Otis Worldwide Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unless otherwise stated, amounts are in U.S. dollars. Otis became an independent public company on April 3, 2020; earlier 2020 and 2019 results reflect the business before separation and may not be fully comparable with results as a standalone company.
Business context and financial performance
Otis manufactures, installs, maintains, repairs and modernizes elevators and escalators. Its two segments are New Equipment and Service. Service includes maintenance and repair as well as modernization.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $3,268 million | $3,313 million | $9,263 million | $9,765 million |
| Operating profit | $454 million | $482 million | $1,199 million | $1,378 million |
| Operating margin | 13.9% | 14.5% | 12.9% | 14.1% |
| Net income attributable to common shareholders | $266 million | $317 million | $655 million | $898 million |
| Diluted EPS | $0.61 | $0.73 | $1.51 | $2.07 |
| Gross margin | 30.0% | 29.4% | 29.9% | 29.3% |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $1,171 million | $1,015 million |
Q3 sales declined 1.4% year over year; nine-month sales declined 5.1%. For the nine-month period, organic sales fell 3.3%, with a 7.0% decline in New Equipment and a 0.5% decline in Service. Gross margin improved 60 basis points in both comparison periods, but reported operating profit and earnings declined.
Segment performance and material changes
- New Equipment: Q3 sales were $1,423 million, down 1.9%, and operating profit was $95 million, down 17.4%; margin fell to 6.7% from 7.9%. Nine-month sales declined 9.0% and operating profit declined 23.7%. Management cited COVID-related volume weakness, under-absorption, field inefficiencies and mix, partly offset by productivity and cost containment.
- Service: Q3 sales were $1,845 million, down 1.0%, while operating profit rose 0.5% to $409 million; margin increased to 22.2% from 21.8%. Nine-month sales declined 2.2%, but operating profit increased 0.8% to $1,190 million. Productivity supported profit; lower volume, price concessions and higher bad-debt expense were offsets.
- Q3 SG&A increased 8.3% to $481 million, and nine-month SG&A increased 4.4% to $1,387 million. Higher separation-related and standalone-company costs more than offset lower employment costs and discretionary spending.
- Nine-month operating profit included approximately $55 million of fixed-asset impairment and $12 million of related license costs. Separation costs were $29 million in Q3 and $82 million for nine months. Restructuring costs were $20 million in Q3 and $46 million for nine months.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $1,733 million; approximately 80% was held by foreign subsidiaries. Total debt was $6,050 million, comprising $538 million of short-term borrowings and $5,512 million of long-term debt. Net debt was $4,317 million.
- Long-term debt increased substantially following issuance of $5.3 billion of notes and a $1.0 billion term loan in connection with the separation. Otis prepaid $750 million of the term loan in September. Average interest expense rate was 2.42% for Q3 and 2.46% for nine months; average debt maturity was approximately 11.1 years.
- Otis had no borrowings under its $1.5 billion revolving credit facility, which backs its commercial-paper program. The company reported compliance with debt covenants at quarter-end. It reported a shareholders’ deficit of $4,024 million, largely reflecting separation-related equity transactions.
- Nine-month operating cash flow was $1,171 million, up $156 million year over year. Investing cash outflow was $289 million; financing cash outflow was $589 million. Cash and cash equivalents rose by $293 million from year-end 2019.
- The board authorized a share-repurchase program of up to $1 billion, but Otis said it did not expect repurchases in 2020 as it focused on deleveraging. Management expects to fund operations mainly through operating cash flow, cash on hand, credit lines and capital-market access.
Outlook, risks and contingencies
The filing gives no quantified earnings or revenue guidance. Management expected COVID-19 to negatively affect the business at least through the remainder of 2020, citing customer liquidity and credit risk, factory or supplier constraints, construction-site closures, order delays or cancellations, and restricted access to equipment for service. The duration and scale of the impact remained uncertain. Management did not expect a significant near-term impact on capital resources or overall liquidity, based on available cash and financing access.
Remaining performance obligations were approximately $16.9 billion at September 30, 2020; Otis expected about 90% to be recognized as sales over the following 24 months. Restructuring actions were expected to produce annual recurring pretax savings of approximately $40 million for 2020 actions and $45 million for 2019 actions as they were implemented. Most remaining actions were targeted for completion in 2020 and 2021.
- Legal and tax: German tax litigation concerns approximately €215 million of claimed tax benefits and estimated interest of approximately €118 million. The company had recorded a €45 million interest accrual; the outcome and any further exposure remain uncertain. A new putative class action challenges adjustments to employee incentive and deferred-compensation awards after the spin-offs; Otis said it believes the claims are without merit and could not estimate a possible loss.
- Other contingencies: Recorded asbestos liabilities were $24 million, the low end of an estimated $24 million–$45 million range, with an approximately $5 million insurance-recovery receivable. Standby letters of credit had maximum potential payments of $142 million; no probable costs were estimated. Environmental obligations were $12 million.
- Other unusual event: A fire at a German manufacturing facility caused immaterial asset and business-interruption losses; Otis had submitted an insurance claim and did not anticipate a material future operational impact.
- Otis stated that COVID-19 could further affect customer payment capacity, demand, supply chains and financing access. Other key risks include separation-related costs and tax treatment, indebtedness, restructuring execution, foreign exchange and litigation.
Important facts for investors to verify
- Whether New Equipment demand and margins stabilize, and whether Service productivity can continue to offset volume and pricing pressure.
- The ongoing cash cost of separation and standalone operations, and progress against restructuring savings and completion targets.
- Debt reduction, commercial-paper use, covenant headroom and the availability and cost of capital-market financing.
- COVID-19 effects on customer collections, bad-debt reserves, orders, installations and service access; the receivables allowance rose to $156 million from $83 million at year-end.
- Developments in the German tax litigation and employee-compensation lawsuit, including any change in estimated exposure or recorded accruals.