Resideo Technologies, Inc. (REZI) Q3 2018 Earnings Report, Transcript and Summary

At this time we would like to welcome everyone to the Resideo Technologies Third Quarter 2018 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]. I would now like to Dean Acosta, Chief Communications Officer of Resideo. Mr. Acosta you may now begin.

Good morning everyone and welcome to the Resideo Q3 earnings call. I'm Dean Acosta, Chief Communications Officer for Resideo. With me today President and CEO of Resideo, Mike Nefkens and Resideo Executive Vice President and Chief Financial Officer, Joe Ragan. You can find a copy of our third quarter earnings release and presentation materials on the Investor Relations page of Resideo.com. Before we get started I 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 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. You can find more details in our 10Q which we filed with the SEC yesterday as well as our other company filings. With that I'd like to turn it over to our President and CEO, Mike Nefkens.

Great and thank you Dean and it's great to be here with you today. So I'm going to start on the presentation here on page 2 and I just like to start by saying good morning everyone I really appreciate you joining on today's call. It's been a special few weeks for Resideo. We've completed our spin off from Honeywell and we began trading as Resideo on the New York Stock Exchange. It's been great to meet with so many investors and other stakeholders over the past few months both before and after our listing. We're inspired by the ongoing support and optimism of our customers and suppliers many of whom were able to celebrate with us as we rang the bell on the New York Stock Exchange. While certain of our financial results have already been released to the market through Honeywell's recent earnings as part of their broader segment disclosure today allows us the opportunity to provide more details to all of you. Since this is our first earnings call Joe and I are going to take you through our third quarter financial results but I'm also going to provide an overview of our business to ground those who may be new to the Resideo story. We started trading on October 29th and we're hitting the ground running on the next phase of Resideo's growth strategy. We start off with a strong liquidity position and we're focused on continuing our consistent performance moving forward as a standalone company. We delivered a solid third quarter across key metrics and Joe will dive deeper into the numbers in just a bit but at a high level I want to call attention to our Q3 revenue growth 4% year over year net of currency and 5% organic growth. As many of you have already heard from Honeywell on their Q3 earnings call we experienced some spin related supply chain issues that temporarily increased our backlog and additional spin related costs that negatively impacted our revenue and EBITDA for the quarter. We are actively addressing these supply chain issues and we're already seeing product flows moving back towards normal volumes. With the spin behind us operationally our team is focused and back on track. While we executed on the final phase of our spin we also garnered some key wins and continue to develop our product pipeline. As many of you know we have two segments in the company, a product segment and a distribution segment and finally we are excited about the momentum our business is showing and we're reaffirming our guidance for full year 2018 and outlook for 2019. We expect our full year 2018 results at the high end of the range, our performance as part of Honeywell over the past three years demonstrates a well-run business that is on track to deliver continued growth in 2018 and beyond. We are excited about our future and focused on continued growth and innovation to create value for our customers and shareholders. So now I want to jump in on page 3 and talk a bit about the business and for those of you who are new to the Resideo story let me back up for a couple minutes here and go through that. So we're simplifying the smart home experience as a leading global provider of critical residential comfort and security solutions. We're in a 150 million homes and we install about 15 million products and solutions a year through retrofit and new installs. We do this through a network of a 100,000 contractors in our global workforce of about 14,500 employees. When we talk about the customers we serve we include the more than 100,000 contractors from both sides of our business. We have a long standing relationship with these professional contractors and I like to call them the Do It For Me Channel which gives us a solid position in the marketplace. It's a critical component in helping consumers upgrade to a home that is more efficient, safer and easier to control. When you break it down we are a well-established business with a very mature channel to market. As I mentioned earlier our business is broken into two segments, products and distribution. On the product side we market under the trusted Honeywell home trademark through a 40 year license. Every connected item we bring as software or firmware as part of the offering so you'll hear me refer to products and software. ADI is our second segment, and ADI is the leading global distributor of low voltage security products. We have over 200 ADI stocking locations all focused on supporting the connected home security contractor. Our two segments break down on the revenue side into approximately a 50/50 split. So I want to spend a moment now going a little deeper on the end to end experiences with our products and this will be on slide 4. So when you look at our products we look at it in a couple categories. We have 3000 active products for the home, those cover the exterior, behind the wall in front of the wall and in the cloud. So first let's take a look at the exterior of the home. Our products for the exterior of the home include exterior cameras, outdoor video, motion detectors and motion viewers. Moving inside the home we're supporting homeowners behind the wall with things like heating controls, furnace and boiler units, hot water controls, humidification, dehumidification, water filtration, water leak detection and freeze detection. Then we talk about on the wall which would be the more traditional thermostat security panels, motion viewer, sound detection, glass break detection etcetera and then we have an established and growing business in the cloud where we have our mobile applications. So that's how we look at our product set. Then on the bottom right you can see our ADI global distribution. We sell our products direct to OEM's and we sell them through distributors where we also have our own global security distributor which we call ADI that gives us a real high touch point to our customers. These are very technical sales with product knowledge sharing because our business is so high touch we're able to create winning solutions for the Do It For Me Channel together with our customers. We have one of the broadest portfolios of anybody in the sector and I think that's a key aspect of what sets us apart. Other technology companies come out with a single product and they think that their one product is going to be the control point in the home. We don't think it goes that way. They don't have a way to get to the customers and they don't have products solutions or connectivity that sits behind the wall which is really the core of any smart home, that's what makes us different. So with that broader introduction to our business I'd like to move on to slide 5 now and I want to talk for a couple minutes about some recent business development activity. We've had a number of key customer wins and made progress towards distributing new products in our pipeline. I will highlight a couple of them for you right now. We're excited about our new agreements with several leading security dealers. They're going to carry our next generation professional residential security platform. We're continuing to expand our partnerships with Scottish Power, Innogy, Crius Energy and Chamberlain are all the ones I'm going to particularly highlight here. We're working with Scottish Power they're a major utility in Scotland and a subsidiary of Iberdrola and we're providing them with connected thermostats and software services that deliver comfort and energy efficiency to their customers. We're also partnering with the Innogy, a Slovakian utility to offer dual branded security products to their consumers to release program. With Crius we're offering Honeywell home connected thermostats through their demand response program which helps homeowners save money and energy. In August Chamberlain announced the integration of its Chamberlin and Liftmaster garage doors with our total connect 2.0 app. Now on the distribution side we're proud that ADI was named the 2018 distributor of the year from Axis Communications which is one of the world's largest security products manufacturers. These are all just a couple of notable examples of what we mean when we say the business is showing momentum and we're excited about the future. So with that I'd like to turn the call over to Joe to walk you through our financials.

Thanks, Mike and good morning everyone. I'd like to start on the next slide, slide 6. I'll walk you through our numbers first for the quarter and then I'll make some comments about our performance year to date which we think is also helpful in framing some of the broader trends in our business especially given this is our first public earnings call. Starting with third quarter performance on a consolidated basis we reported net sales of 1.2 billion up 4% and up 5% on a constant currency basis which we refer to as organic growth. Adjusted EBITDA or the quarter was 117 million representing a 3% decrease from the prior year for or 152 million excluding payments under the environmental indemnity also a 3% decrease from the prior year. As Mike mentioned at the beginning of the call the supply chain issues drove downward pressure on our EBITDA as well as other spin related costs. I will address this in more detail when I discuss segment level results. At a high level without these issues pro-forma adjusted EBITDA would have grown both year over year and sequentially. I'll address the environmental indemnity and we have a slide on this on the appendix but the environmental reimbursement is in our release 10Q and all our slides and it's cast at $140 million with respect to any year, it's a 25 year arrangement and we've modeled that into all of our numbers. Adjusted net income was 88 million up 42%. Next on Slide 7, looking at our number year-to-date also are at 3.56 billion up 8%, adjusted EBITDA was 361 million up 19% over the prior year and 466 million excluding the environmental indemnity up 14% due to our strong first half performance. Adjusted net income was 265 million up 80% year over year reflecting changes in U.S. tax laws. Next on slide 8 if we take a closer look at segment performance overall, you'll see an almost even split between the product and distribution side. On the product side we experienced modest external sales growth for the quarter when factoring in intercompany sales total sales were down modestly for the quarter. Short term then related to supply chain challenges negatively impacted our performance. Profit for the product segment was up 2% and 21% year to date, the product segment has been a steady performer from a revenue perspective. It has continued to grow steadily although at a lower rate than the distribution segment and at the same time has been the strong contributor from a profit and margin perspective. On the distribution side Q3 continued to show strong sales growth of 6%, profit from the distribution segment was up 3% in the quarter and 11% year to date. On Slide 9, from a balance sheet and liquidity perspective we're in a strong position. While not technically part of our third quarter but publicly disclosed in our 10Q we went to the debt markets in early October and secured an additional 1.2 billion in financing which includes 825 million of secured debt and 400 million of senior unsecured notes. Since the spin date we have drawn 135 million on our secured revolving credit facility to facilitate the repositioning of cash post spin which was used in a distribution to Honeywell as part of the spin-off. We have been given a BB+ credit rating from S&P. Before I move on and talk a little bit more about how we see Q4 and ahead to 2019 I think it's important to give you an overview of how we think about capital allocation and what our priorities are there. We have proven our ability to generate steady organic growth historically mid-single digits and we will continue to invest in our business to drive organic growth in the future. Longer term we are targeting a debt to adjusted EBITDA a ratio of two times with existing cash flows as a near term tool to start to delever. From a return on capital standpoint we are planning to consider a modest dividend subject to Board approval which could be introduced in 2019. From an M&A perspective we will focus on select opportunities that would provide access to new technologies, IP development or open up new markets or geographies. On slide 10 we are looking at our full year expectations, we are reaffirming our guidance. We're expecting our results for the full year 2018 to be at the high end of the range. We expect net sales between 47.77 billion and 4.83 billion, adjusted EBITDA between 605 million and 615 million and adjusted EBITDA minus the indemnity of between 465 million and 475 million. We see strong drivers for demand which we expect to continue from the growing demand for and adaptation of smart and connected devices combined with the growing need for expertise to really help people make sense of these technologies and access them more easily. Our business is performing well and we expect the powerful combination of scale, steady growth and market position will give us margin expansion and significant equity valuation uplift going forward. So looking ahead at 2019 we also reiterated our expectations for next year, 4% organic revenue growth, adjusted EBITDA margin of 13% or 10% after the environmental indemnity payment to Honeywell, R&D expense of approximately 125 million and as I mentioned earlier we are planning to consider a modest dividend in 2019 subject to board approval. With that I'm going to turn it back to Mike to close out before we open the call for Q&A.

Great, Joe. Thank you and I just want to close out here on Slide 12 and there are few points here that I just want to summarize this key takeaways from today's call. So first is Resideo has a winning track record with size, scale and a loyal customer base. We have leading positions integrating and running the most critical systems in the home. We're well capitalized for growth and focused on the deleveraging overtime. We're always focused on creating shareholder value and expect with our strong cash flow and liquidity profile that we will be able to return more value to shareholders over time potentially through a modest dividend pending Board approval. Overall I hope you come away from this call with a strong sense for our top line and profitability growth. As I shared earlier we're reaffirming our guidance for full year 2018 at the high end of the range in reaffirming our outlook for 2019. So again thank you for joining our first earnings call today. It's an exciting time for us all here at Resideo and with that I'd like to turn over to the Operator to open up the line for questions please.

[Operator Instructions]. We will take our first question from Ian Zaffino from Oppenheimer. Please go ahead.

This is Mark on for Ian. Thanks for taking our questions. So just a start off can you guys provide any additional insight on the 1% growth you saw in products this quarter maybe if you could give a breakout of how much of the growth was really impacted by spin related supply chain during the quarter and then going forward what do you view as a normalize growth rate and how quickly can you get there? Thanks.

So yes I'll talk a little bit about the spin related to supply chain issues that we put out there because it did affect us in Q3 as expected. I talked about these at Investor Day typically what they are, are items I would just give you a really good example like most of them are believe or not are administrative items. We had an example of customs related issues where paperwork comes under the Honeywell name, product needs to actually be come out under the Resideo name, took a couple days to do that. We also have some planned ships that we're making in Europe as a result of the spin. So these are just items that we knew were in front of us. We planned for it in Q4 I can tell you right now we're already seeing volumes coming back to normal and I told the team and we're still looking out there still a few things we've got to make sure come through before we get clean. So I would tell you we're still seeing a few of those headwinds here in Q4 as expected and we will be fully back in running here by Q1 again the reason that we were able to affirm our guidance at the top end of the range is because we're really working through these items and we're very comfortable that we're on the other side of it now.

Okay, terrific that's great so full power by beginning of 2019?

That's correct.

Okay, great. And then just a quick follow up taking a step back and looking at the larger picture, can you speak to sort of the macro drivers behind the business particularly now with - Resideo's correlation to the housing versus renovation and repairs and how the current state of mark to market can potentially impact your outlook for the balance of 2018 and going to 2019. Thanks.

So that's a great question and I get that a lot so first if you take a look at our financials and if you take a look at our revenue less than 20% of our revenue actually focuses on new home. So we have a natural hedge there. We have done some math on that where we have done an estimate where for every 100,000 homes shift up or down a new home starts our estimate is that it effects our EBITDA close to about $7 million. So you can see that we are not highly correlated to new home starts, it's not a big item for us. For us we look much more at renovation and remodeling. One of the other - one of the best items I think that I've seen yet came out yesterday in Home Depot's announcements were Home Depot came out and said that they are seeing consumers continuing to spend on their homes and one of the other items I saw was you know one of the best macro correlators that we have out there really is the unemployment rate when you look at the low unemployment rate consumers feel confident and they continue to invest in their homes and we're seeing that. So that's kind of how we see both new home starts as well as continued strong consumer spending into the home space which is good for us.

[Operator Instructions]. We will take our next question from Nigel Cove [ph] from Wolfe Research. Please go ahead.

This is Christian [ph] for Nigel. So congrats on the spin and on your first quarter earnings call. just had a few questions here just on the incrementals for distribution, can you just maybe talk about a little bit in detail, seen a little light relative to situation was [ph]?

And you said on distribution?

Correct.

Yes, no I mean I think if you take a look at the growth numbers on distribution they definitely were in the lead here. I think the distribution number was 6% or 7% revenue growth which was what we expected so part of Resideo products where we had some of the supply chain issues also goes through distribution but distribution was really not affected by that and we were very comfortable with the 6% and 7%. One of the things that we got to look at is we did have in the first half of the year due to some of the devastating storms out there we did have higher volumes in Q1 and Q2. So the compares versus that are a bit but 6% growth 6% - 7% growth in distribution for the quarter we were actually very comfortable with.

And then just on CapEx, you guys highlighted that there are some simulated [ph] CapEx not included in the guide. Can you just kind of quantify those that number and what that entails?

Sure. We do Christian and we have talked about some one-time costs related to the spin in CapEx and the onetime costs overall in year one are estimated to be approximately 80 million year two 2020 would be about 60 million, a lot of that is related to IT conversion and of course we have branding changes to make in the factories, in the building etcetera so that's our most recent estimate but the 55 million approximate cash CapEx is to primarily support the 18 manufacturing facilities we have and some of that is for distribution and 10 million of that is capitalized software development.

We will take our next question from Fritz Lou from Alliance Global Investors [ph]. Please go ahead.

I've got a question for you and it's really basically on page 16 and 19 of the presentation where you have basically adjusted pro-forma, adjusted EBITDA? So your EBITDA guidance basically mid-range after the 140 payment to Honeywell is 470 but I mean if I look at your nine month adjusted pro-forma EBITDA of 340, it kind of implies a very high fourth quarter number of about 130. Is that what you're predicting or is the 470 a non-pro forma adjusted EBITDA guidance?

Thanks for the question and I just like to say, thank you to everyone who read all of the tables that we prepared and I'm sorry for that but there is lot in this period of time where we have to continue to reconcile. We are talking about pro forma adjusted EBITDA and we're guiding to the high end of the range, the range was 465 to 475 so we're actually saying more than 470 and that second slide, very good performance in the fourth quarter and we are reaffirming that guidance.

And then next year in '19 you actually expect a drastic drop in CapEx to 1% of sales from running around - I think was 3% in the third quarter?

: That number is actually - that has some accruals in it, that is not cash CapEx. So remember that really part of our legacy Honeywell reporting. The cash CapEx number is about 55 million and that's what we'll maintain going forward which is you're correct about 1%.

[Operator Instructions]. We have a follow-up from [indiscernible] from Wolfe Research. Please go ahead.

Hey, guys. Christian here again. Just wanted to talk about pricing, it's been accelerating with the last three quarters. Can I talk through what is that a function of that mix higher selling pricing and I guess what's the customer response on the back of that? Thanks.

Yes, look on pricing you know we've had very positive so far experience with pricing especially in our [indiscernible] business so we've been able to pass through pricing to our customers to offset any inflation. So we had no issues there. We've been able to get pricing both in our [indiscernible] business and in our distribution business so no issues there whatsoever.

And then is - do you anticipate that this will continue into next year just given?

I think so. We've had - look I've asked the same questions Christian, as well with my team really dug into pricing and the team is good at getting pricing you know where we need it. So I do expect it you know I don't see a change in that trend whatsoever. We've had at least three years that I've been able to really go deep in numbers, we've had no issues whatsoever with pricing.

And we have another question from Aarno Edler with Engine Investments [ph]. Please go ahead.

You guys talk about all these connected customers and I guess all the central points you have, can you talk about some application that you can envision in the future that maybe has not been focus in the past but you can vision playing a bigger role in the future?

Yes so I'll highlight two of them that we're really excited about. So one of the things I mean that we really push we are an IoT company we focus heavily on sensing, on motion detection, on also advanced analytics in our cameras. So that is a focus area of us. We focus heavily now on new use cases so what we don't do is we don't just put a single product out there without knowing exactly what problem it's going to solve, two examples of those that are really like the most basic one is leak detection. So I talk a lot about you know we really are not just a B2C company we're also a B to little B company where we sell to other businesses and a great example of that is into the insurance industry. We now have a leak detection pilot going on with one of the large insurance companies 40,000 leak detectors out there and what we're trying to solve is you know high claims for water damage in homes. So the use case here is to save the insurance company money on having to pay out claims but also save the homeowner from having a destruction in their house due to water leakage behind the walls so this is leakage that you typically don't see. That's a great example. The other that I talk about a lot is things like swimming pool security, we have all of the products out there to be able to solve that problem, right, you read every year about toddlers dying in swimming pools whether it be your own, whether it be a neighbour's pool or what. If you take a look at a combination of our sensors that can measure splashes, sound, that can measure water ripples and our cameras that can tell the difference between an animal, a child and an adult and the way that we can connect and alert to the home and light up the lights in the home and turn on the security system even if it's not armed to alert police, fire department, neighbours etcetera that there is an issue near the pool. So those are the kind of use cases that we are out solving and you need to have the scale, you need to have the products and you also need to have some very good partners behind you as we have that. So those are the kind of things and we have about 20 use cases right now that our R&D teams are working on and we're really excited to get those out to market.

And with no further questions I would like to turn the call back to Mike Nefkens for closing remarks.

Yes, great guy. Hey listen I just want to thank everybody for number one, you know the great questions that we've had over the weeks going into this. This is our first earnings call so I appreciate. I think we had over 100 people on the call is what the team is telling me here which is a great showing and we appreciate the great questions on this call and we're looking forward to the next one. So everyone have a great day and we'll see you next time.

And thank you for your participation. This concludes Resideo Technology Third Quarter 2018 Earnings Conference Call. You may now disconnect.