Thank you for joining our media conference call for the second quarter 2005 results.
With me this morning is Michel Demaré, our chief financial officer.
We had another quarter of strong operational performance building on the momentum we saw at the beginning of the year.
Although we took sizable provisions to improve the longer-term profitability of our transformer business and to cover litigation and regulatory costs we were able to improve our profitability once more.
Our focus remains on improving our business execution quickly and lifting operational efficiency even further.
On the top line, orders and revenues continued to grow at a good pace especially due to the very favorable development of base orders.
This indicates that our markets continued to develop positively.
It also compensated for the reduction in large orders compared to the second quarter of last year.
You will remember at that time, we booked the 390-million dollar power transmission order for the Three Gorges hydro project in China.
The Automation Technologies division led the EBIT improvement in the quarter up 28 percent versus the same period last year.
The effect of operational improvements in the Power Technologies division was unfortunately more than offset by the charge taken for the consolidation of the transformers business that we announced at the end of June.
We also took provisions for some expected regulatory costs.I’ll come back to these in a moment.
We were able to lift our net income by 42 percent to 126 million dollars compared to the second quarter of 2004.
We did this despite the additional costs I just mentioned and a one-time additional charge in interest expense of about 40 million dollars.
Most of this is related to the fine levied against ABB in 1998 following violations of competition rules by a district heating subsidiary.
That business was part of our former Power Generation division and has since been sold.
These charges in total – in both EBIT and finance net – added up to roughly 140 million dollars.
These items reduced our net income in the second quarter compared to our Q1 net income of almost 200 million dollars as I indicated at the end of June.
However, we’ve made a substantial improvement compared to a year ago.
On the balance sheet, we reduced our net debt compared to the first quarter but this is mainly a currency translation effect.
Since the end of March, the dollar has strengthened against the Euro and Swiss franc in which most of our debt is denominated.
Asbestos is on track. I’ll come back to that one.
You saw our revised EBIT margin targets at the end of June. For the remainder of 2005, our focus will be to deliver on those targets to further improve operational efficiency and to push the transformer consolidation program ahead.
Let me now quickly review the key operational developments from the second quarter.
In the Power Technologies division, we saw a solid improvement in base orders across all the businesses and regions.
This more than made up for the big drop in large orders compared to the same quarter a year ago when we booked almost 400 million dollars for the Three Gorges power transmission link. As I said earlier, that’s a positive sign that our end markets continue to develop favorably.
It has also contributed to maintaining a good order backlog which increased 5 percent in local currencies compared to the end of Q1 this year.
Revenues followed this positive base order development with the strongest growth in the products business area. Revenues were flat in local currencies in the systems business area.
We expect the major revenue impact from our recent large HVDC orders in the second half of this year and into 2006.
When it comes to EBIT, we achieved some productivity improvements in the high- and medium-voltage product businesses.
We also recorded a real estate gain in the quarter of about 10 million dollars.
However, these were more than offset by the 66 million dollar in costs taken in the quarter for the consolidation program in the transformers business.
On the systems side, EBIT slipped as a result of the provision required for regulatory expenses. This is related to the irregularities in a power network management unit in the U.S.
As you will recall, we disclosed these matters to the Department of Justice in April and also issued a press release.
Raw materials continued to weigh on the PT EBIT.
However, price increases for some products and other supply management measures allowed us to mitigate the effect to a greater extent than in the first quarter.
The net impact of higher raw materials costs on PT’s EBIT in Q2 was approximately 10 million dollars compared to 15 million dollars in the first quarter.
As a result of all these factors, the PT EBIT margin fell to 5.8 percent compared to 8.2 percent in the second quarter of 2004.
Moving to the Automation Technologies division, they showed another very good performance in the second quarter.
Orders were higher in all regions. As in PT, all AT business areas recorded higher base orders in the quarter compared to Q2 2004.This helped increase revenues by 13 percent in local currencies, a very strong performance.
As I said after Q1, however, we do not expect this pace to continue over the rest of the year.
Along with the higher revenues, EBIT in AT also benefited from several factors: higher factory loading in the product business, continued cost migration efforts and further productivity improvements. That led to a 28-percent increase compared to last year.
It was, by the way, the eleventh consecutive quarterly increase in revenues and EBIT for Automation Technologies. As a result, the division’s EBIT margin continued to expand, up to 10.7 percent from 9.8 percent a year ago.
Here’s a quick overview of the contributions to EBIT. I’ve already discussed PT and AT. Non-core activities reported a 10-million dollar loss in the quarter.
Corporate costs improved by some 35 million dollars. I’ll come back to these items in just a second. Overall, we were able to increase the group EBIT margin in the second quarter and, as I said earlier, despite some significant additional costs.
Non-core activities reported an EBIT loss in the quarter. The oil and gas business remained steady at 13 million dollars but on a lower revenue base.
Building Systems was down 10 million dollars as costs to close some projects offset a break-even result in Germany. In Equity Ventures, we had an asset write-down in one of our investments of about 10 million dollars.
Corporate costs again developed favorably in the second quarter compared to a year ago. We continue to make progress in taking out costs. This is mainly at our larger local head offices, but also in the Zurich headquarters.
Sarbanes-Oxley spending remains at a low level. You can expect to see more impact from this in the second half.
Corporate costs for the first six months of this year are about 180 million dollars.
Nevertheless, we are keeping our guidance for the full year at 450 million dollars.
Discontinued operations continues to be less and less of a factor in our results.
We still have the mark-to-market treatment of the shares set aside for the asbestos trust.
That resulted in an expense of 10 million dollars in the second quarter reflecting the recent increase in our share price.
There’s an expense of 6 million dollars related to the sale of the power lines business in Germany.
The losses in the same quarter a year ago were related to upstream oil and gas, insurance, and our wind energy business.
Our finance net expense increased to 95 million dollars from 50 million dollars last year.
Most of this is the result of a one-time interest expense of some 40 million dollars.
As I mentioned earlier, this is mainly interest on the fine levied against our district heating subsidiary seven years ago. Our effective tax rate also increased slightly in the quarter.
This reflects the tax impact of the various special charges that I described before. These impacts are a matter of timing and are part of the usual fluctuation in tax rates from quarter to quarter.
For the full year, we continue to expect an overall tax rate of between 33 and 35 percent.
Cash flow from operating activities increased by 280 million dollars in the second quarter of this year compared to the year-earlier period.
A number of factors were at play here. Cash flow was higher in PT, with working capital as a percentage of revenues continuing to decrease to below 14 percent at the end of the quarter. In AT, working capital as a percentage of revenues also decreased again compared to a year ago to below 8 percent.
However, in absolute terms, working capital requirements were higher in AT to support their strong revenue growth.We continue to reduce our securitization activities in order to lower our finance costs.
This will have the effect of reducing cash from operations over the rest of the year.
In the first six months of the year, the winding down of securitization in the group reduced cash flow by about 150 million dollars.
Cash flow improved in Non-core, mainly reflecting the high cash outflow a year ago related to the sale of the upstream oil and gas business.
In Corporate, the smaller cash outflow resulted from lower costs, the timing of certain securitization activities, and lower asbestos payments.
Net debt and gearing were both down compared to the end of Q1. We remain committed to reducing our overall financial obligations to bring finance costs down further.
Coming to asbestos, as you know, we filed a revised plan of reorganization for our U.S. subsidiary Combustion Engineering with the U.S. bankruptcy court on June 24th.
This plan was the result of our agreement with claimants that we announced earlier in the year.
The next step will be a hearing on August 19th after which the plan will be submitted to claimants for a vote of approval.
We continue to work with the other parties on all of the issues involved and I can say that so far, the process is moving ahead as expected.
To wrap up, the market outlook for the rest of the year continues to be favorable. We expect top-line growth in the high single-digit range for the full year.
Raw materials prices have stabilized at a high level.
We made progress in mitigating the impact of this increase on EBIT in the second quarter but it is difficult to predict how it will develop over the rest of the year.
Our operational focus will continue to be on lifting business efficiency. That includes executing the transformers consolidation swiftly.
We were expecting to take more restructuring charges in the second quarter for this program and our full-year estimate remains the 120 million dollars.
Of the remaining approximately 50 million dollars, you can expect the biggest impact in the fourth quarter.
Turning to our targets very briefly, nothing new there compared to what we said at the end of June.
We reduced our EBIT margin target for PT as a consequence of the transformer consolidation and the ongoing high raw materials costs.
As a result, we also lowered the Group EBIT margin. The AT EBIT margin target remains unchanged.
Our guidance for Non-core activities remains an operational result of breakeven for the full year, not including the effects of any potential divestments.
In Corporate costs, we are on the way to achieving our target.
We are now working to reach the revised targets for 2005, as we also prepare to provide the market with new medium-term targets on September the 6th.
To re-cap, it was a reasonably good quarter both in terms of market development and operational improvements.Unfortunately, the results were impacted by a number of special charges.
Actually, it would have been a great quarter if it had not been for these extra items.
We kept up the momentum we developed at the beginning of the year and we will keep a tight focus on further operational improvements over the rest of the year.