Allegion plc (ALLE) Q4 2020 Earnings Report, Transcript and Summary

Good day and welcome to the Allegion Fourth Quarter and Full Year 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Tom Martineau, Vice President, Investor Relations and Treasurer. Please go ahead.

Thank you, Alyssa. Good morning, everyone. Welcome and thank you for joining us for Allegion's fourth quarter and full year 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 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 2020 results and provide an outlook for 2021, 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 re-enter the queue. We would like to give everyone an opportunity given the time allotted. Now I would like to turn the call over to Dave.

Thanks Tom. Good morning and thank you for joining us today. 2020 was an extremely difficult year, perhaps the most challenging that I have encountered during my career. I want to take the time to acknowledge the sacrifice and hard work of our employees in helping Allegion deliver strong results in the face of the obstacles presented by the COVID-19 pandemic. Thank you for your diligence, flexibility, and perseverance. Please go to Slide 4. Despite the pressures posed by the global pandemic, Allegion experienced only a modest topline revenue decline in 2020 and we saw pockets of strength during the year. The business, as you may remember, performed extremely well in the first quarter and in the second half of the year the Americas residential business, SimonsVoss business, Interflex, and global portable security businesses in Europe realized good growth. Although revenue was down modestly for the year, we expanded adjusted operating margins by 20 basis points, aided by quickly implementing restructuring and cost management actions to mitigate the volume related COVID-19 impacts. Allegion produced record adjusted earnings per share and increased available cash flow by more than 20 million versus the prior year. We strengthened foundational elements of Allegion’s culture around safety, sustainability, inclusion, diversity, and engagement, which will help drive our continued success as a company. I'm very proud of our commitment to employee safety and customer excellence, which remain top priorities. In 2020 we made improvements in all of our employee safety metrics, which are already industry leading. This has and will be our North Star. I believe that the time and resources we have invested in safety since then paid us back in 2020. We were able to keep our essential employees working and took extra protections to keep people safe, whether they were on the sites or working remotely and our dedication to customer excellence allowed us to better serve our customers. Today, Allegion is greener and cleaner, reducing greenhouse gases and water usage throughout the year. We paid considerable attention to drive progress on inclusion and diversity, creating a strategic framework and leadership commitment to our action agenda. Our team is significantly more engaged, meaning our global employees are more committed to our vision and our workforce than ever before. All Allegion employees are surveyed annually by Gallup in their native language. Our engagement has seen solid improvements since we have been a standalone company. Please go to Slide 5 and I'll walk you through the fourth quarter financial summary. Revenue for the fourth quarter was 727.3 million, an increase of 1.1%. Organic revenue declined six tenths of a percent. Currency tailwinds more than offset the organic revenue decline and the impact of divestitures. Organic revenue in the quarter included Americas residential, SimonsVoss, Interflex, and global portable security in Europe and Australia and New Zealand in the Asia Pacific. These gains were offset by expected headwinds experienced in our Americas non-residential business. Patrick will share more detail on the regions in a moment. Adjusted operating margin increased by 150 basis point in the fourth quarter as we saw the benefits from restructuring and cost reduction actions mitigate deleverage from volume declines. Adjusted earnings per share of a $1.49 increased $0.21, more than 16% versus the prior year. High operating income, favorable share count, and year-over-year tax rates accounted for the increase. Available cash flow for the year came in at 443.2 million, an increase of over 20 million versus the prior year. Higher adjusted earnings and lower capital expenditures were the driving forces for the increase. I encourage all of you to review the body of work and execution of the Allegion team globally versus our competitors and peers in 2020. Solid top line performance in a pandemic, margin expansion, and record cash flows. During the year we leaned out our structure, increased our investment in technology, and retained our go to market resources and strengthened the engagement of our worldwide team in a pandemic, positioning Allegion to exit the COVID plague as a stronger company. Patrick will now walk you through the financial results, and I'll be back to discuss our strategic agenda and 2021 outlook.

Thanks, Dave and good morning, everyone. Thank you for joining today's call. Please go to Slide Number 6. This slide reflects our earnings per share reconciliation for the fourth quarter. For the fourth quarter 2019 reported earnings per share was $0.86, adjusting $0.42 for charges related to restructuring, trade name impairments, as well as loss on divestitures in Turkey and Colombia, the 2019 adjusted earnings per share was a $1.28. Operational earnings were the primary driver for the year-over-year increase. As indicated, operational results increased earnings per share by $0.13 as favorable price, productivity, and material deflationary impacts more than offset reduced volume, related deleverage, as well as plant inefficiencies due to COVID-19. Favorable year-over-year, tax rate and share count drove another $0.06 and $0.02 increase respectively. Interest and other income were slightly positive and offset the slight reduction associated with incremental investments during the quarter. This results in adjusted fourth quarter 2020 earnings per share of a $1.49, an increase of $0.21, or 16.4% compared to the prior year. Lastly, we have a $0.48 per share reduction for charges related to restructuring, M&A costs, impairments, as well as a loss on health for sale assets. This is related to our decision to divest the QMI door business in the Middle East, which is expected to close in Q1 subject to normal regulatory approvals. After giving effect to these items, you arrive at the fourth quarter. 2020 reported earnings per share of $1.01. Please go to Slide Number 7. This slide depicts the components of our revenue growth for the fourth quarter, as well as for the full year 2020. I'll focus on the total Allegion results and cover the regions on their respective slides. As indicated, we experienced a 0.6% organic revenue decline in the fourth quarter. As shown in the trending chart, we saw sequential improvement in the organic revenue decline, as well as positive total growth of 1.1%, with currency tailwinds mitigating the organic decline and divestitures. Price continued to remain strong and helped to offset some of the volume decline. With the fourth quarter performance, you can see that total revenue was down 4.7% for the full year with organic revenue decline of 4.8%. All three regions ended the year down organically with Americas down 4.2%, EMEA lower by 5.1%, and Asia Pacific off 10.6%. All regions experienced organic revenue declines from the prior year as a result of the COVID-19 pandemic. Please go to Slide Number 8. Fourth quarter revenues for the Americas region were 521.2 million, down 1% and 0.7% on an organic basis. The region continued to deliver solid price realization. On volume Americas residential was outstanding, experiencing mid 20% growth boosted by robust retail point of sale, new home construction and electronics growth, which nearly offset the expected decline in the non-residential business caused by lower new construction and discretionary project delays. Electronics revenue was slightly down with good growth in residential offset by reduced commercial electronics, driven by delays in discretionary projects. We continue to see electronics and touchless solutions as long-term growth drivers and expected electronics accelerated growth to resume when market conditions normalize. Americas adjusted operating income of 148.5 million decreased 3.5% versus the prior year period and adjusted operating margin for the quarter was down 70 basis points. The decrease was driven primarily by volume deleverage, plant inefficiencies due to the challenges from COVID-19, and unfavorable mix partially offset by benefits from cost reduction actions, restructuring benefits, and material deflation. Please go to Slide Number 9. Fourth quarter revenues for the EMEA region were 165.3 million, up 10.5% in total and up 3.1% on an organic basis. The organic growth was driven by good price realization and strength in our SimonsVoss, Interflex, and global portable security businesses. These businesses demonstrated resiliency throughout the year and are well-positioned to continue profitable growth in 2021. Currency tailwinds added to the total growth. EMEA adjusted operating income of 24.9 million increased 49.1% versus the prior year period, and adjusted operating margin for the quarter was up 390 basis points. Also note that these results absorbed a 5.1 million environmental remediation charge, which had a 310 basis point negative impact on adjusted operating margins. The margin expansion was primarily driven by the organic growth leverage and the benefits of the restructuring and cost control actions taken throughout the year. Please go to Slide Number 10. Fourth quarter revenues for the Asia Pacific region were 40.8 million, down 6.4% versus the prior year. Organic revenue was down 11.9%. The decline was driven by continued weakness in Korea and slightly offset by growth in Australia and New Zealand, particularly in the residential business. Currency tailwinds muted some of the organic revenue decline. Asia Pacific adjusted operating income for the quarter was 8.2 million, an increase of 6.3 million, with adjusted operating margins up 1570 basis points versus the prior year period. Approximately 4 million of the income increase was attributable to a gain on the sale of a building. Even excluding that, the benefits realized from restructuring and cost control actions drove substantial margin expansion. Please go to Slide Number 11. Available cash flow for 2020 came in at 443.2 million, which is an increase of 20.6 million compared to the prior year period. The increase was driven by higher adjusted net earnings and lower capital expenditures. Looking at the chart to the right, it shows working capital as a percent of revenues decreased based on a four-point quarter average. This was driven by reduced working capital needs from the lower volume. The business continues to generate strong cash flow and conversion of net earnings. Liquidity and our capital structure are in a great position and we will continue to evaluate opportunities to optimize working capital and drive effective cash flow conversion. We resumed share repurchases and acquired approximately 1.1 million shares for approximately $115 million during the fourth quarter. We also announced a 13% increase in our dividend payout later in March. I will now hand the call back over to Dave.

Thank you, Patrick. Please go to Slide Number 12. There's no doubt that throughout the fourth quarter and 2020 as a whole, our vision of seamless access and a safer world continued to drive our business forward. Despite the pandemic and resulting market headwinds, our vision and strategy are progressing on many fronts. We continued our commitments and investments to R&D in 2020, creating a robust pipeline of new product development projects across both our core brands and new electronic product offerings. Our recent acquisition of Yonomi is an example of it's infusing outside thinking, and yet in another way we're making digital and software investments to meet customer needs now and in the future. Yonomi, will accelerate Allegion’s digital journey and product offerings. And our vision remains anchored and are strategic pillars, delivering new value and access and to be the partner of choice, but also in the strength of our historic brands. In fact, throughout the pandemic's Schlage, Von Duprin, SimonsVoss, and Interflex among others in our portfolio, demonstrated both flexibility and creativity to meet customers immediate and changing needs. I couldn't be prouder of how the team grounded our company in sound business practices, while strategic…

Forgive me, ladies and gentlemen, it appears we are having technical difficulties with the speaker location. Please standby while we try to reconnect. Pardon me ladies and gentlemen, thank you for your patience. I would now like to turn the call back over to Dave Petratis. Please go ahead.

Okay, I apologize for that audience. We will go to Slide 12. There's no doubt throughout the fourth quarter and 2020 as a whole, our vision of seamless access and a safer world continue to drive our business forward. Despite the pandemic and resulting market headwinds, our vision and strategy are progressing on many fronts. We continued our commitment and investments to R&D in 2020, creating a robust pipeline of new product and development projects across both our core brands and new electronic product offerings. Our recent acquisition of Yonomi is an example of infusing outside thinking and yet, in another way, we're making digital and software investments to meet customer needs now and in the future. Yonomi will accelerate Allegion’s digital journey and product offerings. And our vision remains anchored in our strategic pillars, delivering new value and access and to be the partner of choice, but also on the strength of our historic brands. In fact, throughout the pandemic Schlage, Von Duprin, SimonsVoss, and Interflex among others in our portfolio demonstrated both flexibility and creativity to meet customers immediate and changing needs. I couldn't be prouder of our team grounded our company in sound business practices was strategically investing for our future to position Allegion for growth as markets rebound. I have said this before and I'll say it again, because of how we've managed our business and how we are investing and because of the engagement, commitment, and resiliency of our employees I believe we'll exit the pandemic stronger than when we started and we are committed to advancing environmental, social, and governance topics. They are important to the company and the communities where we live. Please go to slide 13. Another example from the quarter that demonstrates our focus on Allegion’s future and our vision of seamless access is the creation of Allegion International. As we announced in December, Allegion International officially launched this year on January 1 as a consolidation of the former EMEA and Asia Pacific operating segments. Tim Eckersley is now leading Allegion International, and we are excited to leverage his broad experiences there. As a veteran of the security industry and high growth technologies, and as a longtime leader within our business. Creating Allegion International is designed to drive speed and efficiency by moving decision closer to the customer, simplifying our operating segments, and by reducing overhead in our non-U.S. operations. With this updated operating model in place, we expect to accelerate momentum in electronics growth, software and seamless access in those international markets. Again, we have elite brands with rich histories in Europe and Asia Pacific. While Tim is now leading the way for Allegion International, I want to welcome Luis Orbegoso as Senior Vice President of the Americas. If you haven't already, I encourage you to read our press release or look up Luis's bio on allegion.com. Luis brings a wealth of diverse leadership experiences spanning multiple industries, geographies, and cultures and has a track record of managing through teams through transformation with a focus on operational and customer excellence. He possesses a deep understanding of smart home security, cloud technology, consumer access solutions, as well as commercial and institutional safety, which support our strategic priorities. Needless to say, Tim and Luis are both dedicated to our leadership commitments, delivering value to our customer and shareholders and driving our strategy forward. We are focused and disciplined heading into 2021. Please go to Slide 14. Looking ahead at the 2021 non-residential business, it's important to understand the cyclical nature of this market and where we fit in. In general, we are a late cycle, meaning our products are installed up to a year, sometimes longer after new construction projects start. Our views on commercial institutional markets have not changed. I expect new construction to remain soft this year with institutional markets recovering faster than commercial. I also believe that this recovery will be faster than the 2008 downturn and thus we have maintained our sales and specification capability and capacity while continuing to invest in innovation. Relative to the broader market and competitors Allegion continues to perform well. We continue to provide innovative solutions in our core markets, as well as underserved market opportunities to drive profitable growth. As K through 12 schools, college campuses, and healthcare begin to normalize with regard to the pandemic, we would expect discretionary projects on the non-residential side to pick up in the back half of the year as pent up demand begins to break loose. The residential piece of the Americas business continues to be a bright spot and is expected to grow in 2021 as the undersupply of single family homes continues to be corrected. In addition to the builder channel, DIY projects will continue to drive opportunities as consumers invest in their homes and adopt electronic solutions. We anticipate strength in residential to persist in the foreseeable future. Seamless access, software, and electronics continue to be a long-term growth driver and will remain our top investment priority. They are the future of Allegion. With a strengthened residential and softness in commercial and institutional, we project total organic revenue in the Americas to be down 3% to 4% in 2021. In the Allegion International segments, markets continue to recover and we expect growth in our electronics and system integration businesses, SimonsVoss, Interflex, as well as global portable security business. Currency tailwinds more than offset the expected divestiture of our QMI business and contribute to total growth. For the region, we project total growth of 6% to 7% with organic growth of 2% to 3%. All in for total Allegion we are projecting total revenues to be down a 0.5% to 1.5% and organic revenue decline 1.5% to 2.5%. Please go to Slide 15. Our 2021 outlook for adjusted earnings per share is $4.70 to $4.85. As indicated adjusted operating earnings are expected to decrease 5% to 8%, driven by reduced volumes as a result of the non-residential end markets, incremental investments, and inflationary impacts. We are not immune to the macro-inflationary headwinds especially from steel and electronics components, as well as with freight and transportation. For 2021, we expect an EPS headwind of $0.25 to $0.30 related to direct material input costs and freight inflation alone. We will continue to drive price and productivity to offset but the net benefit will be less than prior years. Incremental investments continue to be a priority as we remain focused on accelerating electronics and seamless access, growth and support of our vision and strategy. These incremental investments predominantly relate to added R&D and engineering capabilities to further develop, enhance, and accelerate new product development. The combination of interest and other expense is expected to be a headwind as some of the more formidable items that we experience in 2020 are non-recurring. Our outlook assumes a full adjusted effective tax rate of approximately 12% and an increase from 11.2% in 2020. It also assumes outstanding weighted average diluted shares of approximately 91 million. The outlook additionally includes $0.10 to $0.15 per share for restructuring charges during the year. As a result, reported EPS is projected to be $4.55 to $4.75. We are projecting our available cash flow for 2021 to be in the $400 million to $420 million range. Please go to Slide 16. We are pleased with our 2020 performance in a pandemic. We saw expanded -- we expanded our operating margins, increased adjustable earnings per share, and delivered higher available cash flow in a difficult macro environment in which we were operating. We have taken actions that will allow Allegion to be leaner and more focused on 2021 as we and the rest of the world navigate and emerge from the pandemic, Allegion will be a stronger company and we are positioned for long-term success. As always, our execution and commitment to driving solid results will remain high. Allegion’s future is bright. Patrick will now -- Patrick and I will now take your questions.

[Operator Instructions]. The first question today comes from Andrew Obin of Bank of America. Please go ahead.

Yes, good morning. Can you hear me?

I can hear you perfect. Sorry for the break in our delivery.

Oh no, don't worry about it. So first question I have is just how you think about North America comps, because if I look at the revenue it's just -- it's a highly unusual year and that Q1 was super strong last year, Q2 very weak, and then things sort of flattened out. So as I think about comps getting positive into the second half, is the issue really first quarter being very strong and then second quarter you resume positive growth in the second quarter or there is any sort of specific dynamic in the second quarter that you see, sorry to get so granular but it was just highly unusual year and I just want to understand your sort of view on second half recovery in 2021?

So I'll jump in here and Patrick can clean up. I'd say as we reflected on 2019 and 2020, I actually saw some softening in the broader building markets as we exited the first half of 2019. Again, we're a late cycle and we carried extremely strong backlog that really helped us through Q1. Then you had the blow up and again we used that strong backlog and the wrap up of projects to really put up, I think, a respectable 2020 for Allegion as we navigated through that. As we go into 2021 and 2022, the backlogs are softened, the new project pipeline is down, and we've got to reposition that. Patrick can talk more about the comps on a quarter-to-quarter basis.

Yeah, so Andrew as you have highlighted, I mean you got it right, Q1 is going to be a difficult comparison because we had really good growth, particularly in the non-residential business. So that's going to be a really tough comp for us. Q2 obviously becomes much easier, particularly on the residential business where we had a plant closure in our Mexico facilities, and we're kind of playing catch up when they reopen, the back half of the quarter. And then, kind of things return I'd say more on a normalized basis in the back half of the year. So, first half it is going to be say down, Q1, up Q2, and then kind of more of a normalized basis, but continued strength in a residential business. Non-residential challenged first half of the year, but getting better as we progress throughout the year, particularly as it relates to discretionary project based business. And, when people start returning to work relative to the easing of the COVID impact, we should start seeing some improvement on that side of the business. Hopefully, that answers what you're looking for.

Yeah, and just a follow-up question, bigger picture question. I think the market we've seen some companies going public that are sort of trying to address building management software and sort of integrate software with hardware, you have some of you larger sort of competitors who do building systems also focus on building management software. And if you look at the numbers, the end market growth opportunity just seems very, very attractive. And I know you guys have thought about it, but I was just wondering, how do you think about Allegion’s ability to participate in what seems to be a very exciting growth, not just in hardware, electronic hardware, but also the software market that goes together with it that seems to be growing quite fast over the next several years? Thank you. And I know you guys have thought about it, but we'd love to get more color.

So I think, Andrew, we have thought very deeply about it, as we rolled out our vision of seamless access almost three years ago. We see the opportunity, we began to venture investments which was amplified by our full acquisition of Yonomi. But we think through the cloud and connect -- great connected products, there's a key role here for Allegion to play. And we continue to invest in position. I would also say the success that we're having in SimonsVoss and Interflex as an indicator of the attractiveness in the market, where both software and really cool hardware comes together. We're pointed right at that market and think that we can carve out a very attractive position for the company.

Alright, thank you.

Our next question comes from Josh Chan of Baird. Please go ahead.

Hi, good morning Dave, Patrick, and Tom.

Good morning.

My first -- good morning, my first question has to do with sort of a combination of international under Tim. I was just wondering if, under his leadership are you anticipating any change in strategy or at least focus, areas of focus versus the historical pattern there in their respective businesses?

So, first, the creation of Allegion International, we've got great confidence in our General Managers. To start there one of the key moves was to simplify and reduce the overall cost of running the international segment. Two is, within those portfolios we think we're well positioned to move ahead, especially as electronic as a driver. Our Gainsborough offerings are being up to date in terms of electronics and we continue to drive the SimonsVoss and Interflex with new products and a supply chain that I think has helped us grow during the pandemic. Third is global portable security with kryptonite, AXA, and Trelock has performed into a nice operating position as demand for bikes and demand for growth as an OEM supplier have been nice. So we expect Tim to advance that and lean into the electronics growth and potentially further acquisitions in that space.

And Josh, I would just add too, you saw it in the numbers we exited 2020 in really good shape. Good organic growth as Dave mentioned on the SimonsVoss and Interflex and global portable security. We would expect that to continue obviously in 2021 leveraging the good work that was done in the back half of 2020. And then on the operational margin performance outstanding Q4 and our outline has always been to continue to improve our margin profile associated with our international region and we would expect that to continue going forward. Again relative to some of the cost actions we took early in 2020 you saw that come through in the year, and we expect that momentum to continue in 2021.

Yeah, that's great -- thank you. And my follow-up is on the non-res specification business recognizing that that's a longer cycle business. Are you seeing any sort of uptick in the early stages of the design process and where in terms of verticals might you be seeing any types of movement or improvement there in terms of the early stages of the design?

So our specification levels have remained strong, and we have continued to invest in digital capability and keeping that specifying capability strong. So we're in a good position. We expect to see a rebound in the second half. There's not been a lot of activity on the campuses of the world, especially the campuses of North America. And as we normalize, we expect some pickup in the second half. As we look at the overall project load, we see positive traction as does institutional products -- projects reload, but also in the hospital sector, where we're very nicely positioned. That whole structure has been severely tested and clearly the economics would suggest that that will be a continued opportunity when we get to the other side of that pandemic, Josh.

Great, thanks for the color and thanks for the time.

Thank you.

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

Yes, good morning everyone. Thanks for all the color on the outlook and as you pointed out your cyclical business, organic growth is going to be soft this year. So I guess that raises the question, given the strength of your cash flow with inorganic growth and so on I am just wondering if you could talk a little bit about how you're thinking about the acquisition growth opportunity in 2021, do we see any departure from the pattern of more bolt-on transactions, do we start leaning into perhaps larger deals as a way to support that acquisition growth? And I guess I'll -- overall just how confident are you in your ability to deliver growth by acquisitions?

I'd say number one strong message from our Board of Directors pulled this lever. Two, we've been active and it's -- we continue to have a pipeline of assets that we aspire for and sometimes you got to be patient. I've always felt that our execution as a company puts pressure on that acquisition pipeline that we aspire for. And I would say the pandemic will force decisions among some of those targets that we acquire that move up into the mid major range. We certainly have made numerous acquisitions here, more a string of pearls. We tend to like things that look more like SimonsVoss and Interflex technology that can help enable our capabilities. And as we think about this world of seamless access, going in with accretive targets that will solve new problems for multifamily, for college campuses where we have a unique position on the door that must be connected. Dave, I remind myself, that hardware is hard and we're doing a great job of connecting that. And we've got the opportunity to come in there with connected devices that will be accelerated through Yonomi, thin cloud opportunities that open up opportunities for growth for Allegion.

Thanks for that. Just a second question, I guess a two part, what's your tax rate risk around Biden's rate increases if those two come to pass? And then secondly, are you kind of -- is there any aspect of your story that you consider to be an infrastructure play such that if we get infrastructure stimulus and infrastructure support legislation, there could be growth drivers there that are not currently reflected in your guidance? Thank you.

So on the tax rates, like any company, multi-industrial company we would be exposed to a rate increase legislative change. We will have to see what happens but that would put obviously pressure on the rate going up. And so we'll just have to kind of see where that goes. Right now our guidance assumes no legislative changes. On the infrastructure spending, obviously, with any money kind of kicking back to the state, local government, so those types of things, I think, would benefit Allegion down the road.

I would say in particular, they're still great or large infrastructure needs K through 12 schools. I think the average school in the United States about 40 years. The security needs, certainly are always there and state municipal government will be investing in that, as well as rethinking some of the challenges that they face during the pandemic. We clearly have the ability to control capacity inside a building, increase the security through electronics, and we think we're in a great position as a company and infrastructure investment I think will naturally follow in those public spaces.

Okay, thank you very much.

Thank you.

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

Hi, good morning guys.

Hey, Josh.

Just a couple questions here. I guess first on the residential side. I know there's some inventory fill that's still going on, clearly strong growth in the quarter. Where do we sit on that and I guess, when do you expect to get back to normal, Dave, I think you said it was going to run through mid-year and I know Patrick reminded us earlier that it was going to be particularly easy comps on resi. So anything we should keep in mind on channel fell or anything else that would kind of add some lumpiness to the resi growth profile here?

I think the mid-year target to normalize backlogs was still the aspiration. We saw our backlog shrink a little bit in December. But we've got work to do in terms of replenishing that channel. We sent a very strong message to our building partners that are non-standard product lead times have been reduced dramatically. We think that will help us grow versus the competition. And we've got new electronic offerings coming out in the second half of the year to match our industry leading Schlage encode products. So, feel good about it but normalization, Josh, certainly by mid-summer barring any blow ups. And, I'd say there's pressure on all manufacturers, especially around the chip thing, our supply chain navigating that wealth, but if -- I don't see it getting materially worse but the pandemic still is having an effect on global supply chains. And again, our strength shines pretty brightly there but mid-year we'll be out of this in a normal way.

Okay, perfect. And then just a follow-up here. Obviously, decrementals have a lot of things going on between inflation mix, you mentioned freight as well. Maybe some way to kind of give some sensitivity because they look pretty heavy, especially including the investment. But we're also talking about small declines and below our mixed business growing and higher mixed business declining. If non-resi does show some upside through the year, what sort of incremental should we put on that growth, is it kind of the 40% to 50%, that we've kind of grown accustomed to since that number is already fully loaded for investments or is there something else working here because, again, small numbers on the top line in terms of movement can distort the margin line?

So I would characterize it this way and hopefully this is helpful as you think about the margin profile for next year or 2021 as it relates to Americas. So a couple things and you touched on one specific relative to our investments that are incremental, associated with R&D and engineering to really push forward the electronics, enhance our product offering going forward. Most of that incremental spend is attached to Americas and so that alone will put pressure on the margin profile associated with Americas. In addition to that you have the incremental inflation that we have highlighted, $0.25 to $0.30 pressure on material input cost. We will do our best to offset that with pricing. But if we break even just the -- math would suggests you're going to have margin pressure attached to that, and then you layer on top of that the mix component, i.e. residential growing faster than non-residential and the non-residential business profile having a higher margin profile, which suggests some additional mix there. So Americas margins will be under pressure in 2021 associated with those three things. We will continue to drive productivity and those types of things to help mitigate that, but there's going to be margin pressure. To come to your second question relative to any growth in the increments associates non-residential, yes. There's going to be some improvement, if we can experience growth in the back half of the year. And you know how we've leveraged historically, I would expect that to continue. And let me make one more point, the margin profile for 2021 being under pressure I view is temporary. Okay, this is a market dynamic, it's not a structural issue associated with Allegion. When business comes back and it will, margin profiles will get better, okay. We will continue to grow margin and we're not in a situation where we've maximized our margin going forward.

I would also add, we certainly got cost out in 2020 and I consciously kept my foot on the accelerator on our specifying and revenue generating resources. We've taken care of these teams through the downturn, and I expect us to get more than our fair share on the upside.

Alright, thanks for the color Dave and Patrick.

Thank you.

The next question comes from Chris Snyder with UBS. Please go ahead.

Thank you for the question. Good morning. So just following up on the 2021 Americas seasonality, is it fair to think that the first half of the year could be up year-on-year just given the easy Q2 comp and then typically you get some level of positive seasonality into the quarter or is that just going to be overwhelmed by the cyclical pressure? And if the first half of the year is up year-on-year, the guidance would suggest pretty material declines in the back half, so hoping you could provide a little bit of color on that?

Yeah, so it is -- so yes, to answer your question succinctly. First, that can be up relative to 2020. Why? It's because of Q2 kind of given the easy comps there. And as Dave mentioned earlier, we're still working off the backlog if you will associated with the residential business. The residential business in Q2 2020 was severely depressed because of our plant closures. And as we progress throughout 2020 and the markets POS continue to accelerate, we're having a hard time catching up with demand. That's going to be worked off if you will in the first half and so the residential business in of itself will be up significantly. Non-resi top comp in Q1, but it kind of normalizes in the back half of the year.

So appreciate all of that color and then just kind of following up. So, for the Americans the guidance of down 300 to 400 bps year-on-year would suggest pretty material duration for Q4 which was down 70 bps organically in the Americas. Is this the result of deeper declines for non-resi from the low double-digit level we saw in Q4 or is it just that residential is normalizing from a mid-20% growth realized in Q4?

I will take the latter so, the double stack on 25% growth year-over-year, much harder comp if you will. Keep in mind Q4 working down backlog, fulfilling stock orders, getting inventory into the channel, that our assumption is not going to repeat itself for 2021 and consequently you have a much difficult comp. Non-res I would expect the rate of decline to improve as we progress during the course of 2021 because of the discretionary business should begin to recover in the back half.

Very helpful. Thank you.

The next question is from Ryan Merkel of William Blair. Please go ahead.

Hey everyone, I guess first off, I had a question on mix and price cost. So what does 2021 guidance assume for the mix headwind and then just clarify, did you say that you expect price to cover costs in 2021?

So on the price cost dynamic, we would expect price to offset material costs in outbound freight, but we're going to be under pressure to mitigate other inflationary impacts, i.e. packaging and those type of things that are also escalating and some of the carry over cost that kind of boomeranged back in 2021, relative to 2020. But as it relates to the price, direct material, expect to be neutral there. I'm sorry, what was your other question?

Mix headwind, what are you assuming guidance for mix headwind?

Yeah. So, we don't give specific guidance on that. But there's going to be headwinds, again, the non-res business being our most profitable segments. That being down residential up will create kind of a mixed headwind. That is a component of the margin degradation as realized Americas for 2021.

Alright, fair enough. And then secondly, just high level. Dave, as you think about 2021, what is the biggest variable, is it vaccine timing or is it how customers respond to building investments in a post COVID world?

I think we need to continue to accelerate the vaccine delivery. The faster we can get campuses to normalize, hospitals to normalize that pent up demand of discretionary projects bows back, I think it puts confidence into our channel which is restocking. And people will get back thinking about the management of their facilities long term. So it's -- we can see that. Actually feel better about state and local budgets than I did a few months ago and have done a lot of looking into the drivers of our business coming out of the last downturn, the financial crisis. Overall, macro economies are in better shape. The commercial will go through certainly a churn, what do we do with the retail space, not necessarily our sweet spot, but there'll be opportunities as those spaces are reconfigured.

Thanks for the color.

Thank you.

The next question is from Julian Mitchell with Barclays. Please go ahead.

Hey, good morning. This is Trish Gorman on for Julian. Hey, so maybe just first question on the QMI sale, can you guys talk a little bit more about the rationale behind this, was this function of the financial profile, was it a function of the end market exposure product line, and then maybe any financial impacts you would expect from that near-term?

So I'd say one, as you look at the market for oil and gas and things are going to drive that part of the world. Clearly a question mark and soft. I'd say two, where did we want to spend our human capital? Clearly, there was pressure in those end markets and our ability to bring together hardware and door solutions didn't feel it was the optimal time. And during the downturn as part of our strategic review, that came up on the portfolio and we chose to exit. So that's how I would describe that situation.

Got it. That makes sense. And then maybe just one on the free cash flow guide down kind of high single-digits for 2021. Can you talk about the moving pieces there, how we should think about CAPEX and then maybe working capital through the year?

Yeah, so down it's really down to commensurate with the earnings guide. And CAPEX is up a little bit year-over-year. We can kind of hover around this 2% of revenue. Working capital don't see any significant movement there. I mean, we will be under a little pressure, we did benefit from the CARES Act. And there'll be some payments coming and some deferrals we had in 2020. So, net-net I still think pretty good conversion and we'll continue to drive that and maximize it to the extent we can.

Got it. Thanks, guys.

Thank you.

The next question is from Jeff Kessler of Imperial Capital. Please go ahead.

Thank you. And I want to give a quick shout out to Luis who I know from his ADT days, so hello Luis and welcome aboard. [Multiple Speakers] Yeah, UTC as well, right. First question is specific to -- can you go back over, give some of divergences between major divergence between GAAP and non-GAAP reporting that you're expecting for 2021?

Yes, predominantly restructuring. So, it's a continuation of some of the programs we announced, but you just can't book the charge until it's actually incurred. And so we have some continuation of those type of things, and expect some continuation of perhaps one or two kind of new smaller type programs going forward.

Right. And then I want to get back to that question of COVID, general question of becoming more seamless into, along with some of the core building software, in my travels and obviously in some of the presentations that I am involved with, we've been talking a lot and this is internationally, this is not just here in the U.S. about -- you can't help but run into now hundreds of companies, some small, some tiny, but some real mid, almost mid-size now that are stressing that. While hardware is the mainstay and software is the tool that it uses, this may reverse in the course of the next, let's call it five to eight years. I'm not going to say two to three, five to eight years probably in which the analytics and visitor management and the entire -- lets just call it the entire the entire realm of software being used is going to be what perhaps drives value and what drives margin for the -- when the end user, particularly when they may start making discretionary decisions. Can you just elaborate on that, I know you have talked about the Yonomi acquisition, that's one step without obviously naming names, what are the types of adjacencies, what are the types of reaches you're looking for here?

So I'd say number one, I looked at companies, Rockwell Automation, Roper, Schneider, where I spent a part, a clear opportunity to take our legacy positions and thrust them into the new world of connectivity, cloud management, to solve customer needs. So, I think that's important. There clearly will be people coming at it from different angles and levels, so I think, our aspiration will be the partner of choice to have open platforms, important here. With that said, I think there's new problems to be solved in the access and security arena. And I think our unique position on the door, along with partners, investment, and further development, we can go in and solve new problems like why does a building have to be open 16 hours a day, why don't I allow that access through as device or, think about how people move through complex buildings. And I know you have Jeff, I think our unique position with connectivity, API's, and SDKs that connect into thin cloud opportunity that we can get more than our share of the growth in these markets.

And this is -- you are basing the same, this is worldwide, I'm assuming.

Absolutely. I think, particularly look at our success with SimonsVoss and Interflex versus some pretty strong players in that space, incredible for Allegion, and those trends are going to continue.

Right, great. Thank you very much. Appreciate it.

Alright, good to hear you.

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

Thank you. We'd like to thank everyone for participating in today's call. Have a safe day.

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