KONE Oyj — Call Transcript 2015

Speaker 11: Good afternoon, everybody, welcome to KONE's Q2 results webcast. In Espoo, Finland today, we have our CEO, Henrik Ehrnrooth, and CFO, Eriikka Söderström. I am Katri Saarenheimo from the investor relations team. As usual, we will start with an overview by Henrik of our key figures and development during the second quarter. After this, we will again have plenty of time for Q&A and discussion. Henrik, please.

Speaker 7: Thank you, Katri. It's also my great pleasure to welcome you to our Q2 webcast, because we have good news to share with you. I must say that I'm very happy about the strong performance that we had in the second quarter. That again shows the good execution and breadth of our performance that we are able to achieve at the moment. I will, as usual, start with our key figures, go a little bit more in detail into orders received, sales, and EBIT. After that, I'll talk about our businesses and the markets, how we have strengthened our competitiveness, and finish up with our market and our guidance for the year. Starting with Q2 and our key numbers. As the heading also says, we had a very strong performance on a broad base. This we can see from starting with our orders received. Our orders received were EUR 2.2 billion, growth of 21.7% compared to last year or 6.3% in comparable currency. Our order book reached an all-time high, EUR 8.6 billion, a growth of 32% or 15% in comparable currency. Our sales grew also, was EUR 2.2 billion, a growth of 15% or 6.8% in comparable currency. What is important with our growth is that it continued to be profitable, that we can see from development of our operating income, which was now EUR 325 million in the quarter, a growth of 23.5% compared to last year. The profitable growth can also be seen from our operating income margin, which now improved from 14.2% to 14.7%. We also had a very strong cash flow. We can say it was exceptionally strong for Q2. It was now EUR 426 million. Our earnings per share grew a little bit over 30% compared to last year and was now EUR 0.51 . A very strong overall and broad-based performance in Q2. Also, if we take a little bit longer perspective and look at the first half of the year, we can also see a similar performance. Good growth in our orders received, which were EUR 4.2 billion, growth of 20.3% or 5.9% in comparable currency. Also, solid sales growth in the first half, total sales of EUR 3.9 billion, growth of 18.6% or 6.9% in comparable currency. We can also see that our growth was profitable if we look at it over a six-month period with an EBIT of EUR 537 million, a growth of a little bit over 21%, and improvement in our operating income margin from 13.5% to 13.8%. Our cash flow operations, a very solid and strong EUR 638 million for the first six months. I am very pleased now that we had a very good performance in Q2 because we can see now on a six-month basis we had a solid cash flow. We had a slightly slower start to the year in terms of cash flow. I think we can see if we look on the six-month perspective that even in a challenging market environment, we have been able to maintain good and healthy business practices, which can be seen from our cash flow. Earnings per share, EUR 0.80 compared to EUR 0.67 in the comparison period. What has been the key enabler of this good development that we have had, I would say it is very good engagement we have amongst our 48,000 people and all of our employees' commitment continues to achieve good results and profitable growth. Of course, a very big thank you to all of our employees for the great work done in the first half of the year. If we look a little bit more closer at the numbers and start with orders received, which grew at 21.7% or 6.3% in comparable currency. Here, we had growth in orders received in all geographic areas and in both new equipment and modernization business. I think the highlight on our orders received is that we had a solid growth in our volume new equipment business with a good growth in both Europe and North America. The growth in Asia Pacific was now somewhat slower due to also very high comparison points, particularly major projects last year. In the important China market, we continue to grow faster than market. We grew at close to 5% in volume terms when the market declined slightly. A continued strong outperformance as well in China. I would say overall, I'm very pleased with our performance on orders received, how broad-based it was, and how well we were able to continue a strong growth in North America and accelerate our growth in Europe. If we then look at pricing and the overall market environment, what we can see is that the fight for market share has continued to be very intense, and we can see that that has had some impact on pricing. What I would say here is that in an environment where fight for market share and the impact on pricing has been tough, we have been able to, for example, in China, grow continuously faster than the market without sacrificing our margins. This, I think, shows the strength of our performance. In an environment where market prices have come down slightly, but we have been able to maintain a solid level of margins for orders received, and this has been achieved through a continuous improvement in our overall competitiveness and through a very good performance of our teams overall. I would say overall broad-based and good performance. If we then look at sales, here the good news is that we had growth in all geographic regions and all of our businesses. If we start geographically, fastest growth was in North America, where our growth was about 14% in comparable currency. Our growth in Asia-Pacific continued to be a solid 7%, and in Europe, Middle East, and Africa, we grew at 4%. If you look at our businesses, what I'm pleased about is that our growth in our services business accelerated slightly. Our growth in services overall was 7.1%, maintenance was 6.4%, and in our modernization business, 8.8%. Clear acceleration and growth in our modernization business. Also, new equipment business continued to grow and was 6.6% overall. Here you can see the solid, broad-based growth that we achieved also in sales. Finally, turning to Operating income. The main reason behind the broad-based positive development was really what we achieved in sales on many fronts. We were able to have a good development in both our services business as well as new equipment business and in each of our geographic regions. I'm very happy about the underlying performance that we had. Translation exchange rates also had a significant positive impact on our Operating income, and they now contributed a little bit more than EUR 40 million to our Operating income. Even taking out that, we can see that the underlying growth was solid. We continued to increase our investments in areas that support our future growth, such as our investments in R&D, process development, and IT, and expanding our footprint in key growth markets in Asia-Pacific. Also, we continued to strengthen our resourcing in North America to cater to the strong growth that we are experiencing in that market. Again, also in Operating income, a very broad-based and positive development. Finally, on our numbers, looking at our business mix. If we start business mix by various business lines, we can see that the trend that we have seen already for a while, which is that our new equipment business continued to increase its share of our sales. That continued, and new equipment was now already 56% of total sales. Here, the main reason for the increase in the share of new equipment was translation exchange rates. Because we have in new equipment business, we have more sales in other currencies than the euro than we would have in, for example, maintenance and modernization. The change in mix was mainly a foreign exchange-driven mix change. Same very much comes when we look at by market. Here, Asia-Pacific was now 44% of total sales. Europe, Middle East, and Africa, 40%. If you look at Americas, it increased from 14% to 16%. That is for both due to the strong underlying growth in Americas comparable currency as well as for translation exchange rates. That's about our numbers. Let me next go into our various business lines. We start with new equipment business, and first about our performance. As I mentioned, I think the most important point is that our orders received in volume business grew clearly. In the major project business, it was now a slight growth as a result of a very significant comparison period last year. The growth, as I mentioned, was strong in North America and also accelerated in Europe, Middle East, and Africa. In Asia-Pacific, we're able to grow in China, in Australia, and in India. Percentage-wise, the growth was the fastest in Australia and India. As I mentioned, in China, we grew at close to 5% in a market that declined slightly. Very strong performance overall. We then look at the various markets. We start with the Europe, Middle East, and Africa region. First of all, markets in Central and North Europe were rather stable. The positive thing is that we saw a stabilization now of the markets in South Europe. Here, a continued recovery, although from a low level in Spain, but also we saw markets such as France start to stabilize. That is, of course, positive. If we look at Europe overall, I would say that we are seeing a slightly more positive overall sentiment than in previous quarters. Not significant, but at least slightly in the right direction. Also, what has developed slightly better than we expected is the overall market in the Middle East that grew from a good level last year. North America, markets continue to grow. The previous trends continued there. Asia Pacific, their market volumes weakened marginally because of the slight decline in new equipment market in China. Markets continue to grow in Australia, and the recovery continued in India. Those were both positive. Now, let me address China again a little bit more in detail because I know there are lots of questions relating to that, I can try to address some of them upfront. The first message related to China is that we had a good performance. We continued to outperform the market and grew faster than the market at close to 5% when the market declined slightly. If we look at the market overall, one of the important points to remember is that the market is not one homogeneous market. The market actually has many different environments within it. If you look at the tier 1 cities, the market development continues to be positive. There is growth in the market. The overall real estate markets are quite strong, and our customers in those markets are developing well and growing. If you, on the other hand, look at some of the lower tier cities, we see a clearly more challenging situation, and we can see that our customers have challenges in getting financing, and also inventory levels are at quite a high level in some of the cities. If we look at the overall market, we can also see that the area where we see most growth is infrastructure, and that is, of course, driven by stimulus measures. Other than that, we do not see a significant impact from stimulus as of yet, but I will return to that. We then look at the overall pricing environment in China. As I mentioned earlier that the competition for market share, particularly in China, is very intense. In particular in China, I would say that we have been able to grow in a declining market without sacrificing our margin, and that we have been able to achieve as a result of a very good development in our overall product competitiveness, the strength of our team on the ground, and our good and broad distribution in the market. I would say if you look at the overall pricing trends, they have continued to be challenging, and we can expect also that that situation continues. Of course, our objective is to continue to improve our competitiveness as we have very successfully done in the past as well. Going forward, we expect the market for this full year, this year to be stable or slightly down. If you look at the impact of government stimulus in the market, that is not significant and we can't really see it as of yet other than in the infrastructure segment. The market remains uncertain and in some places very challenging. I think also we have to see that there are some good news also coming out to the market. In second quarter, for example, real estate transactions increased quite solidly throughout the market, and we could start see in the past few months that pricing improved in the top 100 cities now on a sequential basis. I think that this positive development gives us, again, confidence in our longer-term view in the Chinese market of the continued strong urbanization on the improving quality of urbanization. You can say despite a challenging market, we can see that if competitiveness is strong, it's a big market with a lot of opportunities. It's also possible to, as we have shown, to perform strongly in that market environment. That's again, a little bit more in detail about the Chinese market and our performance there. Let me go to our services business and start with maintenance. As all of you know, one of our most important strategic objectives is to accelerate the growth in our maintenance business. I'm happy to say that our maintenance sales developed positively in all geographic regions on an earlier good trend. In fact, a slight acceleration even. Our sales growth in Asia Pacific continues to be strong. Good overall performance in the maintenance business. If you look at the markets, we can say, first of all, that Europe and North America markets continue to grow, although as before, there continues to be differences in the market environment overall. Competitive environment continues to be tough in many markets. Asia Pacific, here we continue to see very good trends in the market. The markets continue to grow, and that's, of course, a good thing for us given the very strong market position we have in Asia Pacific overall, and that we can see how we are able to turn that into strong sales growth in that region. If you look at our modernization business, here, our orders received grew slightly. Also, our objective here is to accelerate the growth. This is an area where I think we can do better. Modernization sales grew strongly in North America. Here we are doing quite well. In Europe, Middle East and Africa, I believe we have good potential to improve our growth rate. If you look at the markets overall, North America markets continue to grow somewhat. Also markets in Central and North Europe grew. In South Europe, they remained at a weak level. In South Europe, I would like to highlight one positive market, which is Spain. Here we can see again from Spain that when the overall market economic environment improves, then we can also see a clear correlation to the modernization market. As we know, the Spanish economy is recovering, and we can see that clearly in the modernization market. Overall, as I said, many of South European markets still remain challenging. That's about our businesses and our market development. Let me go to our development programs. As you know, we have always three-year cycles in our development programs, and we are now halfway through them. I would say, first of all, that I think we have had solid development in them overall, and we can see that we have strengthened our competitiveness in many areas. Today, we always highlight one of the areas. I want to highlight what we've done in what we call our program, The Most Competitive People Flow Solutions, where our objective is to have the most competitive elevator and escalator offering and develop solutions for smart buildings. First of all, here, the focus is again on how we can strengthen our competitiveness in the key growth markets. That we have done again during the first half of the year. In the first quarter, we launched the KONE I MonoSpace elevator that is specifically designed for the Indian residential market. It brings all of KONE's strength in this product with ride comfort, with energy efficiency. What is new, what we're bringing to the Indian residential market is a much more attractive visual design and options on that side. I think that the attractiveness of the elevators we bring into the residential market in India, we are clearly taking to a new level with this product. I must say that I'm very pleased how this has been received by our customers since it has been launched. Another important growth market at the moment is the overall infrastructure and public transport market. For this, we have launched a new version of our infrastructure escalator, the KONE TransitMaster 140. To again, make sure we have a stronger competitiveness in this key growth segment. Also when we look at the smart buildings, we have strengthened our offering in North America with our People Flow Intelligence solutions. Related to that, we have also launched our Turnstile 100 product in that market. Again, you can see many different improvements in our competitiveness in key growth markets of the world. Finally, our market outlook, which we have slightly specified, starting with the new equipment market. First of all, Asia Pacific. The market is expected to be rather stable in 2015. The Chinese market, as I mentioned already, we expect that to remain stable or decline slightly this year. In Europe, Middle East and Africa, we expect the market to grow slightly. In Central and North Europe, market is expected to be stable or grow slightly. In South Europe, we expect to start to see a recovery, although from a low level, but at least we can start to see a recovery. This we can see through the recovery we're seeing already in Spain and the stabilization of the market in France. In the Middle East, we now expect the market to grow slightly this year. In North America, we expect the good trend to continue, the market to continue to grow. Maintenance market. Here, the overall outlook is the market environment will remain very much similar to what it's been so far. The market to grow overall, but with variations from market to market, and we expect that the development in Asia Pacific will continue to be positive. Modernization market, rather stable in Europe, but continue to grow in North America and Asia Pacific. Given the weight of Europe, we expect the market overall to be rather stable or grow slightly. I would say that perhaps on the positive side, most important changes are that we are seeing a slightly better environment in Europe. Finally, KONE's business outlook. We have now six months of the year behind us, so we have specified our outlook. On sales, we have now narrowed our range a little bit. We expect sales to be between 6%-8% in comparable currencies. Previously, we expected to be between 6%-9%. In the first half year, we've grown at about 7%. I think that this range is very much in line with that. If we look at our operating income, here we now expect it to be EUR 1,190 million-EUR 1,250 million, and here we assume that translation exchange rates now remain at the average level of January to June 2016. Previously, we expected the range to be from EUR 1,140 million-EUR 1,230 million, assuming exchange rates the level of January to March. Previously, we expected that translation exchange rates would bring about EUR 100 million positive to our results. Now we're saying we expect with this translation exchange rate that it will be positive of about EUR 100 million to EUR 120 million. We look at the specification of our range, we can see that actually most of it is because of good underlying performance, but also because of improvement in translation exchange rate. I would say if we look at this outlook, we look at the strong order book we have and the broad-based strong execution we have, I think we have quite a good confidence for our performance for rest of the year. With that, I think we have now good time again for questions.

Speaker 11: Henrik, let's start with questions from people. Jaime Riera for Credit Suisse.

Speaker 8: The strong modernization sales now to it was negative one. Is it lump? Is it underlying sales?

Speaker 7: If you look at our performance over the past quarters, we have had better performance in orders received than in sales. Now we just had more of the sales coming through from the order book. There is some seasonality of it, but it's particularly the good performance in North America where our order book is stronger, and we have grown our orders received over the past couple of years quite strongly where they start to come more through now.

Speaker 8: On the Middle East, you're expecting some growth now. One, could you talk a bit about what's happened in the market?

Speaker 7: We see actually in Middle East, it's interesting, we see quite a broad-based good market in many different countries in the Middle East and many different sectors. There's quite a lot of infrastructure happening, but also the residential market is quite good. It's not one specific market. It's actually quite broad-based.

Speaker 11: Okay. We are now ready to take questions from the line. Handing over to the operator, please.

Speaker 16: Thank you. If you would like to ask a question at this time, please press star one on your telephone keypad. We will just pause for a couple of seconds to allow everyone to signal. We can now take our first question. It comes from Andre Kukhnin of Credit Suisse. Your line is open. Please go ahead.

Speaker 1: Yes, good afternoon. Thanks for taking my questions. Can I start with just a couple of questions on China? Could you tell us or could you confirm that in the backlog, the margins that you're booking right now, that they're comparable to the current backlog or to the sales level given what you said on the pricing environment and on your ability to compete in the falling market without sacrificing profitability?

Speaker 7: As I mentioned, strong competition in the market, I think if you look at how we've been able to strengthen our competitiveness in this market environment, we have been able to compensate the pressure in the market overall. Yes, you're right. The margins that we are booking are consistent with the margins in our backlog.

Speaker 1: Got it. Thank you. Could you tell us in terms of your two brands in China, KONE and Giant KONE, how are they performing against each other and against the market? Are both growing at a similar pace, one outgrowing the other and versus the market?

Speaker 7: First of all, we look at our China market as one whole. It's important to have the two different brands. Of course, when the market environment is different, at some point, one grows more than the other. In this current specific environment, given that the performance is stronger in the higher tier cities with larger customers, we see a better development overall for the KONE brand given the overall market. Here in this, we can also see a slight difference between the two. The situation varies between the two, so I think that's the strength we have is that we can really see the difference in the market and cater to different market environments.

Speaker 1: Got it. Just on Europe, it's nice to see the improvement in sentiment. Could you help us, just thinking about the gearing of that impact on KONE. Should we think about it as a turning point, but in terms of actual meaningful or tangible improvement or impact on your bottom line, it will be somewhat later on once that starts translating into high additions to installed base and therefore maybe pricing pressure easing on service? Would you anticipate actually any early impact from this already from the new equipment piece? Just sort of being aware of very low profitability of that segment. Just how should we think about the impact from Europe getting better on your bottom line?

Speaker 7: Well, I would say, first of all, let's put it in perspective, as I said, slightly. I mean, Europe is going in the right direction. If you look at Europe, Middle East, and Africa, about 40% of our overall sales. Of course it's important. I think what's important here is that now that we had a Asian market that was slightly slower, somewhat slower than we've seen in the past years, we were able to actually grow well because we're able to accelerate our growth in Europe and continue to have a strong growth in North America. Of course, it has some impact when we start delivering these orders. I think you have to remember that our revenue streams come from a broad set of countries, projects, and different businesses in those countries. There's usually not one single market that is driving profitability. As we saw again, it was broad-based. I don't think I can go much more in detail into that. Of course, always, a growing market is more favorable to profitability development overall.

Speaker 1: Great. Thank you, Henrik. Appreciate it.

Speaker 7: Thank you.

Speaker 16: Thank you. We can now take our next question. It comes from Manu Rimpelä of Nordea. Your line is open. Please go ahead.

Speaker 12: Okay. Good afternoon. Two questions from me. Firstly, continuing on the China. You mentioned that you've been outperforming the market, we know that you've been doing that for quite some time already, you say that the improved distribution and improved competitiveness are the main reasons for that and also why you're able to keep prices higher. I was just wondering if you would be able to kind of give some more concrete examples of what this exactly means. Secondly, on the outlook you gave for the group and especially for areas outside of China. You sound cautiously optimistic on Europe and fairly upbeat on U.S. If I look at the order intake on organic basis, excluding China, I think it was up 8% in Q2 compared to last year. I think that's a pretty strong number. Should we read into that 8% is a cautious growth number you think of, or how should we think about that 8% in the context of your comments? Thanks.

Speaker 7: Okay. Can I ask then if going on that we take one question at a time, because I must say that your second question was so long that I must say that I'm not sure I quite understood your second question. I'll start with the first one, where you say if we can give something specific on China. I think the point is that it's a very broad market. We have a broad, I would say very strong team in China. It's a very broad customer base. In a market where you have both strong and weaker situations, it's all about who has the best team on the ground with a strong product competitiveness and good distribution who finds these opportunities. I don't think I can give you any more specifics behind it. It's about even a challenging environment. There are a lot of good opportunities in market. How do you find them? How do you make sure that you have a product that is competitive against it and a sales force that knows where the opportunities are and how you price them? That's what it's all about. It's not about individual situations. It's about having a broad-based structure to be able to deliver that. I must say, sorry, Manu, your second question, I-

Speaker 12: I'll repeat that one

Speaker 7: I didn't understand.

Speaker 12: I think your outlook is. If you look at the orders in Q2 on an organic basis, take out China, I get to a number something like 8% growth in organic order intake outside of China. You sound still fairly cautious on the kind of European recovery and okay upbeat on the U.S. Just trying to understand that how should I think about the cautious comments still on the kind of outlook, but then a pretty strong organic growth outside of China. Should we see that if Europe starts to picking up, then that number should be a lot higher going forward? Just how should I think about that?

Speaker 7: Well, first of all, as you know, we don't guide our orders received, so we don't give an outlook on that. As you know orders received can fluctuate. We have to remember this is one quarter. They can fluctuate quarter to quarter. I would say that our message is that we are slightly, and I would underline the word slightly, more optimistic on Europe when we see the trends in there. We continue to see a good market in North America. Overall, if you have a growing market and if you have your competitiveness in shape, then you can of course find good growth opportunities. I don't know how more I would comment on that.

Speaker 12: Okay. Thank you.

Speaker 7: Thank you.

Speaker 16: We can now take our next question. It comes from Jonathan Hanks of GS. Your line is open. Please go ahead.

Speaker 10: Hi there, Henrik. Just one on China again, sorry about that. Just on payment terms specifically, we just had a number of peers comment on worsening payment terms in China specifically. Just wondering if you'd seen any impact there at all. Thanks.

Speaker 7: Thanks. Well, Eriikka, do you want to address that?

Speaker 3: Yeah. I can comment about the payment terms in China. Yes, there's been a slightly tougher situation due to competition. We have been able to hold on to our good payment terms, so nothing dramatic there. Good cash flow from China.

Speaker 10: Okay, thank you very much.

Speaker 7: I think the key point is you can see our continued strong cash flow. I think that shows how we've been able to run our business.

Speaker 10: Thanks. Very clear.

Speaker 16: Thank you. We can now take our next question. It comes from Michael Hagmann of HSBC. Your line is open. Please go ahead.

Speaker 15: Good afternoon. Several questions, if I may. The first one, if we now look at the fact that you have 45% of your orders from China, 40% of sales. If you look at it from a risk controlling perspective, I was wondering, have you been increasing your controls or changed the way that you manage the cash, how you get the cash out of the country, just in order to make sure that if we see a precipitous decline in demand in China, the company is safeguarded? Second question then would be, what is the risk that as we are now seeing orders-

Speaker 7: Let's take one question at a time.

Speaker 15: Okay. Sure.

Speaker 7: That would be appreciated. First of all, always when a certain market gets more challenging or a specific area in a market is more challenging, clearly you take a deeper look at that, put focus and controls in place, and make sure you strengthen your resourcing in areas to make sure that you collect your money and you maintain your payment terms. Also, as you know, we are being able to repatriate our cash from China. From that perspective, we are in a pretty good situation.

Speaker 15: Okay. If you now look at the order trends, obviously you've been saying that the market is now down in the second quarter. We've seen, as you know, very weak housing starts and obviously also weak completions. I see that we are seeing a sequential improvement in pricing. Nevertheless, there is this overbuild that we have, particularly in the lower tiered cities. How big do you think is the risk that we actually see a meaningful decline in the market for the rest of the year and in 2016?

Speaker 7: Well, as always, the outlooks that we give for the market, that is our best and transparent outlook for the market. We don't believe that we will see a situation that you are describing. We expect the market is set to slightly decline or be stable year-over-year. You again have to remember that the market is not one homogeneous market. There are many different situations, and there are lots of higher tier cities that are actually in pretty good shape, where inventory levels are improving and are not any higher than where they've been on average over the past several years. We continue to see good urbanization in a lot of cities. You have others where the situation is more challenging. When we look at this net, that's how we come to our outlook and based on kind of customer activity and the activity on the ground that we see. That's our best and most transparent outlook for the market.

Speaker 15: Would you dare to look into 2016?

Speaker 7: As you know, Michael, we don't at this stage of the year give an outlook for 2016. I think what's important, as I mentioned, that we still are confident that urbanization will continue to be strong in China, and the quality of urbanization will continue to improve. That is driving the density of elevators and escalators in the market, driving higher standards of living. All of which are positive. I think what I mentioned is that when we start to see now again transaction volumes improving quite strongly in Q2, that gives us confidence that longer term the market has good opportunities, even though we see the clear uncertainty at the moment.

Speaker 15: Thank you. Can I also ask about net working capital trends? Obviously, we had not quite a regular pattern, if you look at the second half of last year, Q1 this year and Q2 this year. Can you give us your expectation for net working capital development in the second half? Thank you.

Speaker 7: Eriikka.

Speaker 3: Yes. First of all, we don't give guidance to our balance sheet items and cash flow either. Yes, we have seen fluctuation, but that is mostly related to payables. I would say that net working capital is negative EUR 950, so we are very pleased with that level.

Speaker 15: Thank you very much.

Speaker 16: Thank you. We can now take our next question. It comes from Fan Fang of Summit View. Please go ahead, sir.

Speaker 4: Hi there. Congratulations on the very good, very solid results for the second quarter. One thing I want to further understand is Your EBIT margin in the second quarter actually advanced a lot. Could you help me to understand what kind of major reason that drives the EBIT margin growth?

Speaker 7: I would say that there are two main reasons behind it. One is the overall solid performance we had on a broad basis. That brought us good profitable growth and good profitability. When we have favorable translation exchange rates at this level, that little bit also helps our margin. Because if you look at costs such as research and development and process development, those are more EUR-weighted, so therefore a shift in exchange rates a little bit helps our margin as well. I would say it's a combination. It's not one specific area. I would say it's the broad-based solid execution, plus a little bit of exchange rates.

Speaker 4: Thank you. Is the low material cost and also parts supply also help to that?

Speaker 7: That has helped a little bit. Eriikka, our raw material impact for the quarter was-

Speaker 3: About EUR 5 million

Speaker 7: about EUR 5 million. We have to remember that one of the areas we said we have strengthened the competitiveness of our offerings. We have slightly benefited, not much, from raw material, but there's been design changes, sourcing impacts and so forth. There are many different areas that contribute to that, That's the reason we've been able to maintain a good and healthy level of our orders received .

Speaker 4: Could you help me to understand the cost structure of your new equipment production?

Speaker 7: In which way?

Speaker 4: How much is from raw materials and parts? How much is from labor, things like that?

Speaker 7: First of all, raw material is not that significant of a part of it. We have to remember that we don't buy really raw material directly. It's embedded in components that we acquire. Most of the standard components elevator we buy from our suppliers. We assemble some of the parts ourselves. I would say most of the cost comes from buying components from our suppliers. Of course, they have all of the components.

Speaker 4: In the cost structure, what's the breakdown of the component supply outsourced from the third party?

Speaker 7: That's a very significant part of our cost base in our new equipment is what we buy from suppliers. I think-

Speaker 4: Do we see price decline from those component suppliers?

Speaker 7: The answer is yes, and you have to look at where does it come from, and it comes from, of course, working with suppliers on improving designs. We have to remember that with the very significant volumes we have, we have a good benefit in the market of getting benefits from that volume. It comes from many different sources.

Speaker 4: Mm-hmm. I see. The other thing I want to understand is you just confirmed that the margin for the backlog is pretty much consistent from previous year. If you look at the new order intake from China, would you say on apple-to-apple basis, the ASP also maintain as pretty much the same level or ASP probably also slightly decline a little bit, which kind of offset by the cost decline. How would you comment on that?

Speaker 7: As I mentioned, because of the fight for market share, there has been price pressures in the market and prices have been declining slightly. Yes, prices have declined slightly, but we have been able to compensate that with improvement in our competitiveness and as a result, been able to defend good margins in our business.

Speaker 4: Thank you. If I use your full year guidance of the EBIT and back out the second half EBIT, which is comparable to the second half of last year.

Speaker 7: I would say if you look at our outlook and I think the point is that we expect a continued solid performance.

Speaker 4: Yeah, it's quite solid. Second half of last year's EBIT margin was, if it's not historically high, it should be close to a historical high. I'm not sure if my calculation is right. If I just use your full year EBIT guidance and then back out the second half EBIT margin for this year, which is quite comparable to last year.

Speaker 7: Okay. Well, we don't guide our margin. We give a range for sales in comparable currencies, and we give a range for operating income. From that, you can see that we expect to continue to have a good and solid development in the second quarter. That's the point.

Speaker 4: Okay. Thank you very much. Clear.

Speaker 7: Thank you.

Speaker 16: Thank you. We can now take our next question. It comes from Guillermo Pein of UBS. Your line is open. Please go ahead.

Speaker 6: Hi, it's Guillermo Pein from UBS. Two questions, if I may. Could you comment a bit on how the price declines in China actually compare to the price declines that you saw in Q1? Is it fair to assume that as order declines for the market, not so much for you, the price competition is probably going to increase going forward?

Speaker 7: I would say that the overall trend, I don't think has changed that much from quarter one, so in that sense, it's not a big surprise. Let's see. I think we continue to expect a very competitive environment, but also we expect that we can continue to perform strongly if you look over a period of time in that market, as we have done so far. I wouldn't expect any significant change to that overall equation.

Speaker 6: The second question is regarding a comment you mentioned earlier about density of elevators. I'm just puzzled a little bit because if total floor space under construction at the moment is roughly flat. Just growing a bit. Actually on your statement, you say that order intake or orders for elevators are actually going down. That would imply actually density is declining rather than increasing. How can we read that density comment from yours? Thank you.

Speaker 7: Well, I think when you look at density, you have to look at it over a fewer period, because when you look at orders and you look at floor space, they don't go exactly in sync. You can't compare them exactly. If you look at it over some period of years, then you can see a continued improvement in the density. What the improvement is exactly right now, that's why it's difficult to say, because you have to average over a number of years for the two statistic data points. They are not quite apples for apples.

Speaker 6: That's interesting because I was doing that, theoretically, I can agree with you on the density comment when you compare elevator installations and new starts. I can see that there's an increasing amount of elevators per total billion sq m have it. If I compare the total elevator installations to the total floor space under construction, it's actually a very, let's say, 1-to-1 relationship, almost 90% correlated. I'm puzzled because new starts is a very early indicator. It takes 2 to 3 years to build in China. I just wonder whether there's actually density increases at all over the last 5 years for the Chinese market.

Speaker 7: We would expect that it has been. I don't have the exact numbers here with me, that's based on our understanding, that definitely has been a continued improvement in density when you look at what types of buildings and how many elevators they have and what regulation requires.

Speaker 6: Okay. Thank you.

Speaker 16: Thank you. We can now take our next question. It comes from Max Lieberich of JP Morgan. Your line is open. Please go ahead.

Speaker 14: Hello. Thanks for taking my question. I want to ask a little bit more about what you're doing with suppliers in order to lower your cost base moving forward. If you tell me more about that and more about the supplier policy, not only in Europe but also in China, that would be interesting. Staying on the topic of suppliers, one of your key suppliers, ThyssenKrupp, recently announced they were starting production of elevators or elevator components in South America in order to service not only the South American but also the North American market. What kind of opportunity do you see there? Did you view that as an opportunity to secure more components from one of your larger suppliers at a slightly lower rate than you may have done historically?

Speaker 7: First of all, I think on the first question you had, I can't give you an exact answer because if there would be one specific area where you could get a very significant improvement, that would mean that you haven't done a good job in the past. This comes from many different streams. It's really a combination of continued development of your offering, of your product, of the materials and components you use them, how you apply them, how you can reduce number of components. Of course, there is some also action on the sourcing side, how you can benefit from increasing volumes you have and standardization and so forth. There's just such a broad plethora of areas you need to look at when you talk about the overall strengthening of your competitiveness. South America supplying to the U.S., we have many suppliers. I don't know exactly what. Maybe it could give us some opportunities. As you know, we are not in South America. Maybe it could help our suppliers in North America. I don't know. We have good suppliers there. There's a good competitive situation. I don't think that that's such a big individual factor for us.

Speaker 14: Okay, thanks very much.

Speaker 16: Thank you. We can now take our next question. It comes from Jinhong Wang of Exane. Your line is open. Please go ahead.

Speaker 9: Hi, thank you for taking my question. It's Jay Wang from Exane. I have a question regarding the service business. China. Could you give us an update on the conversion rate in China in Q2, please? Maybe the sales split between service and new equipment and the growth rate in service. Thank you.

Speaker 7: We continue. First, we start from a growth perspective. We continued strong growth in our service business in China. We've said that it's been compounding recently at about 25%, and it continues to do at that good level. That's positive. It continues still to be less than 10% of our sales, not much use on that front then. Overall, still conversion rates, not a big change. For the KONE brand, we continue to operate at around 60%. Then if we include Giant KONE, for the whole KONE, it's a bit lower.

Speaker 9: That's very clear. Thanks. I have a follow-up. You have increased your workforce in China last year by about 20%. I guess, many of them, therefore, your investment in the service team. How is the headcount development in China for this year, for now, or you have a general target for the end of the year?

Speaker 7: Well, we haven't set specific targets, but we continue to increase our headcount in China, particularly, as you said, on the service side. That's a more, I would say, labor-intensive part of the business. I think there, when you grow, one of the important areas is to continue to get more skilled technicians into your workforce to make sure that you can have a good service delivery. We have very active training programs ongoing in China, and we will continue to expand our service workforce in the market. That's, I guess, how specific we can be there.

Speaker 9: Okay, thank you. Maybe one last question about your American business. We see the order of series this quarter. It seems the biggest driver is volume product. Maybe I'm wrong because I was just reconciling your comment with volume product growth. Can you give a little bit more color on this? Are you getting more market share in the U.S. or it's the general overall market is rebounding more faster? Thank you.

Speaker 7: We believe that we would have grown in the first half of the year clearly faster than the market in the United States. I think we have a good competitiveness there. Market is growing, I believe that we are growing faster than the market.

Speaker 9: The key driver behind this, any reasons? Which segments are growing faster?

Speaker 7: I think it's the segments are growing are both commercial and residential. If you look at the trends in the North American market, they are favorable for us because the Machine-Room-Less segment overall continues to take market share from the hydraulic segment, and we are a very strong player in the Machine-Room-Less market. We have a good overall competitiveness in the market. We have strength in our team. I think in that sense, Just remember, it's not only product, it's team you have on the ground. It's a combination of that then. I think we have been able to improve on both sides.

Speaker 9: Okay. Very clear. Thank you very much.

Speaker 7: Thank you.

Speaker 16: Thank you. We can now move on to our next question. It comes from Glen Liddy of JPMorgan. Please go ahead.

Speaker 5: Good afternoon. In terms of the margins for original equipment, I think in the past you've suggested that China is around the group average, but in developed markets, it's below the group average. Is that still the case?

Speaker 7: Our best new equipment margins are in China. That's correct.

Speaker 5: Going forward, if we've got no growth in China and stronger growth in the rest of the world, do you think you can keep the margin in the order backlog at the current level?

Speaker 7: I wouldn't start speculating on that. I think, you know, Glen, our objective is to continue to grow profitably. If we can continue to improve our competitiveness, we can also improve our profitability in each of the markets. That's how we look at it. The most important point is that when we grow, we grow profitably. There are slight differences in the profitability, but that's the most important point, and that's the way we continue to generate good cash flow and returns in this business.

Speaker 5: For China, are you seeing any cancellations of orders?

Speaker 7: No, not really. I mean, our cancellations overall have continued to be at a very low level as they have been in the past. The answer to that is no.

Speaker 5: In terms of the delivery profile, I know you don't give us an average delivery time, but the order backlog today, particularly for China, stretching over the next 12 months, is it the same percentage of the backlog that will be delivered over the next 12 months as you had over the last 12 months? Or is the time getting longer?

Speaker 7: You want to comment on our delivery backlog profile?

Speaker 3: I would say that the quotation has remained approximately in the same level as in the previous years.

Speaker 5: Okay. Thank you very much.

Speaker 7: Thank you.

Speaker 16: Thank you. We can now take our next question from Ben Wilson of Redburn. Please go ahead, sir.

Speaker 2: Yes, good afternoon, everyone. I've got two questions, please. Firstly, on new equipment pricing, thanks for the comments on China. Can you give some commentary on what pricing developments you've seen in Europe and North America? I know there's some commentary in the press release, perhaps some quantification as to what pricing trends you're seeing there. Thanks.

Speaker 7: First of all, if we start on the most positive area, in North America, our pricing is improving. That's good. In Europe overall, not significant change. You have to remember that many European markets are still quite weak, even though we see the slight positiveness and positive development we have. I think in China, as we said, that pricing is slightly down, given the strong competition for market share there.

Speaker 2: I think in the past you said that your Chinese market pricing at least is down 2%-5%. Can you scale where European pricing is versus that, and where North American pricing is versus that?

Speaker 7: We don't usually open up so detailed. You have to remember, Europe are so many different markets as well and a little bit different development there. I think overall, as I said, positive trends in the U.S., Europe more mixed but more stable, and China, I think we discussed already.

Speaker 2: Okay. Thank you. Just going back on Chinese maintenance. Growth rate still growing at 25%, but I think you said that the conversion rates haven't really changed much, and I'm just curious as to why you're not seeing the conversion rates move up for either Giant KONE or for your KONE brand, given the investment you're doing in maintenance, the workforce there. Perhaps a comment as to why conversion rates appear to have stalled a little bit.

Speaker 7: Well, as you know, the overall market structure is such that there are a lot of independent players that also continue to grow there. I think what's important is that we continue to grow at a very good rate in China, and we have a good performance. I think it's clear that over the coming years, our objective is to increase the conversion rates. Given the market structure, it's not something you'd change overnight. I think our clear objective over the coming years is to improve that.

Speaker 2: Because the conversion rates have been rising, though, from 2007 to 2011 or so, and then they appear to have stalled a bit over the last few years. Do you think it's fair that we've hit kind of a level at which they can't really rise much further?

Speaker 7: I don't think so. I think that as the market develops, I think the focus on quality of service and productivity of service will become more important, and I think then we will have a good position. I'm confident that over time, that will be a favorable development, but it's not something that will change overnight. I would say the good thing is that particularly with the KONE brand, our performance continues to be solid, and we are a very significant presence in the market.

Speaker 2: Have you started to take share yet from competitors' install base in China, or are you still very much focusing on your own install base for now?

Speaker 7: China. Base is predominantly KONE equipment and Giant KONE.

Speaker 2: Okay. Thank you very much.

Speaker 16: Our final question today comes from Martin Fluegelschlaeger. Go ahead, sir.

Speaker 13: Good afternoon. This is Martin Fluegelschlaeger from Kepler Cheuvreux. Two questions, if I may. Just going back to your outlook on new equipment market growth in China. Looking at the recent statistics coming from the National Bureau of Statistics of China. By the way, I'm aware of the statements you made on the heterogeneity of the market. Just looking at those statistics, particularly looking at land purchases and looking at new construction area, looking at inventory levels overall, the outlook of a stable to only slightly declining market, particularly given the fact that Q2 was already slightly declining, seems to be somewhat overly optimistic. How would you respond to such a claim? That's my first question. Secondly, coming back to-

Speaker 7: Martin, let's take again one question at a time.

Speaker 13: Sure.

Speaker 7: I think it provides more clarity that way. I would say, you have to remember that I think first of all, we have a very good team on the ground in China. We have a very broad team on the ground in China, we follow the market very closely there. Of course, have a close relationship with our customers. Based on everything we see in development in the market in China, this is what we believe at the moment, and also when we look at overall real estate investment in the market. This is our best and most transparent view, and what we of course are committed to stick to.

Speaker 13: Okay. Thank you very much. Second question, coming back to EMEA, particularly Europe. If I remember correctly, the statement in the Q1, or sorry, Q2 report was that Europe overall was flattish to slightly up. If I remember also correctly, the statement on your own order intake growth in Europe was looking for clearly growing in Europe. I think those were the words. If there's a discrepancy, are you gaining market share? And if yes, from whom?

Speaker 7: I would say that we had overall a good performance. Did we grow faster than markets? We probably did. Were we taking market share? I don't know. I can't exactly say, but I would say overall, I would say that I think the key message and the key takeaway from the quarter is that our performance was very strong on a broad basis, including Europe. I think that's important, and that's why I'm very happy about how strong the execution we had on a broad basis.

Speaker 13: Okay. Thank you very much.

Speaker 7: Thank you.

Speaker 16: We have one final question from Robert Wertheimer of Commerzbank. Go ahead, sir.

Speaker 17: Good afternoon, ladies and gentlemen. One follow-up on China, if I may. Could you share your view with us on the effect of the stock market drop? It looks like in particular private investors have been hurt, and could there be any spillover effect to developers offering a low hassle return for their properties they sold?

Speaker 7: I think there are better experts to assess the impact of the stock market volatility we've seen in China. I think the best understanding we have is that if they can keep it more stable at these levels, or if the market stays more stable at these levels, the wealth effect should be limited. In the end, the number of private individuals active in the stock market is not that high. At least based on the intelligence and understanding we have so far, it has not had a significant impact on either investments in real estate. In fact, investments in real estate are going up at the moment, and also consumption seems to be pretty solid.

Speaker 17: You're hearing no complaints in the developers, in the real estate developers.

Speaker 7: We have not seen any significant impact on our developer customers from this.

Speaker 17: Good to know. Thanks.

Speaker 7: Thank you.

Speaker 16: As we have no further questions at this time, I'd now return the call back to the speakers for any additional or concluding remarks. Thank you.

Speaker 11: Thank you. We are ready to conclude the call from today. Thank you everybody for your participation, We would like to wish you a very nice rest of the day. Thank you.

Speaker 7: Thank you.

Speaker 16: That shall conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.