Allegion plc

Hello, and welcome to the Allegiant Q4 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star or the one on your telephone keypad. To withdraw your question, please press star or the two. In consideration of the others, we ask that you limit yourself to one question and a follow-up. If you have additional questions, you may re-enter the question queue. Please note, this event is being recorded. And now I'd like to turn the conference over to Michael Ragnus, Vice President of Investor Relations and Treasurer. Please go ahead, sir.

Thank you, Keith. Good morning, everyone. Welcome and thank you for joining us for Allegiant's fourth quarter and full year 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 Allegiant. Our earnings release, which was issued earlier this morning, and the presentation, which we refer to in today's call, are available on our website at Allegiant.com. This call will be recorded and archived on our website. Please go to slides number two and three. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Dave and Patrick will now discuss our fourth quarter and full year 2018 results and provide an outlook for 2019, 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 one follow-up and then reenter the queue. We will do our best to get to everyone given the time allotted. Please go to slide four and I'll turn the call over to Dave.

Thanks, Mike. Good morning and thank you for joining us today. Allegiant saw another quarter of strong top-line revenue growth with strength across all regions. The Americas saw strong volumes in the non-residential business, as end-market fundamentals continue to be positive, particularly in institutional verticals. EMEA and Asia Pacific saw organic growth rates in the mid-single digits. Acquisitions continue to contribute to total company revenue growth. Electronics growth moderated in the fourth quarter, with the Americas seeing approximately 7% growth. Residential electronics performed well. However, the non-residential electronics growth decelerated due to the timing of large orders. We had full-year electronics growth of high teens in the Americas, with strength in both parts of the business. We see the electronics outlook continue to be a long-term positive trend as more and more products become connected for ease of access. As I stated earlier, non-residential U.S. and markets remain healthy with particular strength in institutional verticals. We do see residential new construction softening, but we expect this to be mitigated by electronics and channel initiatives to drive above-market growth. The quarter saw continued inflationary pressures, which we believe will ease in 2019. Commodities have leveled off and we project to have another solid year in price realization with particular strength in our America's non-residential businesses. In the fourth quarter, we delivered nearly 10% adjusted EPS growth, bringing the full year expansion to approximately 14%. as we drove a robust 37% increase in available cash flow, which totaled more than $400 million for the year. Overall, I'm extremely pleased with the revenue performance in both the quarter and the full year. Additionally, while operating margin could have been better, I'm satisfied with the growth in EPS that we delivered in the quarter and the full year. Please go to slide five, and I'll walk through the fourth quarter financial summary. In Q4, Allegiant delivered strong top-line revenue growth. Revenue for the fourth quarter was $702.4 million, an increase of 12.4%, inclusive of organic growth of 6.7%. Acquisitions also contributed to the top-line revenue expansion, offsetting the slightly unfavorable currency impact. All regions grew organically. America has led the way with organic growth of 7.6% in the quarter, driven by strength in our non-residential business. The EMEA region saw organic growth of 4.3%, driven by performance in the Simons Voss and Interflux businesses. Asia Pacific had a nice quarter of organic growth, coming in at 4.6% against a tough comparable. Adjusted operating margins decreased by 130 basis points due to the deluge dilution related to acquisitions made in 2018. Excluding the impact of these acquisitions, the base operating margins were up 20 basis points. Inflationary headwinds continued to pressure margins and exceeded price and productivity in the quarter. The company is committed to driving price realization and productivity actions such that for 2019, The price-productivity-inflation dynamic is expected to be positive, helping to drive margin expansion across all regions of the business. Adjusted earnings per share of $1.22 increased 11 cents, or nearly 10% versus the prior year. The increase was driven by higher operating income, along with a favorable year-over-year tax rate. Available cash flow for the year came in over $408 million, an increase of more than 37% versus prior year. Increased earnings and the non-reoccurring 2017 discretionary pension funding drove the increase. Please go to slide six. Before I turn the call over to Patrick, I want to talk a little about some of the things we are doing in the connected home space. In 2015, Schlage was the first smart lock to respond to, hey, Siri, open my lock. Now, Schlage ENCODE is the first lock to work with the key by Amazon app and ring devices without needing a Wi-Fi hub. It's built right into the lock. With Schlage ENCODE, we took a different approach to development, starting first with the connected home platform and developing a lock around the desired user experience. The user-first approach is part of our strategic plan to develop and integrate with leaders in connected home platforms. In addition, we recently announced the Schlage Connect Z-Wave Plus enhancement and its compatibility with Ring and Schlage Connect ZigBee certified locks, which support home automation systems. Our deep experience in connected home security has made us a go-to partner for a wide variety of platforms and home automation solutions. including Amazon, Ring, Alarm.com, Google, and Apple. We will continue to build relationships to benefit consumers and accelerate adoption of SLEG smart products. Patrick will now walk you through the financial results, and I'll be back to update you on our full year 2019 outlook.

Thanks, Dave, and good morning, everyone. Thank you for joining the call this morning. If you would, please go to slide number seven. This slide depicts the components of our revenue growth for the fourth quarter as well as the full year of 2018. I'll focus on the total Legion results and cover the regions on their respective slides. As indicated, we delivered 6.7% organic growth in the fourth quarter. This performance reflects another strong quarter in the Americas region, which delivered 7.6% organic growth led by the non-residential markets. EMEA and Asia Pacific saw continued momentum with mid-single-digit organic growth. Pricing for Legion in the quarter came in at 1.5%. The company will continue to take necessary pricing actions to help mitigate the impact of ongoing inflationary pressures and any additional tariff impacts. Also during the fourth quarter, acquisitions contributed more than 7% growth, and foreign currency was a slight headwind in all three regions. With the fourth quarter performance, you can see where we ended up for the full year on revenue growth. We delivered more than 13% total revenue growth with double digit top line growth in all three regions. Organic growth came in at 6%, led by the Americas at nearly 7%. Please go to slide number eight. Reported net revenues for the fourth quarter were $702.4 million. As stated earlier, this reflects an increase of 12.7% versus the prior year, up 6.7% on an organic basis. Adjusted operating income of $145.2 million increased nearly 6% over the same timeframe from last year. Adjusted operating margin of 20.7% decreased 130 basis points, with a decrease driven by dilution from acquisitions. Excluding the 2018 acquisitions, adjusted operating margin on the base business was up 20 basis points year over year. Total inflation exceeded price plus productivity by approximately 2.5 million and was dilutive to adjusted operating margins by 70 basis points. We are committed to driving the price, productivity, inflation dynamic positive in 2019 through the following actions. Price realization, improved productivity and operational efficiencies, acquisition and integration performance, and softening inflation during the year. Other headwinds to margin performance were incremental investments, which had a 40 basis point impact on adjusted operating margins. As discussed, these incremental investments accelerate top line growth. Please go to slide number nine. This slide reflects our EPS reconciliation for the fourth quarter. For the fourth quarter of 2017, reported earnings per share was 10 cents. Adjusting $1.01 for the prior year restructuring expenses, integration costs related acquisitions, charges related to U.S. tax reform and debt refinancing, the 2017 adjusted earnings per share was $1.11. Operational results increased earnings per share by 10 cents as favorable price, operating leverage on incremental volume and productivity more than offset inflationary impacts. Favorable year-over-year tax rate drove another 7 cents, with the favorability driven primarily by lower tax rates associated with tax reform, along with favorable discrete items. Acquisitions were a 1 cent drag in the quarter, reflecting worse than anticipated performance, associated with a QMI acquisition in Europe. The impact of incremental investments in the quarter was a two-cent reduction. These incremental investments for new product development, channel strategies, and demand creation spending continue to drive above-market growth and are providing solid returns on our investment. The combination of interest expense, other income, and non-controlling interest decreased earnings per share by three cents. This results in adjusted fourth quarter 2018 earnings per share of $1.22, an increase of 11 cents or nearly 10% compared to the prior year period. Lastly, we have a 17 cent per share benefit primarily driven by adjustments to the provisions related to the enactment of tax reform, which more than offset reductions for charges related to acquisitions and restructuring. After giving effect to these one-time items, you arrive at fourth quarter 2018 reported earnings per share of $1.39. Please go to slide number 10. Fourth quarter revenues for the Americas region were $492.7 million, up 13% on a reported basis and 7.6% organically. The organic growth was driven by strong volume in the non-residential business as well as continued pricing benefits. The electronics growth for the quarter was approximately 7%. Residential electronics in the quarter performed well. However, non-residential electronics growth decelerated due to timing of large orders. For the full year, growth in electronic products was solid, coming in at high teens with strength in both residential and non-residential products. Price realization in the quarter was 1.5%. Pricing in the non-residential business was strong, offset by residential promotional activities. The non-residential business grew low double digits, excluding acquisitions. Residential growth was flat in the quarter with strength in electronics, offset by some cannibalization of the mechanical business. Acquisitions added nearly 6% to total revenue. America's adjusted operating income of $131.8 million increased 5.3% versus the prior year period, and adjusted operating margin for the quarter decreased 190 basis points. The 2018 acquisitions continued to be dilutive, as expected, and had 120 basis point impact. Inflation and incremental investments exceeded price plus productivity in the quarter. Strong volume leverage and positive mix partially offset these impacts. Please go to slide number 11. Fourth quarter revenues for the EMEA region were 157.4 million, up 4.4%, and up 4.3% on an organic basis. The organic growth was driven by solid pricing for the quarter and strength in electronics, led by the Simons Voss and Interflex businesses. The impact of acquisitions offset currency headwinds. EMEA adjusted operating income of $22.5 million decreased approximately 10% versus the prior year period. Adjusted operating margin for the quarter decreased 230 basis points, driven primarily by dilution from acquisitions. As stated earlier, the poor acquisition performance was driven by our QMI business, which experienced reduced revenues in a challenging market environment, a significant mixed shift to lower margin business, along with some operational inefficiencies. We have identified areas of opportunity and have commenced plans to get the QMI business back to profitability. Operational performance improvement will gradually occur throughout the course of 2019. In addition, inflation and incremental investments slightly exceeded price plus productivity. Strong volume leverage offset some of these unfavorable impacts. Please go to slide number 12. Fourth quarter revenues for the Asia Pacific region were 52.3 million, up 44.9% versus the prior year. Organic revenue continued to rebound, growing nicely at 4.6% against a tough comparable. Total revenue growth was driven by the GWA door and access business acquisition. Foreign currency was a headwind for the quarter. Asia Pacific adjusted operating income for the quarter was $6.5 million, an increase of nearly $2 million with adjusted operating margins down 60 basis points versus the prior year period. Solution from acquisitions drove the margin decline. The base business adjusted operating margins were up 120 basis points with price and productivity more than offsetting the unfavorable impacts from inflation and incremental investments. Good volume leverage was able to offset negative mix. Please go to slide number 13. Available cash flow for 2018 came in at $408.7 million, which is an increase of $110.8 million compared to the prior year period. The increase was driven by higher net earnings along with the non-recurring $50 million discretionary pension funding payment that was made in the first quarter of 2017. Available cash flow continues to remain strong and exceeded prior estimates. Working capital as a percent of revenues increased slightly in fourth quarter 2018 when compared to the prior year period. The increase is primarily driven by working capital related to recently acquired businesses. And while working capital as a percent of revenues saw a slight increase, we did see a reduction in the cash conversion cycle. As always, we remain committed to an effective and efficient use of working capital and will continue to evaluate opportunities to minimize investments in working capital and increase available cash flow. I will now hand the call back over to Dave for a view on our full year 2019 outlook. Thank you, Patrick.

Please go to slide number 14. We continue to see favorable trends on our primary end markets in 2019. And it is our expectation that the organic investments combined with our ability to execute will again deliver better than market growth. We also believe the electronic portfolio will continue to outpace mechanical in all regions, and we are well positioned to continue to take advantage of this industry trend. In the Americas, we see continued positive fundamentals in our non-residential verticals led by the institutional markets. We expect the general trend toward electronic products to continue, which will help mitigate the softening that we are expecting in residential new construction. With these expectations, we project organic revenue growth in the Americas of 5% to 6%. We are projecting America's total revenue expansion to also be 5% to 6%, with any remaining impact from the 2018 acquisitions to be offset by currency headwinds. For the EMEA region, we expect strength in our electronics business to more than offset weaknesses in Southern Europe and the United Kingdom. For the region, we project organic growth of 2.5% to 4.5%. Currency headwinds are expected to more than offset acquisition benefits, bringing expected total revenue growth in EMEA region to flat to 2%. In Asia Pacific, we continue to see healthy growth in China, with softening markets in Australia and New Zealand. Organic growth in the region is estimated to be 4% to 6%. And total revenue growth is estimated to be 22 to 24% reflecting the full year impact of the acquisition of Gainesboro Hardware and API. All in, we are projecting total growth of the company at 5 to 6% and organic growth also at 5 to 6%. Please go to slide 15. Our 2019 outlook for adjusted earnings per share is $4.75 to $4.90. an increase of approximately 6% to 9%. As indicated, the earnings increase is driven by revenue growth and operational improvements, as adjusted operating earnings are expected to increase 10% to 14%. Inflationary pressures will continue to be a headwind in the first half of the year, but we anticipate pricing and productivity actions to help drive margin expansion for 2019. Incremental investments continue to be a headwind as we continue to focus on accelerating new product development and channel initiatives, which we believe enable us to keep delivering above-market growth and allowing us to take advantage of the shifting customer preferences to electronic products. Other expenses expected to be a drag on EPS, primarily driven by pension expense. Our outlook assumes a full-year effective tax rate of approximately 16%, an increase from 13.5% in 2018, and outstanding diluted shares of approximately 95.5 million. The outlook also includes a 15 cents per share impact from restructuring charges and acquisition-related costs during the year. As a result, reporting DPS is estimated to be $4.60 to $4.75. We are projecting our available cash flow for 2019 to be in the $430 to $450 million range. Please go to slide 16. We are very pleased with our 2018 top-line growth that delivered organic revenue expansion of 6% driven by electronics, which we see as a positive trend for us in the future. While operating margin could have been better, we did deliver full year adjusted EPS growth of nearly 14% in 2018, and we saw a robust 37% increase in available cash flow to more than 400 million. As we look to 2019, we expect to drive continual organic growth above market. We also expect to deliver solid growth and adjusted EPS and generate substantial available cash flow. We are well positioned for 2019 and are committed to make the world safer, securing the places where people thrive. I want to finish by saying that 2018 also marks Allegiant's first five years as an independent company. From the beginning, we told customers, shareholders, and employees we would deliver sustained, profitable growth and greater value. We have delivered industry-leading organic growth at a five-year CAGR of 5.6%. We have industry-leading margins. We have focused on the safety of our employees, health of our employees, and employee engagement. We invested in the business, especially in electronics, and are positioned nicely for the future. Allegiant is a company our shareholders can be proud to own. Now, Patrick and I will be happy to take your questions.

Yes, thank you. We will now begin the question-and-answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Again, as a courtesy to the others, we ask that you limit yourself to one question and a follow-up. You may re-enter the queue if you have additional questions. So with those instructions in mind, please give us a moment to assemble the roster. And this morning's first question comes from Tim Rose with Baird.

Hi, good morning. This is Josh Hanson for Tim.

Good morning, Josh.

Hi, good morning. I just wanted to ask about the Americas program. segment, the pricing versus productivity and inflation comparison seems to be more challenging this quarter. I know you mentioned the residential price dynamic, but just wondering what were some of the important drivers behind that? Did higher raw material costs start to flow through the balance sheet? Just kind of give us some color on that. It would be great.

Yeah, so, Josh, I would characterize it as follows. You know, we commented really good strength in pricing in the commercial area. Pricing on residential was lower than anticipated, you know, primarily due to promotional activities and some rebates and those type of things. And that ebbs and flows during the course of the year occasionally. So a little bit lower pricing than anticipated in the residential side. On the productivity, continue to get good productivity, particularly on materials. Inflation was more than anticipated, not so much on the raw materials, but more on the non-material side. So inefficiencies associated with non-materials on manufacturing, those type of things. As we look forward to 2019, we believe we have a very strong pipeline in terms of productivity. on both material and productivity projects from a manufacturing perspective. The dynamic will become positive in 2019, and it will continue to get better during the course of the year, particularly on the inflation side where, as you know, the commodities have kind of stabilized today relative to where they were in Q3, but it starts to almost become deflation in the second half of the year. So that will

benefit us as we progress throughout 2019 okay great yeah thanks for the call there patrick um and my for my uh follow-up uh could i ask about the the electronics growth um you mentioned a larger order within the commercial side i guess is it one large project in the prior year or you know some distributor dynamics just you know some color on on What drove that and how to think about electronics growth kind of going into next year?

Yeah, so really good, continued strong growth in resi electronics. It was more of a tough comp, you know, relative to last year on the non-resi side. But as we look forward, again, to 2019, don't see any reason why we can't sustain kind of mid-teens electronics growth across our portfolio. Feel really good where we're positioned, particularly when we look at some of our New products that we've introduced earlier this year, Dave talked about ENCODE. I think that's going to go well for us this year. We've got some other things in the pipeline going forward. So I think we're well positioned to continue to take advantage of this trend. And as you know, it's still low penetration rates overall, you know, from a residential adoption and new homes. And so we think – you know, that will continue to drive, you know, outperformance going forward.

Josh, I would just add, you know, in the institutional commercial, you can get some relatively large projects where you go in and retrofit an entire building or campus. This is what we saw. We continue to be extremely motivated by the growth that we see in electronics and Allegiant's position as we go forward.

Okay, great. Thanks for the call, and thank you.

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

Good morning, Julian. Hi. Good morning. Good morning. Made my first question just around following up on pricing. I think pricing was a bit less of a gross tailwind in Q4 than Q3. It was up, I think, one and a half points. The prior quarter, it was up about just over 2% year on year. So maybe just give a bit more color on why that happened, on the extent of those promotional activities that you just mentioned, and whether you've seen any change in competitive dynamics in any portion of the market in the Americas.

Yeah, so Q4 pricing was anticipated to be sequentially down relative to Q3. And the reason for that is because in Q3, we basically had the effect of two price increases in there. Remember, we pulled forward the price increase at the beginning of the quarter. In 2017, you had a price increase that went into effect in August, and so you had effect of two price increases, if you will, for one of the months in the quarter. So the expectation was that the pricing was going to come down sequentially. 1.5%, you know, is still pretty strong. You know, when we look at you know, how the rest of the market is performing. Commercial, we continue to perform extremely well, very pleased with how the team is pushing price there and remaining competitive on bid quote activity. The decline may be a little bit lighter than expected, and again, it relates to the residential business on the promotional activities and the sell-through to the consumer. So, I don't look at that as necessarily a longer-term impact. Going into 2019 would expect pricing to remain robust and would expect us to be able to deliver the 1.5% increase year-over-year in 2019 relative to 2018.

Thank you, and then my second question would really be about the residential business in the Americas in terms of market landscape. Maybe just clarify how much of your Americas business for 2018 as a whole was residential, and what do you expect the residential piece of your business to grow in 2019?

So think about a residential position about 30%. As we look to 19, the new construction elements of the residential market will be softening. I think that's well understood. In the retrofit side of it, which is our strongest position with our new electronic products, we believe that will give us good opportunities for growth. It is really how we've been positioning the company. In the single-family, multi-family, electronic penetration is low single digits, and we're growing well above that, and we think it sets us up nicely. We have also, in our channel initiatives, had some success winning some large contracts with top builders, and we think overall we'll set up for a nice year in a softer residential environment.

Great. Thank you.

Thank you. And the next question comes from John Brzezinski with Morgan Stanley.

Hi, good morning, guys. Good morning, Josh. Just to follow up on the Resi question there, did you see anything in the fourth quarter in terms of D-stock around a shifting landscape in that channel? Just, you know, it seems like the market share landscape is shifting a little bit notably that a competitor has had some success with some of their offerings. So I'm wondering how much of what you're seeing is response to the new market versus some channel fill by some other folks. Just trying to get my hands around how much of this is short-term noise versus something that's more of a market-driven weakness over time.

I think... In terms of the big box, there was some shifting in terms of the timing of orders as they saw deceleration in the res side of the market. We do see new competitors coming into the electronic space around res. I think if you walk through the Consumer Electronics Show, there's many new entries. I think the number of announcements and enhancements that we made to our product portfolio in terms of connectivity, as well as our channel initiatives, positions us nicely for 2019.

Got it. That's helpful. And then on the 2019 implied margin guidance, Patrick, it looks like relative to the way you guys have framed up operating leverage historically that There's, you know, call it an extra 10 points of incremental margin or maybe, you know, $10 million of EBIT. Should we think about that as kind of the catch-up from 4Q? If I were to include that in 4Q and say that price cost or, you know, some of the other irritation items wouldn't have happened, you would have had a more normal incremental in 4Q. It looks like you're catching that up in 19. Is that directionally fair?

Yeah, I think that's absolutely fair. And as we've indicated on the guidance for 2019, all of the EPS growth is operational related. And it's the pressure on the blow items that we're getting lower than expected earnings per share growth. So the idea here is we're going to continue to press price to the extent we can in the market, remain competitive. And we believe we're well positioned to do that in 2019. The inflation dynamic is subsiding, particularly on the material side. That will benefit us as well. We've got a strong pipeline of productivity actions that we're going to implement. We've got some areas of opportunity for improvement. I'd call it self-help on the M&A integration that we performed lower than anticipated. And then we've initiated some restructuring activities that will help reduce our cost base as well. So collectively... When you add all that together, I think we're well-positioned to execute on margin improvement across all regions of the business. And I feel pretty good, and relative to the guide, it should help us get back to kind of the 2017 margins that we enjoyed in that year.

Josh, I'd add to that. I think I put a lot on the business in 2018, seven acquisitions. You know, we really pressed hard on the digitization, and as we prepared or refreshed our strategic plan and went through our budgets to prepare for 2019, really a heavy emphasis on execution and focus, and I think we'll get that leverage back to our 2017 OI operating margins.

Got it. Thanks for the call. I'll leave it there.

Thank you. And the next question comes from Andrew Obin with Bank of America, Maryland.

Yeah, good morning, guys. Hey, Andrew. Hey. Just a question on cash flow. You guys are generating quite a bit of it, and I would imagine, I think, part of the debt leverage has to do with your tax structure, so maybe you're not going to deliver. Should we expect more emphasis on M&A?

uh because uh you know you did raise dividend very nicely but that's still fairly small or how do you think about in 2019 m a versus buybacks given what the stock price is thank you yeah so i you know i would start off by saying from a capital structure perspective as you guys know we ended the year in the best position uh since spin you know in terms of our leverage ratio which provides us with a lot of optionality and flexibility going forward. I just think we're well positioned there. If you look at our capital allocation strategy, three pillars, organic investments, M&A, shareholder distribution. On the organic investments, you know, we talked about that. We're going to continue to invest in the business for opportunities that will expand our channel presence, getting more of the wallet from our distribution base, as well as expanding our new products through R&D efforts and those type of things, promotional items, demand creation. That's baked in our earnings per share, and we'll continue to manage that with nice earnings growth going forward. So your question on the M&A, as Dave mentioned, we executed a lot of acquisitions in 2018. There's opportunities to continue to drive performance in those and spend maybe a little bit more time continuing to integrate those. And if you look at our history, in terms of acquisition performance. They really start to perform nicely kind of two to three years out, so you have to look at these more on a long-term basis, and we'll continue to drive that execution. Having said that, we will continue to remain active in looking at opportunities to expand our business, either through new products or geographic expansion. Our pipeline remains robust, but the key is we'll be disciplined. And we'll only do transactions that we believe will provide a good return on invested capital going forward, of course. Shareholder distribution, we're not going to hoard cash. And we've always said we're going to utilize the capital that we generate to either do M&A or shareholder distributions through the incremental dividend. You mentioned 29% increase this year. And you can probably see us being more active on share buyback right now. We're going to execute our capital allocation strategy to provide the best return we can for our shareholders going forward. That could be either M&A or shareholder distribution or a combination of those.

And I'll leave the question on digital strategy for the analyst day, but just a question on European growth. What would it take for Europe to get to consistent double-digit margins over time? And I guess EMEA, not Europe, sorry.

I think continued expansion in the electronic portfolios, extremely pleased with the Simon Voss Interflex performance. And I think the European market, Especially in the res side of things, in its infancy, the slowest growth market, as that picks up acceleration, we think we're in a good position to benefit from that.

But you don't feel like you need to scale up significantly in Europe to fill capacity. Do you think you can get it with existing product lines?

Yeah, so I would characterize it this way, you know, as Dave said, you know, continuous improvement to get to kind of our top competitor in that market landscape would require either significant facility rationalization and or scale, you know, getting more back office synergies, those type of things would certainly facilitate that. But, you know, there's still opportunities for continuous improvement and we will you know, continue to drive that.

Fantastic. Thanks a lot.

Thank you. And the next question comes from Rich Quast with Wells Fargo Securities.

Hi. Good morning, everyone. Just a clarification with regards to the electronic lock. So 30% growth in Q3 and 7% this quarter. You referenced some weakness on the non-res side. So was it really more the project side or the comp side? I'm a little confused because your comps have been pretty steady, you know, mid-teens, high-teens over the last couple years. So it seemed to be more project-related. Did you have something come in Q3 and then something fall out of Q4? Is that the right way to think about it, or can you clarify that?

You should think about it as project-related. Remember, we put up a 30 in Q3, which was pretty impressive. You know, the steam came out of that. I think when you think about our electronics growth, I'd look at it on multiple quarters. we continue to be at the high teens level in a market that we think is converting at maybe 7% to 8%.

Okay. But the way to think about it is Q3 had some projects come in that maybe you didn't anticipate, and Q4 had the opposite. Is that on the non-raw side?

That's right.

Correct. Okay. And then just on the inflation side, so on the raw side, it would then finish – finished component side would seem like, you know, you're going to get some tailwind here starting sometime in the first half. Is this really more a labor freight issue? That's what it sounds like. And the productivity initiatives, I imagine you're gearing it towards that. Is there some more color around that?

So on the inflation side, on materials specifically, you know, commodities kind of a mixed bag. Steel still remains higher. than prior year levels. However, zinc and brass, some other major inputs into our products, lower. And so it's collectively, Rich, we're not quite at a point right now where the year over year is going to show significant improvement. It's going to be more back-end loaded, I would say, on materials. And then you do have the continued inflation just on the normal operational stuff. So think about it across the board, whether it be salaries on personnel, freight, packaging, all these type of input costs throughout the supply chain to get our product to customers are, you know, we are experiencing increased costs relative to the prior year. So we'll continue to manage that through cost containment and or, you know, driving productivity, whether it be through CapEx spending or other measures to get, you know, continued efficiencies in our manufacturing footprint.

Okay, and then one last clarification with regards to the guide. Is there a number we can think about in terms of M&A ETS contribution from 2018 into 2019? I assume it's within this $0.62 to $0.77 of operations, but just curious what you expect the 18 acquisitions to add.

Yeah, so minimal because most of them have already lapped, okay? So most of the – acquisitions for Americas has now lapped itself. Europe, there's like a one-month additional month in there. So there's not any really incremental benefit in 2019 related to 2018 acquisitions. I think the key point to mention in the guide, it doesn't assume any additional M&A activity, which would be, you know, accretive to earnings and or share repurchase. So it's kind of Look at it as an organic basis, and, you know, that could be, if executed appropriately, some additional earnings growth.

Okay. Thanks. I'll pass it on.

Thank you. And the next question comes from John Walsh with Credit Suisse.

Hi. Good morning. Good morning. I just wanted to get a little more color around the $15,000 sense of incremental investments, kind of where they live as we think about the segments. And, you know, I know you talked about broadly new product and channel initiatives, but maybe you could also specifically speak about some of those channel initiatives in residential if that's, you know, growing a broader presence in certain retailers or how you think about those strategies.

So the 15 cents on the incremental investments is distributed really basis of the size of the region, so therefore you would have a higher emphasis and investment in Americas relative to Europe and Asia. They are specific around driving new product development, so putting more emphasis and resources in engineering to accelerate New product, get products out to the market faster. The channel initiatives, so think of demand creation, really trying to accelerate electronics growth, whether it be both in the resi and or non-residential segments. We'll continue to do that. Those would be the key items. As you kind of look at phasing in 2019, a little bit more front-end loaded. in our plan for 2019 than what you might have historically seen. So we'll continue to invest in the business. We believe they provide good growth opportunities, good cash-on-cash payback, as well as return on capital.

I would say, in terms of specific initiatives to grow in RESI, More segmentation on the market. I mentioned earlier that we're picking up some wins with the big builders. We think that's driven by our electronic capabilities. Multifamily will continue to be strong in 2019. And this, again, is where electronic access is a value creator for those residential operators. And then working with the big box in terms of point of display and inventory stocking to make sure that we've got the products on the shelves that will help pull through sales of our Schlage products.

Gotcha. Thank you. And then, you know, as a follow-up, you've talked about, you know, investments kind of being front-end loaded here. When we think about the price-cost productivity, you know, you mentioned that in the back half it kind of actually looks like deflation on some of the material costs You know, how should we think about the quarterly cadence or the first half, second half relative to normal history? I mean, I think you normally do about 47% of your OP and EPS in the first half. You know, given those dynamics, should we think that that deviates a little bit or is that still the normal seasonality is still the right way to think about the year?

Yeah, maybe a little bit more back end loaded, I think. You know, it's interesting on the growth side of things, which, you know, we get pretty good operating leverage on growth. You know, coming out of the gate, Q1 is always a little bit lighter, you know, relative to our overall growth. And then it accelerates in Q2, Q3, kind of relative to the seasonality of our business. And, you know, we saw some good acceleration in Q4. So I would kind of think about it in the same type of pattern, but, you know, from a margin perspective, contribution perspective with the inflation kind of subsiding more in the back end of the year. So look at a heavier mix of operational improvement in the second half relative to the first half.

I would add to that we are very intentional in our 2019 budgeting. I think we've got activities that will drive margin expansion. throughout the year, but the nature of it, you know, some of these projects will go over multi-quarters and will pick up momentum as the year goes on.

Great. Thank you.

Thank you. And the next question comes from David McGregor with Longwear Research.

Hi. Rob Auerendahn for David this morning. Can you talk about the month-to-month cadence of growth within the quarter? And then I guess coming into January, can you talk about the government shutdown? Did you see any impact from that at all?

I'd say in terms of the month-to-month growth, we naturally slow down with the construction cycle as we go through the fourth quarter. We saw some of that. I think you also saw, particularly in res, our big box partner maybe backing off some orders because of the softness that was projected in the overall res market.

The other thing I would add, and then you probably experienced this, you know, just across the landscape of various businesses, the cold weather has impacted a little bit. You know, we've had some occasions of factory shutdowns, you know, just because of the extreme cold temperatures in certain regions of the U.S. And so, you know, a little impact there as well.

I'd say government shutdown, we were – more heavily impacted by weather. When mechanical installers, you know, can't get on the job site, you know, you see that. And there's parts of the country that are, you know, having some pretty tough challenges. And, you know, we'll see that as it develops. But I'd hang that on weather versus government shutdown.

Okay. And then just can you remind us about your tariff exposure and what's built into the guidance?

So all tariff exposure is built to the guidance basis of what we know today. You know, we'll see and monitor how that develops going forward. You know, I think you've heard us talk previously that we don't have a lot of exposure because we source, manufacture, and sell pretty much in region. For products that we do import from China to the extent that they're exposed to tariffs beginning in March, that is baked in our guidance. However, as we've indicated, we are mitigating the impact of that either through price increase that we instituted late last year and or productivity, resourcing, those type of things. to minimize those impacts. But all of that is baked in. So a favorable outcome, you know, could be some upside going forward.

All right. Thank you very much.

Thank you. And once again, please press star, then 1 if you would like to ask a question. And the next question comes from Jeffrey Sprague with Vertical Research Partners.

Hey, thank you. Good morning, everyone. Good morning. First, maybe just a housekeeping one from me for Patrick. Patrick, you're guiding the tax rate up year over year, but I think down certainly relative to what I was thinking. I'm not sure where the street was. But the nature of my question is we've seen a number of non-U.S. domiciled companies here recently signaling that they're tripped up on the deductibility of interest expense and are kind of suggesting their tax rates are going to be going up. It doesn't seem like that's caught you here in 2019, but do you have any color on that and why that may or may not be impacting your situation?

Yeah, so I can't really obviously comment on other companies and their particular tax situations, but maybe the general comment is relative to some of these proposed regulations that were issued at the end of the year. They're extremely complex and, you know, as you say, can impact foreign domicile companies as well as multinational companies. And so maybe your commentary is kind of caught up in that. You know, I think there's going to be a lot of commentary, and we'll see kind of where that ends up. But relative to Allegiant, we've, you know, evaluated those extensively with our outside advisors, and, you know, we've made some necessary tweaks, necessary to feel pretty good relative to our 16% effective tax rate guide for 2019. We'll see where it goes going forward, but I think we're okay for 2019. As it relates to interest deductibility relative to the U.S. tax reform in 2017, That does impact us a little bit from a cash tax perspective, and that's baked in our available cash flow number. So our cash taxes, because of some of that limitation, will always be higher than our book provision.

Thank you. That's helpful. And then you mentioned cannibalization as it relates to electronics growth, and, you know, that obviously, I mean, it sounds fairly obvious, right, the outgrowth you're having there. But Is there anything that is starting to impact your manufacturing costs, your footprint, how your plants are lined up as this mix shifts? Anything that's disrupted the margins or is going to require restructuring or anything of size or scope that we should be aware of?

I don't see that, Jeff. We've got a nice position out of the Baja that we think sets that up nicely. Our res electronics are built there, and we think the superior access to market and be able to get those in production quickly really helps us. So feel good about our position. Thank you.

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

Hi, thank you. Good morning, guys. Hey, Joe. Hello. Hey, maybe just kind of touching on the Americas organic guide for a second. Is there a way to maybe parse that out a little bit further? So you guys talked a little bit about, you know, softening and new construction, resi-new construction. But is the expectation then that resi-new is going to be down? And then just any other color around like the different end markets and the buildup to that guide would be helpful.

So our view on residential new construction is softer in 2019 versus 18. I think we mitigate that somewhat through our electronic offerings and our strong position of retrofit. As we move to the non-institutional, we continue to see strength in the educational markets, which is K through 12 and college campuses. That's one of our strongholds. Two things working there. You've got continued investment and electronic conversion. We think health care continues to be a good opportunity for the company, not so much in the big hospitals, but in the trend to go to, you know, smaller medical suites, diagnostic centers, those types of things that you see happening nationwide. And then commercial offices continue to be okay. As I travel around the country, and I have extensively in the last 75 days, I feel a good pulse and beat in the commercial and institutional campuses, and that's reflected in how we see our growth in 19.

Okay, that's helpful, Dave. And if I can maybe follow up on just talking about EMEA for a second, any other additional color you can provide on QMI specifically, and as it relates to the broader margin kind of target in that business for 19, should we expect just like this reacceleration or improvement in margins, can we get to double digits in 19? Just any thoughts there would be helpful.

Yeah, so obviously the QMI performance was disappointing in the quarter. Tough market conditions. And that business is a longer earnings process. So think of installation work. And when jobs get deferred for whatever reason, you're kind of saddled with some fixed costs that hit us in the quarter. We're taking action. to mitigate some of those costs going forward and would expect sequential improvement continuous throughout the year to get back to profitability. So that will start being reported obviously in base business beginning this quarter for Europe. So think of Europe in aggregate along with the rest of the business with continuous margin improvement during the course of the year. you know, either through better performance on this QMI business specifically and or, you know, productivity, you know, the price inflation dynamic getting better. And, you know, so you'll see us, you know, back close to that, you know, double digit operating profit margin for the full year.

Okay. Thank you.

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

Thank you. Thank you for taking the question. With regard, just getting back to the institutional markets in the U.S. and the healthcare markets, realizing that they've been in a lot of people's pipelines for a long time, but nothing's really broken out yet. Does it appear to you right now that these verticals are about to accelerate in terms of your ability to whether you're getting it from the channel or whether you're getting it directly from them, not just educational institutions but other institutions that maybe have been part of a discussion pipeline for a while. Is that pipeline about to be turned really into, if you want to call it a quote, a quote backlog?

I believe, as I look at our backlogs, they remain healthy. More importantly, the spec and quote remain healthy on both of these verticals. I wouldn't characterize it as an acceleration. I just think as we continue to drive portfolio expansion through new products, And acquisitions like AD and TGP, as well as superior execution on working these more complex applications, tend to get more than our fair share. And I look at these markets as solid and our execution to be good, and it's going to benefit us in the next 12 months. Okay.

A follow-up is just against your two major competitors over in Europe. You're somewhat of a newbie with regards to the commercial door manufacturing business. Do you feel that you've learned something on QMI, or is that so much of a one-off that it is not indicative of the dynamics of the door manufacturer market, either in EMEA or in the United States?

Sure. We have been in the hollow metal business since 1970. So this is something under the Steelcraft brand, we're pretty knowledgeable of the space. I think as we moved into the Middle East and look back on that acquisition, number one, you've got market turbulence with some of the political instability in the Middle East. Number two, there was a pretty big change in the mix of business. under the previous ownership that was targeted on prisons that moved. And then third, you've got to be mindful. I don't care if you look at the wood or hollow metal business. These are tough areas to operate. So we're mindful of that. We believe that the acquisition of QMI, Republic, And what we've done with AD systems, which is a sliding door capability, complements our strategy. We'll get those integrated, and they'll perform to our satisfaction in the future.

Okay.

Thank you very much.

Thank you. And as there are no more questions, this concludes the question and answer session. I would like to turn the conference back over to Michael Wagnes for any closing comments.

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

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