ABB's (ABB) CEO Ulrich Spiesshofer on Q1 2017 Results - Earnings Call Transcript

| About: ABB LTD. (ABB)
This article is now exclusive for PRO subscribers.

ABB Ltd (NYSE:ABB) Q1 2017 Earnings Conference Call April 20, 2017 8:00 AM ET


Alanna Abrahamson - Head of IR and Group SVP

Ulrich Spiesshofer - CEO and President

Timo Ihamuotila - CFO

Eric Elzvik - Former CFO and EVP


Benedict Uglow - Morgan Stanley

James Stettler - Barclays

Mark Troman - Bank of America Merrill Lynch

Andreas Willi - JP Morgan Chase

Martin Wilkie - Citigroup

Guillermo Peigneux - UBS Investment Bank

Jeffrey Sprague - Vertical Research Partners

Gael de-Bray - Deutsche Bank AG

Andre Kukhnin - Crédit Suisse AG


Welcome to the ABB First Quarter 2017 Results Analyst and Investors Conference Call. I am Maria, the Chorus Call operator. [Operator Instructions]. At this time, it's my pleasure to hand over to Ms. Alanna Abrahamson, Head of Investor Relations. Please go ahead, Madam.

Alanna Abrahamson

Thank you, Maria. Good afternoon, ladies and gentlemen and welcome to ABB's First Quarter 2017 Results Briefing. We have ABB's President and CEO, Ulrich Spiesshofer; our new Chief Financial Officer, Timo Ihamuotila; and Eric Elzvik with us today. Uli and Timo will discuss the Q1 results, update us on the execution of our Next Level strategy and 2017 outlook.

The press release and presentation were published this morning at 6:45 and can be found on our website. This briefing is being webcast via our IR website as well as being recorded.

Before we start, I would like to draw your attention to Slide 2 as this call will contain forward-looking statements. These statements are based on the company's current estimates, expectations and current assumptions and are therefore subject to certain risks and uncertainties.

With that, I would like to hand over to Uli.

Ulrich Spiesshofer

Thank you, Alanna. Good afternoon, ladies and gentlemen and welcome to our first quarter call. Looking at Slide 3, let me summarize some of the key figures for the quarter. Base orders improved 2% as we're seeing first signals of market stabilization in some process industries and some growth signals in early-cycle businesses. Total orders reflect lower large contract awards in Industrial Automation and Power Grids. Large orders represented 10% of total orders compared to 17% in the same quarter a year ago. But overall, book-to-bill ratio is at 1.07, so we're building revenue for the future.

We delivered 3% revenue growth on the basis of solid execution of our order backlog and good book-to-bill orders. We reported a steady operational EBITA margin at 12.1%. If we consider the communicated 60 basis points insurance reserve adjustment made in 2016, the margin would have been significantly up, demonstrating solid operating leverage and our continued focus on productivity and cost. So our hard work is beginning to pay off.

Cash flow from operating activities improved. However, this improvement primarily reflects the delay in employee incentive payments caused by the criminal case in South Korea.

Now let's turn to Slide 4 and consider our performance in the context of our 3 focus areas, profitable growth, relentless execution and business-led collaboration. ABB is continuing its transformation. In the first quarter, we delivered our second consecutive quarter of revenue growth. As stated earlier, we're building order backlog, we have a book-to-bill ratio of 1.07. We continued our active portfolio management, completing the sale of our high-voltage cables business and recently announced in the acquisition of B&R, a leader in machine and factory automation. We commercially launched ABB Ability, our industry-leading digital offering and are pleased with the very positive customer response.

In relation to relentless execution, we continued to build momentum on performance improvement. As stated earlier, our underlying performance was stronger than the reported numbers suggest if you consider the positive adjustment booked in Q1 2016.

Our White-Collar Productivity program remains on track to deliver increased cost reductions of $1.3 billion by the end of 2017. Net income included a capital gain from the divestment of our cables business. This was partially offset by other charges covering liabilities that are retained from this business and certain other nonoperational items.

Operational earnings per share grew 1% on a constant currency basis to U.S.D 0.28. We continued to make progress on transforming ABB into a leaner and more efficient technology leader. As announced in October, we enhanced our approach to performance and compensation as of January 1 to reward entrepreneurial spirit in our 4 divisions even more. Improved country and account collaboration is driving momentum in food and beverages, 3C and service. For instance, service and software orders were up 7% in the quarter.

In 2016, we set up global and regional service centers to provide our businesses with high-quality back-office services in finance, human resources, information technology and supply chain management. In Q1, we inaugurated our Global Service center in Krakow. This state-of-the-art site is creating white-collar jobs in Poland and is now staffed already with more than 2,000 people.

Please turn to the regional picture on Slide 5. In the Americas orders were up 4% with base orders steady. The United States delivered 5% growth overall with a robust 3% in base orders, mainly driven by robotics, light industries and construction. Canada also delivered positive order development reflecting a large mining order. However, base orders remain weak across all sectors as heavy industry continued to weigh on overall demand. Brazil remained tough and we do not expect any recovery soon.

Europe was positive in the quarter mainly due to continued investment in high-voltage transmission and strong base order development across many end markets. In the quarter, ABB booked a $280 million high-voltage direct current order to link the power networks of France and the U.K. Base order development was strong in Germany, U.K., Finland and Spain.

Asia, Middle East and Africa declined 12%. This was driven by the very tough comparable in China related to a large ultra-high voltage direct current project on the customer side which comprised one large order and many smaller orders last year. If we exclude this project from Q1 2017, growth would have been positive. The underlying demand drivers in China remained positive, driven by robotics, nonresidential construction and power conversion products. India experienced solid growth in the quarter and demand was broadly based across all areas except for process industries. Saudi Arabia, however, continues to be subdued.

All in all, base orders were up 2% overall and in most markets. It was a strong performance in a difficult market environment.

With that, let me hand over for the first time to Timo, our new CFO.

Timo Ihamuotila

Thanks, Uli and good to be here on my first ABB investor call. About 3 weeks into the job, I have had the following experiences, day 2, the B&R acquisition announcement; day 3, first roadshow; day 9, board and AGM; day 12, first business performance reviews; and now, first quarter results announcement. So clock speed at ABB is clearly solid and the ramp-up for me has been very fast which I like.

Now I have met already many people in the ABB investor community and I am looking forward to working with all of you. I have relocated to Zurich and my family will follow after the schools are out in the summer.

Finally, before I go to my prepared remarks, I would like to thank Eric whose help has been instrumental on my introduction to ABB's businesses and finance processes.

So let's turn to Slide 6 showing the Q1 divisional performance. I will take you through some of the highlights. Electrification Products had higher orders, reflecting improved market demand in many markets and sectors. Operating EBITA margins improved on volume, mix, productivity and cost savings. In January 2017, Electrification Products received some businesses from our former Discrete Automation and Motion division, namely, our electric vehicle charging, solar and power quality businesses. This transfer has had a dampening effect on the margins in Electrification Products and the division will most likely be outside its margin corridor for some quarters.

Orders in Robotics and Motion grew 7% in the quarter and 13% on base orders. This order development was driven by strong demand in robotics and light industry as well as market stabilization in some process industries. We saw strong demand in China and the U.S. The margin was impacted by unfavorable mix and low capacity utilization. The demand pattern and the increasing order backlog will ease the situation over time.

In Industrial Automation, total orders were weak on lower large orders specifically related to specialty vessels. However, base orders improved by 2%. Market stabilization is taking hold in some process industries. Industrial Automation has done a great job of cutting costs and increased its operational EBITA margin by 130 points to 13.3% on declining revenues. In other words, the division has adjusted capacity in response to market conditions.

Before we go into Power Grids, I would like to remind everyone that we completed the sale of the high-voltage cables business in February of this year. We're now reporting the cables business in corporate for the previous quarters of 2015 and 2016 and the 2 months in 2017 to ensure you can analyze the underlying business of Power Grids.

Power Grids orders were lower, reflecting the timing of large contract awards and the inherently lumpy nature of those big awards. In Q1 2016 orders -- total orders included numerous mega orders and significant base orders. In particular, we had significant base orders related to an ultra-high voltage direct current project in China as well as orders in Saudi Arabia.

Operational EBITA margin was exceptionally strong for Q1, driven by higher revenues, improved productivity, solid execution and continued cost savings. Please be sure to include in your models the Power Up investment for the quarters to come.

Let's move on to our operational EBITA margin bridge on Slide 7. As previously stated in 2016, we had a $50 million positive adjustment to the Q1 2016 operational EBITA which was related to the cumulative elimination of certain intercompany insurance reserves. So the underlying operational EBITA result in Q1 '16 was $901 million with a margin of 11.5%. In 2017, we achieved approximately $121 million in net savings which came from our ongoing cost-savings program, pricing pressures and our White-Collar Productivity program. Net volumes were positive for the quarter, reflecting the higher revenues which was partially offset by additional investments in growth. Project margins were slightly positive versus a year ago. The mix was unfavorable primarily due to lower-margin products and solutions from Robotics and Motion that were delivered in the quarter.

As discussed earlier, other includes a number of items like salary inflation, bad debt, changes on corporate provisions and other small one-offs. The divested cables business also had a negative impact on operational EBITA in the quarter of $13 million.

All together, the group had achieved operational EBITA of approximately $943 million and a margin of 12.1%. Excluding the insurance adjustment, the improvement was $42 million more in operational EBITA or 60 basis points of margin accretion.

Let's than go into Slide 8. Our working capital program is yielding positive results. As a percentage of revenues, net working capital is steadily declining year-on-year. However, we need to be cognizant that the improvement in cash flow from operating activities is primarily due to the delay in employee incentive payments caused by the South Korea case. We would expect for the first half of 2017 to be at a similar level or slightly better than the first half of 2016.

And with that, let me now hand back over to Uli.

Ulrich Spiesshofer

Thank you, Timo. Before I update you on our Next Level strategy, let me address the big and unexpected challenge we faced in the first quarter, a major case of embezzlement in our South Korea subsidiary. As soon as the incident came to light, I immediately launched a very thorough and deep investigation. We have hired independent investigators and are working closely with the authorities on the local level and INTERPOL globally. We have now reinforced our financial processes to ensure we meet our high standards everywhere. Disciplinary measures has been taken and new rules are already in effect. Let me just remind you, we have a zero-tolerance policy for unethical behavior and we're absolutely serious about its enforcement.

Let's turn to Slide 9. We launched at our Capital Markets Day on October 4 the third stage of our Next Level strategy to unlock further value through our 4 key actions, driving growth in 4 market-leading entrepreneurial divisions, a quantum leap in digital, accelerating momentum in operational excellence and strengthening the global brand.

Moving to Slide 10. In April 4, we truly lift that ambition and announced the acquisition of B&R. This was a true milestone for ABB as we're finally closing the historic gap in machine and factory automation that has existed since ABB was formed. This is our answer to the questions about Programmable Logical Controllers, PLCs, that has been lingered for decades. B&R is a very attractive company and the world's largest pure play in machine and factory automation with its PLCs, industrial PCs, servo motion solutions and applications and design software suite. It operates in an attractive $20 billion machine and factory automation market segment that is growing 4% to 5% per year. It is a proven growth and innovation leader. In the last 20 years, the company has achieved 11% CAGR in a market that was growing at 4% to 5%. So it has continuously increased its market share.

Let me put it this way. Strategically, this is probably the most important deal ABB has ever done. Our 2 portfolios are uniquely compatible, the financial rationale is impeccable and together, we will be able to unlock tremendous growth in attractive industrial markets.

Last, but not least, ABB and B&R are a perfect fit for the digital era. Our combined digitalization offering is unique and we believe both very strongly that open architecture and full connectivity are key to competing on a long term basis. With this acquisition, ABB continues to shift its center of gravity to higher-growth segments and increased competitiveness.

On Slide 11, we talk about what makes B&R so special and a true leader in machine and factory automation with its integrated product, software and solutions portfolio. B&R's PLC, IPC and servo motion in drives and motors are acknowledged amongst the best in the industry and are really at the core of the offering. When combined with B&R's unique application and design software capabilities, they take the performance, productivity and efficiency of the customers' machines and factories to the next level. B&R's application store and digital software are truly revolutionizing the development and use of software-based solutions in the field of a machine and factory automation. With B&R, ABB will be uniquely positioned as an industrial automation provider that offers customers the entire spectrum of technology and software solutions around measurement, control, actuation, robotics, digitalization and electrification.

On Slide 12, it shows that B&R is a truly perfect fit. ABB did not have much in the way of PLCs or IPCs in machine and factory automation. B&R has a strong PLC and IPC offering and is the largest independent player focused on machine and factory automation. We looked at other alternatives, but none would have presented such a perfect strategic fit without significant overlaps.

With B&R, we will be able to add an unrivaled portfolio of automation solutions for machine and factory automation to ABB's world-leading offering in process automation; robotics; our digital platform, Ability; and electrification. We will be uniquely positioned to seize the growth opportunities resulting from the Fourth Industrial Revolution.

Turning to Slide 13. This transformational acquisition will firm up ABB's position as the global #2 in industrial automation as we will be mastering the control of not only in process automation where we're currently the #1, but also in machine and factory automation. In the future, there will be just 2 major players in the world in this segment. Siemens is #1 in factory automation. We're #1 in process automation. And now, we're a key player in factory automation as well.

Please turn to Slide #14. As you can see, we're also truly transforming the Power Grids division for sustainable value-creation. Since 2014, we have more than doubled the operating margin. We're committed to continue the transformation as we shift the center of gravity of this division. We're fundamentally changing the business model and limiting the risk across the business portfolio. We completed the sale of the cables business and are investing in ABB Ability and digitalization with bolt-on acquisitions, as we recently announced.

As well, the team is driving actions around productivity, cost savings and OpEx improvements as well as focusing on excellence in relation to project execution. Power Grids continues to be a partner of choice for national and state grids worldwide as they build out and upgrade infrastructure.

Let's turn to Slide 15. Until recently, ABB was a hidden digital champion. Just last month, we commercially launched ABB Ability with more than 180 customer segment-specific solutions at our ABB Customer World event in Houston with more than 8,000 customers participating. The newly launched ABB Ability will drive growth by integrating all our digital solutions, the historic and the new ones and services into one group-wide powerful global offering.

This will unlock tremendous opportunities for penetration of all customer segments and allow us to replicate the success of each digital offering across a wide range of businesses and markets. ABB Ability cements our leading position in the Fourth Industrial Revolution and supports the competitiveness of our 4 entrepreneurial divisions. We will develop further our next-generation digital solutions on an integrated cloud-led platform in partnership with Microsoft, the world's largest software company. And I can tell you, our customers are really excited about ABB Ability.

Now let's turn to Slide 16. In September 2014, I laid out as part of the Next Level strategy a clear ambition to shift ABB's center of gravity towards strengthened competitiveness, higher growth and lower risk. We continue this transformation forcefully. Since the beginning of the year, a lot has been done and just to name a few, the acquisition of B&R, a leader in machine and factory automation was announced; the acquisition of NUB3D, a specialist in 3D visual inspection was announced and closed and integrated into our Robotics business; our service and software offering and business has grown 7%; we launched commercially ABB Ability; we closed the high-voltage cable service and many more actions. Truly a transformation time for ABB.

Now let's conclude with Slide 17. In summary, ABB delivered solid results. Revenues are up 3% with a book-to-bill ratio of 1.07. Base orders grew 2% and total orders reflect the lower large contract awards in the quarter. Operational EBITA margin was 12.1%. We had solid operating leverage in the quarter, considering the 60 basis points positive insurance reserve adjustment in 2016. Net income was $724 million, reflecting the impact from the sale of the cables business.

Looking ahead, our outlook remains unchanged. Uncertainty still hangs over global markets. Our growth in China is expected to continue and indicators are still positive for the U.S. 2017 can best be characterized as a transitional year for the world and for ABB. Our long term growth drivers remain in place for utilities, industry, transport and infrastructure. We believe the long term outlook is still positive. Thank you.

Alanna Abrahamson

Thank you, Uli and Timo. Before we open up the call for questions, I would like to hand over to Eric for a couple of comments.

Eric Elzvik

Thank you, Alanna. I would just like to thank -- to take this opportunity to thank you all warmly for the good collaboration and the interaction we have had during my over 4 years as the CFO of ABB. I truly enjoyed the dialogue and of course, your sometimes challenging questions and views. We always listen carefully and work hard to bring better insights and health to understand the great opportunities of ABB and it was always important for me to build a mutual trust together. So thank you again to all of you.

Alanna Abrahamson

With that, let's open up the line for questions now.

Question-and-Answer Session


[Operator Instructions]. The first question comes from Benedict Uglow from Morgan Stanley.

Benedict Uglow

Just before I start, yes, I would like to pass on my best wishes to Eric. Thank you very much for all the time and help. Anyway, moving on, 2 questions, please. First of all, on China, the base order intake there obviously is negative, minus 3%. Ulrich, can you give us a sense of base orders in China if we exclude Power, I don't know how much of this was specifically related to Power, but how are the non-Power businesses doing, Electrification Products, Otics and Motion, et cetera.

And if there's any way of quantifying that a little bit, it would help. So that was question one. Question two is simple one, the run rate on the net cost savings has nudged up nicely from the second half of last year, it was running at ballpark $110 million, we're now slightly ahead of $120 million. Can you give us some more color on exactly why the first quarter has been better in terms of the net cost savings? And obviously, to what extent could that be a sustainable run rate?

Ulrich Spiesshofer

Thanks. I will take the first question then we try out our new CFO on the second one. So let me talk you through on China. You have seen China, the total order is down, minus 27% and the base orders are minus 3%. And if you look at the underlying momentum behind that, there's -- a whole negative element of that was due to HVDC project on the customer side in Q1 2016. This HVDC project, the day they are given to us in China, they both flow into large orders and in base orders. So that's the explanation of the minus. The underlying demand on China is quite positive in Robotics, in Discrete, in nonresi construction, electric transport and in Power, that's okay.

The Process segment, however, also remains weak, in line with China's move of a -- from the over investment capacity that they have built. Now let me run you through the 3 other divisions. On Electrification, we see a solid base order growth. It's supported by the pickup of the real estate market. If you go to Robotics and Motion, that's really, at the moment, our growth star in China. It's growing at a double-digit pace and we're very happy with the development there because that's now really hitting right on the sweet spot of China's demand on robotics and in industrial automation, that's good. If you take Industrial Automation, there is a decline in Peter's business and there are basically two reasons, the one is the process industries are still very subdued; and on the other hand, the marine business where we had somewhat really nice orders in the first quarter last year was not that strong this year. So that's the explanation. I would describe the underlying momentum in China as sustainably solid and that's something that we will participate in, in the quarters to come. With that, Timo, over to you.

Timo Ihamuotila

Thanks, Ben. So my first answer in an investor call and thanks, Uli. Yes, when you look at the net savings, this $121 million, I don't know the number from second half of '16, but you said it's $110 million. I mean last year, we had $85 million and that consists of the savings from purchasing and operations, price erosion and then the White-Collar Productivity. And this quarter, we actually had good execution because the purchasing and operations were approximately as big as the price erosion. So really majority of this comes from the White Collar or pretty much everything comes from the White Collar. And having looked at this, it's well in line with the $450 million expected for the full year '17 and we're also tracking pretty well on pushing about half of that to the bottom line.


Next question comes from James Stettler, Barclays Bank.

James Stettler

My two questions are, first of all, can you talk a bit about pricing, what you're seeing and how successful you are in passing on raw material inflation on a group level? And then if we just drill down into Robotics and Motion, you took a lot of costs out last year so somewhat disappointed to see 100 basis point drop there. Can you talk a bit about what's going on? How important the mix was? And how long it's going to take for this -- for the underutilization to be made up if you look at your order inflow coming through?

Ulrich Spiesshofer

Yes, thank you very much for your 2 questions. Sharp, as usual, James. If I take the pricing piece, that's an area that we really need to make sure we stay on our toes. Raw materials are coming up significantly. Some of them hedges run out, we need to make sure that we're prepared on the business that has been protected on the hedging side. As you might remember, Baldor, for example, has built into the business model automated pricing mechanism. So wherever we have that, we have triggered it. But as you rightly say, it's important that they catch that. If you take the pricing dynamics now, we always have the ambition that we say we take supply chain and OpEx together that should at least compensate pricing and then we have the White Collar on top of it then we take a significant part into the business lines. In that space is really what's happening out there.

So you will see from us continued efforts that we neutralize pricing impact, whatever it is, that we get additional gains out of White Collar and that the pricing actions towards the market are being done in a swift way, that we don't get into a squeeze with raising commodity prices. The second piece of Robotics and Motion, yes, look, it's a consideration that we're as concerned about as you are on that topic. Robotics and Motion had a great top line run. So if you take the board -- the base, the base activity and the base orders, it's up 13%. And then the question is what do you do with a business that you know the market is coming back and you have surplus capacity? Do you take all the capacity out right away and then risk that you don't have the capacity to serve the market or do you do a mix.

And basically what you see here is a mix between taking a lot of responsible actions, but not enough to short term optimize the margin, but we have the capacity in place to really execute the backlog that we're building in a pretty sharp momentum going upward. So my expectation is this is probably the trough quarter on Robotics and Motion and from now on, the margin should go only one way, that should be up.


Next question comes from Mark Troman, Bank of America Merrill Lynch.

Mark Troman

Basically, in -- Uli, on process markets, I wondered if you could just go through where you think we're in oil and gas, metals and mining, marine, et cetera, taking out of the sort of large order effect? Obviously, base orders were up 2% in Industrial Automation. I guess the comment is on stabilization. Could you give a bit more color on those process markets which, I guess, affect Robotics and Motion as well as to have they bottomed out, when do you expect to pick up, et cetera? That's my other question.

Ulrich Spiesshofer

Okay. Thank you very much, Mark, for your questions. Let me first make a comment on Industrial Automation. I'm really proud what Peter has done with his team, having a base order growth and a very significant margin accretion whilst the market is still very difficult out there, I think this is really, very, very good results and I'm very happy what Peter and his team have established and accomplished here. That was a good job done. Now let me run you through the end markets and I might go one level further down. If you take oil and gas, if you take upstream exploration, it's still expected to shrink from a customer demand this year and it might even go into '18.

So in upstream exploration, there will be further contraction of the demand on the customer side. On the conventional downstream activities, we see a certain pickup, a small pickup and a growth coming and I'll come back. It's mainly driven by service activities because all the assets are running, small investments and upgrades that we see out there. And the fastest growing is the unconventional oil and gas in North America, that's probably the segment that's fastest growing of all that is out of there. Now if you go from there to mining, we don't see mining coming back in 2017. Yes, there are some OpEx and some service activities, but overall this will remain difficult.

And on metals, we see a couple of activities, we see some discussions on a project. Ability is a very, very good offering for the process industries and the customers reacted very positively, but it's more us than the market that's coming back. And in marine, it continues to do really -- to be a bipolar market. Oil and gas supply vessels really have come down, I would call it a delicate balance in terms of coming down very, very significantly compared to the previous years. At the same time, cruise is growing and we have a very strong position on cruise. I mean, you go on a cruise ship, there's a high likelihood that you meet ABB equipment on any cruise ship in the world.

But that market segment is not big enough to fully compensate the massive contraction on the marine side altogether. So for me, closest this year is a year there are some OpEx and service activities can be picked up. Naturally, there's Ability, we're very, very well positioned to be partner of the customers in improving the operations and get service to a different level. But all together, the large CapEx is not there yet this year.

Mark Troman

Okay. And just, sorry, I did have one more. Sorry, I forgot. The inflation question I think James asked earlier, do you regard that as good for ABB, the fact that some inflation is flowing through the system? Does that give you more opportunity to discuss price points to be a net winner? Or how do you see that?

Ulrich Spiesshofer

Well, first of all, it's a call for action and we need to stay on our toes that we take responsible actions very swiftly because if commodity prices are coming up sharp, we need to make sure that we don't get into a squeeze that you don't want. So that's the first point. Second point is there might be a positive contribution to the top line momentum. I think this is too early to speculate how exactly it will work through. But it's clearly the ambition for us that we're not jeopardizing margins. And if the continued raise of the raw materials will be there, if we manage to keep the margins, then we should therefore call a positive impact on the top line momentum.


Next question comes from Andreas Willi, JPMorgan.

Andreas Willi

I have a question on Grid and one on the earnings bridge. On Grids, obviously you had a very strong start to Q1. You mentioned there are some project benefits. You previously said that for the full year we should look to a similar or slightly improving margin compared to the 9.3% you had last year, but the seasonally weak Q1 is significantly ahead of that. Has anything changed in your thinking for the full year? Or is this just timing and project volatility, what we have seen in Q1?

And the second question on the bridge, following on again from the earlier discussion on price. So if you increase prices to offset raw materials, that would benefit net savings in the bridge and then we would see the negative raw material impact also in the net savings? Or would that be in the other category? Because that's important to know in terms of when we see net savings improve, whether that's just one side of the coin of higher raw materials that we lose elsewhere again.

Ulrich Spiesshofer

I will take the first and then hand over to Timo on the second one. Now let me just run you through the Power Grids story. I think Claudio and his team from an operational perspective are doing a very, very solid job in driving the underlying margin quality of this business. Mind you, in 2014, we had 4.6%; in '16, we had 9.3%; and now we have a quarter where we had 10.3%. So if we look at the underlying momentum, it's exactly what we promised to do, first is the step change program which was completed last October; and now with Power Up, we're fundamentally changing the earnings quality of this business by derisking it, by changing the business model, by focusing more on service, by driving -- by driving new digital offering, services growing very well in this business and it helps us quite a bit going forward. Now if you look at the first quarter, the first quarter is not the year.

In the first Q order, we had really strong execution, very, very good execution by the team. We didn't have any hits on projects and it just speaks for the underlying quality of execution that we had implemented. Don't take that number and just extrapolate it for the full year. We will have -- we will be this year, as we have committed, at least in the 8% to 12% margin range that we have communicated before, so that we will navigate through essentially our ambition to have a solid and constant execution. What I also ask you to keep in mind is we have flagged clearly that we will have cost for the Power Up program. The first quarter was a quarter where we said we had some of the costs, but there will be more coming during the year.

If you look at -- in the first quarter, out of the flagged about $100 million, that we said about $60 million will be operational and $40 million will be nonoperational, yet relatively low consumption of that anticipated cost and that also helped this overall margin. But looking at it, it's great to have Power running at 10%. That's a multiple on any other competitor in this field in terms of profitability in a face of massive transformation. So I think Claudio is doing a good job.

Timo Ihamuotila

Yes and then Andreas, on your second question. So if we look at the commodities, the exchange rated commodities are actually in the other category, but the rest of the cost of goods sold is in -- or that impact is in net savings, so it doesn't really change the answer what I had to the earlier question on the overall situation regarding the $450 million and also pushing 50% of the total White-Collar Productive savings to the bottom line and it is definitely not the biggest driver of the other.


Next question comes from Martin Wilkie from Citi.

Martin Wilkie

This is Martin from Citi. Just 2 unrelated questions, the first one is stepping back to Power Grids. So obviously, we understand the very tough comparable in large orders for Power Grids there. I was wondering if you could just talk a little bit about the tender process as to is that still essentially unchanged given you talked about some weakness in China and the Middle East? Or indeed, it's because of the shift towards software and other parts in Power Grids, perhaps we should expect the run rate of large orders be a little bit lower in the future just to understand that dynamic. And secondly, unrelated obviously to the PLC acquisition just a few weeks ago. Last quarter, you gave a fairly lengthy list of ABB that you might seek to do acquisitions and I just wanted to understand does doing this deal essentially put you offsite for a short while you do integration and so forth? Or are you still seeing a possibility of doing further acquisitions in 2017?

Ulrich Spiesshofer

So good afternoon, Martin and thank you for your questions. If I take the Power Grids situation from a market perspective, there's about 300 HVDC projects in the world in the next couple of years that will come [indiscernible] we need to address. So the underlying growth opportunities on the HVDC side are good. If you look at the amount of solar capacity that will be integrated into the grid and the wind capacity that will be integrated into the grid, it will be at an all-time peak this year and I'd probably say the same next year and the year after again. So there's tremendous opportunities here to play in that market. At the moment, there's a lot of tender activity and early project discussions out there. So our sentiment on the market overall has not changed at all. However, the first quarter was a soft quarter in terms of large projects.

Now you mentioned 2 specific markets, the Middle East and China. Look, in the Middle East, if you look at our Saudi number in the first quarter, Saudi is down minus 40% on base orders and that's mainly on the Power side that's really hitting us very, very strongly together with process that we have there. So this is something that, well, some will come back. There are project discussions out there that impact Saudi, but I think it's too early to call it a full swing back to a solid pattern. On China, the underlying momentum, I was just with the Chinese government 3 weeks ago at an event, the underlying momentum and the ambition there is unchanged. The amount of new power capacity that comes in, in China this year is enormous.

At the same time, there is an additional driver there, retiring a lot of old dirty coal-fired power plants and every mayor gets paid on that how much he retires there and that means we have also a replacement momentum in there in terms of capacity which will be helpful. So there is no change between large and smaller activities in terms of the overall ambition. However, the business model on the larger side, we have changed absolutely fundamentally to ensure we have better underlying margin quality in the incoming backlog into this business. Now going over to your acquisition question, look, we're extremely happy about the B&R acquisition and I can tell you the employee, the customer response was very positive on it. So we're happy on that one. The list of interested area is unchanged.

And I would say for Peter in Industrial Automation, he and his team will now have their hands full with B&R and I would not expect major additional acquisitions in that division. But the way we run it today that we have 4 fully empowered entrepreneurs that run their selected -- each of their divisions, in Tarak's space, in Claudio's space and in Sami's space, I would not rule out that we do something, but we always balance off the integration capacity from a financial perspective, from a balance sheet perspective and very important from a management perspective. It's carved all over my body that this was not adhered to. I think this is something that we have learned and we do now in a very nice way.


Next question comes from Guillermo Peigneux from UBS.

Guillermo Peigneux

Guillermo Peigneux from UBS. Just a couple of questions. First, regarding Power Up, thank you for clarification. I was wondering whether what we should see now is an accelerated pace of investment implementation through the next 3 quarters or the same kind of $100 million times 4 quarters run rate should be expected? And then a second question regarding the subscription business model for software, some of your peers are talking about it. Are you going to follow that transition as well? And can you time it to some extent?

Ulrich Spiesshofer

Now look on Power Up, we guided very clearly, we expect about $100 million cost, $60 million of them operational, $40 million nonoperational during the year. So that's what you should have in your model. We're not giving guidance per quarter, but I already told you that we had relatively low consumption of that one in the first quarter. That gives you a hint how it will be skewed towards the quarters to come. Now on the software side, the question that you're asking is an absolutely crucial and fundamental point that we're working on. Honestly, I'm less worried about the amount of software developers that we need in the future because ABB has already thousands of them and we will have them in the future to do the technical part of the software development.

As you rightly say, the commercial side of the software offering into the market is a very important one and there we're massively enforcing the team, Guido Jouret, our Chief Digital Officer, has not only the task to build up a capability and offering platform. He has also the task to drive the commercialization to a much more -- steadier pay-as-you-use Software-as-a-Service-based business model that we would have more repetitive revenue stream and a more constant revenue stream.

That's one element of our shifting the center of gravity approach. It will impact all 4 of our divisions. Given the size of the software activity in the division, I would expect that in Industrial Automation and in the Power Grids division, usually short term the biggest impact on that one. On the Robotics side, we already have more than 1000 users on RobotStudio that are paying on a subscription basis and do that. We have a lot of continuous revenue stream now on the Asset Health customers that we have out there that are basically paying us a continuous fee going for that. We have changed the business model and some of our SCADA and process controls software offering from a one-off payment and depreciation to a Software-as-a-Service model. So that's a key element and you will see more activities in that field in the future.


Next question comes from Jeffrey Sprague, Vertical Research Partners.

Jeffrey Sprague

Two questions around B&R. The strategic fit is quite obvious and congratulations on getting that done. My question is could you give us a little more color or insight in terms of the investment that needs to be made to integrate it properly, what the integration profile looks like, is there additional R&D investment that you anticipate? And the second part of the question is really kind of one big question, but the second part of the question would be what is really the margin entitlement of that business? 12% EBIT margin doesn't strike me as particularly strong for that business. Perhaps you have some view on the cost structure and where you might be able to take it.

Ulrich Spiesshofer

Jeffrey, let me take the second one first because it leads perfectly into your first question. The stand-alone EBIT margin of a privately owned business, B&R, is 12%. B&R has invested constantly, at least 10% of revenue, in R&D, application development and software development. Now given the size of the business, you can expect some scale advantages of this business coming into ABB and let me just give you a couple of examples for that one. When B&R goes into a new country, they need to open up a branch, they need to file for a business license, they need to hire all the basic people and then they get started. With ABB, we have a platform everywhere, so you should see a G&A leverage which is very significant in the business over time that a business benefits from ABB very attractive G&A platform.

And if you just take SG&A and compare ABB against Rockwell and assume that B&R might be even higher on SG&A than Rockwell, then you see the journey that we will be going together on taking the G&A leverage. The second opportunity is in supply chain management on the cost side. If you take B&R as a EUR 600 million company roughly and you take ABB which is about $20 billion external spend, we're buying a lot of electronics, we're buying a lot of components at a scale that B&R will never do that, so there is an opportunity in using supply chain management. I'd just warn there, it will take some time because the one is price leveling on components that we already have in common, but other components will then need to be designed into the future product generation so this will be something that comes over time.

The third cost synergy and that will have an impact there as well is not on the B&R side, it's on our side, because we will reverse integrate ABB's subscale PLC and servo drive activities into B&R so there will be some efficiency gains coming out of that one as well. So that's the cost aside. And if we look at the growth side, it will be easier for B&R to fund growth in the future whilst the incremental dollar needed to spend for a new country, for a new segment will be lower than it was in the past based on their stand-alone offering. Again, if you take ABB Ability, our digital platform is something that B&R can truly benefit from. So your observation is right.

There is probably music in the 12% number going forward and you can be assured that we will drive this music in a very forceful way. Now on the integration, given that this is a perfect fit with very little overlap with ABB, the integration approach will be the following, number one, this business will become a stand-alone business unit within Peter Terwiesch's Industrial Automation division. Hans Wimmer, the Head of B&R, will continue, together with his entire management team whose continuity has been assured in the future running this business. So we have management continuity. And we have also a certain independence which is good for a business to continue its business model.

The business model of B&R will not be changed. The underlying product range in B&R that we have that is well-established will not be changed. And what we will do is we will drive an integration approach that we call best of both worlds. Hans Wimmer and his team, our people work together and really see who can learn from whom to get the benefits of this combination going. Some of you might have met our Head of Corporate Development, Gregor Kumm. Gregor will relocate with his family to Eggelsberg in Austria and become the integration leader. Gregor has been more than 10 years with ABB, well-accepted and a wonderful person that has been deeply involved in the 10 years of working on this deal. So he's already known by B&R. He's very well-accepted in ABB and he will build a bridge going forward. So it's -- I expect a very smooth integration since we don't have to do any restructuring. This is basically boosting growth for the future as an integration approach.


Next question comes from Gael de-Bray, Deutsche Bank.

Gael de-Bray

So I have 2 questions, please. The first one is in relation to the B&R acquisition, I'd like to better understand the long term growth outlook for the PLC markets in an industrial Internet of Things world. I mean, it seems that more and more intelligence and communication capabilities are being applied now in a more decentralized way on factory floors. So basically sensors, machines and actuators can probably, at some point, displace the importance of PLCs in the value chain, I guess, because they would be able to interact more together, they would be able to get more autonomy.

So basically I'd like to get your views on that, please. And my second question is on the impact of the mix behind the margin improvement that we've now seen for many quarters in Industrial Automation with sales down, but margins actually going up. So I guess my question is what we should expect for margins when the top line hopefully recovers in the course of 2018. I mean, is there still some operating leverage for that business with more upside to margins?

Ulrich Spiesshofer

Okay. Look, Gael, first of all, good afternoon to you. I'm very grateful for the question on B&R and the role of PLC because that's exactly one of the hidden gems of this business. B&R is not a product business. B&R is a solutions business. And if you look at the solution to automated machine, you need measurement sensing, you need to control the brain and you need the actuation. Now where the brain comes from in the solution that B&R puts, for example, on a plastic injection molding machine historically was always the PLC. Now it's PLC or industrial PLC -- or industrial PC. In the future, it might be router based.

And you know what, as long as you have the solution relationship with your customers, it doesn't even matter that much. What matters is that you have the domain expertise, that you understand the process drivers and that's the baby in our operation. Let me just explain the business model, how this works today. So imagine you are a plastic injection molding machinery OEM and you say I want to design the next series of machines. This company sits down with B&R and they jointly design the functionality and automation of the new machine. So B&R works with the engineers of the OEM machinery customer and they design then what is the best automation solution to have a competitive machine parameters. The moment the customer says, okay, that's it, I'm going to put you on my series, B&R is on that series of machine in the future.

So designing that solution will use the building blocks for the solution on the sensing, the control and the actuation side. How exactly these building blocks develop over time will be open and B&R has been an active driver even doing that. So it's exactly the beauty of this alone that we're independent from "just put it in a box and shipping it over" the kind of PLC model, it's not exactly not that one and I'm very happy on that. Your second question on Industrial Automation, yes, if you look -- think Industrial Automation, Peter's target range is 11% to 15% operational EBITA over the cycle. He has managed to be today at 13.3% and that's a really good accretion that has come up over quite a while. If you would see how Peter has transformed his business quite fundamentally, it's remarkable.

Let me start first he was, in terms of White-Collar Productivity, probably the fastest and most robust adaptor on where we want to go in terms of delayering his business, in terms of taking out complexity and making it simpler to operate. Secondly, in terms of risk management and backlog quality, his very rigorous approach to risk management and underlying quality of tenders and tender processes is one that is quite remarkable. The third piece is if you look at the relocation and the footprint change on engineering, he has ramped up very, very significantly engineering resources in India and other emerging marketplaces to complement other places and have a better cost mix on driving this.

And then if you take the overall mix of the business, in Industrial Automation you have about 1/3 software and services today. This will grow very significantly over the years to come, ABB Ability being a key element of it. As a part of ABB Ability, our 800xA control platform that we just rolled out in Houston, the universal I/O is the true technology innovation that helps us to get the customer lower installation time and better adaptation of control solutions. So it's really a mix of technology leadership, of very good execution, of taking out costs that Peter has done and will continue to do going forward. So our ambition is to keep that business firmly within the bandwidth of the margin that we have announced. Now one important point that I always make here is Peter has cut a lot of fat and he has trained the muscle.

There might come a time over time if the market would further contract than we expect today, so it would further contract than we expect today, we would have to have a discussion do we want to start to cut muscle or do we want to keep the muscle because we believe in the market uptake. At the moment, we don't see that risk coming, but we just want to reflect that will be the operating pattern that we will have in the future. You see it in Robotics and Motion with the 13% base order growth there. We have decided, yes, there is a little bit of capacity surplus, but if you look at the growing market, it goes in the right direction. So that's the operating pattern and the mix question from you, Gael.


Our last question comes from Andre Kukhnin from Credit Suisse.

Andre Kukhnin

Really broad ones, I was very interested by your comment on the future of the automation competitive landscape saying there will be really 2 future critical players. Could you please elaborate on that and maybe how you see that playing out, would love to hear more detail. And then the second one just on the Ability commercial launch and really commercialization of that, I guess frankly how are you getting paid for it from the early experience?

Ulrich Spiesshofer

Yes, okay. First, if you take the automation landscape, yes, look, what do you really need to be a clear global automation player. You need a couple of points. First of all, you need to be active in discrete and in process. Siemens is the #1 in discrete, ABB is the #1 in process. We have like a birth defect, we had a gap in the machine and factory automation. We have -- we will close that now with the announced acquisition of B&R. And then we will have an unmatched portfolio. Nobody else in the world has measurement, control, actuation, robotics, a digital platform and electrification for both process and discrete industries. So we're pretty well positioned there.

We have to give it to Siemens that they have done a wonderful job in building up a very strong factory automation capability. They are the #1. We're closing that gap a little bit with B&R and we have the ambition. But what you also need to have is you need to be the master of the control loop to be really relevant long term. And mastering the control loop means you need to have a credible large-scale installed base on the PLC side for factory and you need to have a credible large-scale installed base on DCS in the process automation field. Now, there are 2 players which are at a scale that really differentiates from all the others. If you take the other players, the American players, they are either focused on process only or on discrete only, don't have the similar scale and don't have the comprehensive platform that is out there.

There's even one player that has no control capabilities at all and is just around the sensing and the asset health piece and not in the center of the control loop. So that's the reason why I think we're now pretty well positioned as one of the top 2 players in the world. And naturally, there's no reason to be arrogant, this is a reason to stay humble and to make sure we continue to do our homework going forward. Now your second question on Ability. Yes, look, if you take the 180 solutions that we have launched and use them, they are basically covering the entire span of different commercial models. Our ambition is very clearly to push stronger towards a subscription Software-as-a-Service offering where we have a repetitive, predictable revenue stream at repetitive, predictable margin coming into ABB complementing our today's P&L. This is ramping up nicely and this is something that we expect to come in the future even stronger.

So if you take the planning and software capability set that we have that is RobotStudio or that it's on B&R coming in on the automation studio for virtual commissioning, virtual installation, this is an offering that we basically give to our customers already today on a subscription basis. If you take the control platform that we have both in PLC in the future with B&R and on DCS already with ABB, this is typically a business that you have at the beginning a lot of engineering cost and a lots of engineering revenue. And then you install it and there's a repetitive service opportunity that we need to drive even harder in the future and leverage that opportunity going forward. And then, in addition, we have the asset health capability that a product speak to us and we help a customer to drive operations and maintenance in a way that we have optimized up on speed and yield.

And for that one, the ideal profile is really to have a subscription-based, service-based kind of arrangement. I'd just give you one example. Today, when you buy a ABB robot, you can have a service contract including all that I just described. You pay a couple of $1,000 per robot a year and we provide you a Chinese menu of different service ranging from just giving you the data up to having a certain uptime premise working with your customers. So that's what we're working toward. And I think the underlying margin and revenue quality of ABB will go up over time, volatility will come down, predictability will be enhanced.

Alanna Abrahamson

Thank you, Uli. Thank you, Timo. And thank you, Eric. Thanks, everyone, on the line and appreciate you participating and have a wonderful day. Thank you.


Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call and thank you for participating in the conference. You may now disconnect your lines. Goodbye.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!