Allegion plc (ALLE) Earnings Call Transcript & Summary

All right. Welcome, everybody. Excited to have our next presenters here. We have Allegion fresh off of their Investor Day last week. We have Mike Wagnes, the CFO; and Tom Martineau, Head of Investor Relations. I know, Mike, you've got some prepared comments. So I'll turn the mic over to you. But thanks for being here today.

All right. Thanks, Joe. Good afternoon, everyone. Thank you for joining us today. Hopefully, everyone got a chance to listen to our Investor Day last week. I'm just going to highlight a few slides to just kind of set the stage for Allegion. But to really do this justice, we need to -- I really encourage you all to go listen to our Investor Day. Obviously, we'll start with forward-looking statements. I just ask you just to read it and consider it accordingly. As far as Allegion, our vision is we enable seamless access in a safer world. And what that means in a nutshell is we're looking to provide the most convenient, secure access for users of both physical credentials, the key, or even mobile credentials where the people who need access get access on that secure and convenient way, and those who don't need access are not permitted access. So we keep people safe and secure. And our strategy here is we're a pure-play provider of access and security. And we're pretty close to the knitting of what we are. We've been this way since we spun out from Ingersoll Rand 10 years ago and expect to stay a security and access company. If you look at our business profile, last year, we had $3.3 billion in revenue. We have the leading brands or some of the leading brands in the industry, especially in North America, you could think of Schlage, Von Duprin and LCN. In Europe, you can think of CISA, some really iconic brands. We're also the leading margin company in the industry. So we have the highest EBITDA margins in the industry, and we expect that to continue. And so if you listen to our earnings call last week or our investor -- or 2 weeks ago, or our Investor Day last week, we're going to push the margin expansion story. And you'll hear that from Allegion. We believe that our market-leading margins are a competitive advantage when we think about investors and we drive margin expansion. If you think about our business mix, we added these slides to kind of give you a flavor for where we operate. So our business starting over into the right, we're about half aftermarket, half new build. So we have the stability of an aftermarket business that's very consistent. Then on the middle part, you see the vertical markets in which we play. This is our global footprint where we're 40% institutional. If you look at our business in the Americas, that number is 45%. So we're mostly an institutional vertical market business with commercial, 30% in the Americas; and then resi 25% globally. I think it's important to understand Allegion that institutional, that tends to be public finance, not private finance, stable, very late cycle business. And so when you think of Allegion, and I know there's some narrative out there about commercial office and regional lending, that is not where we play. We're a very institutional heavy business. Think K-12, higher ed, hospitals, health care, which tends to be public finance. And then electronics versus mechanical, this has been growing for us. We're about 30% electronics today. This is the key growth driver for Allegion. We believe that electronics will be a double-digit growth driver for us in the future, continue to be a growth driver -- a strong growth driver. And that is really where we're going to put our investments to drive market outgrowth and shareholder return. In the next 2 slides, I'm just going to give you an example of electronics because it's so key to the story. Think of a higher ed university. When many of the people in this room were in college, you had a mechanical key to get into your room. Your children, they're going to go and there's going to be an electronic lock. And we're going through that transformation today where universities, in this example, Auburn University, we partner with the mega techs: the access control provider in the case of Lenel, the one-card provider in the case of CBORD. This is a partnership where we come with a solution for the end user to have a seamless solution, and this is an opportunity to really accelerate electronics growth. In this university, they ripped off all the mechanical hardware and they're putting on all electronic hardware. So great growth driver for us. Another great opportunity for us is in the multifamily. Similar dynamic, multifamily, traditionally a keyed solution, mechanical solution, it's moving to an electronic solution where the property owner doesn't have to worry about trying to get keys back from tenants when they leave. The ease of showing the property when people and potential tenants want to see the property adds a value that today didn't exist a couple of decades ago. And so moving forward, expect multifamily to be a big growth driver for us as well as that higher ed solution I illustrated before. And then just one more before we get to Q&A, this was what we closed our Investor Day with about Allegion and where we're headed. Number one, as many of you know, we ran into some challenges with supply chain that really hurt us operationally in the end of '21 and into '22. Middle of '22 forward, we're really operating at a high level and you saw that in our Q1 results and our back half of last year as well. So we're kind of back to operating at the level that you expect of Allegion. Electronics is going to be that key growth driver for market outgrowth. We think we're going to outgrow market, and electronics will be that key driver. We're going to continue to invest in our software and services revenue. As many of you know, we made an acquisition earlier in the year to buy plano, a small software company out in Germany. And we bought in '22, the Access Technologies business, which is a great business for us that has a high service component; a stable, high service, high margin business. And most importantly, we generate a lot of cash at Allegion. We're going to deploy that effectively for the benefit of shareholders. So with that, I'm happy to turn it over to Q&A.

Yes. No, no, that's great. Really appreciated the overview, Mike. We're going to dig into a few of those seamless opportunities that you just highlighted. But before we even get there, a lot of changes over the past 18 months, right? You've got -- you took over as CFO. You've got John taking over as CEO. Maybe just talk about like some of the changes that you guys have already started implementing that you're most excited about?

Yes. So it's an exciting time in Allegion. Obviously, we have a new management team. I joined in March as the CFO, but I've been at the company for 12 years. So I'm a company insider. Many of you know me at my former days as the Head of Investor Relations. John joined a few months after me, so he joined a week after we closed Access Tech. And one of the benefits we're really seeing is we're back to operating at a high level. And one of the things we know we struggled with was the supply chain. I feel that operationally, we're executing at an extremely high level. We're also really positioned well to take advantage of the seamless access journey. And one thing in particular John brought is, John's background, he kind of led this technology-fueled growth at Deere. And so they went through this journey a little before Allegion. So coming into a company which had the right strategy, he was able to bring some of his experience to help fuel and accelerate that seamless access strategy. So as we talk about things like software, right, that's a clear example of a direction that Allegion is focusing on here as we accelerate growth. So look for us to be really focused on accelerating growth to drive shareholder return.

Okay, great. So you had the Auburn example, so even beyond K-12. And what does it ultimately take for Auburn to make the decision? Was that retrofitting existing buildings? Was that new building that was going up? And then I don't know, is there any way for you to help size, like what college campus opportunity would look like for you?

Yes. So if you -- I'm reaching from my phone here. So what's happening right now is that the phone is becoming the credential. The days of a physical key will soon be part of your phone. And so a case like Auburn University, here's a university that wants the convenience of a mobile phone application, not just for locks, for the entire campus. So if you go to the student bookstore, you need to have on your credential a secure phone credential where you can pay -- the credential can pay for your books, the food at the dining hall. It's so much more than locks, but locks is a component. So a university will look for a trusted partner like us to work with their other providers on campus, that's why we use the partner of choice, to come with that solution, which includes locks. But it's larger than locks. And in the case of Auburn as well, traditionally a campus, and here's the use case. They'll go every summer and move a mechanical cylinder from dorm room to different dorm rooms. So if you were in Room 306, you couldn't get in the next year. Now with an electronic solution, they don't have to do that. They just remove Joe Ritchie's credential so he doesn't get into that room the next year. So there's a real use case for efficiency that drives a larger university like Auburn to implement a full campus solution. In smaller universities, they'll do it more piecemeal where each summer, they'll do a couple of buildings at a time. But there's a long-term trend that higher ed will get to electronic locking as the standard rather than the exception.

Got it. And to be clear, this is all a retrofit opportunity and where you're partnering with a lot of the software providers and you're providing the hardware associated with it.

Right. we partner with Lenel and CBORD. Obviously, the mega techs own the wallet within the phone. Lenel is the access control, CBORD is the one-card provider. So it's a partnered solution on a retrofit basis where historically, you wouldn't have replaced via a new sale those cylinders or those locks unless they broke. So this shows a market cost opportunity for us for growth because it's a perfectly working device that gets replaced.

Got it. And then my last question along these lines is as you think about your hardware, is it open architecture? Can you -- do you have like the opportunity? Is it exclusively partnering with certain software providers? Like, what's the architecture like?

We are open architecture. Great question. We partner with all access control software partners. So if you look at our website, we have a page which has our 50 PACS partners that we partner with. And so we have an open architecture partner strategy in the case of higher ed where we're going to partner to make that solution. There are certain applications like multifamily where the solution is more sophisticated by the access control partners today. So we go with a turnkey solution where it's a simple Allegion solution of hardware and software. So we can either partner or we can go with our own solution. Don't look for us to be exclusive either way. We think it's a combination of both and not either. So...

And on the multifamily side, I guess my bias would be that that's more of a new construction opportunity than a retrofit opportunity, but am I characterizing it...

Historically, that tended to be the case. You have a dynamic now where property owners are seeing the advantage of putting in that multifamily lock on an existing building. And so there is now starting to be retrofit. If you talked to me 4 or 5 years ago, we would say retrofit was extremely small. Now you're starting to see an acceleration in the retrofit for multifamily as well, highlighting the real above-market growth that electronics would provide us.

Yes. So it's interesting, right, because we're -- we've been talking about electronics growth for a while. And it has been good, but you're still at a point where penetration rates are pretty low, right? I think we're talking around like 10% type penetration rate. So the enthusiasm that I'm hearing in your voice, is that driven by how many like qualifying leads you're being asked to bid for? Or what is really kind of like changing? Because it does feel like there might be an inflection here that's positive?

Yes. So if you followed Allegion for a long time, you would hear us talk about electronics growth historically, and it might have been a little bit more on the residential side. Because your front door, you might have been more adept to change that lock than go with electronic lock. Now the enthusiasm is you're starting to see the momentum in that higher ed, in that multifamily solution. So I think that when you think here enthusiasm, it's really the acceleration on the non-res side that it's something we saw coming over the last half decade. But now we're starting to see more and more momentum, and we just illustrated a couple of examples here. But if you think of K-12, school security is a focus of schools. There's more adoption of security products there as well. So it's really across the product offering, but I do feel momentum coming in electronics. And you saw that in our growth the last 3 quarters. Electronics growth has really started to accelerate for us. Our demand has been strong. So I do think -- think of electronics as a long-term growth driver for us. It's not a -- within 3 years, every lock is electrified. Think of it as a multiple-year, double-digit growth driver as this installed base, which is historically very mechanical, becomes more and more electrified and digital.

Makes sense. At your Investor Day, you talked a lot about Overtur. So maybe for those that aren't as familiar with it, talk us through like how does Overtur actually work? How is it differentiated for you guys?

For Allegion, in our nonresidential business, it really starts with the demand-gen engine and the spec engine in non-res. Overtur is a tool we use to help us take advantage of it. So for our business, we write the specification for an architect to help drive demand for our products. So with that spec writing, Overtur is the tool we use to -- in the design phase to work with architects, but it goes all the way through the life cycle of a building to the end user. So it's a way to create influence throughout all -- if you think about commercial construction, all elements in a life cycle of the business has different influencers, whether it's general contractors, distributors, end users in the design phase with the architect. Overtur is the tool we use to just create more stickiness. And so this is something that we do as the market leader to keep that market-leading position. So we love the additional stickiness that gives us with our existing customers. And it's a tool that makes us more efficient with the architect. And if we could be more efficient with an architect, we can write more specs and drive more revenue.

I imagine that some of your, like large like competitors that are publicly traded, ASSA, dormakaba, like I would imagine that they have similar design architecture as well. I'm curious, like is the share opportunity with this specific application may be targeting more medium-sized or smaller players that aren't investing or can't invest? How are you thinking about the opportunity?

Great question. So we were clearly the first with this tool. But with any tool, your competitors will eventually -- and make the necessary investments to catch up. I think the key thing you see here in Overtur, when you have that as-designed spec and in the tool, when it's time for repair, replace, it just makes it so much harder for someone to not use your product on the repair, replace. And then when you build a new building on that same campus, if you're already suited with the Allegion product, you're more likely to go with Allegion. So it just makes you that much more stickier with your existing customer base, and it stops anyone else from taking some -- not making you able to get that like-for-like. So it just makes like-for-like so much more applicable.

And then so you mentioned plano, the recent acquisition. So just talk through that acquisition specifically. It seems like it's really going to help you with workforce planning. Is -- talk to me about why that's the right adjacency for your business.

It's not an adjacency in this respect. We have an Interflex business out in Europe, which is in workforce management. And so what we did is we bought a small software company that can tack on to our existing Interflex solution to make it more user-friendly and easier to adapt and is, frankly, cheaper than trying to build this business ourselves. So it's a small -- we disclosed the amount in our 10-Q, $35 million purchase price, to really accelerate that business and make it a better tool for the end user today. And Interflex is a great software business we have based in Germany. So it's not a case where we're going outside our swim lane. When we do M&A, look for it to be very closely tied to our existing portfolio where we can buy -- where we can get synergies. In this case, it's deleveraging the Interflex business today, that platform.

Got it. So I'm going to turn to the audience in a minute, if anybody has got any questions. But before we get there, just one quick one since we're talking about M&A. I think you have a goal of 2% to 3% of your sales to come from M&A. You just talked about plano, Access Tech. You seem to be really happy with how that acquisition is performing. What are kind of like the right areas for you to be looking at from an M&A perspective? What does the pipeline look today? And then we'll ask some questions on Access Tech as well.

So if you look at our business, you'll hear us say often, pure-play security and access. So we are very focused on staying close to our core of what our business is and M&A targets being those that can really enhance our overall business portfolio, trying to leverage the existing business. I gave you an example on Investor Day. There was a small business up in Seattle, Washington called AD Systems, makes sliding door solutions for a hospital. We were able to -- we bought the business and then leveraged the demand-gen engine in North America where we were able to put in our sales force and drive over 20% annual growth in that business. Great example of the type of assets we like to add, businesses that leverage the existing either front end of the business, distribution partners, but similar to our existing portfolio, so there's real synergies and not a case of going completely outside of our swim lane. Look for us to be very close to what we do of security and access.

And the pipeline right now?

I would say the pipeline has -- we put considerable efforts to rebuild it. When John came in, one of the things we did is reinstitute regular reviews of pipelines and building pipelines. So I think the pipeline is in a healthy position as well.