KONE Oyj (OTCPK:KNYJF) Q3 2022 Earnings Conference Call October 27, 2022 8:45 AM ET
Company Participants
Natalia Valtasaari – Head, IR
Henrik Ehrnrooth – President and CEO
Ilkka Hara – CFO
Conference Call Participants
Klas Bergelind – Citigroup
Andre Kukhnin – Credit Suisse
Daniela Costa – Goldman Sachs
James Moore – Redburn
Aurelio Calderon – Morgan Stanley
Guillermo Peigneux – UBS
Rizk Maidi – Jefferies
Andrew Wilson – JPMorgan
Panu Laitinmaki – Danske Bank
Joel Spungin – Berenberg
Miguel Borrega – BNP Paribas Exane
Lars Brorson – Barclays
Tomi Railo – DNB
Martin Flueckiger – Kepler Cheuvreux
Natalia Valtasaari
Good afternoon, and welcome to KONE’s Third Quarter Earnings Call. My name is Natalia Valtasaari. I’m KONE’s Head of Investor Relations. And I’m very pleased to be joined here today by our President and CEO, Henrik Ehrnrooth; and by our CFO, Ilkka Hara.
As usual, Henrik will take you through the key highlights of the quarter, both in terms of market and business performance. Ilkka will then follow up with a bit of a deep dive into the financials, and Henrik will wrap up with a summary and the kind of market and business outlook that we see going forward. After that, we’ll take your questions. And please, during the Q&A session, limit yourselves to one question and then one follow-up. You can turn the queue after that, but I’ll try to ensure that as many people as possible have the opportunity to ask question.
With that, I will hand over to Henrik.
Henrik Ehrnrooth
Thank you, Natalia, and a warm welcome to everyone, and good to have you with us today again. Clearly, Q3 had many different situations, both challenging and positive, and we’ll talk about both of them today. If I start just with the highlights. Perhaps the biggest things during Q3 that impacted our performance overall was, number one, the weakening of the Chinese new equipment market. It’s clear that, that had a impact on our business in the third quarter.
At the same time, what was very positive in the third quarter was a continued very strong development of our services business in both maintenance and in modernization. So this, I’m very pleased about.
Another very positive thing in the quarter is that our margins of our orders received continued to improve and actually they improved in all geographic regions now both sequentially and also in total year-over-year. So we can see that the actions we’ve been taking to improve our profitability, something that is a very high focus for us right now, is going in the right direction.
Let me start with Q3 and the key figures for Q3. Orders received at just over €2.155 billion and a decline of 10% in comparable currencies. Here, Ilkka will talk about this in more detail, but China declined clearly, whereas we had growth in rest of the world.
Perhaps a positive thing is our strong order book at almost €9.9 billion, 8.4% up year-over-year. Also, our sales grew at 6.5% to comparable currencies at almost €3 billion. And really here, the highlight was our services business.
Maintenance grew again at a very good rate of 8%. And the growth here was driven by a good combination of good growth in number of units in our service base by pricing, but also in continued good progress with our 24/7 connected services. So that was a key growth driver, but overall, broad-based growth that resulted in 6.5%.
Operating income at €304 million and adjusted EBIT at €306 million, down from €326 million the year before. It’s clear that the decline of margin from 12.5% to 10.2% is not something that we are happy with. It’s clear that from here, we want to improve clearly. What is positive, though, is that we could see that our margins, particularly on new equipment business that they or the bottom in Q2, and we now have sequential improvement, and we expect and of course, want to continue to drive improvement from here.
Cash flow, now at €336 million compared to €365 million a year ago, and EPS down 8.5% to €0.46. But as we always say, 1 quarter is a very short period of time. And now we have already 3 quarters behind us. And if you look at orders received stable compared to last year in comparable currencies, close to €7.2 billion.
And perhaps, again, I talked about the order book. But what is very important here is that this super strong order book that we have, it provides us a very solid foundation going forward, that in combination with our good and growing service base. As remember, we don’t have our service business included other than repairs in the order book. So the combination of these two gives us a very good situation going forward, even in a more challenging environment. So we have a lot to deliver over the coming year or two.
Sales, close to €8 billion, down 3.5% year-over-year. Of course, the biggest impact on our sales year-to-date has been the very significant impact of COVID lockdowns in China in Q2. EBIT — adjusted EBIT at €712 million, down 25% to €950 million and a margin of 8.9%. As I mentioned, this is clearly not something that we are satisfied with. Clearly — ambition is to improve clearly from here. And as I said, that we have started to see an improving trajectory.
And cash flow, now €721 million, down from the exceptionally strong €1.3 billion a year ago. And EPS, €0.97 compared to €1.43 a year before. So we all know that the world economy and the environment has continued to be challenging. When I look at how the KONE’s team is driving improvement and driving performance in this environment, that is something I’m very happy about. I can see a continued good drive and spirit in the team in driving improvements, everything from pricing, focusing on productivity and just making sure that we are making progress in our key focus areas. That is something that is very pleasing.
I’ve been traveling a lot around our units in the past months, and that is the same message and the same reception one gets everywhere. So huge thanks again to the entire KONE team for a great work and what they have been doing.
Now then a little bit on some business update. Highlight this time is how we’re driving momentum in services. I talked already about what is driving our maintenance growth, combination of all factors. I wanted to give a little bit more insight to our 24/7 connected services and modernization. The penetration of our 24/7 connected services is now close to 20% of our KONE equipment.
At the same time, we are also installing 24/7 connected services on all other brands.
And that is something, I think, differentiates us in the market that we can do it both for KONE and for non-KONE-branded equipment. And that’s why we’re also starting to approach 15% overall penetration. But I think key for KONE equipment, we have this good rate now.
Customer benefits are very measurable, but also, we can see that our conversion and retention rates are improving. Now what is even more important is that beginning of this year, we launched our new service called KONE Care DX that is specifically designed for DX-class elevators that we launched in 2019. Now what is great is that this is an evolution of our KONE care service in our 24/7 connected service, and it was the first carbon-neutral maintenance out in the market.
Now we can see that when we look at conversion rates, we look at pricing, we look at all the measures, we are even better with KONE Care DX. So the point here is really that 24/7 connected services is not a static service for us. It’s something we continue to develop and continue to make sure that we can improve outcomes for our customers and for us.
And as we’ve highlighted before, the impact for our customers when we have units connected is the call-out rates are 30% lower, entrapments down 40%. And we can — in 65% cases, we can proactively identify faults, of course, making sure that we can do things proactively and more conveniently for our customers and more productively for us.
Now modernization is also a market that continues to be robust and good. What is interesting is that we’re seeing the classical trends of an aging equipment base that’s continued to drive modernization. It’s very much there. But we also have other trends that are also boosting particularly on the commercial side, but also from a sustainability angle growth here.
So we can see that, for example, offices are getting more modernized than before because if you want to attract, for example, employees back, you need a modern and good office. And then usually, when you modernize, elevators are part of the package. So we’re seeing more younger equipment being upgraded for adaptability and for better experience.
But also, we are seeing focus on sustainability. We can see in some countries, the European Resilience and Recovery Fund also subsidizes elevate the modernization. So good drivers here. Even though economic outlook is uncertain, we can see continued good momentum in this business, which is great, and we have really taken advantage of it.
Now as we said for a few quarters, what is very high up our agenda is to improve our financial performance, in particularly our EBIT margin. That is a combination of pricing action and more dynamic contract models. Here, we’re making good progress. Modernization, we have more than covered the costs — or the increased costs. And in new equipment, we’re making good progress, still some way to go, but momentum is clearly there.
Another focus area has been to how can we reduce our product costs through R&D development, offering development then of course, sourcing actions. Here, I would say, particularly the development in China has been great. Our China team has done a phenomenal job here. And of course, now we also start to see an easing of raw material costs in China, and productivity also improving order book margins.
Then, of course, another driver for our margin improvement is to drive growth in our service business, which we’re doing very much so. Now we can also, of course, see that in the past years, the operating environment has changed very rapidly. It started with COVID-19, and then we had, of course, supply chain disruptions, then we had a war in Ukraine and so forth.
So there’s been rapid changes. And we are therefore now planning to simplify our operating model in order to be able to more rapidly respond to changes like this, but also to improve our efficiency and therefore to support the improvement of our financial performance. That is something that we are planning to do. So those are some highlights and some updates on where we are on these focus areas.
But then market development. And if we start with new equipment markets, we can see that development has been mixed. North America, we can show we’re seeing 1 minus. So actually what happened in North America in a number of units, the market declined a bit. But the market grew significantly monetary value.
And we can see our performance has been excellent in that market. So we can see that prices — overall prices in the market have come up significantly. So therefore, that continues to be good and robust market.
Europe, Middle East and Africa, mixed. War in Ukraine is clearly starting to impact Central and North Europe, whereas South Europe is slightly better and although it declined slightly as well, but the Middle East, of course, with the energy price trends is doing very well. So there, we’re seeing growth.
China, there was a further deterioration in the market declined about 20% now in Q3, and I’ll talk soon a little bit more about the Chinese market. Rest of Asia-Pacific, good development overall. The highlight here is India, which has recovered very strongly after COVID and developing positively.
[indiscernible] a little bit deeper dive into China. So market environment did deteriorate further in Q3 and really the key issue is liquidity constraints for developers. Because of poor liquidity, it’s clear that their construction projects overall are moving slower, and therefore, that, of course, impacts our deliveries as well. COVID-19 restrictions, although they are not quite as severe in this quarter, but we have seen rolling lockdowns around the country has had an impact on consumers’ confidence in ability to buy apartment.
Maintenance markets continue to be good, although now in the quarter, we did see a more mixed modernization activity. Here, we could see that particularly elevators for existing buildings were impacted by overall liquidity and the overall economic situation, whereas then part modernization developed better. We believe that this temporary downturn in the modernization market overall in China is temporary, and we’re going to see an improvement already in Q4.
So if we look at the various statistics, we can unfortunately see that Q3, when we look at either real estate investments or new starts then unfortunately, they did deteriorate further. Where there is some positive development, actually, the trajectory is not quite as bad as it was in the first 9 months, now in the quarter is in completions.
Here, we can clearly see that the need to complete apartments that are started, particularly people who paid down payments, is increasing. So when that gets going, there’s actually a lot of elevators that need to be delivered. So let’s follow that, but that is something that we believe will happen at some point during next year.
Service markets globally continue to be good. I would say maintenance, we are back at a pre-pandemic growth trend, so slight growth in Europe, Middle East and Africa, North America and continued good growth throughout Asia-Pacific. Modernization markets were very strong in the quarter, perhaps most positive with the North American markets but also Europe, Middle East and Africa good markets and Asia-Pacific outside of China.
As I said, that Chinese market were now temporarily lower, but we think this is a temporary phenomenon, and the markets will come back there given the big need for modernizations.
So overall, we can see that, yes, there are challenges in some of the markets, but some of the markets are robust. And what we have done is that we’re really focused on want to grow in the growing markets because that you can do with better margins, and we can see that — and as Ilkka will explain soon, how we’re driving growth, both in maintenance and modernization continues to go well.
And with this, I hand over to Ilkka to talk more about our financial performance.
Ilkka Hara
Thank you, Henrik, and also a warm welcome on my behalf to this third quarter results announcement webcast. I’ll review the financials in more detail, and I’ll start with orders received development for the quarter.
Orders received for third quarter was €2.155 billion, on reported basis down 2.5% and on a comparable basis down 10%. If you look at by geography, clearly, in Americas, we saw very strong performance there. A significant growth in orders received as well as growth in Europe, Middle East, Africa. In Asia-Pacific, excluding China, more stable development, but clearly in a more challenging Chinese market, we saw orders received declined significantly.
We talked about pricing quite a bit over the last quarters, and we continue to see pricing development positively in the quarter. We look at overall, we saw pricing improving in all regions. In modernization, we’re now at the stage where the price improvement have covered the cost increase that we’ve seen now.
In new equipment, we continue to make progress, but there’s still work to be done to cover the cost headwinds that we have. But we’re in the right direction in that area as well. We look at tender outcome, the impact to our margins. So we saw in the third quarter that our orders with this margin improved not only on sequentially, but also year-on-year. And as I said last time, that’s the next milestone we want to get to in order to get faster cost headwinds that we’ve seen.
And now we can say that we are increasing year-on-year. So very pleased to see that now being reached in our third quarter orders margins.
Then to sales. Sales for the quarter were just shy of €3 billion. On a reported basis, growth 14.9%, naturally on a comparable basis less, so 6.5% growth. Very happy about the fact that we grew in all regions. Strongest growth in Europe, Middle East, Africa as well as in Asia-Pacific, both growing at 7%.
Americas growing at 4.5%. Also from a business perspective, all businesses grew, new equipment at 5% and modernization at 8.6%. So a strong number for modernization growth. But also, what I’m very pleased about is that we continue to see our maintenance performing well. And now we can see the growth for the third quarter to be 8%, and that is a very good number. We see improvement in all numbers, whether it’s LIS, whether it’s pricing and also, as Henrik talked about, value-added services, 24/7, as an example, contributing positively.
In to adjusted EBIT and profitability. So adjusted EBIT for the third quarter was €306 million, and the margin was 10.2%. Clearly, the number that we’re happy about, down from last year as 12.5%. While the growth that we saw in all regions as well as in all businesses contributed positively to our profit and as well as the improvement that we continue to see in productivity as well as in good control our fixed costs, contributing to profitability positively.
At the same time, the cost headwind, approximately €30 million to €40 million for the third quarter, driven by material components and logistics costs contributed negatively as well as then the new equipment delivery margins. So the orders that we’re now fulfilling from the past have lower margins, as we’ve talked about, contributing positively as well — contributed negatively in this point. But as we said, now we start to see the prices improving as we look forward, then also quarter-on-quarter from last — third quarter of last year, we’ve seen orders margins improving. So that would be a tailwind for us going forward.
Into cash flow, which for the third quarter was €336 million, while operating income decline contributed negatively. This change in working capital was slightly negative in the quarter. So a slight decrease in advances mainly driven by the orders development in China as well as a slight increase in accounts receivables and the timing of our accounts payable now contributing positively. But as always, between the quarters, some timing differences. So we expect that to reverse in the coming quarters as a result.
But all in all, good cash flow for the business in the third quarter at €336 million.
And with that, I’ll close the financial part and hand over back to Henrik to cover market and business outlook for the rest of the year.
Henrik Ehrnrooth
Thanks, Ilkka. And then if we look at the market, what do we think for total 2022? Of course, we only have a quarter to go now. But if you look at new markets, continue to see a mixed situation with new equipment market in China. We now expect it to decline by over 20% for the full year 2022.
Last quarter, we still expected about 15%. So we have seen deterioration in the outlook, and that’s, of course, due to the liquidity situation, principally.
EMEA overall, pretty stable and North America because of good growth beginning of the year and of course, because of the value growth now growing and Asia-Pacific, excluding China, also developing positively.
Modernization markets, we expect them to continue to grow across regions and being good and robust. And maintenance markets have returned — continued on their pre-pandemic growth trajectory. So good growth opportunities in many parts — or actually all parts of the world and best naturally in Asia-Pacific.
Then our business outlook, we now expect our sales to decline between 1% and 4%, at least we updated roughly a week ago or almost 2 weeks ago. And we expect now our adjusted EBIT to be in the range of €1.010 billion to €1.090 billion. Of course, assuming that exchange rates don’t change a lot from October 2022.
What is driving our performance? It’s clearly the outlook in services and our strong order book. There’s plenty for us to deliver going forward. And also, we are now starting to see the impact of product costs, productivity and pricing actions. As we always said that they will start to be seen towards the latter part of the year, and we expect this start to impact back in Q4.
But of course, what is burning our result is clearly €200 million still headwind from material, logistics and component costs and deteriorated environment in China.
Supply chain constraints continue to be a factor, although we expect supply chain challenges to ease. Supply chains continue to be constrained in many parts of the world.
Now as we are already in the last quarter, we wanted to give a sneak peek into 2023, what we expect to be drivers of positive and also challenges for next year. Clearly, what is positive going into next year that we have a very strong order book and the improving margin of orders received.
So gradually, we start to see that coming through. It’s clear that orders that we book today, we can only see the margins roughly a year out, but still, we have clearly throughout this year, gradually improved our pricing so that we start to be seen next year. Services, we expect continued positive momentum there. And also in Asia, particularly, easing commodity cost headwinds and somewhat improving component availability. In Europe, commodity headwinds continue to be there because of the energy crisis, but Asia, we start to see a clear improvement there.
What are the more challenges going next year? It’s clear that the slowing rotation of the order book. In North America, it’s more of a labor constraint issue. In China, it’s clearly a liquidity issue. And therefore, also the continued liquidity constraints and COVID restrictions in China likely have an impact.
Wage inflation, clearly impacting also cost next year. And then what is unknown, our geopolitical tensions on global supply chains. Clearly, the very tragic war in Ukraine continues to have impact, but let’s see if we have something else. So that’s kind of an unknown for next year. So they’re both good things and challenges that we are proactively dealing with.
So to wrap up. Clearly, the environment in China and given our science there, impacted now our business in Q3. Services, great continued progress that I’m very happy about as well as good progress in pricing overall in all businesses. And then also, we are planning to simplify our operating model to also support long-term financial performance.
So with that, we now have plenty of time for your questions or comments.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Klas Bergelind from Citi.
Klas Bergelind
It’s Klas from Citi. So my first question I had was on the operational gearing in the quarter. Your China sales seems to be up slightly, and you have reiterated the cost catered €200 million with some €30 million, €40 million in the quarter. Despite this, your operational gearing disappointed in the quarter. I hear you on the low equipment margin coming from the backlog. But to what extent is this also other cost inflation such as wages kicking in? And if you could help us with the wage inflation in the quarter and your expectations going into 2023? I’ll start there.
Henrik Ehrnrooth
Do you want to start with that? .
Ilkka Hara
Yes. So on the wage inflation, as we talked about earlier, so yes, we see higher inflation in wages than normally, but it’s not that dramatic. It contributes negatively. But at the end, we actually had a pretty good fixed cost absorption. So some tens of millions that were impacting the — sorry, some tens of millions impact from increasing wage costs, including our installation and as well as our fixed costs, but that’s something that has been more stable throughout the year. So it’s not picking up third quarter as such. .
Henrik Ehrnrooth
I would say, in general, when you look at the quarter, so clearly, services did well. And when we look at our new equipment margins, while they were down year-on-year, still sequentially, we’re now starting to see an improvement, which was positive. So clearly, compared to last year, higher cost. Also, we can see that supply chain constraints in some markets did have an impact on this. If we look at certain semiconductor availability, Q2 and Q3 were perhaps the toughest if we go back a couple of years. Now we see a situation that is improving gradually.
Klas Bergelind
Yes. I guess my question, Henrik, is given that the implied sales guide for the fourth quarter is quite low, right? So — and you are talking about an improving margin again quarter-on-quarter at the midpoint. And if the equipment margin would still be down year-over-year on current cost inflation, that means that you’re pricing, you not feel very good about pricing coming out of the backlog. Is that how we should see the sort of quarter-on-quarter improvement just to get that right because I was a little bit surprised about the low new equipment margin out of the backlog?
Ilkka Hara
No, I think if you think about our new equipment delivery margins. So they are now sequentially improving in Q3, and we do expect them to continue improving in Q4 as well. And then obviously, there are many moving parts for the guidance, but that’s the expectation. We’ve seen now pricing improving in our new equipment since third quarter of last year and also margins as to that extent. So all of that starts to then come through in the P&L as well.
Klas Bergelind
All right. My follow-up then is a question on the €400 million cumulative inflation from raw mats, components and logistics. It’s obviously good to see the order margin improving year-over-year, but that’s against the current cost inflation. I’m interested, again, the cost items at current spot levels, how this could develop into 2023? Would you help us on how you think raw mats, logistics and so forth at current spot rates can sort of impact the bridge into next year? I’ll give it a go at least, let’s see what you say.
Ilkka Hara
You’ve been following us too long. So I guess it’s a bit too early to start giving a more detailed guidance for next year. I will come back to that in conjunction with the fourth quarter results. But I guess, Henrik said already earlier is that we are seeing raw materials and therefore, component costs as well, a bit of a tailwind in China. Whereas in Europe, they continue to be on quite a high level given the energy crisis that we have here. So a mixed bag, I would say, and let’s look at it in a bit more detail when we come to towards the end of the year, also we know that which orders and where we are delivering so give you more details. But I would say mix back tailwind in China and to an extent we delivered to Asia-Pacific from China. But then clearly, Europe is a different development on that perspective.
Operator
The next question comes from the line of Andre Kukhnin from Credit Suisse.
Andre Kukhnin
The question I have really is on the — on your view on the cycle shape in China beyond this year. Not trying to elicit some kind of market forecast, but I just really would love to hear what your base case is for 2023 beyond, do you have it declining further next year? Conceptually, what do you see as a kind of curve or line after that?
Henrik Ehrnrooth
So I think it’s too early to give an outlook for China next year. Of course, we know that the market in China is very policy-driven. What we now have seen is that we have not seen a big change in policies, which would indicate that [indiscernible] change next year. There’s, however, one thing that we would expect to sometimes during next year, start to become more of a tailwind is that there’s clearly a need to finish the semi-finish buildings, particularly where people are paid down payments. And that is a very significant backlog, and we’re talking about actually a lot of elevated demand and deliveries there. That is going to require liquidity for developers to finish the project. But that is something we could see happening. But other than that, we have not seen a lot of changes in policies. So a big recovery in the short term, is not something we’re expecting.
Ilkka Hara
Maybe to add to that, then our view to the service opportunity in China has not changed. So if you think about last — next years to come, I think it continues to be very, very interesting opportunity, both modernization and maintenance. And that’s something that is very key to our strategy also going forward. .
Andre Kukhnin
Absolutely. Absolutely. And as a kind of follow-up to my second question, I just wanted to come back to what we discussed before about the pricing actions and the cost-out effects that you’ve already taken. Could you help us with the number of what we should expect for 2023 from what you’ve done already? What you have got in backlog already?
Ilkka Hara
Well, if I try to give you a bit of a bit of a view to that, and then we’ll come back with more details for ’23. So first, if you start with modernization business where I would say that the progress has been the best in terms of pricing versus cost. So now we are at the stage that we’ve been able to increase prices for the orders we booked in third quarter to cover the cost increases that we have seen. So that’s very good. And in modernization, order book growth rotation is faster than the new equipment. So that just started to positively impact our P&L then in the first half of next year.
Then when it comes to new equipment, we continue to see pricing improving. But if I look at our progress in third quarter, so we’re roughly in — outside of China, 70% there in terms of the price covering the cost increases net of our actions. And whereas in China, I think, as you saw in the quarter, the prices did improve like-for-like compared to last year. But there are — the cost actions that we take in our product cost has been a much bigger driver in our performance.
And also, if you look at the raw materials, there start to be a tailwind, as I said earlier. So in that respect, so if you now look at next year P&L impact from these actions. So it is about year — a bit more than a year to see the order book growth for the orders that we now booked in Q3, which had a positive pricing development. So that’s the way I would try to describe it. And as I said, we’ll come back to that a bit later.
Andre Kukhnin
And then that’s in the context of the half of the €400 million cumulative being offset, right, as a kind of wrap around?
Ilkka Hara
I didn’t give that detail in total, but it’s not a bad proxy as well.
Operator
The next question comes from the line of Daniela Costa from Goldman Sachs.
Daniela Costa
The first question I wanted to ask regarding your last point, Henrik, on your summary, where you said you’re simplifying your operating model to drive long-term financial performance. I just want to see if you could give more — any more color regarding that. I guess your accelerate program is done. So should we be expecting like some sort of restructuring or a new program to follow? That would be my first question.
The second question is just a follow-up on one of the questions earlier. You commented on wage inflation for this year, I guess, sort of a lot of the macro forecast is for higher wage inflation next year. I know you have escalation clauses in the maintenance portfolio. But you — can you talk about how they effectively get implemented? Would you sort of fare wages throughout the year as they are and then get a compensation from the customer at the end of the year? Or is it happening on a continuous basis, and so we should see no impact because you pass on any sort of wage inflation to your customers? Those are my…
Henrik Ehrnrooth
Let me start from the second one. So usually, how it works. So it’s just — first is on part of the contracts have escalation clauses, others like you go, for example, in markets where you have longer-term commercial contracts, then they may have specified like in North America, more specified what the escalation is year-over-year. But in North America also, we know much better the labor cost increase than in Europe. In Europe, which is still the biggest service business for KONE. The way it works is that, in most cases, you have annual escalations, and quite a big part of those happens in Q1. Then you tend to have — you have a labor cost index, you have a CPI or you have another specific index, it varies quite a lot market to market. And you look back 12 months, and that is your escalation clause and clearly that we have had quite of inflation already for a year, so that should be reflected in these indices.
That’s why, for example, we’re going a year back, even though actually, we were able to increase prices quite well or very well, I would say, in maintenance. Some of these indices went so favorable because inflation really started in the second half of last year and the first half didn’t contribute. So now I would say all the indices are more favorable because it’s something you usually look 12 months back and what we can then do in quarter 1. So that’s kind of in a simplified way the ones that you can escalate, that’s how it works for that.
Now — then on these plans to simplify operating model. Just the context here, as I mentioned, it’s clear that when we have a regional designed our operating model, it was for a different platform environment where not too many changes happen all the time. And now we are looking at, hey, how can we be faster responding to changes.
For example, we have now raised our prices very well, but perhaps we should have started earlier. How do we make sure that we react the situations in our organization faster? Also, how can we be quicker in environments like this and bringing solutions to our customers? And it’s clear that we are looking for efficiency metrics as well. So those are kind of details we can share right now. And later, you will, of course, hear more about it.
Operator
Your next question comes from the line of James Moore from Redburn.
James Moore
I have just a few follow-ups, really. I heard all of your qualitative answers on the questions that have been given so far. Just on quantification, I don’t know if you could help us a little bit with, one, is there are restructuring charge tied to the new operating model. Two, wage inflation percentage is it more 3 or 4 this year? And next, does it go up? Some, say, it goes to 4, maybe 5.
Raw materials at current prices next year, are you thinking a tailwind or a headwind? If you don’t want to give a number because you just give the direction at the current level. And finally, perhaps most importantly, could you help us with the difference or quantify the difference in any way or between the order received gross margin and the current P&L gross margin? I mean is this a small difference or a big difference?
Henrik Ehrnrooth
Okay. Those are a few questions. I’ll ask Ilkka, hopefully, you wrote them down so you can start.
Ilkka Hara
I think I have, but let’s see how well I do. I start actually at the end first and then work backwards to your first question. So yes, we are booking orders on a higher margin than we’re delivering right now, but I wouldn’t quantify it that in more detail. But clearly, we expect them to continue to have that tailwind in the coming quarters, supporting our profitability improvement. Raw materials, to help to quantify so it’s too early to say, given the size of China business, where we see the tailwind that’s naturally helping and expect some help from there. But let’s come back to the details when we get to fourth quarter results.
Then you had a question on labor cost inflation that we see and what’s the difference? So maybe that’s actually a good way to describe it. If you’re saying that from 3 to 4, it’s now then 4 to 5 percentage points or so increase. We see the labor cost increasing more, especially in Europe than we’ve seen in the past. Much of Asia-Pacific would have high inflation for a long time.
So it’s not as big of difference compared to the past. And as I said, in North America, our visibility to our own labor cost is quite long given the labor negotiations. So yes, a bit more than we’ve seen in the past, but not that dramatic.
And then on our operational improvements and the things we’re planning to do, let’s see we will come back with more details later. The planning has been commenced and will then update as we go along and we have more detail on that one.
Henrik Ehrnrooth
So it’s likely to have some implications, but let’s come back to that. But thank you. I think you’ve covered all of them.
Ilkka Hara
That’s right.
Henrik Ehrnrooth
Okay. Thanks.
Operator
The next question comes from the line of Aurelio Calderon from Morgan Stanley.
Aurelio Calderon
I’ve got two on China, if I may, please? So the first one is on your order development in China. Just looking at your slide, you showed that you had more than 30% decline, whereas the market declined plus 20%. So I’m just — I just wanted to say if that’s market share-driven or if you’re consciously not going after orders that don’t meet your margin criteria?
Henrik Ehrnrooth
I would say perhaps everywhere, in our new equipment business in Q3, we focused principally on price and margin, not on growth. Therefore, our principal objective was to improve our margins, not necessarily gaining share or growing units.
Aurelio Calderon
Okay. Great. And in terms of order cancellations, you still mentioned in the release that they remain at very low levels. I just wonder if there’s — if you’ve seen any changes in China, especially given obviously the tight liquidity situation of developers? Or are cancellations still in line with what you’ve seen in the past?
Ilkka Hara
Cancellations continue to be — if I look at the full year, to start with, the main driver for cancellations this year has been the fact that we exited our business in Russia, where we actually then had to ourselves cancel the new equipment orders we had in place that we were not going to deliver. In China, overall cancellations continue to be very similar than we’ve seen in the past. So no change there.
Operator
Next question comes from the line of Guillermo Peigneux from UBS.
Guillermo Peigneux
Maybe a follow-up question first and then — on the previous question. So now that you are increasing prices, you’ll be more selective on your order intake maybe. For the part you lose in market share, is it to Chinese companies or is it to Western companies? I’d stay back, and I’d ask the second question later.
Henrik Ehrnrooth
First of all, let’s remember, we talk about one quarter. If you look at year-to-date orders in China or rest of the world, I think we’re doing well, better than the market overall. So this is one quarter and one quarter we’ve put particular focus on the margin development. So it is not something that I would be overly concerned with and just in line with what we’re driving for.
Guillermo Peigneux
Yes. If I may follow-up — I understand, but I wanted to understand who is — when you obviously act as a pricing leader in the Chinese market, can I ask whether it’s the Chinese companies scooping the market for those basically customers that don’t want to accept the higher price? Or you see the Western companies that are doing that in the market — in the Chinese market at this time?
Henrik Ehrnrooth
I don’t think that there is one single — I think there’s a mix, I think, in both categories. If you look at the global players and you look at the more local players, I think you can see gains and losses in both of them. So I don’t think you can point out that this is Chinese that would win and global players losing. It’s not — I don’t think it’s like that.
Ilkka Hara
No, I wouldn’t call out the pattern there, but rather individual cases. And as Henrik said still — said it in the first half, when we were clearly above the market in terms of order development and now the opposite in third quarter that the quarters are a short time to measure market share, to be honest.
Guillermo Peigneux
And maybe a more difficult question. When it comes to new installations in China, and obviously, comparing this year with last year, could you be able to — would you be able to quantify how much of the margin that has been lost is driven by your inability to install versus your negative impact from price to cost?
Ilkka Hara
Well, I think if I start and you can add, Henrik, if you want, so majority of our inability to install, as we said, was really about the lockdowns that we saw in second quarter this year. We estimate that to be roughly €500 million in revenue and the cost impact, including the one-off costs related to operating in this — during the lockdowns to be about €100 million. Now we’ve been able to cover and recover the backlogs that we had in Q2 during the third quarter, and that supports our revenue development going forward. So I don’t think there — there has been complexity to operate during the third quarter in terms of the lockdowns and related complexities, but nothing else on that. And I don’t know how much more I would comment on that. So some tens of millions of extra costs and the rest is the price-cost ratio that is impacting the profitability.
Operator
Next question comes from the line of Rizk Maidi from Jefferies.
Rizk Maidi
I’ll start with the first one. So Henrik, you sounded, I would say, more positive on modernization from Q4, and then on the new construction side of things, a little bit more positive on completion rate next year. What gives you this confidence? And you just had the [NT Xian] obviously, there was a lack of stimulus amount to start there.
Henrik Ehrnrooth
So what we are seeing in the market, we are more positive in China. I think you talk about China modernization. That’s just what we see in the market at the moment. I said at these completions, we are not seeing — well, we can see that the trend in completions is somewhat better than the one for new starts, for example. And then we know that the need to complete many of the apartments particularly housing that has been started already and consumers have paid a down-payment, that need is high. And therefore, we would expect, and that seems to be a lot of expectation in China that there needs to be an acceleration of completing the delayed buildings. We are not seeing that quite yet, but we said that, that’s something we would expect to start happening during next year at some point. When? We have to see.
Ilkka Hara
And maybe you asked still on the modernization side. We continue to see very good growth opportunities, but if you think about the size of the market, it’s still a very small part of the total market.
Rizk Maidi
Understood. The second one is, are you concerned about sort of the pricing development in China now that cost inflation in the country are reverting?
Henrik Ehrnrooth
I would say, when we look at our own cost actions and we see that also material costs are coming down, clearly, the picture is better right now than it was, for example, 3, 4 months ago.
Rizk Maidi
Understood. And just finally, just a clarification. Ilkka, you talked about €400 million cumulative cost inflation. And you said half of that sort of reverts next year. Can you just come back to that point? Is that just on the Asian sort of part of the cost inflation? Or how we should think about that cost element next year?
Ilkka Hara
I guess the €400 million is just adding on what the cost inflation was on the previous year and then this year. And it is really related to the material costs as well as our semiconductor total cost, including the spot price. And then especially on the previous year, logistics cost was a part of that. So that’s the €400 million. And I wasn’t very clear on commenting how much exactly we’ve covered, but rather was asked about somebody else’s estimate.
Operator
The next question comes from the line of Andrew Wilson from JPMorgan.
Andrew Wilson
I’ve got a few on strategy. So I guess, that counts as one plus a follow-up. In terms of China, you also made some helpful comments in terms of giving us a bit of an understanding at least into thought process on next year. Just if you could kind of comment on your sort of strategic thinking from a KONE perspective — whether anything that you’ve seen in the last, I guess, sort of 12 to 18 months has kind of changed the thinking. Whether that be organically what you do in China, but also just thinking a little bit around you’ve previously talked about potential to move to some sort of bolt-on M&A in China and the potential that, that might have on the service side. Just interested, I guess, high level on your thinking on China and KONE’s positioning.
Henrik Ehrnrooth
So our strategy in China is, of course — continues to be stable. It’s clear that we have ambitions to be a very strong player in new equipment market, and we continue to have a very good business there. Even though we can see the market is lower, we continue to have a good business in China. But it’s clear that our strategy in China is very much focused that going forward, we want to drive a big part of the growth from services. That hasn’t changed at all, and we continue to see that as an attractive market going forward.
So I would say, fundamentally, when it comes to China, yes, we’re trying — we’re operating even more in China for China, but that’s not a huge change to the past, but driving really the service business growth and continue to keep a very strong position in the new equipment business.
Andrew Wilson
Maybe on to the connected service side, I think the numbers you’ve obviously helped us with today are, I guess, the rate of acceleration that seems as if it’s probably surprised a little bit on the upside versus previously. I guess, talk a little bit about what you’re seeing in terms of market dynamics. I’m interested if you’re seeing — and you mentioned about the third party, whether you’re beginning to sort of reverse some of the trends with regards to the independent service providers and just from a kind of market share and feedback from customers just to sort of — coming from that?
Henrik Ehrnrooth
I would say when we look at Europe, we look at North America and many of the Asian markets, we are seeing that we are improving our retention rates. We are doing that in general, but in particular with — when we have connected units. And that means that I think we are able to fend off better competition from the small independents, which have more of a struggle to keep up with the technological advancement. But it’s clear that also the small independents continue to have a role in the, I would say, standard residential, older equipment. That’s where they usually play.
But I think what we’ve been focusing on is that we can connect any brand. So if the customer comes to us with a portfolio that usually then will have multiple brands, we can connect the whole portfolio and not only the KONE units. And I think that’s quite a unique thing in the market still today. And that is, of course, helping us overall on retention. I don’t know anything more you would say about that, Ilkka.
Ilkka Hara
Maybe I would expand to cover also DX Class elevators. So if that was — 24/7 Connected Service is available to a wider base. But then when we talk about the DX Class elevators that we launched a bit more than a year ago, there clearly I would expect the retention to be much higher than we’ve seen in the past and the future upgradability through cloud connectivity and all the services that are then in future also available for those units. So let’s see. It’s too early to say what the retention yet is, because it’s been launched relatively recently. But there’s a lot of potential there to drive further improvement in retention for those units.
Operator
The next question comes from the line of Panu Laitinmäki from Danske Bank.
Panu Laitinmaki
I just wanted to ask about your order book. Can you comment how much of that is in China? And out of the China order book, can you comment how much is due to be delivered in ’23 compared to what you had a year ago? And then how much of the Chinese order book is in these semifinished projects that are not moving forward? So just basically trying to understand how much — what is the magnitude of revenues that is depending on whether the kind of projects get finished or not?
Ilkka Hara
Well, I guess, one way to assess that is if you look at China’s contribution to our sales, roughly 30%. So their contribution to order book is less than that, given that we have a slower-moving order book, especially in North America. So that’s one way to think about it. Then when Henrik talked about this potential for these buildings that need to be finished, much of those projects are likely to be ones where the orders have not been granted yet. So it’s not in the order book as such. So I think it’s a further potential for us for both orders and sales.
Henrik Ehrnrooth
And I’m not sure one can really say that it’s something a project that is still — I think all projects that are moving are slightly slower, but most of them aren’t moving. So it just comes a little bit later, the delivery there. And if we look at order book, I do believe that all geographic regions, we are up order book year-over-year.
Ilkka Hara
Yes.
Operator
The next question comes from the line of Joel Spungin from Berenberg.
Joel Spungin
I’ve got two questions actually, one on service and one on China. Maybe if I can just start with China. Could you maybe sort of — obviously, you talked about the liquidity constraints in that market. Could you maybe talk about the situation with regards to getting paid yourself? Have you seen any deterioration in the time it’s taking to get paid?
Have you reviewed your sort of credit position there and had to make any additional provisioning for bad debts or anything like that?
Ilkka Hara
So I would say that overall, in this liquidity situation, liquidity being tight, and our team in China has done actually a very good job managing the credit risk, managing which customers we work with as well as for them which are the projects we’re really partnering with those customers with. So it’s a very detailed analysis are in place to manage the risk. And from our perspective, we’ve been very good at keeping good payment terms with our customers despite quite a strong push on those. And as a result, then also our accounts receivable, we look at the DSOs and so forth, yes, they’ve increased a bit. But I think we’ve been able to manage the situation quite well.
And then also, if I look at — and if you look at the overall budget reservations, naturally, we book better reservation based on a calculation method, it goes up. And we assess the risk, it is somewhat up on a global level, but we have not — we’ve seen that the credit management process works quite well. As I said, in China, it’s always — it’s not only a pricing question, it’s as much about the payment terms and managing those. So managing those holistically is, in my mind, the key to manage the risk as well.
Joel Spungin
Okay, understood. And just maybe just a quick follow-up on that. Would you consider the situation with regards to your working capital position? Is that in part being impacted by payments in China? Or is it not a substantial part of that?
Ilkka Hara
If I look at the year-to-date working capital development, clearly inventories, due to the slower rotation of the order book and overall supply chains, is one of the key drivers. But then advances, given the orders received development in China are lower than in the past, it’s just a function of how many orders you book. Accounts receivable is not a major driver as such for our working capital development this year.
Joel Spungin
Okay. And then just very quickly, maybe on the maintenance side. I just want to ask, obviously, you’ve grown pretty well this year, I think it’s about 8% year-to-date. Are you able to — first, approximately how much of the growth is unit growth? And then maybe could you just also maybe give us a bit of regional color? Are you growing your units in every region? Or is there significant differences between regions?
Ilkka Hara
I guess we’ve been able to grow units faster than we’ve had in the past. But what to me is really the positive overperformance that we’ve seen has been both pricing and then value-added services contributing more than normally. The unit growth is driven by conversion. So a large part of that naturally comes, therefore, from China as such.
Henrik Ehrnrooth
But yes, we do have service business-based growth in all geographic regions. And service business growth in units, we’d probably point up compared to previous year this year. Yes.
Operator
The next question comes from the line of Miguel Borrega from BNP Paribas Exane.
Miguel Borrega
I’ve got two questions. One follow-up from Guillermo, the one you said — I remember you saying lost sales from Q2 in China were about €400 million to €500 million and EBIT loss was about €100 million. Can you give us a sense how much of that was recovered already in Q3? And how much do you still expect to recover out of the total?
Ilkka Hara
I guess we recovered the backlog that was created in Q2 by the time we ended Q3. So there’s no more to recover. Then what backlog and what market, that’s a more difficult question. But clearly, we have not been able to recover all of the lost sales. Some of those orders — we didn’t get all the orders, and we didn’t get all the sales we expected as a result.
Miguel Borrega
And then I know that you don’t want to give any outlook for China, but 2 of your peers have already guided for another leg down next year. If China does go down again, just thinking on the backlog that is still to execute, do you think — how do you think sales will evolve next year? Do you expect China to be less in the mix 2023 versus 2022?
Ilkka Hara
Well, I guess, it’s at this stage of the year still too early to guide for next year. All I can say is that we have all-time high — or close to all-time high order book to deliver and as well as very well-performing services business, as we talked about. So those are the ones we build on. Then coming back to China. So let’s see, there’s a lot when it comes to the policy decisions that are made that influences the shorter-term performance there.
Henrik Ehrnrooth
But its markets are down 20% this year. And if we don’t see a rapid recovery next year, it’s clear it’s going to be a somewhat lower percentage of our sales. But still, we go into next year with a good order book in China.
Operator
Your next question comes from the line of Lars Brorson from Barclays.
Lars Brorson
Can I ask first, to your orders received margins, maybe that’s one [focus]. But if you look at the sequential improvement in OR margins over the course of this year, I wonder whether you could maybe help us rank them between modernization new equipment ex China and new equipment in China. My assumption is that in that order, they have seen the greatest improvement, i.e., led by modernization. And specifically, I wonder whether you could tell us whether orders received margins for your equipment business in China has improved over that period.
Ilkka Hara
Well, as I already said in our comments earlier, so in modernization business, we now have been able to increase prices enough to cover the cost increases. That is by far — from a business perspective, the recovery has been the best there. Then in new equipment business, there are — outside of China, we’ve seen best performance from a margin recovery perspective in North America, followed by Asia Pacific excluding China, then Europe a bit more mixed performance there. But that’s one way to think about it. Then when you forecast that to our sales, naturally, North America has the slowest rotating order book.
So it will take some time to get back to sales. Then in China, so clearly what we’ve said and continues to be the case that where the pricing year-on-year — sorry, year-to-date is down. We had improvement in the third quarter, but year-to-date is down. We’ve seen actually product cost improvement being a much bigger part of the recovery in margins. And we’ve seen 3x maybe higher product cost reductions that we’ve seen in the past.
And now when we look at the raw materials, they start to be also a tailwind contributing positively to the margin. So a bit different dynamics as such.
Lars Brorson
Maybe slightly bigger picture, if I can? Just on modernization, I think one of the interesting developments over the last couple of years is the contraction in modernization margins, not just for you, but for the industry as a whole. I think we have been near the new equipment margins in modernization. I appreciate you don’t get the standardization benefits in modernization as you do in new equipment. And clearly, there’s also been some raw mat headwinds.
But is there an element of, if you say, the digital service opportunity that comes with modernization projects driving more competitive pricing in modernization? Or can you give a bit of color, please, around that sort of development in modernization margin over the last couple of years?
Ilkka Hara
Henrik had some strong reactions. Maybe you want to…
Henrik Ehrnrooth
I don’t know where you have got this that modernization margins would have declined over past years. Yes, there were temporary declines because of increased costs. But as Ilkka said, we have recovered that — actually, structurally, modernization margins, if we look compared to other business, in better shape now than a few years back. And maybe that’s how we develop the business and improve and be able to standardize some of it even more, even though it can be quite different in different projects. But I would say that the trajectory of margins there overall compared to the new equipment is clearly positive and now going in the right direction as well.
Operator
Next question comes from the line of Tomi Railo from DNB.
Tomi Railo
This is Tomi from DNB. I’m also asking a question on the Chinese new equipment margin. So if you could compare — or comment the Chinese new equipment margin compared to the group margin at the moment. And if it’s fair to assume that it [indiscernible] to enhance or dilute the group profitability next year.
Ilkka Hara
Well, I look at our China business, it is contributing to our margins positively. And if you look at the past, clearly, it was a higher margin business. It has come down, but it’s still contributing positively to our margins. Then for next year, I’d like come back to that later.
Tomi Railo
Just a follow-up. Is that comment including maintenance? Or is it for the new equipment?
Ilkka Hara
I made my comment in totality. Given this year — actually, if you think about Q2, that’s very extraordinary period. So trying to annualize as a business in totality is somewhat difficult in this environment.
Operator
The next question comes from the line of Martin Flueckiger from Kepler Cheuvreux.
Martin Flueckiger
First one is on Americas for a change. Just wondering what your order backlog looks like in the Americas these days? And we can expect in terms of deliveries in — over the next 12 to 15 months? That would be my first question. And then the second one is on KONE’s year-to-date pricing in order to receive — if I remember correctly, one of your competitors, they recently gave some indications on their order intake pricing. I was wondering whether we could get some granularity from yourself as well.
Henrik Ehrnrooth
U.S. order backlog is great. And so there’s a lot to deliver over the next 2 to 3 years there. So we have a very strong position there. We have clearly gained market share in North America. So that, we’re going from a good situation. Challenge in North America is that still early this year, we expected more deliveries this year. But we can clearly see there a slowdown in construction site progress mainly due to labor availability. So still projects want to go forward, but labor shortage. And pricing [clear] and good price increases in new equipment across the world. We haven’t — or you want…
Ilkka Hara
We haven’t specified in more detail, but clearly, we’ve seen now since last year’s third quarter pricing improving across the markets and now in third quarter in all markets at the same time.
Henrik Ehrnrooth
And it’s very clear, the improvements, good percentages.
Operator
That is all the time we have for questions. So I will now hand the call back to your host for some closing remarks.
Natalia Valtasaari
Excellent. Thank you for the questions and for the active discussions. If you do have any follow-ups, please do reach out to me or the team. We’re happy to help you. Thanks to everybody who has listened in as well. I hope this has been informative and interesting. And I’d like to wish you a great rest of the day.
Henrik Ehrnrooth
Thank you all.
Ilkka Hara
Thank you.
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