U.S. Markets closed

Edited Transcript of ALLE earnings conference call or presentation 25-Jul-19 12:00pm GMT

Q2 2019 Allegion PLC Earnings Call

Dublin Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Allegion PLC earnings conference call or presentation Thursday, July 25, 2019 at 12:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* David D. Petratis

Allegion plc - Chairman, CEO & President

* Michael Wagnes

Allegion plc - VP of IR & Treasurer

* Patrick S. Shannon

Allegion plc - CFO & Senior VP

================================================================================

Conference Call Participants

================================================================================

* Brett Logan Linzey

Vertical Research Partners, LLC - VP

* David Emerson Ridley-Lane

BofA Merrill Lynch, Research Division - VP

* David Sutherland MacGregor

Longbow Research LLC - CEO and Senior Analyst

* Deepa Bhargavi Narasimhapuram Raghavan

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Jeffrey Ted Kessler

Imperial Capital, LLC, Research Division - MD

* John Fred Walsh

Crédit Suisse AG, Research Division - Director

* Joseph Alfred Ritchie

Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Julian C.H. Mitchell

Barclays Bank PLC, Research Division - Research Analyst

* Timothy Ronald Wojs

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Hello, and welcome to Allegion Q2 Earnings Call. (Operator Instructions) Please note this event is being recorded.

I'd now like to turn the conference over to your host for today, Mike Wagnes. Mr. Wagnes, please go ahead.

--------------------------------------------------------------------------------

Michael Wagnes, Allegion plc - VP of IR & Treasurer [2]

--------------------------------------------------------------------------------

Thank you, Keith. Good morning, everyone. Welcome, and thank you for joining us for Allegion Second Quarter 2019 Earnings Call. On the call 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'll 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 2019 results, which will be followed by a Q&A session. (Operator Instructions) We will do our best to get to everyone given the time allotted.

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

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [3]

--------------------------------------------------------------------------------

Thanks, Mike. Good morning, and thank you for joining us today. We had modest top line revenue growth in the second quarter, and we saw strength in our Americas nonresidential business. Our residential business in the Americas was flat driven by challenging new construction markets. We also experienced currency pressures in our European and Asian businesses. Although our Americas business growth was lower sequentially in the second quarter, overall growth in the first half of the year was strong at 5.7%.

As we look to the remainder of the year, we continue to see healthy end markets in our nonresidential business, particularly in institutional verticals. We believe we are positioned well to take advantage of these healthy markets in the second half of 2019. We also expect that residential markets should start to improve versus what we have seen in the first half of the year.

Americas electronics growth was approximately 9% for the quarter, which was slightly lower than our historical growth rates. Our electronic growth for the quarter was negatively impacted by a slower-than-expected ramp-up in the new residential construction market and focused channel actions that we started in Q1 to drive more consistency and better alignment with our existing partners.

We believe that with these efforts now complete, we are positioned nicely and expect to accelerate electronics growth during the remainder of the year. This is further supported by the healthy demand for the recently launched Schlage Encode residential lock, renewed efforts with existing partners and the benefit of new partners including Lennar. Allegion's combination of brands, expanded product portfolio, technical partnerships, breadth of channel relationships and a large installed base provide us a great opportunity to take advantage of the electronics market as it continues to evolve and grow.

Moving now the Slide, Allegion was able to drive price realization and productivity actions, which more than offset the inflationary pressures we experienced. I'm pleased with the performance as we saw operating margin increase again this quarter.

During the quarter, the company closed its production facility in Turkey. Some products formerly produced at this site for brands in the EMEIA region are in the process of being transferred to other manufacturing locations in Europe. We continuously look for ways to improve Allegion's supply chain. This action will help us to streamline our operational footprint in Europe, which is necessary to maintain sustainable and profitable long-term growth in the region. It's also a normal part of our enterprise excellence strategy focused on driving cost competitive positions in all elements of our supply chain.

In the second quarter, we delivered a slight increase in adjusted EPS driven primarily from operations, which was offset by unfavorable comparables in other income and the tax rate. We're updating the full year revenue outlook. We are now projecting total and organic revenue growth between 4.5% and 5.5%. I'll speak to the individual regions later in the presentation.

Lastly, we are lowering the outlook for reported EPS to a range of $4.50 to $4.65 per share down from $4.60 to $4.75 reflecting the impact of the exiting of the Turkey operations.

We are also tightening the range and raising the midpoint for 2019 adjusted EPS outlook from a range of $4.75 to $4.90 per share to a revised outlook of $4.80 to $4.90 per share.

Please go to Slide 5, and I'll walk you through the second quarter financial summary. Revenue for the second quarter was $731.2 million, an increase of 3.8% inclusive of 3% organic growth. Acquisitions contributed to the top line revenue expansion offsetting the unfavorable currency impact. Americas organic growth came in at 3.3% in the quarter driven by strong price realization.

The EMEIA region saw modest organic growth, and Asia Pacific total revenue was boosted by the Gainsborough acquisition completed last year.

Adjusted operating margin increased by 20 basis points, aided by price and productivity, which more than offset inflation. The businesses continue to focus on driving price realization and productivity savings to combat inflationary pressures.

Adjusted earnings per share of $1.26, increased by $0.01 versus the prior year. As mentioned, the increase was driven primarily by operational performance offset by unfavorable comparables in other income and the tax rate.

Year-to-date available cash flow is down approximately $20 million. The decrease in cash is related to increased capital expenditures and increased working capital to build inventory in advance of the Turkey plant closure.

Please go to Slide 6. In March, we shared our refreshed corporate strategy with you, and we touched on it again in our first quarter call. We've chosen to include it again this quarter to highlight our belief that the 5 strategic pillars that Allegion has laid out are the foundation of our future. The pillars that guide Allegion are: Expanding core markets, we continue to broaden the core business through existing and new channel relationships, digital demand creation and leading products.

To be the partner of choice, delivering seamless access means we're intent on looking beyond our walls and leveraging our partners and ecosystems to drive growth, which includes using open platforms to integrate well with others.

Delivering new value and access, our innovation will focus on the user experience for access as well as working with partners to create unique solutions that increase safety and speed up productivity, we are also intent on bringing new products to market faster.

Capital allocation. Allegion will continue to take a disciplined and flexible approach to capital deployment, one that spans organic investments, acquisitions and shareholder distributions to optimize shareholder returns.

Last, enterprise excellence. Allegion is committed to creating value through productivity, through excellent customer experience and through a culture of safety, health and employee engagement.

Access has been a part of our company's history from 100 years and seamless access will define our company going forward.

Please go to Slide 7. With this continued focus on Allegion's strategic pillars that support our vision and growth strategy, we are excited about the partnership opportunities for the Connected Home. To us, this means being recognized as experts with innovative products in open standards, ultimately allowing for seamless integration with best-in-class players.

You might remember from our Investor Day event that we showcased a variety of our partners for the U.S. residential market, again highlighted on this slide. Our strong presence with retailers, e-commerce and home builders position us well in the Connected Home space.

Schlage Encode, our first ever Wi-Fi enabled Deadbolt is providing -- is proving to be an essential part of our portfolio and working with our partners. Schlage Encode was launched in late Q1, works directly with the Key by Amazon app and Ring devices and is a market-leading part of the Schlage home experience. It will also be part of the Lennar standard home automation offering.

Our work with these partners through innovations like Schlage Encode is a prime example of how we will increase electronic adoptions in the residential market space.

In addition to accelerating electronic adoptions, strategic partnerships will continue to help drive our vision of seamless access in a safer world.

Patrick will now take you through the financial results, and I'll be back to discuss the full year 2019 outlook.

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [4]

--------------------------------------------------------------------------------

Thanks, Dave, and good morning, everyone. Thank you for joining the call today. Please go to Slide #8. This slide depicts the components of our revenue growth for the second quarter. I'll focus on the total Allegion results and cover the regions on their respective slides.

As indicated, we delivered 3% organic growth in the second quarter. Strong price realization of 2.2% drove the organic increase this quarter. The company will continue to take necessary pricing actions to help mitigate the impact of inflationary pressures moving forward.

Also during the second quarter, acquisitions contributed more than 2% growth offsetting the substantial currency headwinds we experienced in both the EMEIA and Asia Pacific regions.

Please go to Slide #9. Reported net revenues for the second quarter were $731.2 million. As stated earlier, this reflects an increase of 3.8% versus the prior year, up 3% on an organic basis.

Adjusted operating income of $157.3 million, increased nearly 5% over the same timeframe last year. Adjusted operating margin of 21.5% increased 20 basis points. Price realization and productivity actions outpaced inflation, which contributed to the operating income increase. Leverage on the incremental volume also contributed to the margin expansion.

Headwinds to margin performance included incremental investments, which had a 70 basis point impact on adjusted operating margins and regional mix driven by acquisitions.

Please go to Slide #10. This slide reflects our earnings per share reconciliation for the second quarter. For the second quarter of 2018, reported earnings per share was $1.19. Adjusting $0.06 for the prior year restructuring expenses and cost related to acquisitions, the Q2 2018 adjusted earnings per share was $1.25.

Operational results increased earnings per share by $0.10 as favorable price, productivity and operating leverage on incremental volume more than offset inflationary impacts and unfavorable currency.

Favorable year-over-year share count drove another $0.01 increase as we executed nearly $70 million in share buyback in the quarter. The combination of interest expense, other expense and noncontrolling interest drove a $0.02 reduction, which is mostly impacted by favorable other income in 2018 that did not repeat.

The year-over-year increase in the tax rate had a $0.04 unfavorable impact primarily driven by the unfavorable mix of income earned in higher tax rate jurisdictions. The impact of incremental investments in the quarter was a $0.04 reduction. These incremental investments are for new product development, channel strategies and demand creation spending. This resulted in adjusted second quarter 2019 earnings per share of $1.26, an increase of $0.01 compared to the prior year.

Lastly, we had a $0.10 per share reduction for charges related to restructuring and acquisitions. After giving effect to these onetime items, you arrive at the second quarter 2019 reported earnings per share of $1.16.

Please go to Slide #11. Second quarter revenues for the Americas region were $545.1 million, up 3.5% on a reported basis and 3.3% organically. The organic growth was driven by strong price realization of 2.5%. When compared to Q2 of last year, we experienced mid-single digit growth in the nonresidential business and residential was essentially flat.

Electronics growth still exceeded total growth in the Americas region coming in at approximately 9%. On a year-to-date basis, the Americas has delivered total growth of 5.7% and organic growth of 5.3%. Americas adjusted operating income of $162.4 million increased 4.2% versus the prior year period and adjusted operating margin for the quarter increased 20 basis points. The increase in adjusted operating margin was driven primarily by price and productivity exceeding inflation. Additionally, leverage on the incremental volumes contributed to the increase. Inflationary pressures are expected to ease during the second half of 2019. Combined with our pipeline of the productivity actions, this should position us for increased margin expansion throughout the remainder of the year. Incremental investments were a 60 basis points decrease on operating margins.

Please go to Slide #12. Second quarter revenues for the EMEIA region were $142.2 million, down 3.8% and up 1.7% on an organic basis. The organic growth was driven primarily by pricing and favorable volume in our portable security, SimonsVoss and Interflex businesses, offsetting weakness in Southern Europe. Total revenue growth was reduced by significant currency headwinds.

As Dave mentioned earlier on the call, during the quarter we closed our manufacturing operations in Turkey. There was minimal impact to revenue and adjusted operating income in the quarter. Dave will discuss the full year impacts related to this closure when he discusses the outlook later in the call.

EMEIA adjusted operating income of $11.4 million decreased 5.8% versus the prior year period. Adjusted operating margin for the quarter decreased 20 basis points. Excluding currency impacts, the region would have seen a 10 basis point increase in margins driven by price and productivity exceeding inflation. Incremental investments were a 60 basis point headwind to operating margin.

Please go to Slide #13. Second quarter revenues for the Asia Pacific region were $43.9 million, up 45.8% versus the prior year. Organic revenue increased 4.7%. Total revenue growth was driven by the Gainsborough acquisition, which increased revenues in the region by more than 47%. Foreign currency was a significant headwind for the quarter reducing revenue by more than 6%.

Asia Pacific adjusted operating income for the quarter was $1.8 million, an increase of $1 million with adjusted operating margins improving 140 basis points versus the prior year period.

Similar to the other regions, the price, productivity and inflation dynamic was positive in the region. Incremental investments were a 120 basis point decline on adjusted operating margins. We are pleased with the continued progress in the Asia Pacific region as the strategy and restructuring initiatives begin to drive operational improvements.

Please go to Slide #14. Year-to-date available cash flow for the second quarter 2019 was $77.7 million, which is a decrease of $20.1 million compared to the prior year period. The decrease is driven by increased capital spending and higher working capital requirements to build inventory in advance of the Turkey plant closure.

Working capital as a percent of revenues increased slightly in the second quarter and the cash conversion cycle was also slightly higher. We continue to remain committed to an effective and efficient use of working capital, and we'll continue to evaluate opportunities to both minimize investments in working capital and increase available cash flow.

Lastly, we are updating our full year available cash flow outlook to a range of $410 million to $430 million. Reduction from the prior outlook is inclusive of the closure of operations in Turkey.

I'll now hand the call back over to Dave for an update on our full year 2019 outlook.

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [5]

--------------------------------------------------------------------------------

Thank you, Patrick. Please go to Slide 15. As can be seen on the slide and was mentioned earlier, we are updating our revenue outlook. The consolidated outlook for total organic revenue is now at a range of 4.5% to 5.5%. In the Americas, we see continued positive fundamentals in our nonresidential verticals led by institutional markets, which we believe will remain strong throughout 2019. In residential, we expect markets to improve versus what we experienced in the first half of the year. In addition, we expect the general positive trend for electronic products to continue for the foreseeable future and believe we are well positioned to take advantage of this long-term trend.

For the European region, we expect continued strength in our electronic business led by SimonsVoss and Interflex. We expect this will more than offset weaknesses we are experiencing in Southern Europe leading to positive organic growth for the region. However, total revenue will be negatively impacted by currency headwinds.

In addition, we have reduced our revenue outlook for the EMEIA region to account for the impacts of our decision to exit operations in Turkey.

In Asia Pacific, we continue to see healthy growth in China with softening markets in Australia and New Zealand, particularly around residential end markets. The total revenue outlook reflects the full year impact of the Gainsborough acquisition, which passed its 1-year anniversary on June 30.

We are also updating our earnings per share outlook with reported EPS at a range of $4.50 to $4.65 per share and adjusted EPS to be between $4.80 and $4.90. This represents adjusted EPS growth of approximately 7% to 9%.

As Patrick stated, we are updating our cash flow outlook to a range of $410 million to $430 million with the reduction from prior outlook inclusive of our closure of our Turkey operations.

The outlook assumes no change in the previous -- in previously provided investment spend of approximately $0.15 per share. The full year adjusted effective tax rate continues to be approximately 16%.

We are updating our outlook for outstanding diluted shares to approximately 94 million, reflecting the buyback activity completed during the first half of the year and including expected share repurchases for the back half of 2019.

The closure of our Turkey operations is expected to have $0.14 to $0.17 impact on the reported EPS, some of which has been seen in Q2 and a $0.02 impact to adjusted EPS in the third quarter.

Please go to Slide 16. A brief summary of Allegion's Q2 performance. Total revenue grew 3.8% in the quarter and 5.2% year-to-date. Organic revenue growth grew 3% in Q2 and 4.3% year-to-date. Adjusted operating margins were up 20 basis points. Adjusted EPS was up slightly.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And the first question comes from Joshua Pokrzywinski from Morgan Stanley.

--------------------------------------------------------------------------------

Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [2]

--------------------------------------------------------------------------------

So Dave, just back on some of the channel strategies or some of the moves that you made in residential to punch up growth a little bit. And I guess, this is the question the follow-up wrapped up in one. What did that cost you in the quarter? How should we think about that as a driver of the acceleration in the back half? And what were those moves specifically?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [3]

--------------------------------------------------------------------------------

So the channel plays that we addressed was really what I'd call maintenance. As we have expanded rapidly especially through e-commerce, there was some clean-up that we needed go do and -- to protect ourselves on pricing. It clearly was reflected in our electronics growth, particularly residential in Q2. We think that's behind us. I'd say in an overall backdrop, particularly in resi, we thought the channel would perform better in new construction. I think it's pretty widely seen that there were some challenges in new construction including we expected acceleration with Lennar. That's progressing, but those were the factors that we went in and worked, and we think it positions us nicely for the second half.

--------------------------------------------------------------------------------

Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [4]

--------------------------------------------------------------------------------

Any numbers that you can share around what you think that costs and what you think that adds going forward?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [5]

--------------------------------------------------------------------------------

I think the numbers are out there in total. Don't want to get into the specifics of it. But the work is behind us and you'll see that performance improve in the second half.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

And the next question comes from Deepa Raghavan with Wells Fargo Securities.

--------------------------------------------------------------------------------

Deepa Bhargavi Narasimhapuram Raghavan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [7]

--------------------------------------------------------------------------------

2 questions for me. Looks like your second half margin assumptions are a little better than some of us are expecting. Can you provide some color on what the expectations are for price realization in the second half? Is that going to be at a 2% run rate for the full year? Also can you parse that out between resi pricing and the Q1 was positive, but demand continues to be flattish there. So how does that compare resi pricing versus nonresi pricing? And then I have a follow-up.

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [8]

--------------------------------------------------------------------------------

Yes. So on the pricing front, as indicated in our comments, really strong price realization in Q2. And just remember relative to our pricing actions, you may recall last year, we implemented the price increase in beginning of July. This year, we pulled it forward to May. So in effect, you had the impact of 2 price increases for this quarter year-over-year. So that's why sequentially and for the quarter year-over-year, you had really strong price realization. As we look forward to the second half, we still anticipate good price realization, but sequentially will be down relative to what you saw in Q2. You're probably looking at an overall impact, we'll call it around 1.5% kind of going forward.

As it relates to the nonresi, resi area in terms of pricing, most of the price realization is coming from nonresidential markets given the strength there and our ability to pass it on to offset inflationary headwinds. So we will continue to see that. You may recall last year, we had some choppiness in the residential segment associated with pricing as related to rebates, promotions, those types of things. A lot of that is subsided, and I'd say as anticipated kind of a flattish pricing environment as it relates to residential and to the extent, we can push, we will, but it's improvement on a net basis after taking into consideration some of those promos and rebates.

--------------------------------------------------------------------------------

Deepa Bhargavi Narasimhapuram Raghavan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [9]

--------------------------------------------------------------------------------

Got it. So it looks like you're not necessarily concerned about nonresi at all even though some of the recent data points like ABI came in a little anemic. Just can you talk to the momentum there in nonresi here in the U.S., specifically institutional? Is that your backlog visibility to end of the year that gives you the confidence that your organic growth in the second half can actually pick up?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [10]

--------------------------------------------------------------------------------

Our backlog visibility is clear, in particular with the commercial institutional backlog. Remember those are long-cycle projects. And we feel very good about the book backlog that's on the business. I think the other thing that's important is long-term trends, particularly in the institutional markets, upgrades of schools, college campuses for higher security needs continue. Today, I'll speak to the Iowa Board of Trustees on campus security. It continues to be a trend. I think we continue to see positives in the hospital segments, and we like our backlog and opportunities going forward.

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [11]

--------------------------------------------------------------------------------

I would just also add Deepa that some of the leading indicators that we look relative to our business is, well, it's kind of macro items. The order, bid quote activity, specification writing continues to be positive, trending upward. And so that's always a good indicator in terms of business down the road. Also from a macro perspective and you look at some of the things, for example, the number of on-referendums, particularly in institutional market continues to remain strong. The construction backlog also is at a healthy level. Some of the things, the job openings in the construction markets continue to be very healthy. And so all these things would indicate that market demand continues to remain strong and as Dave indicated particularly in the institutional segment where we have obviously a strong market position and it's a richer mix of products in our business, which helps us on the margin profile as well.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

(Operator Instructions) And the next question comes from Julian Mitchell with Barclays.

--------------------------------------------------------------------------------

Julian C.H. Mitchell, Barclays Bank PLC, Research Division - Research Analyst [13]

--------------------------------------------------------------------------------

May be just following up. I was particularly interested in what you're seeing in the commercial markets in Americas nonres. And maybe just help me understand a little bit more clearly what drove that slowdown in the nonres growth in Q2? Was it something that happened late in the quarter? Does it just go back to some of those labor shortages you talked about? Or have you seen some of your commercial customers may be pushing some orders or projects to the right because of macro factors rather than labor shortages?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [14]

--------------------------------------------------------------------------------

I think if you look at just pure commercial construction, there continues to be a healthy environment. We obviously like the institutional college campuses more, but as I travel around the nations, you see commercial certainly at its maximum development and output. With that said, in the upper parts of the Midwest, it was extremely wet, that the ways construction activity, shortages of labor, I think, are rapid. We see labor tightness as high as it's ever been since 2008. So we think those factors actually snowplough the length of job. We also see some tightness and extended lead time in door availability, which impact our ability to drive business through. But with that said, overall health of the commercial and institutional part of the market driven by spec, quote and backlog continues to be favorable for Allegion.

--------------------------------------------------------------------------------

Julian C.H. Mitchell, Barclays Bank PLC, Research Division - Research Analyst [15]

--------------------------------------------------------------------------------

And then just my second question maybe switching to the EMEIA region. Maybe help us understand a little bit of context around the Turkey plant closure. Understood that there were some specific macro and economic issues in that country over the last couple of years, in particular, the extent to which those played into the plant decision versus just an overall look at your EMEIA regional capacity and trying to get that capacity down maybe. And how happy you feel now post the Turkey plant shutdown regarding your EMEIA footprint?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [16]

--------------------------------------------------------------------------------

So never happy with any of our footprints till it's fully optimized. So globally, we continue to work. I think, second, I'd remind you that a lot of our acquisition activity has been in Europe. As we brought on new capacity, we felt the opportunity to optimize that was there. Turkey also from -- on macro and political standpoint, a lot of pressure there. And at the end of the day, we thought that the best move from -- to Allegion was to consolidate that and we've executed that at a very good level. I couldn't be prouder of our teams to go and make that move. I think overall our view in Europe is to continue to optimize that footprint to continue to improve our profitability and ability to serve the customer in the region.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

And the next question comes from John Walsh with Crédit Suisse.

--------------------------------------------------------------------------------

John Fred Walsh, Crédit Suisse AG, Research Division - Director [18]

--------------------------------------------------------------------------------

Maybe the follow-up first. Just wanted to better understand the electronics acceleration in the Americas you're talking about in the back half. Just looking at Q3, you obviously have a very difficult compare. Should we expect that to happen as early as the current quarter? Or is it more of a back half commentary about trends just given how it can be kind of lumpy?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [19]

--------------------------------------------------------------------------------

So you will see improved electronics growth sequentially relative to where we were in the first half of the year beginning in Q3. But given the tough comp in Q3 last year, more of it perhaps weighted in Q4. And a lot of that growth associated with some of our what Dave talked about in terms of the channel activities that we have now completed, that's behind us. This new arrangement with Lennar will begin to continue to drive traction there and our Encode product continues to sell through extremely well. So we see continued growth in there. So those 3 activities will boost the electronics growth, particularly in the residential side, and commercial still remains healthy. We have a good backlog of activities and channel partners that will drive that going forward as well.

--------------------------------------------------------------------------------

John Fred Walsh, Crédit Suisse AG, Research Division - Director [20]

--------------------------------------------------------------------------------

Great. And then you talked about the channel with e-commerce. How about Big Box? I mean it was a different product category, but we have heard destocking there. Anything to call out there that would have impacted residential in the quarter?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [21]

--------------------------------------------------------------------------------

I would say the Big Box channel was sluggish, and we expect performance improvement in the second half. I think the Schlage Encode and our strength, Allegion through our Schlage brand and Big Box still have the highest-rated products available. Our partnerships with Ring, Apple, Amazon and those integrations, I think, make a great choice for consumers. And we expect to improve performance in the second half.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

And the next question comes from Tim Wojs with Baird.

--------------------------------------------------------------------------------

Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [23]

--------------------------------------------------------------------------------

So maybe just on Americas margin in the back half of the year. I think just kind of doing some math here, maybe we are looking at an acceleration in the margin improvement from up of 20 basis points in the first half to may be something like up 100 in the back half. And just kind of wondering how much of that do you expect to be driven by just kind of improving price cost? And how much of that should be driven by just core operating leverage?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [24]

--------------------------------------------------------------------------------

So those are the 2 primary components that will drive operating margin accretion in the second half. Feel really good about where we are as we look forward to those opportunities. The price, productivity, inflation dynamic will continue to improve there. So recall relative to the inflation we are getting to easier comps starting here in Q3 as it relates to commodity cost and then pricing and that type of thing. And you may recall our methodology is try to hedge inflation in terms of -- not financial hedges but contracts with suppliers. So we lock into prices on an outward to perhaps 12 months. And as inflation subsides, we see that perhaps later than other people might. So we're going to start reaping the benefits in the second half as it relates to the reduction in commodity costs. That can be a big driver. And then the continued volume leverage and the margin accretion associated with that is a big driver as well. And we had a couple of one-off type of things that are nonrecurring as well. So that collectively will serve to improve the operating margin performance. And I'd just say as a collective company for the full year and we communicated this at the beginning of the year, the objective is to get close to 100 basis points improvement for the full year, which gets us back to kind of like the 2017 levels and still feel like we have good visibility to that relative to the improvement in the price, productivity, inflation dynamic as well as the leverage on the incremental volume.

--------------------------------------------------------------------------------

Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [25]

--------------------------------------------------------------------------------

Okay. Great...

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [26]

--------------------------------------------------------------------------------

I would add Tim that we were pretty clear that we would create a faster dynamic in the second half. I was extremely pleased with how we drove the equation in the first half. And I think we're set up nicely with identifiable projects that will help us achieve our goal.

--------------------------------------------------------------------------------

Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

--------------------------------------------------------------------------------

Great. Okay. And just in a more deflationary environment, I just want to make sure I'm thinking about pricing the right way. You should be able to kind of in your -- every year be able to get some modest price realization, but in an environment with lower raw material cost, that traction is probably towards the lower end of your historical range, right?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [28]

--------------------------------------------------------------------------------

So as you know, we have the ability to pass on price whether in an inflationary period or deflationary environment. We've been fairly successful in doing that. And we'll continue to remain competitive and push that where we can. So this year for example, the gross price increase was lower than last year and last year being the higher inflation period. But on a normalized level, we should always get 1% to 1.5% of price increase across the business.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

And the next question comes from Joe Ritchie with Goldman Sachs.

--------------------------------------------------------------------------------

Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [30]

--------------------------------------------------------------------------------

So just thinking about the growth for the back half of the year again in the Americas. I think this past quarter, you guys did roughly, I think, less than 1% on the volume side and it seems like this needs to pick up, so call it 4%, 4.5% just to get to the low end of the guide. So how -- outside of like what you expect to see as increased penetration on the electronics side, what you do think are the biggest drivers that's going to get you there and seeing the acceleration in 3Q and 4Q?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [31]

--------------------------------------------------------------------------------

Yes. So let me take it by segments of the market maybe. So on the resi side, it's really a combination of couple of things, what we talked about previously on the electronics growth and all the activity there relative to the channel, Lennar, new products introduction as well as channel partnership that will help us drive volumes there. Secondly, on the res side, we see a pickup in the builder channel. Collectively that will help us in terms of push-up more volume. On the nonres side, it's continued strength in the end markets and the healthiness of that and the visibility we have relative to again the order activity specification, backlog, et cetera, I feel fairly positive relative to the volume expectations in the second half.

--------------------------------------------------------------------------------

Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [32]

--------------------------------------------------------------------------------

Okay. Okay. Got it. That makes sense. And I guess, maybe my follow-on there is our thinking about like just seasonality. Last year, things were roughly from an earnings standpoint in line 3Q versus 4Q, but seasonally things kind of shift year-to-year. How are you guys thinking about the composition or the cadence for the second half of the year, 3Q versus 4Q? Is there an expectation that one quarter will be much stronger than the other?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [33]

--------------------------------------------------------------------------------

We don't normally provide the quarterly guidance, but you should anticipate perhaps maybe a little bit higher Q4 and Q3.

--------------------------------------------------------------------------------

Operator [34]

--------------------------------------------------------------------------------

And the next question comes from Jeff Kessler with Imperial Capital.

--------------------------------------------------------------------------------

Jeffrey Ted Kessler, Imperial Capital, LLC, Research Division - MD [35]

--------------------------------------------------------------------------------

Could you go through some of the new products that you believe are going to -- particularly on the electronics side that you think are going to boost growth in the second half, particularly those that are aimed at the institutional market where you seem to be the most optimistic?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [36]

--------------------------------------------------------------------------------

So Encode on the res side would be what we lead with. Second, maybe not so much in terms of new products, but the partnerships that we're continuing delivery with Apple and seamless access on college campuses, you've seen some of our wins. I think, Mercer college is a clear example. Second, work with Lennar. I think early on, we said that we would be open in our ability to go in and partner is providing wins in the marketplace. We've also got our exit devices that are wireless that are driving in the institutional phase. So we think we're set-up well. I would also go back to some of our earlier generations of products, the ADCO has been out several years, but is positioned to be able to provide that open integration and communication capabilities that customers appreciate. There's already installed base of that and our ability to be able to leverage that in new electronic applications is why we are winning.

--------------------------------------------------------------------------------

Jeffrey Ted Kessler, Imperial Capital, LLC, Research Division - MD [37]

--------------------------------------------------------------------------------

Okay. My follow-up question is around Turkey. Could you go a little bit deeper into what are you -- what are your goals in terms of moving production from Turkey to where? And essentially what is -- what are the driving forces that will allow you or makes you think you're going to become much more efficient in having plants that is not in Turkey?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [38]

--------------------------------------------------------------------------------

So through the acquisition pipeline, we developed a capability out of Poland. In 2017, '18, we announced a new facility there. We are filling up that facility. Some of that will come with Turkey and it's really optimizing the supply chain from where we believe is a competitive price market to be able to serve Western Europe. So we think we are nicely positioned. If you look at the history over the last 5 years of the restructuring that we have driven across Europe, it has significantly improved our profitability, and we think this is the next step in that. Our ultimate goal is to continue to incrementally improve operating income year-over-year and this is another step in that process.

--------------------------------------------------------------------------------

Operator [39]

--------------------------------------------------------------------------------

And the next question comes from Andrew Obin with Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [40]

--------------------------------------------------------------------------------

This is David Ridley-Lane on for Andrew. Maybe just following up on that comments on the Turkey operations. Could you quantify sort of a payback period for the -- about $20 million in cash cost relating to that closure?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [41]

--------------------------------------------------------------------------------

So anytime you close a facility in Europe, it's going to have an extended payback period, but it's the right thing to do. It's more of a, I'd say, a risk mitigation activity than a significant payback on a cash basis. Right thing to do, as Dave mentioned, to serve our customers with expedited supply chain capability. And so there are some benefits throughout the supply chain, not so much from a labor arbitrage, but it's definitely the right thing to do and we'll continue to look at opportunities to leverage our footprint going forward.

--------------------------------------------------------------------------------

David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [42]

--------------------------------------------------------------------------------

And then on your comments about optimism for new residential construction. Are those mainly tied to weather? Or are you seeing other reasons why new residential homes in the U.S. would be picking up?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [43]

--------------------------------------------------------------------------------

First, the adoption of electronics, especially Encode 2, we were going through a conversion with Lennar, which will give us top line revenue expansion as we provide them exclusively to their home starts. We continue to have a focused effort on that pro build driven by those electronics. And I think the overall market and it's no surprise as you look at other companies reporting the new home construction was soft, driven by a variety of factors, we don't see a big rush to recovery. We think that it runs flat, but we think ourselves will help us both on new construction and retrofit as we move into the second half.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

And the next question comes from David MacGregor with Longbow Research.

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [45]

--------------------------------------------------------------------------------

One of the things that -- I guess, you're talking about price productivity versus inflation and price and inflation are always a challenge to forecast. Productivity is presumably is up, and you got a better handle on it. Just help us to better understand what productivity should represent quantitatively if you can quantify for us over the next few quarters?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [46]

--------------------------------------------------------------------------------

So I would characterize it this way. As you'd expect in any company, it's all about having a robust pipeline in terms of productivity actions and those would occur either on the sourcing material side and/or at the factory level, labor efficiencies, cost reductions, those types of things. And we got very good visibility in terms of we've already executed. That will take place in the back half of the year as well as opportunities for improvement going forward and that's across all our facilities globally. So feel really good about the healthiness, robustness in terms of our productivity pipeline of both the sourcing material side as well as the throughput in the factory. And then you get the normal leverage of volume overhead leverage equation on the incremental volume that kicks in as well. And as you know, we have very high contribution margins that will contribute to the margin expansion. So it's a combination of a lot of activities that are going to help us going forward. And on the productivity pipeline visibility, we got very good clarity and expectations on that and good visibility.

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [47]

--------------------------------------------------------------------------------

Is there any way you can quantify that for us Patrick?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [48]

--------------------------------------------------------------------------------

I'm sorry, what's the question?

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [49]

--------------------------------------------------------------------------------

Is there any way you can quantify that for us? Or at least give us some sense directionally how productivity should compare year-over-year over the next few quarters?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [50]

--------------------------------------------------------------------------------

Yes. So I'd just say it's increasing year-over-year, and we'd expect that to continue. The other thing I mentioned here too that we sometimes forget about relative to the productivity, but we are starting to reap benefits from the acquired businesses last year. So the margin profile attached to those will increase, as we get more volume leverage integrating with our sales channel and also integrating some of our enterprise excellence methodology there at those facilities are helping us. And so the acquired businesses is part of the equation and building them in through our company and methodology will help our productivity as well.

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [51]

--------------------------------------------------------------------------------

Second question is, just I guess, on price elasticity and specifically maybe with respect to the non-specified commercial business and maybe mechanical residential as well. But it would seem that with the pricing, you're seeing a growing gap between opening price point. And I just wonder if you're seeing people mixing down? Or if that's creating a little more of a headwind for you from an elasticity standpoint? If you can comment on that?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [52]

--------------------------------------------------------------------------------

I haven't really seen it in the marketplace. So normally the price movements on the low end and the high end, we look at it by product, but it stays relatively close. So the differential doesn't move that much between the product categories. And so we're not seeing a migration at all relative to the low price point. It's actually, from our perspective, it’s been one of our channel strategies to have a broader breadth of products in that price point that we could sell through the discretionary market. And so that's been something we continue to drive for the last several years.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

And the next question comes from Jeff Sprague with Vertical Research Partners.

--------------------------------------------------------------------------------

Brett Logan Linzey, Vertical Research Partners, LLC - VP [54]

--------------------------------------------------------------------------------

It's Brett, hoping in for Jeff here. Just a question on the Falcon brand. Obviously, we had relatively newer initiative for the company on the value side, but how has the Falcon category grown through the first half of the year relative to some of the traditional mid-to-premium brands? And then as you think about the spec business and some of the bids that are coming in, have you seen a change in the quality preference, specifically for interior doors, but with the Falcon brand where they -- you now might be able to meet some of those requirements?

--------------------------------------------------------------------------------

David D. Petratis, Allegion plc - Chairman, CEO & President [55]

--------------------------------------------------------------------------------

So remember, we have positioned with 3 brands, Dexter, Falcon, and then our premium Schlage, Von Duprin and LCN. We see nice growth in the Falcon brand, maybe a little bit less in Dexter, but what's happening there when a project gets valued, engineered and we need to compete, we'll pull in those products. You see it a lot in like commercial and you will see Falcon exit devices keyways, Glynn IVES would be another brand that we would use. I think it depends on where you're at in the market segmentation. Hospitals, college campuses are going to go for our performance products. And we are going to continue to use our global capability to offer customers choice.

--------------------------------------------------------------------------------

Brett Logan Linzey, Vertical Research Partners, LLC - VP [56]

--------------------------------------------------------------------------------

Okay. And then just looking at the Americas nonres business up mid-single digits. Is there a way you could separate institutional versus commercial in the quarter, how those performed? And then thinking about the second half, I mean, do you think in commercial can you count some growth or is institutional basically going to carry the day here?

--------------------------------------------------------------------------------

Patrick S. Shannon, Allegion plc - CFO & Senior VP [57]

--------------------------------------------------------------------------------

I think we will see growth across all verticals. Institutional should be a little bit stronger and again that's a richer mix product for us holistically. And so -- but strength across all verticals is the way I would be thinking about it.

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

And as there are no more questions at the present time, I would like to turn the call to Mr. Wagnes for any closing comments.

--------------------------------------------------------------------------------

Michael Wagnes, Allegion plc - VP of IR & Treasurer [59]

--------------------------------------------------------------------------------

We would like to thank you, everyone, for participating in today's call. Please contact me for any further questions, and have a great day.

--------------------------------------------------------------------------------

Operator [60]

--------------------------------------------------------------------------------

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