Siemens AG

XETRA:SIE

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Siemens 2022 Second Quarter Conference Call. As a reminder, this call 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 would like to turn the call over to your host today, Mrs. Eva Riesenhuber, Head of Investor Relations. Please go ahead, ma'am.

[Eva Riesenhuber, executive]

Thank you. Good morning, ladies and gentlemen, and welcome to our Q2 conference call. All Q2 documents were released this morning and can be found also on our IR website. I'm here today with our President and CEO, Roland Busch; and our CFO, Ralf Thomas, who will review the Q2 results and fiscal '22 outlook.

After the presentation, we will then have time for Q&A. The call is scheduled for up to 75 minutes. In addition, Roland and Ralf will host the sell-side a meeting later in the afternoon and will be on roadshow over the next 2 weeks. Since there's a lot on the agenda, with that, I hand over to Roland.

[Roland Busch, executive]

Thank you, Eva. Good morning, everyone, and thank you for joining us to discuss our second quarter results. Before I talk about our strong performance, let me reflect on the turning point we have witnessed in Europe with the war in Ukraine. We strongly condemn this war. And together with the international community, we stand in calling for peace to stop this human tragedy.

As top priority, we immediately supported our 180 employees and their families in Ukraine for their safety and well-being. In addition, we kickstarted humanitarian aid with EUR 2 million for Ukraine refugees and people in the country through our Siemens Caring Hands organization.

Since the war started, our help amounts to more than EUR 14 million. In addition to immediate disaster relief, Siemens matched more than EUR 4.5 million of donations from employees and provided contributions in kind for key technical solutions as well as shelter for refugees. This is accompanied by many private initiatives for -- from our employees which we support as good as we can also with programs to integrate Ukrainian refugees into the labor market. I want to take the opportunity to thank everyone who put a lot of time, effort and personal engagement to help the victims of the war.

This brings me to our operations in Russia, which represents around 1% of our global revenue on group level with around 3,000 employees. Mobility has the largest local footprint with long-term project and service business while our Digital Industries and Smart Infrastructure businesses are based on sales and local service.

After the start of the war, Siemens put all new business in and international deliveries to Russia on hold. The comprehensive international sanctions as well as currently potential countermeasures significantly impact our business activities in Russia, particularly on the rail service and maintenance business.

After thoroughly assessing the situation, Siemens has decided to exit the Russian market for its industrial business. This has not been an easy decision given our duty of care for our employees and our long-standing relationship in a market where we have been active for more than 170 years.

We are evaluating the impact on our people and will support them to the best of our abilities. We've already started to wind down industrial operations and all industrial business activities. This does not include Siemens Healthineers, focused on humanitarian health care, which acts as a separately listed company.

Our Siemens Financial Service operation in Russia is a local equipment leasing business amounting to around 3% of SFS total portfolio. Siemens Financial Service also put all new business on hold at the end of February. We are honoring existing contracts, while we evaluate all options in line with regulatory requirements.

The impact on our second quarter financials amounted to around EUR 600 million on net income due mostly noncash accounting impairments, write-offs and charges. By far, the largest impact was recorded in our Mobility business, and Ralf will give you further details. From today's perspective and under the given circumstances, we see further risks with uncertain timing on net income in the range of low to mid-triple-digit million amount from wind-down effects.

Potential items are mostly noncash charges related to the wind down of legal entities, valuation of assets in Russia at SFS and restructuring. Timing is difficult to predict since the wind down of legal entities also depends on fast-changing local regulations and factors outside our control.

Despite the significant effects from the Siemens Russia exit, I would like to stress that Siemens is confirming the group guidance given at the beginning of fiscal '22. Our strong operational performance in the first half of the fiscal year combined with positive portfolio effects allow us to generally weather the onetime impact from winding down the business in Russia.

Talking about portfolio effects. We now expect the closing of the divestment of the Parcel Logistics business during the second half of fiscal '22, and Ralf will guide you through the details. Looking at key operational highlights from the second quarter, I'm pleased with the progress of our strategic initiatives to drive digital and sustainable business and simplify our portfolio.

Our customers continue to invest in their digital transformation and improve resource and energy efficiency in the wake of rapidly increasing energy and material prices. And our automation and software solutions become even more relevant with tight labor markets and increasing complexity in manufacturing grids or infrastructure.

Order growth momentum of 22% remained very strong across most customer verticals, still with a certain level of preordering due to long lead times. Overall, revenue growth was strong with 9%, excluding effects related to Russia. And I'm particularly proud of our Digital Industries Automation business, again, clearly gaining market share with revenue up by 16%.

This is also clear evidence of our very agile and successful supply chain team. The SaaS transition in Digital Industries accelerated more than expected, leading to annual recurring revenue growth of 13% and the share of Cloud ARR of 9%, up 3 percentage points from last quarter. And I have to say here that we are very happy about this acceleration.

What counts in the end is consistent free cash flow generation, and we delivered again EUR 1.3 billion. All in, together with the proceeds from divestments, this will strengthen our balance sheet further and offers room for accelerating our share buyback program and deleveraging.

However, the macroeconomic environment remains very volatile. The war is amplifying cost inflation and constraints on supply chains where the situation remains very dynamic. During the second quarter, the pandemic impacted productivity in some areas in the U.S. and Europe. Moreover, recent Omicron outbreaks in China and the following lockdowns in Shanghai and Shenzhen, among others, pose a risk for the third quarter.

Missing deliveries from Shanghai have a knock-on effect across China and outside due to supply chain disruptions and logistics congestions. We support our employees in the lockdown areas with care packages and insure health and safety. Our factories in the Shanghai area work either closed-loop production or are in the progress of ramping up.

The situation changes every day, and we expect that we will not be able to fully recover production in the third quarter. We continue to work relentlessly with our supplier network and our own factories to optimize deliveries and master these challenges. Our focus is on mitigating impact on our customers as much as possible.

And we continue to balance cost inflation with timely pricing actions over time. All in, we saw a strong operational performance with continuing growth momentum. As indicated, orders reached an impressive level of EUR 21 billion, up organically by 22% leading to a record backlog of EUR 94 billion.

Our book-to-bill of 1.23 is again excellent. Revenue grew 7% to EUR 17 billion, led by Siemens Healthineers with 16% and with high single-digit growth in Digital Industries and Smart Infrastructure. Mobility recorded revenue reductions due to Russia. Main contributions came from Germany, up 10% and the U.S. increasing by 17%, while China was flat on tough comparables.

Strong operational profitability of 14.6% in Industrial business, excluding Russia-related burden, which amounted to 360 basis points. EPS pre-PPA came in at EUR 1.50, including a negative impact of EUR 0.71 related to effects from Russia. The prior year benefited from the Flender gain.

As I mentioned before, we see strong secular growth trends in all our businesses. Addressable markets are now amounting to EUR 465 billion, complemented by fast-growing adjacent markets in digital and IoT of additional EUR 130 billion. Currently, we are assessing the various short- and long-term effects on midterm market growth. And we are convinced that the underlying growth drivers for Siemens in digitalization, automation, decarbonization, resource efficiency and related stimulus programs are fully intact.

Let me highlight a real source of strength and resilience in our recorded order backlog of EUR 940 billion (sic) [ EUR 94 billion ], which is up more than EUR 20 billion year-over-year. A vast majority of the second half fiscal year revenue is already in our books across all businesses. First and foremost, it is now about stringent execution and supply chain excellence. Visibility in our short-cycle product businesses in Digital Industries and Smart Infrastructure is extraordinarily far-reaching.

It is supported by a high level of advanced reservation payments. In certain areas, substantial orders on hand reached into the first half of fiscal 2023. The long-term project and service backlog of Mobility comes with very healthy gross margins. A key strategic lever for value creation is our goal to grow the digital business annually by around 10% until 2025.

We are very well on track. The revenue exceeding EUR 3 billion in the first half year. Digital Industries is accelerating the SaaS transition and also driving rapid growth in Mendix and supply frame. In addition, we reinforced our growth ambitions with decisive organizational steps in Smart Infrastructure and Mobility.

A dedicated Grid Software unit was set up in January in Smart Infrastructure, bringing around 2,500 software and operational technology experts together. The team just launched a new comprehensive and open Grid Software suite for a net-zero world. In a similar move, we bundled all software businesses, Siemens Mobility, such as HaCon, Sqills or Bytemark under 1 roof. The goal is to optimize customer experience and processes across all modes of transport, leading to faster profitable growth.

Coming back to our DI software business and its crucial strategic transition towards Software-as-a-Service, mainly for our PLM business. In the second quarter, we saw a faster-than-expected acceleration of the transition clearly visible in the numbers. The annual recurring revenue grew by 13% year-over-year to EUR 3.1 billion, ahead of our midterm target of 10% annual growth.

Therein, the key indicator, Cloud ARR, as share of total ARR, grew by 3 percentage point in this quarter alone, up from 6% to 9% overall. Customer feedback is positive and sales teams are very active. We saw an increased flip rate of 44% of PLM renewables, covering almost 70% of the total contract value.

This volume was higher than anticipated. And as the flip side of success translated into lower revenue and profitability in the current quarter. Around 1,250 customers have signed on to the Software-as-a-Service business model in the first half of the fiscal year.

In the second quarter alone, around 50% of customers were small and medium enterprises. Among them, many new customers, in line with our ambition to expand exactly this customer base. Q2 was the strongest quarter for software renewals in the PLM portfolio, and our plan is to continue serving our customers' appetite for SaaS.

Here, you can see some great examples how customers build on our technology and domain know-how to transform their businesses and drive sustainability. No matter whether it is in frontier applications such as underwater farming or for long-term customers working on next-generation trucks and power grids or more sustainable public transport, Siemens has excellent hardware and software solutions addressing our customers' challenges. All these examples demonstrate how the dynamic change towards decarbonization, resource efficiency, and more sustainability, creates significant business momentum for us. In addition, we continue to execute on our DEGREE ambitions.

I want to highlight 2 initiatives. Our share of renewable energy sources stood at 78% in fiscal 2021. We will increase this ratio further, for example, through an additional 10-year solar power purchase agreement in Germany. The war in Ukraine and rising cybersecurity incidents put this topic even higher on public and corporate agenda.

A strong cybersecurity offering is a must-have and a business opportunity, too. We further strengthened our footprint with the opening of a critical infrastructure defense center in Canada, primarily for utility customers. More than 1,300 cybersecurity experts at Siemens operating in 5 global hubs work hard every day to protect our customers and Siemens.

Also, a strong signal for cross-company collaboration is the merger of the Digital Trust Forum with the Siemens' Charter of Trust initiative, and we are happy to welcome Bosch and Deusche Post DHL. With that, over to you, Ralf. Let's take a closer look at operational performance and further financial details.

[Ralf Thomas, executive]

Thank you, Roland, and good morning to everybody. Let me share further details regarding our performance in a very eventful second quarter. Our key markets for digital industries such as automotive, machine building and electronics continued to show strong underlying momentum with some signs of normalization.

Still a considerable portion of the excellent order growth in the short-cycle factory automation and motion control businesses was caused by customer concerns regarding prolonged delivery times. Book-to-bill overall was at a remarkable level of 1.3, further boosting our backlog in digital industries to more than EUR 11.5 billion.

All automation businesses showed massive order growth, up by 38%. Software was up in the mid-teens without closing larger deals during the quarter. We are very pleased that automation revenue rose 16%, achieving record production output by managing ongoing supply chain constraints extremely well.

Even though we can mitigate supply chain shortages step by step, we expect the situation to remain critical beyond fiscal '22, also depending on the development in China. Revenue in Discrete Automation was up 20%. Process Automation continued its recovery and achieved 7% revenue growth. As Roland explained, Software revenues was down 11%, showing the momentum of our accelerated SaaS transition in PLM and the absence of larger contracts in the lumpy EDA business.

While PLM was moderately lower by 4%, EDA showed decrease in the mid-20s on tough comps, while Mendix continued its substantial growth path well above 30%. Margin at 18.1% was lower than expected due to the accelerated SaaS transition with 100 basis points additional impact. Higher incentive accruals due to continued order strength and a noncash write-down of current assets in Russia of around 50 basis points further affected profitability.

Ongoing Cloud investments of EUR 61 million accounted for around 130 basis points of negative margin impact on digital industries level and will, as expected, gradually increase throughout fiscal '22. We're extremely pleased that Digital Industries achieved a stellar free cash flow of more than EUR 1 billion.

Higher inventories in automation needed to stabilize the supply chain were compensated with excellent advanced payments and payables management. In addition, Software contributed strongly with a typical seasonal cash cycle.

Now looking at our key vertical end markets for the next quarters. We expect a continuing positive momentum based on sound investment sentiment and strong fundamentals in most of our key industries. Automotive is expected to see some normalization on a high level and supply chain constraint will continue to restrict customer output in many industries.

Now let me give you the regional perspective on our dynamic top line automation growth. All regions showed double-digit order growth with Europe and China leading the way. China growing rapidly with 27%, Germany and Italy even soaring 37%. Obviously, we expect a further normalization of demand going forward and a gradual reduction of our backlog.

Revenue growth in Automation was broad based on strength in China, up by 25%. Germany up by 8% was driven by motion control mainly. Italy showed 23% revenue growth on strengthened Discrete, while the U.S. Process Automation increased double digit. Although order backlog is at record levels, the outlook for the third quarter is rather complex to assess.

It is largely depending on global component availability as well as length and impact of lockdowns in Shanghai and other regions in China. Our core factories and digital industries in Nanjing and Chengdu are operational. However, the output in customer deliveries are impacted by supply chain disruptions and component availability from Shanghai-based suppliers as well as logistic constraints.

Under the assumption that we see Shanghai ramping up throughout May with no material deterioration in other regions in China, revenue growth at digital industry will be around 10%, will be supported by the third quarter -- in the third quarter by a positive contribution from the software business where larger contracts in EDA are expected to overcompensate for continuing SaaS transition effects in the PLM business.

We expect the profit margin for the third quarter to be around 20%, highly dependent on the development in China and the speed of the SaaS transition. Now let's move on to Smart Infrastructure.

The team delivered strong top line growth in favorable end markets. Margins were up, however, held back by headwinds from the pandemic in Russia. In total, orders were up 22%, driven most notably by more than 30% growth in the Electrical Products business benefiting from ongoing industrial demand.

In addition, Electrification grew above 20% and with large order wins from data center customers such as from a world-leading social media company and strength in semiconductors. Buildings was up around 15% and continued strength in the product business and with accelerating solutions and services activity.

Revenue growth of 8% with the largest contribution from the Electrical Products business, up by 15%. Supply chains were again successfully managed by the team, and factory utilization remains on a high level. Margin performance of 11.1% was up 30 basis points year-over-year, benefiting from higher capacity utilization related to increased revenue as well as structural improvements from our competitiveness program, which is fully on track.

Headwinds from commodities as well as component and logistics cost inflation were to a large degree mitigated by pricing actions. However, improvements were partially offset by headwinds from the pandemic, especially in the Solutions and Services business and initial effects from the lockdown in Shanghai, where 2 factories were temporarily closed in March. Around 40% -- 30 basis points impact was recorded from write-downs in Russia.

Smart Infrastructure made further progress on portfolio simplification with the divestments of a noncore building management and service business in Austria called SGS, which is expected to close in the third quarter. Free cash flow was solid overall, yet somewhat impacted by tight supply chains, leading to higher inventories to secure production.

Looking at the regional top line development, we saw broad-based strong order momentum with all major regions up, led by the U.S. with 39%. Revenue increased in all regions except for China with impressive 10% growth in the U.S. The Service business delivered 7% growth, led by a clear increase in Europe and the Americas.

As in Digital Industries, we are introducing an overview for vertical end-market exposure and market trends for Smart Infrastructure as well. While we see some moderation in commercial buildings due to the knock-on effects from the war in Ukraine, other important verticals such as power distribution, electronics, health care and data centers show healthy and sustainable growth. Based on this, for the third quarter, we see the comparable revenue growth rate to be in line with our full year growth guidance.

We anticipate the third quarter margin at the upper end of the full year guidance range of 12% to 13%, including a mid-double-digit million positive effect from the divestment of SGS. These expectations are under the assumption that the lockdown situation in Shanghai is easing during May and supply chain frictions and related cost inflation do not deteriorate further.

For the third quarter, we expect a slightly negative impact from the cost inflation versus price increase equation. This will then improve in the fourth quarter of fiscal '22. As Roland mentioned, Mobility's financials in the second quarter were massively affected from sanctions on Russia, while operational performance was quite solid.

Order growth of 13% to EUR 2.5 billion was driven by a higher volume from large orders, mainly in rolling stock such as a 50 Vectron locomotives for Czech Railways. We also booked additional 18 trains from the so-called second option for Munich Metro. Rail Infrastructure business was up mid-single digit. The backlog stands at EUR 36 billion with healthy gross margin.

It was impacted by a reduction of EUR 4 billion related to Russia. And our sales funnel continues to look very promising for the quarters ahead. Revenue declined 9% with a revenue reduction of more than EUR 200 million related to projects in Russia from prior periods. Excluding this effect of around 10 percentage points and further revenue not recognized for work performed in the second quarter, Mobility showed moderate growth.

As a result of the sanctions related to Russia, Mobility profit was burdened with impairments, write-downs and other charges of, in total, EUR 567 million. This equals around minus 25.7 percentage points profitability impact with the operational business at a solid 8.4% margin, still impacted by lower productivity due to the pandemic and supply chain friction.

Write-downs and charges were mostly noncash. So the impact for -- on free cash flow was minor in the second quarter. Mobility, therefore, delivered a solid cash performance of EUR 140 million. For the second half of the year, we expect positive cash contributions, yet missing payments from Russian customers will lead to a cash conversion rate clearly below 1 for the full fiscal year. Our assumption for revenue growth for the third quarter is low- to mid-single digits, still affected by missing revenue from Russian projects.

Third quarter margin is seen around 7% still affected by missing contributions from Russian-related projects, [ rails ], material supply and logistic constraints. Let me keep the perspective on below industrial businesses crisp today. All details are in the earnings bridge on Page 28 in the appendix.

Siemens Financial Services showed a robust performance, influenced by charges of EUR 57 million related to Russia, mainly resulting from higher credit risk provisions and a strong positive contribution from the equity business. Value creation at the portfolio companies is in full swing with a EUR 292 million valuation gain in connection with the announced divestment of our stake in Valeo Siemens e-automotive joint venture.

In addition, fully consolidated units improved earnings. A higher loss from the Siemens Energy Investment was again a very unsatisfactory development. In Financing, Elimination and Other, a temporary positive net effect of EUR 177 million in connection with corporate treasury hedging activities related to the Russian ruble were partially offset by a revaluation loss of EUR 119 million on the stake in Thoughtworks.

Tax rate of 31% was temporarily higher in the quarter due to certain nontax deductible items related to Russia. Now free cash flow performance in the second quarter highlights our ability to deliver strong and consistent free cash flow throughout the year on stringent working capital management.

We are confident to continue this path despite supply chain constraints. I want to point out today already that upcoming material divestment proceeds are technically not considered in free cash flow. In the second quarter, the impact on net income from effect related to Russia is also reflected in 2 important parameters of the Siemens financial framework.

First, ROCE, excluding Varian-related M&A effects of 11.1% was outside the target corridor affected by 460 basis points due to Russia-related one-off impacts on net income in the second quarter. We expect this KPI to substantially improve for the full fiscal year '22.

And secondly, 1.6x industrial net debt over EBITDA was slightly above our target with strong operational free cash flow and substantial proceeds from divestments in the second half, we will continue our deleveraging path. As Roland highlighted, we will accelerate our existing share buyback program literally as of tomorrow.

The pension deficit was reduced further to a historic low of EUR 2.2 billion. However, we expect some negative effects from inflation to be reflected at fiscal year-end with actuarial assessments. Let me now summarize some key items and expectations to underpin our outlook for fiscal '22 based on first half year results.

Here, you can see all major effects from our [indiscernible] to simplify our portfolio in fiscal '22. In total, we expect roughly EUR 2.1 billion to EUR 2.3 billion of gains on net income level from these 4 larger divestments, obviously, depending on final closing.

Yunex Traffic and Parcel Logistics are now both expected to close in the second half. The exact timing will be subject to regulatory approvals, obviously. This slide gives you an updated overview on all line items below Industrial businesses and our expectations for fiscal '22. I want to point out a few important topics for your models. Siemens Financial Services operational results in fiscal '22 are expected to be in the lower part of the target range of 15% to 20% return on equity despite charges related to Russia in Q2.

For the Russian business, growing concern is assumed, but a further negative impact related to Russia cannot be excluded at some point, but it is too early to assess this. In Portfolio of Companies, we expect a positive result of around EUR 1.4 billion to EUR 1.6 billion, an impressive proof point for our value creation strategy by implementing full potential plans and then finding best owners for the different businesses.

For the remaining fully owned businesses, we continue our efforts to further improve margins while assessing and implementing strategic options. For Siemens Energy Investment, we anticipate a limited improvement of our net income and equity participation over prior year based on Siemens Energy's expectations.

We are not satisfied with their current performance. The share price development of Siemens Energy was very volatile, and we are looking towards the Siemens Energy Capital Market Day in May for clear perspectives and more certainty. As indicated, we continue to expect PPA effects within our Siemens Energy investments of close to EUR 100 million. For PPA, we expect now around EUR 950 million, slightly higher due to final measurement effects related to Varian.

In Financing, Elimination and Other, you can pencil in a negative contribution of around EUR 300 million for fiscal '22. The tax rate continues to be expected in the range of 25% to 29% without the impact from potential tax reforms, obviously.

Before I close with our outlook, let me point out 2 further topics which are relevant for your model. While FX effects at current rates are seen to have no material effects on margin on group level, top line will be supported by around 200 to 300 basis points. Also based on current macro data and assessment of auditors, we will start in the third quarter to apply high inflation accounting for our operations in Turkey in accordance with IAS 29.

Potential effects are reflected in our group guidance. We will update you, of course, with the third quarter disclosure on those implications.

Let me now close with our outlook. We confirm our financial targets for fiscal '22 for the Siemens Group. They are based on continuing growth in global GDP and our expectation that the challenges to our businesses from COVID-19 and supply chain constraints will not worsen in the remainder of fiscal '22.

Under these conditions, we expect our Industrial business to continue its profitable growth. For the Siemens Group, we expect rates growth of 6% to 8% in comparable revenue and a book-to-bill ratio above 1.

Digital Industry raised its growth assumptions now expecting to achieve comparable revenue growth of 9% to 12%. Profit margin of 19% to 21% is unchanged, including an expected reduction of up to 2 percentage points from fast ramp-up of the strategic transition to Software-as-a-Service in parts of its large software business.

Smart Infrastructure expects comparable revenue growth in the range of 6% to 9%, up by 100 basis points. The profit margin is unchanged at 12% to 13%.

Mobility, which previously expected fiscal '22 comparable revenue growth of 5% to 8%, now expects revenue on the prior year level. Profit margin is expected to be 10% to 10.5% with the expected gain from the sale of Yunex Traffic being sufficient to balance impacts related to the sanctions imposed on Russia. We continue to expect the profitable growth of our industrial business to drive an increase in basic EPS pre-PPA to a range of EUR 8.70 to EUR 9.10, up from EUR 8.32 in fiscal '21.

Net income in fiscal '21 included a positive contribution from divestments and other portfolio related gains, totaling EUR 1.5 billion. We assume a similar positive contribution in fiscal '22 from portfolio-related results net of burdens related to Russia. Portfolio-related results include the sales of Yunex Traffic, the mail and parcel handling business of Siemens Logistics and our stake in Valeo Siemens e-automotive. This outlook excludes burdens from legal and regulatory matters, as always. And with that, I hand it back to you, Eva, looking forward to your questions.

[Eva Riesenhuber, executive]

Thank you very much, Ralf. We are now ready for Q&A. [Operator Instructions] So operator, please open the Q&A now.

[Operator]

[Operator Instructions] And our first question comes from the line of Gael de-Bray from Deutsche Bank.

[Gael de-Bray, analyst]

I have 2 questions related to DI, please. The margin this quarter came noticeably below the 20% margin level. So could you just give me a little bit more impact, a little bit more details on the impact coming from the SaaS acceleration?

Just to be clear, is the 100 bps negative effect on top of what you had expected for the full year, which I think was a negative impact of 200 bps? Or are we still within that range? Still talking about DI, could you also talk about the price cost dynamics for DI this quarter? Because as far as I remember, it's really one of the businesses for which you have always spoken very highly in terms of pricing power. So the margin deterioration came somewhat as a surprise?

And lastly, I can see the print in the U.S. was negative, which somewhat caused the weak performance from [ work well ] his quarter. So is there anything specific in the U.S. market. I mean what makes the U.S. business may be more prone to supply chain challenges?

[Ralf Thomas, executive]

Thank you, Gael. Obviously, in the center of interest, DI also has been attracting a lot of attention from our end to understand the course of the business, but also to come up with a prudent outlook for the business for the rest of the fiscal year.

So let me start with the first question you raised about the DI margin and the SaaS implications. As said, there was 100 basis points that we didn't expect to influence the margin in this quarter. However, this is part and included in our statement that we expect up to 200 bps of margin impact on DI level for the full fiscal year. So if you will, a surprise in the quarter, but not a surprise in dimension and with impact on the full fiscal year. So how can that happen? We've been asking ourselves that quite a lot.

And as we indicated before, a lot of the impact on the margin from the SaaS transition happens at the end of the day via revenue recognition, and you only see -- a, you see a high concentration of revenue then at the end of the quarter, so back-end loaded on the 1 hand side. And on the other hand, you also do know that the numbers of customers that finally make their decision whether or not to put an order in place can really be very -- it's really very hard to predict.

I think Roland gave you a glimpse already at how really impressive the KPIs, tangible KPIs for the progress we made on the SaaS transition have been. And I personally was also very much impressed by the number of more midsized companies that have been finally embarking on that change journey, obviously, seeing the benefits for themselves.

And this is a fact that is putting additional burden on properly predicting. Because if you have 1 or 2 large-scale customers, you can fairly easily assess when, or if they put orders in place that have an impact with a large number of more midsized-based customers, this is hard to assess.

Still, it's important, I think, for you guys as it is important for us to see that we are perfectly making progress, tangible KPIs supporting that, and we continue to follow the pace of our customers. We do see and I personally anticipate that this incremental momentum that has been implemented there will continue. So the third quarter, I believe, will again allow us to then report on a successful acceleration of the transition to SaaS.

Just to mention on the high margin level, the Russian impact couldn't be anticipated, obviously. This is a valuation game there for noncash 50 bps on that, that couldn't be anticipated. I think you have -- you probably understand that. And then it was also -- it wasn't a surprise to us, but it is also a positive, still negative margin impact that due to the top line momentum and the new orders, the sustainable, obviously, a high level of new orders have been then taking us also to accrue for incentives in that field, which also had an impact of around 30 basis points on the margin development in the quarter.

So in a nutshell, everything that we could anticipate, we anticipated in our own internal forecast, assessing finally what the SaaS transition impact is going to be in a single quarter, was difficult and will remain difficult. And I also would like to remind all of us that we said exactly this from the very beginning at the Capital Market Day when we announced the SaaS transition.

So the second part of your question was around the price cost dynamics. And obviously, we do have pricing power. We set that, and we would implement that. It has been successfully been done. So we also continue to see the positive momentum for DI for the second half of the fiscal year.

And when we said we are going to positively -- we are going to be able to positively resolve the economic equation to overcompensate with productivity and pricing what we see on the inflation and on the cost side, is still valid. The achievement of the team so far have been underpinning this very impressively. So I think this was the DI part. Can you repeat the last part of your question? I didn't take a note on that.

[Gael de-Bray, analyst]

Yes. Absolutely. It was also related to DI, for which the automation business was down 7% in the U.S. and...

[Ralf Thomas, executive]

Sorry, the U.S. Yes, I got it. Got it. Yes. I mean for the U.S., for us, I think it's important for Siemens DI, I think it's important that this is a typical process automation market which is different in nature and dynamics. And also with regard to logistical challenges, I do not want to comment on the competitors' performance, but I think we did fairly well.

[Operator]

We will now take our next question from Andreas Willi from JPMorgan.

[Andreas Willi, analyst]

Given that this may be my last question on the Siemens conference call, I wanted to ask about 2 more longer-term topics. First, in an interview last summer, Roland, you stated that you believe Siemens is massively undervalued, but that you expect this to correct as you keep delivering on your plan.

Despite the strong execution, the discount, however, has reached a new high and the Siemens stock did not benefit from being more diversified in the recent equity market correction. Does this change your view around the portfolio, for example, being more aggressive on the scale of the buyback rather than just the timing?

And my second question in terms of the software business, we've seen Chinese authorities putting pressure on their companies to use more domestic suppliers for technology for software. Are you seeing that in your industrial markets as well in terms of where that could lead longer term? And what's your strategy to address this given also that some of your software is exported out of the U.S.?

[Roland Busch, executive]

Yes. Thank you, Willi. And -- Andreas, sorry. And coming back to your first question. So well, it doesn't change my point of view. We have to really get our strategy in place and execute. That's what I believe is the right thing to do. And as I can say, we deliver on our top line with cash flow. And also, even if -- I know that you're disappointed about this 200 basis points on DI.

I mean this is something which we really told you that if there's a chance to accelerate SaaS, we're going to do that, and we see the impact, and I'm not feeling sorry at all about, we really have to execute what we believe is the right thing for us and our customers to do.

We accelerate our share buyback. This is something that we have to do, and I think it's the right time. So we believe in. This is also good for our shareholders. And for me, also regarding the portfolio, I feel very comfortable in what we are doing and really bringing the right technologies at the right time to grow markets with secular growth trends. So doesn't make me really nervous. We don't change our strategy.

Actually, I'm really convinced the more I'm looking into it that we are exactly on the right spot. And if you look a little bit left and right to also competitors that you see that we definitively have the right portfolio. And we [indiscernible] further, as you know, that we are allocating our capital really to where the growth is and where we believe our future is, which is digitalization on the 1 side and the sustainability on the other.

China -- so number 1 is we have -- if you take the whole automation business of our Electrical Products business, this is -- business on the radar screen of the government. We have local competitors. We watch them closely. They grow fast, and we are -- actually, we have put them on the spot. We want to win against them.

This is -- of course, we don't forget the international ones, too. But this is something that we are focusing on. And we feel that are comfortable. We have an extremely high market share. I mean don't forget, for example, the battery manufacturing is one of the verticals growing tremendously fast, billions running in there. We have a very, very strong position in automating batteries, for example, battery manufacturing.

So automation, I would say this is not so much on the government focus. Regarding software, actually, it is the -- Chinese government wants to build more software. But this is -- they come a long way. And the industrial software, which we are serving, actually, there's -- I don't see any major player there. They try to do something. But here, I do believe there's still a strong dependence and it will be on our technology, international technologies coming from us and from our competitor in Europe.

So therefore, I don't see that this is a big problem regarding China. What we do though is that we are bringing in certain areas our customers together. We show them our software and hardware capabilities because they also recognize that you have to bring that together. To bring the reel in the digital world together is exactly what they are looking into.

So I do believe -- and if you have a proper offering, which really connects these 2 worlds, they are more than happy to do that and go on that path. So I would rather, if it comes to the policy of China, I would rather look into other markets, in particular, OEM markets, where they have a stronger influence rather than on the second tier and third tier markets, which we are in.

[Ralf Thomas, executive]

And if I may add 2 more points, Andreas. First, through the share buyback. I mean it's obvious that you said timing is not the only lever, also thinking about scale. I mean we are maneuvering within a given and authorized program at the moment. So timing is always first.

if and when we come to a point, that we would see that the existing program is finding its natural end we, of course, would at the right point in time, then take decisions accordingly.

And the second point I would like to make because you have been introducing your remarks that way. If and when this should really be the last time you are on a Siemens call, I would personally regret, and we will miss you.

[Operator]

We will now take our next call from Guillermo Peigneux from UBS.

[Guillermo Lojo, analyst]

Also, wish you the best, Andreas. I wanted to ask 2 questions. Maybe First 1 related to Russia. Can you share more of the details on the expected low to mid-triple-digit million from the exposure to Russia and which segments or areas are impacted most and also which is the nature of those impacts as we go forward? That's the first question.

The second question is regarding order intake growth. It remains very solid, especially in DI and SI, could you elaborate a little bit around selectivity and pricing of new orders? And how many orders are impacting the backlog margin? I.e., is there still accretion from order intake as we go forward, especially within the context of inflationary pressures?

[Ralf Thomas, executive]

Thank you very much for those questions. Let me start out with Russia, which is obviously a big point in this quarter's this closure. And just to get it right, the EUR 572 million after-tax impact in the second quarter is mainly revals on working capital items, obviously, on assets, on tangible -- intangible assets, but also derecognizing revenues in Mobility to an extent around EUR 200 million, as mentioned before, and also writing down the book value of an equity participation area EUR 100 million.

You will see that in the half year report that we are just issuing and disclosing at the moment. So this is the first impact of the second quarter. We foresee for the remainder of the current fiscal year tangible aspects in a magnitude, give or take, EUR 50 million to EUR 100 million, of which we believe they are likely to come. So if I may spell it out that way, immaterial in nature, and again, noncash, it's about assessing of the value of inventories that may be used into other directions, end, end, end.

So the risk that Roland has been describing in his presentation of low- to mid-triple-digit is coming from residual risk that we don't have control on, yes? I mean if and when, we came to a point that we need to close and deconsolidate legal entities we have in the country. We can't anticipate when that is going to happen and if it's going to happen. But if we come to that point, then accounting technicalities are going to kick in like looking into the equity structure and there may be then effects from exchange rates to recycle OCI, other comprehensive income, and pull it through P&L.

They have 1 thing in common, all these technical effects, they are not cash. They are noncash items. So therefore, we can't anticipate that. There's 1 activity and also Roland described that one, our Siemens Financial Services to have a leasing company in the country, which is under regulatory rules, obviously, we do not any contradiction to any sanctions in that field, no new business, no new products of Siemens being brought into the country, but the existing leasing book is there and is going to be executed on. We are looking into that.

And again, there could be valuation aspects, again, without cash impact at that point in time, and we can't assess the when and the how. So the 3 different buckets should be kept apart, the actuals being booked EUR 572 million after tax, potential risk mid-double digits to up maybe EUR 100 million, and that's what I -- what we see for today for the second half of the fiscal year, maybe. And then just a technical risk, if you will, on the balance sheet that are mostly noncash in nature.

When it comes to your second question around the new orders and the growth momentum, we have been elaborating on that quite frequently and would like to repeat that. We do have pricing power, quite substantial, to compensate for higher costs on the commodity side, but also for logistics and for components. So therefore, the growth in new orders is definitely supported by that pricing impact, yes, as is revenues in the second half of the year.

And the margin quality in our backlog is as excellent as it used to be before. So getting that economic equation as we call it in place and counterbalancing inflation effects on the cost side with pricing and productivity works very well. We expect that to be a net positive at the end of the year for both PI and SI Mobility per nature being a project business is not that very much affected from it.

In many contracts, there is price escalation clauses included for relevant commodities. So therefore, this is different in nature, and we feel quite comfortable with the visibility but also with the quality of the backlog we hold at the moment.

[Operator]

We will now take our next question from Ben Uglow from Morgan Stanley.

[Ben Uglow, analyst]

Without wanting to turn this into a lovefest, best wishes to Andreas, one of the most outstanding industrial analysts of all-time and a fantastic competitor. I wish him all the best and I hope this isn't the last point. But anyway, moving back to core business. Two questions, please. On the revenue side, Ralf, on revenue recognition within the SaaS business, can you just sort of explain that to us in very, very simple terms, from an accounting standpoint, is it the fact that we're getting lower revenues in the existing businesses, i.e., PLM and et cetera? Or is it that we're getting a slower ramp-up in the new business?

And that transition, if we think forward into 2023, does that mean that we actually kind of get a margin benefit later down the road? So that's my question number 1 is properly understand the revenue recognition effect.

Second question is just around China. The order growth is excellent, plus 27%. Can you -- within Digital Industries, can you talk about which industries, which projects, what are the drivers of that order growth and how are you thinking about that in the balance of the year? I'm not interested in lockdowns, but in terms of the structural drivers of that order growth and how they play out over the balance of the year?

[Ralf Thomas, executive]

Thank you, Ben. Revenue recognition in SaaS. You may remember we called it swallowing the fish when we introduced the SaaS transition, and that implicitly means that you do not -- if you compare the SaaS model to the prior model, you recognize revenues later and then implicitly with more stickiness of the business and more resilience and higher margins at the later end.

Why is it so hard to predict that? The nature of the contract, yes, determines to what extent that lower revenue recognition is going to take place. And as I said, if you had only 5 large-scale customer contracts, it's easy to assess. However, and which we appreciate, since we entered the space of midsize company customers, there's a multitude of those contracts, many of them being backloaded in time at the quarterly end.

And therefore, it's really hard to predict how that impact is going to be. What we can see, however, that's why we provide such an abundance of other KPIs to you, which clearly reflect that we are making progress. The number of customers, the portion of SaaS, the cloud portion within that the annual recurring revenue in nature, all that is supposed to give you and ourselves also confidence that we are walking into the right direction and, this is the point now, with increasing speed.

We -- you may remember the first quarter's call, we had -- we said that we hope that after a first sign of confidence, the market would now even better and more eager adopt and embark on that changed journey to SaaS transitioning. And that's obviously happening. We saw the Cloud ARR portion going up from 6% to 9% quarter-over-quarter. We saw the annual recurring revenue growth now 13%.

I mean this is all pretty much encouraging in the sheer number of customers that we saw about more than 500 new customers that are now in the offering phase will also put the same challenge at us for the next quarter to share that with you right away. So what we are doing at the moment, we referred to the facts, we see the KPIs improving, we see the customer contracts coming in, we see more and more customers also of midsized companies, which is good for us, also in terms of resilience and the margin and the strategic perspectives we are targeting. But at the same time, this is not helpful for better anticipating what exactly the impact is going to be at the quarterly end. This is just as it is.

[Ben Uglow, analyst]

Understand. And then on China, perhaps?

[Roland Busch, executive]

Yes. On China, Ben, this is Roland speaking. I cannot agree more with your comments on Andreas, yes. On China, it's -- this goes across our products. So it's end markets. It's Discrete industry as well as process as well as machine tools. So we see here a pull from all sites.

If you look at the verticals which we are serving successfully, I mean, is it automotive, in that case, this is a switch really to electric car production, changing of the manufacturing lines, but batteries, I said before, very, very strong vertical of ours. It's also electronic semiconductors, food and beverage and the like, but machine building also.

So -- and we are able to deliver so far, as I said before, that Nanjing and Chengdu is our big manufacturing sites for our PLCs, which are not going to lock down. So therefore, we see a very, very strong demand. And you know that we have a very, very high market share; very, very strong repetition in the market. So this is all together makes our China DI growing by 27%.

[Eva Riesenhuber, executive]

Thank you very much. In the interest of time, may I please ask our analysts in the queue to limit themselves to 1 question per analyst. Thank you.

[Operator]

We will now take our next question from Alexander Virgo from Bank of America.

[Alexander Virgo, analyst]

I will focus just on cash, if I may. North of EUR 1 billion cash flow generation in DI. And I guess the main point really to draw from SaaS transition is that cash goes up and the certainty of cash goes up, and you've seen margins decline year-on-year in DI, but cash going up. So I just wondered if you could talk a little bit to the dynamics around that?

Should we be thinking about DI as a EUR 4 billion a year free cash business now? And maybe if you could just touch, Ralf, super quickly on the movement in contract liabilities and the cash flow? I appreciate that, that's a real niggly question, but it's a big number. I just wanted to clarify what that was. And I will leave it there and best wishes to Andreas as well, of course, echoing Ben's comments.

[Ralf Thomas, executive]

Thank you, Alex. I really, really appreciate that you raised the topic because I mean, we have been very much focusing on cash and getting that into a more consistent seasonal format for many years, as you know.

I really, really believe that the management teams throughout the value chain now got it to make it not a project, a single hit wonder, but to make it a continuous process. So that's why whenever we touch on one of the levers, yes, that is really quite well to anticipate, we deliberately have been taking positions selectively when it comes to critical inventories, which is just to keep our supply chain stable, and support that and also get operations on safe ground. So this is an intended action that is then also followed through and inventory levels are going down then again after overcoming that peak of the challenge, so to speak.

We also do very consistently collect and we have probably together with the shortages in the market also a quite unique situation that we get advanced payments for our product businesses, in particular, in Asia and with a focus in China, which we haven't been seeing in the past. So we work on establishing that as a market resource, yes, as something that is going to stay there.

And we are also quite consistently looking into opportunities to get patent in place for our logistic chains that allows bundling were meaningful and also decentralized inventories being kept for dynamic use, if I may put it that way, if and when need to change the programs in production locations, in particular, in China with a lockdown that is, I think, of highest importance.

And would like to use the opportunity to also mention this is not restricted to DI. I think it's across the board and also the all-in free cash flow of EUR 1.3 billion, I think, is talking for itself. In particular, in critical times like we have that with a lot of challenges around Russia and also COVID lockdowns and the like.

So technically speaking, the working capital assessment and to what degree do we have percentage of completion impact, yes, on our books, I think that really goes beyond this call. But what you will see with regard to the consistence over several quarters that is pretty much neutralizing itself in terms of the swings and peaks you have in a given quarter as we see that at the moment.

[Operator]

We will now take our next question from Simon Toennessen from Jefferies.

[Simon Toennessen, analyst]

I've got 1 question on the slides you have on the [ DI ] outlook. I think Slide 14 for DI and then I think a bit further down on [ SI ]. The only change on DI is automotive going from up to flat. Can you elaborate a bit on that? Is that basically you're taking a more cautious view on automotive CapEx here or what's the reason for the more flattish market trend you're seeing? And basically, the same true for commercial buildings. It's quite surprised that you do see this flattening given the trends we're seeing in the U.S., for example, accelerating at the moment. If you could just elaborate on those 2, please?

[Roland Busch, executive]

Yes. for the later on commercial buildings, it's more the inflationary part and the interest rates going up, and we have to watch closely and that's mainly driven, in that case, also by the United States, which is, for us, the largest commercial buildings market.

Regarding automotive, it is mostly related to demand. Take China, for example, in lockdown, you don't buy really cars so much -- it's a trend overall that you have some consumer demand is going down. Let's watch that how that goes on in Q3 and Q4.

For me, automotive is still a secular trend because you have a switch from combustion to electrical cars and the demand is there. So therefore, -- but for the time being, I would attribute it more to that one. And have in mind that China is the largest automotive market. So -- and again, I mean, this was not the demand driven, but since we are in the investment part, that's again another point.

This is definitely something where we see still an ongoing secular trend in investing. It comes from the batteries, but it also goes to hold the refurbishment or building new ones for electric cars. So therefore, I don't have too much concerns here. And you see that also machine building is, to some extent, also related to it, all of them going into that one.

[Operator]

We will now take our next question from James Moore from Redburn.

[James Moore, analyst]

Yes. And can I also add my good luck to Andreas after 25 years of competition, the Swiss clock never seemed to miss a second. On DI software, if I could, you mentioned in DI software that over 50% of SaaS customers are SMEs, which seems great. I think you guys were always very strong with the large customers, perhaps never had the same market share with the smaller customers. And I hope that transitioning to SaaS faster than others in PLM might give you an opportunity to take market share there. I wondered if you could give us a flavor for the share of the old ratable revenues, say, over the last 5 years or whatever that came from SMEs? Just trying to understand how significant that is?

[Roland Busch, executive]

Yes. So James, you really phrased it, and this is exactly why we're so excited about it. I cannot give you a precise number, but you are completely right, the share of small- and medium-sized companies with our software offering was very low, also in comparison to our competitors.

This is exactly why we're so excited about it because we are opening up a new customer base, which we didn't attach. They are -- obviously, they like our offerings. We are lowering the entry barrier for them to make it -- to use our offerings. Think also about how fast the Cloud ARR goes up, which is another sign because we provide cloud services. Again, it's a clear sign, it fits together. We are excited, small- and medium-sized customers, very attractive customer base, which we can build up, and we are building up very fast, so we take what we can.

And that's for me, it was, from the very beginning, also part of our strategy that we are not only changing customers, and this is the point which correctly was said before. We are lowering because we are distributing revenue over many years. We're lowering that, but with higher growth rates thereafter and higher margins. So that's what we are working on exactly.

[Eva Riesenhuber, executive]

Thanks a lot to everyone. Thank you very much to everyone, including Andreas for participating today. As always, the team and I will be available for further questions. We are looking forward to continuing our discussion during our upcoming road show. So with that, have a good day and goodbye.

[Operator]

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) 0-692-000-1800, access code 2001476#. Participants in Europe, please call the replay number [phone], access 2001476#. And participants from the United States, please call the replay number [phone], access code 2001476#. This replay service will be available until tomorrow night. A recording of the conference will also available on the Investor Relations section of the Siemens website. The website address is www.siemens.com/investorrelations.