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

Good day. It's my pleasure to have Resideo Technologies joining us today. And with that, I'll turn it over to Jason Willey, Vice President, Investor Relations.

I appreciate it. Thanks for having us here. As Andy said, my name is Jason Willey. I head up Investor Relations for Resideo Technologies. We'll walk through a little bit of an overview of the company and then take a few questions at the end, if there are any. So Resideo is a combination of 2 businesses really: a distribution business, ADI, and a products business. The products business serves the residential market. We're present in over 150 million homes in the U.S. and Europe with our product portfolio. We'll get into a bit of what that portfolio looks like. But safety, security, comfort, HVAC solutions, energy solutions, all the things that really touch the critical systems of your home business has been around -- the products have been around for a long time, the business Resideo itself spun out from Honeywell about 5 years ago. Some brands that a lot of people will probably be familiar with, Honeywell Home, First Alert, which we acquired about 1.5 years ago. So a few things that we'll kind of hit on as we move through the presentation today. Really, Resideo is about serving the professional contractor, both through the products business as well as the distribution business. And we do that through what is a highly -- really highly differentiated broad set of products. We believe we touch on a number of fairly exciting growth trends in both the residential arena, and we'll walk through some of those. And in both the Products business and the distribution business, you see a fairly meaningful opportunity for margin expansion over time. So start with Products & Solutions. So Products & Solutions, $2.8 billion of segment revenue, $527 million of segment operating income in 2022. We split this business into 4 kind of key product categories. Air, about 1/3 of the business. This is driven by our thermostats, which I think is what a lot of people know Resideo and the Honeywell Home brand for. Also do things such as indoor air quality, humidification, dehumidification as well as zoning systems. So really air products focused on your HVAC system within your home. Safety and security, so this includes the First Alert brand, smoke and CO detectors as well as our professional monitor security hardware. So these are the panel sensors, video solutions that serve the backbone of professionally monitored security solutions. So things like an ADT, who is our largest kind of customer in this product area. Water, plus or minus 10% of the products business, a smaller portion of the business. A lot of this is focused in Europe. These are things like shut-off valves, backflow prevention valves. Increasingly, we're doing more on the water leak detection side of things and more connected products in this area. Then fourth area, we call energy. Really, this is kind of our OEM business. So we're a component supplier into various OEMs, servicing water heaters, boilers, furnaces, within the home. So as I kind of said earlier, primary channel here is through the professional contractor. While we do, do a little bit for the DIY market, most of what we do is centered around serving the pro. We do that through several go-to-market channels, through the distributors on the HVAC side. This is people like a Watsco or a Ferguson or a Johnstone; through security dealers, ADI, which is our distribution business. It's the largest channel on the security side. You also have our partnerships with our OEMs. Again, this is where we kind of sell through our energy products to the larger water heater, furnace and heating and cooling vendors. Increasingly, we're looking at alternative channels to market. So this includes things like partnering with utilities' on-demand response programs, also partnering with insurance companies to help enable reduce claims activity through things like water leak detection and water leak prevention, shut-off valves. About 20% of the products business does go through retail. This is predominantly still serving the professional contractor. So this is the pro going into a Home Depot or Lowe's to pick up our products as well as First Alert. And so First Alert is probably the one piece of the business that does predominantly go direct to the consumer or service the DIY market. About 20% of our business on the product side is through the new construction market. So it goes through into the homebuilders. So again, the pro really is the cornerstone of the business here. It's our differentiated kind of value proposition is what we're able to do for and with those professional contractors. So we talked a little bit earlier about some growth opportunities that we believe our products attach fairly well to. Connected home, smart home is obviously something that is talked a lot about. We increasingly have added connectivity into our product portfolio. Thermostats, water leak detection, indoor air quality, monitoring, moving forward, connecting those smoke and CO detectors and being able to tie all that together to be able to provide to our contractors, to end consumers more insight and more intelligence about what's going on in the home. Specifically on the energy management side of things, I think this is where we're working with our utility partners' on-demand response programs, things like grid management. So we not only provide the connected thermostats that help support these programs, but we also have back-end software that helps the utilities run those demand response programs. Within the life safety world, I think you increasingly see people kind of taking awareness about what's going on around them. You've seen pretty meaningful growth here over the last decade or so in terms of security solutions and monitor security solutions within the home. We see opportunity for this going forward, again, to integrate the smoke and the CO into this as well as to bring more kind of video analytics and AI and ML to this world and make the information that you're getting from that video, you get from your security service actually usable and actually add some intelligence to that. And finally, the energy transitions. A lot of this is focused on what's happening in Europe, but I think has -- over time has applicability across our different geographies. We have hydrogen-ready products already in Europe. Increasingly, we're doing components that fit into the heat pump market. Then the margin -- on the margin side of things, as I kind of said earlier, we see opportunities in both businesses to expand the margin profile. A few of the things that are going to drive that, we began the process of optimizing our manufacturing operations. We have plus or minus 15 manufacturing facilities largely in North America and Europe. That portfolio is, while it has helped us through particularly some of the supply chain challenges that we've had, we're very in market in here. And we're very dispersed, particularly in Europe. We manufacture here in North America, largely in Mexico, but we still do have facilities in the U.S. Recently, we announced that we closed one of those facilities in San Diego and moved that manufacturing to Southeast Asia. We see more opportunities for similar types of opportunities with the portfolio over time. One of the things that's ongoing as well is we saw a lot of pressure from inflation and input costs, particularly in 2022. We began to recoup some of those costs. And certainly, we've seen those benefits on the freight side of things but also in some of our material input. We think this will have a meaningful kind of impact on margin as we move through, particularly 2024. Recently, we announced the sale of our Genesis Wire & Cable business. I think this is part of an ongoing effort to look at the portfolio, to divest nonstrategic assets as well as do just some pruning of what was a collection of assets that was inherited at the spin. And so as we indicated, kind of post that Genesis transaction, we do see opportunity to undertaking more of these types of things over time and really kind of focus the portfolio on what the core strategies of the business are. I think really, most importantly, as we think over time about the opportunity in the business is to enhance what we're doing from an innovation perspective. One of the challenges of the structure of the business and the background of the business is it didn't get a lot of investment over time, particularly from a new product development and innovation standpoint. It's been a clear effort of the management team that came in 3 years ago to ramp up those capabilities. Even as we've done some restructuring in 2023, we've been careful to ensure that we continue to make the necessary investments from an innovation and a new product perspective. And one of the things that you'll see in 2023 is we did bring more new products to market relative to what we've been able to do in the previous few years. And we think that we have momentum here, and this will be critical over time as we do look to expand the margins of this business. So let's talk a little bit about ADI. So ADI is our distribution business. So it's a leading security distribution -- low-voltage security distribution platform in the U.S. You can see here the collection of different product categories: intrusion systems, commercial fire, access control, video surveillance, wire and cable. ADI has been a very consistent grower over the past decade-plus. It's a business that has a very traditional industrial distribution model to it, but one that has been consistently able to outperform the overall market. We've been through very strong execution. So a little bit about ADI. As I said, primarily focused on the physical security market. Other key categories, datacom and AD, but the roots of ADI are on the physical security side of things. Predominantly focused in North America, in the U.S. This is a branch-based operation. About 200 branches globally, but the bulk of the opportunity and the revenue today comes from North America and the U.S. specifically. About 2/3 commercial, 1/3 residential. Most of that residential is in the intrusion market, and this is kind of where you see the distribution of our products business; as well as increasingly a little bit of residential AV, which we've kind of entered both organically and also through acquisition. And one of the themes for the business, and I think for distributors in general, is we're seeing more of the business move to digital or e-commerce or what we call touchless sales. So increasingly, our customers are looking to interact with ADI in varied ways. And so one of the areas where we've made a fairly meaningful investment in this business is in our digital capabilities and the ability to transact and interact with our customers in that digital realm. So on the margin kind of theme here, a few areas. One that I kind of just touched on is really kind of that acceleration in e-commerce. So we're up to about 20% of ADI sales come through the e-commerce platform. Significant investment in the back-end infrastructure here, the data management infrastructure. An opportunity we think we're kind of fairly early on in is the exclusive brand side. So today, less than 5% of ADI's overall sales are exclusive or private brands. This is something that has grown significantly faster than the overall business, and we see some pretty meaningful opportunities to drive this higher over time. The gross margins in -- for these products are significantly higher than what we see for our third-party products. The other area of kind of fairly meaningful investment that the team has made over the last 3 years is in what we call sales force enablement and sales force effectiveness. And so this is really giving the sales force tools to be able to understand pricing better, to ensure that the way that they're interacting with the customer is efficient and driving maximum profitability from individual transactions really by providing the kind of data and analytics at the fingertips of the salespeople as they're interacting with the customers. A little bit through the financials. So we see here, been able to grow the revenue fairly nicely over the last several years and at the same time, bring up operating profitability. 2023, based on the kind of midpoint of our guidance that we provided at the last earnings report, going be down very low single digits. We have seen headwinds in the -- predominantly in the residential portions of our business where volumes have been down. But good profile of being able to grow the revenue, increase the profitability over the last several years. At the same time, we're real focused on kind of driving down some of those corporate costs and corporate overhead, made a lot of progress on this front over the last several years. So the most recent quarter, a few highlights from that. We did deliver results that were above the midpoint of our outlook range. As I said, we announced the disposition of our Genesis Wire & Cable business, some $80-plus million of proceeds. It's a very nonstrategic asset for us, largely commodity wire and cable. Able to sell that at a multiple that was actually a premium to where the equity trades. So we think a good transaction for us as well as a good example of the types of opportunities we think do exist within the -- in the portfolio. We did announce some additional restructuring, and we continue to work to bring the cost structure down as we have seen more challenging volumes and more challenging revenues, particularly in the products business. At the same time, that investment has continued in key initiatives around innovation on the product side as well as the digital experience within ADI. So we've been very kind of thoughtful and targeted about where we are cutting and where we are pruning. And we did announce with our Q2 earnings a share repurchase program. So we repurchased $30 million worth of shares on that $150 million kind of authorization. And that's our first share repurchase authorization since we've been a stand-alone company. Balance sheet, I believe very healthy balance sheet. Strong cash position, about $1.4 billion of total debt. We have seen working capital levels remain a bit extended. This is primarily driven by inventory. We built inventory like others in 2022 when we were experiencing supply chain challenges. We continue to work through bringing that inventory down. We've indicated that we expect to have a fairly strong operating cash flow year this year. And to date, we are executing on those improvements relative to what we delivered for last year. But in general, very comfortable with the financial profile of the balance sheet and where we sit from a balance sheet perspective. A little bit about capital allocation. So what we've said is the primary use of capital is expected to be M&A. We've executed on this in both businesses. So we've done some bolt-on transactions when -- within ADI, primarily focused on the audiovisual and datacom markets. Expect to continue to look at those types of transactions. They've been relatively small in size, kind of single-digit millions, low double-digit million transaction values. On the product side, the big deal was First Alert last year. Other than that, we have also done some bolt-ons here largely adding kind of technology capabilities. We did an acquisition in EMEA recently to add some security capabilities and life safety capabilities. We did an acquisition earlier -- or, I guess, about this time last year to add some video capabilities. So a development team there around some next-generation video capabilities for our security solutions. About $100 million of CapEx on an annual basis is kind of where we've been running, plus or minus 2/3 of that -- 50% to 2/3 of that kind of maintenance. The other major areas of investment have been automation in our factories, particularly down in Mexico, as well as some systems upgrades, primarily on the ADI side. We're putting in a new ERP system as well as some of the investments around the digital initiatives. And as I talked about previously, share repurchase authorization, $150 million authorization. We repurchased $30 million on that last quarter. Just kind of close here with a few things on the acquisition front. So as I said, we did the First Alert acquisition about 18 months ago. It's the largest acquisition by far that we've done as a stand-alone company, kind of adding key real estate within the home and smoke and CO market. Deal has performed well, really right in line with what the deal model was. I think we've been able to execute on some additional revenue opportunities, particularly bringing First Alert products into the homebuilder community. That's kind of helped to offset just some slower overall market conditions than what we had originally anticipated when we did the deal, but performing in line with expectations. We've executed on the synergy plan that we laid out. And I think one of the real benefits here, particularly over the long term, and really wasn't in, at least from our financial calculations when we paid for the deal, was the First Alert brand, which we're increasingly using in our security products. I think you'll see more of that over time. And then on the ADI side, I've kind of mentioned a little bit about this. We've done 5 smaller acquisitions, primarily focused on the wire -- sorry, primarily focused on the AD and the datacom markets. Deployed about $60 million of capital, $175 million of annual sales from these 5 assets. And I think very representative of the types of transactions that we would look to do going forward to really build out capabilities in adjacent categories, leverage that footprint we have, leverage the scale advantages that we have within that business. So yes, just to wrap up, again, think we have a very kind of differentiated portfolio, very differentiated path-to-market with our relationships that we have with the professional contractors and we think are unique across the markets that we play in. And we think we do attach to a fair amount of attractive kind of growth opportunities, particularly on the residential side of things when you think about smart home and connectivity in the home, energy management as well as just some of the energy transition initiatives that are going on across the globe. And across both businesses, I think opportunity to continue to improve the market profile of the business through some longer-term structural initiatives. That's what I have for today. And if anyone has any questions, happy to take them.

Jason, I'll start with one. Just following up on some of the M&A focus towards the end of the presentation. What are you guys seeing in the pipeline today? Is there a set of opportunities that you guys are able to evaluate? Or is there a disconnection kind of on valuations?

Yes. I mean, I think we continue to see opportunities out in the market both on the ADI side and on the product side. I think that there is still in some -- particularly in the private kind of company world, still an adjustment in kind of in valuations going on and a bit of a disconnect between the bid and the ask out there. That said, I think, absolutely, there's still kind of actionable things out in the market today. I mean our -- like others, our cost of capital has increased meaningfully over the last 12 months. And we factor that in as we kind of look at the -- look at opportunities and the return potentials from any acquisitions. I think -- so I think inherently, that makes us probably a little more selective than perhaps what we might have been 18 months ago. But I think there is definitely actionable opportunities out in the market on both sides of the business.

And then how do you guys feel about your credit ratings today? Are you guys happy with where you're rated currently? Or do you have any kind of aspirations to get that unsecured rating to investment-grade status over time?

Yes. I mean, I think we're very happy with the financial profile and the balance sheet profile today. I think if you look at the terms we were able to secure on the last couple of transactions that we did in the debt market, I think they reflect the quality of the balance sheet. I think we're in constant conversation with the rating agencies. I don't think there is a massive push to move to investment-grade. I think we appreciate and like the flexibility of where we sit today and, again, I think are most focused on kind of the health of the balance sheet. And again, we're pretty comfortable with the current leverage profile of the business.

Great. Thank you. Thank you very much. Appreciate it.