ABB Ltd
Q4 2017 Earnings Call Transcript

Published: 8 Feb 2018

[Jessica Mitchell:]

Good afternoon and welcome to ABB's full year and fourth quarter 2017 results briefing. The press release and analyst presentation were published this morning at 6

[Ulrich Spiesshofer:]

Thank you, Jess. Good afternoon, ladies and gentlemen, and welcome to our conference call. In today's call, we will start with a review of our 2017 financial performance, followed by an update on the execution of our strategy before presenting the outlook for 2018. Please turn to slide four. Let me begin by putting the past year in context. 2017 was an important transition year for ABB. It was a decisive period in a transformation that began in 2014 with the launch of our Next Level strategy and which has delivered the streamlined and strengthened portfolio and operations you recognize as ABB today. As we stand now, we have a digital first portfolio for customers in utilities industry and transport and infrastructure that is focused on two clear value propositions, bringing electricity from any power plant to any plug and automating industries from natural resources to finished products. We've achieved this crisp and clear portfolio through the consistent disciplined implementation of key actions across our three focus areas of profitable growth, relentless execution and business-led collaboration. We leave our transition year having delivered four consecutive quarters of increasing of base order growth. This base order is higher in all divisions and regions. Our innovative digital solutions offering, ABB Ability, that we launched in spring 2017 commercially has been building good momentum over the year and now we offer more than 210 digital solutions all around the world. Among the key actions to streamline and strengthen our portfolio, we completed the acquisition of B&R and Keymile and announced the acquisition of GE Industrial Solutions. We also divested our high-voltage cable business and changed our business model for engineering procurement and construction called EPC. Beyond these actions, we announced key partnerships with IBM on AI, artificial intelligence, and with Hewlett-Packard Enterprise to jointly develop edge digital industrial solutions. On the execution side, we delivered on our 1000-day White Collar Productivity program, producing $1.3 billion in run rate savings, more than $300 million ahead of our original ambition. Over the same period, our net working capital as a percentage of revenue has been reduced by close to 300 basis points. And that's on top of our regular cost savings and efficiency programs. We have truly built a simpler, leaner, more customer-focused organization and strengthened our leadership and our global ABB brand. Standing here today, I'm proud of what our ABB team has achieved in the massive company transformation. The momentum in the company we have built in 2017 positions us for profitable growth as the global markets are improving. Today's proposal from our board of directors for a ninth consecutive dividend increase to CHF 0.78 per share demonstrates our confidence in the future and our adherence to our dividend policy. In short, we said we will have a better ABB at the end of this transition year. And this is what we delivered. Turn to slide five to let me briefly outline our key results. We delivered a steady financial performance in 2017 despite market headwinds and the dampening effect of our massive transformation efforts. For the full year, total orders were steady with base orders up 5%. We delivered now four consecutive quarters of increasing base order growth. Revenues were up 1% to $34.3 billion and our operational EBITDA margin for the full year was 12.1% and it was impacted by about 30 basis points due to the charges related to the EPC business model change that we announced in the fourth quarter. These charges were taken in the Q4 books. On a comparable basis, the operating margin was steady. Operational earnings per share was 1% lower in constant currency terms and cash flow from operating activities was steady on the solid level of 2016 at $3.799 million for the full year. For the fourth quarter, total orders were 3% lower as strong base order development was more than offset by lower large order in power grids and industrial automation compared to the exceptionally strong prior-year period that you might remember – the large Indian HVDC order as just one example. Service orders increased 7% and revenues were 1% lower. The operational EBITDA margin in the quarter was 10.9%, impacted by approximately $140 million in charges related to the EPC businesses, which more than offset our net savings action. For more details on the results, I will now hand over to Timo.

[Timo Ihamuotila:]

Thank you, Uli. Let's turn now to the regional order development on slide six. As Uli highlighted, we saw strong base order momentum in the quarter, which was delivered across all of our regions. In Europe, orders grew 5% and base orders 8%, benefiting from the positive market developments in industry and transport and infrastructure. Positive contributions were seen in Germany from investments in grid, infrastructure and transport. Norway saw strong demand related to MRO spend in the process industries. Lower demand was seen in some other countries like UK, Italy and Sweden, but this was primarily driven from large order wins from the year before. In the Americas, orders grew 3% and base orders 12%, driven by increased demand in construction and general industry and some recovery in process. Underlying market drivers continued to be positive in the US as base orders grew 11%. Canada saw some selective investment in the process industries and Brazil continues to stabilize, including growth from grid investment and construction. In Asia, Middle East and Africa, total orders was impacted by the large Indian ultra-high-voltage direct current order that was booked the year earlier. Base orders increased 6% with strong contributions from India, Australia and South Korea. China's orders were moderately lower as strong infrastructure and general industry spend would not mitigate lower demand for solutions in process and transmission. All in all, underlying market drivers remain positive. The slide seven briefly summarizes the actions we are taking to further de-risk our portfolio and complete the EPC business model change. In power grids, we continue to shift the portfolio towards more solutions and service offerings, having signed a joint venture agreement with SNC-Lavalin for electrical substation EPC projects. In industrial automation, a joint venture was formed with project expert Arkad for EPC activities in oil and gas. And in robotics and motion, a wind down of turnkey full-train retrofit business was initiated. At the same time, we took operating charges amounting to $140 million across robotics and motion and power grids as well as an additional $76 million non-operational charge on net income in relation to the loss from sale of business to the joint venture with Arkad. As already noted, for Q4, the impact of the operational charges on group operational EBITA margin was 150 basis points and, for the full year, the impact was 30 basis points. All remaining EPC activities are reported as part of the non-core operating unit within corporate and other effective January 1, 2018 and will remain part of this unit reporting to myself until completed or transferred. Going forward, the reporting for our divisions will exclude these legacy businesses. As the transfer of the oil and gas EPC business into the JV with Arkad took place before year-end, this was already excluded from the industrial automation results in Q4. This change will have a material effect on the revenues of the power grid division. On a pro forma basis, for full-year 2017, approximately $400 million of additional revenues will be reported in corporate. The pro forma information is available in the appendix and more detailed information related to past periods will be available second week of March in the investor website. In conclusion, with these activities, we further focus and de-risk our portfolio. On slide eight, I will highlight some key divisional performance for the quarter. In Electrification Products, total orders were 10% higher as all regions and end markets showed strong demand, in particular for data centers, food and beverage and electric vehicle fast charging solutions. Operational EBITA margin for the quarter was 14.7% aided by positive net savings, including improved pricing despite ongoing commodity price headwinds. In Robotics and Motion, total orders improved 6% growing in all regions. The division saw improved demand from process end markets, while larger orders declined due to the timing of tender awards. The operational EBITA margin of 10.8% was primarily impacted by the charges related to the EPC business and continued higher material costs. The EPC charges negatively impacted the operational EBITA margin by 300 basis points. In Industrial Automation, third-party base orders grew 5% on continued operational investment by process customers. Some selective capital expenditure was seen in mining and special vessels. Service continues to support orders with 11% growth. Operational EBITA margin of 14.8% reflects continued strong business execution and the investment in digital. Please remember the Q4 results for industrial automation exclude the EPC business that was transferred to the joint venture with Arkad. B&R continues to deliver solid results, in line with our expectations. In Power Grids, third-party base orders grew 15%, mainly driven by the distribution and industrial sectors. Revenues were 7% lower due to the timing of order backlog execution and the lower order backlog. Service revenues grew 6%. Operational EBITA margin of 7.8% reflects the impact of the EPC charges. Excluding this, the division's margin would have been 240 basis points higher. Excluding the EPC business, the division is within the 2018 target margin corridor for the full year on a pro forma basis. Let's move to our operational EBITA margin bridge on slide nine. In Q4 2017, we continued to deliver on our cost savings programs. We achieved approximately $186 million in net savings, which is comprised of our ongoing cost savings programs, including our White Collar Productivity Programs net of pricing pressure. This positive was partly offset by negative impact from net volume, net commodity price impacts and our continued investment in growth like digital and Power Up investments in particular. Mix was slightly positive due to lower systems volumes compared with the year earlier. The acquisition of B&R and the divestiture of the high-voltage cables business had a net positive impact of $21 million. In the next bar, you can see that the EPC business charges had a significant impact on the quarterly results, $140 million or 150 basis points. Including all of these impacts, the group achieved operational EBITA of $1.021 billion and a margin of 10.9%. Turning on to slide ten, our three-year net working capital program has yielded positive results. Improved discipline resulted in a material reduction of net working capital by $1.9 billion excluding portfolio changes. As a percentage of net revenue, net working capital decreased by 280 basis points. Approximately $1.5 billion of cash was freed up during the program. Although this year, the program comes to an official close, we continue to drive working capital efficiency through improved inventory turns, harmonized payment terms and reduction in overdue receivables. Moving on to slide 11, the information on this slide should be not new. It is more a reminder of what you need to consider when you update your 2018 models for ABB. Starting with orders and revenues, we expect the positive trend in base orders to continue in 2018, although in the first quarter, two less working days will impact order growth in our short cycle businesses, particularly in Electrification Products and Robotics and Motion. At the same time, the weaker order backlog at the end of 2017 will weigh on 2018 revenue growth. On the other hand, short cycle businesses as well as B&R and GE-IS will positively impact revenues. Regarding operational EBITA, let me walk you through some of the headwinds and tailwinds for 2018. As communicated earlier, we expect approximately $100 million of power grids Power Up cost. It is weighted more towards the first half of 2018 and is 60% above the line and 40% below the line. The digital investment will continue. And as we see it now, commodity prices could be a slight headwind. Further, the closing of the GE-IS transaction will have an impact. Assuming we close by the end of the second quarter, we expect a reduction in the operating margin of Electrification Products division of approximately 110 to 130 basis points and, for the group, approximately 30 basis points for 2018. This is consistent with the 6% operating EBITA we communicated when we announced the transaction. As stated earlier, we would expect Electrification Products to reenter the 15% to 19% margin corridor during 2020. Operational EBITA margin impact from B&R is expected to be fairly neutral. Regarding tailwinds, we expect to still see some benefits from the White Collar Productivity Program going into 2018. Mix should be positive. And given the recent currency movements, all other things equal, that should also be a slight tailwind. In addition, let me walk you through some of the impacts for consolidation on corporate line resulting from the transfer of the legacy EPC businesses. Our corporate and other orders and revenues will increase by approximately $400 million. Corporate operational EBITA is expected to be approximately $500 million including the EPC business transfer and further investments in digital. When we look at the below-the-line items for 2018, it is important to note the following. We expect GE-IS to have approximately $100 million of transaction and integration-related cost. Approximately 80%, we expect to be considered as non-operational. Normal restructuring costs will be between $200 million and $250 million. As discussed earlier, we expect approximately $40 million of power up below the line. PPA amortization is expected to be approximately $250 million for 2018 and this does not include GE-IS. We will give further guidance on the PPA impact related to GE-IS once the deal closes. Finance net is expected to be approximately $220 million and the annual effective tax rate approximately 27%. In conclusion, there are still a lot of moving parts. However, we are well-positioned going into 2018. And let me now hand back to Uli.

[Ulrich Spiesshofer:]

Thank you, Timo. Slide 12 now shows our Next Level strategy. You will like this well as it's showing the key actions we committed to as a part of Next Level along our three focus areas of profitable growth, relentless execution and business-led collaboration. At the end of our transition year, we're delivering on these goals. The transition year is over, but we will continue to lift Next Level and we will continue to drive further progress in this area. So, let's look at some of the highlights of the year in more detail. Please turn to the next slide, 13. In 2017, we shaped a streamlined and strengthened ABB. Our digital first portfolio for customers has two clear value propositions, bringing electricity from any power plant to any block and automating industries from natural resources to finished product. We do this through our four market-leading entrepreneurial divisions. These divisions are all, today, number one or number two in their respective markets. If we look at the portfolio across our two value propositions, we see that Power Grids and Electrification Products together hold truly the number one position in the space of plant to plug. And combining our industrial automation and Robotics and Motion business puts us in a strong number two position for automation globally. We said we are well-positioned for future profitable growth. On slide 14, we see the highlights of our growth approach on penetration, innovation and expansion is continuing to drive growth in our four market-leading divisions. Our focus on organic growth through better penetration of existing markets has delivered truly impressive results. For example, in food and beverage, orders are up 20% in 2017 as we won major orders from Heineken and TetraPak, and we have a very strong industrial solutions offering for this industry that helps us and positions us well for future growth. In our microgrids program, orders were up more than 100% over the year and the growth in orders accelerated in the fourth quarter. The bulk of the growth was driven by renewables, digitalization and emerging markets. Our Africa program resulted in a 40% increase in orders for the year in this part of the world and we have been gained much better access to many markets across the continent. Looking at slide 15, innovation is the next lever, the I of the PIE approach. In 2017, we continued to strengthen our technology leadership in each of our divisions. Just to give you a few examples. In Power Grids, we pioneered high-voltage direct current transmission in the 1950s, and we continue to lead in this technology with our innovative and HVDC light solution. This really extends the power range of HVDC transmission from a few tens of megawatts to 3000 MW and 640 KV, enough to power several million households and enable power transmission over more than 2,000 km. In Electrification Products, the division today is the world leader in fast charging solutions for electric vehicle, with more than 6,500 fast charging stations in more than 50 countries all around the world. We started this business as a startup in 2010; and today, we're truly globally leading. To support the message on sustainable transport and overall electrification, we became, in January, the partner and title sponsor of Formula E, the world's first fully electric international motorsport series, and we formed the ABB Formula E for the years to come. Our Industrial Automation division was recently again recognized as the market and technology leader in distributed control systems and we continue to invest to maintain and strengthen that position. Building on the success of our hugely-successful YuMi, the world's first true collaborative tool-armed industrial robot, our Robotics and Motion division last year unveiled the newest member of the YuMi family, a single-armed collaborative robot which combines industry-leading capabilities with a much smaller footprint. On slide 16, we look at the E of our PIE approach expansion. In the first quarter, we close the acquisition of Keymile's Communications Network business to strengthen our number one position in the digital grid. We expect the acquisition of GE Industrial Solutions in the second quarter of this year, which would truly strength our number two position in electrification globally and our market share in the extremely important North American markets. With the acquisition of machine and factory automation leader B&R, we filled a historic gap in ABB's portfolio and offer today one of the most comprehensive industrial automation portfolios in the industry, which allows us to further strengthen our number two position. And finally, we have expanded our robotics capabilities and portfolio by adding artificial intelligence and machine learning to YuMi and many other functionalities. In addition, we have opened a Silicon Valley R&D lab focused on advanced mission and AI for robotics. Now, on slide 17, ABB's quantum leap in digital is integral to our today's and the future profitable growth story. With ABB Ability, which we launched in March commercially in Houston in the US and then took around the world, we now offer more than 210 digital solutions and are ideally positioned to win in the digital space with new and existing end-to-end digital solutions for customers all around the world that build on the intelligent cloud and close the loop with connected devices. Our very large installed base and deep knowledge of our customers' domains is enabling us to build and operate a unique digital solutions offering, which delivers real value to our customers, whether in utilities, industry or transport and infrastructure. These next-generation solutions are being developed on an integrated or open architecture cloud platform in close partnership with Microsoft. The architecture for our ABB solutions extends from device level to edge to cloud. Customers can access our solutions on mobile handheld devices and implement it on a range of installed equipment in all of our target industries. Customers can choose to restrict them to being operated by edge servers since we have the solution together with HP located onsite at a facility. Or they can make use of the full scope of ABB Ability by accessing common services from our global cloud platform. The result is a high level of flexibility and choice and customers are free to expand their use of our integrated solution as they become more familiar and comfortable with them. Please turn to slide number 18. To ensure profitable growth continues in the future, we have been working since 2014 to really shift ABB's center of gravity in terms of strength and competitiveness, more focus on high-growth markets and a better and more attractive risk profile of the business. We have made a lot of progress in 2017. We continue to strengthen our competitiveness by investing heavily in our digital offerings centered around ABB Ability. We are expanding our service portfolio, which is already founded on a very large base of installed equipment. As already noted, major additions to our business portfolio, our acquisition of B&R and the announced acquisition of GE Industrial Solutions, which will give us a greater access to more early-cycle electrification business and helps us with our imbalance towards late-cycle activities. Additionally, we acquired Keymile's communication network business to strengthen our leading position in the digital grid and NUB3D, a specialist in 3D visual inspection software and solutions in robotics. Besides acquiring businesses, we have also divested some that don't fit the intended risk profile or are no longer core, like the high voltage cable business that we completed and closed the transaction in the first quarter in 2017. Overall, we significantly improved the commercial and risk profile of ABB. Beyond these actions, we announced partnerships with IBM on AI and with Hewlett-Packard Enterprise to jointly develop digital industrial solutions that can be developed on-premise, on the edge, on the cloud and hybrid IT environments. Finally, the large-scale change in our business model for EPC that we announced in the first quarter also represents a very important step towards de-risking ABB and improving our commercial profile. On slide 19, you can see where we are in terms of transformation of our Power Grids division. Execution is the hallmark of our Next Level strategy. The turn around and transformation in Power Grids is key to that. Excluding the EPC businesses, Power Grids' profitability was within the target range for 2018, ahead of plan on a pro forma basis, and the division's Power Up program, driving its transformation and value creation is well underway. Profitability has improved more than twofold since we started this journey and now it's about making ABB not only better in the future, it's about making it bigger and better in the area of Power Grids. Power Grids continues to drive the business model changes as it further expands its significant digital and service offering. Moving to slide 20, another hallmark of our execution focus was our 100-day White Collar Productivity Program, which concluded at the end of 2017 and has fully delivered. It reduced the run rate of more than $1.3 billion in savings which was more than $300 million ahead of the original targets. The savings program was implemented within the expected timeframe and cost about $300 million for restructuring and implementation than originally announced. Along with reducing the number of divisions from five to four, we streamlined our regional organization from eight regions to three. We cut the headcount in the headquarters by half here in Zürich and we consolidated more than 60 back-office operations into two global and three regional business service centers. Savings are being partly reinvested in our digital offering, our sales platform and in our brand. Slide 21 shows how compensation has been developed in ABB over the last couple of years. To drive stronger performance orientation we had outlined at our Next Level strategy, we changed our performance and compensation model to focus on individual accountability and responsibility. Four years ago, when we launched the Next Level strategy, the link between individual performance and compensation was unclear and, in many cases, not existent. Today, our compensation system is closely and transparently linked the strategy and performance. Compensation and incentives are dependent on merit and individual performance and the long-term incentive program for executives is wholly linked to attractive shareholder returns. Talking about attractive shareholder returns, if you turn to slide 21, you can see we have been doing a lot of homework and we start to see the results. The total shareholder return for ABB stock in 2017 was a 24% gain in local currency, outperforming our European and US peer group. However, our US peer group includes GE, which has lowered the average for the US group. We still recognize that we have a lot of homework to do if we truly want to compare with the best of the best performers in the US. Our capital allocation priorities remain unchanged. We have continued to raise our dividend progressively for nine times at a sustainable rate and you are seeing a dividend increase proposed again today. We have been funding organic growth through R&D and CapEx projects at attractive cash return on investment. We invest in a focused way in value-creating acquisitions when the conditions are right. And we have returned additional cash to shareholders through share buybacks as it was appropriate. Slide 23 looks ahead to the future. Going forward, we will continue to drive progress along our three focus areas. We will be investing in innovation and we will expand into new fields with our ABB Ability solutions. We will continue to create value through strategic acquisitions and forge partnerships with leading global companies such as those that we already have with Microsoft, IBM and HPE. And we will continue to shift ABB's center of gravity towards greater competitiveness, high-growth segments and lower risk. We will focus relentlessly on world-class operational excellence across the whole organization and we will continue to strengthen the links between strategy, performance, management and compensation. Lastly, we will keep our focus on the market and on running a lean organization. We will always continue to deliver our leadership and stay focused on strengthening the global ABB brand. Let me close with slide 24. ABB is now truly positioned for profitable growth. Our transition has delivered a streamlined and strengthened portfolio and operations. Today, our digital first portfolio for customers in utilities industry and transport and infrastructure has two clear value propositions – bringing electricity from any power plant to any plug and automating industries from natural resources to finished products. With our shift in our center of gravity and the growth momentum we have built in 2017, we are today better positioned in a better market. Our focus is now firmly on relentless execution. This ABB Ability will help our customers take advantage of the efficiency, productivity and performance improvement that digitalization can deliver. And in doing so, we will capture the market opportunities of the energy and fourth industrial revolutions for our customers all around the world. Thank you very much.

[Jessica Mitchell:]

Now, let's open the line for your questions.

[Operator:]

[Operator Instructions]. The first question comes from James Stettler from Barclays. Please go ahead.

[James Stettler:]

Yes. Thank you very much. Good afternoon all. Two questions from my side. First one is a tricky one. But given all the growth you're talking about, given the improvement in the backlog, is there any way to quantify what type of organic revenue growth you'd be expecting sort of to range in 2018? And the second question is around pricing, again, that still seems to be a problem in two of your divisions. What can you do to address that? And do you believe that you are able to get ahead of that inflation trend in 2018? Thank you.

[Ulrich Spiesshofer:]

Yeah. Good afternoon, James. Thank you very much for your question. First of all, let me really, on the one hand, apologize to the entire community for the complexity of this result. When you do a fundamental transition of a company, then you have many, many influencing factors and you see them in our results that are clearly dampened and inferenced heavily by this transition. Now, on the organic revenue piece, we look at different drivers here that we need to consider. First, the underlying base order momentum that we have built is truly significant. If you go back 18 months, we had minus 6 on base orders because many of our markets were contracting. And in fourth quarter, we have now plus 9. So, that's the momentum that we really have the strong ambition to follow also in the next couple of quarters, which will have a positive effect on our business, especially in the early cycle parts of our portfolio. Now dampening that is the lower backlog that entered the year 2018 with compared to the previous year. And it's very clear, it is our ambition, out of the dampening effect of the lower backlog and solid underlying growth momentum to deliver revenue growth during 2018. It's clear the later it gets in the year, the better it will be, and that's the position that we are making for the business going forward that we will enhance the revenue momentum, but we need to appreciate the different drivers that are influencing the overall revenue realization across the portfolio. Now, on pricing, I think you're right. We have in at least one of our business, one-and-a-half of our business, we still have a homework to do. And it's a really tricky one because when the markets come back and the growth starts, and you have seen our really broad-based base order growth across all divisions and regions, on the one hand, you need to manage your cost and capacity in a careful way that you don't get hit by the raw material pricing. On the other hand, you need to have the right capacity to serve the buildup in the backlog and the higher order momentum that they are experiencing. We also need to make sure we have our eye on the ball really on the pricing side, on our own pricing towards the market. And the more technology innovation we have and the better our technological differentiation is, the better it will be and easier it will be to realize better prices and have a higher price realization. So, the cost piece needs to be managed. We need to manage the pricing realization and support that through the right innovation and technology pipeline. And there, I'm pretty confident because even during the very difficult and complex transition years and transformation years, we have kept R&D spending. We are, in fact, spending more money on real R&D because we cut out also there a lot of white-collar activities. So, the pipeline of innovation is rich and that should help us when we launch the new product also with better pricing quality. But it's an ongoing cost that we need to give the right attention to.

[James Stettler:]

Thank you.

[Jessica Mitchell:]

Next question, please.

[Operator:]

The next question comes from Ben Uglow with Morgan Stanley. Please go ahead.

[Ben Uglow:]

Good afternoon, Uli, Timo and Jessica. Thank you for taking the questions. I had two which were basically quite specific to the divisions. And, again, I guess, it's coming back to this question of understanding the backlog and the trajectory of future growth. On industrial automation, we see that the orders are coming mildly positive, 3% over the year, 5% on the quarter. But, obviously, we're now starting with a backlog that is down 10% year-over-year. Could you just give us a sense, during the course of 2018, should we expect the growth to kind of be linear? Are you sort of ramping up throughout the year? Or is it going to be fully backend loaded? So, are we going to have to wait till the second half to see revenue growth in industrial automation? So, that's question number one. Question number two, Robotics and Motion, even if I add back the EPC charges, year-over-year, your margins are down by 60 basis points from 15.5% to 14.9%. Can you really give us an idea of what's going on between the different divisions, i.e. how are the margins of robotics, how are the margins in drives and how are the margins in motors? Where is this gap coming from?

[Ulrich Spiesshofer:]

Good afternoon, Ben. Thanks for your questions. The complexities on IA quite interesting. We have a turning market. We have lower opening backlog. We have an underlying base order momentum and we have B&R coming in in full swing for 2018. Now, let me start just the last one. We are very pleased with the development of B&R. B&R is ahead of the plans regarding integration and financial performance. I think it's really nurturing it in ABB, giving it the right kind of oxygen, investing and growing it has really helped this business to develop extremely well. So, we're very happy with that one. And naturally, given the nature of this business, this should have a good impact on the underlying momentum both on orders and revenue in the IA division. Against that, flows again the lower opening backlog that we have in this division, which is truly about 10% down year-over-year. So, it is our ambition to drive the revenue momentum in this business, in line with the market opportunities, but we have to recognize that the dampening element of the backlog compared to 2017 will be a tough one to managed through the year. It is our ambition that we come out with revenue growth by the end of the year, but it will be clearly weighted towards the second half of the year because we have the backlog impact the first half, primarily in Industrial Automation. On Robotics and Motion, let me see whether Timo wants to take that one.

[Timo Ihamuotila:]

Sure. Thanks, Ben and Uli. If you allow just throwing couple of numbers because I went through kind of like the last year and this year on IA as well, and last year, our orders went down on total level 18%. This year, we are growing 2%. And base orders were minus 6%. And this year, they're plus 3%. So, this is actually a significant change in IA from that perspective. Then, on the RM business, so when we look at the numbers and we take into account the EPC, you're correct to point out, we are below last year's numbers. When we look at Q4, we are approximately at the same level. We can't be pleased with this margin performance in the division. And there are a couple of things working here. So, first of all, you know that we have been impacted by the increased commodity prices. That has impacted the division as well. And there, I would say that especially large motors where there is overall some overcapacity on the market, it has been difficult to move that into the market. In other areas, we have made good progress on moving it to the market during Q3 and Q4. But then also, during Q4, we have been building further capacity on the growing robotics business, which has impacted the margin this year, which we then expect to reverse going into next year. So, overall, our ambition is to have both absolute as well as percentual margin accretion going into 2018.

[Jessica Mitchell:]

Thanks, Ben. Thank you. Next question?

[Operator:]

The next question is from Daniela Costa from Goldman Sachs. Please go ahead.

[Daniela Costa:]

Well, hi. Good afternoon. I have three points as well. You had a sort of quite a significant increase in free cash flow this quarter. Overall, you have good free cash flow conversion. When do you think you could potentially return to the buyback? Or how do you think about cash – capital allocation in general for the next year or two? And then, the second point, just on restructuring, is there anything else you have in mind beyond the White Collar Productivity Program? If you can talk about what else could you do to improve margins given some of your US peers and some divisions, for example, still have higher margins than what you have? Then my final point, just wanted to follow up on the 15% underlying – sorry, base order growth in Power Grids. Can you talk about how much of that – sort of can you talk about the market conditions? What drove that? Is that more of a one-off? Or are you seeing really that market starting to move? Thank you very much.

[Ulrich Spiesshofer:]

Good afternoon, Daniela. Thank you for your three questions. I take number one and three and Timo will take the restructuring question. Yeah, on the free cash flow, thanks for your compliment. You know that cash is very, very high on my agenda and Timo's agenda as well. We're driving it very hard. And I think it's very important to realize, despite the negative impact of the transition efforts that we've had, we have good base order growth and we've got really strong cash generation, which is a sign for a healthy business. Now, in the first half of 2018, we have two large cash-out events. We have the dividends that we will pay and we have the closing of GE Industrial Solutions. So, both of them will weigh on our balance sheet and that's very clear that we will do that. But you're right, should the market conditions prevail and our operational performance be, then we will be soon confronted with the question on what we do in terms of allocating capital. And here, our priorities are unchanged. Number one is allocating cash and capital to driving organic growth. And I'm really pleased to share with you that I think our prioritization and quality of capital allocation, in line with value creation opportunities across the portfolio has significantly improved. And there is tremendous opportunities out there in our two value propositions in the market to grow and create a lot of value in organic investments, be it on the digital side, being it on the robotics side, being it on the e-mobility side. We will continue investing organically to drive good value creation. The second priority in our capital allocation remains our dividend policy. And as you have seen today with the announced intent to raise the dividend for the ninth consecutive time, we stick to our dividend policy of a steadily raising dividend income. And come hell or high water, this is something that is really, really important to me personally and to the company that we deliver on that. The third priority is M&A. And M&A is not only about whether we have the financial capacity. The right target needs to be around and we need to have the acquisition – integration capacity. With B&R and GE Industrial Solutions as well as Keymile, we have made three significant steps. The teams are at the moment either busy with the integration or busy preparing for the integration. So, we need to have that in mind when we consider alternative acquisitions in the future. And we wouldn't rule out re-enforcing and restarting the buyback as the balance sheet develops. But that's something when we get closer to the situation that we will then communicate. Your third question was on the Power Grids. In Power Grids, we are going through fundamental transformation. We have today about 2 times, 2.5 times of the profitability where we were. In the guidance, what we have told Claudio is, in the first couple of years focus on making the business better. If you need to compromise top line, if you need to compromise order sizes, that's perfectly fine. We want to have the business in a better quality. And now on the underlying momentum in Power Grids, I'm pleased to see the momentum ramping up. On the base business, it is absolutely our ambition to keep a solid base order momentum and then to participate also with larger orders going forward as the business model change comes through and we have implemented it. The market overall for Power Grids – that was your sub-question – is developing favorably in 2018. We have now certainty on many governments in Europe, how they're going to position themselves, and it will help with decision-making. The tax build in the US will give the US government money out of the taxation of the re-shored funds that can be used to drive infrastructure stimulus. China and India will continue investing on the power grid. Middle East has quite a bit of investments coming as they move towards more renewable driven power generation. There will be a lot more feed-in points. So, all together, I think the market condition is quite OK. Now, on your other point, your second question on restructuring, let me hand over to Timo.

[Timo Ihamuotila:]

Thanks, Daniela. So, first of all, on the WCP program, even if we don't have restructuring there anymore, we would expect some maybe $250 million of savings to flow through during 2018. And then, as I said, on the normal restructuring, we are looking to have something like $200 million to $250 million. We will go forcefully after underperforming units where we have a lower capacity utilization. And I think another thing which you mentioned on driving margin, we have also increased pure cost-out metrics in our key KPIs on the operating unit and same is actually true for inventory turns. So, that also helps us to drive that.

[Jessica Mitchell:]

Thank you, Daniela. We'll take the next question.

[Operator:]

The next question comes from Mark Troman from Bank of America Merrill Lynch. Please go ahead.

[Mark Troman:]

Yes, thank you very much. Good afternoon, Uli, Timo and Jessica. I've got two questions. One around operating leverage and the other about large orders. So, firstly on operating leverage, 2017 was a transition year. You did portfolio changes, EPC model et cetera, and you've got good base order growth. Hopefully, that will continue. But how should we think about leverage in your growth investments. I think you did $66 million in Q4. I wonder if you could outline how much of that was for 2017 in total and whether that will continue or should we think about – you've done the investments now and now is the time to kind of leverage that investment with future growth. That's question number one. And then, question number two. Just briefly, how should we think about large orders. There are clearly some out there. But at the same time, you scale back your exposure. Large orders, should we think of that as roughly 10% of ABB these days compared to 20%, 25% we used to see many years back? Or how should we think about that? Thank you.

[Ulrich Spiesshofer:]

Yeah. Good afternoon, Mark. And thank you for your questions. Let me start with operating leverage. 2017 was a pretty unique year because if you go through the commercial quality first, we still had a significant change in mix of business. So, the deteriorated size of the business in our most profitable segment was basically compensated with investments in this growth in newer segments that are not yet as profitable. As you rightly say, we had also massive transition costs in 2017 directly and indirectly. And we invested in sales, in branding, in the digital platform. And given all that, if you exclude the EPC charge, we have had a steady margin. So, that's a quite okay result in the context of all the different headwinds/tailwinds that we have. And it's absolutely our ambition to get a good operating leverage in the year 2018 where the transition is behind us, the mix is going in the right direction and the growth is kicking into our cost base which is much leaner than we had it before. It's clear that with all the one-off effect in 2017, it didn't come out that strongly. The numbers are blurred by the contradicting effects of these different elements. But, altogether, we're going in the right direction. The investment in growth in the year overall were north of $100 million that we have done and we will continue to invest going forward because we think it's really important to shape the future ABB. Now, as the impact of the transition wears off, the investment of growth will not drag the margin down. Now, what you also need to understand in the year 2018, we will have GE Industrial Solutions coming in in the mid-year. If that comes in as anticipated, about 6% operating margin, that will have about 30 basis point dampening effect in the year for the full year for ABB. And it's clearly our ambition that we outgrow that and still deliver somewhat margin accretion going forward. Now, on large orders, and I'll give you some anecdotes there that recently happened. And I start with an area that we haven't talked much about, large orders recently, and that's the robotics system business. We have at the moment a competitor out there in this field that is very aggressive in take large scale system orders. We let them have it. We are not coming with some profit warning on robotics. I don't have to do that. And that's something that naturally shows the commercial discipline that we have in the robotics field. In Industrial Automation, we see the first discussion on larger projects coming. And I'll give you some examples. Downstream investments in oil and gas, to build up more refinery capacity, to really put more value add on the barrel of oil is a discussion that we are having actively, for example, in Saudi Arabia. You might remember, we built Sadara as we were the key partner for Saudi Aramco and Dow in the Saudi in the last couple of years. That's a size 3x6 kilometers. And there are two more of these sites in parallel that will, in the next years, be developed. Note this will not lead, immediately in the first half of this year, to large orders, but it's an opportunity that we see. And we see that in many other fields. On the utility side, I'm really happy that we have certainty in Europe in the largest country, Germany, on the new government as of last night and in France that will help us to have more stability and predictability in the European energy policy. And that means the appetite for investment will then be better. In the US, as I've laid out, I would expect the re-shoring of cash and the taxation of that creates significant funds for the government to be deployed on the infrastructure side. I had recently the opportunity to be together with some members of the government and it was very clear that they are committed as a next wave to really take on infrastructure as they have now successfully navigated the tax bill. In China, 2017 was a very low year in terms of large utility orders because there was so much started in 2016. But I think in 2018 and going forward, there's more coming. So, altogether, there's no reason to be pessimistic on this, but we also need to stay cautiously optimistic on the impact of 2018 because the appetite for spending in certain fields is just now starting. And between the first discussion and on order and then later revenue will take a bit of time.

[Jessica Mitchell:]

Thank you. Next question please.

[Operator:]

The next question comes from Andreas Willi from JP Morgan. Please go ahead.

[Mark Troman:]

Good afternoon. Thanks for the time. I've got three questions please. The first one on your process automation business. If you look at the growth there, it seems to be still lacking Honeywell, Emerson or Siemens also on base orders. Maybe you could give us a bit more detail. Is this just marine and the different exposure? Or do you see other shifts happening there? And the second question, maybe you could give where Thomas & Betts and Baldor are today in terms of profits or profitability. I know it may be difficult given these have been integrated. I'm just continuing to struggle to reconcile the performance of the EP and RM division overall over the years, given the M&A spend and where earnings are now relative to where they were four or five years ago before these acquisitions. And the last question on cash flow, you hit the $1.5 billion working capital performance over the last few years. The original target was $2 billion. Maybe you could give some indication where you fell short and what still the potential is going forward. Thank you.

[Ulrich Spiesshofer:]

Good afternoon, Andreas. And thank you for your question. Let's first talk about the process base. In our process automation activities, ex-B&R, we have a certain profile that your rightly caught that is really different than compared to the competitors. First, the marine activities in this field are truly subdued and will remain so for a while because shipping capacity is pretty available out there and there's not much new build on oil and gas, supply vessels and oil and gas transport vessels. It was one of the key areas that we have. Then, if you compare us against Emerson, we are strong in upstream in the North Sea. Emerson is strong in non-conventional in the US and that's, at the moment, a hotspot. And that explains the difference in the profile. Now, it's very clear we need to continue to enhance our investments on the US side and drive more on that one to make it up against them and get going. But, altogether, it's a structural explanation. The underlying performance of our Industrial Automation division is quite okay. If you look at the profitability resilience that Peter and his team have delivered, if you look at the relative pattern in terms of momentum over the last couple of years when the market turned down, it was quite okay. Going forward, we need to structurally address the opportunities that are out there and drive that in a forceful way. Yeah. Thank you for raising Thomas & Betts and Baldor. These are two strong brands and two strong businesses in the ABB portfolio. But it's very clear that, for example, on the Baldor side, the massive contraction on the larger scale motors and, at the same time, the massive commodity pricing swing there has also impacted the profitability. And Sami and the team are working in full swing to get this one into full shape back where it was to ensure that we not only have the top line momentum, but also get the bottom line going the right direction. Now, on cash flow, I hand over to Timo.

[Timo Ihamuotila:]

Yeah, thank you. So, first of all, when we look at the performance of the program, if you just look at the net working capital on the balance sheet, it went down from $5.5 billion to $3.9 billion. So, that's about $1.5 billion, $1.6 billion. But that does not actually take into account very well improved performance which happened in cables, which was then exited, and also B&R, as we have discussed earlier, came in with, let's say, a little less efficient net working capital. And that actually then leads to the performance which we have estimated, is about $1.9 billion. So, we came quite close to the target there in the end and, as said, very good cash performance during Q4. So, now, going forward, we are not giving out any new numbers here, but we're definitely going to continue to drive this and we have now, inside ABB, separated net working capital even further into its three components regarding the accountabilities. As I mentioned, on inventory turns, we have now increased the weight of inventory turns in our KPIs, also impacting bonuses in the operating units. We have some more room there. And as we have discussed earlier, we are actually, on the overall program, behind on inventory turns when we compare to where we want it to be. So, that's number one focus area now going forward. But also, on DPO, we can further harmonize our payment terms. So, we have some work to do there. And also, we made progress on overdue receivables, but we have some work to do there as well. So, we continue to target to release more capital also from net working – more cash from net working capital going forward.

[Jessica Mitchell:]

Thank you. And moving to the next question.

[Operator:]

The next question comes from Martin Wilkie from Citi. Please go ahead.

[Martin Wilkie:]

Yes, thank you. Good afternoon. It's Martin at Citi. Just a couple of questions. The first one on the earnings bridge. So, the net savings looked like they accelerated in the quarter. You've talked a little bit about price and saving. But just don't understand what was the main driver of that net savings number picking up. And if we assume that pricing declines moderate in some of the process markets in 2018, and it sounds like you still have some benefit from the white collar productivities come through. Is that net savings number – at the Q4 level, can that continue into next year? And the second question was, again, just going to back to large order. You talked about some of the longer-term drivers in infrastructure and so forth. But just in terms of the near-term, in terms of actual tendering, has there been any improvement? I appreciate tendering is a lumpy and perhaps a sort of qualitative thing to talk about, but do you feel the tender process has picked up at all or is that still somewhat soft? Thank you.

[Ulrich Spiesshofer:]

So, good afternoon, Martin. And thanks for the question. I take the large order piece and then hand over to Timo on the earnings bridge. As you rightly say, tendering and project management and project preparation of large order is really an art. And there are many, many influencing factors that make our customer say, now I go, I don't go. What we see is, on the utility side, quite some discussions on pretty significant projects. I'll give you an example. Backbone infrastructure building, the large-scale transmission investment in North America will be one of the activities that we see ramping up in the next couple of quarters. There are some tenders underway, as we speak, and hopefully, the regulatory side of the tender process where certain permits and permissions need to be obtained to make sure that a customer can really ask us to quote for a project. Backbone, I'm more optimistic that I was last year that we will see it through. And that this year, that might be the one or the other tender discussion becoming pretty serious and, hopefully, getting even into a bid situation. Whether that leads to new orders this year or next year, we need to see that on that bucket. If I look at the oil and gas activities on the downstream side, we have discussions on potential future tenders, but it's not yet a tender stage that are at a development stage that I would say I'm confident that there are many large-scale tender coming in. So, I know it's a vague answer, but that's the reality out there in life that we're facing. The teams are now really much better positioned to address tender situations. We have improved also the white collar productivity in this situation. So, as they come in, we can faster answer and we can quicker get on the mark with the customers. So, hopefully, they come a little bit more momentum and then we get going. With that, I hand over to Timo on your question on the earnings bridge and the net savings.

[Timo Ihamuotila:]

Yeah, thank you. So, basically, when we look at the net savings, first of all, the WCP impact in there is approximately similar as in previous quarters. So, maybe a bit over $100 million. And as I said, we expect about $250 million still to come in during 2018. We were a little bit ahead during this year. And that's why, earlier, when we communicated this, we said $300 million for 2018. Now, that number is approximately $250 million. When we look at the bridge, the net commodity here is the commodity impact net of our hedges. And as I indicated earlier, in some areas of EP, or most areas of EP and in some areas of RM, we have been able to push the pricing a little bit better to the market and that has had an impact on the better net savings. And, naturally, our ambition is to drive the net savings as hard as possible, so that they would be bigger going forward than what we have on the price impact.

[Jessica Mitchell:]

Thank you. Moving to the next question.

[Operator:]

The next question meet comes from Andre Kukhnin from Credit Suisse. Please go ahead.

[Andre Kukhnin:]

Yes, good afternoon. Thanks very much for taking my questions. Just, firstly, on growth, thank you for providing the market growth outlook and the history. So, when I take the 2017 chart you showed with ABB exposures and market growth rates and run blended, it does add up nicely to the 1% that you've just delivered. For 2018, that implies 2.5%. I just wondered if you could talk about where this can be wrong and where the risks are around this, whether your performance against the markets or the market? And second question is just a quick follow-up on the working days. Timo, you said two less in Q1. But I think the Easter effect in Q1 is just one day. So, just wanted to double check where the second day is coming from?

[Ulrich Spiesshofer:]

Yeah. Andre, thank you very much on your question. Look, the devil is always in the details. And you provide granularity on growth and people do their math and they do the calculation for the future. It's very clear that our ambition is to increase the growth rate going forward. However, I ask you also to consider to take into consideration the backlog situation. On a like-for-like basis, excluding backlog impact, we should accelerate the revenue generation, but the backlog has a dampening piece. So, that's basically the story behind the activities. With the other question, I hand over to Timo.

[Timo Ihamuotila:]

Yes. We have, I think, two things going on here. So, basically, when we just simply look at the weekdays and how the weekends drop in and all that, so we get two working days less. So, that's what's happening.

[Andre Kukhnin:]

Oh, with weekends. Got it. Thank you very much.

[Jessica Mitchell:]

Okay, thank you. And we'll take another question.

[Operator:]

The next question comes from Simon Toennessen from Berenberg. Please go ahead.

[Simon Toennessen:]

Yes. Good afternoon, everyone. And thanks for taking the question. The first one is just on R&D and also maybe CapEx. What are you thinking about in terms of R&D for this year? I think your R&D levels were down about 3% over the last couple of years versus, I think, your German competitor has ramped that up by 15% quite aggressively over this time. And also, CapEx, I think, you're looking for a 5% increase year-over-year versus others being a bit more aggressive here. So, maybe in terms of also allocation, where you thinking the R&D goes, in particular by division, would be helpful. And secondly, just on US tax, I think you talked in the press call a bit about this morning, but why you're not seeing an impact there for the full year and you keep the tax rate at 27% versus most other companies guiding, obviously, for a lower tax rate here. Thank you.

[Ulrich Spiesshofer:]

Yeah, good afternoon. I'll take the first and then hand over to Timo. Look, on R&D, I ask you to consider a couple of effects. First of all, the changes in our portfolio, we divested certain activities and we focused our R&D better on high-growth segments. Second, we have increased R&D productivity very significantly because we have also had my White Collar Productivity in R&D. so, we have caught the administrative part of R&D in a very significant way and we have redeploy that money within R&D. So, we're not taking it down, but we're spending smarter and better and that will have a better impact going forward. And the third impact is the way we have shaped our portfolio today. We have much less complexity than many others in our portfolio. We have really the scale. When your number one or two in the respective business and have the scale, on a relative basis, you might be spending a little bit less. On an absolute basis, we might be still leading. So, I'll give you an example. Nobody spends more money in power grids R&D than ABB given the fact that we are significantly larger than others. On a relative term, this might look slightly different, but that does not concern me that much. So, we will continue to drive R&D going forward. We have not cut it. We have improved it and the quantity of it is up. What we also do on the R&D side, we ensured that the shift towards a stronger electronic software and services portfolio is being supported. So, as just one example, we have now about 500 people working on smart analytics and artificial intelligence, which is a clear investment of the ABB group to really drive towards that. And we have investments in some startups. We get some R&D momentum out of our partnerships that we focus our activities on the core elements of our differentiation and we get the more agnostic R&D contribution from our partners. So, I think this is just a new pattern in getting good R&D momentum going forward. On CapEx, we eat our own food. So, we're putting investments in a smart way in our factories to get more productivity out of existing assets. And that naturally means that you don't need to spend as much money as the one or the other that doesn't do it that way. So, altogether, I think we are very well-positioned. And as you see in our innovation leadership, whether it's on the grid side with HVDC, whether it's on robotics, whether it's on e-mobility, we are truly leading in many innovative areas and many new areas and we have the firm ambition to keep it that way. Now, on the tax side, I hand over to Timo.

[Timo Ihamuotila:]

Yeah. So, on the tax side, as was discussed in the press conference as well, so we continue to keep our expected effective tax rate at 27% and we have a very clean US structure, first of all. So, we don't own many other businesses from US. And at the same time, when the tax reform is happening, there are also some changes in deductions and our other items which we expect actually to pretty much compensate our situation. And that's why, based on the currently available information, we continue to expect the tax rate to be at 27%.

[Jessica Mitchell:]

Okay, thank you. And we'll now take our last question.

[Operator:]

The next question comes from Jeffrey Sprague from Vertical Research. Please go ahead.

[Jeffrey Sprague:]

Good day, everyone, and thanks for squeezing me in. A lot of ground covered here. So, I'll just be brief. Two things. Uli, you made a comment about being bigger and better in Power Grids and, obviously, better has been a focus. Is the comment around bigger tied to some of these project-related opportunities you're talking about or are you considering M&A there? And then, there were a number of questions on cash flow probably dancing around the topic. But when you stir it altogether thinking about CapEx, working capital, your requirements to grow the business here, do you actually expect free cash flow to be able to grow in 2018?

[Ulrich Spiesshofer:]

So, I'll take the first one. Yeah, look, Jeffrey, it's very clear that in the Power Grids transformation, the core focus is on organic growth and increasing the underlying commercial quality. And when I say bigger going forward, you have seen the base order momentum, but it's clearly our ambition also to – with the new business models to participate in the larger order pattern. So, that's one contributor in there. We also have quite a lot of innovative offering that allows to drive penetration in market activities where we have not been so active in the past. The grid consulting piece is one that we are ramping up in a strong way. The entire asset health offering, where we're already leading today, we take that to new geographic markets and drive that. So, I think there is an opportunity to organically grow both through penetration and continuing the innovation. I'm cautious on M&A activities in Power Grids. When the business is in full swing transformation, you don't want to overload the team. We did Keymile in 2017 which was a true technological innovation differentiator on the communication side. On the digital grid, with that, we really put our foot down as the leader of the digital grid space. And we will do that. But you should expect more bolt-on acquisitions in that space, if we do anything transformational, large scale in that space. Now, on the cash flow, I hand over to Timo.

[Timo Ihamuotila:]

Yeah. So, our free cash flow has been pretty much on the $3 billion area during the last years. And if we actually compare to 2016, we had a little bit more CapEx during 2017 than 2016. On the other hand, 2016, cables impacted. So, it's pretty stable also on free cash flow basis when you look at it that way. And going into 2018, yes, our ambition would be to continue to grow free cash flow as well. We have a bit less charges or cash going out related to White Collar Productivity Program. So, that should be enough to cover the other items.

[Ulrich Spiesshofer:]

Thank you, Timo.

[Ulrich Spiesshofer:]

Look, that was the last question. Let me just, one more time, summarize where we stand. In the transition year, we have streamlined and strengthened our ABB. We come out of it with solid underlying base growth momentum. We have been able to have steady results despite all the headwinds that we were experiencing. And going forward, we are firmly committed in a better market situation to deliver a better ABB that's naturally profitably grow. With that, over to Jessica.

[Jessica Mitchell:]

Thank you, everybody, for your time and patience today. And with that, we'll end the call.