Allegion plc (NYSE:ALLE) Q1 2023 Earnings Call Transcript

Allegion plc (NYSE:ALLE) Q1 2023 Earnings Call Transcript April 26, 2023

Allegion plc beats earnings expectations. Reported EPS is $1.58, expectations were $1.36.

Operator: Good morning and welcome to the Allegion First Quarter 2023 Earnings Call. Please note this event is being recorded. I would now like to turn the conference over to Tom Martineau, Vice President of Investor Relations and Treasurer. Please go ahead.

Tom Martineau: Thank you, Andrew. Good morning, everyone. Thank you for joining us for Allegion’s first 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 Slides 2 and 3. 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.

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 4. And I will turn the call over to John.

John Stone: Thanks, Tom. Good morning, everyone. Thanks for joining us today. Allegion delivered another quarter of outstanding operational performance. We reported revenue roughly 27% up and adjusted EPS growth of nearly 40%. Looking at our markets, we see ongoing robust demand in our North America non-residential business, along with strong demand globally for our electronic solutions. We are seeing improvement in electronics components availability. And although supply is still short of demand, Americas Electronics Solutions grew by more than 30% this quarter. Residential markets remain rather soft in the quarter, particularly for the mechanical products and certain international markets also remain soft, particularly our global portable security business, which Mike will address in a few slides.

We expanded margins substantially, up 290 basis points versus prior year. This now represents the fourth quarter in a row of margin expansion for Allegion as pricing momentum continues and efficiency and productivity are accelerating. We remain committed to expanding margins for 2023 and beyond, as you’ll hear on our Investor Day next week. We also realized significant improvement in cash flow year-over-year driven by its favorable earnings and better operating efficiencies. We are raising our outlook for the year on revenue, EPS and cash flow given strong Q1 execution, resilient market demand in non-residential segments, improving electronics availability amid the ongoing industry transformation to electronic smart hardware. Please go to Slide 5.

Revenue for the first quarter was $923 million, an increase of 27.6% compared to ‘22. Organic growth of 15% was driven by favorable volume in the Americas non-residential business and strong price realization across the portfolio. The Access Technologies acquisition contributed approximately 14% to total growth and currency impacts remained a headwind. Adjusted operating margin and adjusted EBITDA margins in the first quarter increased by 290 basis points and 270 basis points respectively. The increases were attributable to favorable price and productivity, positive business mix and volume leverage associated with Americas non-residential growth. Excluding the acquisition of Access Technologies, adjusted operating income margins were up 380 basis points.

Adjusted earnings per share of $1.58 increased $0.45 or approximately 40% versus the prior year. Strong operational performance more than offset the unfavorable impact of anticipated higher interest and tax expense. As previously mentioned, available cash flow was $46.7 million in the quarter, up nearly 300% versus the prior year. Mike will now walk you through the financial results and I’ll be back to discuss our updated 2023 outlook.

Mike Wagnes: Thanks, John and good morning everyone. Thank you for joining today’s call. Please go to Slide #6. This slide reflects our earnings per share reconciliation for the first quarter. For the first quarter of 2022, reported earnings per share was $1.05. After $0.08 of adjustments for the items noted on this slide, 2022 adjusted EPS was $1.13. Operational results were strong in the quarter, adding $0.46 per share, which drove approximately 40% growth. This was driven by double-digit organic revenue growth, favorable operating execution and positive business mix, which more than offset currency headwinds. Acquisitions and divestitures delivered $0.13 to earnings – of earnings per share. This was primarily driven by Access Technologies, which continues to deliver strong results.

Interest expense reduced earnings per share by $0.11 driven by increased debt to finance the acquisition of Access Technologies and higher variable interest rates versus Q1 2022. A higher year-over-year tax rate reduced earnings by $0.03. This resulted in first quarter 2023 adjusted earnings per share of $1.58, an increase of $0.45 or 39.8% compared to the prior year. Lastly, as detailed on the page, we have an $0.18 per share reduction from adjusted EPS to arrive at reported EPS. As we discussed in our last earnings call, this amount now includes an adjustment for all acquisition-related amortization. After giving effect to these items, you arrive at first quarter 2023 reported earnings per share of $1.40. Please go to Slide #7. This slide depicts our revenue growth for the first quarter.

I will talk to the results in total on this slide and address the regions on their respective slides. We delivered 15% organic growth driven by price realization across the portfolio and strong volume growth in the Americas non-residential business. Net acquisition and divestitures contributed 14.1% growth driven by Access Technologies. Currency pressures continue to be a headwind, primarily impacting our International segment bringing the total reported growth to 27.6% in the quarter. Please go to Slide #8. First quarter revenue for the Americas segment was $740.9 million, up 42% on a reported basis and up 22.6% organically. During the first quarter, price realization remained strong, offsetting ongoing inflationary pressures. In non-residential, we continue to see strong end market demand and volume growth, which benefited from the catch-up of improved electronic component supply.

When coupled with price, this drove organic growth to approximately 30%. Our residential business was up mid single-digits, with favorable price offsetting lower volumes. Residential electronics volume growth was strong, but we continue to see weakness in end markets for mechanical products. Electronics growth exceeded 30% for the quarter as we continue to see both improvements in our supply chain and strong demand. Backlogs for non-residential electronic solutions remain elevated as we exit Q1 as demand is still limited by supply availability. Additionally, we expect residential electronics demand to be more aligned to retail point-of-sale as we go forward. We are pleased with the ongoing Access Technologies integrations and results. This business had pro forma revenue growth of approximately 15% versus Q1 2022 and contributing nearly 20% to the Americas reported growth number.

We continue to see the benefits of a stable high-growth service business that Access Technologies provides us and the business is performing as well as we anticipated when we purchased it. Americas adjusted operating income of $198.1 million increased 59.5% versus the prior year period, while adjusted operating margins and adjusted EBITDA margins for the quarter were up 290 and 260 basis points respectively. Excluding Access Technologies, the Americas segment drove 500 basis point improvement in operating margins versus the prior year. Pricing productivity in excess of inflation and investments, volume leverage, along with positive mix, contributed to the margin improvement. Please go to Slide #9. First quarter revenue for Allegion International segment was $182.1 million, down 9.7% on a reported basis and down 4.8% organically.

In the quarter, solid price realization was more than offset by lower volumes, primarily associated with our Portable Securities business. This business benefited from a COVID-related demand surge that extended into the first half of 2022. This resulted in the first half of 2023 having a more difficult comp as the market works its way back to a more normal cycle. Notably, the demand for our electronics and software solutions remained strong in Allegion International. In addition, currency headwinds persisted this quarter and reduced reported revenues by 4.4%. International adjusted operating income of $19.7 million decreased 27% versus the prior year period. Compared to 2022, adjusted operating margins and adjusted EBITDA margins declined 260 and 220 basis points respectively.

The margin decline was primarily driven by reduced volumes. Please go to Slide #10. Year-to-date available cash flow for the first quarter came in at $46.7 million, up $34.9 million versus the prior year. This increase is driven by higher earnings and lower cash used for net working capital partially offset by higher capital expenditures that were mostly related to our new manufacturing facility in Mexico, which is scheduled to come online in the second half of 2023. Working capital as a percent of revenue increased versus the prior year. This is driven partially by the Access Technologies business, which was not owned in Q1 ‘22. Working capital has also increased from Q1 2022 as a result of the investments in inventory we made in the second half of last year to increase our safety stock and protect our customers.

We saw a year-over-year and sequential improvement in inventory turns as we remain committed to manage our working capital more efficiently and drive improvement. The business continues to generate strong cash flow and the balance sheet continues to be in a healthy position. I will now hand it back over to John for an update on our full year 2023 outlook.

John Stone: Thanks Mike. Please go to Slide 11. We continue to expect strong electronics growth and the non-residential market demand in the Americas remains robust. Given the late cycle nature of our business, we expect this strength to continue through 2023. As a result, we are raising our 2023 outlook for the Americas segment, where we expect organic growth to be between 7.5% to 9.5%. We expect total growth inclusive of our Access Technologies acquisition to be between 15% and 17%. We expect to see non-residential organic growth to be up low double-digits with favorability in both price and volume. We still expect the residential business to be down with price mostly offsetting volume declines, which are expected to be in the low to mid single-digit range.

Based on the strength we saw in the second half of 2022, we expect stronger growth in the first half of 2023, which we believe may moderate later in the year against those tougher comparables. There is no change in our outlook for the International segment we expect revenue in that segment to be relatively flat in soft end markets. All-in for the company, we are raising our outlook and expect total revenue growth to be between 11.5% to 13.5%, with organic revenue growth of 5.5% to 7.5%. Please go to Slide 12. As a result of our favorable revenue outlook and strong operational execution, we are raising our adjusted EPS outlook for the year and believe it will be between $6.55 and $6.75. Adjusted operational earnings are expected to increase approximately 13% to 16%.

Interest is still expected to be around a $0.24 per share headwind, reflecting a full year of acquisition-related borrowings and increases to variable interest rates. Tax still expected to be a $0.20 headwind and other income still expected to be around a $0.05 headwind. The outlook continues to assume approximately $0.20 per share for costs related to restructuring and M&A and amortization expense related to acquired backlog. In addition, it excludes approximately $0.40 per share for acquired intangible asset amortization. As a result, reported EPS is now projected to be between $5.95 to $6.15. Lastly, we are increasing our outlook on available cash flow for the year to be in the $480 million to $500 million range. Please go to Slide 13. To summarize, we see strength in our Americas non-residential business and our global electronics solutions continue to provide us with significant growth opportunities, both near and long-term.

We’re very pleased with the performance of our Access Technologies acquisition. The business is performing well, and we love the synergies with our non-res business. We’ve expanded margins for the fourth quarter in a row and remain committed to doing so moving forward. We saw significant improvements in cash flow, and it’s worth mentioning again that we saw improvements in inventory turns in the first quarter of 2023. Overall, we’re off to a great start. In 2023, our team is executing well, and Allegion’s best days are still ahead of us. Please go to Slide 14. And before we turn the call over to Q&A, I’d like to provide a final reminder that you’re all invited to join Mike and myself as well as other members of our executive team next week on Tuesday, May 2 for 2023 Investor and Analyst Day at our Americas headquarters in Carmel, Indiana.

There you’ll have the opportunity to learn about our leadership team, our strategy and our exciting work driving seamless access. Formal presentations will be held 12:30 to 2:30 Eastern Time. And those who attend in person will also get a pretty exciting tour through our technical center following the presentations. This is a really exciting time in our company’s history. We’re a few months away from turning 10 years old, and our current executive team’s first Investor Day together. We hope to see you there. With that, let’s turn to Q&A.

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Q&A Session

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

Julian Mitchell: Hi, good morning. Maybe just a first question around that non-residential Americas outlook and sort of an update there, so I heard you call out, I think, low double-digit revenue growth assumed for non-resi Americas this year. Maybe help us understand kind of what’s the split between price and volume versus your prior assumption? And also, it seems that your revenues you’re getting this big sort of boost from component supply issues easing? And give us some clarity perhaps about how you’re looking at sort of the spec writing the order flow? There is obviously a lot of investor consternation about commercial construction. So any signs of any change in customer appetite there?

Mike Wagnes: Yes. So Julian, why don’t I tackle the kind of the components of the guide, and John can talk to the general business dynamics. If you look at our non-res business, we expect to see both revenue growth driven by price and volume. As you know, we’ve been committed to fight that inflationary pressure. So pricing should be good for the full year. You saw a good pricing in Q1. And then as you look at a full year basis for volume, we will have growth, but not to the level you saw in Q1, obviously. We are running up against that tough comparable in the back half of the year. If you recall, non-resi grew 30% and I think in the third quarter and then greater than 25% in the fourth quarter. So we do have a tougher comparable. And then, John, do you want to talk to the spec activity and other items?

John Stone: Yes. Good morning, Julian, thanks for the questions. I think on the supply chain, you’re exactly right. Component supply has been, I’d say, steadily improving, including on the electronic side. And what we’ve been really happy to see is how quickly the Allegion team has essentially compounded every incremental improvement in the supply chain with better productivity, better operating efficiency in the factory. And our distribution channel sell-through has been quite rapid as lead times have come down. So happy to see that. I would say if you look back to the prepared remarks, Mike had some comments around electronics, particularly on the non-res side of electronics, still have elevated lead times, still have elevated backlogs.

Supply has improved, quantity has improved. It’s still not as linear as we would like to see it, a bit choppy in terms of deliveries. But demand is still very strong, very robust and exciting future there. On just the general activity, I’d say, leading demand indicators: ABI, Dodge new starts, Dodge Construction Index, AIA consensus still reading rather favorable, honestly, choppy. It’s been mixed last few months. But some of those indices are, again, tipping back favorable here and there. For us, we do see strong spec writing activity, and that’s a flywheel that turns all year, every year. And the time between engaging with the architect, writing a specification and turning that into revenue that can sometimes be 18 to 24 months even.

But the spec engine is always running. And right now, it’s running very hard. When you think about quoting, bidding, etcetera, that activity is quite robust as well. So again, we feel good about the non-res business. We feel good about our position in the non-res business through 2023.

Julian Mitchell: Thanks very much. And you did have a very good tailwind in the Americas from that sort of line price and productivity versus inflation and investment spend. I think it was over 300 points in the first quarter as a margin tailwind. So maybe as we think about the balance of the year, how does that – how quickly does that tailwind shrink? Should it still be a tailwind overall in the fourth quarter or is it more kind of back to neutral there? Just trying to understand some of those moving pieces in what you’re guiding for margins this year?

Mike Wagnes: Yes. So if you look at margins for the year, I expect our margins to be up, say, 50 to 100 basis points full year. And in every year moving forward, look for us to drive that margin expansion. You will hear this at Investor Day next week. We’re going to be driving margin expansion moving forward, and we’re committed to doing so. If you look at price productivity inflation investments, that is a big tailwind in Q1. We do have an easier comp in Q1. Obviously, Q3 and Q4, it’s a more challenging comp. I would just add, we expect that to be positive on a dollar basis in the back half of the year. We expect margin expansion for the full year, as I mentioned earlier. And as you think about our business, we are driving the necessary pricing actions to fight the inflationary pressures. We fell a little behind, let’s say, in ‘21 and early ‘22, we’ve taken the necessary actions to ensure that, that doesn’t happen again.

Julian Mitchell: That’s great. Thank you.

John Stone: Thanks, Julian.

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

Joe Ritchie: Hey, guys. Good morning.

John Stone: Hey, Joe.

Joe Ritchie: So can we maybe just follow-on on that pricing discussion? Look, it’s been great to see, particularly in the Americas business here, you’ve had double-digit pricing now for three quarters in a row. I’m just curious, like, have you put additional price increases through for this year? And then like how do you see pricing specifically in Americas progressing as the year goes along?

Mike Wagnes: Hey, Joe, thanks for the question. If you think about our Americas business, starting late ‘21 and all of ‘22, we’ve put in a substantial amount of pricing actions. We are starting to comp up against those pricing actions in ‘23. So as you move through the year, the realization percentage will be highest in the first quarter and then less as you proceed through the year. You’re still going to sell the product at a higher value, but the incremental price realization percent will come down. We do expect our pricing to be very sticky. As you remember, our non-residential business, we do list price adjustments that tend to stick. So we feel good about our pricing, but the magnitude will decline the amount of price realization as we progress through the year.

Joe Ritchie: Okay. Alright. Great. Helpful. And then my follow-on question, like back to the consternation in the market right now on non-res. Your commentary so far have been very positive as you think about the year. I guess maybe just provide a little bit more color how you’re thinking about the potential risk of a slowdown associated with middle market banking concerns and when you would potentially see that in your business with the leading indicators are that you’re looking at?

John Stone: Yes, Joe, this is John. It’s a good question. And it’s top of mind for everyone. I would say, again, if you think about Allegion’s business model, we are late cycle. We are a bit heavily weighted to the institutional segment, which tends to have sources of financing like bond referendums, public finance or these mega projects with large bank finance. So there is part of the business that maybe is not all that susceptible to the regional banks. And certainly, a lot of the business is susceptible to regional bank lending and credit conditions. So could that become an issue? Of course. Are we seeing a big impact right now? No, we’re not. Again, think about engaging with the architect, writing specifications of the classic pull strategy to pull the product through the channel.

The timing from spec to project initiation to when doors and door hardware goes in the building can be 12, 18, 24 months. And so projects that have been started tend to get completed, and I think we’re seeing that right now.