We are the world's largest 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, general contractors, governments, architects and specialized consultants who develop and/or design buildings for residential, commercial, retail or mixed-use activity. We sell our New Equipment directly to customers, as well as through agents and distributors. Through our Service segment, we perform maintenance and repair services for both our own products and those of other manufacturers and provide modernization services to upgrade elevators and escalators. Maintenance services include inspections to ensure code compliance, preventive maintenance offerings and other customized maintenance offerings tailored to meet customer needs, as well as repair services to address equipment and component wear and tear and breakdowns. Modernization services enhance equipment operation and improve building functionality. Modernization offerings can range from relatively simple upgrades of interior finishes and aesthetics to complex upgrades of larger components and sub-systems. Our typical Service customers include building owners, facility managers, housing associations and government agencies that operate buildings where elevators and escalators are installed. We serve our customers through a global network of approximately 69,000 employees. These include sales personnel, field technicians with separate skills in performing installation and service, as well as engineers driving our continued product development and innovation. We function under a centralized operating model whereby a single global strategy is set around New Equipment and Service because we seek to grow our maintenance portfolio, in part, through the conversion of new elevator and escalator installations into service contracts. Accordingly, we benefit from an integrated global strategy, which sets priorities and establishes accountability across the full product lifecycle. The current status of significant factors affecting our business environment in 2020 is discussed below. For additional discussion, refer to the "Business Overview" section in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Form 10 . Separation from United Technologies Corporation OnApril 3, 2020 , the Separation was completed through the distribution of 100% of the outstanding common stock ofOtis to holders of UTC common stock as of the close of business on the record date ofMarch 19, 2020. UTC distributed 433,079,455 shares ofOtis ' common stock, par value$0.01 per share in the Distribution, which was effective at12:01 a.m. Eastern Time , onApril 3, 2020 . As a result of the Distribution, UTC shareholders of record received 0.5 shares ofOtis ' common stock for every share of UTC common stock. As a result of the Distribution,Otis became an independent, publicly- traded company and its common stock is listed under the symbol "OTIS" on the NYSE. Prior to the Separation onApril 3, 2020 , our historical financial statements were prepared on a standalone combined basis and were derived from the consolidated financial statements and accounting records of UTC. For the period subsequent toApril 3, 2020 , our financial statements are presented on a consolidated basis as the Company became a standalone public company. The Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted inthe United States of America . As a result of the Separation during the six month period endedJune 30, 2020 , we have incurred and expect to continue to incur non-recurring Separation-related costs consisting primarily of employee-related costs, costs to establish certain standalone functions and information technology systems, professional services fees, equity award conversations, tax-related items and other transaction-related costs. Additionally, we will incur increased costs as a result of becoming an independent, publicly-traded company, primarily from establishing or expanding the corporate support for our businesses, including information technology, human resources, treasury, tax, internal audit, risk management, stock-based compensation programs, accounting and financial reporting, investor relations, governance, legal, procurement and other services. We believe our cash flows from operations will be sufficient to fund these additional corporate expenses. 36 -------------------------------------------------------------------------------- Table of Contents We entered into a transition services agreement with UTC and Carrier onApril 2, 2020 , in connection with the Separation pursuant to which UTC provides us with certain services and we provide certain services to UTC for a limited time to help ensure an orderly transition following the Separation. The services we receive include, but are not limited to, information technology services, technical and engineering support, application support for operations, legal, payroll, finance, tax and accounting, general administrative services and other support services. For additional discussion, see "Certain Relationships and Related Party Transactions," in our Form 10 . As costs for these services historically were included in the Company's operating results through expense allocations from UTC, the costs associated with theTSA have not been and are not expected to be materially different and, therefore, we do not expect such costs to materially affect our results of operations or cash flows after becoming a standalone company. In connection with the Separation, we entered into the TMA with UTC and Carrier onApril 2, 2020 , that governs the parties' respective rights, responsibilities and obligations with respect to tax matters (including responsibility for taxes, entitlement to refunds, allocation of tax attributes, preparation of tax returns, control of tax contests and other tax matters). Subject to certain exceptions set forth in the TMA, the Company generally is responsible for federal, state and foreign taxes imposed on a separate return basis on the Company (or any of its subsidiaries) with respect to taxable periods (or portions thereof) that ended on or prior to the date of the Distribution. The TMA provides special rules that allocate responsibility for tax liabilities arising from a failure of the Separation transactions to qualify for tax-free treatment based on the reasons for such failure. The TMA also imposes restrictions on each ofOtis and Carrier during the two-year period following the Distribution that are intended to prevent certain transactions from failing to qualify as transactions that are generally tax-free. OnDecember 22, 2017 , the TCJA was enacted which significantly changedU.S. tax law. This new legislation imposed a one-time toll charge, paid in installments over an 8-year period, on deemed repatriated earnings of foreign subsidiaries as ofDecember 31, 2017 . Under the terms of the TMA,Otis will indemnify UTC for a percentage of the toll charge installment payments due afterApril 3, 2020 . As a result, a portion of the future income tax obligations corresponding to the toll charge has been reclassified as a contractual indemnity obligation within Other long-term liabilities on the Condensed Consolidated Balance Sheet. For additional discussion, see "Certain Relationships andRelated Party Transactions," in our Form 10 . In connection with the Separation, we entered into an EMA and Intellectual Property Agreement with UTC and Carrier onApril 2, 2020 . These agreements are not expected to have a material impact on the financial results ofOtis . For additional discussion see "Certain Relationships and Related Party Transactions" in the Form 10 .
Impact of COVID-19 on our Company
A novel strain of coronavirus ("COVID-19") has spread throughout the world, resulting in widespread travel restrictions and extended shutdowns of non-essential businesses. We continue to provide critical maintenance and repair services, however this pandemic has impacted our business, and is expected to continue to impact our business, as limitations remain in force globally. The results of our operations and overall financial performance were impacted during the quarter ended and six month period endedJune 30, 2020 . The broader implications of COVID-19 on our results of operations, including net sales and overall financial performance remain uncertain, however we anticipate it will negatively impact our business during the quarter endedSeptember 30, 2020 and at least the remainder of 2020. Our business has been impacted as a result of the following: •Customer liquidity constraints and related credit reserves •Temporary closure or reduced capacity of our factory operations and those of our suppliers •New equipment job site closures •Cancellations or delays of customer orders •Challenges in accessing units to provide maintenance and repair services •Customer demand impacting our new equipment, maintenance, modernization and repair businesses We currently do not expect any significant impact to our capital and financial resources, including our overall liquidity position based on our available cash and cash equivalents and our access to credit facilities and the capital markets. We are focused on navigating these challenges presented by COVID-19 by preserving our liquidity and managing our cash flow by 37 -------------------------------------------------------------------------------- Table of Contents taking the necessary measures to meet our short-term liquidity needs. Our cost containment actions have included, and could include in the future, but are not limited to, reducing our discretionary spending, reducing payroll costs and restructuring.
See the Liquidity and Financial Condition section for further detail.
We also do not anticipate any material impairments to our goodwill, intangible asset and long-lived asset balances.
See Part I, Item 1A,"Risk Factors" below for further discussion.
CRITICAL ACCOUNTING ESTIMATES Preparation of our Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The accounting policies that involve the most significant estimates, assumptions and management judgments used in preparation of the Condensed Consolidated Financial Statements, or are the most sensitive to change due to outside factors, are discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates" included in our Form 10 . Except as disclosed in Note 6 and Note 19 to our Condensed Consolidated Financial Statements in this Form 10-Q, pertaining to adoption of new accounting pronouncements, there have been no material changes in these policies. RESULTS OF OPERATIONS Net Sales Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 Net sales$ 3,029
(9.6) % (7.1) % The factors contributing to the total percentage change year-over-year in total Net sales for the quarter and six months endedJune 30, 2020 are as follows: Quarter Ended Six Months Ended June 30, 2020 June 30, 2020 Organic volume (6.5) % (4.4) % Foreign currency translation (2.6) % (2.3) % Acquisitions and divestitures, net (0.5) % (0.4) % Total % change (9.6) % (7.1) % The Organic volume decrease of (6.5)% for the quarter endedJune 30, 2020 was driven by a decrease in organic sales of (10.4)% in the New Equipment segment and (3.3)% in the Service segment. The Organic volume decrease of (4.4)% for the six months endedJune 30, 2020 was driven by a decrease in organic sales of (10.1)% in the New Equipment segment with organic sales in the Service segment remaining flat at (0.1)%.
See "Segment Review" below for a discussion of Net sales by segment. Cost of Products and Services Sold
Quarter Ended June 30, Six Months Ended June 30, (dollars in millions) 2020 2019 2020 2019 Total cost of products and services sold$ 2,138
(9.7) % (7.9) % 38
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The factors contributing to the percentage change year-over-year for the quarter and six months endedJune 30, 2020 in total cost of products and services sold are as follows: Quarter Ended Six Months Ended June 30, 2020 June 30, 2020 Organic volume (6.3) % (4.8) % Foreign currency translation (2.9) % (2.4) % Acquisitions and divestitures, net (0.6) % (0.6) % Restructuring 0.1 % (0.1) % Total % change (9.7) % (7.9) % The organic decrease in total cost of products and services sold for the quarter and six months endedJune 30, 2020 was primarily driven by the organic sales decrease noted above. Gross Margin Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 Gross margin$ 891 $ 984 $ 1,788 $ 1,885 Gross margin percentage 29.4 % 29.4 % 29.8 % 29.2 % Gross margin remained consistent for the quarter endedJune 30, 2020 when compared to the same period for 2019, primarily driven by an increase in the Service margin rate and overall segment mix, partially offset by a decrease in the New Equipment margin rate. Gross margin increased 60 basis points for the six months endedJune 30, 2020 when compared to the same period for 2019, primarily driven by an increase in the Service margin rate and overall segment mix. See the Segment Review below for discussion of operating results by segment. Research and Development Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 Research and development$ 37 $ 40 $ 75 $ 79 Percentage of Net sales 1.2 % 1.2 % 1.3 % 1.2 % Research and development spending decreased approximately$3 million for the quarter endedJune 30, 2020 and decreased$4 million for the six months endedJune 30, 2020 compared to the same periods in 2019 as a result of cost containment actions taken in the current year and remained consistent as a percentage of Net sales for both periods. We continue to fund our strategic investment projects and focus on our commitment to Internet of Things technology developing the next generation of connected elevators and escalators.
Selling, General and Administrative
Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 Selling, general and administrative$ 441 $ 444 $ 906 $ 885 Percentage of Net sales 14.6 % 13.2 % 15.1 % 13.7 % Selling, general and administrative expenses remained relatively consistent for the quarter endedJune 30, 2020 when compared to the same period in 2019. Lower employment costs and lower discretionary spending, including cost containment actions taken in response to COVID-19, in addition to the absence of corporate allocations from UTC were partially offset by non-recurring Separation-related costs and incremental standalone public company costs. Selling, general and administrative 39 -------------------------------------------------------------------------------- Table of Contents expenses increased as a percentage of Net sales during the quarter endedJune 30, 2020 , primarily driven by the increase in non-recurring Separation-related costs, incremental standalone public company costs and lower Net sales in 2020. Selling, general and administrative expenses increased$21 million , or 2.4%, for the six months endedJune 30, 2020 when compared to the same period in 2019. Lower employment costs and lower discretionary spending, including cost containment actions taken in response to COVID-19, in addition to the absence of corporate allocations from UTC were more than offset by non-recurring separation costs and incremental standalone public company costs. Selling, general and administrative expenses increased as a percentage of Net sales during the six months endedJune 30, 2020 , primarily driven by the increase in non-recurring Separation costs, incremental standalone public company costs and lower Net sales in 2020. We are continuously evaluating our cost structure and have implemented restructuring actions as a method of keeping our cost structure competitive. For further discussion, see "Restructuring Costs" below and Note 13 in the Notes to the Condensed Consolidated Financial Statements.
Restructuring Costs
Six Months Ended June 30, (dollars in millions) 2020 2019 Restructuring costs$ 26 $ 40 We initiate restructuring actions to keep our cost structure competitive. Charges generally arise from severance related to workforce reductions, and to a lesser degree, facility exit and lease termination costs associated with the consolidation of field and manufacturing operations. We continue to closely monitor the economic environment, especially in light of the economic impact of COVID-19, and may undertake further restructuring actions to keep our cost structure aligned with the demands of the prevailing market conditions. Total Restructuring costs were$26 million for the six months endedJune 30, 2020 and included$23 million of costs related to 2020 actions and$3 million of costs related to 2019 actions. 2020 Actions. During the six months endedJune 30, 2020 , we recorded net pre-tax restructuring charges of$23 million relating to ongoing cost reduction actions initiated in 2020. We are targeting to complete in 2020 and 2021 the majority of the remaining workforce cost reduction actions initiated in 2020. Approximately 85% of the total expected pre-tax charges will require cash payments, which we have funded and expect to continue to fund with cash generated from operations. During the six months endedJune 30, 2020 , we had cash outflows of approximately$7 million related to the 2020 actions. We expect recurring pre-tax savings in continuing operations to increase to approximately$34 million annually over the two-year period subsequent to initiating the actions. 2019 Actions. During the six months endedJune 30, 2020 and 2019, we recorded net pre-tax restructuring charges of$3 million and$34 million , respectively, for actions initiated in 2019. We are targeting to complete in 2020 the majority of the remaining workforce cost reduction actions initiated in 2019. Approximately 94% of the total pre-tax charge will require cash payments, which we have and expect to continue to fund with cash generated from operations. During the six months endedJune 30, 2020 , we had cash outflows of approximately$9 million related to the 2019 actions. We expect to incur additional restructuring charges of$12 million to complete these actions. We expect recurring pre-tax savings to increase over the two-year period after initiating the actions to be approximately$45 million annually, of which approximately$16 million was realized during the six months endedJune 30, 2020 .
In addition, we recorded net pre-tax restructuring costs totaling
Other (Expense) Income, Net
Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 Other (expense) income, net$ 3 $
(19)
Other (expense) income, net primarily includes the impact of changes in the fair value and settlement of embedded and foreign exchange derivatives, gains or losses on sale of businesses and fixed assets, earnings from equity method investments, fair value changes on equity securities, impairments and certain other operating items. The quarter-over-quarter decrease in Other (expense) income, net of$(22) million for the quarter endedJune 30, 2020 when compared to the same period in 2019 is 40 -------------------------------------------------------------------------------- Table of Contents primarily driven by the prior year loss on the expected sale of a business of approximately$(19) million . The remaining activity for the quarter endedJune 30, 2020 when compared to the same period in 2019 remained relatively consistent. The year-over-year increase in Other (expense) income, net of$(37) million for the six months endedJune 30, 2020 when compared to the same period in 2019 is partially driven by a fixed asset impairment of approximately$(55) million and related license costs of approximately$(12) million . These were partially offset by favorable mark-to-market adjustments on foreign currency derivatives and firm commitment derivatives of approximately$20 million , as well as absence of the the loss on the expected sale of a business of approximately$(19) million included in the 2019 results.
Interest Expense (Income), Net
Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 Interest expense (income), net$ 41
Interest expense (income), net primarily relates to interest expense on our external debt, offset by interest income primarily related to interest earned on cash balances, short-term investments and related party activity betweenOtis and UTC in the prior year. The increase in Interest expense (income), net in the quarter and six months endedJune 30, 2020 compared to the same periods in 2019 was primarily driven by approximately$42 million of interest expense on our external debt for the quarter endedJune 30, 2020 and$56 million for the six months endedJune 30, 2020 . The interest expense recognized for the six months endedJune 30, 2020 was partially offset by higher interest income earned on short-term investments when compared to the same period in 2019.
The average interest rate on our external debt for the quarter and six months
ended
For additional discussion of borrowings, see Note 9 to the Condensed Consolidated Financial Statements. Income Taxes
Quarter Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Effective tax rate 29.1 % 28.9 % 33.4 % 29.1 %
The change in the effective tax rate for the quarter and six months ended
The Company will continue to review and incorporate as necessary TCJA changes
related to forthcoming
We anticipate some variability in the tax rate quarter to quarter from potential discrete items.
For additional discussion of income taxes and the effective income tax rate, see Note 12 to the Condensed Consolidated Financial Statements. Noncontrolling Interest in Subsidiaries' Earnings
Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019
Noncontrolling interest in subsidiaries' earnings
Noncontrolling interest in subsidiaries' earnings decreased for the quarter
ended
41 -------------------------------------------------------------------------------- Table of Contents Noncontrolling interest in subsidiaries' earnings increased for the six months endedJune 30, 2020 in comparison to the same period in 2019 was primarily due to an increase in net income from subsidiaries with noncontrolling interests.
There was no other significant activity for the quarter and six months ended
Net Income Attributable to common shareholders
Six Months Ended Quarter Ended June 30, June 30, (dollars in millions, except per share amounts) 2020 2019 2020 2019
Net income attributable to common shareholders
$ 308 $ 389 $ 581 Diluted earnings per share from operations$ 0.52
Net income attributable to common shareholders for the quarter endedJune 30, 2020 includes restructuring charges, net of a tax benefit, of$15 million ($20 million pre-tax), as well as charges relating to significant non-operational and/or nonrecurring items, net of a tax benefit, of approximately$5 million ($21 million pre-tax) which include the non-recurring Separation-related costs and a non-recurring tax benefit of$13 million related to the Separation. These restructuring charges, non-operational and/or nonrecurring items and incremental standalone public company costs were contributors to lower Net income attributable to common shareholders for the quarter endedJune 30, 2020 when compared to the same period in 2019. The effects of the above resulted in an impact of$0.04 on diluted earnings per share for the quarter endedJune 30, 2020 . Net income attributable to common shareholders for the quarter endedJune 30, 2019 includes restructuring charges, net of a tax benefit, of$12 million ($15 million pre-tax) as well as charges relating to significant non-operational and/or nonrecurring items, net of a tax benefit, of approximately$13 million ($22 million pre-tax). The effects of restructuring charges and the non-recurring items resulted in an impact of$0.06 on the basic and diluted earnings per share for the quarter endedJune 30, 2019 . Net income attributable to common shareholders for the six months endedJune 30, 2020 includes restructuring charges, net of a tax benefit, of$19 million ($26 million pre-tax), as well as charges relating to significant non-operational and/or nonrecurring items, net of a tax benefit, of approximately$98 million ($136 million pre-tax) which include the non-recurring separation costs and a fixed asset impairment. These significant non-operational and/or nonrecurring items, and the resulting higher effective tax rate, were the primary contributors to lower Net income attributable to common shareholders for the six months endedJune 30, 2020 when compared to the same period in 2019. The effects of the above resulted in an impact of$0.27 on diluted earnings per share for the six months endedJune 30, 2020 . Net income attributable to common shareholders for the six months endedJune 30, 2019 includes restructuring charges, net of a tax benefit, of$30 million ($40 million pre-tax) as well as charges relating to significant non-operational and/or nonrecurring items, net of a tax benefit, of approximately$14 million ($22 million pre-tax). The effects of restructuring charges and the non-recurring items resulted in an impact of$0.10 on the basic and diluted earnings per share for the six months endedJune 30, 2019 . 42 -------------------------------------------------------------------------------- Table of Contents Segment Review Summary performance for our operating segments for the quarters endedJune 30, 2020 and 2019 was as follows: Net Sales Operating Profit Operating Profit Margin (dollars in millions) 2020 2019 2020 2019 2020 2019 New Equipment$ 1,294 $ 1,500 $ 79 $ 138 6.1 % 9.2 % Service 1,735 1,851 381 388 22.0 % 21.0 % Total segment$ 3,029 $ 3,351 $ 460 $ 526 15.2 % 15.7 % General corporate expenses and other - - (44) (45) - - Total$ 3,029 $ 3,351 $ 416 $ 481 13.7 % 14.4 %
Summary performance for each of the operating segments for the six months ended
Net Sales Operating Profit Operating Profit Margin (dollars in millions) 2020 2019 2020 2019 2020 2019 New Equipment$ 2,417 $ 2,771 $ 143 $ 197 5.9 % 7.1 % Service 3,578 3,681 781 774 21.8 % 21.0 % Total segment$ 5,995 $ 6,452 $ 924 $ 971 15.4 % 15.0 % General corporate expenses and other - - (179) (75) - - Total$ 5,995 $ 6,452 $ 745 $ 896 12.4 % 13.9 % 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, general contractors, architects, governments and specialized consultants 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.
Summary performance for the New Equipment segment for the quarters ended
(dollars in millions) 2020 2019 Change Change Net sales$ 1,294 $ 1,500 $ (206) (13.7) % Cost of sales 1,072 1,209 (137) (11.3) %$ 222 $ 291 $ (69) (23.7) % Operating expenses and other 143 153 (10) (6.5) % Operating profit$ 79 $ 138 $ (59) (42.8) % 43
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New Equipment segment Quarter EndedJune 30, 2020 compared with Quarter EndedJune 30, 2019 Net Sales Cost of Sales Operating Profit Organic/Operational (10.4) % (8.0) % (36.2) % Foreign currency translation (3.2) % (3.5) % (3.7) % Acquisitions/Divestitures, net (0.1) % (0.1) % - % Restructuring cost - % 0.3 % (2.9) % Total % change (13.7) % (11.3) % (42.8) % Net sales The organic sales decrease of (10.4)% was driven by double digit organic sales declines inAmericas and EMEA primarily driven by COVID-19. This was partially offset by low single digit growth inAsia asChina began to recover from the pandemic. Operating profit New Equipment operational profit decreased (36.2)% primarily from the impact of lower volume (32.8)%. Material productivity 13.1% and cost containment actions 7.3% were largely offset by other rate drivers (24.4)% including under-absorption, bad debt and unfavorable mix. New Equipment operating profit was also impacted by foreign currency headwinds of (3.7)% and higher restructuring costs (2.9)%.
Summary performance for the New Equipment segment for the six months ended
(dollars in millions) 2020 2019 Change Change Net sales$ 2,417 $ 2,771 $ (354) (12.8) % Cost of sales 1,986 2,269 (283) (12.5) %$ 431 $ 502 $ (71) (14.1) % Operating expenses and other 288 305 (17) (5.6) % Operating profit$ 143 $ 197 $ (54) (27.4) % New Equipment segment Six Months EndedJune 30, 2020 compared with Six Months EndedJune 30, 2019 Net Sales Cost of Sales Operating Profit Organic/Operational (10.1) % (9.7) % (24.4) % Foreign currency translation (2.6) % (2.7) % (3.5) % Acquisitions/Divestitures, net (0.1) % (0.2) % - % Restructuring cost - % 0.1 % 0.5 % Total % change (12.8) % (12.5) % (27.4) % Net sales
The organic sales decrease of (10.1)% was driven by organic sales declines in all regions primarily due to COVID-19.
Operating profit
New Equipment operational profit decreased (24.4)% primarily from the impact of lower volume (32.4)%. Material productivity 16.6% and cost containment actions, net of incremental standalone public company costs 5.7% were more than offset by other rate drivers (16.3)% including under-absorption and bad debt. New Equipment operating profit was also impacted by foreign currency headwinds of (3.5)% offset by restructuring of 0.5%. 44 -------------------------------------------------------------------------------- Table of Contents 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 the Service segment for the quarters ended
(dollars in millions) 2020 2019
Change Change Net sales$ 1,735 $ 1,851 $ (116) (6.3) % Cost of sales 1,066 1,158 (92) (7.9) %$ 669 $ 693 $ (24) (3.5) % Operating expenses and other 288 305 (17) (5.6) % Operating profit$ 381 $ 388 $ (7) (1.8) % Service segment Quarter EndedJune 30, 2020 compared with Quarter EndedJune 30, 2019 Net Sales Cost of Sales Operating Profit Organic/Operational (3.3) % (4.4) % 0.5 % Foreign currency translation (2.2) % (2.3) % (2.3) % Acquisitions/Divestitures, net (0.8) % (1.0) % - % Restructuring cost - % (0.2) % - % Total % change (6.3) % (7.9) % (1.8) % Net sales
The organic sales decrease of (3.3)% primarily consists of organic sales decreases in maintenance and repair of (3.6)% and modernization of (1.5)%.
Maintenance and repair net sales decreased (6.5)% as a result of an organic sales decrease of (3.6)%, foreign currency headwinds of (2.4)% and decreases related to net acquisitions and divestitures of (0.5)%.
Modernization net sales decreased (5.2)% as a result of organic sales decline of (1.5)%, foreign currency headwinds of (1.8)% and from net acquisitions and divestitures of (1.9)%.
Operating profit
Service operational profit increased 0.5% driven by favorable price and mix, productivity 6.6% and cost containment actions, net of incremental standalone public company costs 3.4% more than offsetting the impact of lower volume (4.0)% and price concessions and bad debt (5.6)%. Service operating profit was also impacted by foreign exchange headwinds of (2.3)% . 45
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Summary performance for the Service segment for the six months ended
(dollars in millions) 2020 2019
Change Change Net sales$ 3,578 $ 3,681 $ (103) (2.8) % Cost of sales 2,221 2,298 (77) (3.4) %$ 1,357 $ 1,383 $ (26) (1.9) % Operating expenses and other 576 609 (33) (5.4) % Operating profit$ 781 $ 774 $ 7 0.9 % Service segment Six Months EndedJune 30, 2020 compared with Six Months EndedJune 30, 2019 Net Sales Cost of Sales Operating Profit Organic/Operational (0.1) % - % 1.4 % Foreign currency translation (2.0) % (2.1) % (2.2) % Acquisitions/Divestitures, net (0.7) % (1.0) % (0.1) % Restructuring cost - % (0.3) % 1.8 % Total % change (2.8) % (3.4) % 0.9 % Net sales
Organic sales remained flat year over year at (0.1)%. The Modernization organic sales increase of 2.6% was partially offset by the maintenance and repair organic sales decrease of (0.6)%.
Modernization net sales decreased (1.1)% year over year which is made up of a 2.6% increase in organic sales, offset by decreases in foreign currency (1.7)% and impact from net acquisitions and divestitures (2.0)%.
Maintenance and repair net sales decreased (3.2)% year over year and was comprised of a (0.6)% organic sales decrease, foreign currency headwinds of (2.1)% and decreases related to net acquisitions and divestitures of (0.5)%.
Operating profit
Service operational profit increased 1.4% with the benefit of favorable productivity, cost containment actions, net of incremental standalone public company costs and pricing and mix, more than offsetting the impact of price concessions and bad debt. Service operating profit was also impacted by foreign currency headwind of (2.2)%, offset by restructuring 1.8%. General corporate expenses and other Six Months Ended Quarter Ended June 30, June 30, (dollars in millions) 2020 2019 2020 2019 General corporate expenses and other (44)
(45)
General corporate expenses and other primarily includes Other income (expense), net and certain corporate overhead costs, non-recurring separation costs and certain incremental standalone public company costs. General corporate expenses and other during the quarter endedJune 30, 2020 remained flat compared to the same period in 2019, as non-recurring Separation-related costs and incremental standalone public company costs, were offset by cost containment actions and the absence of the loss on the expected sale of a business that occurred during the quarter endedJune 30, 2019 . The increase in general corporate expenses and other during the six months endedJune 30, 2020 compared to the same period in 2019, is primarily driven by a fixed asset impairment of approximately$55 million , related license costs of approximately$12 million , non-recurring Separation-related costs of$53 million and incremental standalone public company costs. These were partially offset by favorable mark-to-market adjustments on foreign currency derivatives and firm commitment derivatives of approximately$20 million when compared to the prior period, the loss on the expected sale of a 46 -------------------------------------------------------------------------------- Table of Contents business of approximately$(19) million that occurred during the six months endedJune 30, 2019 and lower employment costs in the six months endedJune 30, 2020 . LIQUIDITY AND FINANCIAL CONDITION (dollars in millions) June 30, 2020 December 31, 2019 Cash and cash equivalents$ 1,912 $ 1,446 Total debt 6,293 39 Net debt (total debt less cash and cash equivalents) 4,381 (1,407) Total equity (3,672) 2,231 Total capitalization (total debt plus total equity) 2,621 2,270
Net capitalization (total debt plus total equity less cash and cash equivalents)
709 824 Total debt to total capitalization 240 % 2 % Net debt to net capitalization 618 % (171) % AtJune 30, 2020 , we had cash and cash equivalents of$1.9 billion , of which approximately 80% was held by the Company's foreign subsidiaries. AfterMarch 31, 2020 and before the Separation, the Company received$190 million of domestic cash contributions from UTC. 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 ofJune 30, 2020 andDecember 31, 2019 , the amount of such restricted cash was approximately$15 million and$13 million , respectively. 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 ofJune 30, 2020 permit us to finance our operations on acceptable terms and conditions, our access to, and the availability of, financing on acceptable terms and conditions in the future will 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.
During the six months ended
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The following is a summary of the debt issuances for the six months ended
(dollars in millions)
Aggregate Principal Issuance Date Description of Debt Balance 03-27-2020 LIBOR plus 112.5 bps term loan due 2023 $ 1,000 02-27-2020 LIBOR plus 45 bps floating rate notes due 2023 500 02-27-2020 2.056% notes due 2025 1,300 02-27-2020 2.293% notes due 2027 500 02-27-2020 2.565% notes due 2030 1,500 02-27-2020 3.112% notes due 2040 750 02-27-2020 3.362% notes due 2050 750 The net proceeds from the above issuances totaling$6.3 billion were used to distribute cash to UTC as part of the Separation during the quarter endedMarch 31, 2020 .
For additional discussion of borrowings, see Note 9 to the Condensed Consolidated Financial Statements.
The Company no longer intends to reinvest certain undistributed earnings of its international subsidiaries that have been previously taxed in theU.S. For the remainder of the Company's undistributed international earnings, unless tax effective to repatriate,Otis 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 capital markets. OnApril 3, 2020 , our Board of Directors authorized a share repurchase program for up to$1 billion of our common stock. Under this program, shares may be purchased on the open market, in privately negotiated transactions, or under accelerated share repurchase ("ASR") programs under plans complying with rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended. We currently do not expect any share repurchases under the program in 2020 as we focus on deleveraging. Cash Flow - Operating Activities Six Months Ended June 30, (dollars in millions) 2020 2019 Net cash flows provided by operating activities$ 823 $ 651 Cash generated from operating activities in the six months endedJune 30, 2020 was$172 million higher than the same period in 2019, primarily due to increased cash inflows for current assets and current liabilities in the six months endedJune 30, 2020 of$272 million compared to the six months endedJune 30, 2019 . There was also increased cash inflows for Other operating activities, net in the six months endedJune 30, 2020 of$55 million compared to the six months endedJune 30, 2019 , primarily due to long-term accruals and other activity. These were partially offset by lower net income in the six months endedJune 30, 2020 of$185 million compared to the six months endedJune 30, 2019 , including incremental standalone public company costs and$53 million of non-recurring separation costs for the six months endedJune 30, 2020 that contributed to the decrease. In the six months endedJune 30, 2020 , cash inflows from current assets and current liabilities were$148 million . The net change in Contract assets, current and Contract liabilities, current improved by$266 million , which was driven by the timing of billings on contracts compared to the progression on current contracts, and Accounts payable and accrued liabilities increased$79 million largely due to the timing of payments for income tax liabilities in certain tax jurisdictions. These were partially offset by Inventories, net, which increased$71 million , due to higher production inventory and purchases of inventory in advance of potential supply chain disruptions due to COVID-19, Other assets, current increased$67 million primarily due to tax prepayments in certain tax jurisdictions, and Accounts receivable, net increased$59 million due to slower collections from customers in certain industries impacted by COVID-19. 48 -------------------------------------------------------------------------------- Table of Contents In the six months endedJune 30, 2019 , cash outflows from current assets and current liabilities were$124 million . Accounts payable and accrued liabilities decreased$156 million due to the timing of payments to suppliers and for income tax liabilities in certain tax jurisdictions and Accounts receivable increased$94 million due to increased billing volume. These were partially offset by the net change in Contract assets, current and Contract liabilities, current of$77 million due to the timing of billings on contracts compared to the progression on current contracts, Other assets, current decreased$25 million due to lower prepaid assets and Inventories, net decreased$24 million due to lower production inventory. Cash Flow - Investing Activities Six Months Ended June
30,
(dollars in millions) 2020
2019
Net cash flows used in investing activities$ (142)
Cash flows used in investing activities for the six months endedJune 30, 2020 and 2019 primarily reflect capital expenditures, investments in businesses and securities and proceeds received on sale of fixed assets. Cash flows used in investing activities in the six months endedJune 30, 2020 compared to the same period in 2019 increased$50 million primarily due to a$51 million increase in investments made in equity securities and a$12 million increase in capital expenditures. These were partially offset by a$16 million decrease in investments in businesses. Cash Flow - Financing Activities Six Months Ended June
30,
(dollars in millions) 2020
2019
Net cash flows used in financing activities$ (180)
Financing activities primarily include issuance of long-term debt, increases (decreases) in short-term borrowings, dividends paid to common shareholders, dividends paid to noncontrolling interests and transfers to and from UTC, consisting of, among other things, cash transfers, distributions, cash investments and changes in receivables and payables betweenOtis and UTC. See Note 5 to the Condensed Consolidated Financial Statements for further discussion on transactions with UTC. Net cash used in financing activities decreased$173 million in the six months endedJune 30, 2020 compared to the same period in 2019 primarily due to the issuance of long-term notes of$5.3 billion and the draw of$1.0 billion from the term loan during the six months endedJune 30, 2020 , which were partially offset by a$6.0 billion increase in net transfers to UTC primarily driven by the distribution of the net proceeds of these borrowings to UTC, an$87 million increase in dividends paid on Common Stock, and a$43 million increase in payment of long-term debt issuance costs. See Note 9 to the Condensed Consolidated Financial Statements for further discussion on borrowings. 49 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements and Contractual Obligations The section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Off-Balance Sheet Arrangements and Contractual Obligations" in the Form 10 provided a table summarizing our contractual obligations and commercial commitments at the end of 2019 that would require the use of funds. As ofJune 30, 2020 , except as described below, there have been no additional material changes in the amounts disclosed in the Form 10 .
A summary of the additional significant obligations that the Company has entered
into during the six months ended
Payments Due by Period (dollars in millions) Total 2020 2021 2022 2023 2024 Thereafter Long-term debt$ 6,306 $ -$ 2 $ 2 $ 1,501 $ 1 $ 4,800 In connection with the Separation and transition to a standalone public company we entered into additional contractual purchase commitments with suppliers, service vendors, and various transition services agreements primarily to support our information technology that are either necessary to operate as a standalone business or are resulting from implementing strategic initiatives. As a result, our off-balance sheet long-term purchase commitments have increased in total by approximately$190 million sinceDecember 31, 2019 . Item 3. Quantitative and Qualitative Disclosures About Market Risk 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. We issue commercial paper, which exposes us to changes in interest rates. Currently, we do not hold any derivative contracts that hedge our interest exposures, but may consider such strategies in the future. There has been no significant change in our exposure to market risk during the quarter and six months endedJune 30, 2020 . For discussion of our exposure to market risk, refer to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk and Risk Management" in the Form 10 .
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