Great. Good afternoon. Thank you for joining us. I'm Tim Wojs, and I cover building products here at Baird. We are delighted to have Allegion join us again this year at our Global Industrial Conference. Allegion is one of the world's largest manufacturers of mechanical and electromechanical locks and security products. From the company, we have President and CEO John Stone up here with me on stage. We have CFO Mike Wagnes, and then we have Josh Pokrzywski, who is VP of IR here in the front row. There is going to be a few prepared remarks from John, and then we will hop into Q&A. Apparently, that TV does not work.
No worries. Great. We'll get through it. I think you know the safe harbor statement, so we'll skip that. And just real quick, for those of you who might not be very familiar with Allegion, just a quick description of our revenue split here that you see on the screen. As Tim said, we are a pure play in security and access products. We are a house of brands. You might know us through our lock brand, Schlage; Panic Exit Devices, Von Duprin, Closers, LCN. These would be some of our flagship brands that are probably more familiar to most people than the company name, Allegion. We concluded 2024 right around $3.8 billion in revenue. Split would be something around 80/20 Americas to our international segment. Our international segment is primarily focused on Australia, New Zealand, and Western Europe, and then the Americas is North America focused.
These are our markets. I would say non-residential in the Americas is by far our largest segment. This would include the institutional verticals like health care, education, higher ed, et cetera. There would be commercial verticals in there that, for us, would encompass office, multifamily, retail. Data centers would be in that commercial vertical as well. We also do have, and it's about 20%-25% of our Americas business, in the single-family res space. That's primarily our Schlage brand that comprises front door and interior door hardware. We do have Allegion International, and again, I talked about the geographic exposure there. I would say our strategy is such that as we look at growth going forward, you can expect the geographic exposure for Allegion to remain rather consistent, that it's North America, it's Western Europe, it's Australia and New Zealand focus for us.
Lastly, a bit of the secret sauce. If you take a casual look at Allegion, I hope you're impressed with the operating margins that we deliver. I'd say it is best to breed in our space by a pretty fair distance. Some of that secret sauce is up here on the slide that you see. We have a unique front end where we are out generating end user demand for our product. We use that demand to write specifications for buildings. We spec in our own products. We use that end user demand to then pull our products through our distribution channel. It is a very resilient, very powerful business model. There are literally only two other companies in the world that have a similar business model at the kind of scale that we do. Good industry structure.
I think we continue to invest in the various elements of the moat that you see here on this page. That is it for the prepared remarks, Tim. I think let's get into the Q&A.
Yeah, no, that's great. Thanks for those. Anybody can raise their hand if they have a question, or you can email session1@rwbaird.com. Maybe just spend a moment kind of on the overall kind of growth strategy for Allegion. I mean, has anything really kind of changed or evolved since you've become CEO? I mean, you've always had this really good North American business. It's an oligopoly, great margins. I think volumes have probably been a little weaker since COVID relative to what they were pre-COVID. Just kind of anything kind of just on the overall growth strategy and any changes or evolutions there.
Yeah, appreciate the question. Tim, I think some key things are different since I joined. First would be investment for organic growth. That would be our top growth priority. If you look at Allegion from 2022 to today, we have expanded operating margins quite a bit, well north of 200 basis points. At the same time we were expanding those operating margins, we have invested even more in R&D. We took R&D as a rate of spend in that same time period from around 2.5% of sales to now north of 3%. Operating margins expanding, but we are investing more in new product development. The product vitality and the pace of new product launches has accelerated, and I think that is now and will continue to be a good driver of organic growth in the core business.
The other key change, I think you've noticed, we've done 14 bolt-on acquisitions in the last two years, so really stepped up the pace there. We've been disciplined with respect to the targets that we've been prospecting and sourcing for potential acquisitions, disciplined on returns, and disciplined on a strategic fit. Every single one of these acquisitions has bolted on directly to one of our existing business units. It's in a geography where we've got distribution channel strength, where we've got brand strength, where we've got a critical mass of talent. In some cases, there's literally been a lift and shift of product into one of our existing ERPs that happens in a matter of days or even weeks. Quick capture of synergies, very happy with the bolt-on M&A progress that we've made.
I think that has been a contributing factor to the share price appreciation this year, and we'd expect that to continue as we look forward.
OK. I guess when you think about kind of growing the variance between growing volume 4%-5% kind of pre-COVID to kind of flattish kind of post-COVID slight growth, is it the fact that the end markets pre-COVID were all kind of growing, but to varying degrees, and now kind of post-COVID you've seen all this kind of choppiness? You have one that's down, one that's flat, one that's up, and they kind of keep oscillating. I guess you can look at it from aggro, and it does not look like you're growing, but then when you kind of go between that next level, it just seems like it's really kind of like a sinking issue. I guess, A, is that correct? Then B, when do you think we could start to see all these end markets kind of resync and grow again?
Yeah, it's an interesting look. You know Allegion spun out of Ingersoll Rand right at the end of 2013. If you take the time period of like 2014 to right before the pandemic, non-res was in that 5%-7% kind of-ish growth. Residential was also growing very nicely too at that time. Take 2020, 2021 out, if you will, they were kind of weird years just with the pandemic and the very quick snapback recovery. Post that, non-res has continued to grow. It's been a very resilient business for us. It's attributed to a lot of contributing factors. Residential, though, has been decidedly different. It's been soft for the last three years. Rather than growing at a 5%-7% or a mid-single digit percent like it was 2014 to 2019, it's been flat-ish to even down, low single.
I think market-wise, that's been the biggest difference in those two chunks of time. Non-res continues to grow nicely, and we're seeing that this year as well. I think also with just a little bit of help on volume on the non-res side, we're able to continue to generate mid-30s kind of operating leverage on that volume, which has helped take best-in-class margins even higher, led by the non-res business. As we look forward into 2026, like we shared on our third quarter call just a few weeks ago, from a market condition standpoint, we see market conditions, non-res continuing to grow, res even still being kind of flattish, is what you could expect out of Allegion.
OK. I guess when you think about just maybe just help us with the lag, because the institutional market is probably your largest market. It's probably your richest mix in terms of products going through that. There's a pretty big lag in terms of when that business starts to recover and when you kind of put your products in. I guess what's the outlook on the institutional side? Have we just kind of started to see that kind of pick up, and there's a kind of a multi-year tailwind here, or has it been pretty strong in the last couple of years, and you just kind of see a continuation of that?
Yeah, institutional has been stable growth the last couple of years. You're right to call out we are, by our very nature, a late-cycle business. If you think of any construction project, the last thing you're going to do is hang the doors, seal the doors, and secure the doors. We're late-cycle on a project basis and then late-cycle overall as a business. I think institutional segment continues to just stable growth. As a segment, as a vertical, it would not have the kind of extreme feast or famine that you might see in some other industries. If we say strong, OK, that could be in the high range of mid-single growth. If we say weak, that could still be low single digit growth in a space like the institutional vertical.
If you go to the commercial side of our business, while you're right, it's not a particular commercial building won't be as product dense as an institution like a hospital or a school would be, but it makes up for that just in terms of addressable market size. A little bit of uptick in commercial like we've seen recently with spec activity in commercial office, which has been very depressed for the last couple of years. Some signs of life here recently just with tenant turnover and tenant fit out in major metro areas that had gone silent for a couple of years with work from home and all that. A little bit of pickup there would be a great tailwind for us. The only other thing to call out, data centers is very fashionable to talk about.
I would say we do write specifications for most of our non-res work. The spec writer that's doing an elementary school or a commercial office or a multifamily building also has the skills and capabilities to develop and write specs and end user standards for the who's who of hyperscaler data centers. We do that too. It's a small part of our business. Of course, it's been growing very nicely. Nice to see that tailwind in the commercial part of our business.
Can you spend just a, I think it kind of gets overlooked just on the specification side. Can you just talk about what that actually means, how it works? And if I can recall from a long time ago, you guys have a lot of spec writers in the market. It's hard to kind of, it's like speaking a different language to go between these two different, multiple different vendors and things. So just can you just talk about the advantage that you have there and how you invest in it?
Yeah, and Mike, you ran our non-res business in the Americas, so if I miss anything, please just jump in. I came from a 20-year career with John Deere. Coming from off-highway and farm machinery into a business where you literally spec your product into the building and then push it or pull it through the channel with that was amazing to watch it work. I would say it is an incredible competitive advantage. There is really only one other company in the world that goes toe to toe with us in that capability. How it evolved over time was doors and door hardware are immense in the amount of detail. It is very intense in the amount of changes, change orders that happen over the life of a construction project to the point where architects just do not want to deal with it anymore.
They literally outsource it to Allegion and to our largest competitor by and large. The capability it takes to write those specs is difficult to develop. We have a dedicated apprentice program where we bring in highly talented civil engineers, train them on how to write specs, and they do that as a great entry-level career into the company. We have invested enormously in software tools that provide cloud-to-cloud connection from our system called Overtur into Revit, which is a very popular civil engineering tool for the architects. Real-time data interchange. We have invested in AI tools to help automate parts of writing specs. There are, whatever, a handful, four or five continuous improvement projects that we are doing on that software tool in any given year. I would also say as you think forward how to maintain and even widen the moat that comes out of that.
For any machine learning model or AI model to work, it's got to have a very large, clean, robust data set underneath it. There are only two companies in the world that have that data set. If anybody's going to figure out how to leverage AI to write specs for buildings, it's going to be the two leaders in the industry today. The spec then turns into recognized revenue at some point in the future. It is the end user demand generation tool. That time to revenue can be nine months for a multifamily complex or three years for a large sports stadium or a large hospital complex. It is not something that we disclose a lot of numbers around because it's difficult to give you line of sight to what exactly that means.
The power of it is immense in terms of adding value all the way upstream in the design phase of the project and throughout all the changes. Ultimately at the point of use, all these millions of SKUs that we manage, we also deliver to the project in like 10-day lead times. Made-to-order business that we've generated the demand for sometimes a year or two in advance. Quite powerful, quite sticky, and quite a high barrier to entry, I would say, into our space.
Yeah, I mean, you mentioned AI. I mean, we've been asking this question kind of throughout the conference. Just, I guess, are you investing in kind of AI on the spec writing side? I guess, what are other examples of kind of AI investments that you've made and any specific outcomes you'd point to?
Yeah, it's a great question. Certainly on the end market area, again, we write specs for. We've developed end user standards for the hyperscalers and their data centers. Whatever you believe about that CapEx cycle and outlook, we are late cycle in that too. I think nice tailwind, but overall small part of our business. I'd say internally, we're doing all the things you would want us to be doing. Investing in AI tools to help automate elements of spec writing. We've got the data sets to do that. Others don't. We're putting AI where it's appropriate in our factories and our manufacturing facilities, computer vision systems to ensure quality and safety, et cetera. We're using generative AI tools for office function efficiencies like you would expect us to do.
Even something that sounds as simple as digitizing purchase orders, because we have thousands of contract hardware distributors as direct customers. We get purchase orders in lots of different formats with lots of different, sometimes even handwritten names for the same piece of hardware. This is our industry. Digitizing that into machine-readable language is something that we've done. The efficiency gains are pretty amazing. They're a game changer for our space. The last thing I'd have you look at, please go visit our website, look at Allegion Ventures portfolio. On the further reaching technology side of how will AI impact the world of physical security, we've made two very notable investments recently. You look on the cap tables that we're on, they're with companies like Insight Partners and Andreessen Horowitz. One was a company called Ambient AI. The other one is Asilon Robotics.
Take a look at what these two companies do. They are category leaders in their space. Allegion has a position on the cap table and therefore a front row seat to see how these technologies play out in the realm of physical security and how these particular companies do in their space. Very excited about that from a further reaching front row seat on technology.
I guess speaking about technology, just kind of the electromechanical kind of business, just kind of big picture, kind of where is that today? And kind of how would you kind of discern the adoption levels within kind of the residential market versus kind of the non-res market? Because I mean, it's obvious we use a lot of stuff residential and you see digital things. But there's a lot of digital, I think, that's kind of in the non-res space. So just kind of where are you on those adoption curves in both of those end markets?
Yeah, adoption is accelerating, I'd say, in both segments. What you tend to see is one of the advantages of our residential business is our partnership with the Megatex, with the smartphone manufacturers. Allegion, I mean, a company our size, we definitely punch above our weight in our relationship with Apple, Google, Samsung. We're a trusted innovation partner to help them expand the shoreline of what they can do with their wallet. We were the first to integrate student IDs, employee IDs, resident keys in the Apple Wallet. We're the first to integrate both Google Wearables and the Google Wallet with the resident key.
Again, those kinds of technologies, those kinds of near-field tap-to-unlock technologies that you start to become more and more commonplace and increasing adoption on a home front door, translating into the commercial space of electronic locks, where spec data would also tell us adoption is increasing rapidly and makes us confident in the outlook. When we talk about our growth entitlement and why we can grow above GDP or above market by a point, it is because of this electronics adoption and our innovation leadership in the space. Commercial e-locks are not new, but think of it on a development continuum of 15 years ago, it was offline electronic locks, Proxcard or whatever would get you in the door.
Security improvements, electronic architecture improvements to wired solutions that still kind of stay the state of the art today, where a control panel is controlling maybe four doors or there is a dedicated door controller on a single door to lock and unlock. Where the puck is going and where Allegion is skating to is real-time connected locks. We have introduced that family some months ago. We are exceeding our business case for 2025. Excited about where that is headed. We hosted our first developers conference just two weeks ago, bringing in video surveillance companies and physical access control building automation companies to teach them how to integrate quickly with our new connected locks. That now is going to be done in hours instead of months that it used to take back in the wired solution or offline days. Big efficiency improvements for the industry. I think that is where innovation is going.
I feel we've carved out a good leadership position on the new commercial e-lock family. We feel that this idea of a point of outgrowth in Allegion's growth entitlement is very much intact.
When you're saying you're talking about hours versus months, I mean, is that the installation of the projects?
No, that's the actual system being able to discover and talk to the lock and make the lock and unlock decision. We do that at the door. The connected lock can do it without the added interface of a panel. There is a lot less low-level code that has to figure out how to talk to each other.
OK, OK. I guess on the software side, you've talked a little bit about implementing more software kind of selectively in certain verticals. I guess how do you decide which verticals you want to kind of play in from a software perspective versus maybe do kind of work in more of a kind of partnership or kind of an integrator type model that's been there historically?
Yeah, it's a great question. I think from a legacy standpoint, our Interflex business in Germany, very successful, fast growing, good margins, has been doing access control, time and attendance, workforce management for large enterprises for a long time. Leave that as its own entity, so to speak. We expect to continue to grow that. It's primarily custom designed for European working environments, European labor laws, and things like that. Kind of a regional product. In the Americas, we see historically underserved verticals like education, like multifamily as spaces where Allegion would have a right to play and a right to win. Not only the core mechanical hardware and electronic hardware, but also the controlling access control software. We've made investments organically for access control software for multifamily with our tool known as Zentra.
That's been in the market for a little over a year now, growing very rapidly. We like having that. We acquired this year a company called Gatewise that does electronic access at the gate for car parks or the perimeter entrance for multifamily. Now Allegion has the ability to go to multifamily with the full solution set. We can also go à la carte. It does not matter does Gatewise or does Zentra or does the e-lock lead the sale. We can offer all of that or we can offer pieces as we go. I like our position there. I do feel we have a right to win. The other software acquisition we made was a company called Waitwhile. They do virtual queuing. This could be today, think of something like a Costco.
If you're a Costco shopper and you're going to get some auto work done, get your tires changed or something like this, you use your Waitwhile app through Costco to get your point in the queue. You can go shop, you get real-time updates. Really, the only thing you lose is time in the line is their value prop. What we see going forward with Waitwhile is just imagine connecting that virtual queue that they set up to an encrypted credential that hits your smartphone wallet and gets you in the door. An easy use case might be think about a university that has hundreds of professors that need to have office hours before big exams. You've got an electronic locking system throughout the faculty buildings. You want to control that. You want to keep people safe.
You also want a perfectly seamless experience for the student when it's their turn to show up. Waitwhile gets you in the queue, attaches a Schlage credential that gets you through our electronic lock at the right time. Through Waitwhile, the university gets just reams of helpful data to help them plan their access and their operation better. Excited to see what we can do with that. Just think about our software strategy as being continuously developing and acquiring software that differentiates our hardware. We're not off to find far-flung speculative adjacencies. We're not off to find software for software's sake. This is software that is connected to and adds value to Allegion hardware, which is what we're pushing for there. Excited about the potential.
I mean, maybe just on the M&A side, I mean, you have done a lot of smaller tuck-in acquisitions. What are the two or three criteria that you're really kind of looking for and assessing? Does it have to kind of fit with your spec? Does it have to, is there kind of a market expansion type play? What are kind of the two or three things that you're really looking for when you're doing these deals?
Yeah, great question. I'm really pleased. May tap the balance sheet for accretive acquisitions. The best material we've got out there is our Capital Markets Day from May material. It'll show you our view from a product category segmentation on parts of our industry that are still less consolidated or even more fragmented. There is roll-up potential there. You can look for us to be disciplined on what are we looking for. It has to fit our strategy. We're a pure play in security and access. It has to generate accretive shareholder returns. You could think on an ROIC north of the cost of capital very quickly on some of these mechanical deals, maybe in year three to five at the far end on some of the more electronics or software transactions, but still accretive returns for our shareholders.
Good cultural fit on the people side. Strategic fit, good returns, good cultural fit, and bolting onto one of our existing business units. The only other constraint I'd ask you to remember when you think about Allegion and the acquisitions is the geographies that we're looking in addition to the product categories are where we are today. This is Western Europe. This is North America. This is Australia, New Zealand. We are not looking for an acquisition to provide a beachhead into a new geography. That's not contemplated at this point.
What about the margins? I mean, I think what's surprised us a little bit is not just the pace of the M&A activity, but also the margins of the companies that you're acquiring kind of before integration even. How important is the margin aspect of it?
It's very important. I'd say that's part of being disciplined in the mechanical space for sure, but also in the technology space. You could imagine in any industry when you look into high technology or software, there's frequently more sizzle than there is steak. We'll proceed very prudently on that. Yeah, we're proud of the margins we generate in our industry. I don't think our M&A strategy is going to put those at risk.
Great. We are out of time. Please join me in thanking the Allegion team for being here.
Thanks, everyone, for attending.