Otis Worldwide Corporation (OTIS) Earnings Call Transcript & Summary

Good Morning. My name is Brendan Luecke, and I'll be covering multi-industry sector at Bernstein. I'd like to welcome all of you today's fireside chat with Otis Elevator. Thank you very much for joining us. Before we dive in, I do want to touch base on a few housekeeping items. We are striving for an interactive session today. So similar to last year, we'll be using Pigeonhole for Q&A. There's a link on the left side of your screen where you can access Pigeonhole. When you click that, a window will open up, and you can submit questions live. You can also vote on them using the little triangle symbol next to a question. We'll moderate and hopefully shape the discussion to the areas that have regarded the greatest interest. Finally, it's my absolute pleasure to introduce Judy Marks, CEO of Otis Elevator. Judy has led Otis since 2017, and became CEO on 2020. Judy, it's absolute pleasure having you here back at SDC again this year. We very much look forward the conversation, [ I understand ] prepared remarks. So I'll hand it off here.

Thanks, Brendan, and good morning, good afternoon and good evening, everyone. Let me start with our cautionary statement. Please note, except where otherwise noted, the company will speak to results from continuing operations, excluding restructuring and significant nonrecurring items. The company will also refer to adjusted results where adjustments were made as though Otis was a stand-alone company in the current period and prior year. 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. I'd also like to point all of the investors to our otisinvestors.com Investor Relations website, where we've recently put an investor pack that's got a variety of information that you might find of interest in detail, again, trying to bring together our first year for you in methods as well as in quantitative information to help you understand our company. So Brendan, it is an absolute pleasure to be here today and to share really what's been going on in Otis, and I would summarize it as a story of foundations and focus. And we spun in April of 2020, April 3, actually, so we're now in our second year as a new company, albeit 168-year-old entity and finding that balance between the agility we need, the focus serving on the markets globally as well as building on the foundations of an incredibly distributed business that optimizes locally to handle local markets in 200 countries and territories. When I think about the megatrends and the business case for our future, it's truly bright. Urbanization will continue to be real. We're seeing that. We saw the resiliency of our Service business, the business itself and, just as important, the resiliency of our 69,000 colleagues, as we experienced a year unlike any other, as we were preparing and started the spin of our business. But the fundamentals and the foundations of why the elevator industry is going to continue to grow are there and we'll continue in the New Equipment business at about a GDP kind of indicator and at the Service business, which most of our investors understand is 80% of our profit that Service business grows at a GDP-plus business rate throughout the globe. So we're encouraged by the recovery we're seeing, and I'll be happy to go through that in the questions as we get to them today. The fundamentals, though, remain strong. And again, the resiliency in a very unusual year and the results we were able to put up. Let me go through some of that for you and break it out in terms of what we were able to accomplish in 2020 and share some updates as well as we performed in the first quarter of '21. Let's start with our Service business. Our Service business is the crown jewel of this company. We have the largest service portfolio of any provider at 2.1 million units. And yet again in '20 it proved resilience 110 basis points of margin expansion, which just showed the benefits of the investments we've been making, the productivity gains we've been able to achieve and incredible, as I said, resiliency of our essential workers, our field professionals, who every day went out and kept hospitals running, kept metros running. And most importantly, what most people don't understand is kept about 55% of our portfolio, which is residential running. So the groceries could be delivered, so that people could continue and sustain their lives, which is such a critical role we have in movement and in motion and vertical transport. Our Service portfolio grew at 2% last year, and we have high expectations that that can grow even faster, again, in a GDP-plus kind of market. And we invested in Service. We deployed 100,000 of our IoT sensors to the installed base on our investment Otis ONE, and we're seeing that investment pay off in terms of attachment rates, which we call conversion as well as retention rates with customers. When we connect, our customers are more loyal. Our New Equipment business, though, was just as important for us to really commit to a sustained investment profile, which we really didn't have prior to the spin. So we invest about 1.6% of our R&D -- of our sales in the R&D and strategic investments. And what that meant for us was innovation. It met new product offerings across the spectrum. We piloted our most sophisticated new elevator, which will get launched later this year, the Gen360 with an electronic safety architecture. We piloted this in Europe where the code allows it. And this is going to be revolutionary in terms of ability to handle more people in less space, safer and connected. But just as important, we looked at the entry-level segment, and we introduced our Gen2 Prime, which allowed us starting last year and 0.7 meters per second, allowed us to move people more effectively and cost effectively in emerging markets. Great pickup in India already, where we manufacture this in our Bangalore factory, and we're already exporting it to Southeast Asia. So our innovation is rich. Our patent portfolio is rich, and we have sustained investment to keep the new Equipment Business going. Beyond the technology, though, for New Equipment, we gained share. We did that through investments, and we did that through sales coverage. And as soon as we spun, we knew we had some gaps in terms of coverage in geographies, especially in China. So we added 800 agents and distributors last year in China, added another 200 in the first quarter of this year. And that's really paying off. It's giving us better traction with the large developers. It's giving us more reach into Tier 1 and Tier 2 cities, where we potentially had a competitive gap with some of our stronger competitors there in China. And it's really given us the ability to grow share. We grew share globally in 2020, 60 basis points, and we grew share 2 points in the first quarter of this year. So between the R&D investment, the sales coverage and just our ability to serve customers locally, we were with them throughout the pandemic, and now that loyalty is paying off, and I couldn't be more pleased with that. And we've also had incredible operational efficiencies. Beyond service productivity and beyond productivity and keeping our supply chain running whole and uninterrupted during the pandemic and now with several supply chain challenges, we experienced and achieved 3% material productivity in 2020 as well as in the first quarter of this year. That was everyone in our New Equipment side of the business focusing on being more effective, more cost-focused and trying to find better leverage with our scale that we just didn't take advantage of before the spin. So operationally, the team is executing very well. We're in a long cycle life safety business. That means there's a regulatory and a code moat around what we do on the New Equipment side, and there hasn't been a new OEM entrant in a while. So that share gain to us on about 900,000 elevators a year in the segment continues to be important, and you're going to see us continue to gain share. We did not do that at the cost of margin. And that's the balance, finding this muscle memory that Otis has to grow. That growth is happening in New Equipment share and in our Service portfolio, which grew 2% last year. And we're doing none of this with draining the backlog. We ended last year with 2% up in backlog in New Equipment. And again, the portfolio grew by 2%. And in first quarter, we saw a 2% portfolio growth and again, backlog growth in our new equipment. So we're winning more, we're executing better and focusing on the little things. And that focus, Brendan, goes everywhere, in every element of our business. We looked at below-the-line items like tax, and we took what was an effective tax rate of 34% at spin. Took it down 360 basis points last year, and we're going to take it down another estimated 90 basis points this year with more room to go. So we're taking a look at everything. And what that does is it gives us the facility and the capability to take the incredible cash machine that, again, we're projecting 120% cash conversion this year. We did better than that in the first quarter and better than that last year. We're going to be able to take that cash and share and really drive shareholder returns. So our capital allocation model, which we expressed and explained in our Investor Day in February 2020, we've accelerated much of that. We finished the debt repayment. We had planned $500 million in January of this year, and we increased our dividend by 20% already in the first quarter, and we were able a year early to drive share repurchases. In January, we introduced -- we announced we're going to do $300 million in share purchases. We completed that in the first quarter. And at our first quarter earnings, we increased that to a cumulative of $500 million of share buybacks this year. So we think our cash generation system is working incredible, negative net working capital in the first quarter. So this is everyone paying attention to details. And that gives us the flexibility to ensure that our ESG strategy is on target as well because ESG is integrated into everything we do. And we know that when we do good, we do well as a business, and we do well globally. So we've published some very aggressive targets. You'll find those on our website. We were a signatory to the UN Global Compact. We started our first CSR program this year in terms of made to move communities. And we will be -- we will reflect the communities we serve, and we will look like and reflect the customers and ensure that every voice here at Otis is heard. Again, couldn't be more proud of the resilience of the business and the resilience of the team and our colleagues and really now just ready to take your questions.

Excellent. Well, thank you so much for the overview. Obviously, the last 15 months have been quite a ride globally. It seems like you've weathered it quite well. I'd like to talk about just sort of how your views have changed since the spin. I mean, last year, we talked about how Otis is an independent would move faster, you'd have a cleaner cost structure, the opportunity to reinvest. Have things played out as you expected? And any new learnings, any surprises?

I think a lot's played out exactly how we expected with focus. Otis is a story of a lot of little details and little pieces coming together because we have 1,400 branch offices, again, spread throughout the globe, all held to the same KPIs. But certain things we knew we needed to change. So the first thing -- one of the first things we did in April, we changed the incentive structure to return our company to a return to growth. Again, not at the cost of margin and as you saw, we had margin expansion last year, and our outlook this year is for sustained margin expansion. Our medium-term outlook is in a 30 bps a year. So not at that cost, but the ability to grow again and to take share. And we did that, again, through the innovation. We did that through expanding sales coverage while reducing our SG&A last year significantly, which is another challenge we took up. We rationalized a lot of the corporate costs that we had inherited from the parents. And I think we've come out as a more agile company. And along those lines, there are still opportunities. We don't have consistent performance across all parts of the world, so we have the ability with technology and actually even with the pandemic going on to share best practices, to measure improvements and to make sure people can learn rapidly from everyone else. I'd like to say we're about a year young and 168 years old in trying to leverage the strength of the brand and everything that came before us. I mean we have the largest service portfolio, which gives us scale and density. But again, are we addressing it consistently? So that gives us great opportunity as we look forward.

Excellent. And I mean, on those opportunities, you mentioned consistency. Are there any specific areas where you do see the greatest opportunity for improvement?

Listen, we shared in our midterm outlook that the greatest improvement is going to come in our Service business. And that's going to come through a combination of productivity driven by the tools and technologies we put in the hands of our incredible field professionals. So 33,000 people out there every day, representing us. We've also -- those applications are not consistently used in terms of adoption rates. So we're continuing to roll those out and make enhancements to them. But probably the biggest lever we added last year was really starting the rapid deployment of connected devices and Otis ONE. And that's what's really -- we decided we were going to invest in the productivity gains, but more importantly, the ecosystem that we are seeing drives additional maintenance pricing and also drives additional customer retention. Our customer retention rate went up almost 1 point last year to 94%. It's the best in the industry. And if you think about that 2.1 million units at 80% of our profit, that's the key is to drive that portfolio. So we deployed 100,000 units, we chose to do this starting with our installed base, so that we would know where we were doing them and so we could optimally place the units by density. We picked the top 6 countries to us in terms of service cost. Again, so not just sprinkling these everywhere, we wanted to be able to capture the savings and just as importantly, show these customers in 6 countries, the U.S., China and 4 in Europe, what the strength of having not just these sensors, but more importantly, the data ecosystem and our data lake and the predictability would be for them in terms of helping them with elevator uptime. And we're really starting to see that yield. So there's opportunity there, and it's really probably the best place we've shown the portfolio growth based on IoT is China, high single digits as we exited 2020 in terms of our portfolio growth, and we had growth in the teens first quarter of this year. So our China team is really leveraging Otis ONE, they're leveraging the sales coverage. And then yes, candidly, you have to be there to be able to provide service. So we've added about 30 service depots in China, so that we're now in cities with Otis Maintenance, so that we have the opportunity to convert the units we've sold and bring them on our portfolio. Service holds great potential for us and great opportunity. And again, it's New Equipment that feeds it. So the more units we can get out there, the more innovative we can be, the more share we gain, then that will drive the Service flywheel. But we make profit on both, and that's probably the biggest difference, Brendan, that people don't realize in the kind of razor, razor blade model. Our New Equipment segment is profitable, and our Service segment is very profitable.

Excellent. I'd like to take a step back and just talk a little bit about the macro and really what you're seeing on the shape of the recovery. But obviously, COVID has played out very differently, when it comes the regions of the world over the last 12 months or so. What are you seeing -- you should -- I imagine you have a pretty privileged viewpoint, just around the residential and commercial construction markets. And what are your expectations for the next 12 to 18 months?

Yes. Let me -- we tend to be a proxy for a lot of companies because we have such a global view. So I'm happy to share what we know and what we've seen and how that varies from what we thought coming into '21 because we've been very, very pleased by what we've seen in terms of even growth in the segments. But let me break it out into residential and commercial. And when I talk about residential, it's the apartment, condominium. It's not single-family home when we talk about it globally. So it's not quite the home market, but it is the residential market. And so we're seeing the residential market. Again, over 55% of our New Equipment, over 55% of our Service portfolio is residential. We're seeing really strong uptick in China. China has remained strong in residential. And again, mid-single-digit plus growth in this segment. We weren't sure it would be that high coming into this year, but we're seeing it a little higher than mid-single-digit plus and especially in residential. In the North America, I'll talk about the U.S. and Canada, commercial actually had a stronger increase in the first quarter than we had anticipated. The residential was down a little. We came into the year expecting North America to be up slightly in terms of the segment. We've revised our estimates and our outlook. America is even stronger. And if you've seen U.S. -- if you've seen our orders performance and our top line performance in North America in first quarter was outstanding. So clearly, the team has optimized our product set and most importantly, I think the trust of our customers who we were with throughout the pandemic. Europe and Asia, we expected low single-digit growth in Europe on New Equipment, mid-single-digit growth in Asia on residential and commercial. They're playing out about where we expected them to. The other probably change that we're seeing is just in terms of repair and modernization on our Service business. So repair is a proxy for usage. So we have contractual maintenance, which is our maintenance business. Again, it's typically a 4-year maintenance contract we enter into globally, less and more depending on certain countries and regions, but on average, 4 years. That was the steady subscription business that had the resiliency and really got us through the pandemic and is the beauty of the largest Service portfolio in the globe. Repair is driven by fixed -- break fix. It's driven by usage. And really in the first quarter of this year, we saw the repair business up versus first quarter of last year. And we didn't anticipate seeing that till the second quarter and second half of the year. So I know a lot of people have a city-centric view in North America, whether it's New York, Seattle, san Francisco. I can tell you, construction is going strong and usage is back. In office, in our portfolio is less than 10%. So everyone gets worried about non-res. I would tell you, non-res is a lot broader than just office. And then modernization for us was up last year. It was driven by strong modernization in some of the mature markets in Asia, mainly driven by safety regulations. But the modernization business grew first quarter '21 versus '20, which is really both modernization and repair coming up very strong compares because COVID hadn't quite hit EMEA in North America first quarter last year until the very end of the quarter. So pleased with the growth in modernization year-over-year for the first quarter as well as repair. And modernization is going to play out in EMEA as we enter the second quarter and the second half of the year explicitly. Again, that's our biggest residential portfolio where the majority of people live in condominiums, all the major metros across Europe. And those condominiums could not get together for their decision-making last year. They have a once a year annual meeting, but because of COVID, that didn't happen. So we have demand delay, not disruption. And I like to say every elevator got a year older last year. And so we think there's going to be modernization opportunities, which is good business in and of itself. It kind of approximates our New Equipment business in terms of margins. But it drives another potential 2 decades of service.

Excellent. That's very helpful. A sort of the [indiscernible] question around COVID again here. How do you think about it almost structurally with respect to the business? I mean, on the one hand, I can say, well, in closed spaces we're bad in the pandemic and, I think, pandemic is probably going to be around for a little while again. And on the other hand, perhaps we need more capacity and new construction to reduce the density. Is there a mental model that you have as you sort of look forward over the next couple of years?

So we -- listen, airflow is critical. And I think we've all learned that through the pandemic and I think we've all learned a lot about airflow, and I've had the opportunity to educate people that airflow is mandated by code in elevators because if you were to be entrapped, clearly, there's a need for flow and there's a need for continuous airflow. We commissioned a study with Purdue University, so that we could get some airflow experts to look at that because it is a closed pace, whether there's 2 of you in it, 20 of you in it. And what the data shows is that a ride in an elevator because of the duration and because of the existing airflow has no more harm than going to shop at a grocery store or than outdoor dining. So we believe and we've seen this in the rest of the world, china first, and we're seeing it everywhere. People are back, they're in elevators that we've introduced and rapidly introduced some health technologies for people, who perhaps still would like some -- the ability not to touch buttons, even though we don't believe that that's how any of this gets spread. So we have gesturing technologies. We have voice technologies. But I think most importantly, it allowed us to really share our apps that allow you to call an elevator from your iPhone to -- or your Android and have the ability to tell it where you want to go and to dispatch it and to work with our dispatch algorithms to do that. So we've innovated on technology. But elevators are here to stay. I just would remind everyone, most people tend to think of elevators in a high-rise environment. Again, I think 55% of our portfolio is residential, and the majority of the New Equipment units we sell globally are 1 and 2 elevator customers. So elevators are ubiquitous. They're not unique to a segment. We measure via rise and speed. So if you're going to buy 1 of our Gen2 elevators, which last year, we sold our 1 million of. If you're going to buy one of those, the aesthetics may look different inside, but the elevator is consistent, whether you're a hospital, a school, a condominium. So we really do have this great offering that really is segment agnostic.

Excellent. And then one last question on macro, before we move on to some of the other pieces of business. I mean, in the U.S., specifically, there's a lot of questions around extended remote work and, frankly, folks moving out of high-density environments into secondary cities and [indiscernible], how do you see this playing out for your business in North America?

Well, what we've seen to date is actually positive. So let me remind you, we were an essential service provider, including our team here in North America. So while we had some work from home here in North America, the majority of our colleagues showed up every day and kept North America moving, especially the U.S. So we actually see it as an opportunity. As I said, to us, an 8-stop elevator is an 8-stop elevator and if someone wants to move to a suburban campus, they still need that 8-stop elevator. So we view it as opportunity. And we've seen the cities already coming back. I think New York is probably the best example where I think we are seeing a rapid acceleration. It tends to be more of a U.S.-centric view that people are moving to the suburbs where there's abundant single-family housing. The rest of the world doesn't have that same ability. When you look at Western Europe or Eastern Europe, it's just -- it tends to be more of a U.S.-centric view. And I'll just remind everybody, 85% of the units we deliver and actually that are bought in New Equipment happen outside the U.S.

Excellent. Okay, great. I'd love to pivot here and [ just chat ] China for a little bit. So we have questions from the audience. Would you want to share a brief update on activity in China, specifically around any concerns you might have about increasingly strained relations between the U.S. and China and perhaps backlash around U.S. brands?

We have been doing business, formed our first JV in China in 1984. We have several JVs there. And we really have been viewed as a Chinese company. We have about 15,000 colleagues in China, and 99% of them are Chinese nationals and run our business there. It's the largest segment in the world for this industry. So almost 60% of all elevators sold are sold in China. It's still -- even if it were to flatten as a segment, it's still as significant versus any other part of the world. So we focus on delivery. We focus on ensuring we have a quality product coming out of our factories there. And we focus on making sure we live within all the regulations and the codes and deliver quality service. And we watch, clearly, as anybody would for any strained relationships, but we believe we're being treated fairly and equitably, whether that's at an inspection -- code inspection or even as we export product from China. So our China business is strong. It's growing. Again, the segment is going to grow mid-single digits. We've not seen any indication as Otis. Again, we have 2 brands in China. We've really spent a lot of time transforming our China business over the past 4 years, and it's growing in both New Equipment service and doing well.

Excellent. That's great to hear. Would you mind offering a little bit of color around peer dynamics and expectations within China? So across the different segments, Services, New Equipment and maybe Tier 1 versus cities?

Yes. So China is -- obviously, as the largest market takes a lot of our appropriately attention and investment. And I think one of the main things we've done is assess how we performed versus our competitive peers. We are not #1 in China, and we have some room to grow there. And Perry, Zheng and our team came back with a focus on a China strategy to help growth. So what we did is we took a look at where China growth was, and we had real -- a fairly good coverage in the Tier 3 through 5 cities, but we were not as competitive with our coverage in Tier 1 and 2. So we looked at our agent and distributor network and, last year, added 800 agents and distributors in China and another 200 in the first quarter of this year, and it's really starting to yield. Where it's yielding for us, Brendan, is in Tier 1 and Tier 2 cities, and we saw us gain share there in the first quarter of this year. And it's yielding with 2 other key segments: one, we call them key accounts, but the large developers. But these large developers are the largest buyers in China versus a volume kind of business. And they have loyalty because they want the OEM to service the product nationwide. So for us, it's important to gain share with those developers, and we've added multiple frame agreements. We had gained share with them in '20 and already in the first quarter of '21. And for us, it's just as important because then we get the service conversion and that loyalty and that retention rate, which for us is 94% globally, it's lower in China. But by bringing on these key developers and these key accounts, that's going to grow for us as well. So we've added sales coverage in China through agents and distributors. We've added a stronger internal network to support those sales channels, starting to show that share gain as well. The other segment that's very strong in China is infrastructure. And our infrastructure, we do better at infrastructure globally, but especially in China. It's not a huge percent of the market, but in China, where they're going to be adding a few hundred airports over the next few years as well as rail, metro service. For us, it's a great market. It's the largest escalator market in the world as well in China. So it's that transformation we went through to become more cost competitive. It's adding technology in terms of our innovative offerings and our Otis ONE. There's a reason we chose China to deploy Otis ONE. And now every unit shipping out of China beyond the additional ones, we're going to put in the installed base. Every New Equipment unit in China will ship with Otis ONE out of our factories. And so we believe we're seeing -- our conversion rate went up by 1 point in '20 in China, which is significant, but more importantly, our portfolio grew high single digits.

Absolutely. So I guess looking forward, through press lately in China, I think they opted to a 3-child policy. Population is eventually going to peak out. Where do you see next wave growth [indiscernible]

Well, global population is not going to peak. And I think, as Otis, we've seen over the decades, population shifts, right? We saw when things changed in Japan and yet Japan is an incredible market for us. That's the beauty of the Service portfolio. The buildings are not being destroyed or destructed. So regardless of how population shifts or in certain markets slows down, that may have an impact on the New Equipment market, but it doesn't -- the Service market continues to be that subscription, that annuity against almost 60% of our revenue, 80% of our profit pool. So we see population is going to continue to grow. It looks like 70% of the population in 2050 is going to be living in cities. And that to us is opportunity. It's opportunity in emerging markets, in Southeast Asia, across whether it's in Indonesia, Malaysia, Vietnam, in India as well as in Latin America and South America. So our mature markets are doing great. We focused on those in terms of margin expansion, and we've also challenged every country leader to grow their share versus the competition. So even if you're in a market that's been fairly stayed for many years, that doesn't mean we can't grow share, and the team's responded wonderfully there.

Excellent. An audience question on this topic, specifically around India. Clearly, much lower elevator density for capita there. What's your long-term view on the business growth prospects in India?