Q4 2023 Resideo Technologies Inc Earnings Call

Participants

Jason Willey; VP, IR; Resideo Technologies, Inc.

Jay Geldmacher; President & CEO; Resideo Technologies, Inc.

Tony Trunzo; CFO; Resideo Technologies, Inc.

Ryan Merkel; Analyst; William Blair & Company

Erik Woodring; Analyst; Morgan Stanley

Presentation

Operator

Hello, ladies and gentlemen, at this time, I would like to welcome everyone to the Resideo Technologies' fourth-quarter 2023 earnings conference call. (Operator instructions)
It is now my pleasure to turn today's call over to Mr. Jason Willey, Vice President of Investor Relations. Mr. Willey, you may now begin.

Jason Willey

Good afternoon, everyone, and thank you for joining us for Resideo's fourth-quarter 2023 earnings call. On today's call will be Jay Geldmacher, Resideo's Chief Executive Officer; and Tony Trunzo, our Chief Financial Officer. The copy of our earnings release and related presentation materials are available on the Investor Relations page of our website at investors dot resideo.com. We would like to remind you that this afternoon's presentation contains forward looking statements statements other than historical facts made during this call may constitute forward-looking statements and are not guarantees future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in Resideo's filings with the Securities and Exchange Commission The company assumes no obligation to update any such forward-looking statements. We identify the principal risks and uncertainties that affect our performance in our annual report on Form 10-K and other SEC filings.
With that, I will turn the call over to Jay.

Jay Geldmacher

Thank you, Jason, and thanks, everyone, for joining us today. We finished 2023 on a strong note Q4 revenue and profitability were above the midpoint of our outlook and cash generation was strong with full year operating cash flow of $440 million. We built momentum throughout the year and order activity within products and solutions. We also made significant progress on our key strategic operational initiatives and in meaningful reducing structural costs. During 2023, we made substantial progress reshaping our portfolio and operations with the divestiture of Genesis and the outsourcing of our casting facility in San Diego. Work continues on rebalancing our product portfolio, manufacturing operations and ADI footprint to help position the business for profitable long-term growth. We expect to have more to share on both fronts as we move through 2024. We also advanced the ball on the partnership front, strengthening our relationship with major insurance providers, establishing new relationships in the energy management market, including our recent announcement with Ford and meaningfully expanding the depth of homebuilder relationships. We have spoken previously about our progress building content with homebuilders. This work is led by our first solar and BRK. professional brands. We've expanded content with existing builders and increase the number of partners we're selling to adding over 20 new builder partners in 2023. We believe we are well positioned to drive growth in this channel as the new construction market recovers. We also expect this additional content will have positive long-term benefits to our potential replacement base.
Our innovation within products and solutions, we significantly improved our new product introduction cadence. This included New Video Doorbell and outdoor camera products for our professionally monitored security offering watching Pro series for the media security market. First Alert branded connected water leak detection and shut off products and the rollout of UL eighth edition smoke detectors. We are seeing results based on all these actions. We're encouraged by order trends within products and solutions, which have stabilized year over year and grew sequentially in Q3 and Q4. Through executing on new product introductions and taking effective cost control actions, we are achieving gross margin expansion despite volume headwinds and continuing to invest in key long-term initiatives. At ADI, we continue to grow our digital capabilities. Building a leading digital experience is critical to customer engagement and is expected to be margin accretive over time. For 2023, e-commerce sales were up 8% year over year. Total touchless sales, which includes e-commerce, electronic data interchange and e-mail automation now account for 38% of ADI's total sales. We made significant investment during 2023 in our product information management and data asset management systems. This work helps to enhance the usability of our web experience with a focus on speed, intuitive search and accuracy of availability and delivery information.
Adi continues to make progress with its expansion into adjacent categories, particularly in the audiovisual market, ADI acquired BTX. in early 2023, adding new capabilities in the professional AV market and in-sourcing custom fiber assemblies for levy was one of ADI's better performing categories in 2023, growing 6% on an organic basis and now accounts for 10% of ADI sales.
With that, I will turn the call over to Tony to discuss our fourth quarter results and 2024 outlook.

Tony Trunzo

Thank you, Jay, and good afternoon. Everyone. fourth quarter financial results exceeded the midpoint of our outlook range for a second consecutive quarter, led by continued momentum in the Products & Solutions business. We drove sequential improvements in gross margin in P & Ls for the third consecutive quarter and generated $263 million in cash flow from operations for the year. Cash flow from operations was $440 million, a record since spin. Over the past three years, we have converted 89% of GAAP net income into free cash flow, demonstrating the strong cash flow characteristics of our business.
Presidio fourth quarter revenue of $1.54 billion was 1% lower than Q4 last year, but flat excluding the sale of our Genesis wire business. Operating income for the quarter was $147 million, an increase of 50% compared to last year. Adjusted EBITDA was $136 million, up 11% compared to Q4 of 2022. Fully diluted earnings per share were $0.56 and $0.48 on a non-GAAP basis compared with $0.26 and $0.25, respectively last year. Non-gaap EPS exceeded the upper end of our guidance range for the quarter.
Products and solutions. Fourth quarter revenue of $683 million was 1% lower than the fourth quarter 2022, but up 2% when adjusting for the sale of Genesis price realization added approximately $16 million to revenue. And overall volumes, excluding the Genesis impact, were down low single digits. First, solar delivered a strong quarter, particularly in residential new construction, and we also saw growth year over year. In lot of products. Orders were up sequentially following the stabilization experienced in the third quarter. While channel inventory remains elevated in some areas, we believe order activity and point-of-sale data indicates channel inventory overall is normalizing products and solutions. Gross margin in Q4 was 39.5%, up 110 basis points compared to last year. Gross margin improved sequentially in each quarter of 2023. We achieved reductions in raw material costs, manufacturing headcount and freight costs, which more than offset the impacts of reduced volumes and labor rate inflation as unit volumes and factory utilization rates recover, we continue to believe P. and S. gross margins can further improve products and solutions.
Fourth quarter operating expense was down $14 million year over year, excluding restructuring costs, products and solutions operating income was 147 million in the fourth quarter, up 50% compared with Q4 2022 and up 16% when adjusting for prior year restructuring charges.
Turning to ADI, Q4 revenue was $854 million, down 1% versus the prior year. The business continued to experience pressure in residential security and video surveillance sales, which was partially offset by growth in access control and professional A/V categories.
Yes. Gross margin in the fourth quarter was 18% compared with 19.1% in Q4 last year. Gross margins were negatively impacted by transitory inflationary pricing benefits experienced in 2020 to reduce vendor rebate activity due to lower volumes and more competitive pricing in certain categories. PTS operating profit of $59 million was down 14% compared with prior Q4, reflecting the lower sales and gross margin on flat operating expenses. Corporate costs were $55 million in Q4, down $12 million compared with the prior year. Adjusting for unusual items in both periods, we drove $3 million of structural cost savings versus the prior period Q4 cash from operations was $263 million, up 89% compared with $139 million in Q4 last year. Improved cash generation and specifically working capital performance was a major initiative throughout 2023, and we more than achieved our objectives for the full year. We generated $440 million in operating cash during the quarter, we repurchased 719,000 shares of our stock for a total cost of $11 million. For the full year, we repurchased 2.6 million shares for $41 million, and our fully diluted share count declined year over year.
As we look toward 2024, our guidance is predicated on the following assumptions. We expect residential repair and remodel activity to be flat to down low single digits year over year. And residential new construction starts to grow by low- to mid-single digits. We have assumed a tracked channel inventory levels largely normalize in the first half of 2024, we expect to drive 50 to 100 basis points of gross margin expansion year over year within products and solutions moving sustained P&S gross margins close to 40% based on the benefits of ongoing efficiency initiatives in an essentially flat market ADR gross margin is expected to be flat for the year as we continue to see year-over-year headwinds from inflationary benefits. In the first half 2024 sales of our Genesis wire business will reduce 2020 for products and solutions security sales by approximately $105 million and operating income by approximately $10 million compared with 2023. At the end of December, we executed an amendment to our contract to directly supply ADT. hardware for their North American residential security offerings. Our agreement now runs through early 2025, at which time deliveries of these products will conclude. Based on this agreement, we expect our 2024 security hardware sales to ADT to decline by approximately $100 million compared with 2023 levels with a similar additional reduction in 2025. The impact of the new agreement is fully reflected in our 2024 outlook and is expected to be immaterial products and solutions 2025 profitability. Our guidance moving forward will focus on revenue, adjusted EBITDA, non-GAAP EPS and operating cash flow. We believe these metrics in combination provide the best view into the health of the business. With that said, here is our outlook. For the first quarter. We expect revenue to be in the range of $1.46 billion to 1.51 billion, adjusted EBITDA in the range of 120 million to 140 million and non-GAAP EPS of 28 to $0.38. The first quarter is typically a slower seasonal period for products and solutions due to reduced new construction activity and more limited restocking by our distribution channel.
For the full-year 2024, we expect revenue to be in the range of $6.08 billion to $6.28 billion. Adjusted EBITDA is expected to be in the range of $560 million to 640 million. Non-GAAP EPS is expected to be in the range of $1.48 to $1.88. We expect to generate at least $320 million of operating cash flow for the full year 2024. We finished 2023 on a positive note with strong Q4 results driven by outperformance in P&S while uneven quarter to quarter. Our cash generation was excellent in 2023 and has been strong since 2020. We are cautiously optimistic about a more accommodating macro backdrop as 2024 progresses. However, the current interest rate environment and related low housing turnover continues to provide headwinds to our business. Despite market uncertainties, our initial 2024 outlook implies low single-digit sales growth at the midpoint, adjusting for the Genesis and ADT. impacts and higher adjusted EBITDA, adjusted EBITDA margin and non-GAAP EPS compared to 2023. As unit volumes and factory utilization rates recover, we continue to believe products and solutions margins will further improve.
I'll now turn the call back to Jay for a few concluding remarks before we take questions.

Jay Geldmacher

Thank you. Looking back on 2023, both businesses navigated significant market headwinds with an almost 20% reduction in existing home sales in the US leading to the weakest housing turnover year since 1995, which had negative implications for our residential security business within both products and solutions and ADI consolidated sales fell only 2% in 2023. Despite these headwinds, because of our strong product offering and customer relationships, we were able to drive price realization within products and solutions and ABI. and broad commercial market exposure provided diversification. We finished the year with strong cash generation, improving order trends and gross margin momentum in our products and solutions business, as Tony noted in his remarks, will be winding down the existing contractual hardware portion of our long-standing relationship with ADT. Since I arrived at Resideo almost four years ago, our team has built a collaborative, constructive relationship with ADT from the executive level down. While we are wrapping up this legacy contract, we believe these relationships have created a strong shared foundation for continued collaboration and partnership.
As we look to 2020 for the products and solutions, we are focused on executing further portfolio and facility optimization efforts as well as increasing velocity of MPI. With our cost actions and transformation work, we believe we are well positioned to drive improved margin and profitability as market conditions improve and ADI. will continue to expand our digital initiatives and build upon our adjacent market and exclusive brands expansion opportunity. Our focus remains firmly on executing our key strategic initiatives while driving profitability, expansion and strong cash flow. I want to again thank the entire Presidio employee base for their outstanding efforts during 2023, and I'm excited to continue to build on the momentum together in 2024.
Operator, we are now ready for questions.

Question and Answer Session

Operator

(Operator instructions) Ryan Merkel, William Blair.

Ryan Merkel

Hey, everyone. Thanks for taking the questions. I wanted to start with the comments about order activity improving and stabilization in the market. But it looks like the first quarter revenue guide is maybe a little softer than we were thinking so is that just seasonality or maybe talk about the cadence of how you see sales progressing in 24, maybe at a stronger second half?

Tony Trunzo

Yes. Hey, Ryan, it's Tony on So yes, there is an element of seasonality in Q1. There is also a security sales are going to be lower because of the the disclosure we just made about about DT. and our expected reduction in revenue from from them during Q1 and also the genesis of the impact of Genesis in Q1, which is at 25 ish million, somewhere somewhere in that ZIP code.
If you look at if you look at the what I'll call the trade channels, it's still a little bit up and down. But by and large, we've seen we've seen inventories begin to work their way down. I think there's still some normalization in some areas that's got to happen in the next couple of quarters. And that's certainly contemplated in our guidance. But then beyond that, I think things really are starting to settle out a little bit as well. So yes, all those things are affecting Q1, and that's why you're going to see a little bit of a ramp as we as we go through 2020 or 2024.

Ryan Merkel

Okay.That's helpful. And then the gross margin in P. and S. stood out. Just curious, are you're going to be able to build off the fourth quarter level as we think about 24 to talk about the pluses and minuses and sort of the direction of gross margin for P&L?

Tony Trunzo

Yes. So yes, that I think the two things we were most excited about in 2023 was our ability to generate significant cash flow a little choppy, but we certainly did a great job, I think over the course of the year.
And the other was the sequential improvement in gross margin in P. and S., we expect that to continue. If you look at it year-over-year quarter to quarter, again, you still might see some some variation, but we've really made a lot of progress underneath kind of all of the volume declines and all that sort of stuff in our in our fundamental cost structure, we talked a little bit about that in the script in terms of what those what those things are and the expectation of, you know, half a point to a point of gross margin expansion in on MP&S this year is predicated on basically flat volumes. So we really feel like there's an opportunity if we see margin I'm sorry, volumes begin to grow again for some really meaningful margin expansion in that business.

Jason Willey

Then I would add also, Ryan, that I talked I think we've been talked about even though our last call together that as supply chains continue to improve the input costs continued to be trend in a favorable fashion. And that has continued, including between material componentry and of course, freight, which is a good thing. And that's just going to continue and the various actions that we've talked about that you guys have heard us talk about over the last couple of quarters cost actions that impacts provides a benefit to us on the gross margin expansion. So I think between what I had said as well, what Tony have said that we feel very positive about the opportunity there for further margin expansion.

Ryan Merkel

Great. Sounds good. Thanks so much. I'll pass it on.

Jay Geldmacher

Thanks, Ryan.

Operator

Erik Woodring, Morgan Stanley.

Erik Woodring

Hi, guys, and thank you for taking the questions.
I have two. Maybe one, just on the clarification point on ADT and just to confirm the North American hardware business seems to be gone after 2025. You're kind of very clear on the trajectory of that, but is there anything else with them? Because, you know, Jay, you mentioned kind of other areas of collaboration and partnership. And so just want to kind of understand it one level higher, how you think about the relationship with ADT after 2025, if there's anything that you can do that's incremental or if you still have a relationship, just how that stands? And then I have a follow-up.
Thank you.

Jay Geldmacher

Yes, thanks, Erik. As we indicated, the legacy hardware program that Tony talked about in terms of that the end of that program into 2025. But as I've not just stated today, but I've indicated for quite some time, our relationship with them is very good and we spend a lot of time on that. And so we're continuing to talk about other opportunities, and we'll keep you guys informed.

Erik Woodring

Okay. Very clear. That. And just maybe for easy about maybe for Tony, is there any any update to how to think about the ceiling for P. and S. gross margins? Like if I just think about some of the comments you've made today. You've obviously taken cost actions on that business. You're getting leverage in that business despite flat volumes. It seems like getting rid of Genesis and a key will be margin accretive. And I'd imagine that when volumes recover, that's all positive for P. and S. gross margins. And so anyway, that's if you think about the longer-term trajectory? Are there any headwinds that I'm missing that I'm that I'm that were not necessarily considering as we think you know, again, one, two, three, four, five years out and that's it for me.
Thanks so much.

Tony Trunzo

Thanks. Thanks, Eric. So I obviously don't have a number for you in terms of the long-term gross margin target for for P. and S. And the reason we don't have one is because of the long list of things you just laid out and the puts and takes around them from where we sit today and there are more from a from a market perspective and from our own execution and our own sort of position in the market, I think the balance is certainly looking out over a few years more tailwinds than headwinds. We've done a really good job maintaining price, which was, if you recall back during the inflationary surge, we were basically matching on increased input costs with our price increases, can that was dilutive to margin because we weren't getting margin on top of it. But we really felt like as input costs abated, we were going to be able to hold price.
And that has proved to be true.
And we have made substantial progress in a number of other manufacturing efficiency areas. We have divested some businesses that are lower margin. And we feel like there are opportunities to grow in some in some higher margin areas. And all of that is happening against a backdrop over the past, I guess five or six quarters of declining volumes as volumes as the decline slows and as volumes flatten out, you're seeing that in the in the gross margins you're seeing a little bit more benefit.
And to the extent that you begin to see Mark hub volumes expand again, I think there's a real opportunity for us to see significant margin expansion and I'd also add just a couple of as a summary, of course, the input costs, I talked about that before in the last call or cost actions that we've been taking the price piece that Tony just talked about, of course, the leverage opportunity when the market begins to come back. But just a couple of additional comments, the portfolio optimization piece that we've been talking quite a bit about. And then the proof of the pudding is things like Genesis as well as operational optimization, like when we closed off the San Diego facility and move that to the offshore third party. We have other opportunities there and we'll share more of those.
And the other that that I wanted to just mention is because with our heavy focus on MPI. just in terms of bringing more new products to market. But also as we as with that and looking at opportunities with more growth tied to MPI., but also Mark margin, our expansion with new products. So all those wrap together, I think is a great way of summarizing. We're not just relying on one or two pieces. We'll I think we have a good plan of attack with all the different items that we've mentioned here between Tony and I.

Erik Woodring

No, that is super helpful. I totally realize there's a lot of moving pieces. So I appreciate all that color and honestly, so thank you course.

Operator

(Operator instructions) Cory Carpenter with JPMorgan. Your line is open.

Hey, this is Danny van for on for Cory Carpenter. Thanks for the questions. On the first, given the uncertain time line of the broader macro recovery, are you think you have any further room to take price if necessary? And maybe if so any color on kind of what that cadence could look like throughout 2024? And then the second, maybe on the pace of product innovation within products and solutions for 2024. Are there any specific verticals to call out for having kind of the most runway? Thanks.

Jay Geldmacher

Sure. So I think standing so on on price, our outlook for 2024 assumes basically 1% on price down. So not as significant factor in our 2024 outlook, I think we'd be cautious about taking us more assertive position there just as as the market has been a little bit soft and we want to remain competitive and and all that all those sorts of things, we're not losing price, which I think is really important because we did achieve a significant amount of price. Incremental leverage on the price line is probably going to have less of a factor on our results than have that operating leverage as we see them as we see expansion in volumes.
But I would agree with that. I would just say that the look and not losing prices it is a very important piece. And as well as the market, we all know we're all watching what's happening out there in the world in terms of inflation and with supply chains have normalized, then you are going to be assuming we're in a situation than that on because there's a lot more competition competitiveness out in the marketplace that we see for both businesses and Danny on it, but you also asked about, I think, Danny Wright on security, MPI. for and for MGI. general, the idea again, Zone five maybe I'm sorry, you had no, I was going to say I'll make comment on NPA in general, and I've said it before, but it's worth saying again, I mean, we have MPIS., who is very important to us in terms of capturing additional market share, looking at opportunities to expand and expand our tool will reach the market in terms of share with new products. We mentioned, you know, this time and before about content in a home. And we also mentioned about being able to add a bunch of additional wins with our R&C builder community. One of the reasons with that is the expansion of our footprint in each one of those new homes. And as we as we continue to do that we will have more new products that will able to expand our footprint there.
So are focusing on the velocity of new products in each one of the segments we serve is top of his big focus for us.
And that's why I've highlighted not just today, but through the past few quarters, with the number of new products that we are bringing to market and there will be more to share.

Thanks.

Operator

There are no further questions time. I will turn the call back to Jason for closing remarks.

Jay Geldmacher

Thank you, everyone, for participating today, and we look forward to speaking with you over the coming weeks and months investment pickup.

Operator

It concludes today's conference call. We thank you for joining. You may now disconnect your lines.