KONE's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Jan.28.14 | About: Kone Oyj (KNYJF)

KONE Corporation (OTCPK:KNYJF) Q4 2013 Earnings Conference Call January 28, 2014 8:45 AM ET

Executives

Karla Lindahl – Director-Investor Relations

Matti Alahuhta – President and Chief Executive Officer

Henrik Ehrnrooth – Chief Financial Officer

Analysts

Ben Maslen – BofA Merrill Lynch

Guillermo Peigneux – UBS

Lars W. Brorson – DNB Bank ASA

Glen Liddy – JPMorgan Securities Plc

Karla Lindahl

Good afternoon, and welcome to KONE’s results release for Q4 and the full year 2013. We have an exciting day today and have shared exciting news, but without any further introductions on that let’s start with the presentation and then questions-and-answers as usual.

So please, Matti go ahead.

Matti Alahuhta

Thank you, Karla. Yes, we have two important news today that we have announced today. We will do it so that we will first have the last year’s report, how our performance was developing last year and then after that Henrik and I, we will tell about how we see the transition in leadership in the beginning or end of March, beginning of April. So let’s start with the financial performance. In addition to our development in Quarter 4 and the full year of last year I will also tell about market development and about some highlights of last year and then final initiative about market outlook and business outlook.

In addition, this year, beginning of this year also marks a start for a new phase not only in the sense of the leadership from the beginning of April, but also with the start of new development programs now. And this why Henrik and I will also tell about our achievements in our previous programs and what our programs for the next three years will be.

So let’s start with Quarter 4 development. It was a good quarter. Orders received was growing by 11.5% and in comparable currencies 16%. This is something Henrik and I are particularly pleased with. The orders received reached a level of EUR 1.47 billion. The order book went up by or grew by 10.6% and in comparable currencies 16% and was more than EUR 5.5 billion end of last year and we have to remember again that we don’t include maintenance contracts in our order book. So, this is that, this gives us a, let’s say, good basis to have started the New Year. In sales 9.4% growth, in comparable currencies 13.1% and this was in fact the first quarter when our sales level exceeded EUR 2 billion.

The growth in operating income has been strong throughout the year. Now in Quarter 4 it was 13.7% and the operating income was EUR 292.8 million, so close to EUR 300 million. And what was particularly lighting, again also the EBIT percentage improved from 13.9% to 14.4% and cash flow continued to be strong at more than EUR 240 million.

Then let’s move to the full year and 2013. The growth in orders received also for the full year was strong, 11.9% and at comparable currencies 14.1% and the orders received these level of EUR 6.15 billion.

The sales was also growing fast 10.4% in comparable currencies 12.6%, and was close to EUR 7 billion, operating income growth was really strong, last year it was 15% reaching EUR 953 million. And what I also like a lot is that that also the operating income margin for the full year improved from slightly more than 13% to close to 13 – 14%.

The cash flow also grew to a record level to above EUR 1.2 billion. The base earnings last year went up from EUR 1.23 to EUR 1.37. and today our Board of Directors had decided that it will propose to the Annual Shareholders Meeting a dividend of EUR 1.

So I have to say that I am again very pleased to view this development, it was a good year and it is, the development is again tends to our the support of our people all around the world. Now at end of the year we had 43,000 people in different continents. So also in this context I want to thank them.

Then, let’s take a look – closer look at how and what was the development been. In order sales and operating income in the first orders. So the orders, growth in orders received was 11.5% than in comparable currencies, 16% the growth was fastest in Asia-Pacific wherein India, Malaysia and China. The growth was very strong also in the Americas and I have to say that our performance in North America clearly improved towards the end of the year broadly. The orders development was relatively good also in this quarter in Europe, Middle East and Africa where the development in orders was best in Great Britain, Germany and Russia. So overall good development in orders received.

Next, sales. The growth in sales was very strong in new equipment, it was close to 20% and in comparable currencies clearly more than 20%. The growth in maintenance also contribute at earlier good levels. And whereas the modernization sales declined. However, in modernizations the orders received was growing. We had sales growth in all main geographical areas.

Then we come to operating income, the good growth in operating income was driven by continuous from progress in Asia-Pacific and also by the overall strong development in North America. The interesting point here is that the EBIT, operating income margin improved also the share of new equipment sales of our total sales increase. And this was fenced to the good work we have been doing in different parts of the urban development pricing competence now the better prices can throw increasingly also in North America and the overall good development in the quality of our operations.

Because of these developments that I have mentioned, our business mix has had again quite significant changes. First of all, the share of new equipments sales of our total sales, grew from 50% to 54%, and while the zero maintenance been slightly down to 32% and modernization to 14%. Geographically, the share of Asia-Pacific grew by 3% points to 38%. But I want to point out that Europe, Middle East and Africa still continues to be the biggest geographical area for us with its 46% share of our sales.

Now the conclusion, about the development of these two business mixes is that this is a good starting point for the future, because we are well positioned to grow because of our strength in Asia-Pacific and on the other hand our global strength in service business gives us a stability to our business.

So let’s now take a look at the little bit longer-term development in our geographical mix in sales. As we have several times discussed, our strategy, growth strategy is based on thinking target setting that we have since 2005 we have been targeting market share growth especially in big growth markets. And at the same time, our objective has all the time to grow our operating income.

And with this let’s say approach, we have been able by focusing on market share let’s say targeting, increasing market share, focusing on the big growth markets we have been able to do both, increase market share and increase operating income, more or less a continuous basis. And you’ll see that the share of Asia-Pacific of our sales has grown from, in this time period from 12% to 38% and the average annual growth in Asia-Pacific has been as high as 26.9%.

However, I have to say that when we remember how many markets in Europe and North America collapsed in 2008, I am almost equally pleased to have the 6% in Americas as an average annual growth and about 5% in Europe, Middle East and Africa. In the sales by business, the share of new equipment has grown from 40% to 54% and the average annual growth in new equipment has been 14% but also in the service businesses between 6% and 7%.

Now let’s next move to the review of how markets developed in Q4. And, I will start with Europe, Middle East and Africa and with the new equipment markets. In Central and North Europe the market declined slightly. The markets in Germany, in Great Britain and Russia we are growing and markets were stable in Switzerland, in Austria and in Sweden. The other markets declined either slightly or a bit more. In South Europe, the demand continue to decline, however, a positive sign was that sequentially the markets in tropic countries in Italy and in Spain were stable. So that is like a promising sign for the future development. However, the market in the third big country France, where the market level has still – has continued to be better, continue to decline quite clearly. In the Middle East and Turkey demand continue to grow.

In modernization, the market grew somewhat in Central and North Europe, but remained weak in South Europe. Modernization market is, we are learning that all the time is very much, very closely correlated, has very correlation to the GDP growth. And maintenance markets grew also where we saw the significant variations between countries, price competition continued to be intense especially in South Europe, but also in some countries in Central and North Europe.

Next North America where growth continued. In new equipment in the United States growth continued driven by residential and office segments. In Canada, the market was stable and in Mexico the demand declined. In the modernization markets, market grew slightly so it developed more positively than in Europe. In maintenance the markets continued to grow, but price competition remained intense particularly in the non-residential segments.

And now Asia-Pacific, their growth continued across the region and accelerated in China and now again some country-specific comments regarding the new equipment market.

In China, the market for market growth accelerated to slightly more than 20%. The full year – this mean that the full year market growth in China was slightly more than 15%. Our growth in fourth quarter was same as market growth slightly more than 20% and for the full year clearly more than market growth at 23%.

And also we tell you – we will tell you our let’s say official estimates of the market sizes globally and in different geographical areas we can already now give a preliminary information that in China our market share last year grew from 17% to 18% and our global market share increased from 18% to 19% – 19%.

Last year actually developed in our case very much as we planned in the beginning of the last year. We expected that the price competition will get tougher by the end of the year and therefore we wanted to have and we will very actively to have a strong start for the year. And we – in the first half we were even able to slightly increase prices. And what happened in the second half when the price competition as typical. It is a pattern that in typically in fourth quarter where the price competition is more and more toughest we weren’t able to maintain our prices and actually continue to increase our margins.

What comes to the let’s say comparison-to-competition, we were the fastest growing company in this industry about when compared to the our 4 key – 3 key competitors so in top four we were growing fast. This means that the distance if we announce another tool increase. When we take all of the medium-size and big companies we were the second fastest growing company in China last year. And I will soon come back to how we see the, expect the market to develop and going forward we see to sort it as well.

In China, the affordable housing segment declined the growth in the affordable housing market size declined slightly. Statistics of the fourth quarter really state data because they also saw let’s say a good indications and a strong – a good indication – a promising indications about the future development. That new constructional land purchases increased by more than 40%, new construction starts by more than 30% and also the new apartment sales continued to grow and was close to 10%.

We estimate that this year the market growth in China will be about 10%. In India, the market growth continued driven by the – especially by the residential segment, but also the activity in last projects was quite strong. In Australia, demand was stable, both in new equipment as well as in modernization. In Southeast Asia, the markets grew somewhat, where markets were growing also the growth was somewhat slower than either previous quarter and in maintenance all other markets continued to grow.

Here are some highlights regarding last year. First of all, we launched in June the KONE UltraRope hoisting technology and in October KONE People Flow Intelligence solutions. The KONE UltraRope has been very well let’s say, we have got a lot of strong interest to this technology and what we already now see regarding this KONE People Flow Intelligence entry is that while we now have an integrated implementation of Access called London station control, this has clearly improved our competitiveness again in the high-rise segment.

Second important point is that the ramp-up of the new global elevator operating that we launched in middle of 2012, has developed as planned and our – and we will be in our full volumes by the end of this year. Also in escalators we had contractors of our product renewal last year, now the design language that we have in escalators is same we have had in elevators and we have got already several a labor source design labor source so for these new products.

And finally, this I have said and we have said also earlier, but it is the highlight of last year that while Forbes has listed the world’s 100 most innovative companies now for three years we have been in the list every year, with improving positions last year we were number 37.

On the right side of this picture you’ll see the, some key features, the new equipment orders we’re growing by 16%, the deliveries by 16% as well and the maintenance base exceeded 950,000.

And now I come to the development programs, this approach there we decide every three years five key development programs that best bring us to profitable growth – growth to our some addition has proven to be a very good way to develop competitive assets and this is now the fourth time we start this kind of new phase.

But here you see the list of our development programs that we worked with 2000 – from 2011 to end of last year and I will just give some let’s say key comments about the development it was good. Customer loyalty improved every year, employee satisfaction as well improved every year and I already talked about these let’s say great product renewal that we have had during the last there years, in service leadership program we got good progress in developing sales capabilities and quality and productivity of feed activities and in delivery chain excellence program we got very good development in the end-to-end logistics chains from suppliers to installation sides.

And now I will ask Henrik to tell about our way forward with the new development programs. Please Henrik.

Henrik Ehrnrooth

So thank you Matti and also welcome on my behalf to our webcast. First off all it is I wanted to say that it’s clearly a huge honor and a very inspiring challenge to succeed Matti as CEO of KONE as of 1st of April. But we’ll come more to that later during this session.

I want to talk about again how we planned to develop KONE during the next three year period. And Matti talked that in already about our development programs and how we use them to constantly develop KONE into a more competitive company.

So, we have for the next three year period we have again chosen five development programs. The first one is want to be the first in customer loyalty. Here our simple target is, to have the most loyal customers in our industry and this means we tend to achieve through a better customer service and customer communication. The second one is we want to have a winning team of true professionals. By this we want to have a committed and competent employee in every job and this will make KONE an even better place to work. And I like just to say a good continuation of the very strong people that KONE has been doing since 2008.

The next three programs are really designed to again further differentiate us from our competition with our product services and solutions. The first one is we want to have the most competitive People Flow Solutions. This is a great continuation of what we’ve been doing and what we have developed in the past years and we’re here we want to have to make that our products become even more competitive every year.

The fourth one is that we want to be the preferred maintenance partner, so that we can continue to drive profitable growth in our maintenance business. Here we’ll renew our maintenance offering and also improving our sales safer. And the last one is to be the top modernization provider. We think that there are significant opportunities in modernization markets both in Europe and North America, and here we want to accelerate our growth by making sure that we have the best modernization solutions in our industry.

But if I then turn to our holistic picture, many of you would know our previous one and we have now updated it with our new development programs. And this picture is that it describes how we in a systematic way develop KONE towards our vision. And first of all, we have our megatrends. We are operating in a growth industry driven by many strong megatrends those are very familiar to most of you, they are urbanization, demographic change, growth in middle-income consumer and aging population. The third one is safety, and then we have environment. So these are continuous good growth drivers for our industry.

Then we have our strategic targets. In the past years we have measured our progress through five measures each year to see how we have developed and whether we have developed in a positive direction as a company. Now we have aligned our strategic targets with these five measures. The strategic targets are, we want to have the most loyal customers in our industry, make KONE into great place to work. Our ambition is to continuously grow fast in our markets and we have the best financial development. And the last one is to be the leader in sustainability.

Then of course essential is that we continuously develop KONE to work sufficient which is that we deliver the best people for experience. This is our promise to our customers and our end-users. And our way to make the strategy live and to get towards our mission our development programs which I talked about already. Then we have high priority areas which are the most important factors in everything we do, and those are safety and quality.

Then all of these development is supported by KONE’s values and by KONE’s way which is our first architecture which describes how we conduct our business. So again our ambition is that every KONE person should know every KONE employee should know what this picture means and understand how in their role can contribute towards our developments. If we achieve that we think we have a very strong possibilities to continue a strong development of KONE.

At this stage I hand over to Matti to finish with our outlook and both market outlook and our business outlook.

Matti Alahuhta

Thank you, Henrik. Next as Henrik mentioned, market outlook. And starting with new equipment, the market in Asia-Pacific is expected to grow clearly. The market in China as I already mentioned is expected to grow by about 10%. The market in the Europe, Middle East and Africa region is expected to grow slightly. So this is let’s say a bit better than what was development last year. We had relatively stable demand in Central and North Europe, and there the slight decline in some parts of South Europe and a growing demand in the Middle East. The market in North America is expected to continue to grow and in modernization the globally the market is expected to grow slightly. In maintenance the market is expected to develop rather well in most countries.

And finally, the business outlook for this year. Net sales is estimated to grow by 6% to 9% as comparable exchange rates as compared to last year. The operating income is expected to be in the range of EUR 980 million to EUR 1,050 million assuming that translation exchange rates don’t materially deviate from the situation or the weakening of 2014.

So this completes the review of our last year’s results. And now we will move to the other big topic, that is, the leadership change in the beginning of April. And now Henrik and I will care of our comments how we see this situation and maybe I will start with that.

The decision to leave KONE as the CEO and President personally and this has been an exciting job in a great company. However, these decisions and the speaking started to develop in my mind gradually during the last 12 months and it was based on a few factors. First of all, KONE’s business is developing at the moment very well. We are in a strong pace at the moment. Secondly, our new development programs also are starting again a new phase at KONE. Thirdly, I am very pleased with the engagement of our personnel of our 43,000 people and also with the spirit that we have in the company. I’m also very pleased with our excellent report with my management team. In our management team we have several strong people and many of them were potential candidates to be my successors.

My newly appointed successor, Henrik has grown very well to his new responsibility during the last five years and he clearly has brought new leadership and new speed to our company. I am convinced that the decision that Henrik will be the new President and CEO after me is a good decision for KONE.

In addition, nine years is already a quite long period as a President and CEO of a company. At the age of 61, which I am now, it starts to be useful to think that though I still want to be in this work couple of years or do I decide to leave it now after nine years in order to be able to start the next phase on my career again with a little bit differentialities and again new kind of learning opportunity on this.

And I decided later to take feed a letter of alternative and not to continue and maybe, then again decided to continue and then finally run it to a phase when I would – be believe that I can’t be a replace. That would not be – would not have been a nice path. So, this means that the beginning of April I will be involved with many, many interesting let’s say responsibilities I planned to continue with my current position self trust and in addition this – my scope of my activities will further expand also with new and even with new kind of interesting challenges.

I see that this is a good chance for KONE and now I ask Henrik how you see the situation and your situation in front of the new challenges us for many, many years to come. Please Henrik.

Henrik Ehrnrooth

Thank you again, Matti. As I already mentioned it is naturally a huge privilege and a very inspiring challenge to take over Matti’s President and CEO of KONE. I would say I’m doing that with great confidence. I have strong confidence that we can continue to develop KONE in a positive way that we have developed KONE in the past years as well. And the reason for my confidence first of all, that reps, diversity and strength of KONE’s management, as well as the knowledge and skills, competences of KONE’s employees more broadly.

So I would say the whole people aspect we have in a very good shape and that’s of course very important. The second important factor is KONE’s culture, we have a very strong culture, a very dedicated people and a culture to continuously drive renewal and improvement. And of course the third one, relates to what I discussed earlier that we operate in an industry with many exciting growth opportunities. So we have growth possibilities, we remain the challenger in our industry and our objective is to continue to grow faster on markets. So we see lot of opportunities on markets and we also see good opportunities to continuously develop KONE into either more competitive company. So I think that all these three factors give me a very strong confidence that we can continue through this very good path of KONE.

Then, even though we will be working for two months together with Matti, he’s still President and CEO until end of March, but this is the last results announcement for him. So I think I wanted to personally thank you for your everything you have done for KONE, for the very strong development during your period, your unbelievable dedication and commitment constantly to this company, and to develop both the company and its people and its leadership. I think I can say that all of us who have worked with you can be very privileged to have been working with you and we have learnt a lot, that has been a true joy and I think that gives us great path going forward.

So with that, I think we will probably hand over then to Q&A and I’ll hand over it to Matti again.

Matti Alahuhta

Thank you Henrik and now we are ready for your questions. And you can ask your questions both in the area of the results or the transition whatever you like.

Question-and-Answer Session

Operator

Thank you Matti and Henrik, let’s start with the questions from those present here, in case you have questions.

Unidentified Analyst

[Indiscernible]. Last year you still delivered some lower margin projects a big project and a strong result in fourth quarter does this indicate that those projects are not more or less delivered out or shall be this gets delivered by this year?

Matti Alahuhta

So the intensive, or the density of those deliveries was highest this year, but we still have these deliveries continuing next year but getting to low levels by the end of next year. The improvement in our North American and U.S. results very much was a result of the delivering of the orders that we had constantly improving let’s say, prices and margins, you remember that already in the middle of 2011 we started to increase prices and have increased the prices quite significantly over the last two and a half years.

Unidentified Analyst

Thank you. And second question about the pricing competition you mentioned in quite many points that price competition is revised up but has there been any changes during the fourth quarter or generally speaking 2013?

Matti Alahuhta

Let’s say so that the price competition continues to become [indiscernible].

Unidentified Analyst

In the future, how this maintenance business growth will continue?

Matti Alahuhta

Well, first of all when we take this specific period that where from 2005 to 2013 and having let’s say closer to 7% growth there I would say that that is a good growth. Then if I would little bit evaluate that can be pleased be the development last year a few factors first of all; conversions continue to be at good levels, globally conversion rates was about 80% then outside China it was between 85% to 90%. In China, we have the highest conversions in the industry. With KONE brand the conversion is, and has been conversion level 60% and when we take also due to consolidation with KONE where historically the maintenance business has been such a priority as in the KONE branded activity the overall conversion rate was 50%.

Then what comes acquisitions we had a relatively good development also in acquisitions they were about one-third of the new additions. Then we had also let’s say a couple of negative factors. First of all, and this is not so interesting point close to in the Western markets be close to 1% of the elevators and escalators they’re taking out of use during last year, so close to 1%. And then let’s say operatively as we have said also earlier wherein the first half of last year we can’t be fully satisfied without development in competition follow-ups. Then we took that to a strong focus in the middle of last year and the development towards the end of the last year was very good. So this means that we have a good possibility to let’s say further improve our maintenance activity from the maintenance base point of view and now as Henrik mentioned, the maintenance is also one of our key development program so that we can develop and that will be stronger.

Karla Lindahl

Okay, so I think we are next ready for the questions from the line, but just before we go there, there are usually quite a few questions during these calls about China share of our orders and sales, so just for your reference there is an additional slide at the very end of our results presentation that highlights some of the key figures for the Chinese market and our performance in 2013 there. So you will see at what rate we estimate the market to have grown last year as well as our growth rate. And in addition to this China share of our overall orders received and of our sales for the full year.

In addition to this, I thought I would here just refer to China share of our orders and sales in the last quarter of the year, so these figures were a little less than 35% of our orders received, so this is China’s share of our Q4 orders received. And roughly 25% of our sales in Q4.

And next we are ready for the first question from the lines. And if I may ask you to please present one question at a time. Thank you.

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Ben Maslen. Please ask your question.

Ben Maslen – BofA Merrill Lynch

Yeah thank you. Hi Matti, hi Henrik. Congratulations to both of you. First question please just on the, going back to the growth of the maintenance base on the new slides 13 which I guess you just touched on them. I mean it still seems like fairly low growth so on its 900 to 950, 000 units given the strong deliveries in the M&A that you mentioned. I mean, how what’s the absolute number of growth that every year as the base growth? So that’s the one point.

The second one, which Matti mentioned was competition balance, how many units we win versus how many units we lose in the market? And Matti you have mentioned in the beginning of the year we were not satisfied with our performance and we had clearly more lose faced than wins, but the situation then improved towards the end of the year. So, when we look at additions we think about gross adds then we think about conversions and acquisitions their conversions were about two-thirds acquisitions one-third and then we had these two negative factors.

Ben Maslen – BofA Merrill Lynch

Okay, thank you. Second question is on sales growth in Asia, we seem to slowdown in the course a quite lots from the rate you saw in the first nine-months, I think it was 11% in Q4, 20% to 30% in the first nine-months. Given orders and the orders and momentum is so strong in Eurasian business and then you tend to have shorter lead-times, just why you saying growth rates slow at the moment in fact it’s a timing issue or is there some deferrals, the capacity in terms of installation staff that would be helpful? Thank you.

Matti Alahuhta

The answer is we got a straightforward because the sales force in Asia-Pacific was in historical currencies EUR 11.8 but in comparable currencies EUR 17.5.

Ben Maslen – BofA Merrill Lynch

Okay, great. So it’s a currency effect?

Matti Alahuhta

Exactly, exactly.

Ben Maslen – BofA Merrill Lynch

And then my final one if I can, just the extra charge you have in financial expenses if your revaluation of your Giant KONE auction. I noticed you had it last year and you had this year, if we assume that the China business keeps growing and Giant KONE keep growing would it be right to assume that you have this revaluation charge every year? Thank you.

Henrik Ehrnrooth

So yes, I can take that question. Yes, exactly as you said the charge related to the revaluation of the auction of the 20% that we had right to buy in Giant KONE and the charge of roughly EUR 23 million that we had in all of this Giant KONE but the majority of it is and if we continue to growth then the value of that auction would increase it here and it’s charge to be there. It is of course at the moment a non-cash charge and you can see it in our balance sheet the value we have for all of such auctions to be able to buyout minority stakes.

Ben Maslen – BofA Merrill Lynch

Got it. Thanks so much

Henrik Ehrnrooth

Thank you.

Operator

The next question comes from the line of [indiscernible]. Please ask your question.

Unidentified Analyst

Yes, hi there. Congratulations again to both of you to your new adventures. And I have two question if I may. The first one was just if it was possible to get the organic growth in service are you excluding the acquired a bit you said 2.6% in constant currencies I assume there was a little bit of that was acquired. And secondly if I may, just on your top line guidance of 6% to 9% in constant currency it seems as though you should practice pretty conservative I have to say in light of that backlog and orders up 16% and 14% on an equivalent basis and generally you do some small acquisitions as well. So, I’m trying to get into my head around why if this is indeed or we should see this as a sort of a normal conservative start to this year and this in particular in light of the 10% demand growth that you are expecting in China which presumably is where you will expense sort of the development that was evolved in front orders in the year. And those were my two questions? Thank you.

Matti Alahuhta

I will start with the latter one and then have Henrik I ask you to comment that first one. Yes I understand your question very well this why only by 6% to 9%. And there are three key reasons, first of all, we have a major order book in nature, a big order book in major projects and in many of those we have very little deliveries during this year and significant deliveries in the future years.

Second is the dynamics in the midst of the U.S. business, we have a good growth there in orders but and the in the mix in orders the steer of mid sized projects has been growing and the again the delivery time from order to delivery is, the time from order to delivery is long question because this is important because of two reasons, first of all, the impact of these means that this consolidation just for this year it decreases our set base in to KONE branding, it decreases our sales compared to the situation if we would not have done this transaction.

And the same is the case also for EBIT, and the impact is strongest in the regarding the beginning of the year and this is again one of elements why also when we look at the, our outlook for this year both growth in both sales and operating income in the beginning of the year is clearly lower compared to last year than in the let’s say, in the rest of the year.

Unidentified Analyst

Okay, thank you.

Henrik Ehrnrooth

I think let me, one thing about this KONE Areeco is a complex one why it has this impact, but one clarification it has in the beginning it has a negative impact to our sales of course it eventually as we recognize the full project it will have a positive impact to our sales. The cash flow profile is very similar to what it was previously, but as far as it impacts of consolidating it.

But your first question was in relation to the growth of our overall service business that will have comparable currencies in Q4 2.6%. First of all, we have to remember here that our maintenance business grew at its historical good rate and we had negative growth in the modernization business. So we had good growth continued good growth in our maintenance business. Yes we did acquire good business during the year and end of the last year but we are not a material part of our sales growth we have a small impact but it was material.

Unidentified Analyst

Okay, so you did grow sort of organic filing constant currencies so that yours positive?

Henrik Ehrnrooth

Clearly, clearly. Yes, in the maintenance business.

Unidentified Analyst

Okay.

Henrik Ehrnrooth

Yes.

Unidentified Analyst

Okay. Okay, thank you.

Henrik Ehrnrooth

Thank you.

Operator

Next question come from the line of Fredericks Paul [ph]. Please ask your question.

Guillermo Peigneux – UBS

Hi good afternoon it’s actually Guillermo Peigneux from UBS. I have three questions, have you guided and or can you guide as to how much your China revenues are actually coming from third and fourth Qs in China? Then secondly, of the 10% growth that you expect for the overall market in China, can you basically guide as how is your backlog looking like versus that and then IUB [ph] why you’re going to outgrowing going into 2014 a year again with all these capacity increases from your competitors, why would you be outgrowing the market? And then last but not the least, when it comes to working capital changes that we saw a EUR 72 million cash out flow which is materially higher than that what you saw actually last year I was wondering the reasons behind this?

Matti Alahuhta

Okay, so for the first question I understood that it related to that what is our let’s say, split and outlook in the different tier cities [ph] in China that we have not opened and communicated. Then the second question, that are more than right thing is so.

Guillermo Peigneux – UBS

Why we believe we can continue to outgrow the market under 10% outlook.

Matti Alahuhta

In China. And then, well the others factors continued to be goals that we had discussed several times here, all the times expanding more and more to the inner parts of China that increases the accessible market for us. And then well I think that and then it is called unitization of two parallel activity, two parallel brands KONE brand and [indiscernible] KONE it has really proven to be towards a very big strength in this phase when the market is very big and then the price competitions has become tougher.

Henrik Ehrnrooth

I could, I’d like to add one which was in your question Guillermo, which was relating to the capacity increased in the industry. We don’t think that capacity increase is a growth driver for anyone in China. Of course one needs a capacity to deliver, but we have to remember that we operate in a very capital-light industry where we assemble the products. So I think we don’t see that that is a concern or that is driving anyone’s growth in China.

Then, your third question was relating to working capital and the negative working capital we had in the quarter. First of all, we say that it’s very normal for us to have negative working capital development in Q2 and Q4. Very much of our service billing happens in Q1 and Q3. So seasonally this was a totally normal thing. In 2012 we had an exceptionally strong performance in working capital in Q4 and I would say that the situation for Q4 in 2013 was a very normal one. At the end of the year our working capital was again more than 600 million negative, which I would consider to be a very good number and during the year we again improved our working capital. So we think actually that cash flow was at a good level in Q4 taken into account seasonal factors.

Matti Alahuhta

I still would like to comment on this, let’s say, production capacity issues and really when taking KONE, a company we’d say close to EUR 7 billion, our annual investments then excluding acquisitions are in the level of 70 million to 80 million and relatively small part of that is in the production capacity. So we never make an item – we don’t believe that other companies as well. For example pricing decision had a bit bad decision based on these investments.

Guillermo Peigneux – UBS

Okay. Then can I ask the question differently maybe. When you look at the European market or the U.S. market and you compare basically total installed capacity from you and your competitors’ total demand, ongoing demand and then you look at the Chinese market and you see total installed capacity or actually the numbers are due probably see at the moment that is going to be intensively total capacity for 2015 versus current demand levels. Is China normal meaning that I basically read reports talking about the fact that maybe 700,000 units capacity will be built by the end of 2015, which the current run rate of installations is around 475 to 500. I just wonder whether China is just normal. And then you have 200,000, 300,000 extra capacity and that is just basically something that you see in other markets as well.

Henrik Ehrnrooth

We’d first see that this is not a – I would say that this is not any kind of issues even, let’s say, without commenting on these specific levels.

Matti Alahuhta

I think I would add to this that I think when you look at what people talk about capacity in China that is probably what they look at where they built their factory – their maximum design capacity. We have to remember in assembly operations these are very modular. It’s quite easy to expand than your capacity at your site and frankly if you have a little bit extra capacity that means that you have an industrial haul that maybe not be fully utilized and that is frankly not a lot of extra capital charge to have that. So we don’t see the concern in the way that you describe it.

Guillermo Peigneux – UBS

This is very helpful. Thank you very much.

Henrik Ehrnrooth

Thank you.

Operator

Question comes from the line of Lars Brorson [DNB Bank ASA]. Please ask your question.

Lars W. Brorson – DNB Bank ASA

Yes. Thank you very much, Matti. Thanks very much for the last few years and best of luck to you and Henrik. Congratulations on the appointment. A couple of questions if I could. First on the your 10% market growth for China in 2014, I was wondering if you could give us your segmental assumptions here across your non-residential, residential and affordable housing segments in terms of what you expect to see here in 2014 and maybe just to that whether you feel this year versus what we saw last year with affordable housing now a smaller portion in 2014 and arguably with liquidity concerns in that market you feel that visibility on your market outlook here is perhaps somewhat reduced from what you had last year?

Matti Alahuhta

Segment wise what we can say is that the affordable house – the peak of the current kind of affordable housing segment is over. It was declining slightly already last year and we expect that to decline also this year. On the other hand we expect to see good growth both in the rest of the residential segment as well as in the commercial segment.

Lars W. Brorson – DNB Bank ASA

You talked about 10% volume growth. What do you expect value growth to be, or maybe I could ask differently, do you expect that to be the same deal as you saw in 2013?

Matti Alahuhta

Henrik, would you like to comment?

Henrik Ehrnrooth

We have not predicated that, but I would say that there shouldn’t be a big reason for it to be a big deviation from what we have seen so far.

Lars W. Brorson – DNB Bank ASA

Thanks, Henrik. And finally if I just could on your maintenance growth in China. You talk about on your last slide, a 35% CAGR since 2006. I think early we’ve talked about a 40% CAGR. I appreciate obviously in the mid-2000 you saw quite low base numbers and therefore quite high growth numbers, but can you give us a sense for how the Chinese maintenance base is growing or did grow in 2013 relatively 2012 and how we should think about that growth either accelerating or decelerating in 2014?

Matti Alahuhta

What we said is that the average annual growth between – the maintenance space between 2006 and 2013 has been more than 35% and earlier we have said that it was less than 40% between 2006 and 2012. The growth has been strong, but it has slightly declined just because so the comparison pace has become a lot higher.

Lars W. Brorson – DNB Bank ASA

Just to be clear. So the growth has declined in 2013 relative to 2012. Is that right?

Matti Alahuhta

Well, slightly just because the – existing maintenance space that is the comparison point has been becoming bigger.

Lars W. Brorson – DNB Bank ASA

If I could ask one final follow-up please. Just on your current order book comment that it currently has a lot of large project orders. Can you give us a sense of the order of magnitude of this and what sort of margin impact we should think about this would have i.e. what percent of orders currently is large project orders relative to what has been, say, in the last five years or so? And any sort of margin differential between that and small base orders would be of interest. Thanks.

Matti Alahuhta

Henrik?

Henrik Ehrnrooth

So our order book in major projects is roughly 30% of our order book that has grown somewhat from previous year. Overall of course our ambition is reprising and otherwise is to continue a good margin development overall. So this mix shift should not have a material impact over time on our margins. I’d like to at last just still clarify on the maintenance growth in China in 2013 that it continue to be at a very good level.

Lars W. Brorson – DNB Bank ASA

That’s clear. Thanks very much.

Operator

(Operator Instructions) The next question comes from the line of Glen Liddy [JPMorgan Securities Plc]. Please ask your question.

Glen Liddy – JPMorgan Securities Plc

Hi, there. And on the tax rate, could you give us an idea what’s going to be changing with your tax rate going forward over this year and next year? And also some comments on the costs of purchasing materials and components if there’s any change in the outlook there.

Matti Alahuhta

Okay. So first of all, as you saw our tax rate for the full year was higher than the previous year. The reason for the higher reported tax rate, there were two specific items that impacted our result, but are not tax deductable. One is this revaluation of these options for acquisitions so that reduced our result, but not tax deductable. And also then we have deferred tax assets in Finland and the Finnish tax rate beginning of 2014 changed from 24.5% to 20% and that impacted when we revalued these deferred tax assets last year that impacted our tax. So therefore last year the comparison point is our tax rate from our normal operational business was 23.6%.

The impact then of the decline in the Finnish statutory tax rate will have an impact of close to 1 percentage point on our overall tax rate, but as you said the comparison point it is 23.6%.

Glen Liddy – JPMorgan Securities Plc

Okay. Thank you.

Operator

There are no further questions at this time. Please continue.

Matti Alahuhta

Karla?

Karla Lindahl

Okay. So before we close the call, I wanted to ask Matti whether there were something that you still wanted to close this call with?

Matti Alahuhta

Yes. I will see many of you still during the next two months in road shows in different countries. However, because this is my last, let’s say, quarterly conference call I want to really thank you for a great cooperation during the last nine years and all of this has been very professional. Also we are all-time learning a lot from you and I have to say this has been very energizing. Thank you.

Karla Lindahl

Thank you very much and have a nice rest of the day and of the week. And let’s stay in touch. Thank you. Bye.

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