Okay, thank you, everybody. Welcome to the Oppenheimer Industrial Conference. I am Ian Zafino. I am the equity research analyst that covers Resideo. I've been covering them since they spun out of Honeywell. With me today is Tom Suran, the company's President of Products and Solutions, and also Mike Carlet, who is the company's CFO. Guys, thank you very much for being here today. We really appreciate it.
Thanks, Ian.
Thanks for having us.
Okay, so now, first of all, very nice quarter last night. Glad to see that stocks reacting very nicely today. Maybe we can back up and do a little bit of a high-level discussion at first, call it. Maybe you could give us a quick overview of just Resideo and the main segments. I know there's ADI, there's products and solutions. Maybe give us a broad overview of that. Thanks.
Sure. At a high level, Resideo operates in two distinct segments. We have our Products & Solutions group, which Tom is the President of, and P&S, you'll hear us call it frequently. The P&S group is focused on developing products that are instrumental to home management, things that attach to the energy, to the security, to the safety aspects of the residential home, and bringing products to light. We have brands such as Honeywell Home, First Alert, BRK, and others that bring those products. Tom will talk a lot more about those. On the other side, we have a distribution business called ADI. ADI's legacy was historically serving the commercial security integrators and professionals that install security solutions in commercial establishments. Over time, we've been growing that to serve more and more professionals and more and more markets.
About 15% of what P&S sells gets sold through ADI, and about 10%-15% of ADI sales are P&S products. Obviously, there's a lot of interaction between those two businesses that ties them together. Both businesses are very focused on serving the professionals and providing products and solutions to those professionals. We think they go really well together. Rob Aarnes, who's not here today, runs our ADI segment. Tom and Rob work closely together to make sure we're serving the needs of those professionals on an aligned basis.
Okay. And then just so maybe I know we have Tom here. Tom, can you just walk us through some of P&S's business, some of its key product offerings, end markets that you're serving, and kind of what you're seeing that's attractive or higher growth areas? Thanks.
Sure. What we do in the P&S business is we're focused on creating products for the controls and sensing in residential homes primarily. Our focus on that is to create differentiated products in specific segments through professional distribution and pro installs. The markets that are in that, we call it AIR. AIR includes the thermostats, the control and sensor HVAC systems, plus indoor air quality systems, humidification, dehumidification, ventilation, filtration, and then grid services, the control of those systems interfacing to utilities to basically optimize the load on the grid. That's one segment, AIR. The next segment would be security. Sometimes we bundle that with our safety. We say security and safety, but they're fairly distinct. Security is the classic for us has been intrusion.
We're pivoting from an intrusion play to a more broad definition of what total security for a resident or small business would be, which would include access control and video. Then safety, what that means, typically it's fire safety for us at this point. That's your smoke detectors that we market under the First Alert brand. We have the water business. The water is for the control and the flow of water, typically in two applications. One is hydronic heating. In many markets, the most efficient means of transferring energy is through water. You see that very commonly in Europe. You also see that in the northeast of the United States. You see that up in Canada. Those are what we call the hydronic systems.
We have potable, which is the classic, just the water flowing out of taps. We make various components to control that flow, regulate pressure, make sure it does not backflow, filter it, what have you. Lastly, we have our OEM or energy business, because these are basically the sale to OEM appliance equipment manufacturers. Our role is to help them with combustion control. Sometimes it is the electronics related to that. Often it is the gas valves, chambers, interface designs. In the United States, it is typically water heater and furnace manufacturers. In Europe, it is the heat pump and boiler manufacturers. That is overall business.
Okay. Can you just help me understand how you go to market in this business? I know there's a big kind of contractor component to that. How large is that? How are you going to market? For me as a residential homeowner, am I able to pick my product, or is that really just what the contractor is giving me? Just help me understand how you go to market. Thanks.
Yeah, sure. We are not a direct-to-consumer company. We sell through three major channels, I guess you could say. One is just the classic distribution channel to go to the pro contractor. Okay? The guy who's going to come up in the truck and install your systems. Hopefully, you have a relationship with him that you're able to kind of have a description of what he's going to be installing and what things you'd like to see. If you know, "Hey, listen, the Resideo Honeywell Home product is what I really want," he should be able to do that. My guess is he's probably going to tell you that that's probably the best solution for you and then explain why. That is very important to us. In fact, if you look at our strategy, we want to be the leader in those markets.
We want to do it through differentiated products. We want to do it through the pros. The other place where pros play is in residential new construction, right? This is all of those homes that are being built by the professional building companies. Sometimes they have employees handling this rather than independent contractors. We will sell to them. Again, that product is typically delivered to them through the distribution channels. Lastly, we sell to retail because 50% of the retail sales at, say, a Home Depot or Lowe's go to contractors. Contractors go there because it is a convenient place for them to pick up products. Of the other remaining 50% that is not purchased by the pros, it is the individual purchasing. Of those, they often purchase the product and then call a pro to install it.
We have to participate because that's where pros are purchasing product in the retail place. That's how we get the product into our customers' hands.
Okay. Can we just dig a little bit deeper into the fire business, fire safety? What are the growth drivers there? Where do you see the market heading?
First, it is a regulated and a code-driven business, right? Just in terms of every residence needs to have one of these in every bedroom and then every hallway between the bedroom and a point of egress. That drives a lot of it. You see it both in the remodel when people do anything to kind of work to the house. There is a replacement market because they have 10-year lives plus the new construction. It is also a key sensor in the home. What you are seeing in one of our new products that we just introduced, our smart connected smoke detector, is the ability to provide awareness when you are not in the house because most smoke detectors just alarm in the home unless it is part of a security system.
This basically would toward messages to your application on your phone so that you can be away from the home and be aware if something has gone wrong in your home, be able to address that. That is one place. The other is it's a key sensor. When you look at the overall whole home, having this integration of all of the various forms of sensing, whether it's coming from what your energy level is or what's happening with your water flow or a leak of water, that's another part of our water business, leak detection, or the temperature thermostat, what's going on or presence, it's a key sensor for an overall awareness of a whole home application because that's our real goal, to provide comfort, protection, and savings through our controlling sensing of the whole home subsystems.
Okay. As you look at what you've been doing, just a segment in general, maybe talk about where you've innovated and then also areas that you think you could continue to innovate in.
Yeah, I would say it's fundamental to what we want to do. We do not want to be a generic provider of anything. We want to provide differentiated products to our customers that they perceive the value that enhances their lives. In every one of those markets that I went through, we're trying to create something new for them. If you go to AIR and say the thermostat, the products we're introducing, we introduced the first Matter thermostat for a low-end product, right? All of a sudden, that was the low-end. We're going to be bringing in a high-end thermostat coming in the second half of this year. There will be a whole product family that's part of an overall platform. It will have features I don't want to pre-announce right now that will take us to a leadership role there.
We're doing the same and say, if you looked at the safety business we just talked about, the fact that we're providing this connected product that's allowing people to have an awareness away from their home to protect and just be aware of that. If you look at what we're doing in the security with what we're going to be offering, not only with the CX4 video systems, the 4K systems, but what we'll be introducing for an overall single pane of glass integrated solution with advanced video analytics in the second half of the year, we'll be announcing some products related to that, and then eventually the overall access control. Then our leak detection, say, in water, what we're doing there. Every one of these product categories we're participating, we want to be the leader in that, and we're going to do that through differentiated solutions.
Okay. Good. That is helpful. Maybe we go to kind of the topic du jour on the tariff side, right? What is the impact now on P&S? Maybe take a step back. What's kind of your manufacturing exposure and footprint? I have a follow-up to that.
Sure. In P&S, we have a global footprint. We typically produce products in the region that we expect it to be consumed. We have facilities in the EU. We have facilities in Asia Pacific. We have facilities in North America. For the North America region, our factories are down in Mexico, although we do have a U.S. factory. If you look at the consumption of product in the U.S. market, which is what's being most heavily tariffed right now, those products are 90% coming out of our Mexican facilities. Of that product that's coming out of the Mexican facilities, 98% is USMCA compliant, which USMCA compliant products are not currently tariffed. They are exempt from tariffs at this point. Of the remaining less than 10% that doesn't come from our Mexican or U.S. facilities, it's a smattering of things.
We are working through how to either bring that product into our facilities or source from a North American supplier. There will be some cases where we are not able to do that, and then we will have to adjust our pricing to our customers. Again, you are going to be dealing with a very small percentage of our overall revenue to the point where it is de minimis. We have been very upfront with communicating this process with our customers. They are very aware exactly how we are going through this.
Okay. If we look at a couple more questions on this, are you noticing anything as far as supply chain issues or anything along those lines as opposed to just the pure dollar amount of the tariffs? What type of pricing do you think you actually would need to offset the minimum exposure that you do have?
In terms of supply chain, we have not seen any disruption to it. Because we are buying at fairly low-level componentry and we are doing a high level of conversion, our factories are high-level conversion, that is why we are USMCA compliant. We have not seen disruption at this point at all. I mean, things could change, but as of now, we are not seeing any disruption. In terms of the pricing that we would need to do, again, it is such a small portion of our sales. The things that have been impacted, there are two major parts to it. There is the rest of world, let us say, which would be EU, Great Britain, Thailand, Taiwan, those miscellaneous products. Some of that is coming from our factories that are offshore that had a specialization and created something that we have brought into the US, for instance, for the water.
In that case, the price increases we've communicated have been approximately 6%. You are dealing with a very small portion of our sales, very, very small. We've communicated that to our customers, and they've been completely accepting it because it's just such a small percentage of the overall. The second piece would be the products coming out of China. This is the one we've worked much more to try to bring products into our own production so we can create greater conversion value. For those products that we're not able to do that, we're going to have to be adjusting pricing much more. You are dealing with immaterial amounts of dollars or even percentages.
Okay. Thank you. Mike, maybe you could touch upon kind of similar conversations at ADI for tariffs and kind of what's going on there to mitigate it. Yeah. Thanks.
Sure. ADI is mostly a distribution company. Over three quarters of what we sell is third-party product where we're bringing it in and reselling it mostly in the North America market with also a pretty big footprint over in EMEA. As we think about the tariff impacts here, we're looking at where our third-party suppliers provide those products, where they source those products, and then how we think about the impacts we're going to have. About 20%-25% of what ADI sells, we believe, is sourced out of China. We look to where those third-party products are sourced. It's coming out of there. We're sort of dependent on what those third parties are going to do vis-à-vis price before we pass it along.
As of today, as we talk to our suppliers, less than a quarter of them have passed along significant price increases. We continue to monitor that. As we absorb those price increases, we pass them along, as does every other distributor. We are not disadvantaged vis-à-vis other distributors. We all get the same impact from those suppliers. We all pass it along on a timely basis. We try to phase that in appropriately. Today, as we are sitting here, we think there are price impacts of 5%-10% based upon the amount of product that is coming primarily, again, out of China. There are other areas as well, but primarily out of China and where we have been told that those prices will increase. As we continue to monitor that, we continue to talk to our suppliers. We continue to talk to our customers about what is coming.
I think everybody understands that not all of that will be passed through, but a significant part will be passed through as suppliers react as time goes by. Obviously, it is a fluid and dynamic environment. We do not want to get too far ahead of ourselves as we think about other potential changes that might be out there. Cannot forecast what is going to happen. We continue to monitor it and look closely at how we think about passing those pricing actions through. I think the really important callout is that as primarily a distribution company, everything we are doing, it is the same as everybody else is feeling. There is no disadvantage or advantage really to any supplier.
You are really back to your just core, why are you going to succeed is back to your core operating principles, your core competitive advantages as you think about the competitive environment.
Okay. In a classic distribution model, typically what would happen is prices go up a dollar. The distribution company might do a dollar plus a margin, right? If the margin is 10%, you would then take it to a $1.10 price increase. Do you think that is going to happen here similarly? Or do you think you might have to, if there is a dollar cost increase, you might not be able to protect your margin as aggressively as kind of in a normal environment where we see costs go up?
Yeah. I think what's fair, what we believe is fair for our customers, is to pass through the dollar impact, not the percentage impact. If the price goes up a dollar or if our cost goes up a dollar, our intention is to raise our price a dollar, not raise it a $1.10. We might see some margin rate degradation because of tariffs. Underneath that, we do believe that we're going to see margin accretion growth, margin rate accretion from our organic activities. That'll probably be somewhat offset by this price activity because, again, we think the fair thing to do is let's protect our EBITDA, let's protect our bottom line. We'll see some margin rate degradation around that as we pass that through. Like every distributor in the very short term, there might be some bumps. You're never going to time this perfectly well.
We have inventory that we purchased at pre-tariff pricing. We are going to try to phase the pricing as appropriately to not overly take advantage of that. Obviously, we are going to do our best to not be on the wrong side of that equation as we think about phasing of the price increases that are out there.
Understood. Okay. Let's talk about the fun stuff on ADI. Maybe help us understand where this business grows, what do the end markets look like, and then how much is commercial versus residential?
Yep. ADI's legacy historically was in the commercial security business. That is still its sweet spot of where it operates. We are the significant provider there to the professionals that go into commercial establishments and are installing all the security cameras, access control that goes into those establishments. That's the sweet spot of Square. It's probably where we live and we have the best competitive advantage. Over years, we've been expanding that business to grow into the data comm area, the pro AV area, the residential AV area. All those are continued growth opportunities for us as we look forward. We're still three quarters plus on the commercial side, about 25% on the residential side. The residential side, primarily through the Snap One acquisition. There was other activity as well, but primarily through Snap One.
That part of the business really does operate at the high end of residential. If you think on the P&S side on Tom's business, we're really broadly across all of residential. A thermostat goes in every house, right? A smoke detector goes in every house. Security can go very much broadly across a number of areas. The residential entertainment AV control areas that ADI through the Snap acquisition operates in are very much at the higher end of the residential market.
Okay. Maybe also help us understand in ADI, what's kind of the competitive advantage of ADI commercial, professional installation, smart homes? What are the advantages here? Also talk about the environment, competitively speaking. Yeah.
Sure. I think ADI's single biggest advantage is operational excellence focused on a customer-first ethos. If Rob was here and was talking about business, Rob and his team are extremely focused on flawless execution, delivering a great experience to the customer, providing the products they need on a timely basis with great information, and putting the customer first all the time allows them to do that. It does provide that competitive advantage. You think about the e-commerce activities, how we think about the omnichannel solution. Everything that's there, it all starts with the customer. Putting the customer first all the time, I think, is the single biggest reason that we're competitively advantaged. Now, we've got 110 locations in the U.S. and dozens of locations throughout the rest of the world. We do have a great footprint that allows us to meet the needs of the customers.
We have great activities on our exclusive brands. Over 20% of what we sell these days is our own branded product. We have great products, not just great distribution, but also great products where we can innovate around those exclusive brands to bring solutions that provide the complete suite of solutions to integrators where they need those products. Obviously, we're primarily a distributor, primarily third-party product distribution. We do look at our exclusive brands as another source of competitive advantage where we understand the needs of the customers as well as anybody else because we're talking to them every single day, and we can therefore deliver the best solutions to them.
Okay. Who are you competing with in that space, and how do you do versus them?
Yeah. I think on the distribution side, there's a number of large distribution companies that are out there, all the normal players that we feel we are well positioned. There's also regional distributors. It is both national distributors, regional distributors, local distributors that are all servicing the same professionals and trying to meet their needs. I think, again, our systems, our operational execution, our focus on flawless execution allows us to meet and beat all those competitors as they're we buy better than everybody or as well as everybody. Again, putting the customer first allows us to compete better than everybody else. On the exclusive brand side, like everyone, every category that we have an exclusive brand, there's a different competitive set that we're thinking about, whether it's our Arachnous networking, whether it's our Episode and Triad speakers, whether it's our Control4 home automation system.
Each one of those is going to have a different suite of product competitors that we're thinking about, how do we operate against them. There is nobody on the product side on the exclusive brands that we look at, say, there is a single competitor that we specifically worry about.
Okay. Good. If anyone has any questions, please put it in the chat, or you could email me at ian.zafino@opco.com, and I'll get your question answered. As far as if we could get a little bit deeper into ADI, you did the Snap One acquisition. Maybe help us understand what you've learned recently. Why did you do the deal? What are you seeing as far as growth opportunities and anything else you want to highlight on that business?
Sure. Listen, we're thrilled with that acquisition. I think I actually came from the Snap One side of the business. As we were going through diligence, I was fortunate enough to meet the Resideo team, the ADI team, the Resideo team, Tom, Rob, Jay, and was fortunate enough that Tony Trunzo, their CFO, said, "Hey, I'm thinking about the next thing, and let's talk about whether you want to stick around." It's been a really great experience for me. It's been great to see how well the two companies at ADI and Snap have come together. We originally met Rob back in 2017. It was even before the spinoff from Honeywell. Rob was running ADI at the time.
We were going through a recapitalization at Snap, and we met Rob, and we walked out of the meeting with Rob, said, "We really should put these two companies together at some point in our lives." It took seven or eight years to get it done, but it was always something that we thought made a lot of sense. If you took ADI's focus on the commercial professional integrator from a more brick-and-mortar standpoint, Snap had been a pure e-commerce business focused on the residential side. Snap was growing into omnichannel. ADI was growing and focusing more on e-commerce omnichannel. We were looking to get a professional. ADI was looking to get a residential. It really was a really great match. As we put the companies together over the last six to nine months now, it has come together really well.
Rob's team is a combination of legacy ADI and Snap folks. It's one organization. It's one sales team. We'll still have separate go-to-market endpoints. There's still Snap locations and ADI locations. It'll take a year or two more from now to really bring the systems together and really fully integrate all the operations. Organizationally, go-to-market, exclusive brands development, all those things are going really, really well. We're ahead of our plan on timing of synergy. We feel great about the amount of synergy that we're generating. More importantly, we think that we're delivering to the customers the experience that we really felt we could by bringing these great organizations together.
Okay. Thanks. If I could just squeeze in one more on ADI, and then we'll move on. On ADI, what are you seeing as far as how go-to-market has changed and how you're interacting with your customers, right? I think things are becoming more digital. There's more e-commerce. There's more analytics. Maybe help us understand what that does to ADI's business, what it does to your contract and relationships, and any other type of color you could add.
You're spot on. I mean, e-commerce and the omnichannel experience is more and more important. People are more and more buying through an online portal, but that does not mitigate the need for the local stores for that local experience. Much of the sales activity still happens at local. Much of the education, the training, learning about products all happens at those local stores that are out there. We think it is really the omnichannel solution. We have invested heavily into the e-commerce solutions that are out there, which is going really well. I think in Q1, I am going to quote a number here that I think is right. I think Rob said yesterday, 15% growth at our e-commerce business in Q1 year over year. That is on an organic basis. That is not talking about Snap One acquisition.
It is more and more important, but I would not think about it as a shift purely to e-commerce. It really is about that omnichannel experience, which changes the relationship. We think we are really well positioned and competitively advantaged on that given the significant investments we have made and even adding Snap into that. Snap's legacy was as an e-commerce company. Bringing those two things together really brings some great expertise to bear on how to really develop those solutions.
Okay. As we look at the M&A environment, what does it look like? Any areas that you feel like you need to bulk up or to bolt on? Yeah, just broadly speaking.
Yeah. I'll let Tom talk about some of the P&S activity. I think broadly, listen, our capital allocation plan is first invest in the business that we have. Two, let's get deleveraged. We obviously have a bunch of we had some leverage as we did the Snap acquisition. We think there's a number of M&A opportunities that are out there that allow geographic expansion for ADI, that allow for us to find more exclusive brand products that might make sense to add to the portfolio, that allow us to expand our customer reach beyond those core residential AV and professional security commercial integrators that are there. We're continually looking for those. Quite frankly, at ADI, we're about halfway through the bulk of the big digest of Snap and ADI acquisition. There'll be years of tail on that on the local side and bringing distribution centers together.
We're well through it. Until we're very comfortable we've done that, I doubt there'll be a big ADI acquisition. We're very, very comfortable there. If the right opportunity's there, we'll certainly look at it. Tom, I've seen a number of opportunities on the product side to think about bolstering the product portfolio. I think.
Anything that's differentiated that provides comfort, protections, and savings to our customers related to the control and sensing in the home, we would be interested in if it's complimentary. One of the key things that we want to stay focused on is the investment in our products to create those differentiated solutions. A key piece of what we're doing is driving scale. When you look at the thermostat business, our scale relative to our competition is significant. The same thing when you look at smoke and safety detection. In the markets we serve, we have driven to make sure we have scale and making sure now more so that we're leveraging that to have a competitive position. We'll look at those companies, but right now, the first priority is investing in the products and our product lines to create a competitive advantage.
Okay. And then more to that point, how are you thinking about now capital allocation priorities? Yeah.
Yeah. Again, as I said, I think our primary capital allocation as we think about cash generation, and we'll generate $375 million of free cash flow this year or cash flow from operations this year, is first to invest in the business. As Tom said, first thing is I book the ADI and edit P&S. Let's make sure we've got great product innovation, great product development, great customer-first solutions that we're bringing out there. We think deleveraging down. We've been very clear that we're going to get back below 2x leverage. If we can see a path getting below 2x leverage in the near term, we'll then think about other types of use of capital, whether that is on the M&A side, whether it's return to shareholders. I think we've proven with both the First Alert acquisition a number of years ago, the Snap One acquisition that we did. We're focused.
We're looking at things that are needle moving. We're focused on things that we have a very high level of confidence with, a lot of synergy that really add a lot of value and create shareholder value as we think about those going forward. We've got a high bar for what we do from an M&A standpoint, but we do look at opportunities that are out there.
Okay. I know it's been de-emphasized recently or less talked about, but maybe can you talk about your ESG efforts and your focus and maybe energy efficiency kind of comments? Thanks.
Tom, you want to talk about the energy efficiency piece of our product portfolio first, and then we can talk about just sort of overall?
Yeah. In most of the market, especially in OEM, improving the combustion and the conversion, electrification, all of those are major thrusts of the industry. Whether it's including what we had recently in most of the industry, a shift in the more greenhouse benign gases. There was a shift in the gas that was R410A to R32, greenhouse more beneficial or less offensive. There was a shift there as we look at combustion systems. We're working on more efficient combustion systems through dampering systems, the Venturi valves, how we're able to kind of get the most. We are seeing still the electrification and the heat pump and how that's being utilized in various markets. It's continually evolving. We participate in all those markets.
I think just overall from a corporate standpoint at ADI, I think our CEO, Jay, his mantra has always been, "Do the right thing." I do not think that changes. I think despite all the noise around some of the ESG activities, I think as a company, do the right thing continues to be our mantra. I think on the environmental side, while there is sustainability, while there are lots of changes that are going on out there, where there is economic benefit, I think there will still be opportunities for us to continue to explore and participate in those. I think the focus is changing from compliance to where there really is benefit. As Tom talked about, there are areas around ESG that really are continually beneficial to our customers, and we are continuing to focus to invest in those areas.
Yeah. I mean, when you think about what makes a great thermostat, one of those things is not only the comfort, but trying to provide that comfort as efficiently as you can. That is a key part of what the thermostat and what we are trying to do to drive not only balancing and driving, improving and maximizing comfort, but maximizing savings. That is what you have seen. That is what has upshifted resources.
Okay. Perfect. We have like one minute left. Anything you want to give us as far as how we should be thinking about 2025 or just any other kind of comments that you'd like to make for investors to get a little bit more understanding of the business?
No, listen, Lee, I think we announced our earnings last night. We were thrilled with our first quarter performance despite all the uncertainty that's out there. If the tariffs weren't making so much noise, I think we'd feel, well, we still feel great about what we can control. The execution that Tom's delivering from a new product development initiative standpoint, continuing to bring those products to market, continuing to bring differentiated products out there, we feel great. ADI is continuing to execute, continuing to enjoy the benefits of bringing Snap and ADI together. Outside of the tariff noise, we feel great about the business. Listen, we'll control what we can control in tariffs. It might change tomorrow. We know what's out there today. Today, we're very, very well positioned.
As things continue to evolve, we'll continue to talk to our customers, continue to talk to our suppliers, and make sure that we are doing all we can to mitigate any impacts. As we sit here today, we feel really good about our position vis-à-vis the uncertainty of the tariff market that's out there.
Perfect. All right, guys. We're out of time, and I know you guys have a big schedule of meetings today, so I'll let you guys get to that. Thank you very much for attending and doing this presentation.
Thanks, Jayden.
Thanks, Jayden. Yes.
Take care, guys.
Appreciate it.