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Executives

Emmanuelle Châtelain - IR

Patrick Kron - Chairman and CEO

Nicolas Tissot - CFO

Analysts

Nick Paton - Execution Noble

James Moore - Redburn

Andreas Willi - JPMorgan

Ben Uglow - Morgan Stanley

Martin Prozesky - Berstein

Martin Wilkie - Deutsche Bank

Olivier Esnou - Exane BNP Paribas

Frederic Stahl - UBS

Alfred Glaser - Cheuvreux

Arnaud Schmit - Natixis

Lisa Randall - Nomura

Gael De-Bray - SG

Ben Elias - Sterne Agee

Alstom SA (OTCPK:AOMFF) F1Q 2011 (Qtr End 06/30/2010) Earnings Call July 20, 2010 10:00 AM ET

Patrick Kron

Good morning ladies and gentlemen and welcome to the conference call on orders and sales for the first quarter of the current fiscal year; that means numbers from the April 1, 2010 to the June 30, 2010. We have published as usual a press release this morning, giving you all the figures by sector and by geography, as well as variations in both reported and organic basis, which mainly includes currency effect.

You will also find a brief summary of the main events of this very active quarter, the most significant being obviously the closing of the acquisition of the Areva transmission, which occurred on June 7, and the creation of the third sector within the group, Alstom Grid.

As orders and sales for Alstom Grid were not yet available on the June 30 for release, the new sector will be fully consolidated on September 30, 2010 in the half year results. And this sector will account for four months that spans from the June 1 till end of September.

Coming back on the publication this morning, orders, as you have seen for the first quarter were at €3.1 billion, clearly still impacted by the lack of large contracts, particularly in Power, as customers continue to lay their investments in new power plants.

The tendering activity remains sustained. Clients are waiting for better economic outlook before finalizing their new large investments. Nevertheless, as you may have seen as well, the flow of medium and small-sized contracts were listed well, and the rail market remained sound, offering opportunities in both developed economies and emerging markets.

The backlog is stable at €42 billion as a consequence of a positive €1.3 billion currency effect. It represents 27 months of sales. If I go by sector, Power recorded orders of just slightly below €2 billion during the quarter. This is a decrease of 35% compared to Q1 last year, and this decrease came for the challenging commercial environment in new equipment, as thermal systems and products received only in the first quarter, small and medium-sized orders.

Thermal services registered a good number of projects for both retrofit and classical regular service, as well as two operation and maintenance contracts in Spain. The numbers in my view confirm the better resilience of this activity. In Renewable, the main orders booked were for hydel contracts in the Americas as well as for wind turbines in Brazil.

In Transport, again you know that this is an activity where orders are bulky. Orders represented €1.1 billion in the quarter. The main contracts booked in the first quarter were locomotives in Russia for slightly above €400 million, as well as suburban trains and maintenance in Sweden. But besides this medium-sized locomotive contract in Russia, no large contracts during the quarter.

A word on sales now. They reached €4.7 billion, slightly down compared to the same period of last year. They grew in Transport by 9% and they started as expected to decline in Power, down 6% versus Q1 of last year, and this is clearly the consequence of the order evolution over the past year in the sector.

Concerning the financial situation of the group, during the first quarter, Alstom turned into a net debt position, and surprisingly due to the financing of Areva transmission for €2.1 billion, the payment of the dividend for €300 million to €400 million as well as the impact on the free cash flow of the low book-to-bill ratio of 0.65 for the quarter.

We gave guidance for the year of 2010/11 and 2011/12 of operating margins between 7% and 8%, which I confirm. This guidance, as already expressed is based upon proper contract execution and gradual recovery of demand. This was the introduction I wanted to make on the comments of this quarterly orders and sales. I thank you for your attention.

And with Nicolas Tissot, our CFO, and Emmanuelle Châtelain, we are now at your disposal to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Nick Paton from Execution Noble.

Nick Paton - Execution Noble

I've got two questions. The first one is on your Power business. It seems as though the market has recovered to some degree, although it's not entirely clear if the market has recovered significantly or just that the suppliers are now starting to offer products at prices which the customers are asking for. And it certainly seems as though Siemens have won quite a few orders for both their H-frame and their F-frame turbine. I just wondered if you could make a comment on why it seems that they are taking market share from you. Is it only that they are being more aggressive on price, or is there some other reason that they are managing to get orders while you are not?

And the second question is, you mentioned in the press release and you said in your opening remarks that sales declined as expected in Power. And I guess it's obvious given the order decline that sales will decline, but I guess we're all a little bit unclear as to the scheduling of those orders for the next few years. So perhaps you could give us some guidance as to what exactly your expectations are for sales for the next couple of years in terms of the gradual ramp-down to a level commensurate with orders. Thanks.

Patrick Kron

Well, I'll first comment on the recovery of the market and the loss of market share. I would not agree on both. I mean, I don't see any fundamental change in the market situation. I commented it a few weeks ago when we had our shareholders meeting, and nothing has fundamentally changed so far. As I said, I consider that on one hand there is a strong interest on the customer base, which materializes into a significant tendering activity.

But on the other end I still see a lag in the decision making by customers, and in the market, in my view, for new projects and very large projects remain unclear. And we may see a positive evolution, but so far I have no elements to quantify and comment on it. You mentioned some orders taken by competitors on H-frame so far. The fact that a competitor has taken one large H-frame order in North America doesn't in my view quantify the evolution of the market.

In terms of pricing, I have not changed my understanding and my view on the market. When you look at the orders taken in new equipments, unfortunately we have not elements to give a comprehensive view on pricing evolution. Some competitors commented on a limited decline in some prices. I said last time that I was expecting that there will be a price pressure on ongoing tenders and I've not changed my mind on this point. Concerning sales evolution, what we have said, is that we expect order of sales to decline this year by a high single digit number for the group, and I confirm this judgment.

What will happen, I don't give guidance per sector. And what will happen next year, we definitely there is trick to evolutions of orders. I mean that definitely is a lack between an order and seeing it in the sales. But still, what will happen next year is not totally unrelated, but what will happen in ordering this one. So again, I don't give additional guidance on things.

Nick Paton - Execution Noble

If I could just maybe quickly on your first answer, I am finding it difficult to sort of reconcile what you're saying with what I can see from the orders, Siemens, because it's not just H-frame turbines that they've installed, they've installed four gas turbines in India, they've had two contracts in the U.S. one of which was for three F-frame turbine another number of F-frame turbines and the H-frame turbine contract. So it's not just the H-frame that they've selling, it seems though that they're taking market share from you in the F-frame turbines as well?

Patrick Kron

As we don't claim 100% market share in this segment, the fact that competitors may have orders is not inconsistent with my statement. If I look at globally at all the orders taking by all the industry, I don't think that it contradicts myself. It means that currently the market is soft and has not yet been rebounding. Does it mean that we are not going to take orders in the coming weeks and months? I don't know, because as I said, we are in an active tendering situation and active tendering means expectations of orders. I mean, we get one. I learned to my expense that it's not good to forecast orders because I don't know if a specific tender will turn into an order.

And additionally, we are going to win the order or if someone else will do. But the fact that Siemens has taken two turbines here and four there doesn't mean that the market is back, that's where mean market share.

Operator

Our next question comes from the line of James Moor from Redburn.

James Moore - Redburn

Patrick, I've got three questions. One is a follow up to Nick's really. Can you say anything about the gross margin in the orders you've taken in the quarter? And in the backlog against what you've delivered in the P&L over the last year or so? Have you got visibility on that gross margin, and has it rolled over from a particular level to being below the P&L? Secondly, just trying to understand your comments about the tendering activity that's been there for a year or so now.

Patrick Kron

Yes.

James Moore - Redburn

Is it that demand is there at a price and you're just not prepared to go to that price, or is that the demand is not there at any price at all currently? And then thirdly, regionally, would it be possible to rank your view on where Power orders are going to come back when they do come back in terms of which is first, which is last, the way it currently looks? So is it that Middle East first, then Asia, then U.S. and Europe just not for a long time, or do you have a view that some of the western markets can come back in the same timeframe as the emerging?

Patrick Kron

Okay. The first point is that on gross margin, again, when you look at the mix of the orders we take, obviously it's a good mix. But unfortunately, the volumes are not there. So we are facing good margins in the backlog and good margins in the order, but at the same time volume issue. So therefore you know that to execute our best, we need the right mix of term fees, equipment and services. As we see some weaknesses in the plant area, the system area and the equipment areas, the margins are good, but the volumes, I mean, there is no element new on that field. And obviously, having the mix that we have is positive in term of matching margins, but negative in terms of volumes, considering the tendering and concerning the issue of the price.

I mean the situation is very simple. The customers don't order the new tickets so far, because of a lack of visibility of their own markets and question marks on whether they need it or not. So in other terms, this is not because we give them a discount that they are going to buy on the power plant in which they are not a 100% sure that they need it. They will first make the decision, "I need it." And then I promise that they will not forget to put all the potential suppliers under pressure to extract as much price as they can for that. And then we see on whether there is discipline in the market or whether there is not. This is the sequence.

Concerning the rebound of the market and where the demand is expected to come, I don't know, I have no crystal ball. But it's clear, and this is something that will not come as a surprise that demand in emerging countries is already there and that the question is probably that because of the low growth rate in Europe, Europe is not necessarily going to be the first to rebound. So I think that we see, what I'm expecting is orders to come first from emerging countries and probably Middle East, and then coming from developed countries but with a specific situations on the mixed season and on the projects. But the general picture of the economy should be reflected in the infrastructure market and in our future orders.

James Moore - Redburn

Just to follow up on your regional comment, if I could. Your Middle East Africa level from '97 to 2007 was an average of 8%, and then it ballooned up to a very strong one-off 25% in '09. Do you think with the development of the Middle East and Africa that we can get back to those high levels, maybe not the full quarter of your Group orders, but move back above the long term average from the low level today, or do you think that was just a one-off?

Patrick Kron

No, I think it will depend. I mean, it's extremely difficult to extract a trend from this type number as you described. It's clear that when we had one year or more or less one-third of the total Power orders coming from Middle East Africa, this was a peak, and this peak was related by the fact because we had one large coal plant in South Africa which is diesel power and diesel plant. In the Gulf plus Shoaiba which is an oil-based power plant in Saudi Arabia. So this is the combination which make the number pick up.

If we reject a number of good orders in Middle East Africa, it will rebound. But it's difficult to consider that under any type of trend, having 30%, 25% or 30% coming from this region is logical. But it can well happen one specific period in time if we get large orders coming from there.

Operator

Our next question comes from the line of Andreas Willi from JPMorgan.

Andreas Willi - JPMorgan

I have two questions. First one on Transport, which surprised with good organic growth in Q1 after a more lackluster 2010, is that just due to the phasing of some specific contracts, or is that a more sustainable run rate?

And the second question on Alstom Grid. Is there anything you can say about the maybe run rate of profitability of that business, or maybe comment relative to what you have said in the past about what level of profitability you will start to consolidate that business?

Patrick Kron

Well, on the second one we will comment during the H1, and give you details on the situation. I mean there is nothing which needs urgent reporting and warnings and early information. As we said, we have no significant surprise in the way we take over this business. That's the first comment.

The second one is, this business is under pressure because of the conduction environment as described by our competitors and as already explained. So I will comment on the profitability of this business in due time.

Concerning Transport, I think that the 9% is a high level. You know that the milestones, recognitions, make some volatility from one quarter to the other. By memory, Q1 of last year was not the brightest quarter, so what I was saying is that we have this growth of Transport by 9% is a high number, especially when you have in mind that we have completed the execution of a large contract in the U.S. in New York, and that this is not repeated this year and this represented €400 billion or €500 billion last year.

So this is normal, and when we close one contract, another one starts etcetera, but this makes a step-down in terms of profile as we executed a significant start to this contract last year, and we have not this contract anymore this year. So to cut a long story short, I'm not expecting anything close to 9% in growth in sales in transport which I hope we'll go, but no I'm not expecting.

Operator

(Operator Instructions) Our next question comes from the line of Ben Uglow from Morgan Stanley.

Ben Uglow - Morgan Stanley

A couple of questions, first of all on Power orders. The new equipment order intake for the quarter, I was a little surprised, it's still very, very low, €405 million. Could you just tell us what the composition of that €405 million is? What sort of orders go in there?

And then I guess the follow-on question is, and I realize this is a very difficult question to answer. If you don't receive any further large contracts in the near term, is this €405 million, is that a sort of trough level that we should think about; i.e., €2 billion of Power orders, is this basically in your view going to be the trough?

And secondly, in terms of the outlook, obviously we're waiting for utilities to make investment decisions. What is the likelihood of a scenario where they just continue to defer? Why can't we see this deferment of tender activity continue well into 2011?

Patrick Kron

On the first one, the €400 million is an addition of small events, equipments and various type of products that we have been selling. I think that the biggest ticket within there is probably one order of €100 million. So nothing in India actually in this team area. So nothing really big. So it's a sum of such small ones.

Is 400 going to be a trough level? I hope frankly speaking, because that means €1.5 billion. If I assume that there are four quarters in a year that makes around €1.5 billion of new equipments and systems. Getting below that number would be a questionable situation.

So I do trust that this is a trough level. But obviously, getting a large ticket on one quarter rather than another one changes the analysis of the specific quarter. So yes, I hope that this is a trough level.

On the deferral of decisions by the European utilities, again there is no clear-cut reason for the situation to change from one day to the other. It will be the evolution of the expectations that on the way they assess their markets and their needs in the market. So as I said, if this situation was to continue, why are (they) flooding us with questions, request and ask for proposals? But again, I've been telling you that the tendering activity was sustained for a significant period of time.

And I didn't hide the fact that I was not sure when it will turn into orders, and I'm still in this (wavering). Some of your colleagues are mentioning orders taken by competitors. There will be orders taken by us at one point in time as well. But first, the market needs to resume.

So you can build any scenario as you want; some can be bright ones, some darker ones. And that's no clue to us except to add the fact that again, customers have an interest in what we do, and I hope it was done one way or another.

Ben Uglow - Morgan Stanley

You specifically mentioned the European utilities. Is it fair to say that the picture outside of Europe is significantly better than what we're seeing within Europe? i.e., if we look at Alstom globally, you're far more confident about securing orders overall than you are simply by looking at your traditional European customer base. Is that a fair statement?

Patrick Kron

Well, I would say not necessarily, because take the U.S. situation, I think that there will be orders in the U.S., and this is not inconsistent with the fact that we have started an operation in Tennessee to address these orders, but it has not yet clearly come so far. So obviously the low growth in Europe combined with addition of capacity doesn't ease the reserve margin situation which was tight 18 months ago and which is less today.

But again, you know that when you order or (plant it), it is for what will happen two to five years from now. So therefore, it's more an anticipation done on what's going to happen somehow in the market. But you talked to the European utilities as much as I do, so you get all the clues as well.

Operator

Our next question comes from Martin Prozesky from Bernstein.

Martin Prozesky - Bernstein

Three questions, please. The first question is on Chattanooga and the ramp-up there. Can you talk a bit about your plans, given you haven't seen orders, as you just mentioned, Patrick? How are you going to ramp that facility up? Is it going to be gradual and what should we expect in terms of negative absorption there?

Second question on Russia. You've got the rail joint venture now there, the stake in Transmashholding. What's happening on Power in Russia? Do you see any signs of potential orders coming out of Russia in terms of the growth in the market overall?

And then last question on headcount. You've been reducing headcount last year in FY'10 mostly through attrition and non-renewal of temporary contracts. Is that continuing or accelerating? Are you still reducing headcount the way you were in FY'10?

Patrick Kron

If I look at Chattanooga, this plants at full speed. We'll employ 350 full time employees. And again, we are going to ramp up this facility depending on the orders we take. So if there are no orders kicking in, it will be a slow ramp up; if we get orders, we have a variety obviously of some equipments under manufacturing in Chattanooga.

We had several, tens of customers visiting the facility, and all of them were extremely supportive by what we are doing there. If the ramp up is slower, it shows that there will some under-absorption, but it's not something material. Again, we are labor-intensive but not really capital-intensive. So the under-absorption would have been, we hire 350 employees, then the market falls off the cliff and we are with these people that we are slow in adapting because we don't want to kill capacity with skilled labor which is difficult to replace.

We are not in this case. We are in a case where we face a slowdown in the market before having the full capacity in place. Therefore, it gives us the flexibility to adapt. In RZD in Russia we are in good shape. You have seen by the way that the relationship is not only platonic but we have built some practical contracts between us, and this has turned into a project between RZD, the Russian Railways and Transmashholding on one hand, plus a contract between Transmashholding and Alstom Transport on the other hand. And this would create activity along the chain. So I think it's a confirmation that we are moving in the right track.

We have also a number of opportunities in the area, Kazakhstan etcetera, in which we are working in Power. There are a number of initiatives there. I would say that the Power market remains challenging in the zone, and we are working there but there is nothing specific that I can report.

On the headcount, the situation is the following: Last year, as you kindly mentioned, we adapted our capacity and more specifically our headcount. We talk about headcounts, because this is the number one parameter within our fixed cost base. I talked about labor intensity and the capital intensity. And last year we reduced our manpower under fixed-term employees. This depends on the service activities, etcetera. It depends on the sizeable activity along the year as well as with permanent employees.

And last year, if you have the numbers in mind we reduced by 2500 our permanent employees, and we've done the same amount for the fixed-term ones. That means 500-plus per quarter, and we are in the same mode currently and quarter-to-quarter we expect a permanent employee reduction of 500 to1000, plus fixed-term adjustments depending on the business needs as they go. And again, if we have the service contract somewhere which implies to higher fixed-term employees, I think we not hesitate before doing.

This being said, we will regularly review, and again I don't think that we have no activities in our factory. I remind you that when you look at the sales level, they remain quite sustained.

This being said, as the orders are going down we are going to fill that in our (concrete) engineering and industrial footprint, and we will regularly, as we did, address the needs of adjustments should they be conformed. I gave guidance of restructuring costs which would increase this year compared to the previous one, which doubled compared to the former one. So this means that we will gradually adapt, plus take some specific actions if and when needed.

Operator

Our next question comes from the line of Martin Wilkie from Deutsche Bank.

Martin Wilkie - Deutsche Bank

A couple of questions related to China. Firstly, there's been a lot of press coverage recently from some of your US and German peers commenting that China's becoming a much more difficult market for international players. I'm just wondering given you've obviously got some local companies there, Wuhan Boiler, Tianjin Hydro and others, have you seen any change in the environment in your Chinese operations?

And then secondly related to Chinese competition; outside of China, we saw China investing significantly in Argentina recently. It seems that some of that order win was helped by financing. I'm wondering if you could comment on whether or not financing for projects is now becoming more of a precondition for winning orders, and if it is, would you have any response or any ability to help some of your customers gain that financing?

Patrick Kron

On the first one may be compared to some of my peers. I've never commented that China was an easy market so I am not going to try on it becoming difficult one. No I mean we're active in China, we've substantially increased our footprint. And you know that we've a strict policy in terms of technology transfers. When we consider that we can go in a technology transfer we do. When we feel it's not Alstom interest and shareholders interest, we don't. And this is what we've done in our high speed train, where, as you have seen, we've not participated in that.

I would say that this is something we're going to continue; so we intend to use our Chinese footprint, one, to participate in the Chinese market. And we'll see if these conditions remain as they were or if they deteriorate. And obviously, should it be the case we'll have to make it clear. But this is the first one. But I want to insist on that. We also want to use our Chinese footprint as a base for exports, that's what we've being doing, typically in Hydro projects in South East Asia. And we intend to continue to do. So I mean Chinese is not an easy market because the history of competition and we participate, and if there anything which needs to be signaled, we'll let it know.

The second one is we've been doing business in China for fifty years. So I mean we've a feel of what happens there. The second one is on financing in Argentina. In Argentina, the projects which have been pronounced and are usually disassociate announcement and action but what has been enough in Argentina is very much related to infrastructure where we have no significant interest. And is also related to some original already available contracts in some metro towns in which we've not been participating. So there were some speculations that they were working on some areas where we were focusing and this has not been the case.

It's clear that financing has probably been supporting the sales of new details. You know that our policy is clear in this area except if I get a unanimous decision of my shareholders take this policy, which I am not expecting and we're not going to provide financing for at least two reasons. The first one is we don't want and the second is we cannot even if we want. So we are not going to provide financing. This being said, we classically work with our customers to provide them with some external sources of financing which whom we have ongoing relationships. So I mean we give some financing services and support to our customers. But this by all means doesn't involve neither Alstom nor obviously its balance sheet. So this is what we do.

This is a comment on Chinese competition and on Chinese involvement in some markets. I would say that in a number of cases, I am not sure that this has been customers taken out of our reach. I mean in some cases the projects were taken by some Chinese competitors with some financing, while not newly available for classical business deals. If the combination of a competitor under state decides to create the customer by providing some financing which is not available under classical business grants, then I would say its effect doesn't take anything from our mouth.

Operator

Our next question comes from the line of Olivier Esnou from Exane

Olivier Esnou - Exane BNP Paribas

Just wanted maybe the date on partnership and opportunities in India, because there's a lot of activity we hear on that market and you're working on some, and maybe you could just tell us where you stand and what are the opportunities for you over the next twelve months. And maybe just rebounding on the last question regarding financing, just to confirm really, in none of your tendering activity has financing been a hurdle preventing you from closing a deal at this stage?

Patrick Kron

The to second one is no, I would say that a number on some projects may be subject to financing. But then it's an order of the day and it is subject to improvising.

I wouldn't say that it has fundamentally changed compared to past situations. We talked about Argentina. Once again, you know that we were prepared to execute their high speed trains project. The high speed train project has not got so far any type of financing and therefore it has never become anything else than a concept. And it has never been booked and that's the way we clearly and transparently address. So nothing changed under the sky.

The first point on India, again we are moving ahead in our partnership with BrightSource to establish manufacturing for taking equipment in India. So this is moving forward. I have the opportunity to meet our Indian partner by the end of last week and we are both continuing financing the place process to go ahead. And we adapt obviously to timing depending on the opportunities. But we are pursuing both and NGPC which is public utility and (IPP) order in line with this base to be established.

Second one comment on Transport. We are looking at a number of opportunities in Transport and should this opportunity materialize, then it will need either establishing an industrial base and/or building a partnership. We are working as an example on some tendering for mass transit, for metros, should we get an order which justifies implementing the factory, we put one in place; so this is one probably a loan possibly with a partner, but likely alone.

We are working on some main line project as well, both renovation and electrical locos should it turn into practical contracts, then we'll also get some partnerships in commercial base, so this is working. Last but not least, you know that in India, we have a very strong position in Grid. We out number one in India in Grid and we intend to speed up this position, not only by the way for Indian market, but probably for broader geographical scope.

Operator

Our next question comes from the line of Frederic Stahl from UBS.

Frederic Stahl - UBS

I have two questions, please. The first one is fairly straightforward. I was wondering if you have a scenario under which you will significantly accelerate the cost cuttings from the current levels. And that's the first one. And then the second one; I was just curious to follow up on the comments you put forward on the Tennessee plant there. I was just wondering if you could give us some more color on your standing and your positioning in the U.S. gas market. The Chattanooga plant is obviously a part of that marketing effort, but can you give us some more color on how you plan to rebuild your position in the gas market in the U.S., and how that's progressing?

Patrick Kron

So the first one is on cost cutting. We definitely are working on cost cutting. You have seen the S&A evolution for instance last year, we continue. And the acceleration of any cost cutting initiatives and capacity adaptation will be generated by the evolution of the needs of the backlog and what we've generated like the orders we take or don't take. I mean, don't consider that we are employing people who are sitting and waiting for the order to come, if we can go faster in cost cutting, we will. And we keep addressing the situation, we have elected for gradual adjustment. If at one point in time, we need to make some step changes, we note that you take one second by doing so.

Again, our mindset is to obviously adapt as fast and as clearly as possible to demand. But at the same time, we know that we need to embed flexibility in our emulation because markets move fast and we can very well see some rebound coming. And therefore, don't want to be in a stupid situation of suffering because of the softening of the demand and suffering because of our inability to swim upwards with the tide, and the tide will come back. So this is the approach; we adapt gradually. If there is a need to make some step changes without hesitation as we've done in the past, we continue to do.

But again, look at the sales and again, we have some activities in our factories. I cannot jump empty there for the sake of providing you with some spicy cost cutting initiatives.

The second one is on Tennessee and gas. We in Tennessee, we are addressing nuclear and thermal, both new built and retrofit. It's clear that we have a GT24, which is an s-class machine which is fit for this market. We have now the manufacturing base to manufacture the key components. The old gets (inaudible). And we'll bid on the market to get some turbines when the demand will be there. And if so, I mean, we come from the old market share. So we are more upside than on downside.

Frederic Stahl - UBS

I agree with that. Can I follow up on the cost cutting? What I was curious on was whether when you mentioned at some point in time we may have to cut costs, my question was if you have a scenario, do you know under what circumstances you have to take that decision?

Patrick Kron

It's not to cut costs. It's adapting capacity from the (technical difficulty). You see what I mean? We have the visibility given by the backlog. We'll see where we are for the time being in a situation where ongoing adjustment and smooth adjustment is possible. If we remain with this low level of order intake for an extended period of time, it's clear that the situation will change and will come from a situation where the gradual adaptation is needed to a situation where we have to go to more radical moves. Not the time here. And please do feel free to ask the question every quarterly rendezvous that we have, because one point in time we can tell you, "Yes, there is a need to go to less smooth adjustments and more significant ones."

Operator

Our next question comes from the line of Alfred Glaser from Cheuvreux.

Alfred Glaser - Cheuvreux

I have two questions. One is on debt that you mentioned in the press release that you have now a net debt position. Could you be a bit more specific about the level of net debt at this stage?

And my second question relates to acquisitions. You previously indicated you would be interested in acquisitions, either in alternative energies or in signaling, for instance. Do you think there is any opportunity around here? What would you be willing to spend in terms of total envelope? And do you think there might be some opportunities to trade or to deal with Palace?

Patrick Kron

On the first one, we don't comment on P&L and balance sheet elements quarterly. Maybe one day all companies will be obliged to do so. So far we don't. The remark made under press release is mandatory because it's an AMS requirement was to comment on our global situation, and the comment is absolutely a basic one, which is to say with 0.65 book-to-build, this puts pressure on the free cash flow.

And by the way, free cash flow being quite volatile over a period of time. So this was the only comment that we wanted to give. And I'm not going to comment on the debt. You will get the full details on it in September. Otherwise, then I talk about margins, margin per sector, free cash flow per sector, etcetera, etcetera.

Alfred Glaser - CA Cheuvreux

And it comes together with the impact of the acquisition of Grid and the payment of the dividend?

Patrick Kron

Exactly, we have clearly a significant cash positive situation at the end of the previous period. We paid the €2.3 billion of Grid, the €0.35 billion of dividend, and this is in excess of the net level that we had. And as the free cash flow, as we said, has been under pressure because of the book-to-build this ends up with a negative number. But nothing more to say, and no other message there.

On acquisitions, nothing new under the sky. So again, remains exactly the same mindset, priority on organic orders and organic development. If there are opportunities, signaling, renewable, etcetera, we will consider in due time. The amount will drive the needs of financing according to what I said in the past, so no new elements there. And Palace, nothing new under the sky. Palace is active with its signaling business.

Operator

Our next question comes from the line of Arnaud Schmit from Natixis.

Arnaud Schmit - Natixis

I had two specific questions, please; first one on Transport. Small orders have apparently been weaker in Q1. Is that suggesting some lower service business, and if so, how will you expect that business going on? And second question on Thermal Services orders, does this reflect strong OEM orders, or do you rather see an upturn in the retrofit and the spare parts?

Patrick Kron

On the Transport order, as I said, is bulky. I consider that there is no underlying trend justifying neither to get excited or get worried about the situation in Transport. So I've no specific comments. Again, this is slightly below some analyst forecast, sorry on that, but this is not for me an issue. It goes up and down. This is in the middle of the picture and nothing specific on transport currently. And no specific trend identified on service, or any worrying trend in my view.

Concerning your second point on service, note, the fact is that it has been a good quarter. It has been a good quarter because of the combination of some OEMs. But these OEMs don't represent, the 1.2 is not the result of a (massive) OEM. This OEM is between 100 globally, and two OEM contracts is between €100 million and €200 million.

So if you extract these two contracts, the rest remains above the €1 billion line. So I mean €1 billion is the current service plus retrofit activities, and this is a good number. So this is in line, you know that. I've been worried, because we had a low quarter last year. And the fact Q4 was a good one; Q1 is not a bad one either. So it confirms that in a weak power market, the service activity is doing quite well.

Operator

Our next question comes from the line of Lisa Randall from Nomura.

Lisa Randall - Nomura

Two questions, please. Just following up on comments you've already made, firstly, on free cash flow, given the Q1 order intake and obviously the impact that has on customer advances, do you still believe that at a group level you'll be able to remain free cash flow positive for the current fiscal year? That's question number one.

And then just secondly, to come back on financing, if we look at the Brazilian high speed contract, which if I'm correct, the government has re-clarified the criteria for that which, again if I'm correct in understanding, it's around 40%, based on financing. Given your comments that you've made on financing, should we assume therefore that that's a contract that you would not be interested in?

Patrick Kron

Sorry, which contract you are talking about?

Lisa Randall - Nomura

The Brazilian one, the high speed contract.

Patrick Kron

Look, to first comment, I don't give guidance on free cash flow, not because I don't want but because I cannot because I don't want. Why? Because it will fundamentally depend on the book-to-bill; it will fundamentally depend within the orders and the mix. When we get service contracts, it's great for the margin, it's nice business, very happy, good risk profile etcetera. Limited down payment of cash, as you know. So it will depend on, one, the global level of orders, and secondly within these orders, which is the top of term key, what type of term key, where in the world etcetera.

So there are a lot of factors which are playing. In some assumptions, it's nice for the cash flow; in some others, it's not as nice. So we'll talk about that in due time. Don't try to extract from me these type of elements.

The second one is on Brazil. We are looking the tender was just issued a couple of days ago. We participate in projects; we have various financing components, that's what I said. And we are in a number of projects where there are specific financing put in place. The problem, what is said is that we don't provide ourselves the financing. But we are associated with financial institutions, bodies etcetera whose job is to give this type of financing.

So in Brazil there is BNDES associated there. There will be some equity partners, etcetera. It's clear that we are not going to provide several billion of financing on Alstom balance sheet and neither several billions, nor €700 million, nothing.

So this is clearly something in which we work, but we need to work with civil works company, other industrial partners, financial partners etcetera and this is an ongoing work. So we are looking at it, and based on the analysis we do and our ability to properly answer to this demand we participate or we not participate. We have by nature (inaudible).

Operator

Our next question comes from the line of Gael De-Bray from SG.

Gael De-Bray - SG

I've got actually one question related to the ongoing contract for the Mecca/Medina high speed train project. Do you confirm that Saudi Arabia actually recently reconsidered the rules of the tender once again? And maybe could you share with us what were the key changes within this tender?

And I was also maybe curious to know what in your view led the Chinese players withdrawing their offer for this specific contract?

And maybe a final question is, are you today a bit more worried? Just looking at your guidance, you explicitly indicate that the operating margin guidance is based on a gradual recovery of demand. So are you today a bit more worried about the pace of this recovery of demand compared to a few months ago when you initially set up the guidance?

Patrick Kron

The first comment is on Saudi Arabia. I usually don't comment on ongoing tenders, and I am not prepared to breach this principle. So if you have any questions in relation to the tender, I suggest that you call the Saudi railways organization and I can provide you with their telephone number. The second one is that I can confirm that we have answered the tender. The third one concerning the Chinese situation, I would also suggest that you call the Chinese. And to the difference with SRO, I cannot provide you with their telephone number because I don't know who has participated, who has not participated.

Concerning the second question that you have asked, I will suggest that you go back to our previous report we made when we issued the guidance. And you will find out that the way we characterize the guidance under (Q1) which has been disclosed this morning is exactly the same one as what we have used last time. So we are neither more, nor less concerned about the evolution of demand. It is just a confirmation of the guidance based on the same number and the same principles.

Operator

Our next question comes from the line of Ben Elias, Sterne Agee.

Ben Elias - Sterne Agee

My question is regarding, when you look at the low intake and the uncertain order intake, how are you thinking in terms of R&D and product development going specially (inaudible) how are you going to compete with Siemens' H-frame or the growing wind turbine market?

Patrick Kron

Thank you, Ben, and it's the last question I answer on field. There is no relationship between the orders of the quarter and our intention in R&D. When we commented on our last year's results, I made it clear that we intend to continue sustained effort in R&D, obviously while prioritizing what needs to be prioritized. And obviously it's not because R&D that we are going to (hold a) monocled window, but we are going to continue our R&D in gas turbines, in wind turbines, as well as elsewhere. So I think that we are spending the proper amount of money in order to maintain and develop our position in this field, and we intend to continue to do so. So we will prioritize by continuing to spend money in R&D. It's easy to say costs in R&D, but unfortunately you pay a high price when they (technical difficulty) our strategy.

Thank you very much, and as I think there are no more questions I would thank you again for your interest. And Emmanuelle and Nicolas and myself remain at your disposal for any additional questions you may have. Thank you so much.

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