Nov 8, 2012
Executives
Mariel von Drathen Peter H. Loescher - Chairman of Managing Board, Chief Executive Officer, President and Chairman of Equity & Employee Stock Committee Josef Kaeser - Chief Financial Officer, Head of Corporate Finance & Controlling, Executive Vice President, Member of The Managing Board and Member of Equity & Employee Stock Committee
Analysts
Michael Hagmann - Nomura International plc Olivier Esnou - Exane BNP Paribas, Research Division Andreas P. Willi - JP Morgan Chase & Co, Research Division Peter Reilly - Deutsche Bank AG, Research Division Martin Prozesky - Sanford C.
Bernstein & Co., LLC., Research Division Fredric Stahl - UBS Investment Bank, Research Division Ben Uglow - Morgan Stanley, Research Division Gael de Bray - Societe Generale Cross Asset Research Nick Webster - Barclays Capital, Research Division Daniel Cunliffe - Nomura Securities Co. Ltd., Research Division William Mackie - Berenberg Bank, Research Division
Mariel von Drathen
Good afternoon, ladies and gentlemen. Welcome to our Fourth Quarter Fiscal Year 2012 Analyst Conference here in London.
This conference is being webcast, so hello to everyone watching us through the webcast. We have with us Siemens' President and CEO, Peter Loescher; and our CFO, Joe Kaeser.
We have a number of things that we want to tell you. We will guide you through the announcements we did this morning.
Every document should be on -- found on our Internet website, Investor Relation. Also, the presentation that we'll walk you through now is being put on that website.
So we will talk to you about Q4 numbers, but also the guidance for last fiscal year. Of course, we will talk also about the guidance we have set for this coming fiscal year.
And we will speak about the program we had mentioned already in the Q3 conference call, and we'll outline to you how we set the priorities for the next 2 years, to reach and to come closer to the One Siemens framework we have set. I would ask you to please put your BlackBerrys and phone on mute so that we make sure that we don't have any issues during the conference.
We will have, after the presentation, a Q&A, give you the opportunity to ask questions. And I'll ask you if you could please clearly mention your name and the company you're from so that everyone watching us through the webcast can follow this correctly.
And, I think, with that, I would hand over to you, Peter.
Peter H. Loescher
Thank you, Mariel. Good afternoon to everybody.
Let's go straight into our afternoon program. Let me start with the new company program 2014.
The new company program 2014 has a clear goal, to refocus the company towards strong margin performance against competition like we have been in fiscal 2011 and support our One Siemens framework for sustainable capital-efficient growth and shareholder return. One major item of Siemens 2014 is a fitness program for our portfolio, both through targeted acquisition on one side but also through divestments for our businesses where we feel that other owners can generate more value than we can.
I will touch up on the recent portfolio moves in a minute. Finally, we will talk about our assumptions and expectations for 2013.
However, let me start with a couple of key takeaways and financials of the fourth quarter of 2012. Orders were moderately down by 4% year-over-year due to continued softness of the global economy, impacting many of our businesses, while Energy posted organic growth due to a large number of orders, mainly in fossil and wind power, revenue growth eased to 1% year-over-year, driven by strong backlog conversion in Energy and strength in Healthcare.
Book-to-bill was just shy of 1 and reached 0.99. Our backlog stood at EUR 98 billion, of which around EUR 41 billion will convert into sales in 2013.
For most of -- for most part, we saw a strong underlying performance for Total Sector profit. However, Total Sector profit is below the prior year, mainly due to substantial burdens of EUR 566 million in the Energy sector, originating from project charges and from a special situation of our remaining activities in Iran, which I will touch up on later.
Since profitability below sectors improved notably, with a positive contribution from equity investments, we achieved a net income from continued operations of almost EUR 1.5 billion, just 2% below the fourth quarter of 2011. Also, free cash flow showed impressive strength at more than EUR 4.3 billion, and Joe will talk about this in more detail later.
During the quarter, the preparations for the OSRAM spinoff progressed as planned. Mostly due to the strong operational finish in the fourth quarter and positive impacts from below-the-sector items, we reached the lower end of our guidance for the full year.
Revenue growth for the fiscal 2012 reached 3%, while the book-to-bill ratio was at EUR 0.98. Income from continuing operations came in at EUR 5.2 billion, including significant adverse effects from legal and regulatory, on the lower right-hand side of the charts, and benefiting from discontinuing the solar business.
If we look at a regional perspective, we clearly can see that the macro indicators, such as BMI in Europe and U.S. or the industrial value added in China, are pointing to a slow growth in the global economy or, I should say, to a slowing growth in the global economy.
This was also evident in our business figures, with moderately declining orders in all 3 geographies. While Germany had tough comps with a series of large orders in the previous year, this was balanced in other European countries such as northwest Europe, where we saw the bulk of our large wind orders.
Base orders overall were flat on a nominal basis in the current quarter. The Middle East grew by 80%, compensated partially for a weaker development in China and India.
China is still in a transition period towards the new administration and, as indicated, we have not seen an uptick in demand in infrastructure projects or in the manufacturing industry yet in China. Overall, emerging markets accounted for 32% of orders in the current quarter.
Growth distribution is different when we are looking at revenues. The Americas delivered clear revenue growth in the fourth quarter, with a very strong Energy business in the U.S.
Emerging markets showed a mixed picture, with 30% growth in Russia but weakness in China and India. Emerging countries accounted for 34% of Siemens' revenue for the quarter.
Now let's go through the sector picture for the quarter and major items that drove profitability. Energy recorded a very good book-to-bill of 1.14 in the quarter, with particular strength in Asia and Australia.
As mentioned, sector profit was sharply down due to several one-offs, the largest impact came from EUR 327 million charge, and they are of EUR 275 million in the oil & gas division with regard to our business in Iran. This charge affected projects conducted under Siemens' previously disclosed policies regarding Iran, addressing sanctions or other forms of trade restrictions imposed by the U.S.
and European Union or other countries or organizations. The underlying business in Fossil and Oil & Gas was again healthy, with a strong product and service business.
I am sure you saw our announcement with regard to the planned divestment of the solar business and, therefore, we are reporting only wind numbers instead of renewable and moved our solar activities to discontinued operations as of Q4. Our hydro activities, mainly the equity share in Voith Siemens Hydro are now held on sector at the sector energy level.
Wind Power delivered industry-leading profitability of 9% based on volume-driven earnings conversion in a challenging, competitive environment, though the next quarter might be weaker again due to the seasonal effects, mostly in offshore. Transmission is well on track with its transformation program and recorded EUR 66 million charges to improve competitiveness in the transformer business.
Additional charges of EUR 67 million for the offshore grid connection projects are related to detailed planning of the approaching offshore installation activities. Let's move on to Healthcare.
Sector Healthcare delivered another excellent quarter, proving that the stringent execution of the Agenda 2013 is paying off. As in previous quarters, growth was driven by a broad-based double-digit revenue increase in China and an improved diagnostics growth performance.
And this compensated for ongoing softness, what we see in Europe as well as in U.S. The jump in profitability was led by an excellent contribution from the Imaging & Therapy Systems business, in parts due to portfolio improvements.
Diagnostics is on schedule with its competitiveness program, while profitability was temporarily slightly lower. In its short-cycle businesses, industry delivered a solid performance in an increasingly volatile market.
We are cautious for the next quarter since we currently see a cooling down in important end markets such as automotive and machine tool builders. Profitability was weaker due to the renewable offerings of the sector such as wind gearboxes and solar inverters.
The sector took action to adjust capacities and optimize the portfolio in this area. Industry is also rigorously executing on further focusing its portfolio with the acquisition of the Belgian software company, LMS International, and the subsequent divestment of the water business, which I will touch up in a few minutes in more detail.
Let's move on to Infrastructure & Cities. Orders were down on a lower volume of large rolling stock orders, while revenues were supported by strength in Americas.
Profit margins saw, in particular in the Power Grid Solution & Products business, a nice upswing supported by strong earnings conversion from higher volume in low and medium voltage. Building Technologies delivered again a seasonal strong profitability, driven by good demand for its energy-saving solution and positive impact from cost reduction actions.
And with that, let me now turn over to you, Joe.
Josef Kaeser
Yes. Thank you very much, Peter.
Hello, everyone, to our conference here in London. Let me now continue with our free cash flow performance for the quarter.
I mean, obviously, the good news is that free cash flow was outstanding. The other news is it should have happened earlier than the last month of the fiscal year.
So we've got to be focused more on a steady performance on free cash flow, and that's got to do obviously with the fact that our turns on average also need to be in the neighborhood between EUR 9 billion or EUR 8.9 billion, what we achieved for the month. And that is something which we also take a serious look at so that the steadiness grows.
The other topic which is worth mentioning, despite a, as I said, impressive number, these are obviously some of the orders which had been expected in October, November's time frame, had already been materializing in September. With that, of course, was an associated prepayment, so there might be some weaker free cash flow as expected in our fiscal Q1 2013.
The other topic I want to mention here in the connection of the yearly projects, which you see in the right-hand side of the slide, obviously shows that -- basically 2 methods I want to mention. First is, you can see that our depreciation and amortization, which amounts to EUR 2.1 billion, is not fully covered and spent by incremental CapEx.
So we've been putting tightness on that matter. So that means that the CapEx will be slower than depreciation, and that's also good for 2013.
The other topic I'd like to mention is, we see that here in the box, is that this topic, that we've got less prepayments associated with our bookings, has been materializing in fiscal 2012 in the neighborhood of EUR 1.2 billion. Now that is some of that is related to the fact that orders have been declining for several quarters in a row if we compare it year-over-year, but there is also a structural impact that more and more customers are less willing to put prepayments on top of the order intake, and that obviously also leads to the fact that we need to look into the pricing policies once we do the bid.
That's important as we go forward, and there are many reasons to that. Obviously, our business has changed a little bit so there is more mix towards product-related topics, to a lesser extent, to turnkey projects.
So that also will basically make sure that on the one hand side, we do not get as much free cash flow for prepayments. On the other hand, as you can imagine, the risk associated with taking turnkey is going down.
If we move on to the so-called below-the-line items for the quarter, as well as then, for the year, I also will be mentioning what to expect in 2013 if we go through the year numbers. But why don't we do the quarter first?
You can see that on top of the strong performance of our sectors coming in at EUR 2.1 billion, which actually included some EUR 500-plus million on adverse one-offs, making the underlying strengths even higher, you could see that for the first time in its existence, NSN was positively contributing to a favorable income in the equity investments. That could go on for a while.
I would also expect a decent quarter on NSN for the current quarter. And if -- been gaining some heads -- some tailwinds here due to the fact that NSN, after all, was early in decent restructuring.
So that could actually help drive profitability and productivity at NSN. But the fact of the matter remains that this obviously is an industry which you rather avoid if you can help it.
We'll be dealing with it and we will continue to drive as much as we can in our limited impact through the business. SFS obviously be coming in at EUR 100 million-plus, which was well above what we had been hoping for.
Reason being that this has also been positively impacted by a few favorable one-offs. But what you also see in Q4, and we expect that to be continuing, is that some credit hits are showing off along the lines, most of them coming from the renewable environment.
This is not a default, but we could clearly see that there is some stress in the system which we carefully watch. We do not expect major adverse impacts in '12 -- in '13, but this is something which we see coming.
It could also be serving as an early indicator that matters are cooling in terms of economic impact. SRE obviously as always -- supposed to be about 0 on its operational performance, supporting the businesses.
So what if you see positives like this 88 in Q4, it has been related to the disposal of assets, which we do not believe we need over a period of time. Corporate items are usually a bit higher in Q4 than year-on-average, coming in at EUR 283 million.
And so did pension and the treasury, which is pretty much in line on what we have expected. And taxes, as you can see, 27%, slightly below what the market should expect in 2013.
So if the market goes to 30% for 2013, that could be a decent number to be on the safe side with. If you go 2012 or for the year, I mean, obviously, the numbers are self-explaining so I'm not trying to explain the numbers which you know already but more what to expect in 2013.
As I mentioned earlier, equity investments ought to be significantly more helpful to the total bottom line as they used to be in '12. NSN got some leeway due to earlier restructuring.
On the other hand, the business itself in a nature could be highly volatile in terms of the impact. SFS, as I said earlier, the EUR 479 million, we were positively impacted by about a EUR 50-plus million equity dividend.
So if that was to be considered as a one-off, that could also be the ballpark to expect going forward. CMPA should not play a major role in the development in '13, while SRE will always be obviously volatile depending on asset disposal.
We continue our policy making long-term fixed costs. Also, we are able over time, that means selling assets and lease it back for a while in order to be flexible over time, depending on market conditions.
As far as corporate items, pensions are concerned, definitely a few favorable one-offs during the course of '12. We've been reporting them, earnings releases or in the conferences.
So if someone wants to take a view on '13 and what to expect for the quarter, I would probably feel safe with a EUR 250 million per quarter on average, on average, including the impact of IAS 19R. So that's obviously been, I said, seasonal.
Usually, Q4 is a bit heavier, 1 and 2 is somewhat lighter as we go along over '13. But that just could be about the pullback, EUR 250 million for corporate items.
So pensions including the new version of the pension return. Corporate treasury and others, obviously highly volatile due to the fact that hedging, which does not qualify for hedge accounting, will -- could have turned either way.
The good news is that wherever it goes, the counterpart sits on the operational business. So if you take a EUR 50 million roundabout to fill that line item on the chart, that could be a number to deal with.
So that much to treasury. And as I already said, tax bracket of 30% is always helpful to be on the slightly conservative side.
Let me now move very quickly because much has been said already to the development of our equity-to-debt swap, which is widely known as a share buyback program, which, in essence, it was. But it had much, much more to it.
By buying back shares and issuing debt to finance it, we actually had EUR 120 million roundabout annual savings, which obviously also helps the cash position. We've been completing our buyback as of yesterday.
We are just a bit shy of the EUR 3 billion. Slightly shy, not really a big deal.
And we completed the whole exercise at an average buyback price of EUR 77. So that also is helpful.
You might have seen the conditions which we got in the bond market. The 2-year-plus was 20 below mid-swap.
The long ADR was 1.5%. That's something which we believe could be helpful over this period of time.
Now that obviously also translates into incremental return to our shareholders. You can see on the right-hand side what it did to the shareholder benefit.
This is what we do, this is what we said. And in this particular case, we did not only say, we also executed on the matter.
In general, you might have seen that -- and I'll come to that later, that, also due to the experience which we have been making on the latest exercise, we have been lifting our payout ratio on the One Siemens financial framework by including not just the cash dividend but obviously also by including some shareholder return elements associated with incremental share buybacks. So the commitment stands 40% to 60% payout, either as a dividend or as a some sort of buying back shares or a combination of both over a period of time.
And obviously, one could also consider that as a view of management, whether the shares are cheap or not. And that's what we believe is important going forward.
If we have a quick look on the corporate of the One Siemens financial framework for 2012. I mean, obviously, revenue growth on the upper left-hand side.
It's been above -- or just about slightly above our competitors' basket. And you should know what the basket is.
And it's available if someone wants to really see it, who is in there and who isn't. I mean, obviously, the fact is that we've been highly benefiting from a very favorable currency impact.
But last year, the impact was different, and we didn't use it either. So that much here.
That could change again, as I said, during the course of changing in the exchange rate. If we look at what this gross did to our margins, one can clearly see that energy at face value has just been bailing out of the marching band.
That's got to do, first and foremost, with the fact that we have been applying a highly conservative view on the impact of incremental sanctions associated with the Iranian customers by changing the accounting method from POC accounting down to cash-based accounting. So that's been the effect.
So the business is not gone. The business is still there, but we have been applying cash accounting, cash-based accounting.
So whenever the money comes, we will realize revenues as well as profitability. The impact, gross before taxes, have been roundabout EUR 350 million.
Either way, in revenues as well as in margins. And if one wants to take that into consideration here, the real number without the Iranian accounting measure would have been 10.3.
Everyone else, as you can see, it's been doing pretty well. Healthcare, obviously now harvesting the benefits of an early -- on Agenda 2013, industry decently in the middle.
And Infrastructure & City, as we have always said, this is going to be something which we are in for in the longer term. This is nothing for the short term because obviously, the fact of the matter, that some divisions needs some incremental boost, remains in place.
Obviously, though, we cannot be that satisfied with the capital efficiency. As you know, it's the centerpiece of our One Siemens operating framework, and it continues to be the centerpiece.
It's been down about 500 basis points like-for-like, obviously from the 21.9% to 17%. I mean, the fact of the matter is that we had a double whammy, profit went down and assets went up.
And if you have a numerator and a denominator, then this is what you get. The good news is we've realized the fact that we need to focus on that matter significantly.
And you can rest assured that obviously, this is in the centerpiece of the program also. So we need to sharpen our senses here.
We've done that as our Siemens 2014. And that's now what Peter is going to explain in more detail, where we want to be, how to get there and what that all gets us in our books.
Peter H. Loescher
Thank you, Joe. As you can see here -- I mean, first of all, we have set a clear-cut target at the Total Sector profit margin level, from 9.5% today to 12% or greater by 2014.
In addition, we also expect that all sectors stay within the EBITDA target margin range, as well as that each one of them is at a better performance level compared to 2012. As part of it, we also expect, of course, transformational charges such as restructuring, write-downs and the likes, up to EUR 1.5 billion.
The majority, around EUR 1 billion, will occur in fiscal 2013. If we look into the different levers and how we split the program, we will split it basically in 5 levers, the first one really focusing on margin improvement, on the gross margin improvement, cost reduction; and the second big lever is actually strengthening our core activities in terms of a fitness program for our overall portfolio.
And both, together, we expect from these 2 levers having the biggest impact. First, with Siemens 2014, we are stepping up our efforts in improving our cost position.
And in this area, we will also see the vast majority of our activities. The single largest lever for optimizing the cost base is now our supply chain management where we see further potential to generate productivity gains of, in total, at least EUR 3 billion in the next 2 years.
And Joe will elaborate this in a minute. A second major lever, we continuously to optimize our global capacity and footprint with a business-by-business approach.
For example, we have announced in recent weeks several measures such as the market-driven capacity adjustments of 600 people in U.S. wind factories.
As a third topic, we see significant potential to further improve process efficiency and quality such as improving the project execution excellence in the project businesses in our large infrastructure businesses, in particularly in the sectors Energy and Infrastructure & Cities. And as I said, this second lever, strengthening our core activities, is of significant essence, and you can see further proof in today's announcements.
We work with rigor to improve our portfolio and strengthen the strongholds, but also fix underperforming businesses or find sustainable solutions elsewhere. Third key enabler is the go-to-market approach where we currently work on a concept to optimize the way how we can best address our respective customer groups and through which sales channels.
For example, the Healthcare products division strives to increase indirect sales above 50% in 2014 after 47% in fiscal 2012. In addition, we look into our local sales and service organizations, how to match best to set up with existing market potential.
And based on this, we will align regional structures and resources in a more flexible way. The fourth lever is to optimize infrastructure.
Through the SG&A program, we made significant progress also in infrastructure costs, but we see further potential to optimize the setup of our support function through shared services such as the bundling of finance functions, which you are well aware of. And finally, we will also look at selected governance functions like IT, HR, legal and compliance to take out complexity and strengthen the entrepreneurial responsibility of our businesses and go further to a risk-focused governance approach.
In terms of -- as you can see, from a series of examples, we are already well underway to execute on Siemens 2014, particularly in a cost reduction portfolio area. And we will give you continuous update on the various topics over the coming quarters and also deep dives and proof points during capital market days and investor conferences.
The first one coming up will be Energy and then Infrastructure & Cities in March next year. The leadership team of Siemens is fully committed to deliver on the One Siemens framework, supported by their targets of Siemens 2014, achieving our Total Sector profit margin of at least 12% by 2014.
Before Joe talks about further financial details of the program, I want to touch up on the recent moves to strengthen our portfolio, which is a top priority of this program. You will see more examples, some bolt-on acquisitions and subsequent divestments of less-profitable businesses in the quarters to come.
Key criteria are whether Siemens is from a strategic perspective and operationally, the best owner to achieve sustainable improvements for the different businesses. A few weeks ago, we announced the divestment of our solar activities where the framework conditions have obviously significantly deteriorated.
And as you all know, the solar market faces substantial overcapacities, strong price pressures in the photovoltaic area, whereas CSP, the concentrated solar power, has remained more of a niche technology. Solar was moved to discontinued operations and delivered around EUR 200 million in sales and even bigger losses, including an impairment charge of EUR 150 million in Q4 2012.
We are in discussions with potential buyers, and we will update you accordingly. Going forward, our renewable offering is focused on wind and hydro.
Today, sector Industry announced also the acquisition of the Belgian software company, LMS International, a well-established provider of CAE, software for simulating and testing mechanic -- Mechatronic systems, mainly in the automotive and in the aerospace industry. LMS is the next building block in a series of acquisitions for our Industry Automation business where we, so far, spent EUR 4 billion for exogenous growth.
And the clear goal is to create a leading suite of software products and solutions for product life cycle management and totally integrated life cycle automation in our focus industries. And LMS will become part of our PLM business.
With this acquisition, Siemens becomes the global #3 in the market segment for simulation and testing software and opens up a strong cross-selling potential for both Siemens hardware and software, as well as for LMS products in Siemens' large installed base. LMS recorded sales of EUR 140 million in the first 9 months of 2012 and has an excellent growth track record, with 25% CAGR over the last 3 years combined with strong operational performance.
The transaction is based on a purchase price of around EUR 680 million, and the closing is expected in early calendar year 2013. However, sector Industry is further focusing the portfolio and allocating resources to the most promising businesses.
The water treatment activities, which have been part of the Industry Automation divisions, will therefore be divested. We thoroughly assessed the options and came to the conclusion that there are 2 limited synergies of the water treatment activities with our core automation drives and industrial software businesses.
After a successful restructuring over the last 18 months, we have put this mainly U.S.-based business with more than EUR 1 billion revenue up for sale, and Joe will go now into the details of the Siemens -- of the other Siemens 2014 levers. So over to you, Joe.
Josef Kaeser
Thank you. Thank you, Peter.
Let's now move on from the structural side of the actions to more the operational topic. And there's quite a number of bottom-up plan and agreed-upon examples.
And before I lead you through a very few of those examples, and there are a lot more like those, I would like to mention that if we talk about the second lever of the program, which is focusing the core portfolio, the assumption in the program, the assumption in the program is that there is not going to be any accretiveness by that point during the duration of the program, okay? Not any accretiveness coming from item #2 during the course of the 2 years program.
However, obviously, this will be highly accretive in the midterm for our spectrum. And I'm sure everyone understands what that means in terms of the combination between buying and selling.
That's very important that you understand the assumption. It may turn out to be differently, but that's the assumption on the program.
As far as the operational topics are concerned, you'll see one each from the 4 sectors. And it's not really helpful for everyone to go through the technical details of it, but if you only look at them on what they get us in terms of savings, you can see the design to cost matter [ph] and fossil frames gets us EUR 250 million through 2014.
The consolidation of mechanical drives in the sector Industry, which is a somewhat sensitive matter because we talk about manufacturing footprint. Here, the manufacturing footprint and consolidation always means that there is some sort of value-add-driven consolidation, but that also will provide us a meaningful 3-digit number on savings.
And you will see a series of those topics, especially related to Industry and Infrastructure where I -- as a majority of manufacturing plants around the world. If you look at radiation oncology on the Healthcare sector, which obviously being already part of the Agenda 2013, which, by the way, is also a material enabler to get done with our 2013 program for the company, you see EUR 100 million profit impact here.
And last but not least, Building Technology, streamlining the regional setup in Europe, which obviously is important to look at because Europe is considered to be a structural change as related to the degree of growing assumptions going forward. And if we understand a method to be structural in nature, this will be restructured; if we believe there is some weakness, which is temporary in nature, we obviously are using different tools so keeping our ability to deliver once it goes up again.
One typical example, by the way, would be the automotive industry. So if there is some temporary weakness in Germany, which cannot be ruled out, at this point in time, we obviously go look to keep the know-how and train people, make sure that the cost of labor will be adequately adjusted.
So if you take all that together, all those 4 examples, what you see here already accounts for about EUR 600 million out of cost reductions of productivity. There's only a few examples, and you will see more of those in a deep dive when we do have the Sector Capital Market Day.
The first one, as Peter mentioned, starting with Energy in December 2012. Now obviously, the single biggest impact on the 2-years program, and you are talking about enabler here, that's very important, to talk about enabler and how to get there, the goal is clear.
The goal is greater, equal 12% sector profit. That's the goal.
And now we talk about how to get there. It's obviously the matter of purchasing design-to-cost elements, and I come to that, what I mean by that.
You may remember that a couple of years ago, 3 years ago, in the meantime, we sat here together with Barbara, and she was explaining to us on how to streamline the purchasing function, on how to make a global powerhouse out of the purchasing functions by doing a lot of things such as managing volume from the corporate point to do e-auctions, global value sourcings, reduction of the supply base, first step and then qualifying it in a second. And here, our numbers here is a track record.
This is what we have been achieving in those 4 elements. And you can basically see that all 4 have been going north.
Mostly, as expected in some parts, we actually were a bit ahead of the goal. You can see where the goals were and where we finally ended up.
So that's good. That's decent.
And some of you might remember that in 2011, actually a year ago, I was showing a slide with a bridge on how gross margin was developing. And you may remember, there was a purchasing item in there with EUR 1.3 billion, purchasing only.
So not that we only took the suppliers down, not that we only increased the global value sourcing, we got something out of it. Yes, and that's '11.
As related to the gross margin, it was EUR 1.3 billion, purchasing only. Okay?
EUR 1.3 billion, just keep that in mind for a while because I'll come back to that later. Now that's been the face of consolidation.
Clean the house, make a powerful purchasing organization out of what we had. That first step, this consolidation now, comes to an end, and we move into the next layer, and the next slide is now combining the different elements of making good products and competitive products out of investment by purchasing.
That's about manufacturing. That's about supply chain and logistics.
That's about engineering. Not research, but the engineering which is close to the product.
And we put that together. We put that together, and out of that action and a series of savings, also in purchasing, we expect a EUR 3 billion -- roundabout a EUR 3 billion productivity and cost saving potential over the period of 2 years.
So if nothing else, divide it by 2. So we have an average number per year which is EUR 1.5 billion.
And as I've said, '11 was EUR 1.3 billion. So it's not that much of a number, which one might believe it's coming out of the sky.
We've done that before, and we'll do it again. And obviously, it's not just about purchasing being the biggest -- the best lever.
It is also about the area where you best put into it, sustainable. Because it involves everything, it gives a sustainable value.
Also the suppliers start negotiating. And then one is $1 short, the other one is $1 long.
And the moment the power changes, it goes the other way. So there's very little restructuring involved.
It goes quick. Again, the savings are quicker.
About 40%, 4-0, 40% of the total cost of the company is about purchasing of services and bill of materials. So you can clearly see how huge the impact is, and this is what we're going to go about.
Now obviously, the design to cost element is nothing, which is for the short term. This is more related in its impact to 2014.
Now if we go to how to get there. And again, it's very important to understand, the goal is we are going to be at 12% or larger percent of profitability for the sector.
Pretax including some charges, which we expect to be about EUR 500 million by the time, and that's what we want to -- that's the goal. Now the question is, how do we get there and what are the assumptions how to get there along the way?
And there are a series of assumptions. Obviously, the first one, as you can see, is the topic of volume digressions.
So that's associated with the question, how do we expect revenues to develop over the course of 2 years? And as you can see, the bar is not that helpful, and that's very long.
That basically means that we actually expect a more modest growth for the next couple of years. If you look at the guidance which we have been putting out for '13, that actually calls for approaching the levels of 2012.
So then, if we talk about modest growth, you can expect that we also would assume some growth resuming in 2014 to put it modest and average. So that's the first assumption.
If they change, they've got upsides. And if they've got downsides, we need to go look how we can incrementally make sure that the 12% stands at the end of 2014.
Second topic to give you some flavor on, again, might be right, might be wrong at the end, but you should know the assumptions, and that's about pricing. If you look at 2013, '14, we expect an average price decline for a whole spectrum of the company of 2.5% to 3%.
That's just about the ballpark we expect. It's a bit more on Healthcare and Industry, should be -- on Energy.
Should be significantly less in Industry and just around the ballpark in Cities & Infrastructure. And that 2.5% to 3% pretty much compares with what we got in 2012.
Here, we had a number of -- effective number of 2.5% price decline over the company spectrum. So that's the assumption here, which obviously has an adverse impact on margin.
Cost inflation, of course, includes merit increases all over the world, which are different in percentages. And it's got some other topics included.
For example, and theoretically, if OpEx increased for some reason, that would be part of this item here. The cost will be increased.
So that's the assumption on how to get there. Yes?
And if some assumption change, then we need to see how that impacts the goal. But the goal stands for 2014.
And the whole program, ladies and gentlemen, the whole program has been designed to support the financial principles of One Siemens. It puts a tighter framework to it than One Siemens was.
One Siemens was more a framework for the operating businesses to be in the centerpiece of 15% to 20%. No matter what they do, they've got their eyes there.
The program now makes sure that we have a somewhat tighter grip on -- that we really get there. Now obviously, if someone designs a program on making sure to get there, this is also the time to look at the framework itself where there is some opportunity to tune it up a little bit and to look what can be improved and what can be changed.
And we actually have been coming up with 2 topics. And you can see that on either side, we have been changing the hurdle rates for M&A slightly.
Instead of being EVA accretive 2 years post-closing, we now say the hurdle rate moves 3 years post-integration. And the second topic is -- was the topic of when do we want to achieve the company's target of [indiscernible] 15% over time.
We looked at it, and we can clearly see that it's more meaningful to put a cash return on it rather than being tied up for many, many years from PPI and what have you, which come along at the M&A. So why have we been changing it?
Well, first of all, it's meaningless to have hurdles which cannot be achieved given the nature of our focus. And the nature of our focus, ladies and gentlemen, is about software.
It is about stickiness in the business, and it is about embedded software and controls, be it in smart grid, be it in Energy, be it in Industry or be it obviously also in Infrastructure & Cities. To a lesser extent, obviously this is for Healthcare because we've been pretty well equipped on Healthcare as far as M&A activities are concerned, especially on the buy side.
Especially on the buy side. Now that's been the reason for that.
And obviously, to make sure that the market understands, this is more about meaningful focus rather than spending more money now. We obviously have put ourselves into the right basket here and said that we want to increase the payout of our profitability, mostly also cash for the profitability.
Rather to have 30 to 50, we go for 40 to 60 in a combined way. So it could be dividend, it could be share buyback or a combination of both.
That's important for the market to understand. And with that, I put it back to Peter to do the guidance and the outlook for 2013.
Peter H. Loescher
Thank you, Joe. Let me briefly summarize our outlook for 2013.
The first year of our program, we expect a moderate order growth, revenue approaching the level of fiscal 2012, both on a like-for-like basis. We expect income from continuing operations in a range between EUR 4.5 billion and EUR 5 billion, including the effect of retrospective adoption of the IAS 19R.
And this also includes charges totaling approximately EUR 1 billion for program-related productivity measures in the sectors. And with this, with the productivity gains realized in our results for fiscal 2014.
Let me bring this to a close. This is a program which is nothing else than the clear commitment of the management team of Siemens to focus on the key element of our One Siemens approach.
And the key element is, how do we do relative to our competitors? And therefore, we have given you a clear transparent target of 12%.
We are committed to achieve this, and we have -- we will follow through this with precise actions. And you can expect from us proof points along the way as we start to get this program being implemented.
And as Joe has highlighted, several of the actions has -- have already started. And with this, I want to close.
And we're happy to take your questions.
Mariel von Drathen
A lot of hands are being raised, so why don't we start with the left of this room. We'll start with Michael Hagmann and then we'll continue with Olivier Esnou on this side.
Michael Hagmann - Nomura International plc
Michael Hagmann, HSBC. If you look at the portfolio optimization, we have now seen some smaller steps with solar and with water.
Obviously, within the portfolio, there are quite a number of businesses which have sub average margins and relatively high execution risk. So the question is, if we go -- look forward, do we see higher though larger disposals?
Or do you think we'd be rather looking at portfolio optimization in the range of businesses with EUR 500 million to EUR 1 billion of revenues?
Peter H. Loescher
Michael, I don't want to speculate here. I mean, what the reality is that we have actually a clear focus on it where we have actually at -- where we thoroughly look at the tail end of our businesses.
And it does not always mean that you have to dispose. We give these business units higher transparency.
They have to come forward to the main board. They have to prove to us that there is a clear-cut strategic planning base how they can actually, long and sustainable, have a strategic plan in place to outperform competition and where we have a lasting competitive edge.
And if along the way we are not convinced about it, we will take the decisive actions, like you have seen it also with Waters. But there is no speculation on our part at this point in time.
Will it large be -- will it be small, and the size of it. But what you should expect is -- as we have also an active program how to strengthen the core of our portfolio, at the same time, you will also and should also expect from us clear-cut disposals bringing them forward.
Michael Hagmann - Nomura International plc
So it could also be a larger business rather than just EUR 1 billion or so?
Peter H. Loescher
I'm just telling you that we should not speculate on size.
Olivier Esnou - Exane BNP Paribas, Research Division
Olivier Esnou, Exane BNP. So a few questions.
First, how have you changed the incentive program of management to align it with the objective of 12%? Secondly, regarding the productivity measure.
So the EUR 3 billion over the next 2 years. I think I understood you said you made EUR 1.3 billion last year of productivity.
Is that correct? I'm not sure I got it right.
But what I would like to know is what you've done over the last 2 years in these specific measures that you're highlighting going forward to get a sense of the track record really. And lastly, if it's possible, this 12% margin for 2014, it's from a portfolio of asset.
I would like to know what is the performance in 2012 for the same portfolio, because you're moving asset out. So I just want to make sure, is the 9.5% that you're reporting in '12 totally comparable in terms of portfolio to the 2014 base?
Peter H. Loescher
Let me start off with the incentive programs. The incentive programs are actually already pretty much aligned in terms of shareholder value creation.
If you remember, the key element, what we put in place, is relative to competition. So whatever you achieve the year before and continuous improvement.
So whatever you have done in the past becomes the starting point in terms of for the next year. And if you perform at the same level, you get less in your pocket.
And the 3 elements, what you are focusing on with the team's cash performance, as Joe has highlighted, EVA performance and growth. And so -- and the alignment is clearly around how we are actually targeting the continuous improvement towards the level of '12.
And this is the kind of -- and this will also clearly be reflected in our overall incentive programs. There's very specific targets to be hit.
Josef Kaeser
Yes, Olivier, to the other 2 questions. So what are -- what is this EUR 1.3 billion all about, which I mentioned earlier.
The EUR 1.3 billion was the effective cost saving as part of the gross margin for purchasing in 2011 over 2010. EUR 1.3 billion effective saving in the cost of goods sold in 2011 out of purchasing as compared to '10.
That is the number, okay? So it has been already achieved.
And I was just giving that example and you have -- might have the slide still that puts it into perspective what we expect from those -- around about EUR 3 billion over 2 years. Because as it only happens, EUR 1.5 billion.
And if we have achieved EUR 1.3 billion in '11, the counts are pretty close. So as far as your other question -- I mean, obviously, the question is a good question.
But remember, I just said that the impact of the portfolio focus in the next 2 years associated with the program is considered to be neutral, yes? Because if I go to the acquisitions with PPA and alike and since we go report it, we consider the impact of item #2 to be neutral during the course of the program, but be highly accretive as we move along in the midterm.
So that actually should answer the question in terms of the impact of it. And whether -- what the spectrum will look like in '14, that's a good discussion to have in '14.
Olivier Esnou - Exane BNP Paribas, Research Division
Maybe just as a follow-up. So should I assume that over the last 2 years, there has not been any specific improvement in terms of optimizing global capacity and footprint and increasing process efficiency?
So this is net new for Siemens? The...
Josef Kaeser
No, no, no. It's been -- there has been sort of -- this sort of net new number, which goes on top of everything.
That means sometimes, you have mixed effects and what have you. But I also want to come back to the slide I was showing in 2011, just about a year ago, on the gross margin development.
There was a EUR 1.3 billion in purchasing and there was a huge number, about EUR 3 billion roundabout, that ballpark, on other productivity, including mix. Now obviously, at that time, the mix was significantly favorable because that was just a time where the short-cycle businesses have been recovering.
Remember? So there was a meaningful portion out of the mix.
But if you just as a ballpark, take half of that for the mix and the other half as productivity, then you have already -- that half, which is about EUR 1.5 billion plus the EUR 1.3 billion, which is a EUR 2.5 billion, EUR 2.8 billion number. So if this company has achieved that before, what is it now going to commit to 2014?
So this is not a rocket science number which never been done before. Yes.
Mariel von Drathen
Okay, we'll continue with Andreas Willi on the third row, please?
Andreas P. Willi - JP Morgan Chase & Co, Research Division
Andreas Willi from JPMorgan. Two questions please.
The first one, on divisional margin volatility, we've had, to the upside in Q4, some very good numbers from some of the divisions that contrasted strongly with what we have seen over a couple of quarters before. We had similar kind of quarterly margin volatility, kind of pre-2007.
And then for a while, it became much more steady. What's your internal analysis why some of these businesses, which are large, the size of other listed companies, can go from 4% margin to 9% to 5% to 7%, which we don't really see in similar-sized companies if they are independent?
And the second question, in terms of hiring and headcount, obviously a lot of questions this morning in the press call. But in terms of just natural attrition and hiring, is there any specific hiring freeze at Siemens now?
Or kind of how do you use the lever of natural attrition to improve productivity?
Peter H. Loescher
Andreas, let me start with the headcount first because it's important. As you know, that this is certainly one of the key levers, what we are able to pull, and we have it clearly on a business-by-business where you have to look at this issue.
So the overall number certainly, there's a very clear and tight focus on it, on this number to pull, of course, as part of this lever. And the other one is we have to have targeted programs on the issue.
Where do we see structural issues? And with structural issues we have to adjust also employment.
I mean, a good example is the 600 people, what we have taken action on, on the Wind business in the U.S. as the PPC basically ran out, out of 1,600.
Joe has also highlighted an example in terms of how we actually adjust on the gearboxes for the wind industry. But it has to be really around the issue where do you have issues where -- basically where we can manage through the cycle.
And then we have to use the flexibility aspects, what we have created together with the employee representatives already in the last downturn, and where we have structural issues. And this will be focused, targeted initiatives.
They will be discussed, they will be agreed with the employee representatives and they will be executed.
Josef Kaeser
Yes. Andreas, maybe on the other topic of volatility.
I mean, I would assume that you have already been considering the so called one-offs, the underlying methods that we usually are very transparent about in the earnings release. Leave that aside for a while.
On areas where we get a lot of volatility, for example -- I'll just pick one. Industry Automation.
As you have seen in Q3, we were at 11.7% profit margin. Now in Q4, we are 15.2%.
There's 2 areas which are usually highly sensitive in nature. One is volume and the other one is mix.
In the Industry Automation business, 11.7% margin was on the back of EUR 2.3 billion profitability, and the 15.2% are on the back of almost EUR 2.7 billion. So volume impact matters massively in areas where we have a series of high automation in our manufacturing place.
Because obviously, you know the more revenues you get out of it, the higher utilization is. So that's an example on how much volume matters in such an environment.
Another topic, for example, has been low medium voltage. There are companies which have medium and high voltage together.
Others have medium on their own, others have low and medium together. Obviously, and maybe to a degree, unfortunately, and we will be looking at it, our low voltage and our medium voltage business is a different world each if it comes to marginal capabilities.
And the more mid-voltage you have as a mix, the better the profit is, the more low voltage we have at this point in time, especially the commodity part of low voltage, not the MCC piece, the bigger impact, of course, the mix is. So we will be seeing that over time, that we have this type of volatility based on volume and mix.
And we will be reporting about it, what the impact has been. Very favorable, by the way, in LMV because there was a lot of voltage in Q4, to a lesser extent, low voltage that may normalize again in Q1, for example.
The other topic, Industrial Automation, volume has been very strong in Q4. Typically, Q1 is not that strong in volume, and you'll be likely seeing the impact on a quarterly basis.
So it is very transparent. It's hardly matters on operational performance which catch us by surprise in the product business.
Obviously, if we go to the project business, that is sort of how we execute on a project. There has been some volatility admittedly in 2012 on project execution on the large matters.
But then even there, there is a turnkey business as related to the product business, and that will obviously cause a significant change in profitability. We will be transparent, we'll talk about it, but we understand the underlying profitability of each in their [indiscernible] segments.
Mariel von Drathen
Okay. Why don't we continue here on the second row?
Peter Reilly and then we'll move over to Martin.
Peter Reilly - Deutsche Bank AG, Research Division
It's Peter Reilly from Deutsche Bank. I had 2 questions please.
Firstly, it seems to me there's a bit of a mismatch between the EUR 1.5 billion charges you're talking about and the sort of actions that are in the presentation. A lot of the actions are fairly low cost in terms of a procurement design-to-cost.
So where is all the money going to go? How much of it's cash?
And is there a lot more announcements still to come in terms of things factory relocations and heavy duty restructuring? And then secondly, you've announced lower hurdle rates for your acquisitions.
Can you just tell us whether LMS is going to achieve these new lower hurdle rates?
Josef Kaeser
Yes, I'd be happy to. Let me start with the EUR 1.5 billion, which obviously go -- EUR 1 billion goes into 2013 as a planning assumption and about EUR 500 million go to '14, okay?
Now obviously, I agree with you that purchasing doesn't really cause a lot of restructuring and one-offs. However, if you look into the just about EUR 1 billion which we mentioned in the program also, which is about cost efficiency and the like, productivity increase, that goes definitely straight against charges we will be taking.
The other topic of consolidating, for example, manufacturing plans, consolidating sites that will go into charges related to the use of that site going forward. So there might be some value pricing methods.
And if you put that EUR 1 billion in savings, which we have been mentioning in the cost savings environment, against the EUR 1.5 billion, you see a payback period of 2.5 to 3 years, which is not all that bad after all. So there is -- there are definite actions behind it.
Now of course, based on certain assumptions the management knows about, there is a highly detailed bottom-up plan for everything, which happens in '13, and there's quite a decent amount of understanding what's got to happen in '14. Yes, and above everything and above all that, there is still management which is accountable for reaching the 12% no matter what the assumption turned out to be.
Because if the assumptions are less favorable in terms of pricing and volume, and one wants to achieve 12%, there's got to be some more to be done. That's the way we look at it, assuming now there's no earth-shattering type of macroeconomic geopolitical topic happening in '14.
But once we are there and it happens, we know what that means. So that's important to understand.
So this is about understanding what do we spend. So as I said, EUR 1.5 billion versus EUR 3 billion, okay, savings, because you said [indiscernible] is material, designed to cost, which is rather not much associated with the transformation charges.
But the rest of the EUR 3 billion, we get and spend EUR 1.5 billion, that's quite a decent return over time. LMS, obviously there are 2 topics one looks into when we go after acquisitions.
One is an acquisition which is strictly needs to -- needs to achieve the hurdle rates, which are products factory which are close to what we have. And there are, in cases -- in exceptional cases, there are investments we are going to take because we believe they're transformatory in nature for a certain business.
And we do believe that LMS is transformatory in nature for Industrial Automation because that embedded software engineering in CAE and PLM will basically drive the change from a more hardware manufacturing automation to a software-driven and software-supported design. This is important to us.
And if we look at Industrial Automation, profits of about EUR 1.3 billion a year over 5 to 10 years, it's important to understand if there is a paradigm change, and that's how we look at it. But if this is so important to Industrial Automation, yes, that we spent that much money, which hardly makes the hurdle rate in [indiscernible] so in terms of cash return, it's pretty close, then there is no room for management to look into something else.
And that's why we said if this is important, you better make sure that you don't compete with other assets, which are also important to be managed like, for example, in this case, Water. And that's the philosophy.
If something is that important that it's informatory [ph], that you just can't afford to lose because you have a EUR 1.3 billion at stake every year, then you better be focused on what you need to do. Yes?
And that's the philosophy on strengthening the core if something is important to get. But then again, if you look at the new hurdle rates in terms of cash return, that LMS is pretty close.
It's in the ballpark of what we have. And even -- and I'll give you one example, which is also important for writing considerations and the like.
The cash drain, if we dispose of water, will be pretty compensated by the free cash flow already of the acquisition. So you can see, if we look at cash rather than some PPA-related return on capital employed, so we pretty much can see that this is something good for us.
Mariel von Drathen
Okay. Maybe you can hand over behind you, to Martin, the mic, please?
Martin Prozesky - Sanford C. Bernstein & Co., LLC., Research Division
Martin Prozesky from Bernstein. Two questions please.
The first, on the revenue guidance for next year. I think it was phrased as, "It will approach the organic revenue of this year," which was, I think, 4%.
Can you give us a bit more context on the macro assumptions there? I mean, it seems quite optimistic given the order trends.
Are there big shipments of trains, for example, in next year? Or what is your macro assumptions into the second half of next year maybe?
And the second question, on Siemens for 2014, are you going to manage this as a kind of a project office? Or is this being ingrained in your operating business?
So just can you give us a sense for are people on point? Just how do you manage this?
Because it's complex.
Peter H. Loescher
Martin, I think this is a -- the second question is a very important one. The answer is very clear.
This is not a centrally managed project organization where we have hundreds of people sitting in the headquarter of Siemens, trying to manage and tell the operating units how to do things. It is, first element, absolute transparency at the board level, fully aligned with budgets and operating responsibilities by division, to be discussed every month in our so-called monthly operating reviews, both Joe and myself have, with all the operating heads.
So that's the kind of operating philosophy, what we put in place. In terms of revenue guidance, macro assumptions.
The macro -- if you look into in terms of what we have already in-house, so you see EUR 41 billion is already basically in our order backlog as we speak going into 2013. What we have assumed is a slowing global economy.
That's the overall macroeconomic assumption. What is not part of our plan is, of course, what Joe was highlighting, if there's any type of scenario where we have a falling off the cliff.
And of course, for us, it's very important that the short-cycle businesses, we have anticipated a slowing environment, but it's not a macroeconomic assumption of any type of falling off the cliff, then we would have, for whatever reason, I mean, then we would have a different scenario to be discussed. That's the kind of macroeconomic assumption, what we would -- as part of the plan.
Mariel von Drathen
Okay. Next question, second row.
Fredric Stahl, please?
Fredric Stahl - UBS Investment Bank, Research Division
Fredric Stahl here from UBS. Just -- maybe you could help us with the allocation of the EUR 1.5 billion of costs that you're taking here and give us an idea how they pan out across the sectors?
Josef Kaeser
The EUR 1.5 billion transformatory?
Fredric Stahl - UBS Investment Bank, Research Division
Yes.
Josef Kaeser
Matters -- [indiscernible] look -- since those charges that -- especially that EUR 1 billion, yes, is also related to several different items such as personnel, sites and alikes, we rather discuss that first with the associated workers' representatives and people who are affected by it and the regions who are affected by it. And then once, we happy to disclose it.
It's just a matter of courtesy. It's obviously important to let the market know what the number is, but it will be a bit too early now to break it down to the sectors, as well as to sites.
So just -- please bear with us that, at this point in time, this is a bit too early. Maybe different in general.
As Peter mentioned, we'll report about the progress on the program and the most important items basically of the quarter in the most support-oriented environments once a year. That's the numbers 3 to 5.
And then we'll also be happy to share what it is, where it is, what it does and what the savings associated to that will be in the end. Okay?
Mariel von Drathen
Okay. I think Ben Uglow in the second row had a question.
Ben Uglow - Morgan Stanley, Research Division
Ben Uglow, Morgan Stanley. First question was for the pricing assumption, Joe.
2.5% to 3%, basically continuing the current trend line feels reasonably conservative. Are you -- is there any part of the portfolio or any part of the business where you feel that we might be reaching a sort of positive pricing point?
Are there any underlying trends in Energy or anywhere in the portfolio where you feel that pricing is close to bottoming out? So that was question number one.
Question number two was, I got a slightly delicate question but it was to -- I'm slightly nervous asking it, but you mentioned the risk-focused governance approach in the slide deck and it seems to me that a lot of the issues we've had this year within Siemens have not been to do with productivity or the core portfolio operation. We've had the repeat of the one-offs.
And I think when we talked about this in May, June at EPG, there was a view that the sign-off, for example, on big, big projects like transmission or whatever it might be, effectively is done by the division head. It's done by the guy who knows the most about the underlying business.
And the point that I think I made at that time was surely, though, that there does need to be somebody at group level who says, "Hang on. This represents a risk to the Siemens P&L and the Siemens balance sheet."
And I just wondered, in terms of your thought process during this year, have you developed a sort of an idea that in terms of signing off on these big projects, things maybe need to change.
Peter H. Loescher
Ben, thank you very much for allowing us to qualify this very important point. When we talk about risk focus, we were not -- or I was not talking about in terms of project risks.
This, we have clearly centralized. It is clearly discussed at the sector CEO level who is reviewing himself the major projects.
So there is absolutely a clear-cut global, centralized approach to ensure that the risk aspect is well -- but this is one aspect. The second one is we have to ensure that we have the right participants as part of the risk assessment.
So in these big projects, in these 4 projects, the North Sea, famous project, we didn't have enough technical expertise in-house to really fully assess this adequately. So that's one element, is ensuring that we have all the adequate resources behind this process and that it is well centralized and well in focus.
I was not talking about this one. I was more referring to the aspects.
Give you another example. Siemens is very used to the assumption that we have a global setup, and then we just cascade functional governance responsibility in the same way.
So we've cascaded this down the way through the business lines, then we go into the cluster organization regions, then we have -- then we go into the cluster. And what we try to ensure going forward is that we don't duplicate structural elements simply in the same way around the world, irrespective if -- at the end of the day, you talk about a big country, you talk about a small country, you talk about a normal business.
So we will much more simplify the overall governance processes in terms of importance of impact, size and not just replicate functional globalization aspects and therefore, also simplify in this respect -- I mean, the EHS organization. I mean, if you have one EHS officer sitting somewhere in a smaller country, of course, you need it project related, you need it around manufacturing sites, but you don't have to cascade this in all 3 metrics dimensions all the way up.
Rather, focus on one and cascade it in one. This is what I was referring to.
Not on the other one. This is very important, that we just have absolutely a clear-cut focus on this one.
Ben Uglow - Morgan Stanley, Research Division
Sorry. And can I just follow up on that one before we talk on pricing?
Peter H. Loescher
Yes.
Ben Uglow - Morgan Stanley, Research Division
I understand that. And I guess I'm looking at this in an extremely simplistic way.
But what, I think, would be interesting would be to have one person on the board, managing board level or however you organize it, who says that every single large project in terms of its balance sheet impact, and I'm talking about a big, big project, several hundreds of millions, that has an absolute mandate to approve that at Siemens group level. My understanding is that is not the case today and isn't -- I mean, is that fair?
Or isn't this something that needs to happen? Because otherwise, you have a continual risk where you have enthusiastic divisional managers promoting very, very big projects.
Peter H. Loescher
It is already the case today, Ben. I mean, this is one of the reason why Joe and myself, and we have decided to have an operational board.
So we have all the sector CEOs sitting around the table and they sign off themselves on these projects. They put it -- so this is what we have already cascaded upwards.
So it's not -- no longer the divisional CEOs signing off for the big projects. We escalated a step up that this responsible sector CEO has absolutely a review process around it, that he is fully aware that he's signing off, that it is ensured that it's actually his personal responsibility ensuring that the process is right.
So this is we have done.
Josef Kaeser
So Ben, on the pricing. I mean, look, if that was -- if that turns out to be conservative, it's great because then we've got upside already on the left-hand -- on the right-hand side.
If nothing else or a buffer for some, which may go south. So -- I mean, that's the -- the answer is we don't know at this time.
We've been looking into the backlog, which has been scheduled already for 2013. We pretty much know what this will look like in terms of pricing.
That's over time what a longer-term-related aspects of project businesses, but we pretty much know that like wind, like fossil or even some transmission topics, which we've got in there. We pretty much know what the pricing will be.
So therefore, that is transparent. And that's why, in terms of potential upside, that leaves us with the short-cycle environment, yes?
And that's mostly in Industry, that's in part IC and, to a less probable part, in Healthcare. Now within Healthcare, it's very little that pricing will ease because it isn't just a matter of competitive pressure but also about how much the customers are willing for -- allowed to pay based on their budgets and their public environment.
On IC, this is [indiscernible] about low, mid voltage. And on Industry, this is about ITT.
I mean, in order to ease pricing, there's got to be some sort of scarcities of supply. Yes?
This -- I mentioned that whole thing. And I don't see that scarcity of supply anytime soon.
Or actually, it's the other way around. So that's why I would be very careful about your jumping to opportunities on this one too quickly.
But those would be the areas where if something positive happens in '14, there could be some ease of those 2.5 to 3. For '13, I do see very limited upside on pricing.
Very limited.
Mariel von Drathen
Okay. We'll move over to Gael de Bray, please.
Gael de Bray - Societe Generale Cross Asset Research
Gael de Bray from Societe Generale. The first question is back on the EUR 3 billion productivity gains per annum you're targeting for the next 2 years.
So actually, you've already done it. This is what you said back in 2011.
But this time, you apparently require a much higher level of restructuring to get the same level of savings. So what else changed compared to a couple of years ago?
And don't you think that to remain on the same margin trajectory, you actually will need more restructuring in the coming years compared to what we've seen in the past? That's basically the new nature of your operations.
The second question is on the comments you made about the cooling down of some of your automotive and emission tools, customers' demands. What -- can you elaborate a bit more on that?
And what does that mean exactly for Industry Automation at the beginning of fiscal 2013? And maybe the last question would be on the portfolio changes.
You've reclassified the solar business to discontinued operations but not the water business yet. So just if you clarify what's the difference between the 2 and why the accounting is different this time?
Josef Kaeser
Okay. Well, let me start with the last one.
I mean, look, the last one, we just decided as early as yesterday. So that's why it was literally impossible to have that already qualified for discontinued.
Whether or not that in the end will qualify for discontinued during -- based on its size, based on its stand-alone asset, this will be something we will be determining. There are rules and regulations to that, and then we'll report what happened to that in -- during the -- after the first quarter and then we'll take it from there.
It was important that we apply the focus, how we do it later in accounting. That's the easy part.
Not always as easy as it looks like, but it's easier. On the topic of cooling down, I mean, what does that do to the business?
First of all, based on our assumption, what it does is that we plan revenues to be down in the Industry sector. As we plan revenues to be down in Energy, we expect the Healthcare to grow and IC also to have some upside.
So that's the plan. Obviously, now the sensitivity, the sensitivity of anything material happening to the short-cycle environment based on its profitability is so high that we felt compelled to mention that as a important need-to-know factor for the guidance.
Because you can expect every EUR 1 billion Industrial Automation or motion control, which is their technology, every EUR 1 billion this business is short of is about EUR 500 million to EUR 600 million to the bottom line like this. Yes?
Don't even think about changing your cost because it goes quicker. That's a fact.
So that's why we are highly sensitive on that one. And that's where I saw close -- as we can be to early indicators on the automotive discrete spectrum, okay, as well as the toolmakers' environment which is also highly related to automotive in the end, like KUKA or [indiscernible] what have you, all those suppliers provided tools to automotive in Germany.
And if you look at the carmakers, especially in Germany, the premium carmakers, they have been very successful. They are a very high level.
They seem to be the last one to be affected by a general weakness in the global environment. However, if you look at the recent Daimler announcement about expanding the Christmas holidays by, I think, a week or even a [indiscernible], this already is something you could clearly smell that this doesn't go any up, right?
And there's been some rebate. Look at the rebates, they've been increasing, China and the likes.
You look at cars pretty cheap as related to a year ago in terms of rebate. If you look at this so-called bells and whistles adding, the so-called special models here, get some stuff which usually cost you a ton of money for free, that also has been picking up.
And there's all signs that it doesn't work that smoothly again as it used to be last year. And that's what we're looking at.
And everything else is going to try to smell something, which is not there yet but could be coming. That's the story on this one, and that's why we are so close early, looking at those early indicators to understand what is that.
Now the good news is if you look into the chain of distribution, if we look at the stocking elements, we can clearly see that the distribution channel is highly alert. Yes?
Sometimes you sell in the moment that -- see that they don't sell out immediately, cancel the next week's or the next month's shipments. So I would not expect the distribution channel to be full or overstocked.
They're very, very sensitive to it. It is a positive because the backslash on the OEMs' supplier is rather low as compared to like 8 or 9.
And the other topic is that we seem that we've seen the bottom in China. Unfortunately, not yet any upswing, which we consider to be in the second half of calendar year 2013, but it seems that we are kind of modeling the bottom now, which is a positive because obviously, another downside seems to be limited at this point in time.
Of the EUR 3 billion numbers through -- I mentioned the 2011 example in terms of -- that this was possible. Has it gotten any worse?
Definitely not because we are moving now to a very short term -- I take it and you give it approach to a more sustainable long-term oriented cooperation between several elements of the value chain, being the supplier, manufacturing and engineering and logistics, and that seems to be more reliable in terms of defendable outcome. So I would not expect that this has gotten any worse.
The sensitivities to the whole matter in the short term, and obviously also to 2014, the sensitivity is that we have a pretty well-staffed fixed cost structure, okay? That's the downside.
And we know that. It doesn't -- and that's something we are highly focused on, on what it means if there would be some volume type of disappointments.
Because remember, the goal stands and the enablers are variable to achieve the goal. That's the mission.
And that's why we have a very, very sensitive look into this fixed cost structure, what the company has and has been building obviously over the course of the past year or 2.
Mariel von Drathen
Okay. We still have a lot of people wanting to ask a question, and we're running a little bit out of time.
But we'll continue on the right-hand side, first with Nick Webster and then with Danielle just behind him.
Nick Webster - Barclays Capital, Research Division
Yes, it's Nick Webster from Barclays. Two things.
Firstly, on the revenue side. You had a target previously of EUR 100 billion.
Is that now sort of unrealistic because it's like we're sort of doing better in cost-cutting mode. Is there a sort of drive for Siemens to be a sort of smaller, more compact, more profitable business?
Or is there still going to be a push, I guess, around larger acquisitions to get to that sort of target? And secondly, just can we get an update on where we are on the transmission projects?
Peter H. Loescher
Nick, there was a -- actually, there was a good reason why we have said, in terms of the portfolio strength in the underlying businesses, should allow us to drive for a growth strategy but always and only in the context of the One Siemens framework. Okay?
And this is what we have always highlighted and there was a good reason why we never put actually a target date against it. So what you should expect from us is that we continue to drive high quality core Siemens businesses which are able to drive profitable growth.
And we will continue to strengthen this type of businesses. And on the other side, we will be absolutely clear-cut focused to ensuring that businesses like Waters and others who have -- who are not living up to the level of performance, what we have said in the One Siemens framework, that we will prune them or that we will take corrective actions in this businesses.
And when we talk about acquisitions, also no change. What we always said, we are focusing organic growth and bolt-on acquisitions.
Now the size of an almost EUR 80 billion company, bolt-on means a couple of billions -- could also mean a couple of billions. But we're not going now in a hyper mode in terms of big acquisition mode to chase a target which we have never actually specified in terms of working towards a given year.
And there was a good reason for this. And the second question what you have asked was...
Mariel von Drathen
Transmission.
Peter H. Loescher
Transmission. Yes.
The 4 projects. The 4 projects, currently there are no news like we have given it before.
So in this quarter, there are no specific news in terms of timing, in terms of how far along are these projects, in terms of completion. The 2 first ones, the big ones are in the range of 60%, 70%, and the 2 later ones, the [indiscernible] one and the first one, I don't remember how it's called, they're actually significantly below it.
So on an average, we are somewhere between 40%, 45%, but no other delays or any news in this respect in this quarter.
Mariel von Drathen
Okay. Maybe we can turn on the mic to Daniel, just behind you.
Daniel Cunliffe - Nomura Securities Co. Ltd., Research Division
It's Daniel Cunliffe from Nomura. Just 2 questions, the first one just picking up on a cash flow point.
You talked about a structural mix shift in cash flow towards products and away from turnkey. If you just run through sort of why that is and also the change in the split of the mix would be helpful.
That was the first question. The second question relates to, I guess, Iran, whether we could expect any potential further charges in the case of a full exit from that country and whether such charges or the size of such charges will be factored into your assumptions on the EUR 4.5 billion to EUR 5 billion?
Josef Kaeser
Okay. We'll be happy to.
Look, on free cash flow, what we said was that we could see -- in 2012, we could see basically pretty much a deterioration on the amount of prepayments and the billings in excess. And there is 3 reasons for that.
First, there is a volume reason, which basically just reflects on the negative growth of the bookings. And obviously, if they are less than a year ago, you'll see that or if nothing else changes also on the back of the prepayments.
That is the first one. The second one, you could also see that we're taking less turnkey projects and more product shipments to those turnkey projects.
So that means that the prepayments usually go to the turnkey [indiscernible] and not too much to the product provider, which is usually not that bad of a deal because products -- profitability is usually much better. And the third one is indeed that some customers are holding liquidity together around rather than accepting -- or bidding in terms to accept a higher cost of capital in the bid.
That's a decision from the customers, right, that they will have it in the bid. I think -- what was I -- what I was explaining to was that we need to expect some further deterioration of the contribution of prepayments to free cash flow development.
That was the message. We discussed that for several years, some of you certainly know that I've been on that for at least more than 2 years.
And now it's been coming, it's been materializing and it played a significant role in the free cash flow development in fiscal 2012. On the matter of Iran, I explained already that it's been assuming the fallout of continued sanctions and the associated impact on the country.
We expect that the payment capabilities might be significantly less, and there is less probability to get paid. That's why we changed from POC accounting to cash-based accounting.
Projects are still there. If they pay, we'll book it.
And that was an impact on revenues of about EUR 350 million, a similar impact obviously on profit before tax. It was about EUR 250 million after tax.
So that's the story this time, forget [ph] anything else going forward. Well, look, I mean, if we have known it now, it will be highly probable, we would have considered it.
It's obviously the standard answer to this one. Secondly, if there's any geopolitical development, which makes matters worse, there could be some more coming because we still are holding assets in order to support the customers.
And thirdly, one thing you just need to have in mind, we need to balance now and understand what exactly do we do with our team, which supports those projects which are running in the country in a time that there is an embargo. Because chances are that at some point in time, hopefully sooner than later, but this is not a plus, there will be a change.
Like it was in Libya, like it was in Iraq, like what have you. And the question is how long are we going to take -- or keep the capabilities to ship once the circumstances change.
And that will obviously be the balance between incurring some cost or let it go. And then if the markets open up for some reason, we are unable to deliver, which is also something to consider.
So that's been the disclaimer which we put into the earnings release, that there could be some charges depending on where the development is. We don't know of any at this time.
If there were any, it would not basically change the EUR 4.5 billion to EUR 5 billion because if you look at the footnotes of the guidance, it does exclude legal and regulatory matters.
Daniel Cunliffe - Nomura Securities Co. Ltd., Research Division
And a quick follow-up. Any sign -- do you have an idea of the potential size of those assets out in Iran?
Just approximate?
Josef Kaeser
It's significantly less than the EUR 350 million we've been taking in Q4.
Mariel von Drathen
So we're seriously running out of time so we'll take one more question here. Will Mackie?
And then we'll have an opportunity, I think, over the next couple of days and then weeks when we are on roadshow to take the other questions. Will?
William Mackie - Berenberg Bank, Research Division
Will Mackie, Berenberg Bank. I'd like to come back to the subject of capital allocation.
You've changed a number of the key targets within Siemens One, particularly on capital allocation, and then also on the payout ratio. So how do you -- how should we think about how you're prioritizing between returning capital to shareholders by dividend or buyback and specifically with relation to how you're prioritizing M&A and inorganic growth?
And then just on that point -- I mean, when we come to raising -- or lowering hurdle rates, what actually drove that decision? Was it that you had been missing many opportunities in the M&A space?
And therefore, is there a larger pipeline of inorganic growth? Or was it rather, dare I say, to justify some of the prior deals?
Josef Kaeser
Thanks for that. I mean, obviously, there has been a few deals which actually have been meeting the hurdle rates but didn't turn out to be very highly successful.
So think about solar or [indiscernible]. So it's not about hurdle rates.
This is about -- or making the acquisitions is not about adhering to the hurdle rates in the first place. This was a disciplinary framework for our organization in order to understand when we need to go to the board or not.
We did also acquisitions which didn't meet the hurdle rates, but then it's got to be escalated up to the managing board to decide whether it is tired of being all red, red traffic lights. We still believe this is a meaningful way.
So this must be more a framework for the organization that to better think about twice if the traffic lights are red to go to the board. So we didn't miss on any acquisitions just because it didn't go anywhere.
And if the organization didn't believe it was necessary, then it was fine. So there was definitely not now a pileup on acquisitions if you looked at it, what do it -- what does it take for the hurdle rates to get them down?
This is not the case, all right? What did drive the change of it?
Well, obviously, we have, as any strategically oriented company, we have a deal book of certain assets which we believe fits well into the spectrum or are important in terms of transforming the company to a different level such as software. So if you assume for a while that Industrial Automation, artifact [ph] technology, [indiscernible] for example, that software more and more determines the combination of hard and software to a meaningful business.
You obviously need to realize that this is not going to make the hurdle rates because if you do the acquisition on high multiples and put a rosy number to it, then this is going to complicate it. And so we looked at them and tried to understand what is the right thing.
And so we've changed it from asset best-based return to cash return. That's in essence what it was.
There is no pileup and there's not going to be any -- I shouldn't say that, any encouragement now to put deals forward which we didn't sign in the first place.
Mariel von Drathen
Okay. Well, thank you very much.
As I said, we will be roadshowing in the course of November in a number of locations. You'll find us in the financial calendar on the slide deck, Page #28.
And then we're very much looking forward to seeing you in our Charlotte location in the U.S., December 10 and 11 for the Energy Capital Market Day. Thank you very much.
Goodbye.