Resideo(REZI) - 2019 Q3 - Quarterly Report

Part I. Financial Information Financial Statements This section presents Resideo Technologies' unaudited interim financial statements, reflecting a significant decrease in net income post-spin-off, influenced by a prior-year tax benefit Consolidated and Combined Interim Statement of Operations Net revenue slightly increased for both three and nine-month periods, but operating profit and net income significantly declined, primarily due to a non-recurring 2018 tax benefit Statement of Operations Highlights (Three Months Ended Sep 30) | Financial Metric | 2019 (in millions) | 2018 (in millions) | Change | | :--- | :--- | :--- | :--- | | Net revenue | $1,226 | $1,200 | +2.2% | | Gross profit | $289 | $347 | -16.7% | | Operating profit | $59 | $128 | -53.9% | | Net income | $8 | $311 | -97.4% | | Diluted EPS | $0.06 | $2.53 | -97.6% | Statement of Operations Highlights (Nine Months Ended Sep 30) | Financial Metric | 2019 (in millions) | 2018 (in millions) | Change | | :--- | :--- | :--- | :--- | | Net revenue | $3,684 | $3,561 | +3.5% | | Gross profit | $898 | $1,036 | -13.3% | | Operating profit | $186 | $388 | -52.1% | | Net income | $45 | $389 | -88.4% | | Diluted EPS | $0.36 | $3.16 | -88.6% | Consolidated Interim Balance Sheet Total assets and liabilities increased as of September 30, 2019, driven by higher inventories, while cash and cash equivalents significantly decreased Balance Sheet Summary | Account | Sep 30, 2019 (in millions) | Dec 31, 2018 (in millions) | | :--- | :--- | :--- | | Assets | | | | Cash and cash equivalents | $132 | $265 | | Inventories | $729 | $628 | | Goodwill | $2,632 | $2,634 | | Total assets | $5,133 | $4,972 | | Liabilities & Equity | | | | Total current liabilities | $1,551 | $1,489 | | Long-term debt | $1,165 | $1,179 | | Obligations payable to Honeywell | $580 | $629 | | Total equity | $1,573 | $1,533 | Consolidated and Combined Interim Statement of Cash Flows The company reported a net cash outflow of $70 million from operating activities for the nine months ended September 30, 2019, a significant reversal from the prior year's inflow Cash Flow Summary (Nine Months Ended Sep 30) | Cash Flow Activity | 2019 (in millions) | 2018 (in millions) | | :--- | :--- | :--- | | Net cash (used for) provided by operating activities | $(70) | $375 | | Net cash used for investing activities | $(83) | $(56) | | Net cash provided by (used for) financing activities | $22 | $(186) | | Net (decrease) increase in cash | $(133) | $128 | Notes to Consolidated and Combined Interim Financial Statements These notes detail the company's post-spin-off financial presentation, new accounting standards, acquisitions, repositioning charges, and environmental liabilities under the Honeywell Reimbursement Agreement - The company separated from Honeywell on October 29, 2018, becoming an independent public company. Financials prior to this date are on a combined basis derived from Honeywell's records[26][28] - Effective January 1, 2019, the company adopted the new lease accounting standard (ASU 2016-02), recognizing an operating lease liability of $115 million and a right-of-use asset of $112 million[41][42] - In 2019, the company acquired Buoy Labs, Whisker Labs, and LifeWhere for a total of $17 million to enhance its smart home and energy efficiency offerings[52][53][54] - A repositioning plan initiated in Q2 2019 resulted in charges of $34 million for the nine months ended Sep 30, 2019, primarily for severance[62] - The company has a liability of $568 million as of Sep 30, 2019, related to the Honeywell Reimbursement Agreement for environmental remediation, with payments capped at $140 million annually[96][101] - Beginning in Q1 2019, the company's Chief Operating Decision Maker (CODM) began evaluating segment performance using Segment Adjusted EBITDA instead of segment profit[117] Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses mixed segment performance, a decline in gross profit margin, negative operating cash flow, and increased goodwill impairment risk, prompting a comprehensive operational review Results of Operations Q3 2019 net revenue increased slightly, but gross profit margin significantly declined due to unfavorable sales mix, inflation, and reallocated costs, while other expenses decreased due to the Honeywell Reimbursement Agreement Net Revenue Change Drivers (vs. Prior Year Period) | Driver | Q3 2019 | Nine Months 2019 | | :--- | :--- | :--- | | Volume | 1% | 3% | | Price | 2% | 2% | | Foreign currency translation | (1)% | (2)% | | Total % change | 2% | 3% | - Gross profit percentage decreased from 29% in Q3 2018 to 24% in Q3 2019. This was primarily driven by a 300 bps impact from sales mix changes, a 100 bps impact from inflation and fixed production costs (including inventory write-downs), and a 100 bps impact from reallocated headquarters costs[127][152] - SG&A expenses increased by $11 million in Q3 2019 compared to Q3 2018, driven by spin-related costs, trademark license fees, repositioning costs, and acquisitions, totaling $43 million, partially offset by $32 million in cost reductions and allocation changes[128][157] - Other expense, net, decreased by $109 million in Q3 2019, primarily because environmental expenses are now subject to the Honeywell Reimbursement Agreement, which caps annual payments at $140 million[160] Review of Business Segments The Products & Solutions segment experienced revenue and EBITDA declines, while the ADI Global Distribution segment showed strong revenue and EBITDA growth in Q3 Products & Solutions Segment Performance (Q3 2019 vs Q3 2018) | Metric | Q3 2019 (in millions) | Q3 2018 (in millions) | % Change | | :--- | :--- | :--- | :--- | | External revenue | $512 | $526 | (3)% | | Segment Adjusted EBITDA | $66 | $107 | (38)% | ADI Global Distribution Segment Performance (Q3 2019 vs Q3 2018) | Metric | Q3 2019 (in millions) | Q3 2018 (in millions) | % Change | | :--- | :--- | :--- | :--- | | External revenue | $714 | $674 | 6% | | Segment Adjusted EBITDA | $48 | $43 | 12% | Capital Resources and Liquidity The company's liquidity weakened due to negative operating cash flow and increased working capital, leading to discussions for amending credit agreement covenants - Operating cash flow was an outflow of $70 million for the nine months ended Sep 30, 2019, compared to an inflow of $375 million for the same period in 2018[180][183] - As of September 30, 2019, cash and cash equivalents were $132 million, and there were $60 million of borrowings under the $350 million Revolving Credit Facility[180] - The company is discussing amendments to its credit agreement's leverage covenant to support its operational review and maintain flexibility for acquisitions[181] Critical Accounting Policies - Goodwill The company faces an increased risk of material goodwill impairment due to performance declines and a significant drop in stock price below book value - As of September 30, 2019, Goodwill was $2.6 billion. The annual impairment test is performed on October 1[189] - Due to revenue declines, a significant drop in stock price, and revised 2019 guidance, there is an increased risk of goodwill impairment. If market price does not recover, a portion of goodwill may be impaired in future periods[191][193] Quantitative and Qualitative Disclosures About Market Risk The company is exposed to interest rate and foreign currency risks, with a significant portion of debt at variable rates and no active hedging for currency fluctuations - As of September 30, 2019, $874 million of the company's $1.3 billion total debt carried variable interest rates. A 100 basis point change in interest rates would impact annual interest expense by approximately $8 million[197] - The company has exposure to foreign currency fluctuations, primarily in the Euro, British Pound, Canadian Dollar, and Czech Koruna. As of September 30, 2019, there were no outstanding hedging arrangements[198] Controls and Procedures Management concluded that disclosure controls and procedures were effective as of September 30, 2019, with no material changes to internal controls during the quarter - The Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2019[202] - There were no changes in internal control over financial reporting during the quarter that materially affected, or are reasonably likely to materially affect, internal controls[203] Part II. Other Information Legal Proceedings The company is involved in various lawsuits and investigations, including significant environmental remediation obligations under the Honeywell Reimbursement Agreement - The company is subject to various lawsuits, investigations, and disputes arising from its business, including commercial, product liability, and environmental matters[204] - Under the Honeywell Reimbursement Agreement, the company is obligated to pay 90% of certain environmental liability payments related to historical contamination from Honeywell's legacy businesses[205] Risk Factors The company faces updated risks including increased competition, climate change impacts, customer concentration, uncertainty from its operational review, and heightened goodwill impairment risk - The company operates in highly competitive markets and experienced lower sales of non-connected thermostats in Q3 2019 due to a poor product line cutover, resulting in lost sales to competitors[207] - Global climate change poses a risk, as a shift away from fossil fuels could reduce demand for the company's thermal solutions. Unseasonable weather also impacts sales, as seen with lower RTS product sales in Q3 2019[211][213] - The company faces risk from customer concentration. In Q3 2019, a significant customer delayed the start date of expected purchases beyond the fourth quarter[214][215] - A new risk factor was added regarding the comprehensive operational and financial review, stating there is no assurance it will achieve the expected results and could cause business disruption[216] - The risk of goodwill impairment has increased. A decline in stock price below book value following revised 2019 guidance could lead to a material impairment charge in the future[217] Exhibits This section lists exhibits filed with the Form 10-Q, including compensation plans and required officer certifications - The Exhibit Index lists all documents filed as part of the Form 10-Q, including management compensation plans and required officer certifications (Sections 302 and 906 of Sarbanes-Oxley)[218][220] Signatures The Form 10-Q was signed and authorized on November 6, 2019, by the Executive Vice President & CFO and the Interim Chief Accounting Officer - The report was signed on November 6, 2019, by Joseph D. Ragan III (EVP & CFO) and AnnMarie Geddes (Interim Chief Accounting Officer)[222]