Item 1A. Risk Factors
Our business, financial condition, operating results and cash flows can be impacted by the factors set forth below, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results.
Risks Related to our Business
We may be affected by global economic, capital market and political conditions in general, and conditions in the construction and infrastructure industries in particular.
Our business, financial condition, operating results and cash flows may be adversely affected by changes in global economic conditions and geopolitical risks, including global credit market conditions, levels of consumer and business confidence, commodity prices, raw material and energy costs, foreign currency exchange rates, interest rates, labor costs, levels of government spending and deficits, trade policies, tariffs and trade barriers, political conditions, regulatory changes, fluctuations in residential and commercial construction activity, pandemic health issues (see discussion of COVID-19 below), natural disasters, actual or anticipated default on sovereign debt, changes as a result of the new U.S. Administration and other challenges that could affect the global economy. These economic and political conditions affect businesses such as ours in a number of ways. In particular, a slowdown in building and remodeling activity or decreased public spending on infrastructure projects could adversely affect our financial performance.
Our business may be further impacted by the COVID-19 pandemic.
During 2020, COVID-19 spread throughout the world, resulting in widespread travel restrictions and extended shutdowns, occupancy limits or other restrictions of non-essential businesses, including construction and hospitality venues, impacting to various extents our factory operations, new equipment installations and access to units under maintenance. The ultimate impact of the COVID-19 pandemic on our business is uncertain at this time and will depend on future developments, including the availability, efficacy and distribution of various vaccines, but further prolonged closures or restrictions throughout the world or the further rollback of reopening measures due to the resurgence of COVID-19 cases and continued decreases in the general level of economic activity may further disrupt our operations and the operations of our suppliers, distributors and customers. Additionally, further tightening of credit in the capital markets could adversely affect our ability to access the capital markets or could result in a significant increase in our borrowing costs. COVID-19 has adversely affected and could further affect the ability of our customers to pay for our products and services and to obtain financing for significant purchases and operations, which has resulted in, and could further result in, a decrease and/or cancellation of orders for our products and services and/or payment delays or defaults. Similarly, COVID-19 has adversely affected and may further affect our supply base and increase the potential for one or more of our suppliers to experience financial distress or bankruptcy, which could impact our ability to fulfill orders on time or at anticipated cost. Additionally, it is unclear what longer term effects the virus will have on the global economy, including the commercial building industry. Any of these factors could have a material adverse effect on our business, results of operations, cash flows and financial condition.
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Our international operations subject us to risk as our results of operations may be adversely affected by changes in local and regional economic conditions, such as fluctuations in exchange rates, risks associated with government policies on international trade and investments, and risks associated with China and other emerging markets.
We conduct our business on a global basis, with approximately 73 percent of our 2020 net sales derived from international operations. Changes in local and regional economic conditions, including fluctuations in exchange rates, may affect product demand and reported profits in our non-U.S. operations, where transactions are generally denominated in local currencies. In addition, currency fluctuations may affect the prices we pay for the materials used in our products. Though we engage in hedging strategies to manage foreign currency exposures in connection with certain cross-border transactions, our operating margins may be negatively impacted by currency fluctuations that result in higher costs or lower revenues for certain cross-border transactions. Our financial statements are denominated in U.S. Dollars. Accordingly, fluctuations in exchange rates may also give rise to gains or losses when financial statements of non-U.S. operating units are translated into U.S. Dollars. Given that the majority of our sales are non-U.S. based, a strengthening of the U.S. Dollar against other major foreign currencies could adversely affect our results of operations.
Our international sales and operations are subject to risks associated with changes in local government laws, regulations and policies, including those related to investments and limitations on foreign ownership of businesses, taxation, foreign exchange controls, capital controls, employment regulations and the repatriation of earnings. Government policies on international trade and investments such as import quotas, capital controls, punitive taxes or tariffs or similar trade barriers, whether imposed by individual governments or regional trade blocs, can affect demand for our products and services, impact the competitive position of our products or services, or encumber our ability to manufacture or sell products in certain countries. The implementation of more restrictive trade policies, including the imposition of tariffs, or the renegotiation of existing trade agreements with the U.S. or countries where we sell large quantities of products and services, procure materials incorporated into our products, manufacture products or recruit and employ employees, including the new U.S. Administration, trade relations between the U.S. and China (as discussed below) and the U.K.’s recent withdrawal from the EU, could have a material adverse effect on our business, results of operations and financial condition, including our ability to recruit and retain employees or deploy certain employees to the geographies where their skills are best utilized. Our international sales and operations are also sensitive to changes in foreign nations’ priorities, including government budgets, as well as to political and economic instability. International transactions may involve increased financial and legal risks due to differing legal systems and customs in foreign countries.
China is currently the largest end market for sales of new equipment in our industry, and sales in China represent over half of our global New Equipment net sales by unit volume. Changes to market and economic conditions in China, or an escalation of trade conflicts between the U.S. and China, may impact our ability to continue New Equipment net sales in China at rates consistent with prior years. Furthermore, as is the case in many countries where we operate, the legal and regulatory regime in China is evolving, and accordingly, we could, in the future, be required to comply with significant requirements unique to China in order to maintain access to Chinese markets.
We expect that sales to emerging markets will continue to account for a significant portion of our sales as those and other developing nations and regions around the world increase their demand for our products and services. A slowdown in urbanization in emerging countries, such as China or India, could adversely affect our financial performance. In addition, as part of our global business model, we operate in certain countries, including Argentina, Brazil, China, India, Indonesia, Mexico, Poland, Russia, South Africa, Ukraine, Turkey and countries in the Middle East, that carry high levels of currency, political, compliance and economic risk. Our emerging market operations can present many risks, including cultural differences (such as employment and business practices), compliance risks, economic and government instability, currency fluctuations, and the imposition of foreign exchange and capital controls. While these factors and their impact are difficult to predict, any one or more of them could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
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We use a variety of raw materials, supplier-provided parts, components, sub-systems and third-party manufacturing services in our business, and significant shortages, supplier capacity constraints, supplier production disruptions or price increases could increase our operating costs and adversely impact the competitive positions of our products.
Our reliance on suppliers (including third-party manufacturers) and commodity markets to secure the raw materials and components used in our products exposes us to volatility in the prices and availability of these materials. Issues with suppliers (such as a disruption in deliveries, capacity constraints, production disruptions, quality issues and supplier closings or bankruptcies), price increases or decreased availability of raw materials or commodities could have a material adverse effect on our ability to meet our commitments to customers, could damage our reputation or could increase our operating costs, any of which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
Adverse changes in our relationships with, or the financial condition, performance or purchasing patterns of, key distributors and agents could adversely affect us.
Certain of our businesses sell a significant amount of their products to key distributors and agents, particularly in China, that have valuable relationships with customers. Some of these distributors and agents also sell our competitors’ products, and if they favor competing products for any reason they may fail to market our products effectively. Adverse changes in our relationships with these distributors and other partners, or adverse developments in their financial condition, performance or purchasing patterns, or compliance practices, could adversely affect our reputation, competitive position, results of operations, cash flows or financial condition.
We design, manufacture, install and service products that incorporate advanced technologies; the introduction of new products and technologies involves risks, and we may not realize the degree or timing of benefits initially anticipated.
We seek to grow our business through the design, development, production, sale and support of innovative products that incorporate advanced technologies. The product and service needs of our customers change and evolve regularly, and we invest substantial amounts in research and development efforts to pursue advancements in technologies, products and services. Our ability to realize the anticipated benefits of our technological advancements, such as the development and execution of advanced digital technologies for the benefit of our New Equipment or Service segment or the development of new products depend on a variety of factors, including meeting development, production, certification and regulatory approval schedules; execution of internal and external performance plans; availability of supplier and internally produced parts and materials; performance of suppliers and subcontractors; hiring and training of qualified personnel; achieving cost and production efficiencies; validation of innovative technologies; and customer interest in new technologies and products and acceptance of products we manufacture or that incorporate technologies we develop.
Our research and development efforts may not result in innovative products or services that incorporate new technologies for our New Equipment and Service segments, or products or services being developed on a timely basis or that meet the needs of our customers as effectively as competitive offerings. In addition, the markets for our products or services, or products that incorporate our technologies, may not develop or grow as we anticipate. We or our customers, suppliers or subcontractors may encounter difficulties in developing and producing new products and services, and may not realize the degree or timing of benefits initially anticipated or may otherwise suffer significant adverse financial consequences. Due to the design complexity of our products, we may experience delays in completing the development and introduction of new products. Any delays could result in increased development costs or divert resources from other projects. If we are unable to successfully develop and timely introduce new products, services and technologies, our competitors may develop competing technologies that gain market acceptance in advance of or instead of our products or services. The possibility also exists that our competitors might develop new technology or offerings that might cause our existing technology and offerings to become obsolete, which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
We operate in a competitive environment and our profitability depends on our ability to accurately estimate the costs and timing of providing our products and services.
Our contracts are typically awarded on a competitive basis. Our quotations and bids are based upon, among other items, the cost to provide the products and services. To generate an acceptable return on our investment in these contracts, we must be able to accurately estimate our costs to provide the services and deliver the products required by the contract and to be able to complete the contracts in a timely manner. If we fail to accurately estimate our costs or the time required to complete a new equipment order, or the extent of required maintenance pursuant to a service contract, the profitability of our contracts may be materially and adversely affected. Some of our contracts provide for liquidated damages if we do not perform in accordance
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with the contract. As a result of these and other factors, we may not be able to provide products and services at competitive prices while maintaining anticipated levels of profitability, which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
Our debt levels and related debt service obligations could have negative consequences; we may need additional debt or equity financing in the future to meet our capital needs, and such financing may not be available on favorable terms, if at all, due to changes in global capital markets, our financial performance or outlook or our credit ratings and may be dilutive to existing shareholders.
As of December 31, 2020, we had $5.3 billion outstanding long-term debt on a consolidated basis and approximately $701 million of short-term debt. Our debt level and related debt service obligations could have negative consequences, including, among others:
•requiring us to dedicate significant cash flow from operations to the payment of principal and interest on our debt, which would reduce funds we have available for other purposes, such as acquisitions and reinvestment in our businesses;
•reducing our flexibility in planning for or reacting to changes in our business and market conditions; and
•exposing us to interest rate risk because a portion of our debt obligations are at variable rates.
We may need additional financing for general corporate purposes. For example, we may need funds to increase our investment in research and development activities, to refinance or repay existing debt, or to make a strategic acquisition. We may be unable to obtain additional financing on terms favorable to us, if at all. Volatility in the world financial markets, including as a result of the COVID-19 pandemic, could increase borrowing costs or affect our ability to access the capital markets. Our ability to issue debt or enter into other financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for our products or services, or in the solvency of our customers, suppliers or distributors or other significantly unfavorable changes in economic conditions.
Otis has been issued an investment grade credit rating from each of Moody’s Investor Services, Inc. and Standard & Poor’s. There can be no assurance that we will be able to maintain our credit ratings, and any actual or anticipated changes or downgrades in our credit ratings, including any announcement that our ratings are under review for a downgrade or similar announcement, could increase the cost of borrowing under any indebtedness we may incur, reduce market capacity for our commercial paper, require the posting of additional collateral under our derivative contracts, or otherwise have a negative impact on our liquidity, capital position and access to the capital markets.
If we raise additional funds through the issuance of equity securities, our shareholders will experience dilution of their ownership interest. And if we raise additional funds by issuing debt, we may be subject to limitations on our operations due to restrictive covenants.
Quarterly cash dividends and share repurchases, if commenced, may be discontinued, accelerated or modified, are subject to a number of uncertainties and may affect the price of Common Stock.
Quarterly cash dividends are a component of our capital allocation strategy, which we fund with operating free cash flow, borrowings and divestitures. We also have authority to repurchase our shares under a share repurchase program, which we have not exercised as of December 31, 2020. In general, dividends and share repurchases, if commenced, may be discontinued, accelerated, suspended or delayed at any time without prior notice. Furthermore, the amount of such dividends and repurchases may be changed, and the amount, timing and frequency of such dividends and repurchases may vary from historical practice or from the company’s stated expectations. Decisions with respect to dividends and share repurchases are subject to the discretion of our Board of Directors and will be based on a variety of factors. Important factors that could cause us to discontinue, limit, suspend, increase or delay our quarterly cash dividends or share repurchases include market conditions, the price of Common Stock, the nature and timing of other investment opportunities, changes in our business strategy, the terms of our financing arrangements, our outlook as to the ability to obtain financing at attractive rates, the impact on our credit ratings and the availability of domestic cash. The reduction or elimination of our cash dividend or share repurchase program could adversely affect the market price of Common Stock. Although our share repurchase program is intended to enhance long-term shareholder value, short-term stock price fluctuations could reduce the program's effectiveness.
See "Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" in this Form 10-K for more information regarding our share repurchase program.
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We engage in acquisitions and divestitures, and may encounter difficulties integrating acquired businesses with, or disposing of businesses from, our current operations; therefore, we may not realize the anticipated benefits of these acquisitions and divestitures.
We seek to grow through strategic acquisitions in addition to internal growth. Our due diligence reviews in connection with our acquisitions may not identify all of the material issues necessary to accurately estimate the cost and potential loss contingencies of a particular transaction, including potential exposure to regulatory sanctions resulting from an acquisition target’s previous activities. For example, we may incur unanticipated costs, expenses or other liabilities as a result of an acquisition target’s violation of applicable laws, such as the U.S. Foreign Corrupt Practices Act (“FCPA”), antitrust, anti-collusion or other anti-corruption laws in non-U.S. jurisdictions. We also may incur unanticipated costs or expenses, including post-closing asset impairment charges, as well as expenses associated with eliminating duplicate facilities, litigation and other liabilities. We may incur unexpected costs associated with labor law, tax or pension matters or to bring acquired assets up to our operating standards. We may encounter difficulties in integrating acquired businesses with our operations, applying our internal controls to these acquired businesses or in managing strategic investments. Additionally, we may not realize the degree or timing of benefits we anticipate when we first enter into a transaction. Any of the foregoing could adversely affect our business and results of operations. In addition, accounting requirements relating to business combinations, including the requirement to expense certain acquisition costs as incurred, may cause us to incur greater earnings volatility and generally lower earnings during periods in which we acquire new businesses.
We also make strategic divestitures from time to time. Our divestitures may result in continued financial exposure to the divested businesses, such as through guarantees, other financial arrangements, continued supply and services arrangements, and environmental and product liability claims, following the transaction. Under these arrangements, nonperformance by those divested businesses could result in obligations being imposed on us that could have a material adverse effect on our competitive position, cash flows, results of operations or financial condition.
For constraints on mergers and acquisition activity after the completion of the distribution, see “Risk Factors—Risks Related to the Separation” below.
We are party to joint ventures and other strategic alliances, which may not be successful and may expose us to special risks and restrictions.
Our business operations depend on various strategic alliances and joint ventures. In certain regions, we operate our business through joint venture relationships or non-wholly owned subsidiaries, including: Otis Electric Elevator Company Limited and Otis Elevator (China) Investment Limited in China; and Zardoya Otis, a publicly traded company whose shares are listed on the Madrid Stock Exchange, in Spain. A significant downturn or deterioration in the business or financial condition of a joint venture partner could affect our results of operations in a particular period. Our joint ventures may experience labor strikes, diminished liquidity or credit unavailability, weak demand for products, delays in the launch of new products or other difficulties in their businesses. Changes in local government laws, regulations and policies, including those related to investments and limitations on foreign ownership of businesses, could adversely impact our ability to participate in and operate our joint ventures, or could result in changes to the ownership structure or allocation of rights in our joint ventures. If we are not successful in maintaining our joint ventures and other strategic partnerships, our financial condition, results of operations and cash flows may be adversely affected.
Joint ventures, strategic alliances and non-wholly owned subsidiaries inherently involve special risks. Whether or not we hold a majority interest or maintain operational control in such arrangements, our partners or other shareholders may (1) have economic or business interests or goals that are inconsistent with or contrary to ours, (2) exercise veto or other rights, to the extent available, to block actions that we believe to be in our or the joint venture’s, strategic alliance’s or non-wholly owned subsidiary’s best interests, (3) take action contrary to our policies or objectives with respect to our investments or business or (4) be unable or unwilling (including as a result of financial or other difficulties) to fulfill their obligations, such as contributing capital to expansion or maintenance projects, under the joint venture, strategic alliance or other agreement. There can be no assurance that any particular joint venture or strategic alliance will be beneficial to us.
We are subject to litigation, product safety and other legal and compliance risks.
We are subject to a variety of litigation, legal and compliance risks. These risks relate to, among other things, product safety, personal injuries, intellectual property rights, contract-related claims, taxes, environmental matters, competition laws and laws governing improper business practices. We could be charged with wrongdoing in connection with such matters. If
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convicted or found liable, we could be subject to significant fines, penalties, repayments and other damages (in certain cases, treble damages).
As a global business, we are subject to complex laws and regulations in the U.S. and other countries in which we operate. Those laws and regulations may be interpreted in different ways. They may also change from time to time, as may related interpretations and other guidance. Changes in laws or regulations could result in higher expenses or changes to business operations that could impact our ability to sell our products and services or sell them at expected profit levels. Uncertainty relating to those laws or regulations may also affect how we operate, structure our investments and enforce our rights.
Product and general liability claims (including claims related to the safety, reliability or maintenance of our products) and accident risks during the production, installation, maintenance and use of our products can result in significant costs, including settlements, punitive damages and other risks such as damage to our reputation, negative publicity and management distraction, which could reduce demand for our products and services.
In addition, the FCPA and other anti-corruption laws generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business. The FCPA applies to companies, individual directors, officers, employees and agents. Under certain anti-corruption laws, companies also may be held liable for the actions of partners or representatives. Certain of our customer relationships are with governmental entities and are, therefore, subject to the FCPA and other anti-corruption laws. Despite meaningful measures that we undertake to seek to ensure lawful conduct, which include training and internal controls, we may not always be able to prevent our employees, partners, joint ventures, agents or distributors from violating the FCPA or other anti-corruption laws. As a result, we could be subject to criminal and civil penalties, disgorgement, changes or enhancements to our compliance measures that could increase our costs, decrease our access to certain sales channels, personnel changes or other remedial actions. Prior to the Separation, UTC, including Otis, was subject to a formal investigation by the SEC related to alleged violations of anti-corruption laws, which resulted in a Settlement Order in which our former parent UTC paid a civil penalty related to certain activities in our business in Russia, China and Kuwait, as well as activities in another UTC business.
Moreover, we are subject to antitrust and anti-collusion laws, including mandatory supply laws and bidding regulations, in various jurisdictions throughout the world. Changes in these laws or their interpretation, administration and/or enforcement may occur over time, and any such changes may limit our future acquisitions or operations, or result in changes to our strategies, sales and distribution structures or other business practices. We are subject to ongoing claims related to alleged violations of anti-collusion laws in certain European countries, where we are subject to claims for overcharges on elevators and escalators related to civil cartel cases. Though we have implemented policies, controls and other measures to prevent collusion or anti-competitive behavior, our controls may not always be effective in preventing our employees, partners, joint ventures, agents or distributors from violating antitrust or anti-collusion laws.
Violations of FCPA, antitrust or other anti-corruption or anti-collusion laws, or allegations of such violations, could disrupt our operations, cause reputational harm, involve significant management distraction and result in a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
We also must comply with various laws and regulations relating to the export of products, services and technology from the U.S. and other countries having jurisdiction over our operations. In the U.S., these laws include, among others, the Export Administration Regulations administered by the Department of Commerce and embargoes and sanctions regulations administered by the Department of the Treasury. In addition, U.S. foreign policy may restrict or prohibit business dealings with certain individuals, entities or countries; changes in these prohibitions can happen suddenly and could result in a material adverse effect on our operations.
For a description of current material legal proceedings, see "Note 21: Contingent Liabilities" to the Consolidated Financial Statements in our 2020 Annual Report.
Our defined benefit Pension plans are subject to financial market risk that could adversely affect our results.
The performance of the financial markets and interest rates can impact our defined benefit pension plan expenses and funding obligations. Significant decreases in the discount rate or investment losses on plan assets may increase our funding obligations. Significant decreases in the discount rate or investment losses on plan assets may increase our funding obligations and adversely impact our financial results. See "Note 13: Employee Benefit Plans" to the Consolidated Financial Statements in our 2020 Annual Report for further discussion on pension plans and related obligations and contingencies.
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Information security, data privacy and identity protection may require significant resources and present certain risks to our business, reputation and financial condition.
We collect, store, have access to and otherwise process certain confidential or sensitive data that may be subject to data privacy and cybersecurity laws, regulations or customer-imposed controls, including proprietary business information, personal data and other information. We also develop products that may in certain cases collect, store, have access to, and otherwise process certain confidential or sensitive data of our customers who purchase and use such products either separately or as a part of another product or system. Although we seek to protect such data and design our products to enable our customers to use them while complying with applicable data privacy and cybersecurity laws and/or customer-imposed controls, both our internal systems and products may be vulnerable to hacking or other cyber-attacks, material security breaches, theft, programming errors or employee errors, which could lead to the compromise of such data, unauthorized access, use, disclosure, modification or destruction of information, improper use of our systems, software solutions or networks, defective products, production downtimes and/or operational disruptions in violation of applicable law and/or contractual obligations. A significant actual or perceived risk of theft, loss, fraudulent use or misuse of customer, employee or other data, whether by us, our suppliers, distributors, customers or other third parties, as a result of employee error or malfeasance, or as a result of the imaging, software, security and other products we incorporate into our products, as well as non-compliance with applicable industry standards or our contractual or other legal obligations or privacy and information security policies regarding such data, could result in costs, fines, litigation or regulatory actions, or could lead customers to select products and services of our competitors. In addition, any such event could harm our reputation, cause unfavorable publicity or otherwise adversely affect certain potential customers’ perception of the security and reliability of our services as well as our credibility and reputation, which could result in lost sales. In addition, because of the global nature of our business, both our internal systems and products must comply with the applicable laws, regulations and standards in a number of jurisdictions, and government enforcement actions and violations of data privacy and cybersecurity laws could be costly or interrupt our business operations. Any of the foregoing factors could result in reputational damage or civil or governmental proceedings, which could result in a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
Our business and financial performance depend on continued substantial investment in information technology infrastructure, which may not yield anticipated benefits, and may be adversely affected by cyber-attacks on information technology infrastructure and products and other business disruptions.
The efficient operation of our business will require continued substantial investment in technology infrastructure systems, including shifting from virtual private networks to cloud-based networks, and we must attract and retain qualified people to operate these systems, expand and improve them, integrate new systems effectively and efficiently convert to new systems when required. An inability to fund, acquire and implement these systems might impact our ability to respond effectively to changing customer expectations, manage our business, scale our solutions effectively or impact our customer service levels, which could put us at a competitive disadvantage and negatively impact our financial results. Repeated or prolonged interruptions of service due to problems with our systems or third-party technologies, whether or not in our control, could have a significant negative impact on our reputation and our ability to sell products and services. Furthermore, we are highly dependent upon a variety of internal computer and telecommunication systems to operate our business. Failure to design, develop and implement new technology infrastructure systems in an effective and timely manner, or to adequately invest in and maintain these systems, could result in the diversion of management’s attention and resources and could materially adversely affect our operating results, competitive position and ability to efficiently manage our business. Our existing information systems may become obsolete, requiring us to transition our systems to a new platform. Such a transition could be time consuming, costly and damaging to our competitive position, and could require additional management resources. Failure to implement and deploy new systems or replacement systems on the schedules anticipated, could materially adversely affect our operating results. See “Risk Factors—Risks Related to the Separation” below for a discussion of risks associated with transitioning our IT infrastructure systems under the TSA .
In addition, our business may be impacted by disruptions to our own or third-party information technology (“IT”) infrastructure, which could result from (among other causes) cyber-attacks on or failures of such infrastructure or compromises to its physical security, as well as from damaging weather or other acts of nature. Cyber-based risks, in particular, are evolving and include attacks on our IT infrastructure, as well as attacks targeting the security, integrity and/or availability of the hardware, software and information installed, stored or transmitted in our products, including after the purchase of those products and when they are installed into third-party products, facilities or infrastructure. Such attacks could disrupt our business operations, our systems or those of third parties, and could impact the ability of our products to work as intended. We have experienced cyber-based attacks, and, due to the evolving threat landscape, may continue to experience them going forward, potentially with more frequency. We continue to make investments and adopt measures designed to enhance our
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protection, detection, response, and recovery capabilities, and to mitigate potential risks to our technology, products, services and operations from potential cyber-attacks. However, given the unpredictability, nature and scope of cyber-attacks, it is possible that potential vulnerabilities could go undetected for an extended period. As a result of a cyber-attack, we could potentially be subject to production downtimes, operational delays or other detrimental impacts on our operations or ability to provide products and services to our customers; destruction or corruption of data; security breaches; manipulation or improper use of our or third-party systems, networks or products; financial losses from remedial actions, loss of business, potential liability, penalties, fines and/or damage to our reputation, any of which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition. Due to the evolving nature of such risks, the impact of any potential incident cannot be predicted. Any disruption to our business due to such issues, or an increase in our costs to cover these issues that is greater than what we have anticipated, could have an adverse effect on our competitive position, results of operations, cash flows or financial condition.
There can be no assurance that our systems will not fail or experience disruptions, and any significant failure or disruption of these systems could prevent us from making sales, ordering supplies, delivering products, providing functional products and otherwise conducting our business.
We depend on our intellectual property, and have access to certain intellectual property and information of our customers, suppliers and distributors; infringement or failure to protect our intellectual property could adversely affect our future growth and success.
We rely on a combination of patents, trademarks, copyrights, trade secrets, nondisclosure agreements, customer and supplier agreements, license agreements, information technology security systems, internal controls and compliance systems and other measures to protect our intellectual property. We also rely on nondisclosure agreements, information technology security systems and other measures to protect certain customer and supplier information and intellectual property that we have in our possession or to which we have access. Our efforts to protect such intellectual property and proprietary rights may not be sufficient. We cannot be sure that our pending patent applications will result in the issuance of patents to us, that patents issued to or licensed by us in the past or in the future will not be challenged or circumvented by competitors or that these patents will be found to be valid or sufficiently broad to preclude our competitors from introducing technologies similar to those covered by our patents and patent applications. Our ability to protect and enforce our intellectual property rights also may be limited. In addition, we may be the target of competitor or other third-party patent enforcement actions seeking substantial monetary damages or seeking to prevent the sale and marketing of certain of our products or services. Our competitive position also may be adversely impacted by limitations on our ability to obtain possession of, and ownership or necessary licenses concerning, data important to the development or provision of our products or service offerings, or by limitations on our ability to restrict the use by others of data related to our products or services. Any of these events or factors could subject us to judgments, penalties and significant litigation costs or temporarily or permanently disrupt our sales and marketing of the affected products or services and could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
Additional tax expense or additional tax exposures could affect our future profitability.
We are subject to income taxes in the United States and various international jurisdictions. Changes to tax laws and regulations, including as a result of the new U.S. Administration, as well as changes and conflicts in related interpretations or other tax guidance could materially impact our tax receivables and liabilities and our deferred tax assets and deferred tax liabilities. Additionally, in the ordinary course of business, we are subject to examinations by various tax authorities. In addition, governmental authorities in various jurisdictions could launch new examinations and expand existing examinations. The global and diverse nature of our operations means that these risks will continue and additional examinations, proceedings and contingencies will arise from time to time. Our competitive position, cash flows, results of operation or financial condition may be affected by the outcome of examinations, proceedings and contingencies that cannot be predicted with certainty.
See “Business Overview,” “Results of Operations - Income Taxes” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” "Note 2: Significant Accounting Policies" and "Note 15: Income Taxes" to the Consolidated Financial Statements in our 2020 Annual Report, for further discussion on income taxes and related contingencies, including our accounting and assessment of the effect of the Tax Cuts and Jobs Act ("TCJA").
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We may not realize expected benefits from our cost reduction and restructuring efforts, and our profitability may be hurt or our business otherwise might be adversely affected.
In order to operate more efficiently and cost effectively, we may adjust employment, optimize our footprint or undertake other restructuring activities. These activities are complex and may involve or require significant changes to our operations. If we do not successfully manage restructuring activities, expected efficiencies and benefits might be delayed or not realized, and our operations and business could be disrupted. Risks associated with these actions and other workforce management issues include unfavorable political responses, unforeseen delays in the implementation of anticipated workforce reductions, additional unexpected costs, adverse effects on employee morale, the failure to meet operational targets due to the loss of employees or work stoppages, any of which may impair our ability to achieve anticipated cost reductions, otherwise harm our business or have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
Risks Related to Our Common Stock
Anti-takeover provisions could enable our Board of Directors to resist a takeover attempt by a third party and limit the power of our shareholders.
Otis’ amended and restated certificate of incorporation and amended and restated bylaws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirers to negotiate with Otis’ Board of Directors rather than to attempt a hostile takeover. These provisions include, among others, (1) the ability of our remaining directors to fill vacancies on Otis’ Board of Directors (except in an instance where a director is removed by shareholders and the resulting vacancy is filled by shareholders); (2) limitations on shareholders’ ability to call a special shareholder meeting; (3) rules regarding how shareholders may present proposals or nominate directors for election at shareholder meetings; and (4) the right of Otis’ Board of Directors to issue preferred stock without shareholder approval.
In addition, we are subject to Section 203 of the Delaware General Corporation Law (“DGCL”), which could have the effect of delaying or preventing a change of control that you may favor. Section 203 provides that, subject to limited exceptions, persons that acquire, or are affiliated with persons that acquire, more than 15 percent of the outstanding voting stock of a Delaware corporation may not engage in a business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or any of its affiliates becomes the holder of more than 15 percent of the corporation’s outstanding voting stock.
We believe these provisions protect our shareholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with Otis’ Board of Directors and by providing Otis’ Board of Directors with more time to assess any acquisition proposal. These provisions are not intended to make Otis immune from takeovers; however, these provisions apply even if the offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that Otis’ Board of Directors determines is not in the best interests of Otis and our shareholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.
In addition, an acquisition or issuance of our stock could trigger the application of Section 355(e) of the Internal Revenue Code ("Code"), causing the distribution of Common Stock pursuant to the Separation to be taxable to RTX. Under the TMA, we would be required to indemnify RTX for the resulting tax, and this indemnity obligation might discourage, delay or prevent a change of control that our shareholders may consider favorable.
Our amended and restated bylaws designate the state courts within the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our shareholders, which could discourage lawsuits against Otis and our directors and officers.
Otis’ amended and restated bylaws provide that unless Otis’ Board of Directors otherwise determines, the state courts within the State of Delaware (or, if no state court located within the State of Delaware has jurisdiction, the federal district court for the District of Delaware) will be the sole and exclusive forum for any derivative action or proceeding brought on behalf of Otis, any action asserting a claim for or based on a breach of a fiduciary duty owed by any current or former director or officer or other employee of Otis to Otis or its shareholders, including a claim alleging the aiding and abetting of such a breach of fiduciary duty, any action asserting a claim against Otis or any current or former director or officer or other employee of Otis arising pursuant to any provision of the DGCL or our amended and restated certificate of incorporation or amended and restated bylaws, any action asserting a claim relating to or involving Otis governed by the internal affairs doctrine, or any action
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asserting an “internal corporate claim” as that term is defined in Section 115 of the DGCL.
To the fullest extent permitted by law, this exclusive forum provision applies to state and federal law claims, including claims under the federal securities laws, including the Securities Exchange Act of 1934, as amended ("Exchange Act"), although Otis shareholders will not be deemed to have waived Otis’ compliance with the federal securities laws and the rules and regulations thereunder. The enforceability of similar exclusive forum provisions in other companies’ organizational documents has been challenged in legal proceedings, and it is possible that, in connection with claims subject to exclusive federal jurisdiction, a court could find the exclusive forum provision contained in the amended and restated bylaws to be inapplicable or unenforceable.
This exclusive forum provision may limit the ability of our shareholders to bring a claim in a judicial forum that such shareholders find favorable for disputes with Otis or our directors or officers, which may discourage such lawsuits against Otis and our directors and officers. Alternatively, if a court were to find this exclusive forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings described above, we may incur additional costs associated with resolving such matters in other jurisdictions, which could negatively affect our business, results of operations and financial condition.
Risks Related to the Separation
Our historical information is not necessarily indicative of the results that we will achieve as a separate, publicly traded company and may not be a reliable indicator of our future results.
The historical information in this Form 10-K and our 2020 Annual Report for the periods prior to the Separation is derived from the combined financial statements and accounting records of our former parent UTC and is based on a number of estimates and assumptions. Accordingly, such historical financial information does not necessarily reflect the financial condition, results of operations or cash flows that we will achieve as a separate, publicly traded company. Prior to the Separation, our business had been operated by UTC as part of its broader corporate organization, rather than as an independent company. As part of our former parent UTC, we were able to enjoy certain benefits from UTC’s operating diversity, purchasing power and opportunities to pursue integrated strategies with UTC’s other businesses. Additionally, UTC or one of its affiliates performed or helped perform various corporate functions for us, such as accounting, auditing, tax, legal, human resources, investor relations, risk management, treasury and other general and administrative functions. Our historical and pro forma financial results reflect allocations of corporate expenses from UTC for such functions, which are likely to be less than the expenses we will incur as a separate publicly traded company. In addition, the diversification of our sales, costs, and cash flows have diminished as a stand-alone company, such that our results of operations, cash flows, working capital and financing requirements may be subject to increased volatility and our ability to fund capital expenditures and investments, and service debt may be diminished and we are no longer able to use cash flow from UTC's other businesses as part of its centralized cash management systems to fund our investments and operations. Accordingly, for these reasons, as well as the additional Risks Related to the Separation noted below, we may not achieve the expected benefits of the Separation.
As a result of the Separation, certain members of management, directors and shareholders may own stock in RTX, Otis and Carrier, and as a result may face actual or potential conflicts of interest.
Management and directors of each of RTX, Otis and Carrier may own common stock in all three companies as a result of the Separation. This ownership overlap could create, or appear to create, potential conflicts of interest when the management and directors of one company face decisions that could have different implications for themselves and the other two companies. For example, potential conflicts of interest could arise in connection with the resolution of any dispute regarding the terms of the agreements governing the separation and Otis’ relationship with RTX and Carrier thereafter.
We could experience temporary interruptions in business operations and incur additional costs as we further develop information technology infrastructure and transition our data to our stand-alone systems.
We are in the process of finalizing development of an IT infrastructure and systems to support our critical business functions, including accounting and reporting, in order to replace many of the systems and functions our former parent UTC previously provided or currently provides under the TSA. We may experience temporary interruptions in business operations if we cannot transition effectively to our own stand-alone systems and functions, which could disrupt our business operations and have a material adverse effect on our profitability.
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We may not be able to engage in desirable capital-raising or strategic transactions as a result of the Separation and the related TMA.
Under current U.S. federal income tax law, a spin-off that otherwise qualifies for tax-free treatment can be rendered taxable to the parent corporation and its shareholders as a result of certain post-spin-off transactions, including certain acquisitions of shares or assets of the spun-off corporation. To preserve the tax-free treatment of the Separation, and in addition to Otis’ indemnity obligation described below, the TMA restricts us, for the two-year period following the Separation, except in specific circumstances, from (1) entering into any transaction pursuant to which all or a portion of the shares of Otis stock would be acquired, whether by merger or otherwise; (2) issuing equity securities beyond certain thresholds; (3) repurchasing shares of Otis stock other than in certain open-market transactions; and (4) ceasing to actively conduct certain of our businesses. The TMA also prohibits us from taking or failing to take any other action that would prevent the Separation and certain related transactions from qualifying as a transaction that is generally tax-free, for U.S. federal income tax purposes, under Sections 355 and 368(a)(1)(D) of the Code or for applicable non-U.S. income tax purposes. Further, the TMA imposes similar restrictions on us and our subsidiaries during the two-year period following the Separation that are intended to prevent certain transactions undertaken as part of the internal reorganization from failing to qualify as transactions that are generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code or for applicable non-U.S. income tax purposes. These restrictions may limit our ability to pursue certain equity issuances, strategic transactions, repurchases or other transactions that we may otherwise believe to be in the best interests of our shareholders or that might increase the value of our business.
In connection with the Separation, each of RTX, Otis and Carrier agreed to indemnify the other parties for certain liabilities. If we are required to pay under these indemnities to RTX and/or Carrier, our financial results could be negatively impacted. Also, the RTX or Carrier indemnities may not be sufficient to hold us harmless from the full amount of liabilities for which RTX and Carrier are allocated responsibility, and RTX and/or Carrier may not be able to satisfy their respective indemnification obligations in the future.
Pursuant to the Separation Agreement, the TMA and the EMA, each party agreed to indemnify the other parties for certain liabilities. Indemnities that we may be required to provide RTX and/or Carrier are not subject to any cap, may be significant and could negatively impact our business. Third parties could also seek to hold us responsible for any of the liabilities that RTX and/or Carrier has agreed to retain. The indemnities from RTX and Carrier for our benefit may not be sufficient to protect us against the full amount of such liabilities, and RTX and/or Carrier may not be able to fully satisfy their respective indemnification obligations. Any amounts we are required to pay pursuant to such indemnification obligations and other liabilities could require us to divert cash that would otherwise have been used in furtherance of our operating business. Moreover, even if we ultimately succeed in recovering from RTX or Carrier, as applicable, we may be temporarily required to bear these losses ourselves. Each of these risks could negatively affect our business, results of operations and financial condition.
If the Separation, together with certain related transactions, were to fail to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes, including as a result of subsequent acquisitions of our stock or the stock of RTX, we, as well as RTX, Carrier, and RTX's shareholders, could be subject to significant tax liabilities. In addition, if certain internal restructuring transactions were to fail to qualify as transactions that are generally tax-free for U.S. federal or non-U.S. income tax purposes, we, as well as RTX and Carrier could be subject to significant tax liabilities. In certain circumstances, we could be required to indemnify RTX for material taxes and other related amounts pursuant to indemnification obligations under the TMA.
In connection the Separation, our former parent UTC received a ruling from the IRS regarding certain U.S. federal income tax matters relating to the Separation and an opinion of outside counsel regarding the qualification of certain elements of the Separation under Section 355 of the Code. The IRS ruling and the opinion of counsel were based upon and rely on, among other things, various facts and assumptions, as well as certain representations, statements and undertakings of UTC (and RTX), Otis and Carrier, including those relating to the past and future conduct of UTC (and RTX), Otis and Carrier. Notwithstanding receipt of the IRS ruling and the opinion of counsel, the IRS could determine that the Separation and/or certain related transactions should be treated as taxable transactions for U.S. federal income tax purposes if it determines that any of the representations, assumptions or undertakings upon which the IRS ruling or the opinion of counsel was based were inaccurate or have not been complied with. In addition, the IRS ruling does not address all of the issues that are relevant to determining whether the Separation, together with certain related transactions, qualifies as a transaction that is generally tax-free for U.S. federal income tax purposes. The opinion of counsel represents the judgment of such counsel and is not binding on the IRS or any court, and the IRS or a court may disagree with the conclusions in the opinion of counsel. Accordingly, notwithstanding
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receipt by UTC of the IRS ruling and the opinion of counsel, there can be no assurance that the IRS will not assert that the Separation and/or certain related transactions did not qualify for tax-free treatment for U.S. federal income tax purposes or that a court would not sustain such a challenge.
If the distribution of Common Stock pursuant to the Separation were to fail to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code, in general, for U.S. federal income tax purposes, RTX would recognize a taxable gain as if it had sold the Common Stock in a taxable sale for its fair market value, and RTX shareholders who received Common Stock in the distribution would be subject to tax as if they had received a taxable distribution equal to the fair market value of such shares. Even if the distribution of Common Stock pursuant to the Separation were to otherwise qualify as a tax-free transaction under Sections 355 and 368(a)(1)(D) of the Code, it may result in taxable gain to RTX (but not its shareholders) under Section 355(e) of the Code if the Separation were deemed to be part of a plan (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, shares representing a 50 percent or greater interest (by vote or value) in RTX or Otis. For this purpose, any acquisitions of RTX or Otis shares within the period beginning two years before the distribution of Common Stock pursuant to the Separation and ending two years after such distribution are presumed to be part of such a plan, although RTX or Otis may be able to rebut that presumption (including by qualifying for one or more safe harbors under applicable Treasury Regulations).
In addition, in connection with and prior to the Separation, UTC and its subsidiaries completed various internal reorganization transactions. With respect to certain transactions undertaken as part of the internal reorganization, UTC obtained tax rulings in certain non-U.S. jurisdictions and/or opinions of external tax advisors, in each case, regarding the tax treatment of such transactions. Such tax rulings and opinions were based upon and relied on, among other things, various facts and assumptions, as well as certain representations (including with respect to certain valuation matters relating to the internal reorganization), statements and undertakings of UTC (and RTX), Otis, Carrier or their respective subsidiaries. If any of these representations or statements were, or become, inaccurate or incomplete, or if RTX, Otis, Carrier or any of their respective subsidiaries do not fulfill or otherwise comply with any such undertakings or covenants, such tax rulings and/or opinions may be invalid or the conclusions reached therein could be jeopardized. Further, notwithstanding receipt of any such tax rulings and/or opinions, there can be no assurance that the relevant taxing authorities will not assert that the tax treatment of the relevant transactions differs from the conclusions reached in the relevant tax rulings and/or opinions. In the event the relevant taxing authorities prevail with any challenge in respect of any relevant transaction, we, as well as RTX and Carrier could be subject to significant tax liabilities.
Under the TMA, Otis generally is required to indemnify RTX and Carrier for any taxes resulting from the Separation and certain related transactions (and any related costs and other damages) to the extent such amounts resulted from (1) an acquisition of all or a portion of the equity securities or assets of Otis, whether by merger or otherwise (and regardless of whether we participated in or otherwise facilitated the acquisition), (2) other actions or failures to act by Otis or (3) certain of Otis’ representations, covenants or undertakings contained in any of the separation-related agreements and documents or in any documents relating to the IRS ruling and/or the opinion of counsel being incorrect or violated. Further, under the TMA, we generally are required to indemnify RTX and Carrier for a specified portion of any taxes (and any related costs and other damages) (a) arising as a result of the failure of the Separation and certain related transactions to qualify as a transaction that is generally tax-free (including as a result of Section 355(e) of the Code) or a failure of any internal separation transaction that is intended to qualify as a transaction that is generally tax-free to so qualify, in each case, to the extent such amounts do not result from a disqualifying action by, or acquisition of equity securities of, Otis, Carrier or RTX or (b) arising from an adjustment, pursuant to an audit or other tax proceeding, with respect to any transaction undertaken in connection with the Separation that is not intended to qualify as a transaction that is generally tax-free. Any such indemnity obligations could be material.
Potential liabilities may arise due to fraudulent transfer considerations, which would adversely affect our financial condition and results of operations.
In connection with the Separation, our former parent UTC undertook several corporate reorganization transactions involving its subsidiaries, which, including the Separation of Otis, may be subject to various fraudulent conveyance and transfer laws. If, under these laws, a court were to determine that, at the time of the separation, any entity involved in these reorganization transactions or the separation: (1) was insolvent, was rendered insolvent by reason of the separation, or had remaining assets constituting unreasonably small capital, and (2) received less than fair consideration in connection with the reorganization; or intended to incur, or believed it would incur, debts beyond its ability to pay these debts as they matured, then the court could void the Separation, in whole or in part, as a fraudulent conveyance or transfer. The court could then require our shareholders to return to RTX some or all of the shares of the Common Stock issued in the distribution, or require RTX or Otis, as the case may be, to fund liabilities of the other company for the benefit of creditors. The measure of insolvency would vary
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depending upon the jurisdiction and the applicable law. Generally, however, an entity would be considered insolvent if the fair value of its assets was less than the amount of its liabilities (including the probable amount of contingent liabilities), or if it incurred debt beyond its ability to repay the debt as it matures. No assurance can be given as to what standard a court would apply to determine insolvency or that a court would determine that Otis or any of its subsidiaries were solvent at the time of or after giving effect to the distribution.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We have a direct physical presence in approximately 80 countries with an overall property portfolio comprising approximately 16 million square feet of space. We have approximately 2,300 facilities, over 90 percent of which are leased and approximately 47 percent, 38 percent and 15 percent of which are located in EMEA, Asia Pacific and the Americas, respectively. We operate over 1,400 branches and offices, 11 R&D centers and 18 manufacturing facilities globally. Our principal manufacturing facilities are located across Brazil, China, Czech Republic, France, India, Korea, Russia, Spain, and the United States, of which 10 are owned. Our principal R&D centers are located in China, the United States, India, France, Germany, Japan and Spain. Our branches and R&D centers typically support both our New Equipment and Service segments.
Our fixed assets as of December 31, 2020 include manufacturing facilities and non-manufacturing facilities, such as warehouses, and a substantial quantity of machinery and equipment, most of which are general purpose machinery and equipment using special jigs, tools and fixtures and in many instances having automatic control features and special adaptations. The facilities, warehouses, machinery and equipment in use as of December 31, 2020 are substantially in good operating condition.
Item 3. Legal Proceedings
For a discussion regarding material legal proceedings, see "Note 21, Contingent Liabilities" to the Consolidated Financial Statements in our 2020 Annual Report.
Item 4. Mine Safety Disclosures
None.
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PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Common Stock is listed on the New York Stock Exchange under the symbol "OTIS". There were approximately 26,400 registered shareholders at January 31, 2021. The Performance Graph appearing in our 2020 Annual Report, filed as Exhibit 13 to this Form 10-K, contains the following data relating to our Common Stock: cumulative shareholder return. The information required by Item 5 with respect to securities authorized for issuance under equity compensation plans is incorporated by reference to Part III, Item 12 of this Form 10-K.
Issuer Purchases of Equity Securities
On April 27, 2020, our Board of Directors authorized a share repurchase program for up to $1 billion of Common Stock. Under this program, shares may be purchased on the open market, in privately negotiated transactions, or under accelerated share repurchase programs under plans complying with rules 10b5-1 and 10b-18 under the Exchange Act. We did not repurchase any shares under the program in 2020 as we focused on deleveraging following the Separation.
Item 6. Selected Financial Data
The Five-Year Summary appearing in our 2020 Annual Report, filed as Exhibit 13 to this Form 10-K, is incorporated herein by reference. See "Notes to Consolidated Financial Statements" in our 2020 Annual Report for a description of the Separation from UTC and any accounting changes materially affecting the comparability of the information reflected in the Five-Year Summary.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The information set forth in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2020 Annual Report, filed as Exhibit 13 to this Form 10-K, is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For information concerning market risk sensitive instruments, see discussion under the heading "Market Risk and Risk Management" in "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in our 2020 Annual Report, and under the headings "Foreign Exchange Exposures" and "Derivatives and Hedging Activity" in "Note 2: Summary of Accounting Policies," as well as "Note 17: Financial Instruments" to the Consolidated Financial Statements in our 2020 Annual Report, filed as Exhibit 13 to this Form 10-K.
Item 8. Financial Statements and Supplementary Data
The 2020 and 2019 Consolidated Balance Sheets, and other consolidated financial statements for the years ended 2020, 2019 and 2018, together with the report thereon of PricewaterhouseCoopers LLP dated February 5, 2021 in our 2020 Annual Report are incorporated herein by reference. The 2020 and 2019 unaudited Selected Quarterly Financial Data appearing in our 2020 Annual Report is incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
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Item 9A. Controls and Procedures
As required by Rule 13a-15(e) under the Exchange Act, we carried out an evaluation under the supervision and with the participation of our management, including the President and Chief Executive Officer ("CEO"), the Executive Vice President and Chief Financial Officer ("CFO") and the Vice President and Chief Accounting Officer ("CAO"), of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2020. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, our CEO, our CFO and our CAO have concluded that, as of December 31, 2020, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our CEO, our CFO and our CAO, as appropriate, to allow timely decisions regarding required disclosure.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the U.S. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Our management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2020. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Our management has concluded that based on its assessment, our internal control over financial reporting was effective as of December 31, 2020. The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in its report which appears in our 2020 Annual Report.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 with respect to directors, the Audit Committee of the Board of Directors and audit committee financial experts is incorporated herein by reference to the section of our Proxy Statement for the 2021 Annual Meeting of Shareholders titled "Corporate governance" (under the subheadings "Proposal 1: Election of directors", "Our board nominees", and "Our leadership and board structure" (including under the subheading "Board committees")).
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Information about our Executive Officers
The following persons are executive officers of Otis Worldwide Corporation:
Name Position Other Business Experience Since 1/1/2016 Age as of 2/5/2021
All of the officers serve at the pleasure of the Board of Directors of Otis Worldwide Corporation.
* As previously disclosed, Ms. Havanec provided the Company with notice of her intent to leave the Company on February 5, 2021.
Information concerning Section 16(a) compliance is incorporated herein by reference to the section of our Proxy Statement for the 2021 Annual Meeting of Shareholders titled "Other important information" under the subheading "Delinquent section 16(a) reports." We have adopted a code of ethics, the Otis Absolutes, that applies to all our directors, officers, employees and representatives. This code is publicly available on our website at http://www.otis.com/How-We-Work/Ethics-And-Compliance/Pages/Default.aspx. Amendments to the code of ethics and any grant of a waiver from a provision of the code requiring disclosure under applicable SEC rules will be disclosed on our website. Our Corporate Governance Guidelines and
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the charters of our Board of Directors’ Audit Committee, Compensation Committee and Nominations and Governance Committee are available on our website at http://www.otis.com/Who-We-Are/Corporate-Governance/Pages/default.aspx. These materials may also be requested in print free of charge by writing to our Investor Relations Department at Otis Worldwide Corporation, One Carrier Place, Investor Relations, Farmington, CT 06032.
Item 11. Executive Compensation
The information required by Item 11 is incorporated herein by reference to the sections of our Proxy Statement for the 2021 Annual Meeting of Shareholders titled "Executive compensation," "Compensation of directors" and "Report of the compensation committee."
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the section of our Proxy Statement for the 2021 Annual Meeting of Shareholders titled "Other important information" under the subheading "Share ownership" (“Beneficial stock ownership of directors and executive officers" and certain beneficial owners”).
Equity Compensation Plan Information
The following table provides information as of December 31, 2020 concerning Common Stock issuable under Otis’ equity compensation plans.
Equity compensation plans not approved by shareholders - - -
(1) Consists of the following issuable shares of Common Stock awarded under the Otis Worldwide Corporation 2020 Long-Term Incentive Plan ("LTIP"): (i) shares of Common Stock issuable upon the exercise of outstanding non-qualified stock options; (ii) shares of Common Stock issuable upon the exercise of outstanding Stock Appreciation Rights ("SARs"); (iii) shares of Common Stock issuable pursuant to outstanding restricted stock unit and performance share unit awards, assuming performance at the target level (up to an additional 9,391 shares of Common Stock could be issued if performance goals are achieved above target); and (iv) shares of Common Stock issuable upon the settlement of outstanding deferred stock units and restricted stock units under the Otis Worldwide Corporation Board of Directors Stock Unit Plan. Under the LTIP, each SAR is exercisable for a number of shares of Common Stock having a value equal to the increase in the market price of a share of such stock from the date the SAR was granted. For purposes of determining the total number of shares to be issued in respect of outstanding SARs, we have used the New York Stock Exchange ("NYSE") closing price for a share of Common Stock on December 31, 2020 of $67.55. The weighted-average exercise price shown in the column above takes into account only the shares identified in clauses (i) and (ii).
(2) Represents the maximum number of shares of Common Stock available to be awarded under the LTIP as of December 31, 2020.Performance share units and restricted stock units ("Full Share Awards") will result in a reduction in the number of shares of Common Stock available for delivery under the LTIP in an amount equal to twice the number of shares to which the award corresponds under the terms of the LTIP.Stock options and SARs do not constitute Full Share Awards and will result in a reduction in the number of shares of Common Stock available for delivery under the 2020 LTIP on a one-for-one basis.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is incorporated herein by reference to the sections of our Proxy Statement for the 2021 Annual Meeting of Shareholders titled "Corporate governance" under the subheading "Our board nominees" (including under the subheading "Director independence") and "Other important information" (under the subheading "Transactions with related persons").
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Item 14. Principal Accounting Fees and Services
The information required by Item 14 is incorporated by reference to the section of our Proxy Statement for the 2021 Annual Meeting of Shareholders titled "Appoint an independent auditor for 2021," including the information provided in that section with regard to "Audit Fees," "Audit-Related Fees," "Tax Fees" and "All Other Fees."
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PART IV
Item 15. Exhibits and Financial Statement Schedule
(a) Financial Statements, Financial Statement Schedules and Exhibits
1.Financial Statements (incorporated herein by reference to the 2020 Annual Report):
Page Number in Annual Report
Report of Independent Registered Public Accounting Firm 21
Consolidated Balance Sheets as of December 31, 2020 and 2019 25
Notes to Consolidated Financial Statements 28
Selected Quarterly Financial Data (Unaudited) 66
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
2.Financial Statement Schedule for the three years ended December 31, 2020:
Page Number in Form 10-K
SCHEDULE II — Valuation and Qualifying Accounts II
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
3.Exhibits:
The following list of exhibits includes exhibits submitted with this Form 10-K as filed with the SEC and those incorporated by reference to other filings.
ExhibitNumber Exhibit Description
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ExhibitNumber Exhibit Description
4.4 Description of Securities*
31
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ExhibitNumber Exhibit Description
32
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ExhibitNumber Exhibit Description
21 Subsidiaries of the Registrant.*
23 Consent of PricewaterhouseCoopers LLP.*
32 Section 1350 Certifications.*
101.SCH XBRL Taxonomy Extension Schema Document.*
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document.*
101.DEF XBRL Taxonomy Extension Definition Linkbase Document.*
101.LAB XBRL Taxonomy Extension Label Linkbase Document.*
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document.*
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Notes to Exhibits List:
* Submitted electronically herewith.
Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Operations for the three years ended December 31, 2020, (ii) Consolidated Statements of Comprehensive Income for the three years ended December 31, 2020, (iii) Consolidated Balance Sheets as of December 31, 2020 and 2019, (iv) Consolidated Statements of Cash Flows for the three years ended December 31, 2020, (v) Consolidated Statements of Changes in Equity for the three years ended December 31, 2020, (vi) Notes to Consolidated Financial Statements, and (vii) Financial Schedule of Valuation and Qualifying Accounts.
Item 16. Form 10-K Summary
None.
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Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
OTIS WORLDWIDE CORPORATION(Registrant)
Dated: February 5, 2021 by: /s/ RAHUL GHAI
Rahul Ghai
Executive Vice President and Chief Financial Officer
Dated: February 5, 2021 by: /s/ MICHAEL P. RYAN
Michael P. Ryan
Vice President and Chief Accounting Officer
35
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
Judith F. Marks
Rahul Ghai
/s/ MICHAEL P. RYAN Vice President and Chief Accounting Officer February 5, 2021
Michael P. Ryan
/s/ JEFFREY H. BLACK* Director
Jeffrey H. Black
/s/ KATHY HOPINKAH HANNAN* Director
Kathy Hopinkah Hannan
/s/ SHAILESH G. JEJURIKAR* Director
Shailesh G. Jejurikar
/s/ CHRISTOPHER J. KEARNEY* Director
Christopher J. Kearney
/s/ HAROLD W. MCGRAW III* Director
Harold W. McGraw III
/s/ MARGARET M.V. PRESTON* Director
Margaret M.V. Preston
/s/ SHELLEY STEWART, JR.* Director
Shelley Stewart, Jr.
/s/ JOHN H. WALKER* Director
John H. Walker
*By: /s/ NORA E. LAFRENIERE
Executive Vice President & Chief General Counsel, as Attorney-in-fact
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Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule
To the Board of Directors and Shareholders of Otis Worldwide Corporation
Our audits of the consolidated financial statements referred to in our report dated February 5, 2021 appearing in the 2020 Annual Report to Shareholders of Otis Worldwide Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
Hartford, Connecticut
February 5, 2021
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OTIS WORLDWIDE CORPORATION
SCHEDULE II - Valuation and Qualifying Accounts
Three years ended December 31, 2020
(Dollars in millions)
Allowance for Doubtful Accounts and Expected Credit Losses:
Provision charged to income 10
Doubtful accounts written off (6)
Provision charged to income 26
Doubtful accounts written off (19)
Other (8)
Impact of credit standard adoption 28
Current period provision for expected credit losses 40
Write-offs charged against the allowance for expected credit losses (20)
Future Income Tax Benefits - Valuation Allowance
Additions charged to income tax expense 15
Reductions credited to income tax expense (5)
Other adjustments (1)
Additions charged to income tax expense 28
Reductions credited to income tax expense —
Other adjustments (2)
Additions charged to income tax expense 63
Reductions credited to income tax expense (13)
Other adjustments, including Separation activity 137
II
Exhibit 13
Excerpt from Otis' 2020 Annual Report to Shareholders for the Year Ended December 31, 2020
Five-Year Summary
For The Year
Cash dividends per common share 0.60 — — — —
At December 31,
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Management's Discussion and Analysis of Financial Condition and Results of Operations
BUSINESS OVERVIEW
We are the world’s leading elevator and escalator manufacturing, installation and service company. Our Company is organized into two segments, New Equipment and Service. Through our New Equipment segment, we design, manufacture, sell and install a wide range of passenger and freight elevators, as well as escalators and moving walkways for residential and commercial buildings and infrastructure projects. Our New Equipment customers include real-estate and building developers and general contractors who develop and/or design buildings for residential, commercial, retail or mixed-use activity. We sell our New Equipment directly to customers, as well as through agents and distributors.
Through our Service segment, we perform maintenance and repair services for both our own products and those of other manufacturers and provide modernization services to upgrade elevators and escalators. Maintenance services include inspections to ensure code compliance, preventive maintenance offerings and other customized maintenance offerings tailored to meet customer needs, as well as repair services to address equipment and component wear and tear and breakdowns. Modernization services enhance equipment operation and improve building functionality. Modernization offerings can range from relatively simple upgrades of interior finishes and aesthetics to complex upgrades of larger components and sub-systems. Our typical Service customers include building owners, facility managers, housing associations and government agencies that operate buildings where elevators and escalators are installed.
We serve our customers through a global network of approximately 69,000 employees. These include sales personnel, field technicians with separate skills in performing installation and service, as well as engineers driving our continued product development and innovation. We function under a centralized operating model whereby we pursue a global strategy set around New Equipment and Service because we seek to grow our maintenance portfolio, in part, through the conversion of new elevator and escalator installations into service contracts. Accordingly, we benefit from an integrated global strategy, which sets priorities and establishes accountability across the full product lifecycle.
For additional discussion, refer to the "Business Overview" section in our Form 10-K.
Separation from United Technologies Corporation
On April 3, 2020, the Separation of each of Otis and Carrier Global Corporation ("Carrier") from United Technologies Corporation, subsequently renamed Raytheon Technologies Corporation ("UTC" or "RTX", as applicable), into separate independent publicly-traded companies was completed through the distribution of 100% of the outstanding common stock of each of Otis and Carrier to holders of UTC common stock as of the close of business on the record date of March 19, 2020. UTC distributed 433,079,455 shares of Otis' common stock, par value $0.01 per share ("Common Stock") in the Distribution, which was effective at 12:01 a.m. Eastern Time, on April 3, 2020. As a result of the Distribution, UTC shareholders of record received 0.5 shares of Common Stock for every share of UTC common stock. As a result of the Distribution, Otis became an independent, publicly-traded company and its Common Stock is listed under the symbol "OTIS" on the New York Stock Exchange ("NYSE").
Prior to the Separation on April 3, 2020, our historical financial statements were prepared on a standalone combined basis and were derived from the consolidated financial statements and accounting records of UTC. For the period subsequent to April 3, 2020, our financial statements are presented on a consolidated basis as the Company became a standalone public company. The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
As a result of the Separation during the year ended December 31, 2020 and our becoming an independent, publicly-traded company, we have incurred non-recurring Separation-related costs and ongoing costs consisting primarily of employee-related costs, costs to establish certain standalone functions and information technology systems, professional services fees, equity award conversions, tax-related items, transaction-related costs and other services. We believe our cash flows from operations will continue to be sufficient to fund any incremental corporate expenses.
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We entered into a transition services agreement ("TSA") with our former parent UTC and Carrier on April 2, 2020, in connection with the Separation pursuant to which RTX provides us with certain services and we provide certain services to RTX for a limited time to help ensure an orderly transition following the Separation. We received and continue to receive services for information technology, technical and engineering support, application support for operations, general administrative services and other support services. Prior to the Separation, costs for these services were allocated from UTC and included in the Company's historical operating expenses and cash flow. For additional discussion, see Note 5 "Related Parties" to the Consolidated Financial Statements.
In connection with the Separation, we entered into a tax matters agreement ("TMA") with our former parent UTC and Carrier on April 2, 2020, that governs the parties’ respective rights, responsibilities and obligations with respect to tax matters (including responsibility for taxes, entitlement to refunds, allocation of tax attributes, preparation of tax returns, control of tax contests and other tax matters).
Subject to certain exceptions set forth in the TMA, the Company generally is responsible for federal, state and foreign taxes imposed on a separate return basis on the Company (or any of its subsidiaries) with respect to taxable periods (or portions thereof) that ended on or prior to the date of the Distribution.
The TMA provides special rules that allocate responsibility for tax liabilities arising from a failure of the Separation and certain related transactions to qualify for tax-free treatment based on the reasons for such failure. The TMA also imposes restrictions on each of Otis and Carrier during the two-year period following the Distribution that are intended to prevent certain transactions from failing to qualify as transactions that are generally tax-free.
On December 22, 2017, the TCJA was enacted which significantly changed U.S. tax law. This new legislation imposed a one-time toll charge, paid in installments over an 8-year period, on deemed repatriated earnings of foreign subsidiaries as of December 31, 2017. Under the terms of the TMA, Otis is required to indemnify RTX for a percentage of the toll charge installment payments (and any adjustments to any prior toll charge installment payments) due after April 3, 2020. As a result, a portion of the future income tax obligations corresponding to the toll charge has been reclassified as a contractual indemnity obligation within Other long-term liabilities on the Consolidated Balance Sheet. For additional discussion, see Note 15 "Income Taxes" to the Consolidated Financial Statements.
In connection with the Separation, we entered into an Employee Matters Agreement ("EMA") and Intellectual Property Agreement with UTC and Carrier on April 2, 2020. These agreements are not expected to have a material impact on the financial results of Otis.
Impact of COVID-19 on our Company
The results of our operations and overall financial performance were impacted due to the COVID-19 pandemic during the year ended December 31, 2020. COVID-19 could have a negative impact to our business, including net sales and overall financial performance in 2021, as a result of the following:
•Customer liquidity constraints and related credit reserves
•Temporary closure or reduced capacity of our factory operations and those of our suppliers
•Limited new equipment job site closures
•Cancellations or delays of customer orders
•Challenges in accessing units to provide maintenance and repair services
•Customer demand impacting our new equipment, maintenance and repair, and modernization businesses
We currently do not expect any significant impact to our capital and financial resources, including our overall liquidity position based on our available cash and cash equivalents and our access to credit facilities and the capital markets, from the COVID-19 pandemic. We are focused on navigating these challenges presented by COVID-19 by continuing to preserve our liquidity and manage our cash flow by taking the necessary measures to meet our short-term liquidity needs. Our cost containment actions have included, and could include in the future, but are not limited to, reducing our discretionary spending, reducing payroll costs and restructuring.
See the Liquidity and Financial Condition section for further detail.
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We have not experienced during the year-ended December 31, 2020 any material impairments to our goodwill, intangible asset and long-lived asset balances as a result of the COVID-19 pandemic and do not currently anticipate any as a result of the COVID-19 pandemic in the future.
Germany Fire
In the quarter ended June 30, 2020 there was a fire at the Company’s manufacturing facility in Germany. As a result of the fire, the Company initially recognized immaterial losses related to the write-down of related fixed assets and facilities and incurred immaterial impacts to operating income due to business interruption during the year ended December 31, 2020. The Company has submitted an insurance claim related to the fire for both property damage and business interruption insurance.
Based on the developments of the insurance claim, the Company has recorded a gain on an expected insurance recovery relating to property damage of approximately $17 million, that is recorded in Other (expense) income, net on the Consolidated Statement of Operations for the year ended December 31, 2020. The Company is continuing to work with insurers to determine the final amounts recoverable for both impacted assets and business interruption. We do not anticipate any additional material impact to our operations in the future from this event.
See Part I, Item 1A,"Risk Factors" in the Form 10-K for further discussion.
RESULTS OF OPERATIONS
Net Sales
Percentage change year-over-year (2.8) % 1.6 % 4.8 %
The factors contributing to the total percentage change year-over-year in total Net sales are as follows:
Organic volume (2.1) % 4.7 %
Foreign currency translation (0.4) % (3.1) %
Acquisitions and divestitures, net (0.2) % (0.1) %
Total % change (2.8) % 1.6 %
The Organic volume decrease of (2.1)% for 2020 was driven by decreases in organic sales of (4.0)% in the New Equipment segment and (0.7)% in the Service segment.
The Organic volume increase of 4.7% for 2019 was driven by increases in organic sales of 4.2% in the New Equipment segment and 5.1% in the Service segment.
See "Segment Review" below for a discussion of Net sales by segment.
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Cost of Products and Services Sold
Percentage change year-over-year (3.4) % 1.1 % 6.6 %
The factors contributing to the percentage change year-over-year in total cost of products and services sold are as follows:
Organic volume (2.7) % 4.6 %
Foreign currency translation (0.5) % (3.3) %
Acquisitions and divestitures, net (0.2) % (0.1) %
Restructuring — % (0.1) %
Total % change (3.4) % 1.1 %
The organic volume decrease in total cost of products and services sold in 2020 was driven by the organic sales decrease noted above, productivity and cost containment actions.
The organic volume increase in cost of products and services sold in 2019 was primarily driven by the organic sales increase above.
Gross Margin
Gross margin increased 40 basis points in 2020 when compared to 2019, primarily driven by an increase in the Service margin rate and overall segment mix, partially offset by a decrease in the New Equipment margin rate.
Gross margin increased 30 basis points in 2019 when compared to 2018, primarily driven by an increase in the Service margin rate, partially offset by a decrease in the New Equipment margin rate.
See the Segment Review below for discussion of operating results by segment.
Research and Development
Percentage of Net sales 1.2 % 1.2 % 1.4 %
Research and development spending decreased approximately $11 million, or (6.7)%, in 2020 compared to 2019 primarily as a result of cost containment actions taken in the current year. Research and development expenses remained relatively consistent as a percentage of Net sales. We continue to fund our strategic investment projects and focus on our commitment to Internet of Things technology developing the next generation of connected elevators and escalators.
Research and development in 2019 reflects the benefit of organizational optimization and lower cost allocations from UTC in 2019 compared to 2018.
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Selling, General and Administrative
Selling, general and administrative expenses increased approximately $114 million, or 6.3%, in 2020, with lower employment costs and lower discretionary spending, including cost containment actions taken in response to COVID-19, and the absence of corporate allocations from UTC, being more than offset by non-recurring Separation-related costs and incremental standalone public company costs. Selling, general and administrative expenses increased as a percentage of Net sales in 2020, primarily driven by the increase in non-recurring Separation-related costs, incremental standalone public company costs and lower Net sales.
Selling, general and administrative expenses increased approximately $75 million, or 4.3%, in 2019. Excluding the favorable impact of foreign exchange fluctuations (3%), the increase is primarily driven by costs in preparation of our Separation from UTC and higher employment and digital technology costs. See Note 5, "Related Parties" for further discussion on costs related to the Separation.
We are continuously evaluating our cost structure and have implemented restructuring actions as a method of keeping our cost structure competitive. For further discussion, see “Restructuring Costs” below and Note 16, "Restructuring Costs" to the Consolidated Financial Statements.
Restructuring Costs
Restructuring costs $ 77 $ 54 $ 69
We initiate restructuring actions to keep our cost structure competitive. Charges generally arise from severance related to workforce reductions, and to a lesser degree, facility exit and lease termination costs associated with the consolidation of field and manufacturing operations. We continue to closely monitor the economic environment, especially in light of the economic impact of COVID-19, and may undertake further restructuring actions to keep our cost structure aligned with the demands of the prevailing market conditions. Total 2020 restructuring costs include $71 million of costs related to 2020 actions and $6 million of costs related to 2019.
2020 Actions. During 2020, we recorded net pre-tax restructuring charges of $71 million relating to cost reduction actions initiated in 2020. We are targeting to complete in 2021 the majority of the remaining workforce cost reduction actions initiated in 2020. Approximately 97% of the total expected pre-tax charges will require cash payments, which we have funded and expect to continue to fund with cash generated from operations. During 2020, we had cash outflows of approximately $29 million related to the 2020 actions. We expect to incur additional restructuring charges of $15 million to complete these actions. We expect recurring pre-tax savings in continuing operations to increase to approximately $57 million annually over the two-year period subsequent to initiating the actions.
2019 Actions. During 2020 and 2019, we recorded net pre-tax restructuring charges of $6 million and $45 million, respectively, for actions initiated in 2019. Approximately 100% of the total pre-tax charge will require cash payments, which we have and expect to continue to fund with cash generated from operations. During 2020, we had cash outflows of approximately $15 million related to the 2019 actions. We expect to incur additional restructuring charges of $3 million to complete these actions. We expect recurring pre-tax savings to increase over the two-year period after initiating the actions to be approximately $45 million annually, of which approximately $35 million was realized during 2020, net of the current year charges.
In addition, we recorded net pre-tax restructuring costs totaling $0 and $9 million in 2020 and 2019, respectively, for restructuring actions initiated in 2018 and prior years. For additional discussion of restructuring, see Note 16, "Restructuring Costs" in the Consolidated Financial Statements.
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Other Income (Expense), Net
Other income (expense), net $ (64) $ (39) $ 25
Other income (expense), net primarily includes the impact of changes in the fair value and settlement of embedded and foreign exchange derivatives, gains or losses on sale of businesses and fixed assets, earnings from equity method investments, fair value changes on equity securities, impairments, non-recurring Separation-related expenses, gains on expected insurance recoveries and certain other infrequent operating income and expense items.
The year-over-year increase in Other income (expense), net in 2020 when compared to 2019 is driven by current year fixed asset impairments of approximately $(71) million and associated license costs of approximately $(14) million and non-recurring Separation-related expenses. These were partially offset by favorable mark-to-market adjustments on foreign currency derivatives of approximately $46 million when compared to the prior year, the absence of the loss on the sale of a business of approximately $19 million included in the 2019 results and a non-recurring gain of approximately $17 million related to an expected insurance recovery recognized for property damage as a result of the fire in our manufacturing facility in Germany in the current year.
The year-over-year change in Other income (expense), net in 2019 when compared to 2018 is primarily due to an increase in unfavorable mark-to-market adjustments on foreign currency derivatives, non-recurring charges in 2019 related to our Separation from UTC and lower gains on sales of certain fixed assets.
See Note 5, "Related Parties" to the Consolidated Financial Statements for further discussion on costs related to the Separation.
Interest Expense (Income), Net
Interest expense (income), net $ 122 $ (14) $ (14)
Interest expense (income), net primarily relates to interest expense on our external debt, offset by interest income earned on cash balances, short-term investments and related party activity between Otis and UTC in the prior years.
The increase in Interest expense (income), net in 2020 compared to 2019 was primarily driven by interest expense of $124 million on our external debt for the year ended December 31, 2020 and debt issuance cost amortization of $5 million. These expenses were offset by interest income on short-term investments. The average interest rate on our external long-term debt for 2020is 2.3%.
Interest expense (income), net remained flat in 2019 in comparison to 2018.
For additional discussion of borrowings, see Note 10, "Borrowings and Lines of Credit" to the Consolidated Financial Statements.
Income Taxes
The 2020 effective tax rate is higher than the statutory U.S. rate primarily due to higher international tax rates as compared to the lower U.S. federal statutory rate and foreign earnings subject to U.S. tax under the provisions of the TCJA.
The 2020 effective tax rate compared to the 2019 effective tax rate reflects a tax benefit of $10 million related to our change in assertion of no longer intending to reinvest certain undistributed earnings made during the year as compared to the liability previously recorded by UTC, a decrease as a result of tax regulations related to the TCJA that were enacted during the
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year, as well as a recognition of a Separation-related foreign tax loss. These were partially offset by incremental withholding taxes in 2020.
The 2019 effective tax rate is higher than the statutory U.S. rate primarily due to higher international tax rates as compared to the lower U.S. federal statutory rate, and the full phase-in of the TCJA.
The 2019 effective tax rate compared to the 2018 effective tax rate reflects a decrease in the cost of U.S. and foreign tax on international activities primarily attributable to the absence of the net tax charge of $143 million as a result of UTC’s change of assertion of no longer intending to reinvest certain undistributed earnings of its international subsidiaries, offset by the full phase-in of the TCJA.
The 2018 effective tax rate is higher than the statutory U.S. rate as it reflects a net tax charge of $143 million as a result of UTC’s change of assertion of no longer intending to reinvest certain undistributed earnings of its international subsidiaries.
For additional discussion of income taxes and the effective income tax rate, see Note 15, "Income Taxes" to the Consolidated Financial Statements.
Noncontrolling Interest in Subsidiaries' Earnings
Noncontrolling interest in subsidiaries' earnings $ 150 $ 151 $ 161
Noncontrolling interest in subsidiaries' earnings remained consistent in 2020 in comparison to 2019.
Net income attributable to noncontrolling interest decreased in 2019 when compared with 2018 primarily due to a decrease in the net income of certain subsidiaries with noncontrolling interest.
Ownership interest in the underlying entities has remained generally consistent year-over-year.
Net Income Attributable to Common Shareholders
(dollars in millions, except per share amounts) 2020 2019 2018
Net income attributable to common shareholders $ 906 $ 1,116 $ 1,049
Diluted earnings per share from operations $ 2.08 $ 2.58 $ 2.42
Net income attributable to common shareholders for the year ended December 31, 2020 includes restructuring charges, net of taxes, of $58 million ($77 million pre-tax), as well as charges relating to significant non-operational and/or non-recurring items, net of taxes, of approximately $132 million ($203 million pre-tax) which include non-recurring Separation-related costs, fixed asset impairments, non-recurring Separation-related tax benefits and the impact of non-recurring tax items. These significant non-operational and/or non-recurring items, along with incremental standalone public company costs were the primary contributors to lower Net income attributable to common shareholders for the year ended December 31, 2020 when compared to the same period in 2019. The effects of the restructuring and the non-operational and non-recurring items above resulted in an impact of $0.44 on diluted earnings per share for the year ended December 31, 2020.
Net income attributable to common shareholders for the year ended December 31, 2019 includes restructuring charges, net of tax benefit, of $39 million ($54 million pre-tax) as well as charges relating to significant non-operational and/or non-recurring items, net of taxes, of approximately $51 million ($69 million pre-tax), which primarily consist of employee-related costs, costs to establish certain standalone functions, information technology systems, professional services fees and other transaction-related costs for our transition to being a standalone public company, in addition to non-recurring losses on disposals of businesses.
Net income attributable to common shareholders for the year ended December 31, 2018 includes restructuring charges, net of tax benefit, of $53 million ($69 million pre-tax) as well as a net charge for certain non-operational and/or non-recurring items, primarily driven by a tax charge of $143 million that will become due when previously reinvested earnings of certain international subsidiaries are remitted.
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Segment Review
Net Sales Operating Profit Operating Profit Margin
General corporate expenses and other — — — (290) (182) (71) — — —
New Equipment
The New Equipment segment designs, manufactures, sells and installs a wide range of passenger and freight elevators, as well as escalators and moving walkways in residential and commercial buildings and infrastructure projects. Our New Equipment customers include real-estate and building developers and general contractors who develop and/or design buildings for residential, commercial, retail or mixed-use activity. We sell directly to customers as well as through agents and distributors.
Total Increase (Decrease)Year-Over-Year for:
Foreign currency translation (0.8) % (0.7) % (2.3) % (3.4) % (3.6) % (4.3) %
Acquisitions/Divestitures, net — % — % — % — % — % — %
Restructuring cost — % 0.1 % (2.8) % — % — % 1.5 %
Other (0.1) % — % (1.3) % 0.1 % — % 1.0 %
2020 Compared with 2019
The organic sales decrease of (4.0)% was primarily driven by organic sales declines in all regions primarily due to impacts of the COVID-19 pandemic.
New Equipment operational profit decreased (12.7)%, as strong material productivity 15.8% and cost containment actions, were more than offset by the impact of lower volume (8.9)% and unfavorable rate drivers (25.1)% due to under-absorption, field inefficiencies, price and mix and higher bad debt expense. New Equipment operating profit was also impacted by foreign currency headwinds, higher restructuring costs and incremental public company standalone costs.
2019 Compared with 2018
The organic sales increase of 4.2% primarily reflects growth in Asia.
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New Equipment operational profit increased 2.6% driven by higher volume 6.8% and lower research and development expenses 3.1%, partially offset by higher selling, general and administrative expenses (7.1)%.
Service
The Service segment performs maintenance and repair services for both our products and those of other manufacturers and provides modernization services to upgrade elevators and escalators. Maintenance services include inspections to ensure code compliance, preventive maintenance offerings and other customized maintenance offerings tailored to meet customer needs, as well as repair services that address equipment and component wear and tear, and breakdowns. Modernization services enhance equipment operation and improve building functionality. Modernization offerings can range from relatively simple upgrades of interior finishes and aesthetics, to complex upgrades of larger components and sub-systems. Our typical Service customers include building owners, facility managers, housing associations and government agencies that operate buildings where elevators and escalators are installed.
Total Increase (Decrease)Year-Over-Year for:
Foreign currency translation (0.1) % (0.1) % 0.2 % (3.0) % (3.0) % (3.4) %
Acquisitions/Divestitures, net (0.3) % (0.6) % (0.1) % — % (0.2) % (0.1) %
Restructuring cost — % (0.1) % (0.7) % — % — % 0.6 %
2020 Compared with 2019
Service sales declined (1.1)% with an organic sales decline of (0.7)% and the remaining decrease due to foreign currency headwinds and the net impact from acquisitions and divestitures. The organic sales decrease (0.7)% primarily consists of organic sales decrease in maintenance and repair of (0.9)%, with organic sales for modernization remaining flat.
Maintenance and repair net sales decreased (1.2)% year over year and was comprised of a (0.9)% organic sales decrease, foreign currency headwinds of (0.1)% and decreases related to net acquisitions and divestitures of (0.2)%.
Modernization net sales decreased (0.9)% year over year and was comprised of a 0.1% organic sales increase, foreign currency tailwinds of 0.1%, more than offset by decreases related to net acquisitions and divestitures (1.1)%.
Service operational profit increased 0.9% with the benefit of favorable productivity 4.2%, pricing and mix 2.3%, and cost containment actions, more than offsetting the combined impact of price concessions and lower volume (3.4)% and higher bad debt expense. Service operating profit was also favorably impacted by foreign currency, offset by higher restructuring costs and incremental public company standalone costs.
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2019 Compared with 2018
The organic sales increase of 5.1% primarily consists of organic increases in maintenance and repair 4.9% and modernization 6.2%.
Maintenance and repair net sales increased 1.7% year over year and was comprised of a 4.9% organic sales increase, offset by foreign currency headwinds of (3.2)%.
Modernization net sales increased 3.6% year over year and was comprised of a 6.2% organic sales increase, offset by foreign currency headwinds of (2.2)% and decreases related to acquisitions and divestitures, net of (0.4)%.
Service operational profit increased 8.3%, driven by higher volume 7.8% and favorable price and mix 6.0%, partially offset by higher selling, general and administrative expenses (4.1)%.
General Corporate Expenses and Other
General corporate expenses and other (290) (182) (71)
General corporate expenses and other increased approximately $108 million in 2020 compared to the same period in 2019, primarily driven by current year fixed asset impairments of $71 million and associated license costs of approximately $14 million, non-recurring Separation-related costs of $119 million in the current year and incremental standalone public company costs. These were partially offset by favorable mark-to-market adjustments on foreign currency derivatives of $46 million when compared to the prior period, the absence of losses on the sale of a business of $19 million that occurred during 2019 and a non-recurring gain of approximately $17 million related to an expected insurance recovery for property damage as a result of the fire in our manufacturing facility in Germany recognized in the current year.
General corporate expenses and other increased approximately $111 million in 2019 compared to the same period in 2018, primarily driven by non-recurring Separation costs and the changes in Other (expense) income, net previously discussed above.
LIQUIDITY AND FINANCIAL CONDITION
Cash and cash equivalents $ 1,782 $ 1,446
Net debt (total debt less cash and cash equivalents) 4,181 (1,407)
Total capitalization (total debt plus total equity) 2,679 2,270
Total debt to total capitalization 223 % 2 %
Net debt to net capitalization 466 % (171) %
At December 31, 2020, we had cash and cash equivalents of approximately $1.8 billion, of which approximately 88% was held by the Company's foreign subsidiaries. We manage our worldwide cash requirements by reviewing available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. On occasion, we are required to maintain cash deposits with certain banks with respect to contractual obligations related to acquisitions and divestitures or other legal obligations. As of December 31, 2020 and 2019, the amount of such restricted cash was approximately $19 million and $13 million, respectively.
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From time to time we may need to access the capital markets to obtain financing. We may incur indebtedness or issue equity as needed. Although we believe that the arrangements in place as of December 31, 2020 permit us to finance our operations on acceptable terms and conditions, our access to, and the availability of, financing on acceptable terms and conditions in the future could be impacted by many factors, including (1) our credit ratings or absence of a credit rating, (2) the liquidity of the overall capital markets and (3) the current state of the economy, including the impact of COVID-19. There can be no assurance that we will continue to have access to the capital markets on terms acceptable to us.
The following is a summary of the debt issuances in 2020:
(dollars in millions)
Issuance Date Description of Debt Aggregate Principal Balance
The following is a summary of the debt repayments in 2020:
(dollars in millions)
Payment Date Description of Debt Total Principal Payments
In 2020 we repaid the $1.0 billion term loan in full, using cash from operations and proceeds from the issuance of Euro denominated and US Dollar denominated commercial paper.
The net proceeds from the above February and March debt issuances totaling $6.3 billion were used to distribute cash to UTC as part of the Separation in 2020.
For additional discussion of borrowings, see Note 10, "Borrowings and Lines of Credit" to the Consolidated Financial Statements.
Following the enactment of the TCJA, and after reassessing as part of the Separation, the Company determined that it no longer intends to reinvest certain undistributed earnings of our international subsidiaries that have been previously taxed in the U.S. For the remainder of the Company’s undistributed international earnings, unless tax effective to repatriate, we will continue to permanently reinvest these earnings.
We expect to fund our ongoing operating, investing and financing requirements mainly through cash flows from operations, available liquidity through cash on hand and available bank lines of credit and access to the capital markets.
On April 27, 2020, our Board of Directors authorized a share repurchase program for up to $1.0 billion of Common Stock. Under this program, shares may be purchased on the open market, in privately negotiated transactions, under accelerated share repurchase programs, or under plans complying with rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended. We expect to commence share repurchases under the program in 2021.
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Cash Flow - Operating Activities
Net cash flows provided by operating activities $ 1,480 $ 1,469 $ 1,550
2020 Compared with 2019
Cash generated from operating activities in 2020 was $11 million higher than 2019, primarily due to increased cash inflows related to current assets and current liabilities activity of $109 million, as described below. There were also increased Other operating activities of $106 million compared to the same period in 2019, primarily due to increased long-term accruals. These were partially offset by lower net income of $211 million, which includes the impact of interest expense on debt, incremental standalone public company costs and non-recurring Separation-related costs in 2020.
2020 Changes in Working Capital
The 2020 cash inflows related to current assets and current liabilities operating activity were $77 million. These cash inflows were primarily driven by:
•Contract assets, current and Contract liabilities, current, net change of $282 million, driven by the timing of billings on contracts compared to the progression on current contracts; and
•Accounts payable, which increased by $20 million primarily due to the timing of payments to suppliers.
The cash inflows were partially offset by cash outflows related to:
•Inventories, net, which increased $76 million, due to the impact of higher production inventory levels related to the timing of deliveries to construction sites; and
•Accounts receivable, net, which increased $163 million due to slower collections and increased customer financing activity.
Additionally, Other current assets decreased by $28 million due to the receipt of indemnification pursuant to the TMA in order to pay foreign tax obligations, partially offset by tax prepayments in certain tax jurisdictions, while Accrued liabilities decreased $14 million largely due to the payment of foreign tax obligations pursuant to the TMA described above and income tax liabilities in certain tax jurisdictions, partially offset by accruals for interest in excess of interest payments. The receipt and payment of indemnification assets and foreign tax obligations resulted in no net cash flow for 2020. See Note 5, "Related Parties" to the Consolidated Financial Statements for further discussion on transactions with our former parent UTC.
2019 Compared with 2018
Cash generated from operating activities in 2019 was $81 million lower than 2018, primarily due to higher income taxes settled with UTC. Cash outflows for working capital increased by $24 million over the prior period to support higher organic sales.
2019 Changes in Working Capital
The 2019 cash outflows related to current assets and current liabilities operating activity were $32 million. These cash outflows were primarily driven by:
•Accounts receivable, net, which increased $191 million due to increased sales volume and timing of receipts of payments;
The cash outflows were partially offset by cash inflows related to:
•Net change in Contract assets, current and Contract liabilities, current of $97 million due to the timing of billings on contracts compared to the progression on current contracts; and
•Inventories, net, which decreased $60 million due to lower production inventory.
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Cash Flow - Investing Activities
Net cash flows used in investing activities $ (353) $ (203) $ (201)
Cash flows used in investing activities primarily reflect capital expenditures, investments in businesses and securities, proceeds received on the sale of fixed assets, and settlement of derivative contracts.
2020 compared to 2019
Investing Activities:
Capital expenditures $ (183) $ (145) $ (38)
Investments in businesses, net of cash acquired (53) (47) (6)
Investments in equity securities (51) — (51)
Receipts (payments) on settlements of derivative contracts (69) (5) (64)
Other investing activities, net 3 (6) 9
Net cash flows used in investing activities $ (353) $ (203) $ (150)
Cash flows used in investing activities in 2020 compared to 2019 increased $150 million, including a $64 million increase in payments on settlements of derivative contracts, a $51 million investment in the current year related to equity securities, a $38 million increase in capital expenditures, and a $6 million increase in investments in businesses. Increases in our capital expenditures reflect investments in assets to support the Separation, as well as investments in software for internal use to support our digital and strategic initiatives.
As discussed in Note 17, "Financial Instruments" to the Consolidated Financial Statements, we enter into derivative instruments for risk management purposes. We operate internationally and, in the normal course of business, are exposed to fluctuations in interest rates and foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating the business. We use derivative instruments, including forward contracts and options, to manage certain foreign currency exposures. The settlement of these derivative instruments resulted in a net cash outflow of $69 million in 2020, which includes $21 million of payments associated with the hedges of foreign-denominated TMA indemnification assets.
2019 compared to 2018
Cash flows used in investing activities in 2019 compared to 2018 remained relatively flat, primarily due to a $27 million decrease in capital expenditures, offset by a $15 million decrease in proceeds received on the sale of certain fixed assets and a $15 million increase in short-term investing activity.
Cash Flow - Financing Activities
Net cash flows used in financing activities $ (844) $ (1,133) $ (1,497)
Financing activities primarily include issuance of long-term debt, increases (decreases) in short-term borrowings, dividends paid to common shareholders, dividends paid to noncontrolling interest and transfers to and from UTC, consisting of, among other things, cash transfers, distributions, cash investments and changes in receivables and payables between Otis and UTC. See Note 5, "Related Parties" to the Consolidated Financial Statements for further discussion on transactions with UTC.
2020 compared to 2019
Net cash used in financing activities decreased $289 million in 2020 compared to 2019, primarily due to the issuance of long-term notes of $5.3 billion, the draw of $1.0 billion from the term loan, and an increase in short-term borrowings of
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$641 million primarily from the issuance of commercial paper in 2020. These were partially offset by a $5.4 billion increase in net transfers to UTC related to the Separation, the full repayment of the $1.0 billion term loan, a $260 million increase in dividends paid on Common Stock, and $43 million in payments of long-term debt issuance costs in 2020. See Note 10, "Borrowings and Lines of Credit" to the Consolidated Financial Statements for further discussion on borrowings.
2019 compared to 2018
Net cash used in financing activities decreased $364 million in 2019 compared to 2018 primarily due to a decrease in Net transfers to UTC.
CRITICAL ACCOUNTING ESTIMATES
Preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Note 2, "Summary of Significant Accounting Policies" to the Consolidated Financial Statements describes the significant accounting policies used in preparation of the Consolidated Financial Statements. Management believes the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. The most significant areas involving management judgments and estimates are described below. Actual results in these areas could differ from management’s estimates.
Revenue Recognition from Contracts with Customers
Effective January 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09 and its related amendments (referred to as "ASC 606”) and elected the modified retrospective approach. The impact of ASC 606 did not significantly change the revenue recognition model for us nor our policies and procedures. For new equipment and modernization contracts, equipment and installation are typically procured in a single contract providing the customer with a complete installed elevator or escalator unit. The combination of equipment and installation promises are typically a single performance obligation. For these performance obligations, revenue is typically recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress. Contract costs are usually incurred over a period of time, which can be several years, and the estimation of these costs requires management’s judgment. Contract costs included in the calculation are comprised of labor, materials, subcontractors’ costs or other direct costs and indirect costs, which include indirect labor costs.
The long-term nature of the contracts, the complexity of the products and the scale of the projects can affect our ability to estimate costs precisely. We review cost estimates on significant new equipment and modernization contracts on a quarterly basis and, for others, no less frequently than annually or when circumstances change and warrant a modification to a previous estimate. We record changes in contract estimates using the cumulative catch-up method and we review changes in contract estimates for their impact on net sales or operating profit in the Consolidated Financial Statements. Modifications are recognized as a cumulative catch-up or treated as a separate accounting contract if the modification adds distinct goods or services and the modification is priced at its stand-alone selling price.
See Note 2, "Summary of Significant Accounting Policies" and Note 4, "Revenue Recognition" to the Consolidated Financial Statements for further discussion.
Income Taxes
The future tax benefit arising from deductible temporary differences and tax carryforwards was $642 million at December 31, 2020 and $619 million at December 31, 2019. Management estimates that our earnings during the periods when the temporary differences become deductible will be generally sufficient to realize the related future income tax benefits, which may be realized over an extended period of time. For those jurisdictions where the expiration date of tax carryforwards or the projected operating results indicate that realization is not likely, a valuation allowance is provided.
In assessing the need for a valuation allowance, we estimate future taxable income, considering the feasibility of ongoing tax planning strategies and the realizability of tax loss carryforwards. Valuation allowances related to deferred tax assets can be affected by changes to tax laws, changes to statutory tax rates and future taxable income levels. In the event we were to determine that we would not be able to realize all or a portion of our deferred tax assets in the future, we would reduce such amounts through an increase to tax expense in the period in which that determination is made or when tax law changes are
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enacted. Conversely, if we were to determine that we would be able to realize our deferred tax assets in the future in excess of the net carrying amounts, we would decrease the recorded valuation allowance through a decrease to tax expense in the period in which that determination is made.
In the ordinary course of business there is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the Consolidated Financial Statements. See Notes 3, "Earnings Per Share" and 14, "Accumulated Other Comprehensive Income (Loss)" to the Consolidated Financial Statements for further discussion. Additionally, see Note 21, "Contingent Liabilities" to the Consolidated Financial Statements for discussion of administrative review proceedings with the German Tax Office.
Goodwill
We have generated goodwill as a result of our acquisitions. At the time of acquisition, we account for business acquisitions using the purchase method of accounting, in accordance with which assets acquired and liabilities assumed are recorded at their respective fair values at the acquisition date. The fair value of the consideration paid, including contingent consideration, is assigned to the assets acquired and liabilities assumed based on their respective fair values. Goodwill represents the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed.
We review our goodwill for impairment on an annual basis at July 1 or more frequently if events or a change in circumstances indicate that the carrying amount may not be recoverable. We test goodwill for impairment at a level within the Company referred to as the reporting unit, which is one level below the business segment level. We have determined there to be three reporting units within each business segment.
In accordance with Accounting Standards Codification (“ASC”) 350, Intangibles – Goodwill and Other, we initially perform a qualitative assessment (commonly known as “step zero”) to determine whether further impairment testing is necessary before performing the two-step test. The qualitative assessment requires judgments by management about economic conditions including the entity’s operating environment, its industry and other market considerations, entity-specific events related to financial performance or loss of key personnel and other events that could impact the reporting unit. If management concludes, based on assessment of relevant events, facts and circumstances, that it is more likely than not that a reporting unit’s fair value is greater than its carrying value, no further impairment testing is required. If we determine, based on this assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying value, we perform a quantitative goodwill impairment test by comparing the reporting unit’s fair value with its carrying value. An impairment loss is recognized for the amount by which the reporting unit’s carrying value exceeds its fair value, up to the total amount of goodwill allocated to the reporting unit. No impairment loss is recognized if the fair value of the reporting exceeds its carrying value.
We completed the annual goodwill impairment test for all of our reporting units as of July 1, 2020 and determined that no adjustment to goodwill was necessary as the fair value of each reporting unit was significantly in excess of the carrying value of each reporting unit.
Contingent Liabilities
Otis is party to litigation related to a number of matters as described in Note 21, "Contingent Liabilities" to the Consolidated Financial Statements. In particular, they may include risks associated with contractual, regulatory and other matters, which may arise in the ordinary course of business. The outcome of these matters may have a material effect on the financial position, results of operations or cash flows. Management regularly analyzes current information about these matters and accrues for contingent losses that are probable and reasonably estimable. To assess the exposure to potential liability, we consult with relevant internal and external counsel. In making the decision regarding the need for loss accruals, management considers the degree of probability of an unfavorable outcome and the ability to make a sufficiently reliable estimate of the amount of loss. See Part I, Item 1A, "Risk Factors" in the Form 10-K for further discussion.
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Employee Benefit Plans
We sponsor domestic and international defined benefit pension and other postretirement plans. Major assumptions used in the accounting for these employee benefit plans include the discount rate, expected return on plan assets, rate of increase in employee compensation levels and mortality rates. Assumptions are determined based on company data and appropriate market indicators, and are evaluated each year at December 31. A change in any of these assumptions would have an effect on net periodic pension and postretirement benefit costs reported in the Consolidated Financial Statements.
In the following table, we show the sensitivity of our pension and other postretirement benefit plan liabilities and net periodic cost to a 25 basis point change in the discount rates for benefit obligations, as of December 31, 2020:
Pension plans
Projected benefit obligation $ (33) $ 34
Net periodic pension (benefit) cost (1) 2
The impact on the accumulated postretirement benefit obligation and on the net periodic postretirement (benefit) cost is less than $1 million.
Pension expense is also sensitive to changes in the expected long-term rate of asset return. An increase or decrease of 25 basis points in the expected long-term rate of asset return would have decreased or increased 2020 pension expense by approximately $2 million.
The weighted-average discount rates used to measure pension liabilities and costs utilize each plan’s specific cash flows and are then compared to high-quality bond indices for reasonableness. Global market interest rates decreased in 2020 as compared with 2019, and, as a result, the weighted-average discount rate used to measure pension liabilities was 1.05% in 2020 and 1.50% in 2019.
See Note 13, "Employee Benefit Plans" to the Consolidated Financial Statements for further discussion.
Off-Balance Sheet Arrangements and Contractual Obligations
We extend a variety of financial guarantees to third parties in support of our business. We also have obligations arising from environmental, health and safety, tax and employment matters. Circumstances that could cause the contingent obligations and liabilities arising from these arrangements to come to fruition include changes in the underlying transaction, non-performance under a contract or deterioration in the financial condition of the guaranteed party.
Below is a summary of our contractual obligations and commitments as of December 31, 2020:
Payments Due by Period
Purchase obligations include amounts committed for the purchase of goods and services under legally enforceable contracts or purchase orders. Where it is not practically feasible to determine the legally enforceable portion of our obligation under certain of our long-term purchase agreements, we include additional expected purchase obligations beyond what may be legally enforceable. In connection with the Separation and transition to a standalone public company, we entered into contractual purchase commitments with suppliers, service vendors, and various transition services agreements to support our information technology that are either necessary to operate as a standalone business or are resulting from implementing
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strategic initiatives.
Other long-term liabilities primarily include amounts on our December 31, 2020 Consolidated Balance Sheet representing obligations under product service and warranty policies, estimated remediation costs, expected contributions under employee benefit programs and $239 million of payables to RTX for reimbursement of tax payments RTX is responsible to pay after the Separation pursuant to the TMA. The timing of expected cash flows associated with these obligations is based upon management's estimates over the terms of these agreements and is largely based upon historical experience.
The above table excludes unrecognized tax benefits of $397 million, the timing of which is uncertain to become payable. See Note 15, "Income Taxes" to the Consolidated Financial Statements for additional discussion on unrecognized tax benefits.
Market Risk and Risk Management
We are exposed to fluctuations in foreign currency exchange rates and commodity prices. To manage certain of those exposures, we use derivative instruments, including forward contracts. Derivative instruments utilized by us in our hedging activities are viewed as risk management tools, involve relatively little complexity and are not used for trading or speculative purposes. We diversify the counterparties used and monitor the concentration of risk to limit our counterparty exposure.
We have evaluated our exposure to changes in foreign currency exchange rates and interest rates in our market risk sensitive instruments, which are primarily cash, debt and derivative instruments, using a value at risk analysis. Based on a 95% confidence level and one-day holding period, at December 31, 2020, the potential loss in fair value on our market risk sensitive instruments was not material in relation to our financial position, results of operations or cash flows. Our calculated value at risk exposure represents an estimate of reasonably possible net losses based on volatilities and correlations, and is not necessarily indicative of actual results. Additionally, any losses or gains on derivative instruments would be mostly offset by corresponding gains or losses in the remeasurement of the underlying transactions being hedged.
Refer to Note 2, "Summary of Significant Accounting Policies", Note 10, "Borrowings and Lines of Credit" and Note 17, "Financial Instruments" to the Consolidated Financial Statements for additional discussion of foreign currency exchange, interest rates and financial instruments, including the aggregate notional amount of our outstanding foreign currency hedges.
Foreign Currency Exposures
The value of certain foreign currencies as compared to the U.S. Dollar may impact Otis’ financial results. We have a high volume of foreign currency exposures that result from our international sales, purchases, investments and other international transactions. International sales were approximately $9.3 billion, $9.5 billion and $9.5 billion in 2020, 2019 and 2018, respectively. We manage foreign currency exposures that are associated with committed foreign currency purchases and sales as well as foreign currency denominated assets and liabilities that are created in the ordinary course of business. More than insignificant exposures, that cannot be naturally offset, are generally hedged with foreign currency derivatives.
For our non-U.S. based entities, a substantial portion of revenues are generated and costs are incurred in local currencies. We transact business in various foreign currencies. which exposes our cash flows and earnings to changes in foreign currency exchange rates. We periodically enter into sales contracts denominated in currencies other than the functional currency of the parties to the transaction, which can create foreign exchange exposure. While the objective of the hedging program is to minimize the foreign currency exchange impact on operating results, there are typically variances between the hedging gains or losses and the translational impact due to the length of hedging contracts, changes in the sales profile, volatility in the exchange rates and other such operational considerations. Otis does not enter into hedging contracts for speculative purposes.
As discussed in Note 17, "Financial Instruments" to the Consolidated Financial Statements as of December 31, 2020, we have €420 million of euro-denominated commercial paper, which qualifies as a net investment hedge against our investments in European businesses. As of December 31, 2020, the net investment hedge is deemed to be effective.
Interest Rate Risk
Our long-term debt portfolio primarily consists of fixed-rate instruments. For any variable rate debt, interest rate changes in the London Interbank Offered Rate ("LIBOR") will impact future earnings and cash flows. From time to time, we may hedge floating rates using interest rate swaps. The hedges would be designated as fair value hedges and the gains and losses on the swaps would be reported in interest expense, reflecting that portion of interest expense at a variable rate.
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Cautionary Note Concerning Factors That May Affect Future Results
This 2020 Annual Report to Shareholders (2020 Annual Report) contains statements which, to the extent they are not statements of historical or present fact, constitute “forward-looking statements” under the securities laws. From time to time, oral or written forward-looking statements may also be included in other information released to the public. These forward-looking statements are intended to provide management’s current expectations or plans for Otis’ future operating and financial performance, based on assumptions currently believed to be valid. Forward-looking statements can be identified by the use of words such as “believe,” “expect,” “expectations,” “plans,” “strategy,” “prospects,” “estimate,” “project,” “target,” “anticipate,” “will,” “should,” “see,” “guidance,” “outlook,” “confident” and other words of similar meaning in connection with a discussion of future operating or financial performance or the Separation. Forward-looking statements may include, among other things, statements relating to future sales, earnings, cash flow, results of operations, uses of cash, dividends, share repurchases, tax rates and other measures of financial performance or potential future plans, strategies or transactions of Otis following the Separation, including the estimated costs associated with the Separation and other statements that are not historical facts. All forward-looking statements involve risks, uncertainties and other factors that may cause actual results to differ materially from those expressed or implied in the forward-looking statements. For those statements, Otis claims the protection of the safe harbor for forward-looking statements contained in the U.S. Private Securities Litigation Reform Act of 1995. Such risks, uncertainties and other factors include, without limitation:
•the effect of economic conditions in the industries and markets in which Otis and its businesses operate in the U.S. and globally and any changes therein, including financial market conditions, fluctuations in commodity prices, interest rates and foreign currency exchange rates, levels of end market demand in construction, the impact of weather conditions, pandemic health issues (including COVID-19 and its effects, among other things, on global supply, demand, and distribution disruptions as the coronavirus outbreak continues and results in an increasingly prolonged period of travel, commercial and/or other similar restrictions and limitations), natural disasters and the financial condition of Otis’ customers and suppliers;
•challenges in the development, production, delivery, support, performance and realization of the anticipated benefits of advanced technologies and new products and services;
•future levels of indebtedness, capital spending and research and development spending;
•future availability of credit and factors that may affect such availability, including credit market conditions and Otis’ capital structure;
•the timing and scope of future repurchases of Otis’ common stock ("Common Stock"), which, if commenced, may be suspended at any time due to various factors, including market conditions and the level of other investing activities and uses of cash;
•delays and disruption in delivery of materials and services from suppliers;
•cost reduction or containment actions, restructuring costs and related savings and other consequences thereof;
•new business and investment opportunities;
•the anticipated benefits of moving away from diversification and balance of operations across product lines, regions and industries;
•the outcome of legal proceedings, investigations and other contingencies;
•pension plan assumptions and future contributions;
•the impact of the negotiation of collective bargaining agreements and labor disputes;
•the effect of changes in political conditions in the U.S., including the new U.S. Administration, and other countries in which Otis and its businesses operate, including the United Kingdom’s recent withdrawal from the European Union, on general market conditions, global trade policies and currency exchange rates in the near term and beyond;
•the effect of changes in tax, environmental, regulatory (including among other things import/export) and other laws and regulations in the U.S. and other countries in which Otis and its businesses operate, including changes as a result of the new U.S. Administration;
•the ability of Otis to retain and hire key personnel;
•the scope, nature, impact or timing of acquisition and divestiture activity, including among other things integration of acquired businesses into existing businesses and realization of synergies and opportunities for growth and innovation and incurrence of related costs;
•the expected benefits of the Separation and the timing thereof;
•a determination by the Internal Revenue Service and other tax authorities that the distribution or certain related transactions should be treated as taxable transactions;
•risks associated with indebtedness incurred as a result of financing transactions undertaken in connection with the Separation;
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•the risk that dis-synergy costs, costs of restructuring transactions and other costs incurred in connection with the Separation will exceed Otis’ estimates; and
•the impact of the Separation on Otis’ businesses, resources, systems, procedures and controls, diversion of management’s attention and the impact on relationships with customers, suppliers, employees and other business counterparties.