Otis Worldwide Corporation (OTIS) Earnings Call Transcript & Summary

Good morning, and welcome to Otis' Second Quarter 2026 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 Imelda Suit, Senior Vice President, Treasurer and Interim Head of Investor Relations. Please go ahead.

Thank you, Krista. Welcome to Otis' Second Quarter 2026 Earnings Conference Call. On the call with me today are Judy Marks, Chair, CEO and President; and Cristina Mendez, 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 and Otis' SEC filings, including our Forms 10-K and 10-Q, provide details on important factors that could cause actual results to differ materially. Now I'd like to turn the call over to Judy.

Thank you, Imelda. Good morning, afternoon and evening, everyone. Thank you for joining us. We hope everyone listening is safe and well. Starting on Slide 3. We achieved significant top line growth as we delivered a solid quarter with a significant step-up in organic sales growth, driven by accelerating service growth and improving trends in new equipment, along with strong cash generation. Service remains the key growth engine of the business with 9% organic sales growth supported by 24% modernization growth, double-digit repair growth and accelerating maintenance trends. Modernization orders were up 9% to end the quarter with a backlog up 26% at constant currency. We strongly believe that the investments we are making in capacity, quality, pricing and commercial execution are enhancing our competitive position and yielding continued growth in our service business. In New Equipment, we're encouraged by the sequential improvement in sales and the stabilization in margins. While orders were down 5% in the quarter, backlog increased 4% at constant currency and the business is showing greater stability supported by a sales turnaround in the Americas at a robust 10% growth. We delivered another quarter of strong cash generation with adjusted free cash flow of $290 million, up 19% year-over-year. The strength of our cash flow reflects the resilience of our business model. Importantly, this allows us to continue investing in growth and strategic investments, including the acquisition of a majority stake in we maintain while also returning a significant portion of free cash flow to shareholders through share repurchases and dividends. In the first half of 2026, we bought back approximately $800 million of shares and raised our dividend 5%. And returning over $1.1 billion to our shareholders. These results reflect our progress in executing our strategy and investing and strengthening our service business. Service margins declined year-over-year as labor and material cost increases have added pressure on margins as we ramp up our operations to execute on our strong repair and modernization backlog. With continued service revenue growth, we expect a sustained recovery in margins in the next quarters. With that, let me turn to our second quarter financial results on Slide 4. Otis delivered net sales of $3.9 billion, with organic sales up 6%. Adjusted operating profit, excluding a $7 million foreign exchange tailwind decreased by $32 million in the quarter, higher volume and price were offset by inflation, mix and productivity impacts. Adjusted operating profit margin declined 180 basis points to 15.2%. Adjusted EPS declined 4% or $0.04 in the quarter due to operational performance, partially offset by favorable foreign exchange rates. I want to take a step back and look at the significant transformation journey we've been on, as shown on Slide 5. From 2020 to 2025, we drove growth through a focus on boosting the size of our portfolio introducing innovative products like Gen3 and Gen360, connecting 1.1 million units on OtisOne and industrializing our modernization business. With keen operational focus, we optimized and developed resiliency in our supply chain and executed on uplift in China transformation programs. These programs yielded sustained operational performance improvement over the past 5 years. Starting this year, we added 4 operational initiatives. First, we drove value-driven AI micro pricing across maintenance and repair. Second, we shifted our portfolio mix focus toward high-value service segments and geographies. Third, we took a proactive approach in our repair offering to drive customer uptime and service growth. And fourth, we made a strategic decision to invest in service quality through our service excellence initiative to sustain portfolio growth in our key markets in the Americas and EMEA. We are seeing early signs of progress in this area and an opportunity to build a stronger operating foundation. The investment in service quality impacted margins in the short term, but we see it as necessary to fuel our growth. Service quality leads to customer satisfaction and retention, which feeds our flywheel for service volume growth across maintenance, repair and modernization. Today, we're sharing our plan to work structurally on our service operating model, which will drive frontline excellence. It's a program to unlock the full value of our operating potential at the local level where our 45,000 field colleagues serve our customers every day. This will be a natural extension of the transformation we started with uplift, which freed the frontline from transactional activities to become more customer-centric. We will standardize our core field and sales processes and drive operational excellence across our front line. Our service operating model will leverage the learnings from the tactical investments we're undertaking in service excellence, which, as I said, are delivering promising results. We have exceptional operating territories across our network that consistently deliver robust growth excellent customer service and strong operational performance. Our objective is to systematically use standardized systems and tools to consistently bring every operating territory to this level of excellence. Our focus on the front line is the logical next step in our journey since spin to build a more consistent, high-performance company. But we still have work to do to get there. Slide 6 summarizes our progress in service margins, which improved sequentially in Q2, but we are still seeing pressure largely from productivity and cost headwinds and the timing of our micro pricing actions. In Q1, we communicated a plan to invest $50 million in service excellence and pricing, with the goal to drive retention improvement and pricing upsides in maintenance and repair. We have invested $15 million in the quarter, on track with the plan, and we're encouraged to see a step change improvement in our service quality metrics. Our service quality index has improved 7 points in the operating territories targeted in the investment plan. In a good portion of these operating territories, we have also seen retention improvement but the recovery timing varies. Although our overall retention rates ex China -- overall retention rate ex China was down this quarter, we believe this will improve as we continue to provide high-quality service to customers. On cost and pricing, we were able to broadly offset the impact of the Middle East conflict with pricing actions and saw a strong ramp-up of our micro price initiatives in the repair business. Productivity and cost headwinds were higher than we anticipated this quarter. This has been driven by 3 main factors: First, our ongoing strategic investments in service excellence, impacted productivity and together with inflationary increases led to higher-than-expected labor and material costs. Second, as we ramped up resources to execute a strong repair and mod backlog, workforce onboarding took longer than expected for newly hired mechanics to reach full effectiveness especially for highly skilled activities in repair and modernization. Third, the acceleration of mod and repair execution required higher labor rates to make resources available where and when needed. We believe a large part of these headwinds are temporary while we adjust our operations through our service operating model to deliver on our growing backlog. With that, I'll turn it over to Cristina to walk through our segment results in more detail.

Thank you, Judy. Starting with service on Slide 7. Service organic sales grew 9% with growth across all lines of business and regions. Maintenance and repair organic sales increased 6%, representing a meaningful sequential acceleration. Maintenance organic sales grew 3%, supported by 3% portfolio growth and 3% pricing partially offset by mix and churn. Reversals continued to gain momentum, growing 12% and delivering the strongest performance in the past 10 quarters. Modernization remains standard. With organic sales increasing 24%, marking the highest growth rate since the spin. Growth was supported by strong customer demand and execution against a robust backlog, which continues to be driven by ongoing orders growth. Modernization orders increased 9% in the quarter, driven by a strong order growth in China, up significantly EMEA and APAC, both up low single digits, partially offset by Americas down mid-single digits due to a tough compare year-over-year. Modernization backlog remains very strong, up 26% year-over-year at constant currency. We remain confident in the long-term repair and modernization opportunity, supported by an [indiscernible] installed base that continues to drive customer demand and create attractive growth opportunities over the long term. The broad-based growth across our service business reflects the progress we are making in executing our strategy, and demonstrates that our focus on driving growth is delivering tangible results. Service operating profit of $599 million increased $16 million at constant currency as higher volume and favorable pricing more than offset higher labor costs, including the impact of ongoing strategic investments and productivity -- cost headwinds and unfavorable mix. Service operating margin was 23.2%, down 170 basis points versus the prior year. Margin performance is impacted by mix with higher modernization growth cost and productivity headwinds and reflects deliberate investments to support service quality initiatives and capacity to execute on service growth. Turning now to New Equipment on Slide 8. New Equipment organic sales declined 1% in the quarter. While market conditions remain challenging, this represents the lowest rate of decline in the past 9 quarters growing in Americas and Asia Pacific was more than offset by lower sales in China and EMEA. Americas sales increased 10%, supported by a strong backlog conversion and a healthy backlog built through orders growth in prior periods. Asia Pacific sales grew low single digits, driven by strength in Japan and India, partially offset by lower sales in Korea. EMEA sales declined 4% and primarily due to weakness in the Middle East and Southern Europe. In China, new equipment sales declined high teens in the quarter, consistent with the backlog decline but reflecting a slight sequential improvement. New Equipment orders declined 5% year-over-year as a double-digit growth in the Americas and low single-digit growth in EMEA were more than offset by declines in APAC due to tough compares and in China. New Equipment backlog increased 4% year-over-year at constant currency, 9% excluding China, providing good visibility into future sales and supporting our confidence in New Equipment stability over the coming quarters. New Equipment operating profit of $40 million declined $30 million at constant currency and operating margin declined 220 basis points to 3.1%, in line with our expectations. The operating profit decline was driven by lower volume and favorable price and mix. Looking ahead, we remain focused on executing our priorities, managing price, volume and cost as we navigate a dynamic new equipment market environment. With a growing backlog, the China market sequentially improving and a strong market demand in many of our geographies, we are positive about the New Equipment projects going forward. Let me now turn it over to Judy to discuss the outlook for the remainder of the year.

Thank you, Cristina. Turning to Slide 9. Our sales outlook and market expectations remain unchanged. We continue to expect the global new equipment market to stabilize with growth in all regions except China. Our global outlook for modernization remains robust with double-digit growth across all regions. We're watching the Middle East conflict but do not expect a significant impact to our outlook. We expect net sales of $15.1 billion to $15.3 billion, with organic sales growth of low to mid-single digits. The quarter reinforced our confidence in the sales growth trajectory of the business. We continue to see strong top line momentum, particularly across our Service segment, while we take actions to strengthen service quality, backlog execution and customer retention to sustain growth. While our revenue outlook remains unchanged. Our focus remains on executing the investments in service quality, balancing productivity and cost management and converting strong demand into sustainable earnings growth over time. With that, let me turn to Slide 10 and discuss the key areas of focus and the progress we're seeing. As we have discussed earlier this year, our priorities have been clear. ramp up top line growth by converting the robust modernization backlog, coupled with our strong growth momentum in repair, capture the flow-through of our micro pricing initiatives, improve service quality to strengthen retention and execute cost reductions in nonfrontline related activities. We are seeing progress in the acceleration of modern repair sales and in micro pricing initiatives in the repair business. However, we have not yet seen a significant improvement in retention. It is taking longer than expected. And because of that, we're tempering our AI micro pricing implementation and maintenance to balance this. We expect this headwind to have about $20 million impact versus our prior outlook for the full year. In addition, while we've executed on our cost reduction program and expect to realize savings for the balance of the year consistent with our prior outlook, we have experienced productivity and cost impacts as discussed previously. We estimate this headwind to have a $50 million incremental impact versus our prior full year outlook. Walk productivity remains below our original expectations we continue to believe that the majority of these pressures are temporary, and the actions we're taking today, together with our service operating model program will support stronger sustained performance over time. In summary, there are 3 takeaways: renew growth remains strong, our service quality metrics are improving and our operational initiatives are progressing. While the timing of retention benefits has shifted, and we have observed headwinds in productivity and costs, we are as confident as ever in our strategy and our service flywheel. With that, let me turn it over to Cristina to summarize our financial outlook.

Thank you, Judy. Turning to our financial outlook on Slide 11. We now expect adjusted operating profit to be in the range of down $30 million to flat on an actual currency basis, and in the range of down $45 million to $15 million at constant currency. The revision reflects the retention and tempered maintenance micro pricing impacts as well as the productivity and cost headwinds mentioned earlier. Our adjusted free cash flow is now expected to be between $1.5 billion to $1.55 billion, in line with the operating profit outlook change. Moving to the 2026 EPS bridge on Slide 12. The reduced operating profit outlook will result in an adjusted EPS range of $4.01 to $4.05. The change versus the previous outlook reflects the adjustments from retention, pricing, productivity and cost as well as a negative impact of $0.04 due to foreign exchange. Providing some color on the third quarter. We expect service organic sales to remain strong at mid-single-digit growth. mainly driven by repair and modernization that will continue to grow on the back of the strong orders momentum. New Equipment organic sales trend versus prior year is expected to continue to improve sequentially. Total adjusted operating profit is expected to be flattish in the third quarter. But with the impact of tax rate cannibalization, we anticipate that it will result in an adjusted EPS decline at a level similar to the first half of the year. For the balance of the year, we expect momentum to build in the second half as the operational actions Judy outlined continue to take hold. Service profit would improve sequentially as productivity increases and the benefits of our initiatives begin to materialize. Together with recovery in new equipment volumes, this positions us for profit growth in the fourth quarter. Stepping back, we recognized in the last quarters, we have faced challenges in service, which we are actively working to address. The execution of UpLift, while setting the foundation of a stronger and more efficient operating model did cause some disruption in service execution in 2025. In addition, portfolio mix has been a headwind driven by geographic mix and a recent increase in cancellations. UpLift has been completed, and our new operating model is working and running stable. We have taken the decision to reinvest in the core of the business, and we recognize 2026 is a year of investment. This requires a cultural shift into service quality and customer centricity impacting certain results. However, we strongly believe that the investments we are making today in service excellence are creating a strong foundation for the future. And as a next step, we plan to systemically drive excellence across our 1,400 operating territories through our service operating model. In addition to the maintenance strategy, we are excited about the sustained growth in repair and modernization that is expected to continue. This and the new equipment business being back to growth in the second half with a growing backlog gives us confidence that we are well positioned to sustain our industry-leading margins and capture growth for years to come. With that, I will kindly ask Krista to open the line for questions. Thank you.

We will now begin the question-and-answer session. [Operator Instructions] And your first question comes from Nigel Coe with Wolfe Research.

Thanks for the details on the guide. Maybe just -- I mean I think you kind of made it clear that you've dialed back on the micro pricing and -- but I wonder if you can maybe just talk about some of the productivity headwinds that you're seeing that wasn't clear. And then maybe, Cristina, could you just maybe just lay out kind of how you see the service margin progression through the balance of the year?

Yes. Thanks, Nigel. So listen, we -- let me be clear what we're doing with the AI micro pricing. First of all, we've seen tremendous success with it in our repair business. We see it. We see it flow through and we see it flow through rather quickly because from the time we take an order, we typically execute that repair backlog in a period of short -- low single-digit months 1 or 2 months and then we see it flow through. So we're very pleased with the ability to get price there. On the maintenance side, there's really 2 factors going on. One, which we've always known as most of our maintenance contracts come up every few years. So we don't have the opportunity to reprice them on an annual basis. So when they come up, we're trying to drive for that. But trying to balance retention rates with additional micro pricing is where we're trying to find that balance, Nigel, that says in the maintenance contract, let's see what's appropriate. We understand where our costs are and the micro pricing is giving us that detail by segmentation. But we also don't want to drive additional potential customers who are on the fence because of our former service quality challenges that we're now investing in, we don't want that to be the tipping point for them. So it's an account-by-account balance when we say we're kind of rebalancing that more so than a wholesale change or a pullback?

Nigel, I'm complementing to your 2 other questions about what happened with productivity and our expectation of service ramp-up -- service margin ramp up in the second half. So first, stepping back, we are very pleased with the service revenue take up in the second quarter. This is in line or even above expectations. And also the investments we portrayed in the last quarter, we said $50 million this year. They are progressing exactly on plan. While we have observed in the second quarter on productivity is twofold. On the one side, as we are investing, we see the cultural shift into quality and customer centricity that is creating some headwinds in productivity that we are actively addressing. The second component is temporary that is related to the ramp-up of resources because we are increasing the number of mechanics that we are allocating into highly skilled activities, repair a modernization and the onboarding time is longer because of the preparation required for those activities. And second is, we have significantly accelerated execution of most 24% in the quarter in order to deliver our customer commitments. And this creates some headwinds in rate in order to have the resources available when and where needed. Now looking into the second half of the year. We are very positive about revenue growth. This is going to continue. We are expecting in service approximately 6% revenue growth in the second half of the year. The reason from 9% to 6% in the second half is because modernization would normalize to a low teens level. Then on the New Equipment side, we are also going to continue growing. In fact, we expect positive growth in Q3 and the margins [indiscernible]. Looking at the margins in service when you compare first half that are around 23.1% to the second half expected around mid-24%, this is a 150 basis point margin expansion in the second half based on 80 basis points from repair price. This is happening. We see that coming in the backlog. 50 basis points coming from modernization and repair volume also happening. We have the orders in place and we have the resources to execute. 30 basis points is the SG&A allocation into service. You may remember that we communicated $10 million restructuring in nonfrontline related activities last quarter. This has been executed in the last 2 months, and we are now going to capture the benefit in the P&L. And we have a little bit of headwinds from FX because of the mix of the -- where the FX moves are coming from. This is assuming the productivity headwinds we have seen in Q2 will continue in the second half, which is an opportunity for us to address and to do better.

Okay. I realize I ask the multi question there. But maybe if I could just follow on. Before I do that, Cristina, I just want to say congratulations on the World Cup. Huge for Spain obviously...

Thank you, Nigel.

Very important, obviously, to mention that. And then just on the retention, Judy, I think you mentioned retention has taken longer to -- improvement taken longer to achieve. So just maybe just kind of put a bow on that point. Why is it taking longer? And are you still confident by year-end, you're going to make progress.

Yes, we're absolutely going to make progress and continue. Nigel, you've always heard me say orders can be lumpy retention varies by quarter, which is why we try not to report it quarter-over-quarter, but we certainly watch it more frequently than that. And what we're seeing is just some -- we had some retention challenges, primarily in our portfolio in the Americas was down, not significantly, but down a little, and that's why we are investing in service excellence, and we're continuing to do that throughout 2026 because where we see we've made the investments we're seeing as the service quality improve -- that hasn't instantaneously changed the retention rate. You're talking about a portfolio of 2.5 million units with the average customer having 4 units. So we -- across the globe. So we have a lot of customers, and we really need to drive the service operating model and buying good service excellence and customer centricity. And all of that, we really are convinced will show improved retention at year-end. We understand how important that is. And we did see portfolio gains in EMEA -- we did see significant portfolio gains in China in high single digits, and we did see it in Asia Pacific as well. So we're comfortable that we have the trajectory to get there. We're also comfortable we've got the initiatives and the folks to get there. I can tell you if you stop any Otis colleague who I really need to thank our 72,000 colleagues are working diligently every day but so many of them are customer-facing. And if I ask them, what do you think is most important? I think they're going to answer first, safety because it's one of our absolutes. And the second thing they're going to say is satisfying our customers. And that's the culture change that we want to ensure in doors and then we measure it through return.

Your next question comes from the line of Jeff Sprague with Vertical Research.

Judy, I just want to come back to retention for a follow-up. Maybe just kind of get to the root cause, sort of the nature of my question is, right, we kind of had the retention disruption with kind of the UpLift program. There was some customer connectivity that wasn't clear until the program was executed and it caused some disruption. I sort of thought that was behind us. So is it really you're seeing just more elasticity to price now as you're moving through this I guess I'm not surprised retention is not going up quickly, but I'm a bit surprised that it's gone in reverse in at least a couple of places.

Yes. Listen, Jeff, it's gone in reverse in a couple of places, but only by -- if you look at the first half of the year, I'm not going to give you a number, but it's a small number of basis points. But you know us to be transparent. We're always going to tell you whether it's up or down and share good news and bad news, but make sure we act on it. It's not pricing elasticity it's not ISP is gaining share. It really is, if you think about a 4-year contract in North America, we still have some residual flow-through regardless of the service excellence we're doing with some customers who were just -- who are choosing to change based on multiple years. . We are focused on addressing that through service excellence. I think the service operating model will address that in total across the enterprise. And so these lighthouse operating territories where we've done the service excellence using the 7% gain and the majority of those -- the clear majority of those have much higher retention rates that track with those service quality metrics. But it's not what people naturally go to on price or on a different service offering from an ISP.

Understood. And then just a comment, I think it was Cristina. I think you said kind of the shift to quality has negatively impacted productivity. Is that indicative of just the higher level of training? Or what's really sort of the root of that?

Well, part of the root of it is as we -- it's really interesting in our industry. And again, with 2.5 million units some mainly Otis but other non-Otis equipment. The equipment is aging, and we see that, obviously, through the great upside we've seen in repair and modernization revenue, and that demand is going to continue but with that comes some more complex maintenance that has to happen on our comprehensive contracts, and so as we see that unfold, that's not so much -- there's some labor involved in that, and we discussed that but there's even more material involved for some of these older -- these contracts where we offer comprehensive service, and we have seen inflation in repair parts. We've seen inflation in raw materials, but especially in repair and spare parts for the [ non-Ernest ] equipment we've seen pretty significant inflation, and we have our maintenance contracts for 4 years. So that's what we need to offset. And we've seen that because of the quality focus. So that's what we need to offset with productivity and eventually with price when that comes up for renewal.

Your next question comes from the line of Alexander Virgo with Evercore ISI.

I wondered if you could just expand a little bit on this tempering of micro pricing point. I think Jeff was talking or alluding to the fact that maybe you've got a bit of price sensitivity, and it sounds like you've still got a bit of a hangover from the sort of legacy customer quality issues. I was wondering how much of this is sort of a function of you trying to push the price up and discovering that actually, these guys are going to walk away. So you're going to just temper that and that's what tempering means. I wondered if you could talk a little bit about what you're expecting before versus what you expect -- it feels like it's quite a big swing. So if you could expand on that, that would be super helpful. And just as a follow-up, on the service margins, Cristina, thank you for all of the detail on that. That's super helpful. You talked -- I just wanted to clarify, ultimately, you talked about productivity headwinds remaining in the second half despite all of the other things you talked about as a tailwind. So as we roll into 2027, what would we -- what should we be thinking about in terms of these productivity headwinds, the $50 million as we look to '27?