Right. Good morning, everyone. Welcome to Allegion. This is Tomo Sano, SMID-cap Industries Analyst at JPMorgan. Today with me, we've got Mike Wagnes, SVP, Chief Financial Officer. Thank you, Mike, for joining us. Let me start by sharing why Allegion is such a really relevant positive print this year. Allegion is a global leader in security and access solutions with strong positions in non-residential and institutional markets, and a clear strategy to accelerate growth in electronics and software-enabled solutions supported by iconic brands and robust free cash flow. With that, Mike, to kick things off, I think it would be helpful to start with an introduction to Allegion, who the company is and what you do and your story, please.
Thank you. Thank you, Tomo, for hosting us, and thanks everyone for joining us today. I gotta make sure I talk into the mic. At Allegion, I'm gonna spend a few minutes just kinda going over a review. Tomo did a quick synopsis. I'll also do a quick overview, and then we'll just do Q&A. We'll start standard traditional cautionary statements. Just take a look at our 10-Ks and 10-Qs related to disclosures, related to non-GAAP and the reconciliations and forward-looking statements. Allegion, we're a global provider of security and access solutions. As Tomo said, iconic brands. Think about it as Schlage, Von Duprin, LCN. If you're in your home, happy in the room, probably have a Schlage lock. You go to your child's school district, you'll see our products littered throughout that school district.
We are a big player in non-residential and residential. Obviously, for us, non-residential Americas is our biggest business. One of the things about our business is, we do a very credible job of expanding margins over time. We are a high margin business, right? We got $4 billion of revenue, 25% EBITDA margins, and we expand them over time. It's something we talk about at all our earnings calls, about our ability to leverage volume, expand growth, drive productivity and pricing. One of the things the last few years, you know, I came here starting in 2022. A few months after me, our CEO, John Stone, joined the company. Our ability to accelerate capital deployment over the last couple years has improved. We're a consistent capital deployer to the benefit of shareholders.
As you think about incremental EPS growth from capital deployment, it's something we've been able to demonstrate over the last few years. Finally, as you think about our markets, they should be improving. If you think about the next five years should be better than the last five years. We think we are primed for accelerated growth, both from market as well as secular trends. We'll talk a lot about electronics probably during the Q&A. It's important for our business. We're able to drive accelerated growth by taking advantage of our strong electronics portfolio. Down below, we got some charts on our mix of business, mostly in Americas business. 80% of our revenue is in the Americas. I'll break that down by market on in a few slides.
Then 20% is in our international segment or outside the Americas. As a business, a quarter of our business is electronics, including software and services. We're over 30% now. Our mechanical, you see, is about 2/3 of our product offering. We're much more than just the lock, right? You think of us as the lock, but it's everything you hang around the door. When there's complexity in the building, that's where we win. As I mentioned, we serve. Our core market is our non-residential business in the Americas, right? Think of school safety, you think of Allegion. We have a unique demand generation model where we create demand by influencing the architect in the design phase and the institutional and end users, and then we pull product through our channel.
It's a business model that only one other player in the industry really has the strength that we have in North America. A key element to our growth is both that core strength, but as well as the improving electronics. In non-residential, residential, and international, it's across the board. Electronics is a big growth driver. Moving over, residential, much smaller for us. You can think of us, our Schlage lock business, and a growth driver for us there, electronics again. Then finally, international. International is a great improvement story for us. If I mentioned in 2013 when we were spinning out, and the company was created, this business had zero operating margin.
We are now at industry standard at mid-teens and a much healthier business model and portfolio than we were a decade and a half ago. Finally, end markets, right? When I speak to you all, we understand how important it is. I'll summarize by saying non-residential, 80/20. Eighty percent of our business is in the non-residential space. Of that, 50%-60% is institutional end markets. You could think of that as a very resilient, stable market. Not much market fluctuation when you think about institutional markets. It's why when you see Allegion, even in bad markets over the last few years, so if you think about 2023, 2022, 2021, very poor Dodge growth data, and we still were able to grow our business. Commercial markets, this is about 30%-35% in there.
That is, commercial office, industrial data centers. For us, data centers is very small, but growing nicely. Finally, multifamily. For Allegion, we put multifamily in our non-res business. Most of the products there are the same nonresidential applications, so you'll see that's where we include it in our results. As you walk away, think of us non-residential, institutional, stable business. With that, we're gonna. I'm gonna come back for Q&A.
Thank you, Mike. This is a great intro for everybody. Let's dive into Q&A, and let's talk about the company transformation and cultural leadership. I think it's Allegion has evolved from traditional mechanical companies, a hardware company, to a more platform-based, innovation-driven leader in the security and access solutions. What have been the most important cultural or organizational changes driving this transformation, Mike?
Yeah. As I mentioned earlier, if you've been listening to Allegion, we talk about electronics. Our industry is kinda steadily evolving from a historically mechanical-only business to an electromechanical business as well. It's now over 30% of the portfolio, and it's really been a net positive for us because it grows faster than the traditional mechanical. If you listen to us on our earnings calls, we believe, in our Investor Day, we can grow this business at a high single digit to low double-digit clip. If you look over history, we've been able to demonstrate that. We're able to get accelerated growth from this electronics trend. I think the positive that we also see there is products get more complex, the market leaders do better.
Electronics is a net plus for the market leaders like Allegion, and we're able to capitalize on this industry trend to drive that accelerated growth.
Thank you, Mike. If you could touch on the technologies or engineering perspectives, how the people actually in your employee base is transforming that actually are driving those from the manufacturing standpoint, design perspectives, and could you talk about that?
Yeah. Sure. When we first started off traditional mechanical, we had to change our engineering base, right? Now that we have more electronic engineers than mechanical, electronic and software, we also have done an effort to platform our electronics offering. Go back 10, 12 years ago, we probably offered point solutions. Today, when we come out with offerings, these are platform solutions, really accelerates our speed to market for future generations and allows us to innovate more quickly and more efficiently. This is an improvement that we've had over the last, I'd say, four or five years, and we've demonstrated this.
If you come to our technology center in Indianapolis, we can show you, but we highlighted this at our Investor Day a few years ago, where this platforming has really resulted in a acceleration of the pace of new product development. If you listen to our earnings calls, we always highlight some of the new products that we release to market. Think of it as a way for us to introduce more products quicker, and more cost-effectively.
Thank you. If you could talk about the topical and thematic and one of your purpose, the safety. How you actually describe yourself in terms of the safety culture and also, what's going on in the market, in terms of the safety as a mega trend?
Yeah. Safety for us is a core value. If you'll think of our values, be safe, be healthy is the top value that we have, right? It's one of our great eight. It's in everything that we do when we operate, whether on the plant floor. It's so important for us to keep our employees safe. Even out in the marketplace, right? School safety, for us, it's paramount. We think of these things, right? If there's an event, right, our goal is to keep children safe. We have examples. John Stone, our CEO, has an example of a cylinder that a channel partner or customer gave to us of a cylinder which had a bullet hole in it. The channel partner handed it to him and said, "Hey, you'll." You see the hole in it.
This cylinder held, and those children were safe and went home that day. I give it as an example 'cause this is core to who we are. We think about this every day, and this kinda influences everything we do as we operate as a company.
Thank you. Diving into our end markets, the U.S. non-residential, especially starting from institutional, the business. Could you talk about the customer new builds and replacement cycles and also what's driving the next three to five-year horizons for your revenue and your competitive landscape as well?
Yeah. I'll just quickly talk to end markets. I showed a little in the prepared remarks. For our business, and it wasn't on the slide, think of our business as being half aftermarket, right? Not subject to market trends, right? From a new build perspective, half the build business, not really impacted. Stuff breaks. In our industry, you're gonna replace it like for like. For Allegion, where we're strongest is when the premium products in that institutional vertical, the school, the healthcare, the higher ed building. What we create is an end user standard. We create a standard for that campus so that any aftermarket is our product as well as any new construction. If you're gonna put a new engineering building on an Allegion campus, it's gonna be our products.
It's a way of keeping ourselves very sticky with our customers and our end users. It really provides a lot of the stability we talk about in our business. Now, one of the efforts we've done to improve or accelerate growth is we put a concentrated effort at accelerating aftermarket growth. One of the things we've done is come out with a new offering of mid-price point products. We highlighted that at our last earnings call, the Von Duprin, LCN, and Schlage mid-price offering. It's a way for us as a premium player in the space and a market leader to do even better, right? And to accelerate growth into that mid-price point. It's a way for us to further diversify the revenue base away from just new build.
The thing about Allegion is don't think of us as cyclical with respect to, let's say, the Dodge data. Think of us as a kind of resilient business with half aftermarket and a sticky end user base.
Thank you, Mike. If it comes to the 50% aftermarket and resilient, what would you say in terms of the market shares given the customer stickiness and aftermarket sales? If you look at the 10 years ago, like, how's the dynamics evolving in your industry?
Yeah. So if you go back to our spin, you know, in 2014 when we were created, we really didn't do as well there as we should have. We didn't get our fair share. We've put efforts over the last decade to continue to improve that aftermarket presence. You've seen it in our growth, right? We have industry-leading growth in the marketplace in North America. Part of that is you just get a little more tailwind from aftermarket. This is something that I don't think will ever be done. We have room to grow as far as, like, improving in the aftermarket. In the institutional, we have that pretty locked down, but as we think about commercial office and others, we'll continue to just try to get a little better there.
I view it as an opportunity, significant improvement over the last decade, but still more opportunity for growth.
Thank you. If you, when you talk about the electronics, the evolutions, what kind of customer base, institutional, commercial or multi-family, would you say, like more high introductions, adaptations of those kinda moves, please?
If you look at the industry. First, I'll start with non-residential. You'll see the perimeter has been electrified for a while. If you think about the interior, whether that's a multifamily unit or an interior door at a campus, a college campus. Just over the last decade, you see an acceleration of those doors being electrified. Those are great opportunities for us. If you look at our last Investor Day, we highlighted a couple examples. Multifamily traditionally is an old key, and when someone leaves, you gotta pay for a locksmith to come and change that cylinder. We can create solutions for our customers where all you have to do is remove the access. That's operating savings for the facility owner and manager.
That's why we're seeing an acceleration in growth in electronics when you think of the interior there, in multifamily. In the case of higher ed, it's the same dynamic, right? Traditionally, you would have a key to get into your dorm room. More and more, that will be a credential, especially mobile credentials. Our first evolution of electronic locks. There was no such thing as digital credentials or mobile credentials. Today, more and more, that's gonna be a driver of electronics, where your credential will be on your phone, not necessarily a key fob, especially in higher ed, in multifamily. That is also an accelerator of growth for us in electronics for both the industry and Allegion.
Thank you, Mike. If you could walk us through the adoption, you know, adoption rates for like by the verticals. Like multifamily have a more electronics versus mechanicals or non-residential versus residentials.
Yeah. Residential, think of electronics as just the perimeter to the home, right? If you live in a single-family home, whole lot of mechanical locks in the interior, that's gonna remain a mechanical solution. In the perimeter, it is becoming more electrified. For us, one of the things about our electronic locks is you could see the average selling price being double and the useful life being shorter, right? That's a net plus for us, right? You can have a home where traditionally our parents may have lived in the same house for 30, 40 years, never changed the locks, right? If you have electronic locks, it's gonna cost twice to when you make the initial purchase. There's a shorter replacement cycle 'cause obviously electronic componentry doesn't have as long a useful life.
There's also a net benefit where technology will improve over time, such that you will take off a working lock and put on a new generational lock. I'll give you an example. My first electronic lock did not have Wi-Fi capability, so when the new solution came out, great advantage to have Wi-Fi capability, so I put a new lock on the door. In the case of non-res, which is the lion's share of our business, right? The lion's share of our business is non-residential. Yet that same dynamic of a replacement cycle with being shorter and the ASP being double, there the technology could be a digital credential. Our first adopters of electronic locks in higher ed didn't have mobile credential capability 'cause it didn't exist.
We're seeing some of those early customers retrofitting to the capability of having a mobile credential. It makes sense in higher ed if you think about students. They have to get access to 10, 20,000 dorm rooms a year, right? Much more efficient for them to do that via a electronic solution, a mobile credential than the traditional mechanical when someone like myself was in college.
Thank you. Mike, could you talk about how do you accelerate the electronics versus the mechanical hardware, the movements by organic versus the M&A, like for Allegion?
From an organic growth perspective, think of electronics as that high single-digit to low double-digit grower for us, and we've been able to demonstrate that over time. Our industry is, it's slower moving on adoption. What I mean by that, if you think about LED lighting. LED lighting, there was massive adoption in a short window. For our industry, think of it as a steady tailwind, right? Steady tailwind to growth where you're not gonna grow 20%, 30%, 40% a year organically in electronics, but it takes a long time to retrofit the old massive installed base over time. As a result, we think we can grow it at that high single, low double-digit clip, and mechanical doesn't grow at that level, right? It's not gonna grow as well as electronics. Electronics is our real accelerated growth driver.
Thank you. If you could talk about the margin expansions and opportunities. If we step back and thinking about how you create high levels of margins versus the competitors, like what makes you unique? What makes you differentiated for creating margin profile?
It's part of our DNA, right? When we think about managing margins, it's something we do extremely well. Part of it is how we manufacture our products. If you go to our Indianapolis facility where we make our exit device, we service the North American market via this one plant that is a highly configured, complex offering. What do I mean by that? We can offer millions of SKUs to our customers out of that plant. It's how we're enabled to maintain the margins that we do. We're extremely efficient, coupled with the premium brand and high-quality products that we have in our demand generation activities which are tops in the industry as well. From a margin perspective, it's a combination of the great front end, where we create demand in the design phase with the architect.
We influence the end user, and we pull the product through the channel, as well as a manufacturing excellence that allows us to really serve our customers very efficiently.
Thank you. If you could talk about the pricing strategies to expand the margins and versus inflation, especially in 2025 and also in 2026. How would you manage the like those kind of inflation by pricing strategy?
As a company, if you listen to our earnings calls, you'll hear us talk about pricing and productivity covers inflation and investment. It is core to us. We talk to every quarter. It's how we think about managing the inputs. If there's inflation, we have to pass that along to pricing, in the form of pricing. For us, how we're able to do it is that great front end that we have in the non-residential business where we're able to command that pricing. In our industry, we're able to compete on value, not price. It's not an industry where it's a race to the bottom. Everyone prices for the value that they create in the marketplace. Being a premium player, we have as strong as anyone's ability to get that pricing, and it's part of our DNA.
The other half, which is, maybe we don't talk as much about but is really important, we have to drive productivity to fund our investments. It's part of what we do and look for us to continue to invest in automation in order to do that, as well as drive an efficient operation. It's a combination of both. It's that pricing and productivity that helps provide some of the tailwinds to margins. If you look at 25, we were subject to significant increases in inflation because of tariffs. As you saw, we were able to manage that and have net positive dollar coming from pricing and productivity in excess of the inflation and investment. If you look at our history, we had a slide in our earnings deck a couple year-ends ago, where we showed that trend over a five-year period.
What you see if you go to that slide is a history of being able to demonstrate that pricing excellence and productivity excellence to drive margin expansion.
Thank you. Mike, if I could double-click on productivities by automation, platforming, and digitalizations, could you give us some examples, like for having those kind of, you know, impact?
Sure. In the case of platforming, I talked about that earlier. For us, it's not just electronics. We're also doing it in our mechanical portfolio. It allows us to drive efficiencies, speed in the case of new product introductions, so you get some leverage on the R&D spend. Even operationally, as you operate your factory, if we can eliminate some of the internal complexity, allows us to run more efficiency. Platforming has been a leg of that. Automation is another leg of that. As a company, we've been increasing our level of CapEx in our plants to drive productivity. We see a step up since I became CFO to now. It's about double the dollars per year. Think of it as a, you know, 2.5% of sales CapEx.
The key thing for us is we're spending the capital, but you're seeing the productivity and you're seeing the margins, right? Investing in automation, both in the plant, but even in the SG&A space, makes us more efficient, and look for us to continue to do that.
Thank you. Let's talk about residential market in the U.S. and how, like, do you see demand in 2026 plus your initiatives to grow for the next couple of years as a strategy.
For us on residential, we've been pretty consistent with our messaging that residential has been soft. In 2026, during our outlook that we provided, let's say a month ago on our earnings call, we said down slightly, right? In 2025, we were down low- to mid-single digits. It's been a softer market for us. Anyone who follows resi knows that's the case with anyone who sells into the residential home. For us, one of the opportunities for growth we've been taking advantage of is electronics. Our electronics in residential has also grown faster than mechanical, not at the high single-digit rate we were talking about, but certainly more than the mechanical.
It's an opportunity for us to either mitigate the weaker market or to drive accelerated growth, depending on how you use the terminology. It is a net plus for us. In our third quarter, we highlighted this in our earnings call, where we had a new product introduction, and you see the growth that can come from innovation. Look for us to continue to innovate in electronic locking across the portfolio, but inclusive of that, it would be the residential business where it does allow us to get some secular growth opportunity.
Thank you. When you talk about innovations, when it comes to AI, could you talk about the opportunities and risk of AI when it comes to your operational excellence of the business model?
If you think about operations, it's a way for us to drive efficiency, a way for us to drive productivity. It's in the early stages. We're all trying to figure out how to leverage it better, and we're gonna be able to leverage that better over time. One of the ways we've been able to initial quick win is we've been able to automate our order entry process with our customers to be more efficient how they get us their orders, eliminating the need for as much manual intervention. It's a way that five years ago we were less efficient than we are today. I think about AI, I see it as an opportunity for us, especially on the cost side. As far as threats, I really don't see a big threat from AI.
We get asked by investors all the time about, you know, is AI gonna disrupt our business? I'll just go back to that complexity of the non-residential business where we create demand by influencing the architect, influencing the end user, creating that standard and having an install base on a campus for decades up to centuries, as well as an elaborate distribution network where we have relationships for decades and longer. All of this combined with offering a broad set of products. Because if you can't provide all elements to the offering of a building, you're gonna be less successful. That is a case where there's only a couple players in North America who could really do this at scale. You know, two to three. Therefore, I think it's an opportunity.
As technology over time advances, it tends to be a plus for the largest players in our space.
Thank you. Could you talk about the risk of electronic solutions when it comes to cybersecurity as well as data security, and how would you tackle with those kind of risk from Allegion?
Obviously, for electronics, this is something that the mechanical we never had to worry about, right? It's something we put considerable time and effort to ensure we have the most secure, safe products and the leading products in the industry. Also with Allegion, it's important to understand where we do and don't play. We are not playing in the enterprise access solutions space. Those would be other companies where we partner with them. That is not just Allegion. Our whole industry will partner with enterprise access solutions or access control solutions. As a result, when you think of Allegion, don't think of us as playing that enterprise access control. Think of us as our partner of choice strategy, where we partner with these players.
Ensuring that we have the most safe, secure products is top of mind for us, whether that's an electronic solution or a mechanical solution.
Thank you. Mike, if you could talk about the international business in terms of the growth opportunities plus the margin expansion opportunity, please.
International, as I mentioned, when we started Allegion, this journey, in 2014, 0% operating margin, right? We were a break-even business. When I was in investor relations, 2016 to 2019, I'd get asked all the time, "Why don't you guys just get out?" What we were able to demonstrate is we've been able to get to industry-standard margins. Our margins in international are up there with the peak players in the space, right? Considerable improvement over time. Couple ways we've done that is operational excellence, bringing some of the capabilities and strengths we have in the Americas and leveraging that internationally.
We've also spent some effort on the portfolio, both on the addition side, where we've added great electronics businesses that drive faster growth and more profitability, and on the sales side, where we've divested some underperforming assets. Think of the Middle East, Korea, China, et cetera. I think it's a combination of both, where if you listen to our earnings calls, we'll say this all the time, it is a much healthier portfolio of products today than fifteen years ago. I think it positions us, so if I, you know, if we think about the next decade, we're gonna be in a much better place than we were ten years ago, right? That's something we're quite proud of, the improvement in the international segment, as a company.
Thank you. Capital allocations, M&A, Mike, could you talk about the, you know, with a strong balance sheet, robust cash generation, how do you prioritize between organic investment, targeted M&A, share repurchases, dividends?
Yeah, we talked about this a bunch at our Investor Day last May. I recommend you all listen to it. We probably spent a good 15-20 minutes on it. I would say it starts with organic growth. Look for us to continue to invest in R&D to drive the right products. That is core to us. We'll continue to do that, right? We help pay for that by driving productivity, but we're always gonna continue to invest in R&D. We've increased our R&D rate from 2021, the rate then to today, 1.5x . What do I mean by that? The dollars spent today are 1.5x the dollars spent in 2021. Organic growth is key. With the remaining free cash flow, because organic investments, R&D, that's within free cash flow.
Historically, think of us as about 50% of our free cash flow will go to M&A. Dividends, payout ratio is about 30%. The remaining 20%, that's where you'll see a share buyback or M&A. We call it the swing factor. Historically, if you look at the historics in that Investor Day deck, you'll see that equates to what share buyback is. You can think of it over time. You know, last year, obviously more M&A. It was a little more last year. But over time, think of it as roughly half the free cash flow will go to acquisitions, 30% dividend, and then we also have the buyback.
Thank you. I think your time is up. I'll wrap it up. Thank you very much, Mike, and thank you, everyone, for joining today.
Thank you.