Allegion Q3 2022 Earnings Call Transcript

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Provided by Quartr
October 28, 2022

There are 10 speakers on the call.

Operator

Good morning, and welcome to the Alrigin Q3 2022 Earnings Conference 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 like to turn the conference over to Tom Martineau, Vice President of Investor Relations and Treasurer. Please go ahead.

Speaker 1

Thank you, Francesca. Good morning, everyone. Thank you for joining us for Allegion's Q3 2022 earnings call. With me today are John Stone, President and Chief Executive Officer and Mike Wagges, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning, which we will refer to in today's call are available on our website at investor.

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 And commentary include non GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details.

Speaker 1

John and Mike will now discuss our Q3 2022 results, which will be followed by a Q and A session. Please for the Q and A, we would like to Each caller to limit themselves to one question and one short follow-up and then reenter the queue. We would like to give everyone an opportunity given The time allotted. Please go to Slide 4, and I'll turn the call over to John.

Speaker 2

Thanks, Tom. Good morning, and thank you all for joining us today. Allegion delivered a very strong Q3. And as we look at the market dynamics, we continue to see strength in the Americas nonresidential sector. Leading indicators for that business like the ABI and AIA consensus are positive and continue to be an expansionary territory, particularly for institutional verticals.

Speaker 2

On the Americas residential side, our business grew nicely in the quarter, but we are seeing signs of a Certainly new construction is impacted by rising mortgage rates and retail point of sale for our We continue to see strength in demand for our electronics and software solutions. Allegion delivered record revenue during the 3rd This is due to the hard work and dedication of our team as we've made significant progress on product redesign and other supply Improvements that are driving strong operational performance across the company. Top line revenue was also aided by robust price realization in Supply Chain. Backlogs in electronics are still elevated as demand for those products has remained strong. At the beginning of the year, we underscored our commitment to aggressively pursue price across all products and in all channels.

Speaker 2

The result This effort is evident in the quarterly results. While we continue to experience inflationary headwinds, our price to assess the need for future price increases. Lastly, the currency pressures impacting our international businesses persist. The reported revenues in the 3rd quarter reflect $26,000,000 of pressure related to foreign exchange rates. Please go to Slide 5.

Speaker 2

At the beginning of the quarter, on July 5, in fact, we officially welcomed the Access Technologies business into the Allegion family. Together, we will deliver long term value for customers, shareholders and employees alike, and we're already moving in that direction. The operational performance of the business was in line with the expectations shared with you in last quarter's earnings call, and our teams are getting well aligned on culture, vision and strategy. Just as important, our early work together affirms that Access Technologies and Allegion are a great combination. We have unique Opportunities to accelerate our seamless access strategy with innovation that will create new value around doors and entrances.

Speaker 2

This is where I get to say a picture says a 1,000 words and we now have a well established recurring service business that positions us to meet new customer needs as devices become more connected and technology advances. And we have an expanded portfolio of products that fills gaps, complements our business and takes full advantage of our demand generation specification engine in the Americas. Bottom line, Access Technologies is a Strong business. It's another category market leader for Allegion. We're off to a great start and excited about the opportunities ahead.

Speaker 2

Now let's turn to Slide 6 and take a look at the quarter performance for more details. Revenue for the Q3 was $914,000,000 an increase of 27.4% compared to last year. Organic revenue growth was 18.6%, attributed to both significant price realization worldwide and strong volume growth in the Americas. The Access Technologies acquisition contributed approximately 12% to the total growth number and currency impacts remain a significant headwind. Mike will share more details on the segment reporting in a moment.

Speaker 2

Adjusted operating margin and adjusted EBITDA Margins increased by 100 basis points each in the 3rd quarter. The increase was driven by volume leverage in the Americas as well as Price and productivity exceeding inflation. These more than offset the margin dilution related to Access Technologies. Excluding the Access Technologies business, adjusted operating income margins were up 2 40 basis points. Adjusted EPS of $1.64 increased $0.08 or approximately 5% versus the prior year.

Speaker 2

Robust Mike will now walk you through the financials, and I'll be back later to discuss our 2022 outlook. Thanks, John, and good morning, everyone. You for joining today's call. Please go to Slide number 7. This slide reflects our earnings per share reconciliation for the Q3.

Speaker 2

For the Q3 of 2021, reported earnings per share was $1.59 and adjusted earnings per share was 1.56 Operational results were very strong in the quarter, adding $0.49 per share, reflecting 31.4% growth. This was driven by strong pricing, volume and operational execution, which more than offset significant inflationary and currency pressures. Access Technologies delivered $0.06 to earnings per share as operational results of $0.10 per share offset $0.04 of intangible amortization. The operational results were as expected and amortization was favorable. A year over year tax rate reduced earnings by $0.28 per share.

Speaker 2

This decline was driven by Tax benefits in 2021 that were non recurring. As anticipated, interest expense was a $0.12 per share drag on earnings, primarily driven by increased debt to finance the acquisition of Access Technologies. Other income was an $0.08 per share reduction as the prior year had some favorable items that did not repeat in 2022. Favorable share count offset the impact of investment spending in the quarter. This results in adjusted Q3 2022 earnings per share of 1 point $0.64 an increase of $0.08 or 5.1 percent compared to the prior year.

Speaker 2

Lastly, we have a $0.34 per share reduction from adjusted EPS to arrive at reported EPS. This reduction is attributable to of $1.30 Please go to Slide number 8. This slide depicts the components of our revenue performance for the quarter. I'll focus on total Allegion results and cover the regions on their respective slides. As indicated, we experienced a robust Residential and Residential led the volume growth.

Speaker 2

Net acquisition and divestitures delivered 12.4% growth, driven by Access Technologies. Currency pressures continue to be a significant headwind, primarily impacting our international segment, bringing the total reported growth to 27.4% in the quarter. Please go to Slide number 9. 3rd quarter revenues for the Americas segment was 747,200,000, up 42.5% on a reported basis up 25.8 percent organically. The segment delivered significant price realization in both our nonresidential and residential businesses as we remain committed to addressing inflation.

Speaker 2

Aided by substantial price and strong volume, nonresidential grew approximately 30% in the quarter. Residential was up mid teens, also driven by both price and volume. A portion of our growth was fueled by backlog reductions as the actions our team undertook helped us improve component availability and shipments in the quarter. Electronics revenue was up approximately 30% and was a significant improvement from the growth rates experienced the past few quarters. This was supported by continued strength in demand and the timing of component availability.

Speaker 2

While it is important to note that Access Technologies contributed mid teens percent to the Americas reported number reported growth numbers. Americas adjusted operating margins and adjusted EBITDA margins for the quarter were up 50 basis points and 80 basis points respectively. This includes Access Technologies, which we previously stated would be dilutive to margins. Excluding Access Technologies, the business drove a 300 basis point improvement in operating margins versus the prior year. Volume leverage contributed to the margin increase and for the quarter price Productivity inflation dynamic was positive both on dollars and margins.

Speaker 2

Please go to Slide number 10. 3rd quarter revenue for our Allegion International segment was $166,500,000 down 13.6% on a reported basis and down 0.8 percent organically. In the quarter, strong price realization mostly offset lower volumes. Lower volumes are attributable to end market softening. However, demand 3rd quarter international adjusted operating margins decreased 180 basis reduced volume and FX pressures, which more than offset favorable impacts of the combination of price productivity and inflation.

Speaker 2

Please go to slide number 11. Year to date available cash flow is 225.6 which is a decrease of more than $102,000,000 compared to the prior year period. This year's available cash flow continues to be in line with 3 pandemic levels. We continue to operate with a strong debt structure with 80% of our debt having fixed interest rates. We We have a strong leverage profile with our net debt to EBITDA ratio at 2.9 times at the end of the quarter.

Speaker 2

We still plan to use the excess cash generated during the remainder of the year to pay down the revolver. This would be after paying The 2022 full year available cash Well, outlook is unchanged from our prior outlook, remaining at a range of $420,000,000 to $440,000,000 I will now hand it back to John for an update on our full year 2022 outlook. Thanks, Mike. So please go to Slide 12. And looking at our full year 2022 outlook and to reiterate a few things said earlier in the call, We see nonresidential market demand in the Americas as remaining strong.

Speaker 2

Leading indicators remain favorable. Further, while demand for electronics Products remain strong, residential markets in the Americas are indeed softening. As you've heard, the Allegiant team has made significant progress Supply chain challenges, our electronics growth was strong this quarter and we continue to navigate the choppiness of component supply. Long term, we expect electronics adoption to remain a growth driver for Allegion. Given this backdrop, we're raising the outlook for Americas and are now projecting total growth to be between 22.5% and 23.5% with organic revenue to be up 13.5 14.5% for the year.

Speaker 2

Alisan International experienced another quarter of solid price realization and stable demand for our electronics and Software Solutions. However, we see the broader markets continue to soften, driven by macroeconomic and geopolitical factors, and currency pressures For the Allegion International segment, we're revising our outlook for total revenue to be down 10.5% to 11.5% with Approximately flat organic growth. All in, for total Legion, we expect revenue growth to be in the 13% to 14% range With organic revenues increasing 9.5% to 10.5%. Please go to Slide 13. We are expecting reported EPS to come in at a range of $4.90 to $5 per share and adjusted EPS to be between 5.40 to $5.50 The adjusted EPS increase from the prior outlook is driven by lower Access Technologies and The revised amortization takes the outlook for the acquisition impact to negative 0 point dollars per share.

Speaker 2

And as a reminder, the incremental investment spend is predominantly related to R and D and technology investments to further accelerate our growth and support our The previous outlook is driven by the loss on the mill rate divestiture and non cash purchase accounting adjustments, which were primarily Recorded in this quarter. Please go to Slide 14 and let's wrap this up. Here's the main themes I hope you heard today. Allegion had a very strong Q3. Our operational performance was exceptional.

Speaker 2

The entire Allegion team deserves a lot of credit for this. The Access Technologies acquisition is off to a great start and performing as expected. We're excited to have this business and the people as a part of the Allegion And to have automated entrance solutions in our portfolio. We've made significant progress on supply chain challenges, although choppiness in electronics Opponents persist. America's nonresidential demand is still strong, leading indicators are still positive, and we continue to see strength and demand for our Global Electronics Products.

Speaker 2

To reiterate, we see electronics adoption as a long term growth driver for Allegion. I'm very proud of the dedication and resiliency of our entire team and the results we've delivered this quarter. With that, Mike and I would

Operator

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

Speaker 2

Hi, good morning guys. Good morning, John.

Speaker 3

Good morning, John.

Speaker 1

Good to hear you on

Speaker 2

the call. Just wanted to dig in a little bit on this kind of

Speaker 4

non resi backlog phenomenon. It's not really a metric you guys talked about Much, but with the growth in the quarter, clearly supply chain improving, everybody gets some product out the door. Can you maybe contextualize How much of the excess backlog you worked off? And how should we think about maybe kind of a normalized margin, because I would imagine the mix on that influences things a lot once we get past that backlog period.

Speaker 2

Yes, Josh. As you know, we had built backlog starting the end of last year And most of that driven by some supply chain as well as really strong demand. As you look at the 3rd quarter, We have better component availability as we talked about on the call. That helped drive more Revenue in the Americas non res at 30%, and not all of that obviously is demand. So we did reduce backlog levels.

Speaker 2

We don't disclose the exact amounts, but we did Close the exact amounts, but we did have a very strong volume growth, which we provided, And that's driven by both demand being strong as well as backlog reductions. With respect to margins, The key thing about margins for us is we're driving that price realization to offset the inflationary pressures that we've been seeing. This quarter, we finally turned the corner on the margin percent. Last quarter, it was offsetting on dollar. So we've made significant progress here as we progressed over the last few quarters on that element.

Speaker 2

So It's those key items I think that have led to the margin expansion you saw. Josh, this is John. I would just add one thing that probably Every manufacturer has dealt with, when we talk about choppiness in the supply chain, without a doubt that injects This or the other inefficiency into the factory. So that's there's been some cost inefficiencies over time that we've been working through and certainly that's On the way towards improvement as well. But just one other nuance there to your question, but that's a good one.

Speaker 2

Thank you.

Speaker 4

Got it. Thanks. And then just quick follow-up on the pricing dynamic. I know you guys and the industry in general honors existing quotes out there. So Price kind of layers in over time.

Speaker 4

What inning are we in, in terms of being caught up on price versus having these outstanding older price quotes?

Speaker 2

Yes, we've been raising price pretty consistently over the last year as we've had such challenges in the inflationary environment. I would say, the dynamic of price productivity and inflation will be positive moving forward. So I wouldn't expect a situation where we turn the other way. We've kept the dynamic positive and expect it to be positive moving forward. Perfect.

Speaker 2

Appreciate the color. Thanks guys. Best of luck.

Operator

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

Speaker 5

Hi, this is Kiran Patel Connor on for Julian Mitchell.

Operator

So I just wanted

Speaker 5

to ask on residential. So it looks like residential growth in the Americas inflected positively. And I just wanted to Get a sense of this is more of a function of supply chains easing versus underlying demand and to what extent do you see this growth as sustainable Going forward, given what we're seeing in the housing market.

Speaker 2

Yes. Thanks for the question. This is John. I would say, going back to our comments, Certainly, the Americas residential market is softening. We're reading the same headlines that you are.

Speaker 2

Higher mortgage rates is Certainly going to have an impact there. I would say our performance in the quarter is without a doubt due to strong demand for our products. We have good products. People like them. We get good reviews.

Speaker 2

Our electronics growth you saw was very strong, which is quite prevalent in the residential sector. But the broader market is Sector. But the broader market is softening without a doubt. I think electronics remains a tailwind for us. And yes, so what more to say there?

Speaker 2

I think that's it. Yes, broader market softening a little bit. Electronics is favorable. That's a tailwind. And yes, so we're still chugging along.

Speaker 5

That's helpful. Thanks. And then my follow-up is just kind of what you're seeing in the channel based on your results today, it doesn't seem as if you're seeing any signs of destocking, which we're seeing in some other industrial markets. So can you give us a color of what you're seeing in channel from an inventories perspective And what underlying demand is looking like relative to that? Thanks.

Speaker 2

Yes, you bet. Very, very relevant question. Thanks for that. I'd say we'd liken it to more Normal levels, I wouldn't necessarily say destocking, restocking, just more normal point of They'll pull through based on retail demand. And I think that's the environment we're getting back to as lead times Normalized to more of what the industry is used to.

Speaker 2

Retail demand pull through is what's going to drive the

Operator

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

Speaker 6

Hey, good morning and thanks for taking the questions. My first question is on 4Q. It looks like guidance implies a little bit of a cut there. Can you unpack any

Speaker 2

Yes. Ryan, if you look at Allegion, we always guide for the full year. In July, we put a guide out there and essentially we reiterated the guide this quarter For the full year, because we're a full year guiding company. With respect to Q4, you can back into some math, see strength in the Americas, Right, America's top line guide implied in the high teens. We are seeing obviously some weakness in that guide internationally, Right, which we called out.

Speaker 2

So overall, our business is seeing strength in Americas led by obviously non res, Which we talked about and seeing some softening internationally. Full year, in line with what we said July. So I Don't think there's major changes from what we told you previously, but you do have some mix between the two regions.

Speaker 6

Got it. That's helpful. And then for my follow-up, you mentioned progress on supply chain, but still some choppiness. Where are there still issues and when do you expect to fully catch up?

Speaker 2

Yes, that's The question of the year, I think, on fully catch up. But I would think of it like this, if 3 or 4 quarters ago, we had like 50 suppliers on the severely delinquent list. Today, That would be 7 or 8. Just to kind of quantify it for you, I think the choppiness still exists Primarily in semiconductors microprocessors. Now the redesign work that Allegion did is obviously having benefits.

Speaker 2

We're seeing strong electronics growth. Some of those suppliers are performing quite well. Some are still having a lot of issues. And it comes So both in terms of quantity that we need to fully meet retail demand, but then also linearity that we need to really have a Productive manufacturing operation. So that's kind of if we double click into what we mean by choppiness.

Speaker 2

I'd say this is definitely continuing on into 2023, but we're making progress and we feel good The progress we've made, we feel good about the improving flexibility and resiliency of our supply base and I think the improvement trend will continue. Thank you.

Operator

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

Speaker 4

Hi, good morning all.

Speaker 2

Good morning. Good morning.

Speaker 7

Congrats on a great quarter. Just back to the price and productivity and specifically within the Americas business, it did step up nicely from, what, dollars 6,000,000 in Q2 to $24,000,000 here in Should we see that continue to move higher into Q4? And then given the wraparound price you should be able Get next year, I mean, should we think of $25,000,000 in Q1 and Q2 of next year at a minimum?

Speaker 2

Yes, Brett, with respect to next year, we'll give an outlook when we come back in Feb. I'm certainly not on the Q3 call going to get That specific of price productivity inflation. However, in general, think of this dynamic as Progressively improving to this point, right? We were weaker last year, negative, got back a positive this quarter on a substantial way. Obviously, volume drives more ability to get That price because you have more revenue.

Speaker 2

But in general, we're going to fight that inflation and have that dynamic Positive moving

Speaker 7

forward. Got it. And then just back to the backlog question. So you're Obviously working here to uncork that specifically on the electronics side. As these supplier additions are ramping here, should we think of the electronics Growth normalizing back to that double digit plus level that Allegion has really observed pretty consistently for several years before the pandemic.

Speaker 7

So going forward, kind of double digit in that territory?

Speaker 2

Yes, especially long term, this is a great growth driver for us And that be a double digit growth business for us as you think about the long term. We talked about choppiness, right, but Long term, this is a double digit growth opportunity for us.

Speaker 7

And just a quick follow-up, Simeon, do you think you have enough availability to Kind of sustain that into Q4 here.

Speaker 2

Yes, I'm not going to guide a specific quarter, but As you looked at our results for the Americas in particular, we have a pretty healthy top line guide in Q4. So you can draw your conclusions to that particular item, but we still see strength in Q4 as indicated in our guide. Appreciate the color.

Speaker 1

Thank you.

Operator

The next question is from Joe O'Dea with Wells Fargo, please go ahead.

Speaker 3

Hi, good morning. I wanted to start on the operational and FX piece Of the guide. And if you could just sort of bridge from prior guide to revised guide, I mean, the numbers didn't change, but what some of the moving parts are Given the strength we saw in the Q3, would have expected to see that, that could have moved up. But if you could just talk kind of The Americas piece, the international piece, the FX piece in terms of what moved from last guide to this one?

Speaker 2

Yes. So Joe, if you think about FX, we actually took down our guidance in July when we reported our Q2 results for currency. So a good chunk of the currency pressure you've seen with the dollar strengthening, We anticipated and put in that guidance that we put out in July. Currency rates have gotten a little worse since that Period of time, but a good chunk of the FX pressure we called out previously. And then with respect to operations, We're right on line with what we said in July for the year.

Speaker 2

Obviously, like I mentioned earlier, a little more strength In Americas, as we took up the revenue outlook there and a little more pressure from markets internationally.

Speaker 3

Okay. And then I wanted to ask on the Americas margin excluding Access Tech. Clearly, some nice progress that we saw sequentially. But when we go back to where kind of pre pandemic margins were, there So, it appears to be some good opportunity there. So, again, kind of bridging to that, I mean, what are the keys to sort of get back to those kinds of margins?

Speaker 3

Pretty good volume this quarter. I'm not sure sort of mix side of things, if still from a price productivity inflation, there's room to go and you have visibility into that. It's kind of a timeline to getting back to where your margins were?

Speaker 2

Yes. If you think about the margin profile in Americas, The strong contribution margin those businesses have as we grow, we should get margin expansion. We've done a much better job this year, driving the price realization offset the inflation. We've been talking about this all year on these calls. We expect that to continue.

Speaker 2

So we think that there's margin runway for the Americas and we'll continue to drive That pricing to offset inflation with an understanding that this has been the most significant inflationary environment I've ever personally experienced and we're going to have to just combat that with the pricing actions. And Joe, this is John. I'd add that, again, there's an electronics angle to this as well. Electrified and connected products Are delivering a substantially higher value to the end customer, which then should also be not just organic growth On the top line, but also a margin expansion opportunity too as electronics adoption continues. So that's an element as well That we're really keen to continue to grow and deliver more value to the customer.

Speaker 3

Just related to that, do you think you're capturing that value proposition Today or do you think there are opportunities to sort of better capture that margin opportunity on the electronics side?

Speaker 2

I think both. I think we're doing very well today and I think there's continued opportunity. That's a tailwind for Allegion.

Speaker 3

Got it. Thank you.

Operator

The next question is from

Speaker 8

This is Joe Nolan on for David MacGregor. First, I just wanted to ask, within the Americas group, can you talk about volume versus price trends for both the non res and residential businesses?

Speaker 2

Yes. Historically, we don't disclose those individual components. What we did share for the quarter was they were both up Pricing and volume for each segment. But the individual numbers, historically, we have not and don't anticipate disclosing that level of

Speaker 6

Okay, got it.

Speaker 8

And then just on the Access Technologies business, I realize it's still early from an integration standpoint, but can you have any update about how that's going in terms of the integration?

Speaker 2

Yes, I appreciate that question. I think as we said in the prepared Comments off to a great start. Our teams are gelling very well. There's This or the other small project win here and there. So and I think the early work On some of the heavy lift in terms of systems and things like this, we'll continue for the next many months, but off to a very good Dart, cultural fit is very good, strategic fit is very good.

Speaker 2

The automatic doors is an Excellent complementary portfolio to the rest of Allegion and just really excited for that team And really excited for the services business that comes along with that. And we're quite bullish on the future there.

Speaker 8

All right, great. Thanks for answering my questions.

Operator

The last question is from Brian

Speaker 9

competitive landscape right now, what you're seeing given the ASSA, Appears to be at least held up some with the DOJ. Can you talk about the opportunity that See out there with Allegion in the competitive environment? Are you gaining market share, losing market share because of this transaction or it doesn't impact you at

Speaker 2

Yes, it's certainly not appropriate for us to comment on that particular situation. I would say we feel good about our product portfolio, about our brands, about our competitive position in the market. I Our 3rd quarter results reflect that, that as we made the supply chain improvements we've continued to talk about, We generate good results. We've been saying for several quarters now, we were supply constrained versus demand constrained, And I think that continued to prove itself out. And so yes, we'll continue to compete vigorously in the segments Where we compete, and I think Allegion's best days are still ahead.

Speaker 9

Okay. As a follow-up, I'll go in a different direction then. Can we talk about, you addressed a little That price increases going forward. Are you starting to see a pushback on the nonresidential market yet In the Americas on price increases and that kind of tells you when you're done. And I just wanted to get kind of an Indication from you what you see in terms of price indication price increases going forward if you feel like you can push more through or you feel Like that you're at the top end of that market?

Speaker 2

Yes, we've put a number of increases in. I would say it all depends on what the future inflationary environment is. But as we sit here today, we would always communicate future price increases to the channel before an earnings call. But expect us, if inflation persists, expect us to pass along pricing To mitigate that, but it all depends on the inflationary environment moving forward. Great.

Speaker 2

Thank you.

Operator

This concludes our Q and A session. I would like to turn the conference over the call over to John Stone for any closing remarks.

Speaker 2

Thanks very much and thanks everyone for attending today. I would just like to again reiterate, we feel like we delivered an outstanding performance this Quarter, the entire Allegion team and our distribution partners deserve credit for that. Access Technologies, Some acquisition off to a great start. We are making the supply chain improvements that we've been promising for a while and you see that reflected in our results. And we see continued strength in the Americas nonresidential end markets and global electronics demand.

Speaker 2

Allegion's best days are still ahead. Thanks very much.

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Allegion Q3 2022
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