Schindler Holding's (SHLAF) CEO Thomas Oetterli on Q4 2016 Results - Earnings Call Transcript

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Schindler Holding AG (OTCPK:SHLAF) Q4 2016 Earnings Conference Call February 15, 2017 3:30 AM ET

Executives

Thomas Oetterli – Chief Executive Officer

Erich Ammann – Chief Financial Officer

Analysts

Bernd Pomrehn – Bank Vontobel

Andrea Ricci – Bank am Bellevue

Martin Husler – Zurcher Kantonalbank

Caroline Price – Fargo Management

Martin Flueckiger – Kepler Cheuvreux

Jolanda Stadelmann – zCapital

Andre Kukhnin – Credit Suisse

Lars – Barclays

Rizk Maidi – Berenberg

Matthew Spurr – Royal Bank of Canada

Operator

Ladies and gentlemen, good morning. Welcome to the Schindler Conference Call on Full Year Results 2016. I’m Desiree, your operator. I would like to remind you that all participants will be in listen-only mode and that the conference is being recorded. [Operator Instructions]

Thomas Oetterli

Good morning, ladies and gentlemen, and welcome to today’s annual results presentation. Thank you for making it here to Lucerne. And thank you to all our conference call and webcast participants for taking the time to listen in, and watch in. I’m here, together with Erich Ammann, our CFO, who will go into all the financial details later, during the meeting. As an introductionary remark, it is fair to say that 2016 was a successful year for Schindler. We kept our direction towards top-line and bottom-line growth.

According to the agenda, I will go, first, into the markets’ overview globally, in Asia, in Americas, and in Europe; Erich will then present the financial details of the results 2016. Afterwards, we will both share our thoughts about the outlook in 2017, before we are available for the Q&A sessions.

Let’s first, have a look into the highlights 2016. We made important strategic progress. Our strategic partnerships with GE Digital and Huawei allow us really to power digital urban mobility. Several acquisitions, whereof two major ones happened in China with Volkslift and in Germany with FB Group, are enhancing our market presence. We had several successful product launches; some were tailor-made for specific markets, like in China; others were global launches, like our new generation of our high-rise product, Schindler 7000.

In addition, we sold our business in Japan beginning of October, and also became a pure player in the elevator and escalator industry as our participation in ALSO reached 5.6% end of January. Operationally, we were able to show top-line growth and margin improvements, and were very pleased about this development. We have a strong order intake with an increase of 4.6% year-on-year in local currency.

Our orders we received as well as our year-end order backlog were above CHF10 billion and reached record levels. Revenue rose by 3.6%, and was within our guidance. Also, profits went up. Operationally, we achieved an EBIT margin of 11.5% and net profit reached CHF823 million and was, therefore, on the upper part of our guidance.

I’m now on Slide 4 and would like to share with you our view on the global markets. In the new installation market, we were facing, overall, a slight decline in the demand. This was mainly driven by the contraction of the further – and the further softening of the Chinese market. Also, India was contracting in 2016, due to the hit in the Q4 by the demonetization effects. Brazil saw some signs of bottoming out, but all the other markets in the world were growing.

The modernization and service markets showed good growth. In the emerging markets, the conversions of our units from the new installation business further increased the installed base. In the more mature markets, we saw modernization opportunities, driven by the aging of the existing installations. Overall, we still saw intense pricing pressure.

Let’s have a look on the global new installation market. In the upper part, you see the split of the global market for Americas, for Europe, and for Asia Pacific. The global market was contracting by about 4% in terms of units. This is mainly due to Asia Pacific, which showed a negative trend, driven by China, and, as I mentioned, also slightly by India. In the lower part, we look at the global market in terms of value. Obviously, Asia Pacific is also here dominating the overall global market, but a bit less than in the units, as the average price per unit is lower than in Europe, and especially than in North America.

The global new installation market development – order intake was increasing aligned with the global demand footprint. As you can see here, in the upper part, the markets developed over the last 12 years from 49% to 76% for the zone Asia Pacific. If you look on the lower part, you see the order intake share of Schindler. In 2004, our share was 23%, now it is 65%. And you see that our strategy to develop a second planet in terms of Asia Pacific is now really paying off.

Let’s go a little bit more into the details for the different markets, and I would like to start with the biggest one, with China. The Chinese market was still weakening in 2016. We assume that the overall market was declining by 6% to 7% in terms of units in the new installation market. However, we saw good service market growth, due to the conversions of newly installed elevators into the portfolio of the different suppliers. Schindler was outperforming the market.

In this challenging environment, we were able to grow in all segments in new installation, driven by the high acceptance of our product portfolio and good order growth in large projects. We were achieving excellent growth in the service business. With the new joint venture with Volkslift, we will further enhance our market presence in the number one market of the world.

In order to support our global footprint in operations, we have finalized the set-up of our Schindler campus in Jiading, in Shanghai. As you can see, the overall set up of this campus is huge. Besides the escalator and the elevator factories, we now also have a big R&D center, including a 200-meter fully operational test tower, as well as our headquarters for China, with a visitor and training center. As a Group with social responsibility, all buildings are certified either as a LEED Silver or LEED Gold building. With these tremendous investments, we are confident that we also have the right focus now for the biggest market in the world.

Let’s have a look on the other part of Asia Pacific. We were seeing mixed market developments. India was weakening in the fourth quarter, due to the new regulations in the real estate sector and the demonetization actions of the government. The Middle East was further suffering from the low oil and gas prices and faced reduced market levels. All the other markets in South East Asia were further growing. Particularly, the service markets were further growing due to conversions.

Schindler performed very well in this mixed environment. In India, we were seeing a flat development, due to the challenging fourth quarter. In all other markets, we saw growth. In South East Asia, even good growth. Our service and our modernization business was very positively developing.

Moving on to the Americas, also here, we saw diverging market trends. The markets in North America are still very robust and showed continued growth in new installations and modernizations across all segments. In Latin America, the markets were growing too; but some of the markets are under pressure, due to weak currencies and rising interest rates.

Finally, we saw some signs in Brazil that the recession will now bottoming out. In this environment, Schindler showed sustainable growth. Successful product introductions in the U.S. led to good growth in new and service business. Schindler was also awarded several large projects; an example, the upgrade and service of Atlanta’s urban public transportation system, MARTA, which we announced already in Q3. A strong service growth resulted in an overall growth in Latin America.

The real rising star for us was Europe: the last continent, and the old continent. Overall, Europe showed a modest growth in the market. Most of the European countries showed positive developments in new installation markets. This trend was slowed down a little bit overall by Russia and Turkey, who showed a negative trend. The aged installed base in many European markets create modernization opportunities.

Schindler was able to continuously expand its performance. In many countries, Schindler was able to grow above market levels; especially, the maintenance and modernization growth was very pleasing. And with our intensified mergers and acquisitions activities, in example, our acquisition of FB Group in Germany, we were able to strengthen our footprint and the density in different markets.

This was the market overview for Asia, Americas, and Europe. And now, let’s move on to the results 2016, and I would like to hand over to Erich for this topic.

Erich Ammann

Thank you, Thomas. Hello, everyone. I am pleased to present the results 2016.

In Q4, orders received reached close to CHF2.7 billion, which is up by 3.6% in Swiss francs and 6.4% in local currencies versus last year. Orders received include all business lines, new installations, modernizations, service, and repairs.

All business lines and all regions recorded good growth. The Europe region made the biggest contribution to the growth in orders received in Q4. Schindler also won a sizeable number of large projects, which supported the good performance of the fourth quarter.

Revenue exceeded CHF2.6 billion in the fourth quarter; and this is up 1.5% in Swiss francs versus the previous year period and up 3.7% in local currencies. We were able to grow revenues nicely in all business lines. The Europe region recorded the highest growth rate in revenues, followed by the Americas and Asia Pacific regions.

In the fourth-quarter 2016, EBIT reported reached CHF352 million, which is significantly higher than last year. However, this result includes a gain of CHF50 million on the sale of the operation in Japan, as well as restructuring cost of CHF9 million.

Before these exceptional items, EBIT reached CHF311 million, which is up 6.8% in local currencies compared to Q4 2015. The EBIT margin before exceptional items reached 11.8%, equivalent to an increase of 40 basis points compared to Q4 2015. We are very pleased with the EBIT improvement of 6.8%, which is close to 2 times the growth rate achieved in revenue.

Net profit reported reached CHF237 million. Adjusted for the gain after tax of CHF31 million on the sale of the operation in Japan, net profit amounts to CHF206 million, corresponding to an increase of 6.2% compared to Q4 2015.

Now let’s have a look at the full-year results, on slide number 14.

Orders received exceeded the CHF10 billion mark for the first time in the Company’s history. In local currencies, orders received increased by 4.6%. Again, all business lines contributed to the pleasing growth. The Americas region generated the largest increase, despite the continued recession in Brazil.

Revenue reached CHF9.7 billion, corresponding to a growth of 3.1% in Swiss francs, and 3.6% in local currencies. All business lines contributed to the growth in revenue. The Europe region recorded the strongest growth, followed by the Americas and the Asia Pacific regions.

EBIT reported reached CHF1.13 billion; this represents an improvement of 7.7% in Swiss francs, and 8.4% in local currencies compared to 2015. This is before exceptional items.

EBIT reported reached CHF1.13 billion; and this includes, however, again, the gain of CHF50 million on the sale of the operation in Japan, as well as restructuring cost of CHF27 million for the full year.

Before exceptional items, EBIT reached CHF1.11 billion; and this represents an improvement of 7.7% in Swiss francs, and 8.4% in local currencies. The EBIT margin before exceptional items reached 11.5%, up 50 basis points compared to last year. The operational improvement was mainly attributable to economies of scale, as well as to efficiency and cost optimization.

Net profit reported amounted to CHF823 million, up by 10.2%. However, it includes two exceptional items: CHF31 million after tax resulting from the sale of our operation in Japan, and a one-time revaluation gain of CHF26 million related to ALSO.

You may remember that since Schindler participation in ALSO fell below the 10% threshold it had been recognized as a financial asset available for sale and valued at market value. In this context, a one-time revaluation gain in the amount of CHF26 million was recorded in the third quarter of 2016. Before these exceptional items, net profit amounts to CHF766 million, compared to CHF747 million last year.

On slide 15, you see further details regarding the revenue growth by region in local currencies. The growth in Europe region has clearly gained momentum, whereas the growth in the Americas region was negatively impacted by the continued recession in Brazil, but still reached close to 4% in 2016. Due to the slowdown in China, the growth rate in Asia Pacific region reduced to 2% to 3% in local currencies.

Order backlog reached a record level of CHF10 billion at the end of 2016, up 6.5% compared to 2015. The backlog includes new installation, modernization, and large repair orders. The service portfolio is excluded from this key figure. The split of the order backlog has slightly changed compared to 2015, but all regions had a higher backlog at the end of 2016 in absolute values. This should support continued growth in 2017 in all regions. The revenue split, you see below by region, remains unchanged compared to 2015.‌

Now let’s turn to slide number 16 for some additional information on cash flow. Cash flow from operating activities decreased by 13.7% to CHF929 million, as net working capital increased compared to the very low level achieved in the previous year. Investments in property, plant, and equipment was at comparable level to last year. The number of employees increased to above 58,000 employees. The additions were mainly made in the Asia Pacific region.

Now let’s turn to slide number 17, which shows the dividend proposal to the General Assembly, in March. Schindler proposes to the General Assembly, on March 16, to pay an ordinary dividend of CHF3, plus an extraordinary dividend of CHF2: this represents a payout ratio of 70.5%.

With the conclusion of the successful divestiture of the ALSO participation, Schindler proposes to distribute the sales proceeds of the participation to the Schindler shareholders in form of this extraordinary dividend.

Now, I would like to hand back to you, Thomas.

Thomas Oetterli

Thank you, Erich. After the game is before the game, so let’s have a look into 2017, and beyond. Let’s start with the megatrends which are driving the demand for elevators and escalators.

Here, when we look on them, we, in fact, can mention two different sets of megatrends which are impacting our industry. On one side, let’s call it the people side, urbanization and demographic changes are supporting the demand for our equipment. And on the other side, technology is also driving our industry.

When we look into the urban environment, more than 1 billion people will move into the cities until the year 2030; this will create further demand for buildings and mobility equipments.

The global middle-class will almost double in the same period. They can afford their own apartments in the urbanized areas, or even a second one. The numbers of persons aged above 60 years will increase by 0.5 billion people. Vertical mobility will become more and more important for those residential buildings where those people are living in.

And the number of one-person households will increase by 50% until 2013. This will increase the demand for apartments and, therefore, for new buildings with elevators. Also, technology will further create demand in the elevator and escalator business, as you can see on slide number 20. The aged installed base in mature markets creates modernization opportunities in order to increase safety and comfort of the installations.

Digitization is part of our everyday life. New business models are possible there in the connected building world. Connectivity of our equipment will become a driver for better service and additional revenue streams. Ecology has become a common value in the world. With more energy-efficient solutions, we want to contribute to a better world. So there are so many positive megatrends which have to be taken into account for our further growth.

What is our response to these megatrends? This you can see on Slide 24. As mentioned many times in the past, Schindler is following a long-term strategy with the following objectives: grow faster than the market and improve profitability, and foster a winning team on all Company levels. In the next few years, until 2020, we will focus on three key sets of initiatives. The first set is about people and organization: attracting the best talents, give them challenging tasks, retain and develop them. This is linked to a high performance culture we would like to further establish at all levels of Schindler.

The second topic is quality. Quality in whatever we do is one of our key directions, and also a key differentiator in the market.

And last, but not least, we would like to have lean structures, which allow an agile approach in today’s fast-turning world. The second cluster of initiatives is about customer and market. We would like to become our customers’ first choice and grow, therefore, faster than the market. Customer-centric behavior, focus on strategic growth markets like China, India, South East Asia, Turkey, and Iran, and manage professionally our installed base will be enablers in this segment.

The third area is the focus on innovation and efficient processes. We want to lead the digitalization of our industry and monetize the so-called Internet of elevators and escalators. With our new innovative products, which are seamlessly based on a modular product concept, we want to reduce our product complexity, and, therefore, our cost position.

And last, but not least, with innovative and efficient processes in the field and in the back-office functions, we want to be reliable and fast for our customers. The megatrends are promising. We have the right initiatives in place. Therefore, we are convinced that we will be able to achieve our global goals in the mid-term.

Based on this mid-term outlook, I now would like to hand over to Erich, who now shares with us the outlook for 2017 for Schindler.

Erich Ammann

Yes, the outlook for 2017 you will find on Slide Number 22. As Thomas just explained, the long-term growth drivers remain intact. However, short-term economic conditions continue to be influenced by political and macroeconomic uncertainties.

Overall for 2017, we see the global new installation market to a flat development. The guidance for us, for Schindler, is that we continue to focus on profitable growth. This is unchanged from 2016, and two years before. Revenue is expected to increase by 3% to 5% in local currencies, which should be possible, looking at our strong backlog and the good order intake in 2016.

As it has been a tradition over the last years, net profit guidance for 2017 will be provided at the time of publication of the half-year results.

Question-and-Answer Session

A - Thomas Oetterli

Thank you very much, Erich. So, dear ladies and gentlemen, thank you very much for the attention. Erich and myself are now available for your questions. We first start with questions here out of the room, and then we will switch to the conference call participants.

So, are there any questions from your side?

Bernd Pomrehn

Bernd Pomrehn from Bank Vontobel. You mentioned intense pricing pressure in several of your markets. Furthermore, we are seeing rising raw material costs, and probably also rising fuel costs for your service lead. Can you please elaborate how these factors will probably impact your performance in 2017? Thank you.

Thomas Oetterli

Maybe, I will start with the pricing initiative; and maybe, Erich, you can a little bit elaborate on the commodity price and fuel price increases. Yes, pricing has become an issue, and not only last year. It is a little bit different from market to market. We saw the biggest pricing pressure in China. Due to the shrinkage of the markets, pricing pressure was up to a high single-digit price reduction in the market. But we also have seen that towards the end of the year, and also in our outlook for the next year, we see that there is some softening of the pricing pressure. It still will be negative in China, but not as high as it has been in the past.

Now in other markets, for example, in North America, we see a very good pricing environment, I have to say. In the U.S., usually when economy is going up prices are going up; when economy is going down prices are very rapidly going down. At the moment, we still have a very good price level in the U.S., and we are benefiting of that.

In Europe, it has been the case that, especially in Southern Europe, in the recent years, since the financial crisis, the pricing was really very, very tremendously pressured down. We saw some softening last year. I have to say, it was a better environment than in the recent years as we also see that economies are starting to develop and to grow; also, our industry is starting to grow in new installation. We, therefore, have seen that there is some softening in the pricing.

And then, I would say, in Asia Pacific, in the rest, outside of China, pricing is, of course, challenging; but it was not an enormous pressure, like, for example, in China. And then, the last market, in Latin America, Latin America is very diverging, I have to say. Some markets are developing very well, for example, Mexico is still a booming environment; whereas, in Brazil, due to the contraction of the market, there was also high price pressures.‌

So we were able to manage these price pressure in the past by reducing our cost position. This was one element. Reducing of cost position is the easiest ways. If you grow and you have more economies of scale you also can negotiate with your suppliers.

Second, cost reduction initiative is our new product platforms. By a better design and more clever design, you can change the level of your cost position in one shot. So you do not have to renegotiate an existing supplier, but you are coming with a new part, which, from the design set up, is cheaper than the part you have before. And the third element we had in terms of cost initiatives is efficiency. We are driving efficiency of the people in the field, and the people also in the back-office functions, every year. This is a continuous exercise you have to do. And with that we were able, as you can see from our margins, to compensate the pricing pressure we had in the past.

Maybe, Erich, you can share a little bit the topic of commodity prices that went up in the last few weeks and months, and also regarding the fuel costs.

Erich Ammann

Yes it’s true that raw materials is going up, and we are obviously observing this very closely. And we have worked with our suppliers over the last month to lock-in some of the pricing or the cost to us, primarily on the components. And this is locked in, depending on the components, three, six, sometimes even nine, months, so we should have some protection there. But I liked very much what Thomas said: the best protection is to work on the cost side, to work on the design, to take out the cost. And I think there we can more than offset these increases.

On fuel oil, it’s more difficult there. Obviously, we do not take actions [ph], we do not take positions. But it’s also not a major cost for us in the global picture. I think we will need to focus more even on cost control, working on – also on structural costs, overhead costs, in the next few years to help achieve efficiency gains also in the overhead cost.

Bernd Pomrehn

Thank you. Maybe, one second question, if I may. Operating cash flow last year was impacted by an increase in net working capital, do you see any structural change there? Or do you expect to bring down net working capital again in 2017, or ongoing? Thank you.

Thomas Oetterli

I think, Erich, that’s a question for you.

Erich Ammann

Thank you. No, that’s a very good question. And we are observing this very carefully. But there are a few drivers that you need to consider. We have mentioned in Brazil the new installation market has reduced as a result of the recession, the ongoing recession there. And in this market we typically get very good down-payments; but with lower order intake, the down-payments have been reduced, which also had a negative impact on net working capital. This is one driver.

Then, I also have to say, in the fourth quarter we had very high billings. Somehow this result came together, the strong fourth quarter, and it was also based on very strong billings in the last month of the year, which ended up in accounts receivables. And this, we are also observing now very carefully, collecting this very fast. First indications are that it’s coming down. But more I can say in January, at the end of the first quarter, when we have the results presentation.

But I think it will come down, but not below the levels we have seen in 2016/beginning of the year. I think it will be challenging to beat, let’s say, the 2015 and the first half of 2016.

Thomas Oetterli

Thank you very much. Are there other questions here out of the room?

Unidentified Analyst

I have got two questions. EBIT margin was up practically quarter by quarter, it’s now more than 13%, do expect to develop this – to have this development in this year, again?

And a second question to the regional rates. You explained that Europe is the rising star, Northern America’s good, Brazil is to come back, and Asia is flat to contracting. Do you expect to have a shift a little bit away from Asia Pacific towards the other two continents? Thanks.

Thomas Oetterli

Thank you very much for the question. Maybe, Erich, you can share the – our expectation for the EBIT margin, and I would go a little bit more into the markets.

Erich Ammann

Yes, can we have slide number 14? I just want to clarify that our margin was 11.5% in 2016, up 50 basis points. And it’s true, we have improved over the last years and last quarter's quite nicely. And, obviously, we continue to work on this. This was part of the guidance. We continue to work on profitable growth. We have invested a lot over the last years in the emerging markets and we now see the benefit coming out, and we will deliver that.

Now, will it be in the same magnitude as we have seen in 2016? I hope. But let’s take it quarter by quarter. And, maybe, we should also then quickly look at Slide number, I think it’s 16, yes, 16 – 15, I’m sorry. I think this is a bit the beauty of our business model and our geographic footprint. This is why we have worked so much on this.

You see that, on the left side, the growth has really changed between 2015 and 2016. Europe, this was the comment, is the rising star in the sense that it has now taken the lead on the growth. Some other zones may have less growth for various reasons. But we are very well distributed around the globe by now and this is showing very well on this slide number 15.

Thomas Oetterli

Thank you very much. Maybe, I can add something about the weight of the different zones, and maybe we can have a look on Slide 6.

I think this shows you, when you look into our business model, in fact, we have two revenue streams. One revenue stream is coming from the new equipment, and the other revenue stream is coming more from the service – from the existing installations installed in the markets. And when you look on new installation, the dominance is with Asia Pacific.

So, for us, it’s very clear that in these new installation markets we have to concentrate to grow faster than the market also in this huge part of the worldwide market. And when you look last year, in terms of units, the market was 76% of the worldwide market. And if you are able to grow faster than the market in this new equipment business you also set the baseline for the future in three, four, five years. Because what is happening is after you have made the new installation then you try to convert the older sold equipment into your service portfolio.

And Asia is the fastest-growing service market. So if we are able really to beat the market in new equipment, having a high conversion rate, we are making or setting the baseline for our Company for the next five to 10 years. So, yes, of course, there was a certain softening, due to the Chinese contraction. I’m quite sure we will also discuss how the outlook will be for 2017. But it stays as a key target and focus area to grow faster than the market in new equipment, in the new installation equipment.

Now, on the other side, and this sometimes we forget, the installed base. If you look into all the elevators and the escalators, which are already installed worldwide, the lion’s share is still with the mature markets. So, with Europe and with North America. And the average age of this portfolio is above 20 years.

I said that once in another meeting: imagine you would be on the road and all the cars you see there are more than 20 years old. The streets would look quite differently to the streets of today. And it’s clear that you have to maintain, you have to repair, you have to modernize this huge installed base very professionally, and you have a lot of opportunities.

So, I think, it’s not a shift of weight between the different markets; it’s just another focus in the different markets. And markets can change very quickly.

With the set-up Erich has shown before, that we now are equally distributed among the different continents, this also makes us less vulnerable for local market developments. So I think our set-up is very balanced, and we want to work on all the different markets equally, but with a different focus.

Other questions?

Andrea Ricci

Andrea Ricci, Bank am Bellevue. A few questions for me, also. Would be nice if you could give us a little bit more color on the order backlog that you have in terms of the quality of this order backlog, in terms of profitability, whether it is in line with the current profitability, or maybe even better than that. That would be very helpful.

And then, if you could elaborate a little bit more on the market dynamics in India. You mentioned that this slowdown is temporary, so why do you think that you will be able to grow again.

And then, the last one, more like in terms of housekeeping, what actually happened with currencies in Q4 that somehow impacted you so much on the revenue line? Thank you.

Thomas Oetterli

Thank you very much for the questions. Maybe, I would start with the market dynamics in India; and, maybe, we then can have a look on the order backlog, and also on the currency question. What happened in India, and I think everybody has seen it in the press, it was overnight, there was a new rule about the INR500 and the INR1,000 banknote.

And what you have to know, that the market itself, all the fundamentals in India are very healthy. You have a country with 1.3 billion people. It’s more or less as big as China. But the market size at the moment is maybe one-eighth of the Chinese market.

But, nevertheless, India, in terms of units, is the second-biggest market in the world, but eight times smaller than China. Now, you can make a guess if they will be able to grow and to become as big as China, or are there other reasons why maybe this will not be the case. But, definitely, the fundamentals of the market are very, very positive. So we believe that the market over the next few years will further continue to grow.

Now, what happened in the fourth quarter, this was a little bit like pushing the brake in a car. Why? Because the whole real estate market is a cash market. Apartments are paid with cash. So people are coming with a suitcase full of INR500 and INR1,000 banknotes and put it on your table and buy an apartment.

Now, if you cannot get those INR500 and INR1,000 banknotes anymore because you first have to go and to open a bank account, and only a very few people in India have a bank account, so this was somehow disturbing the whole construction industry tremendously.

Because what happens is if the developer doesn’t get the suitcase with banknotes he, in the first moment, has no money to push additional new buildings, paying certain suppliers, making new orders. So it was really, for the industry, a short-term shockwave.

Now, how long will it take until we come to a normal modus operandi in the market, there are some slight signs, early this year, that it starts to normalize. But the year is very, very early and we only had one month of observation. I think we have to look on that a little bit closer now also in the first quarter, and I think after the first quarter we will see if this hit now has been eliminated and the market is slightly coming back.

But very important, all the fundamentals of this country are positive. We believe that there is further growth, high single-digit growth in the future, year on year, over the next few years in India.

And, as you know, we are well prepared. We have finalized our manufacturing footprint; we have an elevator factory; we also have constructed an escalator factory; we have a training center under construction as well. So I think we are ready for this growth, which will happen in the future. And we have a very strong reputation, a good product portfolio as well. So I’m quite confident that India will play a major role for us also in the future.

Maybe, Erich, you can share with us the topic of the backlog and the currencies.

Erich Ammann

Yes. Let’s have, again, Slide number 16 – 15. Here, we see the backlog, on the upper-right corner, the split by region. As I commented before, it sits at direct level; it was up 6.5%. Asia Pacific is slightly down. But when you do the math, 43% over CHF10 billion is actually slightly higher than 45% over CHF9.3 billion the year before.

You asked about the quality and the margin, Overall, I have to say, the margin is slightly less at the end of 2016 than what it was at the end of 2015. Our supply chain is challenged. But Thomas has explained this before, that the supply chain has worked, together with our new installation team to bring down the cost, change the designs. And these savings are not yet considered in the backlog, they will now come in form of savings throughout the year 2017.

Let’s go to slide number 63 to discuss the currency impact. Unfortunately, I don’t have the currencies by quarter. This is something we could enhance in the future. But this is looking at it year-on-year. And as you can see, 2016, for once, it was a better year for a company reporting in Swiss francs. There were really some very difficult years, back in 2008, during the financial crisis, through 2011. 2015 was very bad. Now, 2016, most of these currency impacts happened in the fourth quarter and therefore you ask what is the impact of the euro.

The euro has become under pressure; certainly, is a big piece in our revenue. You see the composition of our revenue in Europe, these 40%, so that would have quite a significant impact, amounting to CHF49 million. And, obviously, we also had the pound come under pressure. So there were a few currencies that actually de-valued in the fourth quarter.

Andrea Ricci

Okay.

Martin Husler

Thank you. Martin Husler, Zurcher Kantonalbank. I have three questions. First of all, can you, maybe, shed some more light on the market of China? What’s your expectation for the market 2017 volume, and maybe pricing-wise? And what’s your expectation for Schindler? Will you grow again stronger than the market, which I expect you do?

Then, the second question is turning to your good net cash position. I was just wondering, what are your priorities there? Will you increase dividends in the future? Will you, maybe, think about a new share buyback program? What’s your expectations there? And the last question is about restructuring costs. Should we assume similar amount, of CHF27-ish millions, also for 2017?

Thomas Oetterli

Thank you very much, Martin. If we look on China, of course, this is the most important market in new installation for all the players in our industry. What we have seen in 2015 and 2016 was really a contraction of the market.

Our assumption was that 2015 market was, in terms of units, going down by roughly 5%, and in 2016 something like 6% to 7%. So at the beginning of the year, probably, contraction was higher than towards the end of the year. We saw that there was some softening towards the end of 2016.

And when you look on all the macroeconomic data, so new floor space sold, the number of sales of apartments, the prices for apartments which went through the roof in some cities, and then with some measurements of the government, the government tried to somehow bring some relaxation into the pricing. So all of those macroeconomic data, which are ahead of our order intake, they look promising.

Of course, it’s always a question of time to all the building permissions, really, are they all realized to become a real building? We have seen that some of them there are more permissions than really buildings are starting. And then, you also have to have a look, okay, is there enough land available? So there are different trends in different cities.

Now, overall for China, we are expecting that the reduction of the market will maybe slightly continue in 2017. It’s maybe 0% to 3%, that’s our assessment. Of course, we will update that every single quarter. So it’s really a softening, it’s bottoming now, and we do not expect another hit like we had this year in the market.

As a consequence, you also see, of course, that there must be an impact on pricing. If the market is not following in the same manner any more like in the past, we are expecting that also the pricing situation is becoming less severe than it has been in 2016. This might be a low single-digit, or up to, maybe, up to 5%; it’s difficult to say at the moment. But our expectation is it is something like half of the pricing we saw in 2016.

As a matter of fact, even in the booming years, when market was growing even double-digit in China, market prices went, year on year, always down. One driver, of course, was commodity prices went down, which went down all the years. Now, of course, commodity prices going up. There is a natural pressure that you try to improve your sales prices.

And one part, of course, is that you have to communicate. But if the cake does not become bigger, maybe you are challenged in your wish to increase prices because market price pressure is still there. But we are expecting it will be less severe than in 2016.

Now, when we look into the different areas, or the different markets, we clearly have seen, also in this – in all those macroeconomic data, that the tier 1 and the tier 2 cities, in fact, are developing better than the tier 3, 4, and 5 cities.

The bigger cities, they had an increase in the sales price for apartments; they had a lot of new permissions for constructing new buildings. And they are mainly along the coast. So you go down from Beijing, and then you go down Shandong and Shanghai, Fujian, and then down to Guangzhou Shenzhen in the Guangdong province. This band, in fact, is healthy, and I think also prospering.

Some of the smaller cities they still have high inventories, although, let’s say, the sale of apartments has increased. So if you compare the inventory level with the sales, and you calculate how many months you still have on stock, this has come down. But it’s also fluctuating. And it’s definitely still the highest compared to the tier 1 and the tier 2 cities.

This is how I see, or how we see, the market. It’s becoming less bad than it has been in 2015 and 2016 in terms of unit, and in terms of prices. And I think there are still key growth opportunities in the tier 1 and in the tier 2 cities.

Now, Schindler has about 200 locations in China with own offices. If you take the top 300 offices, 300 cities, we are covering about 200; and the other 100, we are covering with distributors who are working with us. But we just have opened so many offices in the recent years.

Our, let’s say, historical footprint is in the tier 1 and in the tier 2 cities, and this makes us confident that we can participate on the positive development in those cities, so the tier 1 and the tier 2 cities, as it is our historical strong footprint.

On top of that, we have introduced, in late 2016, new Chinese products, we call them the harmonized China product platform; and these are products tailor made for mainly the residential market. And we have seen now, in the first few months, that there is a high acceptance of those products.

Those products, it was mentioned before about cost, they have another design, so they have another cost position. And this will help us also to improve the profitability of our backlog, and will also help us to outgrow the market as a target, which we have in all the markets where we are in. We would like to grow faster than the market, and we are confident that we also are able to do that in 2017 in China.

Maybe this to the Chinese outlook. Maybe, Erich, about net cash and restructuring costs, I would like to hand over to you.

Erich Ammann

And we have slide number 67 to discuss the restructuring cost. Here, you see the restructuring cost from 2013 through 2016. And the guidance, CHF20 million to CHF25 million, for normal restructuring would be appropriate, but in any given year there can be more, as you have seen in 2014. But from today’s perspective, the CHF20 million to CHF25 million, you mentioned, Mr. Husler, is, for me, fine.

Then, looking at net cash question, maybe, can have the dividend slide once more, with slide number 17. Well, first of all, Schindler will pay out more than CHF500 million in form of dividend. The ordinary dividend and the extraordinary dividend of CHF2 in March, this will be more than CHF500 million. So we are distributing cash to the shareholders.

When you look at our net cash, net liquidity position, it is true, it is still very rich, even after the repayment of all the bonds. We have no more debt really outstanding, interest-bearing debt outstanding. Even after that, our net cash position is very solid.

We would like to invest this into our own business. This is really the first priority; that is clear. We will return to shareholders, as you see now with the dividend payment that we are doing in this spring. And share buybacks is really at the discretion of the Board, and there is no decision for the time being to implement another share buyback.

This is where we are. And I think overall, Schindler likes to be independent. We like to have the ammunition to fire, and have the strategic independence also financially, therefore, Schindler will always have maybe a bit more cash on the balance sheet than other companies.

Thomas Oetterli

Maybe an event then.

Caroline Price

Thank you. Caroline Price, Fargo Management. First question is on the revenue growth in Europe. Would you say that was driven more by new installation, or more by service and modernization? Second question is, the employee numbers, I’m just wondering if you have any indication for 2017. Is there any labor agreements? Or if you can give some idea on where you expect the cost per head, what kind of range of increase we can expect there, and what the effect of this mix of adding about 2,000 employees in China would have?

And then, my third question is on the price pressure that you talk about in China. Would you say it’s more acute on the new installation side than on the service side? I’m wondering if you can sort of say, give an idea there of where it’s more evident. Thank you.

Thomas Oetterli

Okay, thank you. So maybe, just very quick, the operating revenue growth in Europe, we grew in all the different businesses, so in the new equipment business, as well as in the existing installation business, more or less on a similar pace. It was really a growth we achieved in operating revenue in all the different businesses.

Now, regarding price pressure in China, it is true, of course, when you look at the industry in this country, historically, it was mainly a manufacturer industry. It was driven by producing elevators, producing escalators, install them, and many of the participants in the industry had not a high focus on the service business. Why? Because it was – many companies were able to do a solid performance just with new equipment sales.

Now, of course, in the last two years this market has become much more under pressure. And it is true that the pricing pressure we are always talking is mainly the new equipment pricing pressure. In the service business overall, prices are lower than in the rest of the market. Why? Because labor costs are much lower than in many other markets. And the service business is much more a labor-intensive business than the new equipment business.

Now the price developments, I think, are driven by customer behavior; that’s one element. But it’s also driven by your service offering you have, and it’s also driven by regulations. So the regulations for the service business in China are very, very strong. In fact, you have, every 14 days, you have to do a service visit. So it’s much, much higher than in the rest of the world. Safety is a very, very critical element. It is observed also by the technical bureau, which is like the official department of the government for lifts and escalators. So they are very, very intensively observing safety. So you have to be certified what kind of work you are allowed to do. There are different types of certifications for companies.

And also, every single employee has to have a governmental certification, which is stating that you are able to do a certain type of work. This can be maintaining a certain elevator, repairing a certain elevator, modernizing a certain elevator. So there are different levels. It’s very highly regulated. I think, due to the fast growth in new installation, the installed base becomes bigger and bigger and bigger; and de facto, in a few years, China will be the biggest service market in the world in terms of units. And also, what you see, that the whole country is changing, more from an industrial mindset more to a service mindset. And I’m sure the buildings are much better, maybe, than – which are constructed now than those who have been constructed 40 years ago.

So elevator lifetime will be longer, and expected to be longer, in the future than it was in the past. So the customers are requesting that you are keeping a good shape of the installation. Then, you have those regulations. And then, if you do a good job, if you have high quality work, if you train your people in the right way, I think you can positively differentiate from competitors, and you are fitting much more in the future demands of the customers who want to have good service. Although today the service price is low, the margin still is good, but I think it will be a fast-growing market over the next 10 years. And also, pricing levels will come up, I am pretty sure.

So today, to finalize, maybe I talked a little bit too long about it, pricing, when we talk about high-single digit reduction, is new installation. Service business, I would say, is more or less stable and has a lot of future opportunities of growth. Maybe, labor costs.

Erich Ammann

Yes. Labor costs, you asked about the labor agreement, Caroline. There is certainly one that we are following very closely in the U.S.; that’s the labor agreement, which will be renewed in the summer with RUEC. The discussion is obviously about merit increases, but this is only one part. The other part is about work rules, work schedules, efficiency that we would like to bring. And also, I think digitalization needs to be part. Thomas explained that the work of our employees will change, and this somehow needs to be considered now in these labor agreements as well. That’s probably the most prominent one that I had on my radar screen.

Caroline Price

If I could just follow up, the addition of those 2,000 employees in China, would that affect the mix of the average salary, so to, maybe, mitigate that somewhat?

Thomas Oetterli

Yes, we are investing into people where we have growth. And, of course, the most prominent growth area is Asia Pacific. So the average salary per employee in Asia Pacific, and typically in China, is much, much lower than the average salary we have in Central Europe or the U.S. So we will have – in terms of average cost per head, we do have a mixed benefit in the future. This is true.

Erich Ammann

And, maybe, just slide number 70 could be quite interesting, to see a little bit the evolution of the number of employees. We are now 70. Here, you see the distribution of the 58,000 employees in the Schindler family compare Asia Pacific only 16 years back, 2000 to 2016, what happened? I mean this is really the footprint change that we did. And it’s also nice to see that even in Switzerland we added more than 700 people to our family here in Switzerland. So we are growing almost everywhere. Rest of Europe, though, was flat, as you can see.

Thomas Oetterli

There is a question here in the front.

Martin Flueckiger

Yes, good morning, gentlemen, Martin Flueckiger from Kepler Cheuvreux. Thanks for taking my questions; three, actually, if I may. The first one would be on order intake. Q4 order intake, at least in my opinion, was quite strong, and I would like to go into a similar discussion, like we’ve had in terms of geographic drivers of revenue growth. I was wondering whether you could provide some more color on the main drivers of strong order intake growth in Q4, both from a geographic, as well as a business perspective, please. That would be my first question.

Then, the second one is on your order pipeline. If I remember correctly, Mr. Ammann, at the Q3 reporting stage you were talking about a healthy pipeline in the U.S. I was wondering whether you could provide us with an update here for all three key regions: U.S., Europe, and Asia.

And my final question would be on your market outlook for the global new installation markets, which you currently assume to be flat in 2017. I was wondering whether you could provide some more color there on your geographic market assumptions. I presume, it’s mostly down to China being flat to slightly down. But Europe and the U.S. market, would be quite interesting to hear your expectations there as well. Thank you very much.

Thomas Oetterli

Okay, so, maybe, when we look on the order intake, which was, you’re right, very pleasing, up in the fourth quarter. In fact, it was in local currencies it went up 6.4%, and it went up everywhere. So we clearly saw, and then talking about values, so we had some pickup also in China in the fourth quarter. I think they have done a very good job. We were benefiting from the product introductions I have mentioned before. So they were contributing very nicely to this order growth.

Secondly, what we also have seen, you remember, we said, during the whole of last year, that at the beginning of the year large projects were somehow it took some time. There were a lot of projects in the pipeline, but they have not been decided. Now, towards the end of the year some of them, not all, but some of them, have been decided. And this helped us also as we were quite strong also getting large projects in high-rise buildings, but also in public transport infrastructure projects, on board.

Even more promising is that our awards pipeline has further increased. So as we only book a large project, or, in general, a project, if we have received a down-payment, so cash. But, of course, signed contracts, between the signing of a contract and you get the down-payment for large projects. This can take a few months until you have the first cash in. And you do not produce, because the cycle time of the whole job can be three, four years.

So you then, first, after the signature, you still have some clarifications, technical clarifications; and then, at the end you are finalizing everything; and then, you get the down-payment.

So there is, in larger projects, quite an important measurement is how many awards do you have, which are not yet booked as order intake? And also there, I can say that our awards pipeline for large projects in high-rise buildings, and the awards pipeline for public transport jobs, has been increased. And this gives us also confidence for our growth, reported growth, in 2017.

So all the different continents have contributed positively to this very good fourth quarter. Maybe, outlook 2017, as we have mentioned just before, we are expecting something like, maybe, 3% reduction in terms of units in China. So this means, if China is 60% of the worldwide market then the rest of the world should grow something like 4% to 5% in order to get a more or less global flat development.

And we clearly see that in Latin America, in Brazil mainly, we do not see that there will be a lot of growth. So this is more flat, but there is no further decline. We see that there is some signs that some construction becomes more lively and there could be maybe towards the end of the year really a pickup also with our order intake. But we assume it will be more or less flat.

North America is a very good shape. So we are not yet in an all-time high peak regarding units, if I compare the markets before the financial crisis, so there is still some possibilities. Probably not tremendous growth any more, but maybe slight single-digit, low single-digit growth. And then, we have Europe; Europe and Asia Pacific, the rest of Asia Pacific. In the rest of Asia Pacific, we clearly see a lot of growth opportunities. We see that the markets can go up another 4%, 5%.

And also, in Europe, Europe is very strong in the construction area, not only in the well-known countries, like Germany, where we have almost a boom in construction, but also the Southern European countries, from a lower base, are still growing. And so that would be my overall assessment. Key driver is China, and the rest of the world is positively developing. If China should come even to a flat development then we would have, globally, a growth of the market. Maybe, Erich, some words for the U.S.?

Erich Ammann

No, I think you have said most of the things. U.S. has a strong pipeline, especially on large projects; we see those coming back. I also look at the infrastructure projects that might come down the road, which should also be positive for elevators and escalators.

Martin Flueckiger

Okay.

Operator

[Operator Instructions]

Unidentified Analyst

Maybe, one question regarding acquisitions. Do you see other possibilities of acquiring several smaller portfolios, especially in Europe, or one acquisition, like FB Group, on a mature market?

Thomas Oetterli

Maybe, we can quickly go through the – to the, what was it, slide, I think, 23 – 21, sorry. So here you see, in the second pillar, customer and market, which is covering more the growth area. This includes, of course, organic growth; but it also includes growth through mergers and acquisitions.

And it is true, in Europe we have a much more heterogeneous landscape where some of the owners of smaller elevator and escalator companies they are thinking to sell their operations to one of the bigger companies. We have been active, very active, in Europe in the last year, I have to say, and also looking on our actual negotiations or discussions we have. I think this will continue, yes.

In most of the European markets, in some of the bigger European markets, we also allow – depending on the acquisition target, we want to have them maybe as a complementary organization to our Schindler organization, so to have like a dual-brand organization. In some of the markets, we are integrating them into our Schindler portfolio.

There are other acquisitions possible. Whenever markets are under pressure, I think it’s a good time, also, to go for acquisitions because there is a concentration process going on. If the environment becomes more tough some are in the front-running place and some just starting to become maybe having more problems, and then they are open to discuss about M&A activity.

So, we are actively pursuing that, but not for all price. We only do it where it makes sense, where it fits, where it culturally fits, but also fits from our geographical footprint. But it’s one of our embedded key initiatives in this growth pillar. Okay? So, maybe, one last question here out of the room, and then we would switch off – switch on to the colleagues who are at conference call.

Jolanda Stadelmann

Jolanda Stadelmann, zCapital. Can you give us an indication of your organic growth rate, probably, for the Company as a whole, and, therefore, the regions?

Erich Ammann

Yes. Overall, I would say there is not much impact from M&A. We have added smaller units over the course of the year. But then, don’t forget, that we also lost Japan, the revenue of Japan, in the fourth quarter. So, basically, the whole fourth quarter was without the Japanese revenue. So, net-net, it’s almost marginally down. There’s not much impact from M&A, although, we were quite active, as Thomas said.

And when you go to the cash flow statement, if I could add, maybe, even there’s a line net investments in participation and intangibles, and this line went up by some CHF70 million, and a lot of this was really due to M&A. But some of them came online throughout the year and will start to have a positive impact in 2017.

Thomas Oetterli

Okay, so then I think we went through all the questions here in the room and I would like to switch on to – or to move on to our participants in the conference call and to go through the different questions there as well.

Operator

I got a first question coming from Andre Kukhnin at Credit Suisse. Please go ahead.

Andre Kukhnin

Yes, good morning. Thanks very much for taking my question, I’ll go on at the time. Firstly, on the backlog growth that you’ve delivered in 2016 vis a vis the top-line sales growth guidance for 2017, obviously, 6.5% backlog growth, and then your sales growth guide tops out at 5%. Is this conservatism? Or is there a backlog kind of extension or potentially slow conversion to sales, given, historically, you’ve been kind of 1-to-1 almost every year?

Erich Ammann

Yes, good morning Andre, this is Erich. I would say, given the experience we had in 2016, we are a bit on the conservative side, I would even call it, maybe, the realistic side. We have seen an extension in the backlog conversion to revenue in 2016, and we have not really seen a change in the recent quarters. So, therefore, we like to stick a little bit with the more conservative view, which might be the realistic one. But let’s get a surprise as we go into the year.

Andre Kukhnin

Absolutely. That’s very clear, thank you. And on the backlog margin comment, are we talking about new equipment here specifically, or is this the total backlog with service?

Thomas Oetterli

No, very clearly, it is the backlog in new installation and modernizations. Service is out. When we report backlog figures, CHF10 billion that I showed before, this is clearly excluding the service portfolio. So to comment on the margin is only for NI, no installation and modernization.

Andre Kukhnin

Got it. And just to understand how that’s calculated, is this essentially your booked orders at the prices that you know vis a vis your current costs as you have sort of the run rate of last three months, or something like this, with the raw material/sourcing prices that you’ve locked in from suppliers so far? Just trying to think sort of how many more moving parts are in there, beyond that.

Thomas Oetterli

The easy answer to your question is, yes, you are right with your assumption that it is based on the price and the cost structure of our pre-calculation we call it internally, our estimate, which is really done component by component, goes down to the labor hours. It’s very detailed. And that is based on the current cost.

And therefore, I made the comment that even though the margin in the order backlog at the end of 2016 is slightly below 2015 they are really challenging our supply chain to now come forth with the savings we discussed before on the products, so that we can actually deliver a higher margin in the P&L. That is the mechanism that we follow.

Andre Kukhnin

Very helpful. Thank you, sir. And how was this factory margin at the end of 2015, compared to the end of 2014, if that’s possible at all?

Erich Ammann

Now I see. But, no, the factory margin is good. I don’t see any issues there going forward. That’s as much as I’d like to say.

Andre Kukhnin

Right, that’s very clear. Thank you. Just on something else. The Europe orders growth in Q4 that you mentioned was the strongest out of the three regions, obviously, against the 6.4% for the Group, and knowing or having some idea what China did there, it must be into double-digits, is this right thinking? And what drove this? Was there anything particularly large that came through in Q4, like we had that matt order in the U.S. in Q3, just to be aware of for the run rate?

Erich Ammann

First of all, and maybe I’ll let Thomas answer after it, first of all, we had very strong large orders. In fact, in Q4 2016 the share of large orders was higher than in 2015, which was quite a surprise, and a change from the previous quarters we experienced in 2016. So large orders really helped achieved this nice performance. Thomas?

Thomas Oetterli

Yes, this was definitely one of the key drivers. Maybe it was not double-digit, maybe it was just high single-digit. On the other side, we also had a very pleasing development in service and repairs. I think this was also accelerating in the second half of the year, which also contributed at the end then to a good margin development. So I think it was large projects, where we have been very successful in the second half; a very good service and repairs development; and it was almost equally distributed on the different zones.

Andre Kukhnin

Got it. Thank you. And last question on China, and on service side, you gave a lot of granularity in describing what sort of level of certification is required there at every stage of supply chain. It sounds like it’s something that has been evolving, and essentially a recent kind of push for those employee-specific certifications and by type of job specifications. Has that actually helped the conversion rates at all? Or do you think it will help in the future?

Thomas Oetterli

Yes, I think it will help for the conversion rate. Our conversion rate, historically, has been, I think, very high in the industry, because as a, let’s say, long-term directive company we always have put a lot of focus that we have a good conversion rate and to fast increase our service base. Yes, of course, those regulations are, at the moment, helping to all the existing players. But you have to know there are thousands of service companies in China. They all have already a license. So there might not be new ones coming in, but there are enough existing ones competing with us every day.

Andre Kukhnin

Okay. But as far as I understand, there is almost two tiers of service: there is the service by OEM or reputable third party, and it’s priced at consistently with what it costs to visit every two weeks for two people, and then there is almost like a just enough, just to fulfil the basic requirement, and self-service falls into that. Is that second bucket also all certified and all official and, therefore, sustainable, in your view?

Thomas Oetterli

Let’s call it like that, they should be all certified. I do not know all of them. There might be the one or the other where there is a timing issue to get the certification. But, in fact, it is true, those companies should, from a law point of view, have all the certification, but not all of them really have. I think this is one part of the development, that there is more and more focus of the government to push that, because the government is interested to have a very high safety level and a very high-quality level. So I think the two days, good companies do have opportunities to grow even faster than in the past.

Andre Kukhnin

Got it. Thank you very much, both of you.

Thomas Oetterli

Thank you, Andre.

Operator

We got next question from Lars at Barclays. Please go ahead.

Lars

Good morning. Thomas and Erich it’s Lars here from Barclays. A couple of things, both on China, and also margin target. But before I get there, maybe, I can just follow up on an earlier question with regard to organic revenue growth. Obviously, there are quite a few moving parts now in the M&A part of your revenue bridge. I think you were suggesting earlier that M&A will have a positive impact in 2017. If that’s net of the sales operations in Japan, which I take to be about a negative 1%, that will mean M&A in 2017 is a good 2%, 3%. Would that be the right kind of way to think about how you see the impact this year, knowing, of course, that you haven’t yet announced meaningful contribution to that part yet? But also, more importantly, is that – how should we think about that in terms of how it’s reflected in your revenue guidance for the year, i.e., the 3% to 5%?

Erich Ammann

Yes. No, I think M&A will have a minor impact on 2017 as well, due to the full-year effect of the China – the Japan sale. We lost one quarter in 2016, and we lose three quarters, if you want, in 2017, of the Japanese revenue compared to the previous year. We purchased some small units, as Thomas has said, including the FB Group, which is a bit larger. But net-net, there will be a very small impact coming from M&A in 2017, due to the Japanese sale.

Lars

Okay, that’s helpful. Thanks. Just on China then, the Q4 growth in China, in value terms, would imply that you must be growing sort of mid to high single-digit in volume terms. That’s really quite impressive in a market which is down, I think, most of your peers are saying, low to mid single-digit in the quarter, even if there’s always a bit of quarterly volatility. To the question earlier around large project orders impact in the quarter, I think that was a European comment you made. I wonder whether you could help us understand whether there was anything in China that meaningfully swung it.

And then, in addition to that, could you talk a little bit about what you are doing now in the base business? The Chinese product platform, quote unquote, is new to me, is that an enhanced or modified version of your 3600 product portfolio? And what really differentiates this? Is this more still around modularization standardizations which are taking the cost position lower? Or is there anything meaningfully, from a product differentiation standpoint, that’s worth noting there?

Thomas Oetterli

Okay, it is true, maybe, first, going to the quarter 4, yes, we had a very good development in Q4 in China. It was, as in Europe, also based on large projects. That was one driver. If you look on the global market, it’s, for large projects, quite a similar set up like for the overall market. So also there 60% to 70% of all the large projects in the world are, in fact, in Asia Pacific, and dominantly in China. So the good trend we had in Europe we also had in China for large projects. We also have won several metro lines in different cities in the public transport and infrastructure area, which also helped us to further growth our sales.

Then, one other driver in Q4 was the introduction of new products. Maybe, to elaborate there a little bit more, yes, it’s true, we, traditionally, we had our 3300 for the machine room-less segment; then, we took that product and changed it into the 3600 for a machine-room product. Both of them are belt elevators.

The Chinese environment is a little bit rougher than maybe a normal European/Swiss environment in terms of how a construction site looks like. There is much more dust. It’s also, after you have finished the building there is much more still construction move going on. Because usually you just have the raw building and then everybody is moving in over the next two years, bringing in the kitchen, bringing in the bathroom, so the elevators are partly misused as a freight elevator.

Now, if you have a very sensitive system you might have an issue afterwards when you still have for two years a lot of dust and the elevator, in fact, is fully running. So for that reason, we decided we want to have a complete product offering. And this new harmonized China platform has two reasons for harmonization. One is, yes, we have started to develop rope elevators, in parallel to the belt elevators, for all the different segments in the residential market.

So we have a 5200, which is a low-end rope elevator; we have a 5400, which is a mid-rise, mid-complex city rope elevator; and we have our 5500, at the moment, which is a belt elevator, and also there we now have a solution with ropes going up to 4 meter per second. So the rope elevators, as the belt elevators, are now covering the whole residential area. And this also gives us some flexibility in terms of cost management, because if raw material costs, on one side go up, or they go down, we can also switch our production from the one or the other traction media.

All the components we have for this harmonized China platform are sourced in China. It has a pure Chinese sourcing and manufacturing footprint. We are producing certain parts by ourself, because we have seen that a certain vertical integration gives us the chance to insource the margin of suppliers; and this gives us an overall better cost position.

It is a – these Chinese products are very competitive in terms of cost. It’s another type of design. They meet the customer requirements. They go more into a good-enough design for lower-end Chinese markets. And for those customers who are more interested in higher offerings, higher-value offerings, we still have our belt elevators.

So we now have a much better footprint in this mass market of residential elevators. And I think this was one reason in Q4, as we have launched two new product lines in this harmonized China platform, to get a better sales growth.

Lars

That’s quite helpful. It’s really quite interesting to hear the success you’re having with belted products in what I understand to be predominantly a ropes market, and also given the challenges that some of your competitors have had there with belted products. Maybe, just on China, finally, can you let me know how much China made up of 2016 revenues?

Erich Ammann

We do not disclose in detail country-specific revenue shares. But it’s growing. And I think we are quite pleased with where we are, with the further improvements that we have in store.

Lars

Just finally from me, you’ve had a very nice margin progression now over the last couple of years. You’re coming out of a very big investment phase in the product portfolio. You’ve got better visibility on the cost improvements that that’s delivering. What’s holding you back now from reinstating a mid-term margin target?

Thomas Oetterli

Well, you know, our statement remains the same. We want to improve every year. This is our dominant path we want to walk on. We are not giving out any long-term profitability targets as we are doing – we are still doing a lot of investments for – into digitization, which is a new animal now, coming up more and more. And all those margin improvements are after this additional investments we do now for the digitization. And still we are working on new products also outside of China.

So, also in the more western markets we continue with our modular products portfolio approach. And this will continue over the next two years, until we have finalized that and have reduced the number of variants by more than 50%, at the moment, in our components. For the next two years, we still have to do a lot of additional investments, but, nevertheless, we still want to improve our margin. Key focus for us is top-line growth; that’s priority number one. Because if you just keep the margin with the top-line growth you immediately, in absolute terms, improve your EBIT.

And then, if we can continuously improve even our margins then we have like a double boost. That’s what we want to do every quarter, every half year, and every year, but we do not want to give ourself an ultimate target. What do you do when you have reached that? Then, you have to come with a new one. So we just continue every year to do a good job, and to improve ourself, and then we will see where it brings us.

Lars

That’s all clear. Thanks very much. Very interesting.

Thomas Oetterli

Thank you very much, Lars.

Operator

I got the next question from Rizk Maidi at Berenberg. Please go ahead.

Rizk Maidi

Yes, good morning, gentlemen. I have a question on Brazil, please. Since you don’t elaborate on how big Brazil is as part of your revenues, can you just tell us how large was the drop in Brazil order intake in 2016, and if you think that drop will still continue to process through your P&L in 2017, please?

Thomas Oetterli

Well, the drop was, in terms of market development, 2016 compared to 2015, quite severe. Market was dropping, definitely, another double-digit, so something slightly above 10%. We are one of the leaders in this market and we were able to keep our market position. But, yes, we were more or less, in the new installation business, dropping with the market development.

Now, we still have opportunities in the service business. And our colleagues in Brazil have done a pretty good job there to mitigate some of the drop we had in the new installation market. We expect now, in 2017, our performance in new installation will be more or less flat. We might come back to an overall slight growth as, also driven by inflation, the service business is still growing.

In terms of mix impact on the overall Group, of course, Brazil is the biggest market in Latin America. But when you remember the slide we had where we saw the distribution of the overall market in Americas, which is something like 45,000 units, and then you can maybe cut by half in order to get, or even more, maybe 60%, 65%, two-thirds is North America and one-third is Latin America, it’s still, in terms of new installation market, small part of the worldwide market.

Rizk Maidi

Okay. And then secondly, on China, maybe one point that we didn’t touch on, which is mix, and I appreciate you had a pretty good order intake in terms of large orders, how we should think about mix going into 2017. You gave a kind of guidance for growth in units pricing, but how should we think about mix, given that you’ve been booking a good portion of large orders in Q4?

Thomas Oetterli

Well, I think the mix will not so much dramatically change because we want, and we have, grown in all the segments in 2016. Maybe, we had stronger growth in large projects towards the end of the year, and we had stronger growth of non-large projects at the beginning of the year. But our strategy is to grow in all the segments.

Public transport usually is an escalator business, a lot of escalators are sold there; heavy-duty escalators for metro stations, for railway stations, or airports. There are a lot of projects now there in the pipeline. We have a very good market position in this public transport segment.

I think we also will further grow, see further growth, in the large project business. Because, as I said, our award pipeline is good, it’s healthy, and they should become now order intake when we receive the down-payment. So we are quite confident that we have a good set up.

Last, but not least, that’s the reason why we have more China tailor-made products with this enhancement of our product portfolio for the residential market, which is, in terms of units, the biggest market. We also see growth opportunities in that area, due to the products; but also, because the footprint of us, considering tier 1 and tier 2 cities, is helping us, because this is more the prospering part in the Chinese residential market. We do not see a mix change; we see growth, so have the ambition to grow in all the different segments.

Rizk Maidi

Okay. Finally, just in terms of 2017, how should we think about the FX impacts on your EBIT, given today’s spot trades? Also, if you can give us a sense for how the raw material inflation could actually impact your EBIT this year? Thanks.

Erich Ammann

Yes, going forward, we don’t have a crystal ball on FX. But as we stand today, I think there should be some positive impacts coming from the Brazilian currency; it has really rebounded nicely in 2016, so that should give us a positive impact. I think, also, the U.S. dollar will help us, has rebounded, and that should help as well, if it stays where it is. I’m more concerned about the euro, quite honestly.

We have a very broad base in Europe, as you have seen in the revenue split, and, therefore, I’m a bit concerned about further pressure. With all the uncertainties we have is the elections in France, I don’t know what’s going to happen to the euro. Therefore, I’m neutral. I would say we have not built in a whole lot of change into our plans for 2017. But one thing I know, I will be wrong, because it will be different.

Thomas Oetterli

Maybe, for commodities, it is quite similar. We had a deep increase in the last few weeks and months. We will see now, after the Chinese New Year, how markets will develop there as well. Because that’s not so untypical, that usually afterwards there is some softening in the pricing of commodities.

Secondly, we are hedged a few months, I think something like nine months ahead, for commodities. So we also have some waiting time until we are really impacted.

Third, you have to work on cost. If commodity prices are going up you have to work on cost, and you have to work on price. The price, of course, you can get in the order intake and it takes a year until you have the impact on your bottom line, because what you have sold usually you cannot so easily change any more the price you have agreed with the customer. So you have to work on cost.

And this is something I think we have proven in the last few years, that we have made big progress now with the finalization of our manufacturing footprint. We also can drive efficiency; we can drive quality; we can drive having less scrap material and using less, in fact, weight for certain elevator solutions with our new product platforms. This should mitigate a potential commodity price increase and cost increase, due to this.

We do not expect that we cannot further improve our margins. Let’s say, positively, we expect we can further improve our margins.

Rizk Maidi

Thanks.

Operator

We have got a last question from – the conference call come from Matthew Spurr at Royal Bank of Canada. Please go ahead.

Matthew Spurr

Good morning. Thanks for taking the question. In terms of China, in terms of your presence now, just thinking about the comments you made last quarter about your branch structure, are you where you want to be now? I think, actually, last quarter you talked about reducing headcount in some areas in China, in some of the tier cities where, basically, you don’t see good prospects.

Thomas Oetterli

Good morning, Matthew, good question. Yes, it’s true, you have several options when you have a challenging market environment. We have just built up a huge network of branches, and this includes the branches of Schindler, but also of our joint venture organization. So the 200 are combined, the two.

Schindler has just built that up in the last three years, so we do not want to get rid of them, and just close them. Why? Because when you start to build it up at the beginning you have zero sales. So every single unit you can win in the market, and every salesman is winning something in the market, you are increasing your market share.

The question is more how much do you want to invest to further increase, in a difficult environment, your market presence in those tier 3, 4, and 5 cities? Dare I say, okay, this is a question we do location by location, how many sales people do we need, depending on what we believe what kind of market share can we achieve in the different cities?

We are very granular. We have, for every single location, our market analysis: what is our share, in what kind of segment, what are the products, and the projects we can go in? Then, we make an assessment and say, okay, maybe in city A we don’t need five salesmen, but we only need three; but maybe in city B, which is very prospering, we don’t need five salesmen, but we need seven.

So the overall number of sales people maybe still increasing, but it’s not increasing everywhere: it’s over proportionally increasing in some booming areas, and it’s maybe slightly reduced in some lower areas. This, let’s say, fine-tuning we do every year, even on a quarterly, or half-yearly basis.

Matthew Spurr

Right, okay. Can I switch to Europe? I think, from the annual report, you said in Europe that southern Europe saw further recovery in construction activity. My question there is does that really matter for new installations as a whole? Just thinking, Spain, Italy, such falls in particularly residential construction levels, so even to get good growth, does it really make a difference?

Thomas Oetterli

Well, it’s a good question if you go on, maybe, – let’s go on the slide, what was it, 20, 21. What you see here on slide 21 is we have, clearly, markets where we have a, let’s say, strong focus; and these are the strategic markets. This is mainly in for the – our new installation business.

So it is China, it is India, it is South East Asia, it is Turkey, and it is Iran: these are the five biggest markets in the world in terms of units. So if you want to be a global key player, you have to be a key player in those five key markets. Otherwise, you are right, increasing your share by 1 or 2 points in a smaller market does not make the big change globally.

Nevertheless, our business is a very decentralized business. And you cannot only look on – in Europe on a single country. Why? Because the requirements from the market in Europe are very similar. It doesn’t matter that the elevator we sell in Spain is more or less the same elevator we sell in Germany.

By adding also in smaller markets – and the market in Spain is maybe as big like a market in Brazil, but even if you increase there in many of those European markets slightly your market presence, and you are growing faster than the overall market in this country, if you then add that up then you get some relevance.

And this you see in our figures in Q4, and also for the whole year. That in Germany you say [indiscernible] and so difficult to translate, I have to say, but if you add a lot of small pieces at the end you have a big ball.

And this is a little bit the strategy in Europe. We have a good presence in Europe, and we are looking for all the opportunities, even there are small ones, because we don’t have to change too much.

We don’t have to have a new product to enter into a market segment in Spain, or in France, or in Italy, or in Eastern Europe. We can use our existing product portfolio and so it is a quick-win growth with not a lot of investments. That’s quite a good opportunity for us. And we were very pleased in the different markets with this development.

So you are right, globally, it may be not – the single market is not so big. But as we have historically a good presence here in Europe, and there is also good value per unit here in Europe, even a small growth in a smaller market can contribute.

Matthew Spurr

Okay.

Erich Ammann

Absolutely. Spain is a very good example that Thomas mentioned. You look at the market at its height, before the financial crisis, was above 30,000 units, and has really dropped down to 6,000, 6,500 units recently, market units. And we had to reduce, obviously, our Company locally as well. But the structure is somewhat inefficient, because certain structures you cannot cut if you want to serve the customers.

Now, if the volume comes back, this structure becomes more efficient. And the key is, as Thomas said, not to add now new cost to it, so that the additional volume is really incremental, is adding incremental benefit to the bottom line, In that sense, I’m really happy that the volume is coming back in some of these countries.

Matthew Spurr

Okay, it makes sense. Can I ask a final quick one for you, Erich? On the accounting, it says in your annual report you’ve got half – it’s about half the revenue from construction contracts. Does the IFRS 15 coming in make any difference to Schindler?

Erich Ammann

Thank you for the question. No, IFRS 15 is – will change, I have to say, in our industry, the accounting quite a bit. But when I look at the bottom line there will not be a whole lot of change. One thing that is quite important is the change of control. Currently, the account, according to percentage of completion, IFRS 11, where we start booking the costs, basically, as they start to incur, already with engineering, a certain [indiscernible] work, is already part of work in progress.

With IFRS, there is a change of control, defined when the customer takes control of the elevator and, therefore, the margin recognition will move out into a – in the period. Now, we will have a restatement at the end of this year/beginning of 2018 that will take care of this. Going forward, this should not be a major issue, because it –the cost will be a bit reset.

Then, you will see also differences in the way we account for free maintenance. IFRS 15 is very clear how you recognize revenue on free maintenance. And there will be some changes coming, and we will inform all the financial community later in the year what we expect from this change. But the bottom line in itself, year on year, I’m not expecting too much change.

Matthew Spurr

Okay. Look forward to seeing that. Thanks very much.

Thomas Oetterli

Thank you very much, Matthew. Ladies and gentlemen, thank you very much for attending this annual press conference. I would like to close now the conference and wish all of you a prospering and healthy year 2017.

Looking forward to our next call, for the first-quarter results 2017, on April 25. Thank you very much, and goodbye.

Operator

Ladies and gentlemen, the conference is now over. Thank you for your participation. You may now disconnect your lines. Goodbye.

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