Allegion Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 26, 2023

There are 12 speakers on the call.

Operator

Good morning, and welcome to the Allegion Second Quarter 2023 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Joby Coyle, Director of Investor Relations, please go ahead.

Speaker 1

Thank you, Drew. Good morning, everyone. Thank you for joining us for Allegion's 2nd quarter 2023 earnings call. With me today are John Stone, President and Chief Executive 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.

Speaker 1

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.

Speaker 1

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.

Speaker 2

Thanks, Joby. Good morning, everyone. Thanks for joining us today. My how time flies. It's hard to This time last year, I was joining you for my first Allegiant earnings call.

Speaker 2

I shared then my belief in our company's mission, our people, our culture And my excitement around this chapter that we're writing in Allegiant's history together. At 1 year end, I'm even more energized about Allegiant's future and I'm more proud of our global team who has just delivered another quarter of outstanding operational performance. Let's go to Slide 3 and talk about some of the highlights. The Allegiant team delivered 18% total growth and we drove Strong margin expansion. In Q2, we increased margins across Americas and International Business segments, both sequentially and year over year, resulting to be a key growth driver for Allegion.

Speaker 2

Demand was strong for our electronic solutions in the 2nd quarter, fueling Allegion's overall revenue growth. In Q2, Strength across both residential and non residential business in our Americas segment totaled nearly 40% Electronics growth over the prior period. We also saw strong Electronics and Software Solutions performance in our International segment. As we work to shape Our non residential markets remain stable and electronics demand continues to be a bright spot in both Americas and International segments. To our reduced lead times due to much improved supply chain and operational execution.

Speaker 2

The Americas Residential business was bolstered by very strong electronic sales, but we're still seeing soft mechanical demand. Certain international end markets, particularly in the portable security business Also remains soft. Overall, our team delivered another strong quarter resulting in a solid first half of twenty twenty three. We are operating at a high level and as a result are raising our outlook for the year for adjusted EPS, which is now expected be in a range of $6.70 to $6.80 I am very proud of the Allegion team's operational performance. I'll provide more color on the outlook later in the presentation.

Speaker 2

Please go to Slide 4. Now let's move Our vision of enabling seamless access in a safer world. What does that mean? It means if you have the right credential, whether Why is this the right strategy and why is this the right strategy now? Because our world is increasingly digital, mobile Because digital credentials and smart hardware not only provide more seamless access experiences, they also provide More rich data to the end user customer and added layers of security.

Speaker 2

We feel this transformation has a long runway ahead. Our vision is supported by a strategy of creating value as a pure play provider of security and access solutions. This is how we differentiate our company and drive innovation for a safer world forward. Building on our legacy, Delivering new value in Access, being the partner of choice and operating with excellence. Please go to Slide 5.

Speaker 2

So this month also reflects the 1st anniversary of the STANLEY Access Technologies acquisition. Acquiring the Access Technologies business was a direct Our teams have integrated very well together. We've taken very good care of our customers and you can see this in our results, which reflects operational performance In line with the business plan, Access Technologies generated revenues of approximately $385,000,000 which represented approximately 10% Overall, we feel great about this highly strategic combination. The Automatic Doors product portfolio is a hand in glove fit with our demand creation and specification This acquisition is greatly enhanced, Allegiant's service capabilities and we look forward to much more long term profitable growth opportunities together. I'll ask Mike now to walk you through the Q2 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 6. Allegion delivered another strong quarter with both top and bottom line growth as well as improving cash flows. Revenue for the Q2 was $912,500,000 an increase of 18% compared to 2022.

Speaker 3

Organic growth of 5.6 percent was driven by price realization along with strong growth in electronics offsetting lower volumes in mechanical products. Our Access Technologies acquisition contributed approximately 12% to total growth. Adjusted operating margin and adjusted EBITDA margin in the 2nd quarter increased by 130 basis points and 110 basis points respectively. These increases were attributable to strong operational execution and favorable price and productivity, which more than offset inflation and investments. Excluding our acquisition of Access Technologies, adjusted operating margin was up 2 70 basis points.

Speaker 3

Adjusted earnings per share of $1.76 increased $0.33 or approximately 23% versus the prior year. Operational performance drove 20% earnings per share growth with additional earnings per share growth coming from acquisitions, offset by the unfavorable impact of anticipated higher interest. Details of our earnings per share performance versus the prior year are in the appendix. Year to date available cash flow is 190,100,000 up nearly 125% versus last year. Please go to Slide number 7.

Speaker 3

I will start by reviewing the revenue results for the enterprise year before turning to our respective regions. In Q2, we delivered 5.6 percent organic growth, driven by price realization across the portfolio. Strong volume growth in electronics was more than offset by volume declines in our mechanical products. Our Access Technologies acquisition served as the primary driver of our 12.5% growth in net acquisitions and divestitures. Currency pressure were minimal in the quarter, bringing total reported growth to 18%.

Speaker 3

First half organic Revenue growth was 10.2% overall, driven by strength in electronics. America's operating growth was nearly 15% and international was down 3%. Please go to Slide number 8. Our Americas segment continued to deliver strong Operating results in the 2nd quarter with revenues of $727,200,000 up 23.8 percent on a reported basis and up 7.7% organically. During the Q2, we achieved double digit price Our electronics growth for the Americas was nearly 40% as we continued to see both improvements in our supply chain and strong demand.

Speaker 3

Electronic component availability was significantly challenged in the first half of twenty twenty two, making the quarter an easier comparison prior year as our supply chains are much healthier now. In the second quarter, we saw soft mechanical volumes as up high single digits for both our non residential and residential Americas businesses. As John mentioned earlier, Access Technology has now been 9.5% versus Q2 2022 and contributed over 16% to the Americas reported growth. Our adjusted operating income of $205,900,000 increased 32.9% versus the prior year While adjusted operating margin and adjusted EBITDA margin for the quarter were up 190 basis points and 180 basis points respectively. Excluding Access Technologies, our Americas segment drove a 4 60 basis point improvement in operating margin versus the prior year.

Speaker 3

85,300,000 flat on a reported basis and down 1% organically. In the quarter, price realization was more than This business benefited from a COVID related demand surge in the first half of last year. We expect this market will normalize and be less of a headwind to our international segment in the second half of this year. Our Electronics and Software Solutions are performing well and reported revenue by 0.6 percent. International adjusted operating income of $20,900,000 increased 2% versus up 30 basis points and 40 basis points, respectively, when compared to last year.

Speaker 3

The margin improvement was primarily driven by favorable price and Productivity in excess of inflation and investment reflecting strong execution by the team. Please go to Slide 10. Year to date available cash flow came in at $190,100,000 up $105,600,000 versus the prior year. This increase is driven by higher earnings and lower cash used for net working capital, primarily offset by higher capital expenditures. Working capital as a percent of revenue increased versus the prior year, partially driven by our Access Technologies business, which was not owned in the first half of last year.

Speaker 3

Working capital management remains a priority of our company as we efficiently turn earnings to cash. As committed, We deleveraged following the acquisition of Access Technologies and our net debt to adjusted EBITDA is back down to 2.1 times. We repaid $60,000,000 on our revolving credit facility in the 2nd quarter and the remaining $30,000,000 outstanding was repaid in the month of July. This means we have completed our repayments of short term borrowings for the acquisition, demonstrating our ability to effectively deploy capital and maintain an investment grade credit rating. Our business continues to generate strong cash flow and our balance sheet continues to be in a healthy position.

Speaker 3

I will now hand it back over to John for an update on our full year 2023 outlook. Thanks, Mike.

Speaker 2

Please go to Slide 11. And as we look at the remainder of 2023, we're tightening our full year revenue outlook, while also increasing our earnings per share outlook. We now expect the Americas segment to be between 15% to 16% for total growth and 7.5% to 8.5% organically. Within the Americas, we expect to see non residential organic growth up high single to low double digits. We expect the residential business to be relatively flat as Electronics growth is expected to offset mechanical weakness in that segment.

Speaker 2

As a reminder, our supply chain challenges in our Americas Business began to recover in the second half of last year, so we'll have a tougher comparable period in the second half of twenty twenty three. Additionally, due to our approved lead times this year and their impact on our non residential customers' ordering patterns, seasonality is expected to Flat in total and down 1% to 2% organically. The comparison for the international business is somewhat Easier in the second half of twenty twenty three as weaker market conditions really started to set in during the second half of last year. All in, for the company, our growth outlook reflects total revenue growth to be between 11.5% to 12.5% And favorable first half margin performance, we're raising our adjusted EPS outlook for the year and believe it will be between $6.70 $6.80 which is approximately 12% to 13.5% over the prior year period. And as you heard from Mike, this is primarily driven by operations Lastly, we're increasing our outlook on available cash flow for 2023 to be in the $500,000,000 to $520,000,000 range.

Speaker 2

Please go to Slide 12. So in summary, Allegion delivered a solid first half of twenty twenty three. Like we said at Investor Day, we've returned I can revisit a little bit about driving organic growth, compounding that organic growth with both margin expansion and capital deployment, resulting in double digit EPS growth and I feel we're well on track to deliver all of that for 2023. As we stay focused on our vision of enabling seamless access in a safer world, I'm confident in our outlook and very proud of what our team and our

Operator

We will now begin the question and answer session. At this time, we will pause momentarily to assemble our roster. The first question comes from Julian Mitchell with Barclays. Please go ahead. Hi, good morning.

Operator

Maybe just a first question to try

Speaker 4

and understand the organic sales Guidance development first off. So you raised the guidance in late April on organic sales and you've taken Down a little bit today. So was it that you saw channel partners and suddenly start to destock sort of late in the second quarter. Maybe help us understand sort of what the process was behind That guidance revision. And then also on the non residential market specifically, It seems that the macro drivers in the Americas are still very good.

Speaker 4

So perhaps a little bit puzzled that you're not seeing new orders coming in to sort of offset the destocking that seems to be happening in some areas.

Speaker 3

Yes, Julien, if you think about the guide, the last few years, we really struggled with lead times and we got considerably better at the end of last year. Our channel partners were maybe a little late to adjust to our reduced So what we saw in the second quarter is they're starting to adjust that ordering pattern to our reduced lead times. Especially on the mechanical side, they are back down to normal and we are, let's say, at March 31. It took a little longer for them to adjust They're ordering, so they're burning through some of the work that they previously ordered. As you know, we're mostly a made to order business, The channel partners will order based on what they think manufacturers can provide product at.

Speaker 3

And so we did have some of that choppiness in the second Expect for us to be total company roughly fifty-fifty first half to back half. And as you look at our guide right now, you would say it's roughly fifty-fifty as a company. So I do think in the second quarter, we did see That channel partners are adjusting to our improvement operationally, which is great because we put a lot of effort to get back to Operating at a high level. And then the second part of your question related to markets, I'll kind of let John answer that.

Speaker 2

Yes, Julian, thanks for the question. And we see some of those same things. And I think when I look If you just aggregate Americas non res a little bit, the institutional segment in particular shows Continues to flash signals of resilience. Healthcare, education, even airports That probably are still in the benefiting phase from the infrastructure bill because airport terminal renewal was one of The funding principles there of that bill, but the institutional segment continues to show Good signals, positive signals. And as you know, that's where our business is a bit heavily weighted.

Speaker 2

Now that being said, are there pockets Weakness, major metro, commercial office, I mean that's been soft for sure. That's no secret. But We're also late cycle. We're heavily weighted towards institutional. That segment seems pretty resilient.

Speaker 2

So in general, yes, we feel Again, that our exposure in non res is quite stable. The end markets are stable there.

Speaker 4

That's helpful. Thank you. And then just my follow-up, just to make sure we sort of calibrated properly within the second half. Clearly, seasonality is abnormal this year. Your revenues were down sequentially in Q2, which is unusual.

Speaker 4

You talked in the prepared remarks about flatter seasonality this year. So should we assume that you have a much Narrower sort of variability between the 3rd and 4th quarter earnings as we look at that and maybe sort of sales and margins also not that different across the 2.

Speaker 3

Yes. Thanks for the question, Julian. Historically, you know us. We don't guide quarters, but if you think about our business, usually have a step down in Q4 versus Q3 in the Americas and it's reverse in international. If you think of the Americas this year, we would expect that to be more Flatter than normal.

Speaker 3

So the way you're thinking about it without giving numbers is correct. You shouldn't see as big a drop off from Q3 to Q4 when you model this versus, let's say, historical norms.

Speaker 2

That's great. Thank you. Thanks, Julian.

Operator

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

Speaker 5

Hi, good morning. Thanks very much. I guess, in terms of that last point and as we think about what's going on with channel partners and volume trends and the swing from 1Q As we think about the back half of the year and how you're thinking about channel inventory levels And given maybe not as much seasonality from 3Q to 4Q, is that based on sort of an expectation that At the end of the Q3, these channel inventories are sort of roughly normalized or just any views on timing of when those channel inventories get to a more or less normal state?

Speaker 2

Yes. Joe, I think you would find and we find on our channel checks and Customer visits a very wide range of answers there. I think our 2 step distribution partners, our wholesalers We'd have a different answer than some of the more traditional contract hardware distributors. And our integrated hardware I think in aggregate, we still hear comments like aftermarket activity It's very strong, particularly in the non res space. Again, and then the leading macros would say the institutional segment is Still pretty resilient.

Speaker 2

So we still see, I'd say, good levels of sell through. And The inventory state of the business is going to be different within the channel. Overall, I think the best way to think about it is you just listen to what Mike said and think first half, second Half fifty-fifty is kind of the way we see 2023 working out.

Speaker 5

And then on the Americas margin Ex access tech at 31%, clearly a really strong margin level. I guess just Framing that relative to some of the comments at the Investor Day and targets to grow margins 50 to 100 bps annually.

Operator

Is there

Speaker 5

anything about the mix that you're seeing or price cost dynamics that make kind of growing off of this base little bit more challenging. Just kind of want to understand some of the strength behind that margin in the quarter.

Speaker 3

Yes. So Joe, great question. As you know, Obviously, the back half of the year won't have as much margin expansion year over year as first half Just because the back half of last year was pretty strong, and so as a result, we still expect to see margin expansion in the back half in total. But it won't be as strong as what you saw in the last two quarters, just due to the prior year comp. If you think of last year, we started to really pick up operationally back half.

Speaker 3

Long term, on Investor Day, I talked about that 50 to 100 basis point improvement. That's part of our operating model and we still believe on a long term basis, we can deliver margin expansion in those levels. Quarter to quarter, it could change by a prior year comp, but think of the operating model where we're going to drive pricing productivity To offset and fund that inflation and investment, drive some expansion with that and the volume leverage. So in total, the operating model I talked about In light that Investor Day still holds and we feel good about the progress we've made in our operational execution over the last

Operator

The next question comes

Speaker 6

John, congrats on the 1 year anniversary.

Speaker 2

Thank you, my friend. Yes.

Speaker 6

So maybe let's just start on pricing. Obviously, very Strong this quarter, Americas was, what, 10% and yet international pricing that actually accelerated in 2Q. Maybe just tell us a little bit about what to expect as we progress through the year and whether you're putting additional pricing

Speaker 3

Yes, Joe, we've talked about this in the past. We fell behind starting in the back half 21, and we've put efforts in to catch up to that inflation dynamic that we struggled with in years past. I feel like we did a pretty good job and have caught up now. The last pricing actions we put in, in our non res business Earlier this year as we discussed in previous earnings calls, so you should think about back half pricing. You will see it step down So if you take a look at last year Q2 to Q3 to Q4, you get an idea of what happened that you can model the price realization this year on, Knowing that the pricing actions have been put in the marketplace, I think it's important to note, we drive pricing actions to recover that inflationary pressures coupled with productivity and investments, so that 4 Item dynamic I've talked about over the last year.

Speaker 3

That still holds, but you will see a step down in the realization percentage due to the prior year comparable.

Speaker 6

Got it. That's helpful, Mike. And my follow on since you referenced that equation, That price and productivity net of inflation and investments is the strongest I think we've seen in really many years. And so can you maybe just break down a little bit what you're seeing on the productivity versus the investment side? And again, how that's expected, The cadence for that going forward through the remainder of the year.

Speaker 3

Yes, Joe, I really don't want to give individual numbers, but I will say you are seeing an improvement in productivity and in our efficiency, right. So as we our supply chains normalize and we operate at a higher level, We are driving a higher level of productivity than what you saw in 2022, 2021. And so we're really excited about The momentum we have in productivity, we expect that to continue as an organization and we do expect To continue to invest in our business to drive that top line growth, thinking about the great opportunity that Electronics and software provides us. So we'll continue to invest in the business. But what you saw this quarter, you do have better operational

Speaker 6

But that just to be Clear that equation is expected to remain like pretty strongly positive in the back half of the year, correct?

Speaker 3

Yes. I don't want to forecast or guide that Just make sure you get the margin rate right as you look at our EPS guide and revenue. I kind of gave you The pricing as well so you can back into the all the dynamics you need for your model, but expect to see margin expansion in the back half. And then as you look at quarters, just be cognizant of our Q3, Q4 comparables of last year as well.

Speaker 6

Understood. Thank you.

Operator

The next question comes from Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Speaker 7

Hi, good morning guys. Hey, guys.

Speaker 2

So just

Speaker 7

want to tease out if we can some of these supply versus demand On the mechanical side, I think we've heard elsewhere in terms of lead time normalizations and destocking. I guess those could be 2 separate things with same concept. But any indicators that you're getting from distributors or maybe specifying architects on Demand signals or sell through in June, maybe just to kind of match up that supply versus

Speaker 2

Yes. Josh, we'll segment this down a little bit. So I think when you look at mechanical products broadly, as we indicated in the comments, Residential Mechanical for us is indeed soft, offset by very strong electronics performance. In the non res side, I think that dynamic, again, you can imagine if for the last 8, 9, 10 months, you're placing your orders and you're not getting delivery for 15, 20 weeks, Then suddenly you're getting delivery in 2 to 4 weeks. It takes a little bit to work through that.

Speaker 2

I think channel checks Have anecdotally indicated things to us like when you look across the Americas, Places like the Midwest, South, Southeast, really, really strong. If you go to some major The metro areas that are probably a bit heavy commercial office, they're pretty light. So it's pockets of strength, pockets of weakness. On balance, we still see good sell through. We still see that the non res market is stable, primarily supported by the institutional segment.

Speaker 7

Super helpful. And then just to pick up some comments that you made and I guess Congrats on the quick delevering post Axis Technologies. I think the Analyst Day, a lot more focused on growth and Inorganic growth was a piece of that. How would you characterize the pipeline right now and what you guys are seeing out there, especially with now higher interest rates and maybe

Speaker 2

Yes, I'd say short of talking about any specific targets I would feel very good about

Speaker 3

the top

Speaker 2

of our funnel in terms of looking for acquisition targets. I think again think of us as a pure play provider of security and access solutions. Now we've talked a lot about the importance of electronics, the importance of controlling software, Really driven by the increasing use of smartphone wallets and mobile credentials. That as a macro tailwind really propelling and giving New uses for smart hardware, electronic access control solutions, we feel again as an industry that's Still all the signals we can find that's still high single digit growth that we can tend to outperform by a point or 2 and get a lease in performance in the low double digit range. And certainly acquisitions plays a part in that.

Speaker 2

And I think as we've said now, you can look for us to be acquisitive. You can look and expect

Operator

Good color. Thanks. I'll leave it there.

Speaker 2

Thank you.

Operator

The next question comes from Andrew Obun with Bank of America. Please go ahead.

Speaker 8

Hey, guys. Good morning.

Speaker 2

Hey, good morning, Andrew.

Speaker 8

Just a question on international market volumes. You highlighted portable Purity weakness, but seems like underlying volumes got sequentially a little bit better. Can you just I know that it's Fairly diverse group of countries. But can you just highlight dynamic maybe by region, Italy, Spain, I don't know, France, Central Europe, Korea, Australia, just any granularity to what's happening there?

Speaker 2

Yes. I'll take a little bit different angle and hope it still answers your question, Andrew, but it's a good question. Thank you. So I'd say, the Portable Security business, without a doubt, volume drag. No doubt about it.

Speaker 2

As Mike mentioned in the prepared comments, the post COVID demand spike that you saw in that space was quite dramatic. We do expect that market is going to normalize as you get into 2024 and 2025. But I'd say and We're not alone in seeing this or commenting on it, but residential in general in Europe is rather weak. And that's by and large a mechanical business. So those volumes are under pressure, there's no doubt.

Speaker 2

Our Electronics Software Solutions would still be in probably the low double to mid teens organic growth. So we feel really good there, which is again more in the commercial side of our business, the non res side of our business. APAC, for us, we do have some China exposure. It's not a lot, but there China is under a lot of pressure. And so our relatively small but profitable business there is certainly lower, Relatively speaking, Australia and New Zealand pretty steady, pretty stable, kind of falling in line with what you see in the Americas, just Stable end markets, our teams are performing well there.

Speaker 8

And just maybe a follow-up question related a, if you could sort of differentiate between what's happening in hospitals and schools because it seems the dynamic is Somewhat different and be a more interesting question, and you guys turned me on to this years ago, but If you look at muni bond issuance and tax receipts, what's your latest read on the environment going to second half in

Speaker 2

I'd say, looking at the institutional segment, you don't see quite the amplitude of It's a little bit steadier. It's a little bit more stable. That is the segment that we perform very well in. That's a segment where codes, Compliance, safety standards for your building really matter and that's where Allegion differentiates and I think really excels. Healthcare has been pretty resilient, education has been pretty resilient, and that's both higher ed and K-twelve.

Speaker 2

School safety is always important. Allegion has for a long time been a very proud and vocal advocate For proper standards, proper codes and compliance, we've increased our human resources, human capital in that space And continue to be, I think, a very positive participant in the industry for school safety there. When we look at things to the second half of your question like muni bonds and state tax revenues, The picture is actually pretty stable, pretty favorable. I'd say State Test revenues look to be relatively high, Mike, what you saw back in the 'eight, 'nine crash, the environment is a little different this year, maybe some COVID stimulus, maybe just Good economic growth, very low unemployment, etcetera. The tax revenues at the state level seems to be pretty good from the data that we see.

Speaker 2

Bond issuance in 2021 and 2022 was very high. And obviously, it's taken a bit of a dip here, but Seems to be sequentially recovering somewhat. Then also remember, Andrew leads in his late cycle. So from Bond issuance to budget development to projects being firmed up to shovel in the dirt, so to speak, to finally Door to door hardware going on, that can take some time. And so I think in general looking at bond issuance over the long term, drawing a So I'd say again, flashing signals of resilience in the institutional segment would be the way we'd see it.

Speaker 8

Thank you.

Speaker 9

Thanks, Todd.

Operator

The next question comes from Ryan Merkel with William Blair. Please go ahead.

Speaker 9

Hey, thanks. Two questions for me. Any way to quantify the impact The order pattern adjustment for mechanical for the full year. And then on Electronics, when do you see the lead times Normalizing there and could we see a similar order pattern adjustment at some point there? Thank you.

Speaker 3

Yes, so I'll talk about the first one. If you think about business Ryan, I keep on talking about that roughly fifty-fifty first half The back half, we so if you think about it for the full year guide, that will be completed by the end of the year. So it really won't have an impact on full year, but you could see a flatter Quarter to quarter variance like we talked about earlier in the call. So for a full year, it's really not Applicable, but when you think about quarterly timing, it does result in a little more Smoothing quarter to quarter over the last 3 than you would normally expect. And then remind me again your second question.

Speaker 2

Electronics? Yes.

Speaker 7

Electronics, should we expect

Speaker 2

to see a similar ordering pattern Where lead times are still a little bit extended, certainly down from the peaks that we saw in the middle of last year, But maybe not yet back to normal, but have been on a pretty good glide path getting back to a more normal, say, 4 to 6 week kind of lead time for those products and backlogs are still a little bit elevated there. Demand is still strong. If you see our Investor Day material talking about the non res mechanical segment low single digit growth industry. The electronics portion would be high single digit growth. So I think that's the main thing as we see that as the key growth driver.

Speaker 2

So will that same dynamic pop up in the channel? It Certainly could, yet to be seen. And I think as we all get a little bit smarter here having gone through these Quite volatile and dynamic times of the supply chain. Maybe with good work, we We can mitigate it, but yet to be seen. I guess I don't have a real good detailed forecast for you there, but we'll be watching out for

Speaker 3

Yes. And just to add, Ryan, just remember that electronics, we talked about it extensively at Investor Day About what a real strong long term growth driver that is for us. So demand there, as John mentioned, is still really strong. So as you think about that Moving forward, that Electronics business should be a double digit growth long term driver for us. So this is not a Couple of quarters of growth.

Speaker 3

This is a long term growth opportunity for us.

Speaker 9

Got it. Thank you.

Operator

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

Speaker 10

Yes. Good morning, everyone. Hi, Damon. Hey, I just wanted to maybe build off Ryan's question on the electronics. And Obviously, a 40% number is a huge number and there's a lot of backlog clearance going on there.

Speaker 10

But can you and you talked about Mike, about the high single digit growth that's underlying that. Is there any way to sort of trifurcate that down between institutional, commercial and residential? Or just give us a better feel for What the second half of this year demand in electronics is likely to look like by sort of that framework?

Speaker 3

Yes. What you'll see, David, a couple of dynamics And I talked about it earlier in the prepared remarks. Immediately, Q2 last year was a little weaker. So you do have some growth here due to a weaker previous year, but still this is now 4 quarters in a row, really strong growth in electronics. We saw strength in both electronics growth in resi as well as non res, so both were strong in the quarter.

Speaker 3

And as we look forward to the end of the year, the back half, we expect to see good growth In Electronics, the one thing I'll remind you is the comps in the back half of last year get much tougher, particularly in Electronics, Right. So if you remember last year, we threw some pretty robust numbers up in the back half. So just make sure you take that into consideration when you model your electronics. But overall, still expect to have some good growth this year and beyond This year on electronics in both res and non res.

Speaker 10

Okay. Thanks for that. And then secondly, just a question on Access Technologies. And I wonder if you could Just talk about the extent to which you've been successful in building out the recurring service revenues in the 1st year of ownership? And maybe just also remind us on the scale of the international business for HE and your growth with that business over the first year?

Speaker 10

Yes. Business for HE and your growth with that business over the 1st year?

Speaker 2

Yes. Really good question, David. We're always thrilled to talk about Access Technology, there's been a great add to the Allegion portfolio. I'd say the service side of the business Has historically been about 40% of the total. It has also historically grown around the low double digit high single, low double digit rate.

Speaker 2

And so we feel really good about that. We see lots of future opportunities And potential there as our overall our total Allegiant service capabilities continue to expand and grow. Then I'd say in terms of an international presence with Access Technologies, it It's quite small. So it's not 0, but it's quite small. This is mainly an Americas business and where we really focus Investments, the new product development and just really staying close to those customer requirements.

Speaker 10

Are you Focus on putting more feet on the street and building the service offering in that sense or can you just talk about how you're investing in that business?

Speaker 2

Yes. So I think certainly it's a I'd say it's a lot of things. We got to put better productivity tools in their hands, better diagnostic tools We're working on a variety of technology there. And then as We work together with certain channel partners as well, making sure we got the right coverage and the right people to take care of those customers. So The human element is important, absolutely.

Speaker 2

Technology is also important there.

Speaker 10

Are you able to find those people? I mean, I am just wondering how much of a struggle it is to identify and recruit and retain those people.

Speaker 2

Okay. So, 3 follow ons. All right. Yes, I'd say obviously We

Speaker 10

said you like to talk about Access Technologies.

Speaker 2

Yes, yes, yes. Don't take advantage of me. Come on. Again, these people are hard to find. I won't sugarcoat it.

Speaker 2

These are very highly very professional technicians, but we put a lot of investment into training and support as well. And so we have to be very choosy because these technicians are the ones keeping our customers up and running. So, it's not just hire as many as you can, it's hire the best and that's what we focus on doing. Thanks very much for the questions. Thanks.

Operator

The next question comes from Brett Linzey with Mizuho America. Please go ahead.

Speaker 11

Hey, thanks. Good morning. Just a question on electronics versus mechanical. I know historically you've said that margin profile is similar, but Curious as you get more scale in that category and considering all the redesigns and the reengineering you did last year, is there headroom for the Elok gross margin to move higher over

Speaker 3

Brett, we think about gross margins for the organization moving higher over time as we drive the price productivity in excess of the inflation and investments and we leverage volume growth. So I don't think it's just Electronics, I think as an organization, we're going to drive margin expansion. With respect Electronics will give us a little more dollars per every unit of sale. That's a dynamic we've talked about in the past. So It's great when we can upsell to an electronic device and it's something we're focused to drive long term.

Speaker 11

Great. And then just on the international side, clearly volumes continue to be weak, but margins pretty solid in the quarter on price and productivity. Assuming the volume environment remains soft, do you think Tim and team can defend operating margins in that low double digit range? Just curious what the sensitivity might be on the upside, the downside?

Speaker 2

Yes. I appreciate the question because we were really Proud of what the international team put up in 2Q, flat revenues roughly and still driving margin expansion to your point. Price productivity, net of inflation and investments is a positive dynamic for that group. I'd say like previous quarters, The Alize International Business is on a much more firm foundation as a business, and we're continuing to Find improvement opportunities. So Tim and the team are performing very, very well.

Speaker 2

We're proud of what they're accomplishing, and I think we're making Good progress against the goals that we've got set out for international. I appreciate you calling that out.

Speaker 11

Yes. Thanks for taking the question.

Operator

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

Speaker 2

Thanks very much and thanks everyone for a really great Q and A. And just to really quickly wrap up the main themes you heard today, electronics continues to be a strong growth engine for us and we believe we're in the early innings of adoption there within the industry. The driver here is the flexibility and added layers of security that are available when you adopt Smart hardware and mobile credentials. Our end markets are stable and while we saw softening in mechanical volumes this quarter as customers adjusted to our improved lead times, indication from our channels show steady demand, stable end markets. The Allegion team continues to deliver outstanding operational performance.

Speaker 2

Our team is controlling the things they can control and they're executing very well in my opinion. This is marked by strong margin expansion and increased cash flow. With this, we're confident in our performance

Operator

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

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Earnings Conference Call
Allegion Q2 2023
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