Allegion plc (ALLE) Earnings Call Transcript & Summary

Great. So thank you, everyone, for joining. It's my pleasure to have for our fireside chat now Allegion, Dave Petratis, Chairman, President and CEO; and also Kevin and Tom from the IR team. So thanks very much for making this time available to us, particularly with earnings going on. I know you had your full year results yesterday morning. So thanks a lot for spending this time. And maybe I'll hand over, first of all, to Dave for some introductory remarks.

Good to be with you, Julian. I think we were together a year ago in Miami, a little bit colder here in Indianapolis today. But really proud of how the company has navigated through the pandemic. So we had our earnings release yesterday. I think the performance of the company noteworthy in terms of our execution, margin expansion, cash flows. We also, during the year, worked hard on our cost structure, which I think will allow us, number one, to keep our revenue and spec writing resources strong. I hope the audience picked that up yesterday, but we are stronger going into this or we're stronger coming out of this pandemic than we went into it. Throughout '20 and '21 additional investments in connectivity, electronics. Electronics, software and connectivity represent 20%, 22% of our total revenues, are growing. It's the fastest-growing part of our business. And our acquisition of Yonomi that we announced gives us capability to move our product sets even faster, bring in outside perspectives that I think are important to move the company into the connected software, cloud-based world. We're there. I think investors may not always be aware. Our Interflex business is predominantly software-related. We combined that with SimonsVoss. And the 2 of them, performing in Europe with a focus on the DAC region, are growing at better than marketplace, better than competitor space. That was reflected in our European results. As we think about this, the new world in which we coin this seamless access, the mechanical complexity does not go away. The mechanical aspects of our business and its complexity remain hard. These are not -- the specification drivers, the master key requirements, the building codes, they are part of the complexity that Allegion manage do not go away. They become more connected and we think open up an avenue of opportunities for growth through the thin cloud, which Yonomi brings, solving new problems for customers that will be -- experience out of pandemic is a good opportunity for growth. Last, couldn't be prouder of the Allegion team as we've gone through this pandemic, record safety. Investors are certainly concerned what is the position of our environmental society and governance. We are one of the safest workforces in the world. We are on the cutting-edge of environmental stewardship in terms of cleanup that you have with the legacy business as well as reducing our carbon footprints, which we think are important. And we'll further disclose that as we issue our annual reports. I've made some pretty strong stance that I think you've recognized speaking in on the importance of diversity and inclusion. It's a topic we can be better, but we think it's an important opportunity for Allegion as we position forward. So with that, proud of my team and think the future has never been brighter at Allegion.

Perfect. Thank you very much. And Dave, maybe just to start off with circling back to some of the outlook comments from yesterday's earnings, maybe the Americas division as it's the largest, clearly, you've guided for that sort of down 3%, 4% revenue base in 2021. Maybe just give any clarity you can around how should we think about the first half decline and the second half decline. And maybe any broad comments around sort of earnings seasonality in the year, first half, second half, just understanding the dynamics around different comps year-on-year in different periods last year.

So my first observation would be as we ran through '19 and '20, we stayed strong longer because of the strength of our backlog and our success in projects. In fact, data that's published by Barclays, you've got a big data set. And you look at building comps, you can see the softening in the institutional commercial markets in the Americas in mid-'19. We didn't see that softness because of our ways of cycle. We put up a strong fourth quarter finish and a record Q1 as we went to the pandemic that was superior to other players. As we went into the pandemic, we ran that backlog through. We're at a backlogs that about 3-year lows, still 12 to 15 weeks' worth of backlog, but low where -- versus where we've been over the last few years. That backlog has to be rebuilt. How does it happen? Number one, we need to see a rebound in the ABI, which is a clear indicator, the Architectural Building Index. It's been sub-50 for the better part of the year. We need some life in that upward trajectory. We'll do well on those projects that are unleashed. As the pandemic unwinds, we expect to see early bounce back or reverse radical in the discretionary and small project parts of the business. That should give us some lift in the second half. We think, too, as people go back into the office, there also will be structural changes that will result in small project businesses. Today, we're already seeing some upward momentum, upward trajectory in our pull-through sales from hardware and contract distributors that was not there in the fourth quarter of 2020. So some optimism before we go back to The Street at the end of Q1, we go out and survey that optimism, what are the views of our wholesale partners then look at the data. I'll let Tom comment about the sequential nature from quarter-to-quarter, first half, second half.

Yes. I think you also saw in our EPS guide, right, some, the operational EPS will be a little bit worse than the earnings decline, right? So we'll see a little bit of pressure on the margin. But we think that's manageable against the revenue pressure, right? As you lever up, we'll lever down a little bit. But the cost actions we took in '20 will help to dampen that and mitigate that. Some of the things that you heard yesterday in the call, mix, we'll continue to face that as residential still remains strong. We think that has legs. Obviously, we're benefiting from a resupply of the channel right now going on. We were down heavily with the plants in Q2 where we had an impact. We've been making strides Q3, Q4 that are carrying us a little bit in Q2. So that's been helping a little bit. But that's strong. It does create a little bit of margin pressure against the commercial business, which is typically a little bit better. You've heard also we're going to continue the investments. We think that the bounce back in this cycle is a little bit faster than, let's say, the back of the '08, '09, '10 type of the cycle, especially in the institutional. We think it's important to keep driving this seamless electronics investment. That will probably be more positioned throughout the year, right? That's what you'd expect. And then the last one we called out in terms of a little headwind might be around the inflation. And so that really bounced hard on us at the end of the year, especially around steel. So we'll see that impact, but you probably expect to see that more in the second half. We typically will go out and lock in our purposes over a period of time. So first half, we've already got the commitments. We'll start to see that flow through probably a little more in the second half. It also gives us a chance to get after the price to help offset that a little bit.

Julian, I'd be remiss. We have some real strength in the res side of the business. We carry into '21 $25 million to $30 million of additional backlog. We worked hard in the second half of '20 to bring that down, but it's still strong. We think demand factors are strong as well in DIY as well as the new builds. Residential single-family construction starts, we think will hover between $1.4 million and $1.6 million probably for the next 3 to 5 years because of the lack of build in the last decade. There's clearly a -- single-family homes are undersupplied. Those are available are being heavily invested in retrofit. Allegion has a wide variety of products that are well positioned, and our supply chains have been extremely robust. So as you think about things like chips, we're not immune, but we're well ahead of those drivers and expect to see good growth in the residential throughout the coming years. I'd also add our electronic suite of products, some of the best in the industry. I just look, our Schlage Encode is the highest-rated WiFi block among all suppliers. And the reviews would be 100x, 1,000x more than some of the players out there. It's extremely well perceived. As we go through the year, additional offerings on that Encode platform that will give new growth opportunities for the business.

That's interesting. Thank you. And maybe following up on that residential points. Should we expect much of a drop in the second half of this year, year-on-year revenue-wise, just because of the comp? Or you think the momentum is such that any drop we see shouldn't be that severe?

Yes. I think you're going to get the momentum. Structurally, the market is going to perform. There will be some headwind that will dampen that a little bit. We don't give the quarterly guidance, so we have a little bit here. But we would say, be reflective of the load-ins that we've been able to catch up on in Q3, Q4. That's why we always stress. Maybe it's better to look at it over a Q2, Q3, Q4, right, because you're catching up on the quarter, right? So the more you spend, we would expect growth in that time frame. How it works out once the quarters, it will be a little bit choppy probably. But overall, we're still expecting health in the market.

Yes. And one comment you've made just now, Dave, around the slope or shape of this non-res Americas recovery, you thought might be faster perhaps than what we've seen 11 years ago or so. Maybe just help us understand what's driving that different pace of improvement? Any particular verticals or end markets that are giving that lift?

So I had to get my head around this because I was rather pessimistic as we ended the year. And as the macroeconomics were updated and we were able to sort through how markets ended the year, a clear difference versus the financial crisis of 2008 is the strength of resi. Across the nation, it's a dynamic that pulls through things like schools, pulls through things like new commercial development. So there's an old adage that land under development doubles every 30 years. And we're clearly in a growth phase on res, and that's dramatically different than it was in the financial crisis of more than a decade ago. I think second, the retail, because of the pandemic as a train wreck, those locations and sites will be repurposed. As a driver that will mean reconfiguration that I think will be a positive for Allegion. And then I think as you move into the return to office, it's clear 20% of people are never going back. But that 80%, again, there'll be reconfiguration, spacing, more openness, office spaces reutilized, and we will get a bump from that. Again, it's not huge. And then tailing that will be the new construction. We see bright spots, hospitals, and it's clearly forecasted to increase in terms of overall investment. You think about it, the hospital systems throughout North America and the world have been severely tested. Our AV systems, our Von Duprin exit devices as people rethink these spaces, we're in a neat position there and add seamless access, we like it. Underlying K-12 schools, the average age of the infrastructure is 40 years. Bond issues remain good. I'm also encouraged by the health of state and municipal budgets. It wasn't until we got into January that the cover came off of that. They've clearly taken a hit, but not nearly as severe as was forecasted, and I think that will help in the snapback. One last element I think is important in the second half and as we move into '21, facility managers at all levels have been worried about social distancing and cleanliness. There's a large backlog of preventive maintenance, a large backlog of small projects that were taken off. Those will come back, and I think it will breathe life into the Allegion business as we move into the second half and into '22.

And Dave, one aspect that's definitely different this time, I suppose, is that notion that you just mentioned and what does it mean for contactless access control, thermal imaging, some of those offerings that I think Allegion is very strong at. So maybe help us understand which of those types of offerings are you seeing kind of the biggest interest in from the customers right now? How durable you think that customer interest will prove?

I think keyless, touchless is a trend that will continue. One is everyone's got a cell phone in their hand on the planet, Apple and others investing in what we call thread technologies that are making security higher access simpler. We will be in the front there on both touchless and keyless. That -- I don't want to discount that the complexity doesn't go away. Things like fire codes will require a mechanical override. And this is what I think sometimes is lost as our industry moves towards connected and touchless access. These building codes are not going to go away. And if the fire department shows up, they're not going to -- they would prefer they have a key to override if the power is out, whatever. This mechanical complexity of our business puts us in a nice position, and these trends will continue. I think the world will look differently at germs. And if people can move through their life and not have to touch a doorknob, you have automatic openings, I think these are investments that operators will make. It's our -- we already see it in Class A commercial structures. How can we move people through security into the elevator up to their office and under their floor and in their office and not touch. As you advance that, it opens up new value propositions. How many people are in the building? Have we exceeded capacity? We're able to do these types of things through our venture arm and partnerships with companies like Openpath; VergeSense, which is capacity. Our investment in Yonomi will help us better position our products for SDKs and APIs to be able to connect with customers, but it's clearly a trend that is going to benefit our industry and benefit Allegion.

And one aspect around sort of changes in business model or evolution of the security industry, we receive a lot of questions, as you can imagine, the last month or 2 on what's happening with Latch and maybe the sort of subscription-based business model that they're trying to sort of propagate. How does Allegion see that subscription-type model? Is it also exploring as a company more sort of recurring revenue streams that can smooth out earnings over time?

So one, I applaud the innovation of companies like Latch and others because they look at problems of access and security from a different lens. I think the value proposition that's presented there opens up opportunities for growth for Allegion. But I look at it from a different perspective. Take an institutional operator. It could be a major hospital or a college campus. How can I put a value proposition on the table that puts them out of the credential and key management aspects of their work, one. And it's going to get pretty complex. You can take like the University of Texas, where I have an almost exclusive installed base. I can, through connectivity and thin cloud, put them out of the credential and key management business. We can step in and offer that whether it's recurring, how we handle that, it's part of the value proposition. But I can't put a cost savings manner on the table. But it's also got to consider other aspects. What if I have a lockdown? What if I have a fire? How do I coordinate with public safety officials that may have to enter? There's a much broader aspect of that than just renting a lock. So I applaud the movement. I think the complexity of our business, the connectivity, the variation and driving a broader value proposition is part of the future we call seamless access. We're doing this today with SimonsVoss and Interflex and growing it at almost double-digit levels. So take a casino in Baden-Baden, Germany. We can provide seamless access to the employees and be aware if a bus pulls up, immediately go to their time and attendance systems and say, "Do I have enough cocktail waitresses? Do I have enough blackjack dealers?" We can also are doing it at hospitals, that says, "Okay, I've got an influx of procedures today. Do I have enough RNs? Do I have enough LTNs, technicians?" So we're on the edges of this, and it's going to continue to advance. I think it's access and technology driving human productivity and solving new value propositions that our industry and Allegion are in a unique position to grow.

Perfect. And on the sort of that broad electromechanical piece, you had mentioned, Dave, it's about low 20s share of firm-wide revenue today. How satisfied were you with the performance of that business in the downturn? What kind of recovery slope should that piece of Allegion have the next year or 2?

So I was not pleased with the commercial institutional piece of it, particularly in the United States, but it's also about our customer base. They weren't worried about an electronic lock, they were worried about keeping people safe. So I got to respect that. I went back and looked at the 8 quarters pre-pandemic growing at low double digits and expect our electronics software and access to continue to grow at that pace as we exit. Certainly, as we begin '22, we should be back on that path.