ABB Grain Ltd. Q2 2010 Earnings Call Transcript

Jul.23.10 | About: ABB LTD. (ABB)

ABB Grain Ltd. (NYSE:ABB)

Q2 2010 Earnings Conference Call

July 22, 2010 09:00 am ET

Executives

Joe Hogan - CEO

Michel Demare - CFO

Analysts

Ben Uglow - Morgan Stanley

Olivier Esnou - Exane

Mark Troman - Bank of America/Merrill Lynch

Andreas Willi - JPMorgan

Axel Funhoff - ING

Martin Wilkie - Deutsche Bank

James Moore - Redburn Partners

Thomas Baumann - Neue Zurcher Bank

Simon Smith - Credit Suisse

Colin Gibson - HSBC

Mark Fielding - Citigroup

Operator

Good morning or good afternoon. I’m Stephanie. The Corus call operator for this conference. Welcome to the ABB Second Quarter 2010 Results Analysts and Investor Conference Call, hosted by Mr. Joe Hogan, CEO. At this time, I would like to turn the conference over to Mr. Joe Hogan, CEO of ABB. Please go ahead Sir.

Joe Hogan

Hi, good afternoon and thanks for joining us today. Michel Demare is with me here too. We are going to review our second quarter results as you know, and as always my comments in the call refer to the presentation that you can download from our website at abb.com. Please refer to chart two for the Safe Harbor text covering any forward-looking statements made today. And I’ll start with a summary of our second quarter performance on chart three. ABB delivered a strong quarterly performance as our costs pick up program in June succeeded in keeping our profitability well within our target range.

We saw a further increase in investor demand for ABB’s energy efficiency solutions, and lifted motors in the automation division by more than 20%. As a result, base orders grew by 15% in local currencies compared to the same quarter in 2009 and were 4% higher than Q1 of this year. At the same time, utilities continued to delay many of our investments into power transmission which is reflected in the 37% decline we saw in large orders.

Nevertheless our order backlog is higher than at the beginning of the year. And revenues declined more slowly down 5% versus Q2 2009 in local currencies than in any other quarters since 2008. Both of these are encouraging signs. We achieved more than $400 million in cost savings this quarter, which combined with an increase in higher margin product revenues in the automation divisions, helped us to generate an operational EBIT margin of 14.6% compared to 14.4% in the same period of 2009. This improvement comes despite additional project costs in the power system division that I’ll come back to shortly.

On cash, the timing of the customer payment influenced the performance, so we have lower cash from operations compared to a year ago. But comparing the total first half cash level we are actually higher than last year so we remain confident in our ability to generate cash.

Chart 4 gives you an overview of the key figures for the quarter, I’ve already discussed the main points. So here I’ll just highlight the improvement in services revenues and the restructuring and derivative costs totaling about a $130 million in the quarter. We’ve also added EBITDA figure here because as we explained to you when the Ventyx deal depreciation and amortization related to the acquisition will impact earnings in the coming quarters. We expect the impact to amount to roughly $40 million for the full year of 2010. Ventyx had a small impact on our results this quarter as we've only included June’s result in our numbers. Ventyx contributed about less than $20 million in both orders and revenues and the impact on EBITDA is also not significant.

Let’s move to chart 5. Here you see some key data at the division level. As already mentioned delays in utility spending continues to weigh in on our power orders. The current short cycle investor recovery however has had a dramatic impact on our automation order intake. And in the case of low voltage products where orders are converted quickly into sales, you can already see the positive impact of the order rebound on revenues. Process Automation also saw a significant order increase, a lot of it in the emerging markets including some large orders in the Middle East and oil and gas and also mineral.

On the EBIT margin side, you can see the impact of our successful cost takeout program across the border. We are evenly able to maintain our power products margins despite lower revenues and continuing price pressure. Power systems margins were again hit by cost overruns associated with the cable projects we mentioned in the first quarter. This amounted to about $80 million and follows an intensive review process undertaken in this quarter aimed at fully and to fully (inaudible) this particular risk.

As we said, for Q1 it’s impossible to do well but we have our hands around this issue. We have already taken major steps to make sure this issue does not arise in similar projects in the future. Turning to the automation divisions, EBIT you see the positive impact from the cost pick up. A favorable product mix and especially in low voltage products, strong incremental margins as we increased output from a lower fixed cost base. In chart six, you will see the development of base cost and large orders in more detail. Base orders were up in all divisions expect power products, and were up by more than than 20% in each of the automation divisions.

The more larger order intake brought the share of large orders down to 11% which is the most we've seen since the end of 2008. You have seen already the $700 million order we won last year from transpower in Germany to build an 800 megawatt link between an offshore wind park in the North Sea and the German mainland. This will certainly go a long way to improving our large order performance over the rest of the year. It’s also a reflection of the continuing very high tender backlog in this business and we hope to see additional large orders in the coming quarters. This will depend to some extent on the world economy maintaining its current momentum. If that continues we would expect to see a return to greater utility spending especially in power and transmission.

Turning to chart seven, you can clearly see how differently our power and Automation businesses have developed through the economic crisis of 2008 and 2009. Our automation businesses were the first to feel the downturn starting already in the third quarter of 2008 and declining more or less steadily throughout, through the third quarter of last year. At same time, our power divisions were still enjoying some significant order growth in early 2008 and orders were relatively steady through most of 2009. Now you can see how automation has comeback on the strength of the industrial recovery while power remains under pressure.

Given what we know today, we would not expect total power orders to bounce back until late this year or into 2011. On chart 8, we give you a regional breakdown of orders for the quarter. In total, emerging market accounted for 51% of total orders in the second quarter. As the economy continued to perform above the global average, we are encouraged to see growth in Europe again mainly driven by demand for automation solutions.

Asia also came back this quarter as China returned to growth again it was our automation businesses that fuelled growth in Asia.. The Middle East and Africa saw a very good quarter due mainly to some large process automation orders in Saudi Arabia. And in the Americas we had some large (fab) orders in Mexico last year that the didn't repeat. So that impacted our power performance, and more than offset our orders increase in the United States.

Let's turn to chart nine for more details on orders by country. Chart nine shows order growth in some of our most important markets. Again it’s the automation businesses that drove growth in China, Germany and the US, our three biggest markets. Industrial demand also supported modest growth in Brazil despite a significant decline in large power orders compared to last year. As I mentioned a moment ago, Saudi Arabia enjoyed a solid quarter with large orders in oil and gas and minerals. Saudi orders amounted to almost $400 million in the second quarter bringing it into the ranks of ABB’s largest markets. India meanwhile continued to struggle. This was a result both of delays in large orders and increasing competition from local producers. So we have some work here to rebuild our order intake.

Turning to chart 10, we also saw some order recovery and process automation in the quarter. Marine, metals, minerals, pulp and paper, also strong double digit growth. It is important to note that this is growth from a low level, while the chart shows a positive trend across all these businesses over the past several quarters. This is mainly in base orders, in effect increasing operational expenditures by our customers as they bring some capacity back online or as they refurbish and upgrade existing facilities. It’s still too early to say that there's a recovery in capital expenditure in the new capacity. This will be a key to a sustained order recovery in process automation.

Chart 11 provides you an update on the power products business. We have a combination of tailwinds and headwinds in second (PP) at the moment. Our overall demand remains muted. We did see an 11% increase in base orders from Q1 to Q2 this year. That is largely the result of higher demand from industrial customers which in turn lifted orders in medium bookings products. On the EBIT margin side, we continue to see pressure on pricing and a negative impact on volume declines.

Although we were able to take out more than $100 million in cost during the quarter which amounted to hold the line on profitability. There are still challenges ahead starting with the delays we see in utility spending on large transmission projects. In China, we still see the effects of increasing competition, we are taking measures to adjust by reducing costs and tapping into the new markets for example in the mid segment range. But the negative impact is likely to continue over the short run.

And finally revenues will remain under pressure over the rest of the year as recent order decreases continue to flow through the P&L. I won’t spend much time on chart 12, other than to say that we could hold our EBIT margin comfortably within our target band in the second quarter. The cost takeout has gained significant traction and the automation recovery especially in low voltage products and discrete automation and motion to continue to support the group margin.

Chart 13 provides you with a reconciliation of our operational EBIT from Q2 last year to Q2 this year. If you compare this to what we showed you in Q1, you’ll see that the volume and under-absorption impact has contracted significantly, about 4% of revenues with just over 1%. At the same time, the expected price erosion in our product businesses was about $200 million in the second quarter or about 2.7% of revenues compared to a $150 million in Q1 which is about 2.2%. The project margin piece is also higher reflecting the additional cost overrun in power systems. The good news is that we were able to more than offset these impacts with excellent execution and cost and we kept our operational margin basically at the same levels last year.

Let’s move to chart 14, to see whether these savings were achieved. So far we've achieved about $2.3 billion in cost savings since we launched this program at the end of 2008. That means we passed the three quarters’ mark. In Q2, we took out more than $400 million accelerating the pace compared to the first quarter. The biggest piece was again in global sourcing where we reduced costs by about a $150 million taking our total sourcing savings up to $1.1 billion. We also saw good reductions through the footprint in operational excellence initiatives as well as lower G&A expenses. The cost so far has been just over $700 million which means we have another $350 to $400 million to go. So we are on track to reach our objective of $3 billion cost to cap by the end of this year at a cost of just over $1 billion.

Chart 15, takes you through some of the actions we’ve taken to put our cash to work. As you know, we closed the Ventyx deal in this quarter, an investment of more than $1 billion. We acquired the US instrumentation business called K-Tec and invested about $20 million in Trilliant, a maker of Smart Grid communication equipment based in California. We also made a $1.2 billion offer to buy UPS major Chloride but as most of you understand we eventually withdrew from the bid.

We continue to look at M&A opportunities applying a very disciplined approach. In addition to these activities we have made an offer to increase our holdings to ABB India to 75% from our current level of 52%. This offer is still running and we should have the results at the end of the month. On CapEx we expect to ramp this down somewhat from last year with full year expenditures near $800 million for 2010. At the same time however, we increased our R&D spend to make sure we maintain our technology leadership. This will remain a key growth driver and competitive differentiator if demand recovers.

Finally, our net cash position at the end of the second quarter amounted to $5.9 billion. Remember that we are paying our dividend for 2009 this month which will affect our Q3 cash backlog to $1.1 billion. Let me conclude on chart 16 with a summary and outlook. I think it’s a fair to say we had a strong quarter, with great execution on cost takeout combining with the automation recovery to allow us to maintain profitability comfortably within our target band.

Looking ahead, our recent performance in automation gives us confidence in the short cycle recovery. A return to order of growth in power transmissions likely only late this year or into 2011. We expect the emerging markets to continue the positive developments that have shown through most of the downturn. Where there is more uncertainty its in the developed world, where there are still some question marks around the strengthened duration of the economy recovery. For that region, we will continue to focus on excellent execution on costs, while we tap opportunities for growth. That concludes my formal remarks. I would like to thank you for your attention and Michel and me would be happy to answer any questions.

Question-and-Answer Session

Operator

The first question is from Mr. Ben Uglow from Morgan Stanley. Please go ahead sir.

Ben Uglow - Morgan Stanley

Two questions. First of all, just on Power Systems, obviously something changed during the quarter. Previously, tell me if I'm being unfair but I think you guys were thinking that you would be back in the 6% to 8% margin range for the year. Now I'm assuming that that's unattainable with some, when do we see 6% margins coming back? Is this all finalized now? So that's question number one. Question number two is on the press release on page 5 you made a very interesting comment suggesting that the EBIT margin adjusted for both derivatives and restructuring was roughly the same in power products in the last two years. My interpretation of that is the underlying EBIT margin is something close to 19% in power products. Am I being too optimistic?

Joe Hogan

You know Ben your second question is rather taking by surprise, I mean power products for this quarter was 18.6%.

[Multiple Speakers]

Joe Hogan

So is that your question actually, absolutely is (inaudible)

Ben Uglow - Morgan Stanley

Yeah.

Michel Demare

So you are disclosed to, 18.6%, yeah.

Ben Uglow - Morgan Stanley

Yeah.

Michel Demare

On the first one Ben while indeed circumstances have changed a little bit from positive comments we had in the first quarter where we said we are optimistic to see the power system margins back up. The fact is the problem has become a little bit more complex to just try to explain it without getting too much in detail we had to deal with the bankruptcy of a subcontractor for the cable laying and the ground (inaudible) for some of the cable projects that we have taken. We placed this contractor by another company that had difficulties to cope with the cost and so we have been basically obliged to change a little bit the business model on some of the contracts that we have hired this company for, and so the problem is that if you execute this contracts in parallel and maybe there's a little bit of a snowball effect and maybe we had underestimated a little bit this impact when we started looking in it in the first quarter. Like Joe mentioned, I think we have now a good understanding of the issue. There is still some downside risk but there is also some upside because also some insurance issues that are related with that. So it’s too early to let's say to draw a bottom line to this issue, obviously we would say its still this additional charge of ($80) million and that’s for the rest of the year, on the 41% of revenue that will be difficult to make up differently so I would say that now if we say before 6 or 7 it will for sure because it’s a 6 for the full year than the 7 we would be hoping for. But yeah on that project from time to time you, on projects of this size and this complexity you get from time to time a problem.

Ben Uglow - Morgan Stanley

Sorry just a bit here, this is a problem on, what's the original misestimate that originally you were thinking this was confined to one project

Michel Demare

Confined to one project and then at the end the fact that this one project got into trouble of course and delay on the few other projects and after that you start missing your deadlines and that is what happens here. Okay, we are catching up, we have found solutions now and the matter is now all we have to see what is the financial, the total financial costs once we have sold all the insurance and custom issues.

Operator

Next question from Mr. Olivier Esnou from Exane. Please go ahead sir.

Olivier Esnou - Exane

A few questions, maybe just following on the previous question, I’m just wondering if you, because supplier bankruptcy can happen; it's a supply chain issue. From where you stand, are you happy with the speed at which the formation went through the government systems of ABB? And are you happy today with the mechanism you have in place to monitor the supply chain? Because if it happens in one division, it could happen in another. Your general thinking on how your view has changed because of this situation.

Michel Demare

Olivier, I would say that on that specific one, it’s not financial governance issue, so I think the numbers were quite transparent for us. It has been basically a long technical judgment on the difficulty of the work we were doing. So basically by switching supply we obviously also start, the supply has its own equipment like trenching equipment for instance and it just appeared that this equipment was not as efficient in the kind of (ground) we had to work with and the supplier that went bankrupt and that obviously is something that it’s difficult to escalate because its in the bottom of ocean to start with, but second it’s always not a matter of clarity or reporting or lack of controls, its basically the fact that the technical conditions got worse and that the alternative supplier we found was less skilled and less well-equipped to handle it

Olivier Esnou - Exane

Just two follow on quickly, some competitors are saying that a part of the improving demand situation, especially maybe the power distribution side in due to restocking. How would you qualify? What’s your view on the impact of restocking, whether it would be in power or maybe also in automation during the quarter? And a last, final question, maybe just your view on corporate costs for the year as I think it was kind of small this quarter and I was just wondering if there's an unusual effect here? Thank you.

Joe Hogan

On the restocking or destocking piece we have to look at it by business. I think it’s a part of our automation businesses, particularly like low voltage products. So I would say we are probably in a domain pattern and they are not necessarily a stocking probably because we've seen a couple of quarters of orders coming back.

[Multiple Speakers]

On process automation whatever I think you can't look at that as restocking, that is demand as facilities start to start up again we are seeing a pull through for different kinds of automation products and equipment and systems that we have. I think when you start to get into your initial part of your question, which is like power, restocking or whatever, I don’t know honestly. But I think you have this figure anything that close through distributors has been down.

Distributors as we all know what they do from a cash standpoint when the market goes down, they are going to protect their cash side and so they are going to do a certain amount of restocking when it comes back and so I have to guess at some of that initial demand and medium voltage and also, we are seeing distribution of transformers that might be somewhat a distribution depending on what the geography is.

On the corporate cost piece, our goal for the $3 billion cost out is $330 million of G&A I believe. We feel confident we will be able to hit that number. I know that it looks like its going to be a struggle but I am sitting right next to the guy who is running it.

Michel Demare

If you remember we had commented in Q1, that we had had some exceptions that shown the G&A a bit higher than one that will you will get a real set of that if you think we are or track and obviously corporate cost is mainly G&A mainly G&A. So we should expect to see these numbers remaining at this low level or even go lower for the next two quarters.

Olivier Esnou - Exane

Actually, at the same time you are reducing your restructuring charge for the year. So, how should I read that? Basically you've done so well on the rest of the cost savings that you think you don't need to do for fixed cost savings going forward to keep the $3 billion? Or any other type of thinking behind reducing it now, while you are still in an environment where you say its kind of uncertain?

Michel Demare

Yeah, on this one, we have exited well on the cost which don’t require any restructuring like sourcing an OpEx for instance and we still see a lot of website in OpEx which is good because that is basically getting more efficient processes than being able to get more efficient processes than being able to get more output for more capacities. I think this is not a conscious decision to reduce the restructuring cost. I would rather say that this as we go through a lot of the cases that we knew would be expensive which just happened to be that I think we have learned at better terms and conditions with what we had initially estimated. So it's nothing that we pull back actually even accelerating some initiatives or adding a new one so that's in all probably still struggling a little bit more than the early divisions. But we have just executed more efficiently than we initial thought.

Operator

Next question is from Mr. Mark Troman from Bank of America/Merrill Lynch. Please go ahead sir.

Mark Troman - Bank of America/Merrill Lynch

Just a couple of questions, first one on pricing. On your chart 13, on the profit bridge you've $200 million roughly for the product price erosion, just roughly, how much of that was power products? That would be the first question. I think it was about 110 or so in Q1. And I guess is it fair to say as you go into Q3 your comparative gets easier for memory it seemed to be that you took a bit of a pricing hit in Q3, but I don't remember it being talked so much about in Q1 and Q2 last year.

So the first question on pricing and the second question a bit open-handed but clearly there are issues in China and India, and I think we know it broadly what the issues are but I'm more interested to hear what you are actually doing to try and remedy the situation. So, maybe some key points on what you're doing in China and India to fight back. That would be very helpful, thank you.

Joe Hogan

I will take the China and India while Michel works on the pricing question. On China you can see that our orders were up in China, 8% for the quarter and but if you dig down into that Mark, what you’ll see is our automation businesses did extremely well there and across the board where this process automation or low voltage products are also discrete automation and motion. So when you look at those businesses and you start to decompose them, there’s a lot of middle market work there.

This is, we adapted those products really well for the Chinese marketplace, we sell it in Chinese industry the kind of industry standards that they have and so we are really part of the flow there. It not kind of a high end strategy with those businesses. When you take a look at our products in China and that's been predominantly when you look at power products and power systems, we sell mostly power products in China. We’ve been really relying on state grid and southern grid to a certain extent. I think you know our business with State Grid is anywhere between $600 million and $800 million a year. And that’s been under pressure particularly in the transformer side. What we are increasingly doing is making sure that we modify our products to make them more cost competitive with the Chinese competitors.

And then secondly is to look at markets outside of just the classic utilities. We are looking at industrial marketplaces and different things that we can adapt these products in China and we called our in China, for-China strategy. We will want to see a lot of our competitors, GE and Siemens talk about taking products and modifying them in China for the Chinese marketplace. We kind of sit back and see the trade. When we look at several of our businesses particularly on the automation side, we’ve been doing that in China for years.

In the power market, we haven’t done as much and we have to move much more rapidly to diversify there and look at that middle market and adopt our product line more for a broader Chinese marketplace. On the Indian side, I will tell you it's a marketplace where our steel from an automation standpoint, I think we’ll see a pick up there in the third quarter.

On the power side, we have some work to do on both gas insulated switchgear and the transformers side. I feel we have a good grasp around it. What we are doing right now to move to 75% the share of our stock will help us. But we want India to be a strong export hub for us too and with that additional share that will really help. But I feel confident we know what to do in India, what we have to do in China. It's execution right now and staying on the things.

Michel Demare

On the pricing Mark, for both products in the second quarter the pricing decline is a little bit accelerated, it has been 4% and 5% so we would just like to transform to, translate it in dollars literally a bit more than half of this $200 million we've lost in price income from BP. In automation it starts being a little bit of different set so, net-net-net we are still losing a little bit of prices in discrete automation but on the other side I would say that the low voltage part, we even (inaudible) to start seeing a fuel price increases but I would say in absolute term its probably neutral for the quarter. So more than half is volt product here.

Mark Troman - Bank of America/Merrill Lynch

Just to follow-up on that, on the discrete automation, is the pricing there, is there something structural there? Or is it more is just a function of the demand? You've still got sales declining, a bit of overcapacity; is that a simple function of the demand or is there something else going on there?

Michel Demare

There is not just one answer there because in discreet automation we have for instance, robotics that are doing extremely well. It was quite a turnaround for robotics (inaudible) in terms of orders and as well in terms of price stabilization. But it’s especially in the larger quarter that we call machines that still a little bit the side of that we still have to stabilize the market.

Mark Troman - Bank of America/Merrill Lynch

And finally, part of the original question was last year the pricing pressure sort of escalated during the year at the group level. Can you just remind us how that profiled through the year, roughly?

Michel Demare

I don’t have here the data of last year so it would be a bit difficult to answer but what you are trying to do guess if we can achieve the same kind of profile in the

second half of the year.

Mark Troman - Bank of America/Merrill Lynch

I guess so because I mean last year, from memory, I think Q1 you didn't really mention much price. Q2 a little bit, Q3 it really was a topic and Q4. So I'm guessing that the comparatives are a bit easier.

Michel Demare

But if you compare to a year ago I think the year ago obviously the automation was also still not doing very well so the two sides of the portfolio, we are starting to shuffle automation, was reviewing the whole. I think what you see here now is clearly as I say the automation is speaking up quite fast, both in terms of volume and the prices are stabilizing. The are buckets actually the medium voltage part of powers is doing pretty well showing but if you are ordering take for the quarter and I think there the prices are really stabilizing, the pressure is really in high voltage and then transformers and there again not that obviously we see a lot of pressure in China, in India, in the Middle East with some other markets or some niche markets like attraction trends for almost all (inaudible) for almost a few location so I would say it’s a bit over different one like you will see before. We feel cautious on the power side. You notice the transformer market for instance is a market that has a lot of inertia so it might take-in all the 6, 12, 18 months before you see really the impact of some role applies that we see in some markets when you hit us.

So far we are happy as to with the margin we have in our backlog but it will be a challenge to keep them at this level. On the other side in automation, the congregation of higher volume and all the cost takeout, you can see in the result of this quarter.

Operator

Next question from Mr. Andreas Willi from JPMorgan.

Andreas Willi - JPMorgan

The first one just following up on power product and the profitability there maybe you can give us a bit more information about the mix, how much mix has been a driver and also with that helping us maybe to understand for the second half and to compare margins then we had a weaker first quarter, stronger second quarter, what was the mixed impact then and what we should expect for the rest of the year. Is there any unusual benefit in Q2 from a particularly specific mix? And then just a couple of sinks to clarify on the financials, the tax rate has started to creep up a little bit, what we should expect for the full year and on Ventyx you said about a $20 million quarterly hit for amortization, is that amortization for the deal or is that amortization within Ventyx for capitalized stuff there?

Michel Demare

Quickly on the last two, all guidance on Ventyx in terms of the amortization of the intangibles that have been recognized in the purchase price accounting, the guidance that we are giving is about $40 million per year, so about $10 million per quarter. Okay so that is on that part in terms of the tax rate indeed it is creeping a little bit high, we assume keeping all guidance at 27% or more because one of the issues we are dealing with for the moment is the uncertainty of having all the restructuring expenses that were in queue to be perfectly tax deductible so it had a little bit case-by-case issues. There's also some trend supply chain uncertainty that need to be resolved so we are not going to tolerate. It is more challenging than it was six months ago. At this stage all tax specialists still believe they can deliver the 27%.

Joe Hogan

On the profitability Andres, lets say you have about $100 million of cost (inaudible) as I mentioned in my opening remarks, and which overwhelmingly is what really helped when you look at that overall operating margin rate as (quarter) percent. There was a mix in there. I can't tell you specifically how rich the mix was but we did have some medium voltage in that.

Michel Demare

Yeah medium voltage is good and then also we have finally stopped bleeding in terms of volume under absorption and distribution transformer for instance and so there's a few fixed costs that we can recover from that part too. So the mix is only starting to play but obviously there's still quite some exposure in transformers and high voltage as well. So, I would still be cautious on that one.

Andreas Willi - JPMorgan

So we shouldn’t use just the Q2 as the kind of the new base for the rest of the year?

Joe Hogan

No this has a dark (inaudible) we face this thing everyday and the team did a great job in the second quarter. We are going to continue to work to cut out things hard and we will encourage you to say that this is a fight. And the longer this recession stays on, the more difficult its going to become.

Michel Demare

The division is at the high side of its range and I think this range is still valid.

Operator

The next question is from Mr. Axel Funhoff from ING. Please go ahead sir.

Axel Funhoff - ING

I have a couple of questions left. You described a very high tendering activity in the power utility industry and obviously also there are very good reasons to spend again. From that perspective, would you say that your expectations, a recovery of utility CapEx spending is just really a couple of quarters out and also when geographically do you expect the utility CapEx cycle to be driven from, that's the first question really.

Joe Hogan

I’ll tell you I think when you look at United States there actually pretty much the 2010 budget was set in 2009 as many of us know and so when you look at that, there was not a lot of money in the marketplace. The demand for electricity was down so we are experiencing a low amount of CapEx for the United States for this year. It was really set in 2009. As most of the consensus out there as we will see an increase in CapEx in the United States in 2011. You can have to guess if that's true but I think a lot of its going to do with US economy, and how robust the swing back is? As Michel indicated in the United States we saw somewhat of strengthening, flattening to strengthening in our distribution transformer business. I should tell that there's some electricity usage increase that's going on out there and that will be the first place that's hit. So I would say 2011 you should see some kind of an improvement in the United States.

In Europe the other projects we are (inaudible) have a lot of the sustainability offshore wind farms, those kinds of things and I think there's a huge bias when you read the statistics, you talk to the customers about transmission and distribution right now versus power generation, and particularly the offshore wind farms and things like that. And so those are the big areas. Now China, after an overwhelming spend in 2009, a little bit less this year, a lot of predictions are that China might be little bit stronger in 2011 too.

Michel Demare

As I mentioned in the beginning there are a lot of projects in the Middle East that we are working so it’s really emerging markets, Middle East, China, India, Brazil and then renewables in general that also create a lot of opportunities.

Axel Funhoff - ING

Makes sense. Second question on your competition, you are obviously getting a lot of questions on intensified competition from China and India and so on. But can you also speak about your traditional competitors, is there anybody who is more aggressive than what we were use to or are there any other new competitors except for those from China specifically.

Joe Hogan

I would say Michel, take care of our outside markets too but I would say that we are seeing the same level of competition with our traditional competitors and it’s on and off depending on what the product is and what the region is. The Chinese in China do give you another look and I would say it’s not necessarily at the high end of the marketplace. It’s a much more in the middle end of the range but they are very excited. The Koreans pose an issue at times too selectively by job as seen by components.

Michel Demare

But you still would agree I think maybe the big change is the Koreans are even more aggressive than they used to be in the past but that's the major change.

Joe Hogan

They do lack a bit idea and obviously Michel and I read all the analysts reports and thoughts and there's a lot of concern about the structural change in the power segment and let's say will there be, there won't be. It will be dictated by capacity, and dictated by demand and we will see how fast demand comes back but secondly remember we have very competitive plans in China, very competitive whether its grappling for the switchgear, it has to do with transformers or whatever and we can exercise that print to be able to compete with people offshore and we will increasingly do that in order to remain competitive in the marketplace and hold on margins at the same time.

Operator

The next question is from Mr. Martin Wilkie from Deutsche Bank

Martin Wilkie - Deutsche Bank

A couple of questions on the automation business, in both discrete and new voltages you saw big jumps in your margin both year-on-year and quarter-on-quarter, it looks like the cost out and the volume side I can understand. But on the mix side was how significant there it was an abnormal mixed development and as we shouldn't expect to be repeated in next quarter or later in the year or was really the cost out and the volume that really drove those margins and then secondly also on those business of phenomenal strengthening of order intake, just if you could comment, was there any change in that trajectory. During the quarter obviously there have been at the macro levels obviously increasing for (inaudible) slowdown in the second half, did you see any sort of peeling off of that order intake towards the end of the quarter or was it pretty consistent inside the quarter. Thanks.

Joe Hogan

The last question first. I would say in trajectory it’s pretty consistent throughout the quarter. In fact we saw base orders and which is the main indicator in this case Martin, will remain stable or even up as we went into June. I am talking about the discrete automation and also low voltage business. We also saw that in process automation too. On, yes about discrete automation motion in those margin, or mix or whatever I think Michel can verify this. Do you think I did go back.

Michel Demare

Yeah I think if you look overall the low voltage products for instance is like you said in the volume and cost take out because (inaudible) and the fact that the places are holding and obviously you get reduced leverage by picking all these fixed costs away. In the discrete automation there's still a little bit of mix also because as I mentioned before the robotic business is really now showing excellent signs of recovery and as you know we have spent a lot of money to restart the business so if we get more volume in the change its quite fast and so we also got a little bit of help from the robotics but we are still losing a lot of money a year ago and in fact (inaudible) so that is quite good but as I mentioned before it is slightly offset as well by the fact that in all large machines business we still have a few things to improve. So a high level of summary I agree, it’s a volume and cost cutting.

Operator

The next question is from Mr. James Moore from Redburn Partners. Please go ahead sir.

James Moore - Redburn Partners

A couple of questions, three questions if I could. In the first half, you had positive mix as a group level on your bridge. Have you got any visibility on how that, at a group level, is going to develop into the second half? And you made some comments on pricing and gross margins. Could you say a little bit about the gross margins and the backlog and where they are against the P&L, and where pricing is in order that are coming in today versus what we're seeing in the P&L? Just so we can think really clearly about how pricing in the P&L should develop going forward. And then finally, on R&D spend you said you are going to lift it. Could you say where it is as a percent of sales today versus last year and where it is going to, so what the delta is?

Joe Hogan

Okay, start it from the end first from the R&D standpoint, we have been listing it year-on-year and so there’s no I’m not announcing a change in operations during an R&D. In general we spend anywhere between 3% and 3.5% of our revenue to R&D and we, it’s a big process within ABB’s understanding exactly where those funds go, and how and we just want to make sure that as we instituted our cost out processes across the company we maintained the radar and we spend to make sure that we are competitive in the marketplace and we continue to do that. As far as positive mix going forward, I’m not ready to call that one (expensive) in these couple of quarters.

Michel Demare

I think this quarter was better because the automation recovery has started to offset the fact that we have less volume in power products so, you will have to have a vision that on one side, automation continues recovery and that on the second side our products stabilize. When it would happen that I think it’s a bit difficult to predict at this stage. If you look at the margins, we will surprise you probably, but I will say we look today at our margins of ordering pick and even our backlog that we are actually slightly improving but we are to be cautious with that as well because the major reason why that improving is that a percentage of that intake that we have read so far this year is way below last year. This quarter 11%, quarter last year was 19% so it is clear that if we start and we firmly count on bagging some of the very large orders in the second half of the year will be either the margin on all this will start coming down because it will just be a mix issue but also so far we are doing well. We are executing still okay despite the problem we have on the power system this quarter but we are also ready for more challenging condition and this is why we are not slowing down the cost cutting program because we still it’s going take a chance to deliver the margins at the bottom line.

James Moore - Redburn Partners

Just a follow-up on that, if you look at your year-over-year pricing as you talked about on revenues and you look at your year-on-year pricing order. Is there a big difference that’s going to hit the second half as the P&L delivers that?

Michel Demare

At this stage, no I would say it’s more or less the same but again once we take large orders it might change and it’s normal. It’s not that large orders have less margins interestingly we are still doing a good margin on ABB count but we also take a lot of other cost that I just passed through that you get on the top line and on which you don’t make any margin.

Operator

Your next question comes from Thomas Baumann from Neue Zurcher Bank.

Michel Demare

I didn’t know that one but its interesting.

Thomas Baumann - Neue Zurcher Bank

I don’t know it’s a promotion or allegations. First to your remark the tender backlog for power systems is close to record levels. Does that refer to the charge you want published earlier we saw a record level in Q2. And also does that still include the $700 million order or in other words direct level is that as per end of June or as end of today.

My second question goes actually to note 11 in your note where you had talked about the accumulative cost of the reshuffling and the expected total cost. There we have $700 accumulated and billing in total makes a difference of $300 for the remainder of the year.

Michel Demare

We said it would be a bit above 300, actually I think so far we have left a guidance for this year of $1.1 and so now we say it will be between $1.50 billion and $1.100.

Thomas Baumann - Neue Zurcher Bank

Probably it should take what you just said and that's okay.

Michel Demare

On the tender backlog, yes indeed it makes reference to (inaudible) based on the chart that we used to show from time to time and so basically what we refer today is the trend that of spending at the end of June. It will be full. We got this with a large order for $700 million in Germany and at this time it was a kind of record high backlog since we have measuring that.

Operator

The next question is from Mr. Simon Smith with Credit Suisse. Please go ahead sir.

Simon Smith - Credit Suisse

I had three questions, first one was with regard to the low voltage products division and obviously a fantastic margin you have achieved there, I think in the commentary you have given so far you have sort of talked about as being more down to sort of volume and cost. If I take that and look at it in the context of the year which we don’t really know the exact seasonality of this business is still being a relatively new reporting structure but this does employ now that you are going to be coming in on an annual basis about the peak margins that you achieved in that division?

Joe Hogan

Well, Simon we separated that from automation products last year to give us more visibility and new more visibility too. You know this is, as you saw it’s a huge amount of leverage on volume, I think 6 points when you take a look at year-on-year and a lot of that came from cost reduction piece and then holding those cost and getting the margin leverage as you would guess. I’d say this shouldn’t be a surprise I mean take a look at competitors in the marketplace I think would launch on 20% to 25% operating profit with there portfolio right now, too, and ours is somewhat similar. So I don’t think it’s out of whack in that sense.

Simon Smith - Credit Suisse

Okay thank you. In terms of India I mean you obviously talked about the competitive environment that you are seeing in China, and you sort of mentioned the fact that the weaker outer flow in India was due to competition and I just wonder if you could maybe classify as to where it is you think you are losing out, I mean is it a situation of you viewing competitors pricing business unrealistic margins and you are having to walk away from it? Is it a case of the type of products that are being purchased in the market whereas you are not strong and you need to move into? Or is there sort of some other dynamic in terms of locals favored over international players that is having an impact on you?

Michel Demare

I’ll take this question because Joe has to reach to the airport to catch a plane. It’s a little bit of everything, on one side there is a few one offs we are constantly deciding to leave some businesses that we don’t think are good for us in the future. I think I mentioned that before for instance the business was for rural electrification. So that had an impact on the top line but as well on the cost of putting off the business like this. The segment is a little bit an issue of competitive activity. It’s a very low priced market in India, high volume with very difficult in terms of being there with the right price level and so we have to deliver it first by improving the volatility and the efficiency of our own factories and as well accelerating the development of our products that specific for this market that is what the market wants to pay for a lot more, we already started that a couple of years but I would say the need to deliver now that has accelerated quite a lot so I was just there recently. I think we see exactly what are the problems we are working on. It’s a journey and one we have to try to get the best but it is extremely competitive for sure. Also the goal in the future is once we have established in the low cost basis to use it as an export hub as well.

Simon Smith - Credit Suisse

Alright, thanks, thank you, just quickly, in your profit bridge, when you show the impacts due to contract margins, the $140 million, does that include the $80 million that relates to [multiple speakers].

Michel Demare

That includes the $80 million, so what you have there is basically two things it’s the cost overruns that you may have on projects like the $80 that will reflect in power systems and also the fact that from time-to-time we just take projects that are very similar in nature but are lower than what we did last year, you can have that on some standard sub-stations for your consumers there also the competition is very intense and what we do there is we quoted the net margin change, because if we have to give you a pricing analysis there, our prices are sometimes are down 25 or 30% and so our cost. So I think it would totally bias the analysis and that’s why we wanted to focus on the net margin sometimes it is more than it was a year ago and that is what we reflect in that column too.

Operator

The next question from Mr. Colin Gibson - HSBC. Please go ahead sir.

Colin Gibson - HSBC

Three questions if I can please. First one on book-to-bill. We've gotten used to, during the last couple of years of downturn, something of a kind of random walk on book-to-bill. We get one strong quarter and then we get one weaker quarter. And I guess that's what we've have a little bit so far this year; a pretty strong quarter from a book-to-bill point of view in Q1 and a weaker one in Q2. How do you see that going into the second half of the year?

Is that kind of random walk trend continuing? Or does the pickup in automation, for example, give you more hope of a more sustainable trend there?

Michel Demare

I would say, yes, I would expect to see a more sustainable trend and again as economies continue like this and that automation business captures as well the change in economic condition. I think on the automation side for sure we should continue seeing a positive book-to-bill and then the second thing is we really expect to book large orders in the second quarter, that should indeed improve the book-to-bill in Power even if some of the product size of the power business may still get challenged. So I would rather expect to stay in the positive territory.

Colin Gibson - HSBC

Second one, I wonder if you could give us a more color on growth in discrete automation. I understand clearly from your comments in the press release and in answer to previous questions that robotics has done particularly well here in the first half of the year. But again, if I take a step back or three steps back and look at factory automation historically, I would have to say the history of the last 10, 15 years has been a bit lackluster. Growth has probably been poorer than most of the vendors would've been hoping. Do you see any signs at the moment that what is happening is just a cyclical bounce back? Or do you think it is the start of something potentially more encouraging than that?

Michel Demare

Well you can probably not give a global answer to that. As Joe said before we are still very cautious with Europe and US because the kind of uptick that we’ve seen this quarter is not exactly in line with what you read in the headlines. So that one we have to continue watching that and be cautious. What happens in Asia on the other side is for sure something that is beyond question mark or if you just Asia for instance automation business, two out of three of the automation business in Asia were up 60% for the quarter.

So it is an extremely strong number, pretty good in the Middle East too. So I think yes, we start seeing a fundamental change and before this all quite had started, you look at some business units in some discrete automation business that have always been an extreme growth factor like low voltage drive for instance, extremely strong good margin business.

Or the power, electronic and medium voltage drives that becomes more and more at the core for lot of the combined power and automation offering that we’ve. Sometimes where you have a little bit more volatilities when you go to the higher components like machines, you know the heavier machines that one depends a little bit more a little bit on real CapEx equipments, so that it’s a bit less and then you have robotics. So we all know where robotics had been. It has really been a terrible collapse in the last three years and now we have a fantastic rebound obviously from a very low basis, but at least we are ready for that. Meanwhile we have cut the cost, we have moved all the production to China and I think now we are extremely well placed to take up the market as it moves on.

Colin Gibson - HSBC

Lastly in terms of your strategic direction, I guess the creation of the Low Voltage Products division together with the chloride bid kind of shows your hand a bit in terms of the way you are thinking about the strategic direction of the Group. Using what is it Emerson's terminology what does your M&A funnel look like in that space? Obviously I'm not asking about individual deals because [multiple speakers] but do you feel you have other ideas to pursue in that space?

Michel Demare

I think what you have to look at is now is not just think of products. You can think okay we were trying to get a specific product there, but we have to also look at applications. For instance, we have clearly seen the data centers, for instance, systems where there is a lot of things to do. UPS will be an interesting part as other ways to offer energy storage solution and even to much more package what we have today in-house in order to have an application specifically for this kind of market. So what you see more and more. I think if you talk about showing your hands, don’t really think so because the market is moving from being just pushing products to a customer in terms of much more building solutions and we have the great portfolio of power on one side, automation on the other. Will it be nice to compliment it, but we will find other ways?

Operator

Next question from Mark Fielding, CT.

Mark Fielding - Citigroup

Actually three questions. The first one, could you just clarify? My impression is that the problem in Power Systems actually relates to three contracts in terms of undersea cabling. Could you just clarify what the sort of total value of these contracts are, where we are on the timeline of them and whether they're approaching the completion?

Michel Demare

Mark, I would pass on that one because I have said it’s a number of contracts. It’s less than five, but I don’t want to get more in detail, because as I say it is also a lot of negotiation with the customers of the insurance company. So I think at this stage we should refrain from getting into this kind of details. So while I say that yes, we take a charge this quarter. It might not be the end of it, but I would not expect that it would get worse than what we have charged this quarter.

So there is another charge, it would even be more than that and I still think there is a lot of upside, once we solved the technical. On these kind of things, you first solve your technical problems, you deliver. Then you sit around the table to try to deal with the recovery. So I leave it there if you don’t mind because it is quite sensitive.

Mark Fielding - Citigroup

Just following up on Power Systems, the answer to Ben's question right at the start of the Q&A you talked about how if this was the end of the charges you still could be towards that 6% margin. I assume on that basis you're talking on a sort of adjusted, not adjusted for the charges but adjusted for derivatives and for restructuring?

Michel Demare

Yes, we have to always judge on an adjusted operating basis because derivatives in that business has a big impact since we do a lot of currency hedging and commodity hedging and nobody knows which direction that goes, with time it will adjust itself. So I’m talking on an operation basis. This quarter actually if you’d correct for hedging, restructuring, it is capable of provision. Actually the business is running at the margin above 7%, so it can still do that for the rest of the quarter. All that I said is that with the $80 million on an annual basis, more at 1% of EBIT, and it will be difficult in the currency constancies to raise the operational EBIT to 8% in order to offset that, that’s why I say I feel more likelihood of being close to 6% than to 7.

Mark Fielding - Citigroup

And finally on the Automation business, could you just talk about how the momentum has developed through the quarter? I mean, your base orders for example for the group don't look like they particularly accelerated quarter-on-quarter. So I'm just trying to get a feel of actually how you are moving through the quarter?

Michel Demare

Well, if I recall in the first quarter we still had negative base orders overall.

Mark Fielding - Citigroup

They were up about 15% Q-on-Q.

Michel Demare

The group base orders were down 5% in the first quarter and now we are up 15% and obviously a lot of these base orders are on the automation side, some on the project side as well which is still down. So I would say, it is really something that we commented in the first quarter that we really reached the bottom for the whole business in February, that was really the disaster month of the quarter. March was much better and after that we have had a pretty smooth pattern to all the second quarter that build up to the good results we show finally today. So it has been a good and positive trend development throughout the quarter.

Operator

And last question for today is from (inaudible) Cheuvreux.

Unidentified Analyst

I was just wondering if you could comment a bit on what you see in Central and Eastern Europe in terms of demand currently. And I had a second question again coming back on Power Products. Given the still uncertain outlook and important price pressure, in particular on the transmission side, do you still envisage to do additional cost cutting in Power Products at some stage? Or do you think currently that the improvement in, for instance, medium voltage will not make this necessary?

Michel Demare

On the second question, in terms of the power product. No, indeed we are working, it’s not drafting plans, because we always say we have all kind of backup plans and so there clearly we still have some problems of capacity utilization and some question marks about how long the recovery will take so the tendency there is to either increase the program and look for additional saving obviously in sourcing as much as we can, but as well in footprint because there also the market has moved quite a lot, so it is needed to do that. So that will happen and that’s why it’s a constant adjustment. This cost cutting program has never being a (inaudible) the same for all

For instance, we have cut G&A, but not selling on R&D and obviously now with the automation business is peaking where even in fact investing and selling in tools businesses, but on the power side, we need to continue trying to keep these costs under control and get more savings. We have (inaudible) the quarter and I think it’s the only way going ahead for it.

On your first question, in terms of Central Europe, I am trying to find some data here. Let’s say Europe overall was up as we showed you before. We had a decent quarter in Russia, although still from a lower base obviously and if I recall I think the business in Poland and Czech was quite not booming, but at least showing positive number. So it has been for the whole of Europe, quite a decent quarter I must say, we hadn’t seen that since quite a while.

Well, thank you very much, that was the last question. I thank you all for your attention. I think it’s the right time to wish you a good summer and we will be talking again at the Capital Market Day in September which Michelle is on September 10th. Thank you very much and have a nice evening. Bye.

Operator

Ladies and gentlemen, the conference is now over. Thank you for choosing the Chorus facility and thanks for participating in the conference. You may now disconnect your lines. Good bye.

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