Earnings Call Transcript
Otis Worldwide Corp (OTIS)
Earnings Call Transcript - OTIS Q3 2022
Operator, Operator
Good day and thank you for standing by. Welcome to Otis' Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Michael Rednor, Senior Director of Investor Relations. Please go ahead, sir.
Michael Rednor, Senior Director of Investor Relations
Thank you, Norma. Welcome to Otis' Third Quarter 2022 Earnings Conference Call. On the call with me today are Judy Marks, Chair, CEO and President; and Anurag Maheshwari, 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. 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, CEO
Thank you, Mike, and thank you, everyone, for joining us. We hope everyone listening is safe and well. Starting with Q3 highlights on Slide 3. Otis delivered a solid third quarter and strong year-to-date results, especially considering the macro headwinds we're facing. We grew organic sales, expanded margins, and achieved mid-single-digit adjusted EPS growth, all largely driven by strong performance of our resilient service business. By executing our strategy, we continue to set ourselves up for the future. This quarter, we demonstrated that performance through accelerating maintenance portfolio growth, which was up 3.8% in the quarter, growing modernization backlog 7% and gaining about one point of New Equipment share year-to-date, with share about flat in the quarter. Year-to-date, the New Equipment market was down mid-single digits, driven by China, which was down about 15%. In the Americas, we are honored to be selected for a modernization project at the iconic Space Needle in Seattle. Otis installed the original elevator in the early 1960s and has been maintaining the units ever since. We will now modernize the landmark's three elevators, including introducing new technologies such as custom design cabs and Compass 360. In Suzhou, part of the Greater Shanghai Metropolitan area, the urban rail network is being expanded once again with the support of Otis. The new Line 8 will be served by nearly 140 Otis escalators and 38 Gen 3 and SkyRise elevators when it begins operations in late 2024. In London, Otis was selected to help modernize an office block into a modern mixed-use development that strives to be the first net zero carbon-enabled office development in London. Otis will provide vertical transportation solutions, including several escalators and elevators equipped with Compass 360 destination dispatching to allow tenants and visitors seamless and efficient access to the building's floors. Lastly, in Korea, we're extending an over 30-year relationship with GS Engineering & Construction to provide more than 55 elevators to the Hanam Apartment Complex. These units will be outfitted with ReGen Drive technology, helping to maximize energy efficiency for the elevator serving 1,500 apartments in the complex. Year-to-date, free cash flow conversion was 106% of GAAP net income, and we kept our capital allocation plans on track with another $300 million of share repurchases in the quarter, completing the $700 million in repurchases we had planned for 2022. With a quarter to go, we feel confident in our cash flow outlook and are increasing our full-year share repurchase outlook to $850 million. We continue to drive important ESG initiatives, a key priority for Otis. This quarter, our efforts resulted in achieving a gold rating with EcoVadis. Now moving to Slide 4, Q3 results and 2022 outlook. New Equipment orders were down 0.8% at constant currency in the third quarter. Excluding China, orders were up 7.4% with growth in all regions. On a rolling 12-month basis, total Otis orders were up 7.6%. Organic sales were up 0.8%, and adjusted operating profit was up $35 million at constant currency with 60 basis points of margin expansion driven by segment mix and strong performance in the Service business. In the quarter, we generated $215 million of free cash flow, which was down versus prior year, driven by an increase in inventory to support backlog conversion and the timing of supplier payments. This brings us to $1 billion year-to-date with 106% conversion of GAAP net income. Looking ahead to our 2022 outlook. We're revising our full-year outlook and now expect organic sales growth of 2% to 2.5%, with net sales in the range of $13.4 million to $13.5 billion. Adjusted operating profit is expected to be approximately $2.1 billion, up $120 million to $140 million, excluding the impacts from foreign exchange. After approximately $175 million in headwinds from foreign exchange translation, adjusted operating profit at actual currency is expected to be down $35 million to $55 million. Adjusted EPS is expected in the range of $3.11 to $3.15, up 5% to 7% versus the prior-year. Lastly, we still expect free cash flow to be robust between $1.5 billion and $1.6 billion or approximately 125% conversion of GAAP net income. We will remain disciplined and balanced on our capital allocation, advancing our bolt-on M&A strategy where it makes sense and returning cash to shareholders through dividends and share repurchases expected to be $850 million versus the $700 million target announced previously. With that, I'll turn it over to Anurag to walk through our Q3 results in more detail.
Anurag Maheshwari, CFO
Thank you, Judy, and good morning, everyone. Starting with third quarter results on Slide 5. Net sales of $3.3 billion were down 7.6%, driven by the broad strengthening of the U.S. dollar, a 7.2% headwind in the quarter. Organically, sales were up 80 basis points, the eighth consecutive quarter of growth driven by service, which increased over 6%. Adjusted operating profit, excluding a $50 million foreign exchange translation headwind, was up $35 million. Drop-through on higher service volume, favorable service pricing, strong SG&A cost control and the benefit from productivity in both segments was partially offset by impact of lower New Equipment volume, commodity price increases and annual wage inflation. Adjusted SG&A expense was down 90 basis points as a percentage of sales as we continue to drive cost reduction and containment to help mitigate the inflationary headwinds. Despite the challenging environment, we maintained investment in the business and R&D spend and other strategic investments were about flat versus the prior-year. Overall, adjusted operating profit margin expanded 60 basis points, driven by segment mix, strong Service performance and cost containment. Adjusted EPS was up 5% or $0.04. An $0.08 headwind from foreign exchange translation was more than offset by strong operational performance driven by the Service segment, accretion from the Zardoya transaction and a benefit of $700 million in share repurchases completed year-to-date. Moving to Slide 6. Q3 New Equipment orders were down slightly at constant currency and up 7.4%, excluding China. Orders in the Americas were up 3% with solid growth and multi-family residential and infrastructure. EMEA orders were up 11% with growth in both Europe and the Middle East, and orders in Asia outside of China were up approximately 10% driven by strong growth in South Korea and India. The strong orders growth over the last 12 months contributed to New Equipment backlog increasing 12% at constant currency with growth in all regions, including China, which was up slightly. Backlog in Americas, EMEA and Asia outside of China was up high-teens. Pricing trends improved year-over-year in all regions, excluding China, where pricing was flat. Globally, pricing on New Equipment orders continues to accelerate and was up 4% leading to sequential backlog margin improvement. New Equipment organic sales were down 5% in the quarter, as mid-single-digit growth in EMEA and low-teens growth in Asia, excluding China was more than offset by a 4% decline in the Americas due to a tough compare, delays in building construction and a high-teens decline in China driven by the challenging market conditions. Sales decline of $191 million and adjusted operating profit declined $23 million, largely from the impact of lower volume and related underabsorption. Commodity inflation of $18 million that was aligned with price expectations was more than offset by productivity and lower SG&A expense. Service segment results on Slide 7. Maintenance portfolio units were up 3.8% with recaptured units more than offsetting cancellations in the quarter. Conversion rate continues to show improvement this year in China, which contributed to mid-teens portfolio growth in the region. Modernization orders growth accelerated to 18% in the quarter with growth in all regions driven by good traction in newer mod package offerings and several major project wins. Backlog was up 7% at constant currency. Service organic sales grew for the seventh consecutive quarter up 6.2% with growth in all lines of business. Maintenance and repair grew 5.4% from the benefit of high single-digit repair volume and growth in contractual maintenance sales that outpaced our unit growth due to improved pricing, which was up three points on a like-for-like basis. Modernization sales continued the recovery that started in Q4 of '21 and were up 10% in the quarter with growth in every region. Service profit at constant FX was up $49 million driven by the drop-through on higher volume, favorable pricing and productivity, which more than offset the headwinds from annual wage increases. As a result of this, margins were up 50 basis points, the 11th consecutive quarter of margin improvement. Overall, despite the significant macro headwinds, our year-to-date results are strong. We gained approximately one point of New Equipment share, delivered the best portfolio growth in over a decade and more than mitigated $195 million of headwinds from FX and commodity inflation through strong execution to achieve an 8.5% EPS growth. Moving to Slide 8 and the revised outlook. These changes reflect revised expectations in the China market outlook, the continued strengthening of the U.S. dollar and our focus on productivity initiatives to offset the headwinds. Starting with sales, we are expecting organic sales to be up 2% to 2.5% versus 2.5% to 3.5% previously. This 75 basis point reduction is driven by lower expectations for China New Equipment, partially offset by an improved modernization outlook in service. The New Equipment margin outlook is down 10 basis points at the midpoint from the impact of lower volume in China offset by cost containment. Service margins are now expected to be up approximately 50 basis points, a 10 basis point reduction from the prior outlook reflecting the mix impact of modernization sales growing faster than the maintenance and repair business. The overall margin outlook remains unchanged versus the prior outlook, and is expected to be up approximately 30 basis points to 15.7%. Adjusted EPS is expected to be in the range of $3.11 to $3.15 up 5% to 7% versus the prior year. This adjusted EPS growth is driven by strong operational execution, accretion from the Zardoya transaction, progress on reducing our tax rate and a lower share count that more than offset $0.47 of headwind from foreign exchange translation and commodity inflation. We now expect free cash flow to be in a range of $1.5 billion to $1.6 billion versus approximately $1.6 billion previously. Foreign exchange translation continues to weigh on cash flow generation, and we anticipate a moderate build in inventory heading into 2023 to support project execution on the growing backlog. On capital deployment, we are increasing the share repurchase target to $850 million, having already completed our previous outlook of $700 million in the first three quarters. This is an over 2x increase from the $300 million to $500 million guidance we had given in the beginning of the year, and combined with a 20% dividend increase, underscores our commitment to return cash to shareholders. Taking a further look at the organic sales outlook on Slide 9. The New Equipment business is projected to be down approximately 2.5% versus down 0.5% to 1% previously. We now expect Asia to be down approximately 6% from down low single-digits previously driven by China. Despite our backlog being up slightly versus the prior year and up from the end of '21, we now expect Otis China organic sales to be down 10%, driven by the shift of project execution to the right and lower market expectations now expected to be down roughly 15%. This has been partially offset by improved outlook in Asia Pacific from the benefit of strong orders growth momentum in India and South Korea. The New Equipment outlook in the Americas and EMEA is unchanged, expected to be flat and up low to mid single-digits, respectively. Turning to Service. We now expect organic sales to be up 6% to 6.5%, an improvement of 50 basis points at the low end, driven by a conversion of modernization backlog that is up 7%. Moving to Slide 10. We expect adjusted EPS growth of 5% to 7%, an $0.18 increase at the midpoint. We expect to more than offset the $110 million headwind from commodities with $230 million to $250 million of operational improvement from higher service volume and pricing, productivity in both segments and other cost containment actions, resulting in profit growth of $120 million to $140 million at constant currency. This is $5 million lower than our prior outlook at the midpoint, driven by reduced China New Equipment volume expectations that we are partially mitigating through better cost containment and productivity. Accretion from the Zardoya transaction, over two points of tax rate reduction versus last year and the benefit from over $1.5 billion of share repurchases since spin, partially offsets the $0.29 or $175 million headwind from the significant strengthening of the U.S. dollar. We have now assumed the euro at $0.97 for the fourth quarter or $1.04 for the full year. Overall, since 2019, this outlook represents 50 basis points of annual margin expansion and low teens three-year adjusted EPS CAGR, reflecting the execution of our long-term strategy and our ability to mitigate the macro challenges we have faced. We feel confident that this momentum, along with our growing backlog and service portfolio sets us up well to deliver strong financial performance in 2023 and beyond. And with that, I will request Norma to please open the line for questions.
Operator, Operator
Thank you. Our first question comes from the line of Nigel Coe with Wolfe Research. Your line is now open.
Nigel Coe, Analyst
Thanks. Good morning. Thanks for the question. So obviously, China is obviously the sort of the big issue. But just wanted to talk about the Americas because you mentioned some project and construction delays in the Americas. I'm just wondering if you could just give us some context on the geographies there. I'm assuming it's the U.S., but if there's anything else going on there, please let us know. And any verticals of standout where you've seen delays?
Judy Marks, CEO
Nigel, it's Judy. Good morning. So it is primarily the U.S. It's not rate-driven. It really is availability of construction labor outside of the elevator part. We're feeling very confident in our ability to be at job sites at the right time. We recognize we're in the critical path, but it's all the other trades from getting the hoistway poured to really just directing the building. So that's really what we're seeing, and it's a delay, it's a slowdown, but it's not going to go away. The buildings are going to get built, but it's going to move some revenue into '23 even from the fourth quarter. So we're watching that carefully. There's really no unique vertical that that's happening. The verticals are really still strong. And if you look at ABI, it's at 51.7, Dodge construction starts. The biggest growth we're seeing is in multifamily residential. And year-to-date, Dodge construction starts for multifamily residential is up 28%. So demand is still strong. Orders are strong, 24.3% year-to-date in the Americas, and we're just seeing a little bit of delay in terms of being able to deliver and record that revenue.
Nigel Coe, Analyst
Yes, I agree with that. And then my second question is really on, I think Anurag, you mentioned 4% pricing on orders, if I caught that right? What is the realized price today? Is it still trending negative today? So I'm just wondering of that 4% as we convert that backlog into 2023, if we have a little bit of good news on commodities, is there a path to expanding New Equipment margins in 2023?
Anurag Maheshwari, CFO
Thank you for your question. The price increase is reflected in the backlog margins, which remained relatively flat year-over-year. In the third quarter for New Equipment, the increase in revenue primarily came from volume, with a $100 million decline in revenue compared to last year, of which $20 million is expected to impact the bottom line. Currently, we are achieving cost neutrality for prices this quarter. As backlog margins improve heading into the end of the year, we anticipate further expansion into 2023 as well.
Judy Marks, CEO
Yes, Nigel, one more thing to note. I'm observing that early trend as well. We saw a two-point increase in New Equipment pricing during the second quarter, and now it has risen by four points this quarter. Given the long cycle, it will take some time to work through the backlog, but we will get there. In terms of commodity fluctuations, the only significant change we've noticed so far is in China. Europe remains uncertain due to energy prices and various ongoing factors. However, we would welcome a decrease in commodity prices as soon as possible, and that will positively impact our operations. This long cycle also provides us the chance to enhance material productivity and manage supply chain issues related to our backlog.
Nigel Coe, Analyst
That's great. Thanks very much.
Operator, Operator
Our next question comes from Jeffrey Sprague with Vertical Research. Your line is now open.
Jeffrey Sprague, Analyst
Thank you. Good morning everyone.
Judy Marks, CEO
Hey, Jeff.
Jeffrey Sprague, Analyst
Hi, good morning. Can we just delve a little deeper now into China? Maybe just frame the order decline, kind of speaking to order declines ex-China, I guess we can all try to do that math, but I'd love to maybe have you frame that up for us. And maybe more importantly, just kind of speak to what's in backlog and sort of your visibility on China revenues over the next two to four quarters or so?
Judy Marks, CEO
Sure. Let me begin, and Anurag, feel free to add in. We currently estimate that the full-year 2022 market growth in China will decrease by about 15%, influenced partly by the lockdowns and partly by the lack of confidence in the property market. Clearly, we do not expect the market to recover in 2022. In the first quarter, we saw a decline of 5%, and in the second quarter, the segment dropped 20%. We believe the third quarter also experienced a 20% decline. Last quarter, we anticipated some easing of COVID restrictions and a return to normalcy, but this situation may not be apparent to those outside of China. The COVID lockdowns are still very much in place, particularly in Tier 3 cities and below. These restrictions are significantly limiting our ability to carry out final shipments and installations. That being said, I am optimistic about the health of our business in China. Regarding New Equipment pricing, we are neutral to favorable in terms of price costs this quarter, which highlights the hard work and resilience of Harry and our team in China. The market segment declined around 20%, and our orders were close to that as well, indicating no share gain this quarter, although we did see some in the first two quarters. Our strategy and initiatives in New Equipment are proceeding as planned, and we've gained market share year-to-date. The only segment that saw growth in China in the third quarter was infrastructure; all other segments were down, including Tier cities, with Tier 1 experiencing the least decline, followed by Tier 2, and further declines after that. Despite these challenges, our teams delivered solid results, as modernization and service continued to grow. This marks our fifth consecutive quarter of mid-teens or higher portfolio growth, with recaptures exceeding cancellations. Looking into 2023, we aren't providing guidance just yet. However, particularly for the China segment, reflecting back to our first Investor Day in February 2020, we anticipated the China segment to reach about 550,000 units annually and remain stable, which was the case pre-COVID in early 2020. It surged to 650,000 last year, so with the estimated 15% decline, we're looking at around 540,000 units. Our preliminary estimates for 2023 suggest the segment will be between 500,000 and 525,000 units. The pricing trends appear rational, and we are effectively reducing costs while commodities and material productivity are performing well. So, in terms of New Equipment, I believe we are positioned well; we have a limited backlog in China, and the fourth quarter will further influence that as we progress through the year. Overall, the total company is up 12% in New Equipment orders, and everyone is seeing growth in modernization as well. I want to remind everyone that we will have around 8 million units in service in China by the end of this year, which will be a critical driver for growth. We will continue to gain market share in New Equipment and execute our strategy, while also seeing ongoing growth in service and our portfolio. Anurag?
Anurag Maheshwari, CFO
Yes. Thanks, Judy. I mean, overall, we feel very good about the market over there. In terms of the backlog, today, Jeff, right, so as Judy said in the prepared comments, we're up 12% on the backlog. And China is slightly up as well relative to last year. So we have a good line of sight over the next few quarters, not only in China and the other regions for the backlog. As you are aware, two-thirds of our revenue for next year will come from the ending backlog. So given where we are today and the pipeline that we have seen on the new order side, good line of sight to convert that into shipment next year.
Jeffrey Sprague, Analyst
Maybe just, thank you for all that color. That was very helpful. Just to maybe shift gears back to mod and maybe it's more of a global question now. But any indication of just kind of economic weakness coloring some of the forward demand around mod, it's a great deal that can certainly be discretionary, at least temporarily discretionary.
Judy Marks, CEO
Jeff, the challenge is this would be the third or fourth year of discretionary. So all of a sudden, there's modernization projects, especially the ones that are technology insertion versus just aesthetics have really started coming to the forefront. 7 million of the units in the world are over 20 years old. So it's a huge mod market, and the team really delivered 18% up in orders, year-to-date up 6.5%. We got a 7% backlog. So I actually think we're seeing the pent-up demand. And again, for those who don't modernize, and the elevators will tend to break down, especially 20 years old, more frequently, which drives our repair business. And between that and just people returning to office, hotels, our repair business is up really nicely.
Jeffrey Sprague, Analyst
Great. Thanks. I'll leave it there.
Operator, Operator
Thank you. One moment for our next question. And our next question comes from Julian Mitchell with Barclays. Your line is now open.
Julian Mitchell, Analyst
Hi, good morning. Maybe just wanted to start with the fourth quarter guidance. So it looks as if you're dialing in a pretty severe sequential margin decline. And I realize maybe there's some deleveraging with fixed cost under absorption because of the China calendar and also the market weakness there. Maybe just highlight if there's anything else driving that big sequential decremental margin. And also just to put a finer point on it in Q4, China New Equipment, I think those sales were down high-teens in the third quarter. Are we expecting a steeper rate of decline year-on-year in the fourth?
Anurag Maheshwari, CFO
Thanks, Julian. This is Anurag here. Let me address the second question first. The rate of decline in the channel is actually slowing in the fourth quarter. While it was in double digits in the third quarter, we expect it to be in low single digits in the fourth quarter. Regarding the fourth quarter margins, particularly in the New Equipment segment, historically, Q4 has shown lower margins for us, hovering around the 5% level. This significantly contrasts with the year-to-date margins in New Equipment. When we provided guidance in July, we projected a margin closer to 6.2% for the second half of the year, assuming a return to more normal conditions in China. However, as indicated in our guidance, the revenue has decreased by about $100 million, primarily due to China, which results in a $20 million impact. This would lead to a 50 basis points margin decline from 6.2% to 5.7%. Thanks to productivity improvements and cost-containment measures, we managed to stabilize it at 6%. A lot of this progress was achieved in the third quarter through various efforts. As we move into the fourth quarter, the volume and commodity costs remain steady, though we anticipate some impact from the regional mix, which may lower margins slightly. We will continue to focus on enhancing productivity in the SG&A area, especially regarding New Equipment. Lastly, we also faced a $50 million foreign exchange headwind in the third quarter, which is expected to increase to about $67 million to $68 million, adding around $17 million to $18 million. So, the margin changes from Q3 to Q4 are largely driven by New Equipment and foreign exchange factors.
Julian Mitchell, Analyst
That's very helpful. Thank you. And then just my follow-up would be around not so much modernization specifically, which I think came up. But more broadly on kind of Europe pricing. I think people are very nervous because of the macro data that you might get a deep and possibly a long European construction slowdown fairly soon. The last time that happened, there was pricing pressure in a number of areas, including elevator service 14 or 13 years ago. Just wanted your thoughts today on the sort of fragmentation of the Europe service market and maybe how Otis kind of practices might be different there? And how does it work in terms of inflation feeding through to your new service contracts for next year in Europe?
Judy Marks, CEO
Yes, let me address that. Service pricing overall increased by three points. In the third quarter, it was quite strong, particularly in the developed mature markets where most of our portfolio is located. This directly relates to your inquiry about Europe’s service pricing. Most of our renewals are up. As we look at the year, our largest renewals occurred in the first quarter and have continued throughout the year. We expect to finish the year with favorable pricing, especially in Europe. We have inflationary clauses, primarily linked to labor rates in Europe and North America, allowing us to raise prices again at the beginning of the new year. What is promising is that the increases will be based on inflation from '21 to '22 when we move into '23, which should lead to higher inflation indices. It is now our responsibility to maximize this since it's outlined in our contracts, and our sales teams are equipped to handle it. We have been managing labor inflation effectively, as indicated by our margin growth, even in Europe. Regarding the general macroeconomic outlook in Europe, especially in the New Equipment sector, things look positive for '22. Orders in this quarter have risen by 11%, with a 10.3% increase over the past year. We're aware of the potential headwinds, but building permits remain stable, which hasn’t shifted. Our objective is to gain market share and build our backlog, which is precisely what Bernardo and our EMEA team are focused on. Comparing this situation to 13 or 14 years ago reveals significant differences. Back then, there was a 10-point margin differentiation between us and our nearest OEM maintenance service competitors, which drove the Otis business. Now, we are much more aligned in terms of pricing, and there is not an oversupply of labor as we saw post-2008 financial crisis when many New Equipment installers transitioned to ISPs. Additionally, we have technologies like Otis ONE that provide advanced customer engagement and enhance productivity. The business landscape is different now, and our performance over the last 10 to 11 quarters reflects that.
Julian Mitchell, Analyst
Great. Thank you.
Operator, Operator
Thank you. One moment for our next question. And our next question comes from Stephen Tusa with JPMorgan. Your line is now open.
Stephen Tusa, Analyst
Hi guys. Good morning.
Judy Marks, CEO
Good morning.
Stephen Tusa, Analyst
Where do you expect to end the year with backlog? Is the book-to-bill ratio still above one, and can it remain above one in the fourth quarter? Could you discuss the regional expectations for orders in the fourth quarter?
Judy Marks, CEO
We've seen really strong orders year-to-date, and I'm pleased with our performance across the Americas, EMEA, and Asia. Although orders in China are down due to a decline in the segment, we haven't lost market share and have remained steady this year. Currently, we have a 12% backlog on New Equipment orders, while our modernization backlog is nearly 7%, which is one of the strongest positions we've had in a long time. Orders can be uneven at times, especially with large New Equipment projects. However, we expect modernization to remain strong throughout our medium-term outlook. As we conclude the year with a 12% backlog conversion, I am optimistic about our prospects for 2023. We have a clear understanding of our New Equipment and modernization backlogs, and our service portfolio is performing well, with repair, modernization, and maintenance all showing increases. Last quarter, our portfolio grew by 3.8%, up from just under 3.5% the previous quarter. We're aiming for a 4% increase when we next report. This growth is contributing positively to our service backlog.
Stephen Tusa, Analyst
Right. So high single-digit constant currency year-over-year is what you're saying for the equipment backlog end of the year? Is that what you're saying?
Judy Marks, CEO
Yes, yes. Correct.
Stephen Tusa, Analyst
And one follow-up, just on the '23. Can you just maybe give us some color around anything that's more mechanical for '23 in the bridge, whether it's FX or cost inflation? Any of that stuff that you'd highlight as part of the bridge for '23 using the prevailing rates today?
Anurag Maheshwari, CFO
Steve, Anurag here. You mean on the FX side, on the Forex side?
Stephen Tusa, Analyst
Yes. Just anything else more mechanical, whether it's raws or anything like that that, on the '23 bridge that you have good visibility on today that you want to just get out there?
Anurag Maheshwari, CFO
Yes. If we consider foreign exchange today, we expect the headwind we experienced this year to carry over into next year, estimated at around $75 million to $100 million. Regarding other financial factors, we will see a portion of the Zardoya accretion next year. Our tax performance has been strong this year, and we anticipate a slight decrease next year, but not significantly. This is the situation with foreign exchange and the overall year. As for 2023, as Judy mentioned, we expect to finish the year with a solid backlog, both in service and new equipment, with service outpacing maintenance growth. The pricing trends currently reflected in the backlog should act as a tailwind for next year, along with commodities. In terms of commodities, we are observing different dynamics across the four regions. In China, we are starting to see prices decline, and the Americas are also stabilizing and decreasing. These factors should serve as tailwinds moving into next year. In the Asia-Pacific region, excluding China, we source primarily from second-tier suppliers, which should also provide a tailwind in the second half of next year. However, Europe remains a concern due to the ongoing energy price situation and the conflict there, leading to relatively flat prices that may not significantly aid our efforts next year.
Judy Marks, CEO
Yes. Steve, the only other thing I'd add is we are watching labor inflation. I think in our case, the great news is more than half of our field workforce is covered by collective bargaining. We shared that we do have a new agreement here with the International Union of Elevator Constructors, the multi-employer union in the U.S. that goes into effect in January. So we've got five years of predictability here. It was a fair agreement, and it looks very similar to the last five years. And with a little increase as it should as is appropriate. But we've got predictability. So now it comes back to us to be able to offset that with price and productivity. And we're watching labor in Europe. We've got some more negotiations coming up. But again, we will manage that. Our backlog, it takes that 12-plus months to work its way through in most countries. So we know what we need to do in terms of productivity and price to offset that. The last part of labor we're watching, just for you to know is or to be aware of are the subcontractors, mainly on the installation side outside the U.S. in several countries. And we've got to offset those increases with price and productivity. We know what we need to do.
Stephen Tusa, Analyst
Great, thanks a lot.
Operator, Operator
Thank you. One moment for our next question. And our next question comes from John Walsh with Credit Suisse. Your line is now open.
John Walsh, Analyst
Hi, good morning and I appreciate you taking the question. Maybe just building off of Steve's question there, just looking more at it from a cash flow perspective. As you think about into next year, obviously, you're carrying higher working capital than normal. I'm curious what you might think normal is, and if we actually revert to that next year? And then maybe just on the supplier timing payments that were called out in this quarter, do those all get made up in Q4? Or is that also a bridge item into '23 for the cash flow?
Anurag Maheshwari, CFO
Good morning, John. Regarding cash flow, we expect it to grow in line with earnings, which will be the primary driver of cash flow. In the third quarter, we used about $150 million of cash, distributed across three areas. The first area was preparing to execute, the second involved receivables, and the third related to timing discrepancies between cash and book taxes. Our backlog is up 12%, and we need to ensure timely product delivery. To achieve this, we've built up inventory and pre-paid some suppliers to secure prices and critical supplies. In terms of receivables, the modernization has progressed faster, leading to increased back-end payments, but there have been delays in certain projects, affecting New Equipment collections. On the tax front, we've successfully reduced the tax rate, but there are timing differences to consider. These factors should largely resolve in the fourth quarter, contributing to our guidance of $1.5 billion to $1.6 billion. Looking ahead to next year, earnings are expected to be the main driver of free cash flow growth.
Judy Marks, CEO
Yes, John, as part of our customer focus, we understand we are essential to every new construction project. The hoistway must be installed, and one of our advantages in the market is that general contractors know we will deliver on time. To achieve this, we increased our inventory and secured some suppliers to ensure we have that capability. I would have preferred better backlog conversion, but we will get there, as it was important to ensure that no job site or customer on the New Equipment side would face issues.
John Walsh, Analyst
Great. That's a very helpful answer. I'm curious if there's a particular driver you can highlight regarding modernization. You mentioned deferred projects earlier, but are you seeing moves towards converting offices into multi-tenant spaces? Are customers focusing on sustainability commitments? We often overlook elevators as significant energy users. Are customers discussing this? Any additional insights into why customers are pursuing these modernizations would be appreciated. Thank you.
Judy Marks, CEO
There are several reasons for this. You've mentioned a few, and another point to consider is the push for a return to the office. Companies are trying to make their workplaces more appealing, particularly in older buildings where elevators might be over 20 years old. Now that employees have options, organizations want to create a more engaging environment to encourage people to come back. We are observing this trend universally. Some of it is due to pent-up demand, some is delayed, and some reflects a significant need. However, much of it is a matter of choice, and we believe this trend will persist.
John Walsh, Analyst
That's great. Thanks for taking the questions.
Judy Marks, CEO
Thanks, John.
Operator, Operator
Thank you. One moment for our next question. And our next question comes from Joseph O'Dea with Wells Fargo. Your line is now open.
Joseph O'Dea, Analyst
Thank you. I'll give you the address of my building because the modernization wouldn't be bad there.
Judy Marks, CEO
Happy to.
Joseph O'Dea, Analyst
I wanted to ask on the Americas, just project experience and delays. And just how that's been trending as it been an issue now for some time? Whether there are any indications of seeing some improvement there over the past, call it, six to nine months? And then as well, just what you're hearing from folks in terms of expectations moving forward and where we get some better project activity or just execution?
Judy Marks, CEO
I believe we're going to see improvements, Joe. It's definitely linked to employment across related trades. As the economy in the U.S. starts to change, we're noticing some positive signs. However, it's important to remember that it's a case-by-case basis and very localized. Construction is inherently local, unlike other trades that work together to complete a building. We expect improvements and better project execution from our team in the Americas, particularly in North America. We're keeping an eye on the same trends as you, and we do anticipate that. The indicators haven't shifted yet; for instance, the Architect's Billing Index remains above 50, and Dodge is still performing well. While we may not see new projects starting at the exceptional rate we've experienced over the past couple of years, we anticipate a solid rate moving forward. We have strong market share, and our team is poised to deliver.
Anurag Maheshwari, CFO
Yes and if I could just add to that. I mean, we see all these underlying secular drivers being very strong. And if you look at the sites, they are actually started gradually opening up. Our guidance for the full-year still remains what was as per the prior guide, which is flat on New Equipment for Americas, so sometime in Q3 and Q4. So we should see Q4 as kind of a turning point as we convert this backlog into revenue. So you should start seeing indicators starting in Q4 itself.
Joseph O'Dea, Analyst
That's helpful. And then I wanted to circle back on fourth quarter margins and specifically on Service and then corporate and other. Corporate and other was a little bit lighter than we expected in the third quarter. Just kind of what you're anticipating in the fourth quarter? And then coming off of a 23.9% service margin in the third quarter. How to think about kind of the bridge into the fourth quarter and some of the moving items there?
Judy Marks, CEO
Yes, Joe, I hope you saw our sustained zealous approach to reducing G&A down 90 bps in this quarter. Anurag's come on board and he is looking, together, we are looking, but he is certainly taking a hard look at G&A structure, what do we need especially in corporate functions. So I'll turn it over to him to talk about fourth quarter, but know that everything that can be contained is being contained in terms of cost without risking investment for our future.
Anurag Maheshwari, CFO
Thanks, Judy. Absolutely. I mean, cost is something we control. We will continue to take a look at it. On the Service margin side, if you look at quarter three, we grew 50 basis points. Year-to-date on service, we are growing at 50 basis points. There's really good performance in terms of pricing for sure, in terms of productivity, in terms of cost. So that's kind of what got us to a very good performance in Q3. We see similar performance in Q4 as well. We'll be at similar margins of 23.9%, 24%, 50 basis points more than last year, right? We will see some catch-up on the cost side because we did contain it very closely in the third quarter. There will be some part of it was permanent, part of it was temporary that we contained. There'll be some snapback in Q4, but we'll continue to look at that. And that should be a tailwind as we enter into the fourth quarter. But just on the Service side, I think the trend, if you look at revenue growth and margin expansion, it is pretty linear through the course of the year, and you expect to see the same in the fourth quarter.
Joseph O'Dea, Analyst
Very helpful. Thank you.
Operator, Operator
Thank you. One moment for our next question. And our next question comes from Gautam Khanna with Cowen. Your line is now open.
Gautam Khanna, Analyst
Hey good morning guys.
Judy Marks, CEO
Good morning.
Anurag Maheshwari, CFO
Hey good morning.
Gautam Khanna, Analyst
I have a couple of questions to follow up on the pricing comments. Regarding the inflation clauses in Europe, North America, and other regions, where do you see the greatest opportunity for repricing services? Is it primarily in Europe, followed by North America? Can you discuss the magnitude by region?
Judy Marks, CEO
I would place Europe as the highest followed by North America.
Gautam Khanna, Analyst
When you consider the overall situation, do you have an insight into what the price, cost, and service might look like next year? It seems positive, but could you provide some context on the extent of that?
Anurag Maheshwari, CFO
Hey Gautam, yes, it's going to be positive. Our medium-term guidance indicates that service should increase by 40 to 50 basis points, and this year we have achieved 50 basis points. We've managed to increase prices while handling inflation and wage costs, as Judy mentioned earlier, both in the Americas and other regions. Looking ahead to next year, we feel good about staying on track with our medium-term guidance regarding margin expansion. We are not only expanding margins, but our modernization business is also growing more rapidly, which presents some challenges to the overall margin in the service sector. We will provide more specific guidance for next year during our January, February call, but we continue to see the positive trend in margin expansion that we are currently experiencing.
Judy Marks, CEO
Yes. It will be a service play, Gautam, next year. As we said in our medium-term guidance. And I think in year one, since we did the Investor Day just this past February, I think we've proven that.
Gautam Khanna, Analyst
Thank you. And then last one on China pricing. Kind of what are your expectations as you move through the next couple of quarters given it looks like the market's long capacity. Do you get a sense of the magnitude of New Equipment pricing pressures next year? Thank you.
Judy Marks, CEO
Yes, we think it looks like it looked this quarter, which will be relatively flat kind of neutral. That will certainly be what we do. We're not seeing irrational pricing, and we get to see it on the infrastructure, their public bids. And so we think it will be flat.
Anurag Maheshwari, CFO
Yes. And Gautam, just to add, in the quarter, even the market being down, we are very happy with the way it is right now, price cost. And if that continues, it's going to be very positive for us.
Judy Marks, CEO
Yes.
Gautam Khanna, Analyst
Great. Thanks.
Anurag Maheshwari, CFO
Thanks.
Operator, Operator
Thank you. One moment for our next question. And our next question comes from Joel Spungin with Berenberg. Your line is open.
Joel Spungin, Analyst
Yes, hi guys. I guess good morning for you all.
Judy Marks, CEO
Yes, good afternoon, Joel.
Joel Spungin, Analyst
Maybe I could just start by talking about the growth in the maintenance reported 3.8% was it in Q3. Is there any sort of color you can give us around the differences by region in terms of where you're seeing the growth in your maintenance units?
Judy Marks, CEO
Yes. The largest growth we're seeing, and I think I mentioned this, it's our fifth consecutive quarter in China with mid-teens plus growth. So that's the largest followed by Asia Pacific, but all four regions are growing. But those two are the biggest hitters in terms of growth rates.
Joel Spungin, Analyst
Okay. But all regions are growing, that was the main thing.
Judy Marks, CEO
Yes.
Joel Spungin, Analyst
Okay. Understood. Regarding your earlier comment, Judy, about the field workforce, you mentioned that half of it is covered by collective bargaining. Can you clarify if this applies to both Service and New Equipment? Additionally, is it fair to assume that the distribution of this labor force aligns with your regional breakdown?
Judy Marks, CEO
Yes. When considering our field workforce, we have 41,000 field professionals, with the majority in Service and some in New Equipment, as we use subcontractors for installations in different regions. In Europe, collective bargaining works councils are integral to how we operate, and we've had a unionized workforce in the United States for many years, similar to what we see in Korea and Japan. The field workforce also includes our factory workers and some professionals, depending on the country. We have been functioning this way for decades, and it defines our go-to-market approach and leadership style. Our colleagues show up for work every day in this environment, which feels normal to us. We are aware of the challenges and opportunities that arise, and we strive to provide 68,000 colleagues with a great working environment and career.
Joel Spungin, Analyst
That's great. Thanks. And maybe just one very quick follow-up. You mentioned, obviously, subcontracted costs being a factor. You're probably aware, obviously, that some companies were calling subcontracted costs out as a potential risk in 2023. Are you able to give us a bit more detail about how important subcontracting costs are on the installation side?
Judy Marks, CEO
So again, we only use them in countries where it makes sense to us. We do have thousands of our own installers and all of our supervisors who are on the job sites are Otis colleagues. The majority of where we use them, as you can imagine, is China, Asia and Europe, and it gives us flexibility in terms of surge because New Equipment has more variability as we've seen over the past few years significantly than the service business. So it gives us the opportunity to manage and lead our workforce while being able to provide solutions. Anurag, anything you want to add?
Anurag Maheshwari, CFO
I think you said it, Judy. I mean these are the markets where we work with subcontractors. We work through this year as well. I mean they are also seeing inflation, but we work on installation productivity with them, right, how we can reduce the hours that it takes to install an elevator? We'll continue doing that, but they've been great partners for us in these regions and we'll continue to be so. So net-net, if you look at New Equipment for next year, both on the top-line as well as on the bottom line, it should do better than the medium-term guidance that we set up.
Judy Marks, CEO
Yes, we are not extending that, Joel. They adopt our ethics, safety program, methods, and tools, so you won't notice a difference. The challenge we face, which our teams are managing well, is ensuring that we have a strong workforce available at a reasonable cost, including these subcontractors.
Joel Spungin, Analyst
Got it. And are those costs booked within cost of goods? Is that as opposed to labor costs?
Anurag Maheshwari, CFO
Yes. Yes, that is correct.
Joel Spungin, Analyst
Great. Okay. Thank you very much.
Operator, Operator
Thank you. And I'm currently showing no further questions at this time. I'd like to hand the conference back over to Ms. Judy Marks for closing comments.
Judy Marks, CEO
Thank you, Norma, and thank you all for joining us today. This solid year-to-date performance, the advancement of our long-term strategy and continued growth in New Equipment backlog and maintenance portfolio units positions us well to deliver on our 2022 outlook and build on that in '23 and beyond. Thank you for joining us. Stay safe and well.
Operator, Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.