Otis Worldwide Corporation (NYSE:OTIS) Q3 2023 Earnings Call Transcript

Otis Worldwide Corporation (NYSE:OTIS) Q3 2023 Earnings Call Transcript October 25, 2023

Otis Worldwide Corporation beats earnings expectations. Reported EPS is $0.95, expectations were $0.87.

Operator: Good morning, and welcome to Otis Third Quarter 2023 Earnings Conference Call. This call is being carried live on the Internet and recorded for replay. Presentation materials are available for download from Otis’ website at www.otis.com. I’ll now turn it over to Michael Rednor, Senior Director of Investor Relations. Please go ahead.

Michael Rednor: Thank you, Michelle. Welcome to Otis’ third quarter 2023 earnings conference call. On the call with me today are Judy Marks, Chair, CEO and President; and Anurag Maheshwari, Executive Vice President and CFO. Please note, except where otherwise noted, the company will speak to results from continuing operations excluding restructuring and significant non-recurring items. A reconciliation of these measures can be found in the appendix of the webcast. We also remind listeners that the presentation contains forward-looking statements, which are subject to risks and uncertainties. Otis’ SEC filings, including our Form 10-K and quarterly reports on Form 10-Q, provide additional details on important factors that could cause actual results to differ materially. Now, I’d like to turn the call over to Judy.

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Judy Marks: Thank you, Mike and thank you everyone for joining us. We hope that everyone listening is safe and well. Starting with Q3 highlights on slide three, Otis achieved strong results in the third quarter marking nine months of solid execution in 2023. We grew organic sales 5.2% with growth in both segments, expanded operating profit margin 60 basis points, and achieved 19% adjusted EPS growth. This marks the 11th consecutive quarter of service organic sales growth, and the 15th quarter where our service operating profit margin has expanded, demonstrating the consistency in our execution and the strength of our strategy. With our fourth consecutive quarter of maintenance portfolio growth above 4% and backlog growth in both new equipment and modernization, we have set ourselves up nicely for the future.

Last quarter, we announced the launch of our Gen 3 core elevator in North America. And in the third quarter, we sold our first units. This new product addresses the needs of our customers and the two to six storey building segment, the largest by volume in North America. We also continue to drive progress toward our ESG commitments. For the second year in a row we achieved a gold rating from EcoVadis, ranking us within the top 5% of all assessed companies. We’re also proud to have been named by Newsweek as one of the world’s most trustworthy companies and one of America’s greenest companies. Let me share a few customer highlights from the third quarter. In British Columbia, Otis is providing seven SkyRise and eight Gen 3 edge elevators for South Yards, a mixed-use development by Anthem properties.

South yards will include more than 2,500 residential units and over 60,000 square feet of retail and office space surrounding a one-acre community park. In Hong Kong SAR, we’re supplying 47 Gen 3 units to enhance access to more than 30 elevated walkways. These elevators will provide improved accessibility for the aging population and people with disabilities, a key part of Hong Kong’s Universal Accessibility Initiative. Construction is expected to be complete in July of 2026. In Saudi Arabia, we secured a contract to modernize 18 elevators at the Saudi National Bank headquarters in Riyadh. As part of the modernization, we’ll upgrade the controllers in the high-rise units, while adding our Otis ONE IoT solution. This new project builds on our existing relationship with the Saudi National Bank headquarters, which has 47 Otis units in total.

And in China, we received a contract to maintain 351 units at Shanghai’s Pudong Airport, with 271 of these returning to the Otis portfolio as a recapture. Pudong Airport is a critical cargo access point in East Asia, while also serving roughly 80 million passengers each year. We’re proud to say we now maintain all Otis units at the airport. We announced our uplift program last quarter and in Q3 we began executing initiatives focused on three essential areas: gaining scale across our global organization to unlock synergies; standardizing our processes to generate efficiencies; and driving supplier and indirect spend optimization. We are on track to meet our stated expected run rate savings of $150 million by mid-year 2025. Taken together, these initiatives drive further value for our customers, organizational effectiveness, and sustainable profitable growth.

Moving to slide four, Q3 results and 2023 outlook. Organic sales in the quarter grew 5.2%. Service was up 8.4% with all lines of business contributing and new equipment up 1% with growth in the Americas, EMEA, and Asia Pacific. Although new equipment orders declined 10% versus the prior year, backlog was up at 2% at constant currency. Our share in the quarter remained relatively flat, leaving us at approximately 50 basis points of share gain year-to-date. Order growth in EMEA and Asia Pacific was more than offset by declines in the Americas and China. In service, modernization orders remain strong, up 13% in Q3. The fifth consecutive quarter of Mod orders grew at above 10%, driven by strong performance in EMEA, China, and Asia Pacific. Mod backlog was up 15%, giving us line of sight to sales over the next several quarters.

With adjusted operating profit growth of $47 million in the quarter, we expanded margins by 60 basis points, driven by 90 basis points of service adjusted operating profit margin expansion. We generated $272 million of free cash flow, driven by higher net income. To summarize, we executed our strategy, growing the portfolio above 4%, increasing our new equipment and Mod backlogs, giving us a strong base to execute on for the next several quarters, while expanding operating profit margins as we drive a consistent operating cadence in the business, ultimately leading to just under 20% EPS growth. Ultimately, we believe we’re set up well, despite the relatively weaker macro picture we’re facing, which I’ll discuss next. For global new equipment unit bookings, Asia Pacific continues to grow, although we now expect it to be up low to mid-single-digits, a step down from our prior expectations.

We anticipate that EMEA will decline high-single-digits in line with our expectations for last quarter. While Americas, we now expect to decline mid-teens and China to decline north of 10%, both worse than we were anticipating just a few months ago, as the macro environment remains challenging. In total, this would leave global new equipment bookings somewhere around 850,000 units, down approximately 10% versus 2022. In service, although global new equipment unit bookings are smaller than we anticipated, we still expect the service installed base to grow nearly 5% this year, as units that were booked two to three years ago and installed one to two years ago roll off their warranty periods. This will put the global service installed base somewhere between 21 million units to 22 million units by year end of which we currently maintain approximately 2.2 million and expect to end the year around 2.3 million units in our maintenance portfolio.

With that as the global backdrop, let me now update you on Otis’s financial outlook. We expect organic sales growth of approximately 5.5% with net sales of about $14.1 billion. Adjusted operating profit is expected to be approximately $2.265 billion, up $170 million at constant currency. At actual currency, adjusted operating profit is expected to be up $140 million, including a foreign exchange headwind of $30 million. We’re raising our outlook for adjusted EPS, now expected to be $3.52, up 11% versus the prior year. We now expect free cash flow of about $1.5 billion, or approximately 105% conversion of GAAP net income. We still expect share repurchases of $800 million. With that, I’ll turn it over to Anurag to walk through our Q3 results in more detail.

Anurag Maheshwari: Thank you, Judy, and good morning everyone. Starting with third quarter results on slide five. Net sales of $3.5 billion grew 5.4% and organic sales were up 5.2% with growth in both segments. Adjusted operating profit was up $52 million at actual FX and $47 million at constant currency with margins expanding 60 basis points to 16.9%. Drop-through on service volume, productivity, and pricing in both segments, and commodity tailwinds were partially offset by inflationary pressures, including annual wage increases and higher corporate costs. Adjusted EPS increased 19% or $0.15, with over half of this improvement coming from strong operational performance and the rest from a combination of a capital allocation initiatives and ongoing effort to reduce the tax rate, which came in at 25.5% in the quarter.

Free cash flow came in at $272 million, up $57 million versus prior year, largely driven by higher net income. Year-to-date, we generated $934 million of free cash flow, $81 million lower versus the prior year, driven by lower down payments on fewer new equipment orders and the continued outperformance of a repair business as this work tends to be paid in [areas] (ph). Moving to slide six. Let me start by giving some color on Q3 new equipment orders and backlog. In the third quarter, at constant currency, new equipment orders declined 10% versus prior year. Despite this, our new equipment backlog increased 2% with mid-teens growth in Asia Pacific, mid-single-digit growth in the Americas, and EMEA roughly flat. China backlog is down low-single-digits.

Sequentially outside of China, our new equipment backlog was relatively stable in all regions. Globally, pricing on new equipment orders was up low-single-digits, building on a similar increase in the third quarter of the prior year. Excluding China, pricing improved by mid-single-digits are better in all regions. Although pricing was down mid-single-digits in China due to macro challenges, we remained price cost neutral in the region from our continued focus on driving material productivity. New equipment organic sales were up 1% in the quarter with strong growth in all regions outside of China. Asia Pacific grew low-teens driven by continued performance in India, as well as traction with major projects. In EMEA, new equipment sales grew high-single-digits underpinned by the significant orders over the past several quarters in Southern Europe and the Middle East, while in the Americas the region grew high-single-digits for the second consecutive quarter, executing on its multi-billion-dollar backlog.

We grew new equipment operating profit by $10 million at constant currency, despite China sales coming in weaker than expected. Driving productivity, pricing flowed through from the backlog, and tailwinds from commodities more than offset the project in regional mixed headwinds, leading to a 7.2% margin in the quarter. Turning to service segment results on slide seven. Maintenance units were up 4.2% with growth in all regions, led by high-teens growth in China for the fourth quarter in a row. We deliver another strong quarter of modernization orders, up 13% including China Mod orders growing double-digits from continued success of new product offerings. Asia-Pacific also grew double-digits due to a number of volume and major project wins with standout performance coming from North Asia.

EMEA Mod orders grew 10% driven by major project wins. At quarter end our Mod backlog was up 15% with growth in all regions. Service revenue came in better-than-expected with all lines of business contributing to organic sales growth of 8.4%. Maintenance and repair was up 8.6% from higher than anticipated repair volumes, and Mod was up 7.6% with growth across all regions highlighted by a double-digit increase in Asia. Service pricing excluding mix and churn came in around 4 points, similar to last quarter’s performance, and adjusted for mix and churn was a net 2 points. Higher volume, favorable pricing, and productivity were partially offset by annual wage increases and higher material costs, leading to $53 million of service profit growth at constant currency.

Service adjusted operating profit margin expanded 90 basis points in the quarter to 24.8%. Overall, we are pleased with our results in the quarter, as well as year-to-date. We’ve grown our new equipment and Mod backlogs, expanded the portfolio at 4% and delivered over 10% EPS growth. Moving to slide eight, and the revised outlook. Starting with sales, total Otis organic sales are expected to be up approximately 5.5% consistent with the midpoint of a prior guide, including slight adjustments by segment. Adjusted operating profit growth at constant currency is expected to be $170 million, a $5 million increase versus the prior guide’s midpoint, and the result of strong performance in the service segment. At actual currency, we expect adjusted operating profit of $2.265 billion, as the better operating performance is offset by a slightly higher foreign exchange headwind, driven by a change in the euro and the weakening of various Asian currencies such as the CNY.

Our margin expectations remain unchanged with service margins expected to expand 50 basis points to 24% and new equipment margins expected to expand 20 basis points to just under 7%. This puts overall operating margins at approximately 16%, up 30 basis points. We have grazed our guidance for adjusted EPS, now expected to be up 11% versus the prior guide, to $3.52. This represents a $0.04 increase versus the prior guide’s midpoint, largely driven by strong operational performance and improvements in below-the-line items, including tax now expected to end the year at 26%. We expect to generate approximately $1.5 billion in free cash flow, a roughly 105% conversion rate, and return substantially all of it to shareholders through $1.35 billion of dividends and share repurchases.

Taking a further look at the organic sales outlook on slide nine. We now expect new equipment organic sales growth of approximately 3% at the low-end of the prior range driven by larger than expected headwinds in China, which we expect to be down mid-single-digits. The Americas and EMAs are still expected to grow mid-single-digits organically. In service, organic sales are expected to be up approximately 7.5%, a 1 point increase versus the midpoint of the prior guide driven by maintenance and repair. Consistent maintenance portfolio growth and pricing, together with another quarter of strong repair volume, enable us to raise the outlook by 130 basis points to up 7.3% versus the prior guide. Modernization organic sales expectations remain unchanged, up 8% as we execute on our backlog, which was up 15% at quarter end.

Moving to slide 10, we have raised our expectations for adjusted EPS and now anticipate growth of approximately 11% or $3.52, a $0.35 increase versus the prior year driven by $0.30 of operational improvement. In closing, we continue to execute well on the things we can control, and our resilient service business is driving profitable growth in an uncertain macroeconomic environment. Our strong year-to-date performance gives us confidence to again raise our EPS outlook and deliver a solid fourth quarter, while positioning us well to perform in ‘24 and beyond. With that, Michelle, please open the line for questions.

Operator: Thank you. [Operator Instructions] The first question comes from Jeffrey Sprague with Vertical Research Partners. Your line is open.

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Q&A Session

Jeffrey Sprague: Thank you. Good morning, everyone. Judy or Anurag, could you just elaborate a little bit more on your view on both America’s and China new equipment, kind of, the downward tick in the outlook, and maybe just some thoughts on kind of even the trajectory as we exit 2023 into 2024 in those particular regions?

Judy Marks: Yes, happy to, Jeff. Let me start with the Americas. So we now believe the new equipment market in the Americas is going to be down mid-teens, and we’re really seeing that with the highest impact being the interest rates remaining high. It really is impacting new project starts. We’ve seen that in the most recent ABI and Dodge data. So we’re watching that closely. I would tell you the residential, it performed the worst in the third quarter, followed by commercial not being great and infrastructure for the quarter being relatively flat. We expect infrastructure to pick up, you know, as we go into ‘24. We tend to see that a little later in the cycle versus the early construction companies with all the infrastructure activity that’s starting.

What I do like about the Americas beyond their performance, and they really had a strong performance in terms of backlog conversion, is we still have strong mid-single-digit backlog on new equipment. That puts us in a really good position, not just for the fourth quarter, but I would tell you with our cycle time in the Americas, it gives us really good line of sight for the next 12 to 18 months, especially in North America, which is the majority of our Americas business. So we’ll wait and see what happens with interest rates. If this does become the new normal, we think people will adjust because housing demand is real. It’s still there. So we have to wait and see where this equilibrium is going come out with the developers and when they go ahead with projects.

We’re not seeing a decline in terms of interest or proposals, so we really, at this point, it’s about people having conviction to start the projects from a development perspective. In China, the new equipment market does remain somewhat weak, and it’s worse than we saw it a quarter ago when we told you we didn’t see that inflection point for book and ship. We’re now saying it’s really down. You know, the China market itself is really down north of 10%. So we are continuing to focus on our pivot in China. And you know, I couldn’t be more proud of our team in China in terms of what we’ve done on the maintenance side to offset this, as well as really how we’ve managed material productivity to be able to drive that cost price neutral scenario in China.

We have picked up share in China for the year and so we will continue even though the backlog is down, our team is continuing to fight for all units and execute our strategy which has been in play, which is focusing on key accounts, mainly state-owned enterprises and continuing new product introduction and expansion on Otis ONE. So our Mod is up in China for the fifth straight quarter, sorry, for this year it’s up double-digits, so for all year. We’ve had the ninth straight quarter in China on the service side of mid to high-teens service growth. So we’re finding a nice place there in terms of this pivot to becoming more of a service provider. But new equipment is our highest margin in China and I think what you see with the results is despite China being down, our other three regions really picked it up nicely for us to be able to hold margins at 7% on new equipment for the quarter and to grow organically 1% even with China down fairly significantly.

So we’ll wait and see what happens in terms of stimulus. Obviously, we’ve seen certain actions already in China in terms of easing monetary support, postponing property taxes, loosening credit policy for mortgages, but we really do — are watching sentiment and liquidity. Those are the two items that we’re watching.

Jeffrey Sprague: Great. And just to shift completely in a different direction, you know, you started the conversation, Judy, with uplift, kind of, getting off the ground. I guess no pun intended. But maybe just a little bit of color. Is it impacting results in Q3? How do you see kind of the staging of that $150 million that you’re talking about?

Judy Marks: Yes, there is no impact in Q3. We just, early days for us, we’ve kicked off the key activities, including the operating model, a lot of education inside the company, and a lot of focus now on process redesign and indirect spend. You’ll see that start coming through slightly in Q4, but 2024 is when you’ll really start seeing that impact and then we’ll achieve the run rate. We’re very comfortable with all the analysis we’ve done, as well as some of the decisions we’ve taken already that the $150 million is absolutely achievable.

Jeffrey Sprague: Great. Thank you.

Operator: Please stand by for our next question. The next question comes from Nigel Coe with Wolfe Research. Your line is open.

Nigel Coe: Thanks. Good morning everyone. So, I understand the kind of like the weakness you’ve update across the globe. I mean, are we seeing any, you know, product cancellations, you know, with the rising rates, you know, some projects not penciled out. So, just wondering on that. And then — but really, I did want to dig a bit more into China with the pricing down, mid-single-digits. I think that the view was that China would not, kind of, be as bad as perhaps prior down cycles, because margins there are much lower. So just curious how you see the risk of further deterioration in China? And you mentioned price costs remaining positive or rather neutral in China. You know, are China margins holding in there? You know, or are we seeing some deterioration in margins?

Judy Marks: Yes, let me start and then I’ll have Anurag. Nigel, we’re not seeing project cancellations at any level different than we have in the past. And we can say that everywhere in the globe. There are always a small amount of project cancellations that occur in which we retain the deposit and the advanced deposit, but nothing unusual there. In terms of China, let me just make sure everyone understands that China now represents about 17% of our global revenue. Now there are several reasons for that. One, is a down China market, but second is with us now out looking, you know, $14.1 billion in revenue and organic growth of 5.5%. You can see that the impact and the pickup of the other three regions in terms of their growth.

So, you know, nice call out, America’s, EMEA, Asia Pacific, really good revenue growth, as you saw in Anurag’s presentation. But China’s now about a 17% of our total revenue down from 20% traditionally. So, you know, that’s just the reality of where the numbers are right now. On price cost, Anurag why don’t you comment?