results, as well as some nonoperational items. Fourth quarter earnings per share is expected to be approximately $0.23.

Let me summarize. ABB is a strong company that performed well in the majority of its portfolio in 2013. Under new management, the PS division will now work relentlessly to finalize the improvement journey. And we will give you regular updates on where we stand next at the annual results presentation on February 13.

At this point, I would like to open the line for questions, but also remind you that all the figures are preliminary, and I'm not able to provide any further information on the full year results. Many thanks for your attention.

Question-and-Answer Session

Operator

The first question is from Mr. Charlie Ferenbach [ph] of AWB [ph] .

Unknown Attendee

You mentioned EBITDA cost of CHF 260 million (sic) [$260 million] which is storm-related stuff and $50 million on, I think, as I understood it, on net level for nonoperating restructuring costs. You may -- could you give us the total figure on EBITDA level and for -- on net level? The second question is, if you may, give us more color on how much this other group legacy issues -- the additional costs you mentioned, but you didn't mention the figure, how much this is. So we have a total of cost on the EBITDA level or on net level. And if you may, could you give us -- tell us something about the weak order impact you mentioned in Power Systems during 2013. How does the latest trend compare, Q3 to Q4?

Ulrich Spiesshofer

Thank you, Charlie, for your questions. I have to check questions #1 and 2. I will have Eric starting to answer. I'd take the order intake question first. On the orders, we still see uncertainty in the markets on the PS side, and that is driven by uncertainty around regulatory environment, some project decision-making delays that we have, so the fourth quarter traded in line with the first 3 months of the year. With that said, I hand over to Eric, who is here with me, to give you a little bit more light on the questions 1 and 2. And I might come in later on those.

Eric Elzvik

Charlie, so as you have seen in the press release, on the operational EBITDA level, we have $260 million from the Power side and the other divisions are broadly in line with our expectation. Below the line -- below operational EBITDA, we have $50 million approximately for additional restructuring in Power Systems. And then we have, as we have spelled out, legacy issues which contain some legal issues, discontinued operations and the effects of divestitures. We'll not go, on this call, into the details. That will come when we release the results. But what we are saying is that the net income, the sum of all, will be approximately $525 million.

Unknown Attendee

$520 million [ph]?

Eric Elzvik

5-2-5 for the quarter.

Operator

The next question is from Mr. Holger Alich, from Handelsblatt.

Holger Alich

I would just like to know a little bit more about this nonoperating things that you have charged for legacy issues on the group. And if you could be a little bit more precise on restructuring costs, what is behind that?

Ulrich Spiesshofer

Look, Eric will start, and then I'm coming in.

Eric Elzvik

Yes. So the nonoperational charges below the line is in the categories of all discontinued operations, all businesses that we stopped a long time ago. We had to take some additional charges for old issues.

Holger Alich

Could you give an example, perhaps? To put it more concrete, what is -- what did you discontinue? What is still causing problems or costs?

Eric Elzvik

Yes. The -- actually, as you know, over the period of some 10 years ago, lots of businesses, including power generation, and there, we have some exposures that we have been managing, and we have taken some small additional charges on that.

Unknown Analyst

Sorry, what was it?

Eric Elzvik

We have -- as you know, we exited a lot of businesses some 10, 15 years ago in different areas, in power generation and in other areas. And for those, there are some discontinued operations exposures that we still have. We are managing those and we have to take some additional charges. But these are all relatively small buckets that sum up to a certain number. And then we have legal issues and then we have -- on divestitures. We are divesting. We are cleaning the portfolio, and we have made a few small divestitures. Some of those have also caused negative impact below the line.

Ulrich Spiesshofer

Look, let me just to give you a little bit of a flavor here. I'll use 1 example. ABB, for historic reasons, had an airport in South Africa in the portfolio. We tried, over many years, to divest it. We were successful divesting that this year, and with this divestiture, we had to take a charge. I'm really glad that we have a better portfolio now because we are not an airport operator. It was a small thing. But this is the kind of things you have and you need to get them out and have a clearer and cleanly focused portfolio.

Holger Alich

Okay. But from this -- just to put the things right. The $260 million charge, operational charge in Q4, the part of that -- I don't know, for me, it's 80% or something came from the storm problems in Power division and the offshore wind parks.

Ulrich Spiesshofer

[indiscernible] about 3 -- that's correct. About 3/4 of the charges in the fourth quarter come from the storm-related and wind -- weather-related issues.

Operator

The next question is from Mr. Patrick Winters from Bloomberg.

Patrick Winters

My first question relates to the storm charges, and I'm just wondering if there's any way which you guys can reduce the risk of that. Or is that just a risk which you have to get used to when you're in the offshore wind business? And a second question relates to the restructuring in response to the -- restructuring-related charges in response to the Power Systems' soft order intake in 2013. Can you just elaborate a little bit on what measures you've taken there?

Ulrich Spiesshofer

Okay. Patrick, let me take the storm charges. Look, if you build offshore operations 30, 40 kilometers out in North Sea, this is a challenging technological task. We are becoming more and more mature in doing this. We are standardizing processes. We learned what to do there. So we are continuously de-risking the business, and we are on a path to get this really, really well under control. Then you have a quarter like the last quarter last year. We had, as we announced earlier, much earlier, some delays on the project. And that means you have an operating pattern that you have to finalize and work on installations in very adverse weather conditions. Now these adverse weather conditions are something that we, unfortunately, can't change. We can work on the timing of the projects, and we are doing this. We have -- we are going through a full review of the entire backlog, including all the time schedules to make sure we optimize this as good as we can. In terms of the processes in the platform, we do whatever we can to really speed up installation processes and through standardization, through prefabrication, make sure that we need to spend as little time as possible outside. But when a storm comes at 220 kilometers an hour, that's a severe hurricane. It is our responsibility to get the teams off the platform, move them onshore and wait until we have safe operating conditions because the one thing is very, very clear. I'd rather take a charge than risking lives in unsafe conditions as the CEO of this group. So in -- as this business becomes more mature, we are also looking to develop, together with financial partners, insurance solutions to get the risk shared. And this is something that we are working on and with the increasing maturity of offshore operations. I'm very confident that these risks will be better managed and less in the future. So that's the storm-related piece, and I have Eric now taking -- or answering on restructuring.

Eric Elzvik

So we have taken, as I said, $50 million additional restructuring charges for the Power Systems business, and that is in response to the soft order intake. You are seeing until Q3 that we are quite much down in the order intake in Power Systems partly because of the realignment projects, where we have decided to take business on a short-term level when it comes to commercial conditions. And the other part is the soft market. So the combination of those 2 have led us to the conclusion of the -- to be proactive and take some needed capacity adjustments to be on the right course for the future.

Ulrich Spiesshofer

Okay, Patrick, I will complement what Eric said here. The operating model in our systems business there, you have a lot of engineering, a lot of partner hours in there also, that you have quite a bit of a flexible cost base that you can work on. So not, the total deviation on orders will hit directly in the restructuring of fixed costs. We are acting here very responsibly, and we try to keep that flexibility in the business model in the future to make sure that when we have market volatility, we can address it with the right kind of operating pattern on the capacity side.

Patrick Winters

So the capacity adjustments, does that mean that some guys in your factory are just working fewer hours? Or have you had to layoff some people or close down some factories?

Ulrich Spiesshofer

Look, Patrick, if you look at the total capacity in the system business, you have contracted hours, and there, you just contract less. We have flexible work hour models in that business, which we're also using. And in some selected cases, we might also have to cut the workforce, but this is the exception. The rule is we use our flexibility in the capacity.

Patrick Winters

Okay. And the Power Systems long-term targets, do those still stand or are you reevaluating those based on those -- on these charges?

Ulrich Spiesshofer

Patrick, as I said in the call earlier in my little speech, we will update you on the targets for all of the divisions, including Power Systems, in the annual press conference. Today, we want to focus on the fourth quarter impacts.

Operator

The next question is from Mr. Yin Zhang [ph] from Reuters.

Unknown Attendee

Two questions, one particularly some details for the historical legal charges you've taken. What's that? Could you maybe quantify how many jobs are you going to cut?

Ulrich Spiesshofer

Look, let me take the second question first, and Eric will comment on legal charges. No, we will not quantify how many jobs we're going to cut because we basically are working on the flexible operating model that we said already. We have announced, in some countries, some limited restructuring that we're working on in western Europe. And going forward, it's our responsibility to make sure that we have a capacity in line that help us to serve the orders at the quality that we wanted. And we also need to make sure that we are not overdoing this capacity, so that site balance will be managed. We are applying, really, on-site this backlog development and the order intake development. With that said, I hand over to Eric to talk about the legal charges for a moment.

Eric Elzvik

Yes. So the legal charges are aspects of provisioning on some of our old historic legal issues. For confidentiality reasons vis-à-vis our counterparts, I will not go in detail what is there. But as a big group, we obviously have legal provisions for various legal cases that were going on, and we had to make certain adjustments to those provisions.

Operator

The next question is from Mr. Andreas Willi from JPMorgan.

Andreas P. Willi - JP Morgan Chase & Co, Research Division

I wanted to clarify something on the total you mentioned, just to understand. Why is it you said that, in total, it's $525 million negative net income effect? If that's so, the underlying result [indiscernible]

Ulrich Spiesshofer

No. It's very important. Thank you for asking that question so we are 100% clear. The expected net income for Q4 is $525 million. It is not a deviation.

Andreas P. Willi - JP Morgan Chase & Co, Research Division

Okay. Yes, that makes a lot of sense. And second, on your comment, the other divisions are in line with your expectations. If you could just indicate whether your expectations are also similar to market expectations based on consensus you have seen?

Ulrich Spiesshofer

Look, Andreas, we are broadly in line.

Operator

The next question is from Mr. Ben Uglow from Morgan Stanley.

Ben Uglow - Morgan Stanley, Research Division

I had a few. First of all, just on the $260 million of charges, can you just remind me, because I've forgotten, how many offshore wind projects are actually -- are you actively working on at the moment? And is this just the -- one that's been going for a while, I think, is for TenneT. Is this mainly around 1 project? Or is it a charge relating to the whole portfolio? So that was question #1. Question #2 is, didn't you cover any of this in terms of writing down the value of these projects or the potential costs in the fourth quarter of 2012? I.e., is this simply just cost overruns on the existing project work? Thirdly, and this may sound like a dumb question, but why is it that on these projects, the contractor, be it ABB or Siemens, whatever, is actually bearing all of the contract risk. In terms of a technologically complex project, which, as you say, is absolutely new, was there no discussion at the beginning with TenneT or any TSO as to sharing some portion of the unusual risk of the contract? And then finally, final question is -- and I appreciate you may not be able to say too much ahead of EBITDA, but the EBITDA margin of 9% [ph] or thereabout that you are hoping to get, do we now think that, structurally, long term, that target could be at risk? Or is this really a genuine one-off?

Ulrich Spiesshofer

Thank you for your question. I think all of your questions are good ones. We have, at the moment, 3 large ones under operation. We have some small ones, but we have 3 large ones. And unfortunately, the storms in the fourth quarter impacted all of these projects. As you can imagine, when you looked at it, the Germans called it Xaver, the Scottish people called it differently, so this is something that's really been in the entire portfolio. The second point is, didn't you cover in the fourth quarter -- yes, we covered in the fourth quarter at that time what we saw there in the fourth quarter of 2012. We couldn't predict the storms that are coming in the fourth quarter of 2013. So this is something when you run a large systems project business in offshore that is coming. And if you have some slippages on the broad project execution, then you get into that at better time of the year, and it's something that we have to avoid in the future. We are working very strongly with the team to have more predictability and reliability in the timeliness of the project. And I'm really confident that this will improve over time. The third point around the technological risk sharing, look, what we show you today in terms of the charges are net charges, so all partners take their share of the hit, and we are working very, very closely with them. In a new operation, or on a new business segment, like offshore, it is very important that you spend a lot of time aligning interest between the wind turbine builders, between the TSOs, between ABB. I can tell you, on Monday, I spent a couple of hours with one of the major wind turbine players, and they had expected a topic that you just mentioned, we had it on the agenda: How can we get even further in working together? So I would say we have good collaboration with the customers there. Essentially, nobody is happy when the storms hit you, and nobody is happy when a project is delayed. But the risk management is one that more and more of the partners are working together in a really good way. And related to your last question on the target, look, I will repeat what I've said before. We will comment on the targets at the annual results in February, so I look forward to answering your questions on that one there.

Ben Uglow - Morgan Stanley, Research Division

Okay, understood. I just have 1 brief follow-up. I mean, just preconceptions, just so I understand it. You accommodated in these charges cost overrun, but the impression I'm getting or the message is that you've not significantly written down the gross margin on this project as 0, such that any profit from here comes straight through, that there is still an element, a significant element of profits baked into the projects. Is that correct?

Ulrich Spiesshofer

Look, what we have done now is we have taken what we see in terms of an impact, and that's the responsibility of management to really make sure we communicated in the proper way. And now we need to continue operating and executing these projects. And by executing the project, hopefully, we also get the right commercial impact on our organization in a positive way.

Operator

Next question is from Mr. Mark Troman, Bank of America Merrill Lynch.

Mark Troman - BofA Merrill Lynch, Research Division

I've just 1 question. I guess, partly addressed before, but to what extent -- or do you think that the issue was isolated in Q4? And as far -- to your best knowledge, these are the charges and provisions and measures that you need to take and that we don't get any kind of repeat of these issues as we go into 2014. So to what extent can we say there is a bit of a line drawn under these issues in terms of what you've announced this morning?

Ulrich Spiesshofer

Mark, I think, we said about 3/4 of the charge is related to the adverse weather conditions. Now we are working very hard from our side to get the projects scheduled in a way that they get less into that time of the year. And [indiscernible] that much. So I'm confident that we, at the moment, have taken the right measures to avoid that magnitude. And hopefully, the storms don't hit us that much. That's force majeure, that's weather conditions, that unfortunately, we can't influence, but we can influence how the pattern of the project looks like.

Mark Troman - BofA Merrill Lynch, Research Division

And the -- I think, again, someone asked a little bit earlier, but the extra $50 million of restructuring. Is that something that you have in mind that you wanted to implement once you've done -- I guess, I mean, you've done more review of the business as the CEO? Or is that in response to new issues that arose in Q4?

Ulrich Spiesshofer

Look, when you took -- takeover a business, it is only -- not only me, it's also Claudio that came in as the new leader, we looked at the operating pattern, we looked at the backlog, we looked at order intake situation and the capacity and then trying to lay them together. We felt it is our responsibility to take the right kind of capacity adjustment measures. We are taking them, and the restructuring-related costs to that is $50 million.

Operator

;

Next question from Andreas Brock, Nordea.

Andreas Brock - Nordea Markets, Research Division

A question here. First of all, USD 260 million feels like a lot of money for a big storm. Could you just break that down into like 2 or 3 main charges, components so that we understand more how they come, like $50 million was for production or $50 million is for safety, something like that? Two, are you sure you don't want to comment the Q4 earnings. Because when -- if I use $525 million, and I work backwards, that should be a pretax income of about $720 million. I think consensus -- we were below consensus, but consensus was still at 1.2 -- over $1.2 billion. So even if I scrape out $300 million from there, pretax income would still be, in consensus, well over $900 million, and looking at PBT of just above $700 million. And it's a massive gap and the shares are going to have -- take a massive hit this morning. So I'm just wondering. Could you please just give us some more comments on the Q4?

Ulrich Spiesshofer

Okay. Look, thank you for your question, Andreas. On the first one, yes, look, if you look at the storm and why is it $260 million, if you look at ADR at the moment, with our platform, we have basically what we call the offshore phase, where you take the installation and you move out to the North Sea. You move the platform out, you get it on the foundation, you get it operational. And there you have very, very tight deadlines, extremely rigorous because this is the most sensitive part of the whole project. Then you have delays in contractually committed schedules. They had quite significant knock-on effects, and these knock-on effect has very high cost impact. The good news is we had no equipment damage, but there are major disruptions in the execution of the projects aggravated by extremely harsh and unprecedented weather. So for example, we had to evacuate one of the platforms multiple times with helicopters to get the people really safe onshore, and that's what we decided to do. I think it was the right thing to do. Unfortunately, the most sensitive phase of the project and the most severe storms came together across a couple of platforms that we are installing. So this is the hit that we had to take. So that's the answer to the storm piece. I'll ask Eric to talk a little bit more, give you more flavor on the Q4 numbers.

Eric Elzvik

Yes. So for the net income, the $525 million is for the quarter, and that's an EPS of $0.23 for the quarter. So that is clearly below the consensus. The latest available consensus we have on our own website is from November, but that's in an update process today. So at the end of the day [ph], we will see where the new consensus comes through. But the $525 million is the number that we will disclose today.

Operator

Next question from Mr. Neil Mike Lucas [ph] from Wall Street Journal.

Unknown Attendee

Sorry, I joined this call slightly late, so I just need to check just who is actually responding to the questions. Eric, the CFO, is it?

Ulrich Spiesshofer

Yes. You have the CFO, Eric Elzvik; and the CEO, Ulrich Spiesshofer.

Unknown Attendee

Okay. I'm just wondering, you say that your EPS is expected to be approximately USD 0.23 for the fourth quarter. Is that -- how does that compare with your target? Did you have a target for the fourth quarter?

Eric Elzvik

No, we have no formal guidance on EPS.

Unknown Attendee

All right. And you mentioned that you are considering job cuts in western Europe. Is this in the Power Systems business?

Ulrich Spiesshofer

Neil, what we are talking this morning about is an operational situation in Power Systems that was impacted by severe storms in the fourth quarter and the low order intake throughout the year. We feel it is our responsibility to address this in the right way, and the restructuring that we have announced is in Power Systems and western Europe.

Unknown Attendee

So you are considering job cuts in western Europe in the Power Systems?

Ulrich Spiesshofer

Yes, we have already announced some of them in some selected countries.

Unknown Attendee

Okay. And when were these announced?

Ulrich Spiesshofer

They're already -- some of them have already been announced.

Unknown Attendee

Okay. And which countries are these?

Ulrich Spiesshofer

A selection of countries in western Europe.

Operator

That was the last question.

Ulrich Spiesshofer

So ladies and gentlemen, thank you very much for being with us this morning. I look forward to see you all when we announce our annual results.

Operator

Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.

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