Q3 2022 Otis Worldwide Corp Earnings Call
Yeah.
Good day and thank you for standing by welcome to the Otis third quarter 2022 earnings Conference call.
This time, all participants are in a listen only mode.
After the Speakers' presentation there'll be a question and answer session to ask a question. During this session you'll need to press star one one on your telephone you will then hear an automated message advising your hand is Reyes. Please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Michael Redner Senior director of Investor Relations.
Please go ahead Sir.
Thank you Norma welcome to Otis third quarter 2022 earnings conference call on the call with me today are Judy marks chair, CEO , and President and Anorak Marsh Whiting 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.
SEC filings, including our Form 10-K, and quarterly reports on Form 10-Q provide details on important factors that could.
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.
Starting with Q3 highlights on slide three Otis delivered a solid third quarter and strong year to date results, especially considering the macro headwinds. We're facing we grew organic sales expanded margins and achieved mid single digit adjusted EPS growth all largely driven by strong performance.
Our resilient service business.
By executing our strategy, we continue to set ourselves up for the future.
This quarter, we demonstrated that performance through accelerating maintenance portfolio growth, which was up three 8% in the quarter growing modernization backlog, 7% and gaining about one point of new equipment share year to date with share about flat in the quarter.
Year to date, the new equipment market was down mid single digits, driven by China, which was down about 15%.
In the Americas, we are honored to be selected for a modernization project at the iconic space needle in Seattle.
Otis installed the original elevators in the early 19 sixties and has been maintaining the units ever since.
We will now modernize the landmarks three elevators, including introducing new technologies, such as custom design cabs and comp comp of $3 60.
In Suzhou part of the greater Shanghai Metropolitan area. The urban rail network is being expanded once again with the support of Otis.
The new line eight will be served by nearly 140 artists escalators and 38 Gen three and Sky rise elevators when it begins operations in late 2024.
In London Otis was selected to help modernize an office block into a modern mixed use development.
Tries to be the first net zero carbon enabled office development in London.
Otis will provide vertical transportation solutions, including several escalators and elevators equipped with accomplished 360 destination dispatching to allow tenants and visitors seamless and efficient access to the buildings floors.
And lastly in Korea, we're extending an over 30 year relationship with G. S engineering and construction to provide more than 55 elevators to the upper Gi apartment complex.
These units will be outfitted with reach and drive technology, helping to maximize energy efficiency for the elevator, serving 1500 apartments in the complex.
Year to date free cash flow conversion was 106% of GAAP net income and we kept our capital allocation plans on track with another $300 million of share repurchases in the quarter completing a 700 million dollar in repurchases we had planned for 2022.
With a quarter to go we feel confident in our cash flow outlook and are increasing our full year share repurchase outlook to $850 million.
And we continue to drive important ESG initiatives, a key priority for Otis this quarter, our efforts resulted in achieving a gold rating with eco goddess.
Now moving to slide four.
Q3 results and 2022 outlook.
New equipment orders were down 0.8% at constant currency in the third quarter.
Excluding China orders were up seven 4% with growth in all regions.
On a rolling 12 month basis.
Total Otis orders were up seven 6%.
Organic sales were up 0.8% and adjusted operating profit was up $35 million at constant currency with 60 basis points of margin expansion driven by segment mix and strong performance in the service business.
In the quarter, we generated $215 million of free cash flow, which was down versus prior year, driven by an increase in inventory to support backlog conversion and the timing of supplier payments.
This brings us to a $1 billion year to date was 106% conversion of GAAP net income.
Looking ahead to our 2022 outlook.
We're revising our full year outlook and now expect organic sales growth of 2% to 2.5% with net sales in a range of $13 four to $13 $5 billion.
Adjusted operating profit is expected to be approximately $2 $1 billion up $120 million to $140 million, excluding the impacts from foreign exchange.
After approximately $175 million and headwinds from foreign exchange translation.
Adjusted operating profit at actual currency is expected to be down $35 million to $55 million.
Adjusted EPS is expected in a range of $3 11 to $3 15 up 5% to 7% versus the prior year.
Lastly, we still expect free cash flow to be robust between one five and $1 $6 billion or approximately 125% conversion of GAAP net income.
We will remain disciplined and balanced on our capital allocation advancing our bolt on M&A strategy, where it makes sense and returning cash to shareholders through dividend and share repurchases expected to be $850 million versus the $700 million target announced previously.
With that I'll turn it over to Iraq to walk through our Q3 results in more detail.
Thank you Judy and good morning, everyone.
Starting with third quarter results on slide five.
It was a $3 $3 billion were down seven 6% driven by the broad strengthening of the U S. Dollar at seven 2% headwind in the quarter.
Organically sales were up 80 basis points, the eighth consecutive quarter of growth driven by servers, which increased over 6%.
Adjusted operating profit, excluding a 15 million dollar foreign exchange translation headwind was up $35 million.
Drop through on higher service volume and favorable service pricing strong SG&A cost control and the benefits from productivity in both segments was partially offset by impact of lower new equipment volume commodity price increases and annual wage inflation.
Adjusted SG&A expense was down 90 basis points as a percentage of sales as we continue to drive cost reduction and containment to help mitigate the inflationary headwinds.
Despite the challenging environment, we maintain investment in the business and R&D spend and other strategic investments were about flat versus the prior year.
Overall, adjusted operating profit margin expanded 60 basis points, driven by segment mix strong service performance and cost containment.
Adjusted EPS was up 5% of <unk>.
And <unk> headwind from foreign exchange translation was more than offset by strong operational performance driven by the service segment accretion from the <unk> transaction and the benefit of $700 million in share repurchases completed year to date.
Moving to slide six.
Q3, new equipment orders were down slightly at constant currency and up seven 4% excluding China.
Orders in the Americas were up 3% with solid growth in multifamily residential and infrastructure.
EMEA orders were up 11% with growth in both Europe , and the middle East and orders in Asia outside of China were up approximately 10% driven by strong growth in South Korea and India.
The strong orders growth over the last 12 months contributed to new equipment backlog, increasing 12% at constant currency with growth in all regions, including China, which was up slightly.
Backlog in Americas, EMEA and Asia outside of China was up high teens.
Pricing trends improved year over year in all regions, excluding China, where pricing was flat.
Globally pricing on new equipment orders continues to accelerate and was up 4% leading to sequential backlog margin improvement.
New equipment organic sales were down 5% in the quarter as mid single digit growth in EMEA and low teens growth in Asia, Excluding China was more than offset by 4% decline in the Americas due to a tough compare and delays in building construction.
And a high teens decline in China, driven by the challenging market conditions.
Sales declined $191 million and adjusted operating profit declined $23 million largely from the impact of lower volume and related under absorption.
Commodity inflation of $18 million that was in line with prior expectations was more than offset by productivity and lower SG&A expense.
Service segment results on slide seven.
Maintaining its portfolio of units were up three 8% with recaptured units more than offsetting cancellations in the quarter.
Conversion rate continues to show improvement this year in China, which contributed to mid teens portfolio growth in the region.
Modernization orders growth accelerated to 18% in the quarter with growth in all regions driven by good traction of newer more package offerings and several major project wins.
Backlog was up 7% at constant currency.
Service organic sales grew for the seventh consecutive quarter up six 2% with growth in all lines of business.
Maintaining and repair grew five 4% from the benefit of high single digit repair volume and growth in contractual maintaining sales that outpaced our unit growth due to improved pricing, which was up three points on a like for like basis.
Modernization sales continue their recovery that started in Q4 of 'twenty, one and we're up 10% in the quarter with growth in every region.
Service profit at constant FX was up $49 million driven by the drop through on higher volume.
Favorable pricing and productivity, which more than offset the headwinds from annual wage increases.
As a result of this margins were up 50 basis points, the 11th consecutive quarter of margin improvement.
Overall, despite the significant macro headwinds our year to date results are strong.
We gained approximately one point of new equipment share.
The best portfolio of growth in over a decade.
And more than mitigate and $195 million of <unk>.
<unk> from FX and commodity inflation through strong execution to achieve an eight 5% EPS growth.
Moving to slide eight and our revised outlook.
These changes reflect revised expectations in the China market outlook there.
Strengthening of the U S dollar and a focus on productivity initiatives to offset the headwinds.
Starting with sales we.
We are expecting organic sales to be up two to two 5% versus two 5% to three 5% previously.
This 75 basis point reduction is driven by lower expectations for China in new equipment, partially offset by an improved modernization outlook in service.
The new equipment margin outlook is down 10 basis points at the midpoint from the impact of lower volume in China offset by cost containment.
Service margins are now expected to be up approximately 50 basis points.
10 basis point reduction 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 three 1% to $3, one five up 5% to 7% versus the prior year.
This adjusted EPS growth is driven by strong operational execution accretion from the zodiac transaction progress on reducing our tax rate and a lower share count and both then offset 47 cents of headwinds from foreign exchange translation and commodity inflation.
We now expect free cash flow to be in a range of one five to $1 6 billion.
Versus approximately $1 6 billion previously.
Foreign exchange translation continues to weigh on cash flow generation and we anticipate a moderate build in inventory heading into 2023 to support project execution on our growing backlog.
On capital deployment, we are increasing the share repurchase target to $850 million, having already completed our previous outlook of $700 million in the first three quarters.
This is an over two X increase from the $300 million to $500 million guidance, we have given in the beginning of the year and combined with the 20% dividend increase underscores our commitment to return cash to shareholders.
Taking a further look at the organic sales outlook on slide nine.
The new equipment business is projected to be down approximately two 5% versus down 0.5% to 1% previously.
We now expect Asia to be down approximately 6% from down low single digits previously driven by China.
Despite our backlog being up slightly versus prior year and up from the end of 'twenty one.
Now expect Otis China organic sales to be down 10% driven by the shift of project execution to the right and lower market expectations now I'd expect it to be down roughly 15%.
This has been partially offset by improved outlook in Asia Pacific from the benefit of strong orders growth momentum in India and South Korea.
The new equipment outlook in the Americas, and EMEA is unchanged.
<unk> to be flat and up low to mid single digits respectively.
Turning to service.
Now, we expect organic sales to be up 6% to six 5% an improvement of 50 basis points at the low end driven by a conversion of modernization backlog that is up 7%.
Moving to slide 10.
We expect adjusted EPS growth of 5% to 7% and 18% increase at the midpoint.
We expect to more than offset the $110 million headwind from commodities with $230 million to $250 million of operational improvement from higher service volume and pricing productivity in both segments and other cost containment actions, resulting in profit growth of $120 million to $140 million at constant.
Currency.
This is $5 million lower than our prior outlook at the midpoint driven by reduced China, new equipment volume expectations that we are partially mitigating through better cost containment and productivity.
Accretion from the <unk> transaction over two points of tax rate reduction versus last year and the benefit from over $1 5 billion of share repurchases since spin.
Partially offsets the 29.
Our $175 million headwind from the significant strengthening of the U S dollar.
We have now assumed a euro at <unk> 97 for the fourth quarter, a 1.0 for the full year.
Overall since 2019 this outlook represents 50 basis points of annual margin expansion and low teens three year adjusted EPS CAGR, reflecting the execution of our long term strategy and our ability to mitigate the macro challenges we have faced.
We feel confident that this momentum along with our growing backlog and service portfolio sets us up well to deliver strong financial performance in 2023 and beyond.
And with that I will request normal to please open the line for questions.
Thank you.
As a reminder to ask a question you will need to press star one on your telephone.
Please wait for your name to be announced please standby, while we compile the Q&A roster.
One moment for our first question.
Our first question comes from the line of Nigel Coe with Wolfe Research. Your line is now open.
Thanks, Good morning, Thanks for the question.
Good morning, Joe.
Uptake China is obviously.
The big issue, but just wanted to talk about the Americas because you.
You mentioned some.
Project and construction delays and the America I'm just wondering if you could just give us some.
Context on the geographies that I am assuming that the U S. But if there's anything else going on that please let us know in any verticals that stand out where you're seeing delays.
And Nigel it's Judy good morning. So it is primarily the U S. It's not rate driven it really is availability of construction labor outside of the elevator.
We're feeling very confident in our ability to be at job sites at the right time, we recognize we are in the critical path, but it's all the other trades from getting the hoist sway poured to really just erecting the building. So that's really what we're seeing and it's a delay it's a delay it's a slowdown but it's.
It's not going to go away the buildings are going to get built but its going to move some some revenue into 'twenty three.
Even from the fourth quarter. So we're watching that carefully theres really no unique vertical that that's happening the verticals are really still strong and if you look at <unk>.
Abi is at $51 seven Dodge construction starts the biggest growth. We're seeing is in multifamily residential and year to date Dodge construction starts for multifamily residential is up 28%. So demand is still strong orders are strong 24, 3% year to date in the.
Because and we're just seeing a little bit of delay in terms of being able to deliver and record that revenue.
Yes, I agree with that.
And then my second question is really on the I think Eric you mentioned, 4%.
Pricing on orders.
I caught that right.
What is the realized price today, there's still trending negative today. So I'm just wondering if that 4%.
We convert that backlog into 2023.
We are a little bit of good news on <unk> is there a path to expanding.
New equipment margins in 2023.
Hey.
Thanks for the question so.
Yes, the price increase firstly, it's coming through on the backlog margins.
As I mentioned right. So this quarter.
Quarter, we did see the backlog margins kind of flattish sequentially relative to I'm.
Im sorry, <unk> it was kind of flattish now I'm talking about throwing it through if you look at the third quarter on the new equipment side.
The flow through to the bottom line. It was essentially on volume. So we have about $100 million <unk> in terms of decline in terms of revenue and $20 million of that should flow through to the bottom line and that is what the <unk> is on the new equipment side. So we kind of hitting the price cost neutrality in the quarter itself right, so and as backlog.
Margins improved from now till the end of the year, we should see that you should see that expansion coming into 2023 as well yeah. Nigel just one other thing what I watch is that early trend as well and we were up two points in second quarter on new equipment pricing and now four points this quarter as a long cycle, it's going to take some time to get through the back.
Log, but it's going to come through in terms of commodities flipping really the only place we've seen that significantly already is China.
And I would say Europe is a question mark there in terms of because of energy prices and everything else going on but we would we would welcome commodities coming down as soon as possible and youll see that flow through that's that that again during our long cycle gives us the opportunity to drive material productivity supply chain everything in our.
Backlog.
That's great thanks very much.
Norma.
Our next question comes from Jeffrey Sprague with vertical research. Your line is now open.
Thank you and good morning, everyone.
Hey, Jeff Hey, Hey, good morning can we just delve a little deeper now into China.
Maybe maybe just frame the order decline.
Kind of speaking to order declines ex China, I guess, we can all try to do that math, but I'd love to maybe have you frame that up for us.
Maybe more importantly.
Just kind of speak to what's in backlog and sort of your visibility.
In China revenues over the next.
Two to four quarters or so.
Sure. Let me, let me start and then on Iraq feel free to jump in so we now view full year 'twenty, two China market growth estimates down 15% roughly.
Some of this is driven to the lockdown some of its demand driven by the property market confidence.
And clearly the market won't recover in 'twenty two.
Q1 was down 5% Q2. The segment was down 20 Q3, we believe it was down 20% as well and last quarter, we assumed COVID-19 would be relieved there'd be somewhat of a return to normal and while this might not be as visible to everyone outside China. The COVID-19 lockdowns are absolutely continuing especially in tier <unk>.
Three and below cities. So those constraints are really constraining us from being able to to do final shipments in terms of delivering them on the trucks and then installing them.
Having said that Geoff I'm feeling good about the health of our business in China when.
When we talked about new equipment pricing just a second ago, we're net price cost neutral to favorable in China. This quarter, which is just a testament to the resiliency and the tenacity of Perry and our China team to be able to to be able to do that the market segment was down about 20%, we were down pretty close to that in orders.
So we didn't there was not there was not a share gain there for us this quarter, although we've had them in the first two quarters, our strategy and our initiatives are on track in new equipment.
Yes, we've gained share year to date, the only segment that was up in China in the third quarter was infrastructure all of the others were down all of the tier cities were down as well, but they were down tier one was down the least tier two next and then it degraded from there in terms of larger down.
In terms of segment.
While all this was happening our teams still deliver modernization grew and service grew again it was our fifth consecutive quarter, where we had mid teens or above portfolio growth, where recaptures outpaced cancellations and so they were all really good positive contributors.
I look into 'twenty three without without you know, we're not going to give a guide right now, but as we look about it added especially in China.
The segment.
If you go back to our first Investor day in February of 2020, we shared we thought the China segment would be about 550000 units a year and be flattish that's where it was in early 'twenty pre COVID-19 it spiked and got up to 650000 last year. If you assume the segments down 15%. It gets you to.
540000 kind of number.
Our early assessment for 'twenty three is the segment is going to be between 500, 525000, and again the pricing we've seen as rational and we're driving costs down commodities are down and material productivity is doing a great job. So on the new equipment side I actually think we're in a good position.
We've got some limited backlog in China fourth quarter will drive that as well as we go into the rest of the year, but the rest of the total companywide were up 12% on new equipment orders everybody's growing in mod as well and I will remind everyone that there are 8 million units at the end of this year.
Our in service in China, So that's going to be the key growth lever, we're still going to be green gaining share in new equipment executing our strategy, but our service growth and portfolio growth will continue.
Thanks, Judy I mean oil we feel very good about the market over there.
In terms of the backlog today, Jeff right.
Judy said in our prepared comments, we are up 12% on the backlog and China is slightly up as well relative to last year. So we have a good line of sight over the next few quarters not only in China and the other regions for the backlog as you are aware two thirds of our revenue for next year will come from the ending backlog, so given where we are today and the Piper.
That we've seen.
On the new order side good line of sight to.
And would that into shipment next year.
And maybe just thank you for all that color that was very helpful.
Just maybe shift gears back to Mod and maybe it's more of a global question now but.
Any indication just kind of economic weakness coloring.
Some of the forward demand around Mod.
There's a great deal that can certainly be discretionary at least temporarily discretionary.
Yes, Jeff the challenges if this would be the third or fourth year of discretionary. So all of a sudden there's modernization projects, especially the ones that are technology insertion versus just a static have really started coming to the forefront, yes $7 million of the units in the world are over 20 years old So it's a huge mod.
And the team really delivered 18% up in orders year to date up six 5%, we got a 7% backlog. So I actually think we're seeing the pent up demand and again for those who don't modernize and the elevators, we'll tend to break down, especially 20 years old more frequently which do.
<unk> our repair business.
And between that and just you know people returning to office hotels, our repair business is up really nicely.
Great. Thanks, I'll leave it there.
Thank you one moment for our next question.
And the next question comes from Julian Mitchell with Barclays. Your line is now open.
Hi, good morning.
Maybe just wanted to start with our fourth quarter guidance. So it looks as if.
Youre dialing in a pretty severe.
Sequential.
The margin decline.
And I realize maybe there's some deleveraging.
Fixed cost under absorption because of.
Okay.
China calendar and also the market weakness there.
Maybe just highlight if there's anything else.
Driving that big sequential decremental margin and also just to put a fine point on it in Q4.
China, New equipment, I think Youll sales were down high teens in the third quarter are we expecting a steeper rate of decline year on year in the fourth.
Hey, things within the southern Rockier.
Let me answer the second question first.
China the rate of decline is actually reducing in the fourth quarter Youre right. It was double digit in the third quarter, but we seem to be low single digit in the fourth quarter right now going back to on the fourth quarter.
Where you see the margin is essentially on the new equipment side of the business right.
If you go back the past few years seasonally Q4 as been a lower margin for us we've been around 5% so margin level and that is the big difference between that.
Rio to date run rate on new equipment margin versus the fourth quarter and when we gave guidance in July at that point in time that was calibrated we said that the guidance margins for this second half of the year for new equipment will be closer to six two.
<unk>, 2%.
Really and that was assuming that China would kind of return back to more normal times, but as you can see in our guide the revenues down by about $100 million Nigel.
And obviously because of China.
Did that flow through at 20% and $20 million. So is that flowing through to the bottom line would have been a 50 basis points margin degradation from six 2% to five 7%, but through productivity through other cost containment, we were able to mitigate it and get it back to 6%.
And clearly a lot of it was <unk> in the third quarter. Both in terms of Closeouts in terms of productivity in terms of cost containment.
As we go into the fourth quarter in terms of volume in terms of.
<unk> that is pretty much constant run rate, where we see a little bit is on the on the regional mix and that kind of makes the margin going to go down.
<unk> said that we'll continue to work on the SG&A side and productivity and it was a little bit more of a set of new equipment, we will kind of drive that through so that is the big one.
And lastly is this FX rate, we add a $50 million of FX headwind in the third quarter that steps up to about 6700 $68 million, so that $70 million to $80 million since between the new equipment, and FX, which is kind of causing the Q4 versus Q3 margins.
That's very helpful. Thank you and then just my follow up would be around.
Not so much in modernization, specifically, which I think came out but more broadly on kind of Europe .
Reising.
I think people are very nervous because of the macro data that you might get.
A deep and possibly alone European construction.
Slow down.
At least soon.
The last time that happened there was pricing pressure.
Number of areas, including elevator service 14 over 13 years ago.
Just wanted your thoughts today on the sort of the fragmentation of the Europe service market and maybe how <unk> kind of.
Practices might be different there.
And how does it work in terms of inflation feeding through to your new service contracts for next year in Europe .
Yeah, Let me, let me start with that one so service pricing in general just fair on a like for like pricing increased three points in the third core quarter was very solid and really was strongest in the developed mature markets globally, where the majority of our portfolio resides so that hits right to the heart of your question.
Julian in terms of really how is Europe doing on service pricing. The majority of renewals are pretty much up when you think about how the year rolls out our largest renewals happen in the first quarter and then over over time. So we should finish the year with that like for like pricing, especially in Europe , we do.
You have inflationary clauses most of them tied to labor, especially in Europe , and North America.
We have the ability to raise raise prices again, when the new year starts and what encourages me is that it'll be index based on 'twenty. One 'twenty two inflation. This year when we start 'twenty three so the inflation indices will be even higher and now it's up to us to go to go get.
That because it's in our contracts and our sales teams are are trained to do that so we've been offsetting the labor inflation is the labor inflation as you can see even in Europe based on the margin expansion. We've had on the general macro economics in Europe .
So far I've got to tell you, especially on the new equipment side.
It looks good in 'twenty two orders are up this quarter, 11% 10, 3% for the 12 months roll we're watching the headwinds.
Building permits are still holding so we haven't seen that change.
And so our goal again is to gain share and build backlog and thats exactly what Bernardo and our EMEA team had been doing.
On your on your last part about comparing the 13 or 14 years ago. It's a very different time now back then we were 10 points.
Differentiation between ourselves and our closest OEM maintenance provide service providers in terms of.
Margins and.
That was that was what was driving the Otis machine at the time right now.
We are much closer very close pricings rational theres not an oversupply of labor likely experienced after the financial crisis and all of those new equipment installers became Isps and there wasn't the technology like Otis one that gives us that that advanced stickiness that customers are really built.
Leaving in now and seeing and it's giving us productivity. So it's a different world and I think our performance over the last 10 or 11 quarter shows that.
Great. Thank you.
Thank you.
One moment for our next question.
Okay.
And our next question comes from Stephen Tusa with Jpmorgan. Your line is now open.
Hey, guys. Good morning, good morning.
So where do you expect to end I'm not sure. If you said it's for was it wasn't out of the first 10 15 minutes, but where do you expect to end the year with backlog is.
Book to Bill still above one.
Or can it be above one in the fourth quarter, maybe just talk about kind of the regional.
Expectations for for orders in the fourth quarter.
Yeah. So.
Really strong orders since year to date.
Luckily we've been doing and it's been it's really been kind of fulsome across Americas, EMEA and Asia, Obviously, China orders.
Our down as the segments down we're.
We're not losing share there we were flattish this year, Steve, but we've got 12% backlog right now on new equipment orders.
And yes.
We're doing Mod Mod orders R. R.
Backlog is almost 7%.
So yes, that's strongest we've had in a really long time.
Orders are there going to be lumpy, we had a great mod orders quarter. This this quarter, we expect <unk> to continue to be strong now and in the whole medium term forecast medium tour guide.
But they will there's times that new equipment orders with major projects will get lumpy, but.
But I would say kind of watch where we end the year being now at 12%, where we've gotten to on backlog conversion, we shouldnt be really strong going into 'twenty three I'm feeling pretty good about line of sight for 'twenty three we know the backlog on the new equipment side, we know the back we'll know the backlog on Mod and our service portfolio.
Is yeah. So I would if you were going to calibrate backlog for fourth quarter.
We enter the fourth quarter I think high single digit.
You can feel good doing that but then on the service side repairs mods up and and maintenance is up because our portfolio is up three 8% last quarter.
Just under three 5% the quarter before.
We hope and plan for that to start with a four when we when we talked to you. The next time and that volume is driving is going to drive really good really good backlog in service right. So so high single digit constant currency year over year is what youre, saying for that for the equipment backlog ended the year yes.
Thank you Larry.
Correct, one follow up just on the 23.
Can you just.
Maybe.
Give us some color around anything thats more mechanical for 'twenty, three and the bridge, whether its forex snapping the line here.
Yes.
Cost inflation at any of that stuff that.
That you'd highlight as part of the bridge for 2003 just using.
Prevailing rates today.
Steve on the rug immuno on FX side on the <unk>.
Anything else anything else more mechanical whether its raws or anything like that that on the 23 bridge that you have good visibility on today that you want to just get out there. Yes. So if you snap the line on foreign exchange today and it will be all be had been up this year that we would see next year. So it will be around $75 million to $100 million.
Right on the below the line stuff, we have a quarter of these <unk> accretion, which will come through next year, we did very well in tax this year it should come down a little bit more next year, so, but nothing materially different over that right. So that I would say is on the FX and in Europe and just under 23 is growing as what Judy said, we're going to end the year with a very good.
Backlog, both on service as well as our new equipment side on service more than maintain into growth.
And where we are on pricing that we're seeing in the backlog today.
That should kind of flow through next year as a tailwind commodity as well if you look at it I mean, we take commodity, but it's a little bit different dynamics in the full regions, China, we started seeing it coming down America's as well, we see it stabilizing coming down so those two should be tailwind as we go into next year.
In the case of.
Asia Pacific ex China, we buy from second tier suppliers majority that should also be a tailwind going into next year, maybe in the second half. It's Europe right just given the what's happening with energy prices. The conflict over there. The prices are still kind of flattish that may not be so much of a tailwind going into next year right, Steve the only other the only other.
The thing I would add is we.
We are watching labor inflation I think in our in our case the <unk>.
Great news is more than half of our field workforce is covered by collective bargaining.
We shared that we do have a new agreement here with the international Union of elevator constructors, the Multiemployer Union in the U S that goes into effect in January . So we've got five years of predictability here. It was a fair agreement and it's.
It looks very similar to the last five years and.
With a little increase as it should as is appropriate but we've got predictability. So now it comes back to us to be able to offset that with price and productivity and we're watching labor in Europe . We've got some more negotiations coming up but again, we will know that our backlog it takes that 12 plus.
Months to work its way through in most countries. So we know what we need to do in terms of productivity and price to offset that the last part of labor. We're watching just for you to know is.
Be aware of it or the subcontractors mainly on the installed there on the installation side outside the U S. In several countries and we've got to offset those increases with price and productivity, we know we need to do.
Great. Thanks, a lot.
Thank you.
One moment for our next question.
And our next question comes from John Walsh with Credit Suisse. Your line is now open.
Hi, good morning, and I appreciate you taking the questions.
Sure Jay.
You know maybe just building off of Steve's question. There just looking more at it from a cash flow perspective, as you think out into next year, obviously, you're carrying higher working capital than normal I'm curious what you might think normal is and if we actually revert to that.
Net next year and then maybe just on the.
The supplier timing payments that were called out in.
In this quarter do those all get made up in Q4 or is that also a bridge item into 'twenty three for the cash flow.
Hey, good morning, John and Rob here.
So just on cash flow as as you kind of think about going forward, we will grow cash pretty much with earnings right now.
And that should be the biggest driver of cash flow now to your second question.
If you look at this quarter quarter, three we use about $150 million of cash and it was around three different buckets. The first bucket was getting ready to execute chicken was around receivables and third was around the timing between cash and book taxes. So on the first part we have a backlog is up 12% we need to be in a P.
Physician to get about product and execute on time, so to do that we built up some inventory prepaid certain suppliers to lock in price as well as critical supply right on the second on receivables. The modernization grew a little bit more faster, which comes in with more backend payment and also because of the delays in projects moving to the right.
There was new equipment collections and on tax we've done a very good job as you saw in the second quarter on bringing the tax rate down. There is just some timing difference between cash and book taxes. So these three things should more or less unwind in the fourth quarter. So as we get into fourth quarter. So which is why we will get to the one 5% to $1 $6 billion.
So basically unwind so as we look into next year. It should be mainly earnings we should be driving the free cash flow growth, yes, John as part of our customer focus.
We understand we are in the critical path of every new construction job that hoist toy has to go in and one of our Differentiators in the market is the general contractors now we will deliver on time and to do that we increased inventory.
Inventory, we locked in some suppliers just to make sure we would have that ability.
Probably would've liked some better backlog conversion.
You asked me, but we'll get there and but we just needed to make sure we weren't going to let a job site or a customer fail on the new equipment side.
Great.
That's a very helpful answer and then if I could just circle back to Modernizations.
Just curious if there is.
Particularly driver to call out.
If you are seeing I mean, you talked about deferred or deferrals earlier.
What about like taking an office and converting it into multi tenant are you seeing that or customer.
Customers buildings trying to make sustainability commitments, we don't always think of the elevators as a big energy user but are you hearing customers talk about that just any more color around why the customers are moving ahead with these modernizations would be would be helpful. Thank you.
Yeah. So it's a variety of reasons you've called out a few of the other one I would add would be is part of return to office people are trying to make the office is more attractive as well, especially those that again, there's so many buildings with elevators are over 20 years old. So now that really people have choices they want to create a more engaging work.
Place they want people to come in.
We're seeing it really across the board some of it's pent up demand some of it to delay some of it is just.
Sure Matic need but the rest is is by choice and we think that's going to continue.
That's great. Thanks for taking the questions. Thanks, Tim. Thank you one moment for our next question.
And our next question comes from Joseph O'dea with Wells Fargo. Your line is now open.
Thank you I'll give you the address of my building because of modernization wouldn't be bad there.
Happy.
Happy to.
I wanted to ask on the Americas, just project experience and delays.
And just how that's been trending has it's been an issue now for some time, whether there are any indications of seeing some improvement there.
Over the past call it six to nine months.
Then as well.
Youre hearing from folks in terms of expectations, moving forward and where we get some better project activity or just execution.
Yeah, I think we're I think we're going to see it get better Joe I think it's absolutely correlated to employment.
In the interest of the trades and you know as as things change in the in the global in the economy in the U S. We're starting to see it get better but again its job by job and it's it's local <unk>.
Construction's local everywhere, so there's no national provider like someone like us in all the other in all the other trades that come together to build a building.
We anticipate an improving and we anticipate better backlog conversion from our from our Americas team, especially in North America.
Watching the same same trends you are but we expect that and we haven't seen the indicators change yet I mean that billing architect's billing index is still over 50.
Dodge is still up so will it be at the world of new starts be it the same amazing right. We've had probably for the last couple of years, probably not at the same great rate, but it'll be at a good rate and we've got we've got really good share there and the team our team will deliver.
Yes.
If I could just add to that.
I mean, we see all of these underlying secular drivers has been very strong.
If you look at the.
The sites are actually started gradually opening up our guidance for the full year still remains.
As per the prior guide, which is flat on new equipment for <unk>.
Americas, So sometime in Q3 and Q4, so we should see Q4 is kind of a turning point.
As we can with this backlog into revenue. So you should start seeing indicators start in Q4 itself.
That's helpful. And then I wanted to circle back on fourth quarter margins and specifically on service and then corporate and other.
Corporate and other was a little bit lighter than we expected in the third quarter, just kind of what youre anticipating in the fourth quarter, and then coming off of a 23, 9% service margin in the third quarter.
How to think about kind of the bridge into the fourth quarter and some of the moving items there.
Yeah, Joe I Hope you saw our sustained zealous approach to reducing G&A down 90 bps in this quarter.
Entourage come onboard and you know he.
He is looking together we are looking but he is certainly taking a hard look at G&A structure, what do we need, especially in corporate functions. So I'll turn it over to him to talk about fourth quarter, but know that everything that can be contained is being contained in terms of cost without risking investment for our future.
Thanks, Judy absolutely I mean cost is something we control we will continue to take a look at it on the service margin side.
If you look at quarter three.
It would be grew 50 basis points year to date on service. We are growing at 50 basis points. It was really good performance in terms of in terms of pricing for sure in terms of productivity in terms of cost. So that's kind of what <unk> got.
Got it so a very good performance in Q3, we see similar performance in Q4 as well will be at similar margins of 23, 9% to 84% 50 basis points more than last.
You are.
We will see some catch up on the cost side, because we did continued very closely in the third quarter there will be some.
Part of it was permanent part of it was temporary that we contain there'll be some snap back in Q4, we'll continue to look at that and that should be a tailwind as we enter into the fourth quarter, but just on the on the service side I think the trend if you look at revenue growth and margin expansion.
It is it is pretty linear through the course of the year and you would expect to see the same in fourth quarter.
Very helpful. Thank you.
Thank you one moment for our next question.
And our next question comes from Gautam Khanna with Cowen. Your line is now open.
Hey, good morning, guys.
Good morning, Hey, good morning.
Uh huh.
Couple of questions just to follow up on some of the pricing comments on the inflation clauses in Europe , North America et cetera.
Whereas the magnitude of the opportunity greatest by region in terms of repricing service.
Is it Europe , followed by North America, just where do you.
Can you speak to the magnitude by region.
I would place Europe is the highest followed by North America.
And then when you roll it up do you have a view on kind of price cost in service next year, what that could be I mean, it's positive but is it can you frame the magnitude.
Yeah.
Hey, Gautam, yes.
Listen, it's going to be positive I mean, our medium term guidance, what we said a service should be up 40 to 50 basis points right. This year, we have 50 basis points.
We've increased price managed inflation managed wage cost as Judy spoke about BT Americas in other places as we go into next year I think we feel good about being on track with our medium term guidance in terms of expansion of margins and we are expanding margins with ultra modernization business growing at a faster clip right, which is which is.
Headwind to the overall margin on the service business. So we'll give more specificity as we get into the January February call for the guidance for next year, but continue to kind of see that margin expansion trajectory than we own today, yeah. It will be a service play.
Gautam next year as we said in our medium term guidance and I think in year. One since we did the Investor day. Just this past February I think we've proven that.
Thank you and the last one on China pricing kind of what are your expectations as you move through.
The next couple of quarters given.
It looks like the market's long capacity.
Do you have a sense for the magnitude of new equipment pricing pressures next year.
We think yeah, we think it looks like it look this quarter, which will be you know relatively flat kind of neutral.
That that'll certainly be what we do we're not seeing irrational pricing and we get to see it on the infrastructure there public bids.
And so we think it'll be flat.
Yes. Thank you.
Yes.
Just to add in the quarter, even the market being down we are very we're very happy with the way. It is right now price cost and if that continues it's going to be very positive for us.
Yes.
Great. Thanks.
Thanks.
One moment for our next question.
And our next question comes from Joel <unk> with Darren words your line is open.
Yes, Hi, Doug.
Yes, good morning.
Good afternoon, Joe.
Maybe I'll just stop by stops.
Just talking about and that.
It makes sense in Italy reported 3.8.
Was it in Q3.
Is there any sort of color you can give us around the differences by region in terms of what youre seeing the growth in your maintenance units.
The largest growth, we're seeing and I think I mentioned this is our fifth consecutive quarter in China with mid teens plus growth. So that's the largest followed by Asia Pacific, but all four regions are growing.
But those those two are the are the biggest hitters in terms of growth rates okay.
But all regions operating levels.
Yes.
Okay understood and then maybe just to set your tax slightly on just coming back on your comment earlier about.
The.
The field workforce and you mentioned that half of the field workforce is covered by a collective bargaining just just so I understand is that across both service and new equipment.
And then as it relates to is it reasonable to think that the split of that labor forces.
In line with your with your regional split.
Yes, so when you think about so yes, it's both it's our field work force. So to me field is Theres 40, yes, we have 41000 field professionals summer in new equipment. The majority are in service because we do use subcontractors to help us with installations in parts of the world.
It's clearly collective bargaining works councils is clearly the way we do business in Europe .
We have had a unionized workforce in the United States for a long time think about Korea, Japan. So it's the field workforce and in many locations, it's our factory workforces as well as well as some of our professionals. It really depends on the country and we have a I think we have been on.
Operating under this for so many decades to assets. It's the way we it's the way we go to market and that's the way we lead our company into the way our colleagues.
Show up for work every day, so it's very normal for us we understand the headwinds when they happen and when we understand the opportunities when they happen and we believe we give 68000 colleagues a great place to work and a great career.
That's great. Thanks, if I may just one very quick follow up you mentioned, obviously, the subcontractor costs being a factor you are probably aware obviously that.
But we're calling subcontracting cost out as a potential risk in 2023 are you able to give us a bit of that.
Detailed about how important subcontracting costs all on the installation side.
So again, we only use them in countries, where it makes sense to us we do have thousands of our own installers and all of our supervisors.
Who are on the job sites are oldest colleagues.
The majority of where we use them as you can imagine is is is China Asia and Europe and it gives us it gives us flexibility.
In terms of surge because new equipment.
Has more variability as we've seen over the past few years significantly than the service business. So it gives us the opportunity to manage manage and lead our workforce, while being able to provide solutions.
You Wanna.
I think you said it Judy I mean, these are the markets, where we work with sub contract as we work through this year as well.
I mean, they're also seeing inflation, but we work on installation productivity with them right. We can reduce the hours that it takes to install an elevator will continue doing that but they've been great partners for us in these regions and we will continue to be so so.
Net net if you look at new equipment for next year both on.
On the top line as well as on the bottom line it should do better than the medium term guidance that we set up and they are an extension of us Joe. They really you know they they take are they they are.
Our ethics, our safety program. Our methods are tools you won't you won't know the difference the chat.
<unk>, we have which our teams are dealing very well with is ensuring we have a robust available workforce at a good price and that includes the subcontractors.
And as those costs within cost of goods.
As it relates to labor costs.
Sorry, what was the question are they were saying.
Tractors, yes.
Yes that is correct, yes, great. Okay. Thank you very much.
Thank you and I'm currently showing no further questions at this time I'd like to hand, the conference back over to MS. Judy marks for closing comments.
Thank you Norma and thank you all for joining us today.
Solid year to date performance advancement of our long term strategy and continued growth in new equipment backlog and maintenance portfolio units positions us well to deliver on our 2022 outlook and build on that strong foundation in 2023 and beyond Thank you for joining us stay safe and well.
This concludes today's conference call. Thank you for your participation you may now disconnect everyone have a wonderful day.
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