Allegion Q3 2021 Earnings Report

Allegion EPS Results

• Actual EPS: $1.56
• Consensus EPS: $1.29
• Beat/Miss: Beat by +$0.27
• One Year Ago EPS: $1.67

Allegion Revenue Results

• Actual Revenue: $717.00 million
• Expected Revenue: $703.29 million
• Beat/Miss: Beat by +$13.71 million
• YoY Revenue Growth: -1.60%

Allegion Announcement Details

• Quarter: Q3 2021
• Date: 10/20/2021
• Time: Before Market Opens
• Conference Call Date: Thursday, October 21, 2021
• Conference Call Time: 8:00AM ET

Allegion (NYSE:ALLE) (NYSE: ALLE) is a global provider of security products and solutions focused on ensuring the safety and security of people and property. The company was formed in December 2013 through a corporate spin-off from Ingersoll Rand and is head­quartered in Dublin, Ireland. Allegion’s core mission is to deliver innovative mechanical and electronic access control systems for a wide range of end markets, including commercial buildings, residential properties, institutional facilities, and industrial sites.

The company’s product portfolio spans mechanical locksets, door closers, exit devices, key systems and cylinders, as well as a growing suite of electronic and smart access control offerings. Allegion brands such as Schlage, LCN, Von Duprin and CISA deliver a comprehensive selection of hard­ware and software solutions designed to meet evolving security needs. The company invests in research and development to advance connected access platforms, mobile credentials and integrated building security management tools.

Allegion operates in more than 130 countries, organizing its business across three main geographic segments: the Americas; Europe, Middle East and Africa (EMEA); and Asia-Pacific. Its global footprint encompasses manufacturing facilities, research centers and distribution networks that support architects, contractors, security consultants and channel partners. Through its international presence, Allegion seeks to adapt product designs and services to local building codes, safety standards and customer requirements.

Since its inception, Allegion has built a leadership position in the security and access control industry by combining longstanding mechanical expertise with rapid expansion into electronic and digital solutions. The company continues to pursue strategic acquisitions and partnerships aimed at broadening its technology portfolio and extending its reach in new markets, while maintaining a focus on product quality, reliability and seamless user experience.

Allegion Q3 2021 Earnings Call Transcript

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.

Presentation

[Operator]

Good morning, and welcome to the Allegion Q3 2021 Earnings Call. All participants will be on listen-only mode. Should you need assistance please signal the conference specialist by pressing star then zero on your telephone keypad. After today's presentation there will be an opportunity to ask questions. To ask a question please press star then one on your telephone keypad. To withdraw your question press star then two. Please note this conference is being recorded. I would now like to turn the conference over to Tom Martineau, Vice President of Investor Relations and Treasurer. Please go ahead.

[Tom Martineau, VP of Investor Relations and Treasurer at Allegion]

Thank you, Andrew. Good morning, everyone. Thank you for joining us for Allegion's Q3 2021 Earnings Call. With me today are David 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 at investor.allegion.com. This call will be recorded and archived on our website. Please go to slides two and three. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections.

[Tom Martineau, VP of Investor Relations and Treasurer at Allegion]

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 discuss our Q3 2021 results, which will be followed by a Q&A session. Please, for the Q&A, we would like to ask each caller to limit themselves to one question and one short follow-up. We would like to give everyone an opportunity given the time allotted. Please go to slide four, and I'll turn the call over to Dave.

[David Petratis, Chairman, President, and CEO at Allegion]

Thanks, Tom. Good morning, and thank you for joining us today. Before we go into our Q3 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 two different awards, the Robert W. Campbell Award and the Jackson Lewis Diversity, Equity & Inclusion Champion Award. 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 in the business operating systems.

[David Petratis, Chairman, President, and CEO at Allegion]

Winners have strong processes and show measurable achievement over a five-year period in EH&S performance that leads to productivity and profitability, and are expected to demonstrate a long-term track record of not just EH&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 experts from around the world, followed by a meticulous audit format at three or more of a company's global sites. 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 & Johnson. Allegion 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 & Inclusion Champion by the Indiana Chamber of Commerce.

[David Petratis, Chairman, President, and CEO at Allegion]

This is a statewide honor that recognizes an organization making significant strides in the workplace. 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. We know there's more work to be done. We're not asking the people of Allegion to agree on everything. 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.

[David Petratis, Chairman, President, and CEO at Allegion]

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. We see this firsthand and external data points to it as well. Please go to slide five. During the quarter, we experienced continued strength in demand, particularly in the Americas non-residential 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 and is across all verticals and product categories.

[David Petratis, Chairman, President, and CEO at Allegion]

The recovery has been faster than we originally anticipated and is expected to continue in the foreseeable future. Residential end market demand is also favorable across both retail point of sale and new home construction. The strength in demand continues to constrain the global supply chain's ability to fully meet demand requirements. 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.

[David Petratis, Chairman, President, and CEO at Allegion]

We have redirected resources and are taking actions such as reconfiguring and redesigning products, as well as developing alternative sources of supply to help alleviate the pressures we are experiencing in procuring electronic components. Additionally, material and freight input costs continued to accelerate during Q3. We now anticipate material and freight inflation to be approximately $60 million 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. Once again, these issues are not Allegion specific, and we expect the global constraints driving these shortages to continue beyond 2021. These challenges led to margin deterioration in the quarter.

[David Petratis, Chairman, President, and CEO at Allegion]

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 4x normal levels. We estimate that widespread shortages have delayed approximately $80 million-$100 million of 2021 revenue. We believe this impact is evenly distributed across the third and fourth quarter. 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 Q3 performance. For more details, please go to slide six. Revenue for Q3 was $717 million, 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.

[David Petratis, Chairman, President, and CEO at Allegion]

Currency tailwind and acquisitions offset the impact of divestitures. Patrick will share more details on the regions in a moment. Adjusted operating margins decreased by 330 basis points in Q3. 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% versus the prior year. The decrease was driven by reduced operating income, offset by a favorable tax rate and share count. Year-to-date available cash flow came in at $327.7 million, an increase of $71.6 million or 28% versus the prior year. The increased cash flow was driven by higher year-to-date net earnings, along with improvement in net working capital and reduced capital expenditures.

[David Petratis, Chairman, President, and CEO at Allegion]

Patrick will now take you through the financial results, and I'll be back later to discuss our 2021 outlook and wrap up.

[Patrick Shannon, SVP and CFO at Allegion]

Thanks, David, good morning, everyone. Thank you for joining today's call. Please go to slide number seven. This slide reflects our earnings per share reconciliation for Q3. For Q3 of 2020, reported earnings per share was $1.58. Adjusting $0.09 for charges related to restructuring and impairment, the 2020 adjusted earnings per share was $1.67. Favorable tax rate drove a $0.13 increase in earnings per share. The negative tax rate for 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. Acquisitions and divestitures had a positive $0.02 per share impact.

[Patrick Shannon, SVP and CFO at Allegion]

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&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 $1.56, a decrease of $0.11 or 6.6% compared to the prior year. 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.

[Patrick Shannon, SVP and CFO at Allegion]

After giving effect to these items, you arrive at the Q3 2021 reported earnings per share of $1.59. Please go to slide number eight. This slide depicts the components of our revenue performance for 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 Q3. The electronics components and labor shortages, primarily in the Americas region, had an impact on our ability to meet the continued strong demand. 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 nine.

[Patrick Shannon, SVP and CFO at Allegion]

Q3 revenues for the Allegion Americas segment were $524.4 million, down 2.7% on a reported basis and 3% organically. As previously stated, the supply chain pressures we are experiencing drove the revenue decline. 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, we expect the price realization to accelerate in the future. On volume, Americas non-residential was down low single digits, driven by the electronics components and labor shortages. Americas residential was down high single digits. This was uniquely driven by the prior year being inflated by channel refill coming out of the pandemic shutdowns experienced in Q2 of 2020.

[Patrick Shannon, SVP and CFO at Allegion]

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 integral to our investment and innovation efforts. Americas adjusted operating income of $133.7 million decreased 19.7% versus the prior year period, and adjusted operating margin for the quarter was down 540 basis points. The decrease was driven by higher material and freight costs, productivity challenges related to inconsistent supply, and volume deleverage. Incremental investments had 100 basis point dilutive impact on adjusted margins. Please go to slide number 10. The Allegion International segment delivered another solid quarter. Q3 revenues were $192.6 million, up 1.7%, and up 2.5% on an organic basis.

[Patrick Shannon, SVP and CFO at Allegion]

We continue to see strength in our SimonsVoss, Interflex, and global portable security businesses, which along with good price realization, drove the organic revenue growth. Favorable currency and acquisition impacts also contributed to total revenue growth and were slightly offset by divestitures. International adjusted operating income of $21.3 million increased 4.9% versus the prior year period. 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. Year-to-date available cash flow for Q3 2021 came in at $327.7 million, which is an increase of $71.6 million compared to the prior year period.

[Patrick Shannon, SVP and CFO at Allegion]

The increase is attributed to higher year-to-date earnings, improvements in net working capital, and reduced 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 four-point quarter average. The business continues to manage working capital efficiently and generates strong cash flow. I will now hand it back over to Dave for some comments on our full year 2021 outlook.

[David Petratis, Chairman, President, and CEO at Allegion]

Thank you, Patrick. Please go to slide number 12. On October 1st, we issued a pre-release to our earnings and updated our 2021 full year outlook for revenue, EPS, and available cash flow. We are reaffirming those updated outlooks. We have talked at length about the demand strength in the Allegion 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 million-$100 million of revenue. The outlook for total revenue in the Allegion Americas is now projected to be at 1%-1.5%, with organic revenue growth at 0.5%-1%.

[David Petratis, Chairman, President, and CEO at Allegion]

In the Allegion International segment, we have not seen as large of an impact from component and labor shortages, and 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%-4.5%, and organic revenue is expected to increase 3%-3.5%. We are expecting reported EPS to come in the range of $4.95-$5.05 per share, and adjusted EPS to be between $5-$5.10. Our outlook for available cash flow is projected to be $460 million-$480 million. The outlook assumes investment spend of approximately $0.15-$0.20 per share. The full year adjusted effective tax rate is expected to be approximately 9%.

[David Petratis, Chairman, President, and CEO at Allegion]

The outlook for outstanding diluted shares is approximately 90.5 million. Please go to slide number 13. As we close the presentation and move on to Q&A, I want to take some time to stress Allegion's strong long-term fundamentals. First, even with the disruption caused by the global pandemic, our strategy around seamless access and electronic transformation remains strong. We expect electronic and seamless access solutions to be the future of access control, and we are using multiple innovation engines to lead the industry. 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 mega tech and leading access control platforms. We are making significant progress on our ESG journey. This is evident with the two awards that we received earlier this month.

[David Petratis, Chairman, President, and CEO at Allegion]

The Campbell Award given by the National Safety Council is a very prestigious honor, and we join an elite group of previous winners. I'm also proud of the Jackson Lewis Diversity, Equity & Inclusion Champion Award, which we received from the Indiana Chamber, which recognizes our proactive leadership in diversity, equity and inclusion. Congratulations to the Allegion team. All markets in America remain robust. We continue to see positive trends from leading indicators like ABI and the Dodge Momentum Index, and expect these trends to continue into 2022. 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 to 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.

[David Petratis, Chairman, President, and CEO at Allegion]

Allegion'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. We have implemented pricing actions that will carry forward into next year and there's substantial backlog to work down. 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. To ask a question you may press star then one on your telephone keypad. If you are using a speakerphone please pick up your handset before pressing your keys. If at any time your question has been addressed and you would like to withdraw your question please press star then two. Again, please limit yourself to one question and one brief follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Joseph O'Dea with Wells Fargo. Please go ahead.

[Joseph O'Dea, Analyst at Wells Fargo]

Hi, good morning, everyone.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning, Joe.

[Joseph O'Dea, Analyst at Wells Fargo]

First question is just related to any visibility you have around the timing of relief from supply chain constraints. You've talked about this extending into 2022, are you seeing anything out there based on conversations with your suppliers that gives you confidence in when you start to see some relief?

[David Petratis, Chairman, President, and CEO at Allegion]

My first observation, your past record sometimes is a predictor. Allegion performed extremely well through the first phases of this pandemic. Number two 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. Feel very good about the performance and the adaptability flexibility. It's clear the electronics is going to be a problem that all companies, including Allegion, will have to adapt to through 2022. An important element of the rest, and it's the complexity of the Allegion supply chain, is the return of labor pressures to our partner suppliers.

[David Petratis, Chairman, President, and CEO at Allegion]

We'll have to continue to monitor. This is everything from castings to power supplies to wire harnesses. There's a labor scarcity across the globe, and again, I believe our ability to adapt and our philosophy to produce in region will help Allegion.

[Joseph O'Dea, Analyst at Wells Fargo]

Then related to backlog and catch up, and you made the comment about backlog being 4x higher than normal, how do you think about managing that? 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 strained production system? You think about managing that and maybe it takes longer to deliver over time, but not straining the production system in that process?

[David Petratis, Chairman, President, and CEO at Allegion]

We've got a lot of experience in production systems, including the man that runs the company, me, 41 years. I like the backlog. I think if component supplies, if that regains health, we will actually pick up efficiencies. There's been gross inefficiencies through COVID, these supply chains. An important element is our ability to bring on and flex our own labor, and I've got high confidence in our ability to do that.

[Joseph O'Dea, Analyst at Wells Fargo]

Great. Thank you.

[Operator]

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

[Joe Ritchie, Analyst at Goldman Sachs]

Thanks. Good morning, everybody.

[David Petratis, Chairman, President, and CEO at Allegion]

Morning, Joe.

[Joe Ritchie, Analyst at Goldman Sachs]

Yes, you guys talk about clearly lots of challenges in the marketplace today. I know that as you kind of think about the Americas margins being down 500 to 600 basis points year-over-year, you had investments of about 100 basis points impacting the margin. Can you maybe parse that out a little bit more for us? 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? Just any other additional color around that would be helpful.

[Patrick Shannon, SVP and CFO at Allegion]

Joe, the significant portion of the margin degradation year-over-year is predominantly inflation and freight costs. We've got productivity challenges associated with some of the component shortages and those type of things, creating inefficiencies at our facilities. If you think about it relative to normally, we've done a 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. 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 increases coming through and offsetting the incremental inflation until going into 2022.

[Patrick Shannon, SVP and CFO at Allegion]

We're still going to be under pressure for the balance of the year. Inflation really accelerated, particularly when you look year-over-year on steel components and those type of things. It's one of these short-term phenomena. If you assume that inflation has kind of peaked today, going into 2022, things will kind of continue to get better, we would expect to be in the positive end of the equation as we progress throughout 2022.

[Joe Ritchie, Analyst at Goldman Sachs]

Got it. That's helpful, Patrick. Maybe just kind of following on there, so it sounds like you're going to be underwater again in Q4. As you think about the pricing that you're putting through, do you typically include a fuel surcharge? Or is this kind of like stickier pricing that you expect to get in the 2022 timeframe? 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 second quarter versus Q3. Curious, any comments around why pricing was a little bit weaker in Q3 versus Q2?

[Patrick Shannon, SVP and CFO at Allegion]

On your first question, 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. Mostly across the product portfolio is through list price increases, is kind of how we manage it. It's more permanent in nature. The year-over-year delta, you kind of have to look at it again by product category. A little pressure in some of the discounts, residential, for example, a little bit harder to kind of pass through the price increases. 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.

[David Petratis, Chairman, President, and CEO at Allegion]

I'd add to this. Our hollow metal business list price increases and surcharges. On the general hardware business, two price increases in the year, and we'll adapt to the pressures as we go into 2022, and certainly going hard at the residential products as well. My message here would be in addition to freight surcharges, we're pulling all levers on price realization. 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 2022.

[Joe Ritchie, Analyst at Goldman Sachs]

Thank you. That's helpful.

[Operator]

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

[Andrew Obin, Analyst at Bank of America]

Yeah. Hi, guys. Good morning.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning, Andrew.

[Andrew Obin, Analyst at Bank of America]

Yeah. 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 distributors to market. 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. The industry structure seems to be quite favorable. Why is it so hard to get a price increase through, or who is being aggressive? Particularly, you seem to highlight residential. Is one player being aggressive? Are people out of Asia being aggressive? Which is surprising because I would've expected they would have difficulties getting stuff on the boat.

[Andrew Obin, Analyst at Bank of America]

Just maybe a little bit more color there. Thank you.

[David Petratis, Chairman, President, and CEO at Allegion]

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 first six months of a construction project. We submit our quotes, get orders at the same time, 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. We eat that inflationary pressure. The cycle for the electrical industry is much faster than ours. We've been aggressive on the price increases as well as surcharges, 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, I hope that color maybe helps you understand leading products, the electrical, versus lagging products on the hardware side.

[Patrick Shannon, SVP and CFO at Allegion]

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. You will begin to see sequential improvement beginning Q4 relative to the price increases we put in the market, and that will continue to accelerate into 2022 year-over-year and sequentially.

[Andrew Obin, Analyst at Bank of America]

In 2022, you'll get some of the benefit of these 2021 price increases. You'll get it, but later.

[Patrick Shannon, SVP and CFO at Allegion]

Yep.

[Andrew Obin, Analyst at Bank of America]

Got you. Just a follow-up question. The difference in performance between North America, and I guess international, which I sort of think mostly Europe. As I think about your brands, Interflex, I guess it is mostly software, but it does have electronic components. If I think about, I guess, CISA is the one that's purely mechanical, but then SimonsVoss, which you highlighted, also has large electronic component. Why are you able to avoid the kind of disruption related to electronic components and labor in Europe that you experience in the U.S. because I would imagine, the electronic components in Europe are also getting sourced in Asia. Thank you.

[David Petratis, Chairman, President, and CEO at Allegion]

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

[Andrew Obin, Analyst at Bank of America]

Got you. I appreciate it. Thanks a lot, Dave.

[David Petratis, Chairman, President, and CEO at Allegion]

You're welcome, Andrew.

[Operator]

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

[Brian Ruttenbur, Analyst at Imperial Capital]

Yes. Thank you very much. My first question, I'm sorry to keep asking about price increases, 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? ASSA has gone up about 15% in total this year. NAPCO's said that 3% they've increased. What have you increased so far this year, and what do you plan to increase on the year?

[Patrick Shannon, SVP and CFO at Allegion]

I would say, again, you have to look across the different product sets. 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. Those that have heavier steel related, i.e., steel doors, those type of things, would carry a much higher price increase realization than your traditional products, locks and exits, closers, those type of things. List prices for the year would be with both price increases, north of 6%, with more to come in the future.

[David Petratis, Chairman, President, and CEO at Allegion]

I think you also got to include the surcharges on top of that. This is a big and, in our quote activities, we apply discount schemes that give us the ability to raise price based on the project. Again, I 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. As we move into 2022, 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.

[Brian Ruttenbur, Analyst at Imperial Capital]

Right. Just as my follow-up real quick, on ASSA, just real quick, maybe make a comment about their move with HHI 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.

[David Petratis, Chairman, President, and CEO at Allegion]

You never want to see your number one competitor and market leader get bigger. Rest assured that we also looked hard at the Kwikset HHI assets over the years. I think, if you really step back and study the dimensions of Kwikset and how they performed under HHI, I believe ASSA will actually bring 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, credibly 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 of this year, three of the top eight locks are ours. We're the number one replacement lock, and it's going to be continued competition against two world leaders.

[Brian Ruttenbur, Analyst at Imperial Capital]

Thank you.

[Operator]

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

[Julian Mitchell, Analyst at Barclays]

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 2006, 2007, and 2008, that upcycle, in terms of projects, did suffer some headwinds because of cost inflation and labor, led developers to delaying projects and so forth. 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.

[David Petratis, Chairman, President, and CEO at Allegion]

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 think I was in five 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 three solid years ahead of us as I think about the strategic planning period, working through the supply chain issues. I think there's key infrastructure needs, and we have a housing economy that's significantly under inventory for single family homes, which also is a generator for commercial and institutional development. I packed that all together, and barring another disruption, I like to go ahead in terms of the business conditions for construction and for Allegion.

[Julian Mitchell, Analyst at Barclays]

I see. You have not seen major projects being deferred or postponed?

[David Petratis, Chairman, President, and CEO at Allegion]

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

[Julian Mitchell, Analyst at Barclays]

That's helpful. Then just a quick follow-up, trying to wrap together your comments on pricing. If you look at 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 break even sort of Q3 of next year? Is that the rough timeline?

[Patrick Shannon, SVP and CFO at Allegion]

Yeah. I would, Q3 next year, positive, 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. The delta, i.e., the gap, between price inflation improving up until that point, the rate of change will get better as we progress.

[David Petratis, Chairman, President, and CEO at Allegion]

Julian, I'd also add, 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 heavy elements of that backlog. The exit devices, heavy complexity, which the supply chain pressures create some challenges in that. 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.

[Julian Mitchell, Analyst at Barclays]

Great. Thank you.

[Operator]

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

[John Walsh, Analyst at Credit Suisse]

Hi. Good morning.

[Patrick Shannon, SVP and CFO at Allegion]

Good morning.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning.

[John Walsh, Analyst at Credit Suisse]

Hi. 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. Maybe it has to do with the mix within non-residential, and you talked about some of your higher margin products now growing backlog. Would just love to unpack that a little bit, why the mix was negative despite the non-residential growing better than residential, at least on a relative basis.

[Patrick Shannon, SVP and CFO at Allegion]

Yeah. You hit on it. It's really within the product portfolio of non-residential 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. It's really within the non-residential business that you're seeing a mix element, given that non-residential was higher than residential for the quarter.

[John Walsh, Analyst at Credit Suisse]

Great. 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. You've seen really good progress there through the year. You've given us the midpoint of your guide, a lot of other information. It does seem like that implies that Q4 Americas margin kind of steps down more than 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?

[Patrick Shannon, SVP and CFO at Allegion]

Yeah. Kind of we touched on it a little bit earlier. It's predominantly given the price inflation dynamics still under pressure. Some of the inefficiencies from a productivity standpoint will continue given the component challenges, supply base. You're going to see some decrements sequentially. As we kind of continue to move into 2022, you wouldn't see, obviously, that big of a change in the first part of the year and then improving certainly in H2.

[John Walsh, Analyst at Credit Suisse]

Okay. Thank you. Appreciate it.

[Patrick Shannon, SVP and CFO at Allegion]

Welcome.

[Operator]

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

[David MacGregor, Analyst at Longbow Research]

Yes. Good morning, everyone.

[Patrick Shannon, SVP and CFO at Allegion]

Good morning.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning.

[David MacGregor, Analyst at Longbow Research]

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 that would be the case. Have you provisions in place through some of your procurement agreements that lock pricing now or hedges that are in place that give you the confidence to say that? If you could just elaborate on that side a bit, I'd appreciate it.

[Patrick Shannon, SVP and CFO at Allegion]

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. 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.

[David MacGregor, Analyst at Longbow Research]

Can you just remind us how much of your business is locked up with annual contracts or supply agreements versus spot purchases? Anything you can elaborate on there would be helpful.

[Patrick Shannon, SVP and CFO at Allegion]

A small portion. It's mostly on raw steel.

[David Petratis, Chairman, President, and CEO at Allegion]

We look forward, and we've got some arrangements with some of our supply base that has fixed rate agreements. Those fluctuate based on changes in the market on a forward basis. It's small. A lot of our supply base is indexed to steel, if you will. It's really just on the purchase of raw steel, which is a small component relative to our overall purchasing.

[David MacGregor, Analyst at Longbow Research]

Thank you for that. Just as a follow-up, 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 or impediment in 2022?

[David Petratis, Chairman, President, and CEO at Allegion]

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. Second, 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. In my mind, extends cycle times for construction projects and what I think are strong business conditions well into the future.

[David MacGregor, Analyst at Longbow Research]

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

[David Petratis, Chairman, President, and CEO at Allegion]

We are investors. I will get off the phone here today. 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 have done it since the creation of the company, number one. Number two, I think manufacturing, I'm extremely proud, it is a great place to develop talent. 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.

[David MacGregor, Analyst at Longbow Research]

Thanks, David.

[Operator]

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

[Tim Wojs, Analyst at Baird]

Hey, guys. Good morning.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning, Tim.

[Tim Wojs, Analyst at Baird]

Maybe just dovetailing off of David's question there. When you think about the new non-residential cycle and how investors should think about it, the leading indicators have obviously been really robust over the last seven or eight months. How would you think about converting those leading indicators into revenue for you guys? Are those new construction projects that could contribute to you in the H2 of 2022, or do you think at this point it's probably more prudent to think 2023?

[David Petratis, Chairman, President, and CEO at Allegion]

I think you've got to take the strong cycle. I look at the macro indicators that you did positive, got to lay on that backlog, which will take the better part of six, seven months for us to eat through. I think extremely robust. I see education, I see healthcare. I've always been concerned about commercial. Extremely positive in terms of the macro. There's lots of money on the sidelines to go reinvent this commercial real estate and the new office of the future. As I look at education, healthcare, commercial, even multifamily has hung in longer. I think investment is going to come in needed infrastructure. We could get an infrastructure bill. As I look at that, Tim, I like it for the next three to five years.

[Tim Wojs, Analyst at Baird]

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

[David Petratis, Chairman, President, and CEO at Allegion]

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?

[Tim Wojs, Analyst at Baird]

Yep.

[David Petratis, Chairman, President, and CEO at Allegion]

Restocking the shelves on retail and e-commerce. That certainly had a fairly significant impact on last year. You're getting into a difficult comp as it relates to our residential business.

[Tim Wojs, Analyst at Baird]

Okay, gotcha. That $80 million-$100 million of deferred revenue, how does that come back next year? Is there some sort of burst that happens and you convert that in 2022, or is it just result in a little bit of a longer cycle?

[David Petratis, Chairman, President, and CEO at Allegion]

No, I think you need to think about it. The flow of components and labor, it's a tailwind as we roll through the year. In a manufacturing environment, you can step up about 20%, just by working Saturdays. You need to think about it. If I go to Sundays, I get 40%. People don't work seven days a week for six months. You got to think about it. It will step up. It's a tailwind. If we get improvement in components, both electronic and general components, we're going to see that as a tailwind as we roll through H1 of next year. If the component situation and labor improves, work about and gain more share.

[Tim Wojs, Analyst at Baird]

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

[David Petratis, Chairman, President, and CEO at Allegion]

Thank you.

[Operator]

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

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Hey, good morning, guys.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Dave, electronics are 20%-ish of the business, probably a little more than that now. That $80 million-$100 million that you talked about does sound pretty biased to Q4, and I guess what precipitates out of that is it's pretty high percentage of electronics. Is that virtually electronics going to zero? Or how should we think about the split of that headwind between the electrified product versus the mechanical product?

[David Petratis, Chairman, President, and CEO at Allegion]

I'd say 40% electronics, 60% mechanical. I think you've been in our factories here in Indianapolis. Complexity when things are humming right is our friend. We'll make 2,200 variations of the Von Duprin 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. 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, shifting over 100 engineers to redesign predominantly boards, but other components. 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.

[David Petratis, Chairman, President, and CEO at Allegion]

I share that example just because the labor thing goes across transportation, supply chain, getting it through the ports, and a level of complexity that I've maybe never seen in my 41 years.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Just thinking about 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? 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?

[David Petratis, Chairman, President, and CEO at Allegion]

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. I think projects will have longer lead times in an environment that's extremely positive in terms of the willingness to invest.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Got it. Thanks, David. Good luck, guys.

[David Petratis, Chairman, President, and CEO at Allegion]

You're welcome.

[Operator]

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

[Chris Snyder, Analyst at UBS]

Thank you. My first question's on the deferred $80 million-$100 million of revenue. Seems like the majority of this is coming from the Americas. Previous commentary, I think, said that it could take six to seven 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 million-$100 million in 2022. Obviously, I know there's some uncertainty around the ability to source components. 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 American segment.

[David Petratis, Chairman, President, and CEO at Allegion]

As you think about 2022, the backlog will be a tailwind. Constrained by availability of electronics, that tightness will run into 2023. The overall labor. 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, there's bottlenecks in labor. These things are going to be moving throughout the year. My fundamental belief is Allegion 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.

[Chris Snyder, Analyst at UBS]

I appreciate that. Then, second question on residential. 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. I guess my question is. Was this maybe the residential softness part of the H2 revenue cut? 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?

[David Petratis, Chairman, President, and CEO at Allegion]

Again, I want you to think about that demand game. The supply chains on res for all suppliers was heavily disrupted in 2020. We were shut down for 15, 16 days. You had a demand surge, and this is very evident from the big box Home Depot, Lowe's reports in terms of increased investments in do it yourself projects. 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. I look at overall demand for res as we move into 2022 as net positive based on continued starts of new construction, solid repair and replacement, and good multifamily.

[David Petratis, Chairman, President, and CEO at Allegion]

That whip that's 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 eight quarters.

[Chris Snyder, Analyst at UBS]

Appreciate that. Thank you.

[Operator]

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

[Ryan Merkel, Analyst at William Blair]

Hey, everyone. Good morning.

[David Petratis, Chairman, President, and CEO at Allegion]

Good morning.

[Ryan Merkel, Analyst at William Blair]

I wanted to follow up on the timing of supply chain getting better. Is it fair to say that margins are bottoming in the H2 of 2021, such that as we get into next year, you could see margins increase year-over-year? Is that maybe more of a H2 2022 event?

[Patrick Shannon, SVP and CFO at Allegion]

Probably more back-end loaded, feel very confident. If you look at the moves we're making on price, again, assuming inflation has peaked, I mean, that's still a question mark, right? I feel very confident relative to pushing through the backlog, getting some efficiencies at our factory productivity, these type of things. We will have margin incremental improvement in 2022 compared to 2021. No doubt in my mind.

[Ryan Merkel, Analyst at William Blair]

All right. That's helpful. Just stepping back, maybe this is a question for David, can you discuss the adoption curve for electronic? Is it faster now? How are your customers rethinking access control in this new environment?

[David Petratis, Chairman, President, and CEO at Allegion]

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 low double-digit growth. Market growing high single digits. We're, in a normalized time, low double digits. A clear trend. You can see it in your everyday life. The overall market still, there's 40 billion openings in the world. Less than 10% of those integrated, bright for our industry and bright for Allegion.

[Ryan Merkel, Analyst at William Blair]

Thank you.

[Operator]

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

[David Petratis, Chairman, President, and CEO at Allegion]

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. Supply chain constraints, labor availability, and inflation are challenging. I'm confident in Allegion's supply capability and adaptability to be strong, and the long-term fundamentals of Allegion remains bright and strong. 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.

Participants

Executives

• David Petratis, Chairman, President, and CEO
• Patrick Shannon, SVP and CFO
• Tom Martineau, VP of Investor Relations and Treasurer

Analysts

• Andrew Obin, Analyst at Bank of America
• Brian Ruttenbur, Analyst at Imperial Capital
• Chris Snyder, Analyst at UBS
• David MacGregor, Analyst at Longbow Research
• Joe Ritchie, Analyst at Goldman Sachs
• John Walsh, Analyst at Credit Suisse
• Joseph O'Dea, Analyst at Wells Fargo
• Josh Pokrzywinski, Analyst at Morgan Stanley
• Julian Mitchell, Analyst at Barclays
• Ryan Merkel, Analyst at William Blair
• Tim Wojs, Analyst at Baird