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, supply chain issues, 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 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.
COVID-19, including variants of the original virus, has continued to spread throughout the world, resulting in prolonged travel restrictions and 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 and treatments for COVID-19, but further prolonged restrictions or the rollback of reopening measures due to higher infection rates may further disrupt our operations and the operations of our suppliers, distributors and customers. 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 and the ongoing economic recovery from the virus have adversely affected and may further affect our supply base and increase the potential for one or more of our suppliers to experience production constraints, distribution challenges, financial distress or bankruptcy, which could impact our ability to fulfill orders on time or at anticipated cost. Additionally, governments, including in the U.S., have enacted, or may enact, vaccine mandates. While the U.S. Supreme Court has recently blocked enforcement of one mandate, other mandates remain in effect, and uncertainty remains around whether additional mandates may be adopted in the future. Such mandates could result in labor disruptions, employee attrition, difficulty securing future labor needs and loss of government contracts. Furthermore, 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 74% of our 2021 net sales derived from international operations. Changes in local and regional economic conditions, including credit conditions and 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 trade relations between the U.S. and China (as discussed below), 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, with our New Equipment sales in China representing approximately 35% of our global New Equipment net sales and over half of our global New Equipment unit volume. Changes to market and economic conditions in China, including credit conditions for our customers, 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, Malaysia, Mexico, Poland, Russia, South Africa, Ukraine, Turkey and certain 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 differences in culturally accepted practices (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.
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, including in connection with the impact of COVID-19 and the ongoing economic recovery), price increases or
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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 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 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.
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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, 2021, we had $7.2 billion outstanding long-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; and
•reducing our flexibility in planning for or reacting to changes in our business and market conditions.
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 inflation concerns from the ongoing recovery from 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 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. If we raise additional funds by issuing debt, we may be subject to limitations on our operations due to restrictive covenants or rating agencies may downgrade our credit rating.
Quarterly cash dividends and share repurchases 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 suspended in connection with the Tender Offer. 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 market price of Common Stock, the nature and timing of other investment and acquisition 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, changes in laws or regulations related thereto or short-term stock price fluctuations could reduce the program's effectiveness.
See Item 5 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 anti-corruption, antitrust, anti-collusion, environmental or income tax laws. 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.
The Tender Offer of Zardoya Otis may not be completed at the price per share anticipated or result in the financial benefit in the time frame expected.
The Tender Offer is subject to approval by the CNMV and other uncertainties. Zardoya Otis shareholders may not tender their shares or there may be competing offers. The Company may not be able to complete the Tender Offer at the anticipated price or, if it does complete the Tender Offer, to realize certain cost and other expected benefits. If the Company is unable to complete the Tender Offer on the anticipated terms, time frame, or at all, the anticipated benefits may not be realized fully or at all, or may take longer to realize than expected, and the value of the Company's Common Stock may decline.
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 in Spain. (See the Risk Factor above regarding the Tender Offer). 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
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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 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, we are subject to the U.S. Foreign Corrupt Practices Act ("FCPA") and other anti-corruption laws that 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 22: Contingent Liabilities" in Item 8 of this Form 10-K.
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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 and adversely impact our financial results. See "Note 13: Employee Benefit Plans" in Item 8 of this Form 10-K for further discussion on pension plans and related obligations and contingencies.
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 personally identifiable or confidential data of our customers who purchase and use such products either separately or as a part of another product or system or by way of access to our websites or social media accounts. 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 and have experienced cyber-attacks in the past, both our internal systems and products may be vulnerable to hacking or further 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 compromise of 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, which continue to evolve, and in certain cases, include provisions that are unclear. Government enforcement actions, including due to geopolitical concerns, 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 partial 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 would 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.
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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 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, 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.
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See “Business Overview” and “Results of Operations - Income Taxes” in Item 7 and "Note 2: Significant Accounting Policies" and "Note 16: Income Taxes" in Item 8 in this Form 10-K, for further discussion on income taxes and related contingencies.
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% 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% 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.
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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 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 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.
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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 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
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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 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% 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.
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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 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 15 million square feet of space as of December 31, 2021, compared to approximately 16 million square feet of space as of December 31, 2020. We have approximately 2,300 facilities, of which approximately 50%, 37% and 13% of which are located in EMEA, Asia 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, 2021 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, 2021 are substantially in good operating condition.
Item 3. Legal Proceedings
For a discussion regarding material legal proceedings, see "Note 22, Contingent Liabilities" to the Consolidated Financial Statements within Item 8 of this Form 10-K.
Item 4. Mine Safety Disclosures
Not applicable.
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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 22,100 registered shareholders at January 21, 2022. 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 in this Form 10-K.
Stock Performance Graph
The following table and graph illustrate the total return from April 3, 2020 (date of Separation) through December 31, 2021, for (1) our Common Stock, (2) the Standard and Poor's ("S&P") 500 Index, and (3) the S&P 500 Industrial Sector Index. The graph and table assume that $100.00 was invested on April 3, 2020 in each of our Common Stock, the S&P 500 Index and the S&P 500 Industrial Select Sector Index, and that any dividends were reinvested. The comparison reflected in the graph and the table are not intended to forecast the future performance of our Common Stock and may not be indicative of our future performance.
Comparison of Cumulative Total Return - Table
Comparison of Cumulative Total Return - Graph
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Issuer Purchases of Equity Securities
The following table provides information about our purchases during the quarter ended December 31, 2021 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act.
October 1 - October 31 — $ — — $ 275
November 1 - November 30 — — — $ 275
December 1 - December 31 — — — $ 275
Total — $ — —
(1) Average price paid per share includes costs associated with the repurchases.
On April 27, 2020, our Board of Directors authorized a share repurchase program for up to $1 billion of Common Stock. As of December 31, 2021, the maximum dollar value of shares that may yet be purchased under this current program was approximately $275 million. 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 Exchange Act. As a result of the increased debt incurred to fund the Tender Offer, we have temporarily suspended our share repurchases as we focus on deleveraging.
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Item 6. [Reserved]
Item 7. 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 function under a centralized operating model whereby we pursue a global strategy set around New Equipment and Service, in large measure, 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 of our business, refer to Item 1 in this Form 10-K.
Zardoya Otis Tender Offer
The Company announced a tender offer to acquire all of the issued and outstanding shares of Zardoya Otis not owned by Otis (the "Tender Offer"). The offer price is €7.07 per share in cash after adjusting for dividends. As of February 4, 2022, the Tender Offer remains outstanding and has not yet been completed. See "Note 1: Business Overview" and "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K, as well as "Liquidity and Financial Condition" in this item, for further details regarding this pending transaction and financing arrangements entered into in connection with the Tender Offer and Item 1A in this Form 10-K for additional risks related to thereto.
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 years ended December 31, 2021 and 2020. COVID-19 has had, and could continue to have, an impact on our business, including impacts to overall financial performance in 2022, as a result of the following, among other things:
•Customer demand impacting our new equipment, maintenance and repair, and modernization businesses
•Cancellations or delays of customer orders
•Customer liquidity constraints and related credit reserves
•Supplier and raw material capacity constraints, delays and related costs
We currently do not expect any significant impact to our capital and financial resources from the COVID-19 pandemic, including our overall liquidity position based on our available cash and cash equivalents and our access to credit facilities and the capital markets.
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See the "Liquidity and Financial Condition" section of this item of this Form 10-K for further detail and Item 1A in this Form 10-K for additional risks related to COVID-19.
Separation from United Technologies Corporation
As previously disclosed, on April 3, 2020, Otis became an independent, publicly-traded company and its Common Stock is listed under the symbol "OTIS" on the New York Stock Exchange ("NYSE") as a result of the separation ("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).
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 our former parent, UTC. For the periods subsequent to April 3, 2020, our financial statements are presented on a consolidated basis as the Company became a standalone public company.
We entered into a transition services agreement ("TSA") and tax matters agreement ("TMA") with our former parent, UTC, and Carrier on April 2, 2020. Under the TSA, we received services for information technology, technical and engineering support, application support for operations, general administrative services and other support services. The TSA and the related trailing exit costs are substantially completed as of December 31, 2021. For additional discussion, see "Note 5: Related Parties" in Item 8 in this Form 10-K.
The TMA 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). For additional discussion, see "Note 5: Related Parties" in Item 8 in this Form 10-K.
See Item 1A in this Form 10-K for discussion on risks related to Separation.
RESULTS OF OPERATIONS
Net Sales
Percentage change year-over-year 12.1 % (2.8) % 1.6 %
The factors contributing to the total percentage change year-over-year in total Net sales are as follows:
Organic volume 8.9 % (2.1) %
Foreign currency translation 3.0 % (0.4) %
Acquisitions and divestitures, net 0.2 % (0.2) %
Other — % (0.1) %
Total % change 12.1 % (2.8) %
The Organic volume increase of 8.9% for 2021 was driven by increases in organic sales of 15.5% in New Equipment and 4.1% in Service.
The Organic volume decrease of (2.1)% for 2020 was driven by decreases in organic sales of (4.0)% in New Equipment and (0.7)% in Service.
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 12.6 % (3.4) % 1.1 %
The factors contributing to the percentage change year-over-year in total cost of products and services sold are as follows:
Organic volume 9.1 % (2.7) %
Foreign currency translation 3.3 % (0.5) %
Acquisitions and divestitures, net 0.2 % (0.2) %
Total % change 12.6 % (3.4) %
The organic increase in total cost of products and services sold in 2021 was driven primarily by the organic sales increases noted above.
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.
Gross Margin
Gross margin decreased 30 basis points in 2021 when compared to 2020, as improvements in gross margin in both New Equipment and Service were more than offset by overall segment mix.
Gross margin increased 40 basis points in 2020 when compared to 2019, primarily driven by improvement in the Service margin and overall segment mix, partially offset by a decrease in the New Equipment margin.
Research and Development
Percentage of Net sales 1.1 % 1.2 % 1.2 %
Research and development spending increased $7 million, or 4.6%, in 2021 compared to 2020. Research and development expense as a percentage of net sales has remained relatively flat year-over-year. Research and development includes product development and innovation, including for IoT and developing the next generation of connected elevators and escalators.
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 2020. Research and development expenses remained relatively consistent as a percentage of Net sales.
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Selling, General and Administrative
2021 Compared with 2020
Selling, general and administrative expenses increased $24 million, or 1.2%, in 2021. The primary drivers of the change are the following:
•Higher employment and information technology costs, including incremental standalone public company costs, and the absence of cost containment actions taken during 2020 in response to COVID-19;
•Impact of unfavorable foreign exchange of $38 million compared to 2020;
•These increases were partially offset by lower non-recurring Separation-related costs and the absence of UTC allocations of $105 million.
Selling, general and administrative expenses as a percentage of Net sales decreased 150 basis points in 2021 compared to 2020, as Net sales increased at a faster rate than expenses.
2020 Compared with 2019
Selling, general and administrative expenses increased approximately $114 million, or 6.3%, in 2020, The primary drivers of the change are the following:
•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
•Higher non-recurring Separation-related costs and incremental standalone public company costs.
Selling, general and administrative expenses as a percentage of Net sales increased 130 basis points in 2020 compared to 2019, primarily driven by the increase in non-recurring Separation-related costs, incremental standalone public company costs and lower Net sales.
Restructuring Costs
Restructuring costs $ 56 $ 77 $ 54
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 office and manufacturing operations. We continue to closely monitor the economic environment and may undertake further restructuring actions to keep our cost structure aligned with the demands of the prevailing market conditions.
Total 2021 restructuring costs include $41 million of costs related to 2021 actions, $13 million of costs related to 2020 actions and $2 million of costs related to pre-2020 actions.
Most of the expected charges will require cash payments, which we have funded and expect to continue to fund with cash generated from operations. During 2021, we had cash outflows of approximately $51 million related to the restructuring actions and expect to make cash payments of $47 million to complete the actions announced, which is comprised of $7 million of additional restructuring expenses and $40 million of existing restructuring accruals as of December 31, 2021.
We generally expect to achieve annual recurring savings within the two-year period subsequent to initiating the actions, including $41 million for the 2021 actions and $55 million for the 2020 actions, of which approximately $66 million was realized for the 2021 and 2020 actions during the current year.
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For additional discussion of restructuring, see Note 17, "Restructuring Costs" in the Consolidated Financial Statements.
Other Income (Expense), Net
Other income (expense), net $ 22 $ (64) $ (39)
Other income (expense), net primarily includes the impact of changes in the fair value and settlement of 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 and certain other operating items.
The change in Other income (expense), net of $86 million in 2021 compared to 2020, was primarily driven by the absence of a fixed asset impairment of $(71) million and related licensing costs of $(14) million recognized during 2020.
The change in Other income (expense), net of $(25) million in 2020 compared to 2019, was driven by fixed asset impairments of $(71) million and related license costs of $(14) million and non-recurring Separation-related expenses. These were partially offset by favorable mark-to-market adjustments on foreign currency derivatives of $46 million when compared to 2019, the absence of the loss on the sale of a business of $19 million included in the 2019 results and a non-recurring gain of $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 2020.
See "Note 5: Related Parties" in Item 8 in this Form 10-K for further discussion on costs related to the Separation.
Interest Expense (Income), Net
Interest expense (income), net $ 136 $ 122 $ (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, in 2019 and prior, related party activity between Otis and our former parent, UTC.
The increase in Interest expense (income), net of $14 million in 2021 compared to 2020, was primarily driven by interest expense on the external debt associated with the Separation, which was not outstanding for the full year of 2020, as well as costs associated with the bridge financing and related guarantees and the interest expense related to the Tender Offer. This was partially offset by lower interest expense as a result of the debt refinancing and debt repayments during 2021. For additional discussion of debt refinancing and repayments, see the "Liquidity and Financial Condition" section below.
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 and debt issuance cost amortization of $5 million in 2020. These expenses were partially offset by interest income on short-term investments.
The average interest rate on our external debt for 2021 and 2020 was 2.3%.
For additional discussion of borrowings, see "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K.
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Income Taxes
The 2021, 2020 and 2019 effective tax rates are 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 U.S. Tax Cuts and Jobs Act ("TCJA").
The 2021 effective tax rate is lower than the 2020 effective tax rate primarily due to the following:
•$16 million tax benefit related to repatriation of foreign earnings as a result of changes to planned debt repayments and in estimates related to Otis’ pre-Separation tax attributes;
•$16 million decrease in U.S. tax related to base erosion and anti-abuse tax in 2021;
•Absence of the tax cost resulting from Separation-related expenses and fixed asset impairment incurred in 2020; and
•The net impact of income tax settlements related to the Separation, as discussed in Note 5, "Related Parties".
The 2020 effective tax rate is lower than the 2019 effective tax rate primarily due to a $10 million tax benefit related to our change in assertion of no longer intending to reinvest certain undistributed earnings of our international subsidiaries made during 2020 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 2020, as well as a recognition of a Separation-related foreign tax loss, all partially offset by incremental withholding taxes in 2020.
For additional discussion of income taxes and the effective income tax rate, see "Note 16: Income Taxes" in Item 8 in this Form 10-K.
Noncontrolling Interest in Subsidiaries' Earnings
Noncontrolling interest in subsidiaries' earnings $ 174 $ 150 $ 151
Noncontrolling interest in subsidiaries' earnings increased in 2021 in comparison to 2020, primarily driven by an increase in net income from non-wholly owned subsidiaries and the impact of foreign exchange rates. Ownership interest in the underlying non-wholly owned subsidiaries has remained generally consistent year-over-year.
For additional discussion of the Zardoya Otis Tender Offer, see "Note 1: Business Overview" in Item 8 in this Form 10-K.
Noncontrolling interest in subsidiaries' earnings remained consistent in 2020 in comparison to 2019.
Net Income Attributable to Otis Worldwide Corporation
(dollars in millions, except per share amounts) 2021 2020 2019
Net income attributable to Otis Worldwide Corporation $ 1,246 $ 906 $ 1,116
Diluted earnings per share $ 2.89 $ 2.08 $ 2.55
Net income attributable to Otis Worldwide Corporation increased in 2021, compared to the same period in 2020, primarily driven by higher operating profit and the benefit of a lower effective tax rate, partially offset by higher noncontrolling interest in subsidiaries' earnings and higher interest expense.
Net income attributable to Otis Worldwide Corporation decreased in 2020, compared to the same period in 2019, primarily driven by non-recurring Separation-related costs, fixed asset impairments, non-recurring Separation-related tax
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benefits, the impact of non-recurring tax items, and incremental standalone public company costs incurred in 2020 after the Separation.
For additional discussion of the net income attributable to shareholders and earnings per share, see "Note 3: Earnings Per Share" in Item 8 in this Form 10-K.
Segment Review
Net Sales Operating Profit Operating Profit Margin
General corporate expenses and other — — — (113) (290) (182) — — —
As previously disclosed in our Quarterly Report on Form 10-Q for the quarter ending June 30, 2021, we changed how we present and discuss operating profit in our Segment Review of the Management’s Discussion and Analysis. Previously, we presented and discussed the percentage change in segment operating profit between periods using organic/operational profit, which excluded the impact of foreign currency translation, acquisitions and divestitures and restructuring costs. We are now presenting and discussing, including for the 2020 to 2019 comparison, the change in the total dollar amount of segment operating profit and the percentage change in operating profit margin between periods. There is no change in the amounts of operating profit that we have previously disclosed. We have continued to use the same key metrics to explain the changes in our operating performance that we previously used. For example, as discussed below, the drivers of the changes in 2021 relative to the prior year are volume, rate drivers, selling general and administrative expense, foreign exchange and restructuring which are consistent with the drivers we have disclosed in the past where applicable. In addition, we will discuss the impact of foreign currency translation, acquisitions and divestitures and restructuring to the extent they are meaningful to understanding our performance. We believe this changed approach aligns better with how we measure our performance.
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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. We also sell New Equipment to government agencies to support infrastructure projects, such as airports, railways or metros.
Summary performance for New Equipment for the years ended December 31, 2021, 2020 and 2019 was as follows:
Total Increase (Decrease)Year-Over-Year for:
Operating profit margin 7.1 % 5.9 % 7.0 %
Summary analysis of the Net sales change for New Equipment for the years ended December 31, 2021 and 2020 compared with the prior years was as follows:
Components of Net sales change: 2021 2020
Foreign currency translation 4.1 % (0.8) %
Acquisitions/Divestitures, net 0.1 % (0.1) %
Total % change 19.7 % (4.9) %
2021 Compared with 2020
The organic sales increase of 15.5% was driven by mid-teens growth in the Americas, high teens growth in Asia and high single digit growth in EMEA.
New Equipment operating profit increased $141 million, primarily due to higher volume of $140 million, with an operating margin increase of 120 basis points. Favorable field installation and material productivity was partially offset by unfavorable price and mix and commodity headwinds. Foreign currency tailwinds of $30 million were more than offset by higher selling, general and administrative costs of $40 million.
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 operating profit decreased $(75) million, with an operating profit margin decrease of 110 basis points. Strong material productivity of $60 million and cost containment actions were more than offset by lower volume of $(35) million and unfavorable rate drivers of $(90) million 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 of $(10) million, higher restructuring costs of $(10) million and incremental public company standalone costs.
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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.
Summary performance for Service for the years ended December 31, 2021, 2020 and 2019 was as follows:
Total Increase (Decrease)Year-Over-Year for:
Summary analysis of the Net sales change for Service for the years ended December 31, 2021 and 2020 compared with the prior years was as follows:
Components of Net sales change: 2021 2020
Organic 4.1 % (0.7) %
Foreign currency translation 2.3 % (0.1) %
Acquisitions/Divestitures, net 0.2 % (0.3) %
Total % change 6.6 % (1.1) %
2021 Compared with 2020
Net Sales
The organic sales increase of 4.1% is due to organic sales increases in maintenance and repair of 4.5% and modernization of 2.5%.
Components of Net sales change: Maintenance and Repair Modernization
Foreign currency translation 2.2 % 1.9 %
Acquisitions/Divestitures, net 0.3 % 0.1 %
Total % change 7.0 % 4.5 %
Operating profit
Service operating profit increased $151 million, primarily due to higher volume of $120 million, with an operating margin increase of 60 basis points. Favorable pricing and mix and lower bad debt expense were partially offset by the absence of the benefit from prior year field actions taken in response to COVID-19. Foreign exchange tailwinds of $35 million and lower restructuring expense of $15 million were more than offset by higher selling general and administrative costs of $60 million, including the impact from cost containment actions taken in the prior year.
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2020 Compared with 2019
Net Sales
The organic sales decrease of (0.7)% is due to a sales decrease in maintenance and repair of (0.9)%, with modernization sales remaining flat.
Components of Net sales change: Maintenance and Repair Modernization
Organic (0.9) % 0.1 %
Foreign currency translation (0.1) % 0.1 %
Acquisitions/Divestitures, net (0.2) % (1.1) %
Total % change (1.2) % (0.9) %
Operating Profit
Service operating profit increased $8 million, with an operating profit margin increase of 30 basis points. Favorable productivity, pricing and mix, and cost containment actions more than offset the combined impact of price concessions, lower volume 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.
General Corporate Expenses and Other
General corporate expenses and other $ (113) $ (290) $ (182)
General corporate expenses and other decreased $(177) million in 2021 compared to 2020, primarily due to the absence of a fixed asset impairment of $(71) million and related licensing costs of $(14) million recognized in 2020, as well as lower non-recurring Separation costs and the absence of UTC allocations of $(108) million.
General corporate expenses and other increased $108 million in 2020 compared to 2019, primarily driven by fixed asset impairments of $71 million and associated license costs of approximately $14 million, non-recurring Separation-related costs of $119 million and incremental standalone public company costs in 2020. 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 as a result of the fire in our manufacturing facility in Germany recognized in 2020.
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LIQUIDITY AND FINANCIAL CONDITION
Cash and cash equivalents $ 1,565 $ 1,782
Net debt (total debt less cash and cash equivalents) 5,708 4,181
Total capitalization (total debt plus total equity) 4,129 2,568
Total debt to total capitalization 176 % 232 %
Net debt to net capitalization 223 % 532 %
As of December 31, 2021, we had cash and cash equivalents of approximately $1.6 billion, of which approximately 91% 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, 2021 and 2020, the amount of such restricted cash was approximately $1.9 billion and $19 million, respectively, including the proceeds from the issuance of debt that is restricted in order to fund the Tender Offer. See further discussion of debt issuances below.
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, 2021 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 long-term debt issuances in 2021 and 2020:
(dollars in millions)
Issuance Date Description of Debt Aggregate Principal Balance
The net proceeds from the February and March 2020 debt issuances listed above, totaling $6.3 billion, were used to distribute cash to UTC as part of the Separation in 2020. The proceeds from the March 2021 issuance of Japanese Yen notes listed above were used to repay a portion of our outstanding Euro denominated commercial paper. The proceeds from the November 2021 issuance of the Euro notes listed above are held in escrow to fund the Tender Offer, which is reflected as Restricted cash on the Consolidated Balance Sheet as of December 31, 2021.
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The following is a summary of the long-term debt repayments in 2021 and 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. In 2021, the commercial paper was repaid in full, using cash from operations and proceeds from the issuance of the Japanese Yen notes. For additional discussion of borrowings, including commercial paper activity, see "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K.
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, of which approximately $725 million has been utilized as of December 31, 2021. 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. During 2021, the Company repurchased 9.7 million shares of Common Stock for approximately $725 million. As a result of the increased debt incurred to fund the Tender Offer, we have temporarily suspended share repurchases as we focus on deleveraging.
Cash Flow - Operating Activities
Net cash flows provided by operating activities $ 1,750 $ 1,480 $ 1,469
2021 Compared with 2020
Cash generated from operating activities in 2021 was $270 million higher than in 2020, primarily due to higher net income of$364 million and increased cash inflows related to current assets and current liabilities activity of $83 million, as described below. These were partially offset by $98 million of lower non-cash adjustments from Net income, including the absence of fixed asset impairments of $71 million in 2020, as well as $106 million of lower Other operating activities, net, primarily due to long-term accruals in 2020.
2021 Changes in Working Capital
The 2021 cash inflows related to current assets and current liabilities operating activity were $160 million, including the following main drivers:
•Accounts payable, which increased by $130 million, primarily due to increased volume;
•Accrued liabilities, which increased by $72 million, primarily due to the timing of payments, which more than offset the payments of $56 million in foreign tax obligations pursuant to the TMA and income tax liabilities in certain jurisdictions;
•Contract assets, current and Contract liabilities, current, net change of $53 million, driven by the timing of billings on contracts compared to the progression on current contracts; and
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•Other current assets, which decreased by $43 million, primarily due to prepaid income tax utilization and indemnification payments received pursuant to the TMA in order to pay foreign tax obligations, partially offset by advanced payments to suppliers; partially offset by
•Accounts receivable, net, which increased by $152 million, primarily due to increased volume.
2020 Compared with 2019
Cash generated from operating activities in 2020 was $11 million higher than in 2019, primarily due to increased cash inflows related to current assets and current liabilities 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:
•Net change in Contract assets, current and Contract liabilities, current 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; partially offset by
•Inventories, net, which increased by $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 by $163 million due to slower collections and increased customer financing activity.
Additionally, Other current assets decreased by $28 million due to receipt of indemnification payments pursuant to the TMA in order to pay foreign tax obligations, partially offset by tax prepayments in certain 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 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" in Item 8 in this Form 10-K for further discussion on transactions with our former parent UTC.
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Cash Flow - Investing Activities
Net cash flows used in investing activities $ (89) $ (353) $ (203)
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.
2021 compared to 2020
Investing Activities:
Capital expenditures $ (156) $ (183) $ 27
Investments in businesses and intangible assets (80) (53) (27)
Proceeds from sale of (investments in) equity securities 40 (51) 91
Receipts (payments) on settlements of derivative contracts 73 (69) 142
Other investing activities, net 34 3 31
Net cash flows used in investing activities $ (89) $ (353) $ 264
Cash flows used in investing activities in 2021 compared to 2020 decreased $264 million, including the following main drivers:
•$142 million higher net cash from the settlement of derivative instruments in 2021, with net cash receipts of $73 million and payments of $69 million in 2021 and 2020, respectively;
•$91 million higher net cash from equity securities, including $58 million of proceeds from the sale of equity securities in 2021, compared to $(51) million of investments made in equity securities in 2020; and
•$31 million higher Other investing activities, net primarily due to property damage insurance proceeds received and discussed below under "Germany Fire", as well as proceeds from the sales of fixed assets.
As discussed in Note 18, "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, foreign exchange rates and commodity prices. 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 and commodity price exposures.
Germany Fire
As previously disclosed, during 2020 there was a fire at the Company’s manufacturing facility in Germany. During 2021, the Company settled the related property damage claim with the insurance company, as reflected in Other investing activities, net in the Consolidated Statements of Cash Flows. During 2021, the Company also reached a final agreement with the insurance company related to the business interruption claim to cover costs incurred as a result of the fire and received the final payments during the year. The impact to our operations or financial results from this event was not material.
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2020 compared to 2019
Investing Activities:
Capital expenditures $ (183) $ (145) $ (38)
Investments in businesses and intangible assets (53) (47) (6)
Proceeds from sale of (investments in) equity securities (51) — (51)
Proceeds from sale of equity securities — — —
Receipts (payments) on settlements of derivative contracts (69) (5) (64)
Other investing activities, net 3 (6) 9
Cash flows used in investing activities in 2020 compared to 2019 increased $150 million, including the following drivers:
•$64 million higher net cash payments from the settlement of derivative instruments in 2020, including $21 million of payments associated with the hedges of foreign-denominated TMA indemnification assets;
•$51 million of investments in 2020 related to equity securities;
•$38 million higher capital expenditures; and
•$6 million higher investments in business.
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Cash Flow - Financing Activities
Net cash flows provided by (used in) financing activities $ 58 $ (844) $ (1,133)
Financing activities primarily include increases or decreases to short-term borrowings, issuance or repayment of long-term debt, dividends paid to common shareholders, repurchases of Common Stock and dividends paid to non-controlling interests. The activity in 2020 and 2019 includes transfers to and from our former parent, UTC, prior to the Separation, consisting of, among other things, cash transfers, distributions, cash investments and changes in receivables and payables. For further discussion on these transfers, see "Note 5: Related Parties" in Item 8 in this Form 10-K.
2021 compared to 2020
Financing Activities:
Increase (decrease) in short-term borrowings, net $ (655) $ 647 $ (1,302)
Payment of debt issuance costs (25) (43) 18
Repayment of long-term debt — (1,000) 1,000
Dividends paid on Common Stock (393) (260) (133)
Repurchases of Common Stock (725) — (725)
Dividends paid to noncontrolling interest (155) (149) (6)
Other financing activities, net (19) (9) (10)
Net cash flows provided by (used in) financing activities $ 58 $ (844) $ 902
Net cash provided by financing activities was $58 million in 2021 compared to net cash used by financing activities of $844 million in 2020, which changed primarily due to the following:
•Net borrowings of $1.4 billion during 2021 compared to net repayments on borrowings of $353 million during 2020. These were comprised of the following activities:
◦Net proceeds from the issuance of long-term debt of $2.0 billion, partially offset by net repayments of short-term borrowings of $655 million during 2021; and
◦Repayments of long-term debt of $1.0 billion, partially offset by net short-term borrowings of $647 million during 2020.
•Repurchases of Common Stock of $725 million and higher dividends paid on Common Stock of $133 million during 2021; and
•Net transfers to UTC related to the Separation of $6.3 billion during 2020, which were primarily funded by the net proceeds from issuance of long-term debt of $6.3 billion during 2020.
Net borrowings in 2021 include €1.6 billion in proceeds from the issuance of Euro denominated notes, which will be used to fund the Tender Offer. For additional discussion of borrowings activity, see "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K.
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2020 compared to 2019
Financing Activities:
Increase (decrease) in short-term borrowings, net $ 647 $ 6 $ 641
Proceeds from issuance of long-term debt 6,300 — 6,300
Payment of debt issuance costs (43) — (43)
Repayment of long-term debt (1,000) — (1,000)
Dividends paid on Common Stock (260) — (260)
Dividends paid to noncontrolling interest (149) (163) 14
Other financing activities, net (9) (4) (5)
Net cash used in financing activities decreased $289 million in 2020 compared to 2019 primarily due to the net proceeds from the issuance of long-term debt of $6.3 billion in 2020, of which $1.0 billion was repaid with $641 million of proceeds from the issuance of short-term commercial paper in 2020 and cash from operations. These net inflows were partially offset by a $5.4 billion increase in net transfers to UTC related to the Separation, and a $260 million increase in dividends paid on Common Stock in 2020. See "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K for further discussion on borrowings.
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Guaranteed Securities: Summarized Financial Information
The following information is provided in compliance with Rule 13-01 of Regulation S-X under the Securities Exchange Act of 1934, as amended, with respect to the 2023 Euro Notes, the 2026 Euro Notes and the 2031 Euro Notes (together the "Euro Notes"), in each case issued by Highland Holdings S.à r.l. (“Highland”), a private limited liability company (société à responsabilité limitée) incorporated and existing under the laws of the Grand Duchy of Luxembourg ("Luxembourg"). The Euro Notes are fully and unconditionally guaranteed by Otis Worldwide Corporation ("OWC") on an unsecured, unsubordinated basis. Refer to "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K for additional information.
Highland is a wholly-owned, indirect consolidated subsidiary of OWC. OWC is incorporated under the laws of Delaware. As a company incorporated and existing under the laws of Luxembourg, and with its registered office in Luxembourg, Highland is subject to Luxembourg insolvency and bankruptcy laws in the event any insolvency proceedings are initiated against it. Luxembourg bankruptcy law is significantly different from, and may be less favorable to creditors than, the bankruptcy law in effect in the United States and may make it more difficult for creditors to recover the amount they could expect to recover in liquidation under U.S. insolvency and bankruptcy rules.
The Euro Notes are not guaranteed by any of OWC's or Highland's subsidiaries (all OWC subsidiaries other than Highland are referred to herein as "non-guarantor subsidiaries"). Holders of the Euro Notes will have a direct claim only against Highland, as issuer, and OWC, as guarantor.
The following tables set forth the summarized financial information as of and for the years ended December 31, 2021 and 2020 of each of OWC and Highland on a standalone basis, which does not include the consolidated impact of the assets, liabilities, and financial results of their subsidiaries except as noted on the tables below, nor does it include any impact of intercompany eliminations as there were no intercompany transactions between OWC and Highland. This summarized financial information is not intended to present the financial position or results of operations of OWC or Highland in accordance with U.S. GAAP.
Year Ended December 31,
OWC Statement of Operations - Standalone and Unconsolidated
Revenue $ — $ —
Cost of revenue — —
Operating expenses 13 10
Income from consolidated subsidiaries 19 4
Net income (loss) excluding income from consolidated subsidiaries (116) (100)
As of December 31,
OWC Balance Sheet - Standalone and Unconsolidated
Current assets (intercompany receivables from non-guarantor subsidiaries) — —
Noncurrent assets, investments in consolidated subsidiaries 1,271 1,348
Noncurrent assets (excluding investments in consolidated subsidiaries) 48 62
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Year Ended December 31,
Highland Statement of Operations - Standalone and Unconsolidated
Revenue $ — $ —
Cost of revenue — —
Operating expenses — —
Income from consolidated subsidiaries 635 445
Net income (loss) excluding income from consolidated subsidiaries (3) (1)
As of December 31,
Highland Balance Sheet - Standalone and Unconsolidated
Current assets (intercompany receivables from non-guarantor subsidiaries) 2 87
Noncurrent assets (investments in consolidated subsidiaries) 12,524 11,251
Noncurrent assets (excluding investments in consolidated subsidiaries) — —
Noncurrent liabilities 1,795 —
CRITICAL ACCOUNTING ESTIMATES
Preparation of the consolidated 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" in Item 8 in this Form 10-K 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
We recognized revenue in accordance with FASB ASC Topic 606: Revenue from Contracts with Customers and its related amendments,(referred to, collectively, as "ASC 606”). 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 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" in Item 8 in this Form 10-K.
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Income Taxes
The future tax benefit arising from deductible temporary differences and tax carryforwards was $647 million as of December 31, 2021 and $642 million as of December 31, 2020. 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 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 "Note 3: Earnings Per Share" and "Note 15: Accumulated Other Comprehensive Income (Loss)" in Item 8 in this Form 10-K for further discussion. Additionally, see "Note 22: Contingent Liabilities" in Item 8 in this Form 10-K 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 operating 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, 2021 and determined that no adjustment to goodwill was necessary as the fair value of each reporting unit was in excess of the carrying value of each reporting unit.
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Contingent Liabilities
Otis is party to litigation related to a number of matters as described in "Note 22: Contingent Liabilities" in Item 8 in this Form 10-K. 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 in this Form 10-K for further discussion.
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 as of 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, 2021:
Pension plans
Projected benefit obligation $ (29) $ 30
Net periodic pension (benefit) cost (2) 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 2021 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 increased in 2021 as compared with 2020, and, as a result, the weighted-average discount rate used to measure pension liabilities was 1.5% in 2021 and 1.1% in 2020.
See "Note 13: Employee Benefit Plans" in Item 8 in this Form 10-K for further discussion.
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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.
Otis' contractual obligations and commitments as of December 31, 2021 are discussed below. See also "Note 13: Employee Benefit Plans" in Item 8 of this Form 10-K for further discussion of our expected pension and postretirement contributions.
Long-term Debt
See "Note 10: Borrowings and Lines of Credit" in Item 8 of this Form 10-K for further discussion of our long-term debt principal payments as of December 31, 2021. In the following table, we show the timing of payments of interest on long-term debt as of December 31, 2021:
Payments Due by Period
Purchase Obligations
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. We enter into contractual purchase commitments with suppliers and service vendors to support our information technology that are either necessary to operate our business or are resulting from implementing strategic initiatives. In the following table, we show the timing of payments of total purchase obligations as of December 31, 2021:
Payments Due by Period
Other Long-term Liabilities
Other long-term liabilities in the table below includes obligations relate to product service and warranty policies, estimated remediation costs and contractual indemnities, and are included in Other long-term liabilities on the "Consolidated Balance Sheets" in Item 8 of this Form 10-K. 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 and were as follows as of December 31, 2021:
Payments Due by Period
The balance above includes $220 million of long-term contractual payables due to RTX for reimbursement of tax payments that RTX is responsible to pay after the Separation pursuant to the TMA. Otis will reimburse RTX for those tax payments through 2027.
Unrecognized Tax Benefits
Otis has unrecognized tax benefits of $392 million as of December 31, 2021, the timing of which is uncertain to become payable. See "Note 16: Income Taxes" in Item 8 in this Form 10-K for additional discussion on unrecognized tax benefits.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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, commodity prices 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, as of December 31, 2021, 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 18: Financial Instruments" in Item 8 in this Form 10-K for additional discussion of foreign currency exchange, interest rates and financial instruments, including the aggregate notional amount of our outstanding foreign currency and commodity price 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 $10.6 billion, $9.3 billion and $9.5 billion in 2021, 2020 and 2019, 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 18: Financial Instruments" in Item 8 in this Form 10-K, as of December 31, 2021 we have ¥21.5 billion ($189 million) of Japanese Yen denominated long-term debt, which qualifies as a net investment hedge against our investments in Japanese businesses. As of December 31, 2021, the net investment hedge is deemed to be effective.
As discussed in "Note 10: Borrowings and Lines of Credit" in Item 8 in this Form 10-K, as of December 31, 2021 we have €1,600 million ($1,807 million) of Euro denominated long-term debt.
Commodity Price Risk
The fluctuation in prices of certain raw materials may impact Otis' financial results. We are exposed to volatility in the prices of commodities used in some of our products and component parts, such as steel, aluminum and copper, among others. When possible and appropriate, we maintain fixed price contracts on raw materials and component parts. However, we are prone to exposure as these contracts expire. When possible and appropriate, we also include price escalation linked to commodity prices in contracts with our customers and take pricing actions for future contracts. However, products and services delivered to our customers are often provided a year or more after being agreed to, and not all raw material price increases can be passed along to customers with existing contracts. Therefore, when commodity price risk is not mitigated by other methods, we may enter into hedging contracts. Otis does not enter into hedging contracts for speculative purposes.
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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.
For information concerning market risk sensitive instruments, see discussion under the headings "Foreign Exchange Exposures" and "Derivatives and Hedging Activity" in "Note 2: Summary of Accounting Policies," as well as "Note 18: Financial Instruments" in Item 8 in this Form 10-K for additional discussion on unrecognized tax benefits.
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Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE
Page
Management's Report on Internal Control Over Financial Reporting 53
Report of Independent Registered Public Accounting Firm (PCAOB ID 238) 54
Consolidated Balance Sheets as of December 31, 2021 and 2020 58
Notes to Consolidated Financial Statements 61
(All other schedules are not required and have been omitted)
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Management's Report on Internal Control over Financial Reporting
The management of Otis 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 United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Management has assessed the effectiveness of Otis' internal control over financial reporting as of December 31, 2021. 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). Management concluded that based on its assessment, Otis' internal control over financial reporting was effective as of December 31, 2021. The effectiveness of Otis' internal control over financial reporting, as of December 31, 2021, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.
OTIS WORLDWIDE CORPORATION(Registrant)
by: /s/ JUDITH F. MARKS
Judith F. Marks
Chair, President and Chief Executive Officer
by: /s/ RAHUL GHAI
Rahul Ghai
Executive Vice President and Chief Financial Officer
by: /s/ MICHAEL P. RYAN
Michael P. Ryan
Vice President and Chief Accounting Officer
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Otis Worldwide Corporation
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Otis Worldwide Corporation and its subsidiaries (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of operations, of comprehensive income, of changes in equity and of cash flows for each of the three years in the period ended December 31, 2021, including the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s 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 purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Revenue Recognition - Estimated Costs at Completion for New Equipment Contracts
As described in Notes 2 and 23 to the consolidated financial statements, the Company recognized $6.4 billion of revenue from new equipment contracts for the year ended December 31, 2021. For new equipment 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 recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress. As disclosed by management, 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. The long-term nature of the contracts, the complexity of the products and the scale of the projects can affect management’s ability to estimate costs precisely. Management reviews cost estimates on significant new equipment 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. Management records changes in contract estimates using the cumulative catch-up method and reviews changes in contract estimates for their impact on net sales or operating profit in the consolidated financial statements. 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 principal considerations for our determination that performing procedures relating to revenue recognition - estimated costs at completion for new equipment contracts is a critical audit matter are the significant judgment by management to determine the estimated costs at contract completion, which in turn led to significant auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence related to the estimated expected labor and indirect labor costs used in the development of estimated costs at contract completion.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the determination of the estimated costs at contract completion and development of the significant assumptions related to the estimated expected labor and indirect labor costs. These procedures also included, among others, evaluating and testing management’s process for developing and modifying estimated costs at contract completion for a sample of contracts, which included evaluating the reasonableness of significant assumptions related to the estimated expected labor and indirect labor costs considered by management specific to each contract. Evaluating the reasonableness of the estimated expected labor and indirect labor costs involved assessing management’s ability to reasonably estimate costs at completion by (i) testing costs incurred to date and obtaining a sample of executed contracts and related change orders, (ii) performing a comparison of the margin, driven by the estimated and actual costs incurred, to that of similar completed equipment contracts, and (iii) evaluating the timely identification of circumstances that may warrant a modification to estimated total cost to complete.
/s/ PricewaterhouseCoopers LLP
Hartford, Connecticut
February 4, 2022
We have served as the Company’s auditor since 2019.
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OTIS WORLDWIDE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in millions, except per share amounts) 2021 2020 2019
Net sales:
Costs and expenses:
Other income (expense), net 22 (64) (39)
Non-service pension cost (benefit) 11 6 (33)
Interest expense (income), net 136 122 (14)
Less: Noncontrolling interest in subsidiaries' earnings 174 150 151