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Executives

Hans Ola Meyer - CFO

Ronnie Leten - President & CEO

Analysts

James Moore - Redburn Partner

Nico Dil - JPMorgan

Mats Liss - Swedbank

Tim Rothery - Goldman Sachs

Ben Maslen - Merrill Lynch

Ola Kinnander - Bloomberg News

Roddy Bridge - Société Générale

Atlas Copco Ab (OTCPK:ATLKY) Q2 2010 Earnings Conference Call July 16, 2010 8:30 AM ET

Operator

Hello and welcome everyone. I have the honor to produce Q2 presentation from Atlas Copco and I will hand over directly to the moderator for today, the CFO, Hans Ola Meyer.

Hans Ola Meyer

And very welcome also from me to everybody and also to everyone that is participating on the telephone conference. Of course, before everybody starts to wonder too much, I can say if you see me doing funny faces or if I move even slower than usual, its because I had a little bit of a bicycle accident a few days ago. But we’ll try to manage anyway. So now we have settled those questions so we don’t need anything on that on the Q&A. So hopefully we’ll get Q&As focusing on the results and so on and so forth.

We will do this in the normal format. I will hand over to Ronnie, has a few slides that he would like to comment on the second quarter and then we will hopefully rather quick Q&A so that everybody can go back to their summer vacations and whatever you are up to.

So, with that very good, I’ll hand over to Ronnie and we’ll take Q&A later on.

Ronnie Leten

Okay, thank you Hans Ola and good afternoon all of you here and good morning of those who are dialing in from the other side of the world. As usually I will go through the presentation and refer to the slides when I move on so that we are talking about the same slide.

Now let’s go immediately to the business highlights. As you have already seen in the press release we have put out, I think is a very strong order growth and we saw that they in all business areas and we saw that almost in all customer segments and in all regions. So it’s an easiest statement to make on that one.

We had record orders received in Asia. We got fantastic order received in South America as well as in Australia. And one thing I would like to say here when you see the third point is a very strong performance in aftermarket.

I think our investments what we have done since years already is really now proven also to yield very good development. It has been so good even that we do not have a mix difference between quarter one compared to quarter two, although you see that the equipment has been growing rapidly.

Record operating margin, if we compare comparable businesses coming from of course very good volume, solid pricing, our efficiency measures, our innovation which we have done over the last 18 months, something, I think is also yielding good result, and of course we should not forget the currency. I think one thing we should make is if we make a comparison sequentially with quarter one to quarter two, it more or less had 1% coming from revaluation of the receivables. And then this was my biggest surprise, I think a very strong operating cash flow.

We then take slide number 4. The figures, they speak for themselves. Operating margins SEK 3.5 billion almost compared to last year. It is 69% up. The earnings per share, more than SEK 2 billion, which is a very solid development and the operating cash flow SEK 2.8 billion.

If I go then to slide number 6, giving you an overview of the different continents, you see its very nice to make a presentation like this when you’ll have double digit, high double digit figures and maybe one could say and I will comment later on when I talk about Australia, we see only plus 15, but I will make my remark later on that one. But anyhow, a very solid development plus 35% in the last three months and in the year if we exclude cancellations almost to 30%.

If I then go to the different continents and we take the Americans and more specific, North America, a very strong development compared to of course to last year when we should also not forget that last year quarter two was a softer quarter, but we see a good development from equipment and also a solid development from the aftermarket.

Now one particular remark here is the demand on industrial equipment, this is really developing well, you see that specially on the Industrial Technique side as well on the compressor side. When we look to the figures plus 56, it is a bit inflated by the Quincy acquisition, which is a bit more than 10%, so if we exclude that it would be come to plus 45.

On Quincy maybe another remark on that, I think it goes very well. The integration is up today according to plan. I think also our distributors from Quincy are on Board and we only have our nose in the direction of growth.

Let me take then South America, all countries are doing extremely well. Of course we always talked about Brazil and Chile but I can say also Argentina and Colombia are doing very well and you see it also in the figures.

Then I go to slide number 8, Europe and Africa. Europe is maybe if we compare with quarter one is maybe the biggest change. We see a bit of a mixed view in Europe where the Nordic as it says here, Eastern Europe and Russia are developing solidly where Southern European and I think it is no surprise for anyone of you, is weak and that’s also what we see. But anyhow, compared to last year, plus 28. Of course it comes if you have countries like Russia, they were really down because they come up now at a reasonable level.

Then talk about Africa. The Northern parts of Central Africa, so that is mainly mining driven, where South Africa is flat, Middle East solid at a good level.

And then going to Asia and Australia, I’m on slide number nine. Like I said already, record in Asia, very strong China and India. It was very strong, the last months in China. But also what is good to see that we have a positive development in Japan. I think we see again, good development in Japan and South Korea, but that was already in quarter one that we saw an upturn. Also the same remark as I made generally, a very good development in the aftermarket, that incurred investments, which we started to do in Asia for years, is also paying back. And that’s always good to see, because we know where our resilience is coming from. And we have a high activity in the manufacturing industry, and I think that’s also no surprise, for anyone of you.

And then Australia, like I said plus 15, but we also should not forget that Australia was quick out of the drop, because that came a bit earlier, but they have a very favorable development, overall, but more specific in the mining segment, that is going extremely well.

That was about the confidence, if we take then the quarter and you’ll see here, it’s not more to say that, you see the big swing. Maybe after [Mittal] though I didn’t believe in that we had a v-shaped recovery, I think. I cannot deny that we have it here although I tried to talk you all out of it when you ask me a couple of months or even a couple of quarters back in that regard.

Then sales bridge, nothing more, only that you see the difference between receipt and revenue, it’s almost $2 billion, our book-to-bill is 1.1. We feel a bit stress in the supply chain, but I don’t think that will be such a big problem forward to continue to get good revenue figures.

Maybe here on price, you can see plus one I think we also see that we are able to get good price management, positive price management into the market. Currency minus three, that is mainly coming from this end.

Then, let us talk about different business areas, not much to say on slide number 13; I think the role of course is developing in the right direction as we keep working capital under control.

If you then take Compressor Technique plus 28% on organic is a fantastic result coming in very good development in standard machines, stationary as well as portables, that’s good to see we see that rental companies in certain continents are really ordering. Very strong China and other emerging markets and we’ve seen a good development in North America and in some markets. In Europe, I think I have seen a good development there. Very strong development on aftermarket, I think they have performed very well. I think the structural changes we did a couple of years back I think is really yielding very good result and also in the emerging market is coming well and the profit 23.2 coming from a good price innovation on these products, the volume, but one should not forget that the euro also has helped, euro, dollar. So we got here a bit more help from the revaluation of the balance sheet as we got in the other business areas. And we keep on further developing over channels with the acquisition here.

Then I go to slide number 16, construction and mining plus 40 organic. So it is always nice to see that, of course we know we compare with a lower quarter in 2009, but anyhow I think it is strong on equipment side as well on after market, I think here also we could say that we have done fantastic on the aftermarket as also on the consumable side.

We continue to see a favorable demand in the mining industry, so that is developing well. Operating margin, 18 fantastic to see that if we can recuperate so quickly. At here, you see there is not so much currency, but there's definitely good volume mix. And I think also the new products, the efficiency measures, we have been taking over the last years.

And then we have a good fantastic launch of new products in Bauma in Germany, so the big exhibition and of course there again is the continuous development of new products we could have, we were able to show here what we have done during the most tough crisis we had in many years and our commitment to new products.

Nothing to say on 17, I think it shows very clear, then (inaudible) plus 40 improvement in all customer segments we go on and we see a very solid recoup in North America and in Asia, I think India and China are doing very well and we see some improvements in Europe and we all know that Europe is a very important for this business area.

And it's good also to see that the MVI industry is investing again and upgrading existing lines or new lines and operating margin, 18.8. I remember last year when I had to make an announcement of loss, you see the big change here. I think the guys in the organization have done a fantastic work to make it a real profitable business again. Of course, volume helps but I think they also have worked hard on the cost savings and we keep investing in this business for those ones who have doubt on that. I think we also strengthened our channel here in United States.

If you look to this slide 19, you’ll see really here the recoup very quickly when we get a good volume and we have taken a couple of measures, it is a very nice business to be in. Then I’m going to slide number 20, what is it now? 21. Yes, the result I think I have nothing more to say that, yes, I think it is a fantastic profit 20.1 and a very strong profit.

We all can see that. I think also basic earnings per share but I think I repeat myself now. Then the profit bridge and I’m sure you will get more questions on that but then I’d hand over later to Hans Ola because he will tell you all the secrets about this bridge, but mainly you can say that the volume and of course the measures we have taken is, you see that in this result, but a lot comes from the price volume on that one. And of course the mix is favorable.

Then, I will skip slide 23 which shows you the different business areas. We can take that later. Then balance sheet, not more to say that you see the cash, but of course we pay dividend and we also paid back one loan of SEK 2 billion, I think the working capital you would see that in the balance sheet capital structure not much is changing.

Loans, I'm now on slide 26, and I think also that there you see one loan is disappeared as we paid it back. Here we come to the cash flow, of course cash flow a very strong absolute figure in profit, of course that helps and then you see also the changing working capital and the increase in rental equipment which is still very modest compared to the growth. But maybe I repeat myself as I settled to last time, maybe this is the last time we come with such a high figure, but you never know how we go to surprise all. But 2.8 from operation is a very solid figure, it’s even higher when you look to 2009 the same quarter.

So then, the outlook, always difficult to make that to see what is next, but when I listen to the market and see to our people, I think we see an overall demand to increase somewhat in the area. We see still a good favorable development in the emerging markets and that for all the business areas. And I think the investments in North America, I believe, they will increase gradually and we will see what happens in Europe with all the matches I've taken on that one.

So, that me, Hans Ola, so…

Hans Ola Meyer

Thank you, Ronnie. We will then move swiftly over to the Q&A session. And before we take the first questions here in Stockholm, perhaps I can ask the operator to repeat the process for the questions on the telephone line.

Question-and-Answer Session

Operator

Thank you ladies and gentlemen. (Operator Instructions).

Hans Ola Meyer

And we will alternate between the Stockholm crowd here and the telephone as usual. If I have the first question here in Stockholm, anyone that volunteers, otherwise we might start. Yes, we have one question here.

Unidentified Analyst

First a question to you Hans Ola and even or to Ronnie of course, on the gearing given the cash flow and development we have, your gearing now if you look at EBITDA, I think is about eight times, right, or 40% on debt/equity, what do you consider over a longer period of time a decent gearing, and how much could you take that up in a shorter timeframe if you would find something very interesting to buy? That’s my first question.

Hans Ola Meyer

Well, I think we have touched this issue before, and I think we can say that the slide that Ronnie showed on net debt to EBITDA, showing a very steady de-leveraging as you point out, comes from a ratio in 2007 of close to 2 and that was just after a major capital restructuring we did at that time.

In talking about the future I think you can say that the readiness to lever the balance sheet with an acquisition or as a result of an acquisition should be seen in that perspective. So I don't think that anyone in the Board has any problem with seeing that there is a capacity to use the strength of the balance sheet. If it goes all the way up to that or somewhere close to that. But whatever number you use, you will come to by just making the numbers that there is ample room for harboring an acquisition or a couple of acquisitions. So any more guidance than that we're not prepared to give at this point in time but that is important to remember. The ambition for the group is always to take all the opportunities for the growth and is important for us to have from a financial side never any doubt that that can be catered for.

Second after that comes of course any other growth project organic. And third, we have shown in the past and it might well be also in the future that on top of that we have room to make certain further adjustments to the capital, but we will come back to that as that appears, so to speak.

Unidentified Analyst

My second question is regarding mining. Ronnie, you highlighted that mining demand's been strong all over the world, have the company sensed any hesitation among customers when it comes to fluctuating commercial prices but also tax issues in Australia and stuff like that, that maybe put some limiting factors to product orders as you saw in the quarter, anything like that?

Ronnie Leten

What we hear, I think its still that it goes solid. I think when it comes to the commodity prices I think also I think most companies in that industry have learned that the long term demand will be strong and I think that they have to continue to keep investing, and that's also when we talk to the leaders of that companies, I think that's what we really get and that's the input we get. I think they look around. Of course, if you have the big drop, but I think the drops are not so tremendous. So I think that trend is still positive.

On the tax one, even on Australia if you hear me talking, it will maybe a bit doubts, but I think that will go on. I think we don't feel it and don't hear that in the market that will hold back

Unidentified Analyst

Hello Andrew (inaudible), I just had two questions regarding ordering take; are there any large orders included or anything which you would call one-off or seasonal effects in both mining and Compressor Technique?

Ronnie Leten

To start on compressive technique and if you would hint a bit to guys in process these big huge one, I think we don't have at this time, unfortunately I should say, so its more spread all over. If you take China, I see more the pattern, it is a lot of small orders, so it’s much more I could say fragmented, which we like more.

When it comes to the mining, I think it’s also spread but of course you have a couple of bigger orders, which you have and that’s typical. If I listen and see, it’s not different from a normal pattern, not much different. So there is a couple of big orders but that you have always seen in this business, it’s not different than say year or two or three years ago. Of course the huge ones, okay then if we will have that we will announce them and you have not seen any so, you didn’t consider that we had huge ones.

Unidentified Analyst

And then last question regarding the EBIT margin in Compressor Technique is a major part of this receivable issue directed towards the Compressor Technique division?

Ronnie Leten

I think there is a significant when this one-off. It’s more in the CT and I am looking to Hans Ola, so yes. I think it’s more of that. But any how I think that the underlying margin I think was still solid, I think when you look to the mix and all that. I have difficulties to talk it really down, so let’s say it this way.

Hans Ola Meyer

Good, so we turn to the telephone conference for two questions please.

Operator

The first question comes from the line of James Moore from Redburn Partners. Please go ahead, your line is now open.

James Moore - Redburn Partners

It’s James Moore, Redburn and three questions if I could. One on, over production and did you over produce in the quarter? I know just your inventories are up SEK 1 billion, was that because of currencies or was there a like-for-like inventory builds and did it effect the margin?

Secondly, how much of the 135 currency gain is the receivable and how much is more classic transaction and then finally you mentioned mix being positive in CT and CMT. I might normally expect an OE recovery for the lower margin OE, perhaps to be a drag on mix, could you perhaps expand a little on what these positive mix issues in CT and CMT are?

Ronnie Leten

Okay Currency I will, Hans Ola you take later. Over production I think we don’t have, I think in our concept the way we work in our flow. We have an assembly to water concept, so I think what you see and the inventory is really transit stock and of course currency revaluation of that one, but it’s not that we have been over producing and which has done maybe, could have a positive effect on the EBIT level, we don’t have that. When it comes to the mix, if I talk about sequential mix, quarter one, quarter two, we look from an aggregate level, the mix equipment of the market between these two quarters is more or less the same.

So I think when you have to look to the result and then you make a comparison with quarter one and quarter two which is maybe easier to make that one than to make the quarter two last year with the quarter two this year as you have of course with the bridge in that one.

Maybe you can take.

Hans Ola Meyer

Yeah, if we expand a little bit further, you asked about the positive currency number that we posted and as always it’s the currency effect comparing Q2 last year with Q2 this year and it is the absolute majority of that this time is due to the change of currencies during Q2 this year, which means that we have to revalue receivables at the end of June to higher exchange rates, let’s say and that means that we have to book that profit in Q2 this year.

Last year in Q2, we had virtually no such effect, so that’s why when we use the bridge concept we get that as a positive. So it's not very much of true underlying better currencies then last year actually nor very big difference compared to Q1 for that matter, so, all what we call is a positive currency is really coming from this, well the absolute majority of it is coming from this revaluation issues.

And it's important to remember that because as we now have done that and we move on to Q3 by definition, it means that we will not have that positive if currency rates now stay stable for 3 months. So, it has affected the margin in Q2 in a positive way, also, sequentially looking at the margin which means that it, everything else equal, it will not appear let’s say, in Q3.

So, I hope that explains that part, perhaps just to add to Ronnie’s comment on overproduction, you have mentioned that the inventory increased about a SEK1 billion in the balance sheet between March and June.

Actually and I don’t have the exact number, but atleast half of that is more related to other things then the real volume buildup of inventory. So, currency primarily. So the statement of Ronnie is perfectly true that the inventory build up is very much linked to what we see in the order intake in a natural way.

James Moore - Redburn Partners

Just going back to your mix point, if the mix was the same Q2 on Q1 and the currency held by percent and your margins jumped 3% or so, what were the other mix effects helping?

Ronnie Leten

I think, if you may come back on that one and maybe to explain a bit more. I think of course, a lot is coming from the volume and I think if you look a bit deeper to the information out here and you look through the cost and you make a comparison from a cost point of view, you have seen that we have not and that's maybe one take away for all of us, I think we have not had many cost increases.

So there is more to come unfortunately on that cost, of course we want to be efficient on that. But now we got a very quick upturn with very low cost and especially when it comes to the functional cost. And that is something which we will see what in the period if we go further, what will happen on that one.

Hans Ola Meyer

Just to expand a little bit further on the mix that, when Ronnie says there was about the same mix as in Q1, we see that as a little bit of a surprise on the positive side. Because normally when you have a ramp up of revenue like we have seen even on the sequential basis, it normally comes through that the equipment invoicing is coming back much quicker so to speak, but in this case they have actually increased about the same which means that we had a very nice profit effect from the revenue increase in this quarter.

Operator

Your next question comes from the line of Nico Dil from JPMorgan.

Nico Dil - JPMorgan

Two quick questions please. One on Compressor Technique, I would like to understand the incremental margin a little bit better, it was close to 100% wondering what exactly what made that incremental margin so high? Second question is really on the construction equipment side of things where I saw an improvement sequentially, wondering whether you can give a little bit of color on that in terms of sort of what type of an improvement you saw which end markets, which geographies, et cetera.

Ronnie Leten

I suggest Hans Ola you take the CT.

Hans Ola Meyer

You start the second one.

Ronnie Leten

The second one, okay. Yeah, I think that the sequential improvement is mainly on the infrastructure construction part. We see there good development although also the whole mining part, although if you compare with quarter one, you could say that its maybe not increased so much, but I think we got say a bit improvement on that part if we take it in your [receive side].

So, it comes mainly from South America, Australia and then you have Asia. Those are the areas where we see good significant improvement, although we can say we take it a bit, talk about the region here. We see also very good development in the Nordic area when you come to see empty on that part, and we should not forget now I’m repeating again all this but, we see also that Russia is gradually coming up. Of course we compare with a very low last year. We are not in Russia up to the level where we were peak rises, but as we see a good development and if you take all these things together, we see a sequential improvement on that.

Hans Ola Meyer

On the Compressor Technique business, Ronnie showed the flow through profit from the revenue increase in one of the graphs, but we saw 69% as we define it ex-currency and ex-non-recurring items and acquisitions on the group and as you rightly say, it was almost 100% on CT. And this is of course a big surprise. We fully understand that since we have explained many, many times that Atlas Copco is not a very operationally geared company. We buy quite a lot of equipment that we put into our machines and then we deliver, so we don’t have a lot of in-house manufacturing. So, how can than the gearing come out like this?

Well, it is a very specific situation and when you have a positive pricing, you have a tremendous come back on revenue and you have a very profitable aftermarket. And on top of that we have the benefit like Ronnie touched upon which is the same for the whole group that this comeback of revenue has happened with a very little addition of functional costs. And if we look at the product cost in average of all the business areas and particularly in CT, we can see actually that there is a quite substantial lower product cost compared to a year ago. In spite of the fact that certain input materials are starting to become more expensive or has become a little bit more expensive, but there has been tremendous work on the innovations side and the efficiency side when it comes to product development.

So, they have so to speak, all of these factors have contributed in the same manner in this quarter. Perhaps just to finish on it if you compare with what we said after the first quarter, we could hardly comment on these things on the same graph because then we had a negative revenue compared to the previous year, but a positive profit improvement so the ratio was very difficult to read.

Now we have a tremendous flow through, but again we come, it’s a very specific situation, when we have this rapid return with also a strong growth on the after market side which is extremely profitable.

Nico Dil - JPMorgan

And price we cannot see…

Hans Ola Meyer

And then price as I mentioned but we shouldn’t forget that is of course coming on top of every thing that we falls all the way through to the profit from the revenue increase. So the only thing we can end the comment is by saying that over time looking forward, we don’t think that one should expect us to have, let’s say anything than the normal type of flow through of 30 to 35 perhaps even 40% in certain locations, when the pricing element is good so to speak. Because that’s the way the group is set up from variable to fixed costs, and this quarter is a very specific one in that respect.

Nico Dil - JPMorgan

I'm sorry, just to clarify, you highlighted 30% to 40% in the more normal environment is that correct?

Hans Ola Meyer

Yes. We then go back with two questions here, we have I think Mats, you had a question here.

Mats Liss - Swedbank

Mats Liss, Swedbank. Couple of questions, first regarding orders, just if you could indicate the delivery times on the orders when we should expect them to be invoiced and also if there has been any bottlenecks during the quarter which have affected your invoicing ability during the quarter and well, also, if you could give some indication about the production rate during the third quarter. I guess it will be up but…

Ronnie Leten

Yes we got a bit of bottlenecks. I think we see in certain products where we have some components more difficult. If we take one example is on the electronic parts, it's not so easy to get the ones we want. So you see that the bit in Industrial Technique where we have some lagging on that part. But when it comes to the orders and delivery time, I think we see a prolongation on the demand, because the supply chain is stressed and we need to ramp up, so you have two sides. We all see ourself, we have to hire more people and second also suppliers have to get the components going on.

If you take a bit on the quarter three, we are ending up now today in the holiday period especially when you take the North America and European site, which will of course have a bit of an effect on our output. But we see a prolongation on the delivery times. Mainly where you see a prolongation, it's mainly on the CMT site where you will see the book-to-bill a bit longer of higher than you would see in CT.

Hans Ola Meyer

Okay, another question here. Yes?

Unidentified Analyst

You talked about the mix effect and I assume that was in revenue you spoke about earlier. In the orders for this quarter do you see the same mix since say first, second quarter? And also when you are talking about delivery times and lack of some components, do you think there will be a need to sort of build inventories to be able to deliver when you sort of get hold of this kind of products from time to time. Thank you

Ronnie Leten

I want answer the last question first. No, I think that is not the way Atlas Copco works. I think we will not be assembling half machines. It doesn’t say that you will never see that in the factory but that is not the standard. I think we will do it when we have the components, so we do that to the complete units. Do you not get any efficiency in inventory? I think that will be a lie if I say no but I think it will not be significant, that’s one.

When it comes to the mix on the orders received side, of course you see a higher equipment than on the aftermarket, so that we will eventually go to a less favorable mix aftermarket equipment when we go further in the future. And that was also one of the reason why I made the remark on that we are having quarter two, a very good aftermarket which lead more or less to the same mix as quarter one, which was a bit of surprise for us.

Hans Ola Meyer

So I think we turn to the telephone conference again. Yes, we will take two more questions then.

Operator

The next question comes from the line of Tim Rothery from Goldman Sachs. Please go ahead, your line is now open.

Tim Rothery - Goldman Sachs

Good afternoon, it’s Tim Rothery here from Goldman Sachs. I was just wondering if you could perhaps just comment on the pricing environment. Obviously you’ve been successful in raising prices or getting good price retention. Is this being supported by bottlenecks in other suppliers and some of your competition in being able to meet this V-shape recovery, or is this just sort of continuation of the long term trends?

And then secondly, within the quarter would you be able to try and quantify what you saw in terms of cost savings and just give an indication of how you see that in the coming quarters? Because I would imagine that as we go through the year the comp effect or the base effect from these cost savings must get tougher as we go forward. Thanks.

Ronnie Leten

Yes, on the price environment I think, of course this price increase what we get is really supported by the continuous innovation and upgrading our products. I think that is the base. I think the rest when it comes to be clever and go against the competition and when they have a bottleneck and all that, I think that will fight back. I think and that is not the practice we try to do. So it is definitely a very solid price management over the years what we do.

Of course it helps when it becomes again, a buyers market and sales market, like it is now I think gradually. Of course it helps to support good price management and increase of prices. When you add much pressure on that part when there is an overall supply, then it’s a bit more difficult to do a positive price management. So we see gradually that the market is turning then it becomes a bit easier to talk about price increase. Maybe you take cost.

Hans Ola Meyer

You asked, if I understood the question right, a little bit about. On the cost side, the savings compared to last year and of course we have pointed out in Q2 and of course in Q1 that that is an important aspect of the profit improvement absolutely. Now, if I understood you right, you are saying that when we compare with Q3 and Q4 last year we already had more substantial savings already last year. That's also true of course, but on the other hand if you look sequentially from a quarter where we just delivered the 20% margin we don't expect that to be any different.

Of course, like Ronnie alluded to earlier and we have said it before, the more than $2 billion personnel related savings that we talked about in 2009 is not going to stick in the way that our business model works. It was an adjustment to the level of business that we saw at that time, but as the revenues are now coming back, as the loads and the factories are building up, of course we will have to increase the number of employees again in the manufacturing and in other places.

So, gradually I would say even as much of a majority of those cost savings will come back, but of course we don't have any problem with that as long as we see that the revenues are also increasing again and that's exactly what we believe that we will see in the next couple of quarters. So yes, it will be more difficult to compare with last year in that respect, but I mean we look from it from where we are today and going forward.

Ronnie Leten

Yes, maybe I can elaborate I think a really believe although, of course we support efficiency and we go for efficiency, but we will get more cost, I think just as an example when the supply chain get under stress and you come late, you get air freight instead of boating and sea freight, you get rush transport. I think we also will invest more in the market. If you see like last year some of the exhibitions, no one went there. Today you have seen in my presentation at Bauma, you went to the World Expo, all these things investments to invest for the future, this is what we will do, we do more on these things. So, these costs, they are coming in more and more, but of course we try to be more efficient as we were pre-crisis that is the challenge I think management has in front of them.

Operator

The next question comes from the line of Ben Maslen from Merrill Lynch.

Ben Maslen - Merrill Lynch

Two questions, firstly on the US, Ronnie, you sound more positive on that market than a lot of your peers and certainly your growth rates is kind of way in excess of them, it this the function of the markets that you are in or is it something structural that’s letting you outperform your market at the moment, be it kind of distributors or products or time to market, that’s the first one. Then secondly China growth rates there on a macro level is slowing into the second half of the year.

Can you just say what you expect for the second half in terms of a kind of sequential and year-on-year growth rates?

Ronnie Leten

I don’t know, how my peers sound. But I can only talk what I see about US. And I see compared to last year and also sequential a good activity in the industrial market and that as I see that in the compressor market as I also see that in general industry from the tools point of view and MVI, I see a good activity for the rental companies that the large rental companies are ordering. They place orders. They want to have deliveries and I see a good underlying activity on the aftermarket. When you talk really construction, road construction and all the construction, that this is less favorable. So that made me say that, I see good activities and demand in US.

When it comes to China, you have seen, we had record China in the second quarter. I am also reading the same information what you read Ben. When I talk to the people on the floor, to all the sales people and all the general managers, they are still active and very positive, but of course they say also if you compare we have a record, can we repeat that in the third quarter and quarter four.

But they still got a lot of activities and that made me say, okay, we will see, we had many times in China that the macro-economical outlooks were a bit more cautious. We saw still some good development. So it’s very difficult to predict on that one. I think we still go full speed ahead in China, I think we can still take more of that market. I think there is still some room for market share and there is still some room for aftermarket, so that is where I bet today on.

Ben Maslen - Merrill Lynch

Maybe, if I could just follow-up on the gas and process compressors. You say that order intake is now picking up again. Where are orders in relation to revenues, the revenue is still declining there or is the backlog kind of comes down or are they fairly stable?

Ronnie Leten

Of course I was just looking a bit to [Mathias] if he had calculated the book-to-bill, but book-to-bill is low. But I think it's not so much different. I think I see when it comes to the gas compressor, we don’t see the peak orders, the big orders we don’t have, but I see all over the place so good activities and they lend reasonable good orders. So where I was much more negative six months ago, I was really concerned, what we will do with all the under absorption we could have. At that time I am not afraid anymore. I see a very solid demand but not peaks. So I see more activity also even on the air separation market which was nine months ago dead, that we see a bit more activities and that’s good for us. I see fewer gas boosters coming, I see geo terminal business picking up on demand. We have not landed many orders, but okay we get that. So I think it is at a reasonable level.

Hans Ola Meyer

We have a question here in the Stockholm, then. Please go ahead.

Ola Kinnander - Bloomberg News

Ola Kinnander with Bloomberg News. Back to the issue of employees, Hans Ola, you said you are expecting that there will be some re-hiring here over the next couple of quarters. Could you be a little bit more specific over what you could expect here? I know you have reduced your workforce by about 6,000 since the crisis.

Ronnie Leten

When Hans Ola mentioned it, I think we compared quarter one, compared to the quarter today, quarter two, and what we see is of course we have more hiring in the manufacturing side because at the end of the day we must deliver what we got as orders that has increased in Sweden has increased in Belgium. We see that also in China, India there we in America, we are hiring again for manufacturing. Where we also see significant hiring is in the aftermarket, i.e. in the service part, that is a significant part of our rehiring and then of course we keep investing in the presence in the market and that’s mainly in the emerging markets where we put more feet in the street area. That is really the organic growth of course, then we had the accusations when you look to the figures. But we are back in the rehiring bases.

Ola Kinnander - Bloomberg News

So approximately how many have you rehired so far?

Ronnie Leten

If you talk quarter-to-quarter…

Hans Ola Meyer

About a thousand people as it is in the report…

Ola Kinnander - Bloomberg News

About a thousand.

Hans Ola Meyer

About a thousand all over the world in those categories that Ronnie mentioned. And that is of course a direct reflection of the.

Ronnie Leten

Volume.

Hans Ola Meyer

The volume increase that we are seeing there.

Hans Ola Meyer

I think then that we have a number of questions on the telephone line so I think we take two more questions from the telephone line, yes.

Operator

Yes the next question comes from the line of Roddy Bridge from Société Générale, please go ahead with the question.

Roddy Bridge - Société Générale

I think you sort of warned us that there is by 1 percentage point extra from this receivable situation and you've had a very positive mix. And but I was really wanting to ask if Ronnie would say anything conceptually about how high margins can really go. I mean at what point do you really start stepping on the internal growth? And what should we be thinking about your CapEx going forward, et cetera.

Ronnie Leten

Yes, how high can the margins be? That is a $1 question. I think one thing is definitely what we don't do and that's also what I push, I am not pushing for a high margin, well you're definitely push internally for growth. It can be internally as also organic growth as well as acquisition well that's what we go.

When you see the margin really changing and really be this level around 20, it comes definitely from a very, very solid aftermarket which is not only, was already good but also we have taken a lot of activities already years back improving the process which is okay now, we could not prove it last year because the volume was really down. Now this year the volume in the aftermarket is there, the structure is there that is more volume and that of course creates a very good contribution.

Second I think all the measures we have taken on the equipment side and Hans Ola also mentioned already on the innovation part on the set up which also has, which support the margin on that part. So I hope big, I don't think I will comment on that and I'm very pleased with the margin we have today. And like I said I would like to, that we even can grow faster in this area.

When it comes to the CapEx we are not a very heavy CapEx organization, there are some plans in preparation for some extension of capacity and that's in the emerging markets is mainly in India and in China where in the coming six months we will make plans to extend over capacity on that one.

The rest on CapEx, you would see a bit more CapEx also eventually on the rental part where we will have a bit more but the rest I don't see any. In future, I don't see big CapEx swings.

Hans Ola Meyer

We believe that if you look a little bit not quarter-by-quarter necessarily but a little bit over a certain period that we will be able on the tangible investments, the CapEx related to the factories and the net CapEx on rental fleet, we believe that we will be able to keep it in the range of 1.5% of 2% of revenue, something in that order. And coming into the recession this last time, we were probably a little bit higher than that but sort of overshooting a little bit temporarily but then we also can bring it down quite drastically if needed, so without jeopardizing the quality of the set top but roughly to give a little bit of some idea for the future at least.

I think we continue on the telephone line.

Operator

The next question comes from the line of (inaudible). Please go ahead with your question.

Unidentified Analyst

Looking at the first year EBIT, your target operating margin is still 15%, is it in your intention to maintain this target given this future number or you want to increase it?

Ronnie Leten

I think like in many other occasions we said that an 8% organic growth plus acquisition over the business cycle and 15% EBIT and always having a very return higher than the [capital base] is our target and we have not reconsidered that part.

Hans Ola Meyer

It is of course to be seen over a full business cycle and you can then of course exactly the way you do argue that we have been over that number for many years now, but its not something that hinders us from both growing and being as profitable as possible. But it’s absolutely true that as Ronnie pointed out that, I mean growing at the 8% level with a good profitability and still having a low capital base that is what we are shooting for because that creates true value. If it sounds like we are downplaying that part of the target, yes, you are probably right.

We continue with some question, we have two more questions on the telephone line.

Operator

The next question comes from the line of (inaudible). Please go ahead with your question.

Unidentified Analyst

Just following up on the question on the balance sheet, you said that the first choose would be the acquisitions and then CapEx in terms of the growth and does that mean that you are probably not intending to go forward to the share buyback program in this quarter? And I think sort of a question here is how much do you look at your share price when assessing share buyback and would the decision be different if you know say your share is down 10%, 15%, I mean how do you look at that?

Hans Ola Meyer

Yes, I think, we of course have a very close dialogue continuously with the Board and also any input from any shareholder is important in that aspect. We believe that the buyback is an important part of being flexible and being able to adjust. But from a priority point of view, the first two as you mentioned yourself and that I said just a minute ago is definitely the key, and that’s where we aim for. But is it the timing issue? Are we desperate to have a balance sheet that looks certain model for every quarter? No, we look at it on a long term basis. We believe that the group has the ability to continuously add value and that normally leads to also a slightly higher share price going forward.

So in that respect, we don’t link it specifically to a certain share price level. We look at it long term and I can not answer if the Board would reason differently at 10% or 20% lower share price. Would we be more aggressive using the mandate or not? I think it has to do with how is the rest of the world then developing in that scenario and how is the relative situation for Atlas Copco compared to the rest of peers and the rest of the world. But, we have the mandate and there is nothing saying that it can not and will not be used but of course we assess the situation every month and every quarter.

I think we have a final question on the telephone line?

Operator

Yes the last question comes from (inaudible).

Unidentified Analyst

Hello Ronnie, hello Hans Ola. (inaudible) three questions. One simple one, just a clarification on your outlook statement, is it sequential or a year-on-year comment. Second question about standard compressors, you mentioned increased demand for standard compressors. Is this specific to some regions or end markets, could you explain how you understand this increased demand and the effect you think it will have on your margins and finally, you currently have very low costs, partly because the recovery has been faster than you expected.

Can you help us estimate the likely amplitude and paste, and pace of the cost to catch up and that we should expect for maybe Q3 and Q4?

Ronnie Leten

Yes maybe the outlook, Hans Ola you can take later. I think on the standard compressor demand, what we mean here is definitely not to get some process and high engineered products compressors that we don’t see that as standard compressors.

Here we talk about the standard oil injected in oil-free compressors where we have seen the demand increases, this is most in all markets, but maybe the southern part of Europe which was not developing, but I see there a good development in all the BRIC countries, so I see this time also Russia.

I see a good development in the smaller compressors also for Germany. So if we take then Europe and I think also the US is developing very well in that part. When it comes to the variable cost, I think I refer a bit to a previous question we got here. Yes, I think how much will be the cost increases are? I think we will definitely and we have to invest in our brands, we have to invest more even in our products, we have to invest in presence, in exhibitions, so we will have definitely a higher cost than we had in quarter one or in quarter two.

But of course, I try as you know when it goes up so quickly and after you come out of a very difficult situation that of course people have the tendency of course. Now we have to recuperate of course and in turn we try to steer this in a very careful way. But if you look to the amount of people which we have increased and the previous question also what we have given the answer. I think we have increased people related to manufacturing, which is volume related, and we have increased the majority of our people, also in service which is again volume related. So I tried to get the cost increase a bit less than the volume increase, that is a bit guidelines I’m using for. Maybe Hans Ola, the outlook?

Hans Ola Meyer

On the outlook, we always try to talk about sequential. Let’s say we stand here in the beginning of July and we try to see the activity level of our customers for the next three to four or five months or something like that. That’s the way we do it.

Unidentified Analyst

Just one thing about the cost catch-up, maybe to ask you in a different way, could you quantify maybe the benefits you had in Q2 of lower than expected costs?

Hans Ola Meyer

We might take turns here in trying to dissect the question. But it's very difficult to give you a statement that this is lower than expected and so on, that's not so much the case, it's just the fact that in the revenue build up that we see, we are still in a mode where we are very selective and careful in the addition of costs and that's why Ronnie repeats that in manufacturing, if you have the type of setup we have, we have to bring in assembly people and so on and so forth. And we have to cater for the very strong aftermarket growth out in the field, that's where the cost comes, but they are still added in a careful way.

Now that cannot continue forever, so if I look into the future, the best guess is that you will see costs being added in more of a normal rate to how our business model looks like which means that we perhaps have something like 20% to 25% fixed cost and the rest is variable. So we move closer to that norm, that's why I previously said that incremental profit going forward needs to go back to some sort of 30% to 40% rather than the extreme high flowthrough that we saw in Q2. That's two sides of the same coin.

Ronnie Leten

Of course you see what if you compare with last year and the beginning of the year, salary increases, you just take that. I think it was very, very low I think if you've seen here in Sweden and I think there are many other countries in the world where salary increases were very modest. I think if the volume goes like this, we will definitely see a demand for salary increase which will then yield a cost increase. And I have mentioned also inefficiency when you have to catch up with late deliveries and all that. These type of cost increases we will get when the volume is more stressed.

Hans Ola Meyer

But at the same time it's important of course that as these costs come back we're also generating more revenue and we are generating from the business that is of course positive. Its not that we are starting to see that the cost increases that we are talking about now is going to hamper our profit margin going forward. It's just that it cannot explode like it did in the second quarter.

Hans Ola Meyer

Thank you very much. With that I think we finalize the call. We thank you for participating here and on the conference call and we take the opportunity to wish you a very nice continuation of the summer.

Ronnie Leten

Thank you. Thank you. See you, bye-bye.

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Source: Atlas Copco Ab Q2 2010 Earnings Conference Call
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