Good day, and welcome to the Allegion First Quarter Earnings Call. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. I would now like to turn the conference over to Thomas Martineau, Vice President, Treasurer and Investor Relations. Please go ahead.

Thomas Martineau - Vice President, Treasurer and Investor Relations

Thank you, Jason. Good morning, everyone. Welcome, and thank you for joining us for Allegion's first quarter 2020 earnings call. With me today are Dave Petratis, Chairman, President and Chief Executive Officer; and Patrick Shannon, Senior Vice President and Chief Financial Officer of Allegion.

Our earnings release, which was issued earlier this morning and the presentation, which we will refer to in today's call are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to Slides 2 and 3. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections.

The Company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Dave and Patrick will now discuss our first quarter 2020 results which will be followed by a Q&A session.

Given the high uncertainty around the duration and severity of the COVID-19 pandemic, we had previously pulled our outlook for 2020 and will not be providing an update during this call. For the Q&A, we would like to ask each caller to limit themselves to one question and one follow-up and then re-enter the queue. We will do our best to get to everyone given the time allotted.

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

David D. Petratis - Chairman, President and Chief Executive Officer

Thanks, Tom. Good morning and thank you for joining us today. Like all responsible global companies, Allegion is closely monitoring and assessing the COVID-19 outbreak, which continues to evolve. We are focused on doing what's right for our employees, customers and communities. We're also maintaining our business health and supporting essential critical infrastructure around the world.

Allegion operates within several different critical infrastructure sectors, making our work essential to our customers and in many case, their customers. Our people create the security and life safety devices so many others depend on, whether for private homes, government buildings or medical facilities. We are regularly called on to provide our products and solutions for hospitals and health care facilities, most recently, new construction for laboratories that will support the fight against COVID-19.

This work gives us clear purpose, especially in these unprecedented times. With the exception of Italy and Mexico, where government health decrees have temporarily paused production, our manufacturing sites may operate.

We monitor for demand and material shortages related to COVID-19, take the necessary short term actions such as adjustments to production, to protect the long-term future of Allegion. Such measures are being implemented in a way that minimizes disruption to customers and the overall business.

In the case of Italy, we are shipping orders for finished goods with government approval, and continue to engage in dialog with Mexican authorities to open prior to the lifting of its general decree. In the meantime, we are working with our supply chain, existing inventory and channel partners to fulfill customer requirements for goods normally coming out of Mexico.

It remains our intention to continue to serve our customers the best of our abilities. You've heard me say before, but it bears repeating. We have one of the safest workforces in the world. I could not be prouder of our company of experts who have leveraged our strength and safety to adapt to the current reality.

We have faced [Phonetic] COVID-19 since mid-January in China, and developed operational practices that keep our people safe. We're modeling best practice safe hygiene guidelines based on standards from the World Health Organization and the Centers for Disease Control and Prevention.

We're conducting deep cleaning of our facilities on a regular basis, we're social distancing we're - and we're limiting crowds. We've increased our personal protective equipment and supplies. There is additional cleaning solution, wipes, hand sanitizers throughout our facilities. Employees can ask for PPE supplies like gloves and where requiring, face mask in manufacturing and distribution facilities.

We paused all non-essential meetings and visitors as well as air travel, early in the crisis. Essential meetings are incurred in virtual ways. We're adhering to government decrees and orders and monitoring health conditions. And wherever possible, and where necessary, employees are working from home.

The strength of Allegion's global supply chain is a major asset and allows us to continue servicing our customers. We have many levers to pull. From utilizing safety stocks in inventories to leveraging dual and alternate supply, to sharing components across our own facilities and regions. Without doubt, these are options that our team have in place, are increasing Allegion's credibility and customer loyalty in the marketplace.

Of course, our business must be healthy to continue to support our employees, customers and communities. We have proactively taken actions to mitigate financial implications associated with COVID-19. These actions include reductions in discretionary spending, elimination of non-essential investments, a hiring freeze and re-prioritization of our capital expenditures, including a temporary suspension of share repurchases.

Importantly, we believe Allegion has an extremely strong balance sheet and liquidity that provides flexibility and positions us well throughout this time. Our net debt to adjusted EBITDA ratio was 1.6 times at December 31, 2019. We have an undrawn credit facility of up to $500 million, if needed and no principal payments due on an outstanding debt until September '22. Our business generates significant cash flow due to industry leading EBITDA margins and low capital intensity. Allegion's available cash flow conversion to earnings ratio has averaged over 100% as a standalone Company.

Yes, there will be challenges ahead. The start of 2020 has made that clear. Allegion can take on great challenges with an engaged safe and healthy workforce, financial strength, legacy brands that have stood the test of time and a steady focus. Allegion will remain true to our values and strong business fundamentals.

Please go to Slide 5. Let's turn to the results for the first quarter. We have a strong disciplined supply chain and our team did an outstanding job navigating the early challenges posed by COVID-19 pandemic, as evidenced by the revenue growth we experienced in the quarter.

In particular, the Americas had a stellar quarter offset by weakness in Europe and Asia Pacific. The Americas region had reported growth of 7.7% and organic growth of 8.2% in the quarter, driven by both non-residential and residential businesses.

EMEA markets continued to be soft through the quarter and our business was further impacted by the COVID-19 pandemic impact beginning in March. For Asia-Pacific, Asian markets, markets remained weak and the region as a whole experienced the COVID-19 impacts as well.

Electronics growth in the Americas came in at 12% in the quarter. We continue to see electronics as a long-term positive trend as more and more products become connected for ease of access. The underlying fundamentals of the business are strong and will serve us well as the global pandemic subsides.

Adjusted operating margins were up 190 basis points in the quarter. Margin expansion led by the Americas regions which saw adjusted margins up 270 basis points. EMEA and Asia Pacific margins were down due to volume declines in both regions. EMEA margins were further pressured by continued operational inefficiencies from the move of our operations from Turkey to Poland.

We highlighted last quarter, our expectation that the impact would carry over in the first half of this year. In the first quarter, adjusted EPS growth came in at a robust 18% and available cash flow was up nearly $44 million versus the prior quarter - prior year.

Overall, I'm very pleased with our Q1 2020 results. That said, the near-term future will be more difficult as we continue to navigate the uncertainty brought on by the COVID-19 pandemic, and I expect financial headwinds. Beyond the expense and cash management actions previously discussed, we are implementing cost reduction actions to optimize and simplify the European and Asia Pacific regions. These actions are intended to address weaker end market fundamentals, enable enhanced customer focus and will help position these regions for future success.

And there is one accounting item to mention, we recognized a $96.3 million non-cash charge related to goodwill and indefinite-lived trade name impairments for our non-US operations predominantly related to the COVID-19 and the expected future impact.

Please go to Slide 6, and I'll take you through the first quarter financial summary. Revenue for the first quarter was $674.7 million, an increase of 3%, inclusive of 4.3% organic growth. Currency headwinds and the impact of the divestitures of our business in Colombia and Turkey offset some of the organic growth. Americas led the way in revenue growth, offsetting the weakness we experienced in EMEA and Asia Pacific. Patrick will share more detail on the regions in a moment.

Adjusted operating margin increased by 190 basis points in the first quarter. As I stated earlier, we saw significant margin expansion in the Americas with declines in Europe and Asia. Adjusted earnings per share of $1.04 increased $0.16 or just over 18% versus the prior year.

The increase was driven primarily by higher operating income, favorable share count and tax rate offset the increase in other expense. Available cash flow came in at $19 million, an increase of nearly $44 million versus the prior year. Increased adjusted earnings and improvement in net working capital were the driving factors for the increase.

Patrick will now walk you through the financial results and I'll be back for a wrap up.

Patrick Shannon - Senior Vice President and Chief Financial Officer

Thanks, Dave and good morning everyone. Thank you for joining today's call. Please go to Slide number 7. This slide depicts the components of our revenue growth for the first quarter. I'll focus on the total Allegion results and cover the regions on their respective slides.

As indicated, we delivered 4.3% organic growth in the first quarter led by the Americas region with strong growth in both the non-residential and residential businesses. Price realization was again solid in the quarter, more than offsetting material inflation. The impact of the divestiture of our businesses in Colombia and Turkey along with continued currency pressure in EMEA and Asia-Pacific were headwinds of total growth.

Please go to slide number 8. Reported net revenues for the first quarter were $674.7 million. As stated earlier, this reflects an increase of 3% versus the prior year, up 4.3% on an organic basis. We delivered good price realization and saw solid volume driven by the Americas region. We experienced an estimated $10 million revenue loss related to COVID-19 during the quarter, primarily in our international regions as a result of business closures.

Adjusted operating income of $128.2 million increased more than 14% over the same timeframe from last year. Adjusted operating margin of 19% increased to 190 basis points. The margin expansion was primarily driven by solid operating leverage on incremental volumes in the Americas along with pricing and productivity outpacing inflation. Headwinds of margin performance include incremental investments, which had a 30 basis point impact on adjusted operating margins and an estimated $4 million impact to adjusted operating income related to COVID-19.

Please go to slide number 9. This slide reflects our earnings per share reconciliation for the first quarter. For the first quarter of 2019, reported earnings per share was $0.84, adjusting $0.04 for the prior year restructuring expenses and integration costs related to acquisitions, the 2019 adjusted earnings per share was $0.88. Operational results increased earnings per share by $0.16 as favorable price, operating leverage on incremental volume and productivity more than offset inflationary impacts and unfavorable currency. A year-over-year decrease in the adjusted effective tax rate drove another $0.04 increase. Favorable year-over-year share count increased adjusted earnings per share by another $0.02.

The impact of incremental investments in the quarter was a $0.02 reduction and an increase in other expenses drove another negative $0.04 per share impact. This results in adjusted first quarter 2020 earnings per share of $1.04, an increase of $0.16, or 18.2% compared to the prior year. Lastly, we had a $1.04 per share reduction for charges primarily related to goodwill and indefinite-lived trade name impairments. These charges were related to COVID-19 and its impact on expected future results. After giving effect to these one-time items, you arrive at first quarter 2020 reported earnings per share of $0.00.

Please go to slide number 10. First quarter revenues for the Americas region were $512.1 million, up 7.7% on a reported basis and up 8.2% organically. The growth was driven by solid price realization and strong volume. Both the non-residential and residential businesses grew high single digits. The business saw growth across all product segments and verticals, particularly in institutional end markets.

The electronics growth for the quarter was 12%. Electronic products continue to be a long-term growth driver as consumers and end-users value the connectivity and convenience they offer over their mechanical counterparts. The overall growth in the Americas reflects the Company's strong position in the market, as well as the returns associated with incremental investments in new product development and channel strategies.

Americas adjusted operating income of $146.6 million increased 19.1% versus the prior-year period and adjusted operating margin for the quarter increased 270 basis points. Volume leverage on the revenue increase along with price and productivity significantly exceeding inflation, drove the substantial margin expansion. The team continues to deliver solid cost leverage and productivity to further improve operating performance in our competitive position. Lastly, incremental investments were a 40 basis point decrease on margins.

Please go to slide number 11. First quarter revenues for the EMEA region were $129.9 million, down 9.1%, and down 6.2% on an organic basis. The lower volume was driven by continued weakening in end markets across the region and COVID-19 impacts primarily in the southern region. The impact of the divestiture of the business in Turkey and currency headwinds also contributed to the reported revenue decline. EMEA adjusted operating income of $3.3 million decreased 71.8% versus the prior-year period.

Adjusted operating margin for the quarter decreased by 570 basis points. Also during the quarter, inflation exceeded price plus productivity. Revenue declines had a negative impact on operating margin and we continue to experience cost pressure associated with the plant relocation from Turkey to Poland. Earlier in April, we announced cost reduction initiatives aimed at optimizing and simplifying our operations, improving our customer service as well as addressing the cost structure in our non-US locations. These are not specific to the COVID-19 pandemic, but part of our long-range business planning process.

Please go to slide number 12. First quarter revenues for the Asia Pacific region were $32.7 million down 11.1% versus the prior year. Organic revenue was down 4.9%. The decline was driven by continued weakness in Australian end markets, primarily residential as well as impacts related to COVID-19. Total revenue continued to be affected by currency headwinds. Asia Pacific adjusted operating loss for the quarter was $1.6 million, a decrease of $0.9 million with adjusted operating margins down 300 basis points versus the prior-year period.

Significant volume declines and unfavorable mix had a large impact on the reduced income and margin. Of note, we did have approximately $95 million in impairment charges for goodwill and indefinite-lived trade names. These charges were related to COVID-19 and its impact to expected future results. As with the EMEA region, the cost reduction actions announced earlier in April will have a favorable impact on operations in Asia Pacific. These actions are also the result of our long-range business planning and not specific to COVID-19 impacts.

Please go to slide number 13. Year-to-date available cash flow for the first quarter of 2020 came in at $19 million, which is an increase of nearly $44 million compared to the prior-year period. The increase was driven by higher adjusted net earnings and improvements in the net working capital. Looking at the chart at the bottom of the slide, it shows working capital as a percent of revenues decreased based on a 4 point quarter average. On a year-over-year, point in time basis, working capital as a percent of revenue was down 220 basis points. This was driven by accelerated turnover in both inventory and receivables.

As always, we remain committed to an effective and efficient use of working capital, we will continue to evaluate opportunities to minimize investments in working capital in order to continue to drive substantial cash flow conversion.

Please go to slide number 14. This slide provides an update on our capital structure. As you can see, our leverage has dropped steadily over the past five years, and we ended 2019 at 2.1 times gross leverage and 1.6 times net leverage to adjusted EBITDA. And looking at our debt maturity profile, we do not have any loans maturing until September 2022. We also have a $500 million untapped credit facility should we need additional liquidity.

Our balance sheet is in a strong position and our high-level cash flow conversion provides us flexibility and optionality to run the business going forward. These same strengths have led Allegion to six consecutive years of annual increase in dividends and our most recent dividend increase of nearly 19%, announced in February remains intact.

During the first quarter, the Company repurchased approximately $94 million of stock. Due to the uncertainties related to the pandemic, we have placed repurchase plans on hold, and we will review further as the year progresses.

I will now hand it back over to Dave to wrap up.

David D. Petratis - Chairman, President and Chief Executive Officer

Thank you, Patrick. Please go to slide number 15. We recently announced that we are withdrawing our outlook for 2020 based on the magnitude and uncertainties surrounding the COVID-19 pandemic. We respect the need for financial guidance for the analyst community and shareholders.

However, the COVID-19 pandemic is ongoing. Health care experts are still learning about the virus and there is tremendous speculation on the economic recovery and the path it will take. The many unknowns include the scope and effect of further government regulatory, fiscal, monetary, and public health responses. Our update will come when we release Q2 2020 results.

The fundamentals of Allegion are strong, and as the world adapts to the new normal, we should have more clarity on the rest of 2020 at that time. We do expect that COVID-19 will have a near-term negative financial impact on the business, including a reduction in year-over-year revenues, operating profit, and cash flow due to government decrees and softening demand.

With that said, Allegion's sound fundamental business strength provides some resiliency in times of economic downturn and our long-term investment thesis remains unchanged. For the past several years, we have delivered above-market organic growth. The strength of our channel relationships, new product development, large installed base, brands, and market positions have helped us continually drive high organic growth than the market.

Since spin, Allegion has delivered a 5.4% organic revenue CAGR. In the first quarter, the Company grew organically at 4.3% with the Americas at 8.2%. Our strategy of seamless access takes full advantage of the keyless and connected technologies, increasingly demanded in our industry. The electronic products needed to facilitate these demands continue to be a long-term growth driver for the Company.

The Americas business experienced 12% growth in electronics in Q1. Even with the growth we have seen in these products, since we became a standalone Company, adoption is still in the early stages. Therefore, the industry conversion opportunity remains robust.

Although Allegion has industry-leading EBIT margins, our focus on price realization, productivity, and cost management allows us to expand margins when volumes are up, like the 170 basis point increase we produced in Q1, but also facilitates the margin profile to be resilient through economic cycles.

Our strong balance sheet, low capital requirements in tandem with the high level of cash flow conversion our business generates, allows us to have capital allocation optionality. We are well within our debt covenants and have no near-term debt repayments. For the six full years that Allegion has been a standalone Company, the conversion of net income to available cash flow has on average exceeded 100%.

The COVID pandemic has caused worldwide disruption in economic markets, whether haltering growing economies or furthering softening ones that were in decline. Nonetheless, we feel that our Company is set up well to weather the storm, and our strong fundamentals will serve us well when the pandemic subsides.

Allegion has the right people in place to help ensure this. Our employees have shown a great deal of adaptability during these uncertain times. I could not be prouder of our people. Our management acted early to mitigate the economic impact. Our supply chain has proven itself to be flexible, proficient, and dependable, and we are positioned to continue leveraging as a strength moving forward.

And of course, our legacy brands have stood the test of time and delivered incredible value. Allegion is strong, its people are resilient and we remain focused and disciplined. I do want to thank every member of the Allegion team on a successful Q1 2020. Everyone stay safe and healthy. And now, Patrick, and I will be happy to take your questions.

Question & Answers

Questions and Answers:

[

Operator

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Tim Wojs from Baird. Please go ahead.

Timothy Wojs - Robert W. Baird & Company - Analyst

Hey gentlemen, good morning. Hope everybody is well. [Speech Overlap]

David D. Petratis - Chairman, President and Chief Executive Officer

Good morning, Tim.

Patrick Shannon - Senior Vice President and Chief Financial Officer

Good morning, Tim.

Timothy Wojs - Robert W. Baird & Company - Analyst

Maybe just my first question, maybe if we can just add a little bit of color of - particularly in Americas, how the demand trajectory you saw kind of trended through the quarter and maybe if you could give us just some flavor of how April has trended here just to give us an idea what Q2 in kind of the near-term may look like?

David D. Petratis - Chairman, President and Chief Executive Officer

Glad to do that. I would say first, the Company got on the COVID-19 response early with a focus on our supply chain and protecting our people with a strategy for us to gain market share in Q1. So we went extremely strong through the first quarter, I think that's reflected in our Americas results and the strength, our ability to keep our supply chain strong. As we got end to March, we saw a slight decline in the last two weeks. But again, we had our foot on the gas, and we communicated that.

As we moved into April, we are 17 days into this, I think the things that we're seeing are rather predictable. We see some softness in the overall residential. I would say, we have a view and a point of sale in the bid box, and I'd say it's of low teens. And I

- as I look at that, I'd say, yeah, that probably makes sense.

Second, I think from a positive standpoint, our - we see softness in bookings in the commercial and institutional. Our backlog is strong. We see the continuation of construction projects and we think if grounds broken, if permits are issued, these projects are going to roll in. As I came into work this morning, I see construction continued to move forward. The last thing I'd add, Tim, is our specs and quotes, continue to be very positive. I know you can inspect yourself and quote yourself right off our clip, but it's a positive indicator that work continues to roll.

Timothy Wojs - Robert W. Baird & Company - Analyst

Okay. Okay. Is that - as you guys look into maybe the back half of this year and into '21, is that really the part of your leading indicator or what might give you confidence that COVID is really more kind of a temporary issue as opposed to something maybe more cyclical for non-residential construction in general?

Thomas Martineau - Vice President, Treasurer and Investor Relations

I think you've got to be more critical than people would call it, the - I think the construction pipeline that we have today, again, projects that are approved and are in progress will roll. I've got uncertainty about '21. Commercial, institutional; commercial is going to be soft. I think that's where the strength of our spec writing, our wholesale channel, whatever the market gives us at Allegion, we expect to do better than the market.

Thanks, Tim.

Operator

The next question comes from Jeff Sprague from Vertical Research. Please go ahead.

Jeffrey Sprague - Vertical Research Partners, LLC - Analyst

Thank you. Good morning, everyone. Hope everyone is well. Thanks for that color and also just trying to now kind of think about, since we're all going to make our assumptions here, could you give us a little additional thought on decrementals and how linear or not linear the relationship is?

In other words, if revenues are down 10%, what do you think the decrementals might be and if they're down 20%, what they might be. And - you know, frame it however you like, but we've all got to kind of take a shot here at what's coming at us, and try to put a stake in the ground in terms of an earnings estimate?

Thomas Martineau - Vice President, Treasurer and Investor Relations

Yeah. So the big question mark, I think Jeff relates to what's on the demand horizon. And as we've highlighted, very difficult to predict. Just kind of given the government decrees and as we've highlighted, we have a couple of plant closures today, that will inhibit us a little bit on the top side, and also will provide some cost pressure just from an under-absorption prospective near-term.

As I think about it, and you try to run some correlations to prior cycles, that type of thing, I mean, everyone knows a way, it was pretty drastic. I think it's too early to make some comparisons to that right now. We're still - as everyone else is collecting data from economists, and a lot of people have different opinions.

But as I think about it, related to Allegion, some couple of points I'd like to highlight why I think we're better positioned than perhaps we were at the last downturn, several reasons. Number one, we have a much stronger business franchise, a lot better stronger portfolio of businesses, as you know, we've divested poor performing businesses, we added businesses to our portfolio that I think are more resilient in a downturn and less susceptible to market downturns.

This whole convergence of electronics is a - you kind of look back ten years ago, it wasn't a big driver in the business and whereas today, it is a driver, it's growing at 1.5 times to 2 times the market today. And as you know, we continue to put up really good numbers related to that.

So I think that's an item that needs to - or will continue to grow, and will be a continued focus for us going forward. And as you know, it's a higher average selling price, similar margin, which means more EBIT dollars. The channel investments we've made are particularly on the repair and retrofit market, discretionary markets.

We have a much broader product portfolio to serve our customers in that segment, and I think we're better positioned to participate in that market segment whereas at time of spend we weren't. I think that will be good for us going forward.

And then to your question on the margin profile, we would say, historically, we've been able to adjust our cost profile. We can react pretty quickly. We historically have shown some margin decrements related to the last cycles, if you kind of go back to '08, small margin deterioration. We adjusted our cost position fairly aggressively.

Pricing, we will continue to push that lever. It was a good driver for us in the quarter. So I would say, maybe some margin pressure, but not substantial, relative to where we are. And if you think about where we are today, we're at a high watermark.

Again, we had another record Q1 performance, up 190 basis points and so we're coming from peak margin performance and we will continue to take the actions necessary to address our cost base.

We talked about those, eliminating the discretionary spend, hiring freeze, kind of re-prioritization of essential investments, you will see a reduction in some of the incremental investment, but we will be focused on long-term areas and so I just - we'll see how things kind of pan out here.

But I think it's going to be more demand-driven and we will adjust our cost profile to meet future demand, both at the factory and SG&A level.

Jeffrey Sprague - Vertical Research Partners, LLC - Analyst

Thanks. And as an unrelated second question, just on the goodwill, it's awful early in the COVID, it sounds like you're kind of using that as kind of a justification for knocking out that goodwill. It sounds like, but you've really beyond kind of COVID made a clear judgment that those acquisitions just have not lived up to the snuff. And I just - I just wonder if any of the other acquisitions in Europe or anything as you've gone through this goodwill testing are kind of close to being on the bubble here?

Thomas Martineau - Vice President, Treasurer and Investor Relations

So, Asia Pacific, as we indicated, a write down there, goodwill and indefinite-lived assets, which pretty much releases the entire balance there. I think there is a de minimis amount that remains.

As we kind of talked about in Q4, the pressure there really given from the Australian market and just weak end-market fundamentals, and so, we've re-looked at that, particularly given the COVID-19, which really accelerated the market decline kind of as we look at it going forward.

And so, put us in a position to kind of do that analysis, which is kind of a discounted cash flow, etc. When we look at Europe, there is some cushion left there. We didn't need to take an impairment.

I think hopefully we took a conservative view on the discounted cash flow and hopefully we're okay, but time will tell. And we'll see where this pans out going forward, but again, end markets continued weakness, particularly in Southern Europe, but I feel really good about our electronics business there in the dramatic area.

You mentioned acquisitions, SimonsVoss has been a home run for us and I think there is some good growth opportunity there going forward. So again, we'll kind of re-evaluate as the year progresses and we'll see what happens when the fog lifts.

Patrick Shannon - Senior Vice President and Chief Financial Officer

I'd add one other comment, as you think about the Asia-Pacific, our acquisition profile has been Australia and one acquisition in Korea. All of those markets were in free fall in the second half of 2019, through the COVID-19 and it's hard to retain that goodwill on the books.

Jeffrey Sprague - Vertical Research Partners, LLC - Analyst

All right. Thanks for the color. Best of luck.

Thomas Martineau - Vice President, Treasurer and Investor Relations

Thank you.

Operator

The next question comes from Andrew Obin, Bank of America. Please go ahead.

Andrew Obin - Bank of America Securities-Merrill Lynch - Analyst

Hi, yes, good morning.

Thomas Martineau - Vice President, Treasurer and Investor Relations

Good morning, Andrew.

Patrick Shannon - Senior Vice President and Chief Financial Officer

Hey, Andrew.

Andrew Obin - Bank of America Securities-Merrill Lynch - Analyst

I'm just wondering, so the first question I have, how should I think about your ability to release working capital in this environment? Because, a lot of companies are telling us that they're going to run off inventories, run for cash. But my understanding also is that a lot of your product in the US is highly customized. So how should I think about your ability to release working capital in second and third quarters as the COVID-19 sort of sweeps through the US?

David D. Petratis - Chairman, President and Chief Executive Officer

Yeah… [Speech Overlap]. Yeah, most companies have downturns, which show a higher cash conversion than earnings because of the run-off and working capital. I think we will be no different in that situation. However, I'd just remind everyone, our working capital as a percent of revenue is fairly low, 4-point average like 6% of revenue. So there's not a lot of room there for significant cash flow conversion on further reductions in the working capital. And actually Q1, we made substantial progress in both inventory returns and receivable DSO.

So there's probably a little improvement there, but I wouldn't look at it as a significant opportunity and further our cash flow generation for us, just kind of given where we are, relative to maybe other industrial companies.

Patrick Shannon - Senior Vice President and Chief Financial Officer

I'd add to that too. One of our objectives coming through the first quarter was to have the right inventory. And we made some investments there. As we go through the summer here, we'll probably run a little stronger on finished good inventories as an opportunity.

The strength of our supply chain and the ability to get the component parts into the right products where we need them, I think gives us an advantage. And then we'll use that advantage in some inventory to try and get orders to help the business.

Andrew Obin - Bank of America Securities-Merrill Lynch - Analyst

And the second question I have sort of unrelated, but given that a lot of municipalities are shut down, how do you deal with the whole? How does the industry deal with the whole permitting process and what does it mean for the construction activity in the summer, both in residential and institutional space? Thank you.

David D. Petratis - Chairman, President and Chief Executive Officer

I think you've got to keep an eye on permits. You've got to assume that, that will - you know, the permitting processes that run through government will slow down. I think though, two - when - whether it's institutional or commercial housing when people want to commit capital, they'll force that process to move forward. But as you well know, permit is a key indicator for us, we'll keep an eye on it and see where that trend goes.

I think today, Andrew from a - you could think about - we, in fact, do go into recovery, the permit process, the ability to do that will loosen up, it's been, how it's capital deployed to be able to go out and drive this industry.

Andrew Obin - Bank of America Securities-Merrill Lynch - Analyst

So you're saying it's economic activity driving permitting process and if the economy improves permitting logjam [Phonetic] will improve as well.

David D. Petratis - Chairman, President and Chief Executive Officer

Yes.

Andrew Obin - Bank of America Securities-Merrill Lynch - Analyst

Thank you very much.

Operator

The next question comes from David MacGregor from Longbow Research. Please go ahead.

David MacGregor - Longbow Research - Analyst

Yeah, good morning, everyone.

David D. Petratis - Chairman, President and Chief Executive Officer

Hey, David.

David MacGregor - Longbow Research - Analyst

Just - hope you're well. Just wanted to ask about the strength of the North American volume here in the first quarter. And there has been various observations for different people in the industry about pull forward, particularly in the case of education, but maybe in some healthcare applications as well. And I'm just wondering if you're able to characterize the degree to which you may have pulled forward revenue from the summer quarters here in 1Q?

David D. Petratis - Chairman, President and Chief Executive Officer

We announced a price increase. So we've get some natural pull through as a result of that, but I'd say generally, as you could look across North America, a rather mild winter. I think - and we executed at a high level. And we picked up opportunities in the quarter that others could not serve. So I'd say a robust market, really in Q4 and Q1, you've got the electronics driver and I think the strength of Allegion shown hard and the price increase pulled forward slight demand, which I like as we go through Q2 to be able to serve the local markets.

David MacGregor - Longbow Research - Analyst

Okay. I guess just as a follow-up. You're undertaking restructuring in Europe. I know you've been working on Turkey for a while now. We talked about that last quarter, again this quarter. And those things never happen quickly, I understand. But when you think about sort of the disparate nature of from a scale and a profitability and a growth standpoint between the North American business and what you're doing now or what you have been doing recently in Europe and Asia, I guess the question at a high level is, do you need to be in Asia and Europe or would this be a stronger business, if you were just solely a North American business.

And as part of that, maybe if you could talk about the extent to which North American results may benefit to some degree from being in Europe and Asia? Thanks.

David D. Petratis - Chairman, President and Chief Executive Officer

I would say it again, the adjustments that we made in the quarter with the restructuring announcement will strengthen those franchises. I think both regions - I'd also emphasize, I've been very clear that we lack scale outside of North America. I think the moves that we're making allow us to focus where we can win, rip out cost, that we think will simplify the business and continue to sharpen our focus on what we call seamless access.

There is some complementary nature to the Australia and New Zealand business especially along residential, which is still developing and I think our SimonsVoss Interflex business which we've been extremely pleased with, gives us a looking glass into seamless access. And again, I think look to Allegion to have more focus on where this business is going, deploy more human and financial capital into that seamless access experience as we compete wherever we're at in the world.

David MacGregor - Longbow Research - Analyst

Okay. Great, thanks very much, gentlemen. Stay well.

Operator

The next question comes from Josh Pokrzywinski from Morgan Stanley. Please go ahead.

Joshua Pokrzywinski - Morgan Stanley & Co., LLC - Analyst

Hi, good morning guys.

David D. Petratis - Chairman, President and Chief Executive Officer

Good morning.

Joshua Pokrzywinski - Morgan Stanley & Co., LLC - Analyst

Just on the pipeline of spec writing that you mentioned was fairly strong. Did folks use this opportunity? Or if you look back at other points in time where we've had kind of pauses in activity, is there kind of a natural lag where everyone says, okay, here's something I was working on, but I'm going to rethink it and maybe that adds three or six months to kind of the recovery timeframe where there is just an air pocket.

Is that the way you guys have experienced in the past and how should we think about kind of like a natural delay as folks kind of get back to work and the economy reopens? Or does activity continue throughout on the spec writing side?

David D. Petratis - Chairman, President and Chief Executive Officer

So, Josh, this is my seventh little disruption in the economy since I began my career in 1980. So I think the experiences give you some strength as you go through this. There will be an air pocket, and that's what we're trying to understand. Our bid quote activity specs, we track that in terms of a dollar level of activity. But you can actually have specs kick back and say, hey, let's revalue, engineer this. You can't look at this current situation and say, hey, there is going to be an air pocket of demand activity because of all supply chain factors, spec writing quotation, wholesale activity, construction, other supply challenges on the construction site.

So it's a part of our thinking. But I think as a lead indicator that spec writing is a clear strength of Allegion, and it will help us as we navigate through this.

Joshua Pokrzywinski - Morgan Stanley & Co., LLC - Analyst

Got it. That's helpful. And then unrelated, and kind of back to Jeff's question on decrementals. If I look back to the same business or at least most of it under Ingersoll ownership back in '09, the margin expansion during that timeframe on a pretty significant revenue decline was pretty phenomenal, hundreds of basis points. Obviously, a higher starting point today, so not all those levers are available.

So Dave or Patrick, can you just remind us some of what happened since then, and maybe what of those actions can be revisited or re-examined today, versus stuff that was maybe more of kind of a one-time realignment of the cost base?

Patrick Shannon - Senior Vice President and Chief Financial Officer

I would characterize it this way, entering the 2008 financial crisis, there was probably more options to reduce the cost profile, particularly on manufacturing footprint. I think IR at the time was fairly aggressive, and closing certain factories related to the security technologies business at the time that helped protect the margin profile. Pricing was another lever, I think was pushed pretty hard. You kind of have to look at it over the 2008, 2010 timeframe, and if I remember correctly, it showed a slight margin decrement over that time period.

I would characterize today, relative to going into the situation where a better franchise, stronger portfolio of businesses that we can maybe protect ourselves more on the top line side, and again we are taking the appropriate actions to reduce our costs structure.

Dave talked about actions we're taking in the international arena. We're doing things here to tighten the belt obviously in Americas, we'll continue to do that and adjust to future demand. I would say quite frankly, we don't, maybe have as many levers to pull, but, having said that, I wouldn't expect a significant margin degradation relative to where we are today. So dollars will come down, on basis of demand, i.e., top line, but margin percent, we'll do we can to try to maintain that.

Joshua Pokrzywinski - Morgan Stanley & Co., LLC - Analyst

Got it. I appreciate the color and best of luck, guys.

David D. Petratis - Chairman, President and Chief Executive Officer

Let me - So one other quick thing that's probably worth noting is that short-term, again, given the governmental decrease and the fact that some of our facilities are closed, I mean, you're going to have, it's going be a lot more choppy, right, I mean, you kind of have - talk about margin profile, you need to really look at it over a 12-month period. You're always going to get hit initially. Immediately, you make adjustments and then you start to kind of level out.

And so just kind of keep that in mind, as you're thinking through those.

Joshua Pokrzywinski - Morgan Stanley & Co., LLC - Analyst

Got it. Will do. Appreciate that.

Operator

The next question comes from John Walsh from Credit Suisse. Please go ahead.

David D. Petratis - Chairman, President and Chief Executive Officer

Good morning, John.

John Walsh - Credit Suisse Securities - Analyst

Hi, good morning, and glad to hear everyone as well. Wanted to follow-on to that question. Clearly, you're getting ahead on the cost actions. Is there a way to quantify how much is kind of structurally - you did make the comment that some of it would have been done regardless of COVID-19 and then kind of those variable cost actions? Just wondering what might come back as volume returns, paying employees, etc and things like that.

Patrick Shannon - Senior Vice President and Chief Financial Officer

So there are variable components relative to our cost structure as you would expect in any business and it can be anything from the way that we have our pricing structure kind of volume rebates. For example, you can look at things like salesmen, commissions, those types of things naturally will come down and correspond with the volume decrease. The things that we're adjusting now, some of the discretionary spend really re-looking at some of our things relative to investments, and making sure that we went through a re-prioritization of those, that's really focused on the things that matter. So that we're coming out of this stronger, particularly on revenue growth opportunities associated with electronics, we're taking that into consideration.

But collectively these variable costs, I mean it's tens of millions, it is how I would - if you're looking for the type of magnitude, we will give you more color as in Q2, as Dave mentioned, when we have a better kind of outlook on revenue, but it's fairly significant.

David D. Petratis - Chairman, President and Chief Executive Officer

I would add, the announced restructuring, we saw significant softening in Asia Pacific and in areas of Europe, as we exited the second half of 2019. We were not pleased with our position and we took actions regardless of the COVID-19 and a pandemic as not. The other thing I would say when you're in the construction-related industries, you do have variation in demand and Allegion's ability to adjust our cost structure, I think can be seen over the last 20 years, and we'll be making the moves that help keep this business strong.

John Walsh - Credit Suisse Securities - Analyst

Great. And then maybe one about end markets. So I guess the CARES Act fixed somewhat of a bonus depreciation glitch. That wasn't part of the tax plan. Wondering if you're hearing from folks that with the QIP adjustment that they're more willing to do interior improvement or if that's something that's nice, but just given the severity of what's happening right now, it's not enough to kind of offset some of the demand.

David D. Petratis - Chairman, President and Chief Executive Officer

I'm not aware of that feature of the CARES Act. I'm sure there's people here at Allegion if we feel that's an opportunity, we'll go after it. So, I can't give you a good response to that one.

John Walsh - Credit Suisse Securities - Analyst

Okay, thanks for the color. Appreciate it.

David D. Petratis - Chairman, President and Chief Executive Officer

Okay. Thank you.

Operator

The next question comes from Joe Ritchie from Goldman Sachs. Please go ahead.

Joe Ritchie - Goldman Sachs - Analyst

Thanks, good morning everyone.

David D. Petratis - Chairman, President and Chief Executive Officer

Good morning.

Joe Ritchie - Goldman Sachs - Analyst

Just kind of - Yeah, just maybe just starting off, I know a lot of the questions so far have been on the forward, but maybe just - maybe just going back to 1Q for a second. Clearly, the margins in the Americas, I mean this is your best 1Q margins by a long shot. I'm just wondering was there anything kind of either like one-time-ish that came through in the quarter or maybe you can elaborate a little bit more on like pricing this quarter and how you expect that to hold up as the year progresses.

Patrick Shannon - Senior Vice President and Chief Financial Officer

Yeah. So nothing unusual in the quarter that accelerated the margin improvement. It's the old blocking and tackling and execution. The team did a great job. We went into the year, I'd say with a really healthy pipeline of productivity activity around both material and the factory. We got great volume leverage on the incremental volume, and then you add on top of that price was good, particularly in the commercial segment, we continue to drive that. And so, everything kind of played out.

And again, no real big surprises. But the team really kind of continued to drive good execution all around.

David D. Petratis - Chairman, President and Chief Executive Officer

I'd go back even farther Joe, as we exited 2018 as a leadership team, we felt we left margin on the table. We put a pipeline of activities and in 2019 that we worked on throughout the year and we picked up strength as we went into the second half of '19 and '20 that strengthened the business.

The other comment I just mentioned too, on the input costs. So think about commodity prices, they've come down. So, year-over-year there was some benefit there where we didn't have any inflation on the material side.

Joe Ritchie - Goldman Sachs - Analyst

Got it. That makes sense. But Patrick, that's something that's going to continue as the year progresses as well, I mean and how sticky you think pricing will be?

Patrick Shannon - Senior Vice President and Chief Financial Officer

Yeah. On basis of the current cost for steel, zinc, copper, brass, etc, that will continue throughout the course of the year, yes.

Joe Ritchie - Goldman Sachs - Analyst

That's helpful. And then maybe my one follow-up. Going back into several years, several quarters, the level of outgrowth you saw this quarter relative to your biggest competitor based in Europe, in the Americas was I think like higher than any other, any other quarter that we've seen. I guess I'm curious, if may be you can elaborate what you're doing or are the effect of the share gains that you're seeing specifically this quarter. And if I know we're all trying to figure out what the demand environment is going to be like, but should you continue to kind of outpace your peers in this downturn?

Patrick Shannon - Senior Vice President and Chief Financial Officer

So I think number one, I'll give you a sports analogy. Why did the Patriots roll up six championships, six rooms, same head coach, great quarterback, good offensive strategy. If you look at our competitors, over the last 24 months, quite a bit of turnover at the top, a lot of management change. One of the strengths of Allegion is our experience. We have a system of management here that we're pretty disciplined to. It doesn't mean it's perfect, but I think the strength of the leadership team, the knowledge that cascades through our business, and some favorable markets regionally in the country helped us to continue to put up growth that we have built on over the last six years. So a combination of things there.

I think the electronics as well is an another, this is an industry trend, and we continue to prioritize our investments to take advantage of that opportunity, and I think it will continue to reward us, Joe.

David D. Petratis - Chairman, President and Chief Executive Officer

And I'll add, Joe. To be fair on the analysis, we did have a little bit easier comparison on residential, you may recall, we had some channel difficulties in Q1 last year. Those obviously have been worked through. We continue to get really good electronics growth and we added a substantial customer on the new construction, Lennar that helped our year-over-year comparisons as well.

Joe Ritchie - Goldman Sachs - Analyst

Yeah. That makes a lot of sense. Thanks, guys.

David D. Petratis - Chairman, President and Chief Executive Officer

Thank you.

Operator

The next question comes from Julian Mitchell from Barclays. Please go ahead.

Julian Mitchell - Barclays Equity Research - Analyst

Hi, good morning. Maybe just wanted to double-check again, the mix of business. So within the Americas, if you could just remind us in terms of 2019 splits, let's say, how much within the resi and non-resi pieces of the business, how much of each of those was related to new build versus aftermarket or replacement activity for Allegion?

Patrick Shannon - Senior Vice President and Chief Financial Officer

So we would say it's around 50-50 collectively across the entire portfolio.

Julian Mitchell - Barclays Equity Research - Analyst

I see.

David D. Petratis - Chairman, President and Chief Executive Officer

Julian, you'd want to think about the non-residential is a little heavier I think on the new construction versus the aftermarket and then it's flipped on the residential, but then it nets out to about 50-50.

Julian Mitchell - Barclays Equity Research - Analyst

Thank you. And how much related to that of your resi sales are going via the Big Box channel nowadays?

Patrick Shannon - Senior Vice President and Chief Financial Officer

So it's a - it's about a third - 40% of the business, 50%, maybe up to 50%.

Julian Mitchell - Barclays Equity Research - Analyst

Thanks very much. And then my second question would following up on that question from Joe around pricing and productivity. So those items were I think almost 200 point tailwind to margins in the first quarter year-on-year. Based on your comments, should we assume that, that remains a very strong tailwind for the next nine months perhaps not quite at the level of Q1, but it should be a material contributor?

Patrick Shannon - Senior Vice President and Chief Financial Officer

Yeah. I think we'll continue to have a tailwind there, but again some of the issues associated with the closure reduced demand as such will put some pressure on those comparisons.

Julian Mitchell - Barclays Equity Research - Analyst

Understood. Thank you very much.

Operator

The next question comes from Jeffrey Kessler from Imperial Capital. Please go ahead.

Jeffrey Kessler - Imperial Capital, LLC - Analyst

Thank you. I hope you guys are doing well.

David D. Petratis - Chairman, President and Chief Executive Officer

And you too.

Jeffrey Kessler - Imperial Capital, LLC - Analyst

A quick question on the - looking at the channel, the integration, and the installation channel, we've been seeing that there is continuation of big projects going on. There is some problems in getting people onto sites at some of the mid-sized projects and obviously when they get on, they have to be wearing the types of PPE and things like that are mandated by the local ordinances. And in some places the smaller SMB market seems to be shut down completely. Can you make some comments on how - once you're getting back from your installers and integrators with regard to their ability to do work on projects, what's continuing, what's out there, were there some restriction on their ability to get to the site. And what's out there which is completely closed down?

David D. Petratis - Chairman, President and Chief Executive Officer

I think it's clearly a step back in terms of being able to go in, service install. Here at Allegion, we have a policy, visitors are highly controlled. We don't want infection. With that said, it depends on where you're at, the Dallas market continues to be very active. We are moving around college campuses, but it's not going to happen in New York City. It certainly could happen in Denver. So again, it depends on where you're at and it puts an air pocket into the work. So I actually think if things straighten themselves out, there'll be a pickup in intensity short-term and over time, it's scheduled itself out.

I do think that normal project activity that we have typically that goes on college campuses will roll to schedule, which is really May through August, it's an important driver for us, could be moved up a little early if access is there, but it depends on where we're at geographically, Jeff.

Jeffrey Kessler - Imperial Capital, LLC - Analyst

Okay.

David D. Petratis - Chairman, President and Chief Executive Officer

Higher infection rates, more difficult access.

Jeffrey Kessler - Imperial Capital, LLC - Analyst

We'll see what happens at West over the next few weeks. Second thing is, do you, what investments have you made and I know you've made some in the past with regard to obviously collaborative spec writing if you want to call that in the cloud, touchless access and obviously things like that. Are you in a position to take market share because of number one, touchless access, number two, some of the - or let's just call it, some of the newer investments that you've made in trying to just make the process easier for your customers? Is that something that can continue in market share gains in the - at least in the Americas for the moment, because it seems to have been - have worked at least over the last year or so?

David D. Petratis - Chairman, President and Chief Executive Officer

I believe if you look at our overall growth, the investments that we're making in collaborative tools overture which we will continue to invest and develop. Overture has been rolled out in the bulk of the world as a collaborative working tool and it's been extremely well received by our partners, spec writers, architects and they have been collaborative in the creation of overture. So I really give Tim Eckersley a credit to creating that.

We continue to invest in the electronics side of this, I think you may have seen Jeff, our investment in Openpath as a partnership and investment that we think will help expand the world of seamless access. [Indecipherable] would be another and our continued investment in electronics and new products.

We also brought together SimonsVoss and Interflex under one leadership team because we believe that that's our looking glass into seamless access and our growth there in electronics in the DAC region is gaining share. So I think you've got the right sense in that collaborative tools, electronics, and seamless access is going to help us as we go through this crisis and come out the other end.

Jeffrey Kessler - Imperial Capital, LLC - Analyst

Is that at the margin or is that something that can actually really move the needle as you come out of the - as we come out of this recession?

David D. Petratis - Chairman, President and Chief Executive Officer

I think the drivers of seamless access, keyless activity, simplifying the world that our customers live in eliminating master key and intelligence that goes with seamless access is going to be a driver for the next two decades.

Jeffrey Kessler - Imperial Capital, LLC - Analyst

Okay, thank you very much, I appreciate it.

David D. Petratis - Chairman, President and Chief Executive Officer

Thank you.

Operator

The next question comes from Deepa Raghavan from Wells Fargo Securities. Please go ahead.

Deepa Raghavan - Wells Fargo Securities, LLC - Analyst

Hey, good morning. Dave, you touched a little bit on the restrictions on construction sites actually impacting project activity especially you mentioned institutional. Now, institutional evolve is considered as long tail in nature, more defensive as we go into a down cycle. Now does that dynamic now make it less defensive this down cycle? And the other - extending that question, if site access continue to be restricted through this construction selling season, does it mean you're able to recover beyond fall or in winter season or you think that's then now pushed to the next construction season, which is next summer?

David D. Petratis - Chairman, President and Chief Executive Officer

So I like our position in institutional. I was looking last night, 22 of the states have - are generally in pretty good financial shape, infrastructure has aged. We still have the driver of security in public settings. So you've got to like that and then our spec activity would also suggest that this whole market continue to develop.

With that said, an earlier question describing air pocket, we're going to have to be - have our eyes wide open and understand that air pocket, part of it is you get some immediate shock, second is, it's that snow effect - cloud effect that we've talked about in the past, projects will get pushed out, so we may see that air pocket again as we moved into ‘ 21 because budgets are a little bit tighter.

So to be seen, I like our institutional position, it's been in my 40 years, the institutional markets have always been a good place to operate, and we'll try and get more than our share out of whatever market is there.

Deepa Raghavan - Wells Fargo Securities, LLC - Analyst

Got it. So can you talk about your Mexico and Italy plant closures? I mean, what kind of, what percent of sales is coming from those two regions? And when you talk about working with your channel partners to ensure demand is wholesale, does it entail higher costs?

Patrick Shannon - Senior Vice President and Chief Financial Officer

So I'll take a stab at the revenue base, I mean just to kind of put it into perspective on Mexico. That's predominantly the supplier for our residential business here in Americas which we've characterized about a third of the overall Americas portfolio. Keep in mind the decree was extended through the end of May.

However, we are - we've got inventory on hand, we're working with our distribution partners to ensure our customers can be served. When that comes back online, there will be a restocking in the channels for the depletion of the inventory. So we're kind of working on that, but I think the message is near-term, you're going to see a decline and obviously in revenue for some piece of that, certainly in Q2.

Italy, again the data, I think on that is May 3rd, is the current decree. We will see that subject to change based on what the government dictates. That might be kind of call it, 20% of our portfolio in Europe. We are shipping finished goods inventory out of the warehouse there in Italy today. So that activity is taking place. It's just the production and manufacturing, etc, right now that were inhibited from producing anything.

However, it doesn't necessarily mean we're losing business. I think it just means delays, deferrals that type of thing because the reality is the customers are closed also. And so they don't have the ability to be able to receive inventory and so this is just going to be a deferral, and we'll see how quickly that may or may not pick up in the back half of this year.

David D. Petratis - Chairman, President and Chief Executive Officer

Deepa, I have to give a shout out to our Italian team, we operated safely longer there than many manufacturers. Same in Mexico, we've got a few extra days until that decree came down. Working hard to petition the government to consider it's essential. I believe in Mexico, we can keep our people safer than they are on the streets. And so we're pushing that. Again, we've got a good supply of residential inventory on the shelf and if we can cut through this, we're going to be in good shape.

Patrick Shannon - Senior Vice President and Chief Financial Officer

All right, Jason?

Operator

There are no more questions in the queue, this concludes our question-and-answer session. I would like to turn the conference back over to Tom Martineau for any closing remarks.

Thomas Martineau - Vice President, Treasurer and Investor Relations

I appreciate it. So we'd like to thank everyone for participating in today's call and today more than ever please have a safe day.

Operator

AI Assistant

ALLEGION PLC

Q1 2020

Earnings Transcript

Find Answers

Ask about any part of the document to get insights, explanations, or key details.