Good morning, and welcome to the Allegion Q2 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note. this event is being recorded. I would now like to turn the conference over to Tom Martineau, Vice President of Investor Relations. Please go ahead..

Good morning, everyone. Thank you for joining us for Allegion's second quarter 2022 earnings call. With me today are Executive Chairman, Dave Petratis; President and Chief Executive Officer, John Stone; and Senior Vice President and Chief Financial Officer, Mike Wagnes.

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 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. We will now discuss our second quarter 2022 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 and then reenter the queue. Now, I'll turn the call over to Dave..

Thanks, Tom. Good morning and thank you for joining us today. Please go to Slide number 4. Before we provide our business and financial overview for you for the quarter, I want to start by acknowledging two significant announcements from the last few months.

In May, I shared my plans to retire from Allegion announcing John Stone as the incoming President and CEO of Allegion. John is the right leader to take Allegion into its next chapter.

And I'm happy to say, Allegion has the right talent, right strategy, and right foundation to successfully execute its vision of seamless access and a safer world under John's leadership. It's been a privilege for you to know John and learn about his service to our country as a West Point graduate, Army Officer and Veteran.

He also has a background in engineering and manufacturing with a track record of leading sustainable profitable growth, building from the core business by layering on new innovation and technology. We are particularly impressed by John's experience, leading Deere & Company’s Intelligence Solutions Group.

John is well versed in connectivity, having guiding the company through the digital transformation for agriculture. He drove value through digital tools, helping the industry become more productive through innovative technologies like automation, artificial intelligence, and machine learning.

He leverages the IoT to deliver wireless data, sensing technologies, as well as innovative remote service capabilities. All of this enhanced the performance and value of traditional mechanical equipment and allowed customers to drive their own operational efficiencies. Most of all, John has experience at managing complexity.

Deere & Company is a complex global business and his leadership opened an important route to precision agriculture during his time there. In many ways, John has already driven growth and success utilizing seamless access strategies.

John, would you like to say a few words?.

Yes. Thank you, Dave and good morning everyone. Thank you for joining our call. I'm looking forward to getting to know each of you a lot better over the coming quarters. Dave, I am super energized to be here, highly motivated by our higher purpose of pioneering safety and motivated by our vision of seamless access for a safer world.

I agree with you that Allegion has a very sound foundation. We've got great brands, great products, a strong team strong culture, and customer relationships that have stood the test of time.

I'm looking forward to visiting more of our sites in the coming weeks, getting to know our employees, our investors, and our customers and learning the business at a deeper level right alongside our experts. I feel it's a really exciting time to be part of Allegion. Back to you, Dave..

Thank you, John. Leading Allegion has been an honor and one of the most rewarding experiences of my professional career. And I'm proud to turn over the reins of this incredible organization to you, John Stone. Please go to Slide number 5. In the second quarter, we shared Allegion's intent to acquire the Access Technologies business from Stanley.

I'm happy to announce that of July 5, Access Technology is now a part of the Allegion family. The Access Technology business bolsters Allegion's seamless access strategy with a category market leader that has more than 90 years of history and innovation. Automatic entrance solutions is a strategic investment that addresses a gap in our portfolio.

We're adding a high growth service and support network to our North American portfolio, which will position us better as devices become more connected. Importantly, bringing the Access Technologies business to Allegion also provides clear synergy and incremental revenue opportunities.

And we believe we're creating a stronger long-term financial profile for our company that will deliver long-term value creation for Allegion’s shareholders. Simply put, with Access Technology as a part of Allegion, we are now able to offer our customers broader solutions and services and continuing to grow profitably.

At this time, I want to go over Access Technology's expected financial impacts for the second half of 2022. We expect the business to deliver approximately 9% growth in the full-year top line number for the Americas segment. We are also projecting the business will be diluted by – to adjusted EPS by approximately $0.10 per share in 2022.

Breaking down that impact further, the Access Technology’s business is expected to deliver $0.20 per share of operational earnings offset by non-cash intangible asset amortization of negative $0.13 per share and increased interest expense related to financing the deal is expected to drive a negative $0.17 per share impact.

I want to reiterate that the Allegion team is proud to welcome the Access Technology's dedicated employees who bring immense talent and expertise in safety, security, and service to our Americas segment, as well as our global organization. We're excited to have you here. Please go to Slide number 6.

As we look at business conditions, American non-residential market demand remains very strong and we expect that to continue. Leading indicators are showing expansionary readings. On the flip side, we are beginning to see some softening in the Allegion International segment and Americas residential markets from previous robust levels.

In international, we are seeing the impacts of geopolitical instability and zero tolerance COVID policies in China that have negatively impacted volume. We continue to make progress on our supply chain actions, which have resulted in improving component availability for mechanical products.

Electronic component challenges continue, however the product redesigns and alternative sourcing actions we have taken set us up better for the remainder of the year and 2023. Looking at price versus cost, we delivered strong price in the quarter across the entire portfolio.

Price realization accelerated again in Q2 and was the driver of organic growth in the quarter. Price exceeded inflation in the quarter and we expect that to continue for the remainder of the year. Allegion will assess the need for future price increases. We remain vigilant to increase – to ensure that price and productivity exceeds inflation.

Lastly, our Allegion International business is experiencing significant currency pressure as the dollar strengthens. In the second quarter, reported revenues reflect 22 million of currency pressure related to foreign exchange rates.

And as noted in our press release, currency headwinds are driving a reduction in our full-year EPS outlook to the effect of $0.09 per share. Now, let's turn to the quarterly performance for more details. Please go to Slide 7. Revenue for the second quarter was 773 million, an increase of 3.5%, compared to last year. Organic revenue growth was 6.4%.

The organic revenue increase in the quarter was driven by significant price realization of 8.4%. The negative volume was driven by the Allegion America's residential business, which was comparing against a robust to Q2 2021 growth rate associated with prior year catch up on COVID related backlog.

It was also impacted by the current year electronic parts shortages. Allegion International delivered organic growth driven by price, but faced volume declines that were driven by COVID-19 lockdowns in China and softening European markets. Mike will share more detail on the business segments in a moment.

Adjusted operating margin and adjusted EBITDA margins increased by 40 basis points and 30 basis points respectively in the second quarter.

The increase was driven by price productivity, exceeding inflation, which include favorable corporate cost, and favorable business mix, which more than offset the negative impacts of volume deleverage and incremental investments. Adjusted earnings per share of $1.37 increased $0.05 or approximately 4% versus the prior year.

Strong operational performance and favorable share count more than offset a favorable impact from FX, investments, other income, and tax rate. Mike will now walk you through the financials and our updated 2022 outlook..

Thanks, Dave, and good morning, everyone. I want to echo Dave's comments in welcoming John as our new President and CEO and in welcoming Access Technology employees to Allegion. Please go to Slide number 8. This slide reflects our earnings per share reconciliation for the second quarter.

For the second quarter of 2021, reported earnings per share was $1.31. Adjusting $0.01 per charges related to restructuring and acquisition expenses, the 2021 adjusted earnings per share was $1.32. Strong operational results increased earnings per share by $0.13, net of $0.05 per share pressure related to FX.

The performance was driven by significant price, which exceeded inflation and business mix driven by the strength of the Americas non-residential business. Favorable share count increased earnings per share by $0.03 and the impact of acquisition and divestitures drove another $0.01 per share.

A higher year-over-year tax rate reduced earnings by $0.02 per share and the combination of interest and other income drove another $0.05 reduction. Investment spending had a $0.05 per share drag on earnings as we continue to invest in the business to fuel long-term growth, expand our electronic capabilities, and drive our seamless access strategy.

This results in an adjusted second quarter 2022 earnings per share of $1.37, an increase of $0.05 or 3.8% compared to the prior year. Lastly, we had a $0.07 per share reduction from the net of non-operating gains and charges related to restructuring, acquisitions, and debt financing costs.

After giving effect to these items, you arrive at the second quarter 2022 reported earnings per share of $1.30. Please go to Slide number 9. 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 6.4% organic revenue growth in the second quarter, driven by strong price realization. Although the total company volume was down, we did see significant strength in our Americas non-residential business, which is starting to benefit from our supply chain actions over the last year.

As mentioned previously, currency headwinds were significant in the quarter and reduced reported revenue by 3%. There was a small impact from acquisitions bringing the total reported growth to 3.5% for Q2. Please go to Slide number 10. Second quarter revenue for the Americas segment was 592.3 million, up 7.8% on a reported basis and up 8% organically.

The segment delivered significant price realization coming in at 9.4% in the quarter. Both the non-residential and residential businesses delivered strong pricing. Pricing helped the non-residential business grow high teens when combined with volume growth.

Residential was down mid-teens driven by a prior year catch-up on COVID related backlogs and continued pressure in electronic components availability. Electronics revenue was down low single digits, driven primarily by electronic component shortages that limit our ability to fully meet demand.

Americas adjusted operating margin and adjusted EBITDA margins for the quarter were down 150 basis points and 160 basis points, respectively. The Q2 margin performance was a sequential improvement from Q1. For the quarter, price exceeded inflation and productivity headwinds on a dollar basis, but were dilutive to operating margins.

Please go to Slide number 11. Second quarter revenue for our Allegion International segment was 180.8 million, down 8.5% on a reported basis and up 1.9% organically.

The organic growth was driven by solid price realization, which more than offset the volume declines experienced as a result of COVID shutdowns in China and geopolitical pressures in Europe. The negative impact related to currency headwinds reduced reported revenues by 10.9% as the U.S.

dollar has strengthened substantially against other foreign currencies. Second quarter international adjusted operating margins decreased 100 basis points, compared to last year and adjusted EBITDA margins were down 60 basis points.

The margin decline was driven by unfavorable impacts from volume and mix, FX, and incremental investments that more than offset the favorable impact of price and productivity exceeding inflation. Please go to Slide number 12.

Year to date available cash flow for the first half of 2022 came in at 84.5 million, which is a decrease of more than 165 million, compared to the prior year. The 84.5 million is more in-line with historical levels. Last year's cash flow was driven primarily by lower working capital, due to the pandemic.

We are now projecting that 2022 full-year available cash flow to be between 420 million and 440 million. The reduction in ACF from the prior outlook is primarily related to investing in inventory to create supply chain resiliency and to better serve our customers.

This will position us to manage backlogs, which are expected to be elevated entering 2023 due to strong non-residential demand. The revised cash flow outlook includes the impact of the Access Technologies business, inclusive of operational cash flows offset by acquisition and integration costs related to the transaction.

As discussed earlier, we closed on the acquisition of Access Technologies business on July 5. The transaction was funded by issuing senior notes and utilization of our revolver.

As mentioned when we announced the acquisition, we expect to use excess cash generated during the remainder of the year to pay down short-term debt to taken on to complete the transaction. This would be after paying expected dividends, which are subject to Board approval. Please go to Slide number 13.

We now turn our attention to the revised revenue outlook. Non-residential markets in the Americas continues to be robust, leading indicators remain positive, and the level of specifications continues to be strong. Consistent with the broader macro industry, we are beginning to see signs of residential softening from robust COVID level peaks.

However, we remain positive on the long-term growth opportunity in residential due to the undersupply of homes to meet demand and the long-term trend of electronic adoption.

We've been aggressive in pursuing price in all channels and products and as a result, expect to deliver solid price realization for the remainder of the year that will more than offset substantial inflationary headwinds.

As noted previously, we expect the newly acquired Access Technologies business to deliver approximately 9% growth for the full-year reported Americas revenue. With these parameters in place, we are now projecting total growth for the Americas to be up 21% to 22% and organic revenue to be up 12% to 13%.

The increase in the Americas organic revenue outlook is primarily driven by price to offset the ongoing inflationary pressures. Allegion International experienced sequential improvement in price realization. However, we are beginning to see markets soften and currency pressures are anticipated to continue.

For Allegion International, we are revising our outlook for total revenue to be down 7% to 8% with organic growth coming in at 2% to 3%. All in for a total Allegion, we expect revenue growth to be in the 13% to 14% range with organic revenue increasing 9% to 10%. Please go to Slide 14.

For our EPS outlook, we are expecting reported EPS to come into a range of $5.05 to $5.15 per share, and adjusted EPS to be between $5.35 to $5.45. These ranges include the approximately negative 10% impact related to Access Technologies acquisition as the discussed earlier.

The updated outlook also includes a $0.09 per share reduction from the prior outlook related to currency pressure. This outlook assumes incremental investments of approximately $0.20 per share.

As a reminder, the incremental investment spend is predominantly related to R&D and technology investments to accelerate future growth and support our seamless access strategy. Also included in the revised outlook is a slight increase in interest expense driven by an increase in variable interest rates on the base business.

This does not include the Access Technologies acquisition, which will have a $0.17 per share negative impact related to financing we secured to close the transaction. That impact is included in the overall $0.10 per share dilution from the acquisition. I will now hand it back to Dave for some closing remarks..

Thank you, Mike. Please go to Slide number 15. To wrap up the main things you heard today, Allegion is excited to welcome John Stone as President and CEO. He brings a wealth of knowledge and expertise that will help Allegion on its seamless access journey. We are also excited to welcome Access Technologies to Allegion.

This is a category market leader with a strategic investment that expands our core business. Globally, Allegion is driving significant price realization and has turned the price productivity inflation dynamic positive.

The supply chain actions we have taken will help efficiency and productivity in our manufacturing locations and along with ongoing price realization will continue to drive pricing and productivity to exceed inflation. Non-residential markets in the Americas continue to be robust.

Leading indicators have been positive for over a year and given the late cycle nature of that business, this bodes well for the near term future, plus we are still sitting on healthy backlog levels that should fuel future growth as supply chains normalize. With that, Mike and I would now be happy to take your questions..

Thank you. [Operator Instructions] The first question is from the line of Julian Mitchell with Barclays. Please go ahead..

Hi, good morning. Thanks very much and wish Dave all the best and thanks for your help and look forward to working with you John.

In terms of – I guess the first question would probably be around – on the residential business, understand you've had, sort of several quarters of very tough comps and sort of a destock that had to happen, maybe help us understand on residential today, where are you on the inventories, kind of in the channel? The comp should get easier in the second half year-on-year, but the broader U.S.

resi demand backdrop is probably worse than you had thought a few months ago.

So, maybe help us understand, kind of what slope of residential revenue growth we should get in the second half of the year and the assumptions behind it?.

So, thank you for your comments, Julian, and for your questions, and support over the years. When I think about the residential market. We moved through this – went through this supply chain, which has been pretty dramatic over the last 24, 36 months. I continue to be positive on residential.

We still have some noise, but there's an undersupply of housing. We'll see some softening in the R&R, but we have maybe been hit harder in res because of the lack of electronic chips. We'll build momentum back over the second half and into 2023. I think the nation's got to build between 800,000 and a million single family homes.

So, I think that's net opportunity as we look at the change..

And Julian, if you think about guides, we don't guide the residential business. We do give outlooks for Americas in total, but just – I'll just agree with you. We had that prior year comp in the second quarter that went up against last year. The second half for this year is much easier comps versus last year..

That's helpful. Thank you. And then just my second question would be around the, sort of the price cost dynamics.

Any updated thoughts around how that plays out in terms of margin impact in the back half? And I suppose based on the recent declines in spot commodity prices, when do you see those perhaps rolling into your gross margins in terms of the timing of those lower costs starting to help the gross margin? And do you think you can retain those savings when they come through or they might have to be passed back to the customer?.

Yes. So, Julian, as you think about price cost, we struggled at the end of last year. We got slightly behind and we put efforts to raise prices to get that price productivity inflation positive. We had improvement in Q1. In Q2, we are now positive.

Like we said, we would be as we look to the back half that continues to be positive for both quarters in the back half, we'll be positive for the full-year and price productivity inflation. We do have substantial inflationary pressures in the back half and we've taken additional pricing actions to mitigate that.

As a result, you'll see that price productivity inflation positive, as well as margin expansion in the back half. If you think about commodity prices, those spot prices are coming down. As you see from the public markets, they're still elevated versus, say historic norms.

Any decrease in commodity prices is not something 2022 we feel because we've been putting in those purchase orders to ensure that we had adequate parts and inventory to meet that demand that we have. So, as you think about price productivity inflation, think of it as a net plus in the back half full-year and we're back to expanding margins..

Great. Thank you..

Thank you. Next question is from the line of David MacGregor with Longbow Research. Please go ahead, sir..

Hi. This is Joe Nolan on for David. Congrats on a nice quarter, guys..

Thanks. Hi, Joe..

So, I was just wondering within the Americas non-residential business, can you just talk about how distributor inventories look? And also just wondering, are you seeing any increase in order cancellations or signs that distributors maybe getting more cautious about holding inventory in a slowing macro environment?.

I would say, as we think about distributor inventory and wholesale pull through, I would say it's normalized. Remember there was a big to pull back 15 months ago as we entered COVID. I would say it's normalized. Wholesalers typically play the price increase gain intelligently.

They'll bring in those orders earlier ahead of a price increase to create a margin opportunity for themselves, but I would say they are solid. There are some deficiencies within our portfolio, which would be electronics, which will improve over the second half of the year. I would say, second half of the question..

Yes, I would say that the – if you think of our business, we've had such supply chain challenges last year. So, as we move forward to this year, our distribution base is looking for product. So, we have very healthy backlogs. Demand is very strong, elevated backlog. So, as we move forward, we feel very confident about the non-residential business..

I would also say, touch base with our teams on cancellations, not seeing it. There's a demand for product flow. There's a very strong construction backlog right at nine months and the indicators would suggest work in for a good 12 months to 18 months of non-residential activity..

Got it. Okay. Thank you. And then just as a quick follow-up on the Access Technologies business, can you just talk about what this acquisition adds revenue wise to your aftermarket business and whether it would be accretive or dilutive to margins on the existing business? Thanks..

Yes. If you think about Access Technologies, when we announced it in April, we talked about that 38% of the business was service revenue. Our business today, we don't have service revenue to a substantial level, especially in the Americas. We have some out in the international, but in the Americas, we don't have that service capability.

So, this is a great asset to add to our existing portfolio as we leverage their strengths with our Allegion Americas strengths..

I would add that in our vision of seamless access and smart connected edge devices on the doors, the service component becomes required by our customers and the ability to grow recurring revenues through services, we like the opportunity..

And I think you also asked about margins. When you think about Access Technologies, we gave some guidance in the April call, how that business is, think of it as a mid-teen EBITDA margin..

Got it. Okay. Thank you very much. I'll pass it along..

Thank you. Next question is from the line of Brett Linzey with Mizuho. Please go ahead, sir..

Hi, good morning and congrats today, best of luck, and welcome to John..

Thank you..

Thank you..

Just wanted to come back to the electronics activity still continues to show just kind of uneven performance here with the chip constraints.

I guess as you've gotten closer to the redesigns and some of these new suppliers coming ramping up here, I mean should we see the electronic growth snap back here in the second half or do you expect this to be still uneven for the next few quarters as you kind of work through some of those new product designs?.

Brett, as you think about revenue growth, so much of it has to do with the prior year comparable. Electronics growth should be better in the back half from a growth percentage as you think about prior year. In addition, we are seeing signs of improvement related to the activity we've been driving on the product redesign.

So, both those areas should lead to better second half growth than what we experienced in the first half..

Okay, got it. And just coming back to the reporting convention and thinking about the guidance framework and now rolling in Access Technologies, have you considered ever moving to ex-amortization? I mean, it is a big number, so that's question one.

And just the follow-up would be, within this new framework, are there any one time items related to integration or anything that we should be thinking about maybe don't repeat, sort of the second half of the year ownership?.

Yes. So, if you think about the one-timers we backed that out of reported EPS to get to our adjusted EPS, right? So, if you look at our guide, we have that at the bottom of the schedule. With respect to amortization expense, we started the year obviously with our guide.

We're using the same presentation that we have when we started the year, but clearly identifying that amortization drag because it is significant for Access Technologies. We're going to get through 2022 using this presentation.

With respect to the future, we can tackle that in the future, but when you think about 2022, we're going to have that amortization in the adjusted EPS, but we're going to clearly show it to you and provide it to you so you can have all those details..

Okay, great. I will pass it along. Thanks..

Thank you. Next question is from the line of Brian Rutenberg with Imperial Capital. Please go ahead, sir..

Yes, thank you very much. A couple of quick questions.

In your guidance for 2022, what do you assume the supply chain will do? Will it get better, worse, the same? Just want to know what are your assumptions are around the supply chain?.

Yes. As you look at our guide for the back half of 2022, we are seeing improvement, especially in the mechanical space in the non-residential business. This is attributable to all the sourcing actions we've taken over the last year.

So, as we think about that non-res growth, right, that high teens that we had, part of that is attributable to a better supply chain due to our activity. Our back half is taking into account what we've known we've done and chips that our partners have committed to get to us or provided us.

Chips are always fragile, as you know, that can move, but this is not seeing a [sea change] [ph] of improvement that we don't have line of sight to. So, if you think about back half, think of it as the activity we've driven is helping provide better confidence in our ability to meet our customers' needs..

I would add two. If you look at some of the macro numbers, [Institutional Supply Management] [ph], deliveries across the board to all industrial players have improved. I'd say number two, the system of all manufacturers remain fragile, a port strike, COVID surge, puts a level of uncertainty that we've grown to navigate, but it remains fragile.

And I'd say, the extensive work Allegion has done on the mechanical and electronics positions us nicely for the second half. We’d factor that in. I think we're not alone. The electronic flows for chips and other components is improving and that will benefit Allegion in 2022 and nicely steps up in 2023..

Great. Thank you..

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back to our Executive Chairman, Dave Petratis, for any closing remarks..

Thank you. This concludes my 56th earning call as a CEO. The balance here at Allegion. This will likely be my last call. I want to thank our shareholders and the financial community for their support over the years. I also want to thank Nelson Peltz and Mike Lamach for the opportunity to create and lead Allegion.

I want to thank Kirk Hachigian and the Allegion Board. Kirk has been with me since the day one. Kirk and the Allegion Board has helped create this company and guide us to where we are today. Last, a heartfelt thank you to the people of Allegion worldwide. You have a great new leader in John Stone. We have done some great work together.

Allegion, your best days are ahead of you. Be safe, be healthy, and thanks for all your contributions. Have a great day..

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