Allegion plc (ALLE) Earnings Call Transcript & Summary

So let's get started. Good -- maybe good evening. I'm Tim Wojs, and I cover building products here at Baird. And we're happy to have Allegion join us again this year at our Global Industrial Conference. Allegion is one of the world's largest manufacturers of mechanical and electromechanical locks and security products. And from the company, we have new CEO, John Stone. We have CFO, Mike Wagnes; and then we have Tom Martineau over here in the audience who's VP of IR and Treasury. So we're going to start with a couple of slides in the prepared remarks from John, and then we'll have time for Q&A. So John, I'll turn the floor over to you.

Thanks, Tim, for the introduction and the invitation here to the conference. And thanks, everybody, for sticking it out this late in the afternoon. In recognition of the time of day, I'm going to skip the forward-looking statements and reconciliation of non-GAAP measures. There's none in here. So real quick, who we are at Allegion. Think of us as a pure-play global provider of security products and solutions. Some characteristics of who we are here just for you to think about and look at. Strong brands, we'll talk about those. Some of those brands with 100-plus year legacies. History of innovation, industry-leading organic growth, strongest EBITDA margins in the space, something we certainly expect to continue. Very strong engineering expertise in the Internet of Things and electrification and communication and miniaturization in very small hardware packages. I've been really impressed with the team as I've come on Board here just really since July. Healthy and also growing service business. I'd expect this to be a continued point of emphasis for Allegion's go-forward strategy. Very engaged workforce, one of the safest workforces in the space. And then balanced and flexible capital deployment strategy. And I'd say, one, that we look to continue to orient more towards growth going forward. Like I mentioned, we are a house of brands, several of these brands over 100 years old, great legacies. So half my time will be spent making sure we live up to that great legacy of brands like Schlage and Von Duprin and LCN and CISA. Half my time gets spent on securing the future with new innovation and new technologies. All of these brands worldwide united around our vision of seamless access in a safer world. And how we go about delivering that 3 ways, really. Some of it, of course, is organic investment, research and development in our own products. That's around electrification, that's around increasing embedded compute inside our hardware. So our hardware has power. Our hardware has communication. Our hardware is increasingly smart that's making each component more valuable and actually connecting it to a variety of networks, a variety of partners that do new and interesting things with the data that we create and curate right at the entry way or at the door. Allegion has its own venture portfolio. You see some of the icons there. We're very active in the startup community. We've built and cultivated a good reputation in the start-up community with venture capital funds as well as a pretty wide network of entrepreneurs. And then lastly, buy. I'd say, Allegion's history since the spin from Ingersoll Rand had a very nice acquisitive period a few years ago, and I'd look for us to continue to be acquisitive going forward, both in terms of hardware portfolios -- going concern hardware portfolios that we find complementary to what Allegion does today as well as investments pushing the edge and pushing the boundaries of new technology relevant to our space. Lastly, just a little bit here, just to focus in on the relevant technologies, the here and now. It's -- electronics is definitely a favorable growth tailwind for our industry. It's a favorable growth tailwind for Allegion. And our history here dates all the way back to Walter Schlage himself. 1909, patented a door lock that would also turn the lights on and off in the house. So I find that kind of interesting. 1909, one of our founding fathers was already thinking about a smart home. Kind of interesting fact for you there. And as access and credentials and identity and security has continued to modernize mid-70s, it became things like proximity cards. Today, our identity, your identity, mine is increasingly digital. It's increasingly mobile, and it's increasingly encrypted, all of which Allegion is really good at in terms of making sure our hardware can interact with a variety of devices, mobile phones, encrypted cards, et cetera. And then interfacing not through WiFi, interfacing through near-field communication, Bluetooth, low energy, et cetera, to the cloud, to any number of smart building-type ecosystems that we need to contribute data to in terms of access, visitor management and whoever is coming in and out of the building. So contactless, touchless technologies that have become very common here during the COVID pandemic, are certainly going to live on and continue. And I feel Allegion is very well positioned to at least lead our space with those types of innovations. So we -- that's a little bit about who we are, who we are not is really heavy PowerPoint guys. So that's it for the slides. Thanks for your patience to just take a quick spin through some high-level introduction to who we are and our products and innovation. And a bit of smart home history from 1909 that you might not have known when you walked in. Thanks very much. Tim, let's take it away.

Yes. Great. No, thanks for that. If you have a question, you can raise your hand or you can e-mail [email protected]. I'm going to ask the stereotypical since you've been here for 3 to 4 months question.

So maybe just -- I mean, spend a minute on your background, maybe some of the key roles that you've held outside of Allegion and -- you've been with the company now for, what, 4 months? Just kind of any sort of initial impressions, I think, would be helpful.

You bet. Thanks for that, Tim. West Point grad, mechanical engineer by education, 8 years active duty army officer, then transitioned out of the Army and went to work for GE as an engineer. Left that -- left GE, got an MBA from Harvard got connected with Deere there and worked for almost 20 years with John Deere and a variety of engineering, manufacturing, operational-type leadership roles. Circumnavigated the globe, and had, I think, a pretty interesting set of opportunities, particularly on the high tech side that helped transform a lot of old machinery into much more high-tech and now, in fact, fully autonomous machines. So quite a good journey there. Got attracted to Allegion because of the words right up there on the slide underneath the logo, Pioneering Safety now resonated with me as a mission as an Army guy or a genetic code, I'm a mission-driven person. So a mission that matters. Safety and security and the idea that our products deliver peace of mind to people, where they live, where they work, where they learn, where they shop. This is really important, and it's work I can feel good about doing and really get passionate about and get behind. In the -- whatever you want to call it, the dating process, got exposed to the Board. It's a small Board. But very engaged, very supportive, I think, really have enjoyed getting to know them and work with them. They're interested for me to bring a more tech-forward, tech-focused approach in terms of orienting our growth strategy and growth factors. And I feel like I can contribute there. The management team at Allegion is very strong and works together extremely well. Everybody is engaged in the business, whether it's a function, lead or a business vertical lead. And I think the culture of Allegion is something pretty special. And that's been -- early impression is fantastic. The teamwork and the can-do attitude and the will come together and do whatever it takes, particularly in the last, whatever, 12 or 18 months that have been one of the most difficult time periods for any manufacturer with a pandemic with how do you keep a factory running when you've got COVID protocols and supply chain problems and the great resignation and all this had everybody in a bit of turmoil. Our team persevered. And I think this last quarter is a result of a lot of efforts to build out the supply chain to be more resilient. So supply chain delivers our factories produce and the retail pull-through was almost instantaneous. So felt really good to get back on track with the kind of operating excellence that Allegion has been known for. And last point, Tim, sorry for such a long-winded answer, but best days are still ahead. We've got a really bright future.

Good, good. That's good to hear. I guess when you look at the assets that Allegion has -- and I mean, correct me if I'm wrong, Mike, I mean, you've probably spent incrementally $100 million or $120 million in terms of investments since you've been public. How do you think about investing in -- when you say seamless access, I mean, there's a lot of things that aren't necessarily mechanical products that might need to be invested in. So I guess, how do you think about the investments that, a, Allegion's already made? And then b, how you kind of think about that going forward?

Do you want to start, Mike, with the already made?

Yes. If you think of our business, we've been investing heavily in R&D since we spun out, driving both new product development. Early on in our journey, there were some investments made in the front end of the business that are sacred to us. So we'll continue to invest in the front end, especially in the North American region where we've put a lot of incremental focus in the early years of Allegion. The incremental investment more recently has been really driving that seamless access strategy, both in R&D, engineering as well as new product development. So those have been the big drivers of our incremental investment more recently.

And I think look to us to again increase investments, both organically and inorganically. We will be acquisitive where there's new capabilities or technology we don't have today or need an accelerant to something where we might have some capability, but need more. I'd say Allegion has very productive development relationships with the mega tech companies, Apples, Googles, Amazons, on all of the different smart home ecosystems. Our Schlage products interface very well with those, easy to set up, get very good reviews. That will continue. On the nonresidential side, commercial and institutional side, electrification, embedded communications, embedded smarts will continue. And then increasingly, if you just look to the press release we had yesterday, acquiring more software-as-a-service elements that are related to seamless access and software that interacts and even controls directly our hardware, is going to be an increasingly important part of our portfolio.

Okay. Okay, good. And is it really in your eyes -- I mean, how much of the product road map or the technology road map's been kind of developed and you just have to execute on it versus you still kind of have a TBD in terms of how seamless access actually kind of rolls out 10 or 15 years from now?

That's a good question. So there's a lot of to-be-discovered white space to-be-captured white space we're moving into, and it's a big addressable market. I think the hardware position that Allegion enjoys in many of its markets. For one, we have to continue to protect that, continue to protect the moat around it, so to speak. But then also, there is additional value that can be created at the door, at the entry way with seamless access. And when -- again, your credentials and your identity is mobile, and it's encrypted. The data generation that other smart building systems will rely on will increasingly come from our products. So on the partner side, in the middle of that slide, we'll still aspire to be the partner of choice to a lot of smart building system providers, but in the access layer itself, we would see that that's where we are the pure play. That's our sandbox, and I think we'll excel at it.

Okay. Maybe just on electromechanical, I guess where is the market today? And when you -- I mean, I think a lot of investors think about it as a residential market, but the bigger opportunity actually has always seemed to be in the commercial market. So I guess, can you may give us a little bit of an update about where that market is, where penetration is? And are you starting to see maybe with COVID or maybe with people changing office space and things like that, are you starting to see more electromechanical progress within the commercial market?

Yes. Do you want to go, Mike?

Sure. Historically, if you look at our industry, the residential space, we introduced the first resi e-lock about a decade ago. So it is lagging historically the perimeter of nonres, which has been electrified for a while. In the case of residential, I think adoption has started to accelerate over the last 5 years and will continue to accelerate moving forward. Nonres the perimeter, there's been a lot of electrification in certain verticals, other vertical markets just scratching the surface. So if you think about multifamily. Multifamily historically, a mechanical solution becoming more and more electrified. So in general, adoption hasn't yet hit an inflection point of critical mass, and we should see more adoption moving forward. And that will give us a natural tailwind to growth as you think about our business in the industry as we move forward. So I'd say early innings with respect to adoption rates in both resi and nonres, especially in select verticals.

I'd pile on, it's particularly critical in the B2B space, these nonres verticals because when you think about it, just picture yourself as an apartment building or a large office building owner operator, do you want to be futzing around with lost keys and mechanical keys and swapping those? It's a high touch time, every turn you turn a tenant. Or would you rather digitally program access and credentials for the units and you have a much more seamless experience to onboard and offboard tenants? You have then a lower operating expense for your building. So there is true recurring value to be generated there.

And then how does your -- how do you think the model -- does the model change for Allegion? I mean do you need to add the software layer on top of that? Do you need to add -- are those the places where you think you need to go?

We do and have some of that today, in fact, with our Interflex business in Germany and then the acquisition we announced just yesterday of Plano. Those 2 businesses basically get stapled together and have a more full stack offering around access and workforce management there, primarily a Germanic region play. Here in the U.S. a few years ago, we acquired ISONAS, which is that software layer for access. Very simple, UI targeted primarily at small and medium businesses with just a few openings and needs an affordable play to interact with their hardware and maintain their data. I think you could expect Allegion to continue to move -- if the electromechanical hardware is this layer of the solution stack, moving that up one layer into that access software is very much appropriate for us to do.

Okay. Okay. Good. Maybe kind of moving over to the Access Technologies business. I mean, you've only owned it about a quarter now. What was...

They onboarded 6 days before me.

There we go. Okay. How -- could you just kind of walk through some of the strategic implications or the strategic drivers of the acquisition? And then I guess as you think about seamless access, I mean, is Access Technologies going to be kind of a platform for more kind of like-minded or similar minded type businesses?

Want to start?

Yes, sure. So when you think about the sliding door space or the Access Technologies space that they play, this has been a product gap that we've had for quite some time. And when you leverage their product with our front-end spec engine, there's real value we can drive in bringing solutions to end users and customers. So the real value we see is really marrying the front-end spec engine we have here at Allegion with the great product offering and solution sets that they have. In addition, they come with interesting service capabilities that we don't have today or we don't have in North America today. So it really gives us a more resilient service arm that historically we did not have. So I really love the synergies on the front end of the 2 businesses. And the fit works very nicely with the existing nonresidential product set.

Thinking a bit forward, again, don't get me in trouble with forward-looking statements, but you think of the -- and all of you go through Stanley Access stores like frequently, maybe on a daily basis. When you think about the real estate that's there and the ability to include very simple sensors to, again, create and capture more value at the point of entry and egress. It's kind of an interesting opportunity in some verticals where, again, Allegion probably hasn't been all that strong in the past. So I'm pretty excited about that.

Okay. Any questions from the audience? I've got one here on the iPad. Just on pricing, could you kind of walk through the pricing cycle? It did seem like, maybe relative to history, it took a little longer for price to kind of come through the market and through the P&L, Kind of where are you on the price cost journey? And I guess, how would you think about those 2 items going into next year?

Yes. So if you think of our business, last year, we fell a little behind the ball in price cost. Historically, we've been great. Back half of last year, we turned negative. It's been a focus of us to drive pricing to exceed that inflationary pressures. Starting in the second quarter, we broke even. Q3, we were positive both margin and in dollar. That was a real focus area as we exited last year, ensuring that we took the necessary actions to pass along this significant inflationary pressures we've been feeling for 15, 18 months now. So I feel we're in a good place where the worst is behind us with respect to the price cost dynamic and that we're positioned nicely, so that we'll be positive on a go-forward basis where price will exceed that inflationary pressures.

Okay. And I guess when you look at your cost basket, I mean, there's a lot of things slowing around. I mean, steel is down a lot. You see kind of raw metals down, but then it seems like based on presentations today, I mean, the component costs still aren't really coming down. So I guess, what's your exposure to raw metals versus components? And I guess, when would you start to see some of that raw materials start to actually impact the component buys?

Yes. Most of our buy is not strict raw mets. It's not raw commodities. So we feel the pressure from suppliers who pass along their labor and overhead components within the products that we get from them. So expect inflationary pressures for us to remain into '23. And we're planning as if inflation is going to be a headwind, and we're going to take the necessary actions to drive pricing such that we have a net positive delta between the 2.

And I guess when you look at the market, most -- I mean, you've got what, 70% of your business is nonres, 30% is res. How would you kind of hop around the different end markets in terms of kind of what you're seeing from an order backlog stocking-type situation?

Let me start. Yes. I think good question. And -- so if you start with the really the core of Allegion's business, the nonresidential institutional heavy business the higher-level indices like the ABI, AIA consensus have been an expansionary territory for a long time, still are in the most recent report. I think that is a good indicator typically of near-term demand, 9 to 12 months of construction activity. So you layer on top of that, Allegion's products are late cycle within that activity. So we feel pretty good about continued demand strength into and through 2023 there. U.S. residential is certainly softening. I mean, mortgage rates have doubled. So definitely that's having an impact. Housing starts are down and admittedly off a very high peak. So softening. The mitigating tailwind is still electronics adoption where we would feel -- we still have even some big box shelf space to fill. We've been short on electronics. The backlog is still pretty robust on electronics. So does that totally mitigate the softness in resi? Not totally, but it is a mitigating factor there. When you look to Allegion International, it's a similar story. So general market softness in Southern Europe where a lot of our business is driven by the same dynamics here, high inflation, high energy costs, just general economic slowdown that were obviously impacted by offset somewhat by continued strength in demand, solid demand for our electronics and software products. So international will be under pressure, residential will be under pressure. Nonres still strong into 2023.

And how much of your nonres business is -- specified project has a product order to kind of attach to it versus goes through a distributor or a locksmith or something like that, where there's actually inventory-type product?

Yes. If you look at our nonres business, it's a little more new construction, and it's really driven by the spec. And then the spec also drives brake fix or repair -- replace where they go like-for-like. So it starts with the specification in nonres, and that helps pull both new construction as well as aftermarket.

Okay. Okay. From a supply chain perspective, just in terms of -- where do you think you are? I mean it seems like the castings have gotten a bit better. Chip's still kind of plus or minus. I mean what are the actions that you've taken internally to -- I don't know if it's going from single source to dual source or just changing companies. I mean how do you kind of see that playing out over the next, call it, 6 to 9 months?

Yes. Tim, at a high level, I'd say, if 12 months ago, there were 50 just red hot delinquent suppliers that were causing line-down situations in our factory, today, that number is 5 or 6, just for order of magnitude of the improvement. Most of that has been driven by, like you say, qualifying new suppliers, dual sourcing, qualifying alternate materials, qualifying new chipsets and write a new embedded firmware to make those work in our electronic products. On the electronics side, still the best word is just choppy. So while we have multiple suppliers where we used to maybe have one for particular components, quantity of supply has definitely improved. You saw that in third quarter. But the linearity of that delivery is still choppy. So if a high-volume manufacturer needs 20,000 of these each week, to make the factory run like it should and get the channel supplied like it should keep our lead time straight, I'll get 30,000 this week. I'll get nothing for 3 weeks and no visibility, no explanation. And then 15,000 will show up. So very bumpy delivery. I'd say, credit Allegion's manufacturing team. They're quite flexible, quite nimble and making the best of lack of visibility and lack of linearity on that delivery. It is improving though, and I think will continue to.

Okay. Okay. Good. And then how about kind of the supply chain into the project itself? Because you guys got to kind of go in late in the building process. How has the project time line itself kind of trended versus normal? So let's say, it used to be an 18-month lead time. Is that still 18 months? Or is it 24 months? And kind of how do you kind of manage that?

You want me to start? It's definitely not just Allegion. So I'd say labor shortage in construction has probably been the most acute pinch point for general contractors and their subcontractors across the country, across the world, in fact. And then being late cycle, probably that insulated us when our lead times used to be 4 weeks or now 14 because of our own supply chain challenges, given that the whole job site was probably late as well. We weren't losing customers, so to speak. And I think that continues to improve as well. So in general, situation getting better, but it's across the whole job site. And again, being late cycle, sometimes we're the beneficiary of that. Sometimes, we've got to get off the job so we can turn the keys over to the landlord.

Right. All right. Okay. Last one, just -- any sort of kind of high-level capital allocation philosophies that you have personally?

Yes, 100%. So think of Allegion to, first and foremost, maintain investment grade. We are today a dividend stock. We will continue to be a dividend stock, growing with -- commensurate with EPS. Then look for us to invest in growth assertively on R&D, on organic growth opportunities as well as look for us to become more acquisitive.

Good. I think we're out of time. So please join me in thanking the Allegion team for being here. Thanks for your time.