Otis Worldwide (OTIS) FY2025 Earnings Quality Report

Grade: F — Negative Equity from Spin-Off Plus Cash/Debt Mismatch

Framework: Schilit *Financial Shenanigans* + Beneish M-Score + forensic accounting principles

Data: SEC EDGAR 10-K (Filed February 5, 2026, FY ended December 31, 2025) + Yahoo Finance

Auditor: PricewaterhouseCoopers LLP — Unqualified opinion (1 critical audit matter: estimated costs at completion for New Equipment and Modernization contracts)

One-line verdict: Otis is structurally unusual: after its April 2020 spin-off from RTX Corporation, the company emerged with $5.4 billion of negative shareholders' equity — a legacy of the dividend paid to United Technologies shareholders at separation — and it is still deepening. Retained earnings show accumulated deficit of $(440)M, treasury stock of $(4.2)B, and AOCI loss of $(1.1)B. Cash of $1.1B covers only 13% of $8.5B in total debt. Service (not New Equipment) now drives the business: Service generated 60%+ of sales with 7% organic growth in 2025, while New Equipment fell 7% as China demand collapsed. Reported net income declined from $1.65B in 2024 to $1.38B in 2025 (-16%), though 2024 was inflated by the one-time $185M German tax litigation benefit plus $200M related interest income. On a clean basis, operating income was roughly flat. The M-Score of -2.43 is just barely below the -2.22 manipulation threshold — the closest to the line of any company in this screen.

The Spin-Off Balance Sheet: Negative Equity as a Permanent Feature

From the Consolidated Balance Sheets, December 31, 2025:

This is not a crisis — it is the direct legacy of the April 2020 spin-off from RTX, when the newly-independent Otis paid a large cash dividend to its former parent that exceeded its then-accumulated earnings. Every year since, the company has bought back stock (total treasury $4.2B) faster than it has earned profits, and dividends have further eroded retained earnings.

Negative equity means the Altman Z-Score (which uses equity/total liabilities) collapses to 0.20, putting OTIS in the "distress" zone. However, this is a mechanical artifact — Otis has $1.4B of free cash flow and 5.5x interest coverage. It is not financially distressed in the real sense. What negative equity does mean: there is no equity cushion to absorb any significant impairment or litigation loss. If China goodwill (part of the $1.7B balance) were written down, it would flow directly into deepening the deficit.

Financial Performance: Service Growing, New Equipment Shrinking

From the Consolidated Statements of Operations and MD&A:

Revenue mix by segment (from MD&A): "The Organic volume was flat for 2025 driven by an increase in organic sales of 5% in Service, offset by a decrease of (7)% in New Equipment."

New Equipment declined 7% organically — China is the culprit. Per Item 1A: "China is currently the largest end market for sales of new equipment in our industry, with our New Equipment net sales in China representing approximately one fifth of our global New Equipment net sales and over half of our global New Equipment unit volume." China real estate weakness has cratered new construction, and OTIS is taking the hit.

Service grew 5% organically, reflecting the shift toward the higher-margin installed base. Gross margin improved 40 bps to 30.3% "primarily due to the increase in Service sales and decrease in New Equipment sales."

The 2024 earnings distortion: net income of $1,645M in 2024 was inflated by a "favorable ruling regarding a German tax litigation… income tax benefits of approximately $185 million and related interest income of approximately $200 million." Offsetting was a $194M indemnification expense to RTX under the Tax Matters Agreement. Net benefit was roughly $191M after-tax. Stripping that, 2024 adjusted net income was closer to $1,454M, meaning 2025's $1,384M is essentially flat on a normalized basis.

UpLift Program: Announced July 2023, UpLift targets $200M annual run-rate savings. Through 2025, $282M in total costs have been incurred ($132M restructuring + $150M transformation). The 2025 UpLift restructuring charge of $76M plus transformation costs of $69M total $145M — material drags on reported earnings.

Cash Flow: Strong Conversion, Buybacks Outpacing FCF

From the Consolidated Statements of Cash Flows:

CFFO/NI of 1.15 is healthy. FCF/NI of ~1.04 shows cash conversion near 100% — exactly what you'd expect from a high-margin service franchise. FCF has been roughly flat at $1.44B for three years.

But shareholder returns of $1.46B in 2025 (dividends $647M + buybacks $809M) almost exactly matched FCF of $1.44B. Any shortfall comes from the balance sheet — more debt or less cash. And indeed, cash dropped from $2.3B to $1.1B in 2025, a $1.2B decrease.

The 18-Point Screening

Revenue Quality

A2 is a real concern: AR grew 7.6% ($3,428M → $3,688M) while revenue grew only 1.2%. Per the cash flow statement, "Accounts receivable, net" was a use of cash of $(111)M in 2025, $(68)M in 2024, and $(239)M in 2023. That's 3 consecutive years of AR consuming cash faster than sales growth would justify. In a service-heavy business where most receivables should turn in 30-60 days, DSO of 93 days is high. The trend is adverse.

Expense Quality

Inventory grew 10% while COGS was roughly flat — the company is building inventory faster than it is selling, consistent with China weakness.

Cash Flow Quality

Cash fell from $2.3B to $1.1B over the year. Buybacks at $809M + dividends at $647M effectively emptied the cash cushion.

Balance Sheet

D1 is technically "pass" because the algorithm returns a negative ratio (goodwill-to-equity is undefined when equity is negative), but the real picture is that $1.7B of goodwill sits on a balance sheet with no equity cushion. Any impairment flows 100% into deeper negative equity. PwC noted in the critical audit matter that OTIS tested goodwill for impairment at July 1, 2025 and "determined in the qualitative assessment that quantitative testing is not necessary. There were no triggering events since the annual impairment test." Given China New Equipment down 7%, the absence of a triggering event is itself worth monitoring.

Acquisition Risk

Manipulation Score

Components: DSRI 1.063 (receivables days rising), GMI 0.986, AQI 1.202 (asset quality deteriorating — other assets rising), SGI 1.012, DEPI 1.168 (depreciation slowing — lower D&A expense recognition), SGAI 1.029, TATA -0.0199, LVGI 1.05.

The DEPI of 1.168 is worth noting: depreciation as a percentage of PP&E is declining. Combined with rising inventories and rising AR relative to sales, the composite M-Score is borderline. -2.43 is close enough to -2.22 that any further deterioration in working capital would flip the signal.

Critical Audit Matter: Cost-at-Completion Estimates

PwC identified estimated costs at completion for New Equipment and Modernization contracts as the sole critical audit matter:

"The Company recognized $5.0 billion and $1.9 billion of revenue from new equipment and modernization contracts, respectively, for the year ended December 31, 2025… For these performance obligations, revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress."

"The principal considerations for our determination that performing procedures relating to revenue recognition - estimated costs at completion for new equipment and modernization contracts is a critical audit matter are the significant judgment by management to determine the estimated costs at contract completion…"

$6.9B of revenue (48% of the $14.4B total) is recognized using management's cost-at-completion judgment. With tariffs adding ~$20M in 2025 costs and similar expected in 2026, and with labor inflation persistent, cost estimates must be continuously refreshed. If contract costs rise faster than expected, cumulative catch-up adjustments would hit the P&L.

Key Risks from the 10-K

1. China New Equipment Collapse

From Item 1A: "China is currently the largest end market for sales of new equipment in our industry, with our New Equipment net sales in China representing approximately one fifth of our global New Equipment net sales and over half of our global New Equipment unit volume and a growing part of our Service segment. Changes to market and economic conditions in China, including credit conditions for our customers, have recently impacted and may continue to impact our ability to maintain New Equipment net sales in China at rates consistent with prior years as well as future growth of our Service segment."

New Equipment organic sales fell 7% in 2025 and 6% in 2024. The China real estate downturn is not over, and the impact cascades: New Equipment installs become Service contracts years later, so every quarter of weak installations erodes the Service pipeline in 3-5 years.

2. Tariff Exposure and Global Trade Policy

From MD&A: "Other than the impact from new tariffs currently in effect of approximately $20 million during 2025 and a similar impact anticipated in 2026, we currently do not expect any significant impact to our capital and financial resources from these macroeconomic conditions." The 10-K warns that "Tariff actions by the U.S. and retaliatory actions by other countries have caused, and may in the future cause, significant disruption and volatility in the financial markets."

71% of OTIS 2025 net sales are derived from international operations — higher than almost any other industrial. A stronger dollar translates foreign sales into fewer reported dollars.

3. German Tax Litigation Aftermath

From MD&A: "Based on additional information received from RTX during the year, which resulted in additional indemnification expense of $67 million, offset by indemnity payments made to RTX of $205 million, the Company now estimates the amount payable to RTX to be $56 million. The indemnification expense is included in Other income (expense), net in the Consolidated Statements of Operations in 2025. This estimate could further change due to the parties' continuing dispute concerning the scope of the final indemnity amount."

4. UpLift Execution Risk

The UpLift transformation is ~2 years old and still generating $145M/year of charges against a supposed $200M run-rate savings benefit. The net is positive only if the savings are sustainable beyond 2026. If the transformation stalls, the charges become permanent cost absorption without the offsetting savings.

5. Negative Equity Structural Feature

While mechanically the result of spin-off choices, negative equity limits financial flexibility: debt covenants, regulatory filings (insurance premium financing, etc.), and rating agency metrics all treat negative-equity companies with extra scrutiny. An equity raise would be strongly dilutive if ever required — at current buyback pace, equity deficit will continue to widen.

6. Concentration in Long-Term Service Contracts

The Service business depends on maintaining 2M+ elevator contracts globally. Contract churn (cancellation for price, switching to independent service providers) is a chronic background risk. Per the elevator industry, service contract attrition runs 3-5% annually.

Summary

Grade: F. Two critical-zone failures (A2 AR acceleration and C4 cash coverage) plus a borderline M-Score drive the F grade, amplified by the unusual negative-equity structure from the RTX spin-off.

Otis is a high-quality service business — 30.3% gross margins, $1.4B of consistent FCF, negative working capital (contract liabilities of $2.6B exceed contract assets of $0.7B, i.e., customers pre-pay), and a well-understood installed base annuity. The operating fundamentals are solid.

But the earnings quality signals are adverse: AR growing faster than revenue for 2 consecutive years, DSO at 93 days and rising, inventory building 10% on flat sales, and capex jumping 21% without a visible revenue reason. These patterns can foreshadow revenue pull-forwards or channel stuffing — things to watch in FY2026.

The M-Score of -2.43 is the closest to the -2.22 manipulation threshold of any company in this screen. It is still in the "pass" zone, but not by much. The DEPI of 1.168 (depreciation slowing) and AQI of 1.202 (non-PP&E asset growth) are the components closest to signaling concern.

The key question for investors: Can OTIS replace the China New Equipment void with modernization and Service growth fast enough to maintain the $1.4B FCF franchise? The answer depends on whether the 2020s will see a global "elevator upgrade" super-cycle as older equipment aged during COVID — a real demand driver — versus whether the industry over-installed during 2014-2021.

**Disclaimer**: This report is based on Otis Worldwide's FY2025 10-K filed with SEC EDGAR on February 5, 2026. This is NOT investment advice.

Data: SEC EDGAR 10-K + Yahoo Finance

Auditor: PricewaterhouseCoopers LLP (Unqualified opinion, 1 critical audit matter — cost-at-completion estimates for new equipment and modernization contracts)

Fiscal year ended: December 31, 2025