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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome everyone to the Resideo Technologies First Quarter Earnings Conference Call. Today's call is being recorded. [Operator Instructions]
I'd now like to introduce Mr. Michael Mercieca, Vice President of Investor Relations. Mr. Mercieca, you may now begin.
Good day everyone. 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 first quarter earnings release and presentation materials on the Investor Relations page at 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 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 accompanying presentation, both of which can be found on 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 it over to our President and CEO Mike Nefkens.
Thanks Michael and good morning everyone and thank you for joining us on today's call.
We're hosting today's call from our Austin, Texas ADI branch. So I'd like to start by highlighting two format changes to our Q1 earnings announcement and call. First, is I hope you've already noticed, we released our earnings material after close of market yesterday that provides you with more time to review the material before the actual call.
Second, we'll be extending the time of our Q&A session to accommodate more questions. Since our last earnings call, we met with many investors, customers and other stakeholders and these changes have been made based on their collective feedback. I hope you find these changes beneficial as well.
So with that let's dive in and move to Slide 2 in the presentation and begin with a summary of what we will cover on today's call. First, I'll start with an overview of our first quarter results at both the consolidated and segment levels. Then we'll provide insights on the markets and segments we serve. Third, we'll focus on how our previously announced cost actions combined with key investments lay the foundation for our strategy and profitable long-term growth acceleration. And last, Q1 financial details and our progress towards guidance for the rest of 2019.
Let's move to Slide 3, which shows highlights of our consolidated first quarter financial results for the business. Net revenue for the business was $1.22 billion during the first quarter of 2019, up 4% from the first quarter of 2018 on a reported basis and up 7% on a constant currency basis. We are especially pleased with the growth figure considering first quarters are usually slower for our business. As a reminder, our operational profile typically weights our earnings generation towards the second half of the year.
Adjusted EBITDA for the business was $92 million, $6 million better than expectations, primarily driven by our cost management efforts. EBITDA was also positively impacted by increased sales volumes and negatively impacted by shift in portfolio mix, specifically the introduction of our new security platform and volume increase in connected products.
Adjusted EPS was $0.29 per share and also exceeded expectations. Our adjusted EPS was impacted by the same items as our EBITDA plus higher interest expense for the quarter. With a solid first quarter in the books, we are well on our way to achieving the growth goals we set out to achieve during our 2018 year-end call.
So now moving to slide 4. We see a breakdown of our Q1 performance by our business segments; Product and Solutions and Global Distribution. Both are leaders in their respective markets and growing. Let's start with our Products and Solutions segment, which experienced strong revenue growth in the first quarter, with sales growing 8% on a constant currency basis.
Growth in the quarter was solid across our core business with high growth in our pro security business, led by the launch of our next generation residential pro security platform. Volume shipments began for our largest customer in February and we expect to be at full capacity across our customer base by the first half of 2020.
Providing a bit more color on our new pro series security platform, it's a comprehensive portfolio redefining the traditional pro security industry. The platform delivers entry-level security protection and scales to a fully integrated smart home security solution. It features new self-contained wireless panels, advanced encrypted sensing and offers dealers one system for easy installation and support.
The expanded line of sensors and life safety devices are interchangeable across the entire platform to help reduce inventory and training costs and user replaceable parts provide added convenience and help to reduce truck loads for our dealers. This is a great example of Resideo leading through innovation in our core business segments.
Next, in our comfort business, we celebrated the award winning launch of multiple products at CES, including our T9 and T10 smart home thermostats. The product segment also saw tangible improvement in supply chain execution, as we work through spin-related headwinds from the past two quarters.
And lastly for products and solutions, adjusted EBITDA was $81 million, above first quarter expectations, but down year-over-year due to new products launch mix headwinds, combined with higher-than-planned product and solution overhead costs, which we're working on.
Now turning to ADI, we saw continued growth in our global distribution segment in the first quarter with business growing 6% on a constant currency basis. Growth was particularly solid in the Americas and EMEA and within our security life safety businesses.
From an investment perspective, we made enhancements in our customer digital experience with the launch of key upgrades to ADI website. Good Q1 progress in ADI, despite one fewer selling day this year than last. And last, EBITDA for the segment grew $5 million to $46 million. So net-net, a good start to the year for both our business segments.
Now, let's move on to Slide 5, where I'll highlight the markets Resideo serves. Starting on the left of the chart in blue, we have Resideo's two segments; Products and Solutions and ADI, and our 2018 annual revenue each listed. I'll begin with our ADI distribution business.
ADI is our global distribution segment and we compete in a $20 billion low-voltage electronics and security distribution market. This segment is growing at roughly 3% to 4% annually and ADI consistently performs above market and we've listed some of our competitors out to the right.
Now, let's move up the chart, for product and solutions business and market. In feedback from investors, it's been to provide a better breakdown of our Products and Solutions business by segment and subsegment. So, we've done that here.
It's important to note that these product lines were not integrated within one segment pre spin. But now that they're together under Resideo, we have the opportunity to unify the strategy, the customer and the do-it-for-me pro experience. It's also an opportunity to remove redundant expenses as part of our cost program.
So back to the chart. I'll start with our $800 million security business. We divide those markets into two; pro security and DIY awareness. Our primary market is pro security and pro security is professionally monitored security system and Resideo performed at market in this $2.9 billion space in 2018.
However, in Q1, we are now growing well above market. Just below pro security is DIY awareness. Think of it as cameras and unmonitored systems are typically sold online or through retail channels and are generally self-installed by consumers. Resideo has small presence in this space.
Moving up the chart to our largest business Products and Solutions' comfort, we broken that down in the four sub-segments. The first, connected thermostats, is a growing market at 10% plus. And we've been performing above market with multiple market gaining launches over the past 12 months, including the T-9 and T-10 smart home thermostats.
Next is traditional temperature control, which includes non-connected thermostats, hydronic heating controls, zoning controls, et cetera. That's a $2.5 billion market where Resideo is the clear leader, but the market traditional temperature control is flat, and we're performing just above that.
Next, we have indoor air quality or IAQ in potable water, which is a $3.7 billion market and growing in the mid-single digits. Resideo has a small presence in this space and we're performing at market. We believe IAQ is an attractive adjacency for us given the heightened air quality concerns by consumers. Companies participating the IAQ arena, are listed to the far right in that column as well.
And fourth, is residential thermal solutions or RTS, which includes the behind-the-wall controls, the hot water heaters, boilers, furnaces, et cetera I In RTS, Resideo has a strong and leading market position and growing well above market.
So to summarize, Resideo has market-leading positions and performance in the markets we serve coupled with solid Q1 improvements in our pro security business. So our work is to gear resilient to accelerate growth even further in these markets.
All right. So now moving on the Slide 6, we'll focus on our progress towards accelerating growth in right-sizing our cost structure. But first, I want to summarize our vision for Resideo and the core tenants of our strategy. So our vision is to provide the homeowner a safe and efficient, secure and healthy home. What we do goes beyond the connector at smarthome.
Connections in analytics sphere be 3,000 products allow us to provide the safe and efficient, secure and healthy home experience. Our strategy is to provide a whole home solutions, powered by Resideo and installed and supported by our pro-channel over 100,000 Resideo certified contractors and partners.
Our whole home solutions are driven by industry-leading positions in comfort, security and we're moving into adjacencies of indoor air, quality and water leak detection. We're simplifying our cost structure and investing to offer industry leading products in the whole home solutions with recurring revenues. Now our programs to support our strategic direction are on track with specific progress in the following areas in Q1.
First, on the leadership and people side, we've made several critical hires in Q1. Amongst them, our President for Products and Solutions and VP of mobile applications. With these key hires in place, we can now go faster. Second, our cost optimization program is well underway with now $10 million in savings expected to be realized in 2019 and $50 million in run rate savings on track for the full-year 2020.
Then third, as discussed earlier, our product launches continue on schedule with the right mix of innovative products across our portfolio. And last, we see numerous complementary market adjacencies to deliver value to our consumers and do it for me pros.
In Q1, we executed on one of those with the acquisition of Buoy Labs, which enables us to expand in water-leak protection to bolster our whole home solutions and recurring revenue potential. So net-net, a solid start to our investment initiatives and cost programs. We're also starting to move beyond some of the supply chain and cost spin burdens.
We still have a long way to go to meet our goals of substantially high-margin recurring revenue. However, the solid Q1 has given us some momentum as we continue our work towards our strategy to accelerate profitable growth.
So now I will turn it over to Joe who will go deeper into our financials for the quarter in 2019.
Thanks Mike.
Putting all this together on Slide 7, you can see our full year 2019 expectations. We reviewed our outlook and are reiterating our guidance for the full year. We've reiterated our adjusted EBITDA guidance at the upper end of our $410 million to $430 million range.
As a reminder, this EBITDA number includes the Honeywell reimbursement agreement payment, which we discussed on our previous earnings call. We are maintaining our assumptions about inflation.
As Mike said, we are executing on our investment programs as planned. So our $30 million investment assumption will stay. We also made a change for our product mix assumption. We are increasing that cost by $10 million as we see headwinds from the rollout of new products.
From a market moderation perspective we are reducing this from $30 million to $20 million based on the slightly improved market outlook and we are now accounting for a $10 million benefit from our cost reduction program for the full year. With all of these pluses and minuses, we are forecasting our guidance to the top of our previously announced range.
I want to take a moment on Slide 8 to highlight some of the volatility in our GAAP results due to the Honeywell reimbursement agreement and why our adjusted results best represent the underlying earnings of our business.
During the quarter, there was a Honeywell sale of one of the properties included in the agreement. This impacted on an income statement basis the other expense line where we normally book the reimbursement agreement, the tax line and ultimately reported net income. The impact of this one entry was a positive $45 million of net income. We've adjusted this item out of our results.
Just to illustrate please focus on the other income line. For the quarter, we recorded a $16 million credit versus last year where we recorded a $52 million in other expense. This illustrates the difference that can occur in a quarter just based on the reimbursement agreement. We expect our go forward results to look like the 2018 number. That's why the adjusted numbers of the best representation of our business.
As we move forward, you can expect that our quarterly results may have significant gains or losses based on the reimbursement agreement and we will adjust as necessary for reporting purposes.
Slide 9 presents our financial position, which is healthy and supports our strategy. As we said before, the early part of the year is typically when we use more cash as part of our normal course of business, which you'll see reflected in our balance sheet.
Our cash usage was driven by CapEx, non-operating payments to Honeywell and mandatory debt repayment. We have also invested in additional inventory due to the rollout in our security business and the growth in ADI.
From the net working capital perspective, we have a source of $17 million, our total debt is approximately $1.2 billion and our net leverage is 2.2 times, up slightly due to our cash usage in the quarter. With $330 million undrawn and available on our $350 million revolver, we're confident that our financial position is strong and continues to support our strategic initiatives and growth plans.
On Slide 10, you will see our complete, full-year guidance. We've reiterated our guidance for growth in a range of 2% to 5% as we gather more visibility into 2019. As I mentioned, we are guiding to the upper end of the adjusted EBITDA range of $410 million to $430 million.
As a point of clarity, when you look at our numbers, this adjusted EBITDA guidance includes our Honeywell reimbursement agreement payment and that is how we expect to guide going forward. Our margin guidance is unchanged for the year at 8% or 11% when you strip out the Honeywell reimbursement agreement payment and our EBITDA profile as Mike alluded to means, we expect to generate about 60% of our operating profits towards the second half year.
We have no change to our CapEx and R&D expectations with CapEx expected to be 1% of revenue, and R&D, expected to be about $135 million for the year. With respect to tax, we're providing guidance for tax on a dollar basis for your models as a result of the complexity of the Honeywell reimbursement agreement. We expect $75 million cash tax for the year. Our balance sheet expectations remain unchanged and capital allocation priorities are clear. We'll prioritize growth, and deleveraging for the year.
With that, I will turn it back over to Mike to close out.
Thanks Joe, and thanks to everyone who joined us for today's call.
So to close, I will summarize the key takeaways from the quarter and why we're excited about both our progress in our future. First, we had an outstanding start to the year in both our business segments, with strong growth in performance above expectations and key metrics, including adjusted EBITDA and adjusted EPS.
Second, we're on track in executing our cost in investment programs and combined there are an essential piece in positioning us is a high margin growth business over the long term. Third, our financial position is strong and our healthy balance sheet will allow us to drive our profitable growth strategy.
And last, this is our third quarter under our belt post spin. We're making progress in all areas. But we're being very measured to ensure progress and we're going to walk before we run. So with that for 2018, we're confident in our growth guidance in the upper end of our EBITDA guidance and we remain optimistic.
Thank you again for your interest in Resideo, and now, we'll turn over to the operator to begin Q&A and we welcome your questions.
[Operator Instructions] We will take our first question. Please go ahead. Your line is open.
It's Ian Zaffino from Oppenheimer. Question would be on kind of the margin evolution as we kind of progressed through the year. You have this new security platform, I got to believe they have a ton of cost absorption on that, also you are now selling, I guess exclusively to one customer and I imagine as you diversify that with the public at higher margins that way as well. So, kind of, where we now as far as maybe the margin headwind that that's creating and then what is the margins then ultimately look like, and what are the margin expansions we'll expecting as you ramp that product and you sell it to non-exclusive partners.
Thank Ian. The margin evolution over the year as you saw it for the first quarter is not much different for the entire year as we just disclosed in the guidance. We will be seeing some progress on the new platforms so we put out. But at the same time, we are going to increase our investments significantly in Q2 and Q3.
So from a profile perspective, we do have seasonality. So, Q1 was actually quite good, Q2 and Q3 are a little bit slower with the higher investment rates and from the new products will get additional scale throughout the year, but for the whole year, we've guided to 8%, which is about what we did in Q1.
And then you had a very successful launch of the T9 and T10 at CES. Now is that the super connected thermostat or - the supper connected coming afterwards and what's kind of the timing of that roll out?. Thanks.
Ian, it's Mike here. So yes, the T9 and T10 are top of the line connected products that have been in the works really for the last year. So and as you mentioned, we launched those very successfully at CES here in January. The T9 is the kind of the do-it-yourself model and T10 is the pro-model. So the thermostat we've been alluding to we'll be launching towards the second half of this year and that will, that is the super connected one that's in the works right now and we expect to be shipping those next year at the first of 2020.
And then a final question, I guess as I look at your - the segment in the market overview, and thanks for providing this, this is super helpful. When I look at the connected thermostat business, I see a green box and obviously you're competing very well against a whole host of players here. Is there an opportunity to get deeper into the DIY awareness kind of where there's other players there, some of them are similar and maybe see similar performance in the DIY awareness, that you're seeing now connected thermostats? Thanks.
Yes, so on that chart that you referring to the DIY awareness is much more security, right. So this is do-it-yourself install security. It's more cameras it send you alerts when there's motion in that kind of thing, but it's not pro-monitored. So that's the segment we referring to on that chart on security for DIY awareness. And as we said, we've got only a little presence in that area. Looking at your question on connected thermostats we typically launch some of our low end thermostats DIY oriented where you can buy the Home Depot or whatever and install them yourself, if you've got some capability there.
But really what we're focused on in our new launches is launching our Pro series type thermostats, which will be installed through the pro-channel and supportive through the pro-channel. We see our thermostats really important piece in the home from a data perspective and our launches this year are going to really show how much more we can do in those areas. So we're looking to really push thermostats we're approaching and as you see on the chart, we have a light presence in the DIY awareness and security.
And we will now take our next question. Please go ahead.
Peter Galbo from BoA. Thanks for taking the question. Mike, I just want to touch on in the updated bridge here reducing the market moderation headwind. I think you guys have called that as 30 million last quarter now at 20 million. The housing data has certainly improved and understanding you kind of want to walk before you run here. But what would kind of give you confidence to remove that bucket altogether is there anything you've seen so far through April and May, that gives you more confidence in that. Any color there would be helpful?
Yes, so there are lot of factors, but the main reason we removed the 10 million out of the market moderation really was just a successful Q1. So I mean that's just kind of the straight up way of looking at it, we really didn't see any moderation. It's finally, we are having some discussions yesterday with some people on Q1 and it seems there was like a 2-week recession where everybody was really worried and then it kind of came back. So we didn't see it in Q1, but looking forward at the year, there's still a lot of year to go.
We see, what's going on with China and potential tariffs and everything else that's on our radar. Obviously the housing starts have kind of ping ponged around, they went down to 1 million back up to 1.1 million. So those are kind of jumping around a little bit. So we just want to see some stabilization there as well to give us confidence to remove that. So obviously we go through our Q2 and we have a Q2 like we have Q1 we'll continue to move down, but as you said, be very measured here as there still lot of 2019 left.
And Mike, maybe you can talk a little bit, just given the increase in the mix headwind, just the differential in margin profile when you guys are selling through to an OEM type customer relative to. If you're just selling kind of directly to a contractor or through, through a higher touch distribution model that might come with more margin would be helpful?
Yes, so a lot of people ask me the question of hey which are your high margin products and how do they work. And really the answer is we sell a lot of our products on contract and straight to the OEMs and they integrated into their products. Typically, those are lower margin than when we sell it aftermarket. So aftermarket is when something breaks and they need a spare part. There we typically get a really good margin where when it goes straight to the contract and into their equipment it's a bit of a lower margin.
So there is a margin spread on our products where the same product will have a very high margin when sold aftermarket a lower margin at the beginning, so that's that. Now, so obviously there's seasonality involved in that and when it gets really cold and systems break we have a much higher aftermarket sales and that gives us some margin tailwind. The other point on the product mix point, that's really important to note here, is also with the launch of our security platform to right now, which were basically rolling out to one of our largest customers.
That is an OEM type contracts it has lower price points. So we're basically rolling that product out first, at the lowest price points while we still have not come up the scale from a manufacturing perspective and that's causing kind of the product mix here so that's how we were looking at the product mix bucket. And as we continue to go faster that's when we've increased the number there.
And maybe just one last one, because you guys didn't touch on it in the prepared remarks. Small acquisition that was done in the quarter just anything you'd like to highlight there. And then I believe you announced a partnership with the Chinese telecom company just how you kind of view the market opportunity there. China being such a small part of your business today and any concerns you have maybe around IP protection in that market? Thanks guys.
Yes, so I'll start with the acquisition and so we'd come out and talk about our investment strategy, and really what we were looking for were tuck-in acquisitions to really solidify our portfolio in certain areas are adjacencies. What we did with Buoy Labs is exactly that. We have our own water leak detection equipment that, that goes into the home. But what we didn't have is we didn't have the analytics, we didn't have the application and we didn't have the product that's able to measure the water flow into the home and auto shut-off the water in the home, if there is an issue.
So we found Buoy Labs, which is just a great little company that have got some amazing engineers, great IP and a great product and it accelerates our path to be able to get recurring revenue in that area tremendously by bringing them in. So that was the first and we're excited about having them as part of our portfolio, the product is in testing right now and that we're expecting to see recurring revenues from that towards the end of the year, beginning of 2020.
Now your question on China let me think here. So obviously we did a partnership with GOME and to sell through retail and kind of think of it as the Home Depot of China. So that's a solid partnership for us, we are slowly doing more in that market and we do see a lot of upside potential there. So we're excited about the GOME partnership and more to come on that.
Will now hear from our next participant, please go ahead.
This is Jeff Kessler at Imperial Capital. Can you talk a little bit about beyond your largest customer on the security side, when you're talking about putting together both a home product selection on the security side as well as integrating heat and cold equipment. When you look at the next level down of companies or both direct dealers as well as channel partners.
What are you finding as the sweet spot for what they want? So that you can maximize to some extent maximize your scale and margin, maximize what they want at their end to satisfy their end users the most. Where are you finding that - where are you finding that compromise that mix that would be, maybe the sweet spot for growth in this company beyond the relationship with your largest - your largest buyer?
So obviously, we're really excited about the launch of our approach here security product and this product is redefining the industry with its self-contain wireless panel, it's encryption, it's sensing capability. I mean this is a true classic example of non-creepy type. So we are not listening to the customer. We're not taking video. It's a true sensing product, so that's wireless and very easy to use for the end user and very easy to install for the dealer and it's got user replacable modules.
So you don't have to do a truck roll to get that out there, which is going to save the dealer quite a bit of money going forward as technology upgrade. Now, your question around the sweet spot for us, as we roll this out to the rest of our customers and being able to integrate, not only the hardware, but the hardware with our software is going to be key for us and then being able to leverage our platform to move into other adjacencies like the GULI [ph] example that was just given.
So, we'll have the capability by the end of the year, beginning of next year. If you are using our application for security products, you're also going to be able to integrate the GULI product and see what's happening with the water in your home and we're going to be able to move into air quality as well.
So that's why we're so excited about these platforms. That's why we're accelerating these platforms is because they give us more opportunity to grow our recurring revenue as we go forward.
My follow-up is when it comes to the distribution business. Could you go into some of the other services, value-added functions that the distribution business provides beyond distribution and getting and improving the relationships that you have with the outside world. What are you doing in distribution to create a higher value proposition for that division?
There's so much focus on half of the product and solutions side of our business that we are just not enough questions about our ADI distributor business, which is half of our revenue. Look we are today, we are broadcasting from one of our ADI facilities here in Austin, Texas.
And I can tell you that I am more optimistic and positive about the distribution business than I ever had been before. I've been here for two days, I've had a chance to talk to multiple customers that have come in to buy products, it is a clear window to exactly what's happening out there with consumers and how they do it from a pro as positioning themselves to be modern, how they're positioning themselves to really drive value for the consumers.
Training is obviously one of the key things at our ADI facility. Our facilities over 200 facilities provided, two contractors when they come in. They're able to train our new products, our new technologies and how to install them quicker, how to be more efficient, they're learning how to work applications for the homeowner et cetera and that's exactly what our ADI team does.
So, so we are very obviously excited about our ADI business, it's been a solid grower for us, solid on the forecasting side and look, it is our number one touch point to the customer. We sell about 15% of product through ADI as residual products, our residual teams have to compete to get shelf space on there as well, just like everybody else, and this is a great business for us. In regards to not touching the end user and know exactly what's happening out there at any given point in time.
And ladies and gentlemen, there are no further questions. That will conclude our call for today. We thank you for your participation. You may now disconnect.