Allegion plc
Item 1. BUSINESS
Overview
Allegion plc ("Allegion," "we," "us" or "the Company") is a leading global provider of security products and solutions that keeps people and assets safe and secure in the places where they reside, work and thrive. We create peace of mind by pioneering safety and security with a vision of seamless access and a safer world. We offer an extensive and versatile portfolio of mechanical and electronic security products across a range of market-leading brands. Our experts across the globe deliver high-quality security products, services and systems, and we use our deep expertise to serve as trusted partners to end-users who seek customized solutions to their security needs.
Access control security products and solutions are critical elements in every building and home. Many door openings are configured to maximize a room’s particular form and function while also meeting local and national building and safety code requirements and end-user security needs. Most buildings have multiple door openings, each serving its own purpose and requiring different specific access-control solutions. Each door must fit exactly within its frame, be prepared precisely for its hinges, synchronize with its specific lockset and corresponding latch and align with a specific key to secure the door. Moreover, with the increasing adoption of the Internet of Things ("IoT"), security products are increasingly linked electronically, integrated into software and popular consumer technology platforms and controlled with mobile applications, creating additional functionality and complexity.
We believe our ability to deliver a wide range of solutions that can be custom-configured to meet end-users’ security needs is a key driver of our success. We accomplish this with:
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Our extensive and versatile product portfolio, combined with our deep expertise, which enables us to deliver the right products and solutions to meet diverse security and functional specifications and to successfully and securely integrate into leading technology and systems;
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Our consultative approach and expertise, which enables us to develop the most efficient and appropriate building security and access-control specifications to fulfill the unique needs of our end-users and their partners, including architects, contractors, home-builders and engineers;
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Our access to and management of key channels in the market, which is critical to delivering our products in an efficient and consistent manner; and
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Our enterprise excellence capabilities, including our global manufacturing operations and agile supply chain, which facilitate our ability to deliver specific product and system configurations to end-users and consumers worldwide, quickly and efficiently.
We believe that the security products industry is growing and will continue to benefit from several global macroeconomic and long-term demographic trends, including:
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The convergence of mechanical and electronic security products;
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Heightened awareness of security and privacy requirements;
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Increased global urbanization; and
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The shift to a digital, interconnected environment.
We believe the security products industry will also benefit from continued growth in institutional, commercial and residential end-markets. As end-users adopt newer technologies in their facilities and homes, we also expect growth in the global electronic product categories we serve to outperform growth in mechanical products.
We operate in three geographic regions: Americas; Europe, Middle East, India and Africa ("EMEIA"); and Asia Pacific. We sell our products and solutions under the following brands:
Allegion Brands
(listed for each region)
We sell a wide range of security and access control solutions for end-users in commercial, institutional and residential facilities worldwide, including the education, healthcare, government, hospitality, commercial office and single and multi-family residential markets. Our leading brands include CISA®, Interflex®, LCN®, Schlage®, SimonsVoss® and Von Duprin®. We believe LCN, Schlage and Von Duprin hold the No. 1 position in their primary product categories in North America while CISA, Interflex and SimonsVoss hold the No.1 or No. 2 position in their primary product categories in certain European markets.
During the year ended December 31, 2019, we generated Net revenues of $2,854.0 million and Operating income of $565.1 million.
History and Developments
We were incorporated in Ireland on May 9, 2013, to hold the commercial and residential security businesses of Ingersoll Rand plc ("Ingersoll Rand"). On December 1, 2013, we became a stand-alone public company after Ingersoll Rand completed the separation of these businesses from the rest of Ingersoll Rand via the transfer of these businesses from Ingersoll Rand to us and the issuance by us of ordinary shares directly to Ingersoll Rand’s shareholders (the "Spin-off"). Our security businesses have long and distinguished operating histories. Several of our brands were established nearly 100 years ago, and many originally created their categories:
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Von Duprin, established in 1908, was awarded the first exit device patent;
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Schlage, established in 1920, was awarded the first patents granted for the cylindrical lock and the push button lock;
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LCN, established in 1926, created the first door closer;
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CISA, established in 1926, devised the first electronically controlled lock; and
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SimonsVoss, established in 1995, created the first keyless digital transponder.
We have built upon these founding legacies since our entry into the security products market through the acquisition of Schlage, Von Duprin and LCN in 1974. Today, we continue to develop and introduce innovative and market-leading products.
In addition, in 2018 we announced the formation of Allegion Ventures, a corporate venture fund that invests in and helps accelerate the growth of companies that have innovative technologies and products. Since its formation, Allegion Ventures has invested nearly $10 million in several early-stage companies that share our pioneering vision and seek to find smart and innovative solutions that help keep people and assets safe and secure in the places where they reside, work and thrive.
Recent examples of successful product launches are illustrated in the table below:
Industry and Competition
The global markets we serve encompass institutional, commercial and residential construction and remodeling markets throughout North America, EMEIA and Asia Pacific. In recent years, as end-users adopt newer technologies in their facilities and single and multi-family homes, including IoT, growth in electronic security products and solutions continues to outperform growth in mechanical security products and solutions. We expect the security products industry will continue to benefit from favorable long-term demographic trends such as continued urbanization of the global population, increased concerns about safety and security and technology-driven innovation.
The security products markets are highly competitive and fragmented throughout the world, with a number of large multi-national companies and thousands of smaller regional and local companies. This high fragmentation primarily reflects local regulatory requirements and highly variable end-user needs. We believe our principal global competitors are Assa Abloy AB and dormakaba Group. We also face competition in various markets and product categories throughout the world, including from Spectrum Brands Holdings, Inc. in the North American residential market. As we move into more technologically-advanced product categories, we may also compete against new, more specialized competitors.
Our success depends on a variety of factors, including brand and reputation, product breadth, innovation, integration with popular technology platforms, quality and delivery capabilities, price and service capabilities. As many of our businesses sell through wholesale distribution, our success also depends on building and partnering with a strong channel network. Although price often serves as an important customer decision point, we also compete based on the breadth and quality of our products and solutions, our ability to custom-configure solutions to meet individual end-user requirements and our global supply chain.
Products and Services
We offer an extensive and versatile portfolio of mechanical and electronic security products across a range of market-leading brands:
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Locks, locksets, portable locks and key systems and services: A broad array of cylindrical and mortise door locksets, security levers and master key systems that are used to protect and control access and a range of portable security products, including bicycle, small vehicle and travel locks. We also offer locksmith services in select locations;
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Door closers, controls and exit devices: An extensive portfolio of life-safety products generally installed on fire doors and facility entrances and exits. Door controls include both mechanical door closers and automatic door operators. Exit devices, also known as panic hardware, provide rapid egress to allow building occupants to exit safely in an emergency;
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Electronic security products and access control systems: A broad range of electrified locks, access control systems, key card and reader systems and accessories, including IoT, Bluetooth Low Energy (BLE), Power over Ethernet and cloud-based solutions;
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Time, attendance and workforce productivity systems: Products and services designed to help business customers manage and monitor workforce access control parameters, attendance and employee scheduling. We offer ongoing aftermarket services in addition to design and installation offerings;
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Doors and door systems: A portfolio of hollow metal, glass, wood and specialty doors and door systems; and
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Other accessories: A variety of additional security and product components, including hinges, door pulls, door stops, bike lights, louvers, weather stripping, thresholds and other accessories, as well as certain bathroom fittings and accessibility aids.
Customers
We sell most of our products and solutions through distribution and retail channels, including specialty distribution, e-commerce and wholesalers. We have built a network of channel partners that help our customers choose the right solution to meet their security needs and help commercial and institutional end-users fulfill and install orders. We also sell through a variety of retail channels, including large do-it-yourself home improvement centers, multiple on-line and e-commerce platforms, as well as small, specialty showroom outlets. We work with our retail partners on developing marketing and merchandising strategies to maximize their sales per square foot of shelf space. Through our Interflex and API Locksmiths businesses and Global Portable Security brands, we also provide products and solutions directly to end-users.
Our 10 largest customers represented approximately 23% of our total Net revenues in 2019. No single customer represented 10% or more of our total Net revenues in 2019.
Sales and Marketing
In markets where we sell through commercial and institutional distribution channels, we employ sales professionals around the world who work with a combination of end-users, security professionals, architects, contractors, engineers and distribution partners to develop specific custom-configured solutions for our end-users’ needs. Our field sales professionals are assisted by specification writers who work with architects, engineers and consultants to help design door openings and security systems to meet end-users’ functional, aesthetic and regulatory requirements. Both groups are supported by dedicated customer care and technical sales-support specialists worldwide. We also support our sales efforts with a variety of marketing efforts, including trade-specific advertising, cooperative distributor merchandising, digital marketing and marketing at a variety of industry trade shows.
In markets in which we sell through retail and home-builder distribution channels, we have teams of sales, merchandising and marketing professionals who help drive brand and product awareness through our channel partners and to consumers. We utilize a variety of advertising and marketing strategies, including traditional consumer media, retail merchandising, digital marketing, retail promotions and builder and consumer trade shows, to support these teams.
We also work actively with several industry bodies around the world to help promote effective and consistent safety and security standards. For example, we are members of Builders Hardware Manufacturers Association (BHMA), Construction Specification Institute, FiRa Consortium, Internet of Things Consortium (IoTC), Physical Security Interoperability Alliance (PSIA), Security Industry Association, Security Technology Alliance, ASSOFERMA (Italy), BHE (Germany) and UNIQ (France).
Production and Distribution
We manufacture our products in our geographic markets around the world. We operate 32 production and assembly facilities, including 15 in Americas, 11 in EMEIA and 6 in Asia Pacific. We own 16 of these facilities and lease the others. Our strategy is to produce in the region of use, wherever appropriate, to allow us to be closer to the end-user and increase efficiency and timely product delivery. Much of our U.S. based residential portfolio is manufactured in the Baja region of Mexico under the Maquiladora, Manufacturing and Export Services Industry ("IMMEX") program (formerly known as the maquiladora program). In managing our network of production facilities, we focus on eliminating excess capacity, reducing cycle time through productivity and harmonizing production practices and safety procedures.
We distribute our products through a broad network of channel partners. In addition, third-party manufacturing and logistics providers perform certain manufacturing, storage and distribution services for us to support certain parts of our manufacturing and distribution network.
Raw Materials
We support our region-of-use production strategy with corresponding region-of-use supplier partners, where available. Our global and regional commodity teams work with production leadership, product management and materials management teams to ensure adequate materials are available for production.
We purchase a wide range of raw materials, including steel, zinc, brass and other non-ferrous metals, to support our production facilities. Where appropriate, we may enter into fixed-cost contracts to lower overall costs.
Intellectual Property
Intellectual property, inclusive of certain patents, trademarks, copyrights, know-how, trade secrets and other proprietary rights, is important to our business. We create, protect and enforce our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to try to ensure the protection and enforcement of our intellectual property rights. We use trademarks on nearly all of our products and believe such distinctive marks are an important factor in creating a market for our goods, in identifying us and in distinguishing our products from others. We consider our CISA, Interflex, LCN, Schlage, SimonsVoss, Von Duprin and other associated trademarks to be among our most valuable assets, and we have registered these trademarks in a number of countries. Although certain proprietary intellectual property rights are important to our success, we do not believe we are materially dependent on any particular patent or license, or any particular group of patents or licenses.
Facilities
We operate through a broad network of sales offices, engineering centers, 32 production and assembly facilities and several distribution centers throughout the world. Our active properties represent approximately 6.6 million square feet, of which approximately 39% is leased. The following table shows the location of our principal worldwide production and assembly facilities:
Research and Development
We are committed to investing in our research and development capabilities with a focus on technology innovations that will deliver growth through the introduction of new products and solutions. In addition, we invest in initiatives that continuously drive improvements in product cost, quality, safety and sustainability.
Our research and development team is managed as a global, collaborative group to identify and develop new technologies and worldwide product platforms. We organize our resources regionally to leverage expertise in local standards and configurations for the benefit of our customers. Further, we operate a global engineering design and technology center in Bangalore, India, to augment and support the regional engineering teams.
Seasonality
Our business experiences seasonality that varies by product line. Because more construction and do-it-yourself projects occur during the second and third calendar quarters of each year in the Northern Hemisphere, our security product sales related to those projects are typically higher in those quarters than in the first and fourth calendar quarters. However, certain other businesses typically experience higher sales in the fourth calendar quarter due to project timing. Net revenues by quarter for the years ended December 31, 2019, 2018 and 2017, are as follows:
Employees
We believe in fundamental standards that support our commitment to our employees, including a commitment to safe and healthy workspaces, respect for diversity and competitive wages and benefits. We are also committed to creating and maintaining a diverse and inclusive environment. As an equal employment opportunity and affirmative action employer, we are fully committed to our equal employment opportunity policy and will not discriminate based on race, sex, color, national origin, creed, religion, pregnancy, age, disability, military status, protected veteran status, sexual orientation, gender identity, genetic information, marital status or
any legally protected status. We are dedicated to fulfilling this commitment as it relates to decisions regarding all employment actions at all levels of employment. As of December 31, 2019, we had approximately 11,000 employees.
Environmental Matters
We have a dedicated environmental program designed to reduce the utilization and generation of hazardous materials during the manufacturing process, as well as to remediate identified environmental concerns. As to the latter, we are currently engaged in site investigations and remediation activities to address environmental cleanup from past operations at current and former production facilities. We also regularly evaluate our remediation methods that are in addition to, or in replacement of, those we currently utilize based upon enhanced technology and regulatory changes.
We are sometimes a party to environmental lawsuits and claims and have received notices of potential violations of environmental laws and regulations from the U.S. Environmental Protection Agency (the "EPA") and similar state authorities. We have also been identified as a potentially responsible party ("PRP") for cleanup costs associated with off-site waste disposal at federal Superfund and state remediation sites. For all such sites, there are other PRPs and, in most instances, our involvement is minimal.
In estimating our liability, we have assumed that we will not bear the entire cost of remediation of any site to the exclusion of other PRPs who may be jointly and severally liable. The ability of other PRPs to participate has been taken into account, based on our understanding of the parties’ financial condition and probable contributions on a per site basis. Additional lawsuits and claims involving environmental matters are likely to arise from time to time in the future. For a further discussion of our potential environmental liabilities, see Note 21 to the Consolidated Financial Statements.
Available Information
We are required to file annual, quarterly and current reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934. The SEC maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The public can obtain any documents that are filed by us at www.sec.gov.
In addition, this Annual Report on Form 10-K, as well as future quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to all of the foregoing reports, are made available free of charge on our Internet website (https://www.allegion.com) as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. The contents of our website are not incorporated by reference in this report.
Item 1A. RISK FACTORS
We discuss our expectations regarding future performance, events and outcomes in this Form 10-K, quarterly and annual reports, press releases and other written and oral communications. All statements except for historical and present factual information are “forward-looking statements” and are based on financial data and business plans available only as of the time the statements are made, which may become outdated or incomplete. Forward-looking statements are inherently uncertain, and investors must recognize that events could significantly differ from our expectations. You should carefully consider the risk factors discussed below, together with all the other information included in this Form 10-K, in evaluating us, our ordinary shares and our senior notes. If any of the risks below actually occurs, our business, financial condition, results of operations and cash flows could be materially and adversely affected. Any such adverse effect may cause the trading price of our ordinary shares to decline, and as a result, you could lose all or part of your investment in us. Our business may also be adversely affected by risks and uncertainties not known to us or risks that we currently believe to be immaterial. We assume no obligation to update any forward-looking statements as a result of new information, future events or other factors.
Risks Related to Our Business
Our global operations subject us to economic risks.
We are incorporated in Ireland and operate in countries worldwide. Our global operations depend on products manufactured, purchased and sold in the U.S. and internationally, including in Australia, China, Europe, Korea, Mexico, New Zealand and the United Arab Emirates. The political, economic and regulatory environments in which we operate are becoming increasingly volatile and uncertain. Accordingly, we are subject to risks that are inherent in operating globally, including:
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Changes to trade agreements, sanctions, import and export regulations, including imposition of burdensome tariffs and quotas, and customs duties;
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Changes in applicable tax regulations and interpretations;
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Economic downturns and social and political instability, including uncertainties and financial, legal, tax and trade implications of the implementation of the United Kingdom’s withdrawal of its membership from the European Union (commonly known as “Brexit”);
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Changes in laws and regulations or imposition of currency restrictions and other restraints in various jurisdictions;
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Limitation of ownership rights, including expropriation of assets by a local government, and limitation on the ability to repatriate earnings;
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Sovereign debt crises and currency instability in developed and developing countries;
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Difficulty in staffing and managing global operations;
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Difficulty in enforcing agreements, collecting receivables and protecting assets through non-U.S. legal systems; and
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Political unrest, national and international conflict, including war, border closures, civil disturbances and terrorist acts.
These risks could increase our cost of doing business in the U.S. and internationally, increase our counterparty risk, disrupt our operations, disrupt the ability of suppliers and customers to fulfill their obligations, increase our effective tax rate, increase the cost of our products, limit our ability to sell products in certain markets, reduce our operating margin, reduce cash flow and negatively impact our ability to compete.
Our business relies on the institutional, commercial and residential construction and remodeling markets.
We primarily rely on the institutional, commercial and residential construction and remodeling markets, which are marked by cyclicality based on overall economic conditions. Weakness or instability in these markets may cause current and potential customers to delay or choose not to make purchases, which could negatively impact the demand for our products and services.
Increased competition, including from technological developments, could adversely affect our business.
The markets in which we operate include a large number of participants, including multi-national companies, regional companies and small local companies. We primarily compete on the basis of quality, innovation, expertise, effective channels to market, breadth of product offering and price. We may be unable to effectively compete on all these bases. Further, in a number of our product offerings, we compete with our retail customers who use their own private labels. If we are unable to anticipate evolving trends in the market or the timing and scale of our competitors’ activities and initiatives, including increased competition from private label brands, the demand for our products and services could be negatively impacted.
In addition, we compete in an industry that is experiencing the convergence of mechanical, electronic and digital products. Technology and innovation play significant roles in the competitive landscape. Our success depends, in part, upon the research,
development and implementation of new technologies and products including obtaining, maintaining and enforcing necessary intellectual property protections. Securing and maintaining key partnerships and alliances, recruiting and retaining highly skilled and qualified employee talent and having access to technologies, services, intellectual property and solutions developed by others will play a significant role in our ability to effectively compete. The continual development of new technologies by existing and new competitors, including non-traditional competitors with significant resources, could adversely affect our ability to sustain operating margins and desirable levels of sales volumes. To remain competitive, we must develop new products and respond to new technologies in a timely manner.
Our growth is dependent, in part, on the development, commercialization and acceptance of new products and services.
We must develop and commercialize new products and services in order to remain competitive in our current and future markets and in order to continue to grow our business. The speed of development by our competitors and new market entrants is increasing. We cannot provide any assurance that any new product or service will be successfully commercialized in a timely manner, if ever, or, if commercialized, will result in returns greater than our investment. Investment in a product or service could divert our attention and resources from other projects that become more commercially viable in the market. We also cannot provide any assurance that any new product or service will be accepted by the market.
Changes in customer and consumer preferences and the inability to maintain beneficial relationships with large customers could adversely affect our business.
We have significant customers, particularly major retailers, although no one customer represented 10% or more of our total Net revenues in any of the past three fiscal years. The loss or material reduction of business, the lack of success of sales initiatives or changes in customer preferences or loyalties for our products related to any such significant customer could have a material adverse impact on our business. In addition, major customers who are volume purchasers are much larger than us and have strong bargaining power with suppliers. This limits our ability to recover cost increases through higher selling prices. Furthermore, unanticipated inventory adjustments by these customers can have a negative impact on sales.
We also sell our products through various trade channels, including traditional retail and e-commerce channels. If we or our major customers are not successful in navigating the shifting consumer preferences to distribution channels such as e-commerce, our expected future revenues may be negatively impacted.
Our brands are important assets of our businesses, and violation of our trademark rights by imitators could negatively impact revenues and brand reputation.
Our brands and trademarks enjoy a reputation for quality and value and are important to our success and competitive position. Unauthorized use of our trademarks may not only erode sales of our products but may also cause significant damage to our brand name and reputation, interfere with relationships with our customers and increase litigation costs. There can be no assurance that our on-going effort to protect our brand and trademark rights will prevent all violations.
Currency exchange rate fluctuations may adversely affect our results.
We are exposed to a variety of market risks, including the effects of changes in currency exchange rates. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Quantitative and Qualitative Disclosure About Market Risk."
Approximately 30% of our 2019 Net revenues were derived outside the U.S., and we expect sales to non-U.S. customers to continue to represent a significant portion of our consolidated Net revenues. Although we may enter into currency exchange contracts to reduce our risk related to currency exchange fluctuations, changes in the relative fair values of currencies occur from time to time and may, in some instances, have a material impact on our results of operations. We do not hedge against all of our currency exposure and therefore, our business will continue to be susceptible to currency fluctuations.
We also translate assets, liabilities, revenues and expenses denominated in non-U.S. dollar currencies into U.S. dollars for our Consolidated Financial Statements based on applicable exchange rates. Consequently, fluctuations in the value of the U.S. dollar compared to other currencies may have a material impact on the value of these items in our Consolidated Financial Statements, even if their value has not changed in their original currency.
Our business and innovation strategies include making acquisitions of, and investments in, external companies. These acquisitions and investments could be unsuccessful or consume significant resources, which could adversely affect our operating and financial results.
We will continue to analyze and evaluate the acquisition of strategic businesses or product lines with the potential to strengthen our industry position or enhance our existing set of products and services offerings. We cannot provide assurance that we will identify or successfully complete acquisitions with suitable candidates in the future, nor can we provide assurance that completed acquisitions will be successful, including efficient integration and creation of synergies.
Some of the businesses we may seek to acquire may be marginally profitable or unprofitable. For these businesses to achieve acceptable levels of profitability, we must improve their management, operations, products and market penetration. We may not be successful in this regard and we may encounter other difficulties in integrating acquired businesses into our existing operations.
Acquisitions may involve significant cash expenditures, debt incurrence, operating losses and expenses. Acquisitions also involve numerous other risks, including:
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Diversion of management time and attention from daily operations;
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Difficulties integrating acquired businesses, technologies and personnel into our business;
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Difficulties completing the transaction in a timely manner;
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Difficulties realizing synergies expected to result from acquisitions;
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Difficulties in obtaining and verifying the financial statements and other business information of acquired businesses;
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Inability to obtain regulatory approvals and/or required financing on favorable terms;
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Potential loss of key employees, key contractual relationships or key customers of acquired companies or of us;
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Difficulties competing in the new markets we enter;
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Assumption of the liabilities and exposure to unforeseen liabilities of acquired companies;
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Dilution of interests of holders of our ordinary shares through the issuance of equity securities or equity-linked securities; and
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Difficulty in integrating financial reporting systems and implementing controls, procedures and policies, including disclosure controls and procedures and internal control over financial reporting, appropriate for public companies of our size at companies that, prior to the acquisition, had lacked such controls, procedures and policies.
Further, as part of Allegion’s innovation strategy, from time to time we invest in start-up companies and/or development stage technology or other companies. In evaluating these opportunities, we follow a structured evaluation process that considers factors such as potential financial returns, new expertise in emerging technology and business benefits. Despite our best efforts to calculate potential return and risk, some or all of these companies we invest in may be unprofitable at the time of, and subsequent to, our investment. We may lose money in these investments, including the potential for future impairment charges on the investments, and the anticipated benefits of the technology and business relationships may be less than expected.
We continually look to expand our services and products into international markets. As we expand into new international markets, we will have only limited experience in marketing and operating services and products in such markets. In some instances, we may rely on the efforts and abilities of foreign business partners in such markets. Certain international markets may be slower than U.S. markets in adopting our services and products, and our operations in such markets may not develop at a rate that supports our level of investment. In addition to the risks outlined above, expansion into certain international markets may require us to compete with local businesses with greater knowledge of the market, including the tastes and preferences of customers and businesses with dominant market shares. Any acquisitions or investments may ultimately harm our business or financial condition; as such, acquisitions may not be successful and may ultimately result in impairment charges.
We may pursue business opportunities that diverge from core business.
We may pursue business opportunities that diverge from our core business, including expanding our products or service offerings, investing in new and unproven technologies and forming new alliances with companies to distribute our products and services. We can offer no assurance that any such business opportunities will prove to be successful. Among other negative effects, our investment in new business opportunities may exceed the returns we realize. Additionally, any new investments could have higher cost structures than our current business, which could reduce operating margins and require more working capital. In the event that working capital requirements exceed operating cash flow, we may be required to draw on our revolving credit facility or pursue other external financing, which may not be readily available.
Our enterprise excellence efforts may not achieve the improvements we expect.
We utilize a number of tools to improve efficiency and productivity. Implementation of new processes to our operations could cause disruptions and may prove to be more difficult, costly or time consuming than expected. There is no assurance that all of our planned enterprise excellence projects will be fully implemented, or if implemented, will realize the expected improvements.
Our restructuring plans may not be successful.
We have in the past restructured or made other adjustments to our workforce and manufacturing footprint in response to market changes, product changes, performance issues, changes in strategy, acquisitions and other internal and external considerations. Historically, these types of restructuring activities have resulted in increased restructuring costs and temporarily reduced productivity. In addition, we may not achieve or sustain the expected growth or cost savings benefits of these restructurings or do so within the expected timeframe. These effects could recur in connection with future acquisitions and other restructurings and our Net revenues and other results of operations could be negatively affected.
Material adverse legal judgments, fines, penalties or settlements could adversely affect our business.
We are currently and may in the future become involved in legal proceedings and disputes incidental to the operation of our business. Our business may be adversely affected by the outcome of these proceedings and other contingencies (including, without limitation, environmental, product liability, antitrust, intellectual property, data protection, privacy and labor and employment matters) that cannot be predicted with certainty. As required by U.S. generally accepted accounting principles ("GAAP"), we establish reserves based on our assessment of contingencies. Subsequent developments in legal proceedings and other contingencies may affect our assessment and estimates of the loss contingency recorded as a reserve, and we may be required to make additional material payments.
Allegations that we have infringed the intellectual property rights of third parties could negatively affect us.
We may be subject to claims of infringement of intellectual property rights by third parties. In particular, we often compete in areas having extensive intellectual property rights owned by others and we have become subject to claims alleging infringement of intellectual property rights of others. In general, if it is determined that one or more of our technologies, products or services infringes the intellectual property rights owned by others, we may be required to cease marketing those products or services, to obtain licenses from the holders of the intellectual property at a material cost or to take other actions to avoid infringing such intellectual property rights. The litigation process is costly and subject to inherent uncertainties, and we may not prevail in litigation matters regardless of the merits of our position. Adverse intellectual property litigation or claims of infringement against us may become extremely disruptive if the plaintiffs succeed in blocking the trade of our products and services and may have a material adverse effect on our business.
Our reputation, ability to do business and results of operations could be impaired by adverse publicity or improper conduct by any of our employees, agents or business partners.
We are subject to regulation under a variety of U.S. federal and state and non-U.S. laws, regulations and policies including laws related to anti-corruption, export and import compliance, anti-trust and money laundering due to our global operations. We cannot provide assurance that our internal controls will always protect us from the improper conduct of our employees, agents and business partners. Any improper conduct could damage our reputation and subject us to, among other things, civil and criminal penalties, material fines, equitable remedies (including profit disgorgement and injunctions on future conduct), securities litigation and a general loss of investor confidence.
Further, adverse publicity, whether or not justified, or allegations of product or service quality issues, even if false or unfounded, could damage our reputation and negatively affect our sales.
Disruptions in our global supply chain, including product manufacturing and logistical services provided by outsourcing partners, may negatively impact our business.
Our ability to meet our customers' needs and achieve cost targets depends on our ability to maintain key manufacturing and supply arrangements, including execution of supply chain optimizations and certain sole supplier or sole manufacturing arrangements. The loss or disruption of such manufacturing and supply arrangements could interrupt product supply and, if not effectively managed and remedied, have an adverse impact on our business.
We outsource certain manufacturing and logistical services to partners located throughout the world. Our reliance on these third parties reduces our control over the manufacturing and delivery process, exposing us to risks including reduced control over quality assurance, product costs, product supply and delivery delays. If we are unable to effectively manage these relationships, or if these third parties experience delays, disruptions, capacity constraints, regulatory issues or quality control problems in their operations or otherwise fail to meet our future requirements for timely delivery, our ability to ship and deliver certain of our products to our customers could be impaired and our business could be harmed.
The effects of global climate change or other unexpected events, including global health crises, may disrupt our operations and have a negative impact on our business.
The effects of global climate change, such as extreme weather conditions and natural disasters occurring more frequently or with more intense effects, or the occurrence of unexpected events, including wildfires, tornadoes, hurricanes, earthquakes, floods, tsunamis and other severe hazards or global health crises, such as the outbreak of Ebola or the Coronavirus, or other rapid outbreak and spread of a communicable disease or virus, in the countries where we operate or sell products and provide services, could adversely affect our operations and financial performance. Extreme weather, natural disasters, power outages or other unexpected events could disrupt our operations by impacting the availability and cost of materials needed for manufacturing, causing physical damage and partial or complete closure of our manufacturing sites or distribution centers, loss of human capital, temporary or long-term disruption in the supply of products and services and disruption in our ability to deliver products and services to customers. These events and disruptions could also increase insurance and other operating costs, including impacting our decisions regarding construction of new facilities to select areas less prone to climate change risks and natural disasters, which could result in indirect financial risks passed through the supply chain or other price modifications to our products and services.
We may be subject to risks relating to our information technology and operational technology systems.
We rely extensively on information technology and operational technology systems, networks and services including hardware, software, firmware and technological applications and platforms (collectively, "IT Systems") to manage and operate our business from end-to-end, including ordering and managing materials from suppliers, design and development, manufacturing, marketing, selling and shipping to customers, invoicing and billing, managing our banking and cash liquidity systems, managing our enterprise resource planning and other accounting and financial systems and complying with regulatory, legal and tax requirements. There can be no assurance that our current IT Systems will function properly. We have invested and will continue to invest in improving our IT Systems. Some of these investments are significant and impact many important operational processes and procedures. There is no assurance that any newly implemented IT Systems will improve our current systems, improve our operations or yield the expected returns on the investments. In addition, the implementation of new IT Systems may cause disruptions in our operations and, if not properly implemented and maintained, negatively impact our business. If our IT Systems cease to function properly or if these systems do not provide the anticipated benefits, our ability to manage our operations could be impaired.
We currently rely on third-party vendors for many of the critical elements of our global information and operational technology infrastructure and their failure to provide effective support for such infrastructure could negatively impact our business and financial results.
We have outsourced many of the critical elements of our global information and operational technology infrastructure to third-party service providers in order to achieve efficiencies. If such service providers do not perform or do not perform effectively, we may not be able to achieve the expected efficiencies and may have to incur additional costs to address failures in providing service by the service providers. Depending on the function involved, such non-performance, ineffective performance or failures of service may lead to business disruptions, processing inefficiencies or security breaches.
Disruptions or breaches of our information systems could adversely affect us.
Despite our implementation of network security measures which have focused on prevention, mitigation, resilience and recovery, our network and products, including access solutions, may be vulnerable to cybersecurity attacks, computer viruses, malicious codes, malware, ransomware, phishing, social engineering, denial of service, hacking, break-ins and similar disruptions. Cybersecurity attacks and intrusion efforts are continuous and evolving, and in certain cases they have been successful at the most robust institutions. The scope and severity of risks that cyber threats present have increased dramatically and include, but are not limited to, malicious software, attempts to gain unauthorized access to data or premises, exploiting weaknesses related to vendors or other third parties that could be exploited to attack our systems, denials of service and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Any such event could have a material adverse effect on our business, operating results and financial condition, as we face regulatory, reputational and litigation risks resulting from potential cyber incidents, as well as the potential of incurring significant remediation costs.
Our daily business operations also require us to collect and/or retain sensitive data such as intellectual property, proprietary business information and data related to customers, employees, suppliers and business partners within our networking infrastructure including data from individuals subject to the European Union's General Data Protection Regulation, that is subject to privacy and security laws, regulations and/or customer-imposed controls. Despite our efforts to protect such data, the loss or breach of such data due to various causes including material security breaches, catastrophic events, extreme weather, natural disasters, power outages, system failures, computer viruses, improper data handling, programming errors, unauthorized access and employee error or malfeasance could result in wide reaching negative impacts to our business, and as such, the ongoing maintenance and security of this information is pertinent to the success of our business operations and our strategic goals.
In addition, we operate in an environment where there are different and potentially conflicting data privacy laws and regulations in effect or expected to go into effect in the future, including regulations related to devices connected through the IoT, in the various jurisdictions in which we operate, and we must understand and comply with such laws and regulations while ensuring our data is secure.
Our networking infrastructure and related assets may be subject to unauthorized access by hackers, employee error or malfeasance or other unforeseen activities. Such issues could result in the disruption of business processes, network degradation and system downtime, along with the potential that a third party will exploit our critical assets such as intellectual property, proprietary business information and data related to our customers, suppliers and business partners. To the extent that such disruptions occur and our business continuity plans do not effectively address these disruptions in a timely manner, they may cause delays in the manufacture or shipment of our products and the cancellation of customer orders and, as a result, our business operating results and financial condition could be materially and adversely affected, resulting in a possible loss of business or brand reputation.
Commodity shortages, price increases and higher energy prices could negatively affect our financial results.
We rely on suppliers to secure commodities, including steel, zinc, brass and other non-ferrous metals, required for the manufacture of our products. A disruption of deliveries from our suppliers or decreased availability of commodities could have an adverse effect on our ability to meet our commitments to customers or increase our operating costs. We believe that available sources of supply will generally be sufficient for our needs for the foreseeable future. Nonetheless, the unavailability of some commodities could have a material adverse impact on our business.
Volatility in the prices of these commodities could increase the costs of our products and services, and we may not be able to pass on these costs to our customers. We do not currently use financial derivatives to hedge against this volatility; however, we utilize firm purchase commitments to mitigate risk. The pricing of some commodities we use is based on market prices. To mitigate this exposure, we may use annual price contracts to minimize the impact of inflation and to benefit from deflation.
Additionally, we are exposed to fluctuations in energy prices due to the instability of current market prices. Higher energy costs increase our operating costs and the cost of shipping our products and supplying services to our customers around the world. Consequently, sharp price increases, the imposition of taxes or an interruption of supply could cause us to lose the ability to effectively manage the risk of rising energy prices and may have an adverse impact on our results of operations and cash flows.
We may be required to recognize impairment charges for our goodwill, indefinite-lived intangible assets and other long-lived assets.
At December 31, 2019, the net carrying value of our goodwill and other indefinite-lived intangible assets totaled approximately $873.3 million and $123.0 million, respectively. Pursuant to GAAP, we are required to annually assess our goodwill, indefinite-lived intangibles and other long-lived assets to determine if they are impaired. In addition, interim assessments must be performed whenever events or changes in circumstances indicate that impairment may have occurred. Significant disruptions to our business, end market conditions and protracted economic weakness, unexpected significant declines in operating results of reporting units, divestitures and market capitalization declines may result in recognition of impairment charges to goodwill or result in the impairment of our indefinite-lived intangible assets or other long-lived assets. Specifically, an unanticipated deterioration in Net revenues and/or operating margins generated by our EMEIA and/or Asia Pacific segments could trigger future impairments in those segments. Any charges relating to such impairments could have a material adverse impact on our results of operations in the periods recognized.
Our ability to successfully grow and expand our business depends on our ability to recruit and retain a highly qualified and diverse workforce.
Our ability to successfully grow and expand our business depends on the contributions and abilities of our employees and key management, including, for example, the ability of our sales force to adapt to any changes made in the sales organization and achieve adequate customer coverage. We must therefore continue to effectively recruit, retain and motivate key management, sales and other highly qualified and skilled personnel to maintain our current business and support our projected growth. A shortage of these key employees for various reasons, including changes in laws and policies regarding immigration and work authorizations in jurisdictions where we have operations, might jeopardize our ability to grow and expand our business.
Our operations are subject to regulatory risks.
Our U.S. and non-U.S. operations are subject to a number of laws and regulations, including fire and building codes and environmental, health and safety standards. We have incurred, and will be required to continue to incur, significant expenditures to comply with these laws and regulations. Changes to, or changes in interpretations of, current laws and regulations could require us to increase our compliance expenditures, cause us to significantly alter or discontinue offering existing products and services or cause us to develop new products and services. Altering current products and services or developing new products and services to comply with changes in the applicable laws and regulations could require significant research and development investments, increase the cost of providing the products and services and adversely affect the demand for our products and services.
In the event a regulatory authority concludes that we are not or have not at all times been in full compliance with these laws or regulations, we could be fined, criminally charged or otherwise sanctioned.
Certain environmental laws assess liability on current or previous owners of real property or operators of manufacturing facilities for the costs of investigation, removal or remediation of hazardous substances or materials at such properties or at properties at which parties have disposed of hazardous substances. Liability for investigative, removal and remedial costs under certain U.S. federal and state laws and certain non-U.S. laws are retroactive, strict and joint and several. In addition to cleanup actions brought by governmental authorities, private parties could bring personal injury or other claims due to the presence of, or exposure to, hazardous substances. We have received notification from U.S. and non-U.S. governmental agencies, including the EPA and similar state environmental agencies, that conditions at a number of current and formerly owned sites where we and others have disposed of hazardous substances require investigation, cleanup and other possible remedial action. These agencies may require that we reimburse the government for its costs incurred at these sites or otherwise pay for the costs of investigation and cleanup of these sites, including by providing compensation for natural resource damage claims from such sites. For more information, see "Business - Environmental Matters."
While we have planned for future capital and operating expenditures to maintain compliance with environmental laws and have accrued for costs related to current remedial efforts, our costs of compliance, or our liabilities arising from past or future releases of, or exposures to, hazardous substances, may exceed our estimates. We may also be subject to additional environmental claims for personal injury or cost recovery actions for remediation of facilities in the future based on our past, present or future business activities.
The capital and credit markets are important to our business.
Instability in U.S. and global capital and credit markets, including market disruptions, limited liquidity and interest rate volatility or reductions in the credit ratings assigned to us by independent ratings agencies, could reduce our access to capital markets or increase the cost of funding our short and long-term credit requirements. In particular, if we are unable to access capital and credit markets on terms that are acceptable to us, we may not be able to make certain investments or fully execute our business plans and strategy.
Our suppliers and customers are also dependent upon the capital and credit markets. Limitations on the ability of customers, suppliers or financial counterparties to access credit could lead to insolvencies of key suppliers and customers, limit or prevent customers from obtaining credit to finance purchases of our products and services and cause delays in the delivery of key products from suppliers.
As a global business, we have a relatively complex tax structure, and there is a risk that tax authorities will disagree with our tax positions.
Since we conduct operations worldwide through our subsidiaries, we are subject to complex transfer pricing regulations in the countries in which we operate. Transfer pricing regulations generally require that, for tax purposes, transactions between us and
our affiliates be priced on a basis that would be comparable to an arm's length transaction and that contemporaneous documentation be maintained to support the tax allocation. Although uniform transfer pricing standards are emerging in many of the countries in which we operate, there is still a relatively high degree of uncertainty and inherent subjectivity in complying with these rules. To the extent that any tax authority disagrees with our transfer pricing policies, we could become subject to significant tax liabilities and penalties. Our tax returns are subject to review by taxing authorities in the jurisdictions in which we operate. Although we believe that we have provided for all tax exposures, the ultimate outcome of a tax review could differ materially from our provisions.
We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities.
Our future effective tax rate and cash tax obligations could be adversely affected by shifts in our mix of earnings in countries with varying statutory tax rates, changes in the valuation of our deferred tax assets or liabilities or changes in tax laws, regulations, interpretations or accounting principles, as well as certain discrete items. In addition, we are subject to regular review and audit by both U.S. and non-U.S. tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions on various tax-related assertions. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, interpretations and rates in various jurisdictions may be subject to significant change, which could materially affect our financial position and results of operations. For example, the 2017 Tax Cuts and Jobs Act (the “Tax Reform Act”) enacted in December 2017 in the U.S. had a significant impact on our cash tax obligations. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed, recommended or implemented changes to existing tax laws or have enacted new laws that could significantly increase our effective tax rate or cash tax obligations in many countries where we do business or require us to change the manner in which we operate our business.
There are risks associated with our outstanding and future indebtedness.
We have approximately $1.4 billion of outstanding indebtedness at December 31, 2019. In addition, we have a senior unsecured revolving credit facility (the "Revolving Facility") that permits borrowings of up to an additional $500 million. Volatility in the credit markets could adversely impact our ability to obtain favorable financing terms in the future. A portion of our cash flows from operations is dedicated to servicing our indebtedness and will not be available for other purposes, including our operations, capital expenditures, payment of dividends, share repurchases or future business opportunities.
Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, reduce or eliminate the payment of dividends, sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In such event, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations.
Additionally, at December 31, 2019, our borrowings include a variable rate term loan facility indexed to LIBOR (the "Term Facility", and together with the Revolving Facility, the "Credit Facilities") with an outstanding balance of $238.8 million, which exposes us to interest rate risk. However, at December 31, 2019, we also have interest rate swaps for $200 million of our floating-rate term loans, which expire in September 2020, to manage our interest rate risk. We are also exposed to the risk of rising interest rates to the extent that we fund our operations with short-term or variable-rate borrowings under our Revolving Facility. If LIBOR or other applicable base rates under our Credit Facilities increase in the future, our Interest expense could increase. Additionally, the regulator that oversees LIBOR has announced that it cannot guarantee LIBOR's availability after 2021. In the event LIBOR is discontinued, replaced, significantly changed or ceases to be recognized as an acceptable benchmark, there may be uncertainty or differences in the calculation of our applicable interest rate or required payment amounts for our Credit Facilities. This could also require different hedging strategies and require renegotiation of our existing Credit Facilities. While we do not currently anticipate the transition from LIBOR and the risks thereto to have a material adverse effect on us, it remains uncertain at this time.
Risks Related to Our Incorporation in Ireland
Irish law differs from the laws in effect in the United States and may afford less protection to holders of our securities.
The U.S. currently does not have a treaty with Ireland providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. As such, there is some uncertainty as to whether the courts of Ireland would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on U.S. federal or state civil liability laws, including the civil liability provisions of the U.S. federal or state securities laws, or hear actions against us or those persons based on those laws.
As an Irish company, we are governed by the Companies Act 2014 of Ireland, as amended, which differs in some material respects from laws generally applicable to U.S. corporations and shareholders, including, among others, differences relating to interested director and officer transactions and shareholder lawsuits. Likewise, the duties of directors and officers of an Irish company generally are owed to the company only. Shareholders of Irish companies generally do not have a personal right of action against directors or officers of the company and may exercise such rights of action on behalf of the company only in limited circumstances. Accordingly, holders of our securities may have more difficulty protecting their interests than would holders of securities of a corporation incorporated in a jurisdiction of the U.S.
In addition, Irish law allows shareholders to authorize share capital which then can be issued by a board of directors without shareholder approval. Also, subject to specified exceptions, Irish law grants statutory preemptive rights to existing shareholders to subscribe for new issuances of shares for cash. At our annual meeting of shareholders, our shareholders authorized our Board of Directors to issue up to 33% of our issued ordinary shares and further authorized our Board of Directors to issue up to 5% of such shares for cash without first offering them to our existing shareholders. Both of these authorizations will expire after a certain period unless renewed by our shareholders, and we cannot guarantee that the renewal of these authorizations will always be approved. If the Directors' authority to issue ordinary shares is not renewed, then we may be limited in our ability to use our shares, for example, as consideration for acquisitions.
Changes in tax laws, regulations or treaties, changes in our status under the tax laws of many jurisdictions or adverse determinations by taxing authorities could increase our tax burden or otherwise affect our financial condition or operating results, as well as subject our shareholders to additional taxes.
The realization of any tax benefit related to our incorporation and tax residence in Ireland could be impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof by the tax authorities of many jurisdictions. From time to time, proposals have been made and/or legislation has been introduced to change the tax laws of various jurisdictions or limit tax treaty benefits that if enacted could materially increase our tax burden and/or our effective tax rate. For instance, recently enacted U.S. tax legislation could modify or eliminate the tax deductibility of various currently deductible payments, which could materially and adversely affect our effective tax rate and cash tax position. Moreover, other legislative proposals could have a material adverse impact on us by overriding certain tax treaties and limiting the treaty benefits on certain payments, which could increase our tax liability. We cannot predict the outcome of any specific legislation in any jurisdiction.
While we monitor proposals that would materially impact our tax burden and/or our effective tax rate and investigate our options, we could still be subject to increased taxation on a going forward basis no matter what action we undertake if certain proposals are enacted, certain tax treaties are amended and/or our interpretation of applicable tax law is challenged and determined to be incorrect. In particular, any changes and/or differing interpretations of applicable tax law that have the effect of disregarding our incorporation in Ireland, limiting our ability to take advantage of tax treaties between jurisdictions, modifying or eliminating the deductibility of various currently deductible payments or increasing the tax burden of operating or being resident in a particular country, could subject us to increased taxation.
Dividends received by our shareholders may be subject to Irish dividend withholding tax.
In certain circumstances, we are required to deduct Irish dividend withholding tax (20% prior to December 31, 2019, 25% thereafter) from dividends paid to our shareholders. In the majority of cases, shareholders residing in the U.S. will not be subject to Irish withholding tax, and shareholders resident in a number of other countries will not be subject to Irish withholding tax provided that they complete certain Irish dividend withholding tax forms. However, some shareholders may be subject to withholding tax, which could discourage the investment in our stock and adversely impact the price of our shares.
Dividends received by our shareholders could be subject to Irish income tax.
Dividends paid in respect of our shares generally are not subject to Irish income tax where the beneficial owner of these dividends is exempt from Irish dividend withholding tax, unless the beneficial owner of the dividend has some connection with Ireland other than his or her shareholding in Allegion.
Our shareholders who receive their dividends subject to Irish dividend withholding tax will generally have no further liability to Irish income tax on the dividends unless the beneficial owner of the dividend has some connection with Ireland other than his or her shareholding in Allegion.
Certain provisions in our Memorandum and Articles of Association, among other things, could prevent or delay an acquisition of us, which could decrease the trading price of our ordinary shares.
Our Memorandum and Articles of Association contains provisions to deter takeover practices, inadequate takeover bids and unsolicited offers. These provisions include, amongst others:
•
A provision of our Articles of Association which generally prohibits us from engaging in a business combination with an interested shareholder (being (i) the beneficial owner, directly or indirectly, of 10% or more of our voting shares or (ii) an affiliate or associate of us that has at any time within the last five years been the beneficial owner, directly or indirectly, of 10% or more of our voting shares), subject to certain exceptions;
•
Rules regarding how shareholders may present proposals or nominate directors for election at shareholder meetings;
•
The right of our Board of Directors to issue preferred shares without shareholder approval in certain circumstances, subject to applicable law; and
•
The ability of our Board of Directors to set the number of directors and to fill vacancies on our Board of Directors in certain circumstances.
We believe these provisions will provide some protection to our shareholders from coercive or otherwise unfair takeover tactics. These provisions are not intended to make us immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that our Board of Directors determines is in our best interests and our shareholders' best interests. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.
In addition, several mandatory provisions of Irish law could prevent or delay an acquisition of us. For example, Irish law does not permit shareholders of an Irish public limited company to take action by written consent with less than unanimous consent. We also will be subject to various provisions of Irish law relating to mandatory bids, voluntary bids, requirements to make a cash offer and minimum price requirements, as well as substantial acquisition rules and rules requiring the disclosure of interests in our shares in certain circumstances. Also, Irish companies, including us, may alter their Memorandum of Association and Articles of Association only with the approval of at least 75% of the votes of the company’s shareholders cast in person or by proxy at a general meeting of the company.
The agreements that we entered into with Ingersoll Rand in connection with the Spin-off generally require Ingersoll Rand’s consent to any assignment by us of our rights and obligations under the agreements. The consent and termination rights set forth in these agreements might discourage, delay or prevent a change of control that shareholders may consider favorable.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
We operate through a broad network of sales offices, engineering centers, 32 production and assembly facilities and several distribution centers throughout the world. Our active properties represent about 6.6 million square feet, of which approximately 39% is leased.
The majority of our plant facilities are owned by us with the remainder under long-term lease arrangements. We believe that our plants have been well maintained, are generally in good condition and are suitable for the conduct of our business.
Item 3. LEGAL PROCEEDINGS
In the normal course of business, we are involved in a variety of lawsuits, claims and legal proceedings, including commercial and contract disputes, employment matters, product liability claims, environmental liabilities, intellectual property disputes and tax-related matters. In our opinion, pending legal matters are not expected to have a material adverse impact on our results of operations, financial condition, liquidity or cash flows.
This item should be read in conjunction with the Company's Risk Factors in Part I, Item 1A for additional information.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
INFORMATION ABOUT OUR EXECUTIVE OFFICERS
The following is a list of executive officers of the Company as of February 18, 2020.
David D. Petratis, age 62, has served as our Chairman, President and Chief Executive Officer since 2013.
Patrick S. Shannon, age 57, has served as our Senior Vice President and Chief Financial Officer since 2013.
Jeffrey N. Braun, age 60, has served as our Senior Vice President and General Counsel since 2014, and Secretary since 2018.
Timothy P. Eckersley, age 58, has served as our Senior Vice President - Americas since 2013.
Tracy L. Kemp, age 51, has served as our Senior Vice President - Chief Customer and Digital Officer since 2019. Ms. Kemp served as our Senior Vice President and Chief Information Officer from 2015 to 2019.
Robert C. Martens, age 49, has served as our Senior Vice President - Chief Innovation and Design Officer since December 2019 and Futurist and President of Allegion Ventures since 2017. Mr. Martens served as Futurist of the Americas region and Director of Connectivity Platforms from 2014 to 2017.
Shelley A. Meador, age 48, has served as our Senior Vice President - Human Resources and Communications since 2016. Ms. Meador served as our Vice President - Tax from 2013 to 2016.
Lucia Veiga Moretti, age 55, has served as our Senior Vice President - EMEIA since 2014.
Chris E. Muhlenkamp, age 62, has served as our Senior Vice President - Global Operations and Integrated Supply Chain since 2014.
Douglas P. Ranck, age 61, has served as our Vice President, Controller and Chief Accounting Officer since 2013.
Vincent Wenos, age 53, has served as our Senior Vice President - Chief Technology Officer since 2019. Mr. Wenos served as our Vice President - Global Technology and Engineering from 2018 to 2019 and served as both our Vice President - Americas Engineering and Vice President - Global Mechanical Products from 2016 to 2018. Mr. Wenos previously served as Vice President - Global Product Development and Technology at Stanley Black & Decker, Inc. (a global diversified consumer and industrial products company).
Jeffrey M. Wood, age 49, has served as our Senior Vice President - Asia Pacific since 2017. Mr. Wood served as our Vice President, Global Supply Management from 2013 to 2017.
All above-listed officers except for Mr. Wenos have been employed by the Company for more than the past five years. No family relationship exists between any of the above-listed executive officers of the Company. All officers are elected to hold office for one year or until their successors are elected and qualified.
PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Information regarding the principal market for our ordinary shares and related shareholder matters is as follows:
Our ordinary shares are traded on the NYSE under the symbol ALLE. As of February 13, 2020, the number of record holders of ordinary shares was 2,430. Information regarding equity compensation plans required to be disclosed pursuant to this Item is incorporated by reference from our Proxy Statement.
Dividend Policy
Our Board of Directors declared dividends of $0.27 per ordinary share on February 6, 2019, April 4, 2019, September 5, 2019 and December 5, 2019. On February 6, 2020, our Board of Directors declared a dividend of $0.32 per ordinary share payable March 31, 2020. We paid a total of $100.6 million in cash for dividends to ordinary shareholders during the year ended December 31, 2019. Future dividends on our ordinary shares, if any, will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements and surplus, financial condition, contractual restrictions and other factors that the Board of Directors may deem relevant, as well as our ability to pay dividends in compliance with the Irish Companies Act. Under the Irish Companies Act, dividends and distributions may only be made from distributable reserves. Distributable reserves, broadly, means the accumulated realized profits of Allegion plc (ALLE-Ireland). In addition, no distribution or dividend may be made unless the net assets of ALLE-Ireland are equal to, or in excess of, the aggregate of ALLE-Ireland’s called up share capital plus undistributable reserves and the distribution does not reduce ALLE-Ireland’s net assets below such aggregate.
Issuer Purchases of Equity Securities
In February 2017, our Board of Directors approved a share repurchase authorization of up to $500 million of the Company's ordinary shares (the "2017 Share Repurchase Authorization"). Based on market conditions, share repurchases are made from time to time in the open market at the discretion of management. On February 6, 2020, the Company's Board of Directors approved a new share repurchase authorization of up to, and including, $800 million of the Company's ordinary shares (the "2020 Share Repurchase Authorization"), replacing the existing 2017 Share Repurchase Authorization. The 2020 Share Repurchase Authorization does not have a prescribed expiration date.
Performance Graph
The annual changes for the five-year period shown below are based on the assumption that $100 had been invested in Allegion plc ordinary shares, the Standard & Poor’s 500 Stock Index ("S&P 500") and the Standard & Poor's 400 Capital Goods Index ("S&P 400 Capital Goods") on December 31, 2014, and that all quarterly dividends were reinvested. The total cumulative dollar returns shown on the graph represent the value that such investments would have had on December 31, 2019.
Item 6. SELECTED FINANCIAL DATA (1)
In millions, except per share amounts:
(a)
Net earnings for the year ended December 31, 2019, includes a $31.4 million (net of tax) loss related to the divestitures of our business operations in Colombia and Turkey.
(b)
Net earnings for the year ended December 31, 2018, includes a $21.9 million tax benefit related to an adjustment to the provisional amounts previously recognized related to the enactment of the Tax Reform Act.
(c)
Net earnings for the year ended December 31, 2017, includes $44.7 million of costs related to the refinancing of our credit facilities and senior notes and a net tax charge of $53.5 million related to the Tax Reform Act.
(d)
Net earnings for the year ended December 31, 2016, includes $84.4 million of losses related to our previously divested Systems Integration business.
(e)
Net earnings from continuing operations for the year ended December 31, 2015, includes $104.2 million of losses related to the divestitures of our Venezuelan operations and our majority stake in our Systems Integration business.
(1) The Company has not restated 2015 - 2017 for the impact of the adoption of ASC Topic 606, "Revenue from Contracts with Customers" ("ASC 606") as of January 1, 2018, nor 2015 for the impact of the adoption of ASU 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" in the fourth quarter of 2016. The Company has also not restated the Total assets for 2015 - 2018 for the impact of the adoption of ASC Topic 842, "Leases" as of January 1, 2019. The impact of excluding the above standards in prior period presentation is not material.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A. Risk Factors in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our consolidated financial statements and the notes thereto, which appears elsewhere in this Annual Report.
Overview
Organization
We are a leading global provider of security products and solutions operating in three geographic regions: Americas, EMEIA and Asia Pacific. We sell a wide range of security products and solutions for end-users in commercial, institutional and residential markets worldwide, including the education, healthcare, government, hospitality, commercial office and single and multi-family residential markets. Our leading brands include CISA, Interflex, LCN, Schlage, SimonsVoss and Von Duprin.
Trends and Economic Events
The security products industry has benefited from accelerated growth in institutional, commercial and residential end-markets in recent years. We also expect the security products industry will benefit from favorable long-term demographic trends such as continued urbanization of the global population, increased concerns about safety and security and technology-driven innovation.
In recent years, growth in electronic security products and solutions continues to outperform mechanical products, and we expect growth in the global electronic security product and solution categories we serve to continue to outperform growth in mechanical products and solutions, as end-users adopt newer technologies in their facilities and homes.
The economic conditions discussed above and a number of other challenges and uncertainties that could affect our businesses are described under Part I, Item 1A, "Risk Factors."
2019 and 2018 Significant Events
Turkey Restructuring and Divestiture
In June 2019, the Company closed its production facility in Turkey to help streamline our footprint in EMEIA. Associated with this closure, we have incurred approximately $8.4 million of qualified restructuring expenses during 2019, which primarily relate to severance and other employee separation costs. We also incurred $4.3 million of non-qualified restructuring expenses during 2019, which represent costs that were directly attributable to the closure, but that did not fall into the severance, exit or disposal category.
During the fourth quarter of 2019, we sold certain of the former production assets of our Turkey facility for total proceeds of approximately $4.1 million. The Company recorded a loss on divestiture of $24.2 million ($25.5 million, net of tax), primarily driven by $25.0 million of cumulative currency translation adjustments previously deferred in equity that were reclassified into earnings upon sale.
Colombia Divestiture
During the fourth quarter of 2019, the Company sold its interests in its Colombia operations. As a result of the sale, the Company recorded a net loss on divestiture of $5.9 million, of which $1.2 million relates to cumulative currency translation adjustments previously deferred in equity that were reclassified into earnings upon sale.
Acquisitions
We completed six business acquisitions in 2018:
Total cash paid for these acquisitions was approximately $373 million (net of cash acquired), including $4.6 million during the year ended December 31, 2019. The incremental impact of these acquisitions for the twelve months ended December 31, 2018 was an increase in Net revenues of approximately $160.2 million and an increase in Operating income of approximately $2.8 million. During the years ended December 31, 2019 and 2018, we incurred $2.0 million and $10.0 million of acquisition and integration related expenses, respectively.
2019 Dividends
We paid quarterly dividends of $0.27 per ordinary share to shareholders on record as of March 15, 2019, June 14, 2019, September 16, 2019, and December 17, 2019. We paid a total of $100.6 million in cash for dividends to ordinary shareholders during the year ended December 31, 2019.
Financing activities
During the year ended December 31, 2019, the Company paid $226.0 million to repurchase 2.3 million ordinary shares on the open market under our 2017 Share Repurchase Authorization.
Additionally, in 2019, we issued $400.0 million of 3.500% Senior Notes due 2029 (the "3.500% Senior Notes"). Net proceeds from the issuance of the 3.500% Senior Notes, along with cash on hand, were utilized to make a $400.0 million principal payment to partially pay down the Company's outstanding term loan facility (the "Term Facility") balance. As a result of this payment, we have satisfied our obligation to make quarterly installments on the Term Facility up to its maturity date, with the remaining outstanding balance of $238.8 million due on September 12, 2022.
Results of Operations - For the years ended December 31
Net Revenues
Net revenues for the year ended December 31, 2019, increased by 4.5%, or $122.3 million, compared to the same period in 2018 due to the following:
The increase in Net revenues was primarily driven by higher volumes, improved pricing and incremental Net revenues from the acquisitions, less divestitures, discussed above. These increases were partially offset by unfavorable foreign currency exchange rate movements.
Net revenues for the year ended December 31, 2018, increased by 13.4%, or $323.5 million, compared to the same period in 2017 due to the following:
The increase in Net revenues was primarily driven by higher volumes in all segments, improved pricing, incremental Net revenues from the acquisitions discussed above and favorable foreign currency exchange rate movements relative to the U.S. Dollar.
Cost of Goods Sold
For the year ended December 31, 2019, Cost of goods sold as a percentage of Net revenues decreased to 56.1% from 57.0% due to the following:
Costs of goods sold as a percentage of Net revenues for the year ended December 31, 2019, decreased due to pricing and productivity in excess of inflation. This decrease was partially offset by the impact of volume/product mix, the impact of the acquisitions and divestitures discussed above, unfavorable foreign currency exchange rate movements and increased restructuring and acquisition costs.
For the year ended December 31, 2018, Cost of goods sold as a percentage of Net revenues increased to 57.0% from 55.4% due to the following:
Costs of goods sold as a percentage of Net revenues for the year ended December 31, 2018, increased primarily due to inflation in excess of pricing and productivity, the impact of acquisitions and increased investment spending. These increases were partially offset by favorable foreign currency exchange rate movements, favorable product mix and volume and decreased restructuring and acquisition costs.
Selling and Administrative Expenses
For the year ended December 31, 2019, Selling and administrative expenses as a percentage of Net revenues increased to 24.1% from 23.7% due to the following:
Selling and administrative expenses as a percentage of Net revenues for the year ended December 31, 2019, increased primarily due to inflation in excess of productivity benefits, the impact of the acquisitions and divestitures discussed above, increased investment spending, higher restructuring and acquisition costs and trade name impairment charges recorded during 2019. These increases were partially offset by favorable leverage due to increased volume and foreign currency exchange rate movements.
For the year ended December 31, 2018, Selling and administrative expenses as a percentage of Net revenues decreased to 23.7% from 24.1% due to the following:
Selling and administrative expenses as a percentage of Net revenues for the year ended December 31, 2018, decreased primarily due to favorable leverage due to increased volume and the impact of acquisitions. These decreases were partially offset by inflation in excess of productivity benefits and increased investment spending.
Operating Income/Margin
Operating income for the year ended December 31, 2019, increased $39.3 million from the same period in 2018, and Operating margin increased to 19.8% from 19.2%, due to the following:
Operating income increased due to pricing and productivity in excess of inflation and favorable volume/product mix. These increases were partially offset by unfavorable foreign currency exchange rate movements, the impact of acquisitions and divestitures, increased investment spending, higher restructuring and acquisition costs and trade name impairment charges recorded during 2019.
Operating margin increased primarily due to pricing and productivity in excess of inflation and favorable volume/product mix. These increases were partially offset by the impact of acquisitions and divestitures, increased investment spending, higher restructuring and acquisition costs and trade name impairment charges recorded during 2019.
Operating income for the year ended December 31, 2018, increased $33.3 million from the same period in 2017, and Operating margin decreased to 19.2% from 20.5%, due to the following:
Operating income increased due to favorable volume/product mix in all segments, foreign currency exchange rate movements, the impact of acquisitions and lower restructuring and acquisition costs. These increases were partially offset by inflation in excess of pricing and productivity and increased investment spending.
Operating margin decreased primarily due to inflation in excess of pricing and productivity, increased investment spending and lower margins from acquisitions made during 2018. These decreases were partially offset by favorable volume/product mix and lower restructuring and acquisition costs.
Interest Expense
Interest expense for the year ended December 31, 2019, increased $2.0 million compared to the same period of 2018, primarily due to a $2.7 million charge related to the write-off of previously deferred financing costs related to our Term Facility. This charge was recognized in conjunction with a $400.0 million principal payment to partially pay down the outstanding Term Facility balance in 2019.
Interest expense for the year ended December 31, 2018, decreased $51.7 million compared to the same period of 2017, primarily due to $44.7 million of costs in 2017 associated with the refinancing of our Credit Facilities, issuance of our 3.200% and 3.550% Senior Notes and redemption of our previously outstanding senior notes in 2017. Lower interest rates on our outstanding indebtedness also contributed to the decrease in Interest expense.
Loss on Divestitures
During the year ended December 31, 2019, we recorded a Loss on divestitures of $30.1 million related to the divestitures of our business operations in Colombia and Turkey.
In June 2019, we closed our production facility in Turkey and subsequently sold certain of the production assets thereof for total proceeds of approximately $4.1 million. We recorded a loss on divestiture of $24.2 million ($25.5 million, net of tax), primarily driven by $25.0 million of cumulative currency translation adjustments previously deferred in equity that were reclassified to earnings upon sale.
Additionally, during the fourth quarter of 2019, we sold our interests in our Colombia operations for an immaterial amount. As a result of the sale, we recorded a net loss on divestiture of $5.9 million, of which $1.2 million relates to cumulative currency translation adjustments previously deferred in equity that were reclassified to earnings upon sale.
Neither of these divestitures is expected to have a material impact on our future results of operations or cash flows.
Other Expense (Income), net
The components of Other expense (income), net, for the years ended December 31 were as follows:
For the year ended December 31, 2019, Other expense (income), net was unfavorable $7.2 million compared to 2018, due primarily to an unfavorable change in Net periodic pension and postretirement benefit cost (income), less service cost, of $9.6 million. This increase in expense was partially offset by investment income of $3.1 million during 2019, which is included within Other in the table above.
For the year ended December 31, 2018, Other income, net decreased by $5.5 million compared with the same period in 2017 due to a cumulative gain of $5.4 million from the sale of iDevices, LLC and gains of $7.3 million related to legal entity liquidations in our Asia Pacific region, of which $2.2 million was attributed to noncontrolling interests, in 2017, neither of which recurred in 2018. These decreases were partially offset by Net periodic pension and postretirement benefit income, less service cost of $2.8 million in 2018, compared to Net periodic pension and postretirement benefit cost, less service cost of $4.3 million in 2017.
Provision for Income Taxes
On December 22, 2017, the President of the United States signed comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Reform Act”). The Tax Reform Act makes broad and complex changes to the U.S. tax code which impacted our years ended December 31, 2019, 2018 and 2017, including, but not limited to (1) reducing the U.S. federal corporate
tax rate, (2) requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, and (3) requiring a review of the future realizability of deferred tax balances.
For the year ended December 31, 2019, our effective tax rate was 15.4%, compared to 8.4% for the year ended December 31, 2018. The increase in the effective tax rate was primarily driven by the favorable benefit related to the Tax Reform Act recorded in 2018 and the tax costs associated with divestitures in 2019.
For the year ended December 31, 2018, our effective tax rate was 8.4%, compared to 30.1% for the year ended December 31, 2017. The effective income tax rate for the year ended December 31, 2018 was positively impacted by guidance related to the Tax Reform Act and the reduction in the US statutory tax rate from 35% to 21%. The effective income tax rate for the year ended December 31, 2017 was negatively impacted by the enactment of the Tax Reform Act, which was partially offset by a release of valuation allowances.
Review of Business Segments
We operate in and report financial results for three segments: Americas, EMEIA and Asia Pacific. These segments represent the level at which our chief operating decision maker reviews company financial performance and makes operating decisions.
Segment operating income is the measure of profit and loss that our chief operating decision maker uses to evaluate the financial performance of the business and as the basis for resource allocation, performance reviews and compensation. For these reasons, we believe that Segment operating income represents the most relevant measure of Segment profit and loss. Our chief operating decision maker may exclude certain charges or gains, such as corporate charges and other special charges, to arrive at a Segment operating income that is a more meaningful measure of profit and loss upon which to base our operating decisions. We define Segment operating margin as Segment operating income as a percentage of the segment's Net revenues.
The segment discussions that follow describe the significant factors contributing to the changes in results for each segment included in Net earnings.
Segment Results of Operations - For the years ended December 31
Americas
Our Americas segment is a leading provider of security products and solutions in approximately 30 countries throughout North America, Central America, the Caribbean and South America. The segment sells a broad range of products and solutions including, locks, locksets, portable locks, key systems, door closers, exit devices, doors and door systems, electronic products and access control systems to end-users in commercial, institutional and residential facilities, including the education, healthcare, government, hospitality, commercial office and single and multi-family residential markets. This segment’s primary brands are LCN, Schlage, Steelcraft and Von Duprin.
2019 vs 2018
Net revenues
Net revenues for the year ended December 31, 2019, increased by 6.3%, or $125.9 million, compared to the same period in 2018, due to the following:
The increase in Net revenues is primarily due to higher volumes, improved pricing and acquisitions during the prior year. These increases were partially offset by unfavorable foreign currency exchange rate movements. Net revenues from non-residential products for the year ended December 31, 2019, increased high single digits compared to the prior year. Net revenues from residential products for the year ended December 31, 2019, increased mid-single digits compared to the prior year.
Operating income/margin
Segment operating income for the year ended December 31, 2019, increased $67.1 million, and Segment operating margin increased to 28.9% from 27.4% compared to the same period in 2018, due to the following:
The increases were primarily due to pricing improvements and productivity in excess of inflation, favorable volume/product mix and decreased restructuring and acquisition costs. These increases were partially offset by increased investment spending, the impact of acquisitions made during 2018 and unfavorable foreign currency exchange rate movements.
2018 vs 2017
Net revenues
Net revenues for the year ended December 31, 2018, increased by 12.5%, or $221.1 million, compared to the same period in 2017, due to the following:
The increase in Net revenues is due to higher volumes, improved pricing and acquisitions made during 2018. Net revenues from non-residential products for the year ended December 31, 2018, increased mid-teens compared to the prior year, primarily driven by higher volumes, improved pricing and acquisitions made during 2018. Net revenues from residential products for the year ended December 31, 2018, increased mid-single digits compared to the prior year.
Operating income/margin
Segment operating income for the year ended December 31, 2018, increased $36.0 million, and Segment operating margin decreased to 27.4% from 28.8% compared to the same period in 2017, due to the following:
Operating income increased primarily due to favorable volume/product mix, favorable foreign currency exchange rate movements, acquisitions made during 2018 and year-over-year decreases in restructuring and acquisition costs. These increases were partially offset by inflation in excess of pricing and productivity and increased investment spending.
Operating margin decreased primarily due to inflation in excess of pricing and productivity, increased investment spending and lower margins from acquisitions. These decreases were partially offset by favorable volume/product mix, favorable foreign currency exchange rate movements and year-over-year decreases in restructuring and acquisition costs.
EMEIA
Our EMEIA segment provides security products and solutions in approximately 85 countries throughout Europe, the Middle East, India and Africa. The segment offers end-users a broad range of products, services and solutions including, locks, locksets, portable locks, key systems, door closers, exit devices, doors and door systems, electronic products and access control systems, as well as time and attendance and workforce productivity solutions. This segment’s primary brands are AXA, Bricard, Briton, CISA, Interflex and SimonsVoss. This segment also resells LCN, Schlage and Von Duprin products, primarily in the Middle East.
2019 vs 2018
Net revenues
Net revenues for the year ended December 31, 2019, decreased by 2.9%, or $17.4 million, compared to the same period in 2018, due to the following:
The decrease in Net revenues is primarily due to unfavorable foreign currency exchange movements and the impact of acquisitions and divestitures. These decreases were partially offset by higher volumes and improved pricing in the current year.
Operating income/margin
Segment operating income for the year ended December 31, 2019, decreased $15.0 million, and Segment operating margin decreased to 6.0% from 8.4% compared to the same period in 2018, due to the following:
Operating income decreased due to unfavorable foreign currency exchange rate movements, the impact of acquisitions and divestitures, increased investment spending, year-over-year increases in restructuring and acquisitions costs and a trade name impairment charge recorded during 2019. These decreases were partially offset by pricing improvements and productivity in excess of inflation and favorable volume/product mix.
Operating margin decreased due to unfavorable foreign currency exchange rate movements, increased investment spending, year-over-year increases in restructuring and acquisitions costs and a trade name impairment charge recorded during 2019. These decreases were partially offset by pricing improvements and productivity in excess of inflation and favorable volume/product mix.
2018 vs 2017
Net revenue
Net revenues for the year ended December 31, 2018, increased by 12.7%, or $66.4 million, compared to the same period in 2017, due to following:
The increase in Net revenues is due to higher volumes, improved pricing, favorable foreign currency exchange rate movements and the impact of an acquisition made during 2018.
Operating income/margin
Segment operating income for the year ended December 31, 2018, increased $5.2 million, while Segment operating margin remained consistent at 8.4% in 2018, due to the following:
Operating income increased due to favorable volume/product mix, pricing improvements and productivity in excess of inflation, favorable foreign currency exchange rate movements and year-over-year decreases in restructuring and acquisition costs. These increases were partially offset by increased investment spending and the impact of an acquisition made during 2018.
Operating margin was unchanged year-over-year at 8.4%. Improvements due to favorable volume/product mix, foreign currency exchange rate movements and year-over-year changes in restructuring and acquisition costs were offset by lower pricing improvements and productivity in excess of inflation, increased investment spending and lower margins from an acquisition made during 2018.
Asia Pacific
Our Asia Pacific segment provides security products, services and solutions in approximately 15 countries throughout the Asia Pacific region. The segment offers end-users a broad range of products, services and solutions including, locks, locksets, portable locks, key systems, door closers, exit devices, electronic products and access control systems. This segment’s primary brands are Brio, Briton, FSH, Gainsborough, Legge, Milre and Schlage.
2019 vs 2018
Net revenues
Net revenues for the year ended December 31, 2019, increased by 9.0%, or $13.8 million, compared to the same period in 2018, due to the following:
The increase in Net revenues was due to an acquisition in the prior year. This increase was partially offset by unfavorable foreign currency exchange rate movements and lower volumes and pricing.
Operating income/margin
Segment operating income for the year ended December 31, 2019, decreased $6.4 million, and Segment operating margin decreased to 0.3% from 4.5% compared to the same period in 2018, due to the following:
Operating income decreased due to unfavorable volume/product mix, foreign currency exchange rate movements, increased investment spending and a trade name impairment charge recorded during 2019. These decreases were partially offset by pricing improvements and productivity in excess of inflation, which includes a $1.1 million recovery of previously remitted non-income taxes, and an acquisition during the prior year.
Operating margin decreased due to unfavorable volume/product mix, increased investment spending, lower margins from an acquisition during the prior year and a trade name impairment charge recorded during 2019. These decreases were partially offset by pricing improvements and productivity in excess of inflation.
2018 vs 2017
Net revenues
Net revenues for the year ended December 31, 2018, increased by 30.7%, or $36.0 million, compared with the same period in 2017, due to the following:
The increase in Net revenues was primarily due to an acquisition made during 2018 and higher volumes. These increases were partially offset by unfavorable foreign currency exchange rate movements and slightly lower pricing.
Operating income/margin
Segment operating income for the year ended December 31, 2018, decreased $2.6 million, and Segment operating margin decreased to 4.5% from 8.1% compared with the same period in 2017, due to the following:
Operating income decreased due to unfavorable volume/product mix, unfavorable foreign currency exchange rate movements, increased investment spending and year-over-year increases in restructuring and acquisition costs. These decreases were partially offset by pricing and productivity improvements in excess of inflation and an acquisition made during 2018.
Operating margin decreased due to unfavorable volume/product mix, unfavorable foreign currency exchange rate movements, increased investment spending, lower margins from an acquisition made during 2018 and year-over-year increases in restructuring and acquisition expenses. These decreases were partially offset by pricing and productivity improvements in excess of inflation.
Liquidity and Capital Resources
Sources and uses of liquidity
Our primary source of liquidity is cash provided by operating activities. Cash provided by operating activities is used to invest in new product development, fund capital expenditures and fund working capital requirements and is expected to be adequate to service any future debt, pay any declared dividends and potentially fund acquisitions and share repurchases. Our ability to fund these capital needs depends on our ongoing ability to generate cash from our operating activities and to access our borrowing facilities (including unused availability under our Revolving Facility) and capital markets. We believe that our future cash provided by operating activities, availability under our Revolving Facility and access to funds on hand and capital markets will provide adequate resources to fund our operating and financing needs.
The following table reflects the major categories of cash flows for the years ended December 31. For additional details, please see the Consolidated Statements of Cash Flows in the Consolidated Financial Statements.
Operating activities
Net cash provided by operating activities for the year ended December 31, 2019, increased $30.4 million compared to 2018, primarily driven by changes in working capital.
Net cash provided by operating activities for the year ended December 31, 2018, increased $110.6 million compared to 2017. This increase was primarily due to higher Net earnings in 2018 and a discretionary $50.0 million contribution to the U.S. qualified defined benefit pension plan in 2017, partially offset by changes in working capital and an increase in cash paid for taxes.
Investing activities
Net cash used in investing activities for the year ended December 31, 2019, decreased $366.2 million compared to 2018. The decrease is primarily due to a $368.5 million reduction in cash payments related to acquisitions and equity investments in businesses, as well as the purchase of $14.3 million of investments during the year ended December 31, 2018, which did not recur in 2019. These decreases were partially offset by an increase in capital expenditures of $16.5 million during 2019 compared to 2018.
Net cash used in investing activities for the year ended December 31, 2018, increased $393.6 million compared to 2017. The increase is primarily due to $376.1 million of cash payments related to acquisitions and equity investments in businesses during 2018, compared to $20.8 million for an acquisition in 2017. Additionally contributing to the increase in Net cash used in investing activities was the purchase of $14.3 million of investments during the year ended December 31, 2018 and the sale of an equity investment during 2017, which resulted in an investing cash inflow of $15.6 million that did not recur in 2018.
Financing activities
Net cash used in financing activities for the year ended December 31, 2019, increased $158.8 million compared to 2018. The increase is primarily due to increases of $158.7 million in share repurchases and $21.2 million in dividend payments year-over-year. Partially offsetting these increases was an $18.2 million decrease in debt repayments, net, compared to 2018.
Net cash used in financing activities for the year ended December 31, 2018, increased $32.5 million compared to 2017. The increase is primarily due to an increase in dividend payments of $18.5 million year-over-year. Additionally, during the year ended December 31, 2018, we repurchased $67.3 million of common shares, compared to $60.0 million during 2017.
Capitalization
At December 31, long-term debt and other borrowings consisted of the following:
As of December 31, 2019, we have an unsecured Credit Agreement in place, consisting of a $700.0 million term loan facility (the “Term Facility”), of which $238.8 million is outstanding at December 31, 2019, and a $500.0 million revolving credit facility (the “Revolving Facility” and, together with the Term Facility, the “Credit Facilities”). The Credit Facilities mature on September 12, 2022.
At inception, the Term Facility was scheduled to amortize in quarterly installments at the following rates: 1.25% per quarter starting December 31, 2017 through December 31, 2020, 2.5% per quarter from March 31, 2021 through June 30, 2022, with the balance due on September 12, 2022. Principal amounts repaid on the Term Facility may not be reborrowed. During the year ended December 31, 2019, we made a $400.0 million principal payment to partially pay down the outstanding Term Facility balance, utilizing all of the net proceeds from the issuance of the 3.500% Senior Notes, plus cash on hand. As a result of this payment, we
have satisfied our obligation to make quarterly installments on the Term Facility up to the maturity date, with the remaining outstanding balance due on September 12, 2022.
The Revolving Facility provides aggregate commitments of up to $500.0 million, which includes up to $100.0 million for the issuance of letters of credit. At December 31, 2019, there were no borrowings outstanding on the Revolving Facility, and we had $16.3 million of letters of credit outstanding. Commitments under the Revolving Facility may be reduced at any time without premium or penalty, and amounts repaid may be reborrowed.
Outstanding borrowings under the Credit Facilities accrue interest at our option of (i) a LIBOR rate plus the applicable margin or (ii) a base rate plus the applicable margin. The applicable margin ranges from 1.125% to 1.500% depending on our credit ratings. To manage our exposure to fluctuations in LIBOR rates, we have interest rate swaps to fix the interest rate for $200.0 million of the outstanding borrowings as of December 31, 2019 (see Note 10 to the Consolidated Financial Statements).
As of December 31, 2019, we also have $400.0 million outstanding of 3.200% Senior Notes due 2024 (the “3.200% Senior Notes”) and $400.0 million outstanding of 3.550% Senior Notes due 2027 (the “3.550% Senior Notes”). The 3.200% Senior Notes and 3.550% Senior Notes require semi-annual interest payments on April 1 and October 1 of each year and will mature on October 1, 2024, and October 1, 2027, respectively. Additionally, during the year ended December 31, 2019, we issued $400.0 million aggregate principal amount of our 3.500% Senior Notes due 2029 (the "3.500% Senior Notes). The 3.500% Senior Notes require semi-annual interest payments on April 1 and October 1, beginning April 1, 2020, and will mature on October 1, 2029. Net proceeds from the issuance of the 3.500% Senior Notes, along with cash on hand, were utilized to make the $400.0 million principal payment on the Term Facility discussed above.
Historically, the majority of our earnings were considered to be permanently reinvested in jurisdictions where we have made, and intend to continue to make, substantial investments to support the ongoing development and growth of our global operations. At December 31, 2019, we have analyzed our working capital requirements and the potential tax liabilities that would be incurred if certain subsidiaries made distributions and concluded that no material changes to our historic permanent reinvestment assertions are required.
Pension Plans
Our investment objective in managing defined benefit plan assets is to ensure that all present and future benefit obligations are met as they come due. We seek to achieve this goal while trying to mitigate volatility in plan funded status, contributions and expense by better matching the characteristics of the plan assets to that of the plan liabilities. Global asset allocation decisions are based on a dynamic approach whereby a plan's allocation to fixed income assets increases as the funded status increases. We monitor plan funded status, asset allocation and the impact of market conditions on our defined benefit plans regularly in addition to investment manager performance. None of our defined benefit pension plans have experienced a significant impact on their liquidity due to volatility in the markets. For further details on pension plan activity, see Note 12 to the Consolidated Financial Statements.
Contractual Obligations
The following table summarizes our contractual cash obligations by required payment periods:
Future interest payments on variable rate long-term debt are estimated based on the rate in effect as of December 31, 2019. Future expected obligations under our pension and postretirement benefit plans, income taxes, environmental and product liability matters have not been included in the contractual cash obligations table above.
Pensions
At December 31, 2019, we had net pension liabilities of $35.0 million, which consist of plan assets of $710.5 million and benefit obligations of $745.5 million. It is our objective to contribute to our pension plans in order to ensure adequate funds are available in the plans to make benefit payments to plan participants and beneficiaries when required. At December 31, 2019, the funded
status of our qualified pension plan for U.S. employees increased to 93.5% from 93.1% at December 31, 2018. The funded status for our non-U.S. pension plans increased to 101.1% at December 31, 2019 from 98.7% at December 31, 2018. The funded status for all of our pension plans at December 31, 2019 increased to 95.3% from 94.1% at December 31, 2018. We currently project that approximately $11.5 million will be contributed to our plans worldwide in 2020. Because the timing and amounts of long-term funding requirements for pension obligations are uncertain, they have been excluded from the preceding table. See Note 12 to the Consolidated Financial Statements for additional information.
Postretirement Benefits Other than Pensions ("OPEB")
At December 31, 2019, we had postretirement benefit obligations of $6.8 million. We fund OPEB costs principally on a pay-as-you-go basis as medical costs are incurred by covered retiree populations. Benefit payments, which are net of expected plan participant contributions and Medicare Part D subsidies, are not expected to be material in 2020. Because the timing and amounts of long-term funding requirements for OPEB obligations are uncertain, they have been excluded from the preceding table.
Income Taxes
At December 31, 2019, we have total unrecognized tax benefits for uncertain tax positions of $37.3 million and $6.2 million of related accrued interest and penalties, net of tax. These liabilities have been excluded from the preceding table as we are unable to reasonably estimate the amount and period in which these liabilities might be paid. See Note 18 to the Consolidated Financial Statements for additional information regarding matters relating to income taxes, including unrecognized tax benefits and tax authority disputes.
Contingent Liabilities
We are involved in various litigation, claims and administrative proceedings, including those related to environmental, asbestos-related and product liability matters. We believe that these liabilities are subject to the uncertainties inherent in estimating future costs for contingent liabilities and will likely be resolved over an extended period of time. Because the timing and amounts of potential future cash flows are uncertain, they have been excluded from the preceding table. See Note 21 to the Consolidated Financial Statements for additional information.
Critical Accounting Policies
Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with those accounting principles requires management to use judgment in making estimates and assumptions based on the relevant information available at the end of each period. These estimates and assumptions have a significant effect on reported amounts of assets and liabilities, revenues and expenses as well as the disclosure of contingent assets and liabilities because they result primarily from the need to make estimates and assumptions on matters that are inherently uncertain. Actual results may differ from estimates. If updated information or actual amounts are different from previous estimates, the revisions are included in our results for the period in which they become known.
The following is a summary of certain accounting estimates and assumptions made by management that we consider critical:
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Goodwill and indefinite-lived intangible assets - We have significant goodwill and indefinite-lived intangible assets on our Consolidated Balance Sheets related to previous business combinations. Our goodwill and other indefinite-lived intangible assets are tested annually during the fourth quarter for impairment or when there is a significant change in events or circumstances that indicate the fair value of an asset is more likely than not less than the carrying amount of the asset.
Recoverability of goodwill is measured at the reporting unit level and starts with a comparison of the carrying amount of a reporting unit to its estimated fair value. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. To the extent that the carrying value of a reporting unit exceeds its estimated fair value, a goodwill impairment charge will be recognized for the amount by which the carrying value of the reporting unit exceeds its fair value, not to exceed the carrying amount of goodwill of the reporting unit.
As quoted market prices are not available for our reporting units, the calculation of their estimated fair values is based on two valuation techniques, a discounted cash flow model (income approach) and a market multiple of earnings (market approach), with each method being weighted in the calculation. The income approach relies on the Company’s estimates of revenue growth rates, margin assumptions and discount rates to estimate future cash flows and explicitly addresses factors such as timing, with due consideration given to forecasting risk. The market approach requires the determination of an appropriate peer group, which is utilized to derive estimated fair values of our reporting units based on selected market
multiples. The market approach reflects the market’s expectations for future growth and risk, with adjustments to account for differences between the selected peer group companies and the subject reporting units.
The estimated fair values for each of our reporting units exceeded their carrying values by more than 15% for the 2019 goodwill impairment test. Assessing the fair value of our reporting units includes, among other things, making key assumptions for estimating future cash flows and appropriate market multiples. These assumptions are subject to a high degree of judgment and complexity. We make every effort to estimate future cash flows as accurately as possible with the information available at the time the forecast is developed. However, changes in assumptions and estimates may affect the estimated fair value of the reporting unit and could result in impairment charges in future periods. Factors that have the potential to create variances in the estimated fair value of the reporting unit include, but are not limited to, the following:
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Decreases in estimated market sizes or market growth rates due to greater-than-expected declines in volumes, pricing pressures or disruptive technology;
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Declines in our market share and penetration assumptions due to increased competition or an inability to develop or launch new products;
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The impacts of market volatility, including greater-than-expected declines in pricing, reductions in volumes or fluctuations in foreign exchange rates;
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The level of success of on-going and future research and development efforts, including those related to recent acquisitions, and increases in the research and development costs necessary to obtain regulatory approvals and launch new products;
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Increases in the price or decreases in the availability of key commodities and the impact of higher energy prices; and
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Increases in our market-participant risk-adjusted weighted-average cost of capital.
Other Indefinite-lived intangible assets - Recoverability of indefinite-lived intangible assets is determined on a relief from royalty methodology, which is based on the implied royalty paid, at an appropriate discount rate, to license the use of an asset rather than owning the asset. The present value of the after-tax cost savings (i.e. royalty relief) indicates the estimated fair value of the asset. Any excess of the carrying value over the estimated fair value is recognized as an impairment loss equal to that excess. Based on the result of our 2019 impairment testing, it was determined that two of our indefinite-lived trade names were impaired. Accordingly, an impairment charge of $5.9 million was recorded in the fourth quarter of 2019 (see Note 6 to the Consolidated Financial Statements for additional information).
A significant increase in the discount rate, decrease in the long-term growth rate, decrease in the royalty rate or substantial reductions in our end-markets and volume assumptions could have a negative impact on the estimated fair values of any of our indefinite-lived intangible assets. The estimates of fair value are based on the best information available as of the date of the assessment, which primarily incorporates management assumptions about expected future cash flows.
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Revenue recognition - Net revenues are recognized based on the satisfaction of performance obligations under the terms of a contract. A performance obligation is a promise in a contract to transfer control of a distinct product or to provide a service, or a bundle of products or services, to a customer, and is the unit of account under ASC 606, "Revenues from Contracts with Customers". We have two principal revenue streams, tangible product sales and services. Approximately 99% of consolidated Net revenues involve contracts with a single performance obligation, the transfer of control of a product or bundle of products to a customer. Transfer of control typically occurs when goods are shipped from our facilities or at other predetermined control transfer points (for instance, destination terms). Net revenues are measured as the amount of consideration we expect to receive in exchange for transferring control of the products and takes into account variable consideration, such as sales incentive programs, including discounts and volume rebates. The existence of these programs does not preclude revenue recognition but does require our best estimate of the variable consideration to be made based on expected activity, as these items are reserved for as a deduction to Net revenues over time based on our historical rates of providing these incentives and annual forecasted sales volumes.
Our remaining Net revenues involve services, including installation and consulting. Unlike the single performance obligation to ship a product or bundle of products, revenue recognition related to services revenues is delayed until the service based performance obligations are satisfied. In some instances, customer acceptance provisions are included in sales arrangements to give the buyer the ability to ensure the service meets the criteria established in the order. In these instances, revenue recognition is deferred until the performance obligations are satisfied, which could include acceptance terms specified in the arrangement being fulfilled through customer acceptance or a demonstration that established criteria have been satisfied.
We do not adjust the transaction price for the effects of a significant financing component, as the time period between control transfer of goods and services is less than one year. Sales, value-added and other similar taxes collected by us are excluded from Net revenues. We also have elected to account for shipping and handling activities that occur after control
of the related goods transfers as fulfillment activities instead of performance obligations. Our payment terms are generally consistent with the industries in which our businesses operate.
Sales returns and customer disputes involving a question of quantity or price are accounted for as variable consideration, and therefore, as a reduction in revenue and a contra receivable. All other incentives or incentive programs where the customer is required to reach a certain level of purchases, remain a customer for a certain period, provide a rebate form or is subject to additional requirements are also considered variable consideration and are accounted for as a reduction of revenue and a liability. Variable consideration is estimated based on the most likely amount we expect to receive from customers. Each of these accruals represents the Company’s best estimate of the most likely amount expected to be received from customers based on historical experience. These estimates are reviewed regularly for accuracy. If updated information or actual amounts are different from previous estimates, the revisions are included in the Company’s results for the period in which they become known. Historically, the aggregate differences, if any, between the Company’s estimates and actual amounts in any year have not had a material impact on the Consolidated Financial Statements. We also offer a standard warranty with most product sales, and the value of such warranty is included in the contractual price. The corresponding cost of the warranty obligation is accrued as a liability (see Note 21).
•
Income taxes - We account for income taxes in accordance with ASC Topic 740. Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. We recognize future tax benefits, such as net operating losses and non-U.S. tax credits, to the extent that realizing these benefits is considered in our judgment to be more likely than not. We regularly review the recoverability of our deferred tax assets considering our historic profitability, projected future taxable income, timing of the reversals of existing temporary differences and the feasibility of our tax planning strategies. Where appropriate, we record a valuation allowance with respect to future tax benefits.
The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which we operate. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and tax balances recorded by us. In addition, tax authorities periodically review income tax returns filed by us and can raise issues regarding our filing positions, timing and amount of income or deductions and the allocation of income among the jurisdictions in which we operate. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a revenue authority with respect to that return. We believe that we have adequately provided for any reasonably foreseeable resolution of these matters. We will adjust our estimates if significant events so dictate. To the extent that the ultimate results differ from our original or adjusted estimates, the effect will be recorded in the provision for income taxes in the period that the matter is finally resolved.
•
Employee benefit plans - We provide a range of benefits to eligible employees and retirees, including pensions, postretirement and postemployment benefits. Determining the cost associated with such benefits is dependent on various actuarial assumptions including discount rates, expected return on plan assets, compensation increases, employee mortality, turnover rates and healthcare cost trend rates. Actuarial valuations are performed to determine expense in accordance with GAAP. Actual results may differ from the actuarial assumptions and are generally accumulated into Accumulated other comprehensive loss and amortized into earnings over future periods.
We review our actuarial assumptions at each measurement date and make modifications to the assumptions based on current rates and trends, if appropriate. The discount rate, the rate of compensation increase and the expected long-term rates of return on plan assets are determined as of each measurement date. Discount rates for all plans are established using hypothetical yield curves based on the yields of corporate bonds rated AA quality. Spot rates are developed from the yield curve and used to discount future benefit payments. The rate of compensation increase is dependent on expected future compensation levels. The expected long-term rate of return on plan assets reflects the average rate of returns expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation. The expected long-term rate of return on plan assets is based on what is achievable given the plan’s investment policy, the types of assets held and the target asset allocation. The expected long-term rate of return is determined as of each measurement date.
We believe the assumptions utilized in recording our obligations under our plans are reasonable based on input from our actuaries, outside investment advisors and information as to assumptions used by plan sponsors.
Changes in any of the assumptions can have an impact on the net periodic pension and postretirement benefit cost. Estimated sensitivities to the expected 2020 net periodic pension benefit cost of a 0.25% rate decline in the two basic assumptions are as follows: the decline in the discount rate would increase expense by approximately $0.9 million and the decline in the estimated return on assets would increase expense by approximately $0.7 million.
•
Business combinations - The fair value of the consideration paid in a business combination is allocated to the tangible and identifiable intangible assets acquired, liabilities assumed and goodwill. Acquired intangible assets primarily include indefinite-lived trade names, customer relationships and completed technologies. The accounting for acquisitions involves a considerable amount of judgment and estimation, including the fair value of acquired intangible assets involving projections of future revenues and cash flows that are either discounted at an estimated discount rate or measured at an estimated royalty rate; fair value of other acquired assets and assumed liabilities, including potential contingencies; and the useful lives of the acquired assets. The assumptions used to determine the fair value of acquired intangible assets include projections developed using internal forecasts, available industry and market data, estimates of long-term growth rates, profitability, customer attrition and royalty rates, which are determined at the time of the business combination. The Company uses an income approach or market approach (or both) in accordance with accepted valuation models for each acquired intangible asset to determine the fair value. The impact of prior or future business combinations on our financial condition or results of operations may be materially impacted by the change in or initial selection of assumptions and estimates.
Recent Accounting Pronouncements
See Note 2 to our Consolidated Financial Statements included in Item 8 herein for a discussion of recently issued and adopted accounting pronouncements.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to fluctuations in currency exchange rates, interest rates and commodity prices which could impact our results of operations and financial condition.
Foreign Currency Exposures
We have operations throughout the world that manufacture and sell products in various international markets. As a result, we are exposed to movements in exchange rates of various currencies against the U.S. dollar as well as against other currencies throughout the world. We actively manage material currency exposures that are associated with purchases and sales and other assets and liabilities at the legal entity level; however, we do not hedge currency translation risk. We attempt to hedge exposures that cannot be naturally offset to an insignificant amount with foreign currency derivatives. Derivative instruments utilized by us in our hedging activities are viewed as risk management tools, involve little complexity and are not used for trading or speculative purposes. To minimize the risk of counter party non-performance, derivative instrument agreements are made only through major financial institutions with significant experience in such derivative instruments.
We evaluate our exposure to changes in currency exchange rates on our foreign currency derivatives using a sensitivity analysis. The sensitivity analysis is a measurement of the potential loss in fair value based on a percentage change in exchange rates. Based on the firmly committed currency derivative instruments in place at December 31, 2019, a hypothetical change in fair value of those derivative instruments assuming a 10% adverse change in exchange rates would result in an additional unrealized loss of approximately $12.7 million. This amount, when realized, would be partially offset by changes in the fair value of the underlying transactions.
Commodity Price Exposures
We are exposed to volatility in the prices of commodities used in some of our products and we use fixed price contracts to manage this exposure. We do not have committed commodity derivative instruments in place at December 31, 2019.
Interest Rate Exposure
Outstanding borrowings under our Credit Facilities accrue interest at our option of (i) a LIBOR rate plus the applicable margin or (ii) a base rate plus the applicable margin. The applicable margin ranges from 1.125% to 1.500% depending on our credit ratings. At December 31, 2019, the outstanding borrowings of $238.8 million under the Term Facility accrue interest at LIBOR plus a margin of 1.250%. To manage our exposure to fluctuations in LIBOR rates, we have interest rate swaps to fix the interest rate for $200.0 million of the outstanding borrowings, which expire in September 2020.
We are also exposed to the risk of rising interest rates to the extent that we fund our operations with short-term or variable-rate borrowings, as we have the ability to incur up to $500 million of additional variable-rate debt under our Revolving Facility. If LIBOR or other applicable base rates of our Credit Facilities increase in the future, our Interest expense could increase.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a)
The following Consolidated Financial Statements and Financial Statement Schedule and the report thereon of PricewaterhouseCoopers LLP dated February 18, 2020, are presented following Item 16 of this Annual Report on Form 10-K.
Consolidated Financial Statements:
Report of independent registered public accounting firm
Consolidated Statements of Comprehensive Income for the years ended December 31, 2019, 2018 and 2017
Consolidated Balance Sheets at December 31, 2019 and 2018
For the years ended December 31, 2019, 2018 and 2017:
Consolidated Statements of Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 2019, 2018 and 2017
(b)
The unaudited selected quarterly financial data for the two years ended December 31, is as follows:
Net earnings from the fourth quarter of 2019 includes a $31.4 million (net of tax) loss on the divestitures of our business operations in Colombia and Turkey.
Net earnings from the fourth quarter of 2018 includes a net tax benefit of $18.6 million related to an adjustment to the provisional accounting related to the Tax Reform Act.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
(a)
Evaluation of Disclosure Controls and Procedures
The Company's management, including its Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2019, that the Company's disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act has been recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and that such information has been accumulated and communicated to the Company's management including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b)
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). We concluded that our internal control over financial reporting was effective as of December 31, 2019.
The effectiveness of our internal control over financial reporting has been audited by PricewaterhouseCoopers LLP, the independent registered public accounting firm, as stated in their report herein.
(c)
Changes in Internal Control Over Financial Reporting
There were no changes in the Company's internal control over financial reporting that occurred during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The Company did implement changes to internal controls due to the adoption of ASC 842 effective January 1, 2019. These changes include implementing a new lease accounting system and processes to evaluate and account for contracts under the new accounting standard. There were no significant changes to the Company's internal control over financial reporting due to the adoption of this new standard.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information regarding our executive officers is included in Part I under the caption "Executive Officers of the Registrant."
The other information required by this item is incorporated herein by reference to the information contained under the headings "Item 1. Election of Directors", "Delinquent Section 16(a) Reports" and "Corporate Governance" in our Proxy Statement.
Item 11. EXECUTIVE COMPENSATION
The other information required by this item is incorporated herein by reference to the information contained under the headings "Compensation Discussion and Analysis", "Executive Compensation" and "Compensation Committee Report" in our Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The other information required by this item is incorporated herein by reference to the information contained under the headings "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" of our Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The other information required by this item is incorporated herein by reference to the information contained under the headings "Corporate Governance" and "Certain Relationships and Related Person Transactions" of our Proxy Statement.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by reference to the information contained under the caption "Fees of the Independent Auditors" in our Proxy Statement.
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. and 2.
Financial statements and financial statement schedule
See Item 8.
3.
Exhibits
The exhibits listed on the accompanying index to exhibits are filed as part of this Annual Report on Form 10-K.
ALLEGION PLC
INDEX TO EXHIBITS
(Item 15(a))
Description
Pursuant to the rules and regulations of the SEC, we have filed certain agreements as exhibits to this Annual Report on Form 10-K. These agreements may contain representations and warranties by the parties. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe our actual state of affairs at the date hereof and should not be relied upon.
(a) Exhibits
Exhibit
Number
Exhibit Description
Method of Filing
2.1
Separation and Distribution Agreement between Ingersoll-Rand plc and Allegion plc, dated November 29, 2013.
Incorporated by reference to Exhibit 2.1 of the Company’s Form 8-K filed with the SEC on December 2, 2013 (File No. 001-35971).
3.1
Amended and Restated Memorandum and Articles of Association of Allegion plc.
Incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed with the SEC on June 13, 2016 (File No. 001-35971).
4.1
Indenture, dated as of October 2, 2017, among Allegion US Holding Company Inc., Allegion plc and Wells Fargo Bank, National Association.
Incorporated by reference to Exhibit 4.1 of the Company's Form 8-K filed October 2, 2017.
4.2
First Supplemental Indenture, dated as of October 2, 2017, among Allegion US Holding Company Inc., Allegion plc and Wells Fargo Bank, National Association.
Incorporated by reference to Exhibit 4.2 of the Company's Form 8-K filed October 2, 2017.
4.3
Form of Global Note representing the 3.200% Senior Notes due 2024.
Incorporated by reference to Exhibit 4.3 of the Company's Form 8-K filed October 2, 2017 (included in Exhibit 4.2).
4.4
Second Supplemental Indenture, dated as of October 2, 2017, among Allegion US Holding Company Inc., Allegion plc and Wells Fargo Bank, National Association.
Incorporated by reference to Exhibit 4.4 of the Company's Form 8-K filed October 2, 2017.
4.5
Form of Global Note representing the 3.550% Senior Notes due 2027.
Incorporated by reference to Exhibit 4.5 of the Company's Form 8-K filed October 2, 2017 (included in Exhibit 4.4).
4.6
Third Supplemental Indenture, dated as of September 27, 2019, among Allegion plc, Allegion US Holding Company Inc. and Wells Fargo Bank, National Association.
Incorporated by reference to Exhibit 4.2 of the Company’s Form 8-K filed September 27, 2019.
4.7
Form of Global Note representing the 3.500% Senior Notes due 2029.
Incorporated by reference to Exhibit 4.3 of the Company's Form 8-K filed September 27, 2019 (included in Exhibit 4.2).
4.8
Description of the Registrant’s Securities registered pursuant to Section 12 of the Securities Exchange Act of 1934.
Filed herewith.
10.1
Form of Separation Agreement and Release. *
Incorporated by reference to Exhibit 10.1 of the Company’s Form 10-K filed with the SEC on February 19, 2019 (File No. 001-35971).
10.2
Tax Matters Agreement between Ingersoll-Rand plc and Allegion plc.
Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed with the SEC on December 2, 2013 (File No. 001-35971).
10.3
Credit Agreement, dated as of September 12, 2017.
Incorporated by reference to Exhibit 10.1 of the Company's Form 8-K filed September 15, 2017.
10.4
Employee Matters Agreement between Ingersoll-Rand plc and Allegion plc.
Incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed with the SEC on December 2, 2013 (File No. 001-35971).
10.5
2013 Incentive Stock Plan. *
Incorporated by reference to Exhibit 10.5 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.6
Executive Deferred Compensation Plan. *
Incorporated by reference to Exhibit 10.6 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.7
Supplemental Employee Savings Plan. *
Filed herewith.
10.8
Elected Officer Supplemental Program. *
Incorporated by reference to Exhibit 10.8 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.9
Key Management Supplemental Program. *
Incorporated by reference to Exhibit 10.9 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.10
Supplemental Pension Plan. *
Incorporated by reference to Exhibit 10.10 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.11
Senior Executive Performance Plan. *
Incorporated by reference to Exhibit 10.11 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.12
David D. Petratis Offer Letter, dated June 19, 2013. *
Incorporated by reference to Exhibit 10.14 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.13
Patrick S. Shannon Offer Letter, dated April 9, 2013. *
Incorporated by reference to Exhibit 10.15 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.14
Timothy P. Eckersley Offer Letter, dated October 3, 2013. *
Incorporated by reference to Exhibit 10.16 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.15
Lucia V. Moretti, Offer Letter, dated February 19, 2014. *
Incorporated by reference to Exhibit 10.1 of the Company's Form 10-K filed with the SEC on February 26, 2016 (File No. 001-35971).
10.16
Jeffrey N. Braun Offer Letter, dated June 13, 2014. *
Incorporated by reference to Exhibit 10.15 of the Company's Form 10-K filed with the SEC on February 17, 2017 (File No. 001-35971).
10.17
Form of Allegion plc Deed Poll Indemnity.
Incorporated by reference to Exhibit 10.21 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.18
Form of Allegion US Holding Company, Inc. Deed Poll Indemnity.
Incorporated by reference to Exhibit 10.22 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.19
Form of Allegion Irish Holding Company Limited Deed Poll Indemnity.
Incorporated by reference to Exhibit 10.23 of the Company’s Registration Statement on Form 10 filed with the SEC on June 17, 2013, as amended (File No. 001-35971).
10.20
Annual Incentive Plan. *
Incorporated by reference to Exhibit 10.1 of the Company's Form 10-K filed with the SEC on March 10, 2014 (File No. 001-35971).
10.21
Change in Control Severance Plan. *
Incorporated by reference to Exhibit 10.2 of the Company's Form 10-K filed with the SEC on March 10, 2014 (File No. 001-35971).
10.22
Form of Restricted Stock Unit Award Agreement. *
Filed herewith.
10.23
Form of Stock Option Award Agreement. *
Filed herewith.
10.24
Form of Performance Stock Unit Award Agreement. *
Filed herewith.
10.25
Form of Special Restricted Stock Unit Award Agreement. *
Incorporated by reference to Exhibit 10.4 of the Company's Form 8-K filed with the SEC on February 9, 2016 (File No. 001-35971).
10.26
Form of Non-Employee Director Restricted Stock Unit Award Agreement. *
Incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q filed with the SEC on April 30, 2015 (File No. 001-35971).
10.27
Share Purchase Agreement dated June 26, 2015 between SimonsVoss Luxco S.à r.l., SimonsVoss Co-Invest GmbH & Co. KG, Mr Frank Rövekamp and Allegion Luxembourg Holding & Financing S.à r.l.
Incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q filed with the SEC on July 30, 2015 (File No. 001-35971).
21.1
List of subsidiaries of Allegion plc.
Filed herewith.
23.1
Consent of Independent Registered Public Accounting Firm.
Filed herewith.
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Filed herewith.
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Filed herewith.
32.1
Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(b) or Rule 15d-14(b) and 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Furnished herewith.
101.INS
XBRL Instance Document.
The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
XBRL Taxonomy Extension Schema Document.
Filed herewith.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
Filed herewith.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
Filed herewith.
101.LAB
XBRL Taxonomy Extension Labels Linkbase Document.
Filed herewith.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
Filed herewith.
* Compensatory plan or arrangement.
Item 16. FORM 10-K SUMMARY
Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ALLEGION PLC
(Registrant)
By:
/s/ David D. Petratis
David D. Petratis
Chief Executive Officer
Date:
February 18, 2020
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ David D. Petratis
Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)
February 18, 2020
(David D. Petratis)
/s/ Patrick S. Shannon
Senior Vice President and Chief Financial Officer (Principal Financial Officer)
February 18, 2020
(Patrick S. Shannon)
/s/ Douglas P. Ranck
Vice President, Controller and Chief Accounting Officer (Principal Accounting Officer)
February 18, 2020
(Douglas P. Ranck)
/s/ Kirk S. Hachigian
Director
February 18, 2020
(Kirk S. Hachigian)
/s/ Steven C. Mizell
Director
February 18, 2020
(Steven C. Mizell)
/s/ Nicole Parent Haughey
Director
February 18, 2020
(Nicole Parent Haughey)
/s/ Dean Schaffer
Director
February 18, 2020
(Dean Schaffer)
/s/ Charles L. Szews
Director
February 18, 2020
(Charles L. Szews)
/s/ Martin E. Welch III
Director
February 18, 2020
(Martin E. Welch III)
ALLEGION PLC
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Comprehensive Income
Consolidated Balance Sheets
Consolidated Statements of Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 2019, 2018 and 2017
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Allegion plc:
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Allegion plc and its subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2019, including the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Change in Accounting Principle
As discussed in Note 2 and Note 11 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Goodwill Impairment Assessment - EMEIA and Asia Pacific Reporting Units
As described in Notes 2 and 5 to the consolidated financial statements, the Company’s consolidated goodwill balance was $873.3 million as of December 31, 2019, and the goodwill associated with the EMEIA and Asia Pacific reporting units was $285.5 million and $102.8 million, respectively. Goodwill is tested annually for impairment during the fourth quarter or whenever there is a significant change in events or circumstances that indicate that the fair value of the reporting unit is more likely than not less than the carrying amount of the reporting unit. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. To the extent that the carrying value of the reporting unit exceeds its estimated fair value, a goodwill impairment charge will be recognized for the amount by which the carrying value of the reporting unit exceeds its fair value, not to exceed the carrying amount of goodwill. Estimated fair value of the Company's reporting units is based on two valuation techniques, a discounted cash flow model (income approach) and a market multiple of earnings (market approach), with each method being weighted in the calculation. The income approach relies on management’s estimates of revenue growth rates, margin assumptions, and discount rates to estimate future cash flows. The market approach requires the determination of an appropriate peer group, which is utilized to derive estimated fair values based on selected market multiples.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment of EMEIA and Asia Pacific reporting units is a critical audit matter are there was significant judgment by management when developing the fair value measurements of the reporting units. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures to evaluate management’s cash flow projections and significant assumptions, including revenue growth rates, margin assumptions, discount rates, peer group determination, and market multiple selection. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained from these procedures.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over the valuation of the Company’s reporting units. These procedures also included, among others, testing management’s process for developing the fair value estimates; evaluating the appropriateness of the discounted cash flow and market multiple models; testing the completeness, accuracy, and relevance of the underlying data used in the models; and evaluating the significant assumptions used by management, including the revenue growth rates, margin assumptions, discount rates, peer group determination, and market multiple selection. Evaluating management’s assumptions relating to revenue growth rates and margin assumptions involved evaluating whether the assumptions used by management were reasonable considering (i) the current and past performance of the reporting units, (ii) the consistency with external market and industry data, and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Evaluating the Company’s peer group determinations included assessing the appropriateness of the identified peer companies. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s discounted cash flow and market multiple models, and certain significant assumptions, including the discount rates, selected peer groups, and market multiples.
/s/ PricewaterhouseCoopers LLP
Indianapolis, Indiana
February 18, 2020
We have served as the Company’s auditor since 2013.
See accompanying notes to consolidated financial statements.
Allegion plc
Consolidated Balance Sheets
In millions, except share amounts
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF COMPANY AND BASIS OF PRESENTATION
Allegion plc, an Irish public limited company, and its consolidated subsidiaries ("Allegion" or "the Company") are a leading global company that provides security products and solutions that keep people and assets safe and secure in the places where they reside, work and thrive. Allegion creates peace of mind by pioneering safety and security with a vision of seamless access and a safer world. The Company offers an extensive and versatile portfolio of mechanical and electronic security products and solutions across a range of market-leading brands including CISA®, Interflex®, LCN®, Schlage®, SimonsVoss® and Von Duprin®.
Basis of presentation: The Consolidated Financial Statements were prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") as defined by the Financial Accounting Standards Board ("FASB") within the FASB Accounting Standards Codification ("ASC").
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of significant accounting policies used in the preparation of the accompanying Consolidated Financial Statements follows:
Principles of Consolidation: The Consolidated Financial Statements include all controlled subsidiaries of the Company. A noncontrolling interest in a subsidiary is considered an ownership interest in a controlled subsidiary that is not attributable to the Company. The Company includes noncontrolling interests as a component of Total equity in the Consolidated Balance Sheets and the Net earnings attributable to noncontrolling interests are presented as an adjustment from Net earnings used to arrive at Net earnings attributable to Allegion plc in the Consolidated Statements of Comprehensive Income.
Equity method affiliates represent unconsolidated entities in which the Company demonstrates significant influence in the affiliate but does not have a controlling financial interest. The Company is also required to consolidate variable interest entities in which it bears a majority of the risk to the entities’ potential losses or stands to gain from a majority of the entities’ expected returns.
Use of Estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Estimates are based on several factors including the facts and circumstances available at the time the estimates are made, historical experience, risk of loss, general economic conditions and trends and the assessment of the probable future outcome. Some of the more significant estimates include useful lives of property, plant and equipment and intangible assets, purchase price allocations of acquired businesses, valuation of assets and liabilities including goodwill and other intangible assets, product warranties, sales allowances, pension plan benefits, postretirement benefits other than pensions, taxes, lease related assets and liabilities, environmental costs and product liability and other contingencies. Actual results could differ from those estimates. Estimates and assumptions are reviewed periodically, and the effects of changes, if any, are reflected in the Consolidated Statements of Comprehensive Income in the period that they are determined.
Currency Translation: Assets and liabilities where the functional currency is not the U.S. dollar have been translated at year-end exchange rates, and income and expense accounts have been translated using average exchange rates throughout the year. Adjustments resulting from the process of translating a subsidiary’s financial statements into the U.S. dollar have been recorded in the Equity section of the Consolidated Balance Sheets within Accumulated other comprehensive loss.
Cash and Cash Equivalents: Cash and cash equivalents include cash on hand, demand deposits and all highly liquid investments with original maturities at the time of purchase of three months or less.
Inventories: Inventories are stated at the lower of cost and net realizable value using the first-in, first-out (FIFO) method.
Allowance for Doubtful Accounts: The Company provides for an allowance for doubtful accounts and notes receivable, which represents the best estimate of probable loss inherent in the Company’s accounts and notes receivable portfolios. The Company's estimates are influenced by a continuing credit evaluation of customers’ financial condition, trade accounts and notes receivable aging and historical loss experience. The Company has reserved $5.6 million and $3.3 million for doubtful accounts and notes receivable as of December 31, 2019 and 2018, respectively.
Property, Plant and Equipment: Property, plant and equipment are stated at cost, less accumulated depreciation. Assets placed in service are recorded at cost and depreciated using the straight-line method over the estimated useful life of the asset except for
leasehold improvements, which are depreciated over the shorter of their economic useful life or their lease term. The range of useful lives used to depreciate property, plant and equipment is as follows:
Repair and maintenance costs that do not extend the useful life of the asset are expensed as incurred. Major replacements and significant improvements that increase asset values and extend useful lives are capitalized.
The Company assesses the recoverability of the carrying value of its property, plant and equipment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be fully recoverable. Recoverability is measured by a comparison of the carrying amount of an asset to the future net undiscounted cash flows expected to be generated by the asset. If the undiscounted cash flows are less than the carrying amount of the asset, an impairment loss is recognized for the amount by which the carrying value of the asset exceeds the fair value of the asset.
Investments: The Company periodically invests in debt or equity securities of start-up companies and/or development stage technology or other companies without acquiring a controlling interest. The Company applies the equity method of accounting when the Company has the ability to exercise significant influence over the operating and financial decision making of the investee. Investments in equity method affiliates totaled $18.2 million and $16.0 million as of December 31, 2019 and 2018, respectively. Debt and equity investments that have readily determinable fair values in which the Company does not have significant influence are generally classified as available-for-sale securities and subsequently measured at fair value with any unrealized holding gains and losses being reported in Other comprehensive income. The Company's investments without readily determinable fair values are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer and are qualitatively assessed for impairment indicators at each reporting period. Investments in debt and equity securities not accounted for under the equity method of accounting totaled $18.1 million and $9.5 million as of December 31, 2019 and 2018, respectively. The Company's investments are principally recorded within Other noncurrent assets within the Consolidated Balance Sheets.
Leases: In accordance with ASC 842, the Company records a right-of-use ("ROU") asset and lease liability for substantially all leases for which it is a lessee. In determining if a contract represents a lease, consideration is given to all relevant facts and circumstances to assess whether or not the contract conveys the right to control the use of an identified asset, either explicit or implicit, for a period of time in exchange for consideration. Judgment and estimation is also required in determining the lease classification and the amount of the ROU asset and corresponding lease liability for each lease, which includes determining the appropriate lease term and an applicable discount rate. The Company assesses the specific terms and conditions of each lease to determine the appropriate classification as either an operating or finance lease. In determining the appropriate length of the lease term, both the minimum period over which lease payments are required plus any renewal options that are both within the Company's control to exercise and are reasonably certain of being exercised as of lease commencement are considered. The Company considers all relevant factors to determine if sufficient incentives exist as of lease commencement to conclude whether or not renewal is reasonably certain. When available, the rate implicit in the lease is utilized as the discount rate to determine the lease liability. If this rate is unavailable, the Company utilizes its incremental borrowing rate as the discount rate, which is the rate at inception of the lease that would hypothetically be incurred to borrow over a similar term the funds needed to purchase the leased asset. Refer to Note 11 for further details on the Company's lease accounting policies.
Goodwill and Intangible Assets: The Company records as goodwill the excess of the purchase price of an acquired business over the fair value of the net assets acquired. In accordance with ASC 350, "Intangibles-Goodwill and Other,", goodwill and other indefinite-lived intangible assets are tested and reviewed annually for impairment during the fourth quarter or whenever there is a significant change in events or circumstances that indicate that the fair value of a reporting unit or indefinite-lived intangible asset is more likely than not less than the carrying amount of the asset.
Recoverability of goodwill is measured at the reporting unit level. The carrying amount of a reporting unit is compared to its estimated fair value. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. To the extent that the carrying value of the reporting unit exceeds its estimated fair value, a goodwill impairment charge will be recognized for the amount by which the carrying value of the reporting unit exceeds its fair value, not to exceed the carrying amount of goodwill of the reporting unit. Estimated fair value of the Company's reporting units is based on two valuation techniques, a discounted cash flow model (income approach) and a market multiple of earnings (market approach), with each method being weighted in the calculation.
Recoverability of other intangible assets with indefinite useful lives (i.e. Trade names) is determined on a relief from royalty methodology, which is based on the implied royalty paid, at an appropriate discount rate, to license the use of an asset rather than owning the asset. The present value of the after-tax cost savings (i.e. royalty relief) indicates the estimated fair value of the asset. Any excess of the carrying value over the estimated fair value is recognized as an impairment loss equal to that excess.
Intangible assets such as completed technologies, patents, customer-related intangible assets and other intangible assets with finite useful lives are amortized on a straight-line basis over their estimated economic lives. The weighted-average useful lives approximate the following:
Recoverability of intangible assets with finite useful lives is assessed in the same manner as property, plant and equipment, as described above.
Income Taxes: The calculation of the Company’s income taxes involves considerable judgment and the use of both estimates and allocations. Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. The Company recognizes future tax benefits, such as net operating losses and tax credits, to the extent that realizing these benefits is considered in its judgment to be more likely than not. The Company regularly reviews the recoverability of its deferred tax assets considering its historic profitability, projected future taxable income, timing of the reversals of existing temporary differences and the feasibility of its tax planning strategies. Where appropriate, the Company records a valuation allowance with respect to future tax benefits.
Cash paid for income taxes, net of refunds, for the twelve months ended December 31, 2019 and 2018 was $103.0 million and $101.7 million, respectively.
Product Warranties: The Company offers a standard warranty with most product sales, and the value of such warranty is included in the contractual sales price. Standard product warranty accruals are recorded at the time of sale and are estimated based upon product warranty terms and historical experience. The Company regularly assesses the adequacy of its liabilities and makes adjustments as necessary based on known or anticipated warranty claims, or as new information becomes available. Refer to Note 21 for further details regarding product warranties.
Revenue Recognition: Net revenues are recognized based on the satisfaction of performance obligations under the terms of a contract. A performance obligation is a promise in a contract to transfer control of a distinct product or to provide a service, or a bundle of products or services, to a customer. The Company has two principal revenue streams, tangible product sales and services. Approximately 99% of consolidated Net revenues involve contracts with a single performance obligation, which is the transfer of control of a product or bundle of products to a customer. The Company's remaining Net revenues involve services, including installation and consulting. See Note 20 for additional information regarding the Company's revenue recognition policies.
Sales returns and customer disputes involving a question of quantity or price are accounted for as variable consideration, and therefore, as a reduction to Net revenues and as a contra receivable. At December 31, 2019 and 2018, the Company had a customer claim accrual (contra receivable) of $36.5 million and $31.6 million, respectively. All other incentives or incentive programs where the customer is required to reach a certain level of purchases, remain a customer for a certain period, provide a rebate form or is subject to additional requirements are also considered variable consideration and are accounted for as a reduction of revenue and a liability. At December 31, 2019 and 2018, the Company had a sales incentive accrual of $37.2 million and $33.9 million, respectively. Variable consideration is estimated based on the most likely amount expected to be received from customers. Each of these accruals represents the Company’s best estimate of the most likely amount expected to be received from customers based on historical experience. These estimates are reviewed regularly for accuracy. If updated information or actual amounts are different from previous estimates, the revisions are included in the Company’s results for the period in which they become known. Historically, the aggregate differences, if any, between the Company’s estimates and actual amounts in any year have not had a material impact on the Consolidated Financial Statements.
Environmental Costs: The Company is subject to laws and regulations relating to protecting the environment. Environmental expenditures relating to current operations are expensed or capitalized as appropriate. Expenditures relating to existing conditions caused by past operations, which do not contribute to current or future revenues, are expensed. Liabilities for remediation costs
are recorded when they are probable and can be reasonably estimated, generally no later than the completion of feasibility studies or the Company’s commitment to a plan of action. The assessment of this liability, which is calculated based on existing technology, does not reflect any offset for possible recoveries from insurance companies and is not discounted. Refer to Note 21 for further details related to environmental matters.
Research and Development Costs: The Company conducts research and development activities for the purpose of developing and improving new products and services. These costs are expensed when incurred. For the years ended December 31, 2019, 2018 and 2017, expenses related to research and development activities amounted to approximately $54.7 million, $54.4 million and $48.3 million, respectively, and consist of salaries, wages, benefits, building costs and other overhead expenses.
Employee Benefit Plans: The Company provides a range of benefits, including pensions, postretirement and postemployment benefits to eligible current and former employees. Determining the costs associated with such benefits is dependent on various actuarial assumptions, including discount rates, expected return on plan assets, compensation increases, employee mortality, turnover rates and healthcare cost trend rates. Actuaries perform the required calculations to determine expense in accordance with GAAP. Actual results may differ from the actuarial estimates and are generally recorded to Accumulated other comprehensive loss and amortized into Net earnings over future periods. The Company reviews its actuarial assumptions at each measurement date and makes modifications to the assumptions based on current rates and trends, if appropriate. Refer to Note 12 for further details on employee benefit plans.
Loss Contingencies: Liabilities are recorded for various contingencies arising in the normal course of business, including litigation and administrative proceedings, environmental matters, product liabilities, product warranties, worker’s compensation and other claims. The Company has recorded reserves in the financial statements related to these matters, which are developed using inputs derived from actuarial estimates and historical and anticipated experience data depending on the nature of the reserve and, in certain instances, with consultation of legal counsel, internal and external consultants and engineers. Subject to the uncertainties inherent in estimating future costs for these types of liabilities, the Company believes its estimated reserves are reasonable and does not believe the final determination of the liabilities with respect to these matters would have a material effect on the financial condition, results of operations, liquidity or cash flows of the Company for any year. Refer to Note 21 for further details related to loss contingencies.
Derivative Instruments: The Company periodically enters into cash flow and other derivative transactions to specifically hedge exposure to various risks related to currency and variable interest rates. The Company recognizes all derivatives on the Consolidated Balance Sheets at their fair value as either assets or liabilities. For designated cash flow hedges, the changes in fair value of the derivative contract is recorded in Other comprehensive income (loss), net of tax, and in Net earnings at the time earnings are affected by the hedged transaction. For undesignated derivative transactions, the changes in the fair value of the derivative contract are immediately recognized in Net earnings. Refer to Note 10 for further details regarding derivative instruments.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements:
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 requires the identification of arrangements that should be accounted for as leases. In general, for lease arrangements of a twelve-month term or greater, these arrangements are to be recognized as assets and liabilities on the balance sheet of the lessee. Under ASU 2016-02, an ROU asset and lease liability are recorded for all leases, whether operating or financing, while the statement of comprehensive income reflects lease expense for operating leases and amortization/interest expense for financing leases. In July 2018, the FASB issued ASU 2018-10, "Codification Improvements to Topic 842 (Leases)", which provided narrow amendments to clarify how to apply certain aspects of ASU 2016-02, and ASU 2018-11, "Leases (Topic 842): Targeted Improvements", which provided an additional transition method by allowing entities to initially apply ASU 2016-02, and subsequent related standards, at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In March 2019, the FASB issued ASU 2019-01, "Leases (Topic 842): Codification Improvements", which exempted entities from having to provide certain interim disclosures in the fiscal year of adoption of ASU 2016-02 and its related standards. These ASUs (collectively “ASC 842”) were effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. The Company adopted ASC 842 on January 1, 2019, utilizing the transition method allowed per ASU 2018-11. Comparative period financial information has not been adjusted for the effects of adopting ASC 842 and no cumulative-effect adjustment was required to the opening balance of Retained earnings on the adoption date.
The Company has also made updates to its systems, policies and internal controls over financial reporting related to the adoption of ASC 842 on January 1, 2019. See Note 11 for further information and expanded disclosure related to the Company's leases.
Recently Issued Accounting Pronouncements:
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." In November 2018, the FASB issued ASU 2018-19, "Codification Improvements to Topic 326, Financial Instruments-Credit Losses". The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. These ASUs are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted ASU 2016-13 and its related updates on January 1, 2020, and the adoption did not have a material impact to the Consolidated Financial Statements, although the Company has made updates to its policies and internal controls over financial reporting as a result of adoption.
In August 2018, the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract." The new guidance aligns the requirements for capitalizing implementation costs incurred in a cloud-based hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted ASU 2018-15 on January 1, 2020, and does not believe the adoption will have a material impact to the Consolidated Financial Statements.
In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." The new guidance is intended to simplify the accounting for income taxes by removing certain exceptions and by updating accounting requirements around franchise taxes, goodwill recognized for tax purposes, the allocation of current and deferred tax expense among legal entities, among other minor changes. The ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company is assessing what impact ASU 2019-12 will have on the Consolidated Financial Statements.
In January 2020, the FASB issued ASU 2020-01, "Investments-Equity Securities (Topic321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815." The amendments in ASU 2020-01 clarify the interaction of the accounting for equity securities under Topic 321 and investments accounted for under the equity method of accounting. The amendments also clarify the accounting for certain forward contracts and purchased options accounted for under Topic 815. The ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company is assessing what impact ASU 2020-01 will have on the Consolidated Financial Statements.
NOTE 3 - INVENTORIES
Inventories are stated at the lower of cost and net realizable value using the first-in, first-out (FIFO) method.
At December 31, the major classes of Inventories were as follows:
NOTE 4 - PROPERTY, PLANT AND EQUIPMENT
At December 31, the major classes of Property, plant and equipment were as follows:
Depreciation expense for the years ended December 31, 2019, 2018 and 2017 was $47.1 million, $46.2 million and $40.0 million, which includes amounts for software amortization of $14.5 million, $15.4 million and $14.3 million, respectively.
NOTE 5 - GOODWILL
The Company records as goodwill the excess of the purchase price over the fair value of the net assets acquired. Once the final valuation has been performed for each acquisition, adjustments may be recorded. The changes in the carrying amount of Goodwill were as follows:
(a)
In 2019, the Company made reclassifications to goodwill across all segments related to a change in how revenue is managed for a specific immaterial product line where revenue previously managed in the Asia Pacific segment is now being managed in the Americas and EMEIA segments.
NOTE 6 - INTANGIBLE ASSETS
The following table sets forth the gross amount and related accumulated amortization of the Company’s intangible assets at December 31:
The Company amortizes intangible assets with finite useful lives on a straight-line basis over their estimated economic lives in accordance with GAAP. Indefinite-lived intangible assets are not subject to amortization, but instead are tested for impairment at least annually (more frequently if certain indicators are present).
Intangible asset amortization expense for the years ended 2019, 2018 and 2017, was $31.2 million, $36.3 million and $22.1 million, respectively. Intangible asset amortization expense for 2018 included the amortization of approximately $6 million of backlog revenue that was acquired during an acquisition in 2018. Future estimated amortization expense on existing intangible assets in each of the next five years amounts to approximately $28.8 million for 2020, $28.8 million for 2021, $28.7 million for 2022, $28.6 million for 2023 and $28.3 million for 2024.
In accordance with the Company’s indefinite-lived intangible asset impairment testing policy outlined in Note 2, the Company performs its annual impairment test in the fourth quarter of each year. During the 2019 impairment testing, it was determined that two of the Company's indefinite-lived trade names were impaired. As such, impairment charges totaling $5.9 million were recorded in the fourth quarter of 2019 and are included within Selling and administrative expenses within the Consolidated Statement of Comprehensive Income. In 2018 and 2017, the Company determined the fair value of all indefinite-lived intangible assets exceeded their respective carrying values, and accordingly, no impairment charges were recorded in either of these years.
NOTE 7 - ACQUISITIONS
In 2018, the Company completed six acquisitions:
Total cash paid for these acquisitions was approximately $373 million (net of cash acquired), including $4.6 million during the year ended December 31, 2019. These acquisitions were accounted for as business combinations. The allocation of the aggregate purchase price to assets acquired and liabilities assumed is complete as of December 31, 2019, and was as follows:
Intangible assets acquired include approximately $59 million of indefinite-lived trade names, $112 million of customer relationships and $33 million of completed technologies and other intangibles, which includes approximately $6 million of acquired backlog revenue. The customer relationships have a 17-year weighted-average useful life, while the completed technologies and other intangibles, excluding the backlog revenue, have a 16-year weighted-average useful life. The backlog revenue was fully amortized as of June 30, 2018.
Goodwill results from several factors including Allegion-specific synergies that were excluded from the cash flow projections used in the valuation of intangible assets and intangible assets that do not qualify for separate recognition, for example, assembled workforce. The majority of the goodwill is expected to be deductible for tax purposes.
The following unaudited pro forma financial information for the year ended December 31, 2018 reflects the consolidated results of operations of the Company as if these acquisitions had taken place on January 1, 2017:
The unaudited pro forma financial information is presented for informational purposes only and does not purport to be indicative of results of operations that would have occurred had the pro forma events taken place on the date indicated or the future consolidated results of operations of the combined company. The unaudited pro forma financial information has been calculated after applying the Company's accounting policies and adjusting the historical financial results to reflect additional items directly attributable to the acquisitions that would have been incurred assuming the acquisitions had occurred on January 1, 2017. Adjustments to historical financial information include removal of backlog revenue acquired as well as acquisition and integration expenses incurred in 2018 related to these acquisitions, partially offset by incremental amortization of intangible assets.
Additionally, in January 2017, the Company acquired Republic Doors & Frames, LLC ("Republic") through one of its subsidiaries.
During the years ended December 31, 2019, 2018 and 2017, the Company incurred $2.0 million, $10.0 million and $4.7 million, respectively, of acquisition and integration related expenses, which are included in Selling and administrative expenses in the Consolidated Statement of Comprehensive Income.
NOTE 8 - DIVESTITURES
In June 2019, the Company closed its production facility in Turkey and subsequently sold certain of the production assets thereof, which collectively met the definition of a business under ASC 805, "Business Combinations" (see Note 16 for further information around the Company's restructuring activities). Total proceeds from the sale were approximately $4.1 million. The Company recorded a loss on divestiture of $24.2 million ($25.5 million, net of tax), primarily driven by $25.0 million of cumulative currency translation adjustments previously deferred in equity that were reclassified to earnings upon sale. The loss is included as a component of Loss on divestitures in the Consolidated Statement of Comprehensive Income.
Additionally, during the fourth quarter of 2019, the Company sold its interests in its Colombia operations for an immaterial amount. As a result of the sale, the Company recorded a net loss on divestiture of $5.9 million, of which $1.2 million relates to cumulative
currency translation adjustments previously deferred in equity that were reclassified to earnings upon sale. The net loss is included as a component of Loss on divestitures in the Consolidated Statement of Comprehensive Income.
Neither of these divestitures is expected to have a material impact on the Company's future results of operations or cash flows.
NOTE 9 - DEBT AND CREDIT FACILITIES
At December 31, long-term debt and other borrowings consisted of the following:
Unsecured Credit Facilities
As of December 31, 2019, the Company has an unsecured Credit Agreement in place, consisting of a $700.0 million term loan facility (the “Term Facility”), of which $238.8 million is outstanding at December 31, 2019, and a $500.0 million revolving credit facility (the “Revolving Facility” and, together with the Term Facility, the “Credit Facilities”). The Credit Facilities mature on September 12, 2022, and are unconditionally guaranteed jointly and severally on an unsecured basis by the Company and Allegion US Holding Company Inc. ("Allegion US Hold Co"), the Company's wholly-owned subsidiary.
At inception, the Term Facility was scheduled to amortize in quarterly installments at the following rates: 1.25% per quarter starting December 31, 2017 through December 31, 2020, 2.5% per quarter from March 31, 2021 through June 30, 2022, with the balance due on September 12, 2022. Principal amounts repaid on the Term Facility may not be reborrowed. During the year ended December 31, 2019, the Company made a $400.0 million principal payment to partially pay down the outstanding Term Facility balance, utilizing all of the net proceeds from the issuance of the 3.500% Senior Notes due 2029 (see below), plus cash on hand. As a result of this payment, the Company has satisfied its obligation to make quarterly installments on the Term Facility up to the maturity date, with the remaining outstanding balance due on September 12, 2022. In conjunction with this principal pay down, the Company recognized a $2.7 million charge related to the write-off of previously deferred financing costs related to the Term Facility, which is included in Interest expense in the Consolidated Statement of Comprehensive Income for the year ended December 31, 2019. The Company repaid a total of $417.5 million of principal on its Term Facility during the year ended December 31, 2019.
The Revolving Facility provides aggregate commitments of up to $500.0 million, which includes up to $100.0 million for the issuance of letters of credit. At December 31, 2019, there were no borrowings outstanding on the Revolving Facility and the Company had $16.3 million of letters of credit outstanding. Commitments under the Revolving Facility may be reduced at any time without premium or penalty, and amounts repaid may be reborrowed. The Company pays certain fees with respect to the Revolving Facility, including an unused commitment fee on the undrawn portion of the Revolving Facility of between 0.125% and 0.200% per year, depending on the Company's credit rating, as well as certain other fees.
Outstanding borrowings under the Credit Facilities accrue interest at the option of the Company of (i) a LIBOR rate plus the applicable margin or (ii) a base rate plus the applicable margin. The applicable margin ranges from 1.125% to 1.500% depending on the Company's credit ratings. At December 31, 2019, the outstanding borrowings under the Term Facility accrue interest at LIBOR plus a margin of 1.250%. To manage the exposure to fluctuations in LIBOR rates, the Company has interest rate swaps to fix the interest rate for $200.0 million of the outstanding borrowings as of December 31, 2019. These interest rate swaps will expire in September 2020 (see Note 10). At December 31, 2019, the weighted-average interest rate for borrowings was 2.68% under the Term Facility (including the effect of interest rate swaps).
The Credit Facilities contain negative and affirmative covenants and events of default that, among other things, limit or restrict the Company's ability to enter into certain transactions. In addition, the Credit Facilities require the Company to comply with a maximum leverage ratio and a minimum interest expense coverage ratio, as defined within the agreement. As of December 31, 2019, the Company was in compliance with all covenants.
Senior Notes
As of December 31, 2019, Allegion US Hold Co has $400.0 million outstanding of its 3.200% Senior Notes due 2024 (the “3.200% Senior Notes”) and $400.0 million outstanding of its 3.550% Senior Notes due 2027 (the “3.550% Senior Notes”), both of which were issued on October 2, 2017. The 3.200% Senior Notes and the 3.550% Senior Notes require semi-annual interest payments on April 1 and October 1 of each year and will mature on October 1, 2024 and October 1, 2027, respectively. The 3.200% Senior Notes and the 3.550% Senior Notes are senior unsecured obligations of Allegion US Hold Co and rank equally with all of Allegion US Hold Co’s existing and future senior unsecured and unsubordinated indebtedness. The guarantee of the 3.200% Senior Notes and the 3.550% Senior Notes is the senior unsecured obligation of the Company and ranks equally with all of the Company's existing and future senior unsecured and unsubordinated indebtedness.
During the year ended December 31, 2019, Allegion plc issued $400.0 million aggregate principal amount of its 3.500% Senior Notes due 2029 (the “3.500% Senior Notes”). The 3.500% Senior Notes require semi-annual interest payments on April 1 and October 1, beginning April 1, 2020, and will mature on October 1, 2029. Net proceeds from the issuance of the 3.500% Senior Notes, along with cash on hand, were utilized to make the $400.0 million principal payment on the Term Facility discussed above. The Company incurred and deferred $4.2 million of discounts and financing costs associated with the 3.500% Senior Notes, which will be amortized to Interest expense over the 10-year term of the 3.500% Senior Notes. The 3.500% Senior Notes are senior unsecured obligations of Allegion plc, are guaranteed by Allegion US Hold Co and rank equally with all of the Company's existing and future senior unsecured indebtedness.
2017 Refinancing
The Company entered into its unsecured Credit Agreement in September 2017, using the proceeds from the Term Facility along with initial borrowings under the Revolving Facility to repay in full the outstanding borrowings under the Company's previously outstanding secured credit facility. Additionally, in October 2017, the Company used the net proceeds from the 3.200% Senior Notes and the 3.550% Senior Notes to redeem in full $600.0 million aggregate of previously outstanding senior notes. Related to these activities, the Company recorded a $33.2 million charge for the redemption premiums associated with the previously outstanding senior notes, non-cash charges of $9.9 million related to the write-off of previously deferred financing costs and $1.6 million of third-party costs. These charges were all recorded within Interest expense in the Consolidated Statement of Comprehensive Income for the year ended December 31, 2017.
Future Repayments
Scheduled principal repayments on indebtedness as of December 31, 2019 were as follows:
Cash paid for interest for the years ended December 31, 2019, 2018 and 2017 was $48.8 million, $52.0 million and $58.4 million, respectively.
NOTE 10 - FINANCIAL INSTRUMENTS
In the normal course of business, the Company uses various financial instruments, including derivative instruments, to manage the risks associated with interest and currency rate exposures. These financial instruments are not used for trading or speculative purposes.
When a derivative contract is entered into, the Company designates the derivative instrument as a cash flow hedge of a forecasted transaction, a cash flow hedge of a recognized asset or liability or as an undesignated derivative. The Company formally documents its hedge relationships, including identification of the derivative instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction. This process includes linking derivative instruments that are designated as hedges to specific assets, liabilities or forecasted transactions.
The fair market value of derivative instruments is determined through market-based valuations and may not be representative of the actual gains or losses that will be recorded when these instruments mature due to future fluctuations in the markets in which they are traded.
The Company assesses at inception and at least quarterly thereafter, whether the derivatives used in cash flow hedging transactions are effective in offsetting the changes in the cash flows of the hedged item. To the extent the derivative is deemed to be an effective hedge, the fair market value changes of the instrument are recorded to Accumulated other comprehensive income (AOCI), while changes in the fair market value of derivatives not deemed to be an effective hedge are recorded in Net earnings in the period of change. If the hedging relationship ceases to be effective subsequent to inception, or it becomes probable that a forecasted transaction is no longer expected to occur, the hedging relationship will be undesignated and any future gains or losses on the derivative instrument will be recorded in Net earnings.
Currency Derivatives
The gross notional amount of the Company’s currency derivatives was $146.4 million and $81.8 million at December 31, 2019 and 2018, respectively. At December 31, 2019 and 2018, a loss of $0.1 million and a gain of $1.8 million, net of tax, respectively, were included in Accumulated other comprehensive loss related to the fair value of the Company’s currency derivatives designated as cash flow hedges. The amount expected to be reclassified into Net earnings over the next twelve months is a loss of approximately $0.1 million. The actual amounts that will be reclassified to Net earnings may vary from this amount as a result of changes in market conditions. Gains and losses associated with the Company’s currency derivatives not designated as hedges are recorded in Net earnings as changes in fair value occur. At December 31, 2019, the maximum term of the Company’s currency derivatives was less than one year.
Interest Rate Swaps
The Company has interest rate swaps to fix the interest rate paid during the contract period related to the Company's variable rate Term Facility. The notional amount of these interest rate swaps was $200.0 million and $250.0 million at December 31, 2019 and 2018, respectively. During the year ended December 31, 2019, the Company settled an interest rate swap with a $50.0 million notional amount in conjunction with the principal pay down on the outstanding Term Facility (see Note 9). The remaining interest rate swaps expire in September 2020 and meet the criteria to be accounted for as cash flow hedges of variable rate interest payments. Consequently, the changes in fair value of the interest rate swaps are recognized in Accumulated other comprehensive loss. At December 31, 2019 and 2018, gains of $0.5 million and $4.3 million, net of tax, respectively, were recorded in Accumulated other comprehensive loss related to these interest rate swaps. The amount expected to be reclassified into Net earnings over the next twelve months is a gain of approximately $0.5 million. The actual amounts that will be reclassified to Net earnings may vary from this amount as a result of changes in market conditions.
The fair values of derivative instruments included within the Consolidated Balance Sheets as of December 31 were as follows:
The amounts associated with derivatives designated as hedges affecting Net earnings and Accumulated other comprehensive loss for the years ended December 31 were as follows:
The gains and losses associated with the Company's non-designated currency derivatives, which are offset by changes in the fair value of the underlying transactions, are included within Other expense (income), net in the Consolidated Statements of Comprehensive Income.
Concentration of Credit Risk
The counterparties to the Company’s forward contracts and swaps consist of a number of investment grade major international financial institutions. The Company could be exposed to losses in the event of nonperformance by the counterparties. However, the credit ratings and the concentration of risk in these financial institutions are monitored on a continuous basis and present no significant credit risk to the Company.
NOTE 11 - LEASES
The Company records a right-of-use ("ROU") asset and lease liability for substantially all leases for which it is a lessee, in accordance with ASC 842. At inception of a contract, the Company considers all relevant facts and circumstances to assess whether or not the contract represents a lease by determining whether or not the contract conveys the right to control the use of an identified asset, either explicit or implicit, for a period of time in exchange for consideration. The Company has no significant lease agreements in place for which the Company is a lessor, and substantially all of the Company's leases for which the Company is a lessee are classified as operating leases. Total rental expense for the twelve months ended December 31, 2019, was $43.2 million and is classified within Cost of goods sold and Selling and administrative expenses within the Consolidated Statement of Comprehensive Income. Rental expense related to short-term leases, variable lease payments or other leases or lease components not included within the ROU asset or lease liability totaled $8.1 million for the twelve months ended December 31, 2019. No material lease costs have been capitalized on the Consolidated Balance Sheet as of December 31, 2019. Total rental expense for the twelve months ended December 31, 2018 and 2017, as determined in accordance with the previous lease guidance, ASC 840, was $42.5 million and $35.5 million, respectively, and is classified within Cost of goods sold and Selling and administrative expenses within the Consolidated Statements of Comprehensive Income.
Upon adoption of ASC 842, the Company utilized the following elections and practical expedients:
•
The Company elected to not separate non-lease components from lease components and instead to account for each separate lease component, and the non-lease components associated with that lease component, as a single lease component.
•
If at the lease commencement date, a lease had a term of less than 12 months and did not include a purchase option that was reasonably certain to be exercised, the Company elected not to apply ASC 842 recognition requirements. Nonetheless, the Company will include leases of less than 12 months within the updated footnote disclosures where applicable.
•
If the Company enters into a large number of leases in the same month with the same terms and conditions, these will be accounted for as a group (portfolio), assuming the lease model under this approach will not materially differ from applying ASC 842 to each individual lease.
•
The Company elected to not reassess arrangements entered into prior than January 1, 2019, in terms of whether an arrangement is or contained a lease, the lease classification applied or to separate initial direct costs.
•
The Company elected to use hindsight in determining the lease term for lease contracts that have historically been renewed or amended.
When available, the Company will utilize the rate implicit in the lease as the discount rate to determine the lease liability in accordance with ASC 842. However, if this rate is not available, the Company will use its incremental borrowing rate as the discount rate, which is the rate at inception of the lease the Company would hypothetically incur to borrow over a similar term the funds needed to purchase the leased asset.
As a lessee, the Company categorizes its leases into two general categories: real estate and equipment leases.
The Company’s real estate lease portfolio includes leased production and assembly facilities, warehouses and distribution centers, office space and to a lesser degree, employee housing. The terms and conditions of real estate leases can vary significantly from lease to lease. The Company has assessed the specific terms and conditions of each real estate lease to determine the amount of the lease payments and the length of the lease term, which includes the minimum period over which lease payments are required plus any renewal options that are both within the Company's control to exercise and reasonably certain of being exercised upon lease commencement. The Company assesses all relevant factors to determine if sufficient incentives exist as of lease commencement to conclude whether or not renewal is reasonably certain. There are no material residual value guarantees provided by the Company nor any restrictions or covenants imposed by the real estate leases to which the Company is a party. In determining the lease liability, the Company utilizes its incremental borrowing rate for debt instruments with terms approximating the weighted-average term for its real estate leases to discount the future lease payments over the lease term to present value. The Company does incur variable lease payments for certain of its real estate leases, such as reimbursements of property taxes, maintenance and other operational costs to the lessor. In general, these variable lease payments are not captured as part of the lease liability or ROU asset, but rather are expensed as incurred.
The Company’s equipment leases include vehicles, material handling equipment, other machinery and equipment utilized in the Company's production and assembly facilities, warehouses and distribution centers, laptops and other IT equipment, and other miscellaneous leased equipment. Most of the equipment leases are for terms ranging from two to five years, although terms and conditions can vary from lease to lease. The Company applies similar estimates and judgments to its equipment lease portfolio in determining the lease payments and lease term as it does to its real estate lease portfolio. There are no material residual value guarantees provided by the Company nor any restrictions or covenants imposed by the equipment leases to which the Company is a party. In determining the lease liability, the Company utilizes its incremental borrowing rate for debt instruments with terms approximating the weighted-average term for its equipment leases to discount the future lease payments over the lease term to present value. The Company does not typically incur variable lease payments related to its equipment leases.
The amounts included within the Consolidated Balance Sheet related to the Company's ROU asset and lease liability at December 31, 2019, were as follows:
The following table summarizes additional information related to the Company's leases for the year ended December 31, 2019:
The Company frequently enters into both real estate and equipment leases in the normal course of business. While there have been lease agreements entered into that have not yet commenced as of December 31, 2019, none of these leases provide new rights or obligations to the Company that are material individually or in the aggregate.
Future Repayments
Future minimum rental commitments for the subsequent five years under non-cancellable operating leases with terms in excess of one year as of December 31, 2018 were as follows:
Scheduled minimum lease payments required under non-cancellable operating leases for both the real estate and equipment lease portfolios for the next five years and thereafter as of December 31, 2019, were as follows:
The difference between the total undiscounted minimum lease payments and the combined current and noncurrent lease liabilities as of December 31, 2019, is due to imputed interest of $10.8 million.
NOTE 12 - PENSIONS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company sponsors several U.S. defined benefit and defined contribution plans covering substantially all U.S. employees. Additionally, the Company has non-U.S. defined benefit and defined contribution plans covering eligible non-U.S. employees. Postretirement benefits, other than pensions, provide healthcare benefits, and in some instances, life insurance benefits for certain eligible employees.
Pension Plans
The noncontributory defined benefit pension plans covering non-collectively bargained U.S. employees provide benefits on an average pay formula while most plans for collectively bargained U.S. employees provide benefits on a flat dollar benefit formula. The non-U.S. pension plans generally provide benefits based on earnings and years of service. The Company also maintains additional other supplemental plans for officers and other key employees.
The following table details information regarding the Company’s pension plans at December 31:
It is the Company’s objective to contribute to the pension plans to ensure adequate funds are available in the plans to make benefit payments to plan participants and beneficiaries when required. However, certain plans are not funded due to either legal, accounting or tax requirements in certain jurisdictions. As of December 31, 2019, approximately 5% of the Company's projected benefit obligation relates to plans that are not funded, of which the majority are non-U.S. plans.
The pretax amounts recognized in Accumulated other comprehensive loss were as follows:
Weighted-average assumptions used:
The accumulated benefit obligation for all U.S. defined benefit pension plans was $332.4 million and $284.8 million at December 31, 2019 and 2018, respectively. The accumulated benefit obligation for all non-U.S. defined benefit pension plans was $396.7 million and $349.1 million at December 31, 2019 and 2018, respectively.
The Company estimates the service and interest cost components of net periodic benefit cost utilizing a full yield-curve approach. Under this approach, the Company applies discounting using the applicable spot rates derived from the yield curve to discount the cash flows used to measure the benefit obligation. These spot rates align to each of the projected benefit obligations and service cost cash flows.
Information regarding pension plans with accumulated benefit obligations more than plan assets were:
Future pension benefit payments are expected to be paid as follows:
The components of the Company’s net periodic pension benefit costs for the years ended December 31 include the following:
The Service cost component of Net periodic pension benefit cost (income) is recorded in Cost of goods sold and Selling and administrative expenses within the Consolidated Statements of Comprehensive Income. The remaining components of Net periodic pension benefit cost (income) are recorded within Other expense (income), net within the Consolidated Statements of Comprehensive Income.
Pension expense for 2020 is projected to be approximately $7.4 million, utilizing the assumptions for calculating the pension benefit obligations at the end of 2019.
Weighted-average assumptions used:
The expected long-term rate of return on plan assets reflects the average rate of returns expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation. The expected long-term rate of return on plan assets is based on what is achievable given the plan’s investment policy, the types of assets held and target asset allocations. The expected long-term rate of return is determined as of the measurement date. Each plan is reviewed, along with its historical returns and target asset allocations, to determine the appropriate expected long-term rate of return on plan assets to be used.
The Company's overall objective in managing defined benefit plan assets is to ensure that all present and future benefit obligations are met as they come due. The goal is to achieve this while trying to mitigate volatility in plan funded status, contributions and expense by better matching the characteristics of the plan assets to that of the plan liabilities. Each plan’s funded status and asset allocation is monitored regularly in addition to investment manager performance.
The fair values of the Company’s U.S. pension plan assets at December 31, 2019, by asset category were as follows:
(a)
Includes a group trust diversified credit fund and real estate investment trust.
The fair values of the Company’s U.S. pension plan assets at December 31, 2018, by asset category were as follows:
(a)
Includes a group trust diversified credit fund.
No material transfers in or out of Level 3 occurred during the year ended December 31, 2019 or 2018.
The Company determines the fair value of its U.S. pension plan assets using the following methodologies:
•
Cash, cash equivalents and short-term investments - Short-term investments are valued at their daily net asset value (NAV) per share or the equivalent based upon the fair value of the underlying investments. NAV per share or the equivalent is used for fair value purposes as a practical expedient and is calculated by the investment manager or sponsor of the fund. These investments primarily consist of short-term investment funds.
•
Common collective trusts - Common collective trust (CCT) funds are not publicly traded and are valued at NAV per share or the equivalent based upon the fair value of the underlying investments. NAV per share or the equivalent is used for fair value purposes as a practical expedient and is calculated by the investment manager or sponsor of the applicable fund. CCT funds consist of a variety of publicly traded securities, including equity mutual funds, U.S. government and agency obligations, corporate and non-U.S. bonds, securitized credit and emerging market debt. There are no unfunded commitments, redemption frequency restrictions or other redemption restrictions related to such investments.
The fair values of the Company’s non-U.S. pension plan assets at December 31, 2019, by asset category were as follows:
(a) Primarily includes a core diversified credit fund and derivative contracts.
The fair values of the Company’s non-U.S. pension plan assets at December 31, 2018, by asset category were as follows:
(a) Primarily includes insurance contracts, mortgage-backed securities, real estate and derivative contracts.
No material transfers in or out of Level 3 occurred during the year ended December 31, 2019 or 2018.
The Company determines the fair value of its non-U.S. pension plan assets using the following methodologies:
•
Cash, cash equivalents and short-term investments - Cash equivalents are valued using a market approach with inputs including quoted market prices for either identical or similar instruments. Short-term investments are valued at the closing price or amount held on deposit by the custodian bank, at fair value by discounting the related cash flows based on current yields of similar instruments with comparable durations considering the credit-worthiness of the issuer, or at their NAV per share or the equivalent based upon the fair value of the underlying investments. NAV per share or the equivalent is used for fair value purposes as a practical expedient and is calculated by the investment manager or sponsor of the fund. These investments primarily consist of short-term investment funds.
•
Equity mutual funds - Equity mutual funds are primarily valued at their NAV per share or the equivalent. NAV per share or the equivalent is used for fair value purposes as a practical expedient. NAV is calculated by the investment manager or sponsor of the fund.
•
Corporate and non-U.S. bonds - Quoted market prices are not available for these securities. Fair values are either estimated using pricing models and/or quoted prices of securities with similar characteristics or discounted cash flows, in which instances such securities are classified as Level 2 or valued at their NAV per share or the equivalent. NAV per share or the equivalent is used for fair value purposes as a practical expedient and are calculated by the investment manager or sponsor of the fund.
The Company made employer contributions of $6.0 million to the U.S. pension plans in 2019, $6.1 million in 2018 and $55.7 million in 2017 (of which $50.0 million was discretionary). The Company made required and discretionary contributions to its non-U.S. pension plans of $10.6 million in 2019, $5.4 million in 2018 and $5.2 million in 2017.
The Company currently projects that approximately $11.5 million will be contributed to its U.S and non-U.S. plans in 2020. The Company’s policy allows it to fund an amount, which could be in excess of or less than the pension cost expensed, subject to the limitations imposed by current tax regulations. The Company anticipates funding the plans in 2020 in accordance with contributions required by funding regulations or the laws of each jurisdiction.
Most of the Company’s U.S. employees are covered by defined contribution plans. Employer contributions are determined based on criteria specific to the individual plans and amounted to approximately $15.6 million, $14.4 million and $14.0 million in 2019, 2018 and 2017, respectively. The Company’s contributions relating to non-U.S. defined contribution plans and other non-U.S. benefit plans were $6.0 million, $8.0 million and $7.0 million in 2019, 2018 and 2017, respectively.
Deferred Compensation Plan
The Company maintains an Executive Deferred Compensation Plan ("EDCP"), which is an unfunded, nonqualified plan that, prior to 2019, permitted certain employees to defer receipt of up to 50% of their annual salary and up to 100% of their annual bonus awards, performance stock plan awards and restricted stock units received upon commencement of employment. As of December 31, 2019 and 2018, the deferred compensation liability balance was $17.4 million and $15.1 million, respectively, which was recorded within Postemployment and other benefit liabilities in the Consolidated Balance Sheets.
Postretirement Benefits Other Than Pensions
The Company sponsors a postretirement ("OPEB") plan that provides for healthcare benefits, and in some instances, life insurance benefits, that cover certain eligible retired employees. The Company funds postretirement benefit obligations principally on a pay-as-you-go basis. Generally, postretirement health benefits are contributory with contributions adjusted annually. Life insurance plans for retirees are primarily noncontributory. Net periodic postretirement benefit income is included within Other expense (income), net within the Consolidated Statements of Comprehensive Income.
The benefit obligation related to the Company's postretirement plans as of December 31, 2019 and 2018 was $6.8 million and $7.6 million, respectively, and is classified as Accrued compensation and benefits and Postemployment and other benefit liabilities within the Consolidated Balance Sheets. Net periodic postretirement benefit income was $0.1 million, $0.5 million and $1.4 million, for the years ended December 31, 2019, 2018 and 2017, respectively. Net period postretirement benefit income (expense) for 2020 is not projected to be material. Benefit payments for postretirement benefits, which are net of expected plan participant contributions and Medicare Part D subsidies, are expected to be less than $1 million per year for the foreseeable future.
NOTE 13 - FAIR VALUE MEASUREMENTS
Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a framework that utilizes the inputs market participants use to determine the fair value of an asset or liability and establishes a fair value hierarchy to prioritize those inputs. The fair value hierarchy is comprised of the three levels described below:
•
Level 1 - Inputs based on quoted prices in active markets for identical assets or liabilities.
•
Level 2 - Inputs other than Level 1 quoted prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
•
Level 3 - Unobservable inputs based on little or no market activity and that are significant to the fair value of the assets and liabilities.
The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability based on the best information available under the circumstances. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Assets and liabilities measured at fair value at December 31, 2019, were as follows:
Assets and liabilities measured at fair value at December 31, 2018, were as follows:
The Company determines the fair value of its financial assets and liabilities using the following methodologies:
•
Investments - These instruments include equity mutual funds and corporate bond funds. The fair value is obtained based on observable market prices quoted on public exchanges for similar instruments.
•
Interest rate swaps - These instruments include interest rate swap contracts related to the Company's variable rate Term Facility. The fair value of the derivative instruments is determined based on quoted prices for the Company's swaps, which is not considered an active market.
•
Foreign currency contracts - These instruments include foreign currency contracts for non-functional currency balance sheet exposures. The fair value of the foreign currency contracts is determined based on a pricing model that uses spot rates and forward prices from actively quoted currency markets that are readily accessible and observable.
•
Deferred compensation and other retirement plans - These include obligations related to deferred compensation and other retirement plans adjusted for market performance. The fair value is obtained based on observable market prices quoted on public exchanges for similar instruments.
•
Debt - These instruments are recorded at cost and include senior notes maturing through 2029. The fair value of the long-term debt instruments is obtained based on observable market prices quoted on public exchanges for similar instruments.
The carrying values of Cash and cash equivalents, Restricted cash, Accounts and notes receivable, Accounts payable and Accrued expenses and other current liabilities are a reasonable estimate of their fair value due to the short-term nature of these instruments.
The methodology used by the Company to determine the fair value of its financial assets and liabilities at December 31, 2019, are the same as those used at December 31, 2018.
NOTE 14 - EQUITY
Ordinary Shares
The reconciliation of Ordinary shares is as follows:
Allegion had 400.0 million ordinary shares authorized and 10.0 million $0.001 par value preferred shares authorized (with none outstanding) at December 31, 2019.
On February 2, 2017, the Company's Board of Directors approved a share repurchase authorization of up to $500 million of the Company's ordinary shares (the "2017 Share Repurchase Authorization"). During the year ended December 31, 2019, the Company paid $226.0 million to repurchase 2.3 million ordinary shares on the open market under the 2017 Share Repurchase Authorization.
On February 6, 2020, the Company's Board of Directors approved a new share repurchase authorization of up to, and including, $800 million of the Company's ordinary shares (the "2020 Share Repurchase Authorization"), replacing the existing 2017 Share Repurchase Authorization. The 2020 Share Repurchase Authorization does not have a prescribed expiration date.
Accumulated Other Comprehensive Loss
The changes in Accumulated other comprehensive loss were as follows:
(a)
During 2017, the Company reclassified $6.4 million between Accumulated other comprehensive loss and Retained earnings to correct a prior period classification error of Pension and OPEB items. The Company does not believe this reclassification is material to 2017 or to any of its previously issued annual or interim financial statements.
(b)
In February 2018, the FASB issued ASU 2018-02, "Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," allowing entities to reclassify tax effects stranded in AOCI as a result of the Tax Reform Act. The Company elected to early adopt and apply the amendments in ASU 2018-02 in 2018. The impact of adoption resulted in the reclassification presented above.
(c)
During 2019, the Company reclassified $26.2 million of cumulative foreign currency translation adjustments to earnings upon the sale of the Company's business operations in Colombia and Turkey, which is included in Foreign currency items in the table above. See Note 8 for further information on these divestitures.
All amounts of Other comprehensive income (loss) attributable to noncontrolling interests on the Consolidated Statements of Equity relate to foreign currency items.
NOTE 15 - SHARE-BASED COMPENSATION
The Company records share-based compensation awards using a fair value method and recognizes compensation expense for an amount equal to the fair value of the share-based payment issued in its financial statements. The Company’s share-based compensation plans include programs for stock options, restricted stock units ("RSUs"), performance stock units ("PSUs") and deferred compensation.
Under the Company's incentive stock plan, the total number of ordinary shares authorized by the shareholders is 8.0 million, of which 3.1 million remain available as of December 31, 2019 for future incentive awards.
Compensation Expense
Share-based compensation expense is included in Cost of goods sold and Selling and administrative expenses within the Consolidated Statements of Comprehensive Income. The following table summarizes the expenses recognized for the years ended December 31:
Stock Options / RSUs
Eligible participants may receive (i) stock options, (ii) RSUs or (iii) a combination of both stock options and RSUs. The fair value of each of the Company’s stock option and RSU awards is expensed on a straight-line basis over the required service period, which is generally the 3-year vesting period. However, for stock options and RSUs granted to retirement eligible employees, the Company recognizes expense for the fair value at the grant date.
The average fair value of the stock options granted for the years ended December 31, 2019, 2018 and 2017, was estimated to be $19.58, $21.29 and $18.22 per share, respectively, using the Black-Scholes option-pricing model. The weighted-average assumptions used were as follows:
Expected volatility is based on the weighted-average combination of the Company's historic volatility and of the implied volatility of a group of the Company’s peers. The risk-free rate of return is based on the yield curve of a zero-coupon U.S. Treasury bond on the date the award is granted with a maturity equal to the expected term of the award. The expected life of the Company’s stock option awards is derived from the simplified approach based on the weighted-average time to vest and the remaining contractual term and represents the period of time that awards are expected to be outstanding.
Changes in options outstanding under the plans for the years ended December 31, 2019, 2018 and 2017, were as follows:
(a)
The weighted-average exercise price of awards represents the exercise price of the awards on the grant date converted to ordinary shares of the Company.
The following table summarizes information concerning currently outstanding and exercisable options:
At December 31, 2019, there was $1.3 million of total unrecognized compensation cost from stock option arrangements granted under the plan, which is primarily related to unvested shares of non-retirement eligible employees. The aggregate intrinsic value of the Company's options exercised during the years ended December 31, 2019 and 2018, was $16.3 million and $11.5 million, respectively. Generally, stock options expire ten years from their date of grant.
The following table summarizes RSU activity for the years ended December 31, 2019, 2018 and 2017:
(a)
The weighted-average grant date fair value represents the fair value of the awards on the grant date converted to ordinary shares of the Company.
At December 31, 2019, there was $7.6 million of total unrecognized compensation cost from RSU arrangements granted under the plan, which is related to unvested shares of non-retirement eligible employees.
Performance Stock
The Company has a Performance Stock Program ("PSP") for key employees which provides awards in the form of PSUs based on performance against pre-established objectives. The annual target award level is expressed as a number of the Company's ordinary shares. All PSUs are settled in the form of ordinary shares unless deferred.
In February 2017, 2018 and 2019, the Company's Compensation Committee granted PSUs that were earned based 50% upon a performance condition, measured at each reporting period by earnings per share ("EPS") performance in relation to pre-established targets set by the Compensation Committee, and 50% upon a market condition, measured by the Company’s relative total shareholder return ("TSR") against the S&P 400 Capital Goods Index over a three-year performance period. The fair values of the market conditions are estimated using a Monte Carlo simulation approach in a risk-neutral framework to model future stock price movements based upon historical volatility, risk-free rates of return and correlation matrix.
The following table summarizes PSU activity for the maximum number of shares that may be issued for the years ended December 31, 2019, 2018 and 2017:
(a)
The weighted-average grant date fair value represents the fair value of the awards on the grant date converted to ordinary shares of the Company.
At December 31, 2019, there was $5.1 million of total unrecognized compensation cost from the PSP based on current performance, which is related to unvested shares. This compensation will be recognized over the required service period, which is generally the three-year vesting period.
Deferred Compensation
Prior to 2019, the Company allowed key employees to defer a portion of their eligible granted PSUs and/or compensation into a number of investment choices including its ordinary share equivalents. Any amounts invested in ordinary share equivalents will be settled in ordinary shares of the Company at the time of distribution.
NOTE 16 - RESTRUCTURING ACTIVITIES
During 2019, 2018, and 2017, the Company recorded $16.5 million, $4.9 million and $12.3 million, respectively, of expenses associated with restructuring activities. Included within the 2019 restructuring expenses are approximately $8.4 million relating to the Company's closure of its production facility in Turkey during the year. The facility was closed to help streamline the Company's operational footprint in the EMEIA region, and these expenses are primarily related to severance and other employee separation costs, including approximately $1.9 million of pension curtailment costs, which are included within Other expense (income), net within the Consolidated Statements of Comprehensive Income. All other restructuring expenses for the years ended December 31, 2019, 2018 and 2017, are included within Cost of goods sold and Selling and administrative expenses within the Consolidated Statements of Comprehensive Income. The Company completed the divestiture of its Turkey business in the fourth quarter of 2019 (see Note 8).
The changes in the restructuring reserve during the years ended December 31, 2019 and 2018, were as follows:
The majority of the costs accrued as of December 31, 2019, will be paid within one year.
The Company also incurred other non-qualified restructuring charges of $5.7 million, $1.6 million and $1.5 million during the years ended December 31, 2019, 2018 and 2017, respectively, in conjunction with the other restructuring plans, which represent costs that are directly attributable to restructuring activities, but that do not fall into the severance, exit or disposal category. Approximately $4.3 million of the non-qualified restructuring expenses incurred during 2019 related to the closure of the Company's production facility in Turkey discussed above. Non-qualified restructuring charges are included within Cost of goods sold and Selling and administrative expenses within the Consolidated Statements of Comprehensive Income.
NOTE 17 - OTHER EXPENSE (INCOME), NET
At December 31, the components of Other expense (income), net were as follows:
Other expense (income), net for the year ended December 31, 2017, included a gain of $5.4 million from the sale of iDevices, LLC, which is included within the Loss (earnings) from and gains on sale of equity investments in the table above. Other expense (income), net for the year ended December 31, 2017, also included gains of $7.3 million related to legal entity liquidations in the Asia Pacific segment, of which $2.2 million was attributed to noncontrolling interests. These gains are included within Other in the table above.
NOTE 18 - INCOME TAXES
Earnings before income taxes for the years ended December 31 were taxed within the following jurisdictions:
The components of the Provision for income taxes for the years ended December 31 were as follows:
The Provision for income taxes differs from the amount of income taxes determined by applying the applicable U.S. statutory income tax rate to pretax income, as a result of the following differences:
(1)
Net of changes in valuation allowances
On December 22, 2017, the Tax Reform Act became law, resulting in broad and complex changes to the U.S. tax code. The impact to the Company's Consolidated Financial Statements during the year ended December 31, 2017, included, but were not limited to, a (1) reduced U.S. federal corporate tax rate from 35.0% to 21.0%, effective January 1, 2018, (2) required a one-time transition tax on certain unrepatriated earnings of non-U.S. subsidiaries and (3) required review of the future realizability of deferred tax balances.
Shortly after the Tax Reform Act was enacted, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which provided guidance on accounting for the Tax Reform Act’s impact. SAB 118 provided a measurement period, which in no case was to extend beyond one year from the Tax Reform Act enactment date, during which a company acting in good faith could complete the accounting for the impacts of the Tax Reform Act under ASC Topic 740. In accordance with SAB 118, the Company reflected the income tax effects of the Tax Reform Act in the reporting period in which the accounting under ASC 740 was completed. The Company recorded a provisional discrete net tax charge of $53.5 million related to the Tax Reform Act during the year ended December 31, 2017. This net charge primarily consisted of a net charge of $24.5 million due to the remeasurement of deferred tax accounts to reflect the corporate rate reduction impact to the Company's net deferred tax balances, a net charge of $22.8 million due to the future realizability of certain deferred tax balances and a net charge for the transition tax of $5.0 million.
In accordance with the expiration of the one-year SAB 118 measurement period, the Company completed the assessment of the income tax effects of the Tax Reform Act in the fourth quarter of 2018. In finalizing the net tax charge resulting from the Tax Reform Act, the Company reversed $22.8 million of previous charges and recorded an additional $0.9 million of transition tax, each of which is described more fully below.
During 2018, the U.S. Internal Revenue Service and Treasury Department released interpretative guidance and accordingly, the Company reversed the $22.8 million of valuation allowance during the year ended December 31, 2018, primarily related to the deductibility of interest limitation carryforward balances and certain executive compensation. Also during 2018, U.S. Internal Revenue Service and Treasury Department released interpretive guidance and draft regulations which resulted in the $0.9 million increase in the transition tax charge. The Company elected to pay the full liability for the deemed repatriation of foreign earnings during the year ended December 31, 2018.
The majority of the Company's earnings are considered permanently reinvested. The transition tax resulted in certain previously untaxed non-U.S. earnings being included in the U.S. federal and state 2017 taxable income. As a result of the Tax Reform Act, the Company analyzed its global working capital requirements and the potential tax liabilities that would be incurred if certain non-U.S. subsidiaries made distributions, which include local country withholding tax and potential U.S. state taxation. Based on this analysis, the Company made no changes to its permanent reinvestment assertions to reinvest the earnings in its non-U.S. subsidiaries outside of the U.S. Thus, the Company has not recorded any incremental withholding or income tax liabilities on its investment in its non-U.S. subsidiaries.
At December 31, a summary of the deferred tax accounts was as follows:
At December 31, 2019, $2.4 million of deferred taxes were recorded for certain undistributed earnings of non-U.S. subsidiaries. Historically, no deferred taxes have been provided for any portion of the remaining undistributed earnings of the Company's subsidiaries since these earnings have been, and will continue to be, permanently reinvested in these subsidiaries. For many reasons, including the number of legal entities and jurisdictions involved, the complexity of the Company's legal entity structure, the complexity of tax laws in the relevant jurisdictions and the impact of projections of income for future years to any calculations, the Company believes it is not practicable to estimate, within any reasonable range, the amount of additional taxes which may be payable upon the distribution of earnings.
At December 31, 2019, the Company had the following tax losses and tax credit carryforwards available to offset taxable income in prior and future years:
The U.S. state loss carryforwards were incurred in various jurisdictions. The non-U.S. loss carryforwards were incurred in various jurisdictions, predominantly in China, Ireland, Italy, Luxembourg and the United Kingdom.
The Company evaluates its deferred income tax assets to determine if valuation allowances are required or should be adjusted. U.S. GAAP requires that companies assess whether valuation allowances should be established against their deferred tax assets based on consideration of all available evidence, both positive and negative, using a "more likely than not" standard. This assessment considers the nature, frequency and amount of recent losses, the duration of statutory carryforward periods and tax planning strategies. In making such judgments, significant weight is given to evidence that can be objectively verified.
Activity associated with the Company’s valuation allowance is as follows:
During the year ended December 31, 2019, the valuation allowance decreased by $116.1 million. This decrease is the result of changes in country specific tax laws, internal restructurings, jurisdictional profitability and changes in judgment and facts regarding the realizability of deferred tax assets.
The Company has total unrecognized tax benefits of $37.3 million and $42.0 million as of December 31, 2019 and 2018, respectively. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $37.3 million as of December 31, 2019. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The Company records interest and penalties associated with the uncertain tax positions within its provision for income taxes. The Company had reserves associated with interest and penalties, net of tax, of $6.2 million and $5.7 million at December 31, 2019 and 2018, respectively. For the years ended December 31, 2019 and 2018, the Company recognized $1.3 million and $0.8 million in net interest and penalties, net of tax, related to these uncertain tax positions.
The total amount of unrecognized tax benefits relating to the Company's tax positions is subject to change based on future events including, but not limited to, the settlements of ongoing audits and/or the expiration of applicable statutes of limitations. Although the outcomes and timing of such events are highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits, excluding interest and penalties, could potentially be reduced by up to approximately $8.6 million during the next 12 months.
The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which the Company operates. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and tax balances recorded by the Company. In addition, tax authorities periodically review income tax returns filed by the Company and can raise issues regarding its filing positions, timing and amount of income or deductions and the allocation of income among the jurisdictions in which the Company operates. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a tax authority with respect to that return. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as Australia, Canada, France, Germany, Italy, Mexico, the Netherlands and the U.S. In general, the examination of the material tax returns of subsidiaries of the Company is complete for the years prior to 2003, with certain matters being resolved through appeals and litigation.
The Company had no indemnity receivables at December 31, 2019, and $5.4 million of indemnity receivables included in Other noncurrent assets at December 31, 2018, primarily related to additional competent authority relief filings.
NOTE 19 - EARNINGS PER SHARE (EPS)
Basic EPS is calculated by dividing Net earnings attributable to Allegion plc by the weighted-average number of ordinary shares outstanding for the applicable period. Diluted EPS is calculated after adjusting the denominator of the basic EPS calculation for the effect of all potentially dilutive ordinary shares, which in the Company’s case, includes shares issuable under share-based compensation plans.
The following table summarizes the weighted-average number of ordinary shares outstanding for basic and diluted earnings per share calculations:
At December 31, 2019, 0.1 million stock options were excluded from the computation of weighted-average diluted shares outstanding because the effect of including these shares would have been anti-dilutive.
NOTE 20 - NET REVENUES
Net revenues are recognized based on the satisfaction of performance obligations under the terms of a contract. A performance obligation is a promise in a contract to transfer control of a distinct product or to provide a service, or a bundle of products or services, to a customer, and is the unit of account under ASC 606. The Company has two principal revenue streams, tangible product sales and services. Approximately 99% of consolidated Net revenues involve contracts with a single performance obligation, which is the transfer of control of a product or bundle of products to a customer. Transfer of control typically occurs when goods are shipped from the Company's facilities or at other predetermined control transfer points (for instance, destination terms). Net revenues are measured as the amount of consideration expected to be received in exchange for transferring control of the products and takes into account variable consideration, such as sales incentive programs including discounts and volume rebates. The existence of these programs does not preclude revenue recognition but does require the Company's best estimate of the variable consideration to be made based on expected activity, as these items are reserved for as a deduction to Net revenues over time based on the Company's historical rates of providing these incentives and annual forecasted sales volumes. The Company also offers a standard warranty with most product sales and the value of such warranty is included in the contractual price. The corresponding cost of the warranty obligation is accrued as a liability (see Note 21).
The Company's remaining Net revenues involve services, including installation and consulting. Unlike the single performance obligation to ship a product or bundle of products, revenue recognition related to services revenues is delayed until the service based performance obligations are satisfied. In some instances, customer acceptance provisions are included in sales arrangements to give the buyer the ability to ensure the service meets the criteria established in the order. In these instances, revenue recognition is deferred until the performance obligations are satisfied, which could include acceptance terms specified in the arrangement being fulfilled through customer acceptance or a demonstration that established criteria have been satisfied. During the years ended December 31, 2019 and 2018, no adjustments related to performance obligations satisfied in previous periods were recorded.
The Company applies the practical expedients allowed under ASC 606 to omit the disclosure of remaining performance obligations for contracts with an original expected duration of one year or less and for contracts where the Company has the right to invoice
for performance completed to date. The transaction price is not adjusted for the effects of a significant financing component, as the time period between control transfer of goods and services is less than one year. Sales, value-added and other similar taxes collected by the Company are excluded from Net revenues. The Company has also elected to account for shipping and handling activities that occur after control of the related goods transfers as fulfillment activities instead of performance obligations. These activities are included in Cost of goods sold in the Consolidated Statements of Comprehensive Income. The Company’s payment terms are generally consistent with the industries in which its businesses operate.
The following table shows the Company's Net revenues related to both tangible product sales and services for the years ended December 31, 2019, 2018 and 2017, respectively, disaggregated by business segment. Net revenues are shown by tangible product sales and services, as contract terms, conditions and economic factors affecting the nature, amount, timing and uncertainty around revenue recognition and cash flows are substantially similar within each of the two principal revenue streams:
(a)
The Company adopted ASC 606 on January 1, 2018, on a modified retrospective basis, and as such, amounts presented for the year ended December 31, 2017, are based on ASC 605.
As of December 31, 2019 and 2018, neither the contract assets related to the Company's right to consideration for work completed but not billed nor the contract liabilities associated with contract revenue were material. As a practical expedient, the Company recognizes incremental costs of obtaining a contract, if any, as an expense when incurred if the amortization period of the asset would have been one year or less. The Company does not have any costs to obtain or fulfill a contract that are capitalized under ASC 606.
NOTE 21 - COMMITMENTS AND CONTINGENCIES
The Company is involved in various litigation, claims and administrative proceedings, including those related to environmental and product warranty matters. Amounts recorded for identified contingent liabilities are estimates, which are reviewed periodically and adjusted to reflect additional information when it becomes available. Subject to the uncertainties inherent in estimating future costs for contingent liabilities, except as expressly set forth in this note, management believes that any liability which may result from these legal matters would not have a material adverse effect on the financial condition, results of operations, liquidity or cash flows of the Company.
Environmental Matters
The Company is dedicated to an environmental program to reduce the utilization and generation of hazardous materials during the manufacturing process and to remediate identified environmental concerns. As to the latter, the Company is currently engaged
in site investigations and remediation activities to address environmental cleanup from past operations at current and former production facilities. The Company regularly evaluates its remediation programs and considers alternative remediation methods that are in addition to, or in replacement of, those currently utilized by the Company based upon enhanced technology and regulatory changes. Changes to the Company's remediation programs may result in increased expenses and increased environmental reserves.
The Company is sometimes a party to environmental lawsuits and claims and has received notices of potential violations of environmental laws and regulations from the U.S. Environmental Protection Agency and similar state authorities. It has also been identified as a potentially responsible party ("PRP") for cleanup costs associated with off-site waste disposal at federal Superfund and state remediation sites. For all such sites, there are other PRPs and, in most instances, the Company’s involvement is minimal.
In estimating its liability, the Company has assumed it will not bear the entire cost of remediation of any site to the exclusion of other PRPs who may be jointly and severally liable. The ability of other PRPs to participate has been taken into account, based on the Company's understanding of the parties’ financial condition and probable contributions on a per site basis. Additional lawsuits and claims involving environmental matters are likely to arise from time to time in the future.
The Company incurred $1.7 million, $2.4 million and $3.2 million of expenses during the years ended December 31, 2019, 2018 and 2017, respectively, for environmental remediation at sites presently or formerly owned or leased by the Company. Environmental remediation costs are recorded in Costs of goods sold within the Consolidated Statements of Comprehensive Income.
As of December 31, 2019 and 2018, the Company has recorded reserves for environmental matters of $19.3 million and $22.6 million, respectively. The total reserve at December 31, 2019 and 2018, included $4.2 million and $6.3 million, respectively, related to remediation of sites previously disposed by the Company. Environmental reserves are classified as Accrued expenses and other current liabilities or Other noncurrent liabilities within the Consolidated Balance Sheets based on their expected term. The Company's total current environmental reserve at December 31, 2019 and 2018, was $6.2 million and $5.6 million, respectively, and the remainder is classified as noncurrent. Given the evolving nature of environmental laws, regulations and technology, the ultimate cost of future compliance is uncertain.
Warranty Liability
Standard product warranty accruals are recorded at the time of sale and are estimated based upon product warranty terms and historical experience. The Company assesses the adequacy of its liabilities and will make adjustments as necessary based on known or anticipated warranty claims, or as new information becomes available.
The changes in the standard product warranty liability for the years ended December 31, were as follows:
Standard product warranty liabilities are classified as Accrued expenses and other current liabilities within the Consolidated Balance Sheets.
NOTE 22 - BUSINESS SEGMENT INFORMATION
The Company classifies its business into the following three reportable segments based on industry and market focus: Americas, EMEIA and Asia Pacific.
The Company largely evaluates performance based on Segment operating income and Segment operating margins. Segment operating income is the measure of profit and loss that the Company’s chief operating decision maker uses to evaluate the financial performance of the business and as the basis for resource allocation, performance reviews and compensation. For these reasons, the Company believes that Segment operating income represents the most relevant measure of segment profit and loss. The Company’s chief operating decision maker may exclude certain charges or gains, such as corporate charges and other special charges, from Operating income to arrive at a Segment operating income that is a more meaningful measure of profit and loss
upon which to base operating decisions. The Company defines Segment operating margin as Segment operating income as a percentage of the segment's Net revenues.
A summary of operations and balance sheet information by reportable segments as of and for the years ended December 31 were as follows:
(a)
Unallocated assets consist primarily of investments in unconsolidated affiliates, fixed assets, deferred income taxes and cash.
Net revenues by destination and product type for the years ended December 31, were as follows:
In fiscal year 2019, 2018 and 2017, no customer exceeded 10% of consolidated Net revenues.
At December 31, long-lived assets by geographic area were as follows:
NOTE 23 - SUBSEQUENT EVENTS
On February 6, 2020, the Company's Board of Directors declared a quarterly dividend of $0.32 cents per ordinary share. The dividend is payable March 31, 2020 to shareholders of record on March 17, 2020.
NOTE 24 - GUARANTOR FINANCIAL INFORMATION
Allegion US Hold Co is the issuer of the 3.200% Senior Notes and 3.550% Senior Notes and is the guarantor of the 3.500% Senior Notes (all three senior notes, collectively, the "Senior Notes"). Allegion plc (the “Parent”) is the issuer of the 3.500% Senior Notes and is the guarantor of the 3.200% Senior Notes and 3.550% Senior Notes. Allegion US Hold Co is 100% owned by the Parent and each of the guarantees of Allegion US Hold Co and the Parent is full and unconditional and joint and several. The following tables present condensed and consolidated financial information of Allegion plc, Allegion US Hold Co, and the other Allegion subsidiaries that are not guarantors (the "Other Subsidiaries") on a combined basis as of December 31, 2019 and 2018, and for the years ended December 31, 2019, 2018 and 2017.
Condensed and Consolidated Statement of Comprehensive Income
For the year ended December 31, 2019
Condensed and Consolidated Statement of Comprehensive Income
For the year ended December 31, 2018
Condensed and Consolidated Statement of Comprehensive Income
For the year ended December 31, 2017
Condensed and Consolidated Balance Sheet
December 31, 2019
Condensed and Consolidated Balance Sheet
December 31, 2018
Condensed and Consolidated Statement of Cash Flows
For the year ended December 31, 2019
Condensed and Consolidated Statement of Cash Flows
For the year ended December 31, 2018
Condensed and Consolidated Statement of Cash Flows
For the year ended December 31, 2017
SCHEDULE II
ALLEGION PLC
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2019, 2018 AND 2017
(Amounts in millions)
*
"Deductions" include accounts and advances written off, less recoveries.