Business context and reporting period
Resideo Technologies, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. The company provides connected-home comfort, security and energy products and operates Products & Solutions and ADI Global Distribution. Resideo became independent from Honeywell in October 2018; 2018 comparative results include pre-spin combined financial information and are not fully comparable to the post-spin 2019 results.
Financial results and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $1,226 million | $1,200 million | $3,684 million | $3,561 million |
| Gross profit / margin | $289 million / 24% | $347 million / 29% | $898 million / 24% | $1,036 million / 29% |
| Operating profit | $59 million | $128 million | $186 million | $388 million |
| Net income | $8 million | $311 million | $45 million | $389 million |
| Diluted EPS | $0.06 | $2.53 | $0.36 | $3.16 |
| Segment Adjusted EBITDA | $114 million | $150 million | $363 million | $457 million |
Q3 revenue rose 2% year over year; nine-month revenue rose 3%. Gross margin fell five percentage points in both comparisons, primarily due to product mix, material and labor inflation, fixed production costs and inventory write-downs. Q3 SG&A was $230 million, up from $219 million; nine-month SG&A was $712 million, up from $648 million.
The 2018 net income comparisons were materially affected by tax benefits: $329 million in Q3 and $323 million for the nine-month period. 2019 tax expense was nil for Q3 and $36 million year to date. Other expense was $35 million in Q3 and $54 million year to date, compared with $144 million and $320 million, respectively, in 2018; the prior-year amounts largely reflected environmental expense before the Honeywell reimbursement arrangement.
At September 30, 2019, cash and cash equivalents were $132 million, down from $265 million at year-end 2018. Operating cash flow was a use of $70 million for the first nine months, versus $375 million provided in 2018; management attributed the deterioration chiefly to lower margins on higher sales and working-capital effects. Investing cash use was $83 million and financing provided $22 million. Accounts receivable were $845 million and inventory was $729 million.
Total debt was $1.253 billion, including $60 million drawn on the $350 million revolving facility; $88 million was due within one year. The company reported $1.165 billion of long-term debt and $580 million of obligations payable to Honeywell. It said cash and available credit were sufficient for capital requirements for at least 12 months, while also discussing a possible leverage-covenant amendment with its agent bank. Capital expenditures for 2019 were expected to be $93 million.
Segments and material changes
- Products & Solutions: External revenue fell 3% to $512 million in Q3, while Segment Adjusted EBITDA fell 38% to $66 million. Nine-month revenue rose 2% to $1.600 billion, but EBITDA declined 33% to $222 million. Q3 weakness reflected lower Comfort thermostat sales and RTS slowdown among large OEM customers, including effects of regulatory changes. Profit was pressured by unfavorable mix, inventory write-downs, production costs and high rebates under a pre-spin contract.
- ADI Global Distribution: Q3 external revenue increased 6% to $714 million and EBITDA rose 12% to $48 million. Nine-month revenue increased 5% to $2.084 billion and EBITDA rose 14% to $141 million, supported by volume and productivity, partly offset by foreign exchange.
- Q3 gross profit declined despite higher revenue. Management cited a 300-basis-point impact from mix and approximately 100 basis points each from inflation/fixed production costs and headquarters costs reclassified from SG&A into cost of goods sold.
Outlook, risks and unusual items
- On October 22, 2019, Resideo announced a comprehensive operational and financial review targeting product cost, gross margin and G&A simplification, and revised its 2019 guidance. The filing text does not provide a clear revised guidance value. Management said the review’s costs could not yet be estimated and cautioned that benefits and implementation outcomes were uncertain.
- Management expected Q3 Products & Solutions headwinds to continue into peak winter demand. A repositioning plan was expected to generate $15 million of incremental pre-tax savings in 2019; the company anticipated another $3 million of repositioning expense after $34 million was recorded in the first nine months.
- The Honeywell Reimbursement Agreement covers 90% of specified environmental payments, subject to recoveries and a $140 million annual cap. Resideo paid $105 million in the first nine months and reported $568 million of related liabilities at September 30. Ultimate environmental costs and timing remain uncertain and could be material.
- Goodwill was $2.632 billion. No interim impairment test was performed for Q3, but management said reduced performance, revised guidance and a share price below book value could contribute to a future impairment; annual testing was planned for Q4.
- Other risks include competitive pressure and thermostat sales losses following a product transition, weather-sensitive demand, delayed purchases by a significant customer, customer concentration, raw-material and foreign-exchange exposure, and the execution and disruption risks of the operational review. The company had no outstanding currency hedges; $874 million of debt carried variable rates.
Important facts for investors to verify
- Review the revised 2019 guidance and the company’s subsequent operational-review actions, estimated costs and realized savings.
- Track Products & Solutions sales, margins and EBITDA, including thermostat recovery, RTS/OEM demand, inventory write-downs and contract rebates.
- Monitor operating cash flow, working capital, revolver usage, covenant discussions and the capacity to meet near-term obligations.
- Assess future Honeywell environmental reimbursements, recoveries, annual-cap utilization and any changes in the $568 million liability.
- Follow the Q4 goodwill impairment assessment and whether market value and segment forecasts support recorded goodwill.
- Account for the exceptional 2018 tax benefits and pre-spin reporting differences when comparing earnings across periods.