Resideo Technologies, Inc. (REZI) Earnings Call Transcript & Summary

Awesome. So good morning, everyone. Thank you for attending here. My name is Erik Woodring. I am Morgan Stanley's IT Hardware analyst here. I am pleased to welcome Tony Trunzo, CFO of Resideo Technologies, to our conference. This is the first time that we've been here together, which is awesome. You joined the company as CFO in the middle of 2020, bringing more than 30 years of experience across finance business strategy, operational leadership prior to joining Resideo, you were at a West Coast private equity firm, and so bringing a lot of experience to the transformation that we're about to discuss. So thank you for joining us today.

Thanks for having us.

Of course. So obviously, as I mentioned, first time here at TMT, maybe for the benefit of everyone on the room and people listening in, maybe if you could just give a quick intro on who Resideo is? And what you do? And then we'll dig in from there.

Sure. Absolutely. Probably known to everybody, but Resideo was a spun off from Honeywell in October of 2018, so a little more than 3 years ago. The business really is in 2 pieces. It's a products and solutions -- what we call a Products & Solutions business, which is hardware. We have a -- in that business, we have a license to the Honeywell Homes brand, which constitutes a significant amount of the revenue base at this point. The product line is thermostats and products and indoor air quality products and water products and OEM products for water heaters and for furnaces. The main distribution channels in that business are really professional channels. We have a small retail business that we just doubled with the acquisition of First Alert. But by and large, it's a professional distribution channel. And then adjacent to that, we also have a distribution business called ADI Global Distribution, which is the leading distributor of low-voltage security and other related products globally. Total revenue, just a little north of $6 billion is our outlook for this year.

Great. Great. So -- and obviously, 2021 was a successful year for you guys. Revenue grew 15%. You expanded margins to both P&S and ADI. despite a challenging, obviously, environment, both supply chain and cost perspective. So maybe just talk about what worked for you guys in 2021? What did you learn that you can kind of bring to 2022 and beyond?

Yes. So Jay Geldmacher, our CEO and I both joined in the early June time frame of 2020. And that first 6, 7 months of 2020 was really responding to COVID, stabilizing the business, building the team, getting the leadership in a position to really understand the nuts and bolts of the business, and then just really pivoting to a much more detailed execution focus. And we -- as 2021 turned, we really began to focus more on kind of what the future of the business was going to look like. And we gave 2024 outlook for a number of our operating parameters in March of last year, so right around a year ago now. I think at the time, if you would have said, hey, your supply chain issues are going to last, not 2 quarters, but 6 or 8.

Who knows.

The trajectory to some of those targets, I think, would have been a little bit different because it's been a challenge, right? And 2021 was a knife fight. Our sales teams did an outstanding job. We grew organically very well. The supply chain issues were significant impediment during the year. We added to our delinquent backlog. And frankly, it had an impact on our manufacturing operations because we didn't -- couldn't be as efficient because we wouldn't have complete kits. I think the theme of 2021 was really navigating through those supply challenges, at least from what's visible on the outside. Underneath all that, we really have been aggressively investing in R&D, trying to address some of the product and technology depth that the company had when we joined, but also looking at what the future brings in terms of a connected home and platforming from a software perspective. And to your point, we were able to deliver, I think, very good results in the context of all of that, but it is certainly -- the pandemic and the supply chain issues have certainly masked the progress that inherently, we feel like we've made in terms of the profitability of the P&S business. And I know we have limited time, so I'm just going to say about ADI. They rocked it again. They had another terrific year.

No, that's great. I'll give you 1 demand question in the near term and then we'll move on to what's more important. But the question I get from investors all the time is just how sustainable is remodeling demand, right? We're 2 years plus into the pandemic. We're lucky enough to be sitting out here today. And so is there some sort of normalization? What would be you respond and any change since we last spoke a few weeks ago? Yes.

Yes. So if you look at -- yes, there's a whole bunch of ways to measure remodeling demand, right? But if you look at the deliveries of core systems like water heaters and furnaces, they're at historically high levels. They're being sustained at that level. And every indication we have from our channel, which, by the way, one of the things we did is we built out a number of different systems so that we could better understand what was happening in terms of channel inventory and those kinds of things. Everything we're seeing from our channel and everything we're hearing from our channel partners is that it's sustainable. I think the -- I'm the CFO, I worry about interest rates, right? We worry about disruption from global events and those sorts of things, but the underlying demand seems to continue to be robust.

And then just any update on supply chain, labor challenges? Obviously, both are headwinds to you. Any insight into when those could potentially end and associated costs?

We -- so one of the things that we probably didn't act on as quickly in 2021 was price changes. We implemented -- we were pretty cautious initially in terms of responding to the increased costs with price. We did become more aggressive in the latter part of the year. And I think that's going to have a positive flow-through for 2022. But as we sit here today, we still think that we're going to be faced with those challenges through the rest of this year. I think most of you guys know this, but we don't -- most of our products don't operate on particularly leading edge semiconductor technology. They're not really modern nodes. And a lot of the investment in some of the trailing nodes is coming slower. So we're not seeing any other folks out there who are starting to see some light at the end of the tunnel. I think we're hopeful, but I can't tell you that we see that improving during 2022. And that's kind of how we crafted our outlook.

Right, right. Fair enough.

One other thing I wanted to mention, when you were talking about the sustainability of growth, I think one of the important things to keep in mind is we believe that our execution during the pandemic helped us to grow market share. We believe that we are better positioned now with our suppliers and with our customers and with our channel, in terms of relationship building and listening to those channels and responding to their needs in a way that we feel like we've been able to grow a little bit faster than the market. And I think that's important to keep in mind when you're at a global demand peak. The question is, can you grow relative to whatever is happening in the market, can you outperform that? And I feel like we're in a much better position to do that now than we were 18 months ago.

Right, right. And then maybe if we think 2 years down the line, you alluded to 2024 targets, you've guided to roughly 6% revenue CAGR starting in 2020. It implies kind of, let's call it, low to mid-single-digit annual growth over the next 3 years. What gives you the confidence that, that is really sustainable? And will the drivers -- underlying drivers perhaps be a little bit different a year from now versus last year versus 3 years from now?

I think they absolutely will be. And I think the next stage of growth drivers is innovation. It's new products. It's new services. It's -- like I said, we're dramatically closer to our customers than we were 18 months ago. We're dramatically closer to our markets. And frankly, we have a clearer vision as to what over the long term, we think those -- our role is in those markets. Very confident that we will, but we're going to have to see that part of the engine really move forward in order for us to continue to outgrow the market.

Right. So perfect transition since you guys -- you and Jay joined summer of 2020, you've made a lot of efforts to transform the company, not just from a revenue standpoint, but from a cost standpoint, from an interaction standpoint, right? We talked about the headquarters and whatnot. What being of this transformation, would you really say that we're in today?

So I think you have to sort of look at it in pieces. If you look at it from a cost standpoint, that's a continuous improvement effort. We've yanked a big chunk of cost out, as you can see. My view from where we sit today is we want to continue to grow the G&A costs slower than revenue. I think that's always an expectation. In terms of transformation of back office and that sort of stuff, we've made good progress. We have more to go. But that's going to be more around scalability and putting ourselves in a position to be a larger company without incremental costs than it is actually yanking cost out. The next piece, obviously, is the gross margin piece. And again, ADI has done a terrific job. Underneath what you're seeing, P&S has done a terrific job as well, but we have delayed some opportunities that we perceived a year or 15 months ago just because we don't want to layer more on the team right now. I mean there's opportunity for us to look more carefully at our manufacturing footprint. There's opportunity to do a more aggressive sort of value engineering, but we have limited R&D resources. And in some cases, they're focused on requalifying parts. So there are certain pieces that -- certain levers that we haven't yet pulled that I think we'll continue to pull in that respect. And I guess that's still "transformation". But in our last earnings script, Jason and I took the word transformation largely out because to me, that's just what you do when you run a business, right? It's not an event that's concluded and you continue to check the transformation box, right?

Right. So then let's talk about the investments into innovation and product development. I think that's a really exciting kind of narrative that's on the forefront of the opportunity here for Resideo. So where are you guys specifically focused? Is that newer age connected devices, is that software enhancements, is that legacy product? How do we think about where those investment dollars are going?

It's a mix. I mean, we've ramped our spending, and we're going to ramp R&D spending pretty significantly this year. A fair bit of that -- I mean, I guess, the buckets I would use is new products and product refreshes of our existing product line. The next is sort of new products and services. And I would probably emphasize services over products in that context because we do see some pretty significant opportunity there. But in order to make that work, we've got to complete some foundational platforming work in terms of software. However, our various businesses before the spin, they were separate businesses inside of Honeywell, and there was not a common cohesive platform. Once we get that done, we're going to put ourselves in a position to have, hate to say, a comprehensive, but certainly broader offering of capabilities to bring to partners in the market. And we -- the first -- there are 2 interesting things that have happened over the last month, way more than 2, but 2 of the interesting things over the last 6 minutes that I'd highlight was the deal we did with Amazon, where we're private labeling the -- their entry-level smart thermostat. There are a lot of really interesting pieces to that. Probably the biggest, though, is it's an example of the kind of -- it's an example of the lens that we see the big tech players through, right? We don't see them necessarily as competitors although they are. We don't see them necessarily as -- we see ourselves as having our own entitlement in the connected home space, where we're going to be very attractive partners to them, whether it's in the kind of thing we did with Amazon or simply being a part of the ecosystem where they've got to pull a bunch of the pieces together, which means that our development is -- our product is really business o business to consumer. It's not really a business-to-business to consumer connection. And then one other thing I want to highlight is alternate distribution channels. We have an emerging business in demand response through utilities. We have a value proposition to offer the insurance market. we have Historically been underrepresented in residential new construction, and we're aggressively pursuing that. You see new -- a number of folks at this conference are presenting with new business models like an open door. We see relationships with folks like that as a really compelling opportunity for us.

Great. Perfect. So something you alluded to earlier was breaking down the silos. I love that term because you kind of took a bunch of businesses that perhaps weren't thought of as being together and said it makes sense to bring these all together and sell these as a solution of products. So not only that, but now you have those businesses build off of your ADI Global Distribution, right? You get [ input there ] and it's almost this virtuous cycle. So what gives you the competitive advantage? Is it really a virtuous cycle that provides a competitive advantage? Is there anything else beyond that, that would make sense to keep both of these businesses kind of in house building off of each other?

Yes, yes. Let me answer that question, but I left out the second really interesting thing I wanted to highlight, which was the acquisition of First Alert. And what was -- there are a lot of really compelling reasons to do that transaction. But foundationally what it did is it gave us more connected real estate, more sensor real estate in the home. And when you talk about the whole ecosystem and you talk about the big tech players and folks like us and system OEMs, having that larger chunk of real estate in the home is a key driver. It makes us a more important partner to those folks. Now to the ADI question, these businesses were completely separate. And -- they're completely separate. Despite the fact that -- well, I'm not going to say despite, but one of the things that we observed very early on was ADI is Products & Solutions largest customer. And they were not being treated as a customer. And P&S was, if not the first, the second largest supplier, maybe top 3 supplier to ADI, and they weren't being treated that way. We were, by and large, not selling our comfort products through ADI. I can't explain why other than we started doing it and we started selling a bunch of them and making money off of it. Just the breaking down of that silo and the collaboration between Phil Theodore, who runs P&S, and Rob Aarnes, who runs ADI and their communication loop, has created substantial opportunities and brought those businesses closer together. ADI is -- they have -- one of their objectives is private label. And there -- they have some expertise in that area. P&S is bringing some expertise to bear. ADI is far ahead of P&S in terms of their digital transformation in terms of their webstore and all that kind of stuff. Our PMS business has very little web sales right now. So those kinds of things where the businesses are working together to really try to create common platforms and synergy across them is I think it's further along than probably we would have expected at this point.

And when we -- we've kind of gone through P&S, but at least on the ADI side, where are the investments into innovation going there? Obviously, there's less, I don't know, "innovation" in terms of how you described it earlier in terms of products, but there's obviously innovation that needs to get done there or that you're in the midst of. So...

Yes. And I think if you ask my kids, what my favorite word is it's kind of weird for a CFO, but it's innovation. And I think if you don't -- if your business isn't innovating in some way, shape or form, you're not long term going to be a winner. The interesting thing about ADI is, when Jay and I showed up, they were chock full of innovative ideas. They've had just been capital starved for a very long time. So I think the M&A activity is more strategic than innovative, but they knew exactly what adjacent categories they wanted to get into, they knew they wanted to get into datacom. They knew they wanted to do more in terms of the Pro and Resi AV market, and we enabled that. They knew they needed to build out a digital platform, and we enabled that. They knew that they needed a new -- they needed a new ERP system, and we've enabled that. The web experience at ADI is expanding and improving quite rapidly. In terms of product innovation, I think there where you're going to see it is in the private label. And it's around our ability to be a really effective, solid, high-margin private label player, owned-brands player while still being seen as the go-to place for the third-party brands that we've been such a supporter of for so long.

Right, right. So let's talk about the cost side. You mentioned it at the top of the conversation, just some of the challenges that, obviously, the supply chain has brought about. As we think to your operating margin targets by 2024, it's about 300 basis points of expansion. And so obviously, you're reinvesting in the business, can you maybe just walk us through what needs to get done over the next 3 years for Resideo to be there?

I think ADI just needs to continue to execute from their standpoint, right? I mean we're seeing a pretty straight line between where we started and where we want to be from a gross margin perspective. Their spending right now is elevated because of all the things that I just described and the investment that's going into that. And I think as we get to the latter part of this time frame, you're going to start to see more operating leverage in that business. For P&S, we have to get through the supply chain challenges so that we can really show kind of how far we've come. In order to continue to drive those margins, though, we've got to get into higher products -- higher-margin Products & Services. And we've got to execute against the engineering imperative that we've laid out.

Perfect. And then, again, you mentioned it earlier, First Alert acquired on -- or announced acquired on February 7, expanded your footprint in the home. How -- maybe just elaborate on why it makes so much sense for Resideo? And then just second to that, how you plan to fund that, if that results in changes to the capital structure or anything like that?

Yes, yes. It is -- I don't think this is well known, but First Alert and our security business were co-owned by Pittway back in the '90s before Pittway was bought by Honeywell. And there was actually a line of First Alert-branded security products sold by Pittway 25 years ago. The businesses are really closely aligned in terms of not just the product but in terms of what the value proposition is, right? It's security and safety in the home. And we see the opportunity to expand the connected component of First Alert as something that's exceptionally attractive. We -- this deal works from a financial perspective, simply on the opportunity to create synergies because of how closely related the businesses are. I mean we're synergy adjusted, we're going to pay 6.5x EBITDA for this business, along with the optionality of really bringing that additional home real estate into the connected ecosystem that we've talked about, same with the optionality with respect to the brand. Those 2 things have more value creation upside above and beyond just bringing 2 historically closely related businesses together from a synergy standpoint.

Beyond First Alert, how should we think about transformational acquisitions versus tuck-ins? And then how much M&A capacity that does Resideo have?

So you asked about...

Capital structure, yes.

Yes. so we did on the -- I think it was -- was it the day that Russia invaded Ukraine or pretty close there to, we did do a $200 million add-on to our Term Loan B. So we completed that, and that was designed to partially fund the First Alert deal. The rest we're going to do with cash. There's no change in our perspective on leverage and the leverage structure of the business. We still want to be at an investment-grade credit profile. S&P did upgrade us in this process. So we're now kind of in the straight BB area. Moving forward, we -- I mean, we generate several hundred million dollars a year in cash. So we certainly have -- and the business is growing from an EBITDA perspective. So we certainly have meaningful capacity. I think right now, with respect to First Alert, we're going to get to demonstrate our ability on the P&S side to integrate a deal. ADI, last year, they did a couple of their small tuck-ins. They announced another one just the other day. We've got more in that pipeline. I think that's kind of regular way stuff that they've shown the ability to do and we're going to continue to do. And then there -- as we go through this technology journey and particularly the software and sensors journey, there's a distinct possibility that you'd see things that look almost like acquihires, right? I mean they don't bring a lot of revenue. They don't necessarily bring a lot of profitability, but they bring a core central capability that it makes more sense to buy than to build internally.

Great. So now with the remaining time, if my math is right, assuming you kind of hit your revenue and the midpoint of our operating margin guidance, normalized earnings power is a bit over $3. That implies your stock is trading sub-8x normalized PE. And so I just want to give you the chance to kind of make the investment case for Resideo. What is underappreciated do you think by the market today?

So I think -- we ask investors that all the time. What is your perspective on what's impacting our valuation? Which, by the way, I'm going to struggle with today, but I have -- for my entire career as a CFO, I've never taken a position, an opinion on valuation because that's what investors get to decide. But we hear about the Honeywell overhang, right? People there -- we think that is a driver of inherent demand for the stock. We hear, you guys have done a great job over the last 18 months, but we want to see more. So we'll keep doing that. And we hear what you were asking about in terms of demand. So I think there's still -- I don't -- I think we're well beyond proven from an execution standpoint, but I still think people want to see more consistency in a few more quarters. I think that's naturally going to help. And here now, we are on another journey from an innovation standpoint. And over the next couple of quarters, we're going to start showing some progress there, too.

Super. Well, We're top of the hour. [indiscernible]

Exactly.

Thank you so much for joining us. Hopefully, we'll be here in 365 days.

Would Love to.

But thank you, everyone, for attending. I appreciate It.

Thanks, Erik.

Thanks, Tony.