Q2 2022 Otis Worldwide Corp Earnings Call
The country.
[music].
Good day and thank you for standing by welcome to the second quarter 2022 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one one.
On your telephone please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today Michael.
Rednour Senior Vice senior director of Investor Relations. Please go ahead.
Thank you Michelle welcome to Otis second quarter 2022 earnings conference call on the call with me today are Judy marks Raul Guy and on Iraq Maheshwari.
Please note, except where otherwise noted the company will speak to results from continuing operations, excluding restructuring and significant 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.
<unk> noticed a second 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.
Thank you Mike and thank you everyone for joining us we hope everyone listening is safe and well I'd like to welcome Anorak Maheshwari and joining US. This morning on Iraq is an experienced executive that many of you have worked with in his prior role leading investor relations at Harris more recently, he has been leading our finance team as CFO in the Asia.
Pacific region since spin I look forward to my partnership with Iraq, and driving growth operational execution and value for our customers colleagues and shareholders.
I want to also take this opportunity to thank rule for his leadership and all of his contributions and transitioning <unk> to an independent company and in championing our long term strategy, we wish him well in his future endeavors.
Before I get into the results and outlook on our Q1 call. We noted our growing concerns about the long term sustainability of our operations in Russia.
At that time, we removed <unk> Russian operations from our 2022 outlook and prior year compares.
Mitch mounting regulations, we concluded that the best solution for our customers colleagues and shareholders was to divest this business and we recently entered into an agreement to do so.
Closing of the transaction is expected imminently we remain.
Hopeful for a return to peace and stability in the region and we will continue to contribute to the ongoing relief and humanitarian efforts in Ukraine.
This quarter and going forward <unk>, Russia operations and related nonrecurring charges are excluded from our adjusted results prior year compares and our outlook.
Moving to Q2 highlights on slide three.
Otis delivered a solid second quarter closing out a strong first half, especially considering the macro headwinds that we faced we grew organic sales expanded margins and achieve 12%, 12% adjusted EPS growth.
We had record new equipment bookings and continue to build our maintenance portfolio that was up nearly three 5% in the quarter.
Our service business continued to deliver this quarter, where we grew sales in all lines of business and expand in margins due to favorable pricing and productivity.
We generated $326 million in free cash flow, while continuing to return cash to shareholders completing another $200 million in share repurchases on top of the 200 million completed in Q1.
In addition, as expected so our Georgia Otis was delisted in early May.
We gained approximately one point of new equipment share in the second quarter, driven by high teens, new equipment orders growth through this in a market that was down mid single digits globally.
New equipment orders in the Americas were particularly strong up 57% despite facing a difficult compare in the prior year.
In Los Angeles, we're supporting the modernization of terminal four at Lax.
<unk> was selected to provide 13 Gen. Three elevators further extending the long term relationship with the general contractor Hensel, Phelps and marking our latest project at L. A X.
In Paris Otis was selected to support the construction of the tour triangle of 180 meter high tower that will include office hospitality and retail spaces.
During the construction phase and Otis Sky build self climbing elevator will ascend is the floors are bill providing speed and simplified logistics to the buildings construction teams.
The building is designed to meet several environmental standards that Otis will help support by providing space saving digitally native solutions like our Gen 360 platform Sky rise double deck elevators and comp was 360 destination dispatching.
In South China is greater Bay area artists to supporting several projects to fuel Smart City development.
In Guangzhou Canton Fair complex, we will provide more than 140 sky rise in Gen. Three elevators as well as escalators for phase four of the Canton fair complex, including Iot systems that will monitor performance in real time.
In Shenzhen, the new China life insurance tower in the Central business District will be served by 20 O to sky rise elevators and in Zhuhai.
This will prevent will provide nearly 90 elevators and escalators for the Nanping Royal Times Square. This project will include Gen. Three elevators equipped with <unk> latest ambiance features and digital technologies, serving passengers headed to offices shopping centers and hotels.
And lastly in Korea, <unk> was selected to provide more than 45 elevators and escalators in the teachers' pension tower, our landmark building in the financial district of Salt.
This project will include our <unk> 360 destination dispatching system to seamlessly move tenants between nearly 50 floors.
Moving to slide four Q2 results and 2022 outlook.
New equipment orders were up 16, 5% at constant currency in the second quarter and up eight 5% on a rolling 12 month basis.
Organic sales were up 0.4% and adjusted operating profit margin expanded 20 basis points and was up $16 million at constant currency driven by strong performance in the service business.
Free cash flow conversion was robust at 102% of GAAP net income.
Looking ahead to our 2022 outlook, we're revising our full year outlook and now expect organic sales growth of two five to three 5% with net sales in the range of $13 six to $13 8 billion.
Adjusted operating profit is expected to be in a range of $2 one to $2 2 billion.
$120 million to $150 million, excluding the impacts from foreign exchange.
After approximately $145 million and headwinds from foreign exchange translation adjusted operating profit at actual currency is expected to be up $5 million to down $25 million.
Adjusted EPS is expected in a range of $3 17.
To $3 21.
Up 7% to 9% versus the prior year.
Lastly, we still expect free cash flow to be robust at about $1 6 billion.
We're approximately 125% conversion of GAAP net income.
We will remain disciplined and balanced on capital allocation advancing our bolt on M&A strategy, where it makes sense and returning cash to shareholders through dividends and share repurchases, which were now in a position to increase to $700 million versus the $500 million target announced previously.
With that I'll turn it over to rule to walk through our Q2 results in more detail.
Thank you Judy and good morning, everyone, starting with second quarter results on slide five.
Net sales of $3 5 billion were down five 8%.
Primarily due to broad strengthening of the U S dollar.
Organic sales were up 40 basis points, the seventh consecutive quarter of growth driven by service, which increased over 5%.
Adjusted operating profit was down $21 million, excluding the impact of translational foreign exchange adjusted operating profit was up $16 million at constant currency.
Drop through on higher service volume.
Favorable service pricing and benefit from productivity in both segments was partially offset by the impact of commodity price increases and annual wage inflation.
We also continued our unrelenting focus on cost containment.
Adjusted SG&A expense was down over $50 million of 90 basis points as a percentage of sales.
Even with inflationary trends in the economy.
Despite the challenging environment, we maintain the investment in the business and R&D spend and other strategic investments were flat versus the prior year.
Adjusted EPS was up 12% of <unk>.
A 6% headwind from foreign exchange translation was more than offset by strong operational performance.
Accretion from the <unk> transaction continued progress on reducing the tax rate and the benefit of $400 million in share repurchases completed year to date.
Moving to slide six.
New equipment orders in the second quarter were up 16, 5% at constant currency.
Orders in the Americas were up over 50% with growth in all verticals on top of nearly 50% growth in Q2 of 2021.
Award, which proceed orders in North America stayed strong and were up five points on a sequential basis.
EMEA orders were up 29% with growth in both Europe , and the middle East and orders in Asia outside of China were up double digits.
Driven by strong growth in South Korea and India.
Their bookings were more than double last year's volume.
Orders in China were down low teens outperforming the market that we estimate was down about 20%.
Strong orders growth contributed to new equipment backlog, increasing 6% and 10% at constant currency.
Clog in China was about flat and backlog in Americas, EMEA and Asia outside of China was up approximately 15%.
Globally pricing of new equipment orders was up low single digits after five straight quarters of year over year decline.
Pricing trends improved year over year in all regions excluding.
Excluding China, where pricing was down low single digits versus the prior year.
New equipment organic sales were down 5% in the quarter as low single digit growth in EMEA and high single digit growth in Asia, Excluding China was more than offset by mid single digit decline in the Americas due to a tough compare from the prior year and slowdown in building construction and.
In a low teens decline in China from Covid related Lockdowns.
Adjusted operating profit was down $28 million at constant currency.
Largely from the impact of lower volume and related under absorption.
Commodity inflation of $35 million that was in line with products for patients was mostly mitigated by installation and material productivity and lower SG&A expense.
Service segment results on slide seven.
Maintenance portfolio units were up nearly three 5% from improvements in retention recaptured and conversion rates with recaptured units more than offsetting cancellations in the quarter.
And China conversion rates continued to improve year over year and contributed to the fourth consecutive quarter of high teens portfolio growth.
Modernization orders growth accelerated to 9% in the quarter.
With growth in all regions driving backlog growth of 4%.
Service organic sales grew for the sixth consecutive quarter up five 2% with growth in all lines of business.
Maintaining to repair grew four 9% as the benefit of strong repair volume and growth in contractual maintaining sales that outpaced our unit growth due to improved pricing, which was up about 3% on a like for like basis.
Modernization sales continued to recovery that started in Q4 of 2021 and were up six 4% in the quarter with.
With growth in every region.
Service profit at constant FX was up $39 million.
Benefit from higher volume.
Favorable pricing and productivity was partially offset by annual wage increases.
Margins were up 50 basis points, the 10th consecutive quarter of margin improvement.
Overall, the first half results reflect solid operational execution with a point of new equipment share gain.
The best portfolio growth in a decade.
And close to $125 million of cost reduction between productivity and SG&A.
These actions helped us manage through the continuing macroeconomic challenges and achieved low single digit organic sales growth.
$50 million of earnings growth at constant FX and 15, 8% adjusted margins.
Cookie basis point improvement over the first half of 2021.
Margins for the first half are up 140 basis points from pre COVID-19 levels of comparable period in 2019.
First half free cash flow generation of $800 million.
50% of our guide for the year enabled us to repay $500 million of debt.
<unk> dividends by 20% and complete $400 million in share repurchases with that let me turn it over to en route to walk through our revised 2022 outlook.
Thanks, Rolla and Judy for the kind introduction and good morning, everyone.
I am excited to be here and look forward to continue the great work role has done in advancing our long term strategy driving operational excellence execution and creating value for our shareholders. Thank you Raul.
Let me start on slide eight with a recalibrated outlook that.
That incorporates the evolving macroeconomic headwinds combined with a continued focus on things we can control.
We are rating service growth driving productivity, optimizing the tax rate and reducing our share count.
Starting with sales we are expecting organic sales to be up two 5% to three 5%, which was half a point lower than the previous guidance driven by a reduction in the new equipment segment, partially offset by better expectations for service.
New equipment sales are lower margins remain unchanged.
<unk> to be down 20 to 60 basis points versus the prior year with the impact of lower volume offset by improved productivity.
Service margins are now expected to be up approximately 60 basis points, a 10 basis point decrease from the prior outlook, reflecting the mix impact of modernization sales growing faster than the maintenance and repair business.
The overall margin outlook remains unchanged versus the prior outlook and is expected to be up approximately 30 basis points to 15, 7%.
Adjusted EPS is expected to be in the range of $3 17 to $3 21 up 7% to 9% versus the prior year.
This high single digit adjusted EPS growth is driven by strong operational execution accretion from the <unk> transaction.
Chris on reducing our tax rate and a lower share count more than offset 42 cents of headwinds from foreign exchange translation and commodity inflation.
Our free cash flow guidance for the year remains unchanged at $1 6 billion and we have increased the 2022 share repurchase target from $500 million assumes $100 million.
Taking a further look at the organic sales outlook on slide nine.
New equipment business is projected to be down <unk>, 5% to 1%.
This is a point and a half decrease from prior outlook at the midpoint driven by revised expectation in the Americas and China.
While the backlog in Americas was up more than 10% shipments are shifting from 2022 to next year from delayed building construction activity by our customers.
As a result, we now expect Americas organic new equipment sales to be about flat versus up low single digits previously.
We expect Asia to be down low single digits from down slightly previously driven by China.
Despite our backlog being flattish versus prior year and up from the end of 'twenty. One we now expect Otis China organic sales to be down mid single digits, driven by lower market expectations now expected to be down approximately 10% at the low end of our prior guidance.
And the impact of Lockdowns during Q2 that have more projects to the right into 'twenty three.
This has been partially offset by improved outlook in Asia Pacific from the benefit of strong orders growth and momentum in India and South Korea.
Outlook on new equipment organic sales in EMEA remains unchanged and is expected to be up low to mid single digits in 2022.
Turning to service, we now expect organic sales to be up five 5% to six 5% an improvement of 50 basis points from the prior outlook of 5% to 6% driven by strong maintaining pricing robust repair order growth in the second quarter and incrementally higher confidence to convert our modernization.
Backlog that is up 4%.
Moving to slide 10, we expect adjusted EPS growth of 7% to 9% or 24% increase at the midpoint.
The 18th or $110 million headwind from commodities is more than offset by the $230 million to $260 million.
Of operational improvement through higher service volume and pricing productivity in both segments and other cost containment actions, resulting in profit growth of $120 million to $150 million at constant currency.
This is $5 million higher than our prior outlook at the midpoint.
Accretion from the Zohar transaction close to two points of tax rate reduction versus last year and the benefit from $1 4 billion of share repurchases since spin is more than offsetting the 24% a $145 million headwind from the unprecedented strengthening of the U S dollar.
We have now assumed a euro at one point or one for the second half of the year of $1 <unk> five for the full year.
Compared to the prior guidance, we are offsetting more than half of the incremental FX headwinds by driving the service business containing costs and reducing the tax rate and an additional point now projected to be 26, 6% for the year at the midpoint.
Overall this outlook clearly reflects our ability to mitigate the macro challenges and deliver another year of solid organic top line growth margin expansion robust free cash and importantly, strong new equipment backlog in service portfolio growth that positions us well for 2023 and beyond.
And with that I will request Michelle to please open the line for questions.
Thank you to ask a question you will need to press star one on your telephone please standby, while we compile the Q&A roster.
And our first question comes from the line of Jeff Sprague with vertical Research partners. Your line is open. Please go ahead.
Thank you and good morning, everyone and congrats.
Sure.
Hope, you're all doing well.
First just on China.
Obviously, a lot of headlines.
The outlook as you presented it.
Down mid single digit for the year end market downturn actually sounds surprisingly okay.
Actually I wonder your your confidence level on that relative to backlog in.
Backlog conversion.
Whats happening on the ground, if you could give us a little update there.
Sure Jeff Good morning, it's Judy.
We are taking our market growth estimates down.
Due to the lockdown and impact that we felt in April and May and we just don't expect that the market will recover fully in 2022, so we've taken the.
The market for 2022 to decline at about 10%, which is the low end of our previous range and I will be sure to disclose that that does not assume or factor in any return to growth or any stimulus listen I'm feeling good about the health of our business in China, our strategy and our initiatives are on track it is helping us.
Gained share as you have seen and we grew faster than the market not just in Q1, but also in this most recent quarter, our new equipment orders were down low teens, but the market was down 20% in the second quarter. So we're outperforming the market and that's really what gives me the confidence that our strategy is working.
Residential infrastructure and industrial were what were strong in the second quarter in China, and the higher tier cities tiers, one through four but especially one in too.
Have really continued to perform for us and the market in general and that's really where we focused our strategy we've doubled our agents and distributors and that is continuing to yield we're now at about.
2250 agents and distributors, who are representing both our product and our services. So net share is often a down China market and we have really also focused on our service strategy.
We're all set we had our fourth consecutive quarter of high teens portfolio growth and Thats, where the growth is going to continue in China. So we're trying to find balance in China, and then we have balance in geography, and our mix China's about 20% of our global revenue and really as you've seen in the second quarter the balance of our.
Business Asia Pacific Europe .
And Americas, just really picked up the pace and we're feeling good the backlogs there across the globe and we've got the new equipment orders that are going to continue to drive our future well into 'twenty three so we're watching China like everyone else, but a really strong Q2 by Perry on the team.
Post the Covid Lockdowns, our factories are manufacturing at peak rates, we've got capacity. If there is a stimulus and in all of our service indicators are really strong when we can tell you across the globe, including China that are recaptures for the first quarter of <unk>.
Exceeded cancellation rates second quarters, having exceeded cancellation rates.
We are managing every <unk> and every metric and the team is delivering.
And Jeff just to add to that Robert.
Just sorry, just to add to that.
Said in my prepared remarks, and I think thats important for everyone to recognize that our backlog in China getting into second half is flattish year over year. So the <unk>.
Orders were down kind of low teen sales were down so we enter into the second half of the year.
Flattish backlog, so as we take as the devising a guide for the year.
We are projecting a sequential improvement in.
And year over year growth will be down about.
Between first quarter and second quarter were down about 9% and the full year is down kind of mid single digit so that does.
Second half is still down but not down to the same extent as the first half. So that's clearly the case and that revenue is going to be up sequentially between first half and second half the conversion to your question is a little bit slower given the lockdown not all the projects that we have projected will.
It will be completed in 2022, so that pushes some demand into 2023. So overall, we think our conversions are going to be down kind of high single digits for the year relative to a very very strong 2021, but there is still kind of inline with where they were pre COVID-19. So conversions are slower than last year, but in line with pre COVID-19 levels. So.
That's where we are.
That sounds great and then.
Just on the Americas I mean, these orders really.
The headline growth itself, and then especially versus the comp is just extraordinarily strong.
I Wonder if you could give us a little bit more context on what's going on there are couple of large lumpy things perhaps.
But also address kind of the revenue slippage.
Primarily.
Job site issues with your customers or you see.
Folks kind of tapping the brakes on economic concerns just any any additional color there on the Americas would be appreciated.
Yeah, well kudos to jam in the Americas team.
Orders are always lumpy, Jeff you know that.
In all industrials, but especially in our business, which is longer cycle.
But this was a this was all volume driven quarter for our Americas team I can't peg it to a significant major projects are huge major orders. So it was just strength and the biggest strength we saw in the Americas was actually in residential and it reflects what we think is this population migration growth.
Because we saw residential uptick in the south in the Western U S and in the tier two cities. So it's fitting that thesis that you are hearing from others, but we're seeing it come through in the orders book. So just really strong performance across the board across all of our branches.
And everybody just just delivering in converting those awards, which is what we measure as well into orders in terms of the 22 some of that moving into 'twenty. Three we told you last quarter that we have some large projects that we didn't expect.
Lot of the revenue to happen until 'twenty three what we are seeing more is not not a shift.
Beyond really labor and job sites.
And it's not our labor, we're fully staffed but it's general construction labor from the general contractors and just a slowness because of the demand in the right places in the right cities, especially in the south and the west So it's a little bit of delay versus our normal cycle time on some of this <unk>.
The revenue come through but it certainly it's going to happen and should bode well for 'twenty three.
Great. Thanks for the color.
Thank you and our next question.
Is from the line of Nigel Coe with Wolfe Research. Your line is open. Please go ahead.
Thanks, Good morning, everyone.
And thanks.
Thanks for all the support and help you've been great. Thank you very much.
Thanks for all the support and help you've been great. Thank you very much.
Good luck.
So I just wanted to maybe.
Just come back to.
Ill comment on China.
Low teens decline.
That spending will be expected, then obviously a lot better than some of your comps so.
Curious how does that compare to your plan comment, but you gave a specific plan for we expected in China than you did but how does that play out.
And more importantly, how does that track through the quarter. I know you are behind the curve kind of mid May just wondering how that track to June and what we're seeing through July so far.
Yes, so Judy Nigel Great to talk to you in June June was a tremendous month for our team.
They just the response was phenomenal and actually our shipments we hit a record level of shipments out of our factories in China in June So we were prepared.
We our factories never shut down just based on Geo location of them in China. So I think we had some some some readiness both our elevator and escalator factories ready to go and then we just needed to produce them, we needed to be able to ship and cross cross boundaries in China certain region.
So the team had gotten prepared for that so June was a strong overdrive.
And July performance continues.
We don't we don't guide to the quarter, but obviously April and May gave us pause, but our team was prepared for it and now we're going to match our cost structure to what we're seeing happening in terms of the market itself. We've done that before but we are not expecting the precipitous drop we saw in 2015.
We don't believe there is a.
And instantaneous type of drop there and we're going to we'll again, we'll match our costs to what we're seeing happen in the market.
Great. Thanks, Judy.
And then on.
The backlog, maybe just give us a little bit of a taste of.
There's still a macro maybe a recession, what typically happens to your backlog do we see.
Cancellations do we typically see push outs.
Should we expect maybe if you can talk about new equipment versus.
Monetization that'd be helpful.
Yes, Nigel what we are seeing right now, yes, there are some projects that cancel but.
It's always the case, but as you know we get in advance when we book an order. So it is not to be booking an order or the unlike some other industrial companies. There has been some concern about.
But given the overall supply chain challenges our people, placing multiple orders that doesn't happen in our industry, creating an.
Elevated wrote an escalator for a certain building.
And youre not going to switch designs midway through the project, so and we get in advance of the cancellation dual happened projects to cancel that get canceled, but we have not seen any change in Italy year trends and build up typically.
Small I mean, it's not a big thing in our business that we have to deal with massive cancellation that we have not seen any of that happen in any material way in terms of changes year over year. So the trends are kind of similar.
Projects do move that I think Julie alluded to that in both I think we've seen that in China in terms of conversion, which to jeffs question and then into Americas as.
As those projects are moving out and I think it's the construction labor shortage in EMEA and in the U S that.
And that is creating some challenges our factories are more or less.
We are having supply chain issues, it's not that we're not having supply chain issues, but as best as we can track it and we're trying to track it very very rigorous view, we are not holding our projects.
The challenges we are facing is the customers are behind in terms of the building construction. So we are seeing that slowdown and that is flowing through our revenue, but you saw our backlog I mean, its up and both on a constant currency.
China is flattish in the other regions are combined up approximately 15% so that bodes really really well for 2023.
Absolutely. Thanks for thanks for that that's great. Thanks Nigel.
Okay.
Thank you.
Our next question comes from the line of Nick Hudson with.
RBC capital markets. Your line is open. Please go ahead.
Yes, hi, everyone. Thanks for taking my questions. The first one is on the tax rate, which was obviously quite a nice tailwind this quarter.
It looks like it was down about five percentage points quarter on quarter.
I know obviously you have been saying that you are working to reduce this on a structural level, but I'm just trying to get my head around what the.
<unk> that we've seen this quarter.
Is completely structural or whether we should.
Expect more normal levels in the next few quarters.
Yes no.
Great progress on reducing our tax rate and we lowered our full year tax rate guide to about 26, and a half plus <unk> six open at the midpoint. So that's about a point reduction from the prior guide and about two points down where we ended in 2021. So that's obviously really good progress in terms of the tax rate within the quarter.
It always timing impact on things that we are working on and when they get booked and the tax rate does fluctuate from quarter to quarter, but the actions that the team is taking is definitely reducing our structural tax rate and that is where we introduced our full year guide.
By about a point.
And now we are well within our medium term guide that we had provided of 25% 27% on Investor day. So we are kind of now in that in that range, which is really good progress.
And the progress has been a little bit more front end loaded we've made more progress than we would anticipating at the beginning of the year, but we are absolutely confident that we will continue to work our way through to that lower end of the guidance and but given the progress that we've made.
The rate of base will not be the same obviously, we're not going to get two points of production every year. So now we are within the range that I think youre going to see some improvement next year, but it's not going to be the same rate that we achieved this year.
That's great. Thank you very much.
My second question.
On the margin profile of Modernisation and just how that compares to.
Yes.
So this business as a whole.
Yes, my gut sense is that it's probably more like new equipment in terms of the profitability of that asset.
Any color you can provide would be helpful.
It's slightly lower than new equipment in our business and.
Typically our work in the modernization you know when you do modernization.
The attractiveness of that project is typically that youll get to renew your service contract for multiple years going forward right. So thats the attractiveness of its highly competed.
And you end up taking a modernization and job.
At lower margins on new equipment, but it's still it's still a profitable line of business. So it's not that we're losing money on modernization jobs as a whole we make money, we make decent margins on it our contribution margins are fairly healthy.
But they are lower and the other part that the other thing that modernization does help us. It does help with net absorption of labor so modernization growth, while the absolute margins that we attribute to that one line of business, maybe lower than others, but it definitely helps us with absorption overall, so it's good to see the growth it's good to see the factory.
Raising our our guide for the year keep in mind that these were challenged all last year on modernization, we had supply chain issues, we couldn't get <unk>, we're not able to get our supply chain ramped up but we are kind of worked our way through that and it's our third consecutive quarter of growth and modernization and now we are raising our guide from 68% for the year, which is.
Which is absolutely fantastic given based on what we had last year, yes, Nick It's Judy we just also very pleased with the progress we have been telling you for a while it was delay but there. This is discussed some of modest discretionary but every elevators now about three years older than than when we just before we spun so the market is.
Growing in Mod and it's got all the attractiveness of that stickiness, we want for the follow on service businesses are all set.
Thanks, guys very clear and <unk> best of luck in the future.
Q.
Thank you and our next question comes from the line of Steve Tusa with Jpmorgan. Your line is open. Please go ahead.
Hey, good morning.
Good morning, Steve.
Rahul Congrats again and thanks for all the help.
Over the last couple of years.
Of course.
Yeah.
Can you guys just give a little bit I think you said, 3% price and service is that right should we assume kind of.
Flattish in new equipment.
Yes, So service pricing was it was up 3% new equipment was actually up low single digits in terms of pricing. So we got price in both segments Steve.
Okay, and we should assume that most of the commodity.
Headwinds what were the.
Out of that I guess, youre guiding now kind of a $108 million 110 million bucks in commodities year over year inflation year over year, what was that number for the quarter.
The $35 million for the quarter, Steve 70 million for the year, So 70 million for the first half. So so <unk> 70 kind of 70% first half and about 40 in the second half.
Yes, that'll year basis, and the vast majority of that is coming in new equipment.
All of it is coming in new equipment, yes, Okay, and then one more question for you just on the on the second half and anything within the two quarters that we should consider from a seasonality perspective should we assume a little more catch up in China in the third quarter, and then a bit of a of a.
Fade on that in the fourth or how do we think about.
The trajectory of EPS.
Just between the third and the fourth.
Yes.
Steve It's under rug here right.
So if you look I think you are asking for the cadence between Q3 and Q4, yes. If you look at if you look at <unk>, both sales and op profit will look very similar to <unk> 22 reported currency and that is due to the large FX impact in the second half of the year right. Let me give you a little bit more details on the organic growth. If you look at our current guide we expect.
The second half to grow organically about 4% with positive growth in both any incentives.
Q3 was extremely strong for us where we grew organically by about 8% with the new equipment and growing mid teens in third quarter and low single digit in the fourth quarter to go we will see sequential growth in new equipment in Q3, it will be done <unk> given the strong compare.
As we get into fourth quarter, we do expect to see the return to organic growth as we can.
There is an easier comparable versus last year and also sequential growth.
On service for the first half we were up five 5% our guide of 6%. So that assumes about six 5% growth for the second half it should be pretty.
Consistent between Q3 and Q4.
In terms of their service growth now moving down to the profit side.
Given what I said instead of a new equipment, we will expect some year on year margin contraction and good quarter related to the under absorption but in.
In fourth quarter, you should see modest margin expansion year on year as the organic sales increase was.
Service I.
I would say, we see a little bit more margin expansion in the fourth quarter than third quarter simply based on the timing of the repair work because because it's more repair revenue coming into the fourth quarter. So overall, we will see margin expansion in both the quarters, but probably be more in Q4 and Q3. So if you take it down to the EPS line after normalizing for the <unk>.
<unk> rates, you'll see a couple of pennies growth in Q3, and the remaining coming out in Q4.
For the rest of the year pretty balanced in terms of our EPS growth through the quarters.
Great. Thanks, a lot I appreciate the color.
Thank you and our next question comes from the line of Julian Mitchell with Barclays. Your line is open. Please go ahead.
Thanks, a lot.
Rahul I wish you all the best in the new role.
Thanks for the help maybe a first question around.
The EMEA business is I don't think thats been touched on.
Too much but maybe help us understand sort of how comfortable do you feel on the service pricing environment in Europe as I know that was a big concern.
A decade ago, when you had a construction downturn there and also on the new equipment side.
Mixed picture from sort of other companies on what's going on in European construction.
Any updates from you on how that's looking in terms of order intake and so forth.
Yes Julien.
Really pleased with the service pricing that we've been seeing now.
Order after quarter in Europe itself. The majority of our service portfolio is western and Southern Europe as you know some in the middle East Southern Africa, but by far more far more heavily skewed towards developed Europe .
More than half of our service portfolio is there which is why the pricing is so important and the team has done a great job.
Again in service pricing, there, so and they had growth in our portfolio for two quarters in a row there in EMEA. So.
All showing the right trajectory by Bernardo and team in terms of the market that itself.
On the new equipment side, the core European markets are really strong.
And we had orders this quarter of 29, 3% for new equipment.
12 month roll of five 5%.
So all the indicators are there we're seeing a lot of those volume business and some nice major projects, whether it be around the Olympics coming to Paris or other places, we're seeing some nice major projects as well.
And so right now the only headwinds we're seeing are in eastern Europe , not surprising based on on the conflict. There. So construction is fine I think Rahul mentioned in one of his responses that that labor is always a challenge in terms of unemployment in Europe and with some of our installation subcontractor.
Factors, so we're managing that very tightly and very closely and we're moving our own labor around region to region country to country intra Europe to be able to handle some of these larger projects.
So I was wondering just to add to that just a couple of things to add on first on the construction outlook and then I'll come back to pricing maybe in a second but on construction outlook. What is good to see is that the construction outlook. The confidence level is up a couple of points, but it's still up and more importantly, what we see in the <unk>.
<unk> permits index. It is probably at the highest level over the last 12 months or so so that is good that the permits is still kind of hanging in there and in fact sequentially up.
From the last the latest output versus the prior report so that is good our proposals at up high single digits in EMEA. So our baseline activity is fairly strong. So its just not that we got the orders, but the underlying trends from both an industry and our own activity are strong as well and then on new equipment. We also got pricing.
In EMEA, our second consecutive quarter now of price improvement in EMEA kind of up mid single digits in the quarter, so sequentially better year over year than we were in the first quarter. So that is good that we are getting pricing as well and new equipment orders and on service I think Judy said it our pricing was up kind of in that low single digit.
On EMEA, but it's good that it's again, it's the same thing that we saw in the first quarter as well. So service pricing is good and that's where you're seeing the margin expansion come through one on service because we won't be able to grow our margins 50 basis points on service. If you were not seeing pricing in Europe , but that would not have happened. So that's an important component of our.
Our margin expansion.
That's helpful. Thank you and then just my quick follow up would be I.
I think you gave some color on the commodity impact this year, which is not really changing from from prior but as we think sort of a little bit further out maybe.
Remind us I suppose on the hedging practices on commodities.
Yes.
And also I suppose how quickly you think that things like lower steel costs will roll in your Cogs.
And what degree of tailwind you might benefit from next year looking at sort of steel spot prices today and again the speed just trying to understand the speed at which.
Changes in those prices relative to your cost of goods sold.
No great question Julian.
<unk> several strategies to lock in our prices with locking with our suppliers.
Ethernet spot are logging into the futures, which is our preferred option, we don't always get there, but we definitely lock in rates with our suppliers.
And we also hedge I think we've discussed before our.
Hedging is a little bit challenging just given that the grades of steel that we buy we don't always have a corresponding index. So we sometimes run the risk of <unk>.
Mark to market accounting on our hedges. So we do use hedges, we just can't use it as widely as we would like just given the nature of what we buy but overall, we had about 80% locked for the year almost 100% locked for Q3 Q4 spend is still slightly open.
So we could end up.
Prices have been coming down I mean, you're clearly seeing if you go to China.
Prices were down 15% in second quarter down about 30% year over year in Q3. So we're definitely seeing the prices come down. So we have a small single digit million tailwind for Q4, we could but the market has been so fluid that we definitely don't want to.
Baked that in now on a year over year basis, you're definitely seeing the benefit come through.
Prices have come down substantially from where they were.
So if you look at Q3 Q4 right now.
Steel in the U S is down 50% year over year. So yes, we should definitely get some favorability into 2023 and that will that will definitely come through as we buy we buy in Q1 and Q2, we will definitely see the favorable impact.
That's great. Thank you thank.
Thank you.
Thank you and our next question comes from the line of Cai von <unk> with Cowen. Your line is open. Please go ahead.
Hi, your line could be on mute.
So let's move to the next question.
Our next question comes from the line of John Walsh with Credit Suisse. Your line is open.
Hi, good morning, and I'll Echo, everyone, Congratulations Raul and entourage.
Thanks, Sean.
Thanks.
Maybe just circling back to China.
You talked a little bit about internal geographies within China.
Just your manufacturing wasn't as impacted by the others due to the Shanghai Lockdown.
Just curious how you think about these share gains you likely saw in the quarter as it relates to China do you think they're sustainable or if it kind of normalizes and maybe only keep a portion of what you gained just any thoughts around that.
John It's our strategy is on track in China, and our team is executing it operationally and I would tell you with excellence, we have figured out and invested in sales coverage, we've invested in product innovation with our gen three offering.
We have our factories some of them are already an industry four <unk> and all of these investments and strategies are paying off we've had share gain now in China for multiple quarters, and we believe it's absolutely sustainable we think we're at the right price point with the most innovate.
<unk> products with the right customer relationships through our agents and distributors and it's all coming together and working so even in even if the segment declines we should still be able to gain share.
Great.
And then you touched on capital allocation, obviously generating a lot of cash.
Just curious as you look at the opportunities should we think about kind of more service portfolio acquisition.
Men software kind of just any color you have there on what we should expect.
Our capital allocation strategy allocates about $50 million to $70 million a year for bolt on.
M&A.
Obviously, this or doing a transaction was.
Great opportunity for us at the right time at the appropriate and fair price and we not only executed it well, but with the squeeze out we're able to execute it as quickly as possible and we're seeing the benefit of that with the <unk> <unk> EPS gain this year and there'll be a little more next year, but really our M&A strategy.
<unk> revolves around adding to our bolt on service business and we've been doing this.
For years it gives us.
You know in places, where we have density and opportunity we make it accretive no later than year, two and we have a playbook for doing it we've got a really good deal book.
Across the globe to continue doing it and that's what you're going to see from us.
Great. Thank you for taking the questions.
Thanks, Sean.
And our next question comes from the line of Mcgill <unk> with Exane BNP Paribas. Your line is open. Please go ahead.
Hi, Good morning, everyone. Thanks for taking my questions. The first one just to follow up on the order intake specifically in the Americas, where he said mostly comes from.
Dan Shull and volume can you give us a flavor for timing of delivery I suppose lead times and residential are shorter and then can you talk about pricing of these new orders do they contribute positively to the backlog margin wise.
Yes, Miguel can I, you said residential and a second word I didn't quite hear could you clarify.
The residential orders in the U S.
Okay, just residential okay, yes so.
Residential in the U S is our traditional cycle time, it's condominium apartment buildings.
And the like it's a typical lead time that we have four for all of our all of our projects.
So we anticipate that that will continue to fill the pipeline again with a strong backlog for our Americas group to execute.
Will do you want to touch on.
Yes, it's about 12 months Miguel so thats typical events, Judy saying like we.
We typically see 12 months and I think these new orders are going to be in.
And the same same range as well so we should see the orders that we're getting now is probably translating into revenue in the second half of next year.
And overall I think in Americas, we got some really good pricing.
In fact pricing was good new equipment pricing was up I think you had said in my prepared remarks up kind of low single digits. So if you and you said China was down.
A couple of points, but that basically implies that all of the regions Americas, EMEA and Asia Pac outside of China was up mid single digits. So we're getting good pricing and implemented these pricing actions in Q2 Q3 of last year, and we had seen the turnaround in Asia Pac and EMEA.
So it was produced really good to see the turnaround in Americas, It's coming just as we had we would have expected, but the pricing overall is.
Slightly better I would say in the Grand scheme of things. So the pricing is good in China, while I just want to comment on China pricing, while the pricing is down keep in mind that the commodity prices to response to Julians question. There we are seeing.
Commodity prices down 15% in the second quarter, 30% in the third quarter, so even even new equipment pricing in China is down we are seeing we are price cost neutral in the second quarter in China. So overall pricing of new equipment is good and America has kind of led the way for us on new equipment pricing, Yeah, and I think what youre seeing in Nogales the entire team.
<unk> is absolutely focused on cost reduction SG&A is down 90 basis points.
The percent of sales this quarter and it just reinforces everything we can control we will and we've said this since we've spun we're going to continue to drive SG&A as a percent of sales.
To be to be as low as absolutely possible, while still investing in our business on the other side.
That's great. Thank you and then just on labor inflation can you give us a flavor for what you've negotiated with the union.
When will that hit.
And whether you expect this to be passed both the new equipment and maintenance.
So we have many agreements for labor negotiations, obviously works councils in Europe . They come up at all different times are U S. Labor negotiation has been concluded.
It's a multi employer agreement and those rates will be effective on one January so we have the and it's a five year agreement. So we have the ability.
And the knowledge, most importantly to offset that with productivity. So we obviously pass through and raise prices, but that has to cover on the service side wage inflation to the best of our ability as well as on the installation side for new equipment, but we offset that with productivity and and then volume and price increase.
Should drop through.
Great and then just one quick question on China can you just quantify the loss.
And EBIT from Q2, and whether this will be fully recovered already in Q3. Thank you.
Yes, I mean, so what I would say is quantification that you can you can debate it right I mean, the overall the sales are down about 12% in the quarter.
Just like in Q1 was down slightly so you can average maybe six seven points I would say is the stuff thats moving around but I think the more important part to focus on as a guide for the year right. I think we provided you guidance for the year, we Havent lost sales. It just shifting revenue from Q2 to Q3, I think we should be able to capture most of that but it all depends on the <unk>.
<unk> of the projects clearly we've spoken about the fact that we expect the market to be softer and we expect conversion rates in China to be slower than they were at.
At the same point last quarter, so conversion rates are slower so some demand shifting to the right, but overall I think the important part to focus on as a guide for the year.
Thank you so much and good luck. Thank you. Thank you. Thank you Michael.
Okay.
And our last question comes from the line of Joel Spungen with Bahrenburg. Your line is open. Please go ahead.
Yes, hi, good morning, everyone.
Judy I was wondering if I could start by asking a question on the comments you made earlier in answer to another question about why you don't think that what's going on in China is similar to the situation.
In 2014, 2015, I mean, if I was to play Devil's advocate for a second I would say well.
Housing inventory levels.
Alarmingly high rates as high as 2014 sales of new floor space on the Cratering.
Why are you.
More sanguine about the outlook for the Chinese market in the longer run.
Yeah, So listen I do believe there are structural changes eventually that will impact the China property market.
But we don't believe Joel that it'll be as precipitous as it was than there was in our industry. Certainly there was tremendous supply overcapacity, which then drove a significant pricing actions.
That made the entire industry far less profitable and that we're not seeing I think we have 90% of the new equipment for.
Fulfillment today is by the top 10 providers almost all of those providers are public companies. They are all.
From the best we can see pricing rationally.
And I will tell you <unk> is in a far more competitive position, we have less factories than we did we have we have a better offering than we did in terms of innovation.
Have a far better sales network. So we are better aligned with this potential gradual slowing and we have the ability to control that far better than that precipitous drop where there was just a buildup from 2000 until 2015, and then a sharp drop off so do I believe.
There are structural changes coming over time absolutely.
But we are far better prepared for that and I expect our team will perform just like we have for the past multiple quarters and actually perform better than our peers.
Thanks Judy.
Just to add to that just to add just a couple of data points to add to what Judy said I mean, if you look at things that are different now I believe from if you will by 2015 2016 first if you look at the inventory residential inventory its a three to four months I didn't has been hanging in there in fact came down a little bit over the last six quarters that it was like three five months of inventory.
Which is lower than $3 eight from and from April and I believe if you go back to 16 and 17 I don't know the numbers in front of me, but I think it was at this point maybe double the levels.
It is today, so at six six and half months of inventory. So that is good and even if you look at the investments that real estate investment now thats about five down about 5% floor space under construction is down about three so yes things are not great, but they are definitely not pointing to the same levels of decline that we saw back in 16 and 17.
And the last the last differentiator I'll give you Joel is that we're seeing the state owned enterprises have a far larger impact and that bodes well for our our relationships as well as our performance in our installed base and our and our customers.
So.
We've been watching not just watching the trends, but our strategy has been to prepare for this.
And we are ready.
That's great. Thanks. Thank you if I could just squeeze squeeze another one in very quickly just to clarify ready with regards to your comments on the North American new equipment market Youre, saying that the delays youre seeing a purely it sounded like a function of issues on the construction side with factors such as labor you are not seeing people delaying.
<unk> projects because of increased concerns about the economic outlook or anything like that.
That's correct, it's labor availability in the right market on the job site from all the trades.
From a people pouring the hoist away with the cement to the general contractors.
Great and thank you Rahul and good luck with your with your new job.
Thank you Joe.
Thank you. This does conclude today's question and answer session and I would now like to turn the conference back over to Judy marks for any further remarks.
Thank you Michelle this solid first half demonstrates the strength of our strategy.
And our ability to execute and adapt to mitigate the significant macroeconomic challenges. We will continue to focus on strong execution to deliver high single digit adjusted EPS growth in 2022 with continued growth in 'twenty three and beyond.
You for joining us today, everyone stay safe and well.
This concludes today's conference call. Thank you for participating today's conference call. Thank you for participating.
The conference will begin shortly to raise your hand during Q&A you can dial one one.
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