Resideo Technologies, Inc. (REZI) Q2 2019 Earnings Report, Transcript and Summary

Welcome, everyone, to the Resideo Technologies Second Quarter Earnings Conference Call. Today's call is being recorded. [Operator Instructions] I would now like to introduce Mr. Michael Mercieca, Vice President of Investor Relations. Mr. Mercieca, you may now begin.

Today, we're pleased to welcome you from the library of the New York Stock Exchange. With me today is President and CEO of Resideo, Mike Nefkens; and Resideo's Chief Financial Officer, Joe Ragan. You can find a copy of our second quarter earnings release and presentation materials on the Investor Relations page of resideo.com. Before we get started, I'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 the company presentation, both of which can be found in 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. With that, I'd like to turn this over to our President and CEO, Mike Nefkens.

Thanks, Michael, and good morning everyone, and thank you for joining us on today’s call. Resideo is now three quarters post the Honeywell spin, and I'm happy to report that we had another solid quarter. We are finally starting to see some normalcy after all the spin work, and we are pleased with the progress against our strategic initiatives. We settled into our new HQ in Austin, Texas, which enables us to have the leadership team in one location. Also, spin-related distractions are minimizing and the field teams have been able to go deep with our pro customers. We've also been able to spend time with many new investors. But most important, our Q2 was strong, keeping us on track to hit our previously provided guidance for 2019. So let's get right into it. First, we'll update you on our overall results for the quarter. Then we'll discuss the results for each of our business segments. Third, I'll walk you through our progress in the market and some of the exact acquisitions we've made to position us for growth acceleration. And last, we'll end with our financials and second half outlook. Turning to Slide 3. For the second quarter, revenue came in at $1.242 billion, up year-over-year 4% on a GAAP basis and 6% on a non-GAAP cost and currency basis. From a top line perspective, we're pleased that growth has spread evenly across our two segments. Adjusted EBITDA after the Honeywell reimbursement payment came in at $81 million and $116 million excluding the reimbursement payment. A solid performance driven by a combination of top line growth and continued cost management. Product mix headwinds around our new product launches continued but were partially offset via cost containment. Adjusted EPS was $0.19 per share and GAAP EPS was a loss of $0.09 per share due to tax effects related to the Honeywell reimbursement agreement. All in all, a solid quarter on both revenue and the EBITDA. Now turning to Slide 4 and our segment performance. Revenue growth was spread evenly across our two segments. For our ADI Global Distribution business, we continue to see solid organic growth in the Americas and EMEA, driven by Security and Life Safety as well as expansion of the Professional A/V growth initiative. We added to our AD product offering announcing a distribution agreement with Samsung Pro, and we continue to win high-value new business throughout North America. We're also pleased to report that ADI was recently highlighted in Security Systems News in addition to being recognized as the top distributor used by SDM Magazine's, SDM 100. Now turning to our Products & Solutions business. P&S reported mid-single-digit growth. Security had another solid growth quarter as we continue to take share resulting from the launch of our new Pro series platform. In comfort, we saw strong volumes in the new T9 and T10 Pro connected thermostats. And in our RTS business, we launched a next-generation universal defrost control for heat pumps. We did see an in-quarter slowdown in the RTS OEM channel, in particular with our hot water heater OEM customers. Now driving harder on the organic side, we boosted our R&D spend as part of our previously announced strategic initiatives, and we expect to announce new product launches in water, comfort, air and security in the second half of the year. On the inorganic front, we completed two acquisitions in the quarter, which I'll talk more about shortly. Looking at P&S segment adjusted EBITDA, both comfort and security are seeing margin pressures due to product mix headwinds, specifically the ramp up of our new security platform and lower margins on connected thermostats. We are working to offset these with cost containment and supply chain and sourcing process improvements. I also want to call out the incredible strides we've made on improving our supply chain. As you may know, we had some supply chain headwinds pre- and post-spin. But due to new supply chain leadership and process changes, we're delivering more on time than ever before and our delivery metrics are the best they've been in five years. This improvement will allow us to be more aggressive on the growth side. Moving to Slide 5. Some of you may remember from last quarter, I walked through our markets in detail. On the chart, we have our two businesses, ADI Global Distribution and Products & Solutions. In P&S, we have broken out our business by product area and are associated addressable market and estimated market growth rates. We then provide some select competitors in our growth versus market on a 12-month rolling basis. The investors I met within Q2 really liked this chart and asked for updates when there are changes. So today, I want to highlight some new developments since last quarter and there are two. First, in the previous quarter's chart, we noted our Security Business is growing at market on a 12-month rolling basis. With two solid growth quarters behind us, we are now moving that box to green as we are growing above market and taking share. Second, for our residential thermal solutions business, as previously noted, we've seen a slowdown in the OEM segment, primarily water heaters. As a result, we are adjusting the market growth of the RTS segment down to reflect changes in the market. Even though that market has slowed, we continue to win in that segment. So closing out on the chart, outside of security DIY, where we really don't play, we have a solid market position in all of the segments we plan, and our objective is to further accelerate our growth in these segments. Now turning to Slide 6. We are seeing solid progress in our long-term growth strategies. A critical of our strategic initiatives to bolster growth is small, tuck-in M&A to strengthen our position in the key home categories of air, water, energy, meaning gas and electric, and security. During the quarter, we acquired technology from Whisker Labs, complementing our connected thermostats offering with industry-leading energy management solutions. We also acquired LifeWhere, which uses machine learning and analytics to predict potential failure on critical home appliances. Both of these acquisitions, along with the Q1 Buoy acquisition in the water area strengthen our position in being able to offer whole home solutions. Our plans are to launch in Q4, with the pro channel a new set of offerings combining our core business with these new acquisitions to offer true next-generation whole home solutions. This launch will bring to market new products and services resulting from our 2019 investments. Thank you. Now I'd like to turn it over to Joe to provide financial details on the quarter.

Thanks, Mike. Last quarter, I highlighted some of the volatility in our GAAP results due to the impact of the Honeywell reimbursement agreement. This quarter, there was little variance in the GAAP and adjusted reimbursement expense. However, there was a large adjusted tax expense impact that brought down adjusted EPS for the quarter. This will normalize for the balance of the year. Overall, our EBITDA outlook for the year remains the same, and we'll touch on guidance in a few minutes. We expect revenue seasonality in the third quarter as we transition between the cooling and heating seasons, reflecting the typical seasonality of the business. We are more than confident we will mitigate any weakness with cost reductions. While we expect margin pressure to continue, we have performed well year-to-date from a revenue perspective, allowing us to maintain our EBITDA outlook. Our cost reduction programs remain on track, and we expect to realize $10 million in savings from them this year. You'll notice in our disclosures that we are reporting onetime repositioning costs related to our $50 million cost reduction program of $25 million, illustrating that the cost takeouts are well underway. Moving to Slide 8. Our financial position remains solid and continues to position us to focus on growth. As I've mentioned in previous calls, the early part of the year is when we typically use cash so you can expect to see our balance sheet reflect this. Cash usage was driven by a buildup of inventory and payments related to the Honeywell reimbursement agreement, and we expect to release a majority of the increase in the next 12 months. Total debt decreased as we amortized a small part of our facility and with $350 million undrawn and available on our revolver, we are confident that our financial position is strong and continues to support our strategic initiatives and growth plans. Slide 9 presents our complete full year guidance. We are reiterating our full year guidance from a revenue and EBITDA perspective with revenue growth of 2% to 5% in the upper end of the adjusted EBITDA range of $410 million to $430 million. As I mentioned, we do expect modest revenue growth in the third quarter, in line with our typical seasonality, but that will be offset by cost efforts to maintain our EBITDA target, and we expect to maintain our revenue target range as well. We also confirm our cash taxes to be paid for the year at approximately $75 million. Our priorities continue to be growth and deleveraging, and we expect that to remain unchanged in the near term. We are confident in our balance sheet, and we are making steady progress towards deleveraging with our long-term leverage target at two times. Now I'd like to turn the call back over Mike.

Thanks, Joe, and thanks to everyone who joined us for today's call. We maintained our momentum in the second quarter, delivering strong financial results in both revenue and EBITDA, putting us on track to hit our previously provided guidance for the year. Our financial position remains strong and right where we need it to be at this point in our journey. Our strategic initiatives are firmly on track with exciting product launches planned for the second half of the year and in 2020. With this momentum, we are moving into a position where we can truly put the pro at the center of the home to provide industry-leading whole home products and services. Thank you. And now I'll turn it over to Michael to open up Q&A.

Okay. Our first question is from Ian Zaffino from Oppenheimer.

[Indiscernible] Okay. Thank you very much. Can you guys just walk through the cadence of the margin improvement in the back half of the year? You called that ADT. What's the actual margin dilution that's causing really – looking to ultimately mitigate that to? And also as your product mix exchanges away from ADT to more third parties, what's the impact on margins there? Thanks.

Hey, this is Mike. And I'll start, and then probably hand it off to Joe here. So yes, so if you take a look at the second half of the year the big step up is going to be on growth. We will be doing about $100 million more in Q4 than we did in Q1, that is very typical for us. It’s what we did last year and it’s what we did the year before as well. So that’s step one, and we are confident. That’s – as we move from the cooling season to the heating season, that is the typical seasonally that we see in this business. Reasoning for it is, there is a higher trade sales versus OEM sales, the trade sales are higher margin sales in the OEM contracted numbers, so that always helps us. And the other is if you take a look at our Security business and our Security business this year and we've been pretty clear about this with the launch of the new platform. As we started, it's down about eight points of margin from where the last platform was at the end of its cycle, which is pretty, pretty typical. We will as volumes ramp up, we'll be getting a couple of points back there towards the end of the year as well. So the real margin improvement is going to be higher trade sales in the second quarter versus OEM sales, which have higher margins, higher heating or heating products typically have higher margins as well as we're selling more gas valves and another type product. And then the third is going to be some improvement that we're going to see on the Security margins from where they currently are.

Yes, Ian this is Joe. And in addition to that you’ll remember that we have called out $10 million of SG&A savings that we're going to have that'll primarily be in Q4. But the other thing you ask an important question on the cadence if you recall in Q2 and Q3, those were our primary quarters for investment in our new products that we're bringing out. I don't know if you remember that. But if you look at the margin profile, Q1, Q2, Q3 to Q4, those investments actually are being made in Q2 and Q3 and have the biggest impact. So you'll see a large or an increase in gross margin and EBITDA margin in Q4 based on the business items that Mike brought up and the cost items that will be lower in Q4.

Okay, thanks. And then just, touching on the second-hand market overview slide Pro Security growing to the 4% and then DIY growing 10% plus. What your customers are telling you about what professionally-installed market is doing and how it's really fair against maybe some of the new entrants on the DIY side? Is it a real competitive threat, or is Pro Security be able to continue to go like this? Thanks.

Yes, so as I said in my prepared remarks, we really don't play in the DIY sector. We've got a couple entry level products that are typically kind of hook products to get people to move into the Pro side. So, we – our focus is on the Pro Security piece. We believe what we are doing from a market perspective and the new products that we're launching are going to be true market making products and going to be much simpler for the end user to use. We're hoping, and we're seeing business models changing now from long-term commitments, contract commitments for Pro Security to shorter, which we think is going to really prop up the Pro market. So, our view on that is we want to push that Pro Security market, we're growing faster than market now. And our job is to make sure that with the dealers and the other partners that we have, that we're providing them world-class products so that they can compete and truly show a higher value in the Pro product versus the DIY product. As you know, Ian, I call the DIY product awareness products. Those products are more for if you want to see your dog running around the home, you want to know, you know, if someone's at the door, those kinds of things. The Pro products are true monitoring in the home, professional monitoring. So two very different things for me.

Okay, great. Thank you very much for the color.

Thanks Ian.

Thank you. [Operator Instructions]

Okay Ryan [ph] we’ll take the next question.

Hi, this is Jeff Kessler at Imperial Capital. With regard to non-ADT business in the Pro market, what are the medium and some of the smaller – but maybe let's shift into the medium regional companies asking for well as you begin to change your product line and advanced it in the fourth quarter, what are they asking for that is different or additive to what they have now to keep them – to keep their value proposition up and higher than if you want to call it the new competition.

Hey, thanks Jeff. This is Mike here I’ll answer that. So yes, so looking at Security, we will be rolling out our new Pro series platform to the general market in Q4. So that in 2020 we'll be rolling it out in Europe. So, we have launched it with our largest customer and we will be rolling it out to general marketing Q4 and then into Europe next year. The difference is on what this product does versus the previous generations of product. It is a fully modular product, meaning that it will eliminate the number of truck rolls that our dealers need to make as technology increase – as technology changes. So the best example of that is as cellular technology changes as it goes from a 4G to 5G, they won't have to roll a truck anymore, they'll be able to send a card straight to the consumer and the consumer can just plug it right into the panel. Versus in the past they'd actually have to go and replace the panel. Also the overall cost of the product is much cheaper and it is going to give our dealers a competitive advantage versus some of the older technologies out there. So, we're really – it simplifies installation, it's easier for training the installers and much more interactive, a much better web interface and phone interface. And it's really future-proofing a lot of the radio sunsets that we've seen out there in the past. So that's the big difference and that's why the largest dealer in the U.S. has gone 100% with us and our largest customer as well is really betting on our product as it's going to really change the profile of their business.

Okay. A follow-up question on ADI. They have really only one competitor of size in the Security side. I am wondering if your plans for ADI also include any level of comfort given that I know that there's a different distribution, there are different channels that Comfort – both the heating and air conditioning are sold into. Nevertheless, is there a possibility for ADI to begin to get into that business as well?

Yes, so looking at our ADI business, right now, our ADI business focuses, as you said, on low-voltage security. They're also – their biggest growth area outside of that is AV right now, so Professional A/V. That's an area we're pushing really hard in. So also, the third item is enterprise connectivity. If you take a look at the connected home and the smart home, what we're really about is making the smart home simple. So where our ADI team, if they're able to sell a connected thermostat, any of the other connected products they will do that. So our plan, Jeff, is that they will be selling connected products in the areas of air, water, security and the behind-the-wall stuff that we call energy. But I wouldn't see them selling a lot of nonconnected products in the Comfort space. So that's the way we're pushing that team, and we're seeing a pretty good uptick there already.

Does the margin mix change at all?

You know what, as you know, it's very product-centric, it depends on the actual product itself. So there is some opportunity there. I have tasked that team with finding 200 basis points of margin improvement over the next two years. So Rob and team are all over that. Part of that will be, exactly what you said, through expanding deeper into connected products.

Great. Thank you very much. I appreciate it.

Thanks Jeff.

Thanks Jeff.

John Lovallo from Bank of America Merrill Lynch.

Hey guys thank you for taking my questions. I'm just trying to get a better handle here on some of the numbers. So maybe we can start with just a commentary around cost control. If I look at 2Q adjusted operating profit, I mean, it was below our model, and it seems like it may have been below what your initial thoughts for last quarter, and it appears to be some volume, some mix and some investment spending. Gross profit, it was about $20 million lower than we had expected. And it seems like EBITDA in the quarter was supported by $22 million or so of lower legal claims and spinoff costs. So I guess the question is twofold. One, do you anticipate the benefit from these legal and spinoff costs continuing? And two, outside of that, where are the cost saves opportunity set you guys manifest in the back half here?

John how are you doing? This is Joe. We would expect that we have continued savings on the SG&A side. We have several programs underway to drive the $10 million attainment this year and the $50 million run rate improvement for 2020. And we are driving across the cost and the company overheads as well as looking at gross margin improvements as well and supply chain. So there are multiple opportunities that we're working currently. So I would expect continued SG&A improvement as we take costs out of that structure, and you should see some improvement on the gross margin line as well.

Okay. May be just going to Slide 7 on the EBITDA walk, and looking at the market moderation bucket. There appears to have been a little bit of cushion in their perhaps, and if we think about – look, I mean, we're bullish on the new construction cycle and repair remodel as well. But I'm just curious what happened in the quarter that allowed you to become $10 million more positive on that bucket because if you look at housing starts, they weren't particularly strong.

They didn't really move from our original number of 1.2 million housing starts. So as we look at that, it hasn't moved very much and we brought some conservatism into the bridge there, just because we didn't have good visibility. And as you know, 100,000 decline in housing starts equals $7 million of EBITDA. So that hasn't happened yet, there's been no change. So we thought it made sense to actually just cut that in half.

Yes John this is Mike here. My view on that was, we got through half the year. So the way we had the market moderation really model this. We really felt $10 million in the first half and $10 million in the second. So getting through half the year, we felt pretty good about that and really didn't see any moderation headwinds. So we've kept the additional $10 million in for the second half.

Got it. Thanks guys.

Thank you.

With that I'll hand it back over to President and CEO, Mike Nefkens for closing.

Great guys. So listen, thank you for joining the call, I really appreciate it. A lot of great question as always and we – as I said in my prepared remarks, we had a solid Q2, there truly is momentum building right now, the investment programs that we we've driven this year, we accelerated a lot of investment from 2020 into the year so that we could launch some of these new products I had preferred to at the end of the year. That's all moving in the right direction. I'm really excited to get those out to market. We really feel there's some true market makers in there in all areas of our business. And it's all about execution. We've shown in Q1 and Q2 that we can execute. Our commitment is to continue that trend going forward, and we look forward to – I know I'm meeting many of you here over the next two days. So thank you for that. Also a quick call out, we are at the NYSE today. We've been asked to actually open the market today. So we'll be up on the stand ringing the bell. And hopefully, we can get great momentum here into the second half of the year. Thank you for attending the call, and look forward to talking to you next time.

Thank you. Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect.