Good afternoon, everyone, welcome to KONE's first half results presentation. My name is Sanna Kaje, I'm the Head of Investor Relations. As usual, I have here with me our President and CEO, Henrik Ehrnrooth, CFO, Ilkka Hara. Henrik will first go through the Q2 highlights, the operating environment. Ilkka will dig a bit deeper into the numbers, in the end, Henrik will go through the outlook. After the presentation, we have again time for your questions. Henrik, please.
Thanks, Sanna. Also warm welcome on my behalf to this Q2 results call. We have again many interesting pieces of information for you interesting news to share during this presentation. I think the highlights that we're going to talk about today are that we had a solid overall execution in an environment that is actually rather challenging. We can see that what we're going to talk about, that our profitability has been burdened by a number of headwinds. Other important highlight we will talk about how we are able to stabilize our business in China after a very challenging couple of years, also how we've seen a great improvement in our customer loyalty in all businesses, which of course is good for us. These are some of the highlights that we will talk about today. Let's start with numbers.
If you look at the Q2 key figures, here, the highlight really is that we were able to turn our orders received back to a slight growth if we look at it in comparable currencies. The orders received were EUR 2.056 billion, growth of 1.1% if you look at it in comparable currencies. Our order book remains very strong at EUR 8.9 billion, it has grown slightly from last year. Also, our sales continue to grow at EUR 2.284 billion. It's a growth of 0.5% or 1.7% in comparable currencies. What we can see, though, is that we have a number of things that are burdening our result, our operating income was now EUR 326 million compared to EUR 349 million a year ago. It's clear that we can't be happy with the fact that our result has declined slightly.
Our relative margin declined from 15.3% to 14.3%. Cash flow remains solid at EUR 320 million. Earnings per share, EUR 0.50 compared to EUR 0.54 last year. If you look at our January to June figure for the first half, here our orders received in comparable currencies were exactly stable compared to previous year. That was, of course, because of the growth we saw in the second quarter. Orders received just shy of EUR 4 billion. Sales was about EUR 4.1 billion, growth of 2.4% in comparable currencies. EBIT, very similar to the second quarter that we had a slight decline, was now EUR 544 million compared to EUR 570 million in the comparison period. Our margin was now 13.3% compared to 14.2% last year. Cash conversion has continued to be good.
Cash flow EUR 626 million, and earnings per share EUR 0.86 compared to EUR 0.90 last year. At this point, again, warm thanks to all KONE's employees for the hard work. You can see that we're facing a number of headwinds in many of our large markets, but I can continue to see a very good fighting spirit, how we continue to drive an improvement throughout the company. We can see a lot of things where we are improving in a really nice way. Those are the highlights of the numbers. If you then look at our business split. If you look at our business mix by business, that hasn't changed much. Share of maintenance slightly increased given the good growth we have in maintenance, but otherwise pretty much the same as last year.
If you look at it from a geographic perspective, North America's share is clearly increasing because of the good growth there, and it's now 20% of our revenues. I think it's good to have, particularly geographically, a better mix balance between our various geographic areas, which we are gaining all the time. I just look at really what were the main positives and headwinds we had in our Q2. I start with the positives. You can see that we had continued sales growth and solid orders in many markets. We look at orders first, we continued to grow our orders in a nice way in both Europe, Middle East and Africa and in North America.
Ilkka will talk more about this, but some of the highlights were continued double-digit growth in the United States, good growth in several South European markets, in Middle East, and also some Central North European markets. So good growth in both of those geographic areas. You look at from a sales perspective, it's clear that it's our services business, particularly maintenance, that is the main growth driver for us. Now another important development during the quarter is that we're starting to see a stabilization in the new equipment business in China. If we go back to 2016 and 2015 as well, we all know that we faced quite a lot of headwinds. We had a market that was declining. We had very significant price competition, and we could also see that customers were choosing more standard specification products. So from mix perspective, that was also slightly adverse.
Those are all headwinds that we had, and that clearly resulted last year in a significant decline in orders received. You look at the situation, we started to take a lot of action to rectify the situation already last year. And I'm happy to say that the actions we're taking are producing results. Pricing now in second quarter was more or less at Q1 level, so we were able to stabilize that. And we've seen a slight improvement as well in the mix of products. Yes, we are still clearly below pricing where it was a year ago, but now sequentially we are stabilizing and therefore, I believe that what we're doing is taking us definitely in the right direction. Another very positive during the quarter is that during the quarter, we conducted our annual customer loyalty survey, where about 30,000 customers gave feedback to us.
We naturally get constant feedback in so-called transactional surveys. This is an annual larger one that we do. The good thing is that we had a good improvement in our customer loyalty in each of our businesses. The main reasons cited by our customers to why they are happy with KONE services are the service mindset and competencies of our people, as well as the quality of our services and products. We also, during the quarter, continue to see a good execution on new strategy. I'll talk about that a little bit more in detail soon. I believe very firmly we're going in the right direction at making KONE constantly a better company. What were the headwinds?
Clearly, our profitability continues to be burdened by a combination of the price pressures that we witnessed, particularly in China last year, as I talked about the three headwinds that we faced. At the same time, clearly higher raw material costs. We also continue to see intense price competition in many large markets. All these are clearly headwinds that we have. From a profit perspective, we also have a slight headwind from the fact that we have proactively decided to increase our investment in R&D, IT to develop new solutions for our customers. This is a positive thing, and we see that the results we're getting from these increased investments are good. Those are the highlights from Q2. I promised I'll talk a little bit more about some snippets of what's happened with our strategy.
I'm going to highlight developments in two of our ways to win, our customer-centric solutions and services, and fast and smart execution. In connection with the Q1 result, we talked a lot about the rollout or actually the introduction of our new KONE Care maintenance offering, as well as our 24/7 Connected Services. New KONE Care, that's our flexible maintenance offering that I believe is a true differentiator in the market, and we can see that the development of both of these continue to be very positive. Customers are giving us very positive feedback. We have better hit rates and prices are good. We are fully on track to have KONE Care and the 24/7 Connected Services available in more than 10 countries by the end of this year. These are really some of our largest countries.
These services will be available to a very significant part of our customers by the end of this year. We also launched a renewed KONE Online platform for our maintenance customers. This we have launched now in a number of countries, and we tested it first again, now it's been launched more broadly. The KONE Online platform is a platform for our customers to get full visibility of what is happening in their buildings, what is happening to the equipment. What have we serviced? What are the service needs? How is the equipment performing just now? A real-time view of them. It's a very clear and good service. It's both an online and a mobile version of it, and this has received very good feedback from our customers and say that this is really the leading solution that they have seen in the market for things like this.
We also launched a number of new products in India for the more affordable end. We expanded our Mono 500 platform in North America. In Europe, we brought new full replacement solutions. In China, we also expanded our offerings to increase its competitiveness, particularly in the commercial segment. All of these, we are bringing new solutions that we think are, again, helping our customers succeed. In the fast and smart execution way to win, here our objective is to find constantly better ways to help our customers improve their productivity, us to work better, and service our customers in a better way. Here we have taken into use a new process for our field supervisors for them to be able to work in a mobile way. As you know, we have talked about how we are connecting all aspects of KONE's business.
We are connecting our customers, our users, our employees, and all the equipment. This is about connecting employees. We already have rolled out globally our latest field tools for our maintenance technicians. We have also enabled our salespeople to work in a very productive way, in a mobile way, and now we're doing the same thing for our field supervisors to enable them to spend their time out in the field with customers and with our maintenance technicians, be effective there. They don't need to spend their time in the office. Again, to improve what we call fast and smart execution, and again, serve our customers in an even better way. These are just some highlights of where we're going. Again, we continue to make good progress. That is about KONE's development and some of the highlights of our business. If I then go to the markets.
New equipment markets in the second quarter continued to decline if you look at it globally, really because of the Asia-Pacific markets. Europe, Middle East, and Africa, we have slight growth because of growth in South Europe and the Middle East. Markets were now more stable in Central and North Europe. North America markets continue to grow from a good level. The markets are strong and actually becoming even stronger. Asia-Pacific, there the market in China declined slightly, but we start to see more stabilization now of the overall price pressure. It's still very intense, probably not as bad as last year. I'll talk about China soon a little bit more in detail. If you look at the rest of Asia-Pacific, there actually markets declined as well. This was mainly due to the fact that the large Indian market declined. Why did India market decline?
There's good underlying demand in the market, we have seen now three significant reforms in the India market since November. We believe that each of these reforms are positive for the long-term health of the market and the economy. However, they have clearly caused uncertainty in the short term. The latest one was the implementation of a Goods and Services Tax nationwide in India at beginning of July. We clearly see that that has impacted the market, although longer term, we believe it's a good thing for India and also our business. We can see that new equipment markets continue to be challenging and mixed. What about China? Let me take a little bit deeper dive in China again. Here I would say the highlight is that the inventory of unsold apartments has continuously improved and getting to a clearly better situation.
That means that the market is becoming healthier from this perspective. We can see that the inventory of unsold apartment in the higher tier cities has been good already for some time in tier 1 and tier 2 cities. However, in lower tier cities, we have seen a clearly elevated inventory level, but that is clearly coming down now as well. Still 20 months is quite high, but we're going in a better direction, and that's very good for the overall market. Actually that from starting last year and increasingly this year, the government has introduced a number of restrictions to cool down the market.
We have now restrictions for housing purchases and mortgages in about, I think, 52 cities, which covers about half of the market. We can clearly see that there is a willingness and effort to cool down the markets that are very hot, and we have seen therefore a growth that's also spread now to the lower cities. I believe it's a good thing that they are a little bit moderating the growth in some parts. What about our market then for the elevator and escalator business? Here we can see that in the first quarter we have slight growth. Now we have slight decline. Pretty stable market first half of the year. We can also see that real estate investments have stayed at a solid level of more than 8% growth.
However, the main driver behind the growth here is really increases in land purchases and land cost. Still, we can see that it's more stabilizing there as well. Overall, I would say China a little bit more stable market. Price competition, overall competition continues to be very intense. I believe that the actions we have taken are showing that we are going the right direction. That's about China. If you then turn to services. Maintenance market, not much new here. Europe, Middle East, and Africa growing slightly, particularly Central and North Europe, and Middle East. South Europe remains very tough as we know. North America is growing.
Just one thing I want to highlight here that we're starting to see in our business as well a very significant impact of a shakeup of the retail sector in the U.S., and we can see how that's impacting our business. Otherwise, it's developing positively except for this segment. Asia-Pacific markets continue to grow at a good rate. Modernization markets, Europe, Middle East, and Africa now stable with a mixed development. North America continues to grow from a good level, and Asia-Pacific continue to grow strongly. There's a lot of good opportunities there. This is about KONE's performance first and then our markets. Now at this stage, I'll hand over to Ilkka Hara to review our financial performance a bit more in detail.
Thank you, Henrik. I'll go through our financials a bit more in detail. As normally, I'll start with orders received. Our orders received in the second quarter reached EUR 2 billion, 56 million. Which represents on a historical basis 0.6% decrease, but on a comparable basis, an increase of 1.1%, which clearly is a positive turn. We're returning to growth in our orders received. If we look at the key drivers for this performance, we did see clear growth in Europe, Middle East, and Africa, as well as in the Americas as a whole. At the same time, our orders did decline in Asia Pacific. If we look at China, particularly within Asia Pacific, our orders received, if you look at sequentially from first quarter to second quarter, we did see stabilized performance on the price like-for-like basis.
At the same time, we did see our mix having a slight positive impact from first quarter to second quarter. Clearly, it's positive. If we look at year-over-year, both volume as well as value decreased slightly compared to previous year in China in our orders received. As you will see, FX had a negative impact to the quarter, EUR 34 million in our orders received. For sales. Sales, we've ended up almost to EUR 2.3 billion with an increase of 0.5% on a historical basis. On a comparable basis, that represents 1.7% growth. If you look at again the drivers for that growth in more detail. Our new equipment business was relatively flat in the quarter, but both modernization as well as maintenance grew. Modernization at 1.9% and maintenance at 5.2%, which is slightly below our historical trend.
If you look at the whole first half, we're closer to 6%, there's some quarterly fluctuation there. Geographically, Europe, Middle East, and Africa growing at 5% is the key highlight, as well as Americas contributing with 3.7% growth in the quarter. In Asia Pacific, a decrease by 1.8%, where we're now seeing the orders received development from previous year, particularly in China now coming into sales. Looking at the operating income. First of all, our operating income reached EUR 326 million in the quarter, which is down 6.4% compared to previous year. Clearly, that's something which we can't feel happy about, and we continue to take action to reverse the trend. On a margin basis, that represents 14.3% margin, which is down 1% compared to previous year.
If you look at the key drivers for our operating income performance, services growth clearly contributed positively towards operating income. Also, we are seeing the actions that we're taking in productivity improvement across the company having a positive impact. At the same time, the headwinds that we're facing from raw materials, as well as the margin pressure that we have witnessed in China in last year, is now coming through to sales and also impacting our operating income. At the same time, we continued our investments to R&D and IT, where we continue to see good opportunities going forward. At the same time, short term, they do burden our operating income. We increased about 0.5% our investments relative to sales in R&D and IT combined. From FX, our operating income had a negative EUR 6 million impact.
With that, I'll hand over back to Henrik to talk a bit about markets and our business outlook for the full year 2017.
Thanks, Ilkka. Wrapping up with our outlook and starting with the market outlook. Here more or less the same as we said in connection first quarter result. China, we expect the market to decline between 0%-5% in units, and our competition will remain intense. We expect that the Asia Pacific market growth will return in the second half, so it will grow slightly for the full year. We also expect that Europe, Middle East, and Africa will grow slightly, as well as North America. The similar trends we've seen beginning of this year in Europe, Middle East, and Africa, and North America. Maintenance market, very much the same trends as we've seen so far. Strong growth in Asia Pacific and slight growth also in other regions.
In modernization, we expect the markets actually now to grow slightly in Europe in the second half to slightly better than in Q2, and markets to grow all slightly in North America and strong growth in Asia Pacific. KONE's business outlook, we have slightly specified our outlook. We now expect our sales to grow between 1%-3% in comparable currencies. Previously, we expected that to be between 0%-3%. The slight specification here is we are halfway through the year, and we have seen a good development. Therefore, we could slightly specify it further. When it comes to our operating income, we expect our EBIT now to be in the range of EUR 1.2 billion-EUR 1.28 billion. Assumes that translation exchange rates stay at approximately the average level of January, June 2017.
Previously, we expected our EBIT to be in the range EUR 1.2 billion-EUR 1.29 billion. Now, the specification really only comes from changes in translation exchange rates. Compared to our outlook that we gave in connection with our Q1 result, now given the changes in currencies, we see a EUR 20 million negative impact for the full year for our EBIT based on just what we have on the average so far, and that is impacting our full-year profit. However, we are still just reducing the midpoint much less because of the underlying positive performance that we had. This shows that we continue to expect solid and good execution for the full year and good development overall. With that, I'll just summarize key highlights. China market continues to be very tough, but we're seeing stabilization based on the actions we've taken.
We're also taking a lot of action to offset many of the headwinds that we have that are impacting our profitability. It's clear that we are not happy with the fact that our EBIT has declined slightly. The good things, which really gives me very strong confidence that we are on the right path, we're going the right direction, is the development of customer loyalty and also the good traction we have in our services that we have recently launched. Because of the good traction we see in this, we continue to invest significantly in our future and in our competitiveness. I'm actually very positive about the pipeline that we have here for the coming years. With that, I believe we have time for questions.
That's right. I'm sure you have some questions. Are there any in the audience? None. Let's go straight to the telephone lines. Operator, please. I would actually like to remind you, please take one question at a time. Thank you.
If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. Looks like we do have a few in the queue already. We'll take our first question from Manu Ramala from Nordea.
Hey, can you
No, I believe at least in this end here in KONE building, we're not able to hear the question.
Please make sure your mute function is turned off.
Operator, can I suggest we go to-
Our next question from Lars Berling with Citi.
Yes. Hi, Henrik and Ilkka. It's Lars from Citi. Can you hear me?
Yeah, we can hear you well.
Okay, very good. Firstly on the sales in China, your orders in China have been down over 10% organic last 12 months. Your sales is only down 5% in China, driving Asia -Pac only down 2%. That looks a bit odd to me. Is it just a timing issue, or will the backlog in China start to unwind faster into the second half? That is my first question.
Thanks. That's a good question. If you look at historically both when we were growing as well as now decreasing. We've seen less volatility in sales than we've seen orders. That's really what's happening. At the same time, we are seeing also the impact of the growth in our maintenance business there playing a role there. That's kind of the highlights from my perspective there.
Ilkka, if the share of service is obviously a very small part, so even if you're growing significantly, equipment will still be the major factor. Should we think about this, that the duration of the backlog is longer than we think? That means that we could still have sort of sales pressure but for a longer time, not only confined to a couple of quarters.
There is some sales pressure for sure that we will see going forward. We haven't seen anything big changing in the order book rotation. There's some fluctuation there and some increase in the order rotation. One of the factors that we're seeing is the customers are actually taking partial deliveries when they're building. Instead of having
Okay
full project completed, they do building by building.
Okay. My second one is on price and mix. I get why mix is better, but just on the pricing there, the market is stabilizing, but we remain at a very high level versus history. There is competition still to gain equipment share to gain from the aftermarket longer term. Henrik, would you say that pricing is stabilizing because of higher raw materials, or do you see that the real competitive pressures are also easing.
It's always difficult to say exactly what they are. We can, of course, comment on ourselves rather than the market. What I would say is that we have taken a lot of action to be able to stabilize our pricing following a significant decline over the past few years. We can see that our actions are producing results. It's clear also that the prices came down significantly last year and the year before. We can see that there are a number, particularly the smaller players, that are quite under pressure at these levels. It's probably a combination of factors. I can't say that there's one specific one. Where is the market going to go? I don't know. We don't predict the future of pricing the market.
The only thing we know is what we are doing. We can see that that has helped to improve our situation somewhat.
My final one is on productivity. Referring back to the visit to Italy, which was very helpful. Thank you for that. Productivity, you have said many times, represents many things. Negotiation with suppliers, flow on the factory floor, design and installation time. When you look ahead, which of those levers will matter more? The reason why I ask is that I suspect that perhaps the easy wins are behind you in terms of supplier negotiations. That it will be the other levers, including automation, that will matter more going forward.
I would say that I would be disappointed if we would have easy levers. I think we've been working quite many aspects on KONE for many years. You know what? The more you look at something, the more you always find opportunities. We have to remember that in our business, what is one of the most significant parts is our field operations, both in installation and in service. That is one of the fundamental parts of our productivity. That we, year after year, have been able to develop. The way you develop it is to improve your processes, to improve your quality. Then you can drive productivity. That we have done. Clearly, we also look at our supply chain all the time with how we work with our suppliers, how we can design better solutions, also then our own factories.
As you know that in our industry, factories, yes, they are important, but they are not that significant part of the overall piece. Yes, we are looking at each aspect, and I would say we have had good development in each over the past years, and we continue to drive hard. It's not one specific thing where we can immediately think we can have a step change, but constantly driving good development forward.
Just to follow up on productivity, thinking about automation. I think it took Italy 2-3 years to go from 50%-90% automation, looking at the AGVs and robotics. Can we really apply the exactly sort of same timing when you look at China? Obviously, different levels of wages and input cost negotiation with suppliers. How can you look at automation in China if you take maybe 2-3 years? Do you think we will go to 70% or 80%, or can we go all the way up to 90%?
Clear that also in China, each of our markets, we continue to drive automation going forward. You have to remember that what we do are slightly different, and we automate everything where we think it makes sense from a quality and productivity perspective. We've seen it's a constant journey that we take, and China will be part of that, but we have automated what we think makes sense to automate there at this point in time. Yes, it will increase over time, and probably the pace of change will increase. This is something you have to constantly do in order to remain competitive in the market. I wouldn't say therefore there's something new. It's each of our supply units have constantly moved forward in this respect. Yes, maybe the pace of change is increasing, but nothing that I would say is fundamentally different.
Thank you, Henrik.
Thank you.
We'll take our next question from Daniela Costa.
Hi, good afternoon. I just wanted to ask you to give us a bit of an update about how you're thinking about capital allocation priorities going forward, shareholder returns versus M&A. You've talked about that a bit over the last couple of quarters. An update there, and then just a quick one on how you see raw material moves impacting for the rest of the year, given the impact we've seen now on the EBIT bridge, but also the recent moves in some of the raw materials. Thank you.
Okay. I'll try to answer the first one, and then I'll hand over to Ilkka. He can build on that and then answer the second question. Yes, we have a strong balance sheet, and over the years, we have continued to increase our dividends. That's what I can say. That's what our board has decided to do historically. We think it makes sense to maintain a strong balance sheet. We know that there are possible opportunities out there in the world. If they come, we would be interested in capturing them. Will they come? What will they be? That's something I don't know. Clearly, we have interest and appetite for further acquisitions. This year has actually been a little bit slower on that front. Of course, we would be interested in also larger ones. That's what I can say.
We look at more the raw material part of the question. We said already in the beginning of the year that we estimate our impact of the increasing raw material prices to be roughly between EUR 50 million-EUR 100 million for the year. If we look at the situation now at the end of the second quarter, we are roughly in the middle of that range when it comes to the impact. What's good to note is that given what we said in first quarter and where we are in second quarter, more than half clearly of that impact is to be expected to be hitting our second half of the year for that.
Thank you. Just follow up on the capital allocation one. How long would you wait until sort of M&A opportunities materialize, and when could you potentially decide would give the cash back to the special dividend or buyback? How would you think about this?
I don't think I can give a specific timing or framework here because it depends on what potential opportunities we see out there and of course situations change. This is a discussion that we need to have with our board from time to time. There's nothing more I can highlight at this point in time.
Thank you.
We'll take our next question from James Moore with Redburn.
Hi, Henrik, Ilkka. Yeah, thanks for taking my questions. They're on margin. On your raw materials more than half comment, would it be fair at current prices to say 25/50 is a rough split and would another sort of 25 spill into the first quarter? Maybe just one by one, a couple of quick small ones.
Well, I think the level of accuracy I'm willing to comment on it's more this, it is going to be more than half of that hitting us in the second half and that's how we want to comment it.
On the R&D, IT-
It's probably too early to start commenting on where we're going to be in Q1 next year. Depends on where prices go. Clear that from this perspective, headwinds continue to increase just from this perspective.
Thanks. On the R&D IT cost, thanks for the 50 basis points comment. I'm just thinking as we roll forward, is this 2017 R&D IT investment exceptional or is it a new level that kind of will persist next year or could it even go up next year?
Let me address it from the perspective that why has R&D IT and such investments, why they are increasing and expenditure there. Historically, of course, more of the R&D was on the equipment side. There was clearly some services and processes for that. If we look at now where the activity is, clearly there's a lot of happening on product side, but there's of course the whole digital part is much more significant than it was in the previous years. The good thing is that we can see that we're also able to bring totally new types of services, new way of adding value to our customers to improve the way we are working. This is the part that is higher and that is also then driving IT platform costs higher and development. I would say we see an increase compared to revenues this year.
Next year we have to see, but it's not that it's a bump and then we go down to the old level, but it's given the environment and the speed of what's happening around us, it is higher. You know what? We see this as a actually positive business opportunity and an ability to differentiate how we can create, again, great services with that and solutions as well for that matter.
Thanks, Henrik. My last piece, if I could, was on the margin question is about orders received margin, which has been slightly down for four quarters in a row. Would you expect that kind of comment to continue into the second half on the orders received margin with the current dynamics that you've discussed?
As you know, we don't comment on potential pricing and margins orders going forward. I think that's something we have to see. It's clear that we have a tough situation, headwinds in many markets and we continue to fight against them, and we continue to improve our pricing capabilities. We have to see where we end up. I don't think we can comment on that much more.
Thanks very much.
Thank you.
We'll take our next question from Andre Kukhnin with Credit Suisse.
Yes, good afternoon. Thanks for taking my question. Can I ask about the pricing dynamics in service in Europe? If you could comment on what you're seeing there and if there are any new trends maybe by regions in Europe.
There's nothing much new. It's clear that South Europe continues to be very tough. There's nothing new there. Central North Europe, the markets where we have seen a more robust new equipment business over the past years are more favorable and this is natural. The markets where you have new units coming into the service base means that the market is growing. Usually those economies are doing better, so there's a more favorable environment than South Europe where new equipment volumes have been very low and competitive situation anyway is very tough, continues to be. Continues to be challenging. I would say nothing much new there compared to what we have commented previously.
If I could just follow up, I mean, what is the normal lag between the meaningful pickup in new equipment orders or deliveries to some alleviation of pressure and pricing for maintenance in any particular market?
You can simply say that from order to delivery, we're talking about one year, then you have the first service. We talk about from order to seeing impact in the market. We talk about a couple of years, but of course you need to see the whole overall activity in the market. It's not the individual order. It does come with a lag. It does follow over time.
Got it, thank you. May I just ask on the component price inflation, in particular in China, just given the size of the business. Are you seeing your suppliers putting prices up to you across the set of components you purchase at the moment?
Of course, it's a mix. It's clear that our suppliers, they're the ones who are being very hard hit by material cost increases. Clearly, we have then negotiations with them, how we mitigate that, how we're able to work. Of course, it's always a negotiation. The volumes we have in China gives us a very favorable situation there. I think we are in a pretty good spot, but clearly that over time comes in and is reflected in your cost. That is just how it is because we also need to make sure that our suppliers are healthy.
Got it. Thank you very much.
Thank you.
We'll take our next question from Rizk Maidi, from Berenberg.
Hi. Thank you for taking my questions. Just one on the margins and orders received, which has declined slightly over here. Can you perhaps tell us how are the margins there versus last quarter and also compared to the margin and the P&L currently, please?
Our margins in orders received have declined slightly year-over-year, and clearly China is the biggest impact here. We are below where we were a year ago. Now, as we said, during the second quarter, we were able to start to stabilize them, but that means still year-over-year, we are down, and that means that still, just given the lag, what we're delivering is higher than what we are taking as orders.
Okay, you're not able to kind of compare it to the margin in previous quarter or just to see where is the margin there versus what the Q2 margin is now?
As I said that, now sequentially, we start to see things starting to stabilize.
Okay, thank you. Just I'm wondering about what you think are the reasons for the mix improving in China, clearly, sequentially. Initially you talked about land prices increasing, real estate developers tending to go for more standard products. Why do you think we see now a kind of a mix improving and how sustainable this improvement is in your view?
Well, let me see. Partly maybe there are some market factors, but they usually don't move that quickly. It's also the actions we have taken and the type of situations that where we can see that we can add the most value and how we work with our customers. It's of course something you also impact with how you target where you're going. There are multiple things behind it, but I think we're starting to see, and we're seeing in China in particular, that buildings are constantly becoming higher. That's a natural result of the fact that land prices are increasing very significantly. Just need to constantly have a more efficient use of land. That, of course, means that you have higher elevators with more floors, usually then higher speed and maybe higher capacity and all this helps also then the mix.
Okay. Thank you. The last one from me is the retail segment in North America, which is weakening. Can you just give us a sense for how big the segment is and what are the rates of decline we're seeing there, just to explain basically what's going on there, please?
The big segments in the U.S. would be first, commercial and some residential. It's not one of the biggest segments, but we can clearly see that that segment is a, I would say, mid-sized segment overall. It's not huge, but we can see a quite significant impact there from the shakeout in the retail industry for the reasons we all know.
Okay, thank you.
Thank you.
We'll take our next question from Lars Brorson with Barclays.
Hi, Henrik. I had a few, if I could. First of all, I thought you might have upgraded your China market outlook today, which obviously you didn't. We now know that you expect, I guess, second half to look pretty much like the first half, so flat to slightly down. Just on the Chinese new equipment market, I'm keen to try and understand how you read the construction indicators in the market, some of which, of course, you have on your page 10, I think it is, in the presentation.
It looks like units for the market has decoupled somewhat this year from the leading indicators, presumably as we've had quite a meaningful housing inventory reduction tier 3 to 5 cities, and presumably also because the sector has been hit, should say hit disproportionately from the cooling measures in lower tier cities, particularly tier 2, which is quite important for the sector. I guess my question is, how do you see the setup now into 2018? I know you're not going to guide me on 2018, but do you think we will see more of a recoupling of the market to these indicators? Do you feel a bit better going into next year than what we've seen this year? Can you give a little color around that? That would be helpful.
Rather than to give an outlook for 2018, let me just address it from the perspective that what I also said when we reviewed the statistics that you just talked about, is when we look at the market from an inventory of unsold apartments perspective, the market has gone clearly in a more healthy and positive direction. That is of course, the fundamental part that will determine how much is being built in the future. Currently, much of the demand has been to absorb some of this excess capacity. We're going in a better direction there, and therefore, if markets continue to develop as they are, you would then probably expect to see more of a recoupling as you explained it.
Any granularity around the different city tiers. Am I right in saying that we're seeing a disproportionate impact from the cooling measures because tier 2 in particular, which I'm guessing is about half of your market, or at least half of your exposure in China, is impacting the business and the market quite materially this year?
That is clearly an impact that these cooling measures are for the bigger cities. As I mentioned, the cooling measures impact about, I think it's 52 cities, and that represents close to half of the market. Yes, that's where the strong markets have been, and that's where we now see actually transaction volumes for apartments and so forth, going down from a high level because of the cooling measures. That's why we have the outlook also for the full year from 0 to -5 is. Now we've been about 0. -5 would mean that these cooling measures start impacting a little more broadly.
Separately, can I ask you, what is the level of growth currently, revenue growth in your Chinese maintenance business?
It's a double-digit level. We have to look at the business from two perspectives. The growth in our service base in China continues to be very strong. Revenues in service business in China is comprised of two or actually three different things. It's a contractual revenue. It's your first service revenue and repairs. The first service revenues that comes included when you buy the new equipment and is of course directly linked to your new equipment volumes that delivered in the past years. Given a decline now in new equipment deliveries, that revenue piece is more flat, whereas the contractual revenue continued to grow at a very good rate.
Does that take us down to low double digits? Would that be fair?
Yeah, that's fair.
Thank you. Separately, if I can just ask on your Operating margin. Sorry, I just want to be clear. Obviously, China is the culprit, as we have now seen for the last four quarters. Lead times in China, probably about six months or so. That's what we've talked about in the past. Am I right in saying that the lower Operating margins this quarter is predominantly, if not exclusively, an impact on 2017 earnings rather than 2018 earnings?
If you look at lead times in China, the fastest can be about six months, then they're nine to 12 months. I wouldn't make that fast of a conclusion, but we have to see where we are towards the end of the year.
A final one, just on India. You lowered APAC new equipment markets outlook. Am I right in saying that's more backward-looking really than forward-looking on the basis that we've seen this material decline in India in the first half? Do you see India lower for longer? I appreciate your view earlier that you see a big opportunity longer term in India. I'm just curious as to what you think we might see in the second half of this year.
Clearly, we start the second half of this year at a lower level than we had expected, or we expect a recovery. Probably the full year market is still below what we had expected in the beginning. We expect now the market to start recovering from these three separate big reforms that we have seen.
That's helpful. Thank you.
Longer term, it's clear that India continues to a very positive market. It's good, but this has short-term uncertainty. Still, for example, the Goods and Services Tax, we see that that is really helping improving a lot doing business in India. We think that's a very good thing.
Indeed. Thank you.
We'll take our next question from Erik Karlsson with Bodenholm Capital.
Firstly, on the maintenance business. It slowed a little bit in terms of growth after a couple of exceptionally strong quarters. Both Q4 last year and Q1 this year were at around 7% local currency growth. The pace dropped a bit now to around 5%. I appreciate that one quarter is way too short period to evaluate this. If you could please share your thoughts on what you think is a reasonable expectation for the next couple of years for the maintenance business. Is it more 5% growth or more the 7%?
As you remember what we have been talking about, rather than say where we think it's going to be over the coming years, we continuously see good growth opportunities in maintenance. I would say that we have some quarters that are above trend. If our trend has been around 6%, that's where we were now in the first half. Just much stronger first quarter and a little bit weaker now second quarter. I wouldn't read too much into that. I think the way we have looked at it ourselves so far, and this is more than backward-looking, is if we're growing it at 6%, we think that that's a good growth for a maintenance business. 7% already is really good and 5% is okay, but it can be better. That's kind of how we calibrate it for ourselves right now.
I appreciate we talk about one percentage point differences, but when you compound a business like this over the long term, one percentage point has an impact.
Absolutely. That's super helpful. Thank you very much. I also had a follow-up question on the orders received margins that you discussed before. Given that we now next quarter will annualize the commentary you made around a slight decrease, logic tells us that the comps now get easier starting next quarter. The offset to that would, of course, then be if margins on orders received have decreased sequentially anywhere in the world materially. If it hasn't, we should see an improvement on a year-on-year basis starting next quarter. My question is really, have you seen the sequential drop in margin anywhere in the world that we should be mindful of in terms of how we think about Q3 now?
Clearly, the biggest impact has been China, and that's what we talked about. We haven't seen that big impact from other markets. You have to remember that markets were still dropping both Q3 and Q4 last year. We said Q1, we said that within the quarter, we started to see a stabilization. What we've said is that quarter-on-quarter, we were more stable. Of course, you then have the mix impact as well. Let's see where we are, but I still think we have comps that are higher for next few quarters. Given the development we saw in both Q3 and Q4 last year.
Can I just follow up on that? We don't know about pricing for China for the second half of the year, but if we were to make the assumption that pricing is stable, would that be enough for you to generate more stable margins on orders received as well, given productivity and so on?
We have to see how all of this develop, I'm not going to start speculating where our margins are going to be on orders for the rest of the year. Clearly, we have productivity that is a positive thing. Constantly, for example, raw material costs continue to be a headwind. We have been rolling quite successfully forward with very good sourcing prices. Our impact comes with quite the delay. We have to see how all this mix. It's always a mix of many things. Clearly still where we are first half of the year, even though we have sequentially improved, clearly we are at a lower level today than we were a year ago. Can we start stabilizing the second half? That we have to see.
Very good. Thank you so much.
Thank you.
We'll take our next question from Ross Broadway with UBS.
Hi, Henrik. Thanks. I work with Guillermo Peigneux-Lojo here at UBS, and I'm in specialist sales. A question on his behalf. Your outlook statement uses January to June FX. Clearly the euro has moved materially since the average level that you've used for your guidance. At current spot, what would your guidance be or how would that impact your outlook for the year?
100% sure.
Thanks. If we look at what would happen if the currencies continue at current rate, that would be a further EUR 20 million negative impact to our results.
That's obviously on the EBIT line?
Yes.
Thank you.
Thank you.
We'll take our next question from Peter Testa with One Investment.
Hi, good afternoon. Two questions from my side. The first one on the Chinese orders, what has been the sequential raw material impact Q2 versus Q1? Has it been the same impact, a little higher impact, or a noticeably higher impact? The second one would be on the U.S., if you can help us understand what explains the slower North American modernization performance in Q2, please. Thank you.
Do you want to, Ilkka, talk about raw material impact Q1 versus Q2?
Yes, I can take that then. What I said earlier, to be very clear here. We are seeing increasing impact of raw materials coming through. As we said earlier, the range that we're seeing the impact is around about the middle of the EUR 50 million-EUR 200 million for the full year. Clearly more than half of that is impacting second half of this year. With that, we are seeing Q1 to Q2 having a bigger impact and more to come on that one during Q3, Q4. That's all included now in our guidance that we gave.
You asked about North America modernization. Actually, if you look at orders received in modernization in North America, they were clearly stronger in Q2 than in Q1. If I look at overall North America sales, we had very strong sales growth in Q1. Now we're seasonally somewhat lower, but I would say the modernization business in North America has actually continued to develop quite nicely.
We'll take our next question from Lucie Carrier with Morgan Stanley.
Hi, good afternoon, gentlemen. Hi, Sanna. Thanks for taking my question. Just a couple of follow-ups. The first one is on China. You've spoken quite a lot about the initiatives you have taken to also stabilize pricing, and I was wondering if you could give a bit more color on those initiatives and how maybe they impact potential dynamics around your market share in China. That's the first question.
If you look at market share in China for us, first half of the year, it's pretty stable. We continue to be the clear market leader there. If I look at the actions, there are a multitude of actions that we are taking to make sure that we're better positioned in the growing segments and the growing markets in China, how we find the opportunities, how we manage our sales and pricing. There are a multitude of things that we are doing to make sure that we are competitive where the markets are the strongest and how we then manage that sales and pricing and those other key things that we are doing and that's kind of a daily work that we do around the world and something where we have taken a little bit extra focus now in China over the past several months.
Okay. Just the second question is also a follow-up on increased R&D and IT investment. I appreciate this is to develop your digital offering as well, but are you able maybe to give some form of guidance in terms of those expenses going forward, either as percentage of sales or percentage of cost? Because they seem to have had quite a large impact of 50 basis points this quarter on the EBIT. If you could calibrate potentially how much more it is going to be going forward compared to history.
What we said on that, or in the Capital Markets Day last year, is it's going to be impact of this year, then we estimate around 40 basis points. Now we talk about 50. That's about the impact you see this year. Then we have to see what investments we continue with next year. Clearly as I said, it's not a one-time effect where it will go away. It's just a broader scope and with the speed in the market, how we have been able to gain speed also and bring things faster to the market is something that is impacting here. We have to see, clearly, we are at a higher level than we were in the history, and that's probably going to continue.
Just maybe to follow up on those effort. From your standpoint, when you kind of launch this project on the digital offering or R&D, IT side, how long does it take for you to come into this cost, see your benefits in terms of top line, but also in terms of operating margin? I'm just trying to get a sense of how this increased investment or focus on R&D and IT, what time it requires to pay off pretty much.
I would say that by and large, we have to remember that we're spending less than 2% of sales in R&D. Last year, we were about 1.5%, 1.6%, and now a little bit higher. We're not talking about massive amounts actually. Therefore, the paybacks are usually quite fast. We're not talking about many years. We take about few years or actually in many cases, even less.
It's really hard to give a specific number because there's also a very large variety of different projects we have ongoing. Some of them are really specific and have maybe a faster payback. At the same time, some of them are really broad where it takes more time to deploy them globally. It really varies a lot.
Yes.
Thank you.
Thank you.
We'll take our next question from Martin Flueckiger with Kepler Cheuvreux.
Good afternoon, Henrik and Martin Flueckiger from Kepler Cheuvreux. Just two questions left from my side. The line wasn't always very good, so I'd just like to start off with a clarification question with regards to the market for new equipment in higher tier cities in China, which declined apparently due to government housing restrictions. I was just wondering what your outlook there was. I think you mentioned it, but I couldn't understand it properly for the second half. Do you see a worsening or a stabilization?
We expect that that's where these restrictions are the tightest and of course, we don't know what government policies will be and what they do to these restrictions. We expect a cool down in the market in this and continue stronger than in the lower tier cities.
Okay, thanks. Secondly, just coming back to your KONE Care and 24/7 Connected Services programs. Could you elaborate a little bit what you've done in the second quarter and what the responses were?
What we have continued to do is we have continued to roll out these services to further customers and further countries. Response continues to be good. Each market we bring it to, we have been able to verify the same benefits we were able to verify with the earlier ones. Customers are satisfied. They see it's something that is a more relevant service for them resulting in better hit rates, better closing of deals on the spot and also on average better pricing.
Perfect. Thank you so much.
Thank you.
We'll take our next question from Matthew Spurr with Royal Bank of Canada.
Hi, good afternoon. I had one coming back for China on your pricing comments. You said pricing is stable in China quarter-on-quarter, and it's been like that for two quarters now. If that continues, eventually we're going to be implying flat year-on-year, which I imagine isn't the case. I guess it's sort of semantics, but what do you mean by stable quarter-on-quarter?
Well, if we look at where we are compared to this time last year, we are at a lower level. The Q2 average pricing was about the same level as Q1. In Q1, we said it within the quarters, the average price for Q1 was lower than the one for Q4, but within Q1 it stabilized and become very granular now. It's actually sometimes difficult to have this granular view, but that's kind of our best judgment. Q2 we were stable to compare to the average level that we saw in Q1.
Right. Okay. I think you've said I can't remember if it's you or one of the peers have said in the past, there's always price pressure in this market, i.e. sort of 3%-5% decline each year, even in good years. It kind of moves around depending on raw materials. I mean, flat year-on-year, flat quarter-on-quarter is quite good then, in that context.
I think we have done a pretty good job in this respect. Yes, over the years, prices have declined each year. We have to remember it's different when actually raw material environment was more favorable and volume increase was very significant. It's a totally different environment than when volumes are actually declining and prices are declining at the same time. We have to remember it's quite a different environment to what it was some years ago.
All right. Can I ask one sort of clarification model type question. For outside of China, so the 65% of order intake by value, is price mix outside of China, is that neutral or is that slightly negative?
Probably pretty neutral. I would say that for our grand scheme of things, it's pretty neutral when it comes to the development there. It's really mainly been China who's been impacted in that respect.
All right. Okay, thanks.
We'll take our next question from Tomi Railo with SEB.
Yes, good afternoon. Also, on China on my behalf, how much is maintenance revenues out of your total China sales currently?
Bit over 10%, has it been.
Not, again, a little bit on that level, but it has obviously increased, but it's not sort of moving towards 15% or?
No, not yet. That would have to
Okay
it would have to grow very, very significantly.
Okay. Can you give any comment on sort of book-to-bill ratio in China or the sort of orders and revenues starting to match it up each other?
You're talking about book-to-bill ratio in China. The thing is that on a quarter-to-quarter basis, there's always different seasonal effects when there's big order quarters versus big delivery quarters. Clearly China's orders have come down. Book-to-bill has not been as strong as in the past.
Yeah, that's what I would say. When you look at the order book rotation, slight increase there, but nothing major when it comes to that.
Then just a clarification. I think you said that North American orders were up double digit. Was that sort of on a reported basis or at constant currencies?
I said United States, that's at constant.
Okay. North American orders-
Sorry. Yes. At comparable currencies. Yes
Okay.
In US dollars.
Overall North American orders?
We said clear growth there, not double digits.
It was really U.S. which was double digit.
That was a strong one this time around, yes.
Thank you.
Thank you.
We'll take our next question from Daniel Glyne with MainFirst.
Yes, hello, thank you very much for taking my questions. I would start with two on the service side. First of all, your modernization organic growth rate has come down quite substantially in the second quarter. I'm wondering whether this is a normalization given the high comparison base or whether this is just a one-off effect.
Clearly, we have grown our modernization business very significantly over the past few years. Clearly, we have a higher comparison point. Now, partly seasonal, partly also growth in orders received hasn't been that strong in the prior quarter. It's a reflection of that, but we continue to see good opportunities, good growth in North America, for example, now in the quarter. Always partly seasonal, partly, of course, a reflection of the growth in orders received in the past couple of quarters. Then, of course, the fact that we start to have quite a high base to compare to.
From what I understand, this step up in growth rates was driven by a new selling approach you implemented in modernization. There are a couple of initiatives also ongoing on the maintenance side. You commented that the long-term growth rates you see roughly at the same ballpark, it remains to be seen where it will land. Is there anything in the pipeline that could cause a similar step change in the growth rate temporarily on the maintenance side like we've seen on the modernization side? Would you expect the initiatives that you have undergoing rather to fade in softly? How should we think about that about the very near future?
What you talk about is our sales management approach and how we find opportunities in modernization. That is actually the same thing we've done on the maintenance side. That has contributed to this. I would say what is driving our growth now in our maintenance business, clearly is good conversions around the world, and actually China going slightly in a better direction there as well. These new services over time, we believe will have a positive impact on our growth rate, but it's clear that we are very early days still today. What you talk about, the sales approach where the modernization, the same thing we've done in maintenance over the past years.
This is already baked in. We wouldn't have to expect that there is a step change in the very near future. Maybe on the China side, also two questions from my end. The first one, you mentioned you're still looking for M&A opportunities globally. Is also maintenance on the cards in China, or is this still something you would exclude from the near future?
That has not been on the radar screen for us at the moment. I would say with the organic growth we have on conversion and so forth, that is what we remain very focused on and how we develop a really leading competence in the service market and have really capable employees where we have put a lot of effort and actually done quite well. Those are the main focuses we have and bringing our new services also to our Chinese customers.
I know it's always hard to comment on the market overall, is your impression that the consolidation will also accelerate on the services side outside KONE?
Let's see. We know that we have a lot of small independent players in both Europe and in Asia still, and let's see if we've seen a constant slide, but that hasn't had a big impact on the overall consolidation of the market.
Okay, maybe finally, one housekeeping question. When you talk about the cooling measures in China, do you primarily refer to the private residential area, or is this also going to spill over the other segments? Because you said it's going to affect half of the market. Do you mean only the private residential, or is this going to reach beyond that part of the market?
Where the cooling measures in place, they relate primarily to mortgages and how many apartments you can own on a private basis. It's mainly we talk about the private residential market, which is the largest segment in China.
All right. Very clear. Thank you very much.
Thank you.
We still have time for maybe two more questions.
We'll take our next question from Glen Lilly with JP Morgan.
Hi. Couple of things. Firstly, in North America, in previous quarters, you flagged that price competition was intense in the aftermarket. Is that changing at all?
That continues to be tough, as markets, maybe more conversions. Yes, it continues to be tough, no big change there, I would say.
I mean, it's very different to Europe. I mean, Southern Europe, you can understand no volume growth in new installations, you've got pretty lively growth in the American market. What's undermining prices in North America?
I would say probably we're going slightly better direction, also in North America, you have a lot of independent players there, this is a market people are fighting for and want to play in. Perhaps we're going a slightly better direction. We have, again, as I mentioned, some segments that are really tough. Yes, perhaps slightly better, not a material difference.
On your new KONE Care contracts, if I'm a building owner or operator and today I've got a choice of a three-year KONE Care contract or a traditional contract, which will I pay more for in absolute money terms over three years?
The good thing with the KONE Care is that you can buy exactly what you need. Some cases you want to buy a little bit extra services, totally flexible for you. It actually depends. Some cases you will pay a little bit less, some cases you will pay more. The scope is totally flexible to suit the needs that you have. Actually, I can't say, it goes actually both directions.
Okay. Finally, you mentioned when you're talking about pricing, how much volume growth do you need to keep your market stable? Assuming you've got no price pressure, what level of volume growth do you need to offset the underlying increases in your operating costs for things like wages and other things?
I think you have constant productivity. When you look at other investments that you're doing, of course, growth is the easiest way to create space for further investments. Clearly we are getting for, when it comes to wage costs and things like that, you need to make sure that you can get productivity to offset that. If you're then growing, that helps you then to develop your margins.
Okay. Thank you very much.
Thank you.
We'll take our final question from Tom Skoglund with Carnegie.
Yes. Hello, this is Tom. I was wondering if you could give a comment on the incorporated China equipment, the kind of margin compared to the group average that you have in your group guidance for this year. Do you still expect to be better than the group average for this year?
China margins are better than group average, we expect that to continue.
This year, certainly. On the cash conversion, it's clear that your cash conversion is weaker now in Q2 than in Q1, and you have had clearly higher cash flow than EBIT also, most years and most quarters historically. Is there anything we should be worried about, or it's just that you had exceptionally strong cash flow in Q1?
Yeah. We look at the cash flow, not in quarters. I think you have to look at it in context of a bit longer term. Even if you look at the first half, we are clearly having a positive cash flow generation there, and there's always some fluctuation quarter by quarter. Also, in this quarter, currencies actually play a negative role to our cash flow. That's actually the main driver there on the change. Nothing dramatic there.
Okay. On acquisitions, is there any reasons you have closed fewer small acquisitions this year than other years? Even it now seems very unlikely that you close a big acquisition within elevators. Have you started to open the box and look in adjacent businesses like access controls or anything else? Are you more and more interested in also going outside elevators if you cannot close a big elevator acquisition?
I would say that the fact that we have had less acquisitions now, both second half of last year, first half of this year, it's just been less available. We continue to be active, and there are numbers, and these things, they come and go. Nothing, I would say, noteworthy there. Clearly, we are interested in finding more, and we hope that we will be able to find more. What we have said is our scope of business is about people flow. We are in a good business. We have a good position here. That is what we want to strengthen. If we look at adjacent, it has to be very much linked to the business and how we strengthen our current people flow business that we have. That's what I can say. I think we are looking at this in a very disciplined manner.
Okay. Thank you.
Thank you.
Thank you, Henrik. Before closing, I would still like to remind everyone that we have our Capital Markets Day coming up on September 29th in London, and you will get a bit more color on our progress then for the next time. Thank you for your active participation. I would like to wish you a nice rest of the week.
Thank you.