Earnings Call Transcript
Otis Worldwide Corp (OTIS)
Earnings Call Transcript - OTIS Q4 2021
Operator, Operator
Good morning, and welcome to Otis' Fourth Quarter 2021 Earnings Conference Call. This call is being carried live on the Internet and recorded for replay. Presentation materials are available for download from Otis' website at www.otis.com. I'll now turn it over to Michael Rednor, Senior Director of Investor Relations.
Michael Rednor, Senior Director of Investor Relations
Thank you, Catherine. Welcome to Otis' Fourth Quarter 2021 Earnings Conference Call. On the call with me today are Judy Marks, President and Chief Executive Officer; and Rahul Ghai, Executive Vice President and Chief Financial Officer. Please note, except where otherwise noted, the Company will speak to results from continuing operations, excluding restructuring and significant nonrecurring items. The Company will also refer to adjusted results where adjustments were made as though Otis was a stand-alone company in the current period and prior year. 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. Otis' 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.
Judy Marks, President and CEO
Thank you, Mike, and thank you, everyone, for joining us. We hope everyone listening is safe and well. We delivered a strong close to an excellent year despite ongoing macro challenges. These results are a testament to the strength of our strategy and the dedication of our colleagues to execute and deliver results for our customers and shareholders. We achieved broad-based organic sales growth, grew adjusted operating profit for the third year in a row, delivered 19% adjusted EPS growth, and generated $1.6 billion in free cash flow while introducing new innovative solutions for our customers and passengers. We remain committed to shareholder value creation and strategically deployed capital, completing $450 million in debt repayment, distributing over $390 million in dividends after raising the dividend 20% versus the prior year, and repurchasing $725 million of Otis shares. Given the strength of our balance sheet, we also announced our tender offer for the remaining interest in Zardoya Otis, an accretive transaction for Otis. New equipment orders were up 7.3% in the fourth quarter and up 13.2% for the year with broad-based growth. In Asia Pacific, we received an order for nearly 280 units supporting Taiwan Taoyuan International Airport's new Terminal 3 building and concourse. This includes 92 escalators, 60 moving walkways, and more than 120 Gen2 elevators equipped with ReGen drive technology that will support the terminal's smart and green design. In November, we received an order for Sawyer's Landing in Miami, Florida. This project extends a decade-long relationship with the developer, and Otis will install over 20 elevator and escalator units. Additionally, Concord Pacific, one of the largest developers in Canada, has selected Otis to support its King Landing project in Toronto, Ontario, extending our nearly decade-long relationship. We'll provide more than a dozen elevators for this mixed-use high-rise. These orders demonstrate the power of long-lasting relationships and our continued investments in providing innovative solutions for our customers. Our strong orders momentum throughout the year led to approximately 115 basis points of new equipment share gain on top of 60 basis points in the prior year. In addition to executing our financial priorities, we remain committed to advancing our ESG initiatives. Our Gen360 next-generation digitally native elevator platform was awarded two environmental product declarations. This platform is positioned to revolutionize our customer and passenger experience while providing energy efficiency benefits that help to reduce the impact on our planet. Gen360 joins our existing suite of energy-efficient products such as the ReGen drive, which can distribute power back into a building. Also in China, we received several awards that recognize our team's achievements in leadership, innovation, and sustainability, including recognition as a 2022 top employer by the Top Employers Institute. And finally, last week, Otis was recognized for the second year in a row as the best place to work for LGBTQ equality by the Human Rights Campaign. This award demonstrates our leadership in creating an inclusive culture where all voices feel safe, welcomed, and heard. Now moving to Slide 4. This year, we grew our industry-leading maintenance portfolio by 3%, our best portfolio growth rate in over a decade. This accelerated maintenance portfolio growth is a key part of our long-term strategy. Equally important is the digital connectivity of units in our service portfolio, and this year, we deployed approximately 100,000 Otis ONE units, bringing total portfolio connectivity to about one-third of our approximately 2.1 million units under our service. Over the medium term, we plan to increase connectivity to approximately 60% of units, up from roughly 25% at the end of 2020. Our operational initiatives also progressed as we rationalized adjusted SG&A expenses, down 40 basis points as a percentage of sales and reduced the adjusted effective tax rate by 190 basis points. This represents significant progress in rightsizing our costs and optimizing our tax structure as an independent company. I'm pleased with our performance in our second year as an independent company as we delivered strong financial results and advanced our ESG initiatives. You can expect to hear more in the coming months with the publishing of our first ESG report. Now turning to Slide 5 and starting with the 2022 industry outlook. While market dynamics remain fluid, the industry's long-term fundamentals are solid. We're encouraged by the strong recovery experienced during 2021 and have confidence this momentum will continue into 2022 in many regions. The new equipment market is expected to be up mid- to high-single digits in the Americas, low single digits in EMEA, and down mid- to high single digits in Asia, driven by uncertainty in China, where we expect the market to be down 5% to 10%. While the China new equipment market faces headwinds, this will not detract from solid growth in the service installed base where approximately 1 million units are added each year to the global base, a mid-single-digit growth rate annually. Industry-installed base in the Americas and EMEA are expected to grow low single digits, and in Asia, we're expecting high single-digit growth driven by China. Service is the foundation of our business, and we expect to grow our service units by more than 3% in 2022 and to eclipse 2.2 million units under maintenance, remaining the largest service portfolio in the industry. Here's our 2022 financial outlook. For the year, we expect organic sales growth of 2.5% to 4.5%. Net sales will be in a range of $14.4 billion to $14.7 billion, up 1% to 3%, accounting for FX headwinds. Adjusted operating profit is expected to be in the range of $2.24 billion to $2.3 billion, up $95 million to $165 million, excluding the expected impacts from foreign exchange. At actual currency, adjusted operating profit is expected to be up $50 million to $120 million. Adjusted EPS is expected in the range of $3.20 to $3.30, up 6% to 10% versus the prior year and $0.24 at the midpoint. Lastly, we expect free cash flow to be robust at about $1.6 billion or approximately 115% to 120% conversion of GAAP net income. We remain highly disciplined in our capital allocation strategy, committed to meeting the needs of all stakeholders through dividends, debt paydown, bolt-on M&A and share repurchases once we complete our deleveraging plans associated with the acquisition of the remainder of Zardoya. With that, I'll turn it over to Rahul to walk through our 2021 results and 2022 outlook in more detail.
Rahul Ghai, CFO
Thank you, Judy, and good morning, everyone. Starting with fourth quarter results on Slide 6. Net sales were up 2.2% to $3.6 billion. Organic sales grew for the fifth consecutive quarter and were up 2.8% with growth in both segments. Adjusted operating profit was up $11 million and up $21 million at constant currency as higher volume, productivity in both segments and favorable service pricing was partially offset by commodity inflation and the absence of temporary cost actions taken in the prior year to alleviate the impact of COVID-19. Fourth quarter adjusted EPS was up 9.1% or $0.06 driven by $0.02 of operating profit growth and $0.02 from a lower adjusted tax rate, benefits from share repurchases done earlier in the year and reduced interest expense from the repayment of debt contributed the balance. Adjusted EPS was $0.06 ahead of the prior outlook, including the favorability from better-than-expected operating profit growth and tax rate that ended at the low end of prior expectations. Moving to Slide 7. New equipment orders were up 7.3% at constant currency. Orders momentum remained strong in Asia, up mid-single digits, including the seventh consecutive quarter of growth in China. Orders were up high teens in the Americas, and awards which precede order booking were up mid-single digits in North America, signaling continued recovery in the booking trends heading into '22. EMEA was flat versus the prior year as mid-single-digit growth in Europe was offset by a decline in the Middle East, from a tough compare on major orders. Proposal volumes in the quarter also continued to show signs of robust demand globally, up double digits, driven by strength in China. Total company backlog increased 1% and 3% at constant currency with growth in all regions, including approximately 5% growth in Asia. Booked margin in the quarter was down slightly more than 0.5 points from a decline in the Americas partially due to customer mix, but the year-over-year trends in the region showed substantial improvement from Q3. This was partially offset by almost one point of improvement in booked margins in Asia with EMEA being about flat. Overall, our pricing on new orders was slightly better than our prior expectations. The backlog margin trend adjusted for mix was about flat sequentially and down about one point versus the prior year. Full year new equipment orders were up 13.2% with growth in all regions with Americas up 14%, EMEA up 4% Asia up 17%, with high teens growth in China. In the fourth quarter, new equipment organic sales were up 1.2% from growth in Asia, up approximately 12%, including mid-teens growth in China. Growth in Asia was partially offset by a decline in the Americas and EMEA driven by tough compares from strong recovery from COVID-19 in the fourth quarter of the prior year. Adjusted operating profit was down $7 million. Commodity inflation of $35 million that was in line with our prior expectations was largely mitigated by installation productivity and favorable performance on projects. Service segment results on Slide 8. Maintenance portfolio was up 3% from broad-based improvements in retention, recaptured and conversion rates. Conversion rate in 2021 was up 3 points globally and up 5 points in China to 45%. This improvement in conversion contributed to high teens portfolio growth in China for the second consecutive quarter. In addition, our retention rate in 2021 continued to improve and is now above 94%. Modernization orders returned to growth in the quarter and were up 18.3% at constant currency with growth in EMEA and the Americas. Overall, modernization backlog was up 6% at constant currency. Service organic sales grew for the fourth consecutive quarter, up 4%, with growth in all lines of business. Maintenance and repair grew 4.3% with continued robust recovery in repair and low single-digit growth in the contractual maintenance sales. Modernization sales were up 2.2%, slightly below our expectations due to continued supply chain challenges. Service adjusted operating profit was up $20 million, with 50 basis points of margin expansion, the eighth consecutive quarter of margin improvement. Profit growth was driven by higher volume, favorable pricing and mix, partially offset by higher costs from the absence of COVID-19 cost containment actions taken in the prior year. Service portfolio pricing was up more than 1% mainly due to price increases in Americas and EMEA. Moving to Slide 9. Overall, for the full year, we carried the momentum from 2020 into 2021 and gained 115 basis points of new equipment share gain, accelerated the rate of maintenance portfolio growth. Organic sales were up almost 9%, with new equipment and service up 15.5% and 4.1%, respectively. This sales growth, our focus on execution, and FX tailwind resulted in $272 million of adjusted operating profit growth. New equipment operating profit was up $105 million versus the prior year at constant currency driven by higher volume and installation productivity. That was more than double what we achieved in 2020. This, combined with our ongoing focus on material productivity, more than offset the unfavorable price mix and headwinds from commodity price increases of approximately $90 million. Margins in the segment expanded 100 basis points, more than offsetting the decline in 2020 and are now above 2019 levels. Service adjusted operating profit was up $104 million versus the prior year at constant currency, driven by higher volume, productivity initiatives and favorable pricing that more than offset the return of costs in the business to support higher activity. Service margins expanded 30 basis points, building on the expansion in 2020 and are now 140 basis points above 2019 levels. Corporate segment costs were about flat for the year despite the step-up in public company expenses from disciplined cost management. Adjusted EPS was up 19% for the year from operating profit increase and a reduction in the tax rate that was down 190 basis points for the year. Adjusted EPS was up about 35% from 2019 for a two-year CAGR of 16%, substantially ahead of our prior medium-term growth expectation. We generated close to $1.6 billion in free cash flow from earnings growth and a rigorous focus on working capital. Working capital is now down more than 50% from 2019 levels. As we look forward to 2022 on Slide 10, we expect service industry growth rates to be consistent with 2021 across all regions and new equipment end markets to show solid growth outside of China. This, combined with higher starting new equipment backlog, strength of the maintenance portfolio and our relentless focus on operational excellence, gives us the confidence to improve across all key metrics in 2022 with organic sales up 2.5% to 4.5% and overall margin expansion of approximately 30 basis points. We expect sales, operating profit and margins to improve in both segments at the midpoint. Adjusted EPS is expected to be in a range of $3.20 to $3.30, up 8% or $0.24 at the midpoint. We expect free cash flow of approximately $1.6 billion between 115% and 120% of GAAP net income. This free cash flow outlook reflects the strong earnings growth expectation, partially offset by an approximately $55 million headwind from a one-time tax-related payment that was previously expected in 2021 and $20 million in incremental capital expenditures to support digital connectivity initiatives. Our capital deployment plans remain on track, and we have already repaid $400 million of debt in January with the remaining deleveraging expected to be completed in the first half. Once our target leverage metrics are met, we plan to recommence share repurchases. Taking a closer look at our organic sales outlook on Slide 11. The new equipment business is projected to be up 0.5% to 3%, supported by the backlog that was up 3% at constant currency in 2021. Americas organic sales growth is expected to be up low single digits, EMEA up mid-single digits. Asia is expected to be up or down slightly with mid- to high single-digit growth in Asia Pacific. China is expected to be flat to down low single digits as growth from higher starting backlog is offset by a decline in the book and ship business. Service segment growth is broad-based and is expected to be up in all regions with maintenance and repair up 4% to 6%, benefiting from a 3% higher starting portfolio, favorable service pricing environment and a continued recovery in repair. Modernization is expected to be up 4% to 6% from 6% higher starting backlog and easing of 2021 supply chain challenges. Overall, organic sales are expected to be up 2.5% to 4.5% and building on the approximately 9% organic growth in 2021. Switching to the EPS bridge on Slide 12. We expect EPS growth of 6% to 10% with operating profit growth of $95 million to $165 million at constant currency, contributing $0.16 to $0.27 to the EPS growth. Operating profit will benefit from increased volume in both segments, service pricing tailwinds and continued savings from material, installation and service productivity initiatives. This will be partially offset by commodity headwinds of approximately $90 million. Foreign exchange translation is expected to be a 7% EPS headwind and mainly from the strengthening of the euro and the yen against the U.S. dollar. Non-controlling interest expense from increased profit in China and other JVs will reduce EPS by $0.02 to $0.04. FX translation impact and increase in non-controlling interest expenses are mostly offset by accretion from the Zardoya transaction. We now have more visibility into the approval process and are increasingly optimistic in the timing of the delisting and expect the transaction to be about $0.10 accretive in 2022. Lastly, we expect to reduce our adjusted tax rate by an additional 50 to 100 basis points this year, adding $0.02 to $0.03 to the EPS. This outlook represents the fourth consecutive year of strong earnings growth as we continue to build on strong execution, mitigate the macro challenges, leverage the investments that we have made, and benefit from our continued end-market recovery. And with that, I'll request Catherine to please open the line for questions.
Operator, Operator
Thank you. Our first question comes from Jeff Sprague with Vertical Research. Your line is open.
Jeff Sprague, Analyst
Thank you. Good morning, everyone.
Rahul Ghai, CFO
Good morning, Jeff.
Jeff Sprague, Analyst
Good morning. Just a couple to start. Just first on the Americas. It looks like you're guiding Otis below your view of the market. Could you just explain what's going on there? I assume it's backlog conversion, but some color would be interesting.
Judy Marks, President and CEO
Yes, Jeff, let me take that. So we're doing a low single-digit guide in the Americas, really strong performance this year in the Americas, up 14% in orders roughly and up 14% in sales. So we are capitalizing on the market as it's growing, and the indices are all looking really positive, both multifamily, non-residential, whether it's Dodge or ABI, everything is looking good, really heading into '22. Our guide really reflects project timing on several major projects that don't drive revenue until very late in '22. It's going to help us in '23 for these large projects, but it really does drive the majority of the Americas guide.
Jeff Sprague, Analyst
And Judy or Rahul, maybe you could just give us a little color on the complexion of the sequential patterns here this year. I would imagine China starts weaker and gets stronger, but would love to hear your view on that. And in terms of price coming through the backlog, counteracting the commodities headwinds, how does that play out? Anything you could share on how to think about the jumping-off point and how we start here in Q1.
Rahul Ghai, CFO
Yes, absolutely. So Jeff, we expect to start the year strong on service growth. Compares are easier. I mean if you go back to Q1 of last year, Q1 was the lowest organic growth quarter in 2021. So compares are easier on service. And our Q1 growth should be more or less consistent with our full-year guidance. Some headwinds from costs coming back since we were still dealing with the pandemic last year, but overall, it should be a really, really strong quarter on service. Given the tough organic growth compares on new equipment in the first half, with 25% growth last year in the first half of 2021, new equipment growth will be stronger in the second half. And also commodity headwinds will predominantly be a first half phenomenon. So, the first half of 2022, new equipment could look like Q4 of 2021 on a year-over-year basis. But sequentially, we do expect Q1 of '22 will be stronger than Q4 of '21 and on both profit and margin. And then Q2 will show improvement over Q1. So, we expect continued sequential improvement in our new equipment business. The FX headwind will also be a first half issue. Keep in mind, the euro was about 1.20 in the first half of '21 and is now trading at 1.11, 1.12 levels. Our guide for the year is 1.12. So, there's a headwind in the first half. And as we go into the second half on FX, the compares get much easier. So if we put all of this together, we faced some pressure on new equipment, organic growth, commodities, some FX headwinds. But the first half profit growth in the Service segment should more or less offset that. And we expect to grow profit kind of in line with our revenue growth in the first half, and EPS will improve year-over-year as well.
Jeff Sprague, Analyst
Great. Appreciate it. Thank you.
Rahul Ghai, CFO
Thank you, Jeff.
Operator, Operator
Thank you. Our next question comes from Miguel Borrega with BNP Paribas Exane. Your line is open.
Miguel Borrega, Analyst
Hi, good morning, everyone. I have two questions, if I may. The first is about your guidance for new equipment sales in 2022. You're indicating that in Asia, it may fluctuate slightly. However, if I look at your orders, there have been seven consecutive quarters of positive growth, and in 2021, the growth was above the mid-teens in order volume in Asia. Could you clarify whether this is due to lead times, or if developers are having more difficulty paying at delivery, or if the lead target has extended further into 2022? Thank you.
Judy Marks, President and CEO
Yes, Miguel, this is Judy. It's not really a lead time issue. We entered the year with our backlog, and our China backlog is up entering 2022, supporting about two-thirds of our backlog for that year. So, we're starting with roughly two-thirds of the China backlog, and the remaining third is book and ship. We're being cautious with the book and ship, monitoring trends and understanding whether it's state-owned enterprise developers or private developers that we're dealing with. We believe this will significantly influence our 2022 performance in China, which will also affect our overall Asia numbers. Orders are quite strong, but how they convert, particularly the book and ship, which represents about a third of our global volume each year, especially in China, is something we're keeping an eye on for next year.
Rahul Ghai, CFO
Let me provide some numbers to support what Judy mentioned. Our Asia backlog is up 5%, with the Asia Pacific backlog increasing at a high single digit rate, and China’s backlog is up approximately 3%. It's important to note that 60% to 65% of our in-year business is based on this backlog. For China, with a 3% backlog increase accounting for two-thirds of our revenue, we expect about 2% growth in the China business. If the book and ship for the year remains flat, that’s the right way to consider it. Our guidance for China suggests it may either remain flat or decline by 3%. Even with a higher starting backlog, we anticipate the book and ship could decrease between 5% and 10% for the remaining portion of revenue. This aligns with Judy's comments about the China market. There is also a chart in the appendix comparing our 2021 orders in China to the market, where our orders outperform the market by about two times. If we can achieve similar performance in 2022, there could be an upside to this outlook. However, it's still early in the year, and the China market is quite dynamic, so we are being cautiously prudent at this stage in our guidance.
Miguel Borrega, Analyst
That's great. Thank you. And then my second question is just coming back to your margin guidance and specifically for new equipment. And could you give us more color on the trajectory? Is this going to be perhaps a second half-weighted profit year for new installations?
Rahul Ghai, CFO
Yes, I think I addressed that in response to Jeff's question. Regarding new equipment, we are expecting about $90 million in commodity headwinds, primarily in the first half. We have accounted for some commodity challenges in the second half due to last year's volatility. However, if commodity prices change positively, the impact may lessen. Currently, we've projected $90 million for commodity headwinds. It’s important to note that growth is anticipated to be slower in the first half compared to the second half, with commodity challenges being more significant earlier in the year. Consequently, we expect our new equipment margins to face slight challenges in the first half, but to improve in the second half. To reiterate, in response to Jeff's inquiry, we anticipate our profit growth to align with our revenue growth in the first half, and we do not foresee a margin contraction in the first half due to service growth.
Miguel Borrega, Analyst
Right. Thanks, Rahul. Correct. Yes. Got it. And then just one last question on your capital allocation strategy, you've suspended the share buyback because you're not focusing on deleveraging post the acquisition of Zardoya. If I'm correct, this would still imply below 2x net debt to EBITDA for next year for 2022. Can you remind us the normalized level that you're seeing the business operating from? Thanks.
Rahul Ghai, CFO
We expect to end the year around 2.1, not below 2. We are very comfortable with our debt levels. Out of the $500 million planned for deleveraging, we've already accomplished $400 million, leaving us with $100 million remaining. Once we can bring the cash back to the U.S., we will initiate our share buyback program. Our guidance indicates that we will restart the share buyback after completing our debt repayment. We will provide more details on the share buyback once we have clarity on the cash repatriation.
Operator, Operator
Thank you. Our next question comes from Julian Mitchell with Barclays. Your line is open.
Julian Mitchell, Analyst
Hi, good morning. Maybe I just wanted to circle back, apologies to China new equipment revenues for a second. So I think you'd said, Rahul, those would be down flat to down low single digits in 2022 from a sort of a revenue standpoint. Just wanted to understand sort of, again, just how you're thinking about that sort of first half and second half and how you'd expect your orders in China, new equipment, to trend going through this year? Just trying to understand that sort of relationship between the orders booked in China and then when they're sort of being billed in the P&L?
Rahul Ghai, CFO
Yes, good morning Julian. To clarify my earlier comments, we anticipate our new equipment revenue in China to be stable or decrease by up to 3%. This is our forecast for growth in the new equipment segment. We have a larger initial backlog that has increased by approximately 3%, which supports my earlier statement. If the book and ship business remains flat year-over-year, it should lead to around a 2% growth, since the backlog constitutes about two-thirds of our revenue. However, if our guidance is flat to down 3%, it would suggest a decline in the book and ship business, approximately 5% to 10%, at both ends of this guidance, aligning with broader market trends. It's important to note that we performed significantly better in China regarding orders in 2021, nearly doubling the market growth. This improvement is not accounted for in our current guidance, so if we can exceed market order growth, there could be potential upside. Regarding the first and second halves of the year, we expect the market to be softer in the first half, primarily due to the tough comparisons from last year, when the market surged by 16% in the first nine months and ended the fourth quarter flat. This means we will face some challenging year-over-year comparisons for 2022, and our order trends will likely reflect this pattern.
Judy Marks, President and CEO
Yes. Let me just add two things, Julian. If you context that the segment is about $650,000 for new equipment in China, even if that down 5% to 10% happens in the segment at the 10% level, we're back to 2020 levels for the China segment. So it's still healthy. We've gained share both for the last two years in China, and the team is performing incredibly well. We actually had record unit orders in 2021. So, we've got momentum with us, but we're trying to be prudent to watch some of the volatility that's happening.
Julian Mitchell, Analyst
Thanks very much. And then maybe just step back from the quarterly moving parts. Two years ago, at the Investor Day, you talked about 20 to 30 basis points of sort of annual operating margin expansion medium term, definitely on track. With that, you're up 30 bps last year, you're guiding this year up 30 bps as well. And I suppose in the round, sort of should we think about 2021 and 2022 in aggregate being sort of fairly typical when we're looking at the sales trends? I understand you've got some price-cost noise, but you've also had higher sales growth than you've guided medium term. So maybe they offset each other. Just trying to understand sort of any big levers, good or bad on the margins beyond this year when you think about the medium term or it's kind of steady as she goes and these years are fairly representative in total.
Judy Marks, President and CEO
I think it's interesting to compare 2020 as a time for cost management during the pandemic, 2021 as a recovery year, and in 2022, we anticipate growth, though at a lower rate than in 2021, which had a higher base. The significant change in 2022 is that we are returning to our core service growth, which is expected to be between 4% and 6%, supported by portfolio growth of 3%. As noted in our guidance, this represents approximately 80% of our profit, where we expect to see 50 basis points of margin expansion in the service segment. New equipment may fluctuate more from year to year, but our service business is what continues to support and drive our performance. This gives you a bit of a preview ahead of Investor Day.
Rahul Ghai, CFO
And keep in mind, Julian, we grew 30 basis points of margin in '21 after absorbing 50 basis points of mix headwinds because new equipment grew much faster.
Judy Marks, President and CEO
Faster than Service levels.
Rahul Ghai, CFO
Adjusted for mix, margins increased by about 80 basis points over the year. We are on track to meet the 30 basis points guidance we provided at Investor Day.
Operator, Operator
Thank you. Our next question comes from Stephen Tusa with JPMorgan. Your line is open.
Stephen Tusa, Analyst
Sorry, I'm a bit on the move here. A straightforward way to ask the question would be what you believe will be the toughest order comparisons in 2022 for China. Should we be prepared for any particular quarter, considering the current level and the comparisons, especially for something that could decrease by double digits for you specifically? Additionally, what level of orders would you need to see this year, given your strong backlog, to feel confident about growing or at least maintaining stability in China in 2023?
Rahul Ghai, CFO
Yes, the quarterly order trend is just hard to predict, Steve. By just nature, the orders are lumpy, right? So, that's...
Judy Marks, President and CEO
We might need Steve to go mute.
Rahul Ghai, CFO
The orders fluctuate, making it difficult to predict any specific quarter. However, as previously mentioned, orders showed significant growth overall. If you review the information on China orders, you'll see that our business in China increased significantly, doubling in size, especially in the first half. While Q4 also experienced year-over-year growth, it wasn't as robust as the first half, yet we still outperformed the market in that quarter. The comparisons to the first half are indeed more favorable. Looking ahead, sustainable growth will depend on several factors, with China being one important aspect. However, it's crucial to note that the rest of our operations are also thriving in strong growth markets. Regions like the Americas, EMEA, and Asia Pacific account for about two-thirds of our new equipment business, indicating a solid growth opportunity beyond 2022. Additionally, the backlog in the Americas should contribute positively in 2023, as many orders from 2022 are expected to ship this year. We are optimistic about maintaining low single-digit growth in new equipment, aligning with our medium-term expectations. We stand by this outlook, with more details to come on Investor Day. Furthermore, with service revenues projected to grow by 4% to 6% this year at a sustainable level, this will also support profit growth into 2023.
Judy Marks, President and CEO
Yes. The other thing, Steve, we're seeing, and we'll show that you see this in our guide for service for '22, but it's going to keep growing as the modernization business. So we show that at 4% to 6% for '22, but we're going in with a 6% backlog there, great orders performance in the fourth quarter, especially in Europe and the Americas where the bulk of that is. So that's going to continue on into '23 as well.
Stephen Tusa, Analyst
Got it. And then just one last one for you. In your guidance, how much of the year-over-year is driven by like some of the more Otis specific initiatives around productivity that you've been hitting on for the last couple of years since coming public?
Rahul Ghai, CFO
Yes, a lot of that, Steve. If you examine our profit guidance, it primarily revolves around volume. However, we are facing $90 million in commodity headwinds, which we are mostly counterbalancing through our productivity efforts related to new equipment. Additionally, while the margin impact from declining backlog margins affects our pricing for new equipment, we are seeing improvements in in-year pricing, which helps offset this. We are managing the commodity challenges through productivity measures on both materials and installations. On the service side, we are not factoring wage inflation impacts into our guidance because the productivity enhancements we are implementing in this area are mitigating those effects. Service profit relies on both volume and pricing, which increased by 1% last year and is currently trending positively for us.
Judy Marks, President and CEO
Yes. And on the service pricing, I'll just amplify a little, I mean, really good performance in Europe, which is where 1.1 million of our 2.1 million units are and the Americas. So, those two make up the bulk of the portfolio, we got a point in '21. We're expecting that much in '22 on price. And Steve, we'll know most of that in the first quarter because that's when most of our renewals happen.
Operator, Operator
Thank you. Our next question comes from John Walsh with Credit Suisse. Your line is open.
John Walsh, Analyst
Hi, good morning. Maybe just a couple of quick clarifications for me. I just want to make sure I'm comparing things apples to apples here. But can you remind us what you're exactly forecasting on that industry new equipment growth slide there on Slide 5? Is that kind of a unit's number? Does that include price? Just would love to get a little more clarity on that.
Judy Marks, President and CEO
Yes, that's a unit's number. That's the easiest way for us to make a global compare.
John Walsh, Analyst
Got you. Great. That's what I thought. Okay. And then maybe just on really strong share gains this year, 115 on top of the 60 you said there. We can see that chart in China where you're outgrowing the market. Can you give us a little bit more color on where some of the other market share gains are coming from broad-based or any geographies you'd call out?
Judy Marks, President and CEO
Yes, it's broad-based, especially this year. We've seen strong performance in the Asia Pacific region, particularly in mature markets. India has also rebounded significantly as a major segment, showing notable recovery in 2021 regarding market share gains. In Europe, while there are many different countries, we performed well in Western Europe. Additionally, I want to highlight some areas in Asia-Pacific outside of China, which has performed exceptionally well.
Operator, Operator
Thank you. Our next question comes from Cai von Rumohr with Cowen. Your line is open.
Cai von Rumohr, Analyst
Yes, thanks so much on good results. So, thank you for you've broke out, I guess, the China risk 10 customers, 2% to 3% of China sales. But what is the risk if they've crossed two to three red lines that basically they stop paying that, that morphs into a bad debt risk?
Rahul Ghai, CFO
Yes, it's a good question, Cai. Our overall business in China has performed very well. Our cash flow in China was strong, and open orders were significantly higher than in 2020. A lot of this is related to working capital, with receivables rising less than 10% alongside a 25% revenue growth in China. Our cash management in the China business has been very effective. However, we are managing the situation carefully on a customer-by-customer basis. As indicated in the chart, only 2% of our customers in China fall into the orange or red line categories of credit risk. We have tightened terms where necessary, but we believe no major changes are needed at this time. For the company overall in 2021, our bad debt expense was actually lower than in 2020, despite a 9% increase in revenue. We are managing the situation effectively and will continue to monitor it closely for 2022.
Judy Marks, President and CEO
Yes, the only other point I would make is that when we analyze a broad group of developers in China, we do a substantial amount of business with our key accounts, particularly the state-owned enterprises and state-owned property developers, who have distinct financing advantages. They are increasing their market share, and as Rahul mentioned, our China team is handling this with great discipline and focus on a daily basis. We are satisfied with how we ended 2021 regarding bad debt, as you noted. However, we are also vigilant and closely monitoring market trends. When necessary, we are opting for cash prepayments to safeguard our balance sheet.
Cai von Rumohr, Analyst
Thank you. And the second question, so you mentioned that you've installed 100,000 Otis ONE units last year. What is the plan for this year? And basically, as you install more units, I think you've made the point that because you have a bigger share of the overall service population of the world, your takeaway opportunity is greater than others. Talk to us a little bit about what you're seeing in terms of service takeaways, too?
Judy Marks, President and CEO
In 2020, we installed 100,000 units and added another 100,000 in 2021. We anticipate a similar performance in 2022 as we aim for a 60% coverage level in the medium term. Part of this is due to our service portfolio not being limited to just Otis units; we initially focused on Otis controllers because we had the most experience and the best technical solutions. We are now broadening our approach. However, there are still older controllers and very old elevators that are not practical to connect. We believe we are on the right track because this strategy is creating the customer stickiness we desire. It enhances our productivity and provides genuine value to our customers by allowing them to monitor their elevators through the Otis ONE app, regardless of whether they are on-site. This has positively impacted our retention rates, which, as Rahul mentioned, have surpassed 94%, leading the industry. Additionally, it is improving our conversion rates. Last year, we launched our Gen3 portfolio globally along with Gen360 in select European countries. These units are now shipped with Otis ONE pre-installed, depending on the factory location. This means our customers start benefiting during the warranty period, particularly in China, which supports both portfolio growth and the conversion rate Rahul mentioned, now at 45% for the year. We have increased our conversion rate in China by 5 points, demonstrating the stickiness we achieve worldwide. Greater connectivity with our customers fosters this stickiness, contributing to our portfolio growth. This strong productivity is also aiding our margin expansion by 50 basis points, particularly in terms of volume and service this year, while importantly, it’s fostering customer loyalty.
Operator, Operator
Thank you. Our next question comes from Nick Housden with RBC Capital Markets. Your line is open.
Nick Housden, Analyst
Hi everyone. Thank you for taking my question. You mentioned that you grew at double the market rate in China in 2021, which is a really impressive result. I'm just wondering what the main drivers of this actually were and just how sustainable it is? I mean was it the case of just picking some low-hanging fruit? Or is this something that we can expect to continue for a few years? Thank you.
Judy Marks, President and CEO
It's the execution of the strategy we implemented just before and during the spin for our growth in China. We increased our agents and distributors to enhance our sales coverage and reach, now totaling 2,200. We're refining our network by eliminating underperforming agents, which we believe positions us well. We experienced growth in Tier 1 and Tier 2 cities this quarter, as well as all year in China, alongside modest growth in infrastructure and strong growth in industrial segments during the fourth quarter. We expanded our sales coverage as part of our strategy. Additionally, we have maintained a strong focus on key accounts that prefer a national provider and value our service, which has positively impacted our conversion and retention rates. Many of these key accounts are state-owned enterprises, and it's crucial to balance our approach between private and state-owned entities amidst the current developments in China. We've also enhanced our relationships and continued to innovate, launching Gen3 in China first last year, achieving thousands of sales. We anticipate that Gen3 will represent about 20% of our shipped units globally in 2022. Our strategy emphasizes coverage, focusing on key accounts in Tier 1 and Tier 2 cities where we had previously lower market share, coupled with innovation and product introduction. We expect to see continued growth in market share despite any potential challenges.
Nick Housden, Analyst
That's very clear. And just kind of following on from that. So obviously, you're taking share in China, which is great. Are you taking it from the other global OEMs? Or is it more some of the local players who are losing out here?
Rahul Ghai, CFO
Yes. That's hard to say, I think exactly. I mean we'll have others report as well. What we really know well is how the market grew and how we grew against that. So that data is published. We have some external agencies that kind of track that. So, we know our performance well. I think as other companies reported, there will be a little bit more clarity on that, but it's hard to say exactly where the share gain is coming from.
Judy Marks, President and CEO
Yes, same with service. It's just hard to say.
Operator, Operator
Thank you. Our next question comes from Joel Spungin with Berenberg. Your line is open.
Joel Spungin, Analyst
I want to follow up on something you mentioned in your prepared remarks about pricing. You indicated that it performed better than expected in the quarter. Could you elaborate on that and provide any insights on pricing trends in the wider industry?
Rahul Ghai, CFO
My comment, Joel, was regarding new equipment pricing, which turned out to be marginally better than we anticipated. In Asia, where the booking time frame is short, we experienced a significant improvement in our booked margin trends compared to last year, and there was also sequential improvement from the last quarter. This is where a large portion of the improvement for the quarter originated. In EMEA, margins were largely flat compared to last year, while margins in the Americas declined year-over-year, partially due to the mix of orders. We did not foresee any improvement in the Americas for the first quarter of next year, considering the order cycle. However, we did observe sequential improvement from the third to the fourth quarter, and the year-over-year trends are encouraging, leading us to expect further enhancements as we enter the first quarter of '22. This summarizes the overall trends in booked margins. Additionally, service pricing was significantly up in the quarter, primarily driven by the Americas and EMEA.
Judy Marks, President and CEO
Yes, Joel. The only area where we are observing significant competition is in the infrastructure segment, largely due to public bids. This is particularly noticeable in Europe and Asia, where the competitive pricing is more evident. We haven't experienced the steep price declines in China that we saw after 2015. While competition is present, it's primarily concentrated in the infrastructure segment.
Joel Spungin, Analyst
Okay. That's helpful. If I can just ask one more thing regarding your comments about the Chinese market in Q4 being a bit better than expected. I'm trying to reconcile that with your outlook for China, where it seems you previously mentioned a flat market in Q3 for '22, and now you're indicating a decline in the mid- to high-single digits. How do we make sense of these two points? Are you already noticing a decrease in activity levels in your early indications for bids in China this year, even considering the tougher comparisons?
Rahul Ghai, CFO
Yes. The China market was stronger than we expected throughout 2021. We began the year anticipating mid-single-digit growth, but it increased by 10%. Even as we approached Q4, we initially expected the market to decline, yet it remained flat, continuing to exceed our expectations. Looking at underlying trends, floor space under construction increased by 5% in 2021, which is about 8% higher than 2019 levels. Additionally, real estate investment rose by approximately 4% for the year. Historically, these trends are closely correlated. However, the weakness stems from new construction starts, which fell by about 11% in 2021. While real estate investment and floor space under construction are up, booking starts are down. This leads us to suggest that the market might decline by 5% to 10%, though this situation remains fluid. We are beginning to see government support, from both central and local authorities, including mortgage leniency, adjustments to the three red line policy, and increased money supply. Local governments, which depend heavily on land sales for their budgets, are also providing some support. Thus, we are observing a mixed scenario, but we believe it's prudent to anticipate a decline of 5% to 10% and adjust our revenue forecasts accordingly. If the situation improves, that would be a much more favorable outcome than being caught off guard by further declines.
Operator, Operator
Thank you. And that's all the time we have for questions. I'd like to turn the call back to Ms. Judy Marks for closing remarks.
Judy Marks, President and CEO
Thank you, Catherine. So to summarize, 2021 was an excellent year for Otis. We executed on our four strategic pillars, introduced innovative new products, made good progress on our ESG initiatives, and demonstrated the strength of our capital management strategy. Our colleagues made all of this possible, delivering for our customers, passengers, and communities globally. The fundamentals of Otis and our industry remain strong, and we're well-positioned to deliver on our 2022 financial outlook, including high single-digit EPS growth and approximately $1.6 billion in free cash flow. We look forward to speaking with you at our Investor Day on February 15 to share more about our strategy and medium-term growth outlook. Thank you for joining us today. Stay safe and well.
Operator, Operator
This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.