Allegion plc ALLE CEO Dave Petratis on Q3 2020 Results

Good morning and welcome to the Allegion 3rd quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your touch-tone phone. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Tom, Vice President of Investor Relations and Treasury. Please go ahead.

Thank you, Andrew. Good morning everyone, welcome and thank you for joining us for Allegion's third quarter 2020 earnings call. With me today are Dave Petratis, Chairman, President and Chief Executive Officer, and Patrick Shannon, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning, and the presentation which we will refer to in today's call are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to slides number two and three. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Dave and Patrick will now discuss our third quarter 2020 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 re-enter the queue. We would like to give everyone an opportunity given the time allotted. Please go to slide four and I'll turn the call over to Dave.

Thanks, Dave. Good morning everyone, thank you for joining today's call. Please go to slide number six. This slide reflects our earnings per share reconciliation for the third quarter. For the third quarter 2019, reported earnings per share was $1.40. Adjusting seven cents for the prior year restructuring expenses, integration costs related to acquisitions, and debt refinancing costs, the 2019 adjusted earnings per share was $1.47. Favorable other income and interest expense increased earnings per share by 15 cents. The increase was driven by an approximately $14 million non-cash currency translation gain related to the liquidation of a legal entity in our EMEA region. This benefit would not be expected to recur in 2021. Favorable year-over-year tax rate and share count combined to provide another positive eight cents per share impact. Operational results decreased earnings per share by three cents driven by volume deleverage that was nearly offset by favorable price and productivity exceeding inflationary impacts, as well as favorable currency. This results in adjusted third quarter 2020 earnings per share of $1.67, an increase of 20 cents or approximately 14% compared to the prior year. Lastly, we have a nine cents per share reduction for charges related to restructuring and impairment costs. After giving effect to these items, you arrive at the third quarter 2020 reported earnings per share of $1.58. Please go to slide number seven. This slide depicts the components of our revenue performance for the third quarter. I'll focus on the total Allegion results and cover the regions on their respective slides. As indicated, we experienced a 3.4% organic revenue decline in the third quarter. The COVID-19 pandemic continued to have an impact on the top line number, although we did realize the benefit of delayed projects from the prior quarter. As shown in the trending chart, revenues rebounded nicely but were short of the very strong quarterly results in the prior year. Despite the difficult and uncertain times we were operating in, the overall business performed very well, particularly in the supply chain and meeting customer requirements. It is also important to note that price remains solid in the quarter, which slightly offset the volume pressure. Currency also provided a tailwind to total growth and more than offset the impact of the divestiture of our businesses in Colombia and Turkey. Please go to slide number eight. Third quarter revenues for the Americas region were $539.1 million, down 5.1% on a reported basis and down 4.6% organically. The decline was driven by volume challenges on the non-residential business due to the COVID-19 pandemic and was partially offset by good price realization and strength in the residential business. The non-residential business was down low double digits. Conversely, residential bounced back nicely and grew at a low double-digit rate. The Americas electronics revenue declined in the mid single digit range as discretionary commercial projects are delayed. We see electronics and touchless solutions continuing to be long-term growth drivers and expect electronics accelerated growth to resume when market conditions normalize. Americas adjusted operating income of $166.6 million decreased 5.1% versus the prior year period, and adjusted operating margin for the quarter was flat. Discretionary cost actions, restructuring benefits, and material deflation mitigated the impacts of volume deleverage and unfavorable mix. Please go to slide number nine. Third quarter revenues for the EMEA region were $148.4 million, up 7.7% and up 2.9% on an organic basis. The organic growth was driven by strength in the global portable security and SimonsVoss businesses, as well as solid price realization. Favorable currency impacts contributed to total revenue growth and was slightly offset by the impact of the divestiture of the business in Turkey. EMEA adjusted operating income of $17.1 million increased 42.5% versus the prior year period. Adjusted operating margin for the quarter increased by 280 basis points. The margin increase was driven primarily by price and productivity exceeding inflation. Productivity was bolstered by benefits from lower operating costs from the restructuring actions taken earlier in the year and discretionary and variable cost reductions. Please go to slide number 10. Third quarter revenues for Asia-Pacific region were $40.9 million, down 4.2% versus the prior year with an organic revenue decline of 6.8%. The decline was driven by continued COVID-19 related impacts and weakness in Korea. Our Australia business performed quite well despite the ongoing pressure in Australian end markets. Currency tailwinds offset some of the organic revenue decline. Asia Pacific adjusted operating income for the quarter was $3.2 million, a decrease of $1.2 million with adjusted operating margins down 250 basis points versus the prior year period. Of note, the prior year operating income includes a $1.1 million favorable one-time item related to the recovery of previously remitted non-income taxes. This had a 260 basis point favorable impact on Asia Pacific margins in Q3 of 2019. Excluding that, margins were essentially flat year over year, with the volume deleverage and unfavorable mix being offset by favorable price and productivity exceeding inflation. Please go to slide number 11. Year-to-date available cash flow for the third quarter 2020 came in at $256 million, which is an increase of just over $26 million compared to the prior year period. The increase was driven by improvements in working capital and reduced capital expenditures which more than offset lower net earnings. Our strong cash flow generation has been an asset to the company. This was evident in the third quarter and will continue to serve us well during the current market environment. Looking at the chart to the right, it shows working capital as a percentage of revenues decreased based on a four-point quarter average. This was driven by reduced working capital needs from the lower volume as well as strong collections performance. The business continues to generate strong cash flow, and we remain committed to an effective and efficient use of working capital. We will continue to evaluate opportunities to optimize working capital and drive effective cash flow conversion. Please go to slide number 12. Our financial liquidity position remains extremely solid. Our net debt to EBITDA ratio is 1.6 based on the last 12 months performance. Our debt covenants are well within the required limits, and we have no near-term debt maturities. Our $500 million credit facility remains untapped. Our quarterly dividend in 2020 increased 18.5% through the third quarter. This is the sixth consecutive year of annual increases. In addition, with strong operational execution and cash generation, the increased cash position since the beginning of the year and better visibility into business conditions, we have resumed share repurchases under our previously authorized $800 million program. As you have heard us say numerous times, we put our excess cash to use as part of our commitment to a flexible and balanced capital allocation strategy. I will now hand it back over to Dave for an update on our full year 2020 outlook.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Please note, you may ask one question and one follow-up and then you may re-enter the queue. At this time, we will pause momentarily to assemble our roster. The first question comes from Chris Snyder of UBS. Please go ahead.

Thank you for the question. Could you just maybe unpack the Q4 guidance a little bit? I guess specifically as it relates to the resi and the non-resi piece in the Americas? And then maybe just following up on the resi piece, I certainly understand your comments on the resi new construction cycle picking up and we've had low household formations for a long time now, so certainly see that view. But I guess specifically as it relates to maybe the restocking cycle, I know there was the Q2 supply chain disruption. Has that restocking cycle fully been realized at this point? Maybe what's kind of like the runway that you see growth just on that end?

Thank you for that color. Very much appreciate it.

The next question comes from Ryan Merkel of William Blair. Please go ahead.

Hey, thanks. Good morning. Nice quarter. Thank you. So first off, Americas electronics revenue down mid single digits is much improved. You gave some remarks that the trend of touchless access is real and happening. Do you expect this business to turn positive in the fourth quarter? And could electronics provide some offset to weaker underlying commercial trends in 2021, or is that a bit of a reach at this point?

That's super helpful. Thanks for that. And then I want to follow up on the four key guide. Maybe ask it a little differently. It seems to imply Americas revenue down mid single digits year over year with flatish margins just like this quarter. So if I have that right, why is there not more improvement in the Americas business in 4Q?

Yep, thanks. For passing on the next question.

The next question comes from Josh Bokowinski of Morgan Stanley. Please go ahead.

Hi, good morning guys. Dave, just coming back first to some of your comments on the channel or push that's necessary in res. And appreciate that kind of side point on maybe some of the interruptions on the electronic side that kept fulfillment maybe capped there. Would you mind quantifying how big of a replenishment still needs to happen? You know, if I remember your comments last time, it was kind of through one queue. Now it sounds like early 2Q, so maybe a bit of a push out there. But you know, how many weeks of inventory or points of demand however you want to put it, does the channel need to kind of get back to normal levels on the resi side?

Great, appreciate that color. And then just a follow-up. Dave, I appreciate that even going back to April that you've been cognizant that the current environment probably doesn't support an awesome 2021 for non-res. I think that's now much more apparent to a broader range of folks. If I kind of take some of your comments as a time series starting from the first quarter earnings, it doesn't really sound like much has changed in the outlook as you guys have seen more data come through and have gotten closer to next year. If anything, some of the bond issuance commentary sounds a bit more supportive than what we would have known back then. Is that reading it right? I mean, how do you feel versus some of those early observations when we were in the first half of the year and this was all still fresh?

Got it. Great color. Thanks, Dave.

The next question comes from Joe Richie of Goldman Sachs. Please go ahead.

Thanks. Good morning, everybody.

Hey, Dave. Just to, you know, I hate to harp on the 4Q commentary, but I just want to make sure I understand it, particularly in America. So it sounds like on the residential side, things are very strong, right? Your backlogs are record levels, electronics is supposed to be up in the fourth quarter. So the implied step down then in 4Q is that just non-res is going to get worse in 4Q versus 3Q? And maybe just any color intra-quarter on how trends played out in non-res would be helpful.

Okay, great, I appreciate the clarification. And then I guess the follow-on question thinking about this a little bit longer term. Ahead of the pandemic, you guys were pretty front-footed in discussing some of the not just supply constraints but really labor constraints in some of these projects moving to completion. I guess as you think about the institutional or non-res markets and what you have in your backlog, how much more visibility do you have into 2021? And how much more backlog you have to complete? I'm just trying to understand how much we've worked through versus what's left to complete before we head into 2021.

Okay, great. Thank you. Thank you all.

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

Hi, good morning. Maybe just moving away from the top line for a second. Very good productivity performance in the quarter with margins up year on year. You booked some more restructuring charges. So maybe as we look at 2021, is there any way that you could describe the sort of carryover fixed cost savings into next year that should support margins? And any sense around perhaps temporary costs that might flow back into the P&L? Really just trying to get a sense of any major moving parts for margins next year aside from volumes.

Yeah, Julia. I would characterize it this way. You may recall in the last quarter conference call we kind of outlined what we are doing this year, this 80 million kind of cost reduction takeout for 2020. And we characterized that as kind of three components: discretionary, variable, structural permanent type of cost savings. And if you look at those specifically on the permanent structural cost savings to answer your question, we've been at it pretty solidly over the last couple of quarters. We're now hitting full stride in terms of the cost takeout associated with that. We've identified some additional measures as well that will help us into 2021. So there's carryover benefit particularly in the first half of 2021 that will help mitigate some of these variable components that boomerang back next year. So I look at those, maybe we're a little upside down if you kind of look at those two independently and sum them up. We will continue to evaluate our cost structure going forward and adjust as necessary based on future demands. We're always looking at that. However, we will continue to invest in the business; that's a core part of our strategy, particularly on the seamless access and growth opportunities associated with that, to really position us well on the growth prospects associated with that going forward as we exit COVID-19. So there's going to be some pressure there relative to those components, and then you're going to have unfortunately unfavorable mix associated with strength in residential better than anticipated and some continued softness associated with the non-residential markets.

Very helpful, thank you, Patrick. And maybe my follow-up would be also away from the top line, just on the balance sheet. I think in the prepared remarks around cash usage, you'd mention that the buyback may be resuming. So maybe just help us understand the appetite for share buybacks, how quickly you want to get underway on that, and how attractive M&A opportunities are today.

Great, thanks Dave and Patrick.

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

Hi, yes, good morning.

I just want to dive in a little bit in institutional markets specifically, education and health care. If I look at the bond issuance here to date, I think as of end of September, education bond issuance was up almost 40% and healthcare I think was down 2%, effectively flat. So within this dynamic, in education the pushback we're getting is that we are going to have new bond issuance in November. I guess people will vote for it, but how what are you hearing from your customers on the education side about the fact that I guess some people they are getting tuition but maybe they're not getting rents for the dorm rooms? So how much pressure is education sector under? And then for healthcare, the issue there is elective surgeries which are coming back, but how are the conversations going with the health care providers in terms of whether they get back to normal? So that's sort of part one. Education and health care, what are you seeing in those two verticals into next year?

And just a follow-up question. Can you just give us any color on what's happening with your market share in discretionary retrofit market? I know it's been a big initiative, you guys have done very well, I believe you continue to do well. But any color on what's happening there?

Fantastic and congratulations, well-executed quarter.

Thank you, Andrew. The next question comes from Tim Weisz of Fair. Please go ahead.

Good morning. Hey, guys. Nice job on the margins. Maybe just the only question I have is just on pricing. As you kind of look at '21, maybe some choppiness in non-res continuing into next year. Any change in how you guys think about pricing in the out years? And really just asking because we are starting to see a little bit of incremental raw material inflation popping up here. So just any commentary on how we should think about price.

Okay, sounds good. Thanks guys. Good luck on the rest of the year.

Thank you. The next question comes from John Walsh of Credit Suisse. Please go ahead.

Hi, good morning.

Just wanted to go back to the language you used around a snap back in the repair retrofit and small projects activity you're looking at or anticipating next year. You talked about that large mobile project which will hit next year, but I'm curious today if you're seeing your customers make those touchless upgrades in the back half of this year or if it's still more of a conversation with them anticipating doing more of the projects next year.

Gotcha, no that makes sense. And then, you know, just thinking about earlier when you were talking about the seamless opportunity, you did use the term 'thinking about the readers.' As I kind of have historically thought about Allegion's position in that product, it was smaller relative to one of your competitors. But how important is having the reader as part of the solution as these customers shift into that seamless world? Is that some place where you need to get bigger? Just trying to understand how that works.

Great. Appreciate that color. Thank you.

The next question comes from Deepa Raghavan of Wells Fargo. Please go ahead.

Hi, good morning all.

Good quarter, by the way. Two questions for me. First one, Dave, can you talk about the momentum or the revenue growth that you're seeing in products that are driving this post-COVID world with touchless, seamless, contactless, Apple iPhones, etc.? These look like strong renovation opportunities. So why would you not see continued tailwinds into first half of next year versus your commentary for a snapback only in second half? And also, can you touch upon how creative these tech-heavy products and software is to your margins? And I have a follow-up.

Yeah, sure. So Deepa, on the margin profile, the electronics would be similar type of margin as your traditional mechanical, but a higher selling price and therefore more even dollars. So to the extent we can continue to push electronics, which we are and we will, that benefits us from an earnings growth perspective.

Great. My follow-up, Patrick, was more on the residential electronics locks performance. As you mentioned yesterday, your smart lock business in residential grew high double digit percent. Q3, did you see similar kind of strength?

Deepa, I would say this: if we didn't have the supply disruption from a supplier, we would have had one of the strongest residential quarters in the company's history.

Oh, got it. Great. Thanks for the color.

The next question comes from David McGregor of Longbow Research. Please go ahead.

Hi, good morning. It's Colton on for David.

I guess can you start by walking us through how the residential point of sale growth played out in the quarter and any new trends you're seeing there?

That's great. I appreciate that. And then as a follow-up, you mentioned some supplier headwinds in the third quarter related to electronics. Can you give us an update on where your supply chain stands today for the segment and if there are any risks that could limit growth in the near term?

Great. Thanks for the color.

The next question comes from Jeff Kessler of Imperial Capital. Thank you.

Thank you. Good morning, guys.

Can you break out EMEA and Asia Pacific just a little bit? Granted they're small, but the fact is that at some point India has to grow again. Where, let's call it vertically and geographically, what was stronger and what was weaker in EMEA?

Great. And in the US now, you used the word NFC. I'm assuming that NFC becomes a key part of the touchless wireless three levels of authority technology. Are you going to be using multiple technologies? Will it be mainly around NFC or will you be adding various types of Bluetooth? I know I'm getting out in the weeds, but the question involves how flexible you are going to be in terms of those technologies. What are people asking for? What are people negotiating for with you? Have they just heard that Apple has taken this on as well and now it's basically going to be a standard? Or are you getting different types of demand for different types of wireless technology per vertical or per type of end user?

All right. Just as a last follow-up to this, as far as getting this out there, was this at the beginning going to cost you more to get these technologies? You've obviously had wireless technologies coming out into the marketplace for several years now, but are these new technologies going to cost you more to get out there? Or as you said before, the ultimate margins remain about the same? Where do the innards of those margins differ from mechanical?

That's great. Okay, thank you very much. Be safe.

This concludes our question and answer session. I would like to turn the conference back over to Tom Martino for any closing remarks.

Hey, thank you. And we'd like to thank everyone for participating in today's call. Have a safe day.

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