Siemens AG

XETRA:SIE

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Siemens 2023 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, Ms. Eva Scherer, Head of Investor Relations. Please go ahead, madam.

[Eva Scherer, Head, IR]

Good morning, ladies and gentlemen. Welcome to our Q2 conference call. All Q2 documents were released at 7:00 a.m. this morning and can be also found on our IR website. I'm here today with our CEO, Roland Busch; and our CFO, Ralf Thomas, who will review the Q2 results. After the presentation, we will then have time for Q&A.

With that, I hand over to Roland.

[Roland Busch, President & CEO]

Thank you, Eva. Good morning, everyone, and thank you for joining us. Today, we'll promote another very successful quarter. And let's begin with some highlights. I'm pleased that we continue with our outstanding performance against the backdrop of a volatile macroeconomic environment. This is execution at its best.

Over the last weeks, I have met many customers and partners across the globe, including the Hannover Fair. And I met with confirmation of the great trust our customers and partners place in our technology and domain know-how. This makes us confident to benefit from ongoing robust investment demand.

Our end-to-end offerings are key to support our customers' transformation to become more competitive, resilient and sustainable. Orders at €23.6 billion grew 15%, driven by the highest quarterly order intake ever for mobility, as well as a very robust demand at Smart Infrastructure, up 9%.

Book-to-bill reached an excellent level of 1.22, pushing order backlog higher again to a record level of €105 billion. This gives us very good visibility for the second half of fiscal 2023 and beyond.

Supply chain constraints eased further, and we made best use of improved component availability to optimize capacity utilization and customer deliveries. Excellent execution led to a strong revenue growth of 15% to more than €19 billion overall. Growth was broad-based with Digital Industries, Smart Infrastructure and Mobility contributing north of 20% each.

Once more, our businesses have proven their leading competitiveness. For example, Digital Industries automation business outpaced its peer group once more with revenue up by an impressive 26%. Smart Infrastructure continued to show great strength with the electrical products and electrification businesses growing by 28%. Top line growth created substantial value with industrial business profit of €2.6 billion. And both DI and SI achieved all-time high operational profitability levels of 23.5% and 15.9%, respectively.

As we committed and in line with our expectations, we caught up in free cash flow generation, €2.7 billion for our Industrial business is a great accomplishment. While delivering on financial performance, we continue to make steady progress in executing our strategy.

As we see attractive secular market opportunities and rising demand for our offerings, our businesses continue to invest in OpEx and CapEx in a stringent targeted manner. I will share some examples in a minute.

The SaaS transition in Digital Industries is fully on track, delivering annual recurring revenue around of a growth of 15% in Q2. Cloud ARR jumped sequentially by around 30% and rose to €804 million, now representing 24% share of total ARR.

After a great first half year, we will further leverage our exceptional order backlog, execution strength and a continuing net positive economic equation. This leads to a high confidence level despite a volatile environment for the second half. Therefore, we raised and narrowed our guidance for fiscal year 2023 for both revenue and growth and earnings.

We are now guiding for revenue growth in a range of 9% to 11%, up 200 basis points on the lower end. And we clearly lift the range for EPS pre PPA, €9.60 to €9.90, up by €0.70 at the lower end. This excludes the effect from the impairment reversal of our stake in Siemens Energy, and Ralf will give you the details later.

Here are the key numbers at a glance. Let me briefly touch on two more topics. Industrial Business profit margin came in at 14.2%. Excluding a noncash one effect at Siemens Healthineers, it even reached an impressive 15.9%. Operational strength resulted in EPS pre PPA at €2.56 when excluding the already communicated noncash effect of €2.01 for the partial impairment reversal of our Siemens Energy stake.

Our strong order backlog stands at a record level of €105 billion, further fueled by strong demand for our system solutions and service businesses. As expected, customers of our product business in DI and partially SI are returning to more normal order patterns due to shorter lead times and improved component availability. This will continue in the quarters ahead and gradually bring down order backlog in the short cycle products and systems to more sustainable levels.

For both, SI and DI, we expect to start fiscal year 2024 with still elevated backlog levels. This enables us to continue to have a high level of visibility going forward. We are confident to achieve our profitable growth targets based on our excellent execution capabilities, including successful management of our supply chain and flexible manufacturing processes. The longer-term project and service backlog of Mobility and Healthineers comes with healthy margins.

We recently concluded our annual strategic business review looking at mid to longer term perspectives. All businesses operate in attractive growth markets with secular drivers such as shrinking skilled labor forces, increasing demand for resources and energy efficiency, glocalization or the rapid expansion of the Internet of Things. On top, regional stimulus programs will add growth opportunities. All in, we expect an average annual market growth of around 7% until 2027 from today's base of close to €500 million. Therein, our software and digital service businesses offer a double-digit market growth opportunity.

Initial growth rates are higher due to the current inflationary environment which we do expect to ease. We will further strengthen and optimize our portfolio through organic investments, targeted bolt-on acquisitions and selected divestments.

Through close collaboration across Siemens, we are pioneering the development and adoption of the latest technologies. Good examples are generative AI, industrial metaverse or additive manufacturing.

Over the next 5 years, the incremental growth opportunity for DI, SI and Mobility is around €175 billion. From a regional perspective, around 60% is expected to come from U.S., the European Union, China and India.

As you can see from recent examples, we will further develop and strengthen our diversified footprint. A key priority is further localization of development supply chain manufacturing and service activities through targeted resource allocation.

Our infrastructure and mobility are currently expanding their U.S. and European footprint. For example, we recently announced a new rolling stock factory in North Carolina. Digital Industries is optimizing and increasing capacities with its flexible twin factory concept between China and Germany. And based on market opportunities, further expansion steps are under consideration.

I just returned from India, the most vibrant of our larger regions with annual growth of around 11% over the next years. In this important market, we are upgrading and digitizing our manufacturing footprint. In addition, India is very important for our global operations as core hub for software development, engineering and services, which we continuously expand.

Just to give you a flavor, the Siemens Group has more than 30,000 employees across India level with our operations in China. Those of you who joined us in Hanover saw firsthand our innovation power, intense customer engagement and the dedication of the Siemens team. A clear highlight was the expansion of our open digital business platform, Siemens Xcelerator. We introduced industrial Operation X, a broad range of interoperable offerings for a more adaptive production. We also have added new cloud-based applications for Building X for smart and sustainable buildings.

Coming back to Industrial Operation X. One highlight is the launch of the first virtual SIMATIC controller. This is a key milestone towards software-based automation, enabling customers to manage OT - operation technology in key environment for specific applications.

Second pillar of Siemens Xcelerator is our growing partner ecosystem. We announced some important new collaborations at the fair, including - the extension of our partnership with Microsoft on the use of generative AI to drive productivity, working with IBM to integrate software solutions for optimizing product development and with a leading pneumatic technology company, Festo, amongst others.

You have heard me highlighting the tremendous opportunities in the fast-growing battery market. Here, Siemens can deliver speed, scale and sustainability for battery manufacturers. In Hanover, we announced and showcased a holistic partnership with Freyr. It ranges from product development, simulation product planning to build and ramp up their planned gigafactory production in Norway and the U.S. This is one of the great examples of how our Digital Industries and Smart Infrastructure offerings come together.

Our customer base is growing rapidly with established Asian players such as CATL or LG Energy Solutions and many new European or U.S. focused companies such as Northvolt, Morrow and ACC. And I'm very proud that high-end battery manufacturer sales force who is majority-owned by Porsche to Siemens just a few days ago.

Our digital business remains on a strong growth trajectory and stands at €3.4 billion after the first 6 months of the year. We are well on track to exceed 10% growth for the full year despite the ongoing SaaS transition in digital industries.

I already mentioned the substantial organic portfolio expansion for Siemens Xcelerator, which will further support growth. Our acquisitions are contributing as well such as mobility software subsidiaries Sqills. Sqills is expanding its customer base in North America. Our long-term rolling stock customer pipeline will implement S3 passenger, the leading inventory and reservation software to scale up operations and maximize seat utilization in Florida.

We continue to see good progress with the strategic transition of our DI software PLM business towards Software as a Service. And let me highlight just a few points. As I mentioned before, the transition is fully on track with the share of cloud ARR at 24% of total ARR. Our cloud business has tripled in 1 year. We now see - even see customers converting into the SaaS model, who switched to their - their perpetual license and related maintenance contracts. More than 7,500 customers have signed on to the Software as a Service business model with further increased share of small and medium enterprises, including startups. And among them, are almost 75% new customers, clear evidence of our ability to expand our existing customer base. Customer transformation rate based on total contract value was temporarily lower in Q2 as two large customers opted to continue with their on-premises solutions to the specific requirements.

Achieving sustainability impact is at the core of our customer requirements. Here, you can see great examples of how we bring our company core technologies, vertical domain know-how and collaboration across Siemens together to achieve superior customer value.

Our 11 company core technologies such as simulation additional twins, data analytics and AI, automation or additive manufacturing are leveraged in all businesses. Daimler Truck will implement a broad range of Siemens Xcelerator software and services portfolio, such as Teamcenter and NX to build an integrated digital engineering platform. The goal is to replace a wide range of legacy systems for the next-generation product development and life cycle management of carbon-neutral transportation by truck and bus.

And coming back to the fast-growing vertical batteries market, U.S.-based core power will build and ramp up its 12 gigawatt hours battery cell production facility in Arizona relying on a comprehensive set of Siemens solutions. The range - they range from critical electrical infrastructure and energy management, which enable automated building operations to digital twin, factory automation and simulation software.

This holistic perspective helps to digitalize the entire battery value chain from design to production and services. And on top, Siemens Financial Services is providing financing expertise and act as equity investor. In vertical farming, this comprehensive approach is highly successful as well, combining intelligent infrastructure and automation technology supported by sophisticated digital and AI technologies.

A great example is the largest vertical farm in Middle East, recently opened by Bustanica. It requires 95% less water and is free of pesticides or chemicals, producing 1 million kilograms of fresh food for the airline Emirates.

Let me finally highlight our large signaling order in Singapore worth more than €300 million where we built on our existing long-term trusted technology partnership with Singapore's Land Transport Authority.

To achieve impact in decarbonization and resource efficiency, close collaboration and growing and expanding ecosystems is a must. A good example is the foundation of Cofinity-X, a joint venture of 10 partners with a goal to create the largest collaborative and open data network of partners in the automotive industry.

We will bring in our digital expertise to offer an open marketplace and digital applications for end-to-end data chains to trace material flows or carbon footprint across the industry. And I'm more than happy that just yesterday, together for sustainability, this is an initiative for 47 international chemical companies, including the largest industry players announced to count on Siemens to decarbonize its value chain. They will use SiGreen, our solution for product carbon footprint management.

A good software unit is complementing its offering, working together with EnergyHub for next-generation distributed energy resources management. And our innovation leadership is the foundation of these successes, which is reflected in patent statistics and innovation awards.

Mobility's air-free brake systems won the prestigious German Innovation Award contributing to more sustainable and efficient operations of trains. All these examples are evidence of our transforming company culture. Siemens has substantially accelerated its speed and continues to execute to match our higher ambition level.

And with that, over to you, Ralf, to give further details regarding our operational performance and outlook for the fiscal year 2023.

[Ralf Thomas, CFO]

Thank you, Roland, and good morning to everyone. Let me share further details of how we capitalized on our excellent execution in the second quarter, which led us to raise our outlook for fiscal '23.

In Digital Industries, we saw the expected normalization of order patterns in our automation businesses at high levels. While investment sentiment continues to be healthy across our core industries, we started to consume order backlog in automation with strong revenue momentum on easing supply chains.

Orders for DI in total were down 10% at €5.3 billion with a book-to-bill for DI overall at 0.95. While orders in discrete automation were substantially lower, process automation was close to prior year levels. The software business was up broad-based in the mid-20s, benefiting from larger contract wins and early renewals, partially balancing lower automation order levels.

As a result, our strong backlog in digital industries decreased moderately to almost €14 billion. Thereof, automation was more than €9.5 billion, only €700 million lower compared to peak levels at the end of first quarter.

Customer cancellations continued to be marginal. We expect more than €8 billion of DI's backlog to convert into revenue in the second half of '23, which gives us very good visibility and confidence going forward. We anticipate the normalization of order patterns to continue in the second half of fiscal '23 with emphasis on the third quarter. This will lead, as indicated before, to book-to-bill rates below 1, resulting in a gradual reduction of order backlog in automation. The anticipated high level of order backlog at the end of fiscal '23, however, will support visibility and our growth trajectory into fiscal '24

Revenue for DI was up a stunning 23%. Automation revenue even rose 26%. Discrete Automation was up 25%, while Process Automation even dropped this performance at 26% revenue growth. Component availability improved further, especially for high-margin products and the teams again did an excellent job to run the factories at high utilization and optimized output.

Risk for shortages of critical components have materially decreased. However, we still stay alert and keep a close eye on all aspects of our supply chain. Software accelerated after a slower start in Q1 and achieved 11% growth. Therein PLM was up in the low teens, while EDA showed high single-digit growth.

The overall margin at 23.5% was truly outstanding, operationally at an all-time high and above the target margin corridor for the first time. Performance was boosted by the automation businesses, while software, as expected, had a softer quarter as due to the successful SaaS transition being in full swing. Software performance is expected to further improve in the second half.

In the automation businesses, execution was flawless with strong profit conversion across the board on high volumes. Optimized capacity utilization came with a very favorable mix on improved availability of components for high-margin products.

Productivity gains and price increases from previous quarters, which materialized now through backlog conversion enabled us to overcompensate cost inflation in the quarter. Although we will see wages and other cost dynamics to increase over the next quarters, we are very confident to keep the economic equation net positive throughout the entire fiscal year '23.

Cloud investments accounted for €75 million in Q2, amounting to 140 basis points of margin impact on digital industries. We continue to expect around €300 million of cloud investments for fiscal '23 in total.

The DI team fully lived up to their commitment of a material catch-up and achieved an excellent free cash flow of €1.2 billion and a cash conversion rate of 0.91 being well above the targeted level. Operating working capital, in particular, inventories is intentionally still on high level to safeguard high-quality revenue growth.

Now looking at our key vertical end markets for the next quarters. We expect continuing market growth momentum, partially driven by embedded price inflation and backlog execution. We closely monitor underlying real investment sentiment, which so far remains positive for our offerings. Our teams are very close to our customers and markets, and we stay vigilant to react quickly if need be.

Now let me give you the regional perspective on our strong top line automation performance. As mentioned, automation orders normalized on a high level against tough comps, which you can see on this slide as well. This was most notably visible in Europe and in China compared to a strong second quarter in fiscal '22, which had materially benefited from pull forward effects as we discussed back then.

Order development in China was volatile with some pandemic aftermath and pre-ordering effects in the previous quarter ahead of price increase expectations. The start into the third quarter is signaling further normalization as expected, based on shortening delivery times and distributors reducing their stock levels.

Outstanding revenue growth in automation was broad-based across the regions. China delivered 9% revenue growth on increasingly tougher comps. Germany, up by 37% and Italy, up by 35% showed strength across the board, while in the U.S., both discrete and process automation increased double digit.

Looking ahead, our teams are fully committed to leverage improved global component availability for stringent and optimized backlog conversion and ultimately, customer satisfaction. Since Digital Industries achieved a fantastic performance in the first half of the year, which we expect to continue, we raised our guidance for revenue growth by 5 percentage points to 17% to 20% for the full fiscal year '23. And we lift and narrow the profit guidance to 22.5% to 23.5%, up 200 basis points at midpoint.

From today's perspective, for the third quarter, we anticipate that DI will achieve revenue growth within the updated range. Furthermore, we expect to approach the updated profit margin range from the South [ph].

For Q3, we expect the software business to show revenue growth rates below Q2 levels, depending on the timing of large EDA orders, which are rather skewed towards the fourth quarter from today's perspective. Software profitability will slightly improve sequentially, however, continues to be impacted by our SaaS transition. Material profitability improvement is expected in Q4, again, mainly due to large EDA orders.

Smart Infrastructure achieved a truly fantastic second quarter performance. The team delivered excellent top line growth in robust end markets, boosting - to another quarterly all-time high combined with excellent cash conversion. In total, orders were up 9%, driven by exceptional 34% growth in the electrification business. It was fueled by larger projects with replicable solutions such as with hyperscalers and in the semiconductors vertical combined with a robust base business. Electrical Products showed 6% growth and Buildings were down by 4%. This led to a very healthy book-to-bill of 1.13.

Revenue growth reached remarkable 21% with the largest contribution from the Electrical Products and Electrification businesses, both up by 28%. The team, again, very successfully managed their supply and logistic chains. And as a result, this was SI's best quarter ever on flawless execution with a margin performance of 15.9% at the upper end of the target corridor, up 480 basis points year-over-year. SI benefited from economies of scale - based on accelerated revenue growth, optimized capacity utilization, as well as ongoing structural cost improvements from our competitiveness program.

Headwinds from cost inflation mainly from merit increases were overcompensated by productivity and pricing actions. As indicated, SI achieved a strong rebound in free cash flow after a softer first quarter with an excellent cash conversion rate at 1.02 despite substantial revenue growth.

Operating working capital was stabilized with lower receivables and temporarily higher inventory levels have started to unwind during the quarter. We will see a continued strong cash flow performance in the second half of fiscal '23.

As in Digital Industries end markets, we continue to see nominal growth in all key verticals, however, also substantially fueled by higher prices and backlog execution. We closely watch underlying trends and continue to see robust demand with real-term growth in all major verticals.

The Commercial Buildings area is seeing some growth deceleration due to a global environment of rising interest rates. Public institutions such as universities and hospitals invest in sustainability offerings to upgrade energy efficiency and intelligence in their buildings.

Power Distribution shows strong growth rates on accelerating renewables build-out and increasing electrification. Progressing digitalization, cloudification and use of AI is driving investment in data center infrastructure.

Looking at the regional top line development, we saw broad-based order momentum reflecting robust demand. As indicated in the first quarter, we saw in Germany, the reversal from a technical effect of preponing service agreements into the first quarter, equaling a negative impact of around 21 percentage points in the second quarter.

China was up by 11% and showed some signs of recovery on easy comps after revising the COVID policy. Revenue increased across the board with the most impressive 29% growth again in the U.S. on strong backlog execution in the electrification and electrical products business.

Smart Infrastructure has developed a very impressive performance record, for example, through gaining market leadership in the medium voltage systems business and building a strong number two position in the electrical products.

For the second half of fiscal '23, we continue to expect robust customer demand with normalization in the product businesses where customers begin to optimize their inventories due to alleviated supply chain peers. We continue to see sequential revenue growth levels with year-over-year growth rates gradually decelerating due to the increasingly tougher comps.

The economic equation is anticipated to remain net positive for the second half of fiscal '23, however, less pronounced than in the first half year due to increasing effects from cost inflation. After a stellar first half of Smart Infrastructure, we raise and narrow our guidance for revenue growth to 14% to 16%, up by 500 basis points at the lower end and lift the profit guidance range by 100 basis points to 14.5% to 15.5%. For the third quarter, we see profitability and comparable revenue growth rate in the raised target range strongly supported by order backlog.

Mobility delivered an excellent quarter on top line. Orders at €6.2 billion marked an all-time quarterly high and included, among others, the previously mentioned major win for locomotives in India and a large signaling order in Singapore, which led to an exceptional book-to-bill of 2.32. The backlog stands at €39 billion with continuing healthy gross margins. And our order pipeline continues to look very promising for the second half of fiscal '23 across all business activities.

Revenue in Q2 was substantially up 33% on double-digit growth in all businesses, led by a major contribution from large projects in rolling stock. The prior year's quarter was impacted by Russia-related revenue reductions. Russia impact added 13 percentage points to this quarter's growth rate.

Profitability at 9.2% benefited from trailing effects of €78 million related to Russia, which were largely offset by incentive accruals and a less favorable business mix. Without these effects, operational performance was around 8%.

Mobility had a neutral free cash flow due to a lower level of larger project down payments and the shift of some customer payments. We expect a clear catch-up in the second half of our fiscal year starting in the third quarter. After a strong first half year with accelerated backlog execution, we lift our outlook for revenue growth to a range of 10% to 12%. The profit margin guidance remains unchanged at 8% to 10%. Our assumption for revenue growth for Q3 is around the lower end of the new corridor on stringent backlog execution. In the third quarter margin is expected in the guided corridor between 8% and 9%.

Let me keep the perspective crisp on below industrial businesses. More details are in the earnings bridge on Page 28 in the appendix of our presentation. Siemens Financial Services is very well positioned, building on prudent risk management and delivered a strong quarter, also benefiting from a high contribution of the equity business.

I'm very pleased with further improved operational performance at the portfolio companies and the announced carve-out of the combined Innomotics business progressing according to plan. The partial reversal of the impairment on our Siemens Energy investment led to a positive noncash effect of €1.6 billion. After the capital increase by Siemens Energy, in which Siemens did not participate, our stake in Siemens Energy was diluted to 31.9%. For this reason, we recorded an additional noncash gain of €235 million.

What counts in the end is free cash flow. Our performance is clear evidence that we do what we say and reflects a material catch-up after the first quarter. Strong profit development converted into excellent free cash flow well above prior year.

Operating working capital was stable with strong collection compensating for growth related and temporary inventory buildup, which we expect to unwind in the coming quarters. Excluding the noncash Siemens Energy impairment reversal effect, cash conversion on an all-in basis reached a strong level of 1.2. We continue to expect another strong free cash flow performance for the full fiscal year '23.

Strong operational performance is also reflected in a rising ROCE well within the targeted range even after excluding the SE impairment reversal effect. Our tight grip on working capital and excellent cash conversion provide tailwind for a rock solid capital structure, and we will further follow our path of deleveraging in the second half year. In times of rising interest rates, a strong investment-grade rating is a value per se as we could see with a well-received bond issuance in February at very attractive rates.

Before I conclude with our overall outlook, I want to briefly point to our updated expectations for below industrial business at half time of fiscal '23 to help you fill your models. We obviously reflected the impact from the tax-free Siemens Energy impairment reversal also on the tax rate and made some incremental updates such as for Siemens Financial Services.

Let me conclude with our outlook for the group. We delivered very consistently on the ambitious commitment shared in November and further upgraded our outlook after a flying start into the first quarter. Our teams have done an excellent job to convert our backlog into revenue and drive profitability, clearly overachieving expectations in the first half year.

Our visibility and confidence for the second half of fiscal '23 has improved even further with €30 billion of expected revenue generation from a very strong backlog. Therefore, we clearly raise and narrow the corridors of our guidance.

On Siemens group level, we now anticipate 9% to 11% comparable revenue growth, up by 200 basis points at the lower end and a book-to-bill ratio above 1. We expect profitable growth of our industrial businesses to drive basic EPS from net income before PPA accounting to a range of €9.60 to €9.90 in fiscal '23, up from a previous range of $8.90 to $9.40. This excludes the €2.01 per share resulting from partial reversal of the previous impairment on Siemens stake in Siemens Energy AG.

Furthermore, this outlook excludes burdens from legal and regulatory matters and material impairments as well as reversals of material impairments. Of course, we monitor macroeconomic and political volatility closely, and we will be able to act swiftly if need be. So in a nutshell, the course is set for a very strong second half of our fiscal year.

And with that, I hand it back to Eva for the Q&A.

[Eva Scherer, Head, IR]

Thank you, Ralf. We are now ready for Q&A. Please limit yourself to one question per person. We want to give as many of you as possible the opportunity to raise their question. Operator, please open the Q&A now.

[Operator]

Thank you. [Operator Instructions] The first question is from the line of Alexander Virgo with Bank of America. Your question please.

[Alexander Virgo, Bank of America]

Thanks very much. Good morning, Roland and Rolf and Eva, thanks for taking my question. I guess if it's one, I'll ask the TAM question. Your existing 3 to 5-year growth ambitions of 5% to 7% was predicated on the TAM growth of 4%, 5%, you're now saying that TAM growth to 2027 is 7%. And I assume you would anticipate being able to maintain your above-market growth that you've done over the last couple of years, particularly given your comments at Hanover. I wonder if you would make any comments on that and in that regard? Thank you

[Roland Busch, President & CEO]

I think you summarized it already, if the market which sits on [Technical Difficulty] and we analyzed it going forward. CAGR going forward for the next 5 years, we see on a 7% level, we definitely don't give up on our ambition to increase our market share. So that's clear.

What we have to look into, of course, is how does the stimulation, and some of that is already baked in, of course, in our numbers, but how that could really drive high-growth markets. Digitalization is another one. We see an electrification of the world. And this is the reason why we see so strong growth in Smart Infrastructure, Electrical products, medium voltage, low voltage, but also any kind of automation in this highly automated businesses like battery manufacturing or semiconductors and the like. So yes, the 7% is that what we see in our markets, and we want to increase market share.

[Alexander Virgo, Bank of America]

Thank you very much, Roland.

[Operator]

The next question is from the line of James Moore with Redburn. Your question please.

[James Moore, Redburn]

Yes. Good morning, everyone. It's hard to know whether to ask about DI or portfolio. I think I'd ask about your portfolio and your balance sheet, if I can. With the Siemens Energy capital raise now behind us, could you update us on your ambition on your stake there and whether you may sell that down? And if so, what time frame?

And when I think about your net debt to EBITDA of one times below your target, the sale of Innomotics? And if you do that, how should we think about capital allocation over the coming period and your priority list? I understand your priority list, but the surplus amount, how should we think about that?

[Ralf Thomas, CFO]

Thanks, James. And with regard to SE shares, we stick to what we discussed the last time. I mean, we are really appreciating that Siemens Energy is in the process of completing the transaction, acquiring the residual shares in Siemens Gamesa. It's not completely done yet. Capital raise is executed. And therefore, we have - we all have more clarity on the way forward, which is appreciated.

As indicated before, we are not in a hurry. We wait for the completion of that transaction. And assuming this is going to be done throughout the next couple of months, we would foresee that we share our concrete plans how to deal with the SE shares on the way forward, maybe with our annual press conference in November when we talk to you again. But on the way there, we are, of course, preparing for that and making plans.

What we do see is that the share price of Siemens Energy has been stabilizing and obviously has a meaningful target pricing in place. We also would like to stress again that we have been selling down the 9.9% Siemens Energy shares from our pension trust completely to zero without creating any noise in a really extremely favorable fees and a dribbling process without any ABB sort of something. We consider that being a success and maybe also, to a certain extent, the role model on the way forward.

However, we also would like to continue with our commitment that we want to safeguard the transitioning of the two companies being separated. You know that we had operational interdependencies with IT services and the like being shared. That is coming to an end sooner or later. So pretty much on time with the plans that have been in place originally.

And we also are progressing with the unwinding of our parental company guarantees that we shared. It's not done yet, but the level of materiality has been coming down substantially when it comes to exposure. All that, we will have a prudent look at and we will conclude from that and share with you our then more precise plan most likely at the end of our fiscal year. So I need to ask you for some patience.

Assuming that the sell-down is going to start then in the next fiscal year, just to give you an example for that and, at the same time, expecting major proceeds also during the course of the next 2 years from Innomotics, this is putting us into a place where we are very comfortably continuing to deleverage. And this is also a source of sourcing our own investment plans on the way forward.

As Roland said, our ambition is to outperform the market. We are in an extremely attractive growth market at the moment. We are in the sweet spot with automation and digitalization and in particular, with the sustainability offerings we have for our customers to help them transitioning in their business models. So there's a huge momentum, and we will be happy to be able to fund all that growth from own sources without tapping on any third party in that regard incrementally, of course.

So with that, we are feeling comfortable. And just to mention it again, I know that you know progressive dividend policy is also something that not many companies can really facilitate for their shareholders in the long term, and we are very confidentially looking into that perspective as well.

[James Moore, Redburn]

Thank you, Ralf.

[Ralf Thomas, CFO]

Welcome, James.

[Operator]

The next question is from the line of Ben Uglow with Morgan Stanley.

[Ben Uglow, Morgan Stanley]

Good morning, Roland, Ralf and Eva. Thank you for taking the question. I was hoping that we could look into or unpack the DI orders a little bit more. And obviously, this requires a bit of guesswork on our part because we don't know exactly the split between automation and software.

But could you just give us a sense, on the software side, within that 25% growth, it looks to me like you've got a few hundred million of additional orders. Are those all coming from Mentor, i.e., on the EDA side? And if so, are those quite long-dated orders? Can you just give us a sort of characteristic on the software side?

On the automation side, again, using a little bit of math and guesswork, it looks like the automation is down ballpark 20 year-on-year. And I'm guessing somewhat similar quarter-on-quarter. I don't know, but I'm guessing mid-teens sequentially, something like that. Can you give us a sense on how you're thinking about the sequential development of orders on the automation side in the second half?

[Ralf Thomas, CFO]

It will be a pleasure to do so, Ben. As you rightfully said, on the DI order side, the positive impact from software was obvious. I mean we have been kind of eating into our backlog on the automation side with about €700 million, and the net decrease for the backlog overall was only €400 million. From that, you can conclude that the gap has been closed by incremental software orders. They have been supported across the board, not only PLM [ph]

You know that EDA is a chunky business, and I shared as much as I can with you on the way forward. From today's perspective, we expect EDA to be back-end loaded in the fourth quarter with new orders and also incremental revenues coming from that. So the third quarter will not be a strength of that business.

Then when it comes to unwinding the backlog of automation, I mean, you saw, as I said, that decreasing in the second quarter by, give or take, €700 million. I do expect that normalization, as we called it, is going to be accelerated in the quarters to come with a focus in the third quarter, as I mentioned before.

So if you - just for modeling, I mean if you would take another €1 billion or maybe €1.5 billion in the third quarter, eating into that backlog from an automation perspective and pretty much the same numbers for the fourth quarter, so give or take, we are still going to sit over and above €7 billion at the end of the fiscal year with a backlog in automation, which still will provide some visibility to us on the way forward then.

But it's in our favor, and it's in our customers' favor to unwind because that long delivery times, we discussed that extensively in the prior quarters, have not been satisfying not for us and not for our customers.

So coming back to normalization, destocking in the channels, having more visibility again and coming back to a meaningful delivery time taking out the psychological impact on the customers' behavior in putting new orders in place will help all of us.

Unfortunately, that pattern on the way forward is going to be pretty erratic. On a monthly basis, we have high fluctuations in the different geographies. We see jumps from one month to another of plus, minus 50% in new orders in some countries. So it's not helpful to speculate on that.

The only thing that I can tell is that we are sitting on really firm grounds on the way forward. We have a grip around delivery times again, better and better because the bottlenecks in the supply chain are kind of getting away. There are still a couple of stumble stones that we hopefully don't hit.

But what I want to say is it's not a walk in the park, but we can manage that better and better. And with that shorter delivery times and a lower stock level on the shelves of our distribution channels, we will have more clarity, most likely at the end of the year and get back to more normal.

Until then, it will be volatile. I personally expect the third quarter in new orders for automation being sequentially down again. Maybe not the magnitude we saw in the first one, but in the second one but definitely down. And maybe that's the trough. Maybe we see the trough in the fourth quarter only.

What we do see, however, I mean, mid-term, and that's what Roland said, I mean we have a really good reason to believe that we are winning market share and that we are going to be seen also as those benefiting the most from stimulus programs on the one hand side, but also for executing on a strong backlog, which we have.

Last word on the quality of the backlog. I mean, it was obvious that in the second quarter with better availability of critical components, we have been pushing our factories into the direction of maximum gross margin, obviously, that has been materializing in 23.5% rent total on DI level. That won't repeat itself on that level, time and again, obviously. But we are very confident that we have good reasons to think about the upper end of our corridor on the way forward when it comes to our financial framework to be reviewed next year maybe.

[Ben Uglow, Morgan Stanley]

That's very helpful. Thank you, all. I'll pass it on.

[Ralf Thomas, CFO]

Thank you, Ben.

[Operator]

The next question is from the line of Andrew Wilson with JPMorgan.

[Andrew Wilson, JPMorgan]

Hi, good morning. Thanks for taking my question. I guess it's somewhat a follow-up to Ben, but maybe a bit broader as well. It's just - obviously, the dynamics in China are quite hard to read from the perspective of destocking. You've talked about inventory in line, particularly in DI. I'm interested in specifically, maybe a broader comment as well in terms of what you're seeing on the ground in China in terms of, I guess, underlying development. Because I think we've heard some - I guess relatively good noise sort of late in the calendar Q1, but then some of the top-down data has maybe weakened off a little bit.

So I guess I'm interested in any broader comments that you can make and also just - yes, just trying to understand that kind of the unwind of the inventories in China and if there's anything more either structural or underlying that we need to think about? Thank you.

[Ralf Thomas, CFO]

Thank you for that question, Andrew. Not really a surprise. And you can imagine that we continue looking into that very diligently. And as always, the last thing I did yesterday was talking to our Chinese staff to be up to date on the matter. So I think you agree that we have been doing amazingly well in China in the second quarter. And again, I think it's a very valuable - value proposition we hold there.

Let me start with my macro view on the matter. I mean, the recovery in China after the COVID lockdown is slow. When you look at matters, I mean, macro data that are publicly available. PMI in April, 49.2% after being well above 51% in March. CPI, give or take zero. So PPI, production price index, has been coming down by 3.5%.

And also what I think is a challenge for the government is youth unemployment is over 20% at the moment, which is an indication that the recovery may be slower than originally expected. On the other hand, we know that the government is very determinedly stepping in if need be. So it's hard to predict when and how.

Leaving the macro scene and looking at our own business, the normalization of the backlog and delivery times is, from my point of view, accelerating compared to the prior quarter, so quarter-over-quarter, definitely a decline in new orders.

As I mentioned towards Ben's question already, the pattern can be very erratic. So a single month like we saw in April doesn't tell a lot. It very much depends on the trend. And what we do see first and foremost is that the top line of the second quarter being strong and as expected, give or take, we also trust in the assessment of our team on the ground that normalization is intensifying, but it's not going to surprise us massively.

So the March levels, so the exit levels that we saw there when it comes to automation and DI was lower than the prior year's quarter last month, yes, but it was not a cliff, yes. So we do see that on the revenue side, we continue to see growth momentum. There is also supply chain challenges still, some bottlenecks on critical parts, but our team is so effectively managing those bottlenecks that we believe they will continue doing that.

Looking at our channel partners there in China. I mean what you typically do see is that there is average stock of 10 to 12 weeks just lately comparing that to what we saw is normal in the past. It was 6 to 8 weeks. So give or take 4 weeks of additional stock on the shelves of our channel partners. That needs to go out at a certain point in time. I can't predict when. But over the course of the next 6 months, I see it happening. If and when it happens quickly, it would be better. To be honest, this would implicitly mean that the third quarter would be effective more than others.

But as all our peers and also macro prognosis is indicating, we do foresee that at the end of the year, the recovery in China is going to be there. And therefore, we see this as a seasonal challenge with an erratic pattern, as said before, but not as a long-term threat to this highly attractive market.

So product business, as I said before, is not only DI, of course. In SI, we see a softer moderation of that process, yes. So if you will, if you saw the level of being affected, probably most affected business unit is factory automation. And those who are not hit or affected intensively is the product businesses in SI.

So with that, I think it's a good perspective to come back more momentum in China with a strong backlog we hold and with the execution strength we saw in the past, and we'll see in the future. We are not scared of the challenge. We will master that.

[Andrew Wilson, JPMorgan]

Thank you very much.

[Operator]

The next question is from the line of Martin Wilkie with Citi. Your question please.

[Martin Wilkie, Citi]

Yes, thank you. Good morning. It's Martin from Citi. Just on the question coming back to Digital Industries. Obviously, a huge focus on the growth outlook over into next year. On software, in particular, I mean, you said the SaaS transition is on track. The revenue growth has gone from negative last quarter to positive this quarter. I know there's a lot more inside that than just simply the phasing of the SaaS transition.

But perhaps you could just sort of unpack that and let us know. Is the SaaS transition, has it reached its peak of drag in terms of what it does to the software growth? And how we should think about that going into next year?

And then just to clarify again, when we think about the software backlog, obviously, you got a big contract this quarter, and just to clarify, when they deliver. But also, just a more sort of technical point, when you're booking contracts on the SaaS transition, how much of that you take upfront, given that the effect of revenue or the like of that SaaS delivery could be a lot more than the contracted revenue? Just to understand a little bit more about how much of that you include in the backlog already? Thank you.

[Ralf Thomas, CFO]

Thank you for that question, Martin. And let me start with the last one, even though it may be not satisfying for you, but there is not the number, not the ratio. It depends on the individual contract that we see what we may do later on - later through on the transitioning to SaaS to share with you a bit more of statistics, but that's too early to do that because we are not in a steady state yet, as you know.

When it comes to the SaaS transitioning itself, I think the numbers have been speaking for themselves. I mean, ARR 14% up and also the 24% of cloud. I think that's quite remarkable. We continue to hit the sweet spot of our own strategy when it comes to having new customers or acquiring customers for the hybrid SaaS model and in particular the number of new customers being about 75% and in particular, small and medium companies, which is a sweet spot of what we are targeting for over and above 80%. I think that's very impressively underpinning that we are on the right path.

Are we done yet? No, we aren't. I think we are pretty much in the middle of transitioning. We get more grip around matters. Our investments are on a very smooth trajectory. We share with you each and every quarter, for this quarter, €75 million, very much on track with the €300 million. We want to invest in cloud solutions for the full fiscal year. So this is very stable, progressing.

Do we have a steady state already? No, we don't, but we see ourselves on the best possible path to accomplish the strategic mission of the project, if you will. So therefore, we need to be patient.

When it comes to the seasonality or the sequence of orders and the chunkiness of the ADA business - EDA business. We talked about that before. Unfortunately, I can't share with you more than I said before in the matter. We had a pickup in top line development with the 11%. I think that was quite meaningful. We also said we won't keep that pace without major EDA contribution, which we don't expect for the third quarter. So it will be volatile quarter-over-quarter.

Fourth quarter seems to be very promising in terms of EDA projects. We are very carefully watching that. And as always, we follow our customers, and we don't try to push them that never has been helping anyone being involved. So therefore, we respectfully follow the timing of our customer needs, and we have been well advised doing so.

So we feel on a very good trajectory, we are making progress. And I think entering into next fiscal year with a backlog over and above €4.5 billion in software is not a bad thing to have. So therefore, we are encouraged by what we accomplished, and we are confident to continue on that level of success and beyond.

[Martin Wilkie, Citi]

Great. Thank you very much.

[Ralf Thomas, CFO]

Martin, welcome.

[Operator]

The next question is from the line of from Gael de-Bray with Deutsche Bank.

[Gael de-Bray, Deutsche Bank]

Hello. Thanks very much. Good morning, everyone. Actually, I have two questions. The first one is for SI. I think SI growth was probably one of the key highlights this quarter as it came well ahead of your peers' performance. So I wonder if you could elaborate on that. And in which segment and geography, in particular, you think you've been gaining market share. So that's question number one.

And then secondly, on - the second question is about Healthineers. What's your view on their commercial and operational performance? And in particular, I wonder if you could maybe discuss a bit more what you think about the return on their past acquisitions and whether there should be any change to their M&A strategy? Thanks very much.

[Ralf Thomas, CFO]

Thank you, Gael. Let me start with the Healthineers part being the responsible Board member. We feel like all the other shareholders was not a moment of greatness in the second quarter. We have been expressing ourselves in that regard.

On the other hand, we also see an asset that is acting in a secular growth market and is clearly leading in market share and in innovation power when it comes to imaging advanced therapy and also with the Varian acquisition, which has been acquired as a market leader.

So we are dissatisfied with the progress of the DX activities, but it has not been hitting the market unexpectedly. Management has been pointing out, there will be challenges and there will be corrections being made on the footprint in capacity. So restructuring wasn't a surprise. The magnitude, I think, is reasonable and is supporting the way forward in that challenge.

When it comes to Varian, I think all shareholders of Siemens Healthineers are very pleased that the acquisition is gaining ground. It's unfortunate that the CEO or former CEO of the Varian business decided to leave the company, but there's plenty of leadership talent at Siemens Healthineers to close that gap.

And we are quite confident we, at Siemens AG, that their trajectory in integrating Varian is on a successful path. They have been also committing to even higher levels compared to the moment of signing the deal. So I tick that off for the moment. It's not done, of course, but on a good trajectory.

And when it comes to other historical acquisitions being made, I mean it was just a failure, obviously, the Corindus acquisition. The technology acquired is brilliant, and it's also providing many, many perspectives for many patients waiting for treatment because robotic does not only mean more accuracy in the long run, but does also mean that there is more capacity available.

And there are millions of patients waiting in underserved areas around the globe where we don't have enough interventional cardiologists and neurologists. So therefore, I think there is opportunity to do that.

On the cardiology piece, which has been written off with that impairment, as you know, I think the timing was just strong and the expectations were flying too high. We may wonder and discuss whether or not COVID was a case of death to that maybe, but it doesn't matter. It's water under the bridge on the way forward. They need to do better, and they will. That's what the management committed themselves to.

So in a nutshell, the second quarter was more than a mixed basket of feelings. It must not repeat itself in that intensity of many floating parts on the way forward for the relevant parts of the portfolio. We consider them to be on a growth trajectory. And obviously, also the share price recovery after disclosure is somewhat underpinning that perspective.

[Roland Busch, President & CEO]

On your first question, we see - and thanks for the comments. So we are very happy with the performance of SI. I mean, we have the differentiate between Electrical Products and Electrification and the Building sector. Obviously, the Building sector is weaker. Also United States, the orders were down minus 1%, Europe, [too] for obvious reasons.

But coming back to the growth drivers, which is basically Electrification, Electrical Products. And here, the customers are - in particular, the customers who are working on or operating on highly reliable power supply, medium voltage and low voltage like data centers, any kind of battery manufacturing, but also semiconductors and the like. They're looking for reliable partners, number one.

Number two, they will look for delivery capacities and capabilities. And number three, of course, a very strong technological product portfolio. And that is what comes together. We have a very good delivery track record in United States. So we are doing very well. There, this Electrification revenue grow, strongly Electrical Products, too.

But we see also in Europe, electrification goes up, distribution systems, which is necessary. I mean if you go for the electrical transformation in Europe, then you need expansion of your medium voltage and low voltage grids and the like. So therefore, this cuts across.

Coming to China, China, the electrical products, they are - they were somehow declining in their top line. Electrification is still up very, very strong. So therefore, this is, as in the other regions are kind of normalization, still on a high level. Growth driven mainly by United States Germany/Europe, and we keep on going.

We don't see that this demand is going to stop. The electrical transformation is just beginning. Think about the share of electric cars, the amount of renewables kicking in. And therefore, we - with our portfolio but also with our regional distribution, including local footprint of delivering capacities, we have a very, very good stance.

[Gael de-Bray, Deutsche Bank]

Okay. Thanks very much.

[Eva Scherer, Head, IR]

We will take one more question.

[Operator]

The next question is from the line of Simon Toennessen with Jefferies. Your question please.

[Simon Toennessen, Jefferies]

Yes. Good morning, Roland and Ralf and Eva. I have one question on your ARR target. It is still 4% cloud-based by '25, but it looks like you're running quite significantly ahead of that target given the 24% you've achieved in Q2.

If I take the run rate over the past 4 to 6 quarters, it looks like you could achieve this target a year earlier, unless you think, I guess, the progress will slow somewhat, given you're growing off a higher level.

At what point do you expect to get to this sweet spot where I guess the software margin will start to accelerate and actually be accretive to DI? Is it as early as the second half of next year or more 2025 story? How do you generally see the linkage between, I guess, the level of cloud-based ARR and the software margin, please?

[Ralf Thomas, CFO]

Simon, I mean, first of all, I'm happy that you agree with our view that they are doing a stunning business. I mean, 24% cloud portion in ARR is quite a success, a huge step forward. Unfortunately, that doesn't mean that we add another 6% every quarter. So that will be too early and too premature to conclude on that. But we feel very much encouraged that we do the right thing at the right time, obviously.

And accelerating is a good thing to do. Extrapolating from that single quarter, I think that would be too early. But of course, I mean, we are doing our utmost to get to that point of 40% earlier if possible, and we will definitely share with you. I personally would not want to conclude on that from today's perspective already, but you are right. We are on a way that seems to be even better than we originally thought it could be.

So doing the right thing at the right time is encouraging to do more. So therefore, we are also supporting our staff on continuing. And it won't be a bottleneck of resources, so something in that field. So we contribute the utmost that we can do.

When it comes to concluding on the SaaS transition and the exit level and when is software business going to be accretive and so on, I think that will take some time before we can conclude on that because what we do on the one hand side is we want to get to the highest possible ground, obviously.

But secondly, and I mentioned that before, the single-biggest priority we have is listening to our customers. And I mean, it looks like we are making massive progress when it comes to the number of customers appreciating that offering and taking it. We also love to see the structure of new customers, 75% and more than 80% of those customers being small and midsized companies, which is that part of the market we are targeting with the exercise.

And we will continue to keep that momentum up as long as we can and continue on that path, depending on how successful we are and how quickly we are doing that. We may consider investing more and longer instead of starting to harvest as soon as possible, and that jury [ph] is still out at the moment.

So again, and I apologize for not being more precise on that. It would not be the right thing to share speculations on the matter, but we are on an excellent path to success there. We may go further than originally expected or shorter - in a shorter period of time, as you said. And we feel encouraged that our transitioning to a SaaS model is very successful and highly appreciated in the market. So maybe you save that question for next year's time again. I will be able then to be more precise, I think.

[Simon Toennessen, Jefferies]

Thank you, Ralf.

[Eva Scherer, Head, IR]

Thanks a lot to everyone for participating today. As always, the team and I will be available for further questions. We look forward to meeting you on our road show over the upcoming weeks. Have a good rest of the day, and goodbye.

[Operator]

Ladies and gentlemen, that will conclude today's conference call, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.