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

Great. So we'll get started. Again, welcome to day 2 of the TMT Conference. My name is Erik Woodring. I lead Morgan Stanley's hardware coverage based out in New York. Before we get started, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures for important disclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So I'm delighted to have 2 individuals from Resideo here today: Tom Surran, the President of the P&S Business, Products & Solutions; and then Chris Lee, Head of Global Investor Relations. Just a small thing, Chris, I'm happy to have you here. I remember meeting you 10 years ago, different company, but great to have you guys here. So thanks for joining us.

Thanks for having us.

Chris, I'm going to start with you, and maybe just go high level because REZI has been on a rather extensive journey since 2018. Can you just lay out for all of us kind of where you stand in this transition from kind of like an aggregation of siloed businesses to where you are today with P&S and ADI? Kind of the broader message. Let's start there, and we can get into specifics.

Yes, sure. No, thanks for the opportunity, Erik. It's good to see you again. Thanks for hosting us. No. Look, we're excited to be here. We're really excited about the prospects ahead for Resideo. Let me frame the value proposition for you, okay? So Resideo has world-class operations and a global scale, and we play in an attractive market. When you look at our 2 business segments, as we noted on our February -- our recent February earnings call, our 2 business segments are very profitable, and they generate durable cash flows. Let me walk you through each of those 2 segments. So in P&S, the focus for the Products & Solutions segment over the last several years has really been to focus on improving the fundamentals and operational execution of the business. That's resulted in significant margin accretion that has really underpinned a foundation for go-forward NPI that we think -- that we're really, really excited about. We also think that enables us to have continued structural margin opportunities ahead of us. For ADI, the strategic investments they made over the last several periods of time in areas like e-commerce and first-party products or exclusive brands have created a structural margin improvement for the ADI business segment. With the acquisition of Snap One, which was closed in June of 2024, Snap One is a really complementary business to ADI not only from a product portfolio perspective but a shared ethos around e-commerce and exclusive brands. We also think that provides an extra leg of margin expansion potential for ADI. When you look at the connecting thread between ADI and P&S, it's really around what we think is our moat, which is the professional installer/integrator customer base, which is over 100,000 individuals strong. And we've built this trusted relationship over many, many years working with these partners of ours who are our customers, where we're enabling quality product and high-touch service to enable those customers to run their businesses profitably and efficiently. So I think the prospects ahead of us are really exciting. I'm really -- I'm excited for the opportunity for Tom to be here and talk a little bit more about the P&S business, specifically around some of the things we're doing around new product introduction.

Perfect. Before we get to NPI, Tom, let me just start high level because P&S, you do a lot of a lot. You sell between multiple different channels, multiple different end markets. And maybe if you could just kind of simplify the key markets for us that you sell into, where you're really focused today, and then we'll maybe go from there.

Sure. So it all ties together with our focus on creating comfort protection and savings for our customers, and that's through the systems that are in the residences and small businesses. So the control and the sensing systems. To take you through the businesses, how they all tie into those, let's start with our smallest business is water, okay? Water is focused on water heating. And that's really where the business originated. It's a little more Euro-centric. And the water heating is primarily used in hydronics and typically in Europe, a little bit in the Northeast. From that, though, we also have some potable systems that are in that market. Then let's go over to our OEM business, which is focused on the supply of components to manufacturers of the appliances that are doing the water heating, typically in heating but also potable. In the U.S., you're going to have the customers that are doing just classic water heaters. And they are all -- all the major players are customers of ours, and we typically do the gas combustion there. In Europe, you've got boilers or primarily the way that both hydronic heating is done as well as the potable water system. And there, we do both the combustion system for those boilers. But we also -- because of our expertise in doing the interface and controls, we've migrated up, and our customers have asked us to provide those interfaces for the heat pumps for the same kind of heating and -- hydronic heating as well as potable systems, [ coffee ] systems. Let's go from there. You would go into our safety products, okay? So this is the smoke detectors and fire extinguishers. Those products are sold through the retail channel as well as through electrical distribution, ending up in typically new construction homes. And then you've got the security offerings we have. And we have a business that has historically been in Europe and part of America, focused more on an OEM market and then also a little bit on the general. And in that market, we sell through distribution almost exclusively other than the OEMs that we provide. Now that's a change where we're becoming more focused on the general market, more through the distribution. And then lastly, you have the Comfort business. And there's some components to it in the Comfort business. But again, we have a very nice business in supplying those systems to the RNC business or residential new construction as well through the HVAC distributors.

Perfect. And you mentioned a few kind of like macro data sets or economic trackers, so to speak, in that. Again, maybe if you just focus on that, which of those kind of data sets or trackers are kind of most closely tied to the P&S business when we think about the high-level drivers of your markets?

We look at 3 primarily. One is the Harvard housing study center leading indicator of remodeling activity. And right now, that's running at about 500 billion on an annual basis, plus or minus a few. It's running a little bit above it. But it's a nice steady level. That's a good level. And remodeling activity, typically, special major remodeling, that's system replacement, and we do very well there. So that's a healthy level. The other one is on new housing construction. We've seen that recover in the last bit. Right now, single-family residential is running at about 700,000 per annum. That is a healthy number, but it's not an equilibrium number. So most economists and forecasters are saying the overall supply of housing should be somewhere about 1.5 million single-family residential. So there is this tailwind to try to pull it up into equilibrium. But it's an okay level. It's a little bit where it was pre-pandemic, but there's some pull towards equilibrium. And then lastly, the major data set we look at is existing home sales. And one of the reasons for that is that's the primary determinant on something like security systems. When people move into houses, they look at the systems, and they say, what do I want to improve or to even make it mine. Sometimes in security, they want to feel another level of safety. In that, you probably know the single-family existing home sales are running at around 4 million units per year. Pre-pandemic, that number was running around 5 million. So we're about 25% under what a balance level is. There's -- people talk about the reason, the high interest rates. People are locked into lower interest rates. So you don't have that mobility, but there's still a pull to go back to kind of a normal healthy level, which would be up another 25%.

Right. Okay. That's really helpful start. And now maybe if we dig into that, starting with -- I guess I was talking about HVAC, Comfort side. Where do we stand in kind of the recovery of this business? You've launched some new products to address that market. Just as we think about the outlook for kind of HVAC and Comfort, how should we be thinking about it? However you want to frame that, of course, whether it's market, share gains, pricing, volume, et cetera.

Yes. I think coming out of the pandemic, there was some supply. There was a lot of inventory in the channel, right? I think that we're past that. I think recently, the industry is in a relatively healthy position. But I think our performance is more focused on us reinvigorating our products and going after it and gaining share in that marketplace. We could talk about what we're doing in some of those. And we've seen some of the products we've brought to market. We brought our new entry price product. But more importantly, that was part of a platform. So we're -- when we reinvigorate, we're going to leverage the scale. And we're making the investments to reinvigorate all our product lines, okay? And we're going to create better value and more differentiation in the products and more value to our customers. And we're always selling through the pros, and we know what they need, and they trust us to provide that.

Okay. And we'll definitely get into the -- all the new product stuff because I think it's incredibly important for this year specifically, too, clearly.

A couple.

Yes. When we talk maybe kind of water and OEM, if we put those together as somewhat related end markets, again, fairly diverse. You sell, as you talked about, widgets, components into water heating. Again, where does this market stand as we're just kind of thinking through the high levels of each of your end market exposure?

Yes. So in Europe, especially, hydronic heating is the standard, right, especially Northern Europe. If you get to Southern Europe, it looks more like an American heating environment. And our Northeast looks more like a European. But hydronic heating is so important. And so what had occurred, and you're talking about maybe what's happened over the last year, is there was a lot of programs and penalties that were put in part by the various European governments. You had Italy. You had Germany. You had Netherlands. You had U.K. They were all doing these various programs trying to -- basically electrification of the systems, deemphasize natural gas because of the situation in Ukraine. That created an unnatural market, which kind of blew up in Q4 of last year. We've kind of worked through that. There was still some massive inventory in the channel that still needs to be worked through. But we're kind of coming out of it, and we're seeing some healthy uptick now, getting back toward a normal level. We saw boilers go from 5 million units per annum in Europe down to 4 million. We're just starting to see that come back to the natural level.

Okay. And then touching on some kind of your electric and fire products. Before ending in security, you had acquired First Alert a handful of years ago. Performed really well for you guys. You also have obviously the BRK brand. You have Honeywell Home. Again, similar to the last few questions. Just kind of where does this end market stand? It stood out very positively.

Great for us. It's performed really well. So this is a product that we sell to 2 channels, retail and the RNC market, again, through electrical distribution. Both markets are doing very well for us. I mean it's just been a fantastic execution by the team. We're, again, very excited about what we'll be bringing forward with NPI. But the past year, Q4, we had a tough comp because there was an evolution in some of the technology, [ UL6, UL8 ], which made a tough comp, but we were very close to the record quarter we had in Q3. We had record sales in retail. About 75% of our retail sales are in this category. It's been great.

Okay. And then let's end on security before we get into new product introductions. Kind of a lot going on in security, obviously, an OEM customer. Then addressing kind of the general market. There's also some NPI related to that. But high level, the security market has been softer generally. I guess my question is like, why is that? What gets that to change?

Okay. So we particularly have been historically participating in what's called the intrusion security market. And that's really been controlled or dictated by what's happening in those existing home sales. That's the primary determinant of replacement cycle on that. So that has been a major headwind. But the other piece, even absent that, if you look at all the categories, where we were participating in intrusion is not really the modern day definition of security. Modern day definition of security is an integrated system that includes video because, I mean, think about it, doorbell is really a security system, right? And that integration of that video has to be part of a total solution, and we're just bringing that out in our refresh of our line in that. So that's where that plays.

Okay. And I'd be remiss if we just didn't kind of touch on the major customer within security. It's been a relative headwind to growth. But at earnings 2 weeks ago, the message was a little bit more positive in that, that headwind isn't as much of a headwind as perhaps you thought it would be, and that headwind is lessening. Can you maybe just help us understand where that relationship stands, what you're trying to do to maybe move it forward?

Yes. Okay. Well, there's -- what occurred in '24 was not, as you said, as much. We had told the market that it was going to be a $100 million decline. It was substantially less than that. As we go into '25, again, it's going to be substantially less than $100 million decline as we go into '25. The relationship with the customer is very strong. The current contract has a termination. It's at the end of 2025. We have healthy dialogue going on with that customer about the future and what value we can bring to them and their customers.

Perfect. So this might be, maybe for me, the most exciting question, maybe gross margins but touching on NPI. So new products. We've obviously touched a bit on it thus far. It's a big focus for the company, again, not just this year but over multiple years. But there's a lot of excitement that I hear from you guys on NPI this year. So can you maybe just -- what's driving that excitement? What should we be looking forward to this year not even just from like a product perspective but from a strategy perspective? It feels like, again, we're talking about kind of connecting things together. And so I would love to just get your view on NPI 2025 and beyond. What's driving the excitement?

Okay. So there's 2 pieces to that. First, yes, the NPI, I think probably -- maybe there's a little bit of disconnect because we know what we're doing on the NPI side, right? And we know what's stacked up for the future, whereas you only get to see what we've released so far, which are really just 2 offerings. But they're part of a bigger train of products that's coming out. And so we know that and probably that you've got to see that coming in this next year.

We see it but without as much of issue as you have shown.

That piece. And then -- but the reality is we've got to win in each of our markets, right? And we're making sure we deliver the best value in each price point in each of our markets. And then we've got, on top of that, the synergies of being able to give an integrated system for the whole home because that's what we do, right? We're playing in the whole home control and sensing. Now did you want to go through kind of what's queued or...

Yes. No, no. To the extent that you can share, we'd love to hear what should get us excited.

I mean let's just start with Comfort. What you saw so far is the Focus Pro. So that's that opening price point product. We had a lot of products on various platforms, and we have scale. I mean we do 15 million thermostats per year. And U.S. competitor is at about 1.5 million. So we've got this whole scale that we were dissipating across. We've concentrated to a single platform. We've introduced this opening price point product. Next, we're going to go to the high end where we weren't playing. We had retrenched a little bit to the middle as we underinvested. Now we're basically making sure we're reestablishing ourselves as a leader in this market. And you're going to see those products starting to come out midyear. And then there's going to be a cadence at a regular cadence, bringing the products that start filling all the way through that. And then we've got products that we want to do in indoor air quality, where we had kind of slipped. Ventilation was an area we want to grow in. We're very strong in zoning. So that's just in that area. Now we could talk about security. I talked a little bit about shifting from just an intrusion-centric to creating that integrated single pane of glass with video as well as access control. There will be an early announcement. Kind of midyear, you'll see some stuff. And then towards the end of the year, you'll really see kind of where we're going. And I think you'll kind of get what we're doing there, and we'll enhance that with our back-end products and the software and the interfaces. In terms of safety, we've got a new product coming out now. It will be early '26 before we create this new platform that we've got that I think will also show something. Comfort, we're always working with our customers there. That's really dictated by their schedule of what they're wanting to do. And then water, we want to broaden out from just that kind of basically the systems related to the hydronic controls, zone valves and a little bit of that pressure regulation and pressure regulators to kind of getting more into the sensing for all homes, right? And we also then want to make sure we create the ability to bring some Euro-centric products into America for our [ ETR ].

Okay. That is extremely thorough. You've got a lot to do. And so if we kind of add together your comments on the market, NPI, if we aggregate that together, kind of what does that mean for P&S growth for 2025? And to the extent that you can talk about beyond that, how should we all be thinking maybe like the longer -- medium- to longer-term CAGR potential for this business?

Okay. Not getting into the specific numbers, but this year, what we're doing is that refresh of all the products. So these are typically in areas where we're already participating, but we're trying to enhance the value to the customers to reestablish ourselves. There'll be growth in '25, but it's not going to like blow your mind out because really, most of these are going to come midyear, latter in the year. And you're going to see those products coming out. And then as we go forward, we get off of just the refresh, and we start expanding the line to the existing products. And then we start going into new categories, and that's where we can really drive some growth.

Okay. That's exciting. So let's shift to the other kind of, to me, really exciting part of the story, which has been gross margins. It's one of the strongest parts, in my opinion, of the Resideo story. You just did 41% gross margins in 2024. That was up 2 points year-over-year. What are the factors specifically that are helping to drive that margin expansion? How sustainable are they? And is this -- where are we kind of in the evolution of the initiatives that you're trying to run through to improve those gross margins?

Yes. So this is kind of like a point like we're just going to do it. I mean let's talk about what margins represent. It's creating value for the customer, right, differentiation. So that -- all that NPI is creating enhanced differentiation, enhanced value more than we've ever done before, okay? And then the other part of the margin, because you're going to price accordingly to charge for that value that you're creating, is to do it efficiently, okay, and how you deliver it. And we're constantly working on, and this you can do even without NPI, which is what you're seeing, is what's that efficiency in the factory. And that includes things like automation of the facility, high factory utilization, balancing the lines because we have a global footprint, where we do the production, always working on kind of making sure we're cost effective in our designs and price of components. So it's delivering the value, right, leveraging that scale and then basically executing efficiently to deliver it. And where does it go? It can go pretty good.

Okay. Good.

We're not close to that.

Obviously, tariffs and geopolitics is kind of ever evolving. We're talking about it right before we started. You guys have been very transparent about where you have manufacturing locations for the P&S business. Obviously, new tariffs in Mexico start today. And I guess my question is, what actions can you take to kind of mitigate those tariffs given your manufacturing exposure? And then any way that we can try to frame that financial impact to the degree it's possible?

Okay. So we took some steps before the implementation of the tariffs to kind of get ready for things. So those were kind of positioning some inventory in various places, even running the factories at a certain level, getting everything coordinated. Now that they're in effect, the first thing we'll do is pricing. We've had communications verbally with almost all of our major customers as well as written correspondence saying that we're going to be adjusting our pricing. Pricing will substantially mitigate the impact of the tariffs, okay? Substantially mitigate. And then after that, you've kind of got a new environment that you have to optimize. We've got a global manufacturing footprint. We have optionality of being able to produce in various locations for various customer bases. But we've got to go and understand exactly what this means. We know the tariffs today in Mexico, Canada. We know that reciprocal tariffs are coming up later in the week or may not. We also know -- exactly, right? And then we...

I'm not going to say what we know.

And then we've been told about then there are these other targeted to low-cost manufacturing countries. You don't want to start spending capital or transition costs and shift your production footprint not knowing kind of a set or at least taking some good estimates about what the world looks like so that you make those investments and you get the return on whatever those investments are. And we have to do that to make sure that we're not competitively disadvantaged. So the pricing is going to take care of us in the first part. But long term, it's a new environment. You re-optimize.

And I realize it might be early, but any -- when you have that written correspondence or even verbal correspondence with customers, is it -- is the answer kind of acceptance? I mean did they have a lot of choice? I think that's the challenge for you guys, right?

Yes. I think our customers were really kind of pleased with us because, yes, they don't love it, right? It's a disruption in some ways. They don't know what the impact will be. But one, we were the first ones to reach out. We basically did it both verbally. We had personal contact with all of them. Then we did it in correspondent. So they were pretty happy with how we handled it. I don't think they love tariffs, but at least that. And then we'll work through the situations where we have contractual items, and we'll be able to execute.

And Erik, just to jump in, just to round out the narrative for Resideo. The ADI side, ADI does have some exposure to tariff-oriented countries. But it's much less exposure, and they will more likely than not pass along those costs similar to what was done in the last time tariffs were implemented.

Okay. Perfect. So Chris, before we maybe turn to ADI and some of the other kind of higher-level stuff, Tom, just to conclude with you on P&S, kind of the message that you want to leave with us on P&S. I'm thinking about competitive differentiation, competitive moat, what you're attempting to continue to build in P&S. Just before we shift to the rest of the business, what's the kind of final message from you?

Yes. I think you got to look at P&S and that home control systems, where we were and our focus on providing those 3 things, right, the comfort, the protection, the savings, and our focus on the Pros to deliver that and then basically the revitalization of the products and delivery of the services. I mean I think that it's not the same company it was just not too long ago, right? This is a very focused effort right now to make this company the leader in comfort. And once we get that, we can talk about how that all goes, a whole another discussion about integrating into the whole control system.

Right. No, thank you for that. Chris, maybe if we go through ADI briefly, just kind of talk to us about the market backdrop. You obviously acquired Snap One, so there's some AV exposure there. AV has been a little bit softer. But just kind of where are we in the cycle given this is more of a commercial exposed business relative to residential on the P&S side?

Yes, that's right. I mean starting there, ADI is 70% exposed to commercial, 30% residential, rough numbers. Q4, they posted a very strong organic growth number of plus 9%, exclusive of Snap. It was really driven by broad-based product category strength and large customer activity in the commercial space. We think that's momentum going into 2025. And once we integrate Snap more, I think we have a greater opportunity and a complementary product portfolio to sell more products to more customers.

And maybe let's talk through Snap One. Talk us through kind of where the integration is for these 2 businesses, the progress you're making on synergies and kind of what the impact that becomes. You mentioned kind of a structural margin story at the top of this. So just help us understand where we are with Snap One right now.

Yes. So the integration is going really well. I think if you -- based on the last several earnings calls, I think Jay, Rob, Mike have all talked really positively about the integration and why it's progressing the way it has. Fundamentally, it's because it's a very good cultural fit, which has engendered a better together ethos and strategy that's pervaded throughout the organization. So they go -- they do things very jointly instead of separately, which has enabled a lot of early thinking -- a lot of early and good thinking that's allowed us, for example, to overachieve on synergy achievement in 2024, achieve 17, the target was 12. It has also given us the confidence to lean in a little bit on the guide that was originally given about $75 million of run rate synergies exiting year 3. I think Mike's language was at least $75 million exiting year 3, which could imply you can deliver more than the $75 million or you could deliver the $75 million earlier. In either case, I think it's a really good proof point around how well the integration is going.

Okay. Perfect. Really helpful. Another initiative, you mentioned e-commerce. I was going to maybe touch on kind of like the private label and one piece stuff simply because Snap One had a big part of their business that was proprietary products only sold through Snap One. So now you guys have that business. What is that -- you integrate Snap One, and you have this kind of private label business. What does that do to kind of long-term ADI growth and margins relative to like the core ADI that we knew pre-Snap One?

Yes. No, look, certainly, I think the [ got you ] thing to walk away with is Snap is complementary. They definitely add to ADI's existing exclusive brand portfolio. The net impact is a greater amount of margin opportunity going forward because the first-party products are more margin-rich than the third-party products. And we continue to innovate and bring out more and more exclusive brands or products under exclusive brands. So I think you should expect that momentum to continue. We also have made investments in e-comm, the digital channel, which was also very much a shared ethos with Snap One given their heritage and digital-first approach. We've seen structural margin improvement by virtue of the digital capabilities and a leading omnichannel experience, which really gives a lot of opportunity to the customer. And we see that influencing their behavior based on the increased volumes going through the digital channel and as a result, increasing our total average daily sales.

Right. Okay. And maybe we'll take this discussion beyond the products and margins and whatnot to M&A and maybe capital allocation more broadly because I understand, obviously, you're still working through the Snap One integration. But this has always been an acquisitive company. And I have to imagine M&A, really both acquisitions but also divestitures of noncore businesses remains top of mind. And so can you maybe just walk us through how you're thinking about REZI's capital allocation priorities and if anything has changed under Mike's new leadership?

Yes. No, I think Mike joining the team has been a very positive addition, building off of the good work that Tony had done in the past. And I think one of the things that they share is a priority to delever, okay? I think we're a very cash flow generative business. We have lots of opportunity to delever likely by building cash on the balance sheet since our maturities for the debt really the most -- the first meaningful payment isn't until 2028 and the bulk of the payment center weighted around 2030 to 2031. So I think that's the #1 priority. To get from our current levels, I think, is a little north of 2 to south of 2. But building that cash on the balance sheet and then enabling that financial flexibility that we want to have.

Okay. Okay. Super. Last handful of questions in the 3 minutes we have left. This is a tough one, but your former parent company splitting into kind of 3 separate companies. Does that have any impact on the indemnification agreement that you -- that you 2 have? Is there anything that you can do to kind of modify what was -- what you guys have called a very strong legal binding agreement? Anything that changes with kind of what's going on, on the Honeywell side?

I think we might have used different terms that, but no, look, I think it's a fair question and a good question. But unfortunately, there's nothing that we can really share. There's no real news about Honeywell's announcement of their corporate action and its direct impact to the reimbursement agreement.

Okay. Okay. And then maybe second to that, just to the extent that you can share an update on the CD&R relationship. So for anyone not aware, CD&R became a cornerstone investor for you guys in 2024. They have 2 Board members -- 2 members on your Board. Just kind of what's their broader thesis? What do you guys talk about? How do you guys interact? And how does that kind of change or influence the strategic direction of the company going forward?

Yes. Look, I think having smart and good money like CD&R backing us, I think you can interpret as a conviction play. I think they see the opportunity to create shareholder value alongside the management team and the Board. I think the 2 members of CD&R who joined our Board, Nate Sleeper and John Stroup, are very dynamic and impressive individuals who I think have complemented the Board very, very well. I'm not privy to the private conversations, but in the times that I've interacted, there seems to be a lot of camaraderie and good idea sharing.

Okay. So maybe just to wrap up, we have a minute left, is just -- and maybe I'll pose this to both of you guys. Chris, you broader. But Tom, you specific on P&S. Just what's most exciting about the story? Or maybe asked a different way, what is most maybe underappreciated about the story that we could all learn more about that could get us more excited?

Why don't you start and then...

Yes, sure. I mean it goes a little bit to kind of we talked about that information disconnect of what we know inside, of what we're doing to this company to revitalize it and become the leader in our market. And I think people don't appreciate fully the strength of the business, the margins that we can actually achieve, the profitability we can achieve, the cash we generate and that, that is something that we can grow with where we see ourselves positioned in the market.

So that's P&S.

Yes. And I think that's a direct correlation with what ADI feels and what the total company feels. I think fundamentally, there's a lot of momentum here that's been underappreciated historically, and it's underappreciated because it's underknown. So that all leads to us being undervalued. I think this is a great opportunity for the investment community to do the work and learn more about the exciting new things we're doing. And I think you'll be pleased with what you'll learn.

Cool. That's a perfect way to end. Thank you, guys.

Thank you very much.

Thank you.

Awesome. Thank you.