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

Hello, everyone. I'm going to give a brief overview of Resideo Technologies. Forward-looking statements. So Resideo is -- operates in two product segments: a products business and a distribution business. The thing that really ties the two together is the fact that we serve the professional -- the contractor community. So you can see here, $5.8 billion of revenue last year, $560 million of operating profit and over $300 million of operating cash flow. As we go through the presentation, I'll get into a little more detail on the two separate businesses. If you think about kind of what are the things that help differentiate Resideo out in the market, we really believe we have an unmatched presence within the home. Our products are present in over 150 million homes globally. We also are the leading distributor of low-voltage security products. So this means that we attach to a very high number of products out in the market. That relationship with the pro is extremely unique. Many of the professionals that we work with have been working with us for decades plus. We go to market under three kind of primary brands: ADI on the distribution side; and then on the products side of the business, the Honeywell Home brand, which is part of a licensing agreement we have with Honeywell coming from the spin in late 2018 as well as the First Alert brand, which is related to the business -- First Alert that we acquired back in the beginning of this year. We really are a trusted partner to the professional contractor. We go to market with a very broad set of products and have a really long-standing history of serving that professional with highly reliable, highly innovative products. I'll start with a little bit about the products business. As you see here, we serve kind of four main product categories. The two largest are the air and the security and safety markets. Within air, that's where we sell our thermostats, which I think is generally what we're best known for. We also go to market in things of indoor air quality, humidification, dehumidification products as well as zoning. In safety and security, this is where the First Alert business resides as well as our traditional kind of residential intrusion business, and this is hardware products servicing the professionally monitored security market. Water products is the smallest of the four product segments. This is things like water leak detection, backflow protection, shutoff valves. The energy product category is primarily an OEM business. We sell components into larger OEMs kind of servicing the markets -- furnace market, water heaters, boilers. We are one of the leading providers of controls and combustion systems that go into these types of products for larger OEMs. These products give us exposure to a number of attractive structural trends out in the market. Connectivity within the home is something that we are seeing increasingly more of. You think about the advent of smart thermostats where we're a leading player in that market. Water leak detection, indoor air quality, even the security market is increasingly seeing more connectivity. Home energy management and savings. And so this is related to things like demand response offerings. You think about the utilities trying to do more here in the U.S. to manage the power needs and manage their grids. A lot of that is done today through being able to control the HVAC systems within the home and the thermostat being the primary mechanism or vehicle into that, and we're the leading player in the thermostat market. The residential and commercial life safety. You're seeing an increasing focus here, particularly domestically on security and personal well-being. And that, we believe, is a structural trend that you will continue to see over the coming years. And then more broadly, just around energy transitions out in the market, certainly, it's a trend that you're seeing kind of in place in Europe now as they're thinking about how do they get away from utilizing and dependency on things like natural gas and move to things like hydrogen, looking to things that are more kind of energy efficient. Our controls and combustion systems have a large role to play in these kind of what we expect will be major energy transitions over the years. So from a go-to-market perspective, as I said before, we're highly focused on the professional contractor. The channels that -- where we go to market are through distributors and, again, servicing the pro directly, our partnerships with larger OEMs out in the market. We work with utilities and insurance companies. And again, this is an example in the demand response market where we'll partner with utilities to go to market to help enable those solutions. The retail in the DIY market has historically been a smaller portion of our business with the acquisition of First Alert. We definitely have added some scale to that retail presence, although what we see with our traditional products really is still servicing the professional contractor through the retail channel more than selling directly to individuals. We also do work with the larger homebuilders. New construction is about 20% of the products business, and we have relationships with a number of the larger homebuilders. Moving to the distribution business. So ADI, as I said before, is the leading distributor of low-voltage security products. This is a very traditional kind of industrial distribution type of business. It's a branch-based network, 190-plus locations, U.S. and EMEA focused, very large selection of products available. It's a business that has seen very steady and consistent growth over the past decade plus, and it's really an execution machine. Today, about 70% of ADI's business is focused around physical security products, and these are things like video surveillance, CCTV, commercial fire products, commercial access and building control. As the business has looked to new and adjacent markets, increasingly, they've built up their presence in the audiovisual market, both the professional and the residential side as well as the data communications market. As you can see here, predominantly a North American business with some presence in EMEA, we actually just recently sold our small business in India. So solely focused on the U.S. -- on the Americas, sorry, and EMEA today. Increasingly, one of the things that we've seen in this market is a desire for customers to transact digitally with the business, so we've put a lot of investment into our e-commerce channel. E-commerce is now 17%, 18% of the sales in this business. Total touchless sales. So if you think about things that utilize e-mail order entry, EDI and e-commerce are now over 35% of the of the business. And what this really does is this enables the salespeople, which are the lifeblood of the business. It frees them up to be able to do more value-add and consultative selling by taking some of that just transactional business out of their hands. As we look at kind of some of the key focus areas for the business, I kind of touched on e-commerce here a little bit. And both with the investment in the website as well as just expanding the different channels in which people are able to interact with ADI to ensure we're kind of where the customer wants us to be through acquisitions. And through some organic investment, we have looked at category expansion, and that's been predominantly in the AV and data communications side of the market. Also looking to kind of expand the area that we're able to serve. A lot of that has been done through investment in inside sales and telesales organizations to where it doesn't make sense necessarily to have a branch, but we find that there's kind of underserved areas of the community. And we've seen very high return on investment in that area. And then at the end of the day, whether it's the e-commerce investment or the direct investment in kind of some of that sales support organization, really, a lot of the focus here is improving the effectiveness of the sales force, giving them better information, more data to be able to have that really value-added interaction with the customers where they can really kind of differentiate that customer experience relative to other competitors out in the market. So a little bit on the financial trends for the business, focused here on the third quarter. It was a mixed quarter for the business. ADI continued to see strong results in the products business, did see some pressure on the demand side of things. It was not broad-based. I think we -- the key air products category continued to see solid momentum in the business. We did see more pressure on the security in some of the energy markets. Continued strong management on the cost side. If you exclude the additional OpEx from First Alert, the core investment in the business is really flat year-over-year. And a lot of the focus of kind of the current management team that's come in has been trying to make sure that we're controlling the controllable costs, controlling the corporate spend, investing efficiently and new things around innovation and R&D. More specifics on the product side of the business. Again, revenue in the third quarter grew 12% year-over-year. This was largely driven by the First Alert acquisition. We did see volumes in the business decline. We continued to see strong price realization. That price realization is helping to offset the meaningful kind of inflation that we are seeing in the market and continue to see largely from a materials standpoint. And that inflation from a gross margin perspective has had an impact on -- while we're covering our dollar inflationary cost, it has had an impact on the overall gross margin of the business. Again, operating expenses here, flat year-over-year, excluding the additional cost from the First Alert acquisition. ADI had another solid quarter. Revenues were up 5% year-over-year. This is -- as was noted before, this is about a 2/3 commercial, 1/3 residential business. We have seen healthier trends and continue to see healthier trends in the commercial market. We saw good growth in the quarter in the core categories, video, fire and access control. The business continues to expand what it's doing in e-commerce, also in private brands, which has been an important part of the margin expansion and the strong kind of progress that this business has made on the gross margin side over the last several quarters. So a little bit on cap structure. As you can see here, net debt is around $1.2 billion. A pretty significant effort made in late 2020 and early '21 to do a restructuring of the balance sheet and the capital structure. And I think we feel very comfortable with the position that we're in here. You can see the current ratings from both Moody's and S&P. A little more detail on the specific debt that we have outstanding. So you can see no maturities before 2028. About half of our Term Loan B is currently swapped out. So feel pretty good about where we sit from that perspective and, certainly, with the notes that we issued last year as well. We don't have any specific leverage targets out there today. I mean what we've stated in the past is we're kind of looking to operate the business within an investment grade envelope, and we think we're very -- in a very good and a very comfortable capital structure position today. A little bit on capital allocation and investment priorities. As we've stated before, investment back in the business, both through inorganic and organic investment. Fairly low capital-intensive business. We expect to spend about $70 million on CapEx this year. I think as we move forward and we look at some projects around automation in some of our factories, I think there's some opportunity for some good high-return investments there. But generally speaking, a fairly low capital-intensity business. We have had a focus on looking at doing value-creative M&A. Done some smaller deals within ADI, again, adding to the Pro AV and the DataCom adjacent markets. We completed the First Alert transaction in the products business earlier this year, which was a more sizable transaction. And really, the kind of the focus there is on the integration of that business into the core of P&S. And I think what we would be looking to do more in the near term is probably look at more tuck-in technology, acquihire-type things on the product side, while we work on integrating First Alert. Published our initial and inaugural ESG report, actually, about a month ago. The team is very proud about the work that's kind of happened here. I think Resideo has a very good story to tell around this given the kind of energy efficiency and energy savings that are brought about inherently in a lot of the products that we offer out into the market. Like with many things in this nature, we're certainly on a journey here, and I think we're in the earlier stages of our journey, but proud to have this out there and the work that the team has done around this. And just the inherent benefit that comes with a number of our products. So wrap things up. Again, as we kind of started here, I think the business is positioned fairly well. Some very attractive kind of secular growth trends around connected home, energy management and, more broadly speaking, security and life safety. That core differentiation of that unmatched relationship that we have with the professional contractor and with the professional channel and the history that exists there, I think, it offers a real meaningful competitive advantage out in the market. Most of the products that we go to market, too, we are in a leading position. And I think that breadth and the leadership in that product portfolio also positions us quite uniquely out in the market to take advantage of the structural trends that I kind of mentioned before. As it relates to kind of adding value through M&A, I think we see opportunity to continue to augment the portfolio with thoughtful value-creative M&A, enhancing positions in the core markets where we're already participating in, looking thoughtfully at adjacent areas to add to. And we think a very compelling financial model over the long term with the ability to grow the top line, have margin expansion as well as strong free cash flow generation that's fairly -- we believe, fairly inherent in this business. With that, I will stop, and thank you, everyone, for listening.