Q4 2022 Otis Worldwide Corp Earnings Call
The conference will begin shortly to raise and lower Johan during Q&A, you can dial star one one.
[music].
Yeah.
Good morning, and welcome to <unk> fourth quarter 2022 earnings Conference call. This call is being carried live on the Internet and recorded for replay presentation materials are available for download from <unk> website at Www Dot Dot com.
I'll now turn the call over to Michael Redner Senior director of Investor Relations. Please go ahead Sir.
Thank you Norma welcome to Otis fourth quarter 2022 earnings conference call on the call with me today are Judy marks chair, CEO , and President and <unk> 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.
<unk> 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.
We're pleased that we ended the year with a strong fourth quarter and solid full year performance in a year characterized by a variety of macro headwinds we enter 2023 with good momentum as we continue to execute our four strategic pillars sustaining new equipment growth accelerating service portfolio growth.
Advancing digitalization, while focusing and empowering our organization.
I am proud of our colleagues around the globe, who delivered these results demonstrating the strategic resiliency of our company as we continue to grow and perform in 2022.
Starting on slide three.
We continued to perform well and new equipment orders growing 7% for the full year.
In the quarter orders grew 4% with particularly strong performance in EMEA and continued solid performance in Asia Pacific.
China orders returned to growth with mid single digit performance in the quarter.
Orders in the Americas were down 4% in the quarter, although the business had a very strong 2022 overall with orders up almost 18%.
Our new equipment adjusted backlog at constant currency is up 11% heading into 2023, giving us solid multiyear visibility to grow sales.
Organic sales increased two 5% driven by service, which grew 6%.
We grew our industry, leading maintenance portfolio by four 1%. It now stands at $2 2 million units, a new milestone for our company.
We delivered seven 5% adjusted EPS growth, despite $156 million and foreign exchange.
Exchange related headwinds we.
We generated $1 $45 billion in free cash flow, allowing us to return $1 $3 billion of cash to shareholders through dividends and share repurchases.
We continue to win many exciting projects based on our innovation, our ability to deliver and the trust customers have in us for.
For example in the Americas Otis was selected to provide our compass destination dispatch system, along with six Sky rise and two Gen. Three elevators for city Center four in Surrey, British Columbia.
23 storey building will be built to LEED gold standards and extends our more than six year relationship with a large group.
In China, Tianjin Metro has been using Otis equipment since opening in 1984.
In November <unk> was selected to provide more than 120 escalators in gen. Three elevators for their new line for northern extension.
Does it takes the number of Otis units on the Port cities, expanding subway network to more than 1500.
These new elevators will be connected to the <unk> I would just one Iot based platform aura.
Already delivering real time monitoring and predictive maintenance for the Metro system.
In the U K, we've had a longstanding relationship with transport for London, including a long term contract through 2042 to manufacture install and maintain the escalators and travel acres on the busy network.
Just recently, we were contracted to provide Battersea station with specialty escalators, specifically designed to run for about 20 hours a day and extend 24 meters in length and nine meters and rise we're playing our part to keep the busy network flowing.
Our ESG initiatives continue to progress in 2022, helping to drive stakeholder value alongside our financial priorities are.
Our manufacturing facility in Florence, South Carolina achieved gold level total resource and use efficiency or true certification recognizing its success in zero waste.
With this achievement Otis has become the first in the elevator industry to have a true certified facility, helping us towards our goal of having all our factories eligible for zero waste to landfill certification by 2025.
We look forward to sharing more about our ESG progress and our second annual ESG report, which is set to be published in the spring.
Moving to slide four.
With strong orders performance in 2022, we were able to achieve approximately one point of new equipment share gain on top of the two point increase between 2020 and 2021.
For the first quarter since Q4 2021, new equipment sales returned to growth as we continued the strong growth in EMEA and Asia Pacific that we've experienced all year, and we're able to overcome supply chain and installation related challenges, especially in the Americas.
These results mitigated the impact of mid single digit new equipment sales decline in China, demonstrating the power of geographic diversification within our business.
Notably, we see China on a recovery path as new equipment sales in the region improved compared to Q3.
Innovation is helping to drive growth across our business. For example, we continued to rollout our digitally connected elevator platforms launching gen. Three in India and expanding the deployment of Gen $3 60 in Europe to the Czech Republic, Poland, Portugal, and Slovakia.
The accelerated portfolio growth. We saw this year is an essential component of our long term strategy and top line growth algorithm.
We believe that disruption in our industry favors the OEM and we are demonstrating this as we deploy our oldest one iot solution into our new equipment product offerings and our service portfolio.
We continue to work towards our goal of increasing connectivity to approximately 60% of the portfolio and we're pleased to have connected more than 100000 additional units this year.
Our service sales force performed well throughout the year with like for like maintenance pricing of three points, helping to mitigate labor cost headwinds within the service business.
For the third year in a row as an independent company, we delivered adjusted operating profit margin expansion and we remain well positioned as we enter 2023 with momentum, especially as we execute on new equipment projects from our backlog.
Now turning to slide five.
In the Americas market in 2022, while North America had a strong year up better than mid single digits. Latin America was roughly flat leading to a market that was up low to mid single digits.
In EMEA Western Europe performed well offset by eastern Europe due to the conflict.
In Asia, the market was down high single digits.
Asia Pacific had a very strong year up approximately 10% with the performance masked by the downturn in China, which we estimate to be down about 15%.
Although market dynamics remain fluid as we've seen over the past several years the long term fundamentals of the industry are well grounded in the service driven growth model.
In 2023 globally, new equipment markets are expected to be down mid single digits and units with flattish markets in the Americas, and EMEA and down mid single digits in Asia, driven by China, where we expect the market to be down 5% to 10%.
Asia Pacific should see another year of mid single digit or better growth driven by urbanization in the region and infrastructure investment.
The global industry installed base is expected to grow at a similar rate to that of 2022 at about mid single digits and reach approximately 21 million units.
In the Americas, and EMEA, we expect low single digit growth and in Asia, We're expecting high single digit growth driven by China.
With this is the industry backdrop for Otis, we expect organic sales growth to be in the range of 4% to 6% with total sales of $13 eight to $14 1 billion up one 5% to 4% at actual FX.
By segment, we expect new equipment will grow 3% to 5% this year with mid single digit growth in the Americas, and EMEA and low single digit growth in Asia.
We expect Asia Pacific to grow at least mid single digits, while we anticipate our China, new equipment business to be about flat for the year.
We're expecting a better China market as we get into the second half of 2023 as COVID-19 related and liquidity constraints in the market should ease on the back of government support.
In the service segment, we anticipate another year of solid growth with the business growing 5% to 7%.
We expect volume and pricing to drive solid mid single digit growth in the maintenance and repair business with higher growth in our modernization business line.
Our modernization orders performed quite well over the past few quarters, and we entered the year with the Mod backlog up 7% at constant currency, we expect 7% sales growth at the midpoint driven by the backlog growth.
Adjusted operating profit is expected to be between two two and $2 $25 billion.
70% to $130 million of actual currency or $130 million to $175 million accounting for foreign exchange headwinds.
We expect adjusted EPS to be in a range of $3 35.
To $3 50.
Up 6% to 10% or approximately 26 cents at the midpoint versus the prior year.
Finally, we expect free cash flow of one $5 billion to $155 billion between 105% to 115% of GAAP net income.
We remain committed to our disciplined and balanced capital allocation strategy and expect to repurchase $600 million to $800 million in shares this year.
Following the new board authorized $2 billion repurchase program.
In addition to paying our dividends and pursuing our typical bolt on M&A strategy.
With that I'll turn it over to Andre to walk through our 2022 results and 2023 outlook in more detail.
Thank you Judy and good morning, everyone, starting with fourth quarter results on slide six for.
For the fourth quarter reported sales of $3 4 billion.
We're down three 6% organic.
Organic sales grew for the ninth consecutive quarter and growth accelerated to 6% our best performance of the year with mid single digit growth in new equipment and high single digit growth in service.
Adjusted operating profit, excluding a $49 million of Forex headwinds increased $39 million.
With constant currency growth in both segments.
Strong service performance, especially on volume and price was partially offset by commodities and mix headwinds in new equipment as well as higher corporate cost.
Adjusted SG&A expense for the quarter and the year improved 80 basis points as a percentage of sales as we remain vigilant on structural cost reduction and cost containment to help mitigate the macro headwinds we have faced.
At the same time, we are committed to growing the business and R&D and strategic investments as a percent of sales remained about flat.
Adjusted EPS grew 4% or <unk> in the quarter driven by operational growth of seven.
This strong operational growth alongside the accretion from <unk> and <unk> hundred $50 million of share repurchases more than offset the <unk> <unk> headwind from Forex.
While the fourth quarter free cash flow conversion was strong at 145% our full year free cash flow came in at 145 billion or 115% of net income lighter than we had anticipated as we built $65 million of inventory to mitigate supply chain challenges and support back.
Log conversion going into 'twenty three.
Moving to new equipment performance on slide seven.
Otis new equipment orders in the quarter increased 4% with EMEA and Asia Pacific up high single digits, and China autos, returning to growth up mid single digits, which more than offset a modest decline in the Americas.
Overall with better than expected orders growth in the quarter. We finished the year with a new equipment adjusted backlog up 11% at constant currency with growth in all regions, including notably in China.
Pricing on new equipment orders in the quarter increased three points led by the Americas with solid performance in EMEA and APAC.
In China, we have been roughly price cost neutral throughout 'twenty, two that's commodity inflation.
We continue to drive productivity to offset pricing pressure in the market.
Fourth quarter, new equipment sales of $1 5 billion.
Returned to growth driven by <unk>.
Thank you.
Got it.
Yes.
With EMEA outperforming our prior expectations.
China sales declined.
Great.
In the middle of the year as the team navigated well through post Lockdown Covid outbreaks.
On the backlog.
Overall strong execution by the team.
<unk> returned to sales growth in the fourth quarter in new equipment.
Operating profit margins were roughly flat for the quarter.
The benefit of higher volume strong productivity and cost containment really mitigated the approximately $25 million headwinds from commodities and Forex.
Now turning to service segment performance on slide eight.
We saw an acceleration in our portfolio growth to over 4% with every region, adding to the portfolio. This year.
With another year of excellent high teens growth in China, and low single digit growth elsewhere. Our portfolio now is about $2 2 million units.
Really a recapture has more than offset our cancellations for the year with conversions as a growth driver.
Additional details on our portfolio growth in 2022 and drivers for future growth can be found in the appendix.
Modernization orders were also a highlight up 13% with growth in all regions, including some major project bookings in the Americas, and Asia Pacific and continued strength from our package offerings.
Our modernization backlog is up 7% versus the prior year, giving us good line of sight for growth in 'twenty three.
Moving onto service sales, we delivered another quarter of strong organic sales growth up almost 7% with growth in all lines of business.
Maintaining its pricing excluding the impact of mixing June came in as expected up about three points for the year contributing approximately one point to overall revenue growth.
Organic modernization sales grew eight 8% and similar to last quarter, we saw broad growth across regions, including double digit growth in both Americas and Asia Pacific.
We finished with our best service margin expansion for the year up 70 basis points in the quarter.
Adjusted operating profit, excluding $42 million of Forex headwind was up $51 million as higher volume favorable pricing and productivity were partially offset by our annual wage increases.
We have now delivered 12 consecutive quarters of service margin expansion with margins, increasing roughly 200 basis points over the past three years.
Slide nine lays out the full year 2022, adjusted EPS Bridge.
Strong operational execution drove 39 cents of constant currency, EPS growth, which mitigated 18th and commodity headwinds leading to operating profit growth of $124 million or 21.
Through our capital allocation strategy, including the accretion from the <unk> transaction and share repurchases of $850 million and optimizing our tax rate, we were able to offset 2006 and forex headwinds.
Overall strong operational performance led to EPS growth of seven 5% or 22.
We finished the year with 2022 adjusted tax rate of 26, 5%, a 220 basis point improvement versus 21, which contributed to EPS growth both in the quarter and for the full year.
Overall, the team performed well throughout 'twenty two by executing on the controllable, which helped us to build a strong backlog grew organic sales expand margins by 30 basis points and returned $1 3 billion to shareholders.
As we look ahead to 2023, the new equipment outlook is on slide 10.
Over the past few years, we have delivered strong orders globally from a combination of market growth or share gain initiatives and incremental pricing actions.
This has resulted in a robust multiyear backlog, giving us good line of sight for the next couple of years.
In 2023, we expect new equipment organic sales to grow between 3% to 5% with Americas, and EMEA up mid single digits and Asia growing low single digits.
Asia Pacific is expected to be up at least mid single digits.
And build the backlog in China is up two points, we expect sales to be about flat, reflecting pressure on the book and ship business from expected market declines in the first half.
We expect new equipment profit margins to be flat to up 40 basis points.
We expect roughly $100 million of tailwind from volume pricing productivity and commodities. This will be partially offset by unfavorable regional and project mix and some snapback in SG&A expense due to 2022 cost containment actions.
We will continue to drive strong productivity on both material and installation and project Closeouts as the year progresses to drive outperformance.
Turning to our service outlook on slide 11.
Starting with sales, we expect another solid year in service and anticipated organic sales, increasing 5% to 7%.
Maintain and repair organic sales are expected to grow four 5% to six 5% driven by maintaining portfolio growth pricing and low to mid single digit repair growth. After two strong years of COVID-19 related recovery.
We expect more than one point of pricing after adjusting for a mixed century.
For modernization, we anticipate organic sales of mid to high single digits as we execute on our solid backlog and drive a book and ship business from new product launches and focus on sales force specialization.
Turning to profit, we expect roughly 50 basis points of margin expansion.
Headwinds from annual wage inflation will be more than offset by volume pricing productivity similar drivers to 2022.
Turning to slide 12 for the 2023 of adjusted EPS Bridge.
We are expecting $3 35 to $3 50 in adjusted EPS.
Even by 23% to 31 of operating profit growth.
We expect to offset <unk> of Forex headwind at the midpoint and a modest increase in interest expense through a lower share count.
<unk> of remaining <unk> accretion and continued optimization of the tax rate.
We plan to complete $600 million to $800 million in share repurchases during the year.
For cadence, we expect strong EPS growth in the second half of the year, while the first half remains roughly flat.
We see the bulk of the FX headwind.
This lockdown COVID-19 impact in China, and a modest supply chain overhang of new equipment in the first quarter.
We anticipate stronger growth sequentially thereafter, including better performance in China in the second half of the year.
Overall, we anticipate Otis organic sales growth of 4% to 6% with approximately 20 to 30 basis points of margin expansion, leading to 6% to 10% EPS growth.
And on cash we expect to generate one five to $1 $5 5 billion.
And free cash flow in 23 of 110% conversion of GAAP net income at the midpoint.
This outlook demonstrates another year of consistent and solid operational execution.
As we continue to mitigate macro challenges and create meaningful shareholder value.
With that I will request nor months. Please open the line for questions.
As a reminder to ask a question you will need to press star one on your telephone to withdraw your question. Please press star one again, please wait for your name to be announced please standby, while we compile the Q&A roster.
Okay.
One moment for our first question <unk> one our first question comes from Julian Mitchell.
Barclays. Your line is now open.
Yeah.
Hi, good morning, and thanks very much.
First off I suppose I, just wanted to dig in a little bit more into the assumptions for how you see the China market starting out the.
For the year in terms of orders.
After a very good.
Q4 performance and maybe just home in a little bit more on the commentary around <unk>.
Some of those headwinds in Q1.
Should we still expect EPS to be up sequentially in the first quarter.
Good morning, Julien, It's Judy let me, let me start with what we're seeing really on the ground I would tell you that the Chinese economy is in a state of recovery now we were really pleased with our team's performance in the fourth quarter again with orders being up in new equipment in what was a challenging quarter with all the <unk>.
Lockdowns.
It's a fluid situation on the ground between liquidity and the Covid related absenteeism as we come back from the Chinese new year, and we're going to watch that closely but 2022 came in where we expected on the market down about 15%. We share we think that was about down 10% in Q4.
<unk> and came in where we thought between 540 550000 units.
Obviously Q4 saw some abrupt changes with COVID-19 between the Lockdowns and then the lifting which led to the outbreaks and what we're monitoring is liquidity easing, which we're seeing and where the consumer sentiment and confidence is in terms of the property market. So as we go through.
The first few quarters of 'twenty three first of all we're very encouraged by the government policy and actions to date.
We are expecting a better second half we have a harder compare in the first half based on what was happening in China first half of 'twenty two.
We did see an up infrastructure market that was the only segment that was up in 'twenty two.
In a 15% down market and we did very well they are carrying the team just executed really well tier one and two in China, where the lease negatively impacted by the down market and again you know our strategy. There has been very focused on agents and distributors on key accounts and we've executed that.
I'll I'll leave it with I'm feeling good about the health of our business in China.
In a down market in 'twenty, two we did well we were down mid single digits versus a down 15% market and in a down 5% to 10% market, we expect to do to do well as well. So we gained share last year, our strategy will enable us to do that and we're going in with backlog I'll, let <unk> talk to the EPS question.
Great. Thanks.
Thanks, Judy Yes, Julian just on the quarter, one let me start with the segments first from a service perspective, we expect to see performance in line with the full year guidance.
Swing factor could be repair and modernization or some mix, but overall, we aren't seeing anything major to call out and expect kind of mid single digit growth and margin expansion. It may be not closer to 50 basis points regarding for the year, but still be good expansion as we ramp through the year. The new equipment is a segment that we do expect some weakness from both a sales and a margin perspective.
Specifically compared to last year, China is a tough compare as the COVID-19 impact didn't really start until the second quarter and while we as Judy mentioned, we do expect better performance in China as we go through the course of the year, we unexpected to happen until the second half of the year.
In America, the team performed very well in the fourth quarter, but theres still some supply chain inefficiencies and labor shortages, which I expected to clear up in the second and third quarter. So overall, we expect sales in the new equipment side to be down quarter over quarter and year over year and margins to be about flattish with where we ended up in the fourth.
<unk>.
Now kind of going through the other line items, starting with corporate expenses.
Last year, the first half was light because of all the cost containment. We did so it is going to the run rate is going to pick up very similar to what we saw in the fourth quarter. So there could be a couple of pennies of headwinds over there and then on the FX side, we've said above the midpoint of $55 million of FX headwind and a bulk of it will come in the first quarter because last year at this.
Point in time, the Euro was $1 15, the renminbi was 635, so though the currencies have improved there is still a significant headwind. So majority of our FX headwind will come into force.
Quarter, so so putting it altogether, we do expect EPS to be down a couple of pennies.
Forex any new equipment incorporate will kind of offset the good performance in service and Azalea accretion to net that down a couple of pennies and sequentially also could be down a penny or two.
That's extremely helpful. Thanks very much.
Thank you one moment for our next question.
Our next question comes from Steve Tusa with Jpmorgan. Your line is now open.
Steve Your line is now open.
Mr. <unk> are you on mute.
Now let's go to the next question. Thank you. Thank you.
One moment for our next question.
Our next question comes from Nick Hoffman with RBC capital markets. Your line is now open.
Yes, hi, everyone. Thanks for taking my question I'll just ask one.
Looking at the outlook.
Maintenance in particular.
Riding for.
For the half to six 5% organic.
Thinking.
Units are increasing as a 4%.
Confident in being able to maintain that kind of level pricing is already at 3% and it's probably going up.
Both the escalation clauses.
Having said that.
And the slight.
So 4% volume, 3% pricing am I wrong to think that at five 5% midpoint in the guidance looks a little bit conservative.
Is it to do with maybe pricing being a bit more competitive in Asia Pacific, where a lot of units, but going any tape.
Let me let me Nick Good afternoon, let me answer the pricing question and then I'll, let <unk> take you through the walk.
Listen we've been pleased like for like pricing similar to Q3 was up three points in Q4 and was very solid as predicted.
Mature markets globally is where we saw really strong service pricing mid single digit gains in the Americas low single digit in EMEA and Asia Pacific.
And as <unk> said in his comments kind of we've got this the margin drivers are really less on price and more on productivity volume and density in China.
But.
We think 2023 like for like should be better than that 3% and thats really driven by the inflationary clauses. We have in the majority of our contracts service contracts, especially in Western Europe and in North America.
Western Europe clauses are backward looking so they will reflect 2022 inflation indices and we are signing those contracts right now a lot a lot of them in the first quarter. So next quarter, we'll be able to be able to share how we're performing on that but pricing pricing is healthy team.
There was a lot of credit we pivoted from being a discount kind of service pricing company for many years to being able to <unk>.
Gain gain price, especially where it was appropriate and justified.
Yes.
Just to add to that in terms of the growth for 'twenty three.
You're right that our growth at the midpoint is very similar to where it is in 2022 with the pieces a little bit different the portfolio growth as you put together, 4% and with Julie spoke about the pricing you add 3% when you adjust for children and mix, we should be up about 6% 423, which is higher than where we were in 2000 to repair.
There is as I mentioned in my prepared comments over the past two or three years, we have been running at a 10% CAGR on the repair business coming out of Covid now typically the repair business will outgrow the maintenance business because as we continue on our strategy.
Their packages, increasing penetration, but this year there'll be able just to be a little bit of a catch up from what happened in the past two to three years and then going forward. It should outpace the maintenance business. So thats why were seeing low to mid single digit and modernization is pretty soon it's around seven ish percent at the midpoint. So those are the pieces, which get us to five 5% now.
Clearly if pricing is a little bit better repair comes in better than that.
<unk> book and ship, there could be a little bit more over there, but right now we feel calibrated at the midpoint of the guidance.
Okay, Great. That's very helpful. Thank you.
One moment for our next question.
And our next question comes from Gautam Khanna with Cowen. Your line is now open.
Hi, guys. This is actually Jack on I forgot today, thanks for the question.
Hey, Jeff.
Yeah.
Hi, there.
Just a quick question kind of just on your perspective on the end market demand.
End of.
Back to Judy's comments on the first question just kind of what youre seeing in the field today.
Maybe by geography, and then by end market.
Maybe kind of parsing.
<unk> versus commercial or infrastructure.
Just anything there would be helpful. And then just if youre seeing any.
With the slowing.
Global macro backdrop here, if youre kind of seeing any any.
Municipalities or other customers sort of deferred projects.
Or kind of what youre seeing in 'twenty three so far.
Sure Jack Let me, let me, let me try and respond to both parts.
Let me start with new equipment, that's I'll break this into new equipment and service and I'll actually start with Asia Pacific.
Where the market overall, and we're really expecting solid growth due to urbanization and infrastructure growth in Korea, and southeast Asia and in India, and we're not seeing any slowing in that part of the world. It is really accelerating and expectations should be for solid growth.
For 2023 in the Americas, we think it's going to be a little a little worse than the market was in 'twenty to 'twenty. Two is an incredibly strong market first half stronger than second half, but as we saw a really strong market.
And we're still seeing the Dodge momentum index rising on construction, but the architect billing index for the past three months has been under 50, including December at 47, and a half. So so we're watching that carefully.
In EMEA, we think flattish, we're balancing potential headwinds, but I will tell you we have seen Europe become far more resilient in terms of the demand.
Including the residential market in Europe is really strong despite all the challenges consumers are facing and the middle East is growing middle.
Middle East, although it's a smaller part of our EMEA.
Has bounced back nicely so that end market is going to grow as well.
Good news in China.
Could it be better year on year than last year second half looks better again segment down we're projecting 5% to 10% and 23 down a little more on the first half and then we expect to see acceleration through the second half. So we look at that as we shared in the 2023 outlook slide and we.
We're prepared for that because we've got this great backlog at 11% on new equipment, when I turn to the service business. It's the end markets just growing in all regions at solid mid single digit growth led by Asia.
And low single digit really in the developed markets and I just make you recall that the new equipment market swings really have minimal impact on the service market, it's going to grow mid single digit year. After year. After year modernization is up nicely in all regions.
And we're ready for that we're going in with a 7% backlog on Mod and we expect <unk> to continue to from a demand side.
To continue to grow in 'twenty, three we have not seen.
A slowing on projects. We've also not seen the impact of the inflationary reduction Act.
It infrastructure.
The reduction act and in North America, yet, we see that later cycle.
In terms of airports metros and other other infrastructure.
Again, we did see good infrastructure it was the only positive.
Sector and segment that grew in China in 'twenty two.
So we're feeling good our backlog will take us through again, we'll watch the book and Bill early in the year, but our backlog. We think is going to take us through our new equipment and Mod and our service business is coming in strong and we're looking forward to 'twenty three.
Thanks, Judy Yes, that's really helpful. And then just one quick one for you.
Really quickly just on price cost assumptions in 'twenty three.
And sort of the backlog margin converting here just kind of what your assumptions are snapping the line.
Seeing raw materials sort of.
Rollover here in 'twenty, three kind of just high level, how you're kind of thinking about price cost in 'twenty three thanks.
Okay, great. Thanks for the question so surprise cost as part of the positive in 'twenty three I mean, you can see it from the margin expansion as well.
Opening of the midpoint so on pricing if you look at this year I mean after a flattish first half.
<unk> seen pricing going up 3% in the back half and our backlog is actually up our backlog margins are up over 100 basis points and what we have is even for next year is about 50 basis points of pricing coming through into the P&L, which is roughly about 30 ish million.
And the reason, it's 50 basis points and not what we have right now is it takes a while for the backlog to convert into revenue and some of that will come in in later years, but so price positive on commodities, we do expect about a <unk>.
$20 million to $30 million tailwind.
If we look back over the past two years, we faced about $180 million of commodity headwind of slightly more than $100 million came from Americas, and China and the rest came from Europe , and Asia and Americas in China of the $100 million odd.
Headwind, we're seeing about $30 million to $40 million of that come back because prices of steel have started coming down and do it 50% locked we still see some of it coming down over the years. So clearly that is very positive. It is actually in EMEA and in Asia Pacific, where we are not seeing the tail winds right now in Europe . If you look at <unk>.
Fill up 85% from where it was two years ago. So clearly there is there is some had been over there and in Asia, we buy a lot from tier two suppliers.
And thats, not yet come down as well, but overall, we see about a $20 million to $30 million tailwind on commodities.
Net net between price and commodities it's positive.
Thank you.
Thank you one moment for our next question.
Okay.
And our next question comes from Nigel Coe with Wolfe Research. Your line is now open.
Thanks, Good morning, everyone.
For the question.
I just wanted to.
Obviously some of the puts and takes.
On margins and I.
I think you called out mix impacts in new equipment. So just maybe just double click on that and just clarify what the mix headwinds.
But my question is really on the investments.
You continue to invest I think it's been very successful on the Recaptures and retention initiatives, but maybe just talk about the focus of our investment spend.
Going forward.
Let me start with the investment spend and then I'll have entourage talk to the mix.
Yes, we are I think <unk> seen Nigel since we became independent we have been obviously focused on our business focused on our markets and we've been extremely <unk>.
<unk> on investments in our strategy that will yield in terms of innovation. So we've done we've continued our investments in our service business.
In making our incredible field professionals more productive.
And thats yielded or the application that they've been using continue to show show incredible promise or tune App is up in terms of usage, 70% in terms of in the field we've got lots.
A lot of our service parts being ordered.
And our sales our field professionals using the upgrade App are also being part of our extended sales force and selling repairs. So all that's working working well, but the linchpin of our strategy is Otis one it's being connected it's having that that predictive transparent information.
<unk> in our ecosystem and we continued on our investment strategy for Otis One again, where we define on the service side, where we're going to install these to get the best yield for both productivity and customer stickiness. So what we're seeing we did we did deploy well over 100000 units.
Again this year on our trajectory to was 60% coverage of whats, becoming a larger portfolio $2 $2 million. This year, we said will be over $2 5 million units by 2026, and our medium term.
That's 60% should be off that that too.
That higher number.
That's where we're heading and we're seeing the results of that.
We're seeing it on the productivity side.
We're running on arrivals are down and we're seeing that also on the customer stickiness side in two ways. One is when we are connected.
Our <unk> product or any connected product.
Getting more in price for service and then we're getting higher conversion rates and higher retention rates or retention rates. This year.
We were pleased with where they're at 94% I look forward to the day that we can report a 95% retention rate.
Does that will have significant <unk>.
Solidity to our service driven growth strategy conversions were up this year.
And I think a lot of that especially in China going up to 48% this year.
They ended was due to our gen three elevators being connected and our oldest one units.
As well.
So globally, we are now at a 64% conversion rate and as China continues on its path to get to 60, which we think is the target then globally, we will be at about 70% conversion and that is our higher margin conversion on the portfolio itself that it is <unk> one.
It is that connected product that gives us the conviction that we can take the four 1% portfolio growth even higher even though this is what we shared for the medium term guide at about 4%. We do believe we can get that higher including in 2023.
So all in all investments in the new equipment side are continuing our R&D spend is there our strategic investments are there. We're really pleased with expanding gen. Three and Gen 360 on the service side the oldest one value proposition for the customers is working and we believe it's reflected in our in our margin expansion.
Pension as well for our shareholders. So let me try rhea for mix. Thanks.
So as you can see on the investments I will continue to invest and to grow our margins last year. We grew about 30 basis points, we should we're guiding for 2030.
And we look for productivity other ways to kind of offset that on the mix, it's too it's regional and product project mix on the regional mix. As you are aware that China, new equipment is a higher margin market for us and even last year in 'twenty two.
Other markets did little bit better than China, but if you look at 'twenty. Three we are guiding for China to be flat, whereas Americas EMEA to be up mid single digit and Asia mid to high single digit so that as a little bit of a regional mix impact, but more bigger mix impact is coming from project mix and over the past two years.
Three years, and yet as you've seen us making announcements when we won a lot of major projects are part of our share growth strategy has obviously been on volume as well as looking at different verticals be it infrastructure others to grow our major projects and the module major projects are definitely come in with very good maintained its business very high stickiness is very good margin.
But they are lower margin than the volume business. So there's a little bit of that impact and a healthy backlog that we have with 11% as we go into 'twenty three and beyond.
Makes sense. Thanks for the detail I guess I'll ask a few questions, but I just wanted to ask a question on you called out 800000 connected elevators.
Today.
Much of those.
Oh, just one connectivity I want to say about half that.
Yeah.
I think thats accurate.
Yeah, great. Thanks, Patrick.
You bet. Thank you one moment for our next question.
And our next question comes from the line of Steve Tusa with Jpmorgan. Your line is now open.
Hey, good morning.
<unk>.
Alright, Thank you I'll call. The Mayo is that we've got some other calls going on this morning, So you overlap sorry about that.
Can we just get a little bit more info on.
Like attrition or retention.
Maybe a little more precision around how much that may have improved year over year.
Obviously, 1% a lot. So there is some nuance there maybe just a little more precision on that.
Yes, so on the 94%.
We've got a there's a chart in the back and Steve We've shared that we our focus is having a net positive net churn.
Between between retention and Recaptures retention. They are the most important units to us we get them at the highest margin and that's where we want to start that individual customer relationship that we hope last decades into modernization and then into just.
For decades so.
It's at 94, its about aligned with last with 'twenty, one I'd say, it's pretty close.
In terms of retention and recapture though was up and you can see that slightly but it was it was upheld and that was really driven by a few items to two I'll call out one is our sales specialization, where we actually have recapture sales reps that.
That is all they do and they focus on on the density and capturing the best the optimal units for Otis because we have to go in at a lower price than we would in a at a normal conversion, but we want to make sure that they are accretive so the recapture specialist really.
We saw them hit their stride.
As we went through 'twenty two and the second is just one.
The <unk> capital investment, we continue to make at the data level on connected units and on offering that when we do go recapture that.
That really makes a difference to our customers I've personally been involved in a few of those sales calls to win some portfolios back.
And it really makes a difference we can show them the visibility they have their dashboard theyre going to have and the whole ecosystem, we offer and so those those two combined have really helped.
And that's really that's been our strategy and it's one that will kind of what we're what we're going to continue doing.
And then just on the attrition and in China I know it said.
Growing part of the install base, but any trends there worth calling out.
I think it's I think it's pretty consistent with 21 is what I would say we didn't see a huge anomalies obviously.
<unk> portfolio in China, Our service portfolio I think we've shared is a little over 325000 units.
And.
That's grown it's our sixth straight quarter of mid to high single digit portfolio growth in China, and so we're continuing recapture did well there.
So we're continuing to monitor that but.
Our team our service teams in China are continuing against six straight quarters, and yes, we expect because of the growth in that segment. Yes, we can see that we expect that to be in the teens again for 'twenty three exactly great. Thanks, a lot. Thanks a lot.
Thank you one as a reminder to ask a question you will need to press star one on your telephone.
And our next question comes from Miguel <unk> with.
Exane BNP Paribas. Your line is now open.
Hi, good morning, everyone.
I've got a couple of questions. The first one on your margins for new equipment in China, I know that you don't disclose this.
But can you give us some color on how this has evolved over the years how does your margin compare today versus for example, pre COVID-19 levels.
<unk>.
At the moment, what is the direction of travel for margins on new orders.
And then maybe longer term can you give us a sense why margins in China will keep being much more profitable than for example, Europe or the U S. Thank you.
Okay. I think there were three questions over there. So so let me start with the China, New equipment margin, Yeah, we don't disclose margin by regions.
If you look at China, new equipment at a slightly higher it's a good margin business for US importantly, if you look at even last year with all of the volume decline the commodities headwinds that we faced we were still able to mitigate a significant amount of that through productivity. So the margins of the new equipment business actually held quite strong because of the productivity business.
Even this year.
Way, we are guiding to our margins to be we're almost back to 2021 levels, despite volume being flattish or slightly down China volumes being down 10% and going through a commodity headwinds of about 150, <unk> hundred $80 million. So clearly the margins are trending in the right direction.
And all I would say is that we are quite happy with the way we've been able to mitigate some of the headwinds to get to where we are right now.
So that's on the on the first question regarding where are new equipment margins. Our backlog is trending up the backlog margin is trending up we've had price increases over the past couple of quarters.
If you look at where we are exiting this year in 2021, our backlog margin declined by one point, we are above a point right now and we were commodities are and where our pricing of new orders and new proposals are going in that that backlog margin should kind of inch up as we move along through the course of the year. We again don't give specific guidance on when it would.
But it is encouraging to see the price sticking.
In the market over there.
Yes.
Yes.
What was the third question I Couldnt quite get the question completely if you could just repeat that.
Well just give us a sense on.
The spread between margins in China, and the rest of the world why shouldn't we see some kind of conversion trending.
Trending down to more like Europe , or the U S.
Mature versus China, Yes, it's still accretive for us in terms of the margins over there and we keep driving productivity.
So it will <unk>.
To do that we kind of embarking upon via digitalization of productivity, we should see the margins kind of inching up I mean net net on the service side, we think 50 basis points margin expansion. This year, which is on the iron of our medium term guidance.
And obviously margins will differ.
By region by country, but with all the tools, we are doing in VC margin expansion across all the regions.
Thank you and then just one last question on free cash flow conversion I want to get your views not only on 2023 with also a little bit further away where do you see this normalizing because 2021 was 128% 2020.
215, and now your guide between 105, and 115% is it basically China contributing less working capital.
And do you see that improving.
In 2023 with more financing to real estate developers maybe.
If we can get some of your color what's going on on the quality in China today.
See any improvements there. Thank you very much.
Yes.
So let me take but actually our working capital in China collection is progressing quite well. If you look at this 2022, we finished at about 115% of net income which was quite good we had a very strong fourth quarter. We came in a little bit lighter was because of the inventory that we built up to make sure that we can support our backlog as we get.
Into 2023 between receivables and payables, we are pretty much there. So so it was more of the inventory built up now what we are guiding at the midpoint for 2023 is 110% of net income is essentially driven by earnings growth with a little bit of a modest.
<unk> from capital expenditures to be embarking on altice, one strategy. So that takes us to 110% net income and as we move forward, we should grow our cash with earnings and that's what we've kind of guided towards and you should see that normalizing around the 110 ish percent level, Yes, Miguel just let me wrap on that but I mean this is that was our <unk>.
Medium term guide that we gave at the Investor day in February of last year, and that's why we beat it in 'twenty two.
And we're staying consistent right now with our with our guide.
With the Investor day.
Thank you.
Thank you.
And I'm currently showing no further questions at this time I would like to hand, the conference back over to Mr. <unk> for any closing remarks, well. Thank you Norma our success in 2022, our third year in a row of performing for all stakeholders demonstrates the strategic resiliency of our business and provides us with confidence as we begin a new year.
Supported by strong industry dynamics, we remain committed to our strategic pillars in order to deliver for our customers shareholders valued communities and the riding public.
We set significant goals for the year ahead, and we look forward to sharing our 2023 success with you please stay safe and well. Thank you.
This concludes today's conference call. Thank you for your participation you may now disconnect everyone have a wonderful day.
The conference will begin shortly.
Lower Johan during Q&A, you can dial star one one.
[music].
Hum.
Sure.
Yeah.
[music].
Yes.
[music].
Okay.
Okay.
Okay.
Okay.
Yeah.
Sure.
Yes.
Okay.
Okay.
[music].
Sure.
Thank you.
[music].
Okay.
Yes.
Yes.
[music].
Yes.
Yes.
Yes.
Yes.
Okay.
[music].
Yes.
Okay.
Yes.
[music].
Okay.
Yes.
[music].
Okay.
[music].