Earnings Call Transcript - OTIS Q3 2020

Operator, Operator

Good morning, and welcome to Otis' Third Quarter 2020 Earnings Conference Call. Today's 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 will now turn it over to Stacy Laszewski, Vice President of FP&A and Investor Relations.

Stacy Laszewski, Vice President of FP&A and Investor Relations

Thank you, Sonia and good morning, everyone. Welcome to Otis' Third Quarter 2020 Earnings 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 non-recurring 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 the 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 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, Stacy and good morning everyone. Thanks for joining us and we hope that everyone listening is safe and well. To start, I want to thank each of our colleagues around the world for their unwavering dedication as we continue to deliver on our commitments to passengers, customers, and shareholders. Overall, as you'll see in our results, our business is trending back towards pre-COVID levels, improving sequentially across all metrics. I'm pleased to share that we had a very strong quarter. We gained share in new equipment, paid down debt, and are raising our outlook with Rahul providing additional details. Our strategy is robust despite the unique environment we're in and as an example of our ability to continue to execute, this quarter we completed the acquisition of Bay State Elevator, expanding our scale and density in the Northeast United States. We're delighted to have the Bay State colleagues join the Otis team, and we remain focused on accelerating growth of our service portfolio, both organically and inorganically. Our bolt-on M&A strategy is working and serves as an accretive source of growth. Innovation is core to Otis. COVID accelerates the need for new health and safety solutions, which we expect to continue post-COVID. Otis is a leader in this space, continuing to bring new products to market and during the quarter we commissioned an elevator airflow study examining the risk of airborne transmission in elevators and how to best mitigate those risks through science-based safety protocols. This study is being led by a Purdue University expert in the spread and prevention of infectious diseases through indoor air systems. We look forward to sharing these findings in the coming months. Furthering our ability to provide innovative cutting-edge products, we opened a new industry 4.0 escalator factory in East China that incorporates intelligent manufacturing, advanced automation, and digital technologies such as 3-D modeling, custom engineering, and real-time quality management. This move continues to rationalize our footprint and build on our legacy of excellence while upgrading our smart manufacturing capabilities for a new era. We continue to deploy iPhones to our field professionals, adding four more countries during this quarter, and the adoption of our suite of apps continues to expand driving service productivity within the organization. In addition, our IoT deployment continues to build momentum, and we have plans in place to enhance the capability of Otis ONE solutions over the next several months to drive productivity in our organization. Despite the challenges introduced by the pandemic, we continue to deploy these units in the U.S., Europe, and China during the first nine months and expect the pace of deployment to accelerate. Otis also received several key orders across each of the regions, highlighted on Slide 3. In Chicago, we received an order to outfit the new Salesforce Tower Chicago office building with over 30 sky-rise and Gen 2 elevators. Each of the passenger elevators will have our new innovative Compass 360 dispatching system allowing for seamless travel in a 60-story building. In China, Otis was selected to support Tianjin’s Metro Expansion Project; we will add approximately 120 elevators to Line 6, bringing the total number of Otis elevators and escalators throughout the Tianjin Metro to approximately 1400 units. This award extends Otis's involvement in infrastructure development in the region, a key strategy for us. And in France, we're helping bring La Défense, the business area of Paris, to new heights with an order to deliver 60 elevators and several escalators to The Link, the next tallest building in France. This project will include CompassPlus, eCall, and OptiSense technologies, creating a faster, safer, and more seamless trip for the passengers. These are just a handful of examples that led to the approximate 70 basis points of new equipment share gain during the first nine months. In terms of liquidity, we ended Q3 with $1.7 billion of cash and continue to maintain a revolving credit facility which serves as a backstop for our commercial paper issuances and an additional source of liquidity if needed. We also made progress on our debt repayment goal of $350 million in 2020, repaying $250 million in the quarter. And as we remain dedicated to delivering results for our customers and shareholders, our commitment to global corporate citizenship has not wavered. Last quarter, I shared with you the launch of our commitment to change. In just three months, we are going to make Otis a more diverse, equitable, and inclusive culture and identify and prioritize actions we need to take to get there. For example, in the quarter we enlisted an outside diversity equity and inclusion expert to independently assess our practices and provide recommendations to guide future decisions and programs. Later during the quarter, we launched Made to Move Communities, a CSR program focused on advancing youth STEM education and providing inclusive mobility solutions for communities in need. This extends Otis's ongoing commitment to the communities where we live and work and we look forward to providing the avenue and resources to help young minds explore new ways to give people freedom to connect and thrive in a taller, faster, smarter world. Turning to Slide 4, Q3 results and 2020 outlook. New equipment orders were up slightly at constant currency with low single-digit growth in EMEA and Asia partially offset by a low single-digit decline in the Americas. China orders were up high single-digits as the business continued its rapid recovery from the impacts of COVID-19. On a rolling 12 months, total Otis orders were down approximately 1%. New equipment backlog continued to grow, up 3% versus the prior year at constant currency. In the third quarter, organic sales were down 1.2% with the new equipment segment down 1% and the service segment down 1.4%. Adjusted operating profit was up $33 million and margin expanded 120 basis points, driven by continued expansion in the service segment on strong contribution from productivity and the benefit from cost containment actions and favorable transactional foreign exchange. Free cash flow was robust at $311 million, with 117% conversion of GAAP net income. While there remains uncertainty around the global recovery from the pandemic, we are encouraged by these strong year-to-date results and the trends we're experiencing, giving us confidence to revise our 2020 outlook. We are improving the organic sales range now expected to be down 2% to 3%. Adjusted operating profit is now expected to be in the range of up $30 million to $40 million, a $60 million improvement versus the prior outlook at the midpoint. We now expect adjusted earnings per share to be approximately $2.42, up $0.17 versus the prior midpoint. This reflects our improved adjusted operating profit outlook, lower adjusted tax rate, and lower net interest costs. Lastly, we expect free cash flow to be robust at approximately $1.15 billion, with full year free cash flow conversion at approximately 135% of GAAP net income. With that, I'll turn it over to Rahul to walk through our results and outlook in more detail.

Rahul Ghai, Executive Vice President and CFO

Thank you, Judy and good morning everyone. Starting with third quarter results on Slide 5. Net sales were $3.3 billion, down 1.4% with a 1.2% decline in organic sales. As anticipated, both the new equipment and service segments declined organically primarily from the impact of COVID-19. Adjusted operating profit in the quarter was up approximately 7% or $33 million and up $30 million at constant currency, as the impact of lower volume, temporary price concessions, and field inefficiencies was more than offset by strong productivity, cost containment, and favorable transactional effects. Our focus on reducing material cost continues to yield results and maintenance hours per unit sustained a downward trajectory. Cost containment efforts that we launched in Q1 of 2020 also helped alleviate the pressure from lower volume and year-to-date SG&A expense was down by more than $60 million year-over-year. At the same time, we continued to invest in the business and R&D expense as a percentage of sales was about flat versus the prior year. Our strong focus on operational execution drove 120 basis points of adjusted margin expansion with continued margin improvement in the service segment. Third quarter adjusted EPS was up 25% or $0.14 from $0.06 of operating profit growth and the balance from a lower adjusted tax rate and a drop in interest costs. These results were better than we had expected in the previous outlook, driven by the stability of the maintenance business, higher savings from service productivity, and progress on reducing the adjusted tax rate. Moving to Slide 6, new equipment orders were up slightly at constant currency and were down approximately 1% on a rolling 12-month basis. Order intake continues to outperform the market and regained approximately 40 basis points of share in the third quarter in a market that was down low single-digits. Book margins were up slightly in the quarter and were flat year-to-date versus the prior year. In the quarter, book margin improvement in China and North America was partially offset by pressure in parts of Asia Pacific and EMEA. New equipment backlog was up 3% at constant currency driven by growth in the Americas, with overall backlog margin improving slightly from Q2 and remaining stable versus the prior year. New equipment organic sales were down 1% as mid-single-digit growth in China was more than offset by declines in Asia-Pacific and parts of EMEA. At constant currency, new equipment adjusted operating profit was down $9 million and margin contracted 50 basis points as strong material productivity and cost containment was more than offset by the impact of under absorption, field inefficiencies, and an unfavorable mix. Service segment results on Slide 7 remained strong in the quarter. Number of units under maintenance contracts increased by over 1% with growth in all major regions and China up more than 6%. Modernization orders were down 7.3% at constant currency as double-digit growth in Asia, driven by the mandated regulatory upgrades in certain markets was more than offset by lower order intake in the Americas and EMEA. Service organic sales were down 1.4% as maintenance demand remains strong while discretionary repair and modernization projects were pushed out. At constant currency adjusted operating profit margin expanded 140 basis points and profit grew $19 million, a strong contribution from productivity and cost containment actions more than offset the impact from the volume decline, temporary price concessions, and an increase in bad debt expense. The service pricing environment, excluding the impact of these price concessions was about flat. Overall, year-to-date results reflect solid performance with $33 million of adjusted profit growth at constant currency and 90 basis points of margin expansion despite organic sales being down 3.3% versus the prior year. The service business was particularly resilient with adjusted operating profit growth of $47 million at constant currency on a slight decline in organic sales, in an extremely challenging market environment. Also, third quarter results reflect sequential improvement in both segments and steady progress towards returning to pre-COVID levels. Access to job sites and buildings has largely returned to normal outside of India and Southeast Asia, and the service call volume is back to 2019 levels in China and Asia-Pacific. And the trends are heading in the right direction in Europe and Americas. We are improving our 2020 outlook to reflect strong progress during the year and these encouraging trends. Turning to Slide 8, we now expect overall organic sales to be down 2% to 3% for the year, up from prior expectations of down 2% to 4% with improvement in both new equipment and service segments. We now expect new equipment sales to be down mid-single-digits and service sales to be flat to down slightly. Adjusted operating profit is expected to be up $30 million to $40 million at constant currency for the year with 60 to 70 basis points of margin expansion. This is an improvement of $60 million versus the prior outlook at midpoint reflecting the strong year-to-date performance, benefit from an improved sales outlook, and higher service productivity. At actual currency, adjusted operating profit is expected to be up $5 million to $15 million, reflecting favorable foreign exchange trends in addition to the operational improvement. Adjusted EPS is now expected to be up 8% versus the prior year to approximately $2.42 and up $0.17 versus the prior midpoint driven by an improved operating profit outlook, lower net interest cost, and a reduced tax rate. We now expect the adjusted tax rate for the year to be about 30.5%, down one point versus the prior outlook. Taking a further look at the organic growth assumptions on Slide 9, in the new equipment segment, Americas is now expected to be down mid-single-digits, reflecting strong recovery in the third quarter with sequential improvement and year-over-year growth in the fourth quarter. EMEA is now expected to be down mid to high single-digits, reflecting a strong recovery in Northern and Eastern Europe. We are improving the Asia outlook driven by better than expected third quarter performance in China. However, we expect Asia to be down in the fourth quarter due to continuing challenges in India and Southeast Asia. In the service segment, we expect the maintenance and repair business to be flat to down slightly with the maintenance sales remaining resilient and a slower recovery in discretionary repairs. We are raising the modernization outlook to be about flat for the year, driven by better than expected performance in Asia Pacific from an effective go to market strategy to tap into the demand created by regulatory requirements. Overall, the outlook of 2% to 3% organic sales decline reflects sequential improvement and return to pre-COVID levels in the fourth quarter at the midpoint. Switching to operating profit on Slide 10, at constant currency operating profit is now expected to be up $30 million to $40 million versus the prior year, reflecting the benefit of solid contribution from materials and service productivity and cost containment actions that are more than offsetting the impact of reduced volume from the COVID-19 pandemic, incremental under absorption of costs, and temporary price concessions in the service business. This represents a $60 million improvement versus the prior expectations with improvements in both new equipment and service segments. The fourth quarter outlook includes incremental investments in the new equipment and service sales channel in China, additional cost to complete the maintenance visits, sequentially higher R&D expense, and the expected step up in public company costs. Foreign exchange is now expected to be a headwind of approximately $25 million, an improvement from a headwind of $40 million to $50 million that we had expected in July, primarily due to the strengthening of the euro against the U.S. dollar. An update on capital deployment on Slide 11. We started 2020 with about $1.4 billion of cash and now expect to generate approximately $1.15 billion of free cash flow in 2020, an improvement of $100 million versus the prior midpoint from higher net income and an improved working capital performance. As Judy mentioned, we repaid $250 million of debt in the quarter with another $100 million of repayment planned for Q4. We also refinanced $500 million of the U.S. stone room towards Euro Commercial Paper Program, our first foreign currency denominated debt transaction, as we continued to evaluate our capital structure. We still expect to return $260 million to shareholders through dividends in Q2 through Q4 and spent approximately $200 million between non-controlling interest and M&A. These actions will allow us to maintain sufficient liquidity and position us to increase cash on the balance sheet by the end of the year, giving us optionality depending on the overall liquidity conditions to start share buyback in 2021. After we complete the previously disclosed $500 million of debt repayment. With that, I'll turn it over to Judy for closing remarks.

Judy Marks, President and CEO

Thanks Rahul. I'm pleased with our year-to-date performance navigating continued COVID challenges while continuing to drive our long-term strategy all in our first year as a standalone company. In early 2021, we'll provide an update on our 2021 and medium term outlook for we continue to expect sustainable growth and global share and are seeing traction with new equipment share of approximately 70 basis points year-to-date. This growth will continue to feed our leading service portfolio, where we remain focused on service transformation initiatives, deploying IoT and digital tools that drive value for our customers, productivity, and margin expansion. We remain committed to driving value for our shareholders, driving EPS growth and robust cash generation, all while investing at sustainable levels to position us to stay at the forefront of this industry. With that, I'd like Sonia to open up the line for questions.

Operator, Operator

Thank you. Our first question comes from Carter Copeland of Melius Research. Your line is now open.

Carter Copeland, Analyst

Hey, good morning everybody.

Judy Marks, President and CEO

Good morning, Carter.

Carter Copeland, Analyst

Just quick ones. One, the Bay State acquisition, did that add any meaningful amount to the service portfolio growth you talked about in the Americas? And then just as a follow-up on Otis ONE and pricing differentials you've seen on those connected units or what your expectation is for those in the future, just high level thoughts on that would be appreciated? Thanks.

Judy Marks, President and CEO

You bet. So Bay State, again, pleased to have them join the Otis family, but that is not material in terms of what contributed to the portfolio growth in the Americas, specifically in North America for the quarter. In terms of Otis ONE, we are ramping up and accelerating our deployment. We've seen productivity gains but in terms of additional subscriptions or revenue, it's still early in terms of where we're able to gain traction on that. It's certainly adding value and productivity; we've seen that in China, we've seen it in Spain, and we're now seeing and hearing from our mechanics in North America in terms of how it's giving them the ability to show up quicker, to have less running on arrivals when they get there because they know it's already running on arrival and they don't have to actually make that service call. So we're pleased with the early results, but it's not anything that's really added to the top line in terms of subscription revenue yet.

Rahul Ghai, Executive Vice President and CFO

So just to add to that Carter, Otis ONE joins the suite of other connected applications that we have like destination dispatch system, elevator management system, and those applications combined add about 30% to 40% of the subscription revenue. So as Judy said our first focus on Otis ONE is productivity and we do feel that the benefit to the customer, both in terms of visibility and better uptime that we can provide will start adding incremental and additional revenue over time. And we see that in Asia and other parts of Europe where we do have remote service capability that we provide through even the phone lines. We are able to get incremental price in those units. So it will help over time but our first focus has been productivity on Otis ONE as we previously stated.

Carter Copeland, Analyst

Great, thank you for the color. I'll let somebody else ask.

Operator, Operator

Thank you. And our next question comes from Steve Tusa of J.P. Morgan. Your line is now open.

Steve Tusa, Analyst

Hey, guys. Good morning.

Judy Marks, President and CEO

Hey, Steve.

Steve Tusa, Analyst

So just first of all on the kind of new equipment guide for the year, it just looks like you kind of took up the high end of the range for some of those or at least move those higher at the high end. And, you're really only removing the low end of the range; is that just kind of some rounding error around some of the regions, it just seems like maybe that total number should have moved up a bit more?

Rahul Ghai, Executive Vice President and CFO

Steve, you're right. We have reviewed the regions and improved the lower end of the range, decreasing it from mid to high single-digits to mid-single-digits. It was previously down by 5% to 10% during the Q1 call, so we are seeing continued progress. The outlook has improved across all regions, with strong performance in Q3, particularly in China and the Americas. We have planned growth for Q4 at the mid and high end. There may be some rounding since we don’t provide specific ranges, so feel free to reach out if you have further questions. Overall, we are optimistic about the business trajectory and anticipate growth in EMEA and the Americas at the mid and high end of the range. We feel confident about our guidance.

Steve Tusa, Analyst

And then just listening to some of these other guys, I mean, Kone, Schindler and you guys are all talking about intense price pressure. And I think Schindler mentioned pricing like 50 times in its presentation or something like that using round numbers. Yet you guys are saying that your booked margin was actually okay in the quarter. Can you try and reconcile like what you're seeing financially in your orders and your business, is it something in the pipeline that you guys all see that is sneaking up on you from a price perspective, it's just going to be a matter of timing or is that just, hey, this is COVID, things are flying around where it's uncertain. So, we just don't want to make any pricing promises on price because it just seems like there's a lot more high-level caution around price, but I don't really see it in orders or the numbers; can you just kind of help reconcile that?

Judy Marks, President and CEO

In the third quarter, we observed improved volumes and strong productivity with stable pricing. Our orders increased slightly, and we recorded a 20 basis points improvement in both margin, which we are very pleased about, particularly following a 70 basis points decline in the second quarter. Additionally, our backlog grew by 3%. Although the market remains competitive, particularly in North America, we experienced low single-digit gains in EMEA and Asia, high single-digit gains in China, but saw a slight decline in the Americas. We are focused on controlling what we can, which includes winning business and increasing market share, leading to approximately 40 basis points growth. We are also executing on our backlog by enhancing productivity and controlling costs. Growing our backlog will significantly support our efforts in 2021 and position us well. Overall, we are satisfied with the improvements from Q2 to Q3, but I want to emphasize that the pricing environment is becoming increasingly competitive, especially in North America.

Rahul Ghai, Executive Vice President and CFO

To add to what Judy mentioned, our year-to-date booked margins are flat, which is a positive sign. The first quarter showed an increase, the second quarter saw a decrease, and the third quarter was back up. Overall, the booked margins have remained steady for the past nine months. Additionally, our backlog has increased, and the backlog margins are better sequentially compared to Q2 and are flat compared to last year. This ties back to your earlier comment about the pipeline. The backlog margins that will influence revenue for next year are flat. As we've stated since our Investor Day, we anticipate a challenging pricing environment. We have expected this, and while the macroeconomic conditions are not ideal, we remain focused on driving productivity. We have been achieving a 3% target for nine months and plan to continue this for the next 12 months without wavering. We will keep improving our execution and maintenance productivity, and if we face pricing pressure, we will find ways to counterbalance that.

Steve Tusa, Analyst

One last quick one for you guys. We're all trying to kind of learn how to compare all these companies over time. And I guess you guys defined share gain differently. These companies, your competitors say different things about the markets. When you guys talk about your kind of market share and how you're competing, are you looking at like very high-level numbers versus the Schindler's and the Kone’s of the world, or are you saying within our specific verticals that's kind of how we analyze it, because that obviously would explain why it's not directly necessarily like a one-for-one read from a Kone or a Schindler, or are you looking kind of high level globally and you're not really paying attention to fighting with those guys and across the different verticals like residential, commercial infrastructure, etcetera?

Rahul Ghai, Executive Vice President and CFO

Yeah, so when we talk about share Steve, we talk about how we have done versus the market. So again, I think Kone and Schindler report and the other companies that don't, so we don't know who exactly we're gaining share from. But the fact is, when we compare our orders, we know that we've outgrown the market and that's how we compare it. So if you look at, it's flat for the quarter, down 1% on a rolling 12-month basis and obviously in this environment, the market we know is down more than 1% on a rolling 12-month basis. And we are down about two points year-to-date. So that's a fairly strong performance given the environment. And so based on the analysis that we do, we believe, as Judy said in her prepared remarks, that we think we've gained about 70 basis points of share and that has allowed us to grow our backlog by about three points.

Judy Marks, President and CEO

And Steve we task every one of our countries to beat share, to grow share in their country and that's going to continue through 2021. So we do look at it at a pretty finite level.

Steve Tusa, Analyst

Great, thanks a lot. Appreciate it.

Rahul Ghai, Executive Vice President and CFO

Thanks, Steve.

Operator, Operator

Thank you. And our next question comes from Julian Mitchell with Barclays. Your line is now open.

Julian Mitchell, Analyst

Hi, good morning. Hey, maybe just the first question around the orders outlook in new equipment. They are sort of flattish in the third quarter globally, down a touch on a trailing 12 months basis. When you look at the overall environment, do you think that this is kind of a status quo level that you're at now for the foreseeable few quarters, maybe there's some regional differences so Americas gets a bit better, but then you start to see China rolling over as comps get tougher, maybe just help us understand how we should think about orders for the next couple of quarters?

Rahul Ghai, Executive Vice President and CFO

Julian, it's challenging to comment on the orders, but we are pleased with our performance year-to-date. As we mentioned in the last call, our goal for 2021 was to finish the year with a strong backlog, and being up 3% year-to-date gives us a lot of confidence. Our next step is to accelerate the backlog conversion for 2021, which will enable us to grow our new equipment business without facing the volume-related challenges we've encountered this year. That's our focus for increasing new equipment revenue next year. Regarding the market, it is mixed. We are noticing a significant rebound in China, while other markets are somewhat softer, as expected. The forecasts are becoming more complicated based on the data; there is some recovery in Asia and China, and Europe appears stable. North America is more varied, but we will see where it leads. Our main focus is on what we can control. I also want to highlight that our proposal activity year-to-date has increased by double digits. This reflects our efforts to expand our sales coverage and bring in more salespeople—we have added over 100 salespeople this year and 700 new channel partners in China. This allows us to increase our proposal activity even in a challenging market, which we hope will positively impact our future orders.

Judy Marks, President and CEO

Yeah and Steve, I'm sorry, Julian. Let me just add one item. We've really tried to take a hard look at the past few weeks or months or certainly starting into this quarter of with the rebound of COVID cases, are we seeing any changes? We're still continuing to see new starts in Europe. We're cautious in North America, especially on non-res. But the Asian economies have turned the corner and China is accelerating and we expect growth next year in the China segment.

Julian Mitchell, Analyst

Thank you very much. And then maybe my second question around the cost and profit outlook. So looking at Slide 20, the standalone costs guidance for this year has come down about 20 million versus the prior guide, but the run rate on standalone costs is unchanged. So I was trying to understand, does that mean that we get a step up in those costs just in the P&L as we see it, of that sort of 40 millionish number into next year or am I misreading it? And then also the separation costs, I think those were close to $30 million in Q3. Did those separation costs abate in the fourth quarter or do we still get some into next year?

Rahul Ghai, Executive Vice President and CFO

All good questions, Julian. We have been focused on reducing our selling, general and administrative expenses and driving a $60 million reduction year-over-year is fantastic. You can see some of that reflected in lower public company costs, which is a positive sign. We don’t have a 2021 number yet because we wanted to provide context and a framework rather than just one figure. Our goal is to not get to 175, but we will give more details and guidance as we discuss the rest of 2021, so more to come on that. It's encouraging that instead of being at 150, we are at 130 this year, which demonstrates the focus and discipline within the company. Regarding separation costs, we previously estimated that our range would be between 140 and 170, primarily from this year and Q1 of next year. We are tracking towards that, with year-to-date numbers around $85 million, which falls between $80 million and $85 million. The remaining amount will occur between Q4 and Q1, completing that separation cost.

Julian Mitchell, Analyst

Perfect. Thank you.

Rahul Ghai, Executive Vice President and CFO

Thank you, Julian.

Operator, Operator

Thank you. And our next question comes from Jeff Sprague of Vertical Research. Your line is now open.

Jeffrey Sprague, Analyst

Thank you. Good morning, everyone. I just wondered if we could focus a little bit more picks up on a couple of the earlier threads, but kind of how and where you're competing. And what I mean by that is, in addition to Kone and Schindler, which we can all see, right, there's probably another competitor that really matter but interestingly in the quarter, it does seem your orders did not grow nearly as much as they did, but your total orders on a global basis actually matched them. Obviously, there can be a lot of noise in a quarter, but are you purposely being more selective in China or are you pursuing kind of opportunities that are maybe further below the radar screen that are inherently more profitable or maybe it's all just a coincidence in the quarter? That's the first question.

Judy Marks, President and CEO

Yes, in China, our orders increased in the high single digits, and our book margin rose for the quarter. We are successfully achieving price increases on our new equipment, which is crucial for us. Sales grew in the mid-single digits, and we also increased prices on our services, expanding our service portfolio by 6% in China, while also gaining market share year-to-date. We believe we performed strongly, particularly in Tier One and Tier Two cities, and made significant progress in strategic areas like infrastructure, where we have invested considerable time and resources. We have added nearly 750 agents and distributors in China this year, reflecting our focused efforts to enhance our reach and capabilities to tap into various opportunities. Additionally, we are pleased to report a return to positive booked margins there. Our commitment to investing in China continues with our new factory, and we plan to invest further in the sales channel in Q4, as Rahul noted, to prepare for what we expect will be a growth segment for us in 2021.

Jeffrey Sprague, Analyst

Right, and then maybe just back to the backlog commentary, certainly understand the relationship and what you're alluding to is an exit backlog growth rate a pretty good indicator of what we should expect for new equipment growth, maybe you could give us just a little bit more color on kind of conversion cycles and Rahul, you made the comment about trying to accelerate conversion of the backlog, just a little more color on how the whole algorithm works, if you could?

Rahul Ghai, Executive Vice President and CFO

Yeah, so just typically what we see is we see in any given year, this is now I am going back a little bit to pre-COVID because what we typically used to see is about two thirds of our revenue, new equipment revenue in a given year coming from backlog. So that's what we would have typically seen. This year it has been a little bit lower just given all the disruptions that we've had, both in the field and in the factories. And our goal is, I think we said previously, our goal is not only to get back to 2019 levels, but drive it a little bit higher than that. And so we'll continue and provide more color and more guidance as we talk about 2021. But typically what you see is two thirds of the revenue for next year coming from backlog.

Jeffrey Sprague, Analyst

Thank you.

Operator, Operator

Thank you. And our next question comes from John Walsh of Credit Suisse. Your line is now open.

John Walsh, Analyst

Hi, good morning.

Judy Marks, President and CEO

Hey, John.

John Walsh, Analyst

Hey, I guess maybe just the first one following on a couple of the pricing questions and sorry to keep bringing up pricing, but when I look at your bridge on Slide 10 and then I just go through each of the last quarters, the new equipment commentary that was called out, we haven't seen pricing and bad debt yet. So I was just curious if that's some conservatism because we're still in COVID or once again, I think to an earlier question that, you know, something's actually going to hit in Q4, so it's just a timing-related issue?

Rahul Ghai, Executive Vice President and CFO

We have noticed that bad debt has increased slightly year-over-year. While it hasn't been significant enough to highlight, it's expected in the current credit environment, and we are being cautious in how we reserve for stock. If things start to go awry, we are ensuring we have adequate reserves in place. Bad debt has been present throughout the first nine months, and although it hasn't been substantial enough to address with each refinance, it accumulates over time. In terms of pricing, you are correct that we haven't specifically mentioned it; our book margins have remained flat year-to-date, as have backlog margins. Looking ahead to Q4, we anticipate a degree of conservatism in case unforeseen events occur. Your observation regarding new equipment pricing is valid and does contribute to our cautious approach.

John Walsh, Analyst

Great, now that's helpful clarification and then maybe just a question on understanding the business a little bit better, but as we think about when service pricing takes effect, I think there's some concern that depending on where vacancy rates are or building utilization rates, that we could see some pressure next year on service. But I think the way as I understand it, there's kind of like rolling waves and would only be a portion that might even be impacted. But can you help us understand how that repricing might work on parts of the service portfolio that on any given year just are kind of naturally rolling off contract?

Judy Marks, President and CEO

Our service contracts vary by region, being multi-year in many places and annual in others. Renewal typically occurs early in the year in Europe, where we have price escalators linked to inflation, and we are monitoring this as we approach next year. In North America, where many of our contracts also reside, most are multi-year, and the concessions we've offered so far have primarily been limited to the hospitality and retail sectors, which together account for under 10% of our global market exposure. These concessions have generally lasted about 90 days and were staggered in their timing. Importantly, we ensure that our costs correspond to any concessions made in terms of the services provided. This strategy has allowed us to sustain our service margins and experience margin expansion. Whenever contracts are up for renewal, we have discussions with customers to ascertain the specific services they require, which enables us to adjust our costs accordingly. We have not encountered any unusual cancellations on the new equipment side or the service side, although occasional job cancellations do occur. Currently, with buildings open and residential units in significant use, we are actively providing maintenance. Our maintenance pricing and services remain strong, but we've noticed a decline in sales for discretionary repairs and modernization as customers make budgetary choices. I hope this information is helpful.

John Walsh, Analyst

Yeah, no, that was very helpful. Appreciate all that color. Thank you.

Operator, Operator

Thank you. And our next question comes from Nigel Coe of Wolfe Research. Your line is now open.

Nigel Coe, Analyst

Hi, good morning.

Rahul Ghai, Executive Vice President and CFO

Good morning.

Nigel Coe, Analyst

Hi. There's a lot of discussion about the churn in the public sector and some government concerns related to it. Are you noticing any cooling measures that could potentially impact 2021? Is there a decline in RP activity, and do you have any concerns regarding China as we approach 2021?

Judy Marks, President and CEO

No, we have not seen any impact from the cooling measures that have been in effect for almost three years. This is true for the infrastructure segment, which is mainly public. Even in the private sector with property developers, there has been no change in volumes or requests for proposals in China. We anticipated that this segment would remain flat at the beginning of the year, but it is actually growing this year, and we believe it will continue to grow next year. We are expecting a very positive outcome in China next year in 2021.

Rahul Ghai, Executive Vice President and CFO

And Nigel, just to add a couple of just quick data points on that I mean, if you look at the domestic loan volume for the real estate developers, that's actually up year-over-year. I think the estimates are like it's up 4% to 5% and the land value that these developers have prepared is up 13%. So they continue to invest in the business.

Nigel Coe, Analyst

That's great to hear. Regarding the discretionary pay you mentioned, I noticed some weakness there. Can you explain the nature of the repairs that are being deferred? Are we talking about cracks in the facade, or is it more about caps not functioning and decreasing from six to four? Will this lead to a significant pent-up demand as we approach next year?

Judy Marks, President and CEO

We do believe this is a demand delay and it will create pent up demand on the repair side. On the modernization side, we believe it will occur. It's challenging to determine what quarter that's going to come back, since so much of the modernization is discretionary. But the repair we believe will happen. Some of it we need access to those buildings, some of it the buildings need more usage and the facility managers are just holding on some of those discretionary repairs. We expect it to bounce back and we think we'll see a little more of it in Q4 and as we go into 2021, we expect our bounce back.

Nigel Coe, Analyst

Thanks, Judy. And then a quick one for Rahul, obviously a lot of cash on the balance sheets. You know, once we get into a more sort of normal environment, whatever that means, how much cash do you think Otis needs to maintain going forward?

Rahul Ghai, Executive Vice President and CFO

That's a good question, Nigel, and we need a few quarters to determine that accurately. A significant portion of the cash is offshore, which complicates things a bit. However, it's safe to say that it's not 1.7 billion; we definitely have more cash than necessary, which is smart in this environment. Looking back to March or April, borrowing was tough in the CP market. We want to be prepared for uncertainty over the next three to six months. Beyond that period, we believe we won't need 1.7 billion. Our goal is to return cash to shareholders when conditions stabilize, and we think we can start to accelerate our share buyback from 2022 into 2021. This is a clear objective for us, and barring any unexpected events, we believe we can achieve it. Right now, it's below 1.7 billion, but we’ll need more quarters to figure out what the exact right number is.

Nigel Coe, Analyst

Great. Thank you very much.

Operator, Operator

Thank you. And our next question comes from Denise Molina of Morningstar. Your line is now open.

Denise Molina, Analyst

Hi, thanks. Thanks for the question. Denise Molina from Morningstar. I am just trying to go back to the comment you made about the 30% to 40% left on service revenue from the connected services. Are those contracts that you think are adding a couple of hundred basis points of margin on top of what you would normally get on a contract? And then is that level of revenue that's expected to carry across to a wider customer base because if you've got a budget for these kind of yearly contracts, just wondering if you're expecting that to be widely adopted for everyone to kind of have another 30% to 40% in their budgets for these services or do you think they're sort of going to be for a certain high tier of your segment, maybe high population building?

Rahul Ghai, Executive Vice President and CFO

My comment about the 30% to 40% was about the various connected solutions we offer, including Otis ONE. We have a management system, destination dispatch, and connected eView systems. When combined, these solutions can contribute approximately 30% to 40% to the revenue from each unit, with minimal additional costs, leading to higher margins and very high retention rates. In response to Carter's question about whether we expect additional revenue from Otis ONE, the answer is yes. However, the 30% to 40% figure is cumulative and won't necessarily mean a doubling of revenue from Otis ONE alone. The customers gain full visibility into their portfolio's performance, resulting in increased uptime. As previously mentioned, we can send a technician immediately when a unit fails, allowing us to know about issues before customers contact us. Therefore, we anticipate revenue growth from this over time. Although it is not our primary focus at the moment, we are investing in and installing these units at our expense because we believe the productivity gains will surpass the costs. Over time, we do expect to generate revenue from this initiative.

Judy Marks, President and CEO

And Denise, our conversion rates and our retention rates on connected elevators beats our industry-leading retention rates across the globe. So we have the ability to actually retain in our service portfolio those connected units at several hundred basis points above what we do with our normal retention rate globally. So that's another added benefit for us. It gives us more years on service and the ability to be with that customer over time, especially when they want additional upgrades over time.

Denise Molina, Analyst

Can I just ask one follow-up on that, because we've heard a lot from Kone and Schindler respond on the connected services and I think we're trying to figure out what the difference is amongst the players. But it sounds like the ISPs are the ones that or maybe not as much as they don't have many elevators kind of feeding information to get those good kind of uptimes. Do you think that's right, do you think that if you were going up against and it's difficult to say that you are going up against another OEM that had the same number of elevators feeding those algorithms, do you think your services would be differentiated still?

Judy Marks, President and CEO

Fifty-five percent of the service market is currently held by ISPs. They are the ones we aim to capture share from in order to expand our service portfolio, which already exceeds 2 million units. We believe that achieving scale and differentiation will provide us with significant data and insights, enabling informed decision-making, predictive and transparent maintenance, and a rapid deployment of our field professionals to enhance uptime. The value derived from data and analytics will be crucial in gaining market share. ISPs possess more than half of the global market share, and our goal is to reclaim our Otis units.

Denise Molina, Analyst

Very helpful, thank you.

Operator, Operator

Thank you. And our next question comes from Cai von Rumohr of Cowen. Your line is now open.

Cai von Rumohr, Analyst

Yes. Thanks so much. So backlog margin, you indicated that it's flat. Schindler on their call talked of pricing getting worse in the third quarter and therefore looking for backlog margin to be down in the fourth quarter. What are you looking for, can you hold that backlog margin in the fourth quarter?

Rahul Ghai, Executive Vice President and CFO

It's difficult to predict the future backlog margin. The positive aspect is that the current margin numbers are encouraging. The backlog margin remains stable compared to last year, and overall, my impression is that the pricing environment for both new equipment and service is mostly steady. There may be some pressures, as we have mentioned in the past. However, the new equipment markets are showing positive trends, with improved margins in China and North America, although there is a bit of pressure in Asia-Pacific, particularly in India and Southeast Asia, as well as in some EMEA markets. It's reassuring to see an increase in booking margin while the backlog margin holds steady. Judy also commented on service pricing, which appears to be stable. Apart from some temporary price concessions that only apply for a short time, the overall service market is maintaining its position. Europe and North America have shown growth, but we do expect some pressure in Asia. Overall, the pricing situation looks manageable. We are prepared for any potential pressures that may arise, although they have not yet appeared, and we feel confident about our current standing.

Judy Marks, President and CEO

Yeah, and we have shown now for multiple straight quarters that we are yielding on the productivity, both on the material productivity side for new equipment and the service productivity side is continuing to yield. And I do credit that to our service business, which has remained resilient despite the discretionary challenges we've been facing. And that's 80% of our margins. And we shared our medium term outlook and basically said our future is based on growing our service portfolio, driving margins in both equipment and service, but in service that plus other actions driving high single-digit EPS. We are on track for our medium term outlook, our strategy is on track, and that's what we're executing.

Cai von Rumohr, Analyst

Terrific and then your third-quarter orders were bolstered by three very large wins that you had. Are you looking for large wins in the fourth quarter or are we looking at a tougher orders compare?

Rahul Ghai, Executive Vice President and CFO

They will likely last into the last quarter as well, Cai. We did achieve a few significant wins in the third quarter of last year, so I'm not sure if those large wins have had much of an impact year-over-year. We have been discussing the factors that are driving our sales performance. If you look at our coverage in specific markets, such as China, the rest of Asia-Pacific, and certain European markets, our sales coverage in targeted areas has increased by about 7 to 10 percentage points. We are performing really well by sticking to the basics. We've added over 700 channel partners in China and more than 100 salespeople. We are increasing our presence on the ground and supporting new segments. Previously, we did not have a product for the entry-tier market, but we do now. We launched it in India and are expanding to Southeast Asia. We are actively pursuing the volume business in markets we had not previously targeted. Overall, we are making a strong effort to continue gaining market share. These large wins reflect our technology and customer relationships, but it goes beyond that.

Cai von Rumohr, Analyst

Terrific, and then last one, so listening to your competitors, the three markets they've all been complaining about are the Americas, Asia, outside of China and Southern Europe, all markets where you have substantially greater percentage of revenues than they do. Can you maybe comment on is that just share gains on your part and you mentioned, 70 bps of share gains, where do you think you're gaining share and where are you maybe losing share?

Judy Marks, President and CEO

We are very satisfied with our results in Korea and Japan, where we are a significant player, particularly in new equipment and services. While our performance in Asia Pacific has been affected by India and Southeast Asia, we are pleased with the market share gains we have achieved. We have made sales investments to address new regulations in Korea and to improve our share in new equipment. In the Americas, we have performed well in Latin America, particularly in Brazil, and continue to see positive results there. However, North America remains competitive, and we will keep a close eye on it. We've gained access to Dodge and ABI data, showing some improvement for next year. We need to manage our backlog conversion efficiently and enhance productivity, particularly in North America, while aligning our costs accordingly. In Southern Europe, where our maintenance portfolio is strong, our teams have effectively managed costs and provided services with minimal concessions. We are seeing new projects starting in Europe, especially in Southern Europe, with some activity in EMEA, although progress is slower in the Middle East. The Asian economies, particularly China, are starting to recover, and other Asian countries are beginning to follow suit. The main challenge we still face is job site access in India, which is under 50%, and parts of Southeast Asia. However, access has returned to the high 90% in other regions, and we've not experienced any retreat due to a resurgence of COVID in North America or EMEA.

Cai von Rumohr, Analyst

Terrific. Thank you very much.

Operator, Operator

Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Judy Marks for any closing remarks.

Judy Marks, President and CEO

Well, let me thank you all again for joining the call this morning. I need and want so much to thank our colleagues for their dedication, as well as all of those on the front line fighting COVID-19. Please stay safe and well. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.