Good afternoon and welcome to KONE's Results Review for Q2. As usual, we'll start with a presentation by President and CEO Matti Alahuhta and continue with your questions and our answers to them. Without any further introductions, Matti, please go ahead.
Thank you, Karla. And welcome to the KONE Quarter Two Conference Call. We have again some very positive news to tell. First of all, in orders received, we had in quarter two a growth of 17.6%. In comparable currencies, 21%. This means that we exceeded in orders received the €1.2 billion level. This level is higher than ever in any quarter in case of KONE. The other positive news is that our operating income continued to develop positively. This time, the growth was 5%. Also, the relative operating income continued to improve. Now I will tell you first about the quarter two and first half numbers. Then, as the main element or part of this presentation, I will tell you about how the markets have been developing in different parts of the world and how we manage KONE in this current situation.
Finally, I will tell about, of course, the market outlook for the full year and the business outlook for the full year. Let's start with the quarter two numbers. The orders received went, as said, by 17.6%. In comparable currencies, 21%. This 21% in the current environment, where construction, level of construction activity is still rather low in many countries outside Asia. The order book went up only slightly. In comparable currencies, it went up by more than 8%. The current level of the order book of about €4 billion gives us a very good basis for the second half of the year. Sales growth was 2.2%. In comparable currencies, 4.8%. Operating income grew by 5% to €184.5 million. The relative operating income improved from 14% to 14.3%. The cash flow was lower than in the comparable period last year.
The reason is that the net working capital grew in the second quarter. The reason here is that we had an exceptionally good level of net working capital in the beginning of quarter two. During the quarter, the balance between advance payments and inventories became a little bit weaker. However, even the current net working capital level and cash flow is strong. When I come to the six months review, we see that more clearly. Here I have the six months' numbers. As I have always said, the longer the period during the year, the more it tells about the business in such as KONE is. The orders received growth, even in this six months' period, was good. It was 17.2%. In comparable currencies, 17.5%. 17.5% during the first six months of this year is naturally something we are very, very pleased with. The order book I already mentioned.
In sales, sales growth was 3.5%. In comparable currencies, 3.8%, which is nicely in line with the full year guidance that we have given both in January and in April. The operating income went up by 6.6% to €303 million. Again, nicely in line with the guidance that we had given in January and in April. The relative operating income increased from 12.6% to 13%. Cash flow for the six first months was strong at €367 million. Next, I will again comment orders, sales, and operating income more in detail. Here you also saw how the development has been in these three parameters. First in orders, then later in sales and operating income in the quarters over the different years. Here you see clearly how this more than €1.2 billion level in orders is clearly higher than the level in any other previous quarter.
The growth was fastest in Asia-Pacific, and there it was strongest in India, Southeast Asia, and China. Saying India first is good news because we are the market leader in India in new equipment. India is the world's second biggest elevator and escalator market in terms of volumes. As we have told earlier this year, the process of urbanization is accelerating at the moment in India. Also in China, the growth in orders was very, very strong. In China, we are now among the three leading companies in this industry. In Europe, Middle East, and Africa, the growth in orders was good. In Central and Northern Europe, we had good development in orders in many countries. For example, in Nordic countries, in Germany, U.K., Netherlands, Belgium, and also in the Middle East. Whereas in Americas, the orders received growth was slightly declining.
However, in the United States, it was slightly increasing. Sales growth was driven very much by the strong progress in Asia-Pacific because as a result of recession and the lower orders level, especially from late 2008 to roughly the middle of 2010, we had somewhat declining, a little bit declining sales in Europe, Middle East, and Africa, and clearly lower in the Americas. Here you see the development in operating income. We have been able to continuously grow our operating income across the different phases of recession and uncertainty. As you see here, the step in Q2 this year was smaller than the peak step we took last year. This is what we have communicated already for a long time. Last year, our good growth in operating income was supported by positive developments in external factors such as currency changes and the favorable situation in raw material costs.
Now, as we are told and as we expected, during the quarter two of this year, both of these areas had some headwind. This means that if we take the external factors out, the development this year has been roughly the same as last year. The additional comment here still is that, as many of you remember, we started to increase our growth-related investments, especially in R&D and in Asia-Pacific already one year ago when we thought that the first phase of recession is over. Here you see the business mix situations regarding the first half of this year. The biggest development and most significant development here is the growth of the share of Asia-Pacific oil sales, which went up from 20% to 26%. As you remember, still in the middle of last decade, this share was less than 10%. Hence, this development has been something very important for us.
From the left side of this picture, from that pie chart, you see that the mix between new equipment and service was very close to the same as one year ago. In comparable currencies, we had a growth of 1% in sales of new equipment and just more than 6% in services. In services, modernization sales declined in quarter two, whereas the growth was at the earlier good level in maintenance. Overall, I would like to say again that the combination of these two mixed pie charts is really becoming an asset for us in order to be able to manage rather well different kinds of market situations globally.
Now I am coming to maybe at least one of the most interesting questions at the moment, that is how have the markets developed during April, June, and after that, I will then also tell how we are managing the situation with this kind of market situation that I will review. Let's start from Europe, Middle East, and Africa. The key point is that the market environment remained mixed in Europe, Middle East, and Africa. In maintenance, the markets continue to develop well, but the price competition remains strong. In modernization, Europe really splits quite clearly to two different kinds of areas. In Central and Northern Europe, the development in the modernization market continued to be quite favorable and providing clear growth opportunities. Whereas the markets in Southern Europe were at a stable level, and the market in France continued to decline.
In the new markets as well, the market development was positive in many countries in Central and Northern Europe, driven by positive development in the residential segment and also by the increasing market activity in major projects. The new markets in Southern Europe continue to be stable at low levels. In Russia, the market activity continued to increase. This started late last year and has continued since. In the Middle East, good development continued in some countries like in Saudi Arabia and Qatar. The overall situation there varied a bit from country to country. In Americas, the key message is that slight recovery continued, but uncertainty remains. Maintenance markets developed well, but the pricing environment remained challenging. Modernization markets, on the other hand, that also the modernization markets that started to develop rather well already end of last year continued to grow.
In new markets, the change is that in the United States, the slight recovery continued in the non-infrastructure-related segments, but the uncertainty in the market increased. What illustrates this development and uncertainty quite well is that the Architecture Billings Index that we have discussed many times was at the level of about 50% during quite many months from end of last year or the latter part of last year to this year. During the last couple of months, it has again been below 50%, a little bit below, indicating a lower level of future orders. In Canada, the market remained active, whereas in Mexico, the market continued to grow from the low levels. In Asia-Pacific, the rapid growth continued in all markets. The modernization and maintenance markets developed positively.
In the new equipment markets, regarding the new equipment markets, I will tell a few comments by all of the, let's say, key markets, starting from China. In China, all segments continued to grow. The growth was fastest in the residential segment. In that segment, it was fastest in affordable housing. Geographically, the growth is at the moment fastest in the inland parts of the country, in the, let's say, medium size and big cities in those areas. China is such a huge market that is in various kinds of phases that it is necessary to see that much more in detail than in just one set of numbers.
Looking forward, I think that the fact that during the first half of the year, the new construction area growth and the area under construction numbers have been growing constantly by more than 20% gives a clear indication that the growth will continue also during the second half. We believe that the growth will be at a somewhat lower level than compared to the very fast growth in the market during the first half. In India, market growth continued and actually was very strong during the first half of the year, driven by the residential market. However, during the latter weeks of the quarter, we saw more and more signals and indications that financing will be getting tougher and maybe will constrain and bring the market growth during the second half to a somewhat lower level than the exceptionally high growth in the first half.
In Australia and in Southeast Asia, the good market development continued. As a summary about this market development globally, I would like to say that the markets in various parts of the world are in very different phases. We have strong growth in Asia-Pacific, good growth opportunities in Central and Northern Europe, and then the weakness of the market for new equipment in Southern Europe and the United States. Therefore, the general comment is that we don't speak about market cycles at this point of time. Instead, it is very important for us, most important for us really, to be very close to the market development all the time, get a deeper understanding of the markets in order to be able to pick up best growth opportunities. Therefore, our approach to target growth also in this kind of environment as a challenge company has the main key action points.
First of all, in this kind of situation, it is even more important to differentiate from competition. Naturally, this is what we are doing through our development programs. As we have said earlier, the set of these five development programs that we started to work in the beginning of this year is such that all of the different programs help us to differentiate from competition. Secondly, the focus on growth markets. This naturally means something more than focusing on Asia, for example. It means that we have to develop better and better understanding of the market developments overall, understand the market by segments better, manage our business by segments better, and in this way have, let's say, more focus, more agility in really targeting the most attractive opportunities to grow.
I already mentioned that we are supporting, we have been supporting and are supporting growth also through selective growth investments, especially in Asia-Pacific and overall globally in R&D. Finally, engaging people. We are investing increasingly in developing our people and developing leadership skills in order to continue to have the good spirit we have in the company. As a conclusion about the market development and our approach, the developments in different parts of the world in the market, they are different. Through these actions, our objective is to continue to create growth also in this environment. As we have seen in our first half order intake numbers, it is possible. Finally, market outlook and business outlook. First, new equipment. In new equipment markets, we expect that the strong growth in Asia-Pacific will continue, however, at somewhat lower level than what it was in the first half.
We also expect that the good activity level and good development in the new equipment in Central and Northern European, in many Central and Northern European countries, will continue, whereas the market for the new equipment in Southern Europe will continue to be at the stable, at the weak level. In what comes to North America, we expect that the slight recovery will continue, however, with increasing uncertainty. The modernization markets are expected to grow slightly. Actually, the growth, we expect that growth will be rather good in the United States and in several countries in Europe, but that decline will still continue somewhat in France. The maintenance markets are expected to continue to develop well. Our full year outlook is unchanged. Our net sales is estimated to grow 0%- 5% at comparable exchange rates as compared to 2010.
The operating income is expected to be in the range of €700 million-€ 750 million, assuming that the translation exchange rates don't deviate materially from the situation of the beginning of 2011. Now we have actually quite a lot of time to your questions.
Good. Thank you, Matti. Let's start with the questions from those present here in Espoo.
Yeah. [Erik Krasal], Swedbank. Regarding your guidance, during the first half of the year, you had 17% order intake increase in comparable currencies. You also expect positive maintenance market development going forward. You don't seem to be expecting sales growth acceleration during the latter half of this year. Why is that? Are the lead times so long these days in equipment deliveries? What's behind this?
I think that not much has happened in lead times. You see that naturally, we have average numbers in lead times. You see that in Europe, Middle East, and Africa and in Americas, our sales level in quarter two was still heavily impacted by the low level of orders in 2009 and the first half of 2010. Our situation for this year is that we have, let's say, very good, let's say, order book coverage for sales of this year. In new equipment, it is about 90%. In modernization, it is about 90%. We feel that our outlook is solid, and we are very confident with that.
Okay. Thanks.
Hello. [Elin Eriotaud] from Evli Bank. In the outlook for Asia-Pacific, when you expect good growth to continue but at a lower level than the first half, does that reflect the financing constraints, or is it that you see some changes in the market in demand?
In India, I mentioned about financing constraints. In India, the growth in new equipment markets during the first half was very fast, very strong, exceptionally strong. There, we have seen that financing constraints might make the growth somewhat lower during the second half. What comes to China? In China, we have seen over the last several years different kinds of phases so that always when the market growth has been a little bit at a low level, the growth has been stimulated. When it has been at a high level, China has taken actions to decrease the growth in order to better manage the continuous development, smooth development of urbanization. We are still in that phase when the growth has been very high. China is really taking actions and having those actions active which will slow down the growth a bit.
This is why in both cases, actually, I see that the slowing, a little bit slower growth, somewhat slower growth than in the first half is only good news in really supporting smooth development not only this year but also in the future.
Thank you. Another question, if I may, about the selective growth in fixed assets. Can you or would you like to quantify that? What kind of growth in fixed costs due to these investments are you seeing?
I think that from our report, you see how our R&D fixed cost investment has been, fixed costs have been growing. What comes to Asia-Pacific, I would like to say that strategically in today's kind of market, it is extremely important that a company such as KONE is well positioned in the biggest growth markets. Of course, we are taking all necessary actions to make that even a stronger point for us.
Thank you.
Do we have any further questions here? Yes, [Iris].
Hi. [Iris Teppanen] from Carnegie. You said that orders increased in the U.S. in Q2. Was the growth rate better than in Q1, or did it come lower?
In quarter one, I think, [Erik], correct me if I am wrong, but I remember that in growth, orders received growth in the U.S. was higher in quarter one than in quarter two.
Okay.
I think that it is, we are still pleased that in the current market in the U.S., we have been able to grow in orders in the first half.
Regarding the outlook for the U.S. market, it seems that the outlook has become somewhat more uncertain. Could you just elaborate a little bit on what has changed from Q1?
I think that a very concrete way is to say that the Architecture Billings Index has moved from being above 50% that it was up to the April number. In May and June, it has been below 50%. Typically, this index is nicely, very, very indicative in what you have to be ready with. I would say that these are not still, let's say, dramatic shifts that we have seen in the U.S. market and what we will possibly see. We have some interesting development in some specific cities like Washington, San Francisco, Boston, some others. If we are able to learn the market better and better, be closer and closer to understanding the markets, I think that we can do rather well also in the coming months.
Thanks. One question still, if I may. You said that modernization sales have declined in Q2, if I understand correct. I think the outlook for the second half is somewhat better than in Q1.
What has happened in modernization this year is that in quarter two, modernization sales went a little bit down, but the orders went up. This is also what we see. These orders going up, we expect also for the full year.
Thank you.
In general, the overall development in the modernization market is positive at the moment.
Yes, and [Erik] from Swedbank again. Regarding your negotiations concerning equipment, pricing, or the timeline during the latter half of this year, what's the outlook there? Do you still strive for annual contracts in equipment going towards 2012? How do you see what's happening there?
Annual contract for?
For equipment orders for 2012.
For equipment.
Annual pricing, I mean.
Okay. In price, now you mean when you tell about annual contracts, I'm a little bit confused. You mean that when we are selling, how are we trying to get prices up?
No, I mean your equipment, you discuss with your equipment vendors. Do you strive for fixed prices for the full 2012?
Okay. Component vendors.
Exactly.
Component vendors. Now I understand. Okay. What we have done for this year and last year, as we have told, we have done fixed-price contracts for a majority of the volumes, but not all, and by purpose. That has been a conscious decision. This is most likely what we will do also for next year. This has been working well. All of that naturally depends very much on the expertise of the sourcing team. You remember that is one of the areas where we have developed the competence very, very actively. Now, if I expand this question a little bit, what comes to material costs and the impact there?
First of all, as we have said, the level of raw material and component raw material contracts, the price level of the contracts that we made for this year, those were higher, somewhat higher than what were the contracts for last year. You remember that in many raw material prices, actually, the growth was in the second half of last year, last autumn. We did those quite early, and that was a good decision. Actually, the good news here, we have both good and bad news here, not dramatic in either direction. The good news here is that in the cases of most raw materials, the price development has not been so bad during the last few months. It has been stable typically, or a little bit up or a little bit down.
Of course, because we have to pay those, that part of sourcing which we have not done well for the fixed pricing, we have to buy that roughly with the spot price. That is somewhat higher than what we have had earlier this year. Therefore, we say that is roughly why we say that we see that the material cost will have somewhat more headwind during the second half than the first half.
Fair enough. Thanks.
Thank you.
It seems that we don't have more questions here for now. Let's look at the questions or let's hear the questions from the lines.
The first question comes from Mr. [Lars Brorson] from DnB NOR . Please go ahead.
Yes, thank you very much. Good afternoon. Can you hear me?
Yes.
Thank you very much for taking my question. I had one follow-up question on the Americas region and one separate question on the Chinese market. Firstly, on Americas, you talk about order growth in the U.S., but yet in the quarter, you talk about declining orders in the Americas. Can I just try to reconcile that order decline with your discussion on the operating environment in the Americas in Q2, where you talk about slight recovery in new equipment and, of course, both maintenance and modernization markets developing well? Can you provide a little more detail on your relative performance in these markets and comment on whether you have lost market share in markets outside of the U.S.? Thank you.
Okay. First of all, good question because this brings the opportunity to bring some further clarification. In the Americas, we are strongly active only in the United States, Mexico, and Canada. We are not active in Latin America. As I said, in quarter two, when we take both Canada, Mexico, and the United States, our orders were slightly declining, very slightly declining. However, it was growing in the United States, but it was slightly somewhat declining in Mexico and Canada. What comes to market shares, we always feel that a quarter is not a period to speak about market share, not even half a year. As a comparison point of view, I would like to say what I expect that you want to hear. Also, what you want to hear is that in the second quarter of last year, we had some, let's say, high level of orders in Mexico.
Canada as well. The comparison point in both Canada and Mexico was very, very high. I would say that our performance continued to be good in Canada, and the overall level was as high. It was just slightly lower than a year ago.
Yep.
The Canadian market has continued to be quite active for a longer period already now.
Yep.
That's very helpful on that question. Thank you very much. I had a second question on your Chinese operations and the dynamics in the Chinese market in Q3. You talk about a partial delay in the government's affordable housing construction plan, which is very consistent with other market commentary we've heard from that market. Can you elaborate on the materiality of this impact in Q1 and any risks either on the upside or the downside in the second half from this delay? Thanks.
I think that, yes, yes. I think that there was news earlier that there is some kind of delay in this affordable housing project. However, latest today, we have, many of us, I think, have read from the newspapers that the Chinese government has confirmed that the plan for this year is in the middle way. We have also seen this, that the growth in the affordable housing has been strong. Its strength naturally has made it possible that the growth in China during the first half has been at such a strong level. It has been, as I said, the residential segment has been the fastest growing segment in China during the first half of this year. The affordable housing segment has been the strongest element in that.
Can I just ask for clarification? You don't see orders being pushed from Q2 into Q3 this year, for example?
I don't see that in any, at least in any major way.
I would say there's no difference. I think it's normal Q2, Q3 cutoffs that we have, that some orders now and some orders later. There's nothing special in this quarter end.
Okay, that's useful. Maybe just finally on China, can I ask you whether you, to what extent you've seen a positive impact from the suspension of purchases of Otis elevators following the accident in Beijing, both in your Chinese market generally and in Beijing specifically?
I think that unfortunate accident happened just a very, very short time ago, and it is too early to say anything to that.
Okay, thank you.
Our next question comes from Mr. Chris Reid from Capital Research. Please go ahead.
Hi. Three questions, please. You talked a little bit about raw materials and the relationship with suppliers. Could you talk a little bit about your ability to negotiate the impact of higher raw material costs when you're negotiating prices with clients? What is possible in the market? Secondly, in terms of [crosstalk].
Let's take one by one. It is more, let's say, helpful for all, I believe. We started actions to increase prices already a few months ago. In some cases, we have succeeded better, and in some cases, worse. Of course, in this kind of situations where there is an uncertainty and even weakness, still uncertainty in many markets and weakness still in several markets, the possibility to get price increases is clearly tougher. The work will continue. It is, in many cases, tough.
Okay, at the beginning of [crosstalk].
I would like to still continue because it is tough. Therefore, in this kind of situation, being able to create growth and continuously actively work to improve quality and productivity is even more important than what it is typically. It is naturally very important always.
Okay.
Okay. Thank you. That's helpful. At the very beginning, you were talking about the growth rates in the second quarter, both the stated numbers and then if you use comparable currencies. Could you go into a little more detail about what the major currencies that were responsible for those adjustments are?
Henrik.
It's clear that the major cuts for us are dollar and dollar-related currencies, then, of course, renminbi. We have, of course, a lot in Nordic countries, we are quite large here, so we have crown. In Europe, we have pound and Australian dollar. What is quite actually interesting, if you look at the first half of this year, is that we are on average pretty much at last year's level, that they have not really gone in tandem, all of these currencies. They have evened out each other. If you look at KONE, we have quite a broad and diversified currency exposure. No single one that is very significant. In the first quarter, we had a little bit of benefit from currencies. In the second quarter, we had a little bit of headwind. For the first half, it's more or less neutral.
Okay. Great. Finally, can you give us an update on the number of units you have under maintenance contract?
Our policy is to keep it only annually, but it has been a good development.
Okay, thank you.
Thank you.
I remind you that if you want to ask a question to the speakers, please press zero one on your telephone keypad.
Do we have any further questions on the lines?
We have a question from Mr. Bernard Horn from Polaris Capital. Please go ahead.
Yes. Good morning. I'd like to just ask a little bit about the comment you made with respect to credit in the second half in, I believe it was China. I'm wondering if you are experiencing any changes in the terms of credit among both your suppliers and your customers. Are you having to provide more or less financing than normal? If you could just kind of comment on what sort of terms you are buying and selling at.
I would like to give Henrik to answer.
I would say that from, if you look at first our customers, no significant changes there. Same thing with our suppliers, that normal terms, there haven't been any significant changes in those relationships. I think Matti's comments were mainly related to India, where interest rates, of course, for a longer period already have been on the increase in order to fight the inflationary trends there. These are the reasons that we have seen from time to time that they have been a more challenging environment for our customers to raise financing for their projects. This is what we're talking about. We can see a little bit foresee that there could be a little bit tighter financing environment in India for our customers in the second half than the first half. That is one of the reasons why we're saying that we think that growth will be somewhat slower.
We still think that the development will be a positive one. We have to remember now, particularly in Q2, that we had exceptionally high growth rates. It's mainly a question of overall availability of financing in the market for our customers. On us needing to finance suppliers or customers, nothing has changed, and that is not our policy to do so.
I would like to add to that that there was a similar kind of situation in the middle of last year, quarter three or so in India.
Quarter four mainly.
Quarter three, maybe mainly quarter four in India. At the end of the year, the situation started to become better. Now, during the first half of this year, the growth in the marketplace has been very high.
Thank you. In terms of your normal credit terms themselves, are you working under the same kinds of terms as you would in the Western countries? It depends on, you know, like 30 or 60-day credit terms on accounts receivables and accounts payables.
There are no major differences in those between, I would say, India, China, and the rest of the world. I think perhaps the difference is that when we look at our new equipment business, in the developing world, we tend to have slightly higher emphasis on advanced payments as a method of managing our credit risk. Payment terms themselves are not that different. We try to make sure that we have more advanced payments, not a big difference, but perhaps slightly more advanced payment weighted in the developing world than perhaps in Europe and the United States.
Okay, thanks very much.
Our next question comes from Mr. [Michael Harleaux] from Merrill Lynch . Please go ahead.
Hi, guys. Just hoping you could give us some outlook really on the working capital development in the second half. What do you guys see there?
As Matti already mentioned, we had in this quarter a slight increase in our working capital. That was due to two factors. First of all, we have a normal seasonal fluctuation in maintenance invoicing, which was very much the same level as in the prior years, which means that we have more maintenance invoicing in the first quarter for the full year, then slightly less in the second quarter. That's very normal. If you look at compared to last year, last year we had a strong improvement in the ratio of our advanced payments related to our total inventories in Q2, whereas we had a slight decline now. We more than compensated the weakness in our or the normal seasonal fluctuation in maintenance business last year by this improvement in the ratio of advanced payments to inventories. We had a slight difference there, but nothing significant.
For the rest of the year, we expect that we will have continued good cash generation and will follow normal patterns. We don't expect anything different from the usual in the second half.
Great. Thanks, guys.
The next question comes from Mr. Mayank Kumar from Goldman Sachs . Please go ahead.
Hi . My question has been answered. Thank you.
There are no further questions from the telephone.
Okay. Thank you. Do we have further questions from those present here at KONE Building?
We have no further questions from here. Unless we have questions from the lines, I think we are ready to finish. Any more questions on the lines?
No, no more questions on the telephone.
Thank you very much. Thank you very much for your attendance and active participation. Have a nice rest of the week.
Thank you.
Thank you.