Good afternoon, everyone, and welcome to KONE's Q3 results presentation. My name is Sanna Kaje and I am the Head of Investor Relations. I have here with me today our President and CEO, Henrik Ehrnrooth, and CFO, Ilkka Hara. As usual, we will start with a presentation by Henrik on the highlights of the quarter.
Thank you, Sanna, and also welcome everyone, both here in the room and everyone following the webcast. It's again a great pleasure to report to you the results we have achieved in the third quarter. We had a good performance again, and I'm particularly pleased that we have continued to perform strongly in an environment that we all know has been challenging already for a while. I think we have again clearly demonstrated that also in a more challenging environment, that we can continue our good performance and find good opportunities out in the markets by working with our customers. As usual, I'll start with our key figures. Go a little bit deeper into some of them. I'll talk about some of the areas, how we have developed KONE and some developments in our programs.
After that, talk about markets and wrap up with our outlook for the markets as well as KONE's outlook. Let's start with the key figures for the third quarter of this year. As you can see from the heading, we had a solid development on a broad basis. Our orders received were EUR 1.77 billion, growth of 0.4%, if we look in comparable currencies, growth was now 3.3%. This I'm pleased about. Our order book remains very strong at EUR 8.7 billion. It's grown at 5.6% in comparable currencies from last year. This naturally gives us a good situation for the coming years. Our sales, EUR 2.17 billion. It declined slightly if we measured in reported currencies. However, in comparable currencies, we continue to grow, and we grew at 1.9%. What is most important with this is that we continue to grow profitably.
Our EBIT of EUR 331 million, we can see improvement in our EBIT margin from 14.9%-15.3%. This was a strong performance. We also continued to have strong cash generation. We've continued very positive cash generation at over EUR 400 million of cash flow in the quarter and also our EPS improved. As we've always said, one quarter is a very short period of time to look at our performance, it's better to look at a slightly longer period of time. Now at this stage of the year, we naturally have nine months to look at. We can see how we've done on a slightly longer term. For the first nine months, we can say that it's been a continued good operating performance. Our orders received at just shy of EUR 5.8 billion. They declined at 3.8% or 1.2% in comparable currencies.
Sales has continued to grow at EUR 6.2 billion, 1.7% growth. In comparable currencies in this type of environment, what I believe is a very solid number, 4%. Perhaps if you look at the first nine months, the highlights are our EBIT of more than EUR 900 million for the first nine months. Improvement in our margin from 14.2% to 14.6%. What I'm very pleased about is the very strong cash flow we have continued to drive at KONE. EUR 1.1 billion of cash flow for the first nine months is a very strong achievement, and I'm very happy about that. Our EPS has also improved from EUR 1.30 to EUR 1.42 for the first nine months. I think it's clear to everyone that performing strongly in an environment like this requires a committed, motivated, and dedicated team. This, I believe we definitely have at KONE.
Everyone at KONE has continued to really look at opportunities, look to find opportunities, how we can improve in this environment. This we've done. My heartfelt thanks to all KONE employees for the great work that they have done during the first nine months are ongoing. What they do for us as a company to drive us forward. Those are the key numbers. Let's go a little bit deeper into orders received, sales, and EBIT. Orders received growth of 3.3% in comparable currencies. Here what I'm very pleased about is that we had a very broad-based, strong performance, and that compensated the challenging situation we are facing in the large Chinese market. Here in Europe, Middle East, and Africa, we continue to grow in double digits, a very strong performance.
In North America, we continued our solid growth from a good level and also rest of Asia Pacific grew in a good way. We can see that the objective we have had during the past years is to find broader-based growth to compensate for what we have already known for a while, the Chinese market is getting more difficult. This we are definitely delivering on. If you look at by business, continued double-digit growth in our modernization business, which I'm very pleased about. It's also here, the efforts we have put in over the past few years to strengthen our modernization business and drive growth is happening. We also had a better month now, a good growth in our major projects business. If we look at China, I know that always a lot of questions about that, and of course, it's an important and big market for us.
In China now this quarter, we did outperform the market. Our orders received grew at close to 5%. If you look at our orders received in monetary value, they declined in high single digits. We can see that the market continues to be price competitive, and we can continue to see a shift in what our customers prefer to lower specification products. If you look at this in combination, impact for us continues to be roughly 5% in price and roughly 5% impact from mix to lower specification products. If you then look at the margins for our orders received, the most important point is that the margin of our order book remains healthy. However, given the price pressure that we have seen in China, the margins for our orders received in the Chinese market did decline slightly now in the third quarter.
Overall, if you look at our orders received, I'm very pleased about the broad-based, strong performance that we have had. I then turn to sales. The growth of 1.9% in comparable currencies. Here the highlight is really our services business. Our services business, we have been delivering good growth in that now for quite some time, and that will continue. Modernization business continued solid double-digit growth at 13.4%, and our maintenance business also a very solid, good 6.1% growth. These then compensated the slight decline we had in our new equipment business. If you look at this by region, both Europe, Middle East and Africa and the Americas growing at good rate, then compensate before a decline in Asia Pacific. Here, Asia Pacific outside of China continued to record strong growth, whereas our sales in China now declined at around 10%.
It's of course, a natural consequence of the fact that our orders received started to decline earlier this year and order delivery lead times are about six to nine months. I think this is totally logical. Overall, very pleased about the growth in our service business, where actually we have been growing at good rates in all geographic regions. Then turn to our operating income, our EBIT. Here, again, very pleased that we continued our profitable growth and improved our margins from 14.9% to 15.3%. The driver of the good improvement in our margin was the positive development we have had in our services business, both maintenance and in modernization. Here we're both growing at good rates and be able to improve our margins through the work that we have done.
It's clear that profitability in new equipment declined slightly, but remained at a good level. That was because sales declined in new equipment. We also continue to have other areas that burden our EBIT development, such as continued increase in investments in research and development in IT, and also foreign exchange continues to be a clear headwind. For the quarter, the headwind from foreign exchange is about EUR 30 million. For the first nine months so far, the headwind from currencies is about EUR 30 million. Overall, through a good development and the actions we have taken, we have been able to continue our good profitable growth. We then turn to our sales split. A natural consequence of the fact that services business has been growing faster than new equipment business, their share of sales also increased, and particularly in modernization.
This is good to a slightly more balanced overall sales mix. If you look by area, it's natural that North America is increasing its share as that's the fastest growing area in terms of sales at the moment. China represented about 30% of our total sales in the quarter, a little bit over 30% of the sales in this quarter. What about our financials? You can see that very good performance, and I'm pleased about the achievements. Let me then next go to how we developed our business, bring again some highlights from our development programs, after which I'll go into more detail into our markets as well as our outlook. Starting with our development programs.
As I believe it's familiar to all of you, we are now in the third year of the current set of development programs, and these are coming to the end at the end of this year. We have had a lot of good achievements, and we continue naturally to drive them with good momentum towards the end. I have two highlights here. In Q3, as usual, we have completed our annual customer loyalty survey, where we got feedback from more than 30,000 customers from around the world. The results remained at a high level, but perhaps the most important development is that we had a good development in our services business. That's really thanks to the structured approach we have had to drive actions based on feedback we have from customers and improve customer communications.
These are very important in the services business, and we're very encouraged that what we do, we can see the results, and that's why we are continuing to drive forward those actions. The other highlight I wanted to bring up here is our most competitive People Flow Solutions Development Program. Here, I'm very pleased to say that we have a very good momentum in the adoption of our key high-rise technologies. Really technologies where we deliver very unique value to our customers and where we have very strong differentiation. Our UltraRope hoisting technology has good momentum. It has been ordered to some very prestigious buildings around the world, and we have a good tender pipeline for it. Our JumpLift construction time elevator has great momentum. This is really a unique solution that KONE provides, how we help our customers speed up construction work, make it safer and better.
We have a number of great customer testimonials, and usually when customers start using this, they realize that the productivity they get out of their construction for high-rise buildings is very strong. We can see that great development for that solution. Also, I would say in virtually all of the commercial buildings where we are delivering the solutions to our customer, they also have a People Flow Intelligence to make people flow in the building smoother, better, with a better experience to users and better monitoring for the building owner. Overall, good momentum in each of these. Then also a very nice accolade we had during the quarter is that Forbes magazine every year lists the 100 most innovative companies in the world. We were sixth year running on this list as the only company in our industry, and we were ranked number 56.
That is, of course, a nice encouragement and recognition for all the work we have done. Naturally, the way we measure the success of our innovation is how our customers view it and the adoption and the added value we can provide to them. That is, of course, a nice encouragement to all of our teams for the good work they have done. That is about our development programs. If I turn to markets. So far, it's all been about how we develop, but now let's talk about markets in more detail. Let's talk about new equipment markets, and I'll take them in the size order of the markets and start with Asia-Pacific. Now, in the quarter, we did see that new equipment markets in Asia-Pacific stabilized. The reason for that is that the decline in the China market moderated in the quarter.
It declined only slightly now in the quarter, although price competition did remain intense in the Chinese market. Rest of Asia-Pacific, slight growth, and because particularly growth in India. If you look at Southeast Asia as a market, pretty stable but mixed. Australia slightly declined from a high level. As you know, Australia has been developing very positively already for many years. It remains strong but came slightly down from a high level. I'll come at the end of this again, little bit back in more details to China. Europe, Middle East, and Africa. We saw some growth in South Europe. That's positive. As we have predicted, the market is recovering, not fast, but it's going in the right direction. Central and North Europe now in the quarter was a slight decline. We continue to see a good momentum and potential in the market.
If we compare to the quarter last year, there was quite a lot of activity in the third quarter of last year. On top of that, Brexit also had an impact on the market. We saw a slight decline, although we think that in many markets there's good momentum, particularly Germany is developing nicely as are many of the Nordic countries. Middle East, rather stable despite the uncertainty in many parts of the region. North America, as you know, we are in the seventh growth year for the market, it's at a good level and it continues to grow slightly from there. This has made that pricing in the market has continued to improve slightly. Overall, we can see a mixed environment on new equipment. Let me again little bit pause here and talk slightly more detail about China.
As I mentioned already in Q3, the market declined now slightly. The decline moderated somewhat compared to the first half of the year. Year to date, our estimate is the market has declined at about 5%. If you look at the monetary value in the market, that has declined significantly more, both as a result of price competition and also what I mentioned, customer preferences going more to affordable product. We can see a clear impact from this. Price competition has continued to be intense. I would say trend pretty much the same as we have seen earlier in the year. As I already talked, what I'm pleased about is that in this quarter, both if we look at units or monetary value, we did outperform the market.
By the units, KONE was up at close to 5%, and in monetary value, our decline was high single digits. What is happening in the Chinese market? We, of course, all see that the market for real estate, like the residential real estate, has been very active and prices have gone up a lot. That is in particular in a limited set of the higher-tier cities where momentum from a property market perspective is very strong. As we know, lower-tier cities, there continues to be an excess supply which is putting a limit on the development there. If you look at total real estate investments, they are growing only slightly. One can question that, why is the market not growing faster given the very positive momentum and a strong market for residential apartments in particular? We have two situations here.
I think we all understand why lower tier cities are not developing better, because the inventory is there. Although they're coming down, they remain at the level where there's still room to be worked on. Therefore, of course, developers are cautious in starting much new in these areas. If we then look at the higher tier cities, what is restricting developers from accelerating the development and meeting more of this demand are very high land prices. That is putting then a limit on the development potential in the higher tier cities. We have these two areas that are impacting, and we can also see that in particular tier 1 cities, there's been a lot of restrictions imposed by the government to cool down the markets overall in these cities.
We're seeing that growth has spread more to tier 2 and tier 3 cities in the vicinity of tier 1. Market continues to be challenging, particularly the residential side, which is the segment that is declining. As you know, our approach continues to be that we are not maximizing market share. What we want to do is to find a good balance between pricing, volume, to have a good development. I think that we've shown we've done so far this year. If we look at the market, what we see from our outlook is that we have slightly changed the outlook for the Chinese market for this year. Earlier, we expected the market will decline between 5% and 10%. Now we expect that the market will decline at about 5% for the full year.
This is because this moderation or decline started perhaps a little bit earlier than we had expected, and also the year-to-date decline is about 5%, so we expect a similar level for the full year. That is again, a little bit more in detail on China. Let's then go back to our markets and go back to our service markets. I'll start with maintenance. Start with largest market, Europe, Middle East, and Africa. Here, markets continue to grow, although a clear difference market to market and price competition continues to be intense. Similar situation North America, some growth and price competition rather intense. Perhaps not as intense as in Europe. Asia Pacific here, development continues to be positive throughout the region because of high new equipment deliveries over the past years. In modernization, markets grew somewhat in Central and North Europe.
South Europe, here we also we have positive news in that we are starting to see early signs of recovery in many of South European markets. That's good after many years of decline. That is definitely a positive news. Both North America and Asia Pacific markets are at a good level and growing slightly. With this, let's wrap up with our outlook. New equipment markets here, Asia Pacific. As I mentioned that China's expected to decline at approximately 5% in units ordered. However, competition is expected to continue intense. Rest of Asia Pacific, some growth. Europe, Middle East, and Africa grows slightly in Europe and stable in Middle East. North America continue the same development we've seen so far. Slight growth from a good level. Maintenance very much the same trends we've seen so far.
Lower growth, but differs country to country with the best growth of course in Asia Pacific. In modernization, also pretty much the same trends we've seen so far. Grow slightly in Europe and continue to grow in both North America and Asia Pacific. In this environment, what do we expect from KONE? We can say that our outlook, we have specified it. We have now nine months behind us, we can make a little bit tighter range. We expect our sales to be between 3%-5% growth in comparable currencies. Previously, we expected between 2% and 6%. We can see we've just narrowed the range. In EBIT, we expect our EBIT to be in the range of EUR 1,260 million-EUR 1,320 million, assuming that translation exchange rates remain at the level of January to September.
If they remain on that average level, the headwind from currencies for this year is about EUR 45 million. Little bit more headwind than we saw when we gave our guidance in Q2. Previously we had EUR 1,250 million-EUR 1,330 million was our previous. Also, despite the fact that we have a little bit more currency headwind, we have tightened the range a bit. Just to wrap up, highlights of this quarter. I'm very pleased about the orders received growth because the good development we have had on a broad basis. Also, strong development in EBIT driven by the positive development we have had in our service business. We can see that even in a difficult environment, we have been able to find good opportunities to develop KONE going forward. With that, I believe we have good time for questions.
Thank you, Henrik. Now it's time for your questions. Please, let's take one question at a time. Do we have any from the audience? I guess not. Most of the people are following us over the telephone line. Operator, I'll hand over to you.
Of course. There are a number of questions in the queue currently, as a reminder, it's star one to ask a question. We'll now take our first question from Ben Maislin of Morgan Stanley. Please go ahead.
Thank you. Good afternoon, Henrik. A couple from me, please. Firstly, just on China. You've nudged up your guidance for this year. I think at the Capital Markets Day, you gave a preliminary view on 2017 that the market would be down, but down less than this year. I just wonder whether that view on 2017 had changed at all given your tweak to the 2016 guidance, firstly. Thank you.
In the Capital Markets Day, we said this, that when we approach going into 2017, we expect that the decline will moderate. That we've seen now already. We haven't given an outlook for all of 2017. It was only as we go into the year. That's a trend we are seeing now, perhaps start a bit earlier than we had expected, but nothing new to report on view for next year.
Thank you. Secondly, you mentioned that you need to step up your investment in R&D and IT going forward. I just wonder whether you'd already started increasing that spending, or we would see that headwind more coming through next year.
If you look at our report, you can see that R&D expenditure is up compared to sales 0.2 percentage points for the third quarter now year-to-date compared to last year. We are. It's gradual. It's not that we're going to have a step change. It's particularly in the services side, perhaps where investments are increasing more.
Got it. Thank you. Then just looking at the dynamics in China. Pricing sounds tough. Just looking at your commentary, it looks like price mix was weaker in Q3 than it was in Q2. You talk about slightly weaker pricing in the backlog, which I guess is coming from China. Given steel's going up in China, wages are going up, how confident are you that you can maintain the current level of margins there? I guess the only way you can do that is with productivity. How much can you keep squeezing out productivity and offsetting what is a tougher market? Thank you.
Yeah. Just to give perspective on this, as you know, over the past couple of years, we have had a very positive development in our overall competitiveness, productivity, and cost competitiveness in overall in China and elsewhere as well, but in particular in China. With that, we have been probably a little bit ahead of the curve of how prices have declined. Of course, but only one of the areas that help that has been declining raw material prices. Clearly we continue with the actions. We believe that there's continuous work we can do. Raw materials, it's clear that the trend currently for them are increasing. That as we now look, it's likely to be a headwind. We have to see how we are able to continue this. So far this year, we have had a good momentum.
Perhaps the raw materials, that's a change in trend that we're looking into next year.
Thanks. I'll get back in the queue. Thanks very much.
Thank you.
We'll now take our next question from Klas Bergelind of Citi. Please go ahead.
Yes. Hi, Henrik. It's Klas of Citi. I was late on the call, so apologies if you have already provided answers on my question. Also want to get back to the price mix. The price mix last quarter was minus 10. Was just wondering if it's similar this quarter. Then back then you said pricing minus five and mix minus five. Was it the similar relationship this time? I'll start there.
I would say very much similar trends, yes. Of course, these are rough numbers. We're not talking about exact, but yes, direction both are similar to what we saw in Q2.
We got some conflicting messages from your peers yesterday with Schindler saying that pricing is worsening and could land at 10% negative towards the end of the year, while Otis said that pricing is now more stable. This obviously depends on each company's previous price levels, the comparative, and also the exposures to Tier 1 through to Tier 3 cities. If we focus on your mix, can we talk a little bit about what you think about pricing going into the second half?
As always, we don't comment on pricing going forward. Each pricing decision is a negotiation between us and our customers. We can look at what history has been. What we can see is that the competition in the market remains intense. We have the trends we were talking about which continue. Pricing that we have to see how that evolves. That's something we can comment once something outcome. Again, that's something we have with our customers negotiation each one separately.
Yeah, no, absolutely. Back to mix. You said lower ASPs throw down the mix. Can you help us understand where you see customers trading down? Is this just a result of mix between cities that have lower demand in Tier 3, 4, which is weighing on the ASPs? Or do you also see customers trading down in Tier 1 and Tier 2?
It's not only in some cities. I would say because of high land prices and other costs also increasing developers, they are looking at all options to find savings there as well. Also, there are a lot of good products in the lower categories. It's not that they are worse elevators or escalators, but taking the elevator side, we're talking about a more standardized product where you have less options when it comes to speeds and sizes and interiors and so forth. It's just that you're going to a more standardized range and therefore, it's more affordable.
Thank you.
That is what we're talking about.
Thank you.
We will now take our next question from Andre Kukhnin of Credit Suisse. Please go ahead.
Yes, good afternoon. Thanks so much for taking my questions. Just a couple. Firstly, in terms of your profitability on those low-end products, would you say it's different to high-end?
Margin, as we discussed before, the good thing, the situation we have is that our core competitiveness is good on a broad basis. It's clear if you sell a more value product, even if you have good percentage margin on that, the monetary value of your profit is going to be less. That's just a mathematical difference. Yes, we have good profitability also on more affordable products.
Great. Yeah, sorry, that was exactly about margins rather than the absolute size of profits. Quite interesting to see your top line in China already declining at 10%, because we thought lead times are just a little bit longer, that you'll see it in Q4 or beginning of 2017. The balance of volume versus price mix within that 10% decline, is it comparable to what you're booking right now or what you've been booking, say, in the last six months? Should we expect it to change substantially? The reason I'm asking is that I think the message has been quite consistent. The prices were reduced at the beginning of the year by everyone, and that's sort of been the same trend.
When we try to run some kind of average selling price calculations or change in value of your orders in China ex FX, it seems to have quite a clear trend of first worse volumes, but better ASP, and now better volumes, low ASP. Just trying to understand whether that's something that we should be actually focusing on, and whether what you're seeing in your sales right now is representative of what you will see, say, in six months' time.
Yeah, I would say this mix shift has probably something that started more Q2, Q3 this year. Perhaps that mix is still coming through if you look at ASP on sales going forward. It's of course a gradual shift. It's not going to happen overnight directly. You can see it in this environment continue to have solid deliveries, and I think it's natural that when the orders declined earlier in the year, we now start to see that in sales.
Right. Just the very last one, if I may. Henrik, at the beginning of the year, it was quite clear a message on China that, look, you're the biggest player now, you're not going to participate in price wars, you're not maximizing market share. We'll look for the mix of profitability and growth. You've said it in this presentation as well. Is this message kind of as absolutely firm right here, right now as it was nine months ago?
You're probably referring to the fact that now we grew faster than the market. We have to remember that one quarter is a very short period of time to measure. You're going to have fluctuations from quarter to quarter. If you look at year-to-date, our development is probably roughly in line with the market. I think that the message is definitely still intact.
Got it. Thank you very much.
Thank you.
We will now take our next question from James Moore of Redburn. Please go ahead.
Yes. Hi, everyone. I've got some questions on China. I wonder if you could help us a little bit more on this price mix. I think you said units down five for you and value, sorry, units up five and your value down high single digits. Does that mean that we're talking about a price mix that's sort of 12%, 13%, 14%? A bit above what you saw last quarter. I wonder if you could help us by splitting that into, is price and mix about half, or has there been a bit of a shift around?
Volume growth, we said close to 5%, probably a little bit less than that then, and then high single digits. We're still looking at roughly five and five. Again, as we discussed in the previous quarter, it's not exactly, but that's roughly what we're talking about. That has remained pretty much the same as it was in Q2.
Thanks. The service margin, you talked about that being up today and driving the better group margin.
Can you say if the equipment margin is flat year-on-year or up year-on-year or down year-on-year on a global basis?
The margin in new equipment continues to be good, but when your volumes are down, also there your absolute profits are down. The main improvement in profitability clearly came from services. Then we have to remember that the new equipment, China was the one where actually the decline is coming from, and that, as you know, is where we have higher margins than in other parts of new equipment business.
Is the percentage margin down in equipment globally?
As a result of that, on a global basis, it will be slightly down, yes.
Right. Okay. Finally, I wonder if you could help us a little bit with the Chinese equipment margin today. I know you don't give it. A number of your peers have. I think in 2014, you talked about it being broadly in line with the group, and I think you helpfully said in 2015 that it had gone up from that. I guess that revenues are still rising or about to turn, but still rising this year in China. Is it fair to say that the Chinese margin has gone up again, and might we dare to think of it as high as 20% yet? I'm thinking about a starting point to try and model the challenges that may come.
Okay. Revenues for China in the third quarter were down in total about close to 10%. Our margins are good. If you look over the past years, up until 2015, we improved our margins significantly each year. That has, of course, been an important driver for our profitability. We have good margins in China. Now, sales in the quarter in China did decline.
Can you help us at all with the starting point versus the group, or is that difficult?
It is above the group, yes.
Okay. Thank you very much.
Thank you.
We will now take our next question from Lars Brorson of Barclays. Please go ahead.
Hi, Henrik. Just two questions from me, please. Just on the outlook for China and the slightly better than earlier expected, can you say by segment where that is coming? Is infrastructure proving to be stronger than you previously expected? You obviously announced a very large order yesterday in China, one of the biggest ever for you in that market. Are you seeing something different in residential or commercial that's proving a little bit better? As you look into 2017, I wonder whether you can give us a sense for whether you see some risk, particularly around tier 1 and 2 cities on the back of the cooling measures we see coming through now.
As you know, the residential market is clearly the largest market. Infrastructure is important, but it's quite a small part of that segment, small part of the overall market. That has continued to develop well because of stimulus measures. Also commercial, more or less stable. I guess it is always the residential market where that drives quite a lot of the bigger movements. Perhaps there a slightly better impact. You're right, they have enacted cooling measures on some of the higher tier cities. We have to see how much that spreads and what the impacts are. If you look at the transaction volumes and the prices, they're of course very strong. It's probably, if you look over a longer period of time, a healthy thing to cool down the situation a bit.
Thanks. Just secondly, a minor question perhaps. On your minorities line, they're in a loss. Is there a special charge coming through or is GiantKONE in an underlying loss, or is there anything else in your minority line that I'm missing?
Peter, you want to take that?
Yeah, sure. Thank you. Yes, that's actually correct. The major driver of that is the closure of our acquisition of GiantKONE. Once that is done, actually, we've seen less volatility going forward.
Sorry, just to be clear. That's a charge, is it? Or is there an underlying loss in GiantKONE?
No, it's an adjustment as we close the transaction on what we had for the year. Nothing material there.
GiantKONE continues to have good profitability.
That's what I thought. Thanks.
Okay, thanks.
We will now take our next question from Manu Rimpelä of Nordea. Please go ahead.
Okay, good afternoon. Can you firstly help me to understand the margin in the third quarter? It was very good and you said in the second quarter that you, I think you used the word like all stars were aligned or it was a very strong performance. Just wondering if that continued into Q3 as well. Are you being able to run the whole engine at a lot better pace now compared to previously, or is that the kind of broad that we're starting to see that service growth picking up and that's driving the margin improvement more than what you're losing in the equipment at the moment?
I would say that each year we have been able to improve our productivity and that continues. As I said, what I'm happy about, and that doesn't always happen, but both in Q2 and now in Q3, the performance was broad-based from many different businesses and regions. We had good execution on a broad basis. Good execution means that you constantly, in this environment, you constantly need to improve your productivity. You need to improve the value you provide to your customers to develop your pricing and so forth. All that has continued.
Okay. One question on China from me as well. You are commenting about the weaker margins in the order intake. Just trying to understand what has changed because you didn't have that comment in Q2. What has changed between Q2 and Q3 to mean that the margins have become weaker?
You have to remember that the margins you book, that's an estimated margin you have of what you deliver when you finish the project. Because of the very good momentum we have had in our competitiveness and cost that we have driven in China, we have been able to be a little bit ahead of the curve, you can say, on price declines. Now perhaps as we can start to see some headwinds in raw materials and others, it's not as easy to be as ahead of the curve. This is probably where the change is coming. We still continue to see a lot of opportunities and we think we can improve our competitiveness. Some things have been external tailwinds are now turning to a little bit headwind.
Okay. The final question in terms of pricing outside of China. Are we starting to see prices for North American services improving? I think you mentioned that the pricing has improved in North America, but was that related to new equipment or services, or both?
In new equipment, we have been able to improve our pricing in North America. Services continues to be very competitive there. Perhaps not quite as competitive as the European market, but particularly on new equipment where the improvements have been seen. In Europe, in the stronger markets, we've been able to improve, particularly where it relates to compensate for costs of new codes and so forth.
Okay. Would you classify if you think globally, excluding China, about the pricing environment, both the new equipment and services that we are kind of starting to enter a phase where you would actually be able to gain some pricing power again after years of not having so much?
Well, we have to see. That all depends on how well we can deliver value to our customers. If you look at the world economy as a whole, we all know that it's quite fragile. I don't think that the external environment will provide a lot of help to that. It all depends on how we can drive forward and provide better value to our customers.
Okay, thank you.
We'll now take our next question from Martin Fluekiger of Kepler Cheuvreux. Please go ahead.
Yeah, good afternoon, gentlemen. Martin Fluekiger from Kepler Cheuvreux. Thanks for taking my questions. Actually, a few of them have already been answered, let me just stick to the ones that remain. Coming back to your statements on the market, the new equipment market in China, I just wanted to clarify. When you talk about markets generally, not just for China, but for all regions, do you talk about the relevant markets for KONE, or do you talk about the entire market? That would be my first question.
We are not present in, for example, South Korea and Japan, we don't talk about those. We talk about the markets where we are present. That's where we have an insight to understand what's happening in them.
Thanks. I understand that. Just within China, because the reason where I'm coming from is also some conflicting statements made by some of your competitors recently compared to the ones that you've made in your Q3 report today. I was just wondering where the difference in assessment between the various peers comes from. Whether it's the geographic positioning, whether it's the market segment positioning. Again, is it the entire market, for instance, in China that you're looking at when you talk about market declines or increases, or is it just the market relevant to you?
As you know, I don't think anyone has as broad of a footprint and broad presence in China as we do. Yes, we look at the whole market. There's always going to be some differences between what we say and someone else says. We have to remember this, that market growth figures, that's not an absolute science. It's based on what we see and our judgment. I don't think that there are massive differences, but our approach in China is to understand the whole market because that's where we think that that's the market that we want to cover.
Okay, thanks. Understood. My second question would be on, I'm not sure whether that GiantKONE question previously that was asked referred to the same item. I was looking at your minority interest, which is negative this quarter. What was the impact there? Sorry.
Again, confirming what I said earlier. It's an adjustment due to the acquisition of the remaining stake in GiantKONE. It's not to do with the profitability of GiantKONE as such.
Understood. Thank you very much.
We will now take our next question from Ryan Gregory of Liberum. Please go ahead.
Yes, good afternoon. Thanks for taking my question. It's just one on cash flow. In the quarter, your EBIT was up 2%, your operating cash was down 7%. We saw a similar development in Q2 as well. Just wondering, could you provide a bit more color on your working capital? I see the cash flow from working capital this quarter was EUR 40 million, which is about half what you've had historically in your third quarters. Is that just a function of the China order declines we've seen, given the favorable payment terms there, or is there something else going on? Thanks.
Do you want to cover that?
Yes, certainly. I think overall, we're very happy with the cash flow as such. EUR 1.1 billion, nine months this year is a good achievement as such. Naturally, there's many components that we work on. We have outside of China included as well, a good balance between advanced payments and inventories. In this difficult environment, I'm quite happy how we performed on that one. Thirdly, I think also to highlight that our receivable collection has progressed well, we've seen progress across the globe, especially in Southern Europe in general, in that respect. All in all, I think a good progress there given the circumstances.
Okay, are you seeing a negative impact from China in terms of advanced payments?
We haven't seen a change in payment terms as such. Obviously that's part of a negotiation with the customers and obviously, any change in sales in China will have an impact there. Overall, it hasn't had a major change to the overall situation.
Okay, great. Thank you.
Ryan, perhaps the only addition I would have to what Ilkka said is, you said that we continue to improve our working capital. As you remember, that working capital was negative to the tune of EUR 1 billion. Continuous to improve working capital and have better cash conversion than an EBIT, I think that's a continuous very strong achievement.
Yeah, sure.
We will now take our next question from Andre Kukhnin of Credit Suisse. Please go ahead.
Oh, hi. Yes, thanks so much for taking the follow-up. I just wanted to ask a more broader question about service, looking into 2017, we kind of go across geographies and across maintenance versus modernization. Should we think of any reason why growth should slow down in those end markets? When we try to add up kind of install base additions and try to run kind of service model, it looks like if anything, we should be accelerating. Then on modernization, it's harder to track, but you seem to be very firm on that than market and some of your peers are very bullish. Any kind of broader thoughts on that looking 2017 without obviously issuing an official outlook would be much appreciated.
If we look at, just going to comment more in general rather than next year. Our service business, we are now been compounding that at around 6% for the past two years, and for a service business like this I would consider that a strong number. Of course, what's helped there has been good growth in deliveries in Asia Pacific. We have a lot of new units coming into service, so I believe that our ambition continues to drive a good growth there. Nothing has changed on that side. Remember, of course, the bigger the base gets, of course, we need to have even more growth the following year to get to the same percentage number. That is just simple maths. The key point is our ambition level continues to be high and want to compound that at a good rate.
Okay. Got it. Thank you. Just to double check on the increased level of investment that you highlighted at the Capital Markets Day, the 20 plus 20 basis points. Of which base is that? Given that you are already ramping it up as you highlighted, and there is already 20 basis points increase in R&D to sales year to date in 2016.
Well, probably if you look at it on a rolling basis from now on. It is not any time going to be each quarter that much, but that's kind of the trend. It can fluctuate from quarter to quarter, but we can see that this year it increased quite a lot. We are going to see increase next year as well. Probably if you look at rolling basis from now on for the next year or so.
Got it. Thank you very much.
Thank you.
We will now take our next question from Michael Kalderis of Bank of America. Please go ahead.
Yeah. Hi, good afternoon. Question, I just want to put your comment on lower gross margin into context. I think in the past you were referring on your pricing pressure. You were able to offset that by your cost competitiveness, basically, supplier and raw materials, each of them being maybe one third, one third, one third. Going forward, I guess raw materials, I mean, the raw material part probably disappears. Do you think that the pressure you can put on your suppliers in an environment where raw materials are stabilizing or going up, are you still able to do that?
I would say as you've seen from how we developed, we have been able to work very successfully together with the suppliers. Of course, we need to work with them on making sure that we can have a sustainable business with them and therefore develop the solution and look at how we do things and what materials and what designs we use and so forth. That will definitely continue. As I said earlier, an added benefit to that, and the main improvement has been through the actions we've taken. That's important. That we believe can continue. The added benefit to that has been the raw materials that have been declining now for a few years and provided a good tailwind. Now, if we look at steel prices, they are up actually quite significantly.
Therefore that's going to from turning from tailwind to a headwind and the work with our suppliers, that continues. This is something that, as external factors more difficult to impact.
Basically if we assume pricing is going down maybe 5%, maybe there's couple of % of this that you can't pass through and that is basically the difference in gross margin in your orders at the moment.
I would say that when we talk about orders received margin that you have to remember that is the estimate of what we have today. The real margin is what we deliver eventually to our customers when everything is delivered and we have done everything. We have to see. At the moment it looks like we are slightly down. I wouldn't quantify it now.
Okay. Thank you. Maybe just to follow up on taking a bit of a longer term perspective on pricing in China. I guess you've had other countries which went through that phase of being very immature, nice margin on the OE and then maturing, getting a bigger services base, with the OE margin probably going down a little bit. How should we think about pricing in China medium term and not just talking about the next few quarters. Is it a market that basically going to see 5% or so pricing pressure for the next 10, 15 years or should we think of it differently?
Again, I can't make comments on pricing going forward. That we have to see. What is good is that the services business is continuing to grow at a good rate. If you look a few years forward, it's clear that the bigger share of the pie of profitability for the industry as a whole, and I believe for us as well, will come from services than it's today. Clearly, you have a gradual shift, but how that will happen, we have to see.
Last one, Henrik, please, on the investment in R&D and IT. We get 20 basis points increase for growth. How should we think on an absolute level as you roll out the kind of initiatives that are supported by those investments? Are these investments going on? You need to do more investments as you go into more countries or is it one-off investment? You do this, you go back to your previous level of R&D, IT or you stay stable? How should we think of it beyond 2017, maybe?
It's clear there's a lot of new technology happening in the market and all this helps us to serve our customers even better and provide better value to them. I think that this is a trend that when technology is moving fast and shifting quite a lot, we are in a certain period of time. We are now in a structurally higher investment environment. However, as I mentioned also in the Capital Markets Day, the results we have from some of the increased investments we've done, for example, on the services side, are very encouraging. We believe that there is a payback, but of course, investments come first and then the payback comes later. I believe that as technology continues to move, that there's probably structurally slightly higher level we need to see over the coming years.
Again, we're very excited at what that can provide us in terms of providing value to our customers and also improving productivity in our business.
I think everyone will agree saying that your capital allocation is already very good. Basically, the way you think about this extra investment at the moment is basically this will allow you to remain above 5% for maintenance and services growth for another many years after the super cycle in China comes to basically slows down. Is it how you thought about that?
Clearly, we are making these investments to continue our good growth, whatever that growth rate is. Yes, why are we doing this is to differentiate from the market overall. We want to provide the best value to our customers, and we do that. We see great growth opportunities in this industry. We see a lot of good growth opportunities in services. Remember, it's a very fragmented market, and with good organic growth in particularly the Asian part of the world. That's what we invest in because we see there's good opportunities there.
Understood. Thanks very much.
Thank you.
We will now take our next question from Glen Liddy of JP Morgan. Please go ahead.
Good afternoon. If you looked at the revenue for Europe or the U.S. in terms of an OE cost relative to the aftermarket value over a period of 10 years, how does that compare in Europe, U.S., and China?
In the U.S., products are more expensive than Europe because you have a higher labor cost there and they tend to be larger and bigger equipment, but also service prices are higher. I kind of look at what is the relative new equipment to service price. I don't think that there's probably going to be massive differences between the two, between the regions. In China, yes, equipment are cheaper, partly because labor cost, partly because volumes and so forth, but also services are slightly cheaper than rest of the world. Is the ratio different? I don't think there's going to be a huge difference.
Is the Chinese aftermarket profitability improving yet or are you still investing a lot so it's not improving in its profitability?
What I would say about our Chinese service business is it has a good profitability.
Okay. Regulatory change in China. Have you got a view on when that might happen to trigger a big wave of aftermarket opportunity?
You've had some regulations over the past years, mainly related to installation and mainly related to bigger repairs. They have not significantly changed the market. In some areas, you have some specific service regulations. We have to see how that changes. If you look over the years, we can see that OEMs is taking, all the time, little bit bigger share of the service market. It's not a huge shift, but it's growing. I remember Bill Johnson showed that in his Capital Markets Day presentation. I believe that trend will continue, and the more demands there are on service as equipment will start aging, also the larger OEMs can show the value from utilizing new technology. I believe that you will start to see a gradual consolidation of the industry.
Finally, on China, direct sales rather than via a third party, is that resulting in different pricing environment? Are you in more control of your prices if you're doing it direct rather than through a third party?
They're a little bit different models. You have different models in China, but there is not a significant difference.
Okay. Thank you very much.
Thank you.
We will now take our next question from Tomi Railo of SEB. Please go ahead.
Hi, this is Tommy from SEB. Hi. Hello, can you hear me?
Now we can hear you, yes.
Okay, good. Apologies. Tomi from SEB. Can you just, also on China, give a comment on the maintenance growth for the third quarter?
We continue to grow at a good rate. Year to date, we are at close to 25%. In the third quarter, we're about 20% growth in China. Continue to compound at a good rate in China.
Thank you.
We will now take our next question from Ben Maslen of Morgan Stanley. Please go ahead.
Yeah, thank you. Just a couple of follow-ups, please. Henrik, there's obviously a lot of focus on the line in the report that says that the relative margin of orders is slightly lower. We've not seen that before, really, so I just wonder what you meant by that. Do you mean that the margin is lower on a like for like basis for the similar equipment? Is it lower because the mix is different? Maybe there's more new equipment in U.S. and Europe, less in China. Is it a mix effect that, as you say, people are trading down in China? I'm just trying to understand, is it a commentary around on a like for like basis, or is it a mix effect that's making the margin come down? Thank you.
This margin call is particularly related to China. There, on a like for like basis, margins are slightly lower. As you know, that's our highest margin new equipment business, that is what has the impact.
Great. Thank you. Just following up on China, can you give us a sense maybe of what the book to bill ratio is on new equipment in China or how your backlog is looking? Just so we can perhaps under-- if revenues in China are down 10% already, how much more of a decline will we have to process as we go into 2017? Any help with that would be appreciated. Thank you.
If you have our book to bill, what it was approximately for China now.
Approximately in the third quarter, if I believe correctly, it was 0.9. That's what I remember.
I think it's around that. You have to remember, Ben, also that third quarter is seasonally something where you have more deliveries and less orders. I think that's not that unusual.
Yeah. Okay. Got it. In terms of looking into next year, you would still see, even if orders flatten out from here, which I guess is what your guidance is implying for the market, there's still a sales decline to process.
Yeah. Orders received declined beginning of the year and first half of the year. In monetary value, they declined and you know that the lead time is 6-9 months usually, so that you can draw your conclusions from.
Thank you. Just coming back to your point on raw material costs and how they can change going forward. Your margin is an estimate of what you deliver now. It may change. If you were to take an elevator order in China now, how much of the component cost is fixed at the point of order, and how much is variable that you will lock in at a point closer to delivery? Thank you.
Because the volumes are so high, you don't do them individually for elevator by elevator. As you know, what we try to do is that we try to lock in our prices on a periodic basis to smooth out any development. This year, we have been successful in locking in our prices at favorable levels. We have to see when those roll over, what the impacts are. You wouldn't do it individually because you have so many equipment in the order book, so you do it more rolling. We know that with locking in prices and hedging, you can do that for a certain period of time, but of course, after a while, the underlying comes through.
Okay. Thank you. Thanks very much.
We will now take our next question from James Moore of Redburn. Please go ahead.
Oh, yes. Thanks. Henrik, I've just got a couple of follow-ups really on the non-Chinese business. Service pricing or maintenance pricing, I wondered if you could comment on pricing there in the U.S. and Europe and how that's changing.
I wouldn't say any significant changes. As you know, what we have talked about for a while is that the South European markets in particular. That's where the most significant price competition has been seen. Given the fact that new equipment volumes have been low for many years there, that means that there's not that much new equipment flowing to market, and that has made them quite competitive. Not a big difference there. North American markets continue to be price competitive but perhaps not quite as significant as we saw about a year back or so.
That's helpful. Thanks. Just on the U.S. market, I wonder if I could ask about the volume demand development. You've had a good run for the last few years, and I'm just thinking about the MRL share of the market, which has gone up a lot from 4% to 60%-70% over time. I think it was asked at the Capital Markets Day, could you remind us what you think that and how fast it keeps going up? Does it stay here or do we go to 95%? Is it going to take a long time, or could it keep running at the same sort of pace? Embedded in that question is also, I see that starts for multifamily buildings, which I guess is where you have lifts, have come down quite a lot and your orders keep going up.
I wonder whether you see some volume clouds on the horizon because of those multifamily starts.
Let's start with this question about machine roomless elevator versus hydraulic. It continues to shift more towards machine roomless. At what pace, I can't say, but that's definitely the trend. Also if you look at buildings in the U.S., they're probably starting to gradually get a little bit higher and we can see that the average floors have gone up a little bit over the past years. A hydraulic elevator usually is used in very low-rise buildings. We think that this trend is going in our favor and a machine roomless elevator just provides better value over the life cycle for the owners and users. We haven't given guidance for next year, but you have to remember that the U.S. market in particular, North America or U.S. market in particular, there's quite a big commercial component.
It's not as residential driven as Europe. Residential has been one of the growing segments and so far we've seen pretty good momentum there of that as well. Maybe you have had some slowdown in some areas but as I said, continued good momentum overall in the market that we address with machine roomless.
That's very helpful. Could I just trouble you for a rough mix of commercial versus resi U.S.?
What would it be? Maybe, this is not an exact number, but commercial will probably still be more than half of the market, whereas in Europe, clearly residential is clearly the largest.
That's really helpful. Thank you very much.
Thank you.
Our final question comes from Martin Flueckiger of Kepler Cheuvreux. Please go ahead.
Thanks for taking my follow-up question. Just looking at your comparable base for Q4 in 2015, I saw some pretty strong growth, if I remember correctly. I think close to 11%. That looks like a tough comp going forward. I'm a little bit surprised that you're still looking or considering 5% is doable, as you put it in your revenue guidance going forward. Is there anything that we should be aware of in particular with regards to top line growth going into Q4 or how should we think about the dynamics going into the final three months of the year? Thank you very much.
Nothing specific there. I would say, if I say a little bit lightheartedly, that we have a tough comp every quarter because we have now been growing our profits for 20 years in a row. I don't think we have had a quarter where we would have an easy comparison point. I don't think that that's anything new for us. No, nothing specific in Q4 and we expect to have a good development towards the end of this year.
Thanks.
Thank you.
I guess it's now time to close the event. Thank you, Henrik.
Thank you.
Thank you, Sanna and thank you all for your good questions. I wish you all a good rest of the week. Thanks.
Thank you