安朗杰 (ALLE) 2021 Q2 法說會逐字稿

Good morning, and welcome to the Allegion Second Quarter 2021 Earnings Call. (Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Tom Martineau. Please go ahead.

Thank you, Andrew. Good morning. Welcome, and thank you for joining us for Allegion's Second Quarter 2021 Earnings Call. With me today are Dave Petratis, Chairman, President and Chief Executive Officer; and Patrick Shannon, Senior Vice President and Chief Financial Officer of Allegion.

Our earnings release, which was issued earlier this morning, and the presentation, which we will refer to in today's call, are available on our website at investor.allegion.com. This call will be recorded and archived on our website.

Please go to Slides 2 and 3. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements.

Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Dave and Patrick will now discuss our second quarter 2021 results, which will be followed by a Q&A session. (Operator Instructions)

Please go to Slide 4, and I'll turn the call over to Dave.

Thanks, Tom. Good morning, and thank you for joining us today. Allegion delivered a very strong quarter, and I would like to thank the employees of Allegion for their contributions and efforts. Our employees are the greatest strength of Allegion. Their dedication to safety and customer excellence is outstanding. And our teams have moved quickly to adapt to opportunities in a dynamic market.

Before I jump into the financials, I want to give you a high-level update on recovery trends and the business overall. The pandemic has changed our world and created volatility throughout the last 18 months, both in terms of the economic contraction last year and the current economic rebound we are seeing. Starting in Q1 and accelerating in Q2, demand surged faster and stronger than expected. This is a positive sign and provides confidence in the sustainable economic recovery. In fact, Allegion is already returning to pre-pandemic demand levels. At the same time, the robust demand is constraining the global supply chain's ability to fully meet the pull for labor and materials, especially electronic components.

Allegion has built a record nonresidential backlog in 2021, which is a healthy sign of strong demand, and we believe Allegion will be well positioned for the remainder of this year and for 2022. In another positive sign of recovery, our Americas electronics grew more than 20% in the second quarter. There was strong demand for electronic residential products and in the nonresidential retrofit, repair and small project opportunities. Allegion is not immune to inflation and the supply chain constraints impacting the industrial markets. Allegion navigated well during Q2, but these industry-wide constraints will persist for the remainder of the year and put pressure on margins for the short term. We will leverage the strength of our supply chain management capabilities as well as price to mitigate these impacts. During the pandemic, we were also able to restructure the business and make it leaner, while keeping our front-facing and strategic investments. Allegion is stronger exiting the pandemic than when we entered it.

Now let's turn to the second quarter performance for more details. Please go to Slide 5. I'm pleased with the company's second quarter results. We delivered strong performance in all areas. Revenue for the second quarter was $746.9 million, an increase of 26.7% or 23.8% organically. The organic revenue increase was driven by the favorable comparable created by last year's shutdowns, solid price realization from the price increase announced earlier this year and the increased market demand, which returned to pre-pandemic levels. Currency tailwinds provided a boost to total revenue and more than offset the impact of divestitures.

Adjusted operating margin increased by 70 basis points in the second quarter. The restructuring and cost management actions taken during 2020 along with volume leverage have offset the accelerated inflation. We are also seeing cost creep back from reductions experienced last year during the pandemic. Mix is also a margin headwind due to our strong residential growth.

Adjusted earnings per share of $1.32 increased $0.40 or 43.5% versus the prior year. The increase was driven largely by the expanded operating income with some benefits also coming from a favorable tax rate and share count. Year-to-date available cash flow came in at $249.6 million, an increase of $146 million versus the prior year. The increased cash flow was driven by higher net earnings, along with improvements in net working capital and reduced capital expenditures.

Please go to Slide 6. Last quarter, I shared with you Allegion's build, borrow, buy approach to accelerating seamless access. Today, I want to briefly focus on the borrow innovation engine in our strategic pillar to be the partner of choice. Allegion participates in recognized, secure industry-leading platforms. We expand our reach through strategic relationships with recognized experts and tech innovators, and we leverage open standards. By doing this, we not only set up Allegion as the partner of choice and a continued leader in the IoT marketplace, we also ensure Allegion has its choice of strategic partners as well. Allegion has a growing breadth of strategic partners, mega tech, software and product integrators, our venture portfolio and technology alliance and industry consortiums. We are executing on our partnership strategic pillar and here are a few recent examples.

Allegion was showcased at Apple's Worldwide Developer Conference. We are expanding our innovation with Apple in both the residential and commercial marketplaces. In the smart home space, Schlage will soon be growing its connected portfolio with a new device that allows people to easily and securely unlock their doors with just a tap using home keys for the iPhone or the Apple Watch. At the same time, we are extending our work with Student ID in the Apple Wallet to offer more access control options to universities and colleges, enterprises and their students plus employees. Allegion renewed our engagement with the Matter Work Group, a mega-tech consortium. Through this partnership, we're working to establish a secure connectivity standard for the future of the smart home that will ultimately allow more seamless connections between more IoT devices.

We announced Allegion Venture investments in both Mint House and Mapped, 2 startups driving new value in a post-COVID world through revolutionary experiences and technology. And we completed a brand-new cloud-to-cloud integration with Openpath, leveraging our ENGAGE technology and Schlage NDE and the LE mobile-enabled smart locks. Through these partnerships, we're investing in promising innovation. We are leveraging developer-friendly APIs and open standards. Allegion is building strategic, commercial and technical relationships. We are collaborating with recognized experts who also understand and embrace how Allegion creates value by securing people and assets with seamless access wherever they reside, work and thrive.

Patrick will now take you through the financial results, and I'll be back to discuss our revised '21 outlook and to wrap up.

Thanks, Dave, and good morning, everyone. Thank you for joining today's call. Please go to Slide #7. This slide reflects our earnings per share reconciliation for the second quarter. For the second quarter 2020, reported earnings per share was $0.80, adjusting $0.12 for charges related to restructuring expenses, the 2020 adjusted earnings per share was $0.92. Operational results increased earnings per share by $0.36, driven by volume leverage, along with continued benefits from cost control measures and restructuring actions taken in 2020. Favorable price and currency also contributed to the increase. The combination of these items offset headwinds from inflation, bounce back variable costs related to reduced volume from the COVID-19 pandemic and unfavorable mix.

Favorable tax rate drove a $0.06 increase in earnings per share. Divestitures had a positive $0.01 per share impact and offset the impact of other income and interest expense. Investment spend increased during the quarter and reduced earnings per share by $0.05. As a reminder, the incremental investment spend is predominantly related to R&D, technology and market investments to accelerate future growth. This results in adjusted second quarter 2021 earnings per share of $1.32, an increase of $0.40 or 43.5% compared to the prior year. Lastly, we had a $0.01 per share reduction related to restructuring charges and acquisition and integration expenses. After giving effect to these items, you arrive at the second quarter 2021 reported earnings per share of $1.31.

Please go to Slide #8. This slide depicts the components of our revenue performance for the second quarter. I'll focus on the total Allegion results and cover the regions on their respective slides. As indicated, we experienced organic revenue growth of 23.8% in the second quarter as higher demand and a favorable comparable drove significant volume increases versus the prior year. We also experienced solid price performance coming in over 2%, which is up sequentially. Currency continued to be a tailwind to total growth and more than offset the impact of divestitures. In total, reported revenue came in at 26.7% growth.

Please go to Slide #9. Second quarter revenues for the Allegion Americas segment were $549.4 million, up 23.7% on a reported basis and 22.9% organically. While the strong growth reflects the impact of COVID-related shutdowns last year, it is also the result of accelerated market demand. The region continued to deliver good price realization. On volume, Americas nonresidential experienced high single-digit growth driven by retrofit, repair and small projects. Americas residential was outstanding, again, experiencing growth of more than 70%. The significant growth from the prior year was primarily due to facility closures in 2020. However, we continue to see strength in retail point-of-sale and new home construction.

Electronics revenue was up high 20s percent. We experienced electronics growth in both the nonresidential and residential businesses. Electronics and touchless solutions will continue to be a long-term growth drivers. The accelerated demand, coupled with labor and parts shortages, especially in electronic components is resulting in elevated backlogs as we enter the third quarter, particularly in nonresidential. The timing of when we see the revenue could shift as the industry works through the supply chain constraints.

Americas adjusted operating income of $150.5 million increased 21.3% versus the prior year period, and adjusted operating margin for the quarter was down 50 basis points. The decrease was driven by headwinds related to inflation, bounce back costs and unfavorable mix more than offsetting the volume leverage. While the price productivity inflation dynamic was slightly positive on a dollar basis, it did have a 60 basis point dilutive impact on adjusted margins as did the incremental investment spend.

Please go to Slide #10. Second quarter revenues for the Allegion International segment were $197.5 million, up 36% and up 26.6% on an organic basis. The organic growth was driven predominantly by strength across all European countries and businesses as markets continue to rebound. Part of the year-over-year growth was due to the comparative impact of COVID-related shutdowns in the prior year. Favorable currency impacts also contributed to total revenue growth and were slightly offset by divestiture impacts. International adjusted operating income of $18.5 million increased more than $18 million versus the prior year period. Adjusted operating margin for the quarter increased by 920 basis points. The margin increase was driven primarily by solid volume leverage, benefits from lower operating costs due to the restructuring and cost control actions taken during 2020 as well as favorable currency impacts. All of these offset the higher inflation and bounce back costs, which had a 150 basis point impact in incremental investments, which were a 20 basis point headwind.

Please go to Slide #11. Year-to-date available cash flow for the second quarter 2021 came in at $249.6 million, which is an increase of $146 million compared to the prior year period. The increase was driven by higher earnings, improvements in net working capital and reduced capital expenditures. Our cash flow generation continues to be a strong asset for the company.

Looking at the chart to the right, it shows working capital as a percent of revenues decreased based on a 4-point quarter average. This was driven by improved asset turnover in both receivables and inventory. The business continues to generate strong cash flow and is well positioned to deliver $500 million in available cash flow for the year.

I will now hand it back over to Dave for an update for our full year 2021 outlook.

Thank you, Patrick. Please go to Slide #12. At the end of Q2, leading indicators continue to be positive. I'm increasingly optimistic on the economic recovery. The Americas residential business continues to be hot. On the nonresidential side of Americas, demand accelerated for retrofit, repair and small projects and is recovering in new construction. However, labor and part charges are proving to be challenging, and we are building a strong backlog that will benefit us in the future. With these parameters in place, we are raising our outlook for total revenue in the Americas to be up 4.5% to 5% and organic revenue to be up 4% to 4.5% in 2021.

In the Allegion International segments, markets continue to recover led by our Germanic and Global Portable Security businesses. Currency tailwinds more than offset the divestiture of our QMI door business and contribute to total growth. For that region, we are raising our outlook for total revenue growth to 13.5% to 14.5% with organic growth of 8.5% to 9.5%. All-in for total Allegion, we are now projecting total revenue to be up 7% to 7.5% and organic revenue to increase to 5.5% to 6%. We are also raising our earnings per share outlook with reported EPS at a range of $5.15 to $5.30 and adjusted EPS to be between $5.25 and $5.40. This guide incorporates pricing actions to mitigate the inspected -- the expected impact of direct material inflation. We anticipate these inflationary challenges will persist for the balance of the year and we will continue to monitor and adapt to changing market conditions.

Our outlook for available cash flow is also being raised and is now projected to be $490 million to $510 million. The outlook assumes investment spend of approximately $0.20 per share. The full adjusted effective tax rate is expected to be approximately 12%. The outlook for outstanding diluted shares continue to be approximately 91 million shares.

Please go to Slide 13. Allegion continued its great start in 2021. We have managed the business extremely well and leading indicators in specific market indices related to our business continue to be positive. Looking forward, we are prepared to navigate the pressures related to accelerated inflation and labor and parts shortages. We are encouraged by the positive resiliency of our supply chain and we will continue to manage these challenges for the balance of the year. Thank you.

Now Patrick and I will be happy to take your questions.

(Operator Instructions) The first question comes from Josh Pokrzywinski with Morgan Stanley.

So I guess first question on the margin front. Obviously, there's kind of the (inaudible) the math on price cost, even though you're positive on a dollar basis. And I would imagine a little bit of mix headwind on the resi side as well. But if you just kind of take a giant step back and put some of the mechanical items aside, do you feel like getting price or managing inflation in logistics and all the other kind of inflationary headwinds, labor is any different than it is -- has been normally? Or is that -- has that gotten a little bit more challenging and sort of hard to parse through some of the different moving pieces there.

Yes. I would characterize it this way, and you're right, there's a lot of (inaudible) the math. But what we've seen is an acceleration of inflation, predominantly in commodity costs, material components, freight, packaging, et cetera. It's continued to be a headwind. As you know, we're pretty aggressive moving on price. And we're taking similar actions in the back half of this year. We went ahead and announced a price increase that will take effect at the beginning of Q4. So there's going to be some margin pressure, I would say, given the acceleration in inflation, particularly in Q3. I expect price to offset material inflation.

The issue is really in some of the other components as it relates to packaging, freight, those type of things. We'll drive productivity to help mitigate those type of things like we have previously. But it's going to be a challenge. There will be some margin pressure in the back half of the year. But I feel very confident relative to margin improvement as we go into 2022 predominantly because of the carryover price, and we'll continue to take pricing actions next year. We'll have an improved mix profile as it relates to the nonresidential business growing faster and accelerating more so than the residential business. And we're not going to have these bounce back costs, which were an issue for us in Q2 and will kind of linger during Q3, Q4 this year.

So I think to answer your question, Josh, we'll continue to manage the business. We'll get through some of these supply chain challenges. That in and of itself will also put a little bit of margin pressure because of some of the inefficiencies at the factories. But we'll manage through it. Margins sequentially will improve in the second half relative to the first half, still down year-over-year. But then in [2020,] expect margin improvement to accelerate.

Got it. That's helpful. And then I guess just a follow-up on the comment, Dave, you made on record backlog. Maybe if you could unpack that a little, because I would imagine some of that is resi where you probably don't really want a lot of backlog there that's more indicative of lead times and supply chain stuff than it is necessarily like a long-cycle business. So maybe break down the components of that? How much is nonresi? Is the market getting better and reopening in retrofit versus we're just carrying more backlog in resi because the whole supply chain's lengthened?

So I want to be clear, the backlog issue is not a residential problem. Our residential backlog slightly above what we'd normally run. The backlog creation has been on the commercial side of the business and the rapid build has really happened over the last 60 to 90 days. The commercial backlog predominantly on the Americas business is double normal, and it was really driven by the acceleration of order demand that we started seeing in April. And I'll give you some backdrop here. You go back December, January, February, March, and we would have talked about this in the Q1 call, commercial institutional demand in the Americas business was down low double digits, and it's like someone turned on a light and it's -- extremely pleased with that demand acceleration. We're doing a good job of, I think, processing that through, but there's supply constraints and it's resulted in a record backlog that I think we'll continue to see.

There's been analysts out there that have said we've done a better job of managing this, and I believe that to be true. Our supply chain is strong and we're going to benefit from that trend. I'd also share one other comment is, the macroeconomic forecast on what I'd say, the commercial break fix was not particularly clear. In fact, I've got economic reports that would suggest that the repair replacement would have been soft even today. That switch came back on. We've gained that opportunity in -- so why couldn't we have seen it? When you shut off access to college campuses, hospitals and commercial buildings for 400 days, you get pent-up demand. And that's what we're seeing reacting positively in the marketplace.

The next question comes from Chris Snyder with UBS.

I kind of want to follow up on the margin commentary, but maybe from a bit of a different angle. So guidance implies a pretty material ramp in margins into the back half of 2021. My back of the envelope math puts maybe margin in the low 21% range versus low to mid 19s in the first half. Could you just kind of help unpack the drivers of the step higher because guidance is not implying much volume leverage into the back half. So is this more price catching up to cost, freight normalizing, mix normalizing? Any color on that step higher into the back half would be appreciated.

Yes. So that trend is not uncharacteristic. From a seasonality perspective, margins, if you kind of look at it over a historical time period, stronger back half of the year. So that's not unusual. I think as we characterized sequentially, margins are expected to increase. It's the year-over-year comparison that we would expect some degradation just kind of given some of the things we outlined relative to inflation.

Appreciate that. And then, I guess, following up also on the record backlogs. It sounds like revenue on some level was constrained just by the supply chain issues that everyone is feeling. And it also sounds like the back half or the full year growth guidance is also reflecting uncertainty as to when these backlogs will be released, whether it's the back half of '21 or into '22. Could you provide any color on maybe how much or how significant revenues were may be constrained in the quarter just because of those supply chain issues? And then how we should -- what level of maybe supply chain conservatism is baked into the full year organic growth guidance?

So we -- when we look at the demand relative to what we could ship, I mean there is going to be a disconnect there, just kind of given the supply chain constraints. And I think you're aware, Chris, we normally carry a light backlog, highly specified engineered product, quick turnover in our manufacturing facilities to the customer. That has been elevated kind of given some of the constraints. But to answer your question specifically, it could be 1%, 1.5% kind of total revenue Allegion that's constrained that will get the revenue. So it's not a question of if, it's just a question of timing. So we look at it as a timing kind of transitory issue. And if the supply chain constraints persist, we'll get that in 2022, which means revenue in '22 would be accelerated more so than the overall market demand.

I would add a couple of other comments. Clearly, supply constraints ended the rapid acceleration of demand that we saw helped build backlog. I would say -- we will -- over this entire pandemic and downturn, the resiliency of the Allegion supply chain, I believe, was stronger than the competition. And we're going to come out of this better. So I feel good about that. I think the other thing you've got to think about, we're not alone in this. In the retrofit community and new construction, the entire project is affected by this. And we just got to navigate in that environment.

The next question comes from Brian Ruttenbur of Imperial Capital.

Yes. So I have 2 questions. Can you talk about the commercial office performance in the quarter? How much was this sector down year-over-year? How much did commercial office represent in terms of revenue in the quarter? I'm just trying to get a data point where you are.

Yes. So we don't really provide revenue by vertical markets. But I would just say, in terms of market demand, i.e., order intake activity, what we're seeing specification, et cetera, commercial office space is lagging institutional segment. And a lot of that is just not kind of keeping pace with what we're seeing in terms of the rebound and repair retrofit, new construction. So hopefully that provides you with ample color there.

I'll maybe give you a little bit more. Again, we don't split out that commercial segment as stand-alone, but the strength that we saw in the first half was really driven by strong wholesale, small project and retrofit business. Where that business ends up, we don't have precise [theory] on, but there's -- the snapback of that volume would say, even in the commercial office space, there's investment going in there to repurpose, to reposition. And I like the opportunity for Allegion as we move through there from an electronic standpoint. You go back 6 months ago, I was concerned about the return to office, and we're going to have a lot of vacancies out there. Capital will go in and redefine that space, and it's going to be good for our industry.

Great. The second question I have, just coming off of ISC West, and meeting with a lot of companies, private and public. We see a lot of competition coming at access control with a total solution. White -- and there's -- one of the trends I'm seeing is white labeling of hardware at a discount and integrating software. So it's all about delivering a total solution, the hardware maybe name doesn't mean as much. And that's what I'm hearing at least. So some of these companies that are investing large sums of money in this total access control solution, that's what we're seeing. Can you address what you're seeing in the industry and how you're addressing this threat?

Okay. In today's presentation, we try to emphasize our build, borrow, buy emphasis and our partnerships with the mega techs. I certainly see this private labeling, white labeling phenomena. I would just suggest the core part of our business has a level of connect -- of complexity and connectivity that I'll bet on over the long haul. When you get into a complex business or a complex event space like you were at ISC West, it's easy to look at this and say, okay, I can have a small offering of white label products. But when you start adding code requirements, master key systems, the connectivity with an Apple, a Google, a Lenel, the game gets a lot tougher.

The next question comes from Julian Mitchell with Barclays.

Just wanted to circle back to the Americas revenue guide for the year. You're embedding, I think, maybe very low single-digit growth year-on-year in the second half in the Americas. Just trying to understand what's embedded in that for residential versus nonresidential? And what sort of pace of slowdown of residential growth you're assuming?

Yes. So Julian, just as a reminder, last year, as we're coming out of the pandemic and demand started to surge for replacement demand on residential products, backlog accelerated channel inventories were depleted. And so a lot of the revenue growth last year was channel fill, big box, retail, e-commerce, et cetera. And so you're getting a tough comp, particularly in the second half as it relates to the residential business. And so that's going to impact the comparability, particularly when you're looking at overall Allegion Americas business. As we indicated, nonresidential business starting to show good demand, a little bit constrained relative to the supply chain issues. But we'll start seeing some growth kind of year-over-year. So it's really that the guide you have to take into account last year had a higher growth component associated with channel fill related to the residential business.

Sure. But I guess I'm trying to understand, are you assuming that residential revenues are down year-on-year in the second half or...

No, they're still increasing.

Okay. Got it. That's just what I wanted to check. And then on the margin front, looking at -- yes, we keep attacking it different ways, but let's look at it sort of second half margin year-on-year because I think that makes more sense in terms of the information you provided in the 10-Q and so on. So it looks like your second half operating margins firm wide may be down something like 100, 200 bps year-on-year in the second half. Is the way to think about that, it's about 200 bps headwind from inflation net of price productivity and then maybe another 100 bps headwind from investment spend. Are those roughly the right orders of magnitude?

Yes. And I would -- just a little bit more color on the price, productivity, inflation dynamic. Included in that guide would include some of the effect of these bounce back costs that we've been highlighting. It was much more pronounced in Q2, but you've got kind of some of those costs that continue in Q3, Q4. So that's some of the pressure as well year-over-year.

The next question comes from David MacGregor with Longbow Research.

This is Joe Nolan on for David MacGregor. I was just wondering, could you talk about field inventory levels in both the residential and commercial business? And then just how you expect the timing of the channel restock play out?

On the residential side, big box, our res pro partners, I think the restocking of that supply chain is essentially complete. There is pressure on any type of electronic-related product. Again, which we're navigating well, but that will be a problem that moves through in the next 4 quarters. On the commercial wholesale side, as I talked about the bounce back in demand, I think part of that is wholesalers seeing the confidence in the marketplace and restocking, but I think much of it's going straight through because of the availability or really green light on small projects that were delayed over a continued period. So I would suggest that the restocking of the wholesale and contract supply chain will be completed over the next 2 to 3 quarters.

Okay. And then also just on your education business, given the year ago pull forward in the timing of seasonal maintenance into 2Q '20, was that a growth headwind that you experienced in 2Q '21 this year? And do you think that becomes a tailwind here in 3Q?

Just state your question again, you broke up.

Sorry. Just on the education business, given the year ago pull forward and the timing of seasonal maintenance into 2Q '20, was that a growth headwind this year in 2Q '21? And does that become a tailwind here in the third quarter?

I would look at the opportunity in K-12 as part of the bounce back, but more a positive as we move into '22 and '23. Americas is going to continue to invest in its K-12 infrastructure from a variety of reasons, age, increased security, more automation, and Allegion will benefit from them. It's clearly a positive.

The next question comes from Andrew Obin with Bank of America.

For a while I thought I would have to use the word unpack in my question. I was wondering if there was a memo that went out to use the term unpack, but that can be added...

I thought you were going to remind me that you had it right on this bounce back.

Oh, I'll take that, too. I guess the question is on pricing. Historically, your pricing has been fairly close to that of your large competitor in North America. This quarter, they seem to be ahead of you. And I was just wondering, is there a difference in approach to channel between the 2 of you? Or is just a matter of timing, as I said, because the industry seems to sort of move in lockstep.

I wouldn't say they're ahead of us. My words to our leaders worldwide is use all tools required to address the extraordinary inflationary forces. We were out with a normal Q1 price increase. We've added surcharges on certain products, and we've announced a end of Q3 price increase, 2 price increases in a year, and the other tools that we're using to mitigate price. I think the industry has been disciplined in our stewardship of making sure that we respond to the incredible inflationary forces who work for us.

Got you. Then the second question, as you and I -- I think I've asked this question a couple of times, but as you face supply chain constraints, are you rethinking either your approach to your internal supply chain, i.e., sort of more automation? Or are you sort of rethinking sourcing, any long-term impact from sort of current disruption in the channel? Or you think once we sort of get rid of the bullwhip effect, things go back to normal fairly fast?

I think the Allegion supply chain is always a strategic item as we think about positioning the business, one. Number two, I'd point to our decrementals during the downturn. Our decrementals on a top line basis was softer than any of the competition, meaning as the markets collapsed, our revenues were stronger on those decrementals, and I would point to supply chain. Third is, I think, clearly, a lot of work going on, I'd say, managing the complexity of what we do. It's everything from boards to grommets to casting. Part of what the Allegion franchise is built on is managing this complexity. Our supply chain does an important part of -- plays a critical part of that, but it's rethinking those partnerships, making sure that we've got the availability of any type of part to be able to move it. We've made some pretty significant industrial investments in automation. Those will continue. I think as we go through this, labor availability is going to be in scarcity on a worldwide basis. And so automation investment, investing with strong suppliers and producing in-region are key drivers for Allegion, Andrew.

The next question comes from Joe Ritchie with Goldman Sachs.

Just a quick question here on the margins. The -- if I take a look at the Americas margins and your commentary around pricing for 4Q, I guess when we think about the sequential change in margins in the Americas, is there kind of like embedded in your expectations that sequentially margins potentially step down in 3Q because of these inflationary pressures and then back up in 4Q? Just trying to understand the cadence a little bit better.

Yes. So you got it right. Q3 margin decrease year-over-year, much more pronounced than Q4. Q4 because of the price increase and some further actions, still down, but improving, not as far down as Q2.

Okay. All right. That's super helpful. And then I guess maybe just one -- maybe one broader question. I know that you guys consistently get compared to your European peer in the U.S. But if we take a step back and just thought about the industry as a whole and the potential consolidation in the locks market in the U.S. Do you guys view the market as being fairly well concentrated today? Are there opportunities to continue to expand either via M&A within the market you see future consolidation? Just curious around your broader thoughts there.

I think over the last decade, this is an industry that's consolidated. I would suggest that that's not moved at the pace that other industries have. So there's opportunities, half step adjacencies. I think the brightest growth aspect for Allegion is in the seamless access technologies. Part of the corporate spend this year is we're investing to try and better understand the future of seamless access and where it could be 5 to 10 years out because of our unique position. And my message here, the industry is going to continue to consolidate it. But I believe through innovation of our unique position on the door electronics, your edge device that it will continue to drive nice growth for Allegion.

The next question comes from Tim Wojs with Baird.

Maybe just -- so first question is on investment. And I guess it's two part. So I guess, first, could you just elaborate a little more on where you're making the actual incremental investments this year? And then secondly, could you just talk about the pipeline build for future investments and how the paybacks on those are kind of prospectively versus history? Are they the kind of same, better or worse? Just kind of curious there.

Yes, Tim. So the majority of the incremental investments would be centered around R&D, technology type of investments centered around driving electronics, revenue growth and market segmentation, i.e., where are the opportunities where we can expand our business and leverage our franchise globally. And so think about that in relation to some of the things Dave talked about in terms of enhancing our partnerships, to have broader connectivity into electronics seamless access ecosystems and solutions, very important for the business going forward. So we're putting monies in those that I think will position us extremely well for growth going forward and will help us continue to grow faster than the broader market is the plan there.

Your question on ROIC, it's always been a really good payback, not only on investment, but on a cash on cash basis. And good things to do that will position us in the marketplace for further growth. And historically, you've kind of seen our revenue kind of trend probably a little bit north of our peer set and would expect that to kind of continue given the level of investments that we're making to position our franchise going forward.

I'd build on that a bit, Tim, to say we've had -- take out the pandemic, we've had 5, 6 years of double-digit electronics growth. And clearly, the market moving that way. We've got, over the next 24 months, a nice pipeline of connected products coming out that it will enhance specific investments in software capabilities, what I call software stacks that enhance the partnerships that we talked about today. You have to have the APIs, SDKs that allow our locks to work in our own ecosystem and work in the complex ecosystems that may be present at a hospital, a college campus. We believe this differentiates us versus one horse ponies that come in with a solution and an important part of our future growth. I'd add one other is segmenting the market and understanding the future 5, 10 years out in multifamily, K-12, college campuses and hospitals. We think we have an important role to play in our installed base, and this connected environment will leverage Allegion's growth.

I just -- Tim, also just think about the movement in technology, how fast things are changing and being part of a broader ecosystem where we can -- our products can seamlessly plug and play into a broader set of solutions, very important. And so investments -- incremental investments will continue. I mean it's part of our DNA in terms of how we think about accelerating growth. And things are moving quickly, and we want to be a market leader in that segment.

On -- in the [deck,] partnerships with the mega techs, which are important, partnerships with the integrators like Lenel, our venture arm, I think you saw the announcement on Openpath, the sale to Motorola Solutions, an excellent example of how we're playing that game and then continue investments in the digital players that help drive our growth.

Okay. Great. No, I really appreciate it. It all makes sense. I guess the second question, just on maybe bigger picture. Could you just frame for us how you're thinking about a recovery and maybe revenue contribution from the specification business? So you're obviously seeing an uptick on the specification side, but when do you think you could start to see that be a meaningful revenue contributor? Is that a full year benefit next year? Or is it skewed towards the second half?

I think you'll see that really gaining some speed Q2 of next year and through the traditional construction season. ABI's been up for 3, 4 consecutive months at really record high, 60. I think we were there for a peak. It takes about 12 to 18 months based on the scope of those projects for us to really start seeing the momentum.

The next question comes from John Walsh with Crédit Suisse.

Maybe just 2 follow-ups here. One, you had a little bit of a discussion there on K-12. You talked about the age, the security, more automation. But one thing you didn't mention was stimulus. And just curious, we're hearing that there's a lot of stimulus already been approved for that vertical. A lot of focus on HVAC, but there is a big demand on the infrastructure side for access control. Are you seeing any of that benefit yet? Or is that what you're kind of talking about might come through in '22 and beyond?

As we try and unpack the stimulus package, we certainly see access control, school security as a part of that. Again, it's dominated, I think, by modernization, things that you talked about HVAC. We're going to benefit as a result of that stimulus. I would also say there will continue to be a drive in the K-12 sector to modernize. The average K-12 structure is 40 years old. Security threats persist and access into schools is becoming more sophisticated because of people's edge device, electronic locks, and Allegion is going to benefit from that.

Great. And then obviously, you've lived through several inflationary cycles. We could argue this one's a little bit different. But can you talk about your ability to hold price when you come out of these inflationary cycles, there's probably some regular pricing activity. I think you used the term surcharges for some things as well that maybe those are a little bit more transitory and go away when inflation abates, but can you just talk about your historical experience there, if we think about margin next year?

Yes, sure, John. So historically, the price increases announced that are permanent in nature, stick going forward, okay, i.e., even in deflationary periods, prices remain the same, and a fairly disciplined industry here. We did announce some surcharges on particular products that are more heavy and steel-related components. And those, of course, go away assuming that the price of steel comes down. But the majority of our price increases are permanent price increase that we expect will stick going forward even when inflation comes down.

I would add to that, the majority of my industrial career in the electrical industry and now security, we have as a guiding management principle, as our input costs go up, I expect to capture that plus. And we're very driven on the inputs as well as the pricing systems here and it's part of our DNA. And it's never been more important as we face inflationary pressures.

The next question comes from Jeff Sprague with Vertical Research.

And maybe just a couple of loose ends here. A lot of ground covered. First, maybe a little shout out to your international friends. Just wonder if you could give a little bit of color on how you're thinking about the margins in the back half there, right? Usually, we start fairly low in the first half and step up materially. I'm assuming from this kind of better run rate here in the first half, you're not expecting the same magnitude of step-up, but I assume the margins are going higher. Could you just elaborate on the trajectory there, the price cost dynamics in those markets collectively, and what, if any, other restructuring benefits you have coming through?

Yes, Jeff. So thanks for bringing that up. Outstanding performance by the international team, particularly when you're looking at not only margin increase, but the top line growth. And that's been a key contributor to the margin expansion there as well. But you may recall, if you kind of look at that segment in isolation, they were probably out in front of this pandemic quicker in terms of reducing costs, managing that side of the equation, restructuring programs that kind of went through both in Europe and Asia Pacific. We also are seeing the benefit of the amalgamation of both the Asia Pacific and European segments coming together as Allegion International. All that combined has really accelerated the margin improvement year-over-year.

The restructuring actions, the benefits we saw in the first half kind of lap, if you will, beginning in Q3. So you're not going to see the step up in margin expansion year-over-year. Seasonally, you know this, Jeff, that the margins expand in Q4 for that segment, in particular, would expect the same seasonal increase, but the year-over-year margin improvement, you're not going to see. There was some onetime benefits in Q4 that are nonrecurring this year, bounce back in cost, higher inflation, these type of things. But the -- great performance first half. We would expect kind of continuous margin improvement going into next year or 2. And so I really like what the team has done there, how they're executing, driving top line growth, those type of things. Great performance.

Right. No, understood. And then just back to kind of the whole backlog top line calculus here. I guess your guide essentially kind of indicates revenues in Q3 and Q4 will be similar to Q2, which is not atypical for your business. But I guess I'm also hearing though that perhaps you're suggesting the top line is just governed here by the supply and other constraints. Is that really the message that there kind of in normal circumstances, there would be more upside into the back half, just unlocking this backlog, but just the physical ability to get it out the door, whether it's your own factory or inputs from suppliers, just keeping a lid on what you can actually execute on in 2021.

You read that correctly. I think we've assessed, okay, what's possible here. We'll move that backlog through. I think we are mindful of the constraints on our supply base. We're also, I think, grounded that labor may be the tightest element in all of this and it affects our customers and suppliers. So you've got to kind of take a stiff view at this when are people going to come back to work and availability improve. We think that's a long-term problem. We think the culture of Allegion, how we run our business and the strength of our supply chain, we'll do better than the competition in that battle.

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

Thanks for joining today's call. Allegion's future remains bright, and I'd like to leave you with some key highlights of our call. Market demand is robust and has returned to pre-pandemic levels faster and stronger than anticipated. This is extremely encouraging. Inflation has accelerated and there are industry-wide supply chain pressures. These constraints are not unique to us, and we will actively manage both of these dynamics. The resulting backlog we are building sets us up well for the remainder of '21 and '22. Last, Allegion is stronger, more structurally sound as we continue to invest during the pandemic. As a result, we are positioned well for profitable growth, and we'll continue to aggressively execute on our strategy of seamless access. Have a great day today. Thanks for your attendance.

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