Otis Worldwide Corporation (NYSE:OTIS) Q4 2022 Earnings Call Transcript

Otis Worldwide Corporation (NYSE:OTIS) Q4 2022 Earnings Call Transcript February 1, 2023

Operator: Good morning, and welcome to Otis’ Fourth Quarter 2022 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 the call over to Michael Rednor, Senior Director of Investor Relations. Please go ahead, sir.

Michael Rednor: Thank you, Norma. Welcome to Otis’ fourth quarter 2022 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 nonrecurring 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 details on important factors that could cause actual results to differ materially. With that, I’d like to turn the call over to Judy.

Judy Marks: Thank you, Mike, and thank you, everyone, for joining us. We hope everyone listening is safe and well. We’re pleased that we ended the year with a strong fourth quarter and solid full year performance in a year characterized by a variety of macro headwinds. We entered 2023 with good momentum as we continue to execute our four strategic pillars, sustaining new equipment growth, accelerating service portfolio growth, advancing digitalization, while focusing and empowering our organization. I’m proud of our colleagues around the globe who delivered these results demonstrating the strategic resiliency of our company as we continue to grow and perform in 2022. Starting on Slide 3. We continue to perform well in New Equipment Orders, growing 7% for the full year.

In the quarter, orders grew 4%, with particularly strong performance in EMEA and continued solid performance in Asia-Pacific. China orders returned to growth with mid single-digit performance in the quarter. Orders in the Americas were down 4% in the quarter, although the business had a very strong 2022 overall, with orders up almost 18%. Our New Equipment adjusted backlog at constant currency is up 11% heading into 2023, giving us solid multiyear visibility to grow sales. Organic sales increased 2.5%, driven by service, which grew 6%. We grew our industry-leading maintenance portfolio by 4.1%. It now stands at 2.2 million units, a new milestone for our company. We delivered 7.5% adjusted EPS growth despite $156 million in foreign exchange-related headwinds.

We generated $1.45 billion in free cash flow, allowing us to return $1.3 billion of cash to shareholders through dividends and share repurchases. We continue to win many exciting projects based on our innovation, ability to deliver and the trust customers have in us. For example, in the Americas, Otis was selected to provide our Compass destination dispatch system, along with six SkyRise and two Gen 3 elevators for City Centre 4 in Surrey, British Columbia. The 23-storey building will be built to lead gold standards and extends our more than six-year relationship with the Lark Group. In China, Tianjin Metro has been using Otis equipment since opening in 1984. In November, Otis was selected to provide more than 120 escalators and Gen 3 elevators for their new Line 4 Northern Extension.

This takes the number of Otis units on the Port City’s expanding subway network to more than 1,500. These new elevators will be connected to the Otis ONE IoT-based platform, already delivering real-time monitoring and predictive maintenance for the metro system. In the UK, we’ve had a long-standing relationship with Transport for London, including a long-term contract through 2042, to manufacture, install and maintain the escalators and travelators on the busy network. Most recently, we were contracted to provide Battersea station with specialty escalators, specifically designed to run for about 20 hours a day and extend 24 meters in length and nine meters in rise. We’re playing our part to keep the busy network flowing. Our ESG initiatives continued to progress in 2022, helping to drive stakeholder value alongside our financial priorities.

Our manufacturing facility in Florence, South Carolina achieved gold level total resource and use efficiency, or true certification, recognizing its success in zero waste. With this achievement, Otis has become the first in the elevator industry to have a true certified facility, helping us towards our goal of having all our factories eligible for zero waste to landfill certification by 2025. We look forward to sharing more about our ESG progress in our second annual ESG report, which is set to be published in the spring. Moving to Slide 4. With strong orders performance in 2022, we were able to achieved approximately one point of new equipment share gain, on top of the two-point increase between 2020 and 2021. For the first quarter since Q4 2021, New Equipment sales returned to growth as we continued the strong growth in EMEA and Asia-Pacific that we’ve experienced all year and were able to overcome supply chain and installation-related challenges, especially in the Americas.

These results mitigated the impact of mid-single-digit New Equipment sales decline in China, demonstrating the power of geographic diversification within our business. Notably, we see China on a recovery path as New Equipment sales in the region improved compared to Q3. Innovation is helping to drive growth across our business. For example, we continue to roll out our digitally-connected elevator platforms, launching Gen 3 in India, and expanding the deployment of Gen360 in Europe to the Czech Republic, Poland, Portugal and Slovakia. The accelerated portfolio growth we saw this year is an essential component of our long-term strategy and top line growth algorithm. We believe the disruption in our industry favors the OEM, and we’re demonstrating this as we deploy our Otis ONE IoT solution into our New Equipment product offerings and our service portfolio.

We continue to work towards our goal of increasing connectivity to approximately 60% of the portfolio, and we’re pleased to have connected more than 100,000 additional units this year. Our service sales force performed well throughout the year, with like-for-like maintenance pricing of three points, helping to mitigate labor cost headwinds within the service business. For the third year in a row as an independent company, we delivered adjusted operating profit margin expansion, and we remain well positioned as we enter 2023 with momentum, especially as we execute on New Equipment projects from our backlog. Now turning to Slide 5. In the Americas market in 2022, while North America had a strong year, up better than mid single-digits, Latin America was roughly flat, leading to a market that was up low to mid single-digits.

In EMEA, Western Europe performed well, offset by Eastern Europe due to the conflict. In Asia, the market was down high single-digits. Asia-Pacific had a very strong year, up approximately 10% with the performance masked by the downturn in China, which we estimate to be down about 15%. Although market dynamics remain fluid, as we’ve seen over the past several years, the long-term fundamentals of the industry are well grounded in the service-driven growth model. In 2023, globally New Equipment markets are expected to be down mid single-digits in units with flattish markets in the Americas and EMEA and down mid single-digits in Asia, driven by China, where we expect the market to be down 5% to 10%. Asia-Pacific should see another year of mid-single-digit or better growth, driven by urbanization in the region and infrastructure investments.

The global industry installed base is expected to grow at a similar rate to that of 2022 at about mid single-digits and reach approximately 21 million units. In the Americas and EMEA, we expect low single-digit growth. And in Asia, we’re expecting high single-digit growth driven by China. With this as the industry backdrop for Otis, we expect organic sales growth to be in the range of 4% to 6%, with total sales of $13.8 billion to $14.1 billion, up 1.5% to 4% at actual FX. By segment, we expect New Equipment will grow 3% to 5% this year, with mid-single-digit growth in the Americas and EMEA and low single-digit growth in Asia. We expect Asia-Pacific to grow at least mid single-digits, while we anticipate our China New Equipment business to be about flat for the year.

We’re expecting a better China market as we get into the second half of 2023 as COVID-related and liquidity constraints in the market should ease on the back of government support. In the Service segment, we anticipate another year of solid growth, with the business growing 5% to 7%. We expect volume and pricing to drive solid mid single-digit growth in the maintenance and repair business, with higher growth in our modernization business line. Our modernization orders performed quite well over the past few quarters, and we entered the year with a MOD backlog up 7% at constant currency. We expect 7% sales growth at the midpoint, driven by the backlog growth. Adjusted operating profit is expected to be between $2.2 billion and $2.25 billion, up $70 million to $130 million of actual currency or $130 million to $175 million accounting for foreign exchange headwinds.

We expect adjusted EPS to be in a range of $3.35 to $3.50, up 6% to 10% or approximately $0.26 at the midpoint versus the prior year. Finally, we expect free cash flow of $1.5 billion to $1.55 billion between 105% to 115% of GAAP net income. We remain committed to our discipline and balanced capital allocation strategy and expect to repurchase $600 million to $800 million in shares this year following the new Board authorized $2 billion repurchase program in addition to paying our dividends and pursuing our typical bolt-on M&A strategy. With that, I’ll turn it over to Anurag to walk through our 2022 results and 2023 outlook in more detail.

Anurag Maheshwari: Thank you, Judy, and good morning, everyone. Starting with fourth quarter results on Slide 6. For the fourth quarter, reported sales of $3.4 billion were down 3.6%. Organic sales grew for the ninth consecutive quarter and growth accelerated to 6%, our best performance of the year with mid-single-digit growth in new equipment and high-single-digit growth in service. Adjusted operating profit excluding a $49 million Forex headwind increased $39 million with constant currency growth in both segments. Strong service performance, especially on volume and price was partially offset by commodities in mixed headwinds and new equipment as well as higher corporate cost. Adjusted SG&A expense for the quarter and the year improved 80 basis points as a percentage of sales, as we remain vigilant on structural cost reduction and cost containment to help mitigate the macro headwinds we have faced.

At the same time, we are committed to growing the business and R&D and strategic investment as a percent of sales remain about flat. Adjusted EPS grew 4% or $0.03 in the quarter driven by operational growth of $0.07. This strong operational growth alongside the accretion from Zardoya and $850 million of share repurchases more than offset the $0.08 headwind from Forex. While the fourth quarter free cash flow conversion was strong at 145%, our full year free cash flow came in at $1.45 billion or 115% of net income lighter than we had anticipated as we built $65 million of inventory to mitigate supply chain challenges and support backlog conversion going into 2023. Moving to new equipment performance on Slide 7. Otis new equipment orders in the quarter increased 4% with EMEA and Asia-Pacific up high single digits and China orders returning to growth of mid-single digits, which more than offset a modest decline in the Americas.

Overall with better than expected orders growth in the quarter, we finished the year with a new equipment adjusted backlog up 11% at constant currency with growth in all regions, including notably in China. Pricing on new equipment orders in the quarter increased 3 points led by the Americas with solid performance in EMEA and APAC. In China, we have been roughly price cost neutral throughout 2022 as commodity inflation eased and we continue to drive productivity to offset pricing pressure in the market. Fourth quarter new equipment sales of $1.5 billion return to growth driven by over 10% growth in the America, EMEA and Asia Pacific with EMEA outperforming our prior expectations. China sales declined at a lower rate than what we saw in the middle of the year as the team navigated well through post lockdown COVID outbreaks to execute on the backlog.

Overall, strong execution by the team will return to sales growth in the fourth quarter in new equipment. Operating profit margins were roughly flat for the quarter. The benefit of higher volume, strong productivity and cost containment nearly mitigated the approximately $25 million headwinds from commodities and Forex. Now turning to Service segment performance on Slide 8. We saw an acceleration in our portfolio growth to over 4% with every region adding to the portfolio this year. With another year of excellent high teens growth in China and low single digit growth elsewhere, our portfolio now is about 2.2 million units. Globally, our recaptures more than offset cancellations for the year with conversions as the growth driver. Additional details on our portfolio growth in 2022 and drivers for future growth can be found in the appendix.

Modernization orders were also a highlight up 13% with growth in all regions, including some major project bookings in the Americas and Asia Pacific and continued strength from a mod package offerings. Our modernization backlog is up 7% versus the prior year, giving us good line of sight for growth in 2023. Moving on to service sales. We delivered another quarter of strong organic sales growth up almost 7% with growth in all lines of business. Maintenance pricing, excluding the impact of mix and churn came in as expected up about 3 points for the year, contributing approximately 1 point to overall revenue growth. Organic modernization sales grew 8.8% and similar to last quarter we saw broad growth across regions, including double digit growth in both Americas and Asia Pacific.

We finished with our best service margin expansion for the year up 70 basis points in the quarter. Adjusted operating profit, excluding $42 million of Forex headwind was up $51 million as higher volume, favorable pricing and productivity were partially offset by our annual wage increases. We have now delivered 12 consecutive quarters of service margin expansion with margins increasing roughly 200 basis points over the past three years. Slide 9 lays out the full year 2022 adjusted EPS bridge. Strong operational execution drove $0.39 of constant currency EPS growth, which mitigated $0. 18 in commodity headwinds leading to operating profit growth of $124 million or $0.21. Through our capital allocation strategy, including the accretion from the Zardoya transaction and share repurchase of $850 million and optimizing a tax rate, we were able to offset $0.26 in Forex headwinds.

Overall, strong operational performance led to EPS growth of 7.5% or $0.22. We finished the year with 2022 adjusted tax rate of 26.5%, a 220 basis point improvement versus 2021, which contributed to EPS growth both in the quarter and for the full year. Overall, the team performed well throughout 2022 by executing on the controllables, which helped us to build a strong backlog, grow organic sales, expand margin by 30 basis points and return $1.3 billion to shareholders. As we look ahead to 2023, the new equipment outlook is on Slide 10. Over the past few years, we have delivered strong orders globally from a combination of market growth, our share gain initiatives and incremental pricing actions. This has resulted in a robust multi-year backlog, giving us good line of sight for the next couple of years.

In 2023, we expect new equipment organic sales to grow between 3% to 5% with Americas and EMEA up mid-single digits and Asia growing low single digits. Asia-Pacific is expected to be up at least mid-single digits, and though the backlog in China is up 2 points, we expect sales to be about flat reflecting pressure on the Book and Ship business from expected market declines in the first half. We expect new equipment profit margins to be flat to up 40 basis points. We expect roughly $100 million of tailwinds from volume, pricing, productivity and commodities. This will be partially offset by unfavorable regional and project mix and some snap back in SG&A expense due to 2022 cost containment actions. We will continue to drive strong productivity on both material and installation and project closeouts as the year progresses to drive out performance.

Turning to our service outlook on Slide 11. Starting with sales, we expect another solid year in service and anticipate organic sales increasing 5% to 7%. Maintenance and repair organic sales are expected to grow 4.5% or 6.5% driven by maintenance portfolio growth, pricing and low to mid-single digit repair growth after two strong years of COVID-related recovery. We expect more than 1 point of pricing after adjusting for mix and churn. For modernization, we anticipate organic sales of mid to high single digits as we execute on a solid backlog and drive our Book and Ship business from new product launches and focus on sales force specialization. Turning to profit, we expect roughly 50 basis points of margin expansion. Headwinds from annual wage inflation will be more than offset by volume, price and productivity similar drivers to 2022.

Turning to Slide 12 for the 2023 adjusted EPS bridge. We are expecting $3.35 to $3.50 in adjusted EPS driven by $0.23 to $0.31 of operating profit growth. We expect to offset $0.09 of Forex headwind at the midpoint and a modest increase in interest expense through a lower share count, $0.04 of remaining Zardoya accretion and continued optimization of a tax rate. We plan to complete $600 million to $800 million in share repurchases during the year. For cadence, we expect strong EPS growth in the second half of the year, while the first half remains roughly flat. We see the bulk of the FX headwind, post lockdown COVID impact in China, and a modest supply chain overhang in new equipment in the first quarter. We anticipate stronger growth sequentially thereafter, including better performance in China in the second half of the year.

Overall, we anticipate Otis organic sales growth of 4% to 6% with approximately 20 basis points to 30 basis points of margin expansion leading to 6% to 10% EPS growth. And on cash, we expect to generate $1.5 billion to $1.55 billion in free cash flow in 2023, 110% conversion of GAAP net income at the midpoint. This outlook demonstrates another year of consistent and solid operational execution as we continue to mitigate macro challenges and create meaningful shareholder value. With that, I will request Norma to please open the line for questions.

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Q&A Session

Operator: Thank you. Our first question comes from Julian Mitchell from Barclays. Your line is now open.

Julian Mitchell: Hi. Good morning and thanks very much. First off, I suppose I just wanted to dig in a little bit more into the assumptions for how you see the China market starting out the year in terms of orders after a very good Q4 performance? And maybe just homing a little bit more on the commentary around some of those headwinds in Q1. Should we still expect EPS to be up kind of sequentially in the first quarter?

Judy Marks: Well, good morning, Julian. It’s Judy. Let me start with what we’re seeing really on the ground. I would tell you that the Chinese economy is in a state of recovery now. We were really pleased with our team’s performance in the fourth quarter, again, with orders being up in new equipment in what was a challenging quarter with all the lockdowns. It’s a fluid situation on the ground between liquidity and the COVID-related absenteeism as we come back from the Chinese New Year. We’re going to watch that closely. But 2022 came in where we expected on the market down about 15%. We shared, we think that was about down 10% in Q4 and came in where we thought between 540,000 and 550,000 units. Obviously Q4 saw some abrupt changes with COVID between the lockdowns and then the lifting, which led to the outbreaks.

And what we’re monitoring is the liquidity easing, which we’re seeing and where the consumer sentiment and confidence is in terms of the property market. So as we go through the first few quarters of 2023, first of all, we’re very encouraged by the government policy and actions to date. We are expecting a better second half. We have a harder compare in the first half based on what was happening in China, first half of 2022. But we did see an up infrastructure market that was the only segment that was up in 2022 in a 15% down market, and we did very well there. Perry and the team just executed really well. Tier 1 and 2 in China were the least negatively impacted by the down market. And again, you know our strategy there has been very focused on agents and distributors on key accounts and we’ve executed that.

So I’ll leave it with, I’m feeling good about the health of our business in China. In a down market in 2022 we did well, we were down mid-single digits versus a down 15% market and in a down 5% to 10% market we expect to do well as well. So we gained share last year. Our strategy will enable us to do that, and we’re going in with backlog. I’ll let Anurag talk to the EPS question.

Anurag Maheshwari: Great. Thanks, Judy. Yes, so Julian, just on the quarter one let me start with the segments first. From a service perspective, we expect to see performance in line with the full year guidance. The swing factor could be repair, modernization or some mix, but overall we aren’t anything major to call out and expect kind of mid-single digit growth and margin expansion. It may be not close to 50 basis points regarding for the year, but still be good at expansion as we ran through the year. The new equipment is a segment that we do expect some weakness from both a sales and a margin perspective. Specifically compared to last year, China as a tough compare as the COVID impact didn’t really start until the second quarter.

And while we €“ as Judy mentioned, we do expect better performance in China as we go through the course of the year. We aren’t expecting it to happen until the second half of the year. In Americas the team performed very well in the fourth quarter. But there is still some supply chain inefficiencies and labor shortages, which I expected to clear up in the second or third quarter. So overall, we expect sales on the new equipment side to be down quarter-over-quarter and year-over-year, and margins to be above flattish with where we ended up in the fourth quarter. Now kind of going to the other line items, starting with corporate expenses. Last year the first half was light because of all the cost containment we did. So it is going to €“ the run rate’s going to pick up very similar to what we saw in the fourth quarter.

So there could be a couple of pennies of headwinds over there. And then on the FX side, we’ve said about at the midpoint $55 million of FX headwind and a bulk of it will come in the first quarter because last year at this point in time the euro was $1.15, the renminbi was $6.35. So though the currencies have improved, there is still a significant headwind. So majority of our FX headwind will come in the first quarter. So putting it all together, we do expect EPS to be down a couple of pennies. As you know, the Forex any new equipment corporate will kind of offset the good performance in service and the Zardoya accretion. So net-net down a couple of pennies and sequentially also could be down $0.01 or $0.02.

Julian Mitchell: That’s extremely helpful. Thanks very much.

Operator: Thank you. One moment for our next question. Our next question comes from Steve Tusa with JPMorgan. Your line is now open. Steve, your line is now open. Mr. Tusa, are you on mute?

Michael Rednor: Norma, let’s go to the next question. Thank you.

Operator: Thank you. One moment for our next question. Our next question comes from Nick Housden with RBC Capital Markets. Your line is now open.

Nick Housden: Yes. Hi, everyone. Thanks for taking my question. I’ll just ask one. Looking at the outlook and maintenance in particular you’re guiding for up 4.5% to 6.5% organic. I’m just thinking, units are increasing over 4% and you seem pretty competent in being able to maintain that kind of level. Pricing is already at 3% and is probably going up as you enforce the escalation clauses and you kind of hinted that in the slide. So 4% volumes, 3% pricing, am I wrong to think that a 5.5% midpoint in the guidance looks a little bit conservative? And is it to do with maybe pricing being a bit more competitive in Asia Pacific, where a lot of the new units are going into? Thanks.

Judy Marks: Let me €“ Nick, good afternoon. Let me answer the pricing question and then I’ll let Anurag take you through the walk. Listen, we’ve been pleased like-for-like pricing similar to Q3 was up 3 points in Q4 and was very solid as predicted. Mature markets globally is where we saw really strong service pricing, mid-single digit gains in the Americas, low single digit in EMEA and Asia Pacific. And as Anurag said in his comments, kind of we’ve got this €“ the margin drivers are really less on price and more on productivity, volume and density in China. But we think 2023, like-for-like should be better than that 3%. And that’s really driven by the inflationary clauses we have in the majority of our contracts €“ service contracts, especially in Western Europe and in North America.

The Western Europe clauses are backward looking, so they will reflect 2022 inflation indices. And we are signing those contracts right now, a lot of them in the first quarter. So next quarter will be able to €“ to be able to share how we’re performing on that. But pricing’s healthy, team deserves a lot of credit. We pivoted from being a discount kind of service pricing company for many years to being able to gain price, especially where it was appropriate and justified.

Anurag Maheshwari: Yes. And just to add to that in terms of the growth for 2023. So yes, you’re right that our growth at the midpoint is very similar to where it is in 2022, but the pieces are a little bit different. The portfolio growth as you put together 4% and what Judy spoke about the pricing, you add 3%, then you adjust for churn and mix, we should be up about 6% for 2023, which is higher than where we were in 2022. Repair is as I mentioned in my prepared comments, over the past two or three years we’ve been running at a 10% CAGR on the Repair business coming out of COVID. Now, typically the Repair business will outgrow the Maintenance business because as we continue on our strategy on new repair packages, increasing penetration.

But this year there’ll be €“ just be a little bit of a catch up from what happened in the past two to three years. And then going forward, it should outpace the Maintenance business. So that’s why we’re saying low to mid-single digit. And modernization is pretty €“ it’s around 7-ish percent at the midpoint. So those are the pieces which get us to 5.5%. Now, clearly, if pricing is a little bit better, repair comes in better, and the modernization book and ship there could be a little bit more over there. But right now we feel well calibrated at the midpoint of the guidance.

Nick Housden: Okay, great. That’s very helpful. Thank you.

Operator: Thank you. One moment for our next question. And our next question comes from Gautam Khanna with Cowen. Your line is now open.

Unidentified Analyst: Hi guys. This is actually Jack on for Gautam today. Thanks for the question.