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

Awesome. So let's get started. For those of you that don't know me, my name is Erik Woodring. I lead the hardware research efforts here at Morgan Stanley. Before we introduce our guests, let me just read -- actually, I have in front of me here. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So joining us for a second year in a row, Tony Trunzo, CFO of Resideo Technologies. Welcome to our conference. Great to have you here. Hope you're feeling okay. But thank you for having us here -- thank you for being here, I should say.

Glad to be here. Appreciate the invitation as always.

So why don't we start with a bit of a look back. You reported earnings a few weeks ago, 2022 is kind of like a bit of the tale of two halves. And so maybe just break down, talk about the demand environment today, kind of commercial versus residential, however you'd like to break it down, what you're hearing from customers, and then we'll go from there.

Yes. So you're right. I mean, '22 was definitely a tale of two halves. We started off really strong, had a great first half of the year. Sort of middle of the third quarter is when we really started to see destocking activity in our channel accelerate, resulted in our Q3 results, which were short of what we had expected. In Q4, we guided a Q4 that was short of what we had expected at the time. The interesting thing about it is this really -- the experience of the last few months really has been a destocking dynamic. It hasn't been a dollars at point of sale. There's a decline in volumes, but the price actions over the last couple of years have more than offset that at the point of sale. So you're seeing -- you're still seeing growth at point of sale. But I mean interest rates -- money actually isn't free anymore, right? And clearly, there's been a response in markets around that, and people have gotten more cautious, and the cost of carrying inventory has gotten to be higher, and I think people didn't want to be caught out. So there was definitely a pretty clear effort to try to bring down inventory in days. And we see from our trade partners, we see there -- we get a monthly report where we see where their inventory is versus where it was, both in terms of dollars and days. And they share with us what their desired inventory levels are as well. And what we've seen historically is they typically don't get to that desired level, even when they're going through a cycle like this. So there's a little bit of reading tea leaves, all of this. What we said on our call a few weeks ago is we see the destocking dynamic really kind of abating and troughing the latter part of this quarter, maybe the first part of the second quarter. I think it's really important to understand from the Resideo-specific point of view, when we look at the data that's available to us, in virtually every category, we're either stable or gaining share. We've added OEMs. We appear to be gaining share at retail. So our -- I can't eat relative performance, I guess. But our relative performance, I think has been good. And when we gave our outlook for 2023, one of the comments we made was this is a year where we're going to have -- there are going to be cyclical challenges, particularly in the first part of the year. We don't think that changes any of the secular dynamics and secular opportunities for us in the residential market. They're still not building enough houses. There's still -- the level of demand in the home is still significant. And we've got a lot of momentum in the business. So from that standpoint, we feel good. But we took the actions that we took in Q3 -- I'm sorry, Q4 and in Q1 in terms of taking costs out of the business really to try to protect the profitability in the short term without overexposing ourselves to compromising any long-term growth. We don't think we've done that at all. But we took the actions we took because relative to the typical dynamic, it's a little tougher for us to be -- to see where the revenue is going to play out for the year, but we do have levers we can pull to drive operating income, and that's why we did what we did.

Okay. Perfect. So I guess if we look beyond the near term, would you say -- and you touched on this, but would you say anything as kind of structurally changed about your end markets or opportunities because of the pandemic, right? Like so I think a lot of the discussion about the pandemic is like how much demand was pulled forward and all of that. I kind of want to reverse that and say, if we think longer term, were there opportunities or new opportunities that were created because of the pandemic for you guys?

I think the world has changed through the pandemic at the margin in favor of a company like Resideo because look, now there isn't -- I don't think there are many more cards to play about what the world is going to look like "post pandemic." We're far enough out. And in our company, the number of hours worked from home and the number of people working from home is still significantly higher than it was pre pandemic. And that's probably not going to change. And we're probably not unique. I think we're -- I think it's quite common. So the home environment and the demand -- I think of it as the consumption of that home asset has settled at what we believe is a structurally higher level than it was pre pandemic. And there were questions, we fielded them a bunch, about how much demand was pulled forward during the pandemic, then you're going to see sort of this big tail off. If you really inspect our markets, there's the residential new construction piece, which is plus or minus a 1/5 of our products business. The repair and remodel is the remainder. And that repair and remodel business, a large proportion of it -- some of it is driven by renovations and that sort of thing. But there's a break-fix element in a water heater. I was just talking to a colleague who's -- who bought a -- who's in the process of buying an older house and they're going to do some remodeling. And I asked him if he was going to buy a new water heater as part of the remodel. The answer is no. We're subject to those dynamics, but there's another component to our business where when people are more intensively using their home systems, the demand for our products is going to go up because we're going to see shorter lifespans in some of those products. And then I won't get into it because maybe you'll ask it later, but then I can talk about the innovation and the product development and the platforming and all that drives it.

Absolutely. We'll definitely get into that. So let's dig a little deeper now. I know this is probably -- I have questions about P&S, but I want to start with ADI. It's been a remarkably consistent business for you guys. What are some of the most important initiatives that Rob and the team at ADI are undergoing today? And again, how does that, if we think about the next 1 to 3 years, translate to growth, margins, all that?

Yes. So that business, we've been -- you're right, it's been a tremendous execution story, and it continues to be a tremendous execution story. One thing that I think you know, Erik, though, maybe not everybody does. We've proactively invested in the business. So if you look at the operating expenses in that business, they've grown with sales. They actually outgrew sales last year. And that's because of sales enablement, that's because of investment in enhancing the web experience. It's because of the operating costs associated with the new ERP system. We're doing those things because we believe that they will create incremental growth in the future. The things that have driven incremental growth today, both in terms of revenue and profitability, have been the migration to our exclusive brands. That business, while still a small amount of the whole, is growing much faster. And the margins in that business are double what they are than our third-party brands. And that's going to continue to be an incremental adder to margin in that business. And the sales enablement piece. We -- our strategy around touchless revenue and around e-commerce is not that, that is a less expensive delivery path, although it is. What it's really designed to do is to take the regular day-to-day interactions and remove them from our sales associates' hands and put our sales associates in a position where, in the branch, they can be consultative selling advisers to our customers. And that's proved to be both a revenue driver and margin enhancement as well.

Okay.

And then the last piece is the M&A piece. And I think we've done 5. They're all small deals, relatively, over the last 3 years or so in that business. And the ability to continue to do that kind of roll up at an individually modest scale, but in aggregate, at a more significant scale over time, should be both margin accretive as well as growth accretive because each one of these deals bring something. It brings another piece of the line card. It brings access to a slightly different market like data com. It maybe brings a little bit of a different geography or brings consolidation. And each one of them, when we look at them, we inspect all of those different pieces to understand how these smaller businesses are really going to be incremental to the whole as well.

It's almost as if you knew the next question that I was going to ask you, which was talking about fragmentation in the distribution business and M&A. And so maybe like the one step further I want to go is when you talk about regions or specialties or products, are there any kind of obvious gaps to you that you can think of today? Or is it, hey, we're in our end markets, we're in the right geos and maybe there's a little more to do here or there. How do you think about that?

We're always looking at the portfolio. And I would say, over the last couple of years, we ramped up the focus on return on invested capital and the margin profile of the business in a given place. The business is predominantly U.S., but we've got a significant European presence. Last year, we ended up actually selling our Asia distribution business, which was -- it was India.

India. Correct.

And those sort of nips and tucks around the portfolio are really designed to drive the profitability and the returns in the business in that way. And in the U.S., we're investing in our distribution channel. We're investing -- I'm sorry, in our distribution centers and our distribution infrastructure. The branch network, as it sits, is pretty comprehensive. We cover -- I forget. Rob has the numbers, but we can deliver to, I think, 90% plus of the population in 2 days and I think 75% of the population in 1 day. So it's pretty well covered. But internationally, we'll continue to look and see if there are opportunities there as well because there are certain places in the world where there are those high-return, high-value kind of opportunities still available to us.

Right. Okay. Perfect. Let's turn to P&S. A lot of moving pieces in this business. Obviously, a few years ago, the initial goal was let's break down these silos and bring these businesses together, sell them as one. I would say how -- or maybe let me ask you this way. Can you walk us through what the most significant headwinds are today in security, comfort, residential, thermal? And if they're temporary, how do you expect them to dissipate volumes to stabilize and kind of get back to kind of how you originally thought about this business when you had your Analyst Day?

Yes. So I kind of look at the world in a now-next-later paradigm for that business. If you go back to our Analyst Day, the now, at the time, had a series of operational opportunities that we saw to drive margins to gross margins in that business to a certain level. None of those have really disappeared. But you've seen a lot of change in the world. We proactively decided not to work to optimize manufacturing because it turns out that our manufacturing, while relatively high cost and relatively rigid, is in market and it enabled us, we think, to execute well when supply chain issues came up. So we stopped. We've put that stuff on hold. And in this last restructuring announcement, this last quarterly announcement, we talked about the fact that we're going to take the first step. The most obvious of those steps will happen beginning this quarter and kind of rolling through 2023. So that's still available to us. We saw pricing as an opportunity. And we got it. We did not necessarily see the inflationary aspect of the input costs that we've seen, both in terms of the components and the parts, but also in terms of labor in certain of our markets. So dollar for dollar, we probably match those inflationary costs. But net-net, those inflationary costs and the price, the way you look at it, they've actually probably diluted margin because we probably haven't earned margin on top of that. The question from here is how sticky is our price versus how sticky are the input costs. And we think our price is pretty sticky in the large majority of places. Not everywhere, but we think we have good stickiness in terms of our pricing. The -- and we have -- we think there are certain commodity inputs that are going to abate. We think there's evidence that freight will improve. There is evidence that some of the real commodities like metals and resins and that sort of stuff will improve. The $64,000 question is what happens with electronic components and semiconductors and all that sort of stuff. And we'll see, because we haven't seen that piece yet. But then beyond that, Erik, there's the value engineering and the redesign of our products that we've achieved some of that. It's not yet visible because of all of this other stuff, but we've achieved some of that. We have the opportunity to achieve more as we get out of a -- what I'll call sort of an immediacy mode of having to requalify parts to be able to deliver and do those kinds of things. We think that one is still there. When does all of that translate into percentage points of margin improvement in that business? We said in the last call, we can't give you a time line because we just don't know when all of that's going to happen. But all of that is still available. And so the now of then and the now of now, the list isn't really different. The mix is probably a little bit different. And then the piece that you also haven't seen in any significant way, although we did start to talk about it on this most recent call, is the product innovation and platforming investments. And we have not pulled back on R&D in a meaningful way as a result of these cost actions that we've taken. We feel like we've made very significant progress in the platforming operation. Platforming work hasn't been reflected yet and probably won't be in the next year or 2. But with the availability of that platform in terms of our product designs, we expect that we'll be able to do -- to have a faster cadence of NPI and to have a broader array of products that have commonality in their platform that makes it a more attractive opportunity for both our main channel, our pro channel, but also as a partner in the connected home space to have more products available on that platform that are -- I hate to say plug and play because nothing is ever really plug and play, but are compatible.

Right, right. So let's touch on that. I want to ask you 2 questions related to that. The first one is more just about the product launch cadence, which is you talked about investing in R&D, you talked about product innovation. I'm going to get to the platforming and kind of software next. But just what should we expect this year from an NPI perspective? I think on the call, you alluded to it being an exciting year. Why is it an exciting year?

Well, I mean, to be honest with you, we haven't -- for some reasons out of our control, but some of them, the silos and the cultural challenges and all that stuff. We have not gotten to where we wanted to be at this stage in the transition and journey of the business in terms of an NPI cadence. I think it's pretty clear that we just -- we haven't really gotten that innovation and NPI motor running at the level that we want it running. We've got a couple -- we announced a couple of new products on the last call. There are more coming this year that we're -- we feel like will help us kind of reposition ourselves in some markets where maybe we've actually kind of lost competitive edge. And I think it's the beginning. I mean we're not -- we're still not the NPI engine that we want to be, but we're starting to see it.

And it's a focus.

And it is absolutely a focus. Jay has -- he now has 3 ninja teams, and I'm probably going to tee you up when I tell you what they are, but one is NPI, one is cash flow and the third is gross margin. And every other week, we talk about everyone.

Yes, yes. So we don't have to touch on gross margin. I see you did a good job -- you did a good job answering that. Last question, again, a lot of moving pieces, but I think that was clear. I do want to touch on kind of the -- when you talk about platforming and ecosystems and connected devices. Let's look 3 to 5 years down the line. Obviously, that's a priority for you today. I guess my question is just how do you -- how does that change the value proposition for Resideo? And how do you get paid for that type of innovation? Magic question.

Yes. So the last 3 years, it's almost 3 years since Jay and I showed up, which is incredible. But the last 3 years have really been foundational work, and we've made a lot of progress. There's more to do, and we talked about a fair bit of that now. We think there is still significant value to deliver in what I call the blocking and tackling, the nuts and bolts, the execution piece of the business. And part of that is demonstrating to investors and to ourselves the resilience of the model through a cycle, demonstrating the value of our channel and the value of our now brand portfolio and the value of our product breadth. The -- I think you can make the argument that the connected home world is less well-defined today in some ways than it was a couple of years ago. And I think we're actually in a somewhat better position competitively because of the work that we've been doing behind the scenes. How we get paid for it ultimately has to go beyond just the hardware. How we go beyond the hardware? I think -- I don't think we want to get out over our skis on that, but we have a clear focus on services revenue probably delivered either through the professional, which I think we've talked about before, but there's an array of services and solutions that can be offered through that channel where we really are the category killer. And through partnerships and through relationships with what I'll call alternative distribution channels, whether that is us being able to bring to bear a lot of real estate in the home, a lot of connected or potentially connectable devices in the home to somebody who's trying to put together a bigger, broader package or whether it's a series of utilities. We have an energy management business today or our demand response business today. It's more demand response than energy management, where we have the ability through our thermostats to control a substantial amount of load. And during peak times, we can manage that load, and we get paid for that today. It's a small business. But those kinds of opportunities through what I would call sort of nontraditional channels, at least from the perspective of what people are used to seeing from Resideo, they're nascent today, but that's where we think that value is going to come from over that 3- to 5-year horizon.

Right. Okay. So you teed me up with the -- talking about the ninjas. So we talked about two of them, right? So let's talk about the third one, cash flow. Why is that such a priority for Jay? What is the goal of the team there to drive improvement from here?

It's a huge priority for the entire leadership team. And there are good reasons, good legitimate reasons why our cash cycle has expanded out. But that doesn't mean we're going to accept that, that's the new normal. And when you look at the costs associated with the incremental working capital in a world where money isn't free anymore, right, it has an impact on gross margin because as your inventory goes up, your inventory reserve costs go up. It potentially squeezes out other investment. I mean, there are meaningful implications to not being efficient with your working capital that ultimately drive other decisions in the business and ultimately drive profitability in a way that we don't want to see. So if you look back -- I mean, we're -- we've expanded our cash cycle by 30 days, something like a couple of hundred million dollars. I mean there's some noise because of First Alert and that sort of stuff, but a couple of hundred million dollars, that's real money. And we're focused on getting it out of the system.

Okay. Good. You mentioned it. I was going to circle back to this, which is just First Alert. Obviously, kind of the flagship acquisition of last year...

Don't you have any questions that I didn't anticipate?

It as if we've talked about this before or something. I don't know. But just give us an update on First Alert, kind of not just from growth and how you think that business is performing, but in terms of integration with the broader Resideo team. Culturally, how that integration is working, synergies, all of that.

Yes. I mean overall, I think things have gone quite well. There's always bumps in the road and that sort of stuff, but we're very much on track for the synergy realization. That business last year delivered nice growth. We're not going to -- going forward, we're probably not going to break it out anymore because it's now more integrated into our security business, and we're seeing the synergy opportunity associated with putting them together. I think the teams are working really well together. There are a number of senior leaders from First Alert who are now important senior leaders in the Products & Solutions business. And importantly, and we -- I think we talked about this last year. The First Alert brand has value for us. So we kind of feel like, I don't want to say we didn't pay for it, but the value creation and return thesis around that business didn't contemplate leveraging the First Alert brand more aggressively through our portfolio. And I think you'll see that over time. I really do.

Okay, okay. And then another thing that you alluded to earlier that I just want to double-click on again is the efforts that you talked about kind of rightsizing the cost side of this business to adjust to not just the current environment to kind of the new normal going forward and become linear and, I guess, more efficient, I guess, is how I would describe it. So what are some of the most important actions you're taking? If you want to describe how that turns into a P&L impact, sure. But really, what I'm more concerned about is how does that strengthen you for the future?

Yes, yes. Well, high operating costs are a demonstration of -- my experience, high operating costs are correlated with harder processes, incrementally more risk, more noise in the system, all that sort of stuff. As you drive costs down, it's not just the cost efficiency, it's the rest of the efficiency sort of in the beast that you see. And I guess I'd point you to our corporate spending, which we've added 2 percentage points to our operating margin line over the last few years by driving down corporate spending while revenue has gone up. I think there has been -- I think there's -- well, I don't think. There's an increasing focus on doing the same thing in the businesses themselves and driving it from that perspective as well. And I didn't -- I wanted to actually throw a couple of other things in there. In terms of the gross margin line, the efficiency there is really around we have achieved significantly more labor efficiency because we've improved our processes and that sort of thing. And you don't see that in the OpEx. Obviously, you see it in the margin. But we think that it's there as well that we can achieve that.

Okay. All right. So we have a couple more minutes. Something we haven't talked about, you alluded to share gains earlier, but just the competitive landscape, and I don't want to focus on other companies, I want to focus on Resideo. But how is the competitive landscape developing from your perspective as you focus on software and product innovation and platforming? Is that giving you a competitive advantage? Is that where you see others going? I'd love to just kind of understand how you see the lay of the land developing.

Yes. I mean that's -- we have 2 minutes and 16 seconds.

Rewind back to 30 minutes.

That's a complicated question. But I think we've learned a lot about where we can truly leverage our strengths in areas where the relative competition is more modest. We've grown share in large -- as I said, in large chunks of the business, really through execution. And as we get to the next level in terms of new products, we think that's going to continue to be the case. We're going to continue to focus on the professional. We're going to continue to focus on platform, and we're going to continue to focus on our participation and matter, the common standards protocol because we think that really positions us as an indispensable partner for other players in the connected home because there's not going to be 1 player that's going to deliver the entirety of this experience. You're -- everything from your garage door opener to your smart speaker is not going to be delivered by the same company. And how all of that works together, both in the context of convenience and simplicity for the homeowner, and we think simplicity is a massively important part of that, but also how it enables -- I talked about energy management and demand response, and there's changes to patterns of power generation and consumption, and electric vehicles are going to have an impact on that. We think this ecosystem, in some ways, has become, as I said, more complex. And our focus really is on, okay, what are the things that we do really well, and how can we incrementally build those out such that we continue to support our legacy strengths while being that indispensable partner.

So we have 30 seconds. I try to do this with every company. I think I enjoy ending like this, but I kind of want to give you the dance floor to leave everybody with a thought everybody here, everybody on the line. Just in terms of what is underappreciated about the Resideo story? What should we all be looking forward to? Why should Resideo be on everyone's radar?

Yes. Look, I think we now have a demonstrated track record as a leadership team in terms of delivering value and creating value through really focused execution. And I think there are a lot of proof points available in that. I think that the ability for anybody to see the growth opportunities in the business, given the cyclical dynamic that we have right now, is difficult. And I understand that. But they're still there. None of the things that we talked about at that Investor Day in 2021 -- was it '21?

Yes, '21.

Yes. I mean almost 2 years ago. None of the opportunities that we talked about then are gone. We've made significant progress on a chunk of them. We have specifically decided to delay some of them because of the reasons we talked about. And I think we were pretty clear at that time that a lot of the development around platforming and around innovation was going to take time. And it's probably taken a little longer than we thought, but this is an organization that is culturally, radically different than it was 3 years ago, and we're going to continue that transformation.

Perfect. That's a great place to end. Thank you for your time.

I appreciate your time, Erik.

Thank you.