Earnings Call Transcript
Otis Worldwide Corp (OTIS)
Earnings Call Transcript - OTIS Q2 2023
Michael Rednor, Senior Director of Investor Relations
Good morning, and welcome to Otis Second Quarter 2023 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.
Judy Marks, Chair, CEO and President
Thank you, Mike, and thank you everyone for joining us. We hope everyone listening is safe and well. Starting with the second quarter highlights on Slide 3. Otis delivered a strong second quarter and a successful first half of the year. In Q2, we grew organic sales high-single digits in both segments, expanded adjusted operating profit margin 20 basis points, and achieved 7% adjusted EPS growth. This performance again demonstrates the strength of our strategy and our ability to execute and deliver. We have momentum going into the second half and beyond, as new equipment share was up slightly in the quarter and up about 50 basis points in the first half, we grew our maintenance portfolio 4.2%, and continue to grow our new equipment and modernization backlogs. We generated $409 million in free cash flow in the quarter, and returned $175 million to shareholders through share repurchases, taking year-to-date repurchases to $350 million. From an innovation standpoint, this quarter we launched our latest elevator in North America, the Gen3 Core, designed specifically to address the needs of customers in the large two to six-story building segment. Gen3 Core is built off the proven design and flat-belt technology of Otis' Gen2 family while also being equipped with Otis ONE, our IoT platform. Gen3 Core will be manufactured in Florence, South Carolina, and sales will begin this fall. Here are some exciting customer highlights from the second quarter. In Montreal, Otis Canada was selected to provide 28 units, including 11 SkyRise units to the Hôpital Vaudreuil-Soulanges. Hospitals require reliable transportation between floors at all times and we're excited to be a part of this important healthcare initiative expected to open in 2026. It's our latest collaboration in Canada with General Contractor Pomerleau. In Egypt, Otis will provide a total of 57 units for the Iconic Tower in El Alamein, including SkyRise and Gen2 elevators as well as our Link escalators. At 267 meters, this will be the second tallest tower in Egypt and will offer more than 200,000 square meters of housing as well as services and leisure. In China, another 280 elevators and escalators from Otis will keep people moving along Tianjin Metro's new Line 7. This project will bring the total number of Otis units on the city's expanding subway network to more than 1,800. Since it opened, Otis equipment has kept Tianjin Metro passengers on the move, and has been a critical part of the country's transportation network since 1984. And as the Indian government continues to invest in transportation infrastructure, Otis will install 255 units, including our heavy-duty public escalators and Gen2 elevators, for the new Bhopal and Indoor Metro. This is the first metro line in the state of Madhya Pradesh and is expected to serve 500,000 passengers daily. All the equipment will be manufactured at our factory in Bengaluru. We made progress on our ESG priorities, and in the second quarter, received Zero Waste to Landfill Certification for all three of our Spanish factories from AENOR, the Spanish Association for Standardization and Certification. This is important progress towards our goal of achieving a 100% factory eligibility for Zero Waste to Landfill Certification by 2025. In addition, our factory in San Sebastian, Spain received its LEED Platinum certification, the first factory in Spain to receive this designation. The facility opened last year and was designed to reduce environmental impact in the construction and operations through materials used in its waste control system. San Sebastian is our fifth factory to achieve LEED certification. We continue pursuing ways we can improve our environmental impact, which is an increasing focus of our colleagues, customers, and shareholders. Moving to Slide 4, Q2 results and 2023 outlook. Overall, organic sales increased 9.5% with all geographic regions exhibiting strong new equipment organic sales growth in the quarter. And in service, all lines of business contributed to our best service organic sales growth performance since spin. We grew our adjusted new equipment backlog at constant currency by 5% compared to prior year and 3% to the prior quarter, despite a tough compare on new equipment orders, which were down 12%. We continued a strong trend in modernization with orders up 16% at constant currency and backlog up 14% in the second quarter. This is the fourth consecutive quarter of 10% or greater mod orders growth. We grew adjusted operating profit by $60 million and expanded margin by 20 basis points. We generated $409 million of free cash flow, a conversion rate of 109% of GAAP net income. Before sharing our updated 2023 outlook, let me update you on our current geographic outlook for new equipment markets. In Asia Pacific, there's no change to our previous outlook. We expect the new equipment market to grow mid-single digits or better, led by India. In EMEA, the market is now expected to be down high-single digits in 2023, worse than our prior expectations of down low- to mid-single digits. This decline is driven by Northern Europe as customer delays in buying decisions persist. The Americas market has weakened over the past few months and we now expect it to be down high-single digits in units. From an end-market perspective, this decline is driven by multifamily residential coming down from a high level over the past two years, slightly offset by a more resilient commercial market. And finally, in China, we now expect the market to be down 10% compared to our prior guide of down 5% to 10%. This decline is primarily driven by a lack of momentum as we exited the second quarter at a weaker run rate than we had anticipated. Despite the weakening of the new equipment markets globally, we've maintained a strong backlog, giving us good visibility to future sales growth. On the service side, there is no change to our outlook for global installed base growth of roughly 5%, led by Asia. Our strong performance in the second quarter and the progress we've made on our strategic imperatives gives us confidence to improve our 2023 outlook. Organic sales are now expected to be in the range of 4.5% to 6%, with net sales in a range of $14 billion to $14.3 billion. Adjusted operating profit is expected to be $2.25 billion to $2.28 billion, up $155 million to $175 million at constant currency. Adjusted operating profit at actual currency is expected to be up $125 million to $155 million, including a $20 million to $30 million headwind from foreign exchange translation. We're raising our guidance for adjusted EPS, and it's now expected in the range of $3.45 to $3.50, up 9% to 10% versus the prior year. Lastly, our expectation for free cash flow remains unchanged at about $1.5 billion to $1.55 billion or approximately 105% to 115% conversion of GAAP net income. We continue to prioritize returning cash to shareholders, and I'm pleased to share we're increasing our share repurchases this year to $800 million. Turning to Slide 5. As announced earlier today, we're launching a program called UpLift to transform our operating model, to continue to drive sustainable profitable growth within our business. After three-plus years as a public company in which we've grown new equipment share, expanded operating margins, grown EPS, built a formidable backlog and returned approximately $2.7 billion in cash to our shareholders, we're designing Otis for the next phase to ensure high performance and resiliency regardless of the economic environment we may face in the future. We're launching UpLift to drive efficiency across the organization while continuing to prioritize the customer experience. Going forward, we expect our sales specialization to continue to accelerate our growth, our innovation cycles to continue at a rapid pace, and our customer intimacy to continue unabated. Our management team is laser-focused on ensuring that our operating performance can achieve a new higher-performance tier through the transformation of our financial processes, improving our supply chain procurement and rightsizing our cost base where needed among other aspects of the program. Throughout the next two years, we expect the program to generate approximately $150 million in savings, as we drive efficiency across the organization. Our plan is to update our shareholders at regular intervals on the progress we're making with this program and ultimately you'll see the results in better performance, growth, operating profit and returns for our shareholders. With that, I'll turn it over to Anurag to walk through our Q2 results in more detail.
Anurag Maheshwari, Executive Vice President and CFO
Thank you, Judy. Starting with second quarter results on Slide 6. Net sales of $3.7 billion were up 6.7% and organic sales were up 9.5%, driven by strong performance in all business lines. Adjusted operating profit was up $49 million at actual FX and $60 million at constant currency. Drop through on higher volume, productivity, and pricing in both segments, and commodity tailwinds were partially offset by inflationary pressures, including annual wage increases, unfavorable new equipment mix, and higher corporate costs. Adjusted EPS increased 7% or $0.06, reflecting $0.11 of benefit from operations. This strong operational performance and accretion from a lower share count were partially offset by a $0.03 headwind from foreign exchange translation and a $0.03 tax headwind as a result of a tough compare. Free cash flow was strong in the quarter at $409 million or 109% conversion, up $83 million. The increase versus prior year was driven by higher net income and improved changes in working capital. Moving to Slide 7. In the second quarter, as we noted previously, new equipment orders faced a tough compare and were down 12% at constant currency. New equipment backlog, however, continues to trend higher, and was up 5% at constant currency versus the prior year and up 3% sequentially, with all regions being up, providing visibility for sales in the second half and beyond. Globally, pricing on new equipment orders was up low-single digits, building on solid pricing improvements from the middle of 2022. Pricing trends improved mid-single digits or better year-over-year in all regions excluding China. While pricing was down low-single digits in China due to deflationary pressure and the softer market, we maintained price-cost neutrality by focusing on material productivity. New equipment organic sales were up nearly 10% in the quarter with all regions contributing. APAC grew double digits, driven by strong performance in Korea and India; EMEA grew high-single digits, primarily from Southern Europe; the Americas grew high-single digits as job site delays and field inefficiencies eased; and China delivered mid-single-digit growth by executing on a stable backlog. Overall, we saw solid execution across all regions. Adjusted operating profit was up $15 million at constant currency. The benefits from higher volume, price beginning to flow from the backlog, strong productivity and better-than-anticipated commodity tailwinds were partially offset by continued unfavorable regional and product mix, transactional FX and higher SG&A expense. Now turning to service segment results on Slide 8. Maintenance units were up 4.2%, with growth in all regions, led by China, where we achieved another quarter of high-teens portfolio growth. Modernization backlog expanded by 14%, with growth across all regions, driven by strong orders growth of 16% in the quarter. Service organic sales grew 9.4%, the highest rate since spin with growth in all business lines. Maintenance and repair grew 9.1% from better-than-expected repair volume. Our portfolio continued to expand 4.2% and we achieved strong pricing, up 4 points on a like-for-like basis. With strong backlog conversion in the quarter, modernization sales were up 10.9%, with particularly strong performance in Asia, including China. Service profit was up $52 million at constant currency as the benefit from higher volume, favorable pricing and productivity were partially offset by annual wage increases and higher material costs. Margins expanded 50 basis points, in line with our full year guidance. Overall, we're pleased with our first half results, where we gained approximately 50 basis points of new equipment share, grew the portfolio again over 4%, increased organic sales by 6.6%, and improved operating profit by $67 million at constant currency, while continuing to grow our backlog in both new equipment and modernization. This provides good growth visibility over the next several quarters. With that, moving to Slide 9 and the revised outlook. Starting with sales. With strong service momentum, we are raising outlook and now expect total Otis organic sales to be up 4.5% to 6% versus the prior guide of 4% to 6%. Adjusted operating profit growth at constant currency is expected to be in the range of $155 million to $175 million, and approximately $15 million increase at the midpoint versus the prior guide, linked to the better-than-expected service volume. Service margins are still expected to expand about 50 basis points to 24% and we anticipate new equipment margins to expand 20 basis points to 6.8%. Overall, margins are expected to be up approximately 30 basis points to 16%, the high end of the previous range. Adjusted EPS is expected to be up 9% to 10% versus the prior year, within the range of $3.45 to $3.50, and approximately $0.03 increase at the midpoint versus the prior outlook, largely the result of strong operational performance. Due to our continued cash mobilization activities, we have increased our share repurchase target to $800 million, and the outlook for free cash flow is $1.5 billion to $1.55 billion or roughly 110% conversion. Now taking a further look at the organic sales outlook. There is no change to the overall new equipment outlook. By region, we still expect the Americas and EMEA to be up mid-single digits, consistent with our prior guide. Within Asia, Asia Pacific is performing better than anticipated, led by India, which we expect to offset a decline in China due to the continuing weak demand environment. Turning to service. Organic sales are now expected to improve by 50 basis points versus the prior outlook to a range of 6% to 7%, with improvement in all business lines. We're increasing the outlook for maintenance and repair organic sales, now expected to be up 5.5% to 6.5% in '23, driven by the strong first half repair volume. Supported by a robust backlog, which is up mid-teens, we are increasing our modernization organic sales outlook to be in the range of 7% to 9%. Moving to Slide 11. We expect adjusted EPS growth of 9% to 10% in the range of $3.45 to $3.50, a $0.31 increase for the full year with $0.29 coming from operations. Overall, with a strong first half behind us, we are well positioned to improve our outlook and deliver solid second half financial performance on the strength of a service-driven business model and focus on operational excellence.
Nigel Coe, Analyst
Thanks. Good morning. Hope everyone's well. So, I guess, first of all, on the new equipment margins, the transition to the 40 basis points high end, down 20 basis points. It's a small move, but you haven't changed your growth outlook. It doesn't feel like the mix is changing much. I'm just wondering what sort of driving that sort of more moderate view, if you will, on margin? And are we still on track for that price-cost tailwind in the back half of the year?
Anurag Maheshwari, Executive Vice President and CFO
Hey, thanks, Nigel, for the question. I guess the first one is what we've done is we just tightened the new equipment margin to 20 basis points. So, as you noted, we haven't changed our sales outlook for new equipment. But within that, China, which we thought was going to be flattish for the year, is going to be down low-single digits. And as you're aware, China is a higher new equipment profit margin market, but we're able to offset that with definitely better commodity tailwinds. Initially we were expecting about $25 million, now about $40 million. Pricing, definitely in the second half is going to be better than the first half. You put the two together, I think we tightened about 20 basis points on the new equipment side.
Nigel Coe, Analyst
Okay. That's very clear. And then my follow-up is on the UpLift program, the $150 million of cost. Maybe just a bit more detail on where you see the opportunities to further streamline the cost base? How much of that $150 million do you think will come to the bottom-line versus being reinvested? And then, is this additive to your other programs? I'm thinking things like the modernization margin initiatives, service productivity initiatives, is this additive to those programs?
Judy Marks, Chair, CEO and President
Yes, Nigel, let me take that. And we're calling it UpLift. I think you called it Uprise. But let me take that. First and foremost, I think it's really important for people to understand why we're doing this now, and then I'll get to kind of where the cost takeout is going to be, which is mainly in G&A. So, it will be additive to our other productivity initiatives as well as our modernization growth. But where it comes from is, we spun a little over three-plus years ago. And since that time, the team and our colleagues, tremendous thanks to them, we've gained share in new equipment, we've driven growth, expanded operating profit margins, we've returned $1 billion in cash to our shareholders, and quarter-after-quarter, we've executed our strategy and performed. And I think it's important to know that we're approaching UpLift from a position of strength. I think it's incumbent on leaders to prepare the company to take us to the next level. And that's what we're doing as an executive leadership team across the company. So, we're going to focus really on three areas. The operating model itself to give us more speed and agility. We're tremendously distributed organization with our 1,400 branch offices serving our customers globally. We want that speed and agility to be more customer-centric. We're going to streamline processes, and that's going to be extremely important. I think it's something we've learned coming out of spin and now through performance that we can be more consistent geographically and we can streamline our processes from financial processes all the way through to really how we sell to customers, and we're looking forward to that. And the third element is taking advantage of our scale and acting as an enterprise and implementing some pretty significant focus on supply chain, especially indirect. So, you add those three together, it adds up to the $150 million we're going to return, which is predominantly through G&A. Again, it's additive to what we're doing. Anything above that we generate, we are planning on reinvesting in our business to give us new capabilities, new competencies, to continue to invest in innovation. We brought more products to market since spin than we have for many years. We're going to continue to do that as we create the connected Otis of the future and take us to the next level.
Julian Mitchell, Analyst
Hi, good morning. Just maybe the first question around the market outlook and the backlog. Because you took down the market outlook in various regions, but the sales guide obviously intact and the backlog is still growing, even with orders down. So, just trying to understand sort of looking ahead, should we expect the backlog to start to shrink sequentially as that end market pressure starts to be exerted? And do you expect to sort of a lower backlog entering 2024, because of the market pressure you called out?
Judy Marks, Chair, CEO and President
Sure, I'll let Anurag address the backlog specifics, but I want to be clear that we do not anticipate a decrease in backlog as we transition from 2023 to 2024. We are very pleased with the 5% growth in backlog. As illustrated in our first appendix chart, we have achieved a record backlog, which provides us with a clear outlook for the future and has significantly contributed to the organic sales growth across both segments. Now, let’s discuss the market conditions before Anurag takes over on backlog details. Starting with Asia Pacific, we expect the new equipment market to continue growing at a mid-single-digit rate. We are experiencing particularly strong demand in India, which is encouraging. Overall, we see the Asia Pacific market continuing this mid-single-digit growth trend. In the Americas, however, the market started weak in the first half, with unit sales down in the mid-teens. We anticipate the second half will remain flat or slightly decline, leading to a high-single-digit decrease for the full year in the market. Although unit sales are slowing, the Americas market has been sequentially flat. We are monitoring all indications closely, speaking with our customers, and reviewing data from Dodge and ABI. I’m also happy to discuss the orders in the Americas as we go through our Q&A. In EMEA, we project a high-single-digit decline for the remainder of 2023, mainly due to the impact of rate changes and a sluggish market, particularly in Northern Europe, with Germany, France, and the UK showing weakness attributed to delays in decision-making and uncertainty. While proposals are still being submitted, decisions from customers will take time. Conversely, Spain and Italy are performing quite well. For the Middle East segment, we expect a low-single-digit increase. We approach the second half in Europe with a solid backlog. With a backlog of this magnitude, we are looking 18 to 24 months ahead. Regarding China, we are forecasting a 10% decline in the market. Although we saw good momentum in April, demand weakened in May, leading to a downturn exiting Q2. This lack of acceleration in the book-and-ship business has pushed us toward the lower end of our anticipated range. It's important to note that the outlook for the new equipment market differs significantly from the service outlook, which remains robust, showing mid-single-digit growth driven primarily by Asia and low-single-digit growth in more developed markets.
Anurag Maheshwari, Executive Vice President and CFO
Absolutely. Thanks, Judy. Even if we assume there is no orders growth, we would expect our backlog to be up low-single digits by the end of the year. And the reason for that, Julian, is because we tend to book more orders in any given year than we ship as some of the orders are larger projects and multi-year in nature. So clearly, I mean, it's not a right analogy, but if you look at our book-to-bill, it's definitely been far higher than 1. So, we booked definitely more orders than we ship over the year. Well, let's even assume if conditions worsen from here and there is a new equipment orders even slightly declines to even mid-single digit, I think we will end the year with backlog at least being higher. More importantly, if you look at our backlog mix today, in Americas, it's still fairly high, which is a multiyear backlog that we have.
Judy Marks, Chair, CEO and President
Yes, even in EMEA, our backlog is up modestly compared to last year and last quarter. We are closely monitoring the backlog. We have always informed our shareholders that the year-end figure is the best indicator for our next year in terms of revenue and profit. We expect this year to be no different.
Julian Mitchell, Analyst
Thanks very much. And then just a quick follow-up as that was a very thorough answer. Just looking at seasonality within the second half, normally your earnings are down slightly sequentially in Q4. I think consensus has you sort of up in Q4 sequentially. So maybe just, is there anything different you're calling out on sort of Q3 versus Q4 earnings this year because of the price-cost or something like that?
Anurag Maheshwari, Executive Vice President and CFO
Yes. If we examine the second half of the year, we achieved approximately $1.72 of EPS in the first six months, which implies around $1.76 in the latter half, with a fairly even distribution between Q3 and Q4 regarding our EPS. Regarding new equipment, we anticipate about 3% growth in the second half. This should be roughly equal across both quarters. We expect to benefit from commodity pricing tailwinds amounting to around $30 million to $40 million, with a slight tilt towards Q4. The margin rate is expected to exceed 7%, with no significant differences between Q3 and Q4. In terms of service, we are looking at an operating profit increase of $40 million to $50 million each quarter, which we expect to see again in Q3 and Q4. Maintenance is performing well, supported by pricing and portfolio growth, and we are making progress in converting our backlog. Overall, we believe our run rate looks strong. There will be some additional corporate expense pressure in Q3 compared to Q4. Considering all these elements, the EPS trajectory between Q3 and Q4 should remain quite similar.
Steve Tusa, Analyst
Hello?
Judy Marks, Chair, CEO and President
Hey, Steve.
Steve Tusa, Analyst
Hey, sorry, I thought I got cut off there for a second. Just a question on China. So, this market is seemingly getting revised down. Just this, whatever recovery was going to come, seems to be deferred. There seems a mixed messaging on stimulus. I mean, I guess, first of all, what's your view on how that market will evolve in '24? And on the services side, isn't there a bit of like a lag as to when you can go after converting those into service agreements? So, like we should be thinking about those opportunities as a two-year lag to the market? And at what stage, if this market remains down, do you have to get a little more aggressive to tweak up that equation of units coming up for conversion versus conversion? Because obviously, if the market is down 10%, and a couple of years later, you're still growing your conversion, that could still mean negative units under management, if this thing kind of continues to bleed lower. Just curious how you're evaluating that equation.
Judy Marks, Chair, CEO and President
Yes, let me address several points. First, regarding our service business, we've seen mid- to high-teens portfolio growth in China for the eighth consecutive quarter. Sally Loh, who now heads our China organization, has been instrumental in driving this growth. We currently have 350,000 units in our portfolio in China, marking a significant increase since we committed to expanding our service business. This growth is yielding returns, and we are improving our conversion rates. In China, despite a 10% decline in the segment during the second quarter, our performance was down only 5%, indicating continued market share gains in new equipment, which is promising for the two-year warranty and our conversion efforts. Although the number of units may decrease, our strategy to open service depots and enhance service conversion with Gen3s connected to Otis ONE is accelerating our conversion rates compared to previous years. Therefore, a slight reduction in volume does not overly concern me. In terms of changes for the second half, we anticipated an uptick, particularly in our book-and-bill business, but as we approached the second half, we did not observe the expected momentum. We recently noted a different tone from the National People's Congress, which could signal potential positive changes, especially in large tier cities. However, our outlook did not factor in such developments. If this change occurs, I remain cautiously optimistic; we are ready with the necessary capacity, sales channels, and innovative products to respond promptly. State-owned enterprises continue to perform well, grow, and acquire land, further validating our key accounts strategy and share growth.
Steve Tusa, Analyst
Great, thanks. And then just one last one for Anurag. With orders down potentially here in the second half, how should we think about the progress flow or the contract liability flow through the cash flow statement?
Anurag Maheshwari, Executive Vice President and CFO
Yes, with orders potentially declining, we will experience lower advance payments. However, we're not predicting that orders will be down in the second half of the year. We've accumulated a significant amount of receivables in the first half due to higher revenue, which should start to unwind in the second half. Therefore, from a cash perspective, I believe we will be in a good position.
Jeffrey Sprague, Analyst
Thank you. Good morning, everyone.
Judy Marks, Chair, CEO and President
Hey, Jeff.
Jeffrey Sprague, Analyst
Just coming back around the price, Anurag, I think you gave us some good color on price, on orders on new equipment. Just wondering if you could give us a little color on what's coming through in revenues at this point on new equipment side and how that might build over the next two or three quarters.
Anurag Maheshwari, Executive Vice President and CFO
Great. Let me start with the second quarter. On the new equipment side, we saw about $5 million in pricing contributing to the bottom line, which was encouraging. We had anticipated a larger impact in the second half. For the second half, we expect around $20 million from this. Looking back, we've implemented six consecutive quarters of price increases, and our backlog margin has improved by over 100 basis points. By the end of the year, we anticipate that backlog margin will increase further as we work through older orders at past prices along with ongoing mid-single digit price increases. If that occurs, every 100 basis points of increase in backlog prices should translate to about 50 basis points or roughly $30 million to $40 million for next year. We expect to see this reflected more in our revenue in the coming year. I believe we are just starting to see the impact of new equipment pricing on our revenue, and it should continue to rise over the next few quarters.
Judy Marks, Chair, CEO and President
Yes, Jeff. We are very happy with mod and its development. It's going to be a topic for many quarters ahead as we've recently added it as a fifth strategic priority for our company. We are focusing on making it more akin to our new equipment business, which means that while it’s currently affecting margins negatively in the service segment, you will see margins improve. I'm pleased to report that we had our fourth consecutive quarter of orders exceeding 10%, with a strong backlog. Asia has stood out for mod, with significant volume and major projects in Asia Pacific, particularly in Japan, Korea, Hong Kong, and India. China is also experiencing rapid growth with our MX mod product, and we expect that growth to continue as units in China age. We are optimistic about mod. As I mentioned in the last call, we plan to apply everything we've learned from new equipment and service to make it more production-ready rather than customized, which will help expand our margins as we generate more revenue through it. Once we complete a mod, we are able to retain and service it at a very high rate, which is much more significant than conversion rates compared to the industry-leading retention rate. This highlights the importance of mod. It enhances our customer relationships, allows us to bring more units into our portfolio, provides customer value, improves energy efficiency, and prepares our services for many years, especially as more buildings are repurposed. There is significant opportunity with offices being converted to multi-use spaces. Mod will be a consistent topic in our discussions every quarter, and you can expect to see continued delivery in terms of orders, backlog, and restarting the service clock.
Nick Housden, Analyst
Yes. Hi, everyone. Thanks for taking the questions. So, it's been another strong performance from repair. I was wondering if you could just remind us how much of maintenance and repair is the repair piece specifically? And how sustainable the growth is? Because I think it's been a couple of quarters now where the growth has surprised to the upside. So, I'm wondering if maybe it's just a structurally stronger market than you maybe thought previously. That's the first one. Thanks.
Judy Marks, Chair, CEO and President
Yes, Nick, good to hear from you. We don't disclose the difference between maintenance and repair. Really strong repair this quarter. And we keep waiting for the quarter where it’s going to slow down. When you go back probably six quarters, we saw a bounce back when office use started picking up post COVID, because we had a little bit of a downturn in the early COVID days. So, it's been a good strong six to eight quarters. But again, as people potentially put off some discretionary mod decisions, your units are still aging and need even more repair. So, really pleased with repair globally. It was strong in every region. And we're not sure how long this can keep up. So, we think we've got it tuned appropriately in the outlook, but I'll let Anurag talk to that from an outlook perspective.
Anurag Maheshwari, Executive Vice President and CFO
Yes. Just a couple of points to add over there. I think the team has really executed very well on the repair side. I mean, after two years of double-digit growth, as we entered this year, we thought that repair would be a low-single-digit growth. So, if you look at our outperformance on the service business, I think it's largely because of repair. Our maintenance portfolio is growing at 4.2%. We have price on a like-to-like basis of 4%. If you adjust for mix and churn, it's 200 basis points and maybe maintenance is more than high-single digits. So, repair is definitely growing double digits in the first half of the year. And it's not only because of coming back to work, just executing on a very good strategy over there. On the second half, the reason you see a step down in the service revenue is because maintenance continues to grow at the same clip, modernization backlog converts, as we're just assuming repair is going to be flattish. Now, we may be a little bit cautious over there. If we continue to execute well, there could be a little bit more upside in the second half of the year.
Nick Housden, Analyst
That's great. And then, maybe just on Otis ONE. Can you just provide us with an update on your kind of general efforts on connectivity and how that's feeding into some of the metrics like retention and conversion, whether there's been any impact on pricing or profitability, and kind of when we might see that if we haven't already? Because I know you've got a slightly different strategy to one of your peers who's maybe pricing for it a bit more directly already. So, just curious to hear how the IoT operation is going.
Judy Marks, Chair, CEO and President
Yes, we're very pleased with the progress. The Otis ONE units are having a significant impact. All our Gen3 units are now shipped with Otis ONE, and our new Gen3 Core, which we introduced this quarter, will include it for North America. This year, we’re shipping a larger volume of Otis ONE due to increased shipments and conversions happening in China. In the past, we indicated around $100,000 a year, but that figure will rise substantially in 2023, keeping us aligned with our medium-term goals. Currently, we have over 800,000 units connected, and Otis ONE is becoming a larger share of that total. We expect to see far more than 100,000 units connecting this year, which is making a real difference. Specifically in China, a major portion of their service productivity gains is attributed to Otis ONE. Our arrival times have improved globally. With connected products, we not only enhance our ability to convert but also to retain, especially since ISPs prefer not to handle Otis elevators with eView screens due to their unique connectivity. We will share detailed figures at the fourth quarter, as connectivity is a key part of our strategy, and it's contributing positively to service pricing. As Anurag mentioned, our service pricing has increased by four points year-over-year. I must commend the EMEA team for achieving mid-single digit growth in service pricing this year, with Bernardo and his team doing an exceptional job. Connectivity plays a significant role in this success. During a recent visit to Portugal, I saw that over half of their portfolio is connected, leading to impressive service margins. Our strategy emphasizes defining connection rather than relying on customer opt-ins for subscriptions; however, we are also gaining subscription services. We decided to invest the capital and determine the rollout of Otis ONE, and this is reflected positively in our service margins.
Josh Pokrzywinski, Analyst
Hi, good morning, all.
Judy Marks, Chair, CEO and President
Hey, Josh.
Josh Pokrzywinski, Analyst
Judy, I want to pick up on a couple of things you already touched on, and I apologize, I jumped on a little late, so you might have covered this on the China question. But how are you seeing the divergence between national accounts and maybe more of the volume business in terms of where the weakness or where the pricing pressure is coming, obviously, kind of downstream implications for what that conversion will look like?
Judy Marks, Chair, CEO and President
Yes, that's a fair question, Josh. We refer to them as key accounts, which are the large developers. Our team has continued to engage with these key accounts. In fact, our share of national or key accounts that are now state-owned enterprises is significantly higher than that of private developers, which is making a notable difference for us. The Tier 1 and Tier 2 cities continue to outperform not just their segment but also show stronger results for Otis compared to lower-tier cities. However, in the lower-tier cities, our performance was largely driven by volume, and our team did fairly well. In the second quarter, the positive segments in China were consistent with the first quarter, particularly in infrastructure and industrial, while the weaknesses were seen more in residential and commercial sectors. I like the strategy we have in place, particularly with the inclusion of state-owned enterprises. We're also closely observing government policies and the new tone being set, as well as potential policy eases regarding mortgages, lending rates, and the overall philosophy on housing shifting from an investment focus to one of living. That phrase was discontinued on Monday after many years. So, we are monitoring it closely. We believe we are well-prepared for the second half, and if there is an upturn due to either stimulus or a change in sentiment that boosts volumes, we are ready to respond and will see that reflected in our results.
Joe O'Dea, Analyst
Hi, good morning. Thanks for taking my question.
Judy Marks, Chair, CEO and President
Yes, thanks, Joe.
Joe O'Dea, Analyst
I wanted to begin by discussing the dynamics of orders, backlog, and revenue. I’d like to understand your perspective on the revenue implications given some changes in end market views for the year, although it seems not to affect your outlook for 2023, and it's unclear if it influences your thoughts for 2024. As you reflect on recent developments and how they might relate to improvements in supply chain, project execution, and whether customers need to order less far in advance, consider factors like interest rates and credit. Given the recent months and revised outlook on demand trends in the markets, could you share any insights on potential revenue implications?
Judy Marks, Chair, CEO and President
Yes. Let me highlight a few key points. The supply chain is getting better, which is evident in the increased volumes we are able to ship, and that has been beneficial. As Anurag mentioned, commodities are also on the upswing. We experienced about a $15 million advantage in the second quarter, and we've raised our forecasts for commodities as well. Prices are up, commodities are improving, and the supply chain is getting better, all of which is quite positive. Our backlog is at a record level, which will help us navigate through 2024 with some certainty, although there are still questions about when and at what level China will recover. Our team in China has excelled in improving material productivity. Despite intense pricing competition in China, we have managed to maintain at least price-cost neutrality, and have slightly exceeded that in the first half of the year. If the market remains stagnant without stimulus, we will adjust and modify our cost structure. However, if conditions improve, we are prepared to respond.