Allegion Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 21, 2021

Key Takeaways

  • Allegion saw continued strength in the Americas nonresidential market, driving record backlogs at approximately four times normal levels.
  • Global supply chain constraints—particularly electronics component and labor shortages—have delayed an estimated $80 – 100 million of 2021 revenue and eroded margins.
  • The company has implemented multiple price increases and is leveraging supply chain management initiatives to offset about $60 million of year-over-year material and freight inflation, with margin improvement expected as constraints ease.
  • In Q3, revenue decreased 1.6% to $717 million and adjusted EPS fell 6.6% to $1.56, while year-to-date available cash flow rose 28% to $327.7 million.
  • Allegion reaffirmed its 2021 full-year guidance, targeting organic revenue growth of 3%–3.5%, adjusted EPS of $4.95–$5.05, and continued strong cash flow generation.
AI Generated. May Contain Errors.
Earnings Conference Call
Allegion Q3 2021
00:00 / 00:00

There are 14 speakers on the call.

Operator

Good morning, and welcome to the Allegion Third Quarter 2021 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask 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. Thank you for joining us for Allegion's Q3 2021 earnings call. With me Today are Dave Petratis, Chairman, President and Chief Executive Officer and Patrick Shannon, 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 atinvestor.

Speaker 1

Allegiant.com. This call will be recorded and archived on our website. 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 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. Dave and Patrick will now Our Q3 2021 results, which will be followed by a Q and A session. Please for the Q and A, we would like to ask each caller to limit themselves We would like to give everyone an opportunity given the time allotted.

Speaker 1

Please go to Slide 4, and I'll turn the call over to Dave.

Speaker 2

Thanks, Tom. Good morning and thank you for joining us today. Before we go into our 3rd quarter results, I'd like to take a minute to acknowledge and congratulate my fellow Allegion team members for their ongoing dedication to the environment, Society and governance. I'm humbled and honored to share that just last week, Allegion was recognized for ESG leadership through 2 different awards, the Robert W. Campbell Award and the Jackson Lewis Diversity, Equity and Inclusion Champion Award.

Speaker 2

The Campbell Award is an annual recognition by the National Safety Council, America's leading nonprofit safety Advocate, it is the premier award for excellence in integrating environmental, health and safety management into Business Operating Systems. Winners have strong processes and show measurable achievement over a 5 year period. In and S performance that leads to productivity and profitability and are expected to demonstrate A long term track record of not just DH and S compliance, but also critical improvements. The prestigious award is also known for its rigorous application process with a Systematic review and audit attached to it. Submissions are reviewed by management, labor, academic and government from around the world, followed by a meticulous audit format at 3 or more of a company's global sites.

Speaker 2

With this in mind, Campbell Award winners are an elite group of organizations. Past winners include Boeing, Cummins, Dow Chemical, DuPont, Honeywell Aerospace and Johnson and Johnson. Allegiant is proud to have our name added to this best in class list. We are also excited to have been named the Jackson Lewis Diversity, Equity and Inclusion Champion by the Indiana Chamber of Commerce. This is a statewide honor that recognizes an organization making significant strides in the workplace.

Speaker 2

The judge noted that Allegion was chosen as its first ever winner of this award because of our company's proactive and intentional diversity, equity and inclusion efforts around the globe. We have strong momentum on our diversity efforts, and we know there's more work to be done. We're not asking the people of Allegion to agree on everything, but we need to be a place where racism and bias are rejected, Where inclusion is a way of life and where all employees feel they belong and can contribute to our business success. Importantly, I've shared before that Allegion's ESG commitments are vital to how our company achieves results and the way we do business. ESG Excellence will give us better long term outcomes across the board, better employee safety, better employee engagement, Better productivity, better creativity, better innovation and stronger financial performance.

Speaker 2

We see this firsthand and external data points to it as well.

Speaker 3

Please go to Slide 5.

Speaker 2

During the quarter, we experienced continued strength in demand, particularly in the Americas nonresidential market. This trend began in Q2 and accelerated through Q3. Leading indicators like ABI and Dodge new construction indices Remain positive. Increased demand is for both discretionary projects and new construction is expected to continue in the foreseeable future. Residential end market demand is also favorable The strength in demand continues to constrain the global supply chain's ability to Fully meet demand requirements.

Speaker 2

Similar to last quarter, this was especially prevalent in electronic Components in Q3. As I'm sure you're aware, this is a global issue and not isolated to Allegion or to any single industry. We have redirected resources and are taking actions such as reconfiguring and redesigning products, Additionally, material and freight input costs continue to accelerate during Q3. We now anticipate material and freight inflation to be approximately $60,000,000 higher compared to last year. In addition to the supply chain pressures we are seeing for electronics, there are also widespread industry shortages of labor And other components.

Speaker 2

Once again, these issues are not Allegion specific, and we expect the global constraints driving these shortages to These challenges led to margin deterioration in the quarter. We will leverage the strength of our supply chain management capabilities as well as price to help mitigate these impacts going forward. During the quarter, the continued robust demand coupled with the supply chain pressures resulted in record backlogs, Approximately 4 times normal levels. We estimate that widespread shortages have delayed approximately $80,000,000 to $100,000,000 of 2021 revenue. We believe this impact is evenly distributed across the 3rd Q4.

Speaker 2

We do not believe this is lost revenue, but expect it will be recovered as supply chain constraints ease. Now let's turn to the 3rd quarter performance for more details. Please go to Slide 6. Revenue for the Q3 was $717,000,000 a decrease of 1.6% on both a reported and organic basis. The organic revenue decrease was driven by lower volume in the Americas region related to the aforementioned electronics, Components and labor shortages, currency tailwind and acquisitions offset the impact of divestitures.

Speaker 2

Patrick will share more details on the regions in a moment. Adjusted operating margins decreased by 3.30 basis points in the 3rd Higher input costs, productivity challenges and volume deleverage drove the majority of the decrease. Incremental investments important to our future growth caused 90 basis points of the decline. Adjusted earnings per share of $1.56 decreased to $0.11 or 6.6 percent versus the prior year. The decrease was driven by reduced operating income, offset by a favorable tax rate and share count.

Speaker 2

Year to date available cash flow came in at $327,700,000 an increase of $71,600,000 or 28% versus The increased cash flow was driven by higher year to date net earnings, along with improvement in net working capital and reduced capital expenditures. Patrick will now take you through the financial And I'll be back later to discuss our 2021 outlook and wrap up.

Speaker 4

Thanks, Dave, and good morning, everyone. Thank you for joining today's Call, please go to Slide number 7. This slide reflects our earnings per share reconciliation for the Q3. For the Q3 2020, reported earnings per share was 1 point 5 Structuring and impairment, the 2020 adjusted earnings per share was $1.67 Favorable tax rate drove a $0.13 increase in earnings per The negative tax rate for the Q3 reflects favorable settlements of uncertain tax positions, a benefit of mix of income As well as the non recurring unfavorable tax impact in 2020 related to certain valuation allowances. Reduced share count drove another favorable $0.04 per share.

Speaker 4

Acquisitions and divestitures had a positive $0.02 per share impact. Operational results decreased earnings per share by $0.21 driven by higher material and freight costs, Productivity challenges and volume deleverage, which more than offset the favorable impacts of price and currency. Investment spend increased during the quarter and reduced earnings per share by $0.06 As a reminder, the incremental investment spend is Predominantly related to R and D, technology and market investments to accelerate future growth. The combination of interest and other income drove another $0.03 per share reduction. This results in adjusted Q3 2021 earnings per share of 1.5 a decrease of $0.11 or 6.6 percent compared to the prior year.

Speaker 4

Lastly, we have a $0.03 per share increase driven by a Gain on the sale of an equity method investment, offset slightly by the combination of restructuring charges and acquisition integration expenses. After giving effect to these items, you arrive at the Q3 2021 reported earnings per share of 1.59 Please go to Slide number 8. This slide depicts the components of our revenue performance for the Q3. I'll focus on the total Allegion results and cover the regions on their respective slides. As indicated, we experienced an organic revenue decline of 1.6 In the Q3, the electronics components and labor shortages primarily in the Americas region had an impact on our ability to meet Strong demand.

Speaker 4

Still, we realized good price performance, which offset some of the volume decline. Currency continued to be a tailwind to total growth and offset the combined impact of acquisitions and divestitures. In total, reported revenue reduced by 1.6%. Please go to Slide number 9. 3rd quarter revenues for the Allegion Americas segment were $524,400,000 down 2.7% on a reported basis and 3% As previously stated, the supply chain pressures we are experiencing drove the revenue decline.

Speaker 4

We are still seeing strong market demand, which has resulted in record backlogs, particularly in the non residential part of the business. The region continued to deliver good price realization. Our latest price increase went into effect at the beginning of October, So we expect the price realization to accelerate in the future. On volume, Americas nonresidential was down low single digits Driven by the electronics components and labor shortages. Americas residential was down high single digits.

Speaker 4

This was uniquely driven by the prior year being inflated by channel refill coming out of the pandemic shutdowns experienced Q2 of 2020. The shortage of electronic components also had a negative impact on residential performance, primarily in the DIY space of big box retail and e commerce. Electronics revenue was down High single digits driven by shortages of electronic components in both the non residential and residential businesses. Electronics and touchless solutions remain a long term growth driver and is an integral to our investment and innovation efforts. America's adjusted operating income of $133,700,000 decreased 19.7% versus the prior year period and adjusted operating margin for the quarter was down 5.40 basis points.

Speaker 4

The decrease was driven by higher material and freight costs, Productivity challenges related to inconsistent supply and volume deleverage. Incremental investments had a 100 basis points dilutive impact on adjusted margins. Please go to Slide number 10. The Allegion International segment delivered another solid quarter. 3rd quarter revenues were $192,600,000 up 1.7% and up 2.5% on an organic basis.

Speaker 4

We continue to see strength in our SimonsVAS, Interflex and Global Portable Security Businesses, which along with good price realization Adjusted operating margin for the quarter increased by 40 basis points. The margin increase was driven primarily by volume leverage Along with favorable impacts from divestitures and currency. The combination of price productivity inflation were an 80 basis point headwind to margins. Incremental investments reduced margins by 40 basis points. Please go to Slide number 11.

Speaker 4

Year to date available cash flow for the Q3 2021 came in at $327,700,000 which is an increase of 71 point $6,000,000 compared to the prior year period. The increase is attributed to higher year to date earnings, improvements in net working capital And reduce capital expenditures. Our cash flow generation continues to be an asset to the company. Looking at the chart to the right, it shows working capital as a percentage of revenues decreased based on a 4 point quarter average. The business continues to manage working capital efficiently and generate strong cash flow.

Speaker 4

I I will now hand it back over to Dave for some comments on our full year 2021 outlook. Thank you, Patrick. Please

Speaker 2

go to Slide number 12. On October 1, we issued a pre release to our earnings and updated our 2021 full year outlook for revenue, earnings per share and available cash flow. We are reaffirming those updated outlooks. We have talked at length about the demand strength in the Americas business as well as supply chain pressures that are having an impact on our ability to meet that demand, which will delay an estimated $80,000,000 to $100,000,000 of revenue. The outlook for total revenue in the Americas is now projected to be at 1% to 1.5% with organic revenue growth at 0.5% to 1%.

Speaker 2

In the Allegiant International segment, we have not seen as large of an impact from component and labor shortages Our SimonsVoss, Interflex and Global Portable Security Businesses continue to perform well. For that region, we expect total revenue growth to be between 12% 13% with organic growth of 9% 10%. All in for total Allegion, total revenue is projected to be up 4% to 4.5% And organic revenue is expected to increase 3% to 3.5%. We are expecting reported EPS to come in, in the range of $4.95 to $5.05 per share and adjusted EPS to be The outlook assumes investment spend of approximately $0.15 to $0.20 per share. The full year adjusted effective tax rate is expected to be approximately 9%.

Speaker 2

The outlook for outstanding diluted shares As we close the presentation and move on to Q and A, I want to take some time to stress Allegion's strong long term fundamentals. 1st, even with the disruption caused by the global pandemic, our strategy around seamless And electronic transformation remains strong. We expect electronic and seamless access solutions You've seen proactive work from Allegion through Allegion Ventures, our recent acquisitions Like Yonomi and in our Interflex business, accelerating our software and tech capabilities. We're making investments and expanding partnerships with MegaTech and leading access control platforms. We are making significant progress on our ESG journey.

Speaker 2

This is evident with the 2 awards that we received earlier this month. The Campbell Award given by the National Safety Council is a very prestigious honor, and we joined an elite group of previous winners. I'm also proud of the Jackson Lewis Diversity, Equity and Inclusion Champion Award, which we received from the Indiana Congratulations to the Allegiant team. All markets in America remain robust. We continue to see Positive trends from leading indicators like ABI and the Dodge New Construction Index and expect these trends to continue Into 2022.

Speaker 2

With the International segment, the strength in our SimonsVoss, Interflex and Global Portable Security business persists. We have aligned and adjusted resources to navigate and adapt the supply chain pressures that the world is experiencing. Actions taken, including the redesign of products, the development of alternative supply sources, and we continue to leverage our pricing power. Allegiant's supply chain will continue to differentiate us and the strength in our backlog would indicate that our channel partners Believe we will navigate through the global pressures better than most. Demand remains strong.

Speaker 2

We have implemented pricing actions that will carry With that backdrop and assuming supply chain pressures Related to inflation and component shortages begin to ease, we expect solid revenue growth With year over year margin improvement and continued strong cash flow generation into 2022. The future of Allegion remains bright. Now Patrick and I will be happy to take your questions.

Operator

We will now begin the question and answer session. 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 Joe O'Dea with Wells Fargo. Please go ahead.

Speaker 5

Hi, good morning everyone.

Speaker 2

Good morning, Joe.

Speaker 5

First question is just related to any visibility you have around the timing of

Speaker 2

So my first observation, your past record sometimes is a predictor. Allegion performed extremely well through the first phases of this pandemic. Number 2 is some of the strength of our supply chain adaptability was evident. If we had not adapted, made design changes over the last couple of quarters, our backlog would even be larger. So feel very good about the Performance and the adaptability flexibility.

Speaker 2

It's clear the electronics is going to be a problem that All companies, including Allegion, will have to adapt to through 2022. I think an important element of the rest and it's The complexity of the Allegiant supply chain is the return of labor pressures to our partner suppliers. This we'll have to continue to monitor. This is everything from castings to power supplies to Wire harnesses, there is a labor scarcity across the globe. And again, I believe Our ability to adapt and our philosophy to produce in region will help Allegion.

Speaker 5

And then related to backlog and catch up and you made the comment about backlog being 4 times higher than normal. How do you think about managing that? So when you do start to get some relief in the supply chain, do you think about kind of Ramping up to deliver to customers as fast as possible, which could then create some inefficiencies in a

Speaker 2

So we've got a lot of experience in production systems, including The man that runs the company, me, 41 years. I think I like the backlog. I think if components If that regains health, we will actually pick up efficiencies. There's Gross inefficiencies through COVID, the supply chains, an important element is our ability to bring on and flex our own labor,

Operator

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

Speaker 6

Thanks. Good morning, everybody.

Speaker 2

Good morning, Joe.

Speaker 6

Yes. You guys talked about clearly lots of challenges In the marketplace today, I know that, as you kind of think about the Americas margins, being down, you know, 500 to 600 basis points Year over year, we had investments of about 100 basis points impacting the margin. Can you maybe parse that out a little bit more for us? Like, Do we know how much of it is coming from higher material and freight costs? How much of it is more kind of like the productivity issues?

Speaker 6

Just any other additional color around that would be helpful.

Speaker 4

Yes, Joe. So the significant portion of the margin degradation year over year is predominantly And freight costs. And then we've got productivity challenges associated with some of The component shortages and those type of things creating inefficiencies at our facilities. So if you think about it relative to normally we've done Good job in terms of managing the price inflation dynamic. We're underwater today as we kind of look at that, price being lower than the incremental material and freight costs, that will get better As we kind of progress here, we're putting in more price increases to make up for the delta.

Speaker 4

One of the challenges is kind of given The high backlog and the fact that a lot of the backlog today is kind of price protected. You don't see The benefit of the price increase is coming through and offsetting the incremental inflation until going into 2022. So we're still going to be under pressure For the balance of the year, when inflation really accelerated, particularly when you look year over year On steel components and those type of things. So it's just it's one of these short term phenomenons. If you assume that inflation has kind Pete, today, going into 2022, things will kind of continue to get better than we would expect to be in the positive end of the equation As we progress throughout 2022.

Speaker 6

Got it. That's helpful, Patrick. And maybe just kind of following on there, As you think about then, it sounds like you're going to be underwater again in the Q4. As you think about like the pricing that you're putting through. Do you typically include a fuel surcharge or is this Kind of like stickier pricing than you expect to get in the 2022 timeframe.

Speaker 6

And then we've also gotten some questions from investors today around the fact that Pricing stepped down on a year over year basis, if you took a look at the Q2 versus 3Q. So curious like Any comments around why pricing was a little bit weaker in 3Q versus 2Q?

Speaker 4

So on your first question, so we manage pricing broadly and it's really dependent upon product category. Some of our products that are more steel related, I. E. Steel doors, those type of things would carry surcharges Associated with that, but mostly across the product portfolio is through list price increases It's kind of how we manage it, so it's more permanent in nature. The year over year delta, you Have to look at it again by product category, a little pressure in some of the discounts.

Speaker 4

Residential, for example, A little bit harder to kind of pass through the price increases. So that's really what you're seeing there. If you kind of Look at the bulk of our business commercial year over year price increase. I'd add to this,

Speaker 2

Our hollow metal business, list price increases and surcharges. On the General Hardware business, 2 price increases in the year and we'll adapt to the pressures as we go into 'twenty two. And certainly going hard at the residential products as well. And my message here Would be in the addition to freight surcharges, we're pulling all levers on price realization. And I think As we get past this momentary surge that occurred in Q2 and Q3 on inflation, We'll continue our discipline around price performance as we move into 'twenty

Speaker 6

Thank you. That's helpful.

Operator

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

Speaker 2

Yes. Hi, guys. Good morning, Andrew. Yes.

Speaker 3

Just to follow-up on Joe's question on pricing. I'm just a little bit surprised by the pricing myself. We did some channel checks with electrical Dave, you would know very well, one of the largest players in North America has price in effect, I think, sort of policy at this point In order to sort of cleanse out the backlog, I think HVAC guys that sell in a lot of similar channels, I think have had like Four price increases this year. I mean the industry structure seems to be quite favorable. Why is it so hard to get a price increase through Or are you who is being aggressive, particularly you seem to highlight residential, is one player being aggressive?

Speaker 3

People out of Asia being aggressive, which is surprising because I would have expected they would have difficulties getting stuff on the boat. Just maybe a little bit more color there. Thank you.

Speaker 2

So I'd give a completely different perspective, Andrew. I know the electrical quite well. Think about the amount of electrical pipe, wire and distribution gear that goes in, in the 1st 6 months of a construction project. We submit our quotes, get orders at the same time and that those products are delivered at the end of that cycle. When we put a quote, that's carried For a period of time, but we honor that order.

Speaker 2

And so we eat that inflationary pressure. The cycle The electrical industry is much faster than ours. We've been aggressive on the price increases as well as surcharges, and It's not apples to apples. We're both in new construction. On new quotes and bids, we're really Raising the levels every day and I hope that color maybe helps you understand Leading products, the electrical versus lagging products on the hardware side.

Speaker 4

And I'll just add, Andrew, it's not a question of Realization, in other words, we'll get the price increase. It's more of a timing issue. So you will begin to see sequential improvement Beginning Q4 relative to the price increases we put into the market and that will continue to accelerate into 2022 Year over year and sequentially.

Speaker 3

In 'twenty two, you'll get some of the benefit of these 'twenty one price increases. You'll get it, but later. Yes. Got you. And just a follow-up question, just the difference in performance between North America And I guess international, which I sort of think mostly Europe, as I think about your brands, IntraFlex, I guess it is mostly software, but it does have electronic components.

Speaker 3

If I think about, I guess, Chiesa is the one that's purely mechanical, but Simon BOSS, which you highlighted also has large electronic component. Why are you able to avoid the kind of disruption related to electronic components on labor In Europe that you experienced in

Speaker 2

the U. S. Because I

Speaker 3

would imagine the electronic components in Europe are also getting sourced in Asia? Thank you.

Speaker 2

So electronic components tight in all sectors of the world. The differences between SimonsVoss, a lesser extent, and InterFlux and the core business in the Americas is pure suppliers. We had designed around the Americas, Texas Instruments, NXP, Texas Both have had their supply chain issues. The European product is more around a different set of suppliers, And it's those differences. And the adaptability important here.

Speaker 2

Many of the newest Allegion products that drive battery efficiency, Wi Fi connectivity that makes us the leading products in the world are closer to the supply chain Challenges in the Americas than they are in Europe.

Speaker 3

Got you. Appreciate it. Thanks a lot, Dave.

Speaker 2

You're welcome, Andrew.

Operator

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

Speaker 7

Yes, thank you very much. My first question, I'm sorry to keep asking about price increases, but I'm going to ask one on that and one on a follow-up on a different subject. The first is on price increases. Can you say specifically how much you've increased prices? Asda has gone up about 15 Multiple in total this year.

Speaker 7

NAPCO's said 3% they've increased. What have you increased so far this year and what do you plan to increase on the year?

Speaker 4

I would say, again, you have to look across the different product sets. So it varies. If you're looking at all price increases, I. E. What we talked about, there's list price, there's surcharges, There's things related to freight.

Speaker 4

Those that have heavier steel related, I. E. Steel doors, those type of things, which carry a much higher Price increased realization than your traditional products locks and exits, closures, those type of things. So List prices for the year would be with both price increases north of 6% With more to come in the future.

Speaker 2

I think you also got to include the surcharges on top of that And this is a big ant. In our quote activities, we apply Discount schemes that give us the ability to raise price based on the project. So again, I We feel very good on our pricing analytics. There's that gap in the backlog that we may have quoted over a year ago. We honor those firm orders and they're delivered sometimes over the periods of years.

Speaker 2

And As we move into 'twenty two, we'll reassess this again and be early and aggressive to make sure that price Continues to cover our input cost as we've done since the creation of the company.

Speaker 7

Right. And then just as my follow-up real quick on OFA, just real quick, maybe Make a comment about their move with HHI and from Spectrum and how you anticipate competing on that. I know we've Spoken offline on that, but I want to just hear what you think how that's going to impact Allegion moving forward?

Speaker 2

So you never want to see your number one competitor and market leader get bigger. Rest assured that we also looked Hard at the QuickSet HHI assets over the years. And I think if you really step back And study the dimensions of QuickSet and how they performed under HHI, I believe also will actually A level of discipline to the market. It's certainly our great Schlage brand, the Kwikset Brands, there's plenty of room to compete and we've met this challenge, I think, Incredibly, over the last several decades, Schlage in terms of its electronic leadership, If you look at Consumer Reports Electronics that I think was published in April this year, 3 of the top 8 locks are ours. We're the number one replacement lock and it's going to be

Operator

The next question comes from Julian Mitchell with Barclays. Please go ahead.

Speaker 8

Hi, good morning. Maybe just a first question perhaps on the demand outlook, which hasn't really been touched on yet. I remember in that upcycle in U. S. Non res in sort of 'six, 'seven and 'eight, that upcycle in terms of projects Did suffer some headwinds because of cost inflation and labor led developers to delaying projects and so forth.

Speaker 8

And so you had these kind of rolling Push outs and delays. Just wondered what your perspectives are on the risks of that type of phenomenon recurring in the current environment when you're talking to developers looking at your quote activity and so forth.

Speaker 2

I'd say, each bust and boom cycle sets its own history. We're still living this aspect of it. But as I review the macro demand factors, Our backlogs and then recent travel, I would think I was in 5 states last week. The sentiment that I feel, see and living here every day at Allegion is I'm extremely positive. I think we've got 3 solid years ahead of us as I think about the Infrastructure needs and we have a housing economy that's significantly under inventory for single family homes, which Also as a generator for commercial and institutional development.

Speaker 2

So I packed that all Together and barring another disruption, I'd like to go ahead in terms of The business conditions are for construction and for Allegiant.

Speaker 8

I see. So you have not Seeing major projects being deferred or postponed?

Speaker 2

We track cancellations and I'd say it's at a normal level.

Speaker 8

That's helpful. And then just a quick follow-up, Trying to wrap together your comments on pricing, if you look at your sort of your operating income bridge, That line for inflation in excess of pricing and productivity, obviously, it's been negative for a couple of quarters now. When you look at the margins in the backlog and the pace of completion, should we assume that that line can go back to sort of breakeven sort of Q3 of next year. Is that the rough timeline?

Speaker 4

Yes, I would Q3 next year is positive. It is what I would anticipate basis of constant inflation relative to what we're seeing Today, in terms of no further increase year over year, but the delta, I. E. The gap Between price inflation improving up until that point. So the rate of change will get better

Speaker 2

Julien, I'd also add, as we as you and I think about that backlog, it's some of the highest margin products that we produce. Electronic locks and exit devices are elements, heavy elements of that backlog. The exit devices heavy complexity, which the supply chain pressures create some challenges in that, but Those supply chain pressures will improve. The mix of that will roll through. In addition to the price increases, I like Our opportunities going forward.

Speaker 8

Great. Thank you.

Operator

The next question comes from John Walsh with Credit Suisse. Please go ahead.

Speaker 9

Hi, good morning.

Speaker 10

Good morning,

Speaker 9

Maybe just to follow on Julian's last question there. If you look In your bridge, I know it's called volume and mix, but it was a headwind year over year, but you actually had Non residential declining less than residential in the Americas. So maybe it has to do with the mix Within non res and you talked about some of your higher margin products now growing backlog, but we'd just love to unpack that a little bit why the mix was Negative despite the non res growing better than residential, at least on a relative

Speaker 4

Yes. So you hit on it. It's really within the product portfolio of nonresidential products. As Dave indicated, High margin products being impacted more and that's kind of what we're seeing in the backlog due to shortages of components. And so it's really within the non residential business that you're seeing a mix element Given that non resi was higher than resi for the quarter.

Speaker 9

Great. And then I'm going to take a stab at this. I think earlier in the year, you kind of pointed international margins up low double digits. Obviously, you've seen really good progress there through the year. You've given us the midpoint of your guide, a lot of other information.

Speaker 9

It does seem like that implies the Q4 Americas margin kind of steps down more And seasonality would assume in Q4 and also just thinking about the decremental still being pretty challenged there. Any Color you can help us on how to think about that from the model perspective or I'll just Leave it there however you'd like to help us out with that sequential decline implied.

Speaker 4

Yes. So kind of we touched on a little bit earlier. It's Predominantly given the price inflation dynamics still under pressure. Some of the inefficiencies From a productivity standpoint, we'll continue given the component challenges, supply base. That's really You're going to see some decrements sequentially, but then as we kind of continue to move into 2022, You wouldn't see obviously that big of a change in the 1st part of the year and then improving certainly in the back half.

Speaker 10

Okay. Thank you. Appreciate it. Welcome.

Operator

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

Speaker 11

Yes. Good morning, everyone. Patrick, you've made Reference a couple of times now to the expectation that maybe inflation has peaked. And I guess I'm just interested in what gives you confidence That would be the case of you provisions in place through some of your procurement agreements that lock pricing now or hedges that are in place to give you the confidence to say that. But If you just elaborate on that, I'd appreciate it.

Speaker 4

So that's kind of the commentary was more around kind of our assumptions right now, I mean if there's continued pressure in the marketplace due to some of the component challenges, then That would certainly put pressure on our assumptions as we look forward to 2022. But if you kind of look at some of The forward forecasting information relative to steel and those type of things, the expectation is that as we go into next year, it starts to Alleviate itself and maybe trend down and that would be positive to what we're thinking today.

Speaker 11

Can you just remind us what how much of your business is locked up with annual contracts or supply agreements versus spot purchases?

Speaker 4

A small portion, it's mostly on raw steel. We kind of look forward and We've got some arrangements with some of our supply base that has fixed rate agreements. Those then kind of fluctuate basis on changes In the market on a forward basis and so it's small. A lot of our supply base is Indexed to steel, if you will. And so it's really just on the purchase of raw steel, which is a Small component relative to our overall purchasing.

Speaker 4

Thank you for that. And then just as a follow-up,

Speaker 11

Can you just talk about installation labor and the extent to which that may be a sort of frustration at this point or how you see that developing as a potential bottleneck

Speaker 2

Some broad comments on labor, and it's from General labor through the trades to professionals, labor is tight, Professional help on a worldwide basis. 2nd, when you look particularly at construction labor, The gap has grown. Skilled trades were a problem going into the pandemic. The problem has widened slightly and in my mind extends Cycle times for construction projects and snow plows, what I think are strong business conditions Well into the future.

Speaker 11

Would you consider at all investing in the development of that labor for the market As a means of just alleviating that constraint?

Speaker 2

We are investors. I will get off the phone here today and it's manufacturing month in the United States. Allegion Plays a very active role in promoting our industry leading culture, Diversity opportunities, tuition reimbursement programs, healthy lifestyle to attract people and I've done it since the creation of the company, number 1. Number 2, I think Manufacturing, I'm extremely proud, is a great place to develop talent And we will make investments in our wage structures to continue to keep Allegion as the best employer With wages and benefits in the communities we operate around the world.

Operator

Thanks, David. The next question comes from Tim Wojs with Baird. Please go ahead.

Speaker 10

Hey, guys. Good morning.

Speaker 2

Good morning, Tim.

Speaker 10

Maybe just dovetailing off of David's Question there, could you just when you think about the new non res cycle and how investors should kind of think about it, The leading indicators have obviously been really robust over the last 7 or 8 months. How would you think about Converting those cycle, it was kind of leading indicators into revenue for you guys. I mean, are those new construction projects that could contribute to you in the second Half of 'twenty two or do you think at this point it's probably more prudent to think 'twenty three?

Speaker 2

I think you've got to take the strong Cycle and as I look at the macro indicators that you did positive, got to lay on that backlog, Which will take the better part of 6, 7 months for us to eat through. And I think Extremely robust. I see education. I see healthcare. I think you've also I've always been concerned about commercial, Extremely positive in terms of the macro.

Speaker 2

There's lots of money on the sidelines to go reinvent this commercial real estate and The new office of the future, so as I look at education, healthcare, commercial, even multifamily is hung on longer. And I think investment is going to come in needed infrastructure. We could get an structure, Bill, so as I look at that, Tim, I like it for the next 3 to 5 years.

Speaker 10

Okay. Okay. And then maybe more of just a modeling question. So you guys outlined that the split on the deferred sales, I think it was kind of even between Q3 and Q4, but I think if you just kind of roll that into the model, I mean there's a bigger, I You're down double digits or that's the implication in the 4th quarter versus down maybe low single digits in Americas in Q3. So Any perspective there you can kind of add as to why that is?

Speaker 10

Is it just seasonality and comps?

Speaker 4

Yes. Seasonality, comps, The component shortages plus last year you may recall with the rebound in our residential business It was coming out of COVID. There was channel refill in the business, right? Restocking The shelves on retail and e commerce and so that certainly had a fairly significant impact on last year, so you're getting into a difficult comp As it relates to our residential business.

Speaker 10

Okay, got you. And that $80,000,000 to $100,000,000 of deferred revenue, I mean, how does that kind of come back next year. I mean, is it is there some sort of burst that kind of happens and you kind of convert that in 2022 or is it just kind of result in a little bit of a longer cycle?

Speaker 2

No, I think you need to think about it depending on the flow of components and labor, It's a tailwind as we roll through the year. And In a manufacturing environment, you can step up about 20% just by working Saturdays. You need to kind of think about it. If I go to Sundays, I get 40%. People don't work 7 days a week For 6 months, you got to think about it will step up.

Speaker 2

It's a tailwind barring If you get if we get improvement in components, both electronic and general components, we're going to see that as a Tailwind as we roll through the first half of next year and If the component situation in labor improves, we'll give out and gain more share.

Speaker 10

Okay. Okay, good. Well, good luck on the rest of the year, guys. Thanks for your time. Thank you.

Operator

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

Speaker 12

Hey, good morning, guys.

Speaker 2

Good morning.

Operator

And Dave, so electronics

Speaker 12

are 20 ish percent of the business, probably a little more than that now. That $80,000,000 to $100,000,000 that you talked about Does sound pretty biased to 4Q. And I guess what precipitates out of that is it's pretty high percentage of electronics. Like is that virtually electronics going to 0 or how should we think about the split of the headwind between the electrified product versus the mechanical product? I'd say 40%

Speaker 2

I'd say 40% electronics, 60% on mechanical. I'd also I think you've been in our factories here in Indianapolis. Complexity, when things are Hamenwright is our friend. We'll make 2,200 variations of the VonDuper and exit device today. And any one of those components in shortage, whether it's a casting, a wire harness, a power supply, an electronic board, Puts pressure on that supply chain and that's what we're living today and confident in our teams to work through it.

Speaker 2

Remember too, it's not necessarily my ability to put labor in the seat, it's also my supply chain. We pulled hard on redesign, shipping over 100 engineers To redesign predominantly boards, but other components. And the second thing I'd say is our flexibility, we've offered to put Our people in sites to help strengthen our supply chain vendors. I share that example just because the labor thing goes across transportation, supply chain, getting it through the And a level of complexity that I've maybe never seen in my 41 years.

Speaker 12

And then just thinking about the kind of the unwind of this current tightness, I think an earlier question asked about trade labor. Is that the biggest governor of how much the business can grow next year? Because it seems like you have the ingredients, the demand is there, maybe a bit more backlog than usual. Is it just How quick can we get installers both on new construction and retrofit? Is that sort of the KPI that we should be focused on?

Speaker 2

I think I would describe it, Josh, is there's pacing constraints in labor From the design phase, we just saw a record ABI through the installation phase. And I think projects will have longer lead times in an environment that's extremely positive in terms of the willingness to invest.

Operator

The next question comes from Chris Snyder with UBS. Please go ahead.

Speaker 10

Thank you.

Speaker 13

So my first question is on the deferred $80,000,000 to $100,000,000 of revenue. It seems like the majority of this is coming from the Americas. Previous commentary, I think, said that it could take 6 to 7 months to work through this Elevated backlog and I think the ability to ramp manufacturing 20% by working Saturdays, I think kind of suggests that this could be realized, this $80,000,000 to $100,000,000 in 2022. And obviously, I know there's some uncertainty around the ability to source components. But I guess is that reasonable to think that this could be realized next year because it's a pretty substantial kind of mid single digit tailwind to the Americas segment?

Speaker 2

As you think about 'twenty two, the backlog will be a tailwind constrained by availability of electronics. That tightness will run into 'twenty three and then the overall labor. We see I don't know if you ever it's an industrial game we call the beer game. Bottlenecks move. There's bottlenecks at the ports.

Speaker 2

There's bottlenecks And labor, these things are going to be moving throughout the year, but my fundamental belief is Allegiant has a superior ability to navigate, the nation and the world will navigate it and we'll see these things ease as we go through and it's a Tailwind to push that backlog through.

Speaker 13

Appreciate that. And then second question on resi. It Sounded like from the prepared remarks that there maybe was some demand softening in the quarter. I think you guys called out do it yourself or DIY slowdown. So I guess my question is, was this maybe the resi softness part of the second half revenue cut?

Speaker 13

And I guess is there any reason to think that this gets better in 2022 as it seems like that could be more demand related than supply chain related?

Speaker 2

So again, I want you to think about that demand game. The supply chains on res For all supplier, what was heavily disrupted in 2020. We were shut down for 15, 16 days. You had a demand search and this is very evident from the big box, Home Depot, Lowe's reports in terms Increased investments and do it yourself projects and then you had also housing picking up pretty rapidly. That Created a demand surge as we started coming out of the lockdowns, record backlog in residential, which we have worked through.

Speaker 2

So I look at overall demand for res as we move into 'twenty two as net positive based on continued starts of new Construction, solid repair and replacement and good multifamily. So That whip is going on the supply chain, make sure you think about that in your models because I think A year ago, I'm sitting here talking through record backlogs in residential. We worked through that. And I would suggest, If you look at our performance versus our competitors that we gained share throughout the last 8 quarters.

Speaker 10

Appreciate that. Thank you.

Operator

And the last questioner will be Ryan Merkel with William Blair. Please go ahead.

Speaker 6

Hey, everyone. Good morning.

Speaker 2

Good morning.

Speaker 7

So I wanted to follow-up on the timing of supply chain getting better. Is it fair to say that margins are bottoming in 2nd half of 'twenty one such that as we get into next year, you could see margins increase year over year or is that maybe more of a second half 'twenty two event?

Speaker 4

Probably more back end loaded, but feel very confident. If you kind of look at the moves we're making on price, Again, assuming inflation is peaked, I mean, that's still a question mark, right? But I feel very confident These type of things, we will have margin incremental improvement in 'twenty two compared to 'twenty one, no doubt in my mind.

Speaker 7

All right. That's helpful. And then just stepping back, maybe this question is for David, but can you discuss the adoption curve for Elektron? Is it faster now? And also how are your customers rethinking access control in this new environment?

Speaker 2

Electronic access, electronic locks, the power of your Edge device and its ability to Interact with secured access is a powerful trend that will positively influence this industry For the coming decades, the electronic adoption is what I would describe as High single digits. In normal times or pre pandemic, we've been able to deliver on that growth at mid or Low single digit or low double digit growth, so market growing high single digits. We're in a normalized time, Low double digits, so a clear trend. You can see it in your everyday life. The overall market still there's 40,000,000,000 openings in the world, less than ten

Operator

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

Speaker 2

Thanks for your questions today. I also want to thank our employees for their Continued commitment, steadfastness in navigating the challenges of the last 22 months. Some final messages. Allegion remains a lighthouse for our safety performance and our ESG Advancements. Demand in our business remains robust and leading indicators are positive.

Speaker 2

Supply chain constraints, labor availability and inflation are challenging. I'm confident in Allegion's Thank you for your time today. Have a safe day.

Operator

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

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