Allegion plc (NYSE:ALLE) Q3 2023 Earnings Call Transcript

Allegion plc (NYSE:ALLE) Q3 2023 Earnings Call Transcript October 31, 2023

Allegion plc beats earnings expectations. Reported EPS is $1.77, expectations were $1.71.

Operator: Good morning, and welcome to the Allegion Third Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jobi Coyle, Director of Investor Relations. Please go ahead.

Jobi Coyle: Thank you, Drew. Good morning, everyone. Thank you for joining us for Allegion’s Third Quarter 2023 Earnings Call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning, and the presentation, which we will refer to in today’s call are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to Slide number 2. Statements made in today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections.

A security specialist installing a home security panel, showing the safety and security the company provides.

The company assumes no obligation to update these forward-looking statements. Today’s presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Please go to Slide 3, and I’ll turn the call over to John.

John Stone: Thanks, Jobi, and good morning, everyone. Thanks for joining us today. This current quarter was all about outstanding operational execution from the entire Allegion team, and I’m pleased with our performance. Electronics demand remains strong with in our opinion a long runway for further adoption. In the quarter, Allegion delivered mid-teens organic growth in electronics and software solutions globally, led by our Americas nonresidential business, which had another robust quarter. We already have the highest margins in our industry, and we’re driving additional expansion at the gross and operating margin levels despite not having some of the mechanical volume tailwinds from a year ago. Our balance sheet is getting stronger.

We delevered from the Access Technologies acquisition quickly and are now building capital to deploy for growth. Bottom-line, Allegion is poised for a record year in total revenue, adjusted operating income and adjusted earnings per share. As a result, we’re raising our guidance for full year adjusted EPS. Please go to Slide 4. So Allegion’s vision of enabling seamless access in a safer world remains core to our company culture, performance and results. Securing people where they live, learn and work has never been more important. We are a pure-play provider of security and access solutions. We have a great legacy of the strongest brands and the highest margins. We operate with excellence and are accelerating our year-over-year productivity with normalized lead times while still managing the massive SKU complexity that we manage in a made-to-order environment.

This makes Allegion a partner of choice, and we’re leveraging that unique position to promote the adoption of open ecosystems that maximize our addressable market. We’re also delivering new value and access, continuing our drive to wrap software and services around our hardware solutions. This is the critical unlock of additional value for our end user customers for Allegion’s growth and for long-term shareholder return. A great proof point of how our company is living this vision and strategy is the Allegion Ventures announcement we made yesterday. Allegion Ventures has made a strategic investment in Ambient AI, whose cutting-edge AI platform utilizes innovative technology to enable seamless access in a safer world. This is the largest investment in Allegion Ventures history, and it reflects the tremendous potential we see in Ambient and Allegion’s collaboration to deliver new value and access.

Please go to Slide 5. I’d like to turn to our capital allocation priorities. When I joined Allegion, we had just announced the acquisition of Access Technologies. And over the last year, I feel we’ve done a good job in quickly delevering back to pre-acquisition levels, while still investing in our business and returning cash to our shareholders. Allegion is an investment-grade company, and we expect to remain an investment-grade company. This is critically important to us. We will continue investing for above-market organic growth prioritizing projects and solutions that drive seamless access and make the world safer. We’re a dividend-paying stock, and you can expect our dividends to grow commensurate with earnings over the long-term. We will also drive growth through acquisitions, considering complementary portfolios like you saw with the Access Technologies business, as well as Software-as-a-Service related to seamless access, like you saw with plano.

High-margin recurring revenue businesses and bolt-on acquisitions that fill portfolio gaps in the hardware space will remain priorities. And while we may increase our debt for the right acquisitions, we’ve demonstrated the ability to quickly delever. Lastly, with regards to share repurchases at a minimum, we will continue to offset incentive compensation, and we will make additional share repurchases as appropriate. Mike will now walk you through third quarter financial results, and I’ll be back to discuss our full year 2023 outlook.

Mike Wagnes: Thanks, John, and good morning, everyone. Thank you for joining today’s call. Please go to Slide number 6. As John shared, Allegion continued to execute at a high level. We delivered another quarter of solid performance with strong electronics growth, sustained margin expansion and healthy cash flows. Revenue for the third quarter was $917.9 million, an increase of 0.5% compared to 2022. We continue to see favorable price realization along with strength in electronics and access technologies. However, ongoing pressure on our residential business, paired with a challenging prior year comparable, resulted in organic revenue decline of 0.6%. Adjusted operating margin and adjusted EBITDA margin in the third quarter both increased by 110 basis points.

Price and productivity in excess of inflation and investment along with strong operational execution more than offset the volume decline impact. On a year-to-date basis, we have achieved the highest adjusted operating margin in our history. I’m pleased with the margin performance over the last 18 months as we have now recaptured the margin loss during our supply chain disruptions. Our operating model and strong execution have positioned us well for future margin expansion. Adjusted earnings per share of $1.94 increased $0.21 or approximately 12% versus the prior year. Operational performance drove nearly $0.10 per share with the remaining coming from tax driven by timing of discrete items versus the prior year. We expect our full year adjusted effective tax rate to be approximately 15%.

You can find further details of our earnings per share performance in the appendix. Year-to-date available cash flow was $320.4 million, an increase of approximately $95 million versus last year, driven by higher earnings. I will provide more details on our cash flow and balance sheet a little later in the presentation. Please go to Slide number 7. This slide provides an overview of our quarterly and year-to-date revenue. I will review our enterprise results here before turning to our respective regions. As I just mentioned, we have reported growth of 0.5% with a decline in organic revenue of 0.6% in the quarter, as price realization offset pressure on mechanical volumes. As you see on the top of the slide, Q3 is comping against our prior year quarter with organic growth of more than 18%.

If you recall that is when our supply chain improvement efforts allowed us to start working through backlogs and past due customer orders and represented the highest organic growth in our company’s history. Currency drove some favorability in the quarter, bringing total reported growth to 5/10. On a year-to-date basis, organic revenue was 6.1% overall with Americas at nearly 9%, driven by strength in our nonresidential business. Our international business is down about 3% year-to-date. Please go to Slide number 8. Our Americas segment continues to deliver strong operating results in the third quarter, expanding margins despite lower volumes. Revenues of $740.9 million was down slightly on a reported basis and flat organically, as favorable pricing was offset by reduced volumes.

Let me disaggregate the components further. The Americas non-residential business was up low single digits against the prior year comp, which grew approximately 30% driven by backlog reductions I just mentioned. On a year-to-date basis, non-residential business has grown double digits. Our Americas residential business is down low teens in the quarter as we continue to see weakness in the residential market as higher interest rates continue to impact new and existing home sales. Our Access Technologies business delivered organic growth of mid-teens, representing another strong quarter of top-line growth and demonstrating the stability that this business provides us. Demand for our electronic solutions remained strong in the Americas. We delivered high teens organic growth in electronics in the quarter, and we continue to see a long runway for further adoption as electronics remains a key growth driver for the long-term.

As we discussed during our second quarter call, mechanical volumes were expected to be a little soft in the third quarter as customers adjusted to our reduced lead times. We feel the channel has worked through this adjustment, and we are back to a more normal book and ship business. Our Americas adjusted operating income of $210.6 million increased 5% versus the prior year period, while adjusted operating margin and adjusted EBITDA margin for the quarter were up 140 and 150 basis points, respectively. Pricing and productivity exceeded inflation and investments driving substantial margin expansion, demonstrating the resiliency of our Americas business model. Please go to Slide number 9. Our International segment executed well in a challenging macroeconomic environment.

Revenues of $177 million was up 3% on a reported basis and down 2.8% organically. Price realization was more than offset by lower volumes, primarily associated with our global portable securities business and our China business, which are operating in challenging markets. We continue to see strength in our electronics and software solutions, which grew low double digits organically in the quarter. In addition, currency was a tailwind this quarter, positively impacting reported revenues by 5.2%. International adjusted operating income of $23.7 million increased over 18% versus the prior year period. We also saw improvements in adjusted operating margin and adjusted EBITDA margins of 180 and 190 basis points, respectively. This substantial margin expansion, despite reduced volumes, highlights the healthier portfolio within our International segment.

Please go to Slide number 10. As I mentioned earlier, year-to-date available cash flow came in at $320.4 million, up nearly $95 million versus the prior year. This increase is driven by higher earnings, partially offset by higher capital expenditures related to our new facility in Mexico, which begins production later this quarter. Working capital as a percent of revenue increased versus the prior year. This was primarily driven by timing of revenue and associated receivables within the quarter as well as timing of payments to suppliers in the prior year. Working capital and inventory management remain a priority for our company as we efficiently turn earnings to cash. Our net debt to adjusted EBITDA is down to 2x as we continue to successfully delever following the Access Technologies acquisition.

We repaid the final $39 million on our revolving credit facility in the quarter, completing our repayments of short-term borrowings associated with that acquisition. We are now back to pre-acquisition leverage levels, which demonstrates our proven track record of effectively deploying capital while maintaining an investment-grade credit rating. Our business continues to generate strong cash flow and our balance sheet continues to be in a healthy position. I’ll now hand the call back over to John for an update on our full year 2023 outlook.

John Stone: Thanks, Mike. Please go to Slide 11. As I mentioned earlier, our company is on track for record full year revenue, adjusted operating income and adjusted EPS in 2023. We’re raising our full year outlook on adjusted EPS and affirming our full year outlook on revenue and available cash flow. We continue to expect the Americas segment to be 15% to 16% for total growth, 7.5% to 8.5% organically, led by our non-residential business, which is still expected to grow high single to low double digits organically. Residential business is expected to be down slightly as markets remain challenged. For international, we continue to expect revenue to be down 1% to flat in total and down 1% to 2% organically. All in for the company, our outlook continues to reflect total revenue growth between 11.5% and 12.5% with organic revenue growth between 5.5% and 6.5%.

Based on our strong operational performance in the third quarter, we’re increasing our adjusted EPS outlook to the range of $6.80 to $6.90, which is approximately 13.5% to 15% growth over the prior year period. Lastly, we still expect our outlook on available cash flow to be in the range of $500 million to $520 million. I’m very proud of the work of the entire Allegion team and our distribution partners over the course of this year and the record results we’re on track to achieve. Looking forward, we’ll provide our full 2024 outlook to you during our fourth quarter call, as we normally do. However, given the uncertainty in the market moving into next year, we wanted to give you some insights into our view of the market dynamics today. First, we expect growth in electronics adoption to continue, driven by the convenience and added security that digital identities and mobile credentials leveraging smartphone wallets provide to our end user customers.

A shift from mechanical systems to electronic access control systems with connected hardware provides efficiencies and operating cost savings for buildings and campuses, and recent channel checks and recent end user visits in the institutional segments in Education and Health Care reinforce this trend. And while small today, our software solutions portfolio is growing, and we look to accelerate this growth into 2024 and beyond. In addition, while the most recent ABI headline dipped, the institutional segment has been very resilient over the last 12 months and 5 of the last 6 months still reading above 50. Allegion’s context is important here. You’ll recall that we’re a late-cycle business and also rather heavily weighted towards the institutional segment.

We have an auto door business with strong backlogs and a blue-chip customer base and a service business that continues to grow. Our channel is in good shape on inventory and our lead times across the portfolio are now normalized. Our supply chain has improved to the point where we can regain market share in the aftermarket space. Expected headwinds are well known at this point. Commercial office in major metro areas is indeed soft. It’s been soft for several months now. However, that part of our business is only a low double-digit percent of our overall Americas portfolio. Weakness in residential and certain international market is expected to continue, particularly for mechanical products, which we’ve highlighted for you throughout this year.

We expect productivity and recent cost actions that we have taken to help drive margin expansion into next year. And before we go to Q&A, I’d like to reiterate what I said at the beginning of the call. Allegion is in a good industry, and we’re well positioned, thanks to the strong execution by our team. We’ve navigated industry cycles very well in the past. And with the improvements we’ve made to our portfolio and operations, we feel confident in our ability to succeed and drive continued organic growth and margin expansion. With that, let’s turn to Q&A.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Joe O’Dea with Wells Fargo. Please go ahead.

Joe O’Dea: So John, maybe on that last point, and I’m not sure you’re sort of willing to maybe elaborate a little bit more, but just the ’24 kind of considerations. I mean it seems like if institutional channel checks are constructive market share gain potential in aftermarket, understandable headwinds on commercial office and resi, but then productivity and cost actions as well. I mean it seems like it’s setting up for margin expansion. Is it also today setting up for top-line growth with the mix of those factors?

John Stone: Yes, Joe. I appreciate the question. I’d say again, the short answer, yes, we see organic growth in the future. I’d just keep bringing you back to Allegion as a late cycle business. We’re heavily weighted towards institutional. If you look at Dodd starts, if you look at ABI, the institutional segment has been very resilient in the last 12 months or even longer. And so yes, we feel pretty good about that, both on driving organic growth as well as, just like you mentioned on the margin expansion side. So margin expansion might not be as robust as you’ve seen these last quarters, but we still feel well-positioned to continue to drive margin expansion productivity and as you heard and as you called out, the cost actions that we’ve taken here recently, still well positioned.

Joe O’Dea: All right. I appreciate that. And then, also just international and maybe level setting on your views on where things stand within that cycle, where we’ve got I think now 6 quarters of volume declines. It’s been, I think, some time that a lot of that has been on portable security. I think electronics has been holding up quite better. But just where you think you are in that cycle? How close you are maybe to a bottom within the international trends?

John Stone: Yes. That’s tough to peg, Joe, like whereas is the bottom. For international, our portfolio spans Europe and Asia Pacific. And certainly, I think we see continued weakness in China, even though that’s a small part of our portfolio. I’d say continued weakness would not be ready to call a bottom. On the portable security business, it’s still a challenged market. There’s no doubt about it. Time to call a bottom. We’re definitely flirting with the bottom, I would say, which could provide a small bit of tailwind into next year and beyond. But you called out the most important piece, and that’s the continued growth around our electronics and software solutions portfolio in Europe. They’ve been performing extremely well.

We’re continuing to invest in that business, like the bolt-on acquisition of plano. That team came on board and is performing very well, integrated very well with our Interflex team. And we see a really bright future there. And in the electronic space, yes, continued growth, and we will continue to drive investments to drive that growth.

Mike Wagnes: Joe, I might also add, if you think about that global portable, we’ve been calling that out all year. So it’s going to be a soft 2023, all 4 quarters. So if you think about next year, it’s not a big headwind, I’m sorry, a big headwind versus the current year because you do have 4 soft quarters. So I think it’s important to understand that dynamic about global portable.

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

Julian Mitchell: Maybe just wanted to circle back to the Americas organic sales outlook. So it looks like the fourth quarter implied is organic sales may be up mid-single digits year-on-year in Q4 and then sort of down mid-single digits sequentially. So just wanted to sort of make sure that’s roughly correct, and any color within that on non-resi versus resi dynamics. And when we look at that plus mid-single digits entry rate into 2024 and the fact that your guidance from the Investor Day was plus mid-single digit for the Americas market, we assuming that kind of run rate can sustain into early ’24?

Mike Wagnes: Yes, Julian, if you think about the current year, so much of the current year growth rates are driven by comps in the prior year. So if you think about Q3, we last year really started to ramp our plants up as we got rid of that excess backlog in mechanical. That continued into Q4 last year. So this year, obviously, back half does have lower growth rates than first half. With respect to the two businesses, I think it’s fair to say that non-residential certainly is healthier or stronger than the residential end markets. So as I think about a full year, think of non-res, double digits, right? And you can do the math to back into the Q4 implied. That residential, we are going to be down slightly this year as we put in the prepared remarks, which is we’ve been saying relatively that this year, whether it’s down slightly or relatively flat all year.

So you do have a dynamic where resi is a little weaker, as we’ve been saying, and the non-res led by institutional is hanging in there. But prior year comps do impact the year-over-year quarterly growth rates.

Julian Mitchell: That’s helpful. Thank you. And it sounds like you’re fairly confident that, that inventory destock process by your sort of customers and channel partners is largely done. Maybe just sort of help us understand the conviction level around that. And when you’re looking at your sort of forward-looking indicators, I think you mentioned backlog down a bit. But maybe any color on sort of the spec writing for the Americas business overall. How does kind of the order patterns change? Have you seen any evidence of project pushouts, that type of thing?