安朗杰 (ALLE) 2016 Q2 法說會逐字稿

Good morning, and welcome to the Allegion second-quarter earnings conference call.

(Operator Instructions)

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

Thank you, Kate. Good morning, everyone. Welcome, and thank of a joining us for the second-quarter 2016 Allegion earnings call.

With me today is David Petratis, Chairman, President and Chief Executive Officer; and Patrick Shannon, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning, and the presentation which we will refer to in today's call, are available on our website at www.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.

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 2016 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 3 and I will turn the call over to Dave.

Thanks, Tom. Good morning, and thank you for joining us today.

I'm extremely pleased with the Company's second quarter results. We continued to deliver profitable growth that reflects continued execution of our growth pillars, as well as the benefits of investments in the business. Revenues of $584.9 million grew 12.6%, reflecting organic growth of 8.9%, as well as the benefit of prior year acquisitions.

The Americas had organic growth of 9.8%, which was driven by strong revenue growth in our non-residential business. This included an anticipated shift in revenue from Q1 to Q2 associated with our ERP implementation at our Indianapolis facility. If you recall, we ended the first quarter with elevated levels of backlog associated with the implementation.

I am pleased to say we made significant progress in the second quarter to improve throughput and reduce the associated backlog. We've caught up on shipments and I expect a normal flow of shipments for the second half of the year. EMEIA organic revenues grew at 3% and our Asia Pacific business had a very strong organic revenue growth of 12.9%.

If we exclude the previously divested system integration business revenues from prior year amounts, the Asia Pacific business achieved organic growth of 23.6%. Adjusted operating income of $125.7 million increased 24.2% versus the prior year. Overall operating margin improved by 200 basis points.

This is the second straight quarter in which all Allegion regions delivered organic revenue growth and margin expansion, once again, demonstrating our ability to officially leverage incremental volume. Adjusted earnings per share of $0.99 increased more than 39% versus the prior year period, driven primarily from improved operating performance, acquisitions, and a lower effective tax rate.

This is our eighth straight quarter with double-digit adjusted earnings per share growth. As a result, we are improving our full-year guidance of organic revenue growth to a range of 5% to 6% and total revenue growth of 8% to 9%. In addition, we are tightening our full-year adjusted EPS guidance to $3.30 to $3.40 per share.

Please go to slide 4. Shifting a bit from the financials, I'm equally pleased with our safety performance of our business. We believe that excellence in safety is a true north metric of enterprise excellence, and having a workforce committed to safety is crucial for continued operational success and delivering shareholder value.

As you can see from the chart, Allegion has consistently been a leader among our peers and other manufacturing companies for total recordable incident rates. We incorporate safety in our business systems and measure ourselves against annual goals. Year-to-date 2016, we continue to see an improvement of 13% by forecasting on risk and a reduction of injuries at home and at work.

Be safe and be healthy is one of Allegion's core values and providing and maintaining a safe work environment is my number one priority. Patrick will now walk you through the financials and I'll be back to discuss our full year 2016 guidance.

Thanks, Dave. Good morning, everyone. Thank you for joining the call this morning.

Please go to slide number 5. This slide depicts the components of our revenue growth for the second quarter. I'll focus on the Allegion results and then cover the regions in the respective slides.

As indicated, we delivered 8.9% organic growth in the second quarter with contributions from all regions. Each region contributed to price realization, as well as volume growth. Foreign currency was a modest headwind in the quarter while acquisitions contributed approximately $40 million of incremental revenue, or 7.7% growth, which more than offset the impact of divestitures.

Please go to slide number 6. Reported net revenues for the quarter were $584.9 million, which is a 12.6% increase versus the prior year period. I was pleased with the revenue growth driven by volume increases, the benefit of acquisitions, and organic contributions from each region. As Dave mentioned earlier, our revenue growth reflects increased shipments following our Q1 ERP implementation at our Indianapolis facility.

We continue to experience solid electronic product growth, which was up in the mid-teens, and we are realizing the benefits of our new product introductions and channel initiatives. Adjusted operating income of $125.7 million increased 24.2% compared to the prior year. The benefit of strong leverage on incremental volumes helped deliver 200 basis points of margin expansion versus the prior year.

All regions delivered improved operating margins and this reflects the fifth straight quarter of year-over-year margin growth. Of note, volume increases in our North America non-residential business contributed to favorable mix in the quarter. I'll discuss this in more detail when reviewing the Americas slide.

I'd also note that we improved our industry-leading adjusted EBITDA margin to 24.2%, an improvement of 260 basis points versus the prior year. All regions improved on this metric in the quarter. Please go to slide number 7.

This slide reflects our EPS reconciliation for the second quarter. For the second quarter of 2015, reported EPS was $0.66. Adjusting $0.05 for prior year restructuring and acquisition related expenditures, the 2015 adjusted EPS was $0.71.

Operational results increased EPS by $0.18 as leverage on incremental volumes, favorable business mix, productivity and price more than offset inflationary impacts. The unfavorable net productivity and inflation reflects the quarterly timing of certain expenditures. And although foreign exchange was a revenue headwind in the quarter, this was offset by our foreign denominated costs resulting in a slight favorability to EPS when compared to the prior year.

The decrease in the adjusted effective tax rate drove a $0.05 per share reduction versus the prior year. The improvement reflects favorable changes in the mix of income earned in lower rate jurisdictions, and the continued execution of the Company's tax planning strategies. Acquisitions net of divestitures added $0.03 in the quarter.

Next, interest and other income were a net $0.03 increase to EPS. The higher interest expense is related to the issuance of senior notes in the prior year. Favorable other net items primarily reflects the sale of non-strategic marketable securities.

This represents the full liquidation of the securities. Lastly, incremental investments related to ongoing growth opportunities, new product development and channel management, as well as corporate initiatives, were a $0.01 reduction. This reflects an adjusted second quarter 2016 EPS of $0.99 per share, an increase of approximately $0.28 or 39.4% versus the prior year period.

Continuing on, we have a negative $0.01 per share reduction for acquisition and restructuring costs. After giving effect to these one-time items, we arrive at the second quarter 2016 reported EPS of $0.98 per share. Please go to slide number 8.

Second quarter revenues for the Americas region were $436.5 million, up 8.6%, or an increase of 9.8% on an organic basis. Growth in our electronics products increased mid-teen percent versus the prior year, as we continue to see better than market growth in this product category in both residential and non-residential markets. The non-residential segment delivered double-digit revenue growth in the quarter.

Pricing remains solid and end markets are performing as expected, with growth in both commercial and institutional areas. Additionally, the second quarter results were inclusive of higher than normal shipments at our Indianapolis facility, which underwent an ERP implementation in Q1 and had experienced delays in shipments. On a year-to-date basis, the non-residential segment grew high-single-digits.

The residential business grew at low-single-digits after excluding the divested Venezuelan business from prior year results. Volume growth in new construction builder channels and e-commerce was partially offset by pricing weakness. On a year-to-date basis, the residential segment has grown mid-single-digits, consistent with the original market expectations shared during our February call.

Americas adjusted operating income of $130 million was up 16.2% versus the prior year period. Adjusted operating margin for the quarter increased 200 basis points. The margin improvement was driven by strong volume leverage and favorable mix, attributable to the strength of non-residential growth.

Overall inflation was largely offset by pricing and productivity in the quarter. The higher inflation reflects some quarterly timing differences. When looking at the year-to-date performance, pricing and productivity more than offset inflation.

We would expect this to be the case for the balance of the year, although we are expecting to see some additional commodity inflation pressure in the second half. And, as noted in the presentation, investments have been a modest headwind year-to-date. We expect additional investment headwind to be back-end loaded for the Americas segment.

Please go to slide number 9. Second quarter revenues for the EMEIA region were $121.6 million, up 44.9%, or up 3% on an organic basis. The organic growth reflected solid price realization and good performance across most geographies.

Acquisitions delivered approximately $35 million in incremental revenue. We have not seen any meaningful impact from the UK/EU referendum vote or Brexit. It's too early to quantify any potential impacts to our business or industry, but I would note that the UK sales are historically less than 10% of our EMEIA portfolio.

EMEIA adjusted operating income of $9.3 million increased 116.3% versus the prior year period. Adjusted operating margin for the quarter increased 250 basis points, and adjusted EBITDA margins increased 440 basis points, reflecting continued improvements in the ongoing business transformation, as well as contributions from the lease and acquisitions, which were accretive to the region's margins. This represents the sixth consecutive quarter with year-over-year margin improvement.

Please go to slide number 10. Second quarter revenues for the Asia Pacific region were $26.8 million, down 20% versus the prior year period. As noted on the slide, the decrease was specific to the divestiture of the system integration business, which drove a $15.2 million reduction in revenues year-over-year.

Excluding the system integration business in prior year numbers, total revenue grew 46.2% and organic revenues grew approximately 23.6%. Most subregions performed well with notable strength in China hardware, and Australia-New Zealand. Asia Pacific adjusted operating income was $2.3 million, which reflects an improvement of $3.7 million versus the prior year period.

Adjusted operating margin for the quarter increased 1,280 basis points versus the prior year period. Operating margins improved 830 basis points excluding the previously divested system integration business and acquisitions. The increase in margin reflects strong volume leverage, cost improvements and year-over-year benefit of divesting the system integration business, as well as the acquisitions.

Please go to slide number 11. Year-to-date available cash flow for the second quarter of 2016 was $84.7 million, a $69.9 million increase versus the prior year. The improvement in available cash flow is primarily attributable to increased earnings, decreased operating cash requirements, and lower capital expenditures.

As evident in the increased ratios on this slide, we now reflect the impact of lease and acquisitions and divestitures in the current numbers. We remain committed to an effective and efficient use of working capital. And lastly, we continue to guide full-year available cash flow of $280 million to $300 million, an increase of 26% to 35% compared to the prior year.

Please go to slide number 12. You will remember our capital allocation strategy that divines a balanced and flexible approach. The Company improved its debt to EBITDA ratio to 3 times at the end of the second quarter, in the middle of our targeted long-term range of 2.75 times to 3.25 times.

This represents a half turn improvement over the ratio at 12/31/15 of 3.5 times. The decrease in the leverage ratio is a component of increased EBITDA and normal debt amortization and demonstrates the ability of our Company to deleverage quickly from profitable growth, low capital requirements and strong cash generation. Additionally, I wanted to highlight that Standard & Poor's had upgraded Allegion to investment grade during the second quarter of 2016.

We continue to see opportunity to fund incremental investments in organic growth for new product development, channel strategies, and enterprise excellence to accelerate core market expansion. Supported by our 2016 performance, we continue to believe these investments will enable the Company to grow at an accelerated pace and faster than the broader market with high returns on invested capital.

We remain focused on growing our portfolio through acquisitions. During the second quarter, we completed the acquisition of Trelock GmbH. Trelock, a portable safety and security provider producing bicycle locks, lights, and electronic control units, strengthens our global portfolio, security and safety offerings.

We will continue to evaluate acquisitions that our core to our business and can expand our global footprint and product portfolio and provide a favorable return on invested capital. And, lastly, we have the opportunity to provide shareholder distributions, increased dividends and share repurchases. In summary, due to consistent high cash flow generation, we have many options to deploy capital that drive value for our shareholders.

I will now hand the call back over to Dave for an update on our full-year 2016 guidance.

Thank you, Patrick. Please go to slide 13.

We are improving our 2016 guidance for revenue and EPS as noted on this slide. We are increasing revenue growth for all regions given first half performance and our expectations for the remainder of the year. This results in total organic revenue improving a full point versus prior guidance to a range of 5% to 6%, and total revenue improving to a range of 8% to 9%.

If we look closer at the Americas business, residential market indicators still suggest continued growth. New construction starts are approaching 1.2 million, with resilient strength in the multi-family segment. The residential aftermarket is also performing well, given increased home pricing and low mortgage rates.

Non-residential markets continue to perform well and we continue to expect slow and steady improvement in our core non-residential segments. Within major institutional verticals, we still expect modest growth in education and are seeing slight improvement in healthcare aftermarket with an increase in renovations and additions. In the commercial segment, office construction remains strong, driven by employment growth and reduced vacancy rates.

European markets have stabilized and we continue to see modest growth in our core geographies, which is reflected in the increase of our organic guidance. We are still recognizing the benefits of prior year acquisitions and are leveraging a broader portfolio to accelerate growth.

In the Asia Pacific segment, we continue to make progress with a focus on mechanical and electrical hardware solutions in growth verticals. For example, multi-family in Australia and New Zealand and transportation in China. We are also tightening and raising the low end of EPS guidance, reflecting confidence in achieving the improved top line outlook.

However, we are anticipating some pressure on second-half earnings due to the inflationary headwinds, second-half weighted investments, and a tax rate at the high end of prior guidance. I would also note that our guidance now reflects the inclusion of the Trelock acquisition for the second half of the year.

Please go to slide 14. Let me finish by reiterating that I'm very pleased with our second quarter execution and results. As a summary, total revenue grew over 12%, organic revenue grew almost 9%.

Operating margin increased 200 basis points. EBITDA margins grew 260 basis points. EPS grew over 39%.

These are strong numbers. We have increased our revenue growth expectations for the year and have tightened the range for our full-year EPS outlook.

Before we take questions, I'd like to take a moment to share some news with regard to an organizational change at Allegion. Tom Martineau will be assuming the role of Vice President of Finance for the EMEIA region. As you know, Tom has been in the Investor Relations role since the creation of Allegion.

During this time, Tom has established the Company's Investor Relations program and has served as a valuable voice of the shareholder community, along with the leadership team. This is a great opportunity for Tom and I'm sure you all want to congratulate him on this exciting move.

As we move forward, Mike Wagnes, Allegion's Vice President and Treasurer, will assume the additional responsibilities of Investor Relations. Mike has been with Allegion and Ingersoll Rand for 10 years and brings a wealth of financial experience that will position him well as the Company's primary representative to the investment community. Congratulations to you both. The transition will occur over the month of August with formal transition by the end of August. Please continue to contact Tom during this time for any investor-related questions.

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

(Operator Instructions)

Joe Ritchie of Goldman Sachs.

Hi, good morning, everyone, and congratulations to both Tom and Mike.

Well deserved, thank you.

My first question, maybe, Dave, just touching on your comments on the inflationary headwinds heading into the second half of the year, it looks like you've got a little bit of a lower pricing benefit this quarter than you did in 1Q.

You have your competitor in Europe that has been talking about putting through pricing increases because of these inflationary pressures, even starting as early as next quarter. And so, maybe, just talk about your ability to pass on additional pricing increases as we head into the second half of the year?

We see inflation on the rise. We think the market remains disciplined and will pass those higher costs through. Extremely pleased with the global supply chain's procurement organization that we've created here at Allegion. It's driving some productivity in the first half, and I think that's how you need to think about the inflation, price productivity take off, as you think about our 2016 results. Patrick's got some comments.

Joe, a couple of quick things. As you saw in the results, Q2 sequentially down a little bit in pricing. Still pretty good traction in non-residential. The pressure there was more the residential side.

Nothing really out of the normal course of business. Some added costs associated with rebates, advertising merchandising credits, those type of things. We would anticipate the back half to improve relative to Q2. As Dave mentioned, still anticipate the kind of pass on, to the extent we can, pricing relative to the increase in inflation.

But there's always a lag attached to that. As it relates to inflation, as you know, the commodity input costs are rising, particularly steel, which is up, the last numbers I saw, like 60%, relative to the beginning of the year in terms of spot rates. That's going to put a little pressure on our numbers in the back half of the year.

Okay. That's fair. One quick follow-up, Patrick. Just on the EMEIA are margins, still continuing to progress there. I think you guys had a double-digit expectation for the year. So I'm just curious whether that's changed at all? Just maybe provide a little bit of color around that.

We're still marching forward to the double-digit expectations in terms of margin performance. I'd say there's a little bit more pressure there in terms of what we originally anticipated, given some of the inflationary headwinds we've talked about. We've stepped up some of our investments in the business, as well, to better position us for growth going forward, particularly as we look at our long-range planning cycle and 2017 and beyond.

That's going to have a little pressure, as well. But if you look at the business in the quarter, good performance, EBIT margins up 250 basis points, EBITDA, 440 basis points. So we like the progress there. We're executing to our margin improvement plan but maybe a little bit of delay.

But collectively, a good story, particularly, when you look at where we started the journey. You may recall 2013 was like a 1% EBIT margin. So significant progress, continue to move forward. Probably not as quick as we would like. But yet, we're not capitulating on our 10% objective.

Joe, I would add to that, fully committed for double-digit profitability in Europe. I think the execution by the team there and the amount of restructuring that has gone on since we created Allegion is noteworthy. Overall, we are confident that we can deliver that.

Great. Thank you.

Andrew Obin of Bank of America.

Yes, good morning, guys.

How are you, Andrew?

Congratulations to Tom and Mike.

Thanks, Andrew.

Just a question on your EPS guidance for the second half. As I look, we have positive top-line growth in the second half. But, basically, your EPS guidance implies no EPS growth, or EPS decline in the second half. I'm just wondering if that's how the math has worked out and we're being conservative, or, we really do think that there is $30 million or $40 million of incremental costs that's going to chew up any operating improvements in the second half of the year?

Yes. I think you have got to look at it and break down the P&L in a couple of segments. We do, as you say, anticipate continued growth, both organically, as well as including the acquisitions. The continued growth in EBIT, EBITDA margin performance, and that's across all regions, in the back half of the year, a little bit increase as it relates to corporate expenditures.

But then when you go below the line, it's when the year-over-year comparabilities get very difficult. You may recall last year, other income was up on the sale of marketable securities. We had a lower tax rate last year because of some favorability, some one-time items there, that are non-recurring, this year. And so it's the below-the-line items that are putting the comparisons difficult in the back half of the year. But continued growth, as you would anticipate, in each of the regions for the balance of the year.

But let me just rephrase the question. Operating leverage in the quarter was in the high 30%s. Do you see a material step down in operating leverage in the second half of the year because of the investments? Because you are describing investments and cost pressures as marginal. But should we see a material decline to a point where we're not going to see any operating leverage in the second half?

There's going to be operating leverage, not to the extent that you saw in Q2. For the reasons that you mentioned, higher back-end loaded investments. When we initially gave our guidance back in the beginning of the year, we were anticipating $0.10 to $0.15 of investment headwinds. We are a little bit north of that guidance now. Inflationary headwinds is also affecting the numbers a little bit. So, collectively, those items are sequentially -- you won't see the margin leverage that you saw in Q2.

I would also add, Andrew, we do have a system here at Allegion that helps us to anticipate the future with confidence. I also want the optionality in investments in our business to invest for the long term. I think this is important as to how we guide the Company. I think we've been good stewards of that investment and I don't want to put myself in a position where we can't make the investment in demand creation activities, the pursuit of electronics, which we think are good for shareholders over the long haul.

And just a follow-up question on discretionary retrofit market in the US. I know you are working to increase your market share there. Any update on the progress as to what you've seen in the quarter and what impact it has had on organic growth in North America in Q2? Thank you.

We continue to be pleased with our execution in the renovation and retrofit segments of the market. We continue to learn and invest and it had an impact on the quarter. With that, as we've learned and expand there, we are creating new segments to go after within the channel. It is an example where we're seeing good growth, but we are also investing in more people capacity to segment the markets and drive growth in the business.

Terrific. Thank you.

Julian Mitchell of Credit Suisse.

Thanks, good morning, and thanks, Tom, for all the help. My first question would be around the residential business in the Americas. As you said, organic sales growth slowed down a little bit year on year in the second quarter versus the first.

Was that all pricing, or did you see something change in volume, as well? And then maybe just give some context around the competitive environment in residential Americas, please.

I would say, look at our growth on a full-year basis. We're mid single digits, there, about what we anticipated. I think you look at the broader community of competitors, there is a price pressure on the opening price point.

As I look at our business in the first half, we grew and improved profitability. Don't really want to get sucked into the opening price points of the market, and there is growth there, we just have chose to play at a higher level.

Very clear, thanks. And then a quick follow-up just on the Asia business. Obviously, a lot of change in the portfolio there, an acquisition, and a big divestment in the past 12 months. How should we be thinking about the pace of improvement in this business, in margins, over the next couple of years, let's say?

We had targeted this year, kind of mid single digits. You saw really good performance in the second quarter, a little bit north of that expectation. The business is somewhat seasonal so you kind of see, particularly in Q4, stronger margins expectations than Q2. Going forward, as the business grows, we will continue to show some leverage, and we are targeting in the near-term horizon, have a 10% margin opportunity, is where we'd like to see the business go with kind of high single-digits to low double-digit growth in that business.

Very helpful.

I would add some to that, I think, if you look at our journey in Asia Pacific, there has been a tremendous transformation in that business. They are focused. They've got the core capabilities of our European product portfolio, our North American product portfolio and our, I think, attacking segments that are helping us drive growth.

There's been some smart capital allocation in acquisitions, and I think we've got a bright future as a small player in Asia Pacific that will benefit us over the long haul.

Thank you.

Jeff Kessler of Imperial Capital.

Thank you, and, again, congratulations to Tom and to Mike. Tom, it's been great working with you. Hopefully, we can keep talking from time to time.

Thanks, Jeff.

When you take a look at the other segments of the security industry that have been reporting, and that have been reporting en masse in terms of what the industry segments are doing. When you look at things like video, when you look at things like overall security integration, those areas have been growing at a little bit of a slower rate than what we are seeing in your area, which is counter to what lots of people have been thinking about, video being the fast grower.

Yes, units have been growing, but, obviously, there's been more price degradation than we've seen on your side because of manufacturing in the Far East. What I'm getting to is what is the reason, what do you see as the value proposition for driving the growth rate that you guys have in your part of the business at or above other parts of the industry level?

I think it goes back to the moat that we describe around in this business and that's the mechanical complexity that we deliver at Allegion in a market that's consolidating. I could look at some direct competitors that are not growing at the pace that we are. Allegion has made investments in our core mechanical, as well as electronic, and I think it helps differentiate us versus some of the electronics that have lower barriers to entry.

You mentioned that the video market has slowed. Clearly, that market is reaching maturity in some cases. But it's really the number of competitors that are out there. We like our position and we think the growth that we're driving because of the complexity and the investments will reward us.

Okay. Just as a quick follow-up, can you give some indication of what percentage of your new sales are now coming from, what we will call, electro-mechanical or electronic, versus pure mechanical?

We've grown the overall portfolio in electronic products, as we indicated, up mid-teens for the quarter. That's commensurate, kind of, a little bit higher than what we saw in Q1. It continues to be a larger part of our portfolio. It's kind of the low-teens to mid-teens area as a total percentage of our portfolio.

Okay, great.

I think too, the acquisitions also complement us. SimonsVoss a great add, Milre, our own presence with Schlage, helps us to understand the importance of the dimensions for customers and technical evolution around firmware, software, miniaturization and battery life that are going to be important in this industry. You integrate that into our mechanical platform, I think it puts us in a nice position.

All right. Great. Thank you very much.

Rich Kwas of Wells Fargo Securities.

Hi, good morning, everyone. And good luck, Tom. Thanks for all the help, too, and look forward to working with you, Mike. On the European margins, is the 10% core still intact for this year, Dave?

I think, certainly, within -- it is achievable. It has some pressure, and it's really on the timing and shifting of tooling to lower cost manufacturing areas. It's a risk point. But our modeling would say achievable.

Is that (multiple speakers).

I want you -- there are several hundred tools that we are moving, and this is not necessarily a casual activity, I would say. So there is some headwinds in the timing. But we believe 10% is achievable. Patrick, anything to add?

Yes, Rich, I would just say, it's not a question of do we get there, it's more of a timing issue. And as Dave indicated, with some of these moves from a production facility perspective, will probably delay the realization of that this year, be pushed into 2017. But the objective remains intact, in terms of the endgame. Again, collectively, looking at the region as a whole, still pretty good performance.

So would the guide incorporate something less than 10% in the spread, in terms of the EPS spread?

Not looking at the region in total, okay. But if you look at the components within the European region, base business versus acquisitions that are accretive to the margins, yes.

Okay, all right. And then, just longer term, on Europe, so does this mean that getting to where an ASSA is right now, and I know you haven't given formal guidance longer term on European margins, but does this push out your original thoughts around that on getting to that level? Or is this kind of, we need catch up, there is a time to catch up, and we still think over a longer term basis we can get to the high-teens type, mid- to high-teens margin rate in Europe at some point?

I think you need to target mid-teens. ASSA, Kaba-Dorma is who we benchmark to. I think it's also dependent on future acquisitions. But we may ground up quickly and I think that mid-teens aspirations is achievable.

Okay, all right. And last quick one for me on electronic growth. So mid-teens is a step up from last quarter, low double digits. Is this the right framework in terms of growth rate going forward here? This mid-teens rate, you are comfortable with that?

Comfortable.

Okay. Thank you.

Jeremie Capron of CLSA.

Thanks, good morning, and thanks, Tom, for all your help in the past few years. Question on the outlook for the second half in the Americas, in particular. It seems like your guidance embeds a slow down in the revenue growth rate. In organic growth, you've been running well above 5% for two years now, with the exception of the first quarter and the production disruptions.

But it seems to me that your guidance embeds something below 5%. Is that correct? And what's driving this pricing slowing down, because your commentary on the markets sounded pretty optimistic. Thanks.

I think you've got to look at first half, second half. Q2 was abnormally high, given some of the catch up relative to the ERP implementation, which we now have behind us. But you kind of look at the first half, mid single digits, second half, slightly lower than that. So your comment is correct.

Predominantly, because last year, we had a really strong quarters, particularly in the residential business where we had some load-ins on new products. You may recall the launch of the Schlage Sense product, which was a big driver in Q4, in particular, last year. That's kind of what we're looking at, difficult comparisons.

But the core business will continue to grow. Again, we are making really good traction on our initiatives in terms of some of the new product launches. The channel initiatives Dave talked about, the retrofit opportunity, getting good traction there. It's more about more difficult comparisons in the back half of the year.

Understood. Going back to the topic of commodities and metal prices going up, can you maybe help us quantify the potential impact, and maybe help us understand the breakdown of your bill of materials?

We won't get into the specifics, in terms of bill of materials. But we had commented previously. Raw commodity cost, roughly 10% of our material purchases, steel being probably 50% of that. So that's the biggest commodity input, that's the biggest mover that we've seen recently.

If you try to quantify it, it's probably putting on additional pressure, $0.02 to $0.03 in the back half of the year. We manage that through supply lock contracts and -- but everything is not hedged. So the unhedged portion kind of flows through the business as we purchase those components. Additionally, obviously, you've got from our supply base, they are buying the same inputs and so you've got pressure in terms of potential cost increases from our suppliers that also come into the equation.

But we'll continue to manage it and offset it. As we said earlier, we have the mechanism to try to do that through pricing.

Great. And maybe just last one from me. I noticed the increase in working capital as a percentage of revenue. Should we reconsider this as transitory?

Yes, so we continue to focus on working capital. A couple of things worth noting here. The acquisitions, so the businesses we've acquired, predominantly being European-based, have higher working capital needs, and that's distorting the year-over-year comparatives.

If you kind of back that out, we are at about 5% working capital as a percentage of revenue, about 50 days cash conversion cycle. So there is some impact of the acquisitions, which -- hey, look, we will continue to drive that and look for ways to become more efficient. Secondly, as it relates to some of these facility moves, and the ERP implementation, you carry higher inventory of safety stock.

As we make those transitions effectively, we'll burn more inventory, and so the number should come down. Longer term basis, I would anticipate us to be able to operate effectively, efficiently at about a 5% working capital as a percentage of revenue.

I would reinforce that our ability to be efficient, I would add to Patrick's comments, it's the peak of the construction season. This business leverages incredibly, don't want a lack of material or finished inventory to inhibit our ability to drive revenue. There's clearly a shift in philosophy about that with Allegion. Have our product available at our wholesalers, in our warehouses, and continue to drive our industry-leading lead times. It helps us to grow.

Thank you. (multiple speakers)

Hey, Jeremie, this is Tom. I would just ask, let's try to keep the question to maybe to one question the rest of the way. We are going to run pretty tight today.

Steven Winoker of Bernstein.

Hi, everybody, this is Peter on for Steve. Could you talk through, put a bit of a finer point on, within the Americas for 2Q, how much of the growth was actually from ERP catch up and, therefore, one-time in nature, and any dynamics we should be expecting from there?

You may recall, Americas, I think, was essentially flat in Q1 and we would anticipate in kind of mid single digits, last quarter. Q2, we caught up, predominantly on the shortfall as it related to the ERP implementation and in the ops. Great progress there. That's why you saw the really high organic growth.

I'm not going to give you a specific number, but just to say, we've gotten all of that, kind of, behind us. You may recall we had anticipated it would be a 50/50 split, Q2, Q3. We are now at a normal run rate, I think, going forward. But it did impact the organic growth. I'd say, maybe 3 points to 4 points.

Yes, and I'd say first quarter was kind of low single digits was the growth rate.

Overall, I guide you to look at the first half year over year, and what I'm pleased with that we're seeing growth in all of our business lines, closers, locks, exit devices. I think it shows the strength of the market.

Okay. That's great. And actually, if I could just sneak in a follow-up, I had thought that in Q1 that absent the ERP impact that electronics growth was in the high-teens, excluding the ERP. And it was higher before that in 2015. Is that a slowing? Or is it sort of steady as she goes and the dynamics are actually pretty consistent?

I think, you need to think about this as mid-teens. Remember, we've had a lot of new product introduction over the last several quarters. Globally, this is forecasted to grow at high single digits. I think our mid-teens reflects our execution and how you ought to think about that.

Okay. Great. Thanks very much.

Tim Wojs of Baird.

Hey, guys, good morning. Tom, it's been great working with you and congrats on the role.

Thanks, Tim.

My question is really just on M&A. I guess I'm curious, how are you feeling about the cadence of M&A this year? And how do we think going forward, what your ideal cadence is?

I'm just asking because last year you did maybe five acquisitions and year to date you are closer to one. I'm curious how the pipeline looks and how you guys could think about the ideal cadence of M&A going forward?

Obviously, we'd like more. It's a function of availability, timing. We continue to work on the pipeline, the relationship building, and it's the nature of the beast. Sometimes these come in dumps and lumps.

But the overall market, the relationship we are building, we feel good about. What's the level of revenue we'd like to add? I'd like to think $50 million to $200 million on an annualized basis would be a nice cadence. But I want to remind you we're going to disciplined in the capital deployment and bolt-on what's right for Allegion. That's how I'd describe it.

Yes, Tim, I would just add, continue to be selective. Make sure it's aligned with our core business and strategies, things that we can leverage well to get a good return on capital. We are just as busy as we were last year.

We're looking at a lot of potential properties at various stages and it just depends. We are not going to over pay for anything. We are going to stick to our knitting and buy some good businesses.

Great. That's helpful color. I appreciate it. Nice work, guys.

Thank you.

Jeffrey Sprague of Vertical Research Partners.

Thank you. Good morning, everyone. Congrats to Tom. Maybe condolences to Mike, it sounds like he's getting two jobs for the price of one. But look forward to working with you.

No good deed goes unpunished for both of these guys.

Exactly. I will keep it to one question. I know we are up against the wall here. Just on the balance sheet, I don't think you were ever actively seeking an upgrade to investment grade. I just wonder, if that now, though, colors you're thinking on the balance sheet at all? Or in your discussions in achieving that upgrade, are the rating agencies comfortable with you at least flexing up to that 3.25%, maybe they are even comfortable with you flexing higher than that with visibility to bring it down? Just give us perspective on your thoughts around that and if there is any change in thinking at all about the balance sheet?

No changes, at least in the near term. We've been very transparent with our financial policies, with the rating agencies, from day one and nothing has changed from that, as you are aware, relative to our capital allocation strategy.

So the upgrade came on the basis of the strength in our franchise and prospects going forward, strong cash generation, good growth prospects, EBITDA, consistency margin profile. All those type of things, I think, factored in the upgrade. I think it's a benefit for us, going forward, and looking at financings that, hopefully, we can take advantage of. But no changes relative to our long-term debt to EBITDA, which we had targeted to 2.75% and 3.25%.

Hey, if we find a good opportunity, transaction, on the horizon, it doesn't mean we can't go north of that and we've communicated that with the rating agency, as well. They understand that. The beautiful thing about our business is we do delever very quickly given the strong margin profile and the cash generation. So they are all aware of that and came on the heels of that information.

Understood. Thanks.

And the final question comes from Robert Barry of Susquehanna.

Hey, guys, good morning. Thanks for fitting me in and congrats to Mike and Tom. A quick housekeeping item. I think you mentioned the target for investment spending is higher now. Did you, or could you say what it is?

And then my question was really on pricing. This fall-off in Americas, especially given -- it seemed like the growth mix was in your favor, right, with non-residential much stronger than residential. So just curious where the pressure is coming from and, to be clear, on what you think is going to improve the pricing as we go forward? Thanks.

On the investment spending, we had incurred, it was about a $0.04 headwind in the first half of the year. We're looking at $0.12 in the back half of the year, pretty much evenly spit, Q3, Q4. So we're stepping up the investment spend. Some of that was planned for but was delayed in the first half of the year.

So that's kind of how that's going to play out. Relative to the pricing, as I mentioned earlier, this quarter, experienced some unfavorable pricing in the residential segment. Would expect that to abate a little bit in the back half of the year, and that's where you get the improvement in pricing.

Then, what's driving the abatement?

Less rebates and advertising, merchandising credits, those type of things, discounts, I would say.

Okay. All right. Thank you.

That concludes our question-and-answer session. I would like to turn the conference back over to Tom Martineau for closing remarks.

We'd like to thank everyone for participating in today's call. Please contact me for further questions, and for my last time, please have a safe day.

Thank you, Tom.

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