Earnings Call Transcript - REZI Q2 2020

Operator, Operator

At this time, I'd like to welcome everyone to the Resideo Technologies Second Quarter 2020 Earnings Conference Call. Today’s call is being recorded. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. I would now like to introduce Page Portas, Director of Investor Relations. Ma'am, please go ahead.

Page Portas, Director of Investor Relations

Good morning and thank you for joining us for Resideo's Earnings Conference Call. We’d 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 differ materially from those in 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 filings. I would now like to turn today’s call over to Jay. Jay?

Jay Geldmacher, CEO

Thank you, Page and good morning everyone. I would like to begin today’s call by thanking the entire Resideo team for the warm welcome they've extended me and for the way they've responded to challenges brought on by the pandemic. I believe that we have dedicated passionate people that want to win, and I'm very excited to get to work with all of them. While our second quarter revenue and earnings were down substantially compared to last year, primarily due to COVID, we are now seeing meaningful improvement in the business. Sales improved sequentially each month through the second quarter, and July sales were above last year in both P&S and ADI. We remain focused on the pandemic-related risks to our employees and our business. In particular, we are monitoring the reposition of business restrictions in several states and in countries where we have important manufacturing operations, as well as supply chain-related risks. That said, demand has returned to pre-COVID levels over the past few weeks in both our ADI and Products & Solutions business, and macro industry trends appear to be improving. Recent industry data and customer feedback are pointing to positive trends in demand for both P&S and ADI. People are spending more time in their homes during the pandemic, which has created increasing usage of home systems, as well as an increase in home renovation and repair projects. Our product portfolio is well-positioned to capitalize on these dynamics. Our previously announced financial and operational review is on track to deliver $30 million to $40 million of savings in 2020 and over $100 million annually in 2021 and beyond. On top of this great work, our new leadership team is already pursuing additional opportunities to improve our balance sheet, reduce our cost structure, improve margins and drive greater top-line growth. These initiatives are in their early stages, and we look forward to communicating them with you as they come to fruition. With that, I'll turn the call over to Tony to discuss our second quarter results.

Tony Trunzo, CFO

Thank you, Jay and good morning, everyone. I would also like to take the opportunity to thank our teams for their warm welcome and for all the work they did over the past few months, keeping things operating in a very challenging environment. I'm excited to be at Resideo and looking forward to the work ahead. Consolidated revenue for the second quarter was $1 billion, a decrease of 17% compared to last Q2. ADI revenue decreased 10% as branch closures and modified or restricted operations resulted in lower customer activity in our stores. Our P&S revenue decreased 26% compared to last year, due to a decline in demand early in the quarter and code-related factory and supply chain issues. Consolidated adjusted EBITDA of $63 million was down 48% in the second quarter compared to last Q2 on lower revenue, an unfavorable product mix in both segments. ADI segment adjusted EBITDA was down 40% to $28 million as a result of lower revenue. ADI is a well-run business, and we chose to take a more limited response to COVID at ADI compared to P&S and our functional groups. Segment adjusted EBITDA was also negatively impacted by reduced supplier rebates and lower early pay discounts. Mitigating these impacts was continued aggressive cost management, always a hallmark at ADI. Although we began the second quarter under widespread lockdowns resulting in many branch closures, ADI saw sequential business improvement each month throughout the quarter and daily sales averages rebounded as restrictions lifted and branches reopened. Today, 80% of ADI branches are fully open and virtually all of our branches are open when including those under modified operations and curbside pickup. Products & Solutions segment adjusted EBITDA of $35 million was down 53%. P&S adjusted EBITDA was negatively impacted by product mix and increased factory costs related to COVID, partially offset by transformation programs and COVID-19 related cost actions. Business activity and orders troughed in April and then improved sequentially each month of the quarter. I'll now speak to some metrics for me not have highlighted on past calls, the plan to incorporate going forward. Please note that these are all unadjusted GAAP measures. Q2 gross margins of 23% was down three points from Q2, 2019 and slightly down from 24% in the first quarter, due to lower revenue coupled with increased factory costs related to COVID safety measures and unfavorable sales mix. Selling, general and administrative expenses for the second quarter totaled $242 million, down 14% or $40 million from Q2 last year and down 3% from Q1, as the company benefited from COVID-related cost management, ongoing transformation initiatives, and lower spin-related expenses. This all flowed through to an operating loss of $6 million for the second quarter compared to an operating profit of $42 million for the prior Q2. Operating margin for the second quarter was a negative 1% compared to a positive 3% last year, as lower sales volume slowed all the way through the P&L and more than offset lower SG&A. The company reported a net loss of $76 million or $0.62 per share in the second quarter. As we've previously discussed, the non-deductibility of payments to Honeywell under the reimbursement agreements result in higher tax expense than the company would otherwise incur. Cash from operations for the first six months of 2020 was $71 million, an increase of $108 million year-over-year, primarily a result of lower working capital tied to the slowdown in business activity. Accrued expenses increased as well, partly due to deferral of the $35 million Honeywell reimbursement agreement payment, and $6 million of trademark licensing agreement payments. I'd like to note the company anticipates an increase in working capital and a decline in accrued liabilities in the third quarter as business conditions improve. On July 30, we made our regularly scheduled $35 million reimbursement agreement payment, as well as a $6 million trademark licensing agreement payment to Honeywell. Honeywell has agreed to defer the Q2 reimbursement agreement payment for an additional 90 days through October 30. We remain in discussions with Honeywell, and we'll update our stakeholders should there be any material developments. For the remainder of 2020, as Jay noted, we are guardedly optimistic. July was a strong month for both ADI and P&S, and we are now seeing sustained order rates well above last year. Strong demand, particularly in P&S appears to be driven by end-user demand rather than channel restocking. Our factories are working aggressively to meet demand and reduce backlog, and we continue to build capacity by investing in new lines and recruiting more direct labor. However, given continued elevated business risk, we are not providing revenue and earnings guidance for the remainder of 2020. If business conditions stabilize, it is our intent to reinstate guidance for 2021. As I said earlier, we will continue to report and discuss adjusted EBITDA as a performance measure as we have in prior quarters. But we will also report and discuss our GAAP results. Beginning in 2021, we intend to deemphasize non-GAAP measures and instead focus on operating income, cash flow from operations and other GAAP measures. As many of you know, I'm a firm believer in the discipline of GAAP reporting and reducing judgment around what adjustments are appropriate to include GAAP presents a clearer picture of actual results against a known benchmark. We will continue to provide all the necessary information to allow investors and other stakeholders to understand our financial performance. And for those of you interested in maintaining a version of adjusted EBITDA for modeling purposes, our financial disclosure will support being able to do so. I'd like to, again, thank the entire team and our investors and analysts. I look forward to engaging with all of you moving forward. With that, I'll turn the call back over to Jay.

Jay Geldmacher, CEO

Thanks, Tony. I wanted to close with a few things. I would like to mention yesterday's announcement from ADT. We have a longstanding relationship with ADT, and they remain a valued business partner of ours. ADT comprises less than 5% of our consolidated revenue over the last 12 months at approximately our consolidated gross margin. There has been no change to the terms of our multiyear relationship, and we look forward to continuing our partnership with ADT. I also want to indicate that while COVID-related risks remain, we were pleased to see the strength of demand and the recovery of our businesses over the past few months. I'm truly excited by the potential of our business and the opportunity to work alongside our teams to make Resideo thrive. We will build on our very strong foundation of product breadth, customer relationships, and a deep history of providing reliable, quality products and services to our thousands of customers, with additional focus on product innovation, efficient operations, and building an action-oriented winning culture. In the coming weeks, I look forward to engaging with many of our customers globally, suppliers, investors, and most importantly, our team members to build the relationships that are critical for our future. So, thank you everyone. This concludes our prepared remarks. I think Page is going to also discuss a few things once again before we get into Q&A.

Page Portas, Director of Investor Relations

Thank you. With us today for the Q&A, we have Andy Teich, Lead Independent Director; Jay Geldmacher, CEO; and Tony Trunzo, CFO.

Operator, Operator

Our first question will come from John Lovallo with Bank of America.

John Lovallo, Analyst

Hey, guys. Thank you for taking my questions, and Jay we appreciate the commentary on the Google, ADT tie-up. I guess, obviously, this is the elephant in the room here. You mentioned, I think, 5% revenue exposure. If I remember correctly, securities about $800 million business for you guys. So is it really just 5% of that, which is the revenue exposure? Is that 5% an all-in number, I guess? And then, I guess, more broadly, what is the risk to raise these content over time, including the sensors, and maybe most importantly, the control panels and then ultimately being able to market your comfort products through the ADT network once Google and ADT start putting out joint products next year.

Jay Geldmacher, CEO

We have a good long-term relationship with ADT, which makes up less than 5% of our total Resideo sales. That's what we can share for now, and I look forward to continuing our partnership with ADT.

John Lovallo, Analyst

Okay. So then just to be clear, I mean, you don't see risk to your content with ADT.

Jay Geldmacher, CEO

Yeah. I think it's too early to comment. I mean, looking at our relationship, it is a multiyear agreement. And that's pretty much what I stated. I think it’s a good partnership and we'll continue to communicate with all of you as we move forward and how that proceeds.

John Lovallo, Analyst

Okay. And then it seems like July trends were positive. Can you just help us maybe quantify what ADI and P&S were up on a year-over-year basis in terms of revenue in July?

Jay Geldmacher, CEO

Tony, you want to comment?

Tony Trunzo, CFO

Hi, John. It's Tony Trunzo. Nice to meet you over a conference call. We're not in a position to disclose percentage increases month-over-month. However, it's unusual for us to comment on post-quarter close results, but we chose to do so this time due to the unique nature of the pandemic and the rapidly changing events that have influenced our performance and others. As I mentioned in my prepared remarks, the lowest point was in April. In both businesses, May was better than April, June was better than May, and July is showing improvement over June. The momentum is clearly upward, and the comparisons are ahead of last year, but we're unable to provide specific monthly year-over-year changes.

John Lovallo, Analyst

Okay. Understandable. And maybe one final one for me. The $50 million of original SG&A savings that you achieved, I think $15 million in 4Q 2019. How has that progressed into the second quarter?

Tony Trunzo, CFO

So, I'm trying to track some numbers that maybe I'm not sure exactly what you're referring to. What I can say, John, is as we indicated on the call that the transformation programs that we initiated earlier in 2020 that were addressed in the Q1 call, and we mentioned today. We continue to expect that the net savings for 2020 to be $30 million to $40 million, which is on a net basis after all of the costs associated with those programs. The vast majority, the large majority of those savings are going to be realized in the second half of this year. So, a lot of what you saw in the first half of this year was particularly on a reported GAAP SG&A basis, was not related to those transformation projects, because the costs to implement them were embedded in the numbers as well. It was a slight positive, but it wasn't a huge number in the first half of the year.

John Lovallo, Analyst

Okay. Got it. Thank you, guys.

Operator, Operator

Thank you. Our next question will come from Craig Irwin with ROTH Capital Partners.

Craig Irwin, Analyst

Good morning, and thanks for taking my questions. So, Jay, I know you've only had less than 90 days on the job now. But as you get a better feel for Resideo and the potential of the company, do you have an idea or maybe a rough framework of what you think the ideal manufacturing footprint would be over the next five or 10 years? And as you look at the product portfolio, do you have a feel for maybe what an ideal mix of internally produced versus outsourced products might look like for Resideo, as you maybe put together a plan to get to this future?

Jay Geldmacher, CEO

Yeah. That's a great question. I mean, and we're looking at all those things right now. With my background, as well as Tony's and Phil Theodore's background, the new kids in the block with our entire Resideo team, we are reviewing all that. I personally have had a lot of experience working on those types of transformational programs to optimize our global operational footprint, as well as our global engineering footprint, and what's the right balance. So, I'm looking forward to being able to share more of that with you guys in the future calls, but that's definitely something that we're spending a lot of time with, and there are a lot of opportunities.

Craig Irwin, Analyst

Great. And then my second question, if I may. Since we are discussing Tyco, many people that follow Resideo or former shareholders believe that the Tyco contract might have been mispriced when it was renegotiated. There is a very long-term history of a close relationship between Honeywell, Resideo, and Tyco. Can you maybe discuss whether you might see an opportunity for a renegotiated or amended contract that could allow for better profitability, considering this is essential for the support of almost 30% of your securities business?

Jay Geldmacher, CEO

I'm assuming you mean ADT?

Craig Irwin, Analyst

Yeah. ADT. Sorry. Yes.

Jay Geldmacher, CEO

To answer your question, I mean, bottom line is we won't have any discussions about that today. Our agreement is a multiyear agreement. And so, we're in that right now. If any of that changes, then, of course, we would share that with you. But that's all we can share with you today.

Craig Irwin, Analyst

Great. And then, the last question, if I may. I really liked the focus on GAAP. It's a pleasant change compared to most of the broader industrial universes where everyone is trying to exclude everything. From a GAAP accounting standpoint, what do you think is reasonable for investors to expect with the GAAP results showing a loss of $76 million this quarter? What do you think are the key factors that we should expect to see decrease in expenses? Obviously, the COVID-related challenges should hope to resolve quickly. But with the spin-off expenses and other tax adjustments tapering off fairly quickly, or do you anticipate significant volatility in your GAAP numbers as we head into 2021?

Jay Geldmacher, CEO

So, Tony?

Tony Trunzo, CFO

It's nice to connect with you over this call, and I hope we can meet in person soon. I'm pleased to hear that you support the transition to GAAP. In my previous role as a CFO at a public company, we never performed a non-GAAP reconciliation, but we did one this quarter. We plan to continue this in Q3 and Q4, but I'm looking forward to the time when we can stop doing non-GAAP reconciliations and the related disclosures in 2021. Regarding what to expect, I've outlined the direction we’re taking with GAAP reporting. Our focus will be on operating income, operating margin, and operating profit, as these figures exclude two major issues related to our partnership with Honeywell and their impact on our financials. The reimbursement agreement payments remain consistent each quarter, but the GAAP effects can be unpredictable for complex reasons, which are accounted for in other income. These figures, therefore, fall outside of operating income discussions and are influenced by that volatility, which we will continue to address quarterly. This volatility will persist as long as we maintain the Honeywell reimbursement agreements. Moreover, those payments aren't tax-deductible for us, leading to a significant tax component on our P&L that isn’t deductible. As we approach a zero net income line, this effect becomes more pronounced. There are intricate tax rules related to this that we can clarify if needed. Concerning other items noted in adjusted EBITDA, you are correct that spin-related costs are decreasing. We still have some outstanding IT program expenses, but those costs are reducing rapidly. We have mentioned previously that the transformation projects underway will yield $30 million to $40 million in net benefits this year, with a significant portion expected in the latter half of the year. By the end of the year, we anticipate reaching a run rate of over $100 million annually. The costs tied to these transformation projects will mainly be incurred in 2020, with some extending into 2021. As mentioned, we won't halt our progress with ongoing projects. We are working diligently behind the scenes to refine our cost structure, enhance our supply chain, and improve manufacturing efficiency and resilience to boost margins. We're also conducting sales activation activities, which will incur expenses in 2021, though I don't have a specific estimate for you at this moment. I expect these costs to be significantly lower than those in 2020. When those expenses occur, we will highlight them in our discussions regarding GAAP and the factors influencing those numbers on a quarterly basis.

Craig Irwin, Analyst

Great. Thank you very much for that.

Operator, Operator

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

Jeff Kessler, Analyst

Thank you for taking my question. And Jay, it’s good to reach you, and Tony and Andy, it's like a reunion, I guess. It's good to talk to you again.

Jay Geldmacher, CEO

Nice to reunion. Yeah.

Jeff Kessler, Analyst

Can someone discuss the product changes or updates that took place in the first half of the year, particularly regarding the acceptance of the new thermostat introduced last year, which may have been launched a bit prematurely? I'm also interested in the accessories for water heaters that did not generate revenue last year but have since annualized. Additionally, I'd like to know about other products contributing to the improvements observed in the last several months.

Jay Geldmacher, CEO

Hello, this is Jay. It's nice to meet you, and I look forward to meeting in person. You raised a lot of points in your question. My response today will be somewhat brief as we are currently evaluating all the products in our pipeline, including the new products in our NPI system and product roadmap. We are reviewing these in detail concerning our investments and their progress. We plan to share this information with all of our investors regarding our complete product roadmap and the technology initiatives we are pursuing as we finish this year and move into next year. We will arrange a time for this discussion, possibly in a technology road show format, which would allow us to delve deeper. I will also be bringing our President of the Products & Solutions group, who has made significant changes since taking over at the beginning of this calendar year. We have a lot to share, but we won't be able to cover everything in today's call.

Jeff Kessler, Analyst

Okay. My second question is about ADI. As you mentioned, ADI didn't require as much remediation assistance as the product side did. Historically, for this company, going back to the demo days and earlier, ADI served as a window into the product side of the business. I believe Roger's expertise was in making ADI that window so you could get a sense of what was happening in the industry. In the initial months of the new company, the product side lacked visibility into ADI. I'm curious if you could talk a bit about what you're doing to re-establish ADI as a window into the overall business landscape. Additionally, could you expand on what ADI is observing regarding product demand and sales trends?

Jay Geldmacher, CEO

ADI is a significant distribution business. As you noted, the company was built and has grown to serve not only our Products & Solutions business but also to support a vast array of companies that they market globally. As they strategically assess what aligns well with them, they are continuing to broaden their reach. This is an area we highlight during Resideo road shows and technology market presentations, where our investment community can learn about the various initiatives they are undertaking to expand their entire product offering, including our own Products & Solutions segment within that portfolio.

Tony Trunzo, CFO

Jeff, you're right. The recent developments at ADI have provided an intriguing perspective, confirming certain observations related to the Products & Solutions side. The strength we've seen is widespread, and while we want to be cautious, the insights from both larger and smaller projects allow us to gain perspective that can influence our Products & Solutions business. The connection between the two businesses is currently strong but has room for improvement. We aim to create a feedback loop that enhances our positioning for greater success in P&S based on the insights we gather from the various markets at ADI, which presents an opportunity for advancement.

Jeff Kessler, Analyst

Okay. One final question. I understand you can't comment on the remediation payments to Honeywell specifically, but is there any potential for flexibility regarding those payments in your discussions with Honeywell about market roles? When you talk to them, does the topic of these remediation payments ever arise? Additionally, is there any possibility that the tax treatment of these payments could be altered or negotiated?

Jay Geldmacher, CEO

Tony?

Tony Trunzo, CFO

Yeah. So, as you guys know, our relationship with Honeywell is complex. There are a lot of vectors to it. We're, obviously, in dialogue with them on a regular basis because of the complexity of that. As you've seen, they have shown a willingness to work with us by deferring the Q2 payment for another 90 days to the end of October as we sort of get through some challenging times in the marketplace. Unfortunately, Jeff, we really can't go any further than that. It's a critical relationship for us. There are certain drivers to it that as we've talked about, and as you highlighted are impactful to our financials. To the extent that there's any change to any of those, we will, of course, be in a position to share when it actually happens. But in terms of really being able to speculate on any of those things that, that wouldn't be appropriate.

Jeff Kessler, Analyst

Okay. Thank you very much, and I look forward to speaking with you in the future and seeing you guys again.

Jay Geldmacher, CEO

Absolutely. And I look forward to meeting with you.

Tony Trunzo, CFO

Thanks, Jeff.

Operator, Operator

Thank you. Our next question comes from Ian Zaffino with Oppenheimer.

Ian Zaffino, Analyst

Hi. Great. Just a follow-up on that last question with the Honeywell payment. Will you have to make that entire payment once the deferral period ends, or will that payment maybe be amortized over the life of the deal? Thanks.

Tony Trunzo, CFO

So, Ian, it's Tony. I can share our current situation, which is that Honeywell has agreed to postpone the payment originally due in the second quarter to October 30 of this year. As it stands now, we will make two cash payments to Honeywell on that date, totaling $70 million. There are no current plans for any deferral or repayment over time. On a related note, our liquidity position has improved over the past 90 days, as reflected in our financials, and we are preparing to make that payment according to the agreement with Honeywell. If anything changes, we will update you accordingly.

Ian Zaffino, Analyst

Okay. Thanks.

Jay Geldmacher, CEO

I think as Tony has already stated that we remain in constant dialogue with Honeywell and we'll update all of you on any developments as we move forward.

Ian Zaffino, Analyst

Thank you for that information. I have a question regarding the security side. Can you provide a breakdown between your business that focuses exclusively on panels and the one dealing with peripherals? Also, how does the sales process work with companies like ADT or other security firms? Is it for the panel alone, or does it include the entire system, which would mean the panel and the peripherals together? Please elaborate on that. Thank you.

Tony Trunzo, CFO

The security business consists of several different parts. I'm not completely sure I follow what you were referring to, but there is a significant element where ADT is a major customer. There's also a segment involving our branded product, as well as some recurring revenue and some international components. I would describe it as quite varied. A portion of it goes through ADI, and it will depend on each job what the product mix will be. I'm not certain that fully answers your question, so feel free to provide more details, and we can explore this further.

Ian Zaffino, Analyst

I was wondering, regarding your relationship with ADT, how much of your sales to them involve the grip platform compared to peripherals like door locks, taps, or window break sensors? Thank you.

Tony Trunzo, CFO

Unfortunately, we're not in a position to get into that level of granularity with respect to ADT. There's just not a lot of color we can offer there. We have a contract with them that obviously is a meaningful one for our business. And we're pleased to be partnered with them. But I can't get into detail about sort of product mix and how that works.

Jay Geldmacher, CEO

What I want to convey is that as we progress over the next few months, I aim to provide you with insights regarding our technology. It’s essential for you to gain a better understanding of how we market our products globally through various channels, including the distinctions among hardware, software, and the sensors associated with them. This will help everyone grasp the bigger picture, and we can enhance your knowledge about our product roadmaps and the advancements in new products and technologies. We will certainly address this.

Ian Zaffino, Analyst

Okay. Great. That'd be really helpful. Thanks so much, guys.

Jay Geldmacher, CEO

Yeah. Thanks.

Operator, Operator

Thank you. This concludes the question-and-answer session and today's call. Thank you for joining us and have a great day.