Good afternoon, and welcome to KONE's third quarter earnings call. My name is Natalia Valtasaari. I'm KONE's Head of Investor Relations, and I'm very pleased to be joined here today by our President and CEO, Henrik Ehrnrooth, and by our CFO, Ilkka Hara. As usual, Henrik will take you through the key highlights of the quarter, both in terms of market and business performance.
Ilkka will then follow up with a bit of a deep dive into the financial. Henrik will wrap up with a summary, and the kind of market and business outlook that we see going forward. After that, we'll take your questions. Please, during the Q&A session, limit yourselves to one question and then one follow-up. You can join the queue after that, but let's try to ensure that as many people as possible have the opportunity to ask questions. With that, I will hand over to Henrik.
Thank you, Natalia, and a warm welcome to everyone, and good to have you with us today again. Clearly, Q3 had many different situations, both challenging and positive, and we'll talk about both of them today. Let me first start just with the highlights. Perhaps the biggest things during Q3 that impacted our performance overall was, number one, the weakening of the Chinese new equipment market.
It's clear that that had impacts on our business in the third quarter. At the same time, what was very positive in the third quarter was a continued very strong development of our services business, in both maintenance and in modernization. So this I'm very pleased about. Another very positive thing in the quarter is that our margins of our orders received continued to improve.
Actually they improved in all geographic regions now, both sequentially and also in total year-over-year. We can see that the actions we've been taking to improve our profitability, something that is a very high focus for us right now, is going in the right direction. Let me start with Q3 and the key figures for Q3. Orders received at just over EUR 2.155 million, and a decline of 10% in comparable currencies.
Here, Ilkka will talk about this in more detail, but China declined clearly, whereas we had growth in rest of the world. Perhaps a positive thing is our strong order book at almost EUR 9.9 billion, 8.4% up year-over-year.
Our sales grew at 6.5% to comparable currencies at almost EUR 3 billion. Really here, the highlight was our services business. Maintenance grew again at a very good rate of 8%, and the growth here was driven by a good combination of good growth in number of units in our service base by pricing, but also in continued good progress with our 24/7 Connected Services.
That was a key growth driver, but overall broad-based growth that resulted in 6.5%. Operating income at EUR 304 million, and adjusted EBIT at EUR 306 million, down from EUR 326 million the year before. It's clear that the decline of margin from 12.5%- 10.2% is not something that we are happy with. It's clear that from here we want to improve clearly.
What is positive, though, is that we could see that our margins, particularly our new equipment business, that they were at the bottom in Q2, and we now have sequential improvement and we expect and of course, want to continue to drive improvement from here. Cash flow now EUR 336 compared to EUR 365 a year ago, and EPS down 8.5% to 0.46 EUR. As we always say, one quarter is a very short period of time, and now we have already three quarters behind us. If you look at orders received, stable, compared to last year in comparable currencies, close to EUR 7.2 billion.
Perhaps, again, I talked about the order book, but what is very important here is that this super strong order book that we have, it provides us a very solid foundation going forward. That in combination with our good and growing service base, as you remember, we don't have our service business included other than repairs in the order book. The combination of these two gives us a very good situation going forward, even in a more challenging environment. We have a lot to deliver over the coming year or two. Sales close to EUR 8 billion, down 3.5% year-over-year. Of course, the biggest impact on our sales year to date has been the very significant impact of COVID lockdowns in China in Q2.
EBIT, adjusted EBIT at EUR 712 million, down 25% to EUR 950 million and a margin of 8.9%. As I mentioned, this is clearly not something that we are satisfied with. Ambition is to improve clearly from here, and as I said that we have started to see an improving trajectory. Cash flow now EUR 721 million, down from the exceptionally strong EUR 1.3 billion a year ago. EPS EUR 0.97 compared to EUR 0.43 year before. We all know that the world economy and the environment has continued to be challenging. When I look at how the KONE team is driving improvement and driving performance in this environment, that is something I'm very happy about.
I can see a continued good drive and spirit in the team in driving improvements, everything from pricing, focusing on productivity, and just making sure that we're making progress in our key focus areas. That is something that is very pleasing. Been traveling a lot around our units in the past months, and that is the same message and the same reception one gets everywhere. Huge thanks again to the entire KONE team for great work and that they have been doing. Now a little bit on some business update. Highlight this time is how we're driving momentum in services. I talked already about what is driving our maintenance growth, combination of all factors. Wanted to give a little bit more insight to our 24/7 Connected Services and modernization.
The penetration of our 24/7 Connected Services is now close to 20% of KONE equipment. At the same time, we are also installing 24/7 Connected Services on all other brands. That is something I think differentiates us in the market that we can do it both for KONE and for non-KONE branded equipment. That's why we also starting to approach a 15% overall penetration. I think key for KONE equipment, we have this good rate now. Customer benefits are very measurable, but also we can see that our conversion and retention rates are improving. Now, what is even more important is that beginning of this year, we launched our new service called KONE Care DX that is specifically designed for our DX Class elevators that we launched in 2019.
Now, what is great is that this is an evolution of our KONE Care service and our 24/7 Connected Service, and it was the first carbon neutral maintenance out in the market. Now, we can see that when we look at conversion rates, we look at pricing, we look at all the measures, they are even better with KONE Care DX. The point here is really that 24/7 Connected Service is not a static service for us. It's something we continue to develop and continue to make sure that we can improve outcomes for our customers and for us. As we've highlighted before, the impact for our customers when we have units connected is that call-out rates are 30% lower, entrapments down 40%, and we can see, in 65 type of cases, we can proactively identify faults.
Of course, making sure that we can do things proactively and more conveniently for our customers and more productively for us. Now, modernization is also a market that continues to be robust and good. What is interesting is that we're seeing the classical trends of an aging equipment base that's continued to drive modernization. It's very much there. We also have other trends that are also boosting, particularly on the commercial side, but also from a sustainability angle growth here. We can see that, for example, offices are getting more modernized than before. Because if you want to attract, for example, employees back, you need to have a modern and good office. Then usually when you modernize, elevators are part of the package. We're seeing more younger equipment being upgraded for adaptability and for better experience.
Also we are seeing focus on sustainability. You know, we can see in some countries, the Recovery and Resilience Facility also subsidizes elevator modernization. Good drivers here, even though economic outlook is uncertain, we can see continued good momentum in this business, which is great, and we have really taken advantage of it. Now, as we said for a few quarters, what is very high up our agenda is to improve our financial performance, in particular our EBIT margin. That is a combination of pricing action and more dynamic contract models. Here we're making good progress. Modernization, we have more than covered the increased costs. Any new equipment, we're making good progress. Still some way to go, but momentum is clearly there.
Another focus area has been to how can we reduce our product costs through R&D development, offering development, then of course, sourcing actions. Here, I would say particularly the development in China has been great. The China team has done a phenomenal job here. Of course, now we also starting to see an easing of raw material costs in China. Productivity also improving order book margins. Of course, another driver for our margin improvement is to drive growth in our service business, which we're doing very much so. Now we can also, of course, see that in the past years the operating environment has changed very rapidly, starting with COVID-19, and then we had, of course, supply chain disruptions, then we had war in Ukraine and so forth.
There's been rapid changes, and we are therefore now planning to simplify our operating model in order to be able to more rapidly respond to changes like this, but also to improve our efficiency and therefore to support the improvement of our financial performance. That is something that we are planning to do. Those are some highlights and some updates on where we are on these focus areas. Market development. If we start with new equipment market, we can see that development has been mixed. North America, we're showing -1%. Actually what's happened in North America, the number of units, the market declined a bit, but the market grew significantly in monetary value. We can see our performance has been excellent in that market.
We can see that prices, overall prices in the market have come up significantly. Therefore, that continues to be good and robust market. Europe, Middle East and Africa, mixed. War in Ukraine is clearly starting to impact Central and North Europe, whereas South Europe is slightly better and although it declined slightly as well, but the Middle East, of course, with the energy price trends is doing very well. There we're seeing growth. China, there was a further deterioration. The market declined about 20% now in Q3, and I'll talk soon a little bit more about the Chinese market. Rest of Asia Pacific, good developments overall. Highlight here is India, which has recovered very strongly after COVID and developing positively. That's probably a little bit deeper dive into China.
Market environment did deteriorate further in Q3. Really the key issue is liquidity constraints for developers. Because of poor liquidity, it's clear that their construction projects overall are moving slower and therefore that, of course, impacts our deliveries as well. COVID-19 restrictions, although they're not quite as severe in this quarter, but we have seen rolling lockdowns around the country has had an impact on consumers' confidence and ability to buy apartments. Maintenance markets continue to be good. Although now in the quarter, we did see a more mixed modernization activity. Here, we could see that particularly elevators for existing buildings were impacted by overall liquidity and the overall economic situation, whereas then park modernization developed better.
We believe that this temporary downturn in the modernization market overall in China is temporary, and we're gonna see an improvement already in Q4. If we look at the various statistics, we can unfortunately see that Q3, when we look at either real estate investments or new starts, then unfortunately they did deteriorate further. Where there is some positive development, actually the trajectory is not quite as bad as it was in the first nine months now in the quarter, is in completions. Here we can clearly see that the need to complete apartments that are started, and particularly people have made down payments, is increasing. When that gets going, there's actually a lot of elevators that need to be delivered.
Let's follow that, but that is something that we believe will happen at some point during next year. Service markets globally continue to be good. I would say maintenance, we are back at a pre-pandemic growth trend. Slight growth in Europe, Middle East and Africa, North America, and continued good growth throughout Asia Pacific. Modernization markets were very strong in the quarter. Perhaps most positive were the North American markets, but also Europe, Middle East, and Africa, good markets and Asia Pacific outside of China. As I said, the Chinese markets were now temporarily lower, but we think this is temporary phenomenon and the markets will come back there given the big need for modernizations. Overall, we can see that, yes, there are challenges in some of the markets, but some of the markets are robust.
What we have done is that we're really focused on what we want to grow in the growing markets because there you can do with better margins, and we can see that, and as Ilkka will explain soon, how we're driving growth both in maintenance and modernization continues to go well. With this, hand over to Ilkka to talk more about our financial performance.
Thank you, Henrik, and also warm welcome on my behalf to this third quarter results announcement webcast. I'll review the financials in more detail, and I'll start with orders received development for the quarter. Orders received for third quarter was EUR 2,155 million. The reported basis down 2.5%, and on a comparable basis, down 10%. If we look at by geography, clearly Americas, we saw very strong performance there. Clearly, significant growth in orders received, as well as growth in Europe, Middle East, Africa. In Asia Pacific, excluding China, more stable development, but clearly in a more challenging Chinese market, we saw orders received decline significantly. We talked about pricing quite a bit over the last quarters, and we continued to see pricing developing positively in the quarter.
We look at overall, we saw pricing improving in all regions. In modernization, we're now at the stage where the price improvements have covered the cost increases we've seen now. In new equipment, we continue to make progress, but there's still work to be done to cover the cost headwinds that we have. We're in the right direction in that area as well. We look at the outcome, the impact to our margins. We saw in the third quarter that our orders received margin improved not only sequentially, but also year-on-year. As I said last time, that's the next milestone we wanna get to in order to get past the cost headwinds that we've seen. Now we can say that we are increasing year-on-year.
Very pleased to see that now being reached in our third quarter orders margin. To sales. Sales for the quarter were just shy of EUR 3 billion. On a reported basis, growth 14.9%. Naturally on a comparable basis, less so 6.5% growth. Very happy about the fact that we grew in all regions. Strongest growth in Europe, Middle East, Africa, as well as in Asia Pacific, both growing at 7%. Americas growing at 4.5%. Also, from business perspective, all businesses grew. New equipment at 5% and modernization at 8.6%. Strong number for modernization growth. But also what I'm very pleased about is that we continue to see our maintenance performing well.
Now the growth for the third quarter to be 8%, and that is a very good number. We see improvement in all numbers, whether it's LIS, whether it's pricing, and also as Henrik talked about, value-added services 24/7, as an example, contributing positively to adjusted EBIT and profitability. Adjusted EBIT for the third quarter was EUR 306 million, and the margin was 10.2%. Clearly, it's not a number that we're happy about, down from last year's at 12.5%. While the growth that we saw in all regions as well as in all businesses contributed positively to our profit, and as well as the improvement that we continue to see in productivity, as well as in good control our fixed costs, contributing to profitability positively.
At the same time, the cost headwind, approximately EUR 30-EUR 40 million for the third quarter, driven by material components and logistics costs, contributed negatively, as well as then the new equipment delivery margins. The orders that we're now fulfilling from the past have lower margins, as we've talked about, contributing positively as well. That's contributing negatively in this point. As we said, now we expect to see the prices improving as we look forward, then also quarter-on-quarter from last third quarter of last year, we've seen orders margins improving. That would be a tailwind for us going forward. To cash flow, which for the third quarter was EUR 336 million. While operating income decline contributed negatively, the change in working capital was slightly negative in the quarter.
Slight decrease in advances, mainly driven by the orders development in China, as well as a slight increase in accounts receivable and the timing of our accounts payable now contributing positively. As always, between the quarters, some timing differences, so we expect that to reverse in the coming quarters, as a result. All in all, good cash flow for the business in the quarter, third quarter at EUR 336 million. With that, I'll close the financial part and hand over back to Henrik to cover market and business outlook for the rest of the year.
Thanks, Ilkka Hara. If we look at the market, what do we think for total 2022? Of course, we only have a quarter to go now. If we look at new equipment markets, continuing to see a mixed situation with new equipment market in China, we now expect it to decline by over 20% for the full year 2022. Last quarter, we still expected about 15%, so we have seen a deterioration in the outlook, and that's of course due to the liquidity situation, principally. EMEA overall, pretty stable. North America, we got a good growth beginning of the year and of course because of the volume growth now growing, and Asia Pacific, excluding China, also developing positively. Modernization markets, we expect them to continue to grow across regions and being good and robust.
Maintenance markets, you know, have returned, actually continue on their pre-pandemic growth trajectory. Good growth opportunities in many parts, although actually all parts of the world and best naturally in Asia Pacific. Our business outlook, we now expect our sales to decline between 1% and 4%. This we updated roughly a week ago or almost two weeks ago. We expect now our adjusted EBIT to be in the range of EUR 1.0 billion- EUR 1.09 billion, of course, assuming that exchange rates don't change a lot from October 2022. What is driving our performance? It's clearly the outlook in services and our strong order book. There's plenty for us to deliver going forward. Also we are now starting to see the impact of product costs, productivity, and pricing actions.
As we always said this, that they will start to be seen towards the latter parts of the year, and we expect to start to see an impact of that in Q4. Of course, what is burning our results is clearly EUR 200 million still headwind from material, logistics, and component costs and deteriorated environment in China. Supply chain constraints continue to be a factor. Although we expect supply chain challenges to ease, supply chains continue to be constrained in many parts of the world. Now, as we are already in the last quarter, we wanted to give a sneak peek into 2023, what we expect to be drivers of positive and also challenges for next year. Clearly, what is positive going into next year is we have very strong order book and the improving margin of orders received.
Gradually we start to see that coming through. It's clear that orders that we book today, we can only see the margins roughly a year out, but still, we have clearly throughout this year gradually improved our pricing so that we'll start to be seen next year. Services, we expect continued positive momentum there. Also in Asia, particularly easing commodity cost headwinds and somewhat improving component availability. In Europe, commodity headwinds continue to be there because of the energy crisis, but in Asia, we start to see a clear improvement there. What are the major challenges going into next year? It's clear that the slowing rotation of the order book. North America, it's more of a labor constraint issue. In China, it's clearly a liquidity issue. Therefore, also the continued liquidity constraints and COVID restrictions in China likely to have an impact.
Wage inflation clearly impacting also, of course, next year. What is an unknown are geopolitical tensions on global supply chains. Clearly, the very tragic war in Ukraine continues to have impacts, but let's see if we have something else. That's kind of an unknown for next year. They're both good things and challenges that we are proactively dealing with. To wrap up. Clearly, the environment in China and given our size there, impacted now our business in Q3. Services, great continued progress. That I'm very happy about, as well as good progress in pricing overall in all businesses. We are planning to simplify our operating model to also support long-term financial performance. With that, we now have plenty of time for your questions or comments.
If you would like to ask a question, please press star one on your telephone keypad. Please ensure your lines are unmuted locally, as you will be advised when to ask your question. We ask that you please limit yourself to one question plus one follow-up. The first question comes from the line of Klas Bergelind from Citi. Please go ahead.
Thank you. Hi, Henrik and Ilkka. Klas at Citi. My first question I had was on the operational gearing in the quarter. Your China sales seem to be up slightly, and you have reiterated the cost savings EUR 200 million with some EUR 30-EUR 40 million in the quarter. Despite this, your operational gearing disappointed in the quarter. I hear you on the low equipment margin coming from the backlog, but to what extent is this also other cost inflation, such as wages kicking in? If you could help us with the wage inflation in the quarter and your expectations going into 2023. I'll start here. Thanks.
Do you wanna start with that?
Yeah. On the wage inflation, as we talked about earlier, yes, we see higher inflation in wages than normally, but it's not that dramatic. It contributes negatively, but at the end, we actually had a pretty good fixed cost absorption. Some tens of millions impact from increasing wage costs, including our installation as well as our pay costs. But that's something that has been more stable throughout the year, so it's not picking up third quarter as such.
I would say in general, when you look at the quarter, clearly services did well. You know, when we look at our new equipment margins, while they were down year-over-year, still sequentially, we're now starting to see an improvement, which was positive. Clearly, you know, compared to last year, higher costs. Also, we can see that supply chain constraints in some markets did have an impact on this. If we look at certain product availability, Q2 and Q3 were perhaps the toughest if we go back a couple of years. Now we see a situation that is improving gradually.
Yeah. I guess my question, Henrik, is given that the implied sales guide for the fourth quarter is quite low, right? You are talking about an improving margin again quarter-over-quarter at the midpoint, if the equipment margin would still be down year-over-year on current cost inflation, that means that your pricing, you're not feeling very good about pricing coming out of the backlog. Is that how we should see this sort of quarter-over-quarter improvement? Just to get that right, 'cause I was a little bit surprised about the low new equipment margin out of the backlog.
No, I think, if you think about our new equipment delivery margins, so they are now sequentially improving in Q3, and we do expect them to continue improving in Q4 as well.
Mm.
Obviously, there are many moving parts for the guidance, but that's the expectation. We've seen our pricing improving in our new equipment since third quarter of last year and also margins as to that extent. All of that-
Mm.
Starts to then come through in the P&L as well.
All right. My follow-up then is a question on this EUR 400 million cumulative inflation from raw mats, components, and logistics. It's obviously good to see the order margin improving year-over-year, but that's against the current cost inflation. I'm interested in, again, the cost items at current spot levels, how these could develop into 2023. Would you help us on how you think raw mat, logistics, and so forth at current spot rates could sort of impact the bridge into next year? I'll give it a go at least. Let's see what you say.
You've been following us too long. I guess it's a bit too early to start giving a more detailed guidance for next year. We'll come back to that in conjunction with the fourth quarter results. I guess the trend we've set already earlier is that we are seeing raw materials and therefore component cost as well been a bit of a tailwind in China. Whereas in Europe they continue to be on quite a high level given the energy crisis that we have here.
A mixed bag, I would say, and let's look at it a bit more detail when we come to towards the end of the year as also we know that which orders and where we are delivering, so give you more details. I would say mixed bag tailwind in China and to an extent we are delivered to Asia Pacific from China. Clearly, Europe is a different development from that perspective.
Got it. Thank you.
Thank you.
The next question comes from the line of Andre Kukhnin from Credit Suisse. Please go ahead.
Good afternoon. Thank you very much for taking our questions. The question I have really is on your view on the cycle shape in China beyond this year. Not trying to elicit some kind of market forecast, but I just really would love to hear what your base case is for 2023 beyond. Do you have it declining further next year? Conceptually, what do you see as a kind of curve or a line after that?
I think it's too early to give an outlook for China next year. We know that the market in China is very policy-driven. What we now have seen is that we have not seen a big change in policies which would indicate that there's not gonna be a huge sort of whole lot of change next year. There is, however, one thing that you know we would expect to sometimes during next year start to become more of a tailwind, is that there's clearly a need to finish the semi-finished buildings, particularly where people have paid a down payment.
That is a very significant backlog. We talk about actually a lot of elevator demand and deliveries there. That is gonna require liquidity for developers to finish the project. That is something we could see happening. Other than that, we have not seen a lot of changes in policies. A big, you know, recovery in the short term is not something we're expecting.
Maybe to add to that, then our view to the service opportunity in China has not changed. If you think about next years to come, I think it continues to be very, very interesting opportunity, both modernization and maintenance. That's something that is very key to our strategy also going forward.
Absolutely. Thank you for sharing this. As a kind of follow-up or semi second question, I just wanted to come back to what we discussed before about the pricing actions and the cost out effects that you've already taken. Could you help us with a number of what we should expect for 2023 from what you've done already, what you have got in backlog already?
Well, if I try to give you a bit of a view to that, and then we'll come back with more details for 2023. First, if you start with modernization business where I would say that the progress has been the best in terms of pricing versus cost. Now we are at the stage that we've been able to increase prices for the orders we booked in third quarter to cover the cost increases that we've seen. That's very good and in modernization order book rotation is faster than the new equipment. That should be starting to positively impact our P&L then in the first half of next year.
When it comes to new equipment, we continue to see pricing improving. If I look at our progress in third quarter, we're roughly, outside of China, 70% there in terms of the price covering the cost increases net of our actions. Whereas in China, I think, as you saw in the quarter, the prices did improve like for like compared to last year, but there the cost actions that we take in our product cost has been much bigger driver in our performance. Also if you look at the raw materials, they start to be a tailwind as I said earlier.
In that respect, if you now look at next year P&L impact from these actions, it is about a year, a bit more than a year to see the order book rotating for the orders that we now booked in Q3 which would add a positive pricing development. That's the way I would try to describe it. As I said, we'll come back to that a bit later.
That's in the context of the half of the EUR 400 million cumulative being offset, right? As a kind of wraparound.
I didn't give that detail in total, but it's not a bad proxy as such.
Very helpful. Thank you very much to both of you.
Thank you.
The next question comes from the line of Daniela Costa from Goldman Sachs. Please go ahead.
Hi. Good afternoon, everyone. Thanks for taking my questions. The first question I wanted to ask regarding your last point, Henrik, on your summary, where you said you're simplifying your operating model to drive long-term financial performance. I just wanted to see if you could give any more color regarding that. I guess your Accelerate program is done, so should we be expecting, like, some sort of restructuring or a new program to follow? That would be my first question. The second question is just a follow-up on one of the questions earlier. You commented on wage inflation for this year. I guess sort of a lot of the macro forecast is for higher wage inflation next year.
I know you have escalation clauses in the maintenance portfolio, but can you talk about how they effectively get implemented? Would you sort of bear wages throughout the year as they are and then get a compensation from the customer at the end of the year? Or is it happening on a continuous basis, and so we should see no impact because you pass on any sort of wage inflation to your customers? Those are my-
Let me start from the second one. Usually, how it works, it's first only a part of the contracts have escalation clauses. Others, like if you, for example, in markets where you have longer term commercial contracts, then they may have specified, like in North America, more specified what the escalation is year over year. In North America also we know much better the labor cost increase than in Europe. In Europe, which is still the biggest service business for KONE, the way it works is that in most cases you have annual escalations, and quite a big part of those happens in Q1. You have a labor cost index, you have CPI, or you have another specific index. It varies quite a lot market- to- market.
You look back 12 months, and that is your you know escalation clause. Clearly that we have had quite overinflation already for a year, so that should be reflected in these indices. That's why, for example, we're going a year back even though actually we were able to increase prices quite well or very well, I would say, in maintenance. Some of these indices weren't so favorable because inflation really started the second half of last year, and the first half didn't contribute. Now I would say all the indices are more favorable because it's something you usually look 12 months back and what we can then do in quarter one. That's kind of, in a simplified way, the ones that you can escalate that how it works for them.
On these plans to simplify operating model. To adjust the context here, as I mentioned, that it's clear that, you know, when we have originally designed our operating model, it was for a different type of environment where not so many changes happen all the time. Now we are looking at, hey, how can we be faster responding to changes? You know, for example, we have now raised our prices very well, but perhaps we should have started earlier. How do we make sure that we react to situations in our organization faster? Also, how can we be quicker in environments like this to bringing solutions to our customers? It's clear that we are looking for efficiency metrics as well. Those are kind of details we can share right now, and later you will of course hear more about it.
Thank you.
The next question comes from the line of James Moore from Redburn. Please go ahead.
Yeah, thanks for taking my questions. Hi, everyone. I have just a few follow-ups, really. I heard all of your qualitative answers on the questions that have been given so far. Just on quantification, I don't know if you could help us a little bit with, one, is there a structuring charge tied to the new operating model? Two, wage inflation percentage, is it more 3% or 4% this year? And next, does it go up? Some say it goes to 4%, maybe 5%. Raw materials at current prices next year, are you thinking a tailwind or a headwind if you don't want to give a number? Could you just give the direction at the current level?
Finally, perhaps most importantly, could you help us with the difference or quantify the difference in any way, between the order received gross margin and the current P&L gross margin? I mean, is it a small difference or a big difference?
Okay. Those were a few questions. I'll ask Ilkka. Hopefully, you wrote them down, so you can start.
I think I have, but let's see how well I do. I'll start actually at the end first and then work backwards to your first question. Yes, we are booking orders on a higher margin than we're delivering right now. I wouldn't quantify that in more detail. Clearly we expect them to continue to have that tailwind in the coming quarters supporting our profitability improvement. Raw materials to help to quantify. It's too early to say, given the size of China business, where we see the tailwind, that's naturally helping and expect some help from there. Let's come back to the details when we get to fourth quarter results.
You had question on labor cost inflation that we see, and what's the difference? Maybe that's actually a good way to describe it if you're saying that from 3-4, it's now 4-5 percentage point or so increase. We see the labor cost increasing more especially in Europe than we've seen in the past. Much of Asia Pacific we've had a high inflation for a long time, so it's not as big a difference compared to the past. As said, in North America, our visibility to our own labor cost is quite long given the labor negotiations. Yes, a bit more than we've seen in the past, but not that dramatic.
And then on operational improvement and the things we're planning to do, let's see, we'll come back with more details later. The planning has been commenced and we'll then update as we go along, and we have more detail on that one.
Thanks. Okay.
Clear that. It's likely to have some implications, but let's come back to that. Thank you. I think you've covered all of them.
I tried.
Okay. Thank you.
Thanks. Thanks.
The next question comes from the line of Aurelio Calderon from Morgan Stanley. Please go ahead.
Hi. Good afternoon, Henrik, Ilkka. Thanks for taking my questions. I've got two on China, if I may please. The first one is on your order development in China. Just looking at your slide, you showed that you had more than 30% decline, whereas the market declined by 20%. I just wanted to check if that's market share driven or is you consciously not going after orders that don't meet your margin criteria?
I would say perhaps, everywhere, in our new equipment business in Q3, we focused principally on price and margin, not on growth. That was our, you know, principal objective was to improve our margins, not necessarily gaining share or growing in unit.
Okay, great. In terms of order cancellations, you still mentioned in the release that they remain at very low levels. I just wonder if you've seen any changes in China, especially given obviously the tight liquidity situation of developers, or are cancellations still in line with what you've seen in the past?
Cancellations continue to be. If I look at the full year, to start with, the main driver for cancellations this year has been the fact that we exited our business in Russia, where we actually then had to ourselves cancel the new equipment orders we had in place, that we were not going to deliver. In China, overall, cancellations continue to be very similar than we've seen in the past. No change there.
Okay, thank you.
Next question comes from the line of Guillermo Peigneux from UBS. Please go ahead.
Hi. Good afternoon. Thank you for taking my question. Maybe a follow-up question first and then on the previous question. Now that you are increasing prices or being more selective on your order intake, maybe for the part you lose in market share, is it to Chinese companies or is it to Western companies? I stay back and I ask the second question later.
You know, first of all, let's remember, we talked about one quarter. If you look at year-to-date orders in China, rest of the world, I think we're doing well, better than the market overall. This is one quarter and one quarter with a particular focus on the margin development. It is not something that I would be overly concerned with and just in line with what we're driving for.
Yeah, the information follow-up, I understand. I wanted to understand when you obviously act as a pricing leader in the Chinese market, can I ask whether, you know, is the Chinese companies, you know, scooping the market for those basically customers that don't want to accept a higher price, or is it the Western companies that are doing that in the market, in the Chinese market at least?
I don't think that there is one single. I think there's a mix, I think in both, you know, categories. If you look at the global players and you look at the more local players, I think you can see gains and losses in both of them. I don't think you can point out that this is Chinese that would win and global players losing. It's not. I don't think it's like that.
No, I wouldn't call out the pattern there, but rather, individual cases. As Henrik said, still said it in the first half when we're clearly above the market in terms of orders development and now, the opposite in third quarter, that these quarters are a short time to measure market share, to be honest.
Thank you. Maybe a more difficult question when it comes to new installations in China and obviously comparing this year with last year. Would you be able to quantify how much of the margin that has been lost is driven by your inability to install versus your negative impact from price to cost?
I think if I start and you can add, Henrik, if you want. Majority of our inability to install, as we said, was really about the lockdowns that we saw in second quarter this year. We estimate that to be roughly EUR 500 million in revenue and the cost impact, including the one, of course, related to operating in this during the lockdowns, to be about EUR 100 million. Now we've been able to cover and recover the backlogs that we had in the Q2 during the third quarter and also support our revenue development going forward.
I don't think there has been complexity to operate during the third quarter in terms of the lockdowns and related complexities, but nothing else than that. I don't know how much more I would comment on that. Some tens of millions EUR of extra costs and the rest is the price cost ratio that is impacting the profitability.
That is very helpful. Thank you.
Next question comes from the line of Rizk Maidi from Jefferies. Please go ahead.
Yes, hi. Thanks for taking the questions. I'll start with the first one. Henrik, you sounded, I'd say more positive on modernization from Q4 than on the new construction side of things, a little bit more positive on completion rate next year. What gives you this confidence when we just had the NPC, and obviously there was a lack of stimulus amounts at the start there?
What we're seeing in the market, we are more positive in China. I think you talk about China, about modernization. That's just what we see in the market at the moment. I said that these completions. Well, we can see that the trend in completions is somewhat better than the one for new starts, for example. And then we know that the need to complete many of the apartments, particularly housing, that have been started already and consumers have paid a down payment, that need is high. And therefore, we would expect, and that seems to be a lot of expectation in China, that there needs to be an acceleration of completing the delayed buildings. We are not seeing that quite yet, but we said that that's something we would expect to start happening during next year at some point. When we have to see.
Maybe to add that still on the modernization side, we continue.
Yeah.
To see very good growth opportunities. If you think about the size of the market, it's still a very small part of the total market.
Understood. The second one is, are you concerned about sort of the pricing development in China now that cost inflation in the country are reverting?
I would say when we look at our own cost actions, and we see that also material costs are coming down, clearly the picture is better right now than it was, for example, three, four months ago.
Understood. Just finally, a clarification. Ilkka talks about EUR 400 million cumulative cost inflation, and you said half of that sort of reverting. Actually, can you just come back to that point? If that's just on the Asian sort of part of the cost inflation, or maybe how we should think about that cost element next year.
I guess the EUR 400 million is just adding on what the cost inflation was on the previous year and then this year. It is really related to the material costs as well as our semiconductor total cost, including the spot buys. Especially on the previous year, logistics cost was a part of that. That's the EUR 400 million. I wasn't very clear on commenting how much exactly we've covered, but rather was asked about somebody else's estimate.
Okay, thanks.
Thank you.
The next question comes from the line of Andrew Wilson from JP Morgan. Please go ahead.
Hi. Good afternoon. Thanks for taking my questions. I've got two on strategy, so I guess that counts as one, plus a follow-up. In terms of China, you obviously made some helpful comments in terms of giving us a bit of an understanding, at least into thought process on next year. If you'd kind of comment on your sort of strategic thinking from a KONE perspective, I wonder whether anything that you've seen in the last, I guess sort of 12-18 months has kind of changed the thinking. Whether that be organically what you're doing in China, but also just thinking a little bit around, you've previously talked about potential to move some sort of bolt-on M&A in China and the potential that that might have on the service. I'm just interested, I guess, high level on your thinking on China and KONE's positioning.
Our strategy in China is of course continues to be stable. It's clear that we have ambitions to be a very strong player in new equipment market, and we continue to have a very good business there. Even though we can see the market is lower, we continue to have a good business in China. It's clear that our strategy in China is very much focused that going forward we want to drive a big part of the growth from services. That hasn't changed at all, and we continue to see that as an attractive market going forward. I would say fundamentally, when it comes to China, yes, we're operating even more in China for China. That's, you know, not a huge change to the past, but driving really the service business growth and continue to keep a very strong position in the new equipment business.
Thank you. Maybe onto the Connected Service side, where I think the numbers you've obviously helped us with today are, I guess the rate of acceleration there seems as if it's probably surprised a little bit on the upside versus previously. I guess, talk a little bit about what you're seeing in terms of market dynamics. I'm interested if you're seeing, and you mentioned about the third party, whether you're beginning to reverse some of the trends with regards to the independent service providers and just from a kind of market share and feedback from customers just to sort of coming from there.
I would say when we look at Europe, we look at North America and many of the Asian markets, we are seeing that we are improving our retention rates. We are doing that in general, but in particular with when we have connected units. That means that I think we are able to fend off better competition from the small independents, which you know have a more of a struggle to keep up with the technological advancement. It's clear that also the small independents they continue to have a role in the I would say standard residential older equipment. That's where they usually play. I think what we've been focusing on is that we can connect any brand.
If the customer comes to us with a portfolio that usually then will have multiple brands, we can connect the whole portfolio, not only the KONE units. I think that's quite a unique thing in the market still today. That is, of course, helping us overall on retention. I don't know anything more you would say about that, Ilkka.
Maybe I would expand to cover also DX Class elevators. If that was, 24/7 Connected Services is available to a wider base. When we talk about the DX Class elevators that we launched a bit more than a year ago, there clearly I would expect the retention to be much higher than we've seen in the past. The future upgradability through cloud connectivity and all the services that are then in future also available for those units. Let's see. It's too early to say what the retention yet is because it's been launched relatively recently, but clearly there there's a lot of potential there to drive further improvement in retention for those units.
Great. Thank you for that.
Thank you.
The next question comes from the line of Panu Laitinmäki from Danske Bank. Please go ahead.
Yes, thank you. I just wanted to ask about your order book. Can you comment how much of that is in China? Out of the China order book, can you comment how much is due to be delivered in 2023, compared to what you had a year ago? How much of the Chinese order book is in these semi-finished projects that are not moving forward? Just basically trying to understand how much, what is the magnitude of revenues that is depending on whether the kind of projects get finished or not?
Well, I guess one way to assess that is if you look at China's contribution to our sales, roughly 30%. Their contribution to order book is less than that, given that we have a slower moving order book, especially in North America. That's one way to think about it. When Henrik talked about this potential for these buildings that need to be finished, much of those projects are likely to be ones where the orders have not been granted yet. It's not in the order book, as such. I think it's further potential for us to both orders and sales.
I'm not sure one can really say that it's something, a project that is slower. I think all projects that are moving are slightly slower, but most of them are moving, so it just comes a little bit later, the delivery there. If we look at order book, I do believe that all geographic regions we are up order book year over year.
Yes.
Okay. Thank you.
The next question comes from the line of Joel Spungin from Berenberg. Please go ahead.
Yeah. Hi. Good afternoon. I've got two questions, actually. One on service and one on China. Maybe we're gonna start with China. Could you maybe sort of, obviously you talked about the liquidity constraints in that market. Could you maybe talk about the situation with regards to getting paid yourself? Have you seen any deterioration in the time it's taking to get paid? Have you reviewed your sort of credit position there, and had to make any additional provisioning for bad debts or anything like that?
I would say that overall, in this liquidity situation, liquidity being tight and our team in China has done actually a very good job managing the credit risk, managing which customers we work with, as well as for then which of the projects we're really partnering with those customers with. It's a very detailed analysis are in place to manage the risk. From our perspective, we've been very good at keeping good payment terms with our customers despite quite a strong push on those. As a result, then also our accounts receivable, if I look at the DSO and so forth, yes, they've increased a bit, but I think we've been able to manage the situation quite well.
If you look at the overall bad debt reservations, naturally, we book bad debt reservations based on a calculator method. It goes up and we assess the risk. It is somewhat up on a global level, but we've seen that the credit management process works quite well. As I said, in China, it's always, it's not only pricing question, it's as much about the payment terms and managing those. Managing those holistically is in my mind the key to manage the risk as well.
Okay. Understood. Just maybe a quick follow-up on that. Would you consider that the, you know, the situation with regards to your working capital position is that in part being impacted by payments in China? Is it not a substantial part of that?
If I look at year to date working capital development, clearly inventories due to the slower rotation of the order book and overall supply chains is one of the key drivers. Advances given the orders received development in China are lower than in the past. It's just a function of how many orders you book. Accounts receivable is not a major driver, as such, for our working capital development this year.
Okay. Thanks for that. Then just very quickly, maybe on the maintenance side, I just want to ask, obviously, you've grown, you know, pretty well this year. I think about 8% year to date. Are you able to tell us approximately how much of the growth is unit growth? Then maybe could you just also maybe give us a bit of regional color? Are you growing your units in every region? Is there significant differences between regions?
I guess, we've been able to grow units faster than we've had in the past. What to me is really the positive overperformance that we've seen has been both pricing and then value-added services contributing more than normally. The unit growth is driven by conversions, so a large part of that naturally comes therefore from China, as such.
Yes, we do have service base growth in all geographic regions. Service business growth in units we are probably points up compared to previous years this year. Yeah.
Okay. Thank you very much.
Thank you.
The next question comes from the line of Miguel Borrega from BNP Paribas Exane. Please go ahead.
Hi, good afternoon, everyone. I've got two questions. One follow-up from Guillermo. The one you said, I remember you saying lost sales from Q2 in China were about EUR 400 million-EUR 500 million, and EBIT loss was about EUR 100 million. Can you give us a sense how much of that was recovered already in Q3? How much do you still expect to recover out of the total?
I guess we recovered the backlog that was created in Q2 by the time we ended Q3, so there's no more to recover. What's backlog and what's market, that's a more difficult question. Clearly, we have not been able to recover all of the lost sales. Some of those orders, we didn't get all the orders and we didn't get all the sales we expected as a result.
Thank you. I know that you don't want to give any outlook for China, but, you know, two of your peers have already guided for another leg down next year. If China does go down again, just thinking on the backlog that is still to execute, how do you think sales will evolve next year? Do you expect China to be less in the mix, 2023 versus 2022? Thank you very much.
Well, I guess it's at this stage of the year still too early to guide for next year. All I can say is that we have an all-time high or close to all-time high order book to deliver as well as very well-performing services business as we talked about. Those are the ones we build on. Coming back to China, so let's see. There's a lot when it comes to the policy decisions that are made that influences the low short-term performance there.
If markets are down 20% this year, and if we don't see a rapid recovery next year, it's clear it's gonna be somewhat lower percentage of our sales. Still, we go into next year with a good order book in China.
Thank you very much.
The next question comes from the line of Lars Brorson from Barclays. Please go ahead.
Thanks for fitting me in. Hi, Henrik, Ilkka, and Natalia. Can I ask first to your orders received margins? Maybe that's one for Ilkka. If you look at the sequential improvement in OR margins over the course of this year, I wonder whether you could maybe help us rank them between modernization, new equipment ex-China, and new equipment in China. My assumption is that in that order, they have seen the greatest improvement, i.e., led by modernization. Specifically, I wonder whether you could tell us whether orders received margins for your new equipment business in China has improved over the period.
Well, as I already said in our comment earlier, in modernization business, we now have been able to increase prices enough to cover the cost increases. By that is by far, from a business perspective, the recovery has been the best there. In new equipment business, there, outside of China, we've seen best performance from a margin recovery perspective in North America, followed by Asia Pacific, excluding China, and then Europe, a bit more mixed performance there. That's the one way to think about it.
When you forecast that to our sales, naturally, North America has the slowest rotating order book, so it will take some time to get that to sales. In China, clearly what we've said and continues to be the case, that where the pricing year-over-year, year to date is down. We had improvement in third quarter, but year to date is down. We've seen actually product cost improvement being much bigger part of the recovery in margins. We've seen three times maybe higher product cost reductions than we've seen in the past. Now when we look at the raw materials, they start to be also a tailwind, contributing positively to the margin. A bit different dynamics as such.
Thank you, Ilkka. Maybe slightly bigger picture, if I can. Just on modernization. I think one of the interesting developments over the last couple of years is the contraction in modernization margins, not just for you, but for the industry as a whole. I think we have been near the new equipment margins in modernization. I appreciate you don't get the standardization benefits in modernization as you do in new equipment. Clearly there's also been some raw material headwinds. Is there an element of the digital service opportunity that comes with modernization projects driving more competitive pricing in modernization? Can you give a bit of color, please, around that sort of development in modernization margins over the last couple of years?
Henrik had a lot of strong reactions. Maybe you wanna answer.
I don't know where you have got this, that modernization margins would have declined over past years. Yes, they have had a temporary decline because of increased costs. As Ilkka said, we have recovered that. Actually, structurally, modernization margins, if you look, are compared to other business, in better shape now than in a few years back. Maybe that's how we developed the business and improved and you know been able to standardize some of it even more, even though it can be quite different in different projects. I would say that the trajectory of margins there overall, compared to, for example, new equipment, is clearly positive and now going in the right direction as well.
Thank you both.
Next question. It comes from the line of Tomi Railo from DNB. Please go ahead.
Hi, Henrik, Ilkka, this is Tomi from DNB. I'm also asking a question on the Chinese new equipment margin. If you could compare or comment the Chinese new equipment margin compared to the group margin at the moment, and if it's fair to assume that it recovers to enhance or dilute the group profitability next year.
Well, if I look at our China business, it is contributing to our margins positively. If you look at the past, clearly it was a higher margin business. It has come down, but still contributing positively to our margins. For next year, let's come back to that later.
Just to follow up, is that comment including maintenance or is it for the new equipment?
I made my comment in totality. Given this figure, actually, if you think about Q2, it's very extraordinary period. Trying to annualize the business as totality is somewhat difficult in this environment.
Understand. Thanks.
The next question comes from the line of Martin Flückiger from Kepler Cheuvreux. Please go ahead.
Yeah. Afternoon, gents and Natalia. Thanks for taking my question. First one is on Americas for a change. Just wondering what your order backlog looks like in the Americas these days and next 12-15 months. That would be my first question. The second one is on your KONE's year-to-date pricing in orders received. If I remember correctly, one of your competitors very recently gave some indications on their order intake pricing. I was wondering, you know, whether we could get some granularity from you yourself as well. Thanks.
U.S. order backlog is great, and so there's a lot to deliver over the next two to three years there. We have a very strong position there. You know, we have clearly gained market share in North America, so that we're going from a good situation. Challenge in North America is that still early this year we expected more deliveries this year, but we can clearly see the slowdown in construction site progress, mainly due to labor availability. Still projects want to go forward, but labor shortage. Pricing, clear and good price increases in new equipment across the wold. [inaudible]
We haven't specified in more detail, but clearly we've seen now since last year's third quarter pricing improving across the market, and now in third quarter in all markets at the same time.
It's very clear the improvement, so good percentages.
Great. Thanks.
All right.
That is all the time we have for questions, so I will now hand the call back to your host for some closing remarks.
Excellent. Thank you. Thank you for the questions and for the very active discussion. If you do have any follow-ups, please do reach out to me or the team. We're happy to help you. Thanks to everybody who's listened in as well. I hope this has been informative and interesting, and I'd like to wish you all a great rest of the day.
Thank you all.
Thank you.