Abb Ltd (ABB) 2007 Q2 法說會逐字稿

Good afternoon and this is the Chorus Call conference operator. Welcome to the ABB 2007 Second Quarter Results Analysts and Investors Conference Call, hosted by Mr. Fred Kindle, CEO and Mr. Michel Demare, CFO of ABB.

As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation there will be an opportunity to ask questions. We would kindly ask each caller to limit themselves to two questions only. For those journalists who have called in, your participation is in listen-only mode. This call must not be recorded for publication or broadcast. A replay of this call will be available for two weeks following the conference. [OPERATOR INSTRUCTIONS].

At this time I would like to turn the conference over to Mr. Fred Kindle, CEO. Please go ahead sir.

Thank you very much ma'am. Good afternoon ladies and gentlemen. Thank you for joining our analysts and investors conference call for the second quarter 2007 results. With me is Michel Demare, our Chief Financial Officer. My comments in this call refer to the presentation that you can download from our website at abb.com.

Let's start with chart two, the Safe Harbor Statement, please refer to that chart for our Safe Harbor text regarding forward-looking statements that may be made today.

Chart three, strong growth outstanding operating margins. Let me start with an overview of our performance on chart three. Our second quarter was marked by continued strong growth with outstanding operating margins. As a market and technology leader, ABB continues to benefit from strong global investments in energy efficiency as well as power and industrial infrastructure. Electrical utilities in the OECD countries continued to invest in girds and upgrades and interconnections to improve the efficiency and reliability of the power networks.

In the emerging markets, the expansion of power infrastructure to support high GDP growth also continued in the second quarter. Soaring oil and commodity prices drove investments by our industrial automation customers to expand capacity and make existing assets more productive.

Our probability benefited from the combination of market strength and our ongoing focus on better businesses execution. We repeated the very strong performance of the first quarter with improvements across all divisions and regions. In local currencies orders were up 20% to $8.7 billion and revenues increased 21% to $7.1 billion. Our order backlog continued to expand and is now above $20 billion. We broke to the $1 billion level for EBIT in the quarter, and lifted our EBIT margin once again up to 14.4% compared to 11.4% a year ago.

Our net income almost doubled to $729 million. Also contributing to the net income increase, were a lowered tax rate and an improved net finance results, actually a small part of this in the quarter. Cash flow was higher despite the increasing working capital requirements to support our rapid growth.

We finalized the disposal of the two equity ventures investments we announced in February. With that and the pending sale of our Lummus Oil Gas and Petrochemicals business, we have almost completed our disposal of non-core assets.

Our balance sheet remains strong with net cash at $2.4 billion at gearing which we define as total debt divided by total debt plus equity at 25%.

We also announced in the quarter the appointment of Ravi Uppal, the head of our business in India and the Southern Asia region to the Executive Committee effective July 1st. Ravi will be responsible for all ABB regions and countries in the role of Head of Global Markets. He'll also be responsible for the Group Account Management functions. Ravi brings many years of valuable experience to the senior management team and we are extremely happy to have him on Board. And besides that let me just mention Ravi will also be on stage on our September 5, Strategy Day.

You will also have seen that we recently made some additional disclosure to the U.S. Department of Justice and the U.S. Securities and Exchange Commission regarding suspect payments in a number of countries. That is usual in this kind of situation, I am unable to give you details so long this investigation is going on. I can say however, that this disclosure was the result of our own internal audit and compliance program. I will come back to this issue shortly.

Let's go to chart 4, looking at chart 4 let me quickly review the key figures of the quarter. Group orders were up 20% in local currencies. The biggest contributor to the improvement was the Power Systems division where large orders more than doubled compared to the same quarter last year. Order highlights for the division in the quarter were a subsea cable connection between the UK and the Netherlands to improve the efficiency of the European power grids and substation orders from the Middle East where economic expansion continues to drive demand for more power.

Orders increased at a double digit pace in all of the other divisions as well except for automation products where a flat order growth for engineered products and the low-voltage systems business dampened the otherwise continuing strong growth in standard products.

Overall the industrial market for our automation divisions remained attractive in the quarter with order growth led by the minerals and metals business, where high commodity prices continue to fuel investments.

I would like to point out that as expected the extremely high order growth rates that we saw in 2006 in the automation divisions such as the 20% growth in automation products or the 32% growth in process automations that we saw on the second quarter of 2006 have not been repeated. Those were not sustainable rates as we have said for several quarters. Nevertheless, orders continue to improve at an attractive rate in both divisions.

Revenues up 21%, continued the catch-up trend we have seen in the last two quarters as our strong order backlog starts to feed through to sales. EBIT and EBIT margins were higher in all of or divisions, reflecting the good market demand, strong capacity utilization, better project management and continued cost reduction efforts. As a result, our EBIT grew 60% and as I mentioned a moment ago, amounted to more than $1 billion, the first time we have achieved this level of EBIT in a single quarter. The same can be said about net income by the way.

Our EBIT margin also hit another peak, 14.4%, thanks to very strong markets and our continued cost improvements.

Finally, cash flow from operations increased compared to a year ago, despite increases in working capital that are needed to fund our asset growth.

Chart 5, in chart 5 you can see how we continue to build our track record of steady profitable growth. We have now built 17 straight quarters of year-on-year improvements in EBIT margin, dating back to the second quarter of 2003.

Over that period we have added 11 percentage points to EBIT margin. That reflects not only our very strong markets and better business execution but also the reduced volatility in our performance and the cleaner results we have been able to generate.

Chart six. Chart six shows the strength of our broad geographic scope. Orders continue to grow at a healthy pace in all of our key regions. China and India maintains the long-term growth trends, orders from the Middle East increased by almost 50%, bouncing back strongly after relatively weak first quarter. Orders from Europe were up 13% in local currencies, led by very good growth in all divisions in Central and Eastern Europe. In the U.S. meanwhile, turned in another strong quarter with orders up 27% in local currencies, the need to replace aging power equipment was a key growth driver in the U.S.

Chart seven. In chart seven you see the development of our order backlog, up almost $6 billion since the end of the second quarter year ago and $2 billion higher than at the end of the first quarter. While this gives us a high level of confidence going forward, it also poses challenges. We need to continue to carefully control costs, deliver top quality, and deliver on time.

Chart eight. Chat eight provides you with a quick overview of our performance by division. Starting with power products, orders increased by 11% and revenues by 30% in local currencies and orders were higher in all businesses regions during the quarter.

Revenues increased in all businesses and the strong EBIT margin of 16.9% mainly reflects factories running near capacity, improved productivity and effective supply management to mitigate high raw material costs.

Power systems had a sharp increase in orders during the quarter to $2.2 billion, a 50% increase compared to a year earlier. This is primarily the result of the doubling of large orders in the period. Our base orders also remained strong.

Revenues grew across all businesses and reached 20% in local currencies based on solid execution of a strong order backlog. EBIT rose significantly and the margin increased to 8.4% from 6% one year ago.

The Automation Products division increased orders by 8% and revenues by 21% still in local currencies. As I mentioned earlier, order growth for standard products remained strong but engineered product and systems orders were flat compared to the second quarter a year ago. Revenues grew as a result of higher volumes and price increases higher raw material costs. The revenue growth and good capacity utilization led to a 43% increase in EBIT, and pushed EBIT margins of this division to 17.4%.

In Process Automation demand for automation continued to show strength in all sectors. Orders increased in all regions except Europe where a number of large marine orders won in the second quarter of 2006 were not repeated this year. Revenues in the quarter grew significantly up 16% to $1.6 billion reflecting the execution of the high level of orders taken in recent quarters. EBIT and EBIT margin increased again, pushed by higher revenues continuing operational improvements and tighter execution of large projects.

Finally, Robotics recorded a 40% increase in orders. Although this is compared to a relatively weak 2006 base line it is still encouraging. This reflects the success of efforts to increase orders from industries such as packaging, consumer electronics and foods. Orders also increased from the automotive sector. EBIT and EBIT margin were higher, reflecting the continued focus on cost efficiency and improved project execution.

So overall a very good quarter with continued growth and excellent EBIT margins, whether we can sustain those margins or even surpass them depends to a very large extent on future market developments. We'll have more to say about that in September when we present our strategy to 2011. In the meantime, I would reiterate what I have said in past quarters that we believe, we can still improve our profitability through internal measures such as further migrating production and engineering capacity lower cost countries and improving risk management and project execution in large orders. Our ambition remains to keep improving profitability and to take maximum advantage of the good market environment we are in.

Chart 9 please. Chart 9 gives you a summary of financial development below the EBIT line. Net finance expense was actually a positive in the quarter, mainly because we have less debt to service. The year-on-year improvement also reflects the non-recurrence of approximately $60 million in costs in the second quarter of last year related to the induced conversion of our $968 million convertible bonds. Our tax rate was down to about a very low 25%, in the second quarter compared to 29%, a year ago, which also contributed to our higher net income.

The deduction for minority interest is up once more on the continuing growth of our joint ventures in China and our listed Indian subsidiaries. Discontinued operations produced a small positive result in the quarter as the settlement relates to past disposal more than offset smaller loss in ABB Lummus Global.

Chart 10, in chart 10 you can see an overview of our key balance sheet ratios, all of which continued to move in the right direction, our net cash position remains basically unchanged compared to the first quarter mainly because we paid annual dividends to shareholders during the quarter, which amounted to about $450.

When it comes to use of cash, our first priority remains investing in our existing businesses, where we have significant organic value creation potential. This means for example investing in R&D to maintaining our technology lead and expanding our capacities in high-growth emerging markets. We, of course, also continued to actively screen and evaluate potential acquisitions that make strategic sense, where we have the capacity to successfully integrate them and that meets our value recreation criteria.

We continued to take disciplined approach in this area, and as we have said before, if we cannot make an acquisition that meets our criteria this year we will look at ways to return the cash to our shareholders in due course.

Let me also point out that we achieved a return on capital employed in the second quarter of more than 25% this is after tax obviously, up from 17% a year ago. This reflects not only the strong growth in EBIT we have experienced over a past 12 months and the lower tax rate but also our focus on improving our capital efficiency.

We have seen only a modest increase in our capital employed during a periods of high growth in order backlog revenues and EBIT. The result is a significant improvement in ABB's ability to create value.

Chart 11. Chart 11 shows the cash flow development by division. The divisions with the highest level of project and systems activities that is power systems, process automation, robotics, had lower cash flow in the quarter. This reflects the higher working capital requirements of these businesses as they work through their order backlogs. For a group as a whole however cash flow from operations in the dollar terms improved versus the same quarter a year ago.

As a percentage of revenues, net working capital increased by a percentage point compared to last year at this time. However, we believe this is still an acceptable development given our current 20% top line growth rate.

Chart 12, turning to chart 12, let me quickly summarize our second quarter results were excellent. Our global markets remained robust. Our lead positions, strong technology and brand and our broad geographic scope puts us in a great position to take advantage of that growth. And our top line developments, all organic, proves that clearly.

Combined with our ongoing focus on business execution our profitability continues to improve, however managing this higher level of growth has its challenges, finding enough people and the right people, making sure our quality remains high, delivering on time, balancing the need for greater capacity against the risk of having too much capacity should the market turn. These are among our operational priorities over the rest of the year.

Additionally, we continue to examine strategic acquisition opportunities and complete the disposal of our non-core assets including Lummus.

Finally the success for developments of our strategic medium-term road map and target is on track. The Board of Directors have signed off on our plan and we are now preparing for our Strategy Day on September 5.

As for our recent discloser to the DOJ and the SEC, as I have said before compliance and business ethics has been and will remain the top management priority in ABB. We have rigorous processes in place to bring these activities to light so that we can eliminate them from our company. We've also extensive training programs both to ensure that our employees know and understand the rules, and to force the culture that promotes ethical behavior and encourages those who know about non-compliant activities to expose them.

We cooperate closely regulators to ensure that they have all the information they need to investigate these cases. We have set high standards of ethical behavior and we will simply not tolerate any activities that do not meet the standards. And we will continue our proactive policies externally to cooperate with authorities and internally to promote excellence in business ethics and to eliminate unacceptable behaviors.

Let's go the last chart; chart 13. Finally, looking at our outlook for the remainder of 2007 on chart 13, we expect the business environment for ABB during the rest of 2007 to remain in line with a positive market situation in 2006 and the first half of this year. Demand for power infrastructure is expected to continue in a higher level in all regions. Automation related industrial investments are expected to continue at the higher level in most sectors, although the lower growth rate seen in 2006.

In addition, ABB is well positioned to benefit from investments to mitigate climate change with energy efficient products and systems. Our order growth is expected to continue on a higher level but to moderate somewhat over the remainder of 2007 compared to the extraordinarily high order growth experienced in 2006 and the first half of 2007.

With that ladies and gentlemen, I would like to thank you for your attention and open the phone to questions now. Thank you.

Excuse me. This is the Chorus Call conference operator. We will now begin the question-and-answer session. [OPERATOR INSTRUCTIONS]. The first question is from Mr. Julian Mitchell, Credit Suisse. Please go ahead sir.

Hi, yes thanks. Two questions please, the first question is in your Power Products division, if we look at the last sort of six quarters, five of them have had order growth above 20%. Obviously, the June quarter your order growth was an 11 -- I was just curious, if you see any change in the demand environment over this simply one quarter and sort of and that's the end of it. And the second question was in the Power Systems business. If you felt there was anything in terms of geographic mix or types of project you are working on in that division that really boosted the margins in the second quarter? And thirdly just on going back to power products, sorry, within transformers, if you could just give us an update on what your expectations are for restructuring charges this year? Thanks.

Okay thank you Julian for your questions, I take with the power products and Michel will answer power systems. Power product, yes you're correct. The growth rate was a little bit lower, than what we had seen in previous quarters, it was actually local currency was 11% and US dollar 15%, which is not too bad to start with, but nevertheless a little lower. Is this indicative of a trend? We don't think so, I mean let's face it. It's hard to say while we continue to grow 20% plus, for the quarters to come. But 11% is on the other hand also not an indication of a break or change in trends. We do face the issue that that we have this denominator effect. I mean, we have grown tremendously, the past few quarters, and the air is getting a little thin, the higher we go to maintain those high growth rates. But I would say the overall quality of the power sector, the demand in this market is still at the same level as we had seen before. So I would hope that we see again strong order intake in future quarters, whether it's going to be at the 20% level or not, I simply cannot say. We don't know that, but the prospects are still positive.

As for transformers, your question again was --

That was on restructuring charges.

Higher restructuring charges, ' simply put, yes we didn't have a lot of the restructuring charge in the first half because factories are really full working at high -- very high capacity there really wasn't any need to restructure, but some of the aspect of the restructuring program that we announced in 2005, will continue and we do expect charges of about 40 million in the second half, probably more in the fourth quarter than the third quarter. Michel on PS.

Yes, on PS your questions about the margin in PS. I would say, no. It's more of a continuous improvement than one specific factor that made this margin come up to this quarter. Obviously, you know about the demand that is really very strong for the moment in many different areas. We have had a very rich quarter, both in terms of large substation orders as well as HVDC cables with net order. And I think what is really starting to pay off with the margin now is the selectively in tender offering that we have talked many times about and as well a much better execution. So we are not carrying any more of these big losers in portfolio of projects and we do execute it [quality of work] for the moment on the backlog that we have when we start also getting now some traction from gradually moving our engineering footprints towards the lower cost countries.

Yes. Just to add to what Michel just said, obviously in PS we have different business units, we have business units at deal with a lot of proprietary technology like HVDC, HVDC lights and FACTS where just by their [proprietariness] of the technology, lets call it more easy to generate the higher margin level.

If we go substations, that depending what kind of substation...

[Various] substations.

It is more competitive, but even here I think our focus and execution is paying off, we have been able to increase the margins in substations in the last quarters and that is also important for the overall profitability of PS.

Great thanks.

Thank you, Julian, next question please.

Next question is from Andreas Willi, J.P. Morgan. Please go ahead, sir.

Good afternoon, I have three questions please, the first one is on your base order growth if you could give the like-for-like base order growth rates for Q2? The second question is on the tax rate, which is obviously coming down faster than originally expected, what should we use for the full year and if then that is already, could it decline further thereafter? And the -- I think that the previous question has been answered so it's just two questions.

Okay. Okay so let me start with the tax rate Andreas, good afternoon. So indeed we had a very good tax rate this quarter 25.2%. The results are clearly of the fact that the profitability in the countries has been improving as well, we are particularly happy with the current results in the United States where I think we have a lot of operational improvements and also where I think we have done a pretty good job in terms of price increases.

So obviously having better results in the U.S. helps a lot using these tax-losses-carry-forwards that we have there. So it is mainly the tax planning and operating. Now can we sustain to 25% a quarter after quarter, I would still be a bit careful there. I think we, this year we'll go towards the 25% in any case below 28%. I would may be a little bit more aggressive than that but I would still not model a 25% for the full year. So probably something on 26.5% - 27% is more appropriate.

As for you question Andreas regarding base order growth. It was for the whole Group, it was in nominal currency 18% in local currency 13%. Without going in to details, the differences between the divisions are very similar to the overall growth development, meaning we had very good development in the both Power Products and Systems and robotics. And somewhat lower level developments in Automation Products and Process Automation.

With these base order growth rates coming down a bit, is that basically a change in mix that will stay with us for some quarters that you still get a lot of large orders but maybe the base order growth is flattening out a little bit?

I would say partly yes of course, if you have a strong large order development that doesn't necessarily go at the cost of low orders, but the kind of overshadows it. I would say more important is, I would expect a slight difference between the dynamics of future development on the power sector versus the automation sector. I think that is more pronounced. The power sector runs a little bit, by its own dynamics because of these necessary investments around the globe, whereas automation is to some extent more directly related to GDP and let's face it, to a 20% plus order growth in automation in the long-term, its' not sustainable in the long-term.

Yeah, I would conclude with that well for sure. It's different customer, different type of products, so it's not because we take a high number of large orders, that the base orders suffer from it, it's really a different trend. But it's for sure clear that for the moment we are, we ask to quote on much higher number of large projects than before and that, in fact the average size of these large orders is also bigger. So, that is more on market trend but I don't think it has any impact on the progression of base orders and let's say, yes 13% is still a pretty decent rate.

Thank you.

Thank you, Andreas. Next question please.

Next question is from James Stettler, Dresdner. Please go ahead sir.

Yes, thank you and good afternoon. Looking at the Power Systems division percentage of orders in North America or the Americas is down to 8%, are you really seeing any signs of the pick up there in that market? First question. The second question is could you just talk through what's going on in Lummus what's happening there to the underlying profitability of the business?

Hi James, thank you very much with your questions. The first one -- no we do see a very positive development in North America, one has to differentiate that that North America that the market how it works is different from Europe, North America is less so, the systems markets than for instance Europe. Because we have a lot of independent contractors that actually do the work, they source the components and equipment from suppliers like us. So it's the development of PP in North America is actually quite more indicative of the market development than PS. In PS it is much more exposed with the volatility of the one or the other large order. So to comeback to, it naturally means yes, North America is doing much better than two years ago. It's been a very positive development.

Yes.

And through North America obviously, major player there is U.S. and in fact in U.S. in both power divisions we had a very good quarter, order intake was at 40% in Power Products, and 33% in Power Systems. So what you may see as well as may be some volatility of order intake in Canada and Mexico, U.S. was pretty good

Especially Canada was.

Yes, well.

And as for your second question regarding Lummus...

Yeah regarding Lummus we are obviously the first in the process of selling it on one title, we're in the process of cleaning it. I would say that one a pure operational basis Lummus would have reported a high-single digit margin this quarter, but we are still in the cleaning process with some of this old contracts that have been haunting us for a while and that's why finally the final bottom line result of Lummus was a small loss. Actually an old loss, it goes back even before the year 2000, but we are wholly through that.

And you are confident you'll be able to sell it this year?

Yeah, we are. The process keeps on, I think we had openly told you that we didn't expect this thing to happen in two months, because its quite a complex business with a lot of things that take time to due diligence, so I would say we are in line. The interest is there.

Great, thank you.

Thank you, James. Next question please.

Next question comes from Mr. Mark Troman, Merrill Lynch. Please go ahead sir.

Yes, good afternoon gentleman. First question, Fred, you mentioned about automation and engineered products and system orders I think were flattening out a bit, can you just a provide a bit more detail no that is that particular to one or across the globe?

Its Mark thanks. It's a tricky answer because again it's long quarter. This is the -- systems we have same characteristics as in other divisions, these larger projects come and go. And this quarter it simply didn't happen, that's the reason why we try to point out the standard development, which were still pretty, pretty attractive. So we were lacking a little bit the large orders in this two product lines. And let's hope that we see more of them coming through the next in the following quarter and then things will back up in shape.

Okay and kind of just a follow on from that, in terms of let's say based order demand and inquiries you see across the world, the U.S., there's obviously some concerns there in construction related segments, are you seeing any sort of slowdown in any sectors?

Well, we are also, -- the one in the market participants but also market watchers, because we are not exposed -- as exposed to construction as others are and yes I think we do see some certain slowdown in that sector but we have not been hit as much as other got hit.

Okay and then finally, just a bit of number housekeeping. I think there was an early question on tax; in terms of the net financial charge and the discontinued line, what should we expect for the year Michel?

Yes Mark you have seen the next finance expense. This quarter is actually an income of 1 million. Obviously it improves fast with our financial situation it was a way of a little bit exceptional. We had also some point exchange gains, linked with some disposals we have made during the quarter. So I would still expect to see the finance expense and net finance expense for the next two quarter but the more normal run rate now should be around 16 million a quarter I would say.

Okay.

Well there are additional finance net. In terms of discontinued as we have mentioned, Lummus was a very small loss on the other side when could release a provision after the settlement that we had on the legal claim for a disposal that took place years ago. So the positive number that we see there is also one off. I would expect for the rest of the year the discontinued operations should mainly reflect the results of Lummus and so I don't think it will have a huge impact on your net income line.

Thank you very much gentlemen.

Thank you Mark. The next question please.

Next question from Mr. Martin Wilkie, Deutsche Bank. Please go ahead, sir.

Good afternoon guys, a couple of questions please. All the cash flow obviously, some investment in working capital that you talked about. But could you just let us know how you see working capital developing over the remainder of the year with this sort of a one-off ramp up if you like? You previously talked about the converting net income free cash flow of slightly less than a 100%, is that the number we should still be thinking about in terms of cash flow. And secondly just a clarification on the equities ventures business that you sold. I think that business will be sold for $490 million. I just want to clarify is that cash will be fully received in this quarter or is there still some payment outstanding on that?

Okay, let me start with the second one, if don't mind. Yes indeed. We sold it for 490, we got an advance payment of about 100 million in the first quarter and the rest was paid this quarter, now when you try to reconcile the cash flow from disposable of businesses you have to also take into the account the fact that we close the Building System transaction in this quarter as well, and off with the Building System went as well the cash that was on the balance sheet of that business. That's why you end up with a number that if I recall for this quarter is about 220 on the net basis.

Okay.

So, that is in reconciliation. In terms of net working capital, as we mentioned there is clearly for the moment some pressure in terms of working capital especially on the inventory, running a lot of work in process and there's maybe also a bit more accumulation of high cost of raw materials because we are working on so many projects at the same time, we are now in all calculations at 12.7% in terms of net working capital to sales. We are still working hard now to bring it lower, I want to get it back in the 11% range somewhere. As you know, usually our cash flow will still have a seasonal pattern especially in the fourth quarter. However, we are not aiming this year, and I think we've said this a few times to the 100% conversion. First because, the net income this year is there's no provision, so of course it's a real cash profit on the segment as well, we are ramping up our CapEx, we will spend this year more CapEx than depreciation. So if you put all that together I think we would be perfectly satisfied to end up the year with 85% or 90% conversion.

Okay, thank you very much.

Thank you Martin. Our next question please?

The next question is from Mr. [Sam Edmund] Goldman Sachs, please go ahead sir.

Yes thank you good afternoon to everyone. A couple of questions please, over the past few quarters you have been talking about the incremental margin and declining somewhat particularly as the mix is perhaps shifted between the more the product business and into the systems business and if anything, it looks like in the second quarter the incremental margins improved. I was just wondering if you could give us some thoughts, as [how's] on the order book and the margins you can see in the order book whether the price increases we hear about are net price increases, and therefore we should expect to actually greater incremental margin than historic going forwards?

And the other question was just on electrical steel where one of the company today has been talking about the shortage of electrical steel and whether in terms of actual supply rather than just price. And whether you are seeing any shortage of materials that may be could hinder your capacity expansions? Thanks.

Okay Sam thanks for your question. I will try to answer the electrical steel question and I pass on the [growth curve] margin question to Michel because I was always of opinion that it would improve again but my...

Thank you Fred.

Let's go back to electrical steel, yes indeed. Electrical steel is probably the one commodity where we not only have pretty sharp price increases but at times even shortages. We are so far being able to secure our supply, and that's fair to say that thanks to our size we are one of the largest users of electrical steel in the world. We have extremely good relationship with key suppliers for instance with steel manufacturers in Japan. We have also farmed contracts, so while we continue to watch that in order not to a run into a surprise where all of the sudden we do have a shortage and cannot deliver anymore. So far, we've been to able to deal with that pretty well, so far. And I would expect that we can continue to do so and if it hits us, it most likely will hit all of us even worse than us. So I think it's a situation where our size really is playing into our favor. Next, the drop in our margins, Michel.

As far as drop down margin I think the conversation we have had through the last quarter is obviously that the drop down margin need to come down at point in time when you start having the market growth like this. Plus you utilize your unused capacity which is a quick increment, it would be bottleneck and get the lot of it too, obviously we deliver much more now a days, by building additional capacity, so you can expect that an incremental margin, especially on the product business will not remain in 40% like we experienced some quarter.

But we have said as well, and now we're talking about even I personally say it would remain above 20% as long as the market remains good and I think now we are 24% automation products, 27% in the power products and probably we'll be able to sustain as long as the demand remained strong as it did, and if we don't get too many shocks in commodity price increase. As long as we can manage that to the continuous process, we are still quite optimistic there.

And just in terms of the order book, is there anything in fairly with the market improving, you've seen prices improving.

Yes, we obviously don't really quote on that but all I can say we monitored that closely, the margins on the order intake as well as on the backlog and all I can say is we are very satisfied with what we see there.

Thanks very much.

Thank you very much, let's move on to next question.

Next question from [Don Chen, Davis Advisors] please go ahead sir.

Hi, good afternoon. Congratulations on the good results. I had two questions, the first relating to basically that your China outlook. I'm pretty sure you're well aware of the belated five year report came out, and they're investigating, I think the estimates anywhere from 25 and 35 billion a year T&D. I'm just curious in terms of your contribution to that market when you see tings looking forward, let's say in the next five years or may be even more than that. The government is clearly focused on allocating more and more of that dollar windfall to sort of local competitors. And just wanted to see what your opinion was in terms of how ABB China can continue to benefit from that mix whether you expect to be overtime lose market share or it becomes sort of a case of rising tide lift, or both [maybe].

Second question was I think you had the press release came out with your I guess -- when you talked about just little of the payments by some of your subs I don't know if you went into detail of that but I was hoping can you elaborate a little more? Thanks.

Okay Don thanks very much. Let me start with the China question. So China your assumption basically is correct on the [environment] we see a continued positive outlook on how the economy the China's economy will develop and what kind of these investments are needed for the next few yeas on the power grids. So it's a positive situation to start with. At the same time the Chinese government has been, still is very focused on having technology been transferred into China and helping local companies to compete and so on. And this is something we have to face up to. Will this be a fundamental consequence to ABB?. I don't think really when it comes down to value creation. On the one hand we have to basically adjust to new competitive scenarios, for instance we have to think about introducing product lines that maybe positioned on a cheaper price level in order to make sure we participate also in a medium market segment and not only the top-line segment but that would create actually additional volume. On the other hand, we may see more large deals or large projects where we don't get the full volume anymore because we will not be the lead supplier who gets the big project within the -- orders with suppliers from China but the opposite could be true. So, it could be for a large deal, the Chinese government utility picks a low cost supplier to be the main contract than these sub-supplier. The question then remains what does it really mean to ABB, what kind of value-add do we still have in the system, what kind of margin. Is it just cosmetic that we don't account for all this sales anymore instead of announcing a $500 million deal as only 270 left, [for the rest] since it's the same margin or are we going to lose margin value-added in reality because all the players are coming into the picture.

At the moment we feel that this development will not seriously hurt us. That's our perception, because when it comes down to noble products and real technologies that are proprietary, we will still be in the game in one way or the other and that will eventually account to the bottom line. So, yes there is an increase in challenge as in China. This has always been the case, but in the last 15 years we have always been able to adapt to them and to meet the challenges and this will also be the theme for the future. As for payments, I don't know Michel, if we [legal today]?

No, I can take it, sure. Well then I think you will appreciate that the reason we can't disclose to you any kind of details whether which kind of amount is involved, which kind of potential sanction either because we can't. Because it's the investigation process also because may be we just don't know what the impact might be at this stage. All we can say is this it's a wrong crusade that we have embarked on that we are working with these since quite a while. That I think we very openly communicated with investors and shareholders about it. It's another step here we are now looking at the number of case some of them going way back in history some orders having zero ramification in more recent times and it is just part of the process here our internal process to dig out the tools and bring it them to the authorities when needed and then obviously take the internal measures internally and at the same time corporate with the authorities when it is required. So it's not just a brand new fact it's just another step in the long and painful process.

Okay.

I think let me add a few words here because it is not a trivial matter and let's be realistic about this. I would expect that even let's say five years down the road we will continue to have compliance issues, and not because we failed in our efforts it's just because the way that's the way human beings work. If you think of both the nation and the crime rate there is not a single nation around that has the crime rate to zero. Our ambition here -- it must be to create a culture that is supported by systems and processes where we do rids of this case where people know exactly what they are supposed to do, how to conduct business, where the tone at the top is to right one, that we set the right examples and that the longer the more of the majority of this people follow us and then we can eradicate those cases that are not acceptable. But let's be a realistic even in the future there will be errors made this is a human effect. We are exposed in an industry where we have this, it's a systemic issue and the temptation is there and it will continue to be there as long as you deal in certain countries and certain regions of this world with certain types of customers and therefore we have to do everything to make sure that we can deal with the topic in the right fashion. That's what we are doing. But that doesn't mean this is it, and three years down the road this topic will be resolved so we have don't to talk about it anymore. Unfortunately there will be cases again in the future.

And I think to complement, it's a one side creating a culture on the second side, it is also creating a controlled environment that allows us to mitigate the risk a little bit in that regard. And I think that we have done quite some progress in the last year to improve this controlled environment. Obviously the past is there and we have to deal with it and clean it and that's what we are doing.

Quite a few of you work for, I would say, large banks and financial services institutions. Have a check with your internal compliance officer and how many cases they have. That's the way it is unfortunately.

Understood. Thanks a lot.

Thank you. Next question please.

The next question is from Mr. Gerhard Moore, Societe Generale. Please go ahead, sir.

Hi, good afternoon. I have three questions please. First of all, can you give us an indication of what pricing trends were in the quarter for the group. And secondly, if you could give us an indication of what those trends were for transformers?

And the next question is really on the market for distribution products. I think you mentioned that you saw some weakness in North America. Are there any other markets where you're seeing weakness? And a final question if I can. It's really within your Automation Products business, could you let us know how happy you are with your product range within that business and do you feel that you have all the technologies you need?

Okay. Maybe I'll start off with one or the other question and then turn over to Michel. As for pricing for the group, the ABB Group is a large organization and we have everything from standup products that cost $1 a piece up to $500 million order so it's pretty difficult to give a generic statement. But it's fair to state at this moment the overall average of the group prices is still rising. Obviously, directly supported by the still increasing raw material costs which prompt us to pass on this price increases to our customers.

Having said that there is always one or the other product line but this is not the case where we are facing increasing competition or where the market demands, there are competitive rivalry if the price decreases but this is the minority of the case. So we have not seen a breaking trend that all of a sudden the market is turning against us and price decrease, competitive pressures are changing the picture of the game.

The same is true by the way about transformers which you specifically asked for. There I know the raw material price situation is still similar to what it has been 5 months, 6 months and 12 months ago, which means that the raw material prices are still increasing or on a very high level and this obviously is an industry problem and the industry as such has passed on the prices as much as possible to customers. So it seems that they are as in the group maybe even more accentuated.

As for Automation Products, I think it's fair to say that this is a very wide portfolio of related products starting from low voltage, find a low voltage in your household going to low voltage systems to control products to breakers and switches to drives to electric motors all sorts of things. The wide universe and yes, in there is quite a few things that I would love to have, and we don't have it yet. But I think this is a topic that we are going to address on September 5 in our strategy communication, so I would take to defer that at a little bit for two months and then we can talk about it. As for your second that was Michel, weakness, your question, what was it.

Of the markets where we saw some weakness, well I must say it's one of the fantastic issue that we have for the moment that really every market is working quite strongly at this stage, obviously you can always find some room for improvement. We mentioned the construction sector in the U.S. where we are not so much exposed. Now we are more exposed to the construction sector in Europe, especially Germany where it is a bit weaker than the rest, meaning it only was single-digit. I would say for the rest not really one industrial sector that we could really characterize as weak because sometimes emerging market compensates for more weakness in the mature market. So at this stage we are really seeing a very uniform trend of double-digit growth in most of the geographic areas. So I wouldn't think of singling out any particular here.

Okay.

Did we answer your question Gerhard?

Yes. Thank you very much.

Fred Kindle Yeah. Thank you. Next question please.

Next question from Mr. Mats Liss, Swedbank. Please go ahead, sir.

Yes. Thank you. It's Mats Liss, Swedbank. Just three questions here. First about orders. If you are giving up any due to the lack of the production capacities and the related one there, if you look at the order backlog, what part is up for delivery this year and next if you can give some indication there? And finally about the minority interest, if the Q2 performance is good indication for the rest of the year? Thank you.

Okay, thank you Matt for your questions. With regard to orders backlog production capacity that theme of your question let me state that we continuously watch the backlog situation and the order situation across the divisions. We reference as long key parameter that we look at which is on time deliveries. And it's interesting to note that by far the majority of this indicators across the group are on a good level that means between let's say 85% and 95% regard to on time delivery. And is compared to a year ago they have not worsened, so it is a situation that is still pretty much in control. That means we can cope with current avalanche of orders with the current massive project activity. Having said that yes, there is a few product lines where this is not the case where we actually have problems. These are classic occasions where the investments into necessary factory equipment that are more heavy, more difficult, more time-consuming to build up. I am talking here about large machines, larger motors, smaller generators which we still make a few transformers lines like large power transformers, where we see that delivery times are extending beyond one year.

So there we have a few problems, we also have a few problems with product lines where we actually shifted manufacturing capacity or added manufacturing capacity in newly developing economies like Estonia and we now have problems to get the people. So it's not only technical capacity, it's also people capacity. So to come back to your actual question I would say from a real group point of view you are not losing orders to any large extent because we couldn't fulfill them.

And slightly lower level or more intricate or more granular levels the answer is yes, there will be potential to get a few orders more if we had in-house, result a few capacity issues or if the delivery times were a little shorter than what I just pointed out. But I think it's a second order of magnitude and not impacting the overall growth performance of the group.

When it comes to minority interest, obviously as you know most of the minority interest comes from the joint ventures we have in China and our list of subsidiaries that we have in India. Obviously these are two geographies that either we'll need three new work forces for the moment both an issue of growth -- revenue growth, but as well profitability. So, yet I think it's a trend that you would see continuing throughout the year.

Just coming back to the first question again. As you'll probably know we have stepped up capacity, expenditures quite massively compared to previous years. This year 2007 is the first one that we actually budgeted CapEx above the depreciation rate by about 20%, order of magnitude, whereas in previous years, I think the year before it was above deprecation rate and previous year it was clearly below. So, we have acted upon this increase in order intake and I think overall they have pretty good control and we have also to make sure that we don't overdo the capacity increase if in case the market should turn against you. We are -- if you compare to last year, year-to-date we are 100 million ahead in terms of CapEx spending, and let's also take into account the fact that we spent majority of this CapEx in low-cost countries. So we also get more capacity out of this money than one would spend it in the mature countries. Die we answer your question Matt?

Okay. Just about the order backlog there, what part should we expect to get delivered in '07 and '08 could you give some rough figure there, percentage wise, perhaps?

You mean out of the 20 billion for the group?

Yeah.

Yeah. If we look at it -- we can look at it from this approach that the revenues on average are or more less 75% coming out of the backlog. So you have the do the reverse calculation but we are already in July now, so there is probably by the time I would say early half of the backlog which is already extending over the next year, but there's a rule of thumb that is what you can look at it, we generate 75% of the revenues from the open backlog. The rest of the backlog obviously extends much longer. We already have orders there that we will be executed in 2009.

Yeah.

Okay.

Okay. Thanks a lot.

Thank you. Next question, please.

Next question coming from Mr. Colin Gibson, HSBC. Please go ahead, sir.

Hi. Good afternoon. Three quick questions if I can. All areas that you have touched upon briefly, just asking for more clarification. First off, your outlook comment is almost unchanged versus the first quarter apart from automation where you have seen delivery you've chosen to be a little bit more cautious. Obviously, I can see the order growth rates in the automation businesses, but can you comment whether there's anything more specifically that's prompted you to get a little bit more cautious on the outlook statement there?

Secondly I think from the past few months if anybody has asked you about M&A, you've said that -- words to the effect that you had looked at a number of obvious larger acquisitions, but we're struggling to see value in them. I am slightly misquoting you maybe but I think that's roughly what you had been saying. Would that form of words still characterize where you are in M&A?

And lastly, going back to the question of the U.S. business, another trends where is to, earlier on in the call, granted that you are seeing the business coming through in Power Products as opposed to Power Systems at the moment but do you still think there is a reasonable outlook for larger project-based business coming through, transmission corridor of power business coming through in the U.S. sometime in the next year or two?

Okay. Maybe Michel will take outlook in U.S. and the M&A?

Okay as far the U.S. business, the answer is yes. I mean besides what I said before and that's the truth the market looks slightly different from Europe and other places with more independent contractors being in the game. And therefore more rate on the power product side to reflect actual market situation in PS. Having said that, yes that is potential for large scale orders in the future. This has to do with things that we talked about before, the sourcing about the energy bill is taking time to take effect. But the effect will come and we will see some of these corridor investments that you are hinting at. So there is potential that will come forward, whether it will happen or start to happen this year or the next year is open but it will at some point come to bear fruit with ABB. Okay?

Yeah.

Then for the outlook statement, yes you are in principal right, we haven't changed our outlook statements which basically says the situation is more or less the same as it was before it is almost equally good. And from that point of view there's no need to change it at all. We did change a little bit with the wording [APS] it's absolutely correct, but that's not a reflection of the market gotten worse but more a reflection of the fact that the previous growth rates were just extraordinarily high. We actually expected this order growth rate to come down even a quarter early, but it hasn't. Now it has come down, will it go back up again? It's quite possible, but from our point of view we try to be prudent. We'd rather state yes, it maybe a more realistic level of growth rate for the future than what we have seen before. As a matter of fact we don't have a crystal ball either. We can talk about it three months from now.

Sure.

Sorry about that.

And hi Colin good afternoon. Regarding the M&A part, I think your statement is right. We have done a lot of homework internally. I think we have seen lot of targets that would look very good in our portfolio, no question about it, about that. But at the end of the day as you say it's kind of value, companies have a lot of value but only if you pay the right price for them the moment we kind of fail to in the kind of prices we see in the market for the moment whether we can really [return] value to the shareholders. We keep working, we keep analyzing potential synergies we are ready to ask if something becomes attractive.

Thanks a lot.

Okay, thank you Colin. May I ask the operator to bring us the last question for today because it's already past four o'clock I realized.

The last question is from Christel Monot, UBS. Please go ahead.

Yes, hi, good afternoon gentlemen. I have three questions please, very quickly, as the first one is on pricing, raw material inflation and SG&A inflation quickly. I think you gave us an indication of what pricing was in Q1, you said it contributed roughly to one-third of the 15% organic growth [Q2 and Q1]. Could you give us a flavor of what it was like in Q2 out of the 21% organic growth revenues we saw.

And quickly on SG&A inflation, it looks to me like it was much below the order growth compared to the previous quarter where you say that it should be quite correlated, so is it an indication of what we should be foreseeing forwards? The second question is on the cash flow. There is a change in provision because of the positive effect of 144 million, could you let us know what is it about? And lastly, on the SEC filing. The fact that yourself have come to the SEC with this suspect payment issues, do you have any feeling whether it is going to lead to a lower fine potentially like it was in the GIS issue in Europe? Thank you.

Thank you, Crystal, for your long question.

Sorry about that.

No problem, let me start with the SEC question. The fact of the matter is it. As we pointed out it includes number of different cases and we are between the rock and a hard place because we cannot talk about it. The examination is still ongoing so there is certain openness to what this will lead to and therefore we really cannot comment on the magnitude and size of these cases. Not even with regard to the character or timing of these cases. I can only go so far to tell you that quite a few of these cases are old cases, some of them even have been in public domain before they have been known. But some the cases not only happened in the past but have ramifications into the present and maybe a few cases that have been newly discovered, whatever.

So it's a mixed bag of different things. I think important is that we have, with our own systems and processes, we have recognized these qualities, these items we have analyzed and brought them forward to the respective authorities. Now it remains to be seen what it all means, how the authorities will coordinate the approach with us and what the implication will be.

Clearly, there will be a cost. This doesn't come for free. On the one hand we have investigation cost which is in our current period expense but there may also fines in the future. I would love to be able to say it's not material, but I think they cannot, I cannot say that because it's not up to us, there is a third party involved which is the government law authorities and they have their own say how they view this. So we have to wait and see and that's the only means of checking it.

More importantly, is the fact that we have, for the last two years we have taken steps to really address this compliance and business ethics topic in a very, very strict and forceful way. We have always been very explicit, you may recall us to come forward with press release, you could talk about it in quarterly teleconference calls because we were of the opinion that it is important to be explicit about it, otherwise our people don't take it serious.

We have made this an extremely serious topic. We have let go of a number of people, not only in 2007 but in previous years. We have taken every conceivable measure to move forward, but it is not enough. We are not excellent yet. And our ambition must be to drive down the frequency and magnitude of these cases to a level where we can feel proud about it. And that's not the case yet. And in the meantime you know we have to do what has been the case in this quarter. We have to discover the cases and we have to deal with them, we have to go to the authorities and we have to inform the market, you about what has happened as far as we can go. So that's as much as I could say, unfortunately no more.

Plus, I can take the two other questions if you want. Krystal, on the pricing, I think that the trend is continuing to evolve. You can look it all the progressions thing is more a one-third pricing, two-third volume. It is probably more 50-50 and if you go down to division mark ball park because of the amount of the commodity raw materials that they have. Overall, we're still doing pretty well as I commented before, we like what we see in the overall backlog margins, which means that despite the substantial increase that we have seen again this quarter and some of our raw materials like copper, like crude oil or carbon steel that were all double-digit increase. We're still seeing a progression of our gross margin. So that shows that the pricing put together with the hedging is still yielding positive results from that regard.

As far as your question on provisions is concerned, the largest part of this provision really is linked to the fact that we had the large asbestos payment this quarter and so that obviously means that we will use the related provision that we have in the balance sheet. The rest is also obviously linked to the fact that now revenues start kicking in and when you see the 21% growth in revenues that also means that projects have reached the end stage and then you can release the provision which is also a sign of the execution is improved.

Do you mind if I follow-up? Just on SG&A where inflation versus orders inflation?

Can you repeat the question there, because --.

Okay, sorry. I remember in the first quarter and previous quarter there had been some questions on the fact that SG&A inflation was quite high, and I remember you commented that it was more related to the order growth than the revenues growth. And in this quarter revenues are still growing quite fast but SG&A inflation was only 11%. Is there any specific [inaudible] spinning there and what should be the trend going forward?

No, I think it was a pretty good quarter overall. Obviously, one significant impact we now see in our SG&A as the Sarbanes-Oxley costs are starting to down to a reasonable expenses anymore. We are no more in this project mode but are now embedding it into our normal processes and so, obviously the cost of that is going down because it's mainly internal costs. So, that has obviously helped quite a lot. I think for the rest, we are very happy with the development that we have seen in SG&A. And if you analyze it really the selling efforts continue and we invest there, but the G&A performance has really improved quite a lot, especially as a percent of revenue. Now it really gets diluted quite fast.

Okay. Thanks a lot for this.

Sure Crystal. Well, thank you and thank everybody for listening in this conference call for the second quarter results of ABB. We're looking forward to taking to you again. Some of you I will meet and Michele, meets tomorrow on our road show to London and to Switzerland. I hope we see or hear most from you again on September 5, at our Strategy Day and then later on in the year for the third quarter release. So thank you very much and have a nice day.

Thank you. Good bye.

Ladies and gentlemen, the conference call is now over and you may disconnect your telephone. Thank you very much for calling. Good bye.