(In millions, except per share amounts)
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations is intended to help you understand the results of
operations and financial condition of
Overview and Business Trends
We are a leading global manufacturer and distributor of technology-driven products and solutions that help homeowners and businesses stay connected and in control of their comfort, security, and energy use. We are a leader in the home heating, ventilation and air conditioning controls, and security markets. We have a global footprint serving commercial and residential end-markets. We manage our business operations through two operating segments, Products & Solutions and ADI Global Distribution. Our Products & Solutions segment consists of comfort, security, and residential thermal products and solutions. Our offerings include temperature and humidity control, thermal and combustion solutions, water and air solutions, as well as security panels, sensors, peripherals, wire and cable, communications devices, video cameras, awareness solutions, cloud infrastructure, installation and maintenance tools, and related software. Our ADI Global Distribution business is the leading wholesale distributor of low-voltage security products including intrusion, access control, and video products and participates significantly in the broader related markets of smart home, fire, power, audio, ProAV, networking, communications, wire and cable, and data communications. The Products & Solutions segment, consistent with our industry, has a higher gross and operating profit margin profile in comparison to the ADI Global Distribution segment.
During the fourth quarter of 2020, we made a change to our reportable segments. Previously we allocated corporate costs to the Products & Solutions segment as well as the ADI Global Distribution segment. We now report corporate costs separately, as Corporate, from the two operating segments. In addition, during the fourth quarter of 2020, our Chief Operating Decision Maker moved towards making financial decisions and allocating resources based on segment Operating profit, rather than Segment Adjusted EBITDA. These changes were designed to better align accountability and authority, give a clearer view into the operational performance of the two segments and increase accountability for management of corporate spending.
Our financial performance is influenced by several macro factors such as repair and remodeling activity, residential and non-residential construction, employment rates, and overall macro environment. The global outbreak of a novel coronavirus disease ("COVID-19") created economic disruption. Starting at the end of the first quarter of 2020, we experienced constrained supply and slowed customer demand, as well as temporary closures of several of our ADI Global Distribution branches, that adversely impacted business, results of operations and overall financial performance. Although there remains uncertainty as to the continuing implications of COVID-19, customer demand has improved and ongoing cost actions and transformation efforts contributed to the improvements in the Company's operations and overall financial performance. We continue to experience constrained supply.
Third Quarter Highlights
Net revenue increased
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Third quarter net income was
Selling, general and administrative expense for the three months ended
Research and development expense for the three months ended
We ended the third quarter with
COVID-19 Pandemic
The
Our visibility toward future performance is more limited than is typical due to the uncertainty surrounding the duration and ultimate impact of COVID-19 and its variants, and the mitigation measures that are implemented by governmental authorities. We also expect business conditions to remain challenging, with global shortages in key materials and components in certain instances impacting our ability to supply certain products. In response to these challenges, we will continue to focus on those factors that we can control: closely managing and controlling our expenses; aligning our production schedules with demand in a proactive manner as there are changes in market conditions to minimize our cash operating costs; and pursuing further improvements in the productivity and effectiveness of our manufacturing, selling, and administrative activities.
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Current Quarter Developments Senior Notes
On
On
Basis of Presentation
Our financial statements are presented on a consolidated basis (collectively,
the "Interim Financial Statements"). The Interim Financial Statements have been
prepared in accordance with accounting principles generally accepted in
Reclassification
The prior year segment information was recast to present Corporate separately as well as present segment Operating profit which replaces Segment Adjusted EBITDA. See Note 4. Segment Financial Data of Notes to Consolidated Interim Financial Statements for additional information. Certain reclassifications have been made to prior period financial statements to conform to the classification adopted in the current period.
The prior year unaudited Consolidated Interim Statements of Operations were reclassified to present Research and development expenses as a separate line item within the statements. Research and development expenses were formerly included within Selling, general and administrative expenses.
Components of Operating Results
Net Revenue
We manage our global business operations through two operating segments, Products & Solutions and ADI Global Distribution:
Products & Solutions: We generate the majority of our Product & Solutions net revenue primarily from residential end-markets. Our Products & Solutions segment includes traditional products, as well as connected products, which we define as any device with the capability to be monitored or controlled from a remote location by an end-user or service provider. Our products are sold through a network of HVAC, plumbing, security, and electrical distributors including our ADI Global Distribution business, OEMs, and service providers such as HVAC contractors, security dealers, and plumbers. We also sell some products via retail and online channels.
ADI Global Distribution: We generate revenue through the distribution of low-voltage electronic and security products, as well as smart home, fire, power, audio and ProAV, networking, communications, wire and cable, and data communications that are delivered through a comprehensive network of professional contractors, distributors and OEMs, as well as major retailers and online merchants. In addition to our own security products, ADI Global Distribution distributes products from industry-leading manufacturers and also carries a line of private label products. We sell these products to contractors that service non-residential and residential end-users. 14% of ADI Global Distribution's net revenue is supplied by our Products & Solutions segment. Management estimates that in 2020 and 2021 approximately two-thirds of ADI Global Distribution's net revenue was attributed to non-residential end markets and one-third to residential end markets.
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Cost of Goods Sold
Products & Solutions: Cost of goods sold includes costs associated with raw materials, assembly, shipping and handling of those products? costs of personnel-related expenses, including pension benefits, and equipment associated with manufacturing support, logistics and quality assurance, non-research and development engineering costs, and costs of certain intangible assets.
ADI Global Distribution: Cost of goods sold consists primarily of inventory-related costs and includes labor and personnel-related expenses.
Selling, General and Administrative Expense
Selling, general and administrative expense includes trademark royalty expenses, sales incentives and commissions, professional fees, legal fees, promotional and advertising expenses, personnel-related expenses, including stock compensation expense and pension benefits, and research and development expenses.
Other Expense, Net
Other expense, net consists primarily of Reimbursement Agreement expenses for certain Honeywell environmental liability payments. For further information see the "Reimbursement Agreement" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 12. Commitments and Contingencies of Notes to Interim Financial Statements of this Form 10-Q. Other expense, net also includes debt extinguishment costs incurred as a result of the Senior Notes due 2026 redemption and the execution of the A&R Credit Agreement as well as foreign exchange gains and losses and other non-operating related expense or income.
Interest Expense
Interest expense consists of interest on our short and long-term obligations, including our senior notes, term credit facilities, revolving credit facilities, and any realized gains or losses from our interest rate swaps. Interest expense on our obligations includes contractual interest, amortization of the debt discount, and amortization of deferred financing costs.
Tax Expense
Provision for income taxes includes both domestic and foreign income taxes at
the applicable statutory tax rates, adjusted for
Results of Operations
The following table sets forth our selected unaudited consolidated interim statements of operations for the periods presented:
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