Allegion plc (ALLE) Earnings Call Transcript & Summary

Great. Well, thanks, everyone, for attending the fireside chat. It's my pleasure to have next Allegion, Dave Petratis, Chairman, President and CEO; and of course, many of you also know Tom Martineau. So welcome back. Dave, thanks very much for coming. Maybe just give us some updates of the -- some of the secular moves that you're seeing in the access control industry. Particularly on the residential side, I think there's been a swath of new product launches [Audio Gap] out there. Discuss maybe some of those and also where you stand on the relationship [Audio Gap] some of the Internet service providers that are moving into that home security [Audio Gap]

So at Allegion, we define the electronic conversions as seamless access. In my 40 years of industrial activity, it's just a great opportunity in terms of the growth opportunity in the marketplace. You may have heard me say this, there's 40 billion doors in the world. Only about 5% of them are connected. And that's our opportunity. As we think about the world and where Allegion plays in terms of seamless access, some of the fastest convergence is going on in the world. In the Asia Pacific, Korea would be the most advanced. We're there with our Milre business at almost 70% penetration. China is moving quickly from a low point, let's say, 5% penetration, could potentially get to 50%. Certainly, in the next decade, it could be faster than that. The U.S., all-in, both residential and institutional, we would say, moves at about 10%. The fastest convergence is moving in residential, then multifamily. Institutional, commercial about half of that. And Europe, really moving the slowest. So big opportunity. I like the way Allegion's positioned. There are new entrants to the market, especially in the res side of it. I've told -- I suggested in the meetings today, if you went to the 2018 Consumer Electronics Show, there were over 200 new entrants of security locks. That sorted it out -- itself out a year down to 100. There's a level of complexity, connectivity, battery life and duty cycle that I think is maybe underestimated in terms of entry into this market. You can also throw channels in there as well. But -- and that complexity moves up as you move into the commercial and institutional. And I can't emphasize that enough. If you take U.S. res, it's a relatively homogenous, how you get into your home or through your garage. But as you move into the complexity of a building like this, it ramps up significantly. When you get to Europe, some of the mechanical challenges are unique from market to market. And it's because of the width of the door, the width of the cylinder. These are natural barriers to entry, and each market presents different challenges.

Got it. And within residential, you maybe weren't the biggest earliest mover with some of those ISPs coming in, hold up nicely as that market has [Audio Gap] go through some of it [Audio Gap] problems. How do you assess that penetration curve today? And maybe just remind us some of your main partnerships across that ISP [Audio Gap].

So we were one of the earliest transcend into electronic locks, units of push buttons. First player, Siri, open the lock, which was pretty incredible. As the ISPs became more present in the space, Amazon, Google, I would put us in a position of fast follower. In some cases, that was very sound on our part. Think about the introduction of Amazon Key. I think in the first 72 hours, it was presented and withdrawn from the marketplace. There's -- sometimes in business, you want to be -- lead with your chin. You want to be the first. I think that's a clear example where we saw weaknesses in the operating system that value -- violated one of our primary business drivers, and that's keep the families and areas safe. So today, well penetrated, well integrated, Amazon, Google, Apple, Alibaba. It's an important part of what we do. And it's part of the complexity, it's what I call the spaghetti. When you're in connecting with the IoT in home networks and these mega-techs, this is not necessarily just an easy path.

What challenges does dealing with that partner set presents in terms of pricing something that we assume from the outside that must be in that [Audio Gap] to what extent is that true? And what are some of the other hurdles that maybe make you and some of your industry [Audio Gap] is layering [Audio Gap] partners there?

So Julian, for an old guy like me, sometimes you got to step back and say, "Well, what else is the role of these players?" Amazon wants to sell you commercial goods. Apple wants to sell you more Apple devices. Google really wants more about the data and the information. So where are these players positioned and what's opportunistic for Allegion? Think about last-mile delivery. Amazon, pretty important in that. Both on a connectivity basis, am I going to allow you in the door or ease of access, but also from a commercial standpoint, we spend a lot of products through Amazon. So a play there. When I think about Google, it's all about the access and management of data and how do we position there. I think they've been less aggressive an early mover with the Nest technology. Has that really been a play that has driven substantial growth? I'd say, probably not. I would say Apple HomeKit, again, we were the first company to be positioned, Siri, open the lock, and they squandered maybe that position which they're trying to retreat for. So each one brings a unique set of capabilities. Allegion has been very firm from the beginning that we would be open in terms of our connectivity capability and interfaces. And I think that's differentiated us early and then remembering our value proposition. You may not want Alexa opening the door if you're on the front curb of your home with a megaphone. Think about that.

Yes.

Alexa, open the door. Well, is it your voice, is it my voice? These are little details that we sweat that we think are important. We do think as we move forward, our edge devices, our cellphones, our smart devices will be important interfaces that have to be based on security and reliability. That answer your question?

Yes, that's very clear.

Again, you go back to me, what are the position of these players and how are they -- how do they derive profits from their ecosystems and how can I maximize that is something we've spent time thinking deeply about.

Your view would be, yes, to an extent you deal with each of them on their own term, like negotiating [Audio Gap] figuring out next steps, you've got to look at [Audio Gap]

Even farther, we have our strategy around seamless access and what we call the 1 page plan. One of the objectives is to be a partner of choice. That's at the mega-tech, that's at the integrated level, and that's at the wholesale level. And I'd say, especially with these mega-tech relationship, it's still being defined.

That's clear. And if we look at overall sort of electromechanical growth, pretty healthy again in the [Audio Gap] is finished. What do you think is a good sort of 3- to 5-year assumption we should dial in, in the Americas or globally for [Audio Gap]

I think we put up a very strong year in the Americas. I think that continues moving forward. I think you can take your GDP number, we'll do better from -- with that and then need to add in this electronic conversion. So we'd say low single digits, 3% to 5%, I think is what we've got out there.

Plus the GDP. You're talking about electronics growth?

Yes.

Yes. Looking into the high single-digit.

High single-digit electronic.

You can get into maybe the low double.

Yes.

Depends on the adoption and acceleration.

I think, I'd just challenge it. Go around your neighborhoods, the perimeters of buildings, electronics and seamless access, you see it, but when you get inside of a complex structure, pick a college campus, this is still territory to be grown and developed.

What are the main barriers for that [Audio Gap] going to pitch for your [Audio Gap] get more electronic access control in large commercial [Audio Gap] How those conversations -- you've been charge of Allegion since the spinout from Ingersoll. How has that conversation changed [Audio Gap] large [Audio Gap] nonresidential?

Let's talk institutional, especially K-12 and college campus. There's a dialogue going on, on every campus on the continent around security, physical security access. It involves everything from the PTA to the local police department, fire and response because security is on the minds of Americans. You move into the college areas, you need to be ready for assault. And we saw that in the U.K. last night. Security and preparedness is in the minds of the world and Americans. You see it in bond issues. Typically in the institutional situation, school districts will go to the voters and say, "We want to make a large capital allocation to increase infrastructure." Allegion is involved with the preparation of that bond proposal that -- I think, last November, there were hundreds of millions of dollars on the ballot. I think just in the state of Texas, there was like 80 propositions, and they generally are approved in an overwhelming rate. So there's a catalyst there. There's also a long cycle time. Once it is approved, then we go to work. That could be 12 to 24 months of deployment. One that I was intimately involved with, a small college campus in Western Iowa, about 10,000 students, 1,500 openings. That process took about 36 months. And heavily electronic, multiple campuses, if you have a lockdown situation, you may be pressing a button in even a different town or city. Think about a sprawling college campus, how do I improve my infrastructure? Another thing that I think is interesting, think about your favorite college campus. If they have a physics building, why is the physics building wide open 16 hours a day? Does it have to be? Seamless access gives us the ability, if I'm registered for physics class, my edge device will allow me into that building and maybe to the exact floor and room. And you just limited exposures to the building, to potential thefts and other threats that can be exposed. Why is Allegion unique to that? We have a unique position on every opening. And the complexity of that opening can get quite deep depending on the application that we're trying to solve, introduce then connectivity. And I like our opportunity.

And if you look at the margin rate [Audio Gap] electromechanical field, is that sort of playing out largely as you expected? I realize you don't [Audio Gap] out in the financial [Audio Gap] Maybe just talk about the evolution of the profitability of that?

Yes. I mean I think the way we look at it, the electronics gives us an opportunity to do a higher average sales price. We expect to be able to drive that. But even at maybe similar margins on the mechanical side, as you're introducing the products, it gives you that benefit of the lift. We like that position.

I think, too, you take, like, the Schlage Encode, which has been wildly successful. You log on today, that's a $225 lock versus a mechanical lock that might go to $125. The margin play there is nice. Higher selling price with a consistent gross margin.

And how the -- you mentioned, Dave, a few minutes ago, the number of new entrants [Audio Gap] but it's large and maybe [Audio Gap] coming [Audio Gap] out. What does that mean for your R&D [Audio Gap] think that as a share of sales, R&D [Audio Gap] spending more every year, but your sales are growing [Audio Gap]

We have consistently stepped up our investment in the company to be able to drive growth in new products as well as channel segmentation almost every year. I think there's an inherent step up year-to-year because of the changes in electronics, the ability to stay current with the mega-techs. Every time Apple upgrades a degree from 13.1 to 13.2, we've got potential changes in our software stacks to make sure that's there. So you've got ongoing investment. The opportunity in that is a couple. One is electronics, from an engineering perspective, are good for about 7 years. Technically, they're good for about 15 years. Battery, circuit series degrade. You introduce an area of obsolescence that we may not have enjoyed in the past. Think about the house you grew up in, same key, same lock, probably for the entire time. As you introduce electronics, you get obsolescence that I like, that I think will be opportunistic for Allegion. As you're creating the ability to source data and develop new forms of access through edge devices, it opens up new opportunities to grow the business, potentially extract rents, new ways to optimize spaces and access that I think are compelling.

How do you assess, from a cyclical standpoint, now where we sit in the Americas right now in terms of non-res, commercial, institutional and residential? You've been talking for maybe 18 months about commercial, multifamily particularly maybe softening. How do you see those 3 [Audio Gap]?