Resideo Technologies, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Amounts are in millions of dollars, except per-share data. Resideo supplies home comfort, security and energy-use products and software, and distributes low-voltage electronic and security products through ADI Global Distribution.
Financial results and liquidity
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $1,029 | $1,242 | $2,208 | $2,458 |
| Gross profit / margin | $236 / 23% | $323 / 26% | $520 / 24% | $655 / 27% |
| Operating income (loss) | $(6) | $42 | $28 | $127 |
| Net income (loss) | $(76) | $(11) | $(97) | $37 |
| Diluted EPS | $(0.62) | $(0.09) | $(0.79) | $0.30 |
| Segment Adjusted EBITDA | $63 | $122 | $162 | $249 |
Q2 revenue fell 17% year over year, primarily from lower volumes amid COVID-19; first-half revenue declined 10%. Q2 gross margin contracted 3 percentage points. Management attributed the margin pressure to lower volumes (200 basis points unfavorable), COVID-related factory safety costs (100 bps unfavorable) and sales mix (100 bps unfavorable), partly offset by transformation savings (100 bps favorable). SG&A fell $39 in Q2 to $242, but was 24% of revenue versus 23% a year earlier. Other expense was $29 in Q2 and $71 for the first half; first-half expense included $69 related to the Honeywell Reimbursement Agreement, versus $22 in the prior-year period.
By segment, Q2 Products & Solutions external revenue was $398, down 26%, and Segment Adjusted EBITDA was $35, down 53%. ADI Global Distribution revenue was $631, down 10%, and Segment Adjusted EBITDA was $28, down 40%. First-half revenue declines were 20% and 3%, respectively. Segment Adjusted EBITDA is a non-GAAP measure as defined by the company.
First-half operating cash flow was $71, compared with cash used of $37 in 2019. Investing activities used $66, including $35 for acquisitions; financing provided $241, including $250 of revolving-credit borrowings. Cash rose to $362 from $122 at year-end. At June 30, total debt was $1,427, including $250 drawn on the $350 revolving facility; $287 was classified as current and $1,140 as long-term. Working-capital balances included receivables of $704 and inventory of $614. Total current assets were $1,843 and current liabilities $1,662.
Material changes and unusual items
- The pandemic caused constrained supply, weaker customer demand, temporary facility closures or restricted operations in some locations, and additional employee-safety costs. Revenue declined in both segments.
- Management reduced expenses, aligned production with demand, deferred or reduced nonessential capital spending, optimized working capital, and used salary reductions and furloughs. It expected cash to decrease during the second half of 2020.
- The company expected $30–$40 of incremental pretax savings in 2020 versus 2019 from restructuring and related actions, net of implementation costs. First-half restructuring expense was $20; cash payments were $14.
- Management stated that cash, cash equivalents and available credit were expected to be sufficient for capital requirements for at least the next 12 months. It also cautioned that visibility was limited and business conditions were expected to remain challenging.
- On July 28, 2020, Resideo and Honeywell further deferred a $35 quarterly reimbursement payment until no later than October 30, 2020; Resideo said it would pay the next $35 quarterly installment by July 30. Honeywell-related reimbursement liabilities totaled $619 at June 30. The agreement relates to environmental obligations and includes a $140 annual cap, subject to its terms.
- Goodwill was $2,638. Management reported that the Products & Solutions reporting unit, with approximately $1,997 of goodwill, had fair value only 10% above carrying value and warned adverse developments could require impairment.
- Resideo acquired Herman ProAV in February for approximately $36, expanding ADI’s professional AV business.
- Resideo recorded tax expense of $23 in Q2 despite a pretax loss of $53; first-half tax expense was $19 despite a pretax loss of $78. The filing attributes interim tax calculations to jurisdictional effects, valuation allowances and other specific items.
Risks, contingencies and other matters
Key risks include the duration and effects of COVID-19 on demand, operations, suppliers and customers; liquidity and debt-covenant exposure if conditions deteriorate; foreign exchange and variable interest rates; and possible goodwill impairment. Approximately $1,047 of debt carried variable rates; management estimated that a 100-basis-point rate change would affect annual interest expense by about $9.
The company disclosed a securities class action alleging misleading statements about business performance, supply-chain efficiency and other matters; a motion to dismiss was filed July 10, 2020. A related shareholder derivative complaint was filed July 6, with a proposed stay pending resolution of the class action motion. The company said it would defend both, but outcomes and potential costs are uncertain. Environmental liabilities and the Honeywell reimbursement obligations may also result in material future costs; the ultimate timing and amounts are not clear.
Management identified no material changes to the previously reported risk factors other than the COVID-19 and management-turnover disclosures and the revised contingencies discussion. Disclosure controls were concluded effective at a reasonable assurance level; no material change in internal control over financial reporting was reported.
Comparability note: Beginning in 2020, research and development expense was reclassified from cost of goods sold to SG&A. Prior-year gross profit increased and SG&A increased by $27 for Q2 and $46 for the first half under the revised presentation; net income was unchanged.
Important facts for investors to verify
- Whether revenue, margins and segment profitability recover as COVID-related disruptions ease, and whether transformation savings offset volume and cost pressures.
- Cash generation and second-half cash use, revolving-credit availability, debt maturities and compliance with leverage covenants.
- Timing and funding of deferred Honeywell payments, and the development of environmental and tax indemnity obligations.
- Whether the Products & Solutions goodwill valuation withstands changes in operating performance, market conditions and discount rates.
- Potential costs and outcomes of the securities and derivative litigation, and whether restructuring savings are achieved net of implementation costs.