Siemens AG (OTCPK:SIEGY) Q3 2016 Earnings Conference Call August 4, 2016 3:45 AM ET
Sabine Reichel - Head of Investor Relations
Josef Kaeser - President and Chief Executive Officer
Ralf Thomas - Chief Financial Officer
Andreas Willi - JPMorgan
Ben Uglow - Morgan Stanley
Mark Troman - Bank of America Merrill Lynch
Peter Reilly - Jefferies
Simon Toennessen - Berenberg
Gaël Bray - Deutsche Bank
Andre Kukhnin - Credit Suisse
Good morning, ladies and gentlemen, and welcome to the Siemens' 2016 Third Quarter Conference Call. As a reminder, this conference is being recorded.
Before we begin, I would like to draw your attention to the Safe Harbor statement on page 2 of the Siemens' presentation. This conference call may include forward-looking statements. These statements are based on the company's current expectations and certain assumptions and are, therefore, subject to certain risks and uncertainties.
At this time, I'd like to turn the call over to your host today, Mrs. Sabine Reichel, Head of Investor Relations. Please go ahead, madam.
Good morning, ladies and gentlemen, and welcome to our Q3 conference call. The earnings release and the Q3 presentation was released at 7:00 AM this morning. You can download all files on our website. The call is also webcast via our IR website.
Our President and CEO, Joe Kaeser; and our CFO, Ralf Thomas, are here this morning to review the Q3 results with you. Joe will start with a brief presentation, and then we will have time for Q&A with Joe and Ralf.
And with that, I would like to hand over to Joe.
Thank you, Sabine. Good morning, everyone, and thank you for joining us at our third quarter conference call. Strong results of this quarter demonstrate that we [indiscernible] have been successfully executing our commitments laid out in Vision 2020. We delivered what we promised, and we will continue to work hard on achieving our goals.
Above and beyond our operational strengths and reliable execution, we will further accelerate our innovation excellence and strengthen our portfolio in smart ways. In June, we announced the planned merger of Siemens Wind Power business with Gamesa. We intend to own 59% of the merged entity. We do have substantial growth potential, highly complementary strength and a strong value proposition towards our customers to help them get their cost down and revenues up.
Just a few weeks ago, we announced the foundation of what we call next47, the [indiscernible] a startup company that we will foster this up to five years, encourage and thus, accelerate the development of new technologies, business models, and creative innovation.
Over next five years, we plan to invest about €1 million in five attractive innovation fields, the centralized electrification, artificial intelligence, autonomous machines including advanced robotics, reconnected e-mobility and block-chain applications. So, we drive execution of our Vision 2020 concept in all areas having the sustainable and long-term element of responsible entrepreneurship in mind.
As for the short term, we drive performance. And Q3 was about outperformance. We delivered strong top line growth despite continued sluggish economic environment and accelerating global uncertainties due also with the impact of the Brexit vote. We will stay focused, manage the challenges, and capture opportunities on dedicated customer projects across the globe and on areas that we can provide tangible value and support, execute on our self-help potential such as our cost cutting program [indiscernible] fixing underperforming businesses and drive base productivity in all areas of the company.
We did well compared to the industry, actually very well. Orders continue to grow. They're clearly up 10%, excluding currency effects, driven by some major orders in Power as well as in Wind Power. The accelerated revenue grows to 9%, excluding currency effects and 7% on an organic base. Wind Power as well as Power and Gas delivered double-digit growth while all other divisions achieved moderate growth rates except Process Industries and Drives, and I will come to PD in a minute.
Industrial profit margin was at 10%, up 130 basis points year-over-year with hardly any support from FX for the company. Eight of nine divisions are in the target margin range with margin expansion in most divisions, particularly in Power and Gas, Energy Management and Wind Power.
Our 1 by 16 cost savings program is well on track. We're confident to achieve €950 million to €1 billion cost savings by the end of fiscal 2016 already as compared to the previously-planned €850 million to €950 million. So, Ralf is on top of these matters, and I really, really like what we see here in terms of executing on our cost savings in 2016.
Net income of €1.4 billion is unchanged versus prior year. Main reasons are a significant negative swing in the Hanau asset retirement obligation due to lower interest rates, as well as tough comps from the positive onetime effects in discontinued operations a year ago. This amounts to a total €300 million like-for-like swing. So, the underlying profit improvement is also pretty visible in the net income after tax.
Finally, we made good progress and achieved a strong free cash flow development of €1.6 billion in the third quarter mainly due to improved working capital management. So, all in all, a great quarter and I'm proud of my team executing well in a complicated environment.
Now, let's look at some key developments in the division. Power and gas continues to operate in a market environment with significant overcapacities resulting in a highly competitive market. As demonstrated in Capital Markets Day in Houston, the team works hard and successfully to drive synergies, productivity, and innovation.
We shipped 16 large gas turbines in the quarter, among those 7 H-class turbines. Our Egypt megaproject is progressing well as planned with 11 H-class turbines and 11 generators already at the foundation on site. This ramp up was a major driver for a convincing revenue growth of 22% in the quarter. However, we expect revenue growth to soften in the fourth quarter on top of comparables in the divisions. As already mentioned, wind power has taken-in major orders including a €1.4-billion order from the Beatrice Offshore Windfarm in the UK. The division increased is backlog to almost €16 billion. So, backlog conversion and good service turns drove revenue growth in both onshore and offshore.
With €1.7 billion, we achieved the quarterly revenue ever in the wind business. The division is making excellent progress in optimizing its supply chain and pushing for productivity on all levels. This and the better mix help to drive the profit range beyond the target margin range to 8.3%. I would have to say the Wind Power team has built a very solid performance track record and is ready for contributing a strong business into the world's strongest wind enterprise together with Gamesa.
We also like what we see from the Energy Management team who executed well on their plan and continue to improve performance across most businesses, in particular transmission solutions and high voltage products. We also like the progress of the transformer business, which has been one of the, what we called, underperforming businesses in the space. There's a profit margin of 8.3%. Energy Management is back with a target range and it's our expected division to be in that range also for the full year in 2016 and counting.
A third highlight of the third quarter, we received - was that we received a significant order in China, which is also a great technology milestone. This is about a delivery of the first 1100 KB converted transformers for the world's largest HVDC connection with almost 3,300 kilometers length and 12-gigawatt transmission capacity between [indiscernible].
Building Technology delivered a solid set of numbers across the board with double-digit order growth, driven by some large project awards east and west of the Atlantic. Higher revenues translated into improved margins, benefiting from a strong product business. The leadership team is focusing on service and expanding its strong automation and digitalization platform in the business.
Digital Factory is coping well with the ongoing low growth, actually, retreating environment and continues to benefit from its strong position in the fast-growing PLM Software business, forming the Digital Factory division two years ago by combining factory automation, motion control and PLM clearly has paid off. Revenue growth was driven by Software business' double-digit growth in China, while the short-cycle business overall was about flat year-over-year as we expected it to come in.
From a regional perspective, the short-cycle business was weak in the U.S. and the China, and flattish in Germany, while other European countries fully compensated for these markets although on easier comps compared to last quarter a year-ago. Despite the low-growth environment, profitability came in at a really decent level of 15.7% including negative effects totaling €39 million from integration costs as well as deferred revenue adjustments related to the CD-adapco acquisition.
The integration of CD-adapco into our PLM business unit has been working very well. The team is excited and we are already ahead of our plans after the first quarter. We do see good - actually, a really good growth momentum in the business, and the acquisition has been very well-received by our customers and our partners.
As Jürgen Brandes explained during the recent Capital Markets Day, Process Industries and Drives faces ongoing weak cyclical demand from commodity-related industries and needs to address also its structural challenges first and foremost, regional footprint and reducing overcapacities around the world.
The negotiations with the employee representatives regard to planned capacity adjustments and footprint alignments are progressing reasonably well, and we do see a good chance to have an agreement by year-end already.
We booked around €40 million of severance charges in Q3 with the majority still [indiscernible] expected in the fourth quarter, potentially some overflowing to fiscal Q1 2017 depending on the progress of the agreements going forward.
Mobility delivered another strong quarter regarding profitability by stringent execution and over the positive effects from large projects. Orders were sharply lower on the back of tough comps to the third quarter 2015. We continue to be pleased with our healthcare business which delivered sustainable performance on high levels.
Top-line growth was mainly driven by our diagnostic imaging business. From a regional perspective, we like to see double-digit growth in China. Equipment orders in China were up more than 20%, and Healthineer margins were solid and benefited from foreign currency tailwind of around 80 basis points.
Just two days ago, we introduced a new and superior lab diagnostics, next-generation platform which we call Atellica at the AACC Conference. This was and has been a multiyear effort which will help us to favorably reposition ourselves in the market. Shipments will commence during the next fiscal year.
Let me now, ladies and gentlemen, close with our financial outlook for the remainder of the current fiscal year with three quarters already behind us. As we continue strong performance in the first nine months of fiscal 2016 and despite deteriorating market conditions, we raised our previous expectations for basic EPS from net income in the range of €6.00 to €6.40 to the new range of €6.50 to €6.70. All other statements of the outlook for fiscal year 2016 remain unchanged.
With that, Ralf and I are happy to take your questions, and I'll return the mic to Sabine. Thank you.
Thank you. Operator, we would like to open the Q&A now.
Thank you, ladies and gentlemen. We will start today's question-and-answer session. [Operator Instructions] And our first question comes from the line of Andreas Willi of JPMorgan.
Yes. Good morning, Joe, Ralf and Sabine. My first question is on Wind Power which had another good quarter ahead of the deal with Gamesa. Did it already benefit from the adjustment to the structural cost, especially the reduction in costs you allocate to that business on real estate and other matters or was it just been an underlying improvement? And if it's the second, then it looks like the Gamesa side had a better much deal in terms of the much higher Siemens profitability you contribute to the asset to the combined company.
The second question is related to Power and Gas. Maybe you could help you us a bit there on the phasing of the remaining revenues from Egypt, kind of how much of the €5.5 billion order has already materialized in revenues and when do you expect that to be completed and what do you expect for [indiscernible] for next year? The book-to-bill looks like to be around be around 0.67%, so still some revenue pressure to come. Do you expect cost savings there to be able to maintain margins in that business as revenues continue to come down? Thank you.
Hi, Andreas. Let me, maybe, quickly go to Wind Power. Obviously, the team has been doing its job there in getting the supply chain in order and price productivity. We also introduced the new generations of turbines in both offshore as well as onshore, so that is a good underlying improvement. We also mentioned that there's been a structural mix also contributing to the improvements, so it's been a bit of both.
Who's got the better deal or the worse here, time will tell. We believe that we did the right things because, obviously, reform - we basically initiate consolidation and reform a global champion, our will. And so, we still feel good about what we see. Actually, in both areas. You also might have seen that Gamesa was coming up with strong numbers, beating estimates. And now we have been following [indiscernible]. Actually, it just tells me that this is going to be a good combination if and when it finally materializes, but that's what we need to do first and then we'll take it from there.
Maybe, Ralf, on the...
So, Andreas, with regard to each of them, we are just quite happy that we are starting to convert into revenues with all the three major projects out there. By the way, it's also fairly good that we have a strong free cash flow from the payment coming in in that area.
As discussed in the past, we have been putting a regime in place and agreements in place that allow us not to be in any risk position in that regard. So, overall, our contribution in terms of inventories and being - and preparational efforts are covered as indicated before.
So, at the end of this fiscal year, we will get close, as we said, also to first fire of the first place in December. And from then on, we will most likely see two quarters of strong revenue recognition from that that will then, again, flatten out over the course of the rest of the fiscal year 2017.
So, in terms of numbers, I think it would be too early to describe that. But what you should be aware of and what we are happy that we can confirm that we are not taking any higher level of risk in terms of having more assets on our books compared to that what we had been planning for.
And so, with the margin development, I mean, we have been consistently working also on getting our cost position to a point that is as efficient as it can be. And we also have been bundling forces in terms of making sure that the procurement bill is developing in a favorable way. And all that is falling in place according to the plans that we have been making so far.
On top of that, of course, the overall PD entity is also benefiting from the implementation of PG 2020, taking massively cost out and sharpening also our profile in terms of footprint, getting closer to markets. And there's also, of course, a portion of 1 by 16 that is having an impact on PG 2020 and the execution in that field.
Then, with regards to Dresser, I mean, at the moment, as Lisa probably has been explaining very well in the Capital Market Day, I mean, we are pleased to say that even though the market environment didn't change for the better, it's still very much on track in terms of making sure that the synergies are coming in. I mean, you heard us saying that they are even a bit beyond than what we had been originally expecting. And from that perspective, we are doing fairly well.
When it comes to book-to-bill, I think over the third quarter, we were in the area of around 0.8. And we expect the same dimension for the full fiscal year to materialize. Next year, there's a slight improvement plan from today's perspective, but it will definitely not exceed one in terms of book-to-bill ratio going forward.
Yeah. I know a lot of topics related to 2017. We are going to comment on when we do the outlook for 2017 in November.
Maybe just on the inventory revaluation in service, what that relate to Wind Power?
Yeah. In total, I mean, let me just give you a bit of color what the background is. I mean, this is just in refining our methods and how to assess availability and valuation of spare parts in our inventory. So, it's materializing in the service business, in our internal structure. And it's a change in the accounting estimate because what we have been accomplishing is - I mean, we got closer to the real pattern of usage in terms of spare parts and inventories. And with the more transparency, more details being available, also more individualized spare parts for different jobs and locations, we are now in a position to move from a flat rate in terms of accounting, estimating the value of those spare parts into a more differentiated assessment of different inventory classes reflecting the individual technical risk, if you will. And that has been allowing us to, A, turn the assets quicker; and B, then also release reserves to an amount of €47 million for that particular business in PS.
Thank you very much.
You're welcome, Andreas.
Our next question comes from the line of Ben Uglow of Morgan Stanley. Please go ahead.
Yes. Good morning, Joe, Ralf and Sabine. I think probably a few of the questions are going to be quite similar around the phasing and getting to the backlog conversion in energy. I guess my question is similar to Andreas'. If we strip Egypt out, you've actually had some very significant order wins outside. So, even in the quarter, I look at the U.S. [indiscernible], Israel, Bolivia, China. And my question is as we look forward into 2017, ex the Egypt effect, should we be thinking that this business is growing mid-single digit, low-single digit, high-single digit? Can you give us a frame of reference for thinking about the fossil power business, revenue conversion or the backlog conversion or the backlog conversion into 2017? So, that's issue number one.
Issue number two is just on China. Obviously, we saw this across a few companies, 12% order growth in China in the quarter. You mentioned that healthcare was particularly strong. Were there any other areas where you saw an upturn or an improvement in China activity in the quarter?
Yeah. Thank you, Ben. Let me start with the last part or the second question you have been raising. I mean if you take exchange rate of the equation, I mean we had a very strong quarter in China in terms of growth rates when it comes to Power and Gas, but also Energy Management has been benefiting a lot. So, these two were outstanding, if you will, in terms of growth rates. So, we have been commenting already that the equipment business in our indiscernible] business has been developing quite nicely, high teens. And also, building technology has been picking quite favorably with double-digit growth rate.
When it comes the automation piece of the market in China, I mean it has - the last quarters already have been showing - it has been continuing that the product business was fairly slow with a moderation contraction but PL, our software business has been holding strong. And so, therefore, I mean it's kind of paying off that we have been in this space at the point in time when we have been making the market familiar with the productivity potential that our solutions are offering, implementing logical software in automation business and allowing both growth efficiency and also high quality levels for our customers in that field.
And so, when we talked about the backlog and the conversion, I mean, there is a lot of math, of course, in it. I mean, PG is sitting on €46 billion of backlog, which is representing about 40% of our overall backlog at the end of the third quarter.
And what you typically see in terms of conversion of that backlog is that one-third, roughly, is always that part that is going to be converted into revenues in the next fiscal year. So, that equation or that rule of thumb is also applicable now for 2017.
As Joe said, I mean, we will take the time and share with you our view on fiscal 2017 in more detail at a later point in time. But what you need to bear in mind while quoting all these project wins that we have, that most of them have also a strong service piece in their numbers that we are telling you.
And that means that only with a time delay of something between one-and-a-half and two years, after we are accomplishing the products being delivered and the projects being completed, the service revenue piece is going to kick in.
So, therefore, most of these projects that we have been winning lately in the power and gas space will have their impact on next fiscal year. But bear in mind that the strong margin service portion will most likely kick in at a later point in time than 2017.
And with regards to what do we expect for 2017, just roughly in terms of giving you an understanding of what we expect in the relevant backlogs being converted in PG, Wind Power and Mobility, that is in the area of 20%, yeah.
On top of that, there always needs to be short-term book-and-bill projects that roll over into revenue fairly quickly. And I have been mentioning the service contracts in most of these major deals anyway. So, in total, next fiscal year will benefit from project business in that field, but that also means that the revenue mix is going into the direction of Wind Power, Energy Management, Mobility and PG.
That's very helpful. Thank you.
Our next question comes from the line of Mark Troman of Bank of America Merrill Lynch.
Yeah. Thank you. Good morning, Joe, Ralf and Sabine. Three short questions, please, if I could. Firstly, the €1 billion looks or pretty to €1 billion of overhead efficiency looks to be delivered this year. I wonder what your view is on scope for further efficiency gains as you look past that. Or does the focus shift to more the divisional performance in terms of improving the divisions rather than the overhead structure? I wonder if you could comment on how Siemens progresses in terms of efficiency.
Second question on the short-cycle outlook, Joe. I mean, it looks like Digital Factory is stabilizing, and you described China being down and other parts of Europe doing well. Can you outline how you see those cycles? Have we bottomed on the equipment side in China and the U.S. and some of those weaker parts of the short cycle business?
And then, finally, just a quick one on Healthcare. It all looked pretty healthy with growth, et cetera. But margins were down 40, 50 basis points year-on-year. I just wondered if there's a reason for that. If there was that some investment going on or was it exceptional last year? Thank you. I wonder if you could explain that. Thank you.
Mark, thank you for three interesting themes you're touching with your questions. Let me start with 1 by 16 and what's next that's actually the core of your question. I mean, first of all, we are really happy that we have been keeping momentum in 1 by 16. And as far as it looks now, we will really get very close to the €1 billion being completed by the end of the fiscal year's program.
But also bear in mind that what we said in the beginning when we have been introducing the program to you guys, saying that this is, on the one-hand side, a program taking cost out from the support functions and the administrative processes within the divisions, but it's also the start of changing the mindset to a continuous improvement exercise that would not look at the cost base only, but also cater for the needs of flexibility, how to swiftly respond to changes in the market in our portfolio, making us more agile.
And from that perspective, the 3% to 5% cost productivity overall, including these activities, is still high on our agenda and so is a continuous effort to benchmark ourselves and to learn from that what we can afford, on the one-hand side with competitors and other companies, but also on listening carefully to our internal customers what they need and what they don't need. And whenever we see opportunities to drop certain items that are not in the area that our customers are finally paying us for, we are not hesitant to address those areas. And that's what we are just doing very consistently, and we also discussed that intensively up to the managing board.
So, from that perspective, it will be a continuous improvement in that field that is not only addressing cost, but also flexibility associated to swiftly respond to market needs.
With regards to the short-cycle business, I think it's fair to say that you have been describing the overall picture fairly well in China. We saw the short-cycle business on the product and declining moderately. And as I said before, we had double-digit growth rates in the software arena. Solution business is also suffering a bit in that area of China. And the U.S. also had a modest decline when it comes to the product short-cycle business. Software was rather flat in that area, in that geography. And it looks like the customer mood for domestic business is slightly improving in that area outside the oil and gas arena.
In Germany, we have been pretty flat, short-cycle business and software, both. And the rest of the European landscape was especially benefiting from Italy with the strong export industry, as you do know in the machine building industries. So, short cycle was there up by a mid-single-digit number and was also driven by certain market segments like packaging industries which have been benefiting from export industries.
So, with regards to bottoming out in China, it's hard to tell, to be honest, because it's a different picture from market segment to market segment. It would be too early to finally conclude, but it's still - that automotive is still benefiting in the Chinese environment. And, as you know, as long as automotive is having momentum, the overall sector is benefiting and is giving it a certain cushion net that is helping with keeping the business on moderate growth levels then.
With regard to healthcare, I think you have been already answering the question by yourself, Mark. I mean we have been mentioning before that we are very happy with the overall performance of our healthcare - of our Healthineers. And the fact that the quarterly margin has been a bit down year-over-year does not contradict the fact that this is a very strong and growing business. Especially the imaging part, it's very much benefiting from wins and market share in relevant industries.
As you heard us launching Atellica, that's the in-vitro diagnostic product that we have been introducing which is really, I think, a huge step in the marketplace. It's not only allowing 10 times faster than conventional conveyor movements on the magnetic transport system. It's also allowing a more modular, scalable and flexible setup for up to 10 components with more than 300 customizable configurations.
And the floor space productivity, which is of utmost importance in those diagnostic centers, is extremely improving on a square-meter basis combined with a higher reliability we expect from that new product being introduced.
I think we are on the right way. And you are right, we have been investing substantially. The benefit from that, we will not see before the end of the next fiscal year earliest because you do know name of the game is that you first roll out the instrument and then make the biggest step in terms of profitability when the reagents are picking in which is substantially later.
Very helpful. Thank you very much.
Our next question comes from the line of Peter Reilly of Jefferies.
Good morning, everybody. I've got three questions, please. Firstly, just coming back on to healthcare, you're talking obviously very positively about the business organically, but [indiscernible] the growth rate over the last three quarters have gone plus 11, plus 5 and plus 2. So, quite a rapid fall off on the growth rate. Is that just the normal lumpiness from quarter-to-quarter? And is there any trend that we should be concerned about?
Secondly, on the Wind business, you've had two courses of very strong growth and we're told at the Capital Markets Day, you've been deliberately holding back the growth rate because you had loss of efficiency and supply chain issues to work through. I'm just wondering with the record backlog whether we're now - if we can [indiscernible] it for a second at the start of the period of much stronger growth as you can convert the backlog more quickly.
And then, lastly, on BT, if I understood correctly, you talked about winning more projects, investing in home automation. It's obviously been a very successful turnaround, but is this margin risk looking forward as I'm assuming that the large project in home automation are both going to be margin-dilutive going forward?
Thank you, Peter. Let me start with BT. I mean, when we talk projects in BT, this is not close to being comparable to other projects like we have them in Energy Management and the like. So, BT is very selective in projects and, therefore, very well balancing between service, product and project business in terms of solutions. They do that on a very selective basis and very balanced, as I said. I don't - I would not expect any incremental risk being derived from the fact that growth in the third quarter was driven by that, the project in that particular quarter. Of course, this is a result of quite a long preparational phase, and it very much depends on when they are matured for signing. So, I wouldn't call it untypical. It just happens to be quite condensed in the third quarter.
I think the margin development and also the ability of our BT business to convert margin into cash flow is really outstanding for years. And I agree, they do have a certain pattern in seasonality. Over the last years, we always saw that very strong fourth quarter, then coming - being driven by revenues and growth rates. But I would not see any different impact from the projects that have been mentioned for the third quarter's top line development there.
With regards to Wind Power and the second quarter in a row with really very impressive results, I think you have been hitting the nail there. It is about conversion and utilization of the existing capacities. And for quite some times, we have been reporting back to you guys that they are still in the late stage of industrialization of their value chains. They get - they have been getting a firmer and firmer grip around those areas, including in and outbound logistics which are playing a major role in that field as you can imagine.
So, the €16 billion of backlog that we hold at the moment are quite impressive. The scheduling and the reliability of the scheduling for their production activities is more and more reliable. So, therefore, we also expect them to continue executing on high levels of manufacturing quality where they have been suffering from in the past.
The conversion of the backlog is also, of course, depending on the service piece in it. And we are happy that also, our digitalization strategy is more and more kicking into and materializing into long-term service contracts which, of course, will not materialize in terms of revenue any time soon but rather, on the long-end.
And the first question about healthcare. I mean, you know that I myself have been spending quite a substantial amount of time of my career in the healthcare business in the imaging arena. And, therefore, even though you wouldn't expect it to happen, there is also a certain seasonal pattern in the quarterly development of the healthcare top line development.
And I would also not ignore the fact that some of our competitors may have becoming pretty much under pressure after the strong results we have been achieving in the prior quarters. I'm not seeing any trends, in particular, on the imaging side that which down guides ourselves. But, as I said before, when it comes to in-vitro diagnostics, before we see the full impact of Atellica, it will take a couple of more quarters in the marketplace.
That's very helpful. Thank you very much.
Our next question comes from the line of Simon Toennessen of Berenberg.
Yes. Good morning, Joe, Ralf and Sabine. My first question, on Digital Factory. I think if I exclude the integration cost and the deferred revenues you had for CD, we get to about a flattish margin in the quarter.
With growing PLM business and also CD positively contributing, I just wonder about mix, why the margin hasn't improved because of the higher margin software content growing [indiscernible] and some of the other areas within the division?
And maybe as a follow-up for the Digital Factory, just curious after you've already seen the CD business a bit more now since January and the announcement, how is the engagement with customers going particularly as you probably intend to leverage the strong PLM business that you currently have?
And then last question on Process and Drives. I mean with the oil price back in the low 40s and we've heard a lot management teams at this quarterly result season talking about no oil and gas demand recovery before the second half of next year, and that - this could be for you, even the first quarter of your fiscal 2018. How do you feel about the current cost measures you're doing in PD, obviously, in relation to you getting back into the margin corridor? If I just do my math on the additional headcounts you're doing, I'm still not quite getting there in terms of the bottom end of the margin guidance that you're trying to achieve for in terms of the profits that we need to achieve. Just a bit more clarity there would be very helpful. Thank you very much
Simon, thank you for your questions. I mean let me start with the Digital Factory. And your analysis is absolutely perfectly right in terms of taking out the integration cost and the haircut with regards to revenue in the acquired software business, which is typical for those industries, but has been kind of outstandingly high in this particular quarter. We still will see impact from the revenue haircut in the next two quarters, but on a substantially lower level. That's one extraordinary impact, of course.
The other one, with regard to the mix between automation product business and software business, it's right that we are shifting the focus into the software arena. But it's also right that the product business, especially under a growth scenario, is delivering extremely high margin conversion. So, therefore, before we come to the point to replace the high-product margin conversion of a growth environment in product business by the margins of software, that will still take us a bit of time.
So, it's not the margin levels only. It's also the conversion from growth. So, that's something we need to bear in mind when we try to anticipate the future mix. And, of course, also integrating the portfolio of the companies we have been acquiring in the past will also unfold the synergetic level only over the course of the next couple of quarters, even though we are very well proceeding with our integration efforts in the CD-adapco, as Joe has been reporting on already.
When it comes to Process Industries and Drives, are the cost measures comprehensive enough? That was the way I have been perceiving in your question. And how long will it take before we will finally end up again, back again, in the target margin corridor? I think it's, first of all, important to say that, I mean, what we see has two different reasons. I mean one of them being that the markets and the commodity-related environment are still down. And we wouldn't expect a quick recovery any time soon.
On the other hand, we invest in our footprint, getting closer to the growth markets and to our key customers, but also in becoming more flexible to respond quickly if need be for market demands changing.
With that being implemented, I think the measures that we have been indicating and which are just in the process of completing negotiations with the representatives of labor and the union, that's the one thing before they materialize, bringing us back into the margin ranges that will take quite some time. And the timing horizon you have been describing before for the competitive environment late 2017, early 2018, I think that's a reasonable timeframe to talk about.
Thanks. And the customer engagement with CD now after the acquisition, how is that progressing?
That's what I meant when I said it's working well...
...when it comes to integration. I mean, what we need to be aware of - I mean, this is a fairly small company compared to the activities we have been holding already. And for them, it's extremely exciting and also a huge opportunity to address channels that they couldn't address before.
The selected customer base that they are bringing now to our business is also very interesting because it's a different kind of customer bases which we didn't have full access to also with our products. But it's too early to finally assess, even though it's just a few months back that we have been closing the deal. And we will keep you posted as we proceed.
Perfect. Thanks, Ralf.
Our next question comes from the line of Gaël De Bray of Deutsche Bank.
Yes. Hello. Good morning, everybody. Could you talk a bit more about the outlook for the short-cycle activities in the U.S. because we have pretty mixed signals out there? And could you also talk about the trends in emerging markets where orders in the quarter dropped 15%?
The other question I had was on the so-called underperforming businesses. That'd be great if you could give us some update on the aggregated margin performance for this €15 billion of turnover, and tell us about which units are running ahead or behind the targeted margin ambition for next year.
And if I can, just one final question on the guidance, which has been revised, so that's obviously great. But it still implies an EPS of just between €1.2 and €1.4 in the first quarter, so clearly down from the €1.65 reported in Q3. So, apart from the higher restructuring charges for PD, what's driving the cushion here? Thank you.
So, let me, Gaël, start with the short-cycle business. I have been elaborating a bit on that already on the prior - on the question before. But specifically in the U.S., the current picture confirms the mix development of the last month, and automotive is one of the best-performing industries, reports only a modest growth, means that normally you would not see any other sources having such a massive impact on the overall demand. So, therefore, we stay conservatively with our estimate for the development of the quarters to come. Machinery business continues to suffer and shows also a moderate decline. So, the overall expectations for us in that key market is rather cautious for the near future.
In the emerging markets, of course, that picture may be even a bit more pronounced, but in principle, the same is applicable. We do not expect a quick recovery in those markets. I mean, if you look into Brazil and also other major economies in the emerging market environment, you would not see what could trigger a quick recovery any time soon.
So, we need to be prepared that this is going to be a very uncertain environment and, as Joe has been elaborating on before, geopolitical tensions seem not to go away. Uncertainties from that part combined with also the low pace in the commodity-related markets would rather suggest to be conservative and cautious with any outlook in the development of short-cycle businesses in those areas.
With regard to the underperforming businesses, I mean, we have been sharing with you last quarter that we expect the current fiscal year, a nice development taking place. You remember last fiscal, we just have been returning back into the black with a 1% margin for that part of our portfolio. We told you that we expect a substantial improvement in fiscal 2016. We have been mentioning the figure of 3% margin, and this is still standing.
This is what we can see happening for fiscal 2016, but it's too early to talk about the pre-size further development. We are absolutely committed to make sure that we allocate our capital into those directions of profitable growth, sustainable profit pools and aligned of course with our strategic setting of Vision 2020 along the lines of E-A-D and that I think what we have been telling you also in prior meetings and therefore consistency in that placement.
When it comes to our expectations with regard to EPS and what has been finally driving us with regards to updating our outlook. Of course, we are seeing momentum in our top line development which is giving us quite some visibility now for the last quarter of the year. We have been spending a lot of time and effort also with regards to what we expect in those areas which we call below the line. You do know that there's a couple of things we don't have an impact on like interest rates, driving long-term liabilities like our asset retirement obligation which had substantial impact year-over-year on the quarterly development.
The swing was more than €200 million. So, from that perspective, we gave it a lot of thought and we have been building our opinion on good visibility for the last piece of the quarter, the next eight weeks of course as Joe has been mentioning before. Also, the horizon, the spend being narrowed substantially compared to what we told you before is also an indicator that we feel quite comfortable with the development, and also have a fair assessment of the challenges and the risks and the opportunities ahead.
Okay. Thank you very much.
Operator, we'll take the last question now.
Our next question comes from the line of Andre Kukhnin of Credit Suisse.
Yes. Good morning. Thanks so much for taking my questions. First one on Digital Factory. In Asia, your orders grew this quarter and this wasn't the case in the last quarter. You say it's all from software, but actually software was already growing in the previous quarters. So, could you give us a bit more color on what changed their compared to previous quarter and how that's developing?
Secondly, on PLM more generally, clearly, the strategy is paying off in the businesses, working very well. Could you tell us whether you're winning orders from new customers or new customer types here or is this high penetration of kind of existing known customer base?
And very finally, on PG, you said pricing is still tough. There's a lot of overcapacity. Could you give us some numbers on this, how tough and how that's changed compared to previous quarters?
Andre, let me start with the last one. There was not a substantial change in terms of pricing pressure in the PG markets. We still talk in the area of 4% to 5%, I think, on average. But each and every single project is really under scrutiny of the same players. So, it's not that the overall picture has been changing substantially, but there's such a clear visibility for all the major players that we literally meet them in all the relevant boardrooms on a regular basis. So, the intensity of competition is high and it includes all aspects including financing.
So, when I talked about the Digital Factory development in China, I was elaborating on sales, when I said that the software has been making good in the double-digit area. On a new order basis, that may vary very much from quarter-to-quarter because this is, in terms of decision-making, pretty much a project or a large decision for any company placing orders with us.
In China, in general, we see a stabilization and moderate expansion path in some areas. And as I have been pointing out already, automotive and electrical equipment has quite some stimulus, also from lower taxes for car buyers in China, while machinery is still only very modestly increasing in terms of momentum. So, no significant change in the picture.
And you also need to bear in mind that in that industry, it's also very relevant what the channels are doing whether there is a sell-in or a net sell-out of the channel. So, it's not that you can easily conclude from a single quarter's development that a trend may be established from that.
Yeah. And let me maybe give you a bit of a flavor on the Digital Factory and the customer acquisition program and behavior, what we see. If you look at Digital Factory, there are three elements in their channels. It's factory automation, it's motion control and it's PLM software simulation and associated topics, also systems integration of the PLMPs into the supply chain and enterprise resource planning.
Manufacturing automation, in general, is mostly related to discrete industries. There's obviously a large chunk of car manufacturing and the likes, but also in other areas like, for example, appliances. And that one, it's somewhat flat. There are some pockets of excellence from Chinese car makers all the way through what people call gigafactory in Nevada. Even that needs manufacturing automation, and we are part of it. So, that is somewhat flattish-plus X.
You see in the bottom here, I'm not sure whether this will go up any time soon, but it stabilizes on all levels. The real issue we are currently a bit concerned about is the area of motion control. That's obviously the machine tool-making, reason being that is was down, and there was some activity on kind of new ideas, but it's kind of fallen back into a flattish minus X environment. And this is market, it's not us. We've seen that even worse in some other leading contenders in the space.
So, the third one is still empty, so product life cycle management, and this now is mostly about decisions. And that's what the whole method is all about today in these grid factories. The whole world is not so much about CapEx and expansion. It is about efficiency, gaining efficiency, gaining productivity, gaining energy efficiency. And that's why the PLM piece is starting to take off so much even in countries and regions where one would have said well, you know, on a scale from industry 1.0 to industry 4.0, they are just making the transition maybe from 1 to 2.
And that's why also, even in China, the PLM piece, the software business is very strong. People are after efficiency. And if you do efficiency, you go to tender market, you do design to cost. And automatically, you know you are running to simulation requirements. Also in China, because Chinese engineers who are really good at what they do have become costly also in the meantime. And that's how we win over this. That's how we win new customers.
On the question earlier of CD-adapco. That's mostly also to discrete car manufacturing. You might remember when we talked about a deal, about half announcements, almost 70% is car industry. It's flow control and air flow optimization. So, that's actually similar customers but different labs. And that's actually the beauty of it. So we are combining the bits and pieces, the silos, so to speak, of that industry into a totally integrated automation portal. And that's what Siemens is what up to and all about. So, we do win new customers and we do win new orders on the back of completing our spectrum. And that's what we are continuing to work on.
On short cycle, in general, we've talked about motion control, factory automation, but there's another element and that's low voltage in EM which I just want to complete. We've done very well in the voltage both the wired accessories mostly in China, which has been related to construction business, which have been coming down quite a lot. Then we compensate for it. It's the newly rolled out circuit breaker at MCCB. MCCB devices, they have been taking quite a market share to new product that's cost effective and also price effective.
So, overall, on Digital Factory, I believe the combination of all three is why Siemens outperforms. We will continue to integrate supply chain and PLM as one, efficiency two. Going forward, that's always been our strategy and we're doing well on this one. So, I think it's fair to say that Siemens will outperform the market going forward, but the market is not going to be very helpful in terms of everyone or help everyone growing.
I think with that, I'll give it back to Sabine. Thank you.
Thank you. So, operator, I think we are now done with our call. Would you like to have the closing remarks?
That will conclude today's conference call. Thank you for your participation, ladies and gentlemen.
Okay. Thank you for everyone and have a nice summer break. Bye.
That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. Once again, let me repeat the instant replay numbers. Participants in Germany, please call the replay number +49 692 222 2236; access code, 4313959#. Participants in Europe, please call the replay number +44 203 427 0598; access code, 4313959#. And participants from the United States, please call the replay number +1-347-366-9565; access code, 4313959#.
This replay service will be available for 48 hours. A recording of this conference call will also be available on the Investor Relations section of the Siemens website. The website address is www.siemens.com/investorrelations.
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