Allegion plc

Good morning and welcome to the Allegiant third quarter 2021 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's questions, 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 Martineau, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Andrew. Good morning, everyone. Thank you for joining us for Allegiant's third quarter 2021 earnings call. With me today are Dave Petratis, Chairman, President, and Chief Executive Officer of and Patrick Shannon, Senior Vice President and Chief Financial Officer of Allegiant. 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.allegiant.com. This call will be recorded and archived on our website. Please go to slides 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 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 2021 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. 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, Tom.

Good morning and thank you for joining us today. Before we go into our third quarter results, I'd like to take a minute to acknowledge and congratulate my fellow Allegiant team members for their ongoing dedication to the environment, society, and governance. I'm humbled and honored to share that just last week Allegiant was recognized for ESG leadership through two different awards. the Robert W. Campbell Award, and the Jackson Lewis Diversity, Equity, and Inclusion Champion Award. The Campbell Award is an annual recognition by the National Safety Council, America's leading nonprofit safety advocate. It is the premier award for excellence in integrating environmental, health, and safety management into business operating systems. Winners have strong processes and show measurable achievement over a five-year period in EH&S performance that leads to productivity and profitability and are expected to demonstrate a long-term track record of not just EH&S compliance, but also critical improvements. The prestigious award is also known for its rigorous application process with a systematic review and audit attached to it. Submissions are reviewed by management, labor, academic, and government experts from around the world, followed by a meticulous audit format at three or more of a company's global sites. With this in mind, Campbell Award winners are an elite group of organizations. Past winners include Boeing, Cummings, Dow Chemical, DuPont, Honeywell Aerospace, and Johnson & Johnson. Allegiant is proud to have our name added to this best-in-class list. We are also excited to have been named the Jackson Lewis Diversity, Equity, and Inclusion Champion by the Indiana Chamber of Commerce. This is a statewide honor that recognizes an organization making significant strides in the workplace. The judge noted that Allegiant was chosen as its first ever winner of this award because of our company's proactive and intentional diversity, equity, and inclusion efforts around the globe. We have strong momentum on our diversity efforts, and we know there's more work to be done. We're not asking the people of Allegiant to agree on everything, but we need to be a place where racism and bias are rejected. where inclusion is a way of life and where all employees feel they belong and can contribute to our business success. Importantly, I've shared before that Allegiant's ESG commitments are vital to how our company achieves results and the way we do business. ESG excellence will give us better long-term outcomes across the board. Better employee safety, better employee engagement, better productivity, better creativity, better innovation, and stronger financial performance. We see this firsthand, and external data points to it as well. Please go to slide five. During the quarter, we experienced continued strength in demand, particularly in the America's non-residential market. This trend began in Q2 and accelerated through Q3. Leading indicators like ABI and Dodge New Construction indices remain positive. Increased demand is for both discretionary projects and new construction and is across all verticals and product categories. The recovery has been faster than we originally anticipated and is expected to continue in the foreseeable future. Residential and market demand is also favorable across both retail point of sale and new home construction. The strength in demand continues to constrain the global supply chain's ability to fully meet demand requirements. Similar to last quarter, this was especially prevalent in electronic components in Q3. As I'm sure you're aware, this is a global issue and not isolated to Allegiant or to any single industry. We have redirected resources and are taking actions such as reconfiguring and redesigning products, as well as developing alternative sources of supply to help alleviate the pressures we are experiencing in procuring electronic components. Additionally, material and freight input costs continue to accelerate during Q3. We now anticipate material and freight inflation to be approximately $60 million higher compared to last year. In addition to the supply chain pressures we are seeing for electronics, there are also widespread industry shortages of labor and other components. Once again, these issues are not allegiance specific, and we expect the global constraints driving these shortages to continue beyond 2021. These challenges led to margin deterioration in the quarter. We will leverage the strength of our supply chain management capabilities as well as price to help mitigate these impacts going forward. During the quarter, the continued road must demand coupled with the supply chain pressures resulted in record backlogs. approximately four times normal levels. We estimate that widespread shortages have delayed approximately 80 to 100 million of 2021 revenue. We believe this impact is evenly distributed across the third and fourth quarter. We do not believe this is lost revenue, but expect it will be recovered as supply chain constraints ease. Now let's turn to the third quarter performance for more details. Please go to slide six. Revenue for the third quarter was $717 million, a decrease of 1.6% on both a reported and organic basis. The organic revenue decrease was driven by lower volume in the Americas region related to the aforementioned electronics, components, and labor shortages. Currency tailwind and acquisitions offset the impact of divestitures. Patrick will share more details on the regions in a moment. Adjusted operating margins decreased by 330 basis points in the third quarter. Higher input costs, productivity challenges, and volume deleverage drove the majority of the decrease. Incremental investments, important to our future growth. caused 90 basis points of the decline. Adjusted earnings per share of $1.56 decreased to 11 cents or 6.6% versus the prior year. The decrease was driven by reduced operating income offset by a favorable tax rate and share count. Year-to-date available cash flow came in at $327.7 million, an increase of $71.6 million or 28% versus the prior year. The increased cash flow was driven by higher year-to-date net earnings, along with improvement in net working capital and reduced capital expenditures. Patrick will now take you through the financial results, and I'll be back later to discuss our 2021 outlook and wrap up.

Thanks, Dave, and good morning, everyone. Thank you for joining today's call. Please go to slide number seven. This slide reflects our earnings per share reconciliation for the third quarter. For the third quarter of 2020, reported earnings per share was $1.58. Adjusting nine cents for charges related to restructuring and impairment, the 2020 adjusted earnings per share was $1.67. Favorable tax rate drove a 13-cent increase in earnings per share. The negative tax rate for the third quarter reflects favorable settlements of uncertain tax positions, a benefit of mix of income, as well as the non-recurring unfavorable tax impact in 2020 related to certain valuation allowances. Reduced share count drove another favorable $0.04 per share. Acquisitions and divestitures had a positive $0.02 per share impact. Operational results decreased earnings per share by $0.21, driven by higher material and freight costs, productivity challenges, and volume deleverage, which more than offset the favorable impacts of price and currency. Investment spend increased during the quarter and reduced earnings per share by $0.06. As a reminder, the incremental investment spend is predominantly related to R&D, technology, and market investments to accelerate future growth. The combination of interest and other income drove another $0.03 per share reduction. This results in adjusted third quarter 2021 earnings per share of $1.56, a decrease of 11 cents or 6.6% compared to the prior year. Lastly, we have a 3 cent per share increase driven by a gain on the sale of an equity method investment, offset slightly by the combination of restructuring charges and acquisition integration expenses. After giving effect to these items, you arrive at the third quarter 2021 reported earnings per share of $1.59. Please go to slide number eight. This slide depicts the components of our revenue performance for the third quarter. I'll focus on the total legion results and cover the regions on their respective slides. As indicated, we experienced an organic revenue decline of 1.6 percent in the third quarter. The electronics, components, and labor shortages, primarily in America's region, had an impact on our ability to meet the continued strong demand. Still, we realized good price performance, which offset some of the volume decline. Currency continued to be a tailwind to total growth and offset the combined impact of acquisitions and divestitures. In total, reported revenue reduced by 1.6 percent. Please go to slide number nine. Third-quarter revenues for the Allegiant Americas segment were $524.4 million, down 2.7 percent on a reported basis and 3 percent organically. As previously stated, the supply chain pressures we are experiencing drove the revenue decline. We are still seeing strong market demand, which has resulted in record backlogs, particularly in the non-residential part of the business. The region continued to deliver good price realization. Our latest price increase went into effect at the beginning of October, so we expect the price realization to accelerate in the future. On volume, America's non-residential was down low single digits driven by the electronics components and labor shortages. America's residential was down high single digits. This was uniquely driven by the prior year being inflated by channel refill coming out of the pandemic shutdowns experienced in Q2 of 2020. The shortage of electronic components also had a negative impact on residential performance, primarily in the DIY space of big box retail and e-commerce. Electronics revenue was down high single digits, driven by shortages of electronic components in both the non-residential and residential businesses. Electronics and touchless solutions remain a long-term growth driver and is an integral to our investment and innovation efforts. America's adjusted operating income of $133.7 million decreased 19.7 percent versus the prior year period, and adjusted operating margin for the quarter was down 540 basis points. The decrease was driven by higher material and freight costs, productivity challenges related to inconsistent supply, and volume deleverage. Incremental investments had a 100 basis point dilutive impact on adjusted margins. Please go to slide number 10. The Allegiant international segment delivered another solid quarter. Third quarter revenues were 192.6 million, up 1.7 percent, and up 2.5 percent on an organic basis. We continue to see strength in our Simon's VOS, Interflex and global portable security businesses, which, along with good price realization, drove the organic revenue growth. Favorable currency and acquisition impacts also contributed to total revenue growth and were slightly offset by divestitures. International adjusted operating income of $21.3 million increased 4.9 percent versus the prior year period. Adjusted operating margin for the quarter increased by 40 basis points. The margin increase was driven primarily by volume leverage along with favorable impacts from divestitures and currency. The combination of price, productivity, and inflation were an 80 basis point headwind to margins. Incremental investments reduced margins by 40 basis points. Please go to slide number 11. Year-to-date available cash flow for the third quarter 2021 came in at $327.7 million. which is an increase of $71.6 million compared to the prior year period. The increase is attributed to higher year-to-date earnings, improvements in net working capital, and reduced capital expenditures. Our cash flow generation continues to be an asset to the company. Looking at the chart to the right, it shows working capital as a percentage of revenues decreased based on a four-point quarter average. The business continues to manage working capital efficiently and generate strong cash flow. I will now hand it back over to Dave for some comments on our full-year 2021 outlook.

Thank you, Patrick. Please go to slide number 12. On October 1st, we issued a prerelease to our earnings and updated our 2021 full-year outlook for revenue, earnings per share, and available cash flow. We are reaffirming those updated outlooks. We have talked at length about the demand strength in the Americans' business as well as supply chain pressures that are having an impact on our ability to meet that demand, which will delay an estimated $80 to $100 million of revenue. The outlook for total revenue in the Americans is now projected to be at 1% to 1.5%, with organic revenue growth at 0.5% to 1%. In the Allegiant International segment, we have not seen as large of an impact from component and labor shortages, and our Simons Voss, Interflex, and global portable security businesses continue to perform well. For that region, we expect total revenue growth to be between 12% and 13%, with organic growth of 9% to 10%. All in for Total Allegiant. Total revenue is projected to be up 4% to 4.5%, and organic revenue is expected to increase 3% to 3.5%. We are expecting reported EPS to come in in the range of $4.95 to $5.05 per share, and adjusted EPS to be between $5 and $5.10. Our outlook for available cash flow is projected to be 460 to 480 million. The outlook assumes investment spend of approximately 15 to 20 cents per share. The full year adjusted effective tax rate is expected to be approximately 9%. The outlook for outstanding diluted shares is approximately 90.5 million. Please go to slide number 13. As we close the presentation and move on to Q&A, I want to take some time to stress Allegiant's strong long-term fundamentals. First, even with the disruption caused by the global pandemic, our strategy around seamless access and electronic transformation remains strong. We expect electronic and seamless access solutions to be the future of access control, and we are using multiple innovation engines to lead the industry. You've seen proactive work from Allegiant through Allegiant Ventures, our recent acquisitions, like you know me, and in our InterFlex business, accelerating our software and tech capabilities. We're making investments and expanding partnerships with megatechs and leading access control platforms. We are making significant progress on our ESG journey. This is evident with the two awards that we received earlier this month. The Campbell Award given by the National Safety Council is a very prestigious honor, and we join an elite group of previous winners. I'm also proud of the Jackson Lewis Diversity, Equity and Inclusion Champion Award, which we received from the Indiana Chamber, which recognizes our proactive leadership in diversity, equity and inclusion. Congratulations to the Allegiant team. All markets in America remain robust. We continue to see positive trends from leading indicators like ABI, and the Dodge New Construction Index and expect these trends to continue into 2022. With the international segment, the strength in our Simons Voss Interflex and global portable security business persists. We have aligned and adjusted resources to navigate and adapt the supply chain pressures that the world is experiencing. Actions taken, including the redesign of products, the development of alternative supply sources, and we continue to leverage our pricing power. Allegiant's supply chain will continue to differentiate us, and the strength in our backlog would indicate that our channel partners believe we will navigate through the global pressures better than most. Demand remains strong. We have implemented pricing actions that will carry forward into next year, and there's substantial backlog to work down. With that backdrop and assuming supply chain pressures related to inflation and component shortages begin to ease, we expect solid revenue growth with year-over-year margin improvement and continued strong cash flow generation in the 2022. The future of Allegiant remains bright. Now, Patrick and I will be happy to take your questions.

We will now begin the question and answer session. To ask a question, you may press star then one 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. Again, please limit yourself to one question and one brief follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Joe O'Day with Wells Fargo. Please go ahead.

Hi. Good morning, everyone.

Good morning, Joe.

First question is just related to any visibility you have around the timing of relief from supply chain constraints. You've talked about this extending into 2022. Are you seeing anything out there based on conversations with your suppliers that gives you confidence in when you start to see some relief?

So my first observation, your past record sometimes is a predictor. Allegiant performed extremely well, you know, through the first phases of this pandemic. Number two is some of the strength of our supply chain adaptability was evident. If we had not adapted, made design changes over the last couple of quarters, our backlog would even be larger. So feel very good about the performance and the adaptability flexibility. It's clear the electronics is going to be a problem that all companies, including the Legion, will have to adapt to through 2022. I think an important element of the rest, and it's the complexity of the Legion supply chain, is the return of labor pressures to our partner suppliers. You know, this, you know, we'll have to continue to monitor. This is everything from castings to power supplies to wire harnesses. There's a labor scarcity across the globe. And, again, I believe our ability to adapt and our philosophy to produce in region will help Allegiant.

And then related to backlog and catch-up, and you made the comment about backlog being four times higher than normal, how do you think about managing that? So when you do start to get some relief in the supply chain, do you think about kind of ramping up to deliver to customers as fast as possible, which could then create some inefficiencies in a strain production system? Or do you think about managing that and maybe it takes time longer to deliver over time, but not straining the production system in that process.

So we've got a lot of experience in production systems, including the man that runs the company, me, 41 years. I think I like the backlog. I think if components applies, you know, if that regains health, we will actually pick up efficiencies. There's been gross inefficiencies through COVID, these supply chains. An important element is our ability to bring on and flex our own labor, and I've got high confidence in our ability to do that.

Great. Thank you.

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

Thanks. Good morning, everybody. Good morning, Joe. You guys talked about clearly lots of challenges in the marketplace today. I know that as you kind of think about the America's margins being down, you know, 500 to 600 basis points year over year, you had investments of about 100 basis points impacting the margin. Can you maybe parse that out a little bit more for us? Like, Do we know how much of it is coming from higher material and freight costs? How much of it is more kind of like the productivity issues? Just any other additional color around that would be helpful.

Yeah, Joe. So the significant portion of the margin degradation year over year is predominantly inflation and freight costs. And then, you know, we've got productivity challenges, you know, associated with some of the the component shortages and those type of things, creating inefficiencies at our facilities. So if you think about it relative to, normally we've done a good job in terms of managing the price inflation dynamic. We're underwater today as we kind of look at that, you know, price being lower than the incremental material and freight costs. That will get better. You know, as we kind of progress here, we're putting in more price increases to make up for the delta. One of the challenges is, you know, kind of given the high backlog and the fact that a lot of the backlog today is kind of price protected, you don't see the benefit of the price increases coming through and offsetting the incremental inflation until going into 2022. So, we're still going to be under pressure, you know, for the balance of the year. But inflation really accelerated, particularly when you look year over year, you know, on steel components and those type of things. So, it's one of these short-term phenomenas. You know, if you assume that inflation has kind of peaked today, you know, going into 2022, things will kind of continue to get better than we would expect to be on the positive end of the equation as we progress throughout 2022.

Got it. That's helpful, Patrick. And maybe just kind of following on there, as you think about then, you know, if it sounds like you're going to be underwater again in the fourth quarter, as you think about like the, you know, the pricing that you're putting through, do you typically include a fuel surcharge or is this kind of like stickier pricing than you expect to get in the 2022 timeframe? And then we've also gotten some questions from investors today around the fact that that pricing stepped down on a year over year basis, if you took a look at the second quarter versus 3Q. So curious, like, any comments around, you know, why pricing was a little bit weaker in 3Q versus 2Q?

So on your first question, so we manage pricing broadly, and it's really dependent upon product category. You know, some of our products that are more steel-related, i.e., steel doors, those type of things, would carry surcharges associated with that. You know, but mostly across the product portfolio is through list price increases is kind of how we manage it. So, it's more permanent in nature. You know, the year-over-year delta, you kind of have to look at it, again, by product category. a little pressure in some of the discounts. You know, residential, for example, a little bit harder to kind of pass through the price increases. So, that's really what you're seeing there. If you kind of look at the bulk of our business commercial year-over-year, you know, price increase.

I'd add to this, our hollow metal business, list price increases and surcharges. on the general hardware business, two price increases in the year and will adapt to the pressures as we go into 22. And, you know, certainly going hard at the residential products as well. And my message here, you know, would be in the addition to freight surcharges, we're pulling all levers on price realization. And I think as we get past this momentary surge that occurred in Q2 and Q3 on inflation. We'll continue our discipline around price performance as we move into 22.

Thank you. That's helpful.

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

Yeah. Hi, guys. Good morning, Andrew. Yeah, just to follow up on Joe's question on pricing, I'm just a little bit surprised by the pricing myself. You know, we did some channel checks with electrical distributors in the market. Dave, you would know very well one of the largest players in North America has price and effect, I think, sort of policy at this point in order to sort of clean and cleanse out the backlog. I think HVAC guys that sell on a lot of similar channels, I think, have had like four price increases this year. I mean, the industry structure seems to be quite favorable. Why is it so hard to get a price increase through? Or, you know, who is being aggressive? Particularly, you seem to highlight residential. Is one player being aggressive? Are people out of Asia being aggressive, which is surprising because I would have expected, you know, they would have difficulties getting stuff on the boat. Just maybe a little bit more color there. Thank you.

I'd give a completely different perspective, Andrew. I know the electrical quite well. Think about the amount of electrical pipe, wire, and distribution gear that goes in in the first six months of a construction project. We submit our quotes, get orders at the same time, and those products are delivered at the end of that cycle. When we put a quote, you know, that's carried for a period of time, but we honor that order. And so we eat that inflationary pressure. The cycle for the electrical industry is much faster than ours. We've been aggressive on the price increases as well as surcharges. And it's not apples to apples. We're both in new construction. On new quotes and bids, you know, we're really raising the levels every day. And, you know, I hope that color maybe helps you understand, you know, leading products, the electrical versus lagging products on the hardware side.

And I'll just add, Andrew, it's not a question of realization. In other words, we'll get the price increase. It's more of a timing issue. So you will begin to see sequential improvement. beginning Q4 relative to the price increases we put in the market. And that will continue to accelerate into 2022, year over year and sequentially.

In 2022, you'll get some of the benefit of these 21 price increases. You'll get it, but later.

Yep.

Gotcha. And just a follow-up question. Just a difference in performance between North America and and I guess international, which I sort of think mostly Europe. You know, as I think about your brands, you know, Intraflex, I guess it is mostly software, but it does have electronic components. If, you know, if I think about, I guess, Chisa is the one that's purely mechanical, but then Simon Boss, which you highlighted, also has large electronic components. Why are you able to avoid the kind of disruption related to electronic components and labor in Europe that you experience in the U.S.? Because I would imagine the electronic components in Europe are also getting sourced in Asia. Thank you.

So electronic components type in all sectors of the world. The differences between Simons Vosk, a lesser extent, and Interflex and the core business in the Americas is pure suppliers. We had designed around the Americas, Texas Instruments, NXP. Both have had their supply chain issues. The European products more around a different set of suppliers. It's those differences. And, you know, the adaptability important here. Many of the newest Allegiant products that drive battery efficiency, Wi-Fi connectivity that makes us the leading products in the world are closer to the supply chain challenges in the Americas than they are in Europe. Gotcha. I appreciate it. Thanks a lot, Dave. You're welcome, Andrew.

The next question comes from Brian Ruttenberg with Imperial Capital. Please go ahead.

Yes, thank you very much. My first question, I'm sorry to keep asking about price increases, but I'm going to ask one on that and one on a follow-up on a different subject. But the first is on price increases. Can you say specifically how much you've increased prices? You know, AASA has gone up about 15% in multiple in total this year. NAPCOs, you know, said 3% they've increased. What have you increased so far this year, and what do you plan to increase, you know, on the year?

You know, I would say, again, you have to look across the different product sets, so it varies. If you're looking at all price increases, i.e., what we talked about, there's list price, there's surcharges, There's things related to freight. Those that have heavier steel-related, i.e., steel doors, those type of things, would carry a much higher price increase realization than your traditional, you know, products, locks and exits, closers, those type of things. So list prices for the year would be with both price increases north of 6% with more to come in the future.

I think you also got a include, you know, the surcharges on top of that. And, and this is a big and, in our quote activities, we apply discount schemes that give us the ability to raise price based on the project. So, again, I feel very good on our pricing analytics. there's that gap in the backlog that we may have quoted over a year ago. We honor those firm orders, and they're delivered, you know, sometimes over, you know, the periods of years. And as we move into 22, you know, we'll reassess this again and be early and aggressive to make sure that, you know, price continues to cover our input cost as we've done, you know, since the creation of the company.

Right, and then just as my follow-up real quick on AASA, just real quick, maybe make a comment about their move with HHI from Spectrum and how you anticipate competing on that. I know we've spoken offline on that, but I want to just hear what you think, how that's going to impact Allegiant moving forward.

You never want to see your number one competitor or market leader get bigger. Rest assured that we also looked hard at the Kwikset HHI assets over the years. I think if you really step back and study the dimensions of Kwikset and how they performed under HHI, I believe also will actually bring a level of discipline to the market. You know, it's certainly, you know, our great Schlage brand, the Kwikset brand, you know, there's plenty of room to compete. And, you know, we've met this challenge, I think, credibly, you know, over the last several decades. You know, Schlage, in terms of its electronic leadership, If you look at Consumer Reports electronics that I think was published in April this year, three of the top eight locks are ours. We're the number one replacement lock, and it's going to be continued competition against two world leaders.

Thank you.

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

Hi, good morning. Maybe just a first question perhaps on the demand outlook, which hasn't really been touched on yet. You know, I remember in that up cycle in US non-res in sort of 06, 07 and 08, that up cycle in terms of projects did suffer some headwinds because of cost inflation and labor, you know, led developers to delaying projects and so forth. And so you had these kind of rolling push outs and delays. Just wondered what your perspectives are on the risks of that type of phenomenon recurring in the current environment when you're talking to developers, looking at your quote activity and so forth.

I'd say, you know, each bust and boom cycle, you know, sets its own history. You know, we're still living this aspect of it. But as I review the macro demand factors, our backlogs, and then recent travel, I think I was in five states last week. The sentiment that I feel, see, and am living here, you know, every day at Allegiant is I'm extremely positive. I think we've got, you know, you know, three solid years ahead of us as I think about the strategic planning period, working through the supply chain issues. I think there's key infrastructure needs, and we have a housing economy that's significantly under inventory for single-family homes, which also is a generator for commercial and institutional development. You know, I packed that all together, and barring another disruption, I'd like to go ahead in terms of the business conditions, you know, for construction and for allegiance.

I see. So you have not seen major projects being deferred or postponed?

We track cancellations and cancellations. I'd say it's at a normal level.

That's helpful. And then just a quick follow-up, you know, trying to wrap together your comments on pricing. If you look at your sort of, you know, your operating income bridge, that line for inflation in excess of pricing and productivity, obviously it's been negative for a couple of quarters now. When you look at the margins in the backlog and the pace of completion, Should we assume that that line can go back to sort of break-even sort of third quarter of next year? Is that the rough timeline?

I would, Q3 next year, positive is what I would anticipate, basis of constant inflation relative to what we're seeing today, you know, in terms of no further increase year over year. But the delta, the gap between price inflation improving, you know, up until that point. So the rate of change will get better as we progress.

Julian, I'd also add, as you and I think about that backlog, it's some of the highest margin products that we produce. Electronic locks and exit devices are elements, heavy elements of that backlog. The exit devices, heavy complexity, you know, which, you know, the supply chain pressures create some challenges in that. But those supply chain pressures will improve. The mix of that will roll through. In addition, the price increases. I like our opportunities going forward.

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

Hi. Good morning. Good morning. Hi. Maybe just to follow on Julian's last question there, if you look, you know, in your bridge, I know it's called volume and mix, but it was a headwind year over year, but you actually had non-residential declining less than residential in the Americas. So maybe it has to do with the mix within non-res, and you talked about some of your higher margin products now growing backlog. But we'd just love to unpack that a little bit, why the mix was negative despite the non-res growing better than residential, at least on a relative basis.

Yeah, so you hit on it. It's really within the product portfolio of non-residential products. You know, as Dave indicated, high-margin products being impacted more, and that's kind of what we're seeing in the backlog due to, you know, shortages of components. And so it's really within the non-residential business that you're seeing a mix element. you know, given that non-resi was higher than resi for the quarter.

Great. And then I'm going to take a stab at this. I think earlier in the year, you know, you kind of pointed international margins up low double digits. Obviously, you've seen really good progress there through the year. You've given us the midpoint of your guide, a lot of other information. It does seem like that implies the Q4 America's margin kind of steps down more than seasonality would assume in Q4, and also just thinking about the decremental still being pretty challenged there. Any color you can help us on how to think about that from the model perspective, or I'll just leave it there, however you'd like to help us out with that sequential decline implied.

Yeah, so kind of we touched on a little bit earlier, it's predominantly given the price inflation dynamics still under pressure. Some of the inefficiencies, you know, from a productivity standpoint will continue given the component challenges, supply base. That's really the, you know, you're going to see some decrements sequentially. But then as we kind of continue to move into 2022, you know, you wouldn't see obviously that big of a change, you know, in the first part of the year and then improving certainly in the back half.

Okay. Thank you. Appreciate it. You're welcome.

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

Yes, good morning, everyone. Patrick, you've made reference a couple of times now to the expectation that maybe inflation has peaked. And I guess I'm just interested in what gives you confidence that that would be the case. Have you provisions in place through some of your procurement agreements that lock pricing now or hedges that are in place to give you the confidence to say that? But if you just elaborate on that, I'd appreciate it.

So, that's kind of, you know, the commentary was more around kind of our assumptions right now. I mean, if there's continued pressure in the marketplace due, you know, to some of the component challenges, then that would certainly put pressure on our assumptions as we look forward to 2022. But if you kind of look at some of the forward forecasting information, you know, relative to steel and those type of things, The expectation is that as we go into next year, it starts to alleviate itself and maybe trend down, and that would be positive to what we're thinking today.

Can you just remind us how much of your business is locked up with annual contracts or supply agreements for spot purchases? It's a small portion.

It's mostly on raw steel contracts. You know, we kind of look forward and we've got some arrangements with some of our supply base that has fixed rate agreements. Those then kind of fluctuate basis on, you know, changes in the market on a forward basis. And so, it's small. A lot of our supply base is indexed to steel, if you will. And so, it's really just on the purchase of raw steel, which is a small component. relative to our overall purchasing.

Thank you for that. And then just as a follow-up, can you just talk about installation labor and the extent to which that may be a sort of frustration at this point, or how you see that developing as a potential bottleneck or impediment in 2022?

Some broad comments on labor, and it's, you know, from... general labor through the trades to professionals. Labor is tight professional help on a worldwide basis. Second, when you look particularly at construction labor, the gap has grown. Skilled trades were a problem going into the pandemic. the problem has widened slightly and, in my mind, extends cycle times, you know, for construction projects and snow plows, you know, what I think are strong business conditions, you know, well into the future.

Would you consider at all investing in the development of that labor for the market as a means of, you know, just alleviating that constraint?

We are investors. I will get off the phone here today, and it's manufacturing month in the United States. Allegiant plays a very active role in promoting our industry-leading culture, diversity opportunities, tuition reimbursement programs. healthy lifestyle to attract people and have done it, you know, since the creation of the company, number one. Number two, I think, you know, manufacturing, I'm extremely proud, is a great place to, you know, to develop talent. And we will make investments in our wage structures to continue to keep Allegiant as the best employer in you know, with wages and benefits in the communities we operate in around the world.

Thanks, David.

The next question comes from Tim Weiss with Baird. Please go ahead.

Hey, guys. Good morning.

Good morning, Tim.

Maybe just dovetailing off of David's question there, when you think about the new non-res cycle and how investors should think about it, the leading indicators have obviously been really robust over the last seven or eight months. How would you think about converting those leading indicators into revenue for you guys? Are those new construction projects that could contribute to you in the second half of 22? Or do you think at this point it's probably more prudent to think 23?

I think you've got to take the strong cycle. And, you know, as I look at the macro indicators that you did positive, you've got to lay on that backlog, you know, which will, you know, take the better part of six, seven months for us to eat through, you know, And I think, you know, extremely robust. You know, I see education. I see healthcare. I think you've also, I've always been concerned about commercial, extremely positive in terms of the macro. There's lots of money on the sidelines to go reinvent this commercial real estate and, you know, the new office of the future. So as I look at education, healthcare, commercial, even multifamily is hung on longer. And I think, you know, investment is going to come in needed infrastructure. We could get an infrastructure bill. So as I look at that, Tim, I like it, you know, for the next three to five years.

Okay. Okay. And then maybe more of just a modeling question. So you guys outlined that the split on the deferred sales, I think, was kind of even between Q3 and Q4. Right. I think if you just kind of roll that into the model, I mean, there's a bigger, I think you're down double digits, or that's the implication in the fourth quarter versus down maybe low single digits in America in Q3. So any perspective there you can kind of add as to why that is? Is it just seasonality and comps?

Yeah, seasonality, comps, you know, the component shortages, plus last year you may recall with the rebound in our residential business, you know, it was coming out of COVID. there was channel refill in the business, right? Restocking the shelves on, on retail and e-commerce. And so that certainly had a fairly significant impact on last year. So you're getting into a difficult comp as it relates to our residential business.

Okay. Okay. Gotcha. And, and that 80 to a hundred million of deferred revenue. I mean, how does that kind of come back next year? I mean, is it, Is there some sort of burst that kind of happens and you kind of convert that in 22, or does it just kind of result in a little bit of a longer cycle?

No, I think you need to think about it. Depending on the flow of components and labor, you know, it's a tailwind as we roll through the year. In a manufacturing environment, you know, you can step up, you know, about 20%, you know, just by working Saturdays. You need to kind of think about it. If I go to Sundays, I get 40%. People don't work seven days a week, you know, for six months. You've got to think about it will step up. It's a tailwind, you know, barring, you know, if we get improvement in components, both electronic and, You know, general components, we're going to see that as a tailwind as we roll through the first half of next year. And if the component situation in labor improves, you know, work it out and gain more share.

Okay. Okay, good. Well, good luck on the rest of the year, guys. Thanks for your time. Thank you.

The next question comes from John Pokerwinski with Morgan Stanley. Please go ahead.

Hey, good morning, guys. Good morning. Hey, Dave, so electronics are, you know, 20-ish percent of the business, probably a little more than that now. That 80 to 100 million that you talked about does sound pretty biased to 4Q, and I guess what precipitates out of that is it's a pretty high percentage of electronics. Like is that virtually electronics going to zero? Or, you know, how should we think about the split of the headwind between the electrified product versus the mechanical product?

I'd say 40% electronics, 60% mechanical. I'd also, I think you've been in our factories here in Indianapolis. Complexity when things are humming right is our friend. We'll make 2,200 variations of the Von Dupern exit device today. And, you know, any one of those components in shortage, whether it's a casting, a wire harness, a power supply, an electronic board, puts pressure on that supply chain. And that's what we're living today. And confident in our teams, you know, to work through it. Remember, too, it's not necessarily my ability to put labor in the seat. It's also my supply chain. We pulled hard on redesign, shifting over 100 engineers to redesign predominantly boards but other components. The second thing I'd say is our flexibility. We've offered to put our people in sites to help strengthen our supply chain vendors. And, you know, I share that example just because the labor thing goes across transportation, supply chain, getting it through the ports, and a level of complexity that I've maybe never seen in my 41 years.

And then just thinking about the, you know, kind of the unwind of this current tightness, you know, I think an earlier question asked about, you know, trade labor. Is that the biggest governor of how much the business can grow next year? Because it seems like you have the ingredients. The demand is there, maybe a bit more backlog than usual. You know, is it just how quick can we get, you know, installers both on new construction and retrofit? Is that, you know, sort of the KPI that we should be focused on?

I think I would describe it just as there's pacing constraints in labor that from the design phase, you know, we just saw a record ABI through the installation phase. And I think projects will have longer lead times in an environment that's extremely positive in terms of the willingness to invest. Got it.

Thanks, Dave. You're welcome.

The next question comes from Chris Snyder with UBS. Please go ahead.

Thank you. Thank you. So my first question is on the deferred $80 to $100 million of revenue. It seems like the majority of this is coming from the Americas. Previous commentary, I think, said that it could take six to seven months to work through this elevated backlog and, you know, I think the ability to ramp manufacturing 20% by working Saturdays. You know, I think it kind of suggests that this could be realized, this $80 to $100 million in 2022, right? And obviously I know there's some uncertainty around the ability to source components, but I guess is that reasonable to think that this could be realized next year? Because it's a pretty substantial kind of mid-single-digit tailwind to the American segment.

As you think about 22, the backlog will be a tailwind. Constrained by availability of electronics, you know, that tightness will run into 23. and then the overall labor. It's an industrial game we call the beer game. Bottlenecks move. There's bottlenecks at the ports. There's bottlenecks in labor. These things are going to be moving throughout the year. You know, my fundamental belief is, you know, Allegiant has a superior ability to navigate. The nation and the world will navigate it, and we'll see these things ease as we go through, and it's a tailwind to push that backlog through.

I appreciate that. And then, you know, second question on Resi. It sounded like from the prepared remarks that there may be with some demand softening in the quarter. I think you guys called out do-it-yourself or DIY slowdown. So I guess my question is, Was this maybe the resi softness part of the second half revenue cut? And I guess, is there any reason to think that this gets better in 22, as it seems like that could be more demand-related than supply chain-related?

So, again, I want you to think about that demand game. You know, the supply chains on res for all supplier was heavily disrupted in 20. We were shut down for 15, 16 days. You had a demand surge, and this is, you know, very evident, you know, from the big box Home Depot, Lowe's reports in terms of increased investments and do-it-yourself projects. And then you had also housing, you know, picking up pretty rapidly. That created a demand surge as we started coming out of the lockdowns. record backlog in residential, which we have worked through. So, I look at overall demand for res as we move into 22 as net positive, you know, based on continued starts of new construction, solid repair and replacement, and good multifamily. So, that whip is going on the supply chain. Make sure you think about that in your models because You know, I think a year ago I'm sitting here talking through record backlogs in residential. We worked through that. And I would suggest if you look at, you know, our performance versus our competitors, that we gain share throughout the last eight quarters.

Appreciate that. Thank you.

And the last questioner will be Ryan Merkle with William Blair. Please go ahead.

Hey, everyone. Good morning. Good morning. So I wanted to follow up on the timing of supply chain getting better. Is it fair to say that margins are bottoming in the second half at 21, such that as we get into next year, you could see margins increase year over year, or is that maybe more of a second half 22 event?

Probably more back-end loaded, but feel very confident. You know, if you kind of look at the moves we're making on price, you know, again, assuming inflation has peaked, I mean, that's still a question mark, right? But I feel very confident relative to, you know, pushing through the backlog, getting some efficiencies that are factory productivity, these type of things. We will have margined. incremental improvement in 22 compared to 21, no doubt in my mind.

All right, that's helpful. And then just stepping back, maybe this is a question for David, but can you discuss the adoption curve for electronics? Is it faster now? And also, how are your customers rethinking access control in this new environment?

Electronic access, electronic locks – The power of your edge device and its ability to interact, you know, with secured access is a powerful trend that will positively influence this industry for the coming decades. The electronic adoption is what I would describe as high single digits. In normal times, or pre pandemic, we've been able to deliver on that growth that mid or excuse me, low single digit or low double digit growth. So market growing, high single digits were in a normalized time, low double digits. So, you know, a clear trend. You can see it in your everyday life. The overall market still, you know, there's 40 billion openings in the world. Less than 10% of those integrated, so bright for our industry and bright for Allegiant.

Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Dave Petratis, our Chairman, President, and CEO, for any closing remarks.

Thanks for your questions today. I also want to thank our employees. for their continued commitment, steadfastness in navigating the challenges of the last 22 months. Some final messages. Allegiant remains a lighthouse for our safety performance and our ESG advancements. Demand in our business remains robust and leading indicators are positive. Supply chain constraints, labor availability, and inflation are challenging. I'm confident in Allegiant's supply capability and adaptability to be strong, and the long-term fundamentals of Allegiant remains bright and strong. Thank you for your time today. Have a safe day.

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