Allegion Q1 2023 Earnings Call Transcript

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Provided by Quartr
April 26, 2023

Key Takeaways

  • Allegion reported Q1 revenue of $923 million, a 27.6% increase (15% organic), and delivered adjusted EPS of $1.58, up 39.8% year-over-year, while expanding adjusted operating margin by 290 bps.
  • The North American nonresidential business saw robust demand and roughly 30% organic growth, complemented by strong global growth in electronic solutions, although the international portable security unit remained soft.
  • In the Americas segment, excluding the Access Technologies acquisition, operating margins improved by 500 bps, with Access Technologies itself contributing about 15% pro forma revenue growth and 20% to reported segment growth.
  • Available cash flow rose to $46.7 million in Q1, up nearly 300% year-over-year, driven by higher earnings and improved working capital, and the full-year cash flow outlook was raised to $480 – 500 million.
  • The company raised its 2023 guidance, projecting total revenue growth of 15 – 17% (including acquisitions) and adjusted EPS of $6.55 – 6.75, reflecting strong execution and resilient market demand.
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Earnings Conference Call
Allegion Q1 2023
00:00 / 00:00

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Operator

Good morning, and welcome to the Allegion first quarter 2023 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing Star, then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star, then one on your telephone keypad. To withdraw your question, please press Star, then two. 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.

Tom Martineau
Tom Martineau
Vice President of Investor Relations and Treasurer at Allegion

Thank you, Andrew. Good morning, everyone. Thank you for joining us for Allegion's first quarter 2023 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 slides two and three. 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.

Tom Martineau
Tom Martineau
Vice President of Investor Relations and Treasurer at Allegion

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 four, and I'll turn the call over to John.

John Stone
John Stone
President and CEO at Allegion

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%. Looking at our markets, we see ongoing robust demand in our North America non-residential business, along with strong demand globally for our electronic solutions. We're seeing improvement in electronics components availability, and although supply is still short of demand, Americas' electronic solutions grew by more than 30% this quarter. Residential markets remain rather soft in the quarter, particularly for the mechanical products, 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 290 basis points versus prior year.

John Stone
John Stone
President and CEO at Allegion

This now represents the fourth quarter in a row of margin expansion for Allegion as pricing momentum continues and efficiency and productivity are accelerating. We remain committed to expanding margins for 2023 and beyond, as you'll hear in our Investor Day next week. We also realized significant improvement in cash flow year-over-year, driven by favorable earnings and better operating efficiencies. We're raising our outlook for the year on revenue, EPS, and cash flow, given strong Q1 execution, resilient market demand in non-residential segments, improving electronics availability amid the ongoing industry transformation to electronic smart hardware. Please go to slide five. Revenue for the first quarter was $923 million, an increase of 27.6% compared to 2022. Organic growth of 15% was driven by favorable volume in the Americas non-residential business and strong price realization across the portfolio.

John Stone
John Stone
President and CEO at Allegion

The Access Technologies acquisition contributed approximately 14% to total growth, currency impacts remained a headwind. Adjusted operating margin and adjusted EBITDA margins in the first quarter 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 non-residential growth. Excluding the acquisition of Access Technologies, adjusted operating income margins were up 380 basis points. 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 in tax expense. As previously mentioned, available cash flow was $46.7 million in the quarter, up nearly 300% versus the prior year.

John Stone
John Stone
President and CEO at Allegion

Mike will now walk you through the financial results, and I'll be back to discuss our updated 2023 outlook.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Thanks, John. Good morning, everyone. Thank you for joining today's call. Please go to slide number six. This slide reflects our earnings per share reconciliation for the first quarter. For the first quarter 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. 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 expense reduced earnings per share by $0.11, driven by increased debt to finance the acquisition of Access Technologies.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Higher variable interest rates versus Q1 2022. A higher year-over-year tax rate reduced earnings by $0.03. This resulted in first quarter 2023 adjusted earnings per share of $1.58, an increase of $0.45 or 39.8% compared to the prior year. Lastly, as detailed on the page, we have an $0.18 per share reduction from adjusted EPS to arrive at reported EPS. As we discussed in our last earnings call, this amount now includes an adjustment for all acquisition-related amortization. After giving effect to these items, you arrive at first quarter 2023 reported earnings per share of $1.40. Please go to slide number seven. This slide depicts our revenue growth for the first quarter. I will talk to the results in total on this slide and address the regions on their respective slides.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

We delivered 15% organic growth, driven by price realization across the portfolio and strong volume growth in the Americas nonresidential business. Net acquisition and divestitures contributed 14.1% growth, driven by Access Technologies. Currency pressures continued to be a headwind, primarily impacting our international segment, bringing the total reported growth to 27.6% in the quarter. Please go to slide number 8. First quarter revenue for the Americas segment was $740.9 million, up 42% on a reported basis and up 22.6% organically. During the first quarter, price realization remained strong, offsetting ongoing inflationary pressures. In nonresidential, we continued to see strong end market demand and volume growth, which benefited from the catch-up and improved electronic component supply. When coupled with price, this drove organic growth to approximately 30%.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Our residential business was up mid-single digits, with favorable price offsetting lower volumes. Residential electronics volume growth was strong, but we continue to see weakness in end markets for mechanical products. Electronics growth exceeded 30% for the quarter as we continue to see both improvements in our supply chain and strong demand. Backlogs for non-residential electronic solutions remain elevated 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. We are pleased with the ongoing Access Technologies integrations and results. This business had pro forma revenue growth of approximately 15% versus Q1 2022 and contributing nearly 20% to the Americas reported growth number.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

We continue to see the 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 $198.1 million increased 59.5% versus the prior year period, while adjusted operating margins and adjusted EBITDA margins for the quarter were up 290 and 260 basis points, respectively. Excluding Access Technologies, the Americas segment drove 500 basis point improvement in operating margins versus the prior year. Price and productivity in excess of inflation and investments, buying leverage along with positive mix contributed to the margin improvement. Please go to slide number nine.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

First quarter revenue for our Allegion International segment was $182.1 million, down 9.7% on a reported basis and down 4.8% organically. In the quarter, solid price realization was more than offset by lower volumes, primarily associated with our portable security business. This business benefited from a COVID-related demand surge that extended into the first half of 2022. This resulted in the first half of 2023 having a more difficult comp as the market works its way back to a more normal cycle. Notably, the demand for our electronics and software solutions remained strong in the Allegion International. Currency headwinds persisted this quarter and reduced reported revenues by 4.4%. International adjusted operating income of $19.7 million decreased 27% versus the prior year period.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Compared to 2022, adjusted operating margins and adjusted EBITDA margins declined 260 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 first quarter came in at $46.7 million, up $34.9 million versus the prior year. 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 2023. Working capital as a % of revenue increased versus the prior year. This is driven partially by the Access Technologies business, which was not owned in Q1 2022.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Working capital has also increased 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. 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 2023 outlook.

John Stone
John Stone
President and CEO at Allegion

Thanks, Mike. Please go to slide 11. We continue to expect strong electronics growth and the non-residential market demand in the Americas remains robust. Given the late cycle nature of our business, we expect this strength to continue through 2023. As a result, we're raising our 2023 outlook for the Americas segment, where we expect organic growth to be between 7.5%-9.5%. 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.

John Stone
John Stone
President and CEO at Allegion

Based on the strength we saw in the second half of 2022, we expect stronger growth in the first half of 2023, which we believe may moderate later in the year against those tougher comparables. There's no change in our outlook for the international segment. We expect revenue in that segment to be relatively flat in soft end markets. All in for the company, we're raising our outlook and expect total revenue growth to be between 11.5%-13.5%, with organic revenue growth of 5.5%-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 and $6.75.

John Stone
John Stone
President and CEO at Allegion

Adjusted operational earnings are expected to increase approximately 13%-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, other income still expected to be around a $0.05 headwind. The outlook continues to assume approximately $0.20 per share for costs related to restructuring and M&A and amortization expense related to acquired backlog. It excludes approximately $0.40 per share for acquired intangible asset amortization. Reported EPS is now projected to be between $5.95-$6.15. Lastly, we're increasing our outlook on available cash flow for the year to be in the $480 million-$500 million range. Please go to slide 13.

John Stone
John Stone
President and CEO at Allegion

To summarize, we see strength in our Americas non-residential business and our global electronic solutions continue to provide us with significant 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. We've expanded margins for the fourth quarter 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 first quarter of 2023. 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.

John Stone
John Stone
President and CEO at Allegion

Before we turn the call over to Q&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 the 2nd, for our 2023 Investor and Analyst Day at our America's headquarters in Carmel, Indiana. 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 P.M. to 2:30 P.M. Eastern Time, and those who attend in person will also get a pretty exciting tour through our technical center following the presentations. 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 first Investor Day together. We hope to see you there.

John Stone
John Stone
President and CEO at Allegion

With that, let's turn to Q&A.

Operator

We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you'd like to withdraw your question, please press star than two. Again, please limit yourself to one question and one brief follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Julian Mitchell with Barclays. Please go ahead.

Julian Mitchell
Julian Mitchell
Managing Director, U.S. Industrials Equity Research Analyst at Barclays

Hi, good morning. Maybe, just a first question around that non-residential Americas outlook and sort of an update there. 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. Also it seems that your revenues are getting this big sort of boost from component supply issues easing. 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. Any signs of any change in customer appetites there?

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Yeah. Julian, why don't I tackle the kind of the components of the guide, and John can talk to the general, you know, business dynamics.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

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, pricing should be good for the full year. You saw a good price in Q1. 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-res, grew, you know, 30% and I think in the third quarter and then greater than 25% in the fourth quarter. We do have a tougher comparable. John, you wanna talk to the spec activity and other items?

John Stone
John Stone
President and CEO at Allegion

Yeah. Good morning, Julian. Thanks for the questions. I think on the supply chain, you're exactly right. Component supply has been, I'd say, steadily improving, including on the electronic side. 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. Our distribution channel sell-through has been quite rapid as lead times have come down. Happy to see that. I would say, you know, 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 backlogs. Supply has improved, quantity has improved.

John Stone
John Stone
President and CEO at Allegion

It's still not as linear as we would like to see it, a bit choppy in terms of deliveries. Demand is still very strong, very robust, and exciting future there. On just the general activity, I'd say, you know, leading demand indicators, ABIs, Dodge new starts, Dodge Construction Index, AIA consensus, still reading rather favorable, honestly. Choppy, you know, it's been mixed last few months. Some of those indices are again, tipping back favorable here and there. For us, we do see strong spec writing activity, that's a flywheel that turns all year, every year. You know, the time between engaging with the architect, writing a specification, and turning that into revenue, that can sometimes be 18-24 months even.

John Stone
John Stone
President and CEO at Allegion

The spec engine is always running, and right now it's running very hard. When you think about quoting, bidding, et cetera, that activity is quite robust as well. Again, we feel good about the non-res business. We feel good about our position in the non-res business through 2023.

Julian Mitchell
Julian Mitchell
Managing Director, U.S. Industrials Equity Research Analyst at Barclays

Thanks very much. You know, 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 first quarter as a margin tailwind. Maybe, you know, as we think about the balance of the year, how quickly does that tailwind shrink? You know, should it still be a tailwind overall in the fourth quarter, or is it more kind of back to neutral there? Just trying to understand, you know, some of those moving pieces in what you're guiding from margins this year.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

If you look at margins for the year, expect our margins to be up, say 50-100 basis points full year. In every year moving forward, look for us to drive that margin expansion. You'll hear this at Investor Day next week. We're gonna 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. We do have an easier comp in Q1. Obviously, Q3 and 4, it's a more challenging comp. I would just add, we expect that to be positive on a dollar basis. You know, in the back half of the year, we expect margin expansion for the full year, as I mentioned earlier.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

You know, 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 2021 and early 2022. We've taken the necessary actions to ensure that that doesn't happen again.

Julian Mitchell
Julian Mitchell
Managing Director, U.S. Industrials Equity Research Analyst at Barclays

That's great. Thank you.

John Stone
John Stone
President and CEO at Allegion

Thanks, Julian.

Operator

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

Joe Ritchie
Joe Ritchie
Managing Director, Senior Equity Research Analyst (Industrials) at Industrials

Hey, guys. Good morning.

John Stone
John Stone
President and CEO at Allegion

Hey, Joe.

Joe Ritchie
Joe Ritchie
Managing Director, Senior Equity Research Analyst (Industrials) at Industrials

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

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Hey, Joe, thanks for the question. If you think about our Americas business starting late 2021 and all of 2022, we've put in a substantial amount of pricing actions. We are starting to comp up against those pricing actions in 2023. As you move through the year, the realization % will be highest in the first quarter and then less as you proceed through the year. You're still gonna sell the product at a higher value, but the incremental price realization % will come down.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

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

Joe Ritchie
Joe Ritchie
Managing Director, Senior Equity Research Analyst (Industrials) at Industrials

Okay. All right, great. Helpful. 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 on how you're thinking about the potential risk of a slowdown associated with, you know, 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.

John Stone
John Stone
President and CEO at Allegion

Joe, this is John. That'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 institutional segment, which tends to have sources of financing like bond referendums, public finance, or, you know, these mega projects with large bank finance. 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. You know, could that become an issue? Of course. Are we seeing a big impact right now? No, we're not.

John Stone
John Stone
President and CEO at Allegion

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. Projects that have been started tend to get completed, I think we're seeing that right now.

Joe Ritchie
Joe Ritchie
Managing Director, Senior Equity Research Analyst (Industrials) at Industrials

Makes a lot of sense. Thank you.

Operator

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

Jeff Sprague
Founder and Managing Partner at Vertical Research Partners

Hey, thank you. Good morning.

John Stone
John Stone
President and CEO at Allegion

Morning, Jeff.

Jeff Sprague
Founder and Managing Partner at Vertical Research Partners

Hey, good morning. My question actually kind of picks up a little bit on some of that last point, John. Can you actually see kind of stimulus flowing into those institutional markets or, you know, kind of anything else that gives you maybe more visibility than you would typically have at this point in time?

John Stone
John Stone
President and CEO at Allegion

Yeah, 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, you know, we're like... Anyway, I'd say you see stimulus 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, et cetera. I think certainly that's flowing. I think there's still stimulus dollars left. Those tend to take a long time to work their way through the system.

John Stone
John Stone
President and CEO at Allegion

You know, I would say again, the leading indicators for our non-res industries still read positive. Our spec writing activity is quite robust. Our quoting, bidding activity in the channel is still robust. Given the fact that, you know, mechanical supply chain has improved, we're back to book and ship, we're back to made to order there, you know, sell through on the channel has been pretty strong. I think at least now we would just still continue to reiterate we feel good about non-res through 2023.

Jeff Sprague
Founder and Managing Partner at Vertical Research Partners

Great. Not to steal the thunder from next week, but, you know, have people walking out of there next week, you know, what is, you know, if they took away one thing from the meeting, that maybe they didn't know or understand about Allegion or was, you know, important to accentuate, what would that be?

John Stone
John Stone
President and CEO at Allegion

Yeah, I appreciate the prelude to that question, Jeff. It's good. No, I'd say let's hold the fireworks around the strategy and the technology and all that for now. What I'm really excited about is getting all of you over here. You can come in, see what we're doing, see what we're all about, and get some more time with this new leadership team. 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.

Jeff Sprague
Founder and Managing Partner at Vertical Research Partners

Great. Thanks a lot.

Operator

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

Joe O'Dea
Joe O'Dea
Managing Director and Equity Research at Wells Fargo

Hi, good morning.

John Stone
John Stone
President and CEO at Allegion

Hey, Joe.

Joe O'Dea
Joe O'Dea
Managing Director and Equity Research at Wells Fargo

Wanted to start on Americas margin, excluding Access Technologies. This looks like, I think maybe the strongest first quarter ever, and seems like a faster recovery in those margins than you anticipated earlier this year. Could you talk a little bit about the factors that contributed to that quarter? I think then moving forward, you know, anything, you know, unusual about the quarter that would persist as we continue to move through the year?

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Yeah, Joe, if you look at the first quarter, we had an extremely strong non-residential revenue quarter. As you know, that is our strongest margin business. We had positive mix there.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

A very elevated revenue number versus what we were in the previous Q1. We had both combinations working in our favor. As we move through the year, the one item I do wanna 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 start-up costs that are gonna be a headwind to margin rate that's in the assumed guide. You know, obviously, we're gonna be conservative when you think about start-up costs of a new plant so that we're, you know, adequately prudent in that, in that guidance.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

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.

Joe O'Dea
Joe O'Dea
Managing Director and Equity Research at Wells Fargo

Maybe just a clarifying point on that. I think given seasonality, the first quarter 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, you know, just kind of volume seasonality, where we would see margins improve, or those costs such that we wouldn't?

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Yeah. 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 if uplift delta versus Q1 than maybe historically you've seen. You know, the investments. Think of the investment for the plan. You could see, you know, 10, 20 basis points full year impact from that level of investment.

John Stone
John Stone
President and CEO at Allegion

Yeah. I would add, I think, you know, looking at Allegion's historic seasonality, both for volumes and obviously resulting margins and operating leverage and whatnot, given how the supply chain disruptions of late 2021, early 2022, somewhat moved sales volume from one quarter to the next, I think we've gotta be a little bit careful on applying just direct historic seasonality. You know, 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 said, 50 to 100 basis points, and continue to do that in future years as well.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

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

Joe O'Dea
Joe O'Dea
Managing Director and Equity Research at Wells Fargo

Got it. 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. So, you know, 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, you know, given what should be a pretty solid backlog and this underlying demand. Just wanna make sure that, you know, think about those factors all correctly.

John Stone
John Stone
President and CEO at Allegion

Yeah. I think that's why we took the organic growth guide up, the total growth guide up, the 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. You know, I think again, quarter to quarter looks different just because of the comps last year. Full year, we feel good about the guide.

Joe O'Dea
Joe O'Dea
Managing Director and Equity Research at Wells Fargo

Great. Thanks a lot.

Operator

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

David MacGregor
David MacGregor
Founder and Senior Analyst at Longbow Research

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

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Thank you.

David MacGregor
David MacGregor
Founder and Senior Analyst at Longbow Research

I wanted to ask about pricing in the non-res business 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. 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.

Mike Wagnes
Mike Wagnes
Senior Vice President and Chief Financial Officer at Allegion

Yeah, David, if you think about the non-res business, you know, new construction tends to be quoted work where it is, you know, bid. Historically, it is an industry where everyone competes on value or the market leaders, I should say, compete on value, not price. As there's inflation, market participants drive pricing actions to cover, to cover inflationary pressures. Since there's a higher inflationary pressure, we're able to get more pricing. 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. It tends to be a very complex configured offering, and that allows, you know, everyone to compete on the value of their portfolio.

David MacGregor
David MacGregor
Founder and Senior Analyst at Longbow Research

Yeah. I mean, I think that's always been the case. It just seems like right now it's a more rational space and maybe you're there's just enough business to go around that everybody doesn't have to compete quite as hard. I don't know if you can comment on that or not.

John Stone
John Stone
President and CEO at Allegion

I would just say for us in our perspective, I don't wanna talk about anyone else. It's the inflationary pressures that we felt the last two years

John Stone
John Stone
President and CEO at Allegion

The pricing is catching up to some of those pressures. You really have to look at it over the last few years, and we've been able to mitigate some of those inflationary pressures that we felt, you know, end of 2021, 2022, and into early 2023.

David MacGregor
David MacGregor
Founder and Senior Analyst at Longbow Research

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

John Stone
John Stone
President and CEO at Allegion

Yeah, we do field visits all the time. I think, you know, again, let's divide this a bit between electronic products and mechanical products. On mechanical products, most of our lead times would be back to a normal level, which puts us and our distribution channel in kind of a made-to-order book and ship type model. Destocking, restocking is not really a dynamic we see in the majority of the channel. In some of the two-steps, some of the large wholesalers, perhaps. You know, I think the evidence that we have seen and the anecdotal evidence at least is, you know, demand is pretty robust. Sell through is pretty rapid.

John Stone
John Stone
President and CEO at Allegion

You know, again, as lead times normalize, ordering behavior adjusts and adapts back to that more normal lead time. There are, you know, some of our electronic products, our commercial electronic products, like we said, still elevated lead times, elevated backlogs, and that, you know, we're just working hard with the supply base and 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 not quite there yet.

David MacGregor
David MacGregor
Founder and Senior Analyst at Longbow Research

Thanks very much.

Operator

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

Brian Ruttenbur
Brian Ruttenbur
Managing Director and Equity Research Security and Defense at Imperial Capital

Yeah, 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 price increases, trying to read the tea leaves here, in the second half of 2023 in your guidance. Is that correct?

John Stone
John Stone
President and CEO at Allegion

We would always announce a price increase to the channel before we would on an earnings call. I would just say, if you look at our pricing and you try to model it for the back half of the year, you gotta just take a look at how much price started to accelerate to two, three, and four last year, which is driving some of the reduction in the overall realization. It's important to note, you're still selling the product at the same price. 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.

Brian Ruttenbur
Brian Ruttenbur
Managing Director and Equity Research Security and Defense at Imperial Capital

Thank you. 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 breadbox, you know, 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 levels, excuse me, to Q1 and Q2?

John Stone
John Stone
President and CEO at Allegion

Yeah. I'd really not, don't really wanna 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, you know, don't model something where the summer season is significantly less than than Q1. We still have summers that tend to be pretty strong.

Brian Ruttenbur
Brian Ruttenbur
Managing Director and Equity Research Security and Defense at Imperial Capital

Great. Thank you very much.

Operator

This concludes our question and answer session. At this time, I would like to turn the conference back over to John Stone, President and CEO, for any closing remarks.

John Stone
John Stone
President and CEO at Allegion

Okay. Well, thanks everyone for joining. Thank you for your questions. Again, would 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. Just to summarize, continue to see strength in Americas' non-res and global electronic solutions. Very pleased, very happy with the Access Technologies acquisition and how that's starting to perform. 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 am 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.

Executives
    • John Stone
      John Stone
      President and CEO
    • Mike Wagnes
      Mike Wagnes
      Senior Vice President and Chief Financial Officer
    • Tom Martineau
      Tom Martineau
      Vice President of Investor Relations and Treasurer
Analysts
    • Brian Ruttenbur
      Managing Director and Equity Research Security and Defense at Imperial Capital
    • David MacGregor
      Founder and Senior Analyst at Longbow Research
    • Jeff Sprague
      Founder and Managing Partner at Vertical Research Partners
    • Joe O'Dea
      Managing Director and Equity Research at Wells Fargo
    • Joe Ritchie
      Managing Director, Senior Equity Research Analyst (Industrials) at Industrials
    • Julian Mitchell
      Managing Director, U.S. Industrials Equity Research Analyst at Barclays
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