Allegion plc (ALLE) Earnings Call Transcript & Summary

Good day, everyone. My name is Stefan and I'll be your conference operator today. At this time, I'd like to welcome you to the Allegion Second Quarter Earnings Call. [Operator Instructions] At this time, I'd like to turn the call over to Josh Pokrzywinski, Vice President of Investor Relations.

Thank you, Stefan. Good morning, everyone. Thank you for joining us for Allegion's Second Quarter 2026 Earnings Call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning, and the presentation, which we will refer to in today's call, are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Please go to Slide 3, and I'll turn the call over to John.

Thanks, Josh. Good morning, everyone. Thanks for joining us. Second quarter results were driven by strong organic growth in the Americas, and we see continued momentum in nonresidential indicators. Our specification activity has been robust for several quarters and includes the breadth of our core institutional markets cyclical improvement in commercial verticals like office and multifamily and strong growth in data center, which is still small compared to some of our legacy markets that will continue to gain relevance as that installed base grows and fuels aftermarket over time. I'm also pleased with the return to Americas margin expansion. In our International segment, we made progress on the ERP challenges experienced in the first quarter, consistent with our expectations. We saw strong sequential margin improvement and expect to build on that in the second half of the year. However, demand is weaker in several of our European markets, including Germany, which is our largest market, and we have taken additional restructuring actions in response. With respect to our full year, we are raising our reported revenue outlook to 7.5% to 8.5% and our outlook for organic revenue growth to 3.5% to 4.5% based on stronger expected demand in the Americas, partially offset by weaker international demand. We are raising our adjusted EPS outlook to $8.85 to $9. I'll provide additional details on this later in the call. Please go to Slide 4. Let's take a look at capital allocation, starting with our organic investments and ongoing demand trend for electronics. Higher education offers a clear example of continued secular growth in electronics, as demand for mobile technology increases on college campuses, these customers are moving from plastic cards and mechanical keys to contactless mobile credentials provided and managed by Allegion. This also drives large-scale hardware modernization. In a recent example from our team, 2 flagship university deployments turned into multimillion dollar opportunities for our company, stemming from thousands of Allegion reader and luck upgrades paired with system-wide Allegion credential standardization. We also see off-campus housing and property managers adopting the same approach, extending secure seamless access from the campuses where students learn into the communities where they live and connect. These upgrades deliver real benefits simpler credential management and updates, lower installation costs, faster integration and improved security and convenience for the end user. As mobile credential adoption spreads across core institutional markets, our organic investments position Allegion to capture these hardware upgrade cycles, driving deeper customer loyalty and long-term electronics growth and shareholder value. Turning to M&A. We spent $70 million in acquisitions in the first quarter and did not complete any acquisitions in the second quarter. We continue to cultivate a pipeline of opportunities that complement our portfolio. Allegion paid $47 million in dividends and we repurchased $120 million of Allegiant shares in the second quarter. And as we've said in the past, you can expect Allegion to be balanced, disciplined and consistent with capital deployment oriented towards profitable growth and driving long-term returns for shareholders. At current share price levels, we do see attractive valuation in our shares and expect to remain active in the second half. However, consistent with past practice, our outlook does not include additional share repurchase. Mike will now walk you through second quarter financial results.

Thanks, John, and good morning, everyone. Thank you for joining today's call. Please go to Slide #5. Revenue for the second quarter was approximately $1.2 billion, an increase of 12.7% compared to last year. Organic revenue increased 6.9% in the quarter, driven by strength in our Americas segment. The enterprise organic revenue increase was driven by both price realization and volume. Q2 adjusted operating margin was 24.2%, up 50 basis points compared to last year. Price and productivity net of inflation and investment and inclusive of transactional FX was favorable by $11.8 million and was a 30 basis point tailwind to margin rate. Volume leverage was also a tailwind to margin rate in the quarter. This favorability was partially offset by acquisitions, which were a 30 basis point headwind to margins. I'll provide more details on revenue and margins within each of the regions. Adjusted earnings per share of $2.40 increased $0.36 or 17.6% versus the prior year. Operating income, inclusive of acquisitions drove the majority of the year-over-year EPS growth with a slight tailwind from tax and share count, partially offset by interest and other. Finally, year-to-date available cash flow was $260.8 million, down 5.3% from the prior year. I'll provide more details on cash flow and the balance sheet a little later in the presentation. Please go to Slide #6. Our Americas segment delivered revenue of $918.6 million, which was up 11.8% on a reported basis and up 8.9% on an organic basis. Our nonresidential business increased high single digits organically driven by price and volume growth. Demand for our nonres products remains healthy. And as John mentioned earlier, spec activity continues to be strong. Our residential business also grew high single digits, driven by both price and volume. Resi growth in Q2 was particularly strong in electronics, which can fluctuate quarter-to-quarter. Electronics revenue for this segment was up low teens for the quarter as both res and nonres were strong. On a year-to-date basis, electronics grew high single digits, consistent with our long-term expectations. In addition, acquisitions contributed 2.9 points of growth in the quarter. Americas adjusted operating income of $276.4 million increased 12.5% versus the prior year. Adjusted operating margins were up 20 basis points in the quarter. Pricing productivity net of inflation and investment and inclusive of transactional FX was favorable by $10.8 million and was a 10 basis point tailwind to margins. The transactional foreign currency headwind of $2 million related to the prior year benefit that we disclosed in Q2 last year. Volume leverage was a tailwind to margin rates and acquisitions were a 40 basis point headwind as expected. Please go to Slide #7. Our International segment delivered revenue of $232.9 million, which was up 16.2% on a reported basis, but down 1.2% organically. The organic revenue decline was the result of weaker demand in some of our markets, including Germany, as John discussed earlier. Net acquisitions contributed 14.3% to segment revenue. Currency was also a tailwind, positively impacting reported revenue by 3.1%. International adjusted operating income of $28.8 million increased 9.9% versus the prior year. Adjusted operating margin for the quarter decreased 70 basis points. Price and productivity net of inflation and investment was 120 basis point headwind to margin rate in the quarter. Volume deleverage was also a headwind to margins. These declines were partially offset by an 80 basis point tailwind from acquisitions. Margins did increase 440 basis points sequentially as the company worked to improve production rates following the ERP disruptions experienced in Q1. Please go to Slide 8, and I will provide an overview of our cash flow and balance sheet. Year-to-date available cash flow was $260.8 million, down 5.3% versus the prior year. The cash flow decrease was primarily driven by timing of sales, which were stronger later in the quarter, resulting in higher receivable balances at quarter end. For 2026, we still anticipate our ACF conversion will be approximately 85% to 95% of adjusted net income. Next, working capital as a percent of revenue increased in the second quarter due in part to acquired working capital as well as higher receivables just mentioned. Finally, our balance sheet remains healthy with net debt to adjusted EBITDA at 1.6x. I will now hand the call back over to John.

Thanks, Mike. Please go to Slide 9. Midway through the year, we are raising our organic revenue growth outlook to 3.5% to 4.5% and adjusted earnings per share outlook to $8.85 to $9.00. We're raising our reported revenue outlook to 7.5% to 8.5% based on changes to the organic growth range. You can find more details on our outlook in the appendix. In the Americas, we're raising our organic assumption to the higher end of mid-single digits, reflecting pricing associated with increased inflation as well as a healthier demand environment, primarily in non-res. We announced pricing actions in the quarter to cover the higher inflation we were experiencing, and we'll continue to monitor the tariff and input cost environment to cover additional inflationary pressures if needed. As we said in the first quarter, we expect Americas margin expansion in the second half. Our outlook does not include potential EPA refunds due to uncertainty on future refund timing and as we prioritize communicating with our customers first. We would not expect any pencil EPA refund to have a material impact on EPS. For international, we expect to catch up on production impacts from the ERP implementation during the remainder of the year. And while we expect better revenue and margin performance in the second half, weak market demand in Europe, particularly Germany, supports reducing our full year outlook to a low single-digit organic decline. We're also truing up inorganic assumptions around FX and a modest reduction to M&A contribution as those businesses faced weaker markets this year as well. In total for 2026, we expect to deliver high single-digit to low double-digit EPS growth in line with our long-term earnings framework. Consistent with prior practice, the outlook does not include the benefit of future capital deployment, and as a result, the outlook assumes a share count of 85.9 million shares. Please go to Slide 10. In summary, Allegion delivered double-digit revenue growth, high-teens adjusted earnings per share growth and return capital to shareholders. We see momentum building in our largest market, which gives us confidence in our organic growth potential over the next several years. The Allegiant team expects to continue delivering on our commitments and driving value for shareholders. And with that, we'll take your questions.

[Operator Instructions] Our first question will come from Tim Wojs from Robert W. Baird & Company.

I guess, maybe just first question, I guess, particularly on the volumes in North America, I mean, it seems like the quarter itself was better from a volume perspective for you guys. I'm just kind of curious what was better relative to your expectations? And what is your expectation for Americas volume in the second half of the year?

Yes, Tim. Certainly, we had a real strong second quarter from a volume and total revenue. The quarter itself was as strong as I can remember in some time. there was strength across both res and nonres, res demand has been really solid, and we feel will continue to have strong demand patterns moving forward when you think of '26 and '27. Residential certainly stronger than we expected, high single digit at the higher end of that, obviously, with the close to 9% organic. That was a little stronger. That was driven by electronics. The 1 item I would note for Allegion here in the second quarter in the Americas, we did put a price increase out in the market at the end of May. That does result in customers ordering a little in advance of that. So that led to the stronger June you could have seen a little pull forward as you think of Q3 into Q2, but not much. I mean underlying demand is in the high singles when you think about the second quarter maybe just not as high as 9% for the segment. But overall, really good demand. And as you think moving forward, non-res feel real good. In the case of residential, encouraged by the quarter we just had, I would say the outlook doesn't assume that level of performance moving forward. I think there's -- we're a little prudent to not take 1 quarter and then extrapolate that as a trend moving forward. So I think there's more modest assumptions in residential in the outlook, although feel good that great to see our residential business growing as strongly as it did in the second quarter?

Okay. Okay. That's helpful. And then I guess maybe just stepping back, can you -- is there any way to put numbers or any sort of kind of color or trend around what you're seeing from like a spec quoting activity and how that's kind of tracked the past 3 to 4 quarters? I'm just trying to get a better kind of visual or understanding of how that specifically that nonres spec activity has changed over the last 3 to 4 quarters and what that might mean for volumes as we think about 2027 here?

Tim, this is John. It's a good question. And I think certainly, you picked up on the commentary from Q1, where we said spec activity was strong to even very strong that strength, that momentum has continued through second quarter. It's as strong as I've seen since I joined the company. And we're very encouraged by it. And I think certainly, we feel it supports our outlook for the current year. And with specs generally indicating or being a good indication of project work and revenue in the next 12 to 18 months. We -- as we said, we feel this lays a good foundation for organic growth in for the next couple of years. We don't release specific numbers around spec. I think it's not prudent to do that because the line of sight to revenue is always a little lumpy. So better just to let you know, like we said in the prepared remarks, we see broad-based strength across the core institutional verticals, we do see cyclical recovery in commercial verticals. AIA consensus came out this week with -- that indicates some acceleration in the commercial space into 2027. So there's more signal than noise at this point for -- but what feels like improving nonres demand.

Our next question will come from Alexander Virgo with ISI Evercore.

I wondered if you could talk a little bit about Europe and the evolution of demand there. I think your -- 1 of your main competitors last week actually reported accelerating growth in Europe, albeit low slow. So I just wondered if you could give us a little bit of comment there around some of the drivers of the difference in performance and perhaps the -- a bit of color around that the deceleration or deterioration that you called out in -- especially in Germany?

Yes. Very fair question and something we've been watching pretty closely. I think when you look at our exposure in Europe, primarily Southern Europe and overweighted in Germany. If you look at Germany GDP growth forecasts sequentially been taking that down with every update in the last or 9 months. And we're feeling that. I think confident in the businesses there. They're good businesses. Our electronics businesses in Europe are very strong, great margins, been good growth. The macro backdrop in Germany has just been worsening. And so that does have an outsized impact on us in our mechanical businesses largely exposed to Southern Europe and countries like Italy and Spain have been hanging in there consistent with our expectations. It's not great, like you say, it's not it's not huge, but hanging in with expectations. It's just been a sequential decline in demand in Germany that's had a bit of an outsized impact on us.

Okay. That's very helpful. And just as a kind of extension of that, I guess, the pricing side of things and the pricing that you've obviously been able to push through in the Americas is encouraging to see. I'm getting that the weakness in the broader market in international makes pricing a little bit more difficult. So I just wondered if you could just maybe talk a little bit about the second half and how we might think about that. .

Yes. Certainly, if you think about our business, our pricing ability in North America, particularly nonresidential is our strongest across the company. I would expect though to see positive pricing. And as we talked about in the prepared remarks, we're also really focused on driving cost actions. So as you think about the margin performance for the international business, you should see expansion in the second half of margins. And that would be a combination of pricing, but as well as restructuring and cost activity to drive better margin performance.

Our next question will come from Rafe Jadrosich with Bank of America.

Just to start, can you just talk a little bit about the -- obviously, the acceleration on Americas residential. Like how do you think about kind of quantifying the prebuy relative to the sell-through rate there? And just how do we think about potentially the cadence as we go through the back half of the year?