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?

Anurag Maheshwari: Yes, so on price cost as you mentioned Nigel, we are, you know, either neutral or positive right? In China definitely pricing the new equipment side is coming down, but we are driving hard on material productivity, and the — it’s a deflationary economy over there as well. So a combination of that and this pricing discipline in the market, you put all of that together. Right now, price cost is favorable, and we are able to offset the China mix as you saw in third quarter with a new equipment margin being at 7.2%. And even if you look at the fourth quarter implied outlook its — new equipment margin is going to be about 7%, even though China is going to be down. So and a couple of reasons one is obviously the price cost in China.

Second, pricing in all the other markets that has gone up over the past 12, 15-months, which is in our backlog, has started flushing through to the P&L. We again saw this quarter another $10 million pick up of pricing. We’re going to see that similar in the next quarter, and commodities are tailwind. So if I look at pricing in the backlog overall, which is probably up 50 basis points to 70 basis points, and if we snap the line on commodity today, right, we should still see another $40 million or so tailwind next year. You add these two things together, I think it more than kind of makes up for the China mix for us to believe that a new equipment is at a sustainable margin rate.

Nigel Coe: Okay, great. And I know there’s about three questions in there, but if I can get one more as a follow-on, just to follow-on Jeff’s question on the uplift program at that point in time. So obviously the $150 million run rate, I’m assuming that’s an exit $25 million run rate. What would you feel comfortable in a dialed in for FY ‘24 in terms of cost savings and what sort of restructuring would be associated with that savings?

Judy Marks: Well, we’re not going to guide yet for ‘24 uplift savings. So we just need to be, yes, we’re not prepared to do that yet. We’ll get back to you, obviously, when we do our ‘24 guide to let you know what’s going to be in that late January. In terms of restructuring, I think we’ve been…

Anurag Maheshwari: Exactly. So first is, you know, program’s off to a great start, as Judy mentioned. We’ll give an update next year. In terms of to achieve the $150 million of savings, the restructuring cost is about $150 million. It’s a one-on-one, right? It’s going to start this quarter, but obviously we’re going to start seeing the savings coming in next year.

Nigel Coe: That’s great. Thank you very much.

Operator: Please stand by for the next question. The next question comes from Julian Mitchell with Barclays. Your line is open.

Julian Mitchell: Hi. Good morning. I just wanted to start off with the global new equipment revenue outlook. So you’ve been, you know, feeding off a good backlog there and the organic sales maybe flat to up 1% year-on-year in new equipment in the back half of the current year? I just wondered though when you look at the sort of 12-month rolling on new equipment orders down 4%, year-to-date down 6%, last quarter down 10%, and then we think about sort of the nature of how quickly the backlog wears off. It’s very fast in China, slower the rest of the world? Is it sort of base assumption as we start out next year that new equipment sales are down then as those weaker orders feed through?

Anurag Maheshwari: Yes. Hey, thanks for the question, Julian. Yes, so firstly, you know, our backlog is up 2% right now on the new equipment side. We do think that even if orders are down low to mid-single-digits in the fourth quarter, our backlog is going to be flattish to slightly up. And the reason is because we tend to book more orders than revenue over the past couple of years, some of them being major projects. So our assumption is that backlogs should be flattish to up by end of the year. Now within that, America’s, Europe, and Asia Pacific, if you put that together, that backlog is up low to mid-single-digit. And that represents roughly about two-thirds of a new equipment revenue. So that should be kind of up low to mid-single-digit next year, let’s say low-single-digit.

The big variable, of course, is one-third of the revenue, which is China. Right now China backlog is down low-single-digit. It could be down mid-single-digit by end of the year. And what happens to the market over there? It could be flattish, it could be down 10%, it could be up, right? So that we do not know as to where that’s going to happen. But let’s assume that the market goes down next year and then China is probably down 5%. So that would mean that our new equipment revenue could be flattish. So — but if I put things in a perspective, it could be flattish, it could be up 2%, it could be down 2%. But 2% or 3% of new equipment revenue is about a couple of $100 million of revenue. And if we look at our margin, it’s about $14 million, $15 million, $18 million of profit, so it’s just $0.02 or $0.03 of EPS.

If you look at what we did this year, we more than overcame that through the service business, which is why we, you know, our guide bent up every quarter because of lack of service. So we think we should be able to make that up next year through our service business.

Julian Mitchell: That’s very helpful. And thanks, Anurag. And maybe just my follow-up would be around the service margins perhaps. So, you know, one element is, you know, if I just, maybe it’s some incorrect math’s, but it looks like the service margin in Q4 in the guide is down sequentially off flat sales and sort of flattish year-on-year, despite a big increase year-to-date. So just wanted to check if that’s right and if it’s just conservatism or what have you? And then secondly, on the service margin, how are we thinking about sort of price cost or price net of material cost and service wages playing out? Is that, sort of, getting larger into next year or narrowing as a tailwind? Just any context around that, please.

Anurag Maheshwari: Oh, absolutely. So I’ll break it up into two separate questions over here. So first is, yes, the guide implies 24% margin for service in the fourth quarter, which is eventually down 80 basis points, but we’re going to exit the year at what we guided for the full-year, which is 24%. It’s a very healthy margin rate. It’s from last year where we actually, it’s a tough compare because last year we grew margins by 60 basis points, 70 basis points in the same quarter. And the reason there’s a difference between the 24.8% and 24% is largely two things. It’s the mix, we — I mean, we are very encouraged. I mean, the performance in third quarter margin was fantastic. I mean, if you look at the portfolio maintenance side, portfolio is growing, pricing is sticking, we are flushing more backlog into revenue, and the repair business, which we thought after two years of very high growth was going to slow down, is not, and it’s because of the strategy of the team of penetrating more of the portfolio, and that mix was high in the third quarter and obviously productivity which helped us get to the 24.8%.

The big difference between Q3 and Q4 is now we’re assuming that repair to be flattish in the fourth quarter and Mod growing double-digit. So that is a mixed impact which is leading for the margins to be lower, but net-net, we’re exiting the year at what we guided, so feel pretty good about it on the service side.

Judy Marks: Yes, Julian, on the second question where you’re talking about wages and inflation, inflation on the service side, while we have had wage inflation, you know, we know we need to offset that with productivity, and what we’ve been doing with price has been fairly significant. We have another quarter where our service pricing, like-for-like is up 4 points, and with inflation staying pretty high, especially in EMEA and in the Americas, we should be able to as we negotiate the majority of our maintenance contracts, you know, first, second quarter next year, which are mainly backward looking for this year’s inflation, we expect to be able to get price again at levels comparable to that for 2024. We have line of sight now, the majority of our ‘23 maintenance contracts are in the books, as our commodity prices and everything else as we go with 2.5 months left to go now.

So we’re actually feeling pretty good about service pricing for next year and price cost. And we’ve negotiated with the majority of our collective bargaining across the globe. Most of our mechanics are represented. And I think, I know we’ve treated them fairly and we’re able to recover that in both price and productivity.

Julian Mitchell: Great, thank you.

Operator: Please stand by for the next question. The next question comes from Joe O’Dea with Wells Fargo. Your line is open.

Joe O’Dea: Hi. Good morning. Thanks for taking my questions. I wanted to circle back to the backlog comments and could you just expand on how much of next 12-months revenue you generally have visibility into based on backlog levels and talk about that in America’s and Europe and then in China. And in particular in China, then the mix that would be coming out of backlog and the mix would be book-and-ship and what you’re seeing in some of those book-and-ship trends recently?

Anurag Maheshwari: Yes, absolutely. If you look at a backlog, it is significantly more than a 12-month revenue, because we got major projects in there. We have other kind of long-tailed projects as well. But very specifically, the reason why I said earlier we have confidence of America and Europe, kind of, growing low-single-digit next year is the back half — even if we snap the line today, we have very high visibility of that converting. We enter any political year with 80%, 90% of America’s and EMEA revenue coming out of backlog. Followed by that is Asia-Pacific Ex-China, which is probably a little bit lower, depending upon the geography mix, but that backlog is up very healthy. It’s probably double-digit up, right? Then China is the only one where we have higher book-and-ship.

So when we enter the year, I would say two-thirds of that revenue probably comes from the backlog and a third comes from the book-in-ship, which is why for three out of four regions, we feel it’s low-single-digit growth for next year. China is the only variable that we need to see how the next few month’s go.

Joe O’Dea: Got it. That’s helpful. And then just some perspective on where China volumes are. Can you talk about for the total market where unit volumes have been over the last several years where they’re trending this year? How you think it’s setting up in terms of next year for some perspective on the current softness relative to recent strength?

Judy Marks: Yes, Joe, we would tell you that, you know, if you go back to peak years in China, we probably peaked the segment, peaked new equipment at about 650,000 units. That’s been coming down now for the past two years, and we’re at about 450,000 currently for this year. Still 450,000 of the 850,000 global units. So still a large healthy market. And 450,000 you’d probably have to go back to 2018-ish timeframe to where we had, you know, obviously pre-COVID to having a market like this. And so we still think it’s a very attractive market. We’ve gained share there this year as we look in China and we will continue to execute our strategies of our agents and distributors being our partners, which we now have about 2,350 agents and distributors, more than twice since we spun.

We focus on our key accounts. And we’ve also really focused on the Tier cities that are having an impact. So if you look at the third quarter, Tier 1 cities, Beijing, Shanghai had the best market segments. And then, you know, obviously it trailed off as you got all the way to Tier 5. So we’ve adjusted our strategy. That’s why our agents and distributors are so helpful, as well as our internal sales folks that support them. The key accounts, again, those relationships are strong, and they are yielding for us.

Joe O’Dea: Thank you. I appreciate the details.

Operator: Please stand by for the next question. The next question comes from Steve Tusa with JPMorgan. Your line is open.

Steve Tusa: Hey, good morning.

Anurag Maheshwari: Hey, good morning, Steve.

Steve Tusa: You mentioned the trends of what’s going on in China. I think one of your competitors had some pretty big orders numbers there today. Can you maybe help reconcile that? Because I think you guys are obviously, I think you were down, but maybe could you just maybe help reconcile what the difference might be? Obviously, any quarter there’s some lumpiness, but just curious from a share perspective there, just trying to tie those two things together.

Judy Marks: Yes, I think you’re going to, I mean, orders are lumpy, kind of, across the board for both modernization and new equipment. And I would argue share is also, kind of, hard to measure on a quarterly basis and something more you’d like to do on an annual level when you really have some fidelity in the information. I can’t comment on what our competitors are doing, but I can tell you that, you know, we’re, again, our China team is executing our strategy. In a down market, you know, our China team has both driven cost out in terms of material productivity. So that, again, if you look at and you step back, you know, we’re driving growth in all lines of business in Otis, especially in service. We’re seeing good growth in three regions outside of China.

But our China team has really in despite a tough macro environment on new equipment, has really now added this service component, which now we’re at 365,000 units in our portfolio in China, more than double from when we spun. And our China modernization business has grown double-digits this year. So we’re finding we’re moving Mod into the factory, so we’re optimizing the cost basis there, and you’re going to see that modernization business really in China, as well as globally take off. And for us, we need to watch that mix. That’s what Anurag commented on for fourth quarter for service margins. But we think, we know it’s actually worth getting that modernization business, because it will bring more units to our portfolio. So we’re going to end this year at 2.3 million units in our portfolio.

And when you think about 1% portfolio growth throughout the decade before we spun, and now us, four straight quarters over 4%, we’re going to end this year at 2.3 million units. And that is the strongest, but it’s still at 2.3 million units of a $21 million, $22 million segment leaves us lots of room for growth. And that’s why we’re convinced the service-driven growth strategy globally is the right answer for us and our shareholders.

Steve Tusa: Yes, clearly the service is very strong. Just a question on cash flow, I missed the first part of the call, but any reason for that tweak on cash specifically?

Anurag Maheshwari: Oh yes, absolutely. It’s two weeks, okay, So firstly on cash we are at about $934 million. We got $550 million and I guess your question is tweaking it to the low-end of the guidance is two reasons; one is clearly lower down payments, because of new equipment orders which have been a little bit lower. But second is also a repair business which has grown very, we started this year would be low-single-digit repair. It’s growing at a very good rate. Great for sales, great for profit on the P&L side, but we do get paid after we complete our work, so it’s a little bit of a receivable drag. I think it’s a combination of these two reasons why you see a little bit of a tweak in the cash flow guide.

Judy Marks: Yes, and for any of our customers listening, Steve, I think it’s important they know that when they need a repair, we do the repair. And then we make sure we bill and follow-up to collect. And that’s really what happens in that repair world. We know customers, if they’ve got an elevator down, we’re going to get them back up.

Steve Tusa: Sorry, sorry, one last quick one. A lot of volatility in multifamily in the U.S., kind of hard to tell where that business is going. Any impact on you guys from that? And thanks a lot for the answers to the questions.

Judy Marks: Yes, so I mean, that multifamily was our, from a market perspective, a segment perspective, was the worst performing in the U.S. this past quarter. Now, it’s down off record highs for multiple years, and there’s still demand for it, but we’re just seeing the developers slow down on the start button, which is when we get those advances that Anurag was talking about in his cash answer. So we’ll wait and see. If rates stay where they are, you know, developers will figure out the math for this because demand is still there for housing. So, you know, we’re in a wait and see, but our backlog in especially in North America is strong mid-single-digit, including a lot of multifamily in the backlog. So we’re going to keep performing, and then our team will drive the orders as they come.

Steve Tusa: Great. Thanks a lot.

Operator: Please stand by for the next question. The next question comes from Nick Housden with RBC. Your line is open.

Nick Housden: Yes. Hi Judy, Anurag, Mike. Thanks for the questions. So, yes, just on that free cash flow point, I mean, it looks like China is never going to go back to that 650,000 unit mark. So I’m just wondering if that means that over the medium term there needs to be a permanent reset on the expectations for cash conversion from the current 100%, 110% target that you’ve already got. That’s the first one, thanks.

Judy Marks: Well, I can take that 1. The answer is no. No reset.

Nick Housden: Okay.

Anurag Maheshwari: There’s no reset because, I mean, at the two — with the new, lower — definitely lower orders, but also we’re executing on high backlogs. All these will normalize and the repair revenue will also, kind of, we start converting more into cash. So I don’t think there’s any reason for us to reset the target, yes.

Nick Housden: Okay. Great. Very clear. And then just a second question on some of the competitive dynamics in modernization. So it sounds like when you guys or some of your European competitors modernize a unit, especially in China, it’s almost always someone else’s unit and very often it’s one of the Asian competitors units that you’re modernizing and then moving into your own portfolio. Are the Asian guys just not focused on modernization? Or why does it seem to be the case that you are kind of eating their lunch there?

Judy Marks: Well, your hypothesis that most of our modernization is on non-Otis equipment in China is accurate. But remember, our China market share is or our share of segment in service is pretty low, because 75% of all the units in China are maintained by ISPs. So I wouldn’t specifically say it’s, you know, some of the units we’re getting back, our Otis units that are not on portfolio. Many are non-Otis units, but they’re not necessarily, you know, Japanese or European. I can’t comment on who they are. What we’ve done is we’ve created very innovative packages to be able to put our hardware on non-Otis equipment to modernize it, to add new technology, and then to convert it into our portfolio.

Nick Housden: Okay, great, Thank you.

Operator: [Operator Instructions] Our Next question comes from Gautam Khanna with TD Cowen. Your line is open.

Gautam Khanna: Hey, good morning, guys.

Judy Marks: Good morning.

Gautam Khanna: I had two questions. First, Anurag, on your comment about escalators next year being comparable to that of this year. I was just wondering if you could elaborate maybe by region and why that’s so given the level of inflation this year seems below that of last year? And then I have a follow-up.

Anurag Maheshwari: Yes. Sorry, you got an email on the service business, the price escalation?

Gautam Khanna: Yes.

Anurag Maheshwari: Yes. So, yes, listen. Let’s start with Europe where we got about half of our portfolio over there. Inflation is still pretty high in Europe, not as high as last year, but not too far off from there. And most of our contracts are right now in negotiation and they’re obviously linked to an index. So we feel pretty good about the pricing increase in Europe next year. It could be around the mid-single-digit level again, so that’s really encouraging. Inflation in America is also not coming down to a great extent, so we should see that. So these two definitely give us confidence on our pricing going up. The rest of Asia has always been a low to mid-single-digit price increase. That will continue. And China, I think, as I mentioned earlier, there is more price discipline, but it’s never been a price escalator market on the service side.

So put all of that together, it gives us confidence there’s going to be another good price increase next year on top of our portfolio growth, which should mean that our maintenance business should grow mid-single-digit plus.

Gautam Khanna: Okay. And just a quick follow-up. Could you talk a little bit about any trends in churn coming down in the quarter? And maybe year-to-date on service renewals?

Judy Marks: So we will share our statistics at our fourth quarter earnings. We do that on an annual basis, but there’s no significant changes that we’ve seen, but we’ll share that next quarter.

Gautam Khanna: Thank you.

Operator: I show no further questions at this time. I would now like to turn the call back to Judy Marks for closing remarks.

Judy Marks: Yes, thank you, Michelle. Our service-driven business model is working as we approach 2.3 million units in our portfolio by year-end with the compounding lifetime value of each additional unit. Year-to-date results are indicative of the strength of our strategy as we continue to prioritize value creation for our shareholders for the remainder of 2023 and beyond. Thank you for joining us today. Stay safe and well.

Operator: Thank you for participating. This concludes today’s conference call. You may now disconnect.