February 24, 2011 | Transcript Audio Conference Call in English WEG S.A.


February 24, 2011 | Transcript

Audio Conference Call in English

4th Quarter 2010 Results


Operator: Good morning ladies and gentlemen and welcome to the audio conference call of WEG S.A. 2010 4th Quarter Results.

Thank you for standing by. As a reminder, this conference is being recorded and at this time all participants are in a listen-only mode. Later we will conduct a question and answer session and information to participate will be given at that time. If you should require assistance during the call, please press the star key followed by zero (*0).

To obtain the quarterly results press release or the presentation that we will be using during this conference please go to WEG’s investor relations page at www.weg.net/ir.

Transcript | Audio Conference Call in English 4th Quarter 2010 Results 1

Before we proceed we would like to clarify that the statements that may be made during this conference call relating to WEG’s business perspectives, projections and operating and financial goals and to WEG’s potential future growth are Management beliefs and expectations, as well as information that are currently available. These statements involve risks, uncertainties and the use of assumptions, as they relate to future events and as such depend on circumstances that may or may not be present.

Investors should understand that the general economic conditions, conditions of the industry and other operating factors may affect WEG’s future performance and lead to results that may differ materially from those expressed in such future considerations.

With us today in Jaraguá do Sul we have Mr. Laurence Beltrão Gomes, Finance and

Investor Relations Officer; Mr. Wilson Watsko, Controller and Mr. Luís Fernando Oliveira,

Investor Relations Manager. Please go ahead sir.

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Mr. Laurence Beltrão Gomes: Good morning everyone, it is always a pleasure to have you in these opportunities. As always we will follow a known script that includes a quick overview with general comments and some additional details followed by a question and answer session.

We would like to highlight some aspects: 2010 was a recovery year; our product line is broad and diverse and we have products in markets with very different dynamics. It is always important to take it into consideration when analyzing WEG's results. We have a short-cycle business with a serial production characteristic and a long-cycle business where products are completely engineered.

The 15% growth in 4Q shows that we have resumed our growth pace even at a very competitive environment. We also highlight that we managed to close the year with growth over 2009 - that is, the gradual recovery of the market that we have been talking about is a reality.

This market is changing rapidly with some clear trends such as the smart grids, the increasing importance of energy efficiency - which is recognized even by the Government - with some countries adopting minimum efficiency standards.

In Brazil wind power appears as a new and important renewable source of energy creating new opportunities.

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Turning to slide 4, the recovery of the Brazilian industrial production was robust, reaching growth of more than 10.5% in 2010. It seems clear that the recovery goes beyond simple inventory replenishment and the occupation of productive capacity. We believe these are the first stages in a consistent investment cycle in industrial capacity.

Outside of Brazil we also see positive signs. Markets with less dynamic economies have achieved good performance as can be seen in the graph. In Brazilian reais the external market grew above 24% and in dollars almost 26%. Remember that this growth was obtained in the context of the appreciation of the Brazilian real.

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Slide 5 shows the distribution of sales among the various regional markets and the physical presence of WEG in the world. We have a few changes in this situation: the

Brazilian domestic market has maintained its relative importance, both because of the appreciation of the real and because of the good performance.

Outside Brazil we highlight the growth: North and Latin America are recovering well, albeit at a moderate pace. The US remains quite positive with market share gains. Our position in Latin America is very strong. Asia remains strong, especially in China and in India. The new plant in India was officially opened last week. We continue to do well in Africa, which has become one of our good markets outside Brazil. Europe follows with no major change, it is not recovering smartly but it is not worsening either.

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On slide 6 we can see the mix of the products sold. Consumer goods continue to perform well with good credit, employment and income conditions in Brazil stimulating the consumption of global durable such as white goods.

Investment in expansion of industrial capacity continues. BNDES' performance remains important and the PSI program was key to the starting up of investment in some sectors.

Outside Brazil we have a combination of recovery in demand and market share gains. The recovery in GTD is led by transmission and distribution businesses, which are long-cycle products per excellence. In Generation we were focused on distributed generation with alternative sources. The prospects are attractive, but recovery occurs at a slower pace.

Now I would like to call Mr. Luís Fernando Oliveira to give some additional details on the quarter. Please Luís Fernando, you can proceed.

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Mr. Luís Fernando Oliveira: Hello, good morning everyone. We are now moving to slide number 7. Basically we can see here very little change in the breakdown comparing to

4Q09 in distribution of the different components of the cost.

We highlight here that the cost of raw materials (steel and copper, the main ones) continues to increase and we have been able up to now to neutralize this impact by adopting a very careful exposure management policy. Basically we see the pass-through of those cost increases happening at a natural pace. It is natural in this industry because those cost increases affect every other participant in the market; the pass-through is quite natural, it happens naturally.

By the same token the fact that most of the products that we manufacture are customized means that we are constantly repricing those products as we are giving the prices each and every time we make a new proposal for selling those products.

All in all we have been able to neutralize and we are very careful on managing the exposure that we might have for products that we have to deliver in the future. If we have sold anything for future delivery we should be able to obtain the raw materials at the prices that are implied in the selling price. So far we have been able and we have been quite active on making sure that we make the system work.

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Moving to page number 8 we can see the main changes on Ebitda on this graph. The positive changes in gross revenue, higher prices, higher volumes of sales, changes in product mix and incorporation of the acquisitions that we made this year produced a total increase of around R$ 260 million, which is being offset to some extent by the currency appreciation, which produced a negative impact of R$ 8 million.

The negative impact of cost of goods sold of R$ 140 million approximately is the result of this poor product mix we have been discussing. The negative impacts on the increase of operating expenses, general and administrative are relatively small, as small are the changes on the profit sharing scheme that we have.

The net effect was an absolute negative change in Ebitda of R$ 4.4 million, which leaves

Ebitda practically unchanged compared to last year and Ebitda margin of 17.8% for the quarter.

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On slide number 9 we have the graphical representation of cash flow for 2010. We can see here that cash flow from operating activities remains strong, despite the pressure for working capital which is quite natural when you have moments of acceleration of revenues you typically use more working capital in those situations, even though we have been able to maintain a fairly strong operating cash flow.

Cash flow for investment activities shows the continuation of the investments in production capacity and the acquisitions that we made throughout the year and we are continuing to pursue the lengthening of the debt profile that we have been doing this year. We have been accessing some very attractive credit lines, we highlight during this quarter BNDES and the IFC. During this quarter we got the cash from contracts that we have been closing over the past few months.

The variation in the cash accumulated in 2010 remains largely positive and we should continue to put this cash into work over the next few years.

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If you turn to page number 10 we can see the evolution of the investments in fixed assets over the past few quarters. You have to always keep in mind that there is a lot of fluctuation depending on how the investments are committed, but we highlight two things that are definitely the most important Capex ones that we had for 2010: first was the new high-voltage electric motors and generators plant in Hosur, India. As Mr. Gomes already has mentioned it has officially started production last Friday, which was a fairly good day according to the Indian culture.

And we also highlight the new commercial electric motors plant in Linhares, in the

Northeastern part of Brazil in the State of Espírito Santo, which is already in preoperational stage. We should see the official startup of this plant over the next few weeks.

We continue to focus on the areas of great demand. We have a lot of flexibility for the

Capex program, we always stress that. We have the ability to speed up or slow down if that might be the case the Capex program. For 2011 we are forecasting R$ 193 million for the Capex program - that is the initial estimate that we have for the year. If that might be the case we can speed up or - we hope that is not the case, that is not how we foresee it

- but if that might be the case we can slow it down as well.

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Finally we would like to, before we move on to the questions and answers session, we would like to remember some very important points: the first one is that the economic recovery is very clear and the scenario is already better towards the end of this year.

Global economy growth is led and continues to be led by the emerging economies and that should continue to increase the demand for infrastructure investment into the future.

We have been talking about trends such as the smart grid and energy efficiency. They are very important trends because they improve the products and lead to a more technical and qualified competitive environment. It is very important to consider: our products are not commodities.

Infrastructure spending in Brazil should continue at accelerated pace in the coming years.

Events like the Olympics and the World Cup as well as the Growth Acceleration Programs I and II should continue to generate additional businesses.

The investments in oil exploration in the pre-salt layer, for example, are one of such examples of those new opportunities.

Throughout 2010 we made some acquisitions both in the Brazilian market and abroad.

WEG has a great willingness to invest taking advantage of the opportunities if those opportunities are attractive. This trend makes us confident that WEG, which has built over the years one of the most comprehensive industrial structures in the industry, and which at various times has shown the ability to expand production capacity in line with the market, will and can take advantage of this cycle of consistent investment to grow in a robust and sustainable way for the coming years.

We are now ready to entertain any questions that you might have and I turn back to the operators to conduct a question-and-answer session. Please go ahead.

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Q&A Session


Excuse me. Ladies and gentlemen we will now begin the Q&A Session. If you have a question please press the star key followed by the one key (*1) on your touch-tone phone.

If at any time you would like to remove yourself from the questioning queue press star two


Excuse me. Our first question comes from Tarim Silvestre from Credit Suisse.

Mr. Tarim Silvestre: Hi, good morning everyone. I have in fact two questions, one is related to the margins that you guys posted in 1Q. I would like to understand what is... I already know that you guys expect to recover to a normalized level in 2011, but how fast we might see this improvement?

And second related to the plant that you guys opened in India I would like to see, to listen a little bit your view regarding the potential market opportunities in that front. Thank you.

Mr. Oliveira: Well, thank you Tarim. Well, first of all the speed of the recovery in the margins is the proverbial US$ 1 million-question. It is a natural trend. As we go on we expect the business to start improving. It evolves from short-cycle consumer goods towards longcycle processing industry and as we go from one end to the other of the spectrum it is natural that we see the margin improvement and that is what we expect, that is the natural trend.

How fast that is going to happen it remains to be seen and we definitely expect to have a more normal year in that sense, but it remains to be seen how fast we are going to be able to see that happening.

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Regarding the plant in India we are fairly excited with India. India is quite a unique opportunity in several ways. Probably India is one of the few very large markets in the world where we had the opportunity of penetrating in a very attractive part of the market. Typically you enter a market - which is a kind of funny to say - but you enter a market through the entry-level kind of product: typically low-voltage motors more geared towards the industrial segment.

In India we were able to find opportunities of selling very technical products geared towards the infrastructure market. So that is a very unique, very attractive market. We are very excited about the opportunities we have in India. Actually India is already - it is not something for the future - it is already a reality because we have been selling to India for the past few years, producing and exporting out of Brazil, and have been seeing so many good opportunities that we decided to have this planned out there.

We see this plant as very important to strengthen our position in the Indian market going forward and we definitely see several other options as well in high-tension products and everything.

And more so another very important aspect of the Indian plant you have to remember,

India is high-voltage products. We have another plant in the region, which is China, geared towards the low-voltage kind of products. Those two plans they form a platform of products and we can definitely have a more complete presence in that part of the world with those two plants, regardless if we might have additional investments to make in the future to complement the platform; but we already have in place a very strong and quite complete platform of products for those markets in the future.

Mr. Silvestre: Ok Luís, thank you.

Operator: Excuse me. Our next question comes from Augusto Ensiki with Morgan Stanley.

Mr. Augusto Ensiki: Hi, good morning gentlemen. A couple of questions, firstly you mentioned that you had market share gains in the US and I wonder if you could expand a little bit, what is your market share and among the specific product lines over there.

And secondly regarding Capex, of the 194 million planned for this year if you can give me a little breakdown in terms of how much of that is maintenance and the expansion, growth

Capex, what is the main focus of the 194 million. Thank you.

Mr. Oliveira: Well, starting with the Capex plan you can notice at first sight it is a little bit lower than this year, which... the reason is as we had two new plants coming in line, they were basically built in 2010 and we now have to focus on making sure those plans start to operate at the normal production pace.

So that is going to be the focus of the industrial part, the industrial theme over the next few months, which explains the reason why the Capex is going to be a little bit lower this year.

We always stress this point: it is hard to make the division of what is maintenance Capex and what is expansion Capex, because the way we characterize we are always debottlenecking the production capacity, we are always going after what is holding us back; so we go after... we identify those points of slowdown, so to say, and we go there and make the expansion that is very focused on that particular point. So it is hard to make

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the division.

If you look at longer-term you can make a fair assumption, I would say, using depreciation as the best proxy for maintenance Capex; but we tend not to use this kind of concept internally to tell you the truth.

Mr. Ensiki: Understood.

Mr. Oliveira: The first part of your question, sorry, can you repeat that?

Mr. Ensiki: It was regarding your comment that you are having market share gains in the

US, I was wondering if you could tell us what is the product line or how much your market share is over there.

Mr. Oliveira: Well, basically in the US we are more focused in industrial products and we are just introducing the transformer business in the US and in industrial products we are more focused in the motors part of the business, motors plus drives; we have been introducing some of the electronics around the motor over the past few years, we have been quite successful in this introduction.

There is no official number for that, it is hard to come around any official number, we do have some access to some studies from the market that indicate that. Especially if you look what has been happening in the US market there is quite a few transactions happening: the number one player in the US was recently acquired; the number three bought a part of the number four player in the motor business; you have another large in a market niche, but a large player exiting this business and selling out to somebody that was not in the business before.

So all those things made those players, as we say, they took their eye off the ball and we took advantage of this opportunity, we have been very aggressive in this market. We have been saying that for a while and the results are definitely showing.

We have been having a larger share of the business of very important clients that we have in the United States. We would split the business with five other competitors, we are now having the lion's share of the business of those clients.

It is becoming quite apparent that some of the large competitors that we have in the US market they were a kind of distracted over 2010 and we definitely took advantage on that.

Even though we cannot come up with a final number. We estimate to have a single-digit market share in the United States, a kind of middle single-digit market share of a fairly large market, which puts us among the leaders in this market. It is a very fragmented one.

Mr. Ensiki: I see, just still talking about industrial motors and not so much for transformers yet.

Mr. Oliveira: The transformers businesses doing alright, it is definitely following the business plan that we have. We are still in the first stages of this penetration, it is difficult to penetrate that market by selling to the customers that are more after the pricing than technical features of the product.

As you build a critical mass you start to go after the other parts of the business. That is exactly the point we are right now: we are ramping up this business for the future. To tell

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you the truth it is going exactly according to the plan.

Mr. Ensiki: I understand, thank you very much.

Mr. Oliveira: Thank you.

Operator: Excuse me. Our next question comes from Bruno Giardino with Santander.

Mr. Bruno Giardino: Hi good morning everyone. I have actually two questions, the first one in this path converting short-term products into long-cycle products how do you believe, or in which stage do you believe your GTD Division is currently?

And the second question is in regards to wind power projects: have you been receiving some orders for wind power producers in this division? Thank you.

Mr. Oliveira: Thank you for the questions Bruno. Well, basically your second question yes, we are already selling to some of the players that won the concessions in the last auction.

The product that we have ready is the T&D product: we are selling substations, for example, for those large wind farms that were auctioned last year. That is the product that we have already available right now at this point and actually that is part of the explanation why we have been saying that T&D has been leading the recovery in the GTD segment.

T&D tends to be a more... a little bit less specific, a bit more general and electro is pretty much the same regardless of how you are generating. So the products that we can offer can be applied to whatever kind of source of energy you are talking about.

Regarding the other part of the business, the generation part of the wind industry, we are seeing our options, we are still figuring out the best options to operate in this market, we are still in that stage.

Regarding your question on where we are it is hard to pinpoint, because for example in

T&D we are selling substations. Substations are high up in the one end of the spectrum; substations tend to be very complex products incorporating several of the products that we manufacture, a lot of automation around; so substations is a very high-end product.

At the same time we continue to have a fairly brief business for simpler transformers as well. So what we can say is that T&D is a few steps ahead of the generation business in this recovery. The generation business we are still not seeing the same dynamism that we are seeing in T&D.

And that tends to a reason as the wind power generation has been making so much noise, has been grabbing all the headlines, because for specific reasons that in the global market this particular source of energy made a large splash in Brazil, which detracts a little bit the other energy sources that we are more involved with: small hydro, biomass; for different reasons they are still holding back, we are seeing a little bit from the lower price that we saw in the auction last year.

Longer-term we see those two... we see a new equilibrium being reached in this market and we definitely see those two sources that continue to be very attractive going forward.

So it is really a matter of the market figuring it out, this new energy price equilibrium for the renewables more than anything.

Mr. Giardino: Ok and just a follow up: do you have products for the G part of the business

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in the wind power generation or are you still developing it?

Mr. Oliveira: That is what we are trying to figure out. That is the part that we said we are still figuring out the options that we have. We want to have a complete solution, but we are seeing the best way to come up with the complete solution.

Mr. Giardino: Ok thank you Luís.

Mr. Oliveira: Thank you.

Operator: Excuse me. Our next question comes from Luis Vallarino with Citigroup.

Mr. Luis Vallarino: Hi good morning everyone. My main question has already been answered, but I was wondering also if you can maybe give us some idea of what sort of capacity utilization are you seeing right now, what you are seeing by the end of this year, and especially if you can differentiate it between the medium and large-size equipment and basically the domestic use motors. Thank you.

Mr. Oliveira: Sure, thank you for your question Luis. On average 90% capacity utilization, which is a kind... capacity is always a tough concept, we always stress that for us, because we do not have an apples-to-apples comparison because of the customization of the product.

We can make some approximation: we consider the 90%-level to be close to the ideal one as it maximizes the return on invested capital because above that you start to have some extra costs, you run into extra costs. So 90% would be the ideal.

We are very close to that, but there is a lot of diversity: for example in some segments

(especially the ones geared towards the domestic market) not necessarily the domesticuse market, but the Brazilian market it is a little bit higher capacity utilization at this point and in other parts not so much.

Overall, even in product lines where you would characterize as longer-cycle we are close to this full capacity utilization, but with a poorer product mix, that is very clear. For example in the generation business for example two, three years ago we would be at full capacity producing generation systems; right now we are close to full capacity producing smaller generators and that is one thing.

Overall you would characterize capacity utilization was an impact for us, a negative for us last year, 2009. For 2010 that is not the problem anymore; we are close to the capacity utilization that allows us to dilute fixed costs. The main reason for lower margins in 2010 was basically the poor product mix, which is contrary to what happened, diverse of 2009.

Going forward we expect 2011 to be a more normal year in both fronts.

Mr. Vallarino: thanks very much.

Mr. Oliveira: Ok thank you.

Operator: Excuse me. Ladies and gentlemen as a reminder, if you would like to pose a question please press the star key followed by the one key (*1) on your touch-tone phone now.

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Excuse me. That does conclude today the WEG audio conference. Thank you very much for your participation, have a good day and thank you for using Chorus Call Brasil.

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