Mike Wagnes - Allegion Plc David D. Petratis - Allegion Plc Patrick S. Shannon - Allegion Plc.

Joe Ritchie - Goldman Sachs & Co. LLC Josh K. Chan - Robert W. Baird & Co., Inc. Rich M. Kwas - Wells Fargo Securities LLC Julian Mitchell - Barclays Capital, Inc. Andrew Burris Obin - Bank of America Merrill Lynch Jeffrey Ted Kessler - Imperial Capital LLC Jeffrey Todd Sprague - Vertical Research Partners LLC David S.

MacGregor - Longbow Research LLC Rizk Maidi - Joh. Berenberg, Gossler & Co. KG (United Kingdom).

Good morning and welcome to Allegion's Second Quarter Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that today's event is being recorded. Now, I'd like to turn the conference over to Michael Wagnes. Please go ahead, sir..

Thank you, Keith. Good morning, everyone. Welcome and thank you for joining us for Allegion's second quarter 2018 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'll refer to in today's call are available on our website at allegion.com. This call will be recorded and archived on our website. Please go to slide number 2.

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 SEC filings for a description of some of the factors that may cause actual results to vary from anticipated results.

The company assumes no obligation to update these forward-looking statements. Please go to slide number 3. Our release and today's commentary include non-GAAP financial measures, which exclude the impact of restructuring and acquisition expenses in current year and prior-year results.

We believe these adjustments reflect the underlying performance of the business when discussing operational results and comparing to the prior-year periods. Please refer to the reconciliation in the financial tables of our press release for further details.

Dave and Patrick will discuss our second quarter 2018 results, which will be followed by a Q&A session. For the Q&A, we would like to ask each caller to limit themselves to one question and then re-enter the queue. 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 Dave..

Thank you, Mike. Good morning and thank you for joining us today. I want to start the call with some highlights from the second quarter.

Allegion saw a strong top line revenue growth in the second quarter led by the Americas region, which saw solid volumes in both the non-residential and residential businesses as end market fundamentals continue to be solid. Pricing was good in both the Americas and European regions.

Acquisitions are contributing nicely to the total company revenue expansion, and global electronics growth continues to be strong, which we see as a long-term trend. In the quarter, we experienced slight margin declines as acquisitions were diluted as expected.

Excluding the acquisitions, adjusted operating margins were flat year-over-year as all three regions saw continued inflationary pressures. I'm very pleased with our ability to manage those inflationary forces and maintain organic margins through both pricing and cost actions, once again leading the industry.

In the second quarter, we delivered double-digit adjusted EPS growth, driven by operational performance and accretive acquisitions. The EPS performance highlights our continued focus on driving increased shareholder value.

Cash flow continues to be solid and increased year-over-year even after excluding the impact of the discretionary pension payment made last year. Please go to slide 5, and I'll walk you through the second quarter financial summary.

As you saw in the morning's press release, revenue for the second quarter was $704.7 million, an increase of 12.4%, reflecting organic growth of 5.2%. Benefits from acquisitions and foreign currency tailwinds also contributed to top line growth. All regions grew organically.

The Americas led the way with organic growth of 6.6% in the quarter, supported by solid volume in both non-residential and residential businesses. High-teens growth in electronics and favorable price. The EMEIA region saw organic growth of 1.4% against the tough comparable. And Asia Pacific, organic growth came in at 0.7%.

Adjusted operating income of $150 million (sic) [$150.1 million] increased nearly 10% versus the prior year. Adjusted operating margin decreased by 50 basis points due to continued inflationary pressures, incremental investments, and expected margin dilution related to our recent acquisitions.

Excluding the impact of the recent acquisitions, the base business operating margins were flat year-over-year, while EBITDA margins increased. Adjusted earnings per share of $1.25 increased $0.14 or approximately 13% versus the prior year. Additionally, we are updating our revenue and EPS outlooks.

Full year reported revenue growth outlook is 12.5% to 13.5% and includes the recent acquisitions of GWA Door & Access business and ISONAS. Organic growth remains at 4% to 5%. Reported EPS outlook is now at $4.15 to $4.35 per share with adjusted full EPS outlook remaining at $4.35 to $4.50 per share, reflecting growth of approximately 10% to 14%.

Please go to slide 6. Before I turn the call over to Patrick, I want to discuss our recent acquisitions of GWA's Door & Access business and ISONAS, both of which closed in July.

The strategic acquisition of GWA Door & Access business including the renowned Australian brand, Gainsborough Hardware, bolstered Allegion's presence in Australia and significantly increases our scale in the Asia Pacific region.

With this addition, we're enhancing our residential presence with market-leading positions and long-standing customer relationships, while accelerating our development of electronic security solutions. This is consistent with Allegion's growth strategy in the region and highly complementary to our core business.

The acquisition also provides us increased distribution and allows for both revenue and cost synergies when combined with our existing business in Australia. In the Americas, the addition of ISONAS brings a strong pipeline of innovation that will benefit from Allegion's expertise in safety and security as well as our extensive market presence.

ISONAS has edge-computing technology that provides innovative access control solutions for non-residential markets and will expand our intellectual property in this segment. ISONAS intelligent devices, like its popular integrated reader-controllers, utilizing power over Ethernet, making them easy to install and cost-effective for customers.

Both of these newest additions to the Allegion family expand our core product portfolio, while accelerating electronic adaptation across the industry. We're confident in our ability to further expand the reach of their products and technology as well as increase their capacity for growth to drive shareholder value.

Patrick will now walk you through the financial results and I'll be back to discuss our full year 2018 outlook..

Thanks, Dave, and good morning, everyone. Thank you for joining the call this morning. If you would, please go to slide number 7. The 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 5.2% organic growth in the second quarter. The solid organic growth reflects strong performance in the Americas region, which saw solid volumes in both the non-residential and residential businesses, and high-teens growth in electronic products.

Pricing was favorable in the quarter as the company remains disciplined in taking necessary actions to help mitigate the impact of continued inflationary pressures.

Second quarter price realization was strong in our Americas non-residential and EMEIA businesses, but were partially offset by price-related reductions associated with the highly competitive mechanical market segment of our Americas residential retail business.

We expect price realization to improve slightly in the back half of 2018 due to the Americas non-residential price increase that went into effect in July. During the quarter, acquisitions contributed 5.4% growth and foreign currency was a tailwind, particularly in the EMEIA region. Please go to slide number 8.

Reported net revenues for the quarter were $704.7 million. As stated earlier, this reflects an increase of 12.4% versus the prior year, up 5.2% on an organic basis. Adjusted operating income of $150.1 million increased nearly 10% over the same timeframe from last year.

Adjusted operating margin of 21.3% decreased 50 basis points, primarily due to the dilutive nature of the recent acquisitions. Excluding acquisitions, adjusted operating margins on the base business were flat year-over-year.

Inflationary pressures slightly exceeded price plus productivity, less than $1 million, as we are taking other necessary cost containment actions to drive productivity to mitigate the impact of inflationary headwinds. Other headwinds to margin performance were incremental investments, which had a 70-basis-point impact on adjusted operating margins.

And while our recent acquisitions were dilutive to Allegion margins, as previously anticipated, they were accretive to adjusted earnings per share. Overall, our recently completed acquisitions from the first half of 2018 are performing well.

They are delivering good top line performance with expected margins and, in aggregate, are immediately accretive to adjusted earnings per share. Please go to slide number 9. This slide reflects our EPS reconciliation for the second quarter. For the second quarter 2017, reported earnings per share was $1.10.

Adjusting $0.01 for the prior-year restructuring expenses and integration cost-related acquisitions, the 2017 adjusted earnings per share was $1.11. Operational results increased EPS by $0.13 as favorable price, strong operating leverage and productivity more than offset inflationary impacts. Acquisitions contributed $0.03 in the quarter.

The combination of interest expense, other income, non-controlling interest, and tax expense increased earnings per share by $0.02, with favorability from interest offset by the prior-year gain on the sale of an equity investment. Moving on, the impact of incremental investments in the quarter was a $0.04 reduction.

The incremental investments relate to ongoing growth opportunities for new product development and channel strategies as well as demand creation spending to take advantage of acceleration in the residential electronics market. These incremental investments have continued to enhance growth and are providing solid returns on investment.

This results in adjusted first (sic) [second] quarter 2018 EPS of $1.25 per share, an increase of $0.14 or approximately 13% compared to the prior year. Continuing on, we have a $0.06 per share reduction for acquisition-related and restructuring charges.

After giving effect to these one-time items, you arrive at the second quarter 2018 reported earnings per share of $1.19. Please go to slide number 10. Second quarter revenues for the Americas region were $526.8 million, up 12.4% on a reported basis and 6.6% organically.

The organic growth was driven by solid volume in both non-residential and residential products. The non-residential business grew high-single digits excluding acquisitions. Residential experienced mid-single digit growth.

Pricing was strong in non-residential, but was partially offset by pressures in residential retail pricing, particularly on our mechanical portfolio. The TGP and AD Systems acquisitions added 5.6% growth to total revenue. We also experienced another strong quarter for electromechanical products, which grew high-teens.

Similar to last year, we announced a price increase to go into effect in early Q3. As a result, the year-over-year impact related to customer-accelerated purchases in advance of the increase are comparable.

Americas' adjusted operating income of $155.8 million increased 9.9% versus the prior year period and adjusted operating margin for the quarter decreased 70 basis points. The decrease in adjusted operating margin was driven by the dilutive nature of Allegion's recent acquisitions, which was expected.

Excluding acquisitions, adjusted operating margins on the base business were up slightly year-over-year as favorable product and business mix were able to overcome the impact of high inflation, which exceeded price and productivity in the quarter. The incremental investment headwind was offset with positive volume leverage.

Please go to slide number 11. Second quarter revenues for the EMEIA region were $147.8 million, up 14.4% and up 1.4% on an organic basis. The organic growth was driven by solid pricing for the quarter. A tough comparable in the quarter caused the year-over-year volume growth to be a bit muted as markets remained mostly favorable.

The reported revenue increase was boosted by currency tailwinds along with contributions from the recently acquired QMI business. EMEIA adjusted operating income of $12.1 million increased 34.4% versus the prior year period.

Adjusted operating margin for the quarter increased 120 basis points, with price and productivity more than offsetting inflation and incremental investments. The EMEIA region also saw adjusted operating margin dilution from its acquisitions. Please go to slide number 12.

Second quarter revenues for the Asia Pacific region were $30.1 million, up 3.1% versus the prior year. Organic revenue increased 0.7%. Total revenue was supported by favorable foreign currency impacts.

Asia Pacific adjusted operating income for the quarter was $0.8 million, with adjusted operating margins down 520 basis points versus the prior-year period. The Asia Pacific region saw continued inflationary pressures, outweigh price and productivity.

Unfavorable product and geographic mix as well as incremental investments further drove reductions in income and margin. As a result, we have commenced planned restructuring actions late in the second quarter, which will drive operational improvements in the second half of the year and align to our overall regional strategy.

Please go to slide number 13. Year-to-date, available cash flow for the second quarter 2018 was $97.8 million, which is an increase of $55.2 million compared to the prior year period.

The increase is driven by the non-recurring $50 million discretionary pension funding payment that was made in the first quarter of 2017, along with higher net earnings, partially offset by higher working capital acquirements.

Working capital as a percent of revenues and the ratio for the cash conversion cycle increased in the second quarter 2018 when compared to the prior year period. The increase is primarily driven by working capital related to recently acquired businesses.

We remain committed to an effective and efficient use of working capital, and we'll continue to evaluate opportunities to minimize investments and working capital. Lastly, we are affirming our full year available cash flow outlook of $380 million to $400 million. I'll now hand the call back over to Dave for an update on our full year 2018 outlook..

Thank you, Patrick. Please go to slide 14. As noted on the slide, given performance during the first half and our expectations for the remainder of the year, we are raising total and organic revenue growth in the Americas and tightening the range for both total and organic revenue growth in Europe.

In addition, we are raising total revenue growth for Asia Pacific, reflecting the recent acquisition of GWA's Door & Access business in Australia, while taking down organic revenue growth in Asia Pacific, reflecting first half performance.

This results in the consolidated outlook for total revenue increasing to a range of 12.5% to 13.5% and organic revenue remaining at a range of 4% to 5%. If we look closer at the Americas business, end market fundamentals remain solid.

We see positive indicators in non-residential verticals and stable demand in single-family construction, combined with vigorous demand for residential electronic products. As I have mentioned in previous quarters, we continue to experience constraints across the construction supply chain, which causes delays in overall project construction.

These delays can have an impact on the timing of our revenue and can cause some choppiness from quarter-to-quarter. European market indicators remain positive and continue to be bolstered by general macroeconomic conditions such as high consumer confidence and low unemployment that remain favorable to markets.

The GDP in our key economies are growing, and total revenue growth continues to be assisted by FX tailwinds. In the Asia Pacific region, timing of projects can cause large impacts on growth rates from quarter-to-quarter. Similar to EMEIA, FX tailwinds continue to contribute to overall revenue growth.

The large increase in total revenue outlook for Asia Pacific is to account for the acquired GWA Door & Access business. We expect inflationary pressures to continue throughout the year. As stated in the first quarter earnings call, we have taken actions to mitigate the impacts of inflation.

The pricing increases announced last quarter for the Americas went into effect earlier in July. We're updating our reported earnings per share outlook of $4.15 to $4.35 and affirm adjusted earnings per share of $4.35 to $4.50. This represents adjusted EPS growth of approximately 10% to 14%.

As Patrick just stated, we're also affirming our cash flow outlook of $380 million to $400 million. Along with the revenue impacts of the recently acquired businesses, the EPS outlook also includes the acquisitions.

Also included in the outlook is the assumption for investment spend of approximately $0.15 per share, which is an increase of $0.05 per share from our previous outlook.

The increased investment spend represents an increase in our new product development and demand creation activities primarily for electronic products in the Americas to further accelerate growth, supported by our high-teens growth year-to-year.

The outlook also assumes the full year tax rate to be approximately 15% to 16%, with the second half rate higher than the 14.8% adjusted tax rate experienced in the first half of 2018. Outstanding diluted shares included in the outlook are approximately 96 million. Please go to slide 15. In summary, Allegion total revenue grew more than 12%.

Organic revenue grew just over 5%. Adjusted operating margins were down 50 basis points and were flat when excluding the impacts of acquisitions. Adjusted EPS saw nearly 13% growth in the quarter. Full year total revenue growth outlook increased to 12.5% to 13.5%, inclusive of the recent announced acquisitions.

Full year organic revenue remains at 4% to 5%. Full year reported EPS outlook updated to $4.15 to $4.35 per share. Full year adjusted EPS held at $4.35 to $4.50. Now, Patrick and I will be happy to take your questions..

Thank you. We will now begin the question-and-answer session. And this morning's first question comes from Joe Ritchie with Goldman Sachs..

Thank you. Good morning, everyone..

Good morning, Joe..

Hey. Maybe my first question out, the Americas organic growth turned out to be a little bit better than we expected this quarter.

And I'm just wondering, did you guys get any sense on whether there was any pull-forward demand from your pricing actions that took place in July?.

I would say it's comparable from what we saw a year ago. I think you can always expect some pull-through because of pricing actions. But as we ended the quarter and extend into the early weeks of July, demand remains strong. We particularly like the activity in the institutional space and feel good about demand through the balance of the year..

Okay. That's helpful, Dave. And maybe if I were to kind of shift gears a little bit and just talk about the inflationary pressures that you're feeling. So, obviously, putting through a nice price increase in July. I'm just curious whether you expect both price and productivity to offset inflation in the second half of the year.

I may have missed that earlier. And then, I have a follow-on on that just to – I want to dig into Americas a little bit..

Yeah. So, Joe, as we indicated in the second quarter as well as year-to-date, a little bit underwater, not significantly when you look at that equation in terms of price productivity offsetting inflation.

Our expectation given the price increase that goes into full effect this quarter is that pricing will improve sequentially in the second half compared to the first half. We're going to continue to drive productivity-contained costs and those type of actions.

And so, we would expect in the second half that we'll be favorable on that equation in terms of price and productivity offsetting inflation. Inflation is expected to be a little bit higher than what we anticipated. So we're going to be driving price and productivity harder to help mitigate that going forward..

Okay. Great. And then just following on on the Americas side, you mentioned earlier in your comments around resi mechanical being competitive. Can you just give us an update to size that business for us today? And then, any color that you can give us around the competitive pressure you see in that business? That would be helpful..

So think total U.S. res about $400 million. I would say our position in that market is strongly influenced by the retrofit. In new construction, especially the surge in multi-family, it's been led by opening price point. It's an extremely competitive part of the business.

Our position is really in the retrofit and the growth in the electronics, and it yields one of the more profitable segments in that residential space compared to competitors. I'll say it another way. We make more margin on the sale of a residential lock than anybody else in the space.

We've got excellent share and aren't aggressively looking to go position ourselves on that opening price point, which is an important space. But at the end of the day, we want to maximize the returns, so we play the game a little differently..

Got it. Understood. Thank you, guys..

Thank you. And the next question comes from Josh Chan with Baird..

Hi. Good morning, Dave, Patrick, Mike..

Good morning..

Hey..

Good morning, all. Thanks for the color on the residential side. I want to switch to the non-res side.

So with your price increase in Q3, are you seeing kind of competitors follow and do you expect that increase to be realized to the extent that normally would?.

So we've seen our major global competitors fall in line. I think you've heard us talk that this industry is disciplined. I would describe Allegion as – led the way in terms of our price announcements, I think movement on discounts, and I think it reflected in our results versus the competitors.

So, I think there'll be good price discipline and almost required with the amount of inflation this industry has seen over the last year..

And I would just add that the price realization in the commercial segment has continued to be strong. And you go out with a total list price increase. You don't always get that. There's always going to be some discounts relative to that top line number, but that's just to remain competitive in the marketplace.

But so far, we've been getting really good price realization in the commercial segment and would expect that to continue, particularly with the recently announced price increase that went into effect at the beginning of this quarter..

Okay. And then on the mix side of things, could you talk about how your premium brands are growing relative to sort of our your mid-price point brands? And if you can throw in anything that you're seeing on the import side that could sort of influence the mix equation, more color on that would be great. Thanks..

Our premium brands performed well in the first half. Remember too that we've got initiatives through things like Pro Express to grow those price sliding brands and I think that's predictable. But the strength of our Von Duprin, Schlage and LCN brands are noteworthy in the first half. We have solid growth across the entire portfolio.

You're aware of our channel led discretionary business which has – we introduced some lower price point products. Those are performing extremely well as well. So, we're getting good growth from those, which will be at the lower end. But no real mix issues within the commercial portfolio of products..

Okay. And then, the last question from me is nice to see the Americas organic growth move higher. It looks like that in the first half you're already growing at that pace and the comps get easier in the second half if I'm not mistaken.

So, is there some possibility that you could maybe do a little bit better than the range given sort of the easier comps? How are you thinking about that in the second half?.

So, you noted that we did increase the organic growth outlook for Americas specifically given the Q2 performance. And if you just kind of work the math, you would expect a little bit higher perhaps organic growth back half of the year relative to the first half.

And so as Dave indicated earlier, like the demand that we're seeing in the end markets continues to remain real positive and we'll kind of continue to see how the market evolves in the second half of the year, but like what we've seen so far..

All right. Great. Good luck in the second half..

Thank you, Josh..

Thank you. And the next question comes from Rich Kwas of Wells Fargo Securities..

Hi. Good morning, everyone..

Good morning, Rich..

Hey, so on the residential price, one of your competitors had some fulfillment issues back in Q1; seem to be a little less willing to push their price.

Is that kind of the factor here on the residential side or how much of the – how would you split that between structural issues with imports and I know you just went through where you play, but just curious on the go forward basis as we think out longer term, the dynamics here in residential..

I think our large competitor reported this morning, looks like that's behind them. Their ERP challenges, you'd have to think there'll be some movement there. It's difficult in the big box space. So I'd drive it at that. Any price realization in that part of the market would be welcome. So think a little bit about that. We play in a unique space.

In the residential retail, really like our electronics position. We're going to make some investments in the second half that we think will grow demand, product enhancements that will improve capability with some of the communication protocols that are solid products. And it's a little bit different positioning just in the lower part of the market.

So, we think that market will continue to be active, especially around the retrofit, and it will reward us..

Yeah. Rich, I would just add a little bit more color..

Yeah..

The commentary on some of the price pressure on our residential mechanical portfolio, really, around discounts, not the price to the retailers or new home construction builders but more on the discount.

So, a little bit higher than anticipated rebates, returns, promotional discounts, those type of things, which, quite frankly, can vary a lot quarter-to-quarter. There's peaks and troughs. You've heard us mentioned this previously on past quarters.

And going forward, we don't – hopefully, we're not anticipating that type of activity that we saw in quarter two. So, it really depends on activity specific, big box retailers and those type of things..

So, is it fair to say that you feel more insulated from import competition in the residential market, in general?.

Restate that again? It broke up..

Is it fair to say that you feel more insulated from import offshore competition in the residential market because you don't play at the very low end? Is that a fair statement or how would you characterize the import competition, not talking about some of the larger guys?.

So, I do believe we're better insulated. I think we've got a superior supply chain. As I think about the residential market – as I think about the commercial institutional markets, opening price point, mid-price point, we got a better engine. And you start throwing in things like tariffs, there's importers that are going to have some challenges..

Okay, great. And then a real quick one.

Just, Patrick, as we think about second half of the year, I mean your seasonality has bounced around a bit from Q3 to Q4 in terms of full year earnings contribution, is there any color you can provide us on how we should think about the balance of Q3 and Q4 within the EPS guidance?.

So, we don't give quarterly guidance, Rich. I think you're aware of that. But the seasonality itself doesn't really change in terms of top line relative to prior periods, if you look at the percentage of the full year. So, I would look at that.

What I will provide is as we think about margins going forward, we indicated base business flat in Q2, still under water on a year-to-date basis, but that side of the business improving in the second half, so that for the full year, you're kind of on a flattish type of organic base business, excluding acquisitions from a margin standpoint..

Okay. Thank you..

Yeah..

Thank you. And the next question comes from Julian Mitchell with Barclays..

Thanks. Good morning. Just sticking I guess, to the two-question rule. The first one is really on the acquisitions. Those are about a 50 bps drag to adjusted margins in Q2.

What are you dialing in for the second half for that margin headwind globally? And related to that, is there any color you could give on the organic growth or base margin profile of the very recent or most recent acquisitions?.

So, I would characterize – so you're right, 50 basis points headwind on margins, given the acquisitions. And I'll just reiterate that the acquisitions themselves are performing to plan, and just given the profile of the business, lower than our industry leading EBIT and EBITDA margins.

And so consequently, they do collectively have an impact on our aggregate margins. Going forward, for the second half of the year, without getting into too much detail, you would expect a similar type of drag on the margins in the second half.

And one of the issues going forward – not issue, but just kind of the tyranny of the math, if you will, on the Gainsborough acquisition, has a lower margin profile than even the acquisitions announced earlier in the year. And so that's going to have a – weigh a little bit more heavily in terms of the dilution on the overall margin profile..

Got it. Thank you. And then, my follow-up would be, I think you've talked a lot about the Americas region already, so maybe switching to Asia. Just give us a broader update on what's happening there. You took down the organic sales guide, but you're also doing a restructuring and throwing on a large acquisition.

So there's a lot, I guess, to handle for that local management team. Just maybe sort of walk us through how you're thinking about the strategy in Asia right now..

So, there is a transformation led by Jeff Wood who was sent to the region last year. He's put a plan together and he's executing on that plan. His OI was a little weaker in the first half. That was driven by strong project activity in the previous year. We really did well in the Macau region with the casino build outs.

Those were good margin projects that can't be replaced. But the broader repositioning in that region is to more effectively position Allegion in the growth of electronics, and we like what we see there. And it's a little bit of a high wire act as we transform the year, but they're going to improve in the second half.

And I think with the addition of Gainsborough and the other acquisitions that we've made, we're in a good position to move in coordination with the strategic plan over the next few years. You step back even 24 months ago, got out of – or got out of....

Bocom..

...Bocom, we've got a clear driver to lower our cost structure and position the company that – in the end-markets that line up better with our strengths. And they're doing a good job with that..

Thank you very much..

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

Good morning..

Hey, Andrew..

Hopefully I can count to two, because some people certainly have issues with that. So....

Well I'm going to leave that up to you, Andrew..

Okay. So question one, do you guys – I'm looking actually – one of my colleagues pointed out that in homebuilding channel, people have inflationary pressures this quarter. We've seen something similar with Pentair in their retail channel.

Do you think, in an inflationary environment there is a structural difference between selling to institutions and selling to individuals, and somehow you have to adjust your pricing strategy to differentiate between these two channels?.

I think the channels are different.

We're competing on different product attributes and when you take one of our institutional products like a Von Duprin exit device, a LCN closer, the duty cycle that that delivers over its lifecycle is different and commands a higher premium than a residential door handle that needs to operate maybe for the cycle of ownership, which is seven years or less..

Right.

And any sort of structural adjustments that you need to make in retail channels to adjust for that in an inflationary environment?.

I think we always need to try and position ourselves for the pressures of inflation. We also have to be cognizant of our position. If you go into the retail, you'll typically see our brands are in the premium section. And as competition enters, we've got to be sensitive that we don't price ourselves out of the marketplace. There is a point obtained..

A follow-up question. You guys were able to sort of beat up on your competition over the past couple of years. The company in Northern Europe has been somewhat distracted. Another company was merging.

Do you feel – as I sort of look at this big box pressure, what's happening in Asia, do you think part of what's happening is just those guys getting their act together and just sort of payback for you beating up on them for so many years?.

I think electronics, the growth of the access through electronics brings new entrants and to me the behaviors are predictable. I think we have navigated that pretty well with suspect – with commentary on the retail.

Globally, I would say that we have done a good job executing our strategy with the opportunities that we have and the performance of the business, and our performance says that. I think....

You can continue to execute globally, right? You think the strategies, the playbook still works?.

I believe it still works. I really like our opportunities around access and electronics..

Terrific. Thanks a lot..

I'll give you a second answer there, Andrew. I really like our opportunities around access and electronics..

Terrific..

Okay. Thank you. And the next question comes from Jeffrey Kessler with Imperial..

Thank you. At the last tradeshow that we saw you folks, I believe, was ESX, you came out, well, you actually reintroduced an electronic – I just want to call it a wireless door closer. And it seems to me that that was one of, if not, the real highlights of that entire show.

So, the question to you is, given the fact that you do a lot of work with the channel, a lot of work with specifiers, people like that, where is – if you want to call it, where is the ecosystem in building security at this point with regard to accepting some of these new products that you've come out with over the last six months that seem to have the type of potential that your SMB-level door locks had?.

Jeff, I think the product is the RURN (00:45:17)..

Yes..

It's a nice innovation. Our acquisition of ISONAS builds along those types of things. Our increased investment in the second half and as we go into 2019, we think the adoption of electronic access control is in its infancy. And we believe that Allegion is in a great position to drive seamless access across our customers.

We think we can simplify and improve the user experience. We think we can improve security. And we're going to be aggressive to go out and help our customers, architects and end users, integrators to adopt that. We have continued to develop a very strong value proposition that we think will enhance the customer experience.

So, in its infancy with great opportunities. I want to say one more thing. I couldn't be more pleased with our global electronic growth. We characterize that as high teens. In the fastest moving markets, we think that half of that in terms of overall market growth. And it's going to continue to be a priority for our company..

Okay.

Along those lines, my follow-up question, which is question number two is, over in Europe, can you describe the ability – what you're doing in electronics, particularly through influencers like SimonsVoss to bring, again, greater awareness to the channels in Europe, even though they're a bit different, to start accepting electronics and access control that have electronics in them, and start building up a base in that electronics area that can begin to mirror what you're doing over here?.

So, the European market moves a little bit slower, part of it's the complexity of that market from a mechanical standpoint. SimonsVoss continues to be a great capital deployment, really pleased with that advancement. I think something that may not have caught your attention is our investment in Nuki, which is important on the residential side of it.

But look at Allegion to focus on some key verticals to bring our electronic, our mechanical capability together, to bring end-to-end solutions that we think will help us grow..

Okay, great. Thank you very much..

Thank you, Jeff..

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

Thank you. Good day, everyone..

Good morning..

Hey. Two from me also. There's been a little bit of chatter out there that there's been kind of a pickup in import competition in the commercial stock and flow business. And folks like yourself getting spec'd in on projects, but then budgets get tight and push comes to shove and some of the lower-end stuff is actually sneaking into the jobs.

To what degree are you seeing that? Is Falcon your response to that? And just wondering if the pricing actually is getting a little bit messier in the commercial market..

I think any time you've got development projects that are on the margins of returns as a developer, they're going to – when you see inflationary pressures that we've seen, they'll go back and sharpen their pencils. That typically results in, what we call, value engineering.

And we think our Falcon and Dexter brands that we've been working on over the last couple of years give us the ability to stay in the hunt. This is an area of the business, when we created Allegion five years ago, that we would just fold our tent. So, we think we've developed the capability. There's always going to be projects like that.

And yes, it's happening in the marketplace..

And then second question, unrelated. The inflationary pressures at one level are quite obvious, but then we're also looking at brass, i.e., copper and zinc kind of falling out of bed here in the last couple of months.

Can you just give us some sense of where your key inflationary pressures are now? Is it freight, is it coming through in labor, or is it still really kind of the metals complex? But I think Patrick said things are actually getting sequentially worse..

Yeah. So, if you look at the components of our inflation, a big piece of it is steel-related and that would not only be the raw material component but stampings, castings, those type of things that come through the broader supply chain.

If you look at the cost on a per pound basis, it really hasn't changed since when we talked 90 days ago, whereas, as you mentioned, the zinc, brass, aluminum, et cetera, has come down. So hopefully, we get some relief going forward on that part of the equation, but it's really steel.

And then as you mentioned, freights, packaging, those type of things, ancillary type of costs in our supply chain has increased higher than what we had originally anticipated..

Thank you..

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

Yes. Good morning, everyone..

Good morning, David..

And David, congratulations on a good quarter..

Thank you..

Great job..

I think I'm proud of the team and – it's meeting the challenge of these inflationary headwinds. Pretty formidable. Throwing some chairs on top of that. I think we performed well. And it says a lot about the character of Allegion that we're going to defend the profitability of our business..

Yeah. I mean, your performance on managing inflation really stands out versus so many other companies on my coverage list this quarter. So congrats there. I want to just go back because you've made a few different comments today around the commercial business. And Patrick started off by talking about the fact that you're getting price traction there.

And another point you mentioned that you're likely to get a little bit of protection from the tariffs against that import flow, although you weren't very specific about that. Now you mentioned a moment ago about Dexter and Falcon.

And I guess you're pushing through pricing out the spread between where you're pricing either your high-end or you're tactical brands is opening up versus that import flow.

Are you concerned about the second half? And you've managed it so well up to now, but does it kick in and become a more formidable issue in the second half, people mixing down a little more into those tactical brands, or do you get that protection from the tariffs and that gives you a little bit of leeway?.

Tariffs really have a little effect on us. In some of the opening price point, mid-price point, it could be opportunistic, but to be determined. But in terms of how I think about the tariffs, it's really – they're rounding here, number one. Number two, I like the end market fundamentals.

I think I'm mindful we're in one of the longest recoveries in history, but as I look out end market fundamentals especially around institutional, which we like, are positive, I think we comment on chop. Labor still concerns me. I just ran a price increase through, what are the effects of that.

I think through July it seems like our demand continues to be solid. And I think as we've shown in the first half, we're going to be able to manage through the different variables and continue to operate at a good level here at Allegion..

What did that commercial business – what impact did that have on that 5.2% consolidated organic growth in the quarter?.

David, if you look at what we've put in the slides we said that commercial ex-acquisitions or nonres ex-acquisitions was higher than res. We don't give the exact numbers. But we did give some detail on the slide..

I'm just trying to get the commercial versus the institutional, which is a-.

We don't disclose that detail..

Sure.

Can you – is there any way you could just size that business for us, your most recent sizing?.

Yeah. If you think about nonres, nonres is about 70% of the Americas..

Right..

And of that, 60% is institutional, 40% is commercial..

Okay. Thanks. My second question was just on the K-12 in the college business. It's seasonal business. This is the time of the year that typically favors.

How was the growth there this year versus say last year?.

The growth from 2017 to 2018 across the institutional segment was up. And we – as we look out to 2019, our anticipation is that it will stay at that level..

For K-12 in college?.

Yes. K-12, there's a demand for increased security. And college campuses and K-12 from an infrastructure standpoint are still trying to dig themselves out of the deficit that was created from 2008 to 2012..

All right. So the growth there over index the broader 5.2% number..

We're not getting into a detailed vertical growth rates. David..

Okay. All right. Great. Thanks very much and congrats on the progress..

Thank you..

Thank you. And the next question comes from Rizk Maidi with Berenberg..

Yes. Hi, guys. I'll stick to two. Number one, as we're hearing some companies talking about labor shortages happening in some of the European countries, France, Holland, and Germany, your biggest competitor in Europe warned about demand in France, where housing permits, housing starts are down mid to high-single digits year-to-date.

Is this something you guys have seen?.

I don't think I'm in a position to comment. As we went through the quarter, it was not an issue..

Okay. And then, secondly, on – you said that you're expecting the price plus productivity in excess of cost inflation to be positive in nature.

Can you just remind us if you are still expecting this equation to be positive for the full year?.

So slightly positive, which requires us to be second half relative to first half to be more positive. So I think we mentioned earlier first half slightly underwater, managing the inflationary headwinds fairly well through pricing actions, and that's going to continue.

But pricing improvement should – and productivity exceed inflation at the back half of the year..

Okay. And then finally on the trade tariffs, I appreciate you guys touching on them.

But just from a logistic perspective, do you source any components from China, or do you feel you have to change anything from a supply chain perspective if those tariffs gets implemented?.

We do source components in and products from China. It's common in the industry. We have the flexibility in our supply chain to make adjustments globally, and including in-sourcing. So our industrial teams, our designs are set up to be able to have the adaptability to respond..

Thank you..

We'll see where that proposed legislation ends up. Any partial year impact states that it's not a significant exposure. We do a lot of in-region sourcing. And so, yes, there was an impact. We'll wait and see what the final legislation comes out. But any impact for this year is well-contained within our guidance. No problem there..

Thank you..

Thank you..

Thank you. And this concludes our question-and-answer session. So I'd like to return the floor back to Mike Wagnes for any closing comments..

I want to thank everyone for participating in the call today. Please reach out to me and contact me for any further questions and have a great day..

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