Allegion Q1 2023 Earnings Call Transcript

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April 26, 2023

There are 10 speakers on the call.

Operator

Good morning, and welcome to the Allegion First Quarter 2023 Earnings Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Tom Martineau, Vice President of Investor Relations and Treasurer. Please go ahead.

Speaker 1

Thank you, Andrew. Good morning, everyone. 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.

Speaker 1

Please go to Slides 23. Statements made in today's call that are not historical facts are considered forward looking statements and are made pursuant to the Safe Harbor 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 4, and I'll turn the call over to John.

Speaker 2

Thanks, Tom. Good morning, everyone. Thanks for joining us today. Allegion delivered another quarter of outstanding operational performance. We reported revenue roughly 27% up and adjusted EPS growth of nearly 40%.

Speaker 2

Looking at our markets, we see ongoing robust demand in our North American non residential business along with strong demand globally for our electronic solutions. And certain international markets also remain soft, particularly our global portable security business, which Mike will address in a few slides. We expanded margins substantially, up 2 90 basis points versus prior year. This now represents the 4th quarter in a row of margin We're raising our outlook for the year on revenue, EPS and cash flow, given strong Q1 execution, resilient market demand in nonresidential segments, Improving electronics availability amid the ongoing industry transformation to electronics smart hardware. Please go to Slide 5.

Speaker 2

Revenue for the Q1 was $923,000,000 an increase of 27.6% compared to 22. Organic growth of 15% was driven by favorable volume in the Americas non residential business and strong price realization across the portfolio. Adjusted operating margin and adjusted EBITDA margins in the Q1 increased by 290 basis points and 270 basis points respectively. The increases were attributable to favorable price and productivity, positive business mix and volume leverage associated with Americas nonresidential Excluding the acquisition of Access Technologies, adjusted operating income margins were up 3.80 basis Adjusted earnings per share of $1.58 increased $0.45 or approximately 40% versus the prior year. Strong operational performance more than offset the unfavorable impact of anticipated higher interest and tax expense.

Speaker 2

As previously mentioned, available cash flow was $46,700,000 in the quarter, up nearly 300% versus the prior year. Mike will now walk you through the financial results and I'll be back to discuss our updated 2023 outlook.

Speaker 3

Thanks, John, and good morning, everyone. Thank you for joining today's call. Please go to Slide number 6. This slide reflects our earnings per share reconciliation for the Q1. For the Q1 of 2022, reported earnings per share was $1.05 After $0.08 of adjustments for the items noted on the slide, 2022 adjusted EPS was $1.13 Operational results were strong in the quarter, adding $0.46 per share, which drove approximately 40% growth.

Speaker 3

This was driven by double digit organic revenue growth, favorable operating execution and positive business mix, which more than offset currency headwinds. Acquisitions and divestitures delivered $0.13 of earnings per share. This was primarily driven by Access Technologies, which continues to deliver strong results. Interest and higher variable interest rates versus Q1 2022. A higher year over year tax rate reduced earnings by $0.03 This resulted in Q1 2023 adjusted earnings per share of $1.58 an increase of $0.45 or 39.8 percent compared to the Lastly, as detailed on the page, we have an for all acquisition related amortization.

Speaker 3

After giving effect to these items, you arrive at Q1 2023 reported earnings per share of $1.40 Please go to Slide number 7. This slide depicts our revenue growth for the Q1. I will talk to the results in total on this slide and address the regions on their respective slides. We delivered 15% organic growth driven by price 1st quarter revenue for the Americas segment was $740,900,000 up 42% on a reported basis up 22.6 percent organically. During the Q1, price realization remained strong, offsetting ongoing inflationary pressures.

Speaker 3

In non residential, we continue to see strong end market demand and volume growth, which benefited from the catch up of improved electronic component supply. When coupled with price, this drove organic growth to approximately 30%. Our residential business was up mid single digits with Electronics growth exceeded 30% for the quarter as we continue to see both improvements in our supply chain and strong demand. Backlogs for nonresidentialelectronic solutions remain elevated as we exit Q1 as demand is still limited by supply availability. Additionally, we expect residential electronics demand to be more aligned to retail point of sale as we go forward.

Speaker 3

We are pleased with the ongoing Access Technologies integrations and results. This business had pro form a revenue growth of approximately 15% versus Q1 2022 and contributed nearly 20% to the Americas reported growth number. We continue to see benefits of a stable high growth service business that Access Technologies provides us and the business is performing as well as we anticipated when we purchased it. Americas adjusted operating income of $198,100,000 increased 59.5% versus the prior year period, while adjusted operating margins and adjusted EBITDA margins for the quarter were up 290 basis points and 2.60 basis points respectively. Excluding Access Technologies, the Americas segment drove 500 basis point improvement in operating margins versus the prior year.

Speaker 3

Pricing productivity in excess of inflation and investments, volume leverage along with positive mix contributed to the margin improvement. Please go to slide number 9. 1st quarter revenue for our Legion International segment was 182 In the quarter, solid price realization was more than offset by lower volumes, primarily associated with our portable securities business. This business benefited from a COVID related demand surge that extended into the first half of twenty twenty two. This resulted in the first half of Notably, the demand for our electronics and software solutions remained strong in Allegion International.

Speaker 3

In addition, 700,000 decreased 27% versus the prior year period. Compared to 2022, adjusted operating margins and Adjusted EBITDA margins declined 260 basis points and 220 basis points, respectively. The margin decline was primarily driven by reduced volumes. Please go to slide number 10. Year to date available cash flow for the Q1 came in at $46,700,000 up $34,900,000 versus the prior year.

Speaker 3

This increase is driven by higher earnings and lower cash used for net working capital, partially offset by higher capital expenditures that were mostly related to our new manufacturing facility in Mexico, which is scheduled to come online in the second half of twenty twenty three. Working capital as a percent of revenue increased versus the prior year. This is driven partially by the Access Technologies business, which was not owned in Q1 2022. Working capital has also from Q1 2022 as a result of investments in inventory we made in the second half of last year to increase our safety stock and protect our customers. We saw a year over year and sequential improvement in inventory turns as we remain committed to manage our working capital more efficiently and drive improvement.

Speaker 3

The business continues to generate strong cash flow and the balance sheet continues to be in a healthy position. I will now hand it back over to John for an update on our full year

Speaker 2

Thanks, Mike. Please go to Slide 11.

Speaker 3

We continue to expect

Speaker 2

We expect total growth inclusive of our Access Technologies acquisition to be between 15% 17%. We expect to see non residential organic growth to be up low double digits with favorability in both price and volume. We still expect the residential business to be down with price mostly offsetting volume declines, which are expected to be in the low to mid single digit range. Based on the strength we saw in the second half of twenty twenty two, we expect stronger growth in the first half of twenty twenty three, which we believe may moderate later in the year against those tougher comparables. There is no change in our outlook for the international segment.

Speaker 2

We Total revenue growth to be between 11.5% to 13.5% with organic revenue growth of 5.5% to 7.5%. Please go to Slide 12. As a result of our favorable revenue outlook and strong operational execution, We're raising our adjusted EPS outlook for the year and believe it will be between $6.55 6.75 Adjusted operational earnings are expected to increase approximately 13% to 16%. Interest is still expected to be around a $0.24 per share headwind, reflecting a full year of acquisition related borrowings and increases to variable interest rates. Tax still expected to be a $0.20 headwind and other income still expected to be around a $0.05 headwind.

Speaker 2

The outlook continues to assume approximately Our outlook on available cash flow for the year to be in the $480,000,000 to $500,000,000 range. Please go to Slide 13. To summarize, we see strength in our Americas non residential business and our global electronic solutions continue to provide us with growth opportunities both near and long term. We're very pleased with the performance of our Access Technologies acquisition. The business is performing well and we love the synergies with our non res business.

Speaker 2

We've expanded margins for the Q4 in a row and remain Committed to doing so moving forward. We saw significant improvements in cash flow and it's worth mentioning again that we saw improvements in inventory turns in the Q1 of Overall, we're off to a great start. In 2023, our team is executing well and Allegion's best days are still ahead of us. Please go to Slide 14. And before we turn the call over to Q and A, I'd like to provide a final reminder that you're all invited to join Mike and myself as well as other members of our executive team next week on Tuesday, May 2, for 2023 Investor and Analyst Day at our Americas headquarters in Carmel, Indiana.

Speaker 2

There you'll have the opportunity to learn about our leadership team, our strategy and our exciting work driving seamless access. Formal presentations will be held 12:30 to 2:30 Eastern Time and those who attend in person will also get a pretty exciting tour through our This is a really exciting time in our company's history. We're a few months away from turning 10 years old and our current executive team's 1st investor today together. We hope to see you there. With that, let's turn to Q and A.

Operator

We will now begin the question and answer The first question comes from Julian Mitchell with Barclays. Please go ahead.

Speaker 4

Hi, good morning. Maybe just a first question around that nonresidential Americas outlook and sort of an update there. So I heard you call out, I think, low double digit revenue growth assumed for non resi Americas this year. Maybe help us understand kind of what's The split between price and volume versus your prior assumption. And also, It seems that your revenues, you're getting this big sort of boost from component supply issues easing.

Speaker 4

And give us some clarity perhaps about how you're looking at sort of the spec writing, the order flow. There's obviously a lot of investor consternation about commercial construction. So any signs of any change in customer appetites there?

Speaker 3

Yes. So Julian, why don't I tackle the kind of the components of the guide and John can talk to the general business dynamics. If you look at our non res business, we expect to see both revenue growth driven by price and volume. As you know, we've been committed to fight that inflationary pressure. So pricing should be good for the full year.

Speaker 3

You saw a good price in Q1. And then as you look at a full year basis for volume, we will have growth, but not to the level you saw in Q1, obviously. We are running up against that tough comparable in the back half of the year. If you recall, non resi grew 30% and I think in the 3rd quarter and then greater than 25% in the 4th quarter. So we do have a tougher comparable.

Speaker 3

And then John, you want to talk to the spec activity and other items?

Speaker 2

Yes. Good morning, Julie, and thanks for the questions. I think on the supply Shane, you're exactly right. Component supply has been, I'd say, steadily improving, including on the electronic side. And what we've been really happy to see is how quickly the Allegion team has essentially compounded every incremental improvement in the Supply chain with better productivity, better operating efficiency in the factory and our distribution channel sell through has been quite rapid As lead times have come down.

Speaker 2

So happy to see that. I would say, if you look back to the prepared remarks, Mike had some Comments around electronics, particularly on the non res side of electronics, still have elevated lead times, still have elevated back Supply has improved, quantity has improved. It's still not as linear as we would like to see it, a bit choppy in terms of deliveries. But demand is still very strong, very robust and exciting future there. On just the General activity, I'd say leading demand indicators, ABIs, Dodge new starts, Stodd's Construction Index, AIA consensus still reading rather favorable, honestly, choppy.

Speaker 2

It's been mixed last few months. But some of those indices are again tipping back favorable here and there. For us, we do see strong spec writing activity and that's a flywheel that turns all year, every year. And the time between Engaging with the architect, writing a specification and turning that into revenue, that can sometimes be 18 to 24 months even. But the spec

Speaker 5

engine is always running and

Speaker 2

right now it's is always running and right now it's running very hard. When you think about quoting, bidding, etcetera, that activity is Quite robust as well. So again, we feel good about the non res business. We feel good about our position in the non res business through 2023.

Speaker 4

Thanks very much. And you did have a very good tailwind in the Americas From that sort of line price and productivity versus inflation and investment spend, I think it was over 300 points In the Q1, there's a margin tailwind. So maybe as we think about the balance of the year, How does that how quickly does that tailwind shrink? Should it still be a tailwind overall In the Q4, is it more kind of back to neutral there? Just trying to understand some of those moving pieces in what you're guiding from margins this year?

Speaker 3

Yes. So if you look at margins for the year, expect our margins to be up, say 50 basis points to 100 basis points full year And in every year moving forward, look for us to drive that margin expansion. You'll hear this at Investor Day next week. We're going to be driving margin expansion moving forward and we're committed to doing so. If you look at price productivity inflation investments, That is a big tailwind in Q1.

Speaker 3

We do have an easier comp in Q1. Obviously, Q3 and Q4, it's a more challenging comp. I would just add, we expect that to be positive on On a dollar basis, in the back half of the year, we expect margin expansion For the full year, as I mentioned earlier, and as you think about our business, We are driving the necessary pricing actions to fight the inflationary pressures. We fell a little behind, let's say in 'twenty one and early We've taken the necessary actions to ensure that doesn't happen again.

Speaker 6

That's great. Thank you.

Speaker 2

Thanks, Julian.

Operator

The next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Speaker 7

Hey, guys. Good morning.

Speaker 2

Hey, Joel.

Speaker 7

So can we maybe just follow on on that pricing Look, it's been great to see you particularly in the Americas business here. You've had double digit pricing now for 3 quarters in a row. I'm just curious like have you put additional price increases through for this year? And then like how do you see Pricing specifically in Americas progressing as the year goes along.

Speaker 3

Hey, Joe, thanks for the question. If you think about our Americas business starting late 'twenty one and all of 'twenty two, we've put in Stanceful amount of pricing actions. We are starting to comp up against those pricing actions in 'twenty three. So as you move through the year, the realization percentage will be highest in the Q1 and then less as you Through the year, you're still going to sell the product at a higher value, but the incremental price realization percent will come down. We do expect our pricing to be very sticky.

Speaker 3

As you remember, our non residential business, We do list price adjustments that tend to stick. So we feel good about our pricing, The magnitude will decline the amount of price realization as we progress through the year.

Speaker 7

Okay. All right, great. Helpful. And then my follow on question, like back to the consternation in the market right now on non res, Your commentary so far have been very positive as you think about the year. I guess maybe just provide a little bit more color how you're thinking about The potential risk of a slowdown associated with middle market banking concerns and when you would potentially see that in your business and what the leading indicators are that you're looking at?

Speaker 2

Yes. Jill, this is John. It's a good question and It's top of mind for everyone. I would say again, if you think about Allegion's business model, we are late cycle. We are a bit heavily weighted to the Segment, which tends to have sources of financing like bond referendums, public finance Or these mega projects with large bank finance.

Speaker 2

So there's part of the business that maybe is not all that Susceptible to the regional banks and certainly a lot of the business is susceptible to regional bank lending and credit conditions. So could that become an 2, of course. Are we seeing a big impact right now? No, we're not. Again, think about Engaging with the architect, writing specifications of the classic pull strategy to pull the product through the channel, the Timing from spec to project initiation to when doors and door hardware goes in the building Can be 12, 18, 24 months.

Speaker 2

And so projects that have been started tend to get completed. And I think we're seeing that right now.

Operator

The next question comes from Jeff Sprague with Vertical Research Partners. Please go ahead.

Speaker 5

Hey, thank you. Good morning. Good morning, Jeff. Hey, good morning. My question actually kind of picks up a little bit on some of that last point, John.

Speaker 5

Can you Actually see kind of stimulus flowing into those institutional markets or kind of anything else that gives you maybe more visibility than you would typically have at this point in time?

Speaker 2

Yes, that's good question. And I think it's always Tricky to see. When we sell through distribution, you're not quite sure the Source of the project, the source of the financing, we're like anyway, I'd say And airport terminal renewals that was a big part of the Infrastructure and Jobs Act. You know there's funding Going to higher ed through the emergency relief fund back from the COVID days to help with contactless, touchless, which goes very well into seamless Access and electronic locks and credentials, etcetera. So I think certainly that's flowing.

Speaker 2

I think there's still stimulus dollars Left, those tend to take a long time to work their way through the system. I would say again, the leading indicators for our non res 3 still read positive. Our spec writing activity is quite robust. Our quoting, bidding Activity in the channel is still robust. And given the fact that mechanical supply chain has improved, we're back to We're back to made to order there.

Speaker 2

Sell through on the channel has been pretty strong. And so I think at least now we would just Still continue to reiterate, we feel good about non res through 2023.

Speaker 5

Great. And then Not to steal the thunder from next week, but you have people walking out of there next week. What if they took away one thing from the meeting that maybe they didn't know or understand about Allegion or was

Speaker 2

Yes, I appreciate the prelude to that question, Jeff. That's good. I'd say let's hold the fireworks around the strategy And all that for now. What I'm really excited about is getting all of you over here. You can come in and see what we're doing, see what we're all about and get More time with this new leadership team.

Speaker 2

That's important to us. We just appreciate the chance to spend some time with you and share with you what we're working on.

Speaker 5

Great. Thanks a lot.

Operator

The next question comes from Joe O'Dea with Wells Fargo. Please go ahead. Hi, good morning.

Speaker 3

Good morning, Sal.

Speaker 8

I wanted to start on Americas margin excluding AccessTech. This looks like, I think, maybe the strongest first quarter ever, and seems like a faster

Speaker 5

So could you talk a

Speaker 8

little bit about the factors that contributed to that this Quarter. And I think then moving forward, anything unusual about the quarter that wouldn't

Speaker 3

Yes, Joe, if you look at the Q1, we had an extremely strong non residential revenue Quarter, as you know, that is our strongest margin business. So we had positive mix there And a very elevated revenue number versus what we were in the previous Q1. So we had both combinations working in our favor. As we move through the year, the one item I do want to highlight, we are ramping up that new manufacturing facility in Mexico. Q1 doesn't have any real cost there, but as we move through the year, there is investment in startup costs that are going to be a head Win to margin rate that's in the assumed guide.

Speaker 3

And obviously, we're going to be conservative when you think about startup Cost of the new plant, so that we're adequately prudent in that guidance. But in general, I would say the Factors that drive margin expansion, the productivity that is accelerating from what it was last year, the pricing actions, which we feel good about. I think the activity we're driving is sustainable and should be a long term margin expansion driver for the business.

Speaker 8

And maybe just a clarifying point on that. I think given seasonality, the Q1 margin tends to be one of the lower of the year. But Given the sort of Mexico factory considerations, is it still reasonable to think about just kind of volume seasonality where we would see margins improve Or are those costs such that we wouldn't?

Speaker 3

Yes, I would say if you think about the margin Percentage in Q1, historically less. However, if you look at that dollar amount of revenue for commercial, you would not have the same Size of margin uplift delta versus Q1 than maybe historically you've seen. And then the investments, think of the investments for the plant, you could see 10 basis points, 20 basis points full year impact From that level of investment.

Speaker 2

Yes, I would add, I think Looking at Allegion's historic seasonality, both for volumes and then obviously resulting margins and operating leverage and whatnot, Given how the supply chain disruptions of late 'twenty one, early 'twenty two, somewhat moved sales volume 1 quarter to the next, I think we've got to be a little bit careful on applying just direct historic seasonality. But that being said, we feel confident in the guide and feel confident that we're in a position to continue to expand margins, like Mike 5,200 bps and continue to do that in future years as well.

Speaker 3

Joe, just to clarify that number for the Plant, that would be closer to the 20 basis points.

Speaker 8

Got it. And then, John, maybe on your point, just as we think about sort of backlog that you have to burn and you have Supply chain improving, but on top of it sounds like sort of underlying demand conditions remain pretty healthy. And How do we sort of combine all those factors as we do think about seasonality and we would think that as you go into the middle of the year, you do improve given what should be a

Speaker 2

Yes. I think that's why we took the organic growth guide up, the total growth guide up, EPS guide up That we do feel like we got off to a really good start. We do feel that non res demand is robust. And I think, again, quarter to quarter looks different just because of the comps last year. But full year, we feel good about the guidance.

Speaker 8

Great. Thanks a lot.

Operator

The next question comes from David MacGregor with Longbow Research. Please go ahead.

Speaker 6

Yes. Good morning, everyone. Congratulations on the results. Great quarter.

Speaker 8

Thanks.

Speaker 6

I wanted to ask about pricing in the non res And specifically in your spec writing business, because this is a business that, at least as I understand, it doesn't rely as much on MSRP as much as it's a negotiated price. And obviously, very strong price realization there. Is it just a more competitively rational space right now and that's really facilitating the price realization? Or Maybe just talk about what you're seeing competitively in that spec writing space.

Speaker 3

Yes, David, if you think about the non res business, New construction tends to be quoted work where it is bid. Historically, it is an 3 where everyone competes on value or the market leaders, I should say, compete on value, not price. And so As there is inflation, market participants drive pricing actions to cover inflationary Pressures and since there's a higher inflationary pressure, we're able to get more pricing. But the key takeaway on this industry is Everyone competes on value. It's not a race to the bottom on pricing in the non residential business.

Speaker 3

It tends to be a very complex configured offering and that allows everyone to compete on

Speaker 2

the value of their portfolio.

Speaker 6

Yes. I mean, I think that's always been the case. It just seems like right now, it's a more rational space. And Maybe there's just enough business to go around that everybody's everybody doesn't have to compete quite as hard.

Speaker 5

But I don't know if

Speaker 6

you can comment on that or not.

Speaker 3

I would just say for us in our perspective, I don't want to talk about anyone else. It's the inflationary pressures that we felt the last 2 years and the pricing is catching up to some of those pressures. And so You really have to look at it over the last few years and we've been able to mitigate some of those pricing I'm sorry, the inflationary pressures that we felt End of 'twenty one, 'twenty two and into early 'twenty three.

Speaker 6

Okay, great. Second question, just on the distribution channel. In terms of sort of the commercial 2 step distributors, are they restocking at this point? Was that a contributing dynamic this quarter?

Speaker 2

Yes, we do field visits all the time. And I think, Again, let's divide this a bit between electronic products and mechanical products. So on mechanical products, most of our lead times would Be back to a normal level, which puts us and our distribution channel and kind of a made to order book and ship Type model. And so destocking, restocking is not really a dynamic We see in the majority of the channel. And some of the 2 steps, some of the large wholesalers perhaps, but I think the evidence that we have seen and the anecdotal evidence at least is demand is Pretty robust.

Speaker 2

Sell through is pretty rapid. And again, as lead times Normalize ordering behavior, adjust and adapts back to that more normal lead time. There are some of our electronic products, our Commercial electronic products, like we said, still elevated lead times, elevated backlogs and that we're just working hard with the supply base Our redesigns and new suppliers are coming on board just to catch up to demand and get that Part of the business back into this book and ship normal lead time space. We're just we're not quite there yet.

Speaker 6

Thanks very much.

Operator

The next question comes from Brian Rutenberg with Imperial Capital. Please go ahead.

Speaker 9

Yes. Thank you very much. Let me talk a little bit about pricing plans for the rest of the year and what you have built into your guidance. It sounds like there's less pricing increases, trying to read the tea leaves here, in the second half of 23 in your guidance, is that correct?

Speaker 3

We would always announce a price increase to the channel before we would on an earnings Paul, I would just say, if you look at our pricing and you try to model it for the back half of the year, you got to just take a look at how much In the overall realization, but it's important to note, you're still selling the product at the same price. So it's not like you're selling it for less dollar value, It's just the incremental realization percentage will decline versus a more challenging comparable.

Speaker 9

Okay. Thank you. And then my next question is about Q2. I know you don't normally comment specifically on a quarter, But maybe you can give us bigger than a bread box, smaller than a tractor trailer kind of guidance in the second quarter In terms of versus Q1, should we be seeing revenues and gross margins at relatively similar level, excuse me, to Q1 and Q2?

Speaker 3

Yes, I really not don't really want to give Specifics on a quarter per se, but a full year. The only thing I would say is Q1 obviously a little higher than historically we would do in the first Quarter, but I wouldn't anticipate, don't model something where the summer season is significantly less In Q1, we still have summers that tend to be pretty strong.

Operator

And at this time, I would like to turn the conference back over to John Stone, President and CEO, for any closing remarks.

Speaker 2

Well, thanks everyone for joining. Thank you for your questions. And again, we'd like to reiterate our invitation to all of you For next week's Investor and Analyst Day, hope to see you all here in person, both for our management presentations and the tour through the tech center, Very excited about that. And just to summarize, continue to see strength in America's non res and global electronic solutions. Very pleased, very happy with the Access Technologies acquisition and how that's starting to perform.

Speaker 2

Very happy and remain committed about our margin expansion and we'll continue that into the future. Improvements in cash flow and just overall, I I'm really proud of the entire Allegion team and our distribution partners to get us off to such a great start in 2023.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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