At this time, I'd like to welcome everyone to the Resideo Technologies third quarter 2018 earnings conference call. Today's call is being recorded. All participants will be in a listen-only mode until the formal question and answer portion of the call. If anyone should require operator assistance during the call, please press star zero on your telephone keypad. I would now like to introduce Mr. Dean Acosta, Chief Communications Officer of Resideo. Mr. Acosta, you may now begin.
Good morning, everyone, and welcome to the Resideo Q3 earnings call. I'm Dean Acosta, Chief Communications Officer for Resideo. With me today is President and CEO of Resideo, Mike Nefkins, and Resideo Executive Vice President and Chief Financial Officer, Joe Ragan. You can find a copy of our third quarter earnings release and presentation materials on the investor relations page of 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 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. You can find more details in our 10-Q, which we filed with the SEC yesterday, as well as our other company filings. With that, I'd like to turn it over to our President and CEO, Mike Nefkens.
Great, and thank you, Dean, and it's great to be here with you today. I'm going to start on the presentation here on page two, and I'd just like to start by saying good morning, everyone, and I really appreciate you joining on today's call. It's been a special few weeks for Resideo. We've completed our spin-off from Honeywell, and we began trading as Resideo on the New York Stock Exchange. It's been great to meet with so many investors and other stakeholders over the past few months, both before and after our listing. We're inspired by the ongoing support and optimism of our customers and suppliers, many of whom were able to celebrate with us as we rang the bell on the New York Stock Exchange.
While certain of our financial results have already been released to the market through Honeywell's recent earnings as part of their broader segment disclosure, today allows us the opportunity to provide more detail to all of you. Since this is our first earnings call, Joe and I are going to take you through our third quarter financial results. I'm also going to provide an overview of our business to ground those who may be new to the Resideo story. We started trading on October 29th, and we're hitting the ground running on the next phase of Resideo's growth strategy. We start off with a strong liquidity position, and we're focused on continuing our consistent performance moving forward as a standalone company. We delivered a solid third quarter across key metrics, Joe will dive deeper into the numbers in just a bit.
At a high level, I want to call attention to our Q3 revenue growth, 4% year-over-year net of currency and 5% organic growth. As many of you have already heard from Honeywell on their Q3 earnings call, we experienced some spin-related supply chain issues that temporarily increased our backlog and additional spin-related costs that negatively impacted our revenue and EBITDA for the quarter. We are actively addressing these supply chain issues, we're already seeing product flows moving back towards normal volumes. With the spin behind us, operationally our team is focused and back on track. While we executed on the final phase of our spin, we also garnered some key wins and continued to develop our product pipeline. As many of you know, we have two segments in the company, a product segment and a distribution segment.
Finally, we're excited about the momentum our business is showing, and we're reaffirming our guidance for full year 2018 and outlook for 2019. We expect our full year 2018 results at the high end of the range. Our performance as part of Honeywell over the past three years demonstrates a well-run business that is on track to deliver continued growth in 2018 and beyond. We're excited about our future and focused on continued growth and innovation to create value for our customers and shareholders. Now I want to jump in on page three and talk a bit about the business. For those of you who are new to the Resideo story, let me back up for a couple minutes here and go through that. We're simplifying the smart home experience as a leading global provider of critical residential comfort and security solutions.
We're in 150 million homes, we install about 15 million products and solutions a year through retrofit and new installs. We do this through our network of 100,000 contractors in our global workforce of about 14,500 employees. When we talk about the customers we serve, we include the more than 100,000 contractors from both sides of our business. We have a long-standing relationship with these professional contractors, I like to call them the do it for me channel, which gives us a solid position in the marketplace. It's a critical component in helping consumers upgrade to a home that is more efficient, safer, and easier to control. When you break it down, we're a well-established business with a very mature channel to market. As I mentioned earlier, our business is broken into two segments, products and distribution.
On the product side, we market under the trusted Honeywell Home trademark through a 40-year license. Every connected item we bring has software or firmware as part of the offering. You'll hear me refer to products and software. ADI is our second segment, ADI is the leading global distributor of low voltage security products. We have over 200 ADI stocking locations, all focused on supporting the connected home security contractor. Our two segments break down on the revenue side into approximately a 50/50 split. I want to spend a moment now going a little deeper on the end-to-end experiences with our products, and this would be on slide four. When you look at our products, we look at it in a couple of categories. We have 3,000 active products for the home.
Those cover the exterior, behind the wall, in front of the wall, and in the cloud. First, let's take a look at the exterior of the home. Our products for the exterior of the home include exterior cameras, outdoor video, motion detectors, and motion viewers. Moving inside the home, we're supporting homeowners behind the wall with things like heating controls, furnace and boiler units, hot water controls, humidification, dehumidification, water filtration, water leak detection, and freeze detection. We talk about on the wall, which would be the more traditional thermostats, security panels, motion viewers, sound detection, glass break detection, et cetera. We have an established and growing business in the cloud where we have our mobile applications. That's how we look at our product set. On the bottom right, you can see our ADI Global Distribution.
We sell our products direct to OEMs, and we sell them through distributors, but we also have our own global security distributor, which we call ADI. That gives us a real high touch point to our customers. These are very technical sales with product knowledge sharing. Because our business is so high touch, we're able to create winning solutions for the do-it-for-me channel together with our customers. We have one of the broadest portfolios of anybody in the sector, and I think that's a key aspect of what sets us apart. Other technology companies come out with a single product, and they think that their one product is going to be the control point in the home. We don't think it goes that way. They don't have the channel.
They don't have a way to get to the customers, and they don't have product solutions or connectivity that sits behind the wall, which is really the core of any smart home. That's what makes us different. With that broader introduction to our business, I'd like to move on to slide five now, and I want to talk for a couple of minutes about some recent business development activity. We've had a number of key customer wins and made progress towards distributing new products in our pipeline. I'll highlight a couple of them for you right now. We're excited about our new agreements with several leading security dealers. They're going to carry our next generation professional residential security platform. We're continuing to expand our partnerships with ScottishPower, Innogy, Crius Energy, and Chamberlain, are all the ones I'm going to particularly highlight here. We're working with ScottishPower.
They're a major utility in Scotland and a subsidiary of Iberdrola. We're providing them with connected thermostats and software services that deliver comfort and energy efficiency to their customers. We're also partnering with Innogy, a Slovakian utility, to offer dual-branded security products to their consumers through a lease program. With Crius, we're offering Honeywell Home connected thermostats through their demand response program, which helps homeowners save money and energy. In August, Chamberlain announced the integration of its Chamberlain and LiftMaster garage doors with our Total Connect 2.0 app. On the distribution side, we're proud that ADI was named the 2018 Distributor of the Year from Axis Communications, which is one of the world's largest security products manufacturers. These are all just a couple of notable examples of what we mean when we say the business is showing momentum and we're excited about the future.
With that, I'd like to turn the call over to Joe to walk you through our financials.
Thanks, Mike, and good morning, everyone. I'd like to start on the next slide six. I'll walk you through our numbers, first for the quarter, and then I'll make some comments about our performance year-to-date, which we think is also helpful in framing some of the broader trends in our business, especially given this is our first public earnings call. Starting with third quarter performance on a consolidated basis, we reported net sales of $1.2 billion, up 4%, and up 5% on a constant currency basis, which we refer to as organic growth. Adjusted EBITDA for the quarter was $117 million, representing a 3% decrease from the prior year, or $152 million excluding payments under the environmental indemnity, also a 3% decrease from the prior year.
As Mike mentioned at the beginning of the call, the supply chain issues drove downward pressure on our EBITDA as well as other spin-related costs. I will address this in more detail when I discuss segment-level results. At a high level, without these issues, pro forma adjusted EBITDA would have grown both year-over-year and sequentially. I'll address the environmental indemnity, and we have a slide on this in the appendix, but the environmental reimbursement is in our release, 10-Q, and all our slides, and it's capped at $140 million with respect to any year. It's a 25-year arrangement, and we've modeled that into all of our numbers. Adjusted net income was $88 million, up 42%. On slide seven, looking at our numbers year-to-date, sales are at $3.56 billion, up 8%.
Adjusted EBITDA was $361 million, up 19% over the prior year, and $466 million excluding the environmental indemnity, up 14% due to our strong first half performance. Adjusted net income was $265 million, up 80% year-over-year, reflecting changes in U.S. tax laws. On slide eight, if we take a closer look at segment performance overall, you'll see an almost even split between the products and distribution side. On the product side, we experienced modest external sales growth for the quarter. When factoring in intercompany sales, total sales were down modestly for the quarter. Short term, spin-related supply chain challenges negatively impacted our performance. Profit for the product segment was up 2% and 21% year-to-date. The product segment has been a steady performer from a revenue perspective.
It has continued to grow steadily, although at a lower rate than the distribution segment, and at the same time has been a strong contributor from a profit and margin perspective. On the distribution side, Q3 continued to show strong sales growth of 6%. Profit from the distribution segment was up 3% in the quarter and 11% year-to-date. On slide nine, from a balance sheet and liquidity perspective, we're in a strong position. While not technically part of our third quarter, but publicly disclosed in our 10-Q, we went to the debt markets in early October and secured an additional $1.2 billion in financing, which includes $825 million of secured debt and $400 million of senior unsecured notes.
Since the spin date, we have drawn $135 million on our secured revolving credit facility to facilitate the repositioning of cash post-spin, which was used in a distribution to Honeywell as part of the spin-off. We have been given a BB+ credit rating from S&P. Before I move on and talk a little bit more about how we see Q4 and ahead to 2019, I think it's important to give you an overview of how we think about capital allocation and what our priorities are there. We have proven our ability to generate steady organic growth, historically mid-single digits, and we will continue to invest in our business to drive organic growth in the future. Longer term, we're targeting a debt to adjusted EBITDA ratio of 2 times with existing cash flows as a near-term tool to start to de-lever.
From a return on capital standpoint, we are planning to consider a modest dividend subject to board approval, which could be introduced in 2019. From an M&A perspective, we will focus on select opportunities that would provide access to new technologies, IP development, or open up new markets or geographies for us. On slide 10, looking at our full year expectations, we are reaffirming our guidance. We're expecting our results for the full year 2018 to be at the high end of the range. We expect net sales between $4.77 billion and $4.83 billion, adjusted EBITDA between $605 million and $615 million, and adjusted EBITDA minus the indemnity of between $465 million and $475 million.
We see strong drivers for demand, which we expect to continue from the growing demand for and adaptation of smart and connected devices, combined with the growing need for expertise to really help people make sense of these technologies and access them more easily. Our business is performing well, and we expect the powerful combination of scale, steady growth, and market position will give us margin expansion and significant equity valuation uplift going forward. Looking ahead at 2019, we also reiterated our expectations for next year. 4% organic revenue growth, adjusted EBITDA margin of 13% or 10% after the environmental indemnity payment to Honeywell. R&D expense of approximately $125 million. As I mentioned earlier, we are planning to consider a modest dividend in 2019 subject to board approval. With that, I'm going to turn it back to Mike to close out before we open the call to Q&A.
Great, Joe. Thank you. I just want to close out here on slide 12. There are a few points here that I just want to summarize as key takeaways from today's call. First is Resideo has a winning track record with size, scale, and a loyal customer base. We have leading positions integrating and running the most critical systems in the home. We're well-capitalized for growth and focused on de-leveraging over time. We're always focused on creating shareholder value and expect with our strong cash flow and liquidity profile that we'll be able to return more value to shareholders over time, potentially through a modest dividend pending board approval. Overall, I hope you come away from this call with a strong sense for our top line and profitability growth.
As I shared earlier, we're reaffirming our guidance for full year 2018 at the high end of the range and reaffirming our outlook for 2019. Again, thank you for joining our first earnings call today. It's an exciting time for us all here at Resideo. With that, I'd like to turn it over to the operator to open up the line for questions, please.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one to ask a question, and we will take our first question from Ian Zaffino from Oppenheimer. Please go ahead.
Great. Good morning, guys. This is Mark on for Ian. Thanks for taking our questions.
Good morning.
Just to start off, can you guys provide any additional insight on the 1% growth you saw in products this quarter? Maybe if you could give a breakout of how much of the growth was really impacted by spin-related supply chain noise during the quarter. Going forward, what do you view as a normalized growth rate, and how quickly can you get there? Thanks.
Yeah. Great, Mark. Thanks for the question. I'll talk a little bit about the spin-related supply chain issues that we put out there because it did affect us in Q3 as expected. I talked about these at Investor Day. Typically, what they are are items. I'll just give you a really good example. Most of them, believe it or not, are administrative items. We had an example of customs-related issues where paperwork comes in under the Honeywell name. A product needs to actually come out under the Resideo name. Took a couple of days to do that. We also have some plant shifts that we're making in Europe as a result of the spin. These are just items that we knew were in front of us. We planned for it. In Q4, I can tell you right now, we're already seeing volumes coming back to normal.
I've told the team, we're still looking out. There's still a few things we got to make sure come through before we get clean. I would tell you we're still seeing a few of those headwinds here in Q4 as expected. We'll be fully back and running here by Q1. Again, the reason that we were able to affirm our guidance at the top end of the range is because we're already working through these items. We're very comfortable that we're on the other side of it now.
Okay. Terrific. That's great. Full power by beginning of 2019.
That's correct.
Okay. Great. Just a quick follow-up. Taking a step back and looking at the larger picture, can you speak to sort of the macro drivers behind the business, particularly with Resideo's correlation to housing versus renovation and repairs, how the current state of the market can potentially impact your outlook for the balance of 2018 and going to 2019? Thanks.
Great. Thanks, Mark. That's a great question, and I get that a lot. First, if you take a look at our financials and you take a look at our revenue, less than 20% of our revenue actually focuses on new homes. We have a natural hedge there. We have done some math on that, where we have done an estimate where for every 100,000 home shifts up or down in new home starts, our estimate is it affects our EBITDA close to about $7 million. You can see that we are not highly correlated to new home starts. It's not a big item for us. For us, we look much more at renovation and remodeling.
One of the best items I think that I've seen yet came out yesterday in Home Depot's announcements, where Home Depot came out and said that they're seeing consumers continuing to spend on their homes. One of the other items I saw was one of the best macro correlators that we have out there really is the unemployment rate. When you look at a low unemployment rate, consumers feel confident, and they continue to invest in their homes, and we're seeing that. That's kind of how we see both new home starts as well as a continued strong consumer spending into the home space, which is good for us.
Okay, great. Thanks for all the insight, guys. Look forward to 2019.
Yep. Thanks, Mark and Ian. Appreciate it.
Once again, that is star one to ask a question. We will take our next question from Nigel Coe from Wolfe Research. Please go ahead.
Morning, Mike and Joe. This is Christian for Nigel.
Morning, Christian.
Hi, Christian.
Congrats on the spin and on your first quarter earnings call. Just had a few questions here. Just on the incrementals for distribution, can you just maybe talk about it a little bit in detail? They seem a little light relative to what our expectation was.
You said on distribution?
Correct.
If you take a look at the growth numbers on distribution, they definitely were in the lead here. The distribution number was 6% or 7% revenue growth, which was what we expected. Part of Resideo products where we had some of the supply chain issues also goes through distribution. Distribution was really not affected by that, and we were very comfortable with the 6% and 7%. One of the things that we've got to look at is we did have in the first half of the year, due to some of the devastating storms out there, we did have higher volumes in Q1 and Q2. 6% growth, 6%, 7% growth in distribution for the quarter, we were actually very comfortable with.
Got it, Mike. Thanks. Just on CapEx, you guys highlight that there's some spin-related CapEx not included in the guide. Can you just kind of quantify those? That number and what that entails? Thanks.
Sure. We do have, Christian, and we've talked about some one-time costs related to the spend in CapEx. The one-time costs overall in year one are estimated to be approximately $80 million. Year two, 2020, would be about $60 million. A lot of that is related to IT conversions and of course, we have branding changes to make in the factories, in the buildings, et cetera. That's our most recent estimate. The $55 million approximate cash CapEx is to primarily support the 18 manufacturing facilities we have. Some of that is for distribution, and $10 million of that is capitalized software development.
Got it, Joe. Thanks for the answers. Good. Back in queue.
Thanks for that.
We will take our next question from Fritz Lu from Allianz Global Investors . Please go ahead.
Hi. Good morning, guys. I got a question for you, it's really basically on page 16 and 19 of the presentation, where you have basically adjusted and pro forma adjusted EBITDA.
Okay.
Your EBITDA guidance, basically mid-range after the $140 payment to Honeywell is $470. If I look at your nine-month adjusted pro forma EBITDA of $340, it kind of implies a very high fourth quarter number of about $130. Is that what you're predicting, or is the $470 a non-pro forma adjusted EBITDA guidance?
Yeah. Fritz, thanks for the question. I'd just like to say thank you to everyone who read all of the tables that we prepared, and I'm sorry for that. There's a lot in this period of time where we have to continue to reconcile. We are talking about pro forma adjusted EBITDA, and we are guiding to the high end of the range. The range was $465-$475. We are actually saying more than $470, Fritz.
Okay.
That does imply very good performance in the fourth quarter, and we are reaffirming that guidance.
Okay, thank you. Next year, in 2019, you actually expect a drastic drop in CapEx to 1% of sales from-
Well-
It's running around, I think it was 3% in the third quarter?
Yeah, that number actually has some accruals in it that is not cash CapEx. Remember, that's really part of our legacy Honeywell reporting. The cash CapEx number is about $55 million, and that's what we'll maintain going forward, which is, you're correct, about 1%.
$55 a year. Okay. Thank you.
Thank you.
That's it for me. Thanks, guys.
Once again, if you would like to ask a question, please signal by pressing star one. We have a follow-up from Nigel Coe from Wolfe Research. Please go ahead.
Hey, guys. Christian here again. Just wanted to talk about pricing. It's been accelerating over the last three quarters. Just kind of talk through, is that a function of, is it mix? Is it higher selling pricing? I guess, what's the customer response on the back of that? Thanks.
Yeah, look, on pricing, we've had very positive so far experience with pricing, especially in our HVAC business. We've been able to pass through pricing to our customers to offset any inflation. We've had no issues there. We've been able to get pricing both in our HVAC business and in our distribution business. No issues there whatsoever.
Got it. Thanks. Do you anticipate that this would continue into next year?
I think so. Look, I've asked the same questions, Christian, as well with my team, really dug into pricing. The team is good at getting pricing where we need it. I don't see a change in that trend whatsoever. We've had at least the three years that I've been able to really go deep into the numbers. We've had no issues whatsoever with pricing.
That's helpful. Thank you.
Yep.
We have another question from Arno Adler with NGen Investments. Please go ahead.
Hi. Can you hear me?
Yeah. Hey, Arno. Here you are. Good morning.
Hi. You guys talk about all these connected customers and I guess all the sensor points you have. Can you talk about some application that you can envision in the future that maybe has not been a focus in the past, but you can envision playing a bigger role in the future?
I'll highlight two of them that we're really excited about. One of the things that we really push, we are an IoT company. We focus heavily on sensing, on motion detection, on also advanced analytics in our cameras. That is a focus area of us. We focus heavily now on new use cases. What we don't do is we don't just put a single product out there without knowing exactly what problem it's going to solve. Two examples of those that I really like, the most basic one is leak detection.
I talk a lot about we really are not just a B2C company, we're also a B2B company, where we sell to other businesses. A great example of that is into the insurance industry. We now have a leak detection pilot going on with one of the large insurance companies, 40,000 leak detectors out there. What we're trying to solve is high claims for water damage in homes. The use case here is to save the insurance company money on having to pay out claims, but also save the homeowner from having destruction in their house due to water leakage behind the walls. This is leakage that you typically don't see. That's a great example. The other that I talk about a lot is things like swimming pool security. We have all of the products out there to be able to solve that problem, right?
You read every year about toddlers dying in swimming pools, whether it be your own, whether it be a neighbor's pool or what. If you take a look at a combination of our sensors that can measure splashes, sound, that can measure water ripples, and our cameras that can tell the difference between an animal, a child, and an adult, and the way that we can connect an alert to the home and light up the lights in the home and turn on the security system, even if it's not armed, to alert police, fire department, neighbors, et cetera, that there's an issue near the pool. Those are the kind of use cases that we're out solving, you need to have the scale, you need to have the products, you also need to have some very good partners behind you, we have that.
Those are the kind of things. We have about 20 use cases right now that our R&D teams are working on, we're really excited to get those out to market.
Thank you.
With no further questions, I would like to turn the call back to Mike Nefkins for closing remarks.
Yeah. Great, guys. Hey, listen, I just want to thank everybody for number one the great questions that we've had over the weeks going into this. This is our first earnings call, so I appreciate, I think we had over 100 people on the call, is what the team is telling me here, which is a great showing. We appreciate the great questions on this call, and we're looking forward to the next one. Everyone have a great day, and we'll see you next time.
Thank you for your participation. This concludes the Resideo Technologies Third Quarter 2018 Earnings Conference Call. You may now disconnect.