Allegion plc (ALLE) Earnings Call Transcript & Summary

Great. Good afternoon. Thanks for joining us. I'm Tim Wojs, I cover building products here at Baird. We're delighted to have Allegion join us again this year at our Global Industrial Conference. Allegion is a global provider of security and access control solutions. They offer mechanical and electronic products that keep people safe and assets safe. Their key brands include Schlage, LCN and vonduprin. From the company, we have President and CEO, John Stone, and we have CFO, Mike Wagnes, up on stage here with me. Maybe, John, if you could just start off with a kind of prepared remarks, just kind of state of the union, and then we'll hop into Q&A.

Yes, you bet. And I appreciate it, Tim. It's been a great conference so far. Thanks for everybody attending I think those of you who have followed us, you know who we are and what we are, as Tim said, pure play in security and access. We're overweight North American nonres. We have highest margins, great brands and a good industry structure. I think notably, we've seen North American nonres inflect positively lately, which has been good to see after a couple of tough years post pandemic. And I'd say the electronics tailwind that we've talked about for some time is very much intact. So as our industry continues to digitize and electrify, we feel we're an innovation leader in that space and continue to see electronics being a high single-digit growth driver for the business.

Okay. Okay. Great. Thanks. If anybody has any questions, you can just kind of raise your hand here. Maybe just, John, like I don't -- you don't have specific guidance for 2027, but just as you kind of think about next year, what's kind of the big picture kind of swing factors, either positive or negative to keep in mind? When are you thinking about kind of the top line?

Yes, great question and certainly top of mind for a lot of folks here at the conference. And as is typical with our third quarter earnings, we did provide a slide and some commentary, at least as an early view into 2027. And I think the overarching headline is we feel good about the nonres environment. The spec activity we've been talking about for the last several quarters now continues to be strong. That strength is broad-based. And I'd say non-res could look a lot next year like it looks this year in terms of overall growth. some price realization, some volumes. So what that exact mix is, isn't that important right now, but I'd say we feel good about non-res. On international and resi, we've told you, we're not calling market bottoms or anything like that. But I'd say it continued to be soft markets. Really, when we think about swing factor going into the year, Tim, I would just probably look at resi. We're not contemplating a res recovery. But if conditions changed and they're less some. I think that would certainly be upside to the way we're looking at 2027 right now.

Okay. Maybe just on nonres, I mean, there's been a lot of, I don't know, kind of conflicting messages from different companies on kind of the nonres market in '27. I think over the course of this year, you've kind of been talking about kind of building as you've kind of gone through the year. So maybe just talk about the composition of what you're seeing in kind of the backlog? And are there any specific end markets that you've got better visibility to or might differentiate you guys versus some other people?

Yes. It's a fair question. I'd say just with a point of clarification around the specifications that we write. It's very early in the design phase, consulting with an end user consulting with an architect or a general contractor or all of the above. and it's related to establishing end-user standards for doors and door hardware. That specification typically, as a rule of thumb would be we see that turning into revenue 12 to 24 months later. So it's not like a backlog like you might have in some other industry spaces. But our specativity has been very strong, both in the number of specifications we're writing as well as the dollar value I'd say some verticals obviously stand out. Certainly, data centers are growing very, very fast. We've carved out what I feel is a very strong competitive position there with a hardware. -- and I think have established a strong end-user standards and specifications with the who's who of hyperscalers -- so as those designs go more modular, I think that also plays to our strengths as that's a bit of a trend you might pick up on from time to time. But the specification data would show us broad-based strength. And data center, we quantified 5% of our nonres revenue. So that's quite a bit smaller than the large institutional verticals that would be more on the range of 50% to 60% of our nonres business. And those verticals are showing growth. What's different in recent months than the past couple of years would be the commercial vertical office and multifamily are no longer the headwinds they were back in '22 through '24. So some bits of green shoots here and there in different places. But overall, good, I think health care has been another area, just a bright spot when you look at the institutional verticals of strength.

Okay. And has the -- I don't know if you guys you may get this level of detail you may not, but like are you seeing new construction be a similar amount of the backlog and R&R be similar? Or is there a mix difference between those 2 in terms of what you're kind of seeing in the spec backlog?

Yes. Very fair. At a high level, I would always encourage you to think of our business as 50-50 split. Those aren't super precise numbers, but 50% aftermarket, 50% new build. Does it fluctuate from time to time in any given year. Yes, maybe some, but 50-50 is a good way to think about it. And I'd say, again, back to the data center comment, that's all new build right now. So it would skew that direction, but that's also the next large installed base that we're building.

Okay. I guess on that, I mean, what have you done in the data center business to kind of carve that out? I mean, is it your same competitive set? Is it somebody different? Do you feel like you're kind of share. Maybe just kind of talk a little bit about maybe what you're doing in the data center, kind of what you purposely built out and how that compares to others.

Yes. It's a great question. I'm really proud of the team and proud of how we've tackled this one. it really plays to our strengths, and we run our playbook. So get in early with the end user. These are end users that we're looking for standard sets of construction plans and materials, if you will. So as they expand, they don't have to reinvent the wheel every time, right? They can take a standard set of, in our case, doors and door hardware and then extrapolate that as they grow. That plays exactly to our strengths. That's the playbook we're running. Feel really good about that. Some recent acquisitions have played a role here, too. If you look back to 2024, we acquired a company called Kroger Specialty Products, and they make doors. These are different than our standard Hollimetal doors and custom-made to very high security environments and also a data center environment because you have needs to not only lock and secure for human traffic, but also to provide RF interference resistance and sound mitigation transmission through the door. So a piece of wood with a hinge and a pull like over here. Cheap door. A data center door. This is a premium product in and of itself.

Okay. Okay. So it's been a combination of kind of deliberate kind of focus on your side, but then also some M&A that's kind of open up.

It run the playbook, be that trusted adviser, be that partner of choice to help consult all of the entry and egress that they need. -- in a very high security environment and then help them standardize that playbook as they grow. So it played right to our strengths.

Okay. How are you -- I mean, you guys have a really big kind of spec specing network, if you will. I guess how does that compare to the competition here in the U.S.? And how are you kind of implementing AI there to maybe improve just the the content, the ability to serve, those types of things.

Great question. And really, Tim, there's 2 of us. There's -- we and our largest competitor that have in the capability, the expertise and the human capital to write specifications and be the consultative adviser smaller short liners with narrow product portfolios are not going to compete in the same way that the 2 large guys do. I do think that has meant over the last few years that the 2 largest competitors have probably gained share versus some of the smaller guys. That trend will probably continue because we are seeing project size gradually tick up -- so the complexity gets a little more as well. With respect to AI, Allegion has been all in on AI since 2022. We've got a dedicated team, central lead. We've got private behind our firewall instances of the leading -- we use it all across the company in different functions to include spec writing on the specs themselves, think of it as being that automated workflow that speeds up response time to -- or request for quote or speeds up response time to a change request as the project is happening. The other thing to keep in mind is some folks want to ask about the risk of AI and spec writing, like what if some kid in a garage with a start-up right a spec will have to pick a hardware set. which one do you think they're going to pick. They're going to come to us, right? I mean even alphabetically, we have an advantage over our largest competitor -- but I think, again, we don't make money off of the specification. That's really just the end-user relationship and the value that we add to the architect because architects don't want to deal with doors and door hardware anymore. So we do it for them. the money is made on the hardware itself. That's where we add the value.

Okay. I mean you've said a couple of times that project size in complexity is increasing. Is that just sheerly the types of projects you're doing? Or are you getting more content, electronics per square foot, and it's making those projects actually become.

Yes, that's a great question and great way to ask it. I think the overall trend we have seen is project size has just been trending up over time. Certainly, with the bolt-on acquisitions we've done -- we do have a higher share of wallet in a lot of projects. We do have a more robust portfolio at this point. In addition to the organic R&D new product development we've been doing. We highlight both on our quarterly earnings calls. So you can see that progression over time. So yes, it's probably a bit of both. It probably is some share of wallet. And then also just a market phenomenon as well. Project size has been trending.

Okay. How do you think about kind of new technologies and R&D and kind of development of those? I mean, electronics is a big kind of part of it. There's some stuff that, I guess, an access control that could get kind of really cool in a couple of years if you're just kind of walking around an office and it kind of knows your credential and you can just open a door. How close are we like things like Bluetooth or phone credentials becoming kind of more broadly adopted?

Great, great question. And I think look at higher ed as a good case study. Higher ed university campuses were early adopters of electronic locks a decade ago. You see -- and we talk about it, the cliche, you'll hear in the industry space is an Elo versus this mechanical counterpart twice the price, half the life -- so that shorter life cycle is starting to come to roost, to be honest with you. We're seeing higher ed in particular, upgrade old e-locks for new e-locks for just that kind of functionality to where my phone is my identity through the smartphone wallet. It's my credential. It's how I move around campus. -- and that security is personalized to me. So it's a more modern student experience that the universities are looking for, and it's also more secure. So that upgrade cycle is happening. We've got the technology where it's in a resi lock right now that has been released, and that's frequently a good engineering sandbox. You can release new resi pretty quickly. The mega techs like to work with us there. to where just walking up to the door through ultra wide band between the phone and the lock our lock understands your position, it understands your direction of travel and then infers your intent. Are you just walking by the door? Or are you walking to come through the door and it will display that intent to you and unlock as you approach if your intent is to come in. So that's there. We do see commercial potential for that, then look forward to rolling that out.

Okay. How do you guys think about software because you're a very big product company, but then there's a software kind of or kind of an element to it. So just how are you kind of thinking about software and kind of making sure you're kind of getting your fair share there while still kind of being like a very good product company?

Absolutely. It's a great question. And I think AI has made that space even more interesting to a company like us. So for a long time, we've been doing all of the better software and the lock itself or the other piece of hardware itself and then making sure that, that embedded software interacts with the access control system of whatever building we're in. In recent years, we have introduced our own access control system targeted first at multifamily because we saw that as a really underserved vertical that is a place where we've got great product reputation. But as your point now, we can wrap some access control software that differentiates our locks a little bit further, a very simple, easy to use, easy to set up tool, which is what that vertical needs. We do plan to expand that to other verticals as we go. The AI tools like Cloud, in particular, software development, a lot easier. So it gives a hardware company like us quicker path and a more capable path to market with tools like that, whereas hardware is still hard and still capital-intensive. So I feel really good that the hardware guys ability to move up stack into some of that software just got a lot easier.

Yes. Okay. Okay. And I guess on -- how would you kind of think about the electromechanical businesses if you had to delineate between kind of residential and kind of nonresidential. What are it sounds like there's an upgrade cycle and some of the early adopters of higher ed. What else are you seeing in electromechanical and kind of the nonres base? And then what about the res space?