Earnings Call Transcript
RESIDEO TECHNOLOGIES, INC. (REZI)
Earnings Call Transcript - REZI Q3 2020
Operator, Operator
Ladies and gentlemen, I would like to welcome everyone to the Resideo Technologies Third Quarter 2020 Earnings Conference Call. Today's call is being recorded. It is now my pleasure to introduce Mr. Jason Willey, Senior Director of Investor Relations. Mr. Willey, you may now begin.
Jason Willey, Senior Director of Investor Relations
Good morning, everyone, and thank you for joining us for Resideo's Third Quarter 2020 Earnings Conference Call. On today's call will be Jay Geldmacher, Resideo's Chief Executive Officer; and Tony Trunzo, our Chief Financial Officer. A copy of our earnings release and related presentation materials are available on the Investor Relations page of our website at investors.resideo.com. We would like to remind you that this morning's presentation contains forward-looking statements. Statements other than historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may vary materially from those on the forward-looking statements as a result of a number of factors, including those described from time to time in Resideo's filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements. Additionally, during our call today, we will refer to certain non-GAAP financial information. A reconciliation of our GAAP to non-GAAP results is included in the company's earnings press release and accompanying presentation, both of which can be found on the Investor Relations section of our website. We identify the principal risks and uncertainties that affect our performance in our annual report on Form 10-K and other SEC filings. I will now turn the call over to Jay.
Jay Geldmacher, CEO
Thank you, Jason, and good morning, everyone. During the third quarter, we saw a meaningful improvement in demand across our markets. This demand enabled us to leverage our extensive product portfolio, unmatched relationships with the professional channel, and the broad reach of our ADI distribution platform to deliver a significant improvement in the year-over-year and sequential financial results. At ADI, revenue grew 11% year-over-year in the third quarter, reflecting another quarter of outperformance relative to the markets it serves. The ADI team has a long track record of executing on value-enhancing growth initiatives and a well-defined strategy for driving continued outperformance. Within Products & Solutions, we grew revenue 12% compared with the third quarter of 2019. We saw underlying strength in each of our end markets, which translated to top-line growth and gross margin expansion. Across the business, COVID-19 dynamics shifted from a meaningful headwind in the second quarter to a tailwind in Q3. As we indicated on our Q2 call, underlying demand and customer behavior trended positive as Q2 progressed and into July. This momentum accelerated as we moved through the third quarter. People continue to spend more time in their homes, which we believe is creating increased attention on the home and a desire to invest, driving demand for renovation and repair projects and home security. With leading solutions and distribution reach across home comfort and security markets, our business is well-positioned to capitalize on the current positive market trends, which we believe have durability beyond 1 or 2 quarters. Looking back on my first 5 months at Resideo, there's been significant progress on driving operational improvement and an accelerated focus on innovation. We solidified the senior leadership team, adding individuals with proven track records of delivering efficiency improvements, cost discipline, and growth. We reorganized Products & Solutions to bring needed operational focus while at the same time, better structuring the organization to move quicker to address customer needs, product innovation, and new market development. The strengthening and reorganizing of our teams are critical to unlocking long-term value at Resideo. In August, we added Jeff Frank as Senior Vice President of Product Innovation to create cohesion across the organization around new innovation in our product roadmap and engagement in strategic market development. The innovation organization is new within Resideo, and Jeff and his team bring fresh perspective to our technology development, joined by a multi-decade track record of successfully bringing new products to market. The formation of the innovation team and their focus on unifying software, platforms, and user experience across the business is critical to ensuring our position as a leader in enabling the connected home ecosystem. In October, Phil Theodore, who joined Resideo earlier this year to lead our transformation efforts, took on the role of President of our Products & Solutions segment. Phil is the hands-on operationally focused leader essential for executing on the transformation of this business, leading the efficiency efforts and positioning the business for sustained growth. As we look to accelerate product development and bring historically siloed product lines together as one business. We have reorganized Products & Solutions to integrate engineering and product line management. These changes are designed to foster collaboration across the entire product portfolio and establish linkages critical to bringing innovative new products to market quickly and cost-effectively while ensuring we are aligned with the needs of our customers. As we make these organizational changes, we recognize the need to maintain our focus on bringing operational discipline and accountability to the business while driving sustainable long-term revenue growth. I view transformation as a continuous journey and not a discrete project or program. Our transformation team, now reporting to Tony, will continue leading this crucial work at Resideo with a focus on ingraining these critical values into the culture of Resideo. I have focused much of my time over the past few months on directly engaging with senior leadership of our key customers and partners. I believe building these relationships will allow us to better understand our customers' needs, identify opportunities for collaboration, and inform our decisions around product development, marketing support, and other critical areas. I've also challenged the team to accelerate our engagement related to partnerships and strategic relationships. While we have a broad suite of products in the residential solutions market, the market itself is substantial. And there's meaningful opportunity to partner in areas where we are clearly differentiated or can leverage the innovations of others to create greater value. With that, I will turn the call over to Tony to discuss our third-quarter financial performance in more detail.
Anthony Trunzo, CFO
Thank you, Jay, and good morning, everyone. Consolidated revenue for the third quarter was $1.4 billion, an increase of 11% compared to the prior year. As Jay indicated, we saw strong demand across the business during the third quarter. Q3 gross margin of 27.2% was up approximately 200 basis points from Q3 last year, primarily due to improved cost absorption on stronger revenue and cost savings from transformation programs. Selling, general and administrative expenses for the third quarter totaled $239 million, down 4% from Q3 last year due largely to net savings generated from our cost-reduction initiatives as well as COVID-19-related cost savings. Higher revenue, improved gross margin, and lower spending resulted in an operating profit of $131 million for the third quarter compared to $59 million in the prior year. GAAP net income for the third quarter was $75 million or $0.60 per fully diluted common share. Consolidated adjusted EBITDA of $188 million was up 65% compared to the prior year. ADI revenue of $790 million increased 11%, which included an approximate 2.8 percentage point benefit from acquisitions. Demand returned across the business, particularly for products serving the residential market in North America and for large project business. While ADI experienced some COVID-related disruptions to its branch network during Q3, the impact was much less than the second quarter and more than offset by strong e-commerce revenue. ADI has stepped up its investment in e-commerce, and we expect these initiatives to aid revenue growth and margin improvement moving forward. ADI segment adjusted EBITDA was up 8% to $52 million due to higher revenue and a continued focus on cost management. These positives were partially offset by unfavorable product mix and the increased investment in several long-term strategic initiatives. Products & Solutions Q3 revenue was $572 million, up 12% compared to last year due to improved end market demand, particularly in the security and comfort markets. Products & Solutions exited the quarter with backlog well above typical levels, which reflects continuing strong demand as well as COVID-19-related impacts on our manufacturing operations and supply chain. Products & Solutions segment adjusted EBITDA of $136 million was more than double Q3 of last year. The improved performance reflects higher revenue, sourcing, productivity initiatives, and cost reductions. Beginning with Q1 2021, we will report our corporate costs separately. This change will better align accountability and authority, give a clearer view into the operational performance of the two segments, and increase accountability of the management on corporate spending. Consolidated cash from operations for the third quarter was $21 million, up $54 million year-over-year due to improved net income and an increase in accrued liabilities. As expected, cash from operations in Q3 was impacted by higher receivables as sales grew sequentially. At the end of Q3, Resideo had cash and cash equivalents of $260 million, total outstanding debt of $1.3 billion and $200 million undrawn on its $350 million revolving credit facility. On October 30, we made our regularly scheduled $35 million reimbursement agreement payment to Honeywell, and we also made a $35 million payment that was originally due in April that had been previously deferred. We remain focused on driving costs lower, accelerating innovation, and ingraining a culture of continuous improvement and growth. Over time, we will move away from specific cost-reduction programs and instead focus on making efficiency and cost savings part of our DNA, with results that will be visible in improved margins and overall financial performance. As it relates to our current transformation program, we now expect between $40 million and $45 million of net savings for the full year 2020. We will provide more detail on future transformation initiatives with our Q4 results. Given the improved visibility in our business, we are reinstating guidance for the fourth quarter of this year. We currently expect Q4 revenue in the range of $1.36 billion to $1.41 billion, GAAP operating profit in the range of $130 million to $140 million, and adjusted EBITDA in the range of $180 million to $190 million. Our October results and the healthy demand we continue to see across the business support the outlook we are providing today. However, rising COVID cases around the world create additional market and operational uncertainties. Our Q4 outlook does not factor in new restrictions that could materially impact customer activity, industry supply chains, our manufacturing facilities, or our ADI branches. As always, we will prioritize the safety of our employees over all other considerations. As part of our budget process for 2021, we are evaluating incremental growth investments across Resideo. At ADI, these investments will include systems enhancements, e-commerce initiatives, and targeted M&A. Within Products & Solutions, investment will be focused on driving new innovation and new product development. Investment in these areas will be reinforced by the recent organizational changes and leadership additions that Jay discussed. We will dive deeper into these areas when we report our Q4 results and at our Investor Day that we plan to host in early March. As a reminder, beginning in 2021, we intend to deemphasize non-GAAP measures and focus on operating profit, cash flow from operations, and other GAAP measures. In our view, GAAP presents a clearer picture of actual results against a known benchmark. I'll now turn the call back to Jay for a few concluding remarks before we take questions.
Jay Geldmacher, CEO
Thanks, Tony. While we continue to closely monitor COVID-19-related risks in our operations and supply chain, we are encouraged by the strong customer demand we are currently seeing. As we move through our 2021 planning process and continue to refine our long-term strategy, we are focused on rightsizing our cost structure, driving efficiencies to deliver further gross margin enhancement, and accelerating our new product introduction process to ensure we are positioned for long-term growth. We intend to capitalize on the current demand tailwinds across our markets as we execute on our transformation efforts. The current business strength opens opportunities to accelerate the changes and investments we are making to drive innovation and efficiencies in the business. We look forward to providing more details when we report our full-year results in February and at an Investor Day in early March. As I look back at my first 5 months at Resideo, I'm even more encouraged by the opportunities that I see for long-term value creation. While there is meaningful work to be done, I believe we have an incredibly strong foundation. This foundation, combined with ongoing transformation efforts and the new talent we are bringing on board, give me tremendous excitement about Resideo's future. In closing, I would like to thank our employees for their dedication and effort over the past quarter. Across the organization, people have stepped up to ensure we meet the needs of our customers, while at the same time, embracing the changes necessary to create a platform for long-term sustainable success for Resideo. This concludes our prepared remarks, and operator, we are now ready for questions.
Operator, Operator
Our first question will come from John Lovallo with the Bank of America.
John Lovallo, Analyst
The first one is, it looks like the transformation programs really started gaining traction in the quarter. And it looks like you took up your cost savings targets. Can you just help us understand where you saw the most traction in the quarter and where the incremental opportunity is?
Jay Geldmacher, CEO
Tony, you want to comment on that?
Anthony Trunzo, CFO
Yes, John. In any transformation program, the initial benefits are often seen in the cost structure, particularly in SG&A and somewhat in your fixed overhead within COGS. As we progress, these benefits should start to show more in the COGS line and eventually lead to an increase in revenue as we implement sales activation programs and begin to see their effects. This process usually takes some time. The $40 million to $45 million figure we provided is primarily reflected in operating expenses, which aligns with the majority of costs when viewed on a GAAP basis. This is why we shared the net number. Looking ahead, we are rolling out programs related to integrated business planning and other initiatives that should significantly improve our gross margin. Additionally, initiatives such as our profitability management office are expected to gain momentum over the next few quarters.
John Lovallo, Analyst
Okay. That's helpful. And then the big surprise in the quarter from where we sit at least was that 23.8% Products & Solutions margin. And what we're trying to figure out here is sort of the sustainability of that. It looks like the fourth quarter would imply something north of 20% as well. So we just kind of wanted to dig a little bit more into what were the biggest drivers there? Is this 20% sort of a good sustainable run rate number? Any thoughts on that would be helpful.
Anthony Trunzo, CFO
So John, that gives me the opportunity to tell you that we will give a clearer view as to long-term metrics and long-term expectations with respect to things like margins at that Investor Day that we referenced in early March. We're still grinding through a long-term plan that would indicate what we think is not only sustainable but over time trending upward to what we think is ultimately achievable. The margins we saw this quarter, there's nothing in the quarter given the revenue number that would suggest that it's not sustainable. In fact, product mix was slightly unfavorable in the quarter. We got really good operating leverage off of our fixed costs, and that's a significant benefit in a business like this. To the extent we continue to see good revenue performance, there's nothing to suggest that that margin level isn't sustainable.
Jay Geldmacher, CEO
I want to emphasize that the transformation office we've established is focused on margin enhancements. As I mentioned earlier, this initiative is becoming an integral part of our company culture and is not a temporary measure. Enhancing margins will consistently be a priority for us as we move forward, supported by a dedicated team that is committed to this mission within the organization.
John Lovallo, Analyst
That's good to hear. If I can just squeeze one more in here. On the ADI side, revenue was up nicely, 11-ish percent. Margin was flat. It seemed like there were some investments that were made in the quarter for growth. Can you just help us understand maybe what those investments were and maybe the magnitude of that and if you think those are going to persist?
Anthony Trunzo, CFO
Yes. So as we said on the Q2 call, ADI is a business that deserves more investment. Rob and his team have done an absolutely incredible job with that business over the last couple of years, really operating on a shoestring. And we're changing that. We are investing more aggressively in some sales initiatives like outbound telesales. We're investing in e-commerce in a meaningful way. We'll be investing in the underlying systems in a meaningful way. So yes, those things will continue. Having said that, we still expect the ADI business to continue to perform at the margin level consistent with what it's done historically. These investments are designed to really drive the business forward from the strong foundation that it sits on today.
Operator, Operator
Our next question comes from Ian Zaffino with Oppenheimer.
Ian Zaffino, Analyst
Can you talk a little bit about the product mix you mentioned? Could you elaborate on how security compares to comfort and care?
Anthony Trunzo, CFO
Yes. Ian, we are not going to go into great detail about customer-level margins or margins by the previous segments, as we are currently working on breaking down those silos and transforming them into product lines within a more unified Products & Solutions environment. That said, we have noted that we currently have a significant backlog due to demand and a somewhat constrained supply chain. This situation has led us to prioritize our OEM business, which includes aspects of both security and the former RTS business. However, this OEM business generally yields lower margins compared to our typical business operations.
Jay Geldmacher, CEO
Yes. I'll add to that. From the comments that both Tony and I made, you'll hear us discuss this more as we move forward. By eliminating the silos created by the individual product lines and product groups within Products & Solutions, we expect to achieve greater efficiencies, productivity, and importantly, innovation. This new approach will allow us to view everything through a different lens, fostering total innovation across all products within P&S. As I mentioned, we will gain significant efficiencies and productivity, and I am equally excited about the innovation this will bring across those segments.
Ian Zaffino, Analyst
Got you. So basically, when you referred to mix, you were talking more about more OE versus aftermarket versus product line?
Anthony Trunzo, CFO
Yes. That's right.
Ian Zaffino, Analyst
Can you share your thoughts on how ADI and its products are collaborating? Is there a stronger effort to enhance their partnership? You mentioned breaking down silos in the product area, but what about between different business divisions? Are there any opportunities there, or should we expect anything specific?
Jay Geldmacher, CEO
I believe we have a significant opportunity for closer collaboration between ADI and the Products & Solutions group. As Products & Solutions plans their future product road maps, they are also discussing further initiatives with ADI. This collaboration is part of our efforts to break down silos, and I can see that the two groups are working more closely than ever, and we are strongly encouraging this. I anticipate more opportunities as a result of this collaboration.
Anthony Trunzo, CFO
Ian, to put a super fine point on it. Our P&S business' largest customer is ADI.
Ian Zaffino, Analyst
That's a great point.
Anthony Trunzo, CFO
We have not only focused on managing relationships but also on building connections at the executive and senior levels with our major customers. This approach is crucial for ADI as it is for our other key customers. We are making significant progress in this area.
Operator, Operator
Our next question comes from Craig Irwin with ROTH Capital Partners.
Craig Irwin, Analyst
First, congratulations on the strong results. I wanted to ask a little bit about channel contribution to the strength that you saw this quarter. Was there much variance between your traditional distribution OEM and factory direct customers? And can you maybe comment on whether or not some of this might have been catch-up spending for projects that were delayed in the COVID environment we experienced starting this past March?
Anthony Trunzo, CFO
Sure. Jay, I'll start and then you can pop in as well.
Jay Geldmacher, CEO
Yes.
Anthony Trunzo, CFO
We cannot break it down by channel as requested. As I mentioned earlier, the OEM business is somewhat less profitable than the aftermarket and other segments. Going deep into the channel details isn't feasible for us right now, as we are focused on driving a unified perspective within Products & Solutions regarding product development and innovation. This effort will blur existing silos. Regarding how much of the current situation is due to channel restocking, it's not easy to determine. However, after four to five months of strong demand across the board, it's clear that the demand extends beyond mere restocking. There has been a fundamental increase in demand throughout the entire home connected ecosystem we serve. This leads us to believe that the level of demand will remain strong beyond the next quarter or two, suggesting a fundamental change has occurred. One strong indicator of this is our significant backlog.
Jay Geldmacher, CEO
I agree with Tony on that. We analyze the market similarly to you and assess how everyone is performing in this area. When we review that data and the results overall, it reinforces everything Tony just mentioned.
Craig Irwin, Analyst
Okay. Excellent. So then if we take an approach of maybe summing the March and the June quarters' results together, your revenue on a combined basis was down just a tad year-over-year, but your EBITDA was up something in the low teens. Clearly, there's leverage to what's been done in the last 6 months of the last year. Can you maybe expand on where this leverage is coming from? And specifically, how does this get amplified over the next couple of quarters? Are there discrete actions that we should watch for or monitor to understand the proportionate impact?
Anthony Trunzo, CFO
So Craig, I didn't track the Q1 to Q2 commentary you just made.
Craig Irwin, Analyst
Add Q2 and Q3 together, compare them for 2020 over 2019. It's down just a tad, but your EBITDA is up 13%.
Anthony Trunzo, CFO
I see. Yes. I understand your question. While I haven't done the exact calculations you mentioned, it doesn't surprise me. This connects back to my initial point that when we implement these transformations, the initial savings come from SG&A and fixed overhead. Many actions were taken at Resideo this past spring and summer, and we're currently seeing the benefits. This is why the impact of our transformation programs appears to be more pronounced in the second half of this year. It's essentially a series of overlapping opportunities. The first is in G&A, the second involves improving profitability and gross margins in our factories, and the third relates to sales activation. Currently, the factory operations are benefiting from strong demand, which has a significant impact. However, this story is far from over. We're pursuing an initiative within P&S called integrated business planning, which we believe will enhance margins and efficiency. The business carried a substantial SG&A burden following the spin-off over the past year to year and a half, and optimizing this cost structure was our first step, but certainly not the only one. As we move forward, I anticipate we'll have ongoing discussions about margins every quarter for quite a while. As I've mentioned, we're not merely addressing separate programs anymore; we're embedding a cost-conscious approach into the very fabric of the business. This includes accountability for costs, ensuring every expenditure has an owner who is responsible for it and is actively deciding how to allocate that spending. This concept is relatively new in some areas of Resideo, and we've made significant strides in this regard. On the margin front, we are not satisfied with our current position and will keep striving for improvement.
Jay Geldmacher, CEO
Yes. I want to emphasize that this represents a new way for the company to operate, and we are excited about it. The discrete projects initiated as part of the transformation efforts before Tony and I joined were already in progress, and we helped to accelerate them. However, what excites me most is the cultural change and the long-term transformation of our organizational DNA, which will integrate into everyone's daily business practices. This transformation will not only enhance margins but also impact all functional areas of the business. Our new way of thinking and operating daily will be a continuous journey, rather than a single program that is completed and forgotten. It will be a fundamental aspect of our identity, and we are actively promoting this within the organization. We have established a transformation office to champion these efforts.
Anthony Trunzo, CFO
I want to emphasize one more point, and this is important. As I mentioned in the first call, we are focusing on GAAP results for our reported earnings. When expenses are added back, it can sometimes seem like there’s a leniency on spending. We are moving away from that approach. The organization clearly understands this shift and has reacted very positively. Emphasizing accountability for spending is a significant cultural change that leads to powerful results.
Craig Irwin, Analyst
Great. And then last question, if I may. Priorities for new product development. You guys are obviously completely reinventing the approach and picking your priorities carefully about where you spend your dollars. Can you maybe share with us what you see as top priorities for new product development? Are there areas where you think the portfolio really does need to be refreshed to see better traction? Or are things just more broadly spread across the portfolio and a little bit more sort of opportunistic?
Jay Geldmacher, CEO
I’ll go ahead and address this, and Tony can add more. As we mentioned, we have an Investor Day scheduled for March where we will thoroughly discuss our overall product strategy and answer many of the questions you've raised. Additionally, the innovation office I referred to is focused on dismantling silos and examining the complete ecosystem of our product offerings. This group will work on driving future product technologies and strategies while leveraging our existing product base, with an emphasis on accelerating innovation and introducing new technologies. Our approach also includes exploring strategic partnerships to enhance our product roadmap and strategies as we progress.
Anthony Trunzo, CFO
Yes, Craig, we'll provide more details on that as we progress. The decisions regarding this matter are, as I previously mentioned and as Jay discussed regarding the reorganization of P&S, something I encourage you all to consider beyond just security, RTS, and comfort. Focus instead on the overall product line opportunities available to Resideo. We need to address market demands by directing our investments into areas where we can effectively compete, where there is potential for strong growth, and where profitable margins can be achieved. This is an ongoing process since these factors evolve over time. However, as we move ahead, I believe we will be able to offer you a clearer understanding of what our priorities will entail.
Craig Irwin, Analyst
Great. Congratulations on the solid progress.
Jay Geldmacher, CEO
Thank you.
Anthony Trunzo, CFO
Thanks, Craig. Appreciate that.
Operator, Operator
Thank you. That concludes our time for Q&A. And with that, we'd like to thank you for attending the Resideo Technologies Third Quarter 2020 Earnings Conference Call. You may disconnect your phone lines, and thank you for joining us today.