Go ahead and get started. My name is Adam Tindall. Thanks everybody for joining. This is, you know, tangentially adjacent to my connected devices coverage. I don't formally cover Resideo, but very happy to have the team joining us here today. Really interesting story, a ton of moving parts. Mike and I were just talking about some of those that have created a lot of investor interest recently, and we're gonna touch on those. Our format's just a fireside chat. Would love to keep it interactive, so if you have questions, please feel free to raise your hand. But we do have, again, Mike Carlet, CFO, and Chris Lee, who is Global Head of Strategic Finance at Resideo. So with that, let's go ahead and get started. Mike, obviously glad to have you back for a second year in a row.
been a lot of talk about what's happened over the last year, so maybe we'll just start with a high-level overview of the company, background, market opportunity, and key value proposition.
Absolutely. You know, Resideo is a two-segment business. We were spun off from Honeywell eight years ago, for those who don't know the story. Yeah, a little bit eight years, 2018. And really, as we operate in two segments, one is our ADI distribution segment. In fact, we have our North America CFO of our ADI segment, Kevin, sitting over here in the audience. And ADI is the leader in low-voltage distribution, mostly in the commercial market. Also bought Snap One about a year and a half ago, which is where I came from, which was also the leader on the high-end residential audio-video distribution and specialty products out of the business around Control4 and things like that.
So very, very focused on the professional installer, the professional integrator, who's coming in, putting that exit sign in, putting in the security, the access control in commercial establishments, and also going to high-end residential and doing, you know, all of your speakers and your network and your security and surveillance in your home. So that's one side of the business. The other segment, our products and security business, is brands you're probably familiar with, such as First Alert, Honeywell Home, and others, that operates in a number of product categories around safety, security, water, energy, air quality, that all are around the infrastructure of the home. So when Adam talks about tangentially, you know, a lot of what we do is the systems that are embedded in the home. When somebody moves out of a home, the stuff that our products touch, they don't take with them.
They don't take the smoke alarm with them. They don't take the thermostat with them. They typically don't take the security system with them. All that stuff stays in the home, right? But these are part, these are part and parcel of the home, and putting the technology in the home around those products to support the infrastructure of the home, being the leading sensing and control company, for those products, is what we're aiming to do on the product side of the business.
Perfect. And we hinted at this, but wanted to shift to some of the more recent developments for Resideo. Can you touch on where Resideo stands today following the Honeywell settlement? Maybe just touch on the Honeywell settlement and the announced spinoff of ADI. We're gonna hit on those in more detail, but just some high-level thoughts first.
Yeah. When Honeywell spun the company off, they put in place the, nominally called the Indemnification and Reimbursement Agreement. It was a complicated financial instrument that basically had Resideo indemnifying Honeywell for Honeywell's environmental liabilities. And it was capped at $35 million a quarter or $140 million a year, but for eight years, there was this liability. The company, every quarter, would have to pay Honeywell $35 million. That was gonna last for 25 years from the date of spin. It was confusing. It had the word environmental in it, which, you know, wasn't our environmental liabilities, but obviously caused concern. So it really complicated the Resideo story, dramatically.
Held back investor interest.
Held back investor interest.
Non-starter.
That's exactly right, Adam. And so, you know, for a number of years, we had asked Honeywell if we could change the nature of that relationship. They were always like, you know, we like it the way it is. But they were kind enough to answer the phone this year. We had some good conversations with them. We were able to convert that, monetize that. We settled that liability for $1.625 billion, which is effectively the present value of the future cash flows at $35 million. But able to change it into something. The word environmental has now gone away. It's now just Term Loan B. So it's just normal sort of debt. People sort of understand that. And that liability went away. In conjunction with that liability going away, when that liability existed, there were covenants around it.
There was restriction of what could and couldn't do. And for years, the company had said, you know, there was some rationale when Honeywell spun off ADI and, and the product or the two segments together about why they did it, but really, these are two separate businesses. One more focused on commercial, one more focused on residential, one more focused on distribution, one more focused on product development. One with very different margin profiles as product and distribution businesses. And so we always thought, you know, the investor confusion, not just about the IRA, but around why are these two things together and what's the peer set and how do we value this. Very confusing. So we also thought we had the opportunity now to separate these two businesses. So we announced in conjunction with the IRA settlement that we were going to spin off ADI.
I like the word separate more than spin. Spin sometimes has a negative connotation. Like, these are two good, strong fundamental businesses. They're just different. They're not constrained by being together. You know, somebody has to own the business, I always say, and so they happen to be under common ownership, but it's confusing, and so we think allowing each business to operate separately, make its own capital allocation decisions, make its own strategic decisions is the right thing for each one, so we announced that in July, the end of July. We said we'll get it done by the second half of next year, and we are deep in the throes of working through all the operating, you know, things you need to do to get those two businesses to be separate.
Just take it all on at once, right?
Yeah, why not?
And in addition, Jay, CEO, has announced his intention to retire after the separation.
That's right.
Maybe just talk. So we've got, you know, the liability put away. We've got a separation of the two businesses, and then we're gonna have different leadership. Just talk about, like, the leadership and how you're approaching continuity through the spin or separation.
Yeah.
and what the priorities for building out those standalone teams look like.
Yeah. You know, the two leaders of those two segments today, Rob Aarnes on the ADI side, who's been the leader of that business for over a decade, Tom Surran, who came on board about two years ago to run the product side of the business, have been there. They will be the CEOs of each business upon separation. Effectively, as we said, those two businesses run very, very independently today. So we've got a relatively small corporate team. There's about 300 people out of 15,000-ish in corporate. Two of them are sitting here. You know, about 100 are in, like, IT, cybersecurity. So you've got corporate HR, corporate finance, corporate legal, but the rest of the businesses operate separately today. And Rob and Tom have them today. And so, you know, it's great. They're gonna step in, become the leaders of each one of those businesses.
We're thrilled to see them both be able to do that, and we'll build the teams around them. We'll take those corporate folks and figure out who goes where over the next three, four, five months as we continue to work through that. That's actually the easy part of this. I would actually say the long pole in the tent of the operational separation is more about the IT systems. It always is. Despite the fact that businesses operate very independently, they mostly have separate ERP. They are separate procurement teams. Everything's different. There's about 20% of our IT platforms that are combined, whether that's your HR system, whether that's your corporate network, whether that's, you know, your financial consolidation reporting tool, all those things there. So we've gotta work through all the IT separation.
I would say that's the single biggest variable of determining, you know, we said second half of next year, whether it happens earlier or later in second half of next year, is how comfortable we that we've gotten through all that operational separation and that both businesses are capable of standing on their own two feet. We're not gonna do it sooner than we need to because we wanna make sure each one is set up for success.
I'm gonna go off script for a second, but just as, you know, we have investors in the audience and stuff, and you're too, they're gonna have two different assets to pick from or potentially own both, right?
Yeah.
If you were to kinda like summarize, you know, company A, company B, what would be the, you know, main characteristics? What kind of investor would be interested in one side of the spin or separation and the other side of the separation? If you could kinda like lay out the case for each.
Yeah. Actually, Chris, you're sitting up here. Why don't you, since you run IR, why don't you take that?
Thanks for the opportunity.
No problem.
So look, I think if you look at the value proposition for Products and Solutions, it's a leader in the building products category. We have a broad portfolio, as Mike said, that, you know, is really tied to the infrastructure of the house. And we see a, you know, a go-forward financial profile that we'll share more details on as we get closer to the spin. But the way we'd encourage everyone to think about it is a low single digit to mid-single digit organic revenue grower with a very healthy margin expansion story. Today, they're printing about 43% gross margin as of the last quarterly print, end of September. And we see a path for, call it a 300-500 basis points move in, call it the next three to five years.
That's really underpinned around continued structural efficiencies in our operations and a new product introduction strategy, that is focused on product differentiation that'll allow us to take share in the marketplace and, while doing so, drive volume adoption and take price for a bit of the differentiation. That will continue to, you know, spawn a durable cash flow stream. Our Adjusted EBITDA margin today is 25%, and we see a lot of the gross margin expansion dripping down to Adjusted EBITDA over time. So that's the P&S value proposition. On ADI, it is the leader in the low-voltage security and residential AV categories and has a growth opportunity into adjacent product categories, which is professional AV and Datacom. We see their profile, or before I go into profile, their strategy is very straightforward.
They want to be the biggest player in the market in their categories 'cause scale matters. They wanna sell to as many customers as possible and, while doing so, earn and retain their loyalty to, you know, have more and more transactional volume and dollars. That'll translate into a mid-single-digit to high-single-digit growth, organic growth profile with, again, a what we think is an exciting margin expansion story. Today, they're at low 20% gross margins. We see that moving a couple hundred basis points over the next five years. Their goal is to get to a 10% adjusted EBITDA margin. Today, on a segment basis, they're somewhere around 6%-7%.
They have clear building blocks and advantages in areas like exclusive brands and e-commerce, along with some levers we can pull from an operating margin standpoint as we gain efficiencies in our business that I think, you know, provide the bridge to that 10% goal.
That's a great summary. I'm gonna pause there to see if there are any questions or, you know, as investors kinda think about either side, would, you know, welcome any feedback. I'm sure you're getting some in meetings. I'm not sure if you wanna touch on maybe some of the early feedback that you're getting on, you know, both sides, of the business.
I think, Adam, it's interesting. Back to the fundamental, why are we separating the business? Those are different businesses. They're different profiles. There are some investors who look at the distribution business and say, "Boy, that's a great business. I really don't like the product business for X, Y, or Z reason, and I love the distribution business." You have other folks that say, "Boy, I love that product business. Look at those margins or whatever it's gonna be, whatever attraction that." And I'm not really sure about this distribution business. So I think that's some of the confusion that we have to deal with today as a sum of the parts business. And I think, again, freeing up businesses to have the right investor base that is focused on, you know, the right fundamentals of each business, allowing them to make their own strategic decision.
That's what, that's why we're separating. It's not, people always ask what's gonna change when we separate the businesses. And the businesses today run pretty separately. So it's not like there's gonna be this, "Oh my God, I've had, you know, an arm and a half tied behind my back." There'll be some step change, but it's mostly about the clarity of each one to operate independently, deploy the capital as they see fit without having to worry about the other side of the house.
Questions? I don't think I've had a single question this entire conference.
No.
Yeah.
I'll send you the next presentation.
Yeah, please. Lob a softball in. All right. Maybe we'll touch on capital structure. You know, it particularly with the two businesses, right? So you made the largest payment to a company in history to retire the Honeywell liability. And I could go through the long answer or long part of this question, but I'll just kinda give you the gist. You know, maybe lay out the capital structure of each side, the current capital structure and optimal on each side of the house as we think about the ongoing entities.
Yeah. Our goal has been to maintain a near investment grade leverage profile, debt profile with, you know, double B credit rating. We maintain that despite the fact that we monetize that $1.5 billion, $1.6 billion that's there. You know, going in, we view, again, both businesses are good businesses. We're not gonna overburden one versus the other. We're not trying to, we're not gonna do to either business what, you know, has been to other spinoffs where you try to, you know, put too much on and make one side look better than the other. We think proportionally, both sides carrying their proportional amount of that leverage makes sense. We think that both of them will be focused on getting their leverage down. We'd like to see the business closer to 2X.
Very comfortable running it where it is today, but I think the market would say, you know, we like 2X a lot better than we like 3X from a leverage standpoint. And so we wanna, you know, focus on deleveraging. We'll delever a little bit between now and spin date from cash flow generation. Don't know the specifics, right? And we'll iterate on that between now and six months from now, eight months from now when we actually effectuate the spin. But going in, we think both will have, you know, comparable structures. Some would argue the distribution business is a little bit more predictable, could take a little bit more. We'll figure that out as we go through the whole specifics.
But I think they're both gonna be very close to each other, and both relative with a proportional share and both focused, again, on having the right leverage profile, thinking about 2X as the right target number. Now, as long as you got visibility to that, I always say you're okay being above that as long as you have clarity on how do I get there in the near future.
So you have a little bit of wiggle room at the end to maybe, on the margin, put a little bit more on one side or the other. And then, post that, obviously, there's gonna be a period of trying to get, you know, closer to 2X. But as we think about opportunity for capital allocation over time on either side of the house, is there, you know, one side that has maybe a little bit more M&A or roll-up or, you know, opportunity from that standpoint, or one side that has more, you know, return of cash to shareholders? What would it, you know, sort of look like from a capital allocation post-optimal capital structure?
Yeah. Listen, there's no shortage of M&A opportunities in each one. Now, whether there's opportunities, whether you should do them or not, it's a different story. As you think about the strategy of each business, how do you think about the expansion opportunities, what's organic versus inorganic? But there clearly are opportunities for each business to grow. We, you know, Chris mentioned the Pro AV and datacom side of the businesses. You know, I would not view ADI as a big roll-up in the existing business. I would look at it more as opportunity for expansion through M&A into those adjacency, adjacent categories. Similarly, on P&S, you know, we're in these core, systems of the home. And there are parts of those systems where we are the market leader, and there are parts where we only have bits and pieces of it.
And so, again, filling out the portfolio with the right products where it makes sense for us to leverage our existing infrastructure, our manufacturing base, our sales force, our supply chain, to add those things on would all be opportunities. But it's gonna be disciplined. You know, the, I think the company's been very disciplined over its life, two significant M&A activities. One was buying First Alert, about four years ago, which has been a great acquisition on the product side, and one buying Snap One on the distribution side, about two years ago, year and a half ago.
Where you got some of the best execs. So the key aspect of Snap One.
Find out what's up.
Yeah, specifically find.
But I think, again, you know, when you look at companies that are making $100 million of EBITDA and you say that they're $75 million of synergy, like those are high bars. And I think that's the discipline that both Rob and Tom have. That's what the current board has. You know, obviously, there'll be some board changes and separate boards, but I think that's the kind of opportunities we'll continue to look for. And I think those opportunities are there. But outside of them, have the right balance sheet, have the right leverage, invest in the right organic opportunities, and think about the right opportunities to return cash to shareholders is obviously a big part of the story.
And to round it to bring it full circle, we do intend to have an investor day for each company before we effect the spin and start the regular-way trading. The timetable for the separation is still intended to be in the second half of 2026. If you go by the letter of the law of what we disclose, this past July, we said, you know, roughly 12 months from the date of announcement. So use that as sort of the proxy for now. And we'll certainly update the market as we get more details as we continue to work through the process.
But I think I answered your earlier question. This isn't just about the spin. You know, a lot of times you do this, and it's about talking about the spin. We really think we have the opportunity and the responsibility to talk about this. It's both a re-IPO of Resideo, the P&S business, which is gonna be fundamentally different. You know, it's these businesses are ADI actually has more revenue than P&S. P&S has more profit. So it really is, in ways, a separation of equals as we go through this. Both good businesses, both strong businesses. And we want each business to be able to tell its story as we go into this and do it on a standalone basis. So we're looking forward to doing that.
Makes a ton of sense. Wanted to rewind back to Resideo Proper as it stands right now. About a year and a half ago, closed the acquisition of Snap One. Obviously, you know, a sizable deal. Just talk about, you know, where we are in that integration process and, you know, what the customer reactions have been of the combined business and any lessons learned in that deal.
So I think from integration, I would view the integration as sort of two-pronged. It's more than that, but the two main prongs. One is bring the teams together, bring the operating cadence together, bring the, you know, how we run the businesses together. And Rob and the ADI team have done a phenomenal job of doing that. There is no more Snap team. It's one team. It's the ADI team. They are running this entire business. The sales team is one. The supply chain is one, which is awesome. And they did that pretty quickly, and they took a bunch of costs out while they did it, which is wonderful. The second piece of it then is getting through all of the specific, you know, operating, operation of the business. So Snap, different stores, like there's still 40 plus or minus Snap storefronts that are out there.
There's still a separate e-commerce platform. We have a lot of cross-sell going on, so all the Snap exclusive brands are available at ADI. A lot of the ADI third-party products available at Snap, but they still go to market somewhat separately, so while the teams are one, we've gotta bring that together. ADI was in the middle of a big ERP implementation as we announced last quarter. We had to get that done, so we converted all the ADI stores over to a new ERP system off of their 40-year-old green screen AS400 system, so we've gotta get that humming. When that's done, then we can start converting the Snap stores onto that same platform, consolidating stores. You know, we don't need. ADI had about 100 stores. Snap had about 40. We don't need 140 stores in the U.S. We'll consolidate stores. We'll re-platform it.
We have store of the future, which really combines bringing that audio-video product into the ADI footprint. And so there'll be some locations where one of the stores is the right location and footprint. There'll be some markets where you have to actually go to a new location. We're working on that over the next 18-24 months. So that's the big piece of it. I think the integration, the deal's gone great. I think the Snap business in general has been a little bit challenged on the top line. You know, the housing market has not been great at that high, and it's been a little bit more challenged. Control4 aspect of it, where Adam and I originally met, way back in the day, has just announced their upgrade. New operating platform came out over the summer. That's been great and well received.
So that's reinvigorated that a little bit. So I think overall it's really good. Customers are happy. Employees are happy. You know, we've gotta continue to work through all the hard work to bring these things together. But I think we feel really confident about our execution.
And just to pile on, 'cause I think, you know, Adam, you asked about customer reactions to the deal. And I think customers have reacted very positively. If you're a professional and you're, you know, doing multiple trades, you know, be it a security or HVAC, for example, you can use ADI as that one-stop shop to buy everything you need on a regular or recurring basis to, you know, get your projects done and do it in a timely fashion so that they can, you know, you as a professional can make more money. I think it also, for us, creates a lot of cross-sell synergies because the customer base can now avail themselves of more products that were previously unavailable to them.
And that's part of the synergy target that we put out there in June 2024 when we closed the deal just for everyone's benefit. We committed to a $75 million run rate synergy achievement as we exit year three of the acquisition. So exiting year three would be sometime in 2027 today. And we'll give the numerical disclosure likely on our next earnings call. But we're doing quite well, and we're well ahead of that synergy target, so much that, you know, we believe we can either deliver more than the 75, deliver the 75 sooner, or do both.
I guess because that's gonna go into a post-separation, I would assume the incremental synergy would accrue more to the P&S side, or am I?
On the ADI side.
Oh, on the ADI side. Okay.
Yeah. Yeah. Whole Snap One acquisition is on the ADI side.
Oh, okay. So you're bucketed over there. Okay. Got it. Okay. So, tracking at or above the $75 million, which obviously gives you, or should give investors some confidence in future capital allocation decisions. I think it's a good case study.
Yep.
For what you can do as a combined company. I did wanna ask, Mike, you touched on kind of demand environment. Obviously at the high end, the old Control4 business and stuff, understandable that there might be some challenges there. But if you were to sort of, you know, summarize, we're at a tech and consumer conference, just what you're seeing in near-term demand, especially as we enter the holiday season.
Yeah. It's, you know, again, we view the professional as our customer. And so a lot of our products on both the ADI side and on the Resideo P&S side, being sold to professional, a lot of it, particularly on the residential side, tied to those housing metrics, you know, whether it's, you know, commercial new construction, whether it's the remodel index, whether it's resale activity. It's been a relatively anemic market for a couple of years, and it remains a relatively anemic market. There's some choppiness around it sometimes, but it's nothing like it's great. And we think it's below, you know, most people, and I'm not an expert on this, but I can read the same things everybody else reads, right? We're below, like, where we think the housing levels need to be in this country.
And so we view that as a perspective tailwind down the road. Right now, it remains just. It's not getting worse, but it doesn't seem to be getting much better. There is a little bit of noise right now on big ticket items. You know, there's a lot of disruption in the HVAC market right now, part of it, a lot of it driven by the change in the refrigerant that's used in HVAC systems. And so that's caused some market disruption. While that market disruption's going on, there's also noise about, you know, are consumers deferring a little bit on that side? Was there a little bit of pull ahead on that during COVID? That's a little bit confusing out there, but mostly just market disruption. We don't see the underlying drivers, you know, of construction, of remodel. They haven't changed significantly.
We think over the long term, there's more upside than downside. But we're predicting they remain relatively, you know, anemic for the foreseeable, you know, short to midterm.
To pile on, just to clarify some of Mike's comments, I think the exposure to the residential macro is really more so for the product side of the house, the remaining co. Resideo, where approximately 80% of the revenue for the products business comes from the residential market. If you contrast that with the distribution business, about 70% of their revenue comes from the commercial market. I think one of the interesting secular trends that we've been experiencing is around the security thematic. I think there's you know been a lot of well-publicized incidents that are impactful. And part of the impact is to drive some of the end user customer behavior to rip and replace out their technology for the latest and greatest technology.
And what they're ripping out is two-year-old, three-year-old technology that still works really well, but they're choosing to make the investment for the latest and greatest camera with the best resolution or something that fits better in the IT stack or something that integrates an AI capability. And when you look at some of these end user use cases, be it a bank, a retail store, I think these are clear and present use cases where our technology and our distribution, our product and distribution businesses really tie in nicely to what we're experiencing daily.
Got it. I did wanna ask more on the P&S side, just the competitive environment. I know we're, going back to Control4 days, constantly having to defend against Amazon and Google and big tech, but it's, it's kind of changed. We had Arlo here earlier. They're partnering with ADT. They've talked about that publicly and having success with Verisure and a variety of dealers. So these DIY companies actually getting further into the service provider channel. Maybe just sort of summarize what you're seeing from the competitive environment in that side of the business.
Yeah. I'm sorry. I think we all know that the big tech threat and opportunity has diminished. Like their capital decisions are putting their capital use in other places now. I think that, again, I think our system's being of the home, right? So we're not a consumer company. You can go into Lowe's and Home Depot and buy our thermostats or buy our smoke detectors, but we really view the professional as our customer. And I think, you know, professional products to professional installers that are easy to install, easy to support, allow them to make margin continues to be a theme. That sounds very familiar to the old Control4 and Snap days too, I'm sure. And it's very familiar to the ADI side as well. So I think that, overall, the product threats are minimal, for the market leaders. There's opportunities.
I think on the consumer products, it still is very frothy. But on the professional products, I think it's much less so. Professionals like those products that they can rely on. And I don't think that's changing. And I think some of the DIY folks are against it. They're looking to professional installers as an opportunity. But I think generally across the board, we are the leader in many of those products. And, you know, it's really hard to displace us.
There's gonna be exciting times ahead. What's the kind of sum it up, the key message that you wanna leave investors with today?
Yeah. Listen, these are two good companies that happen to be under common ownership. Settling the IRAs created the opportunity for us to allow them to stand on their own two feet. You know, everybody asks how I think it's gonna go. I think Rob and Tom are awesome leaders. They're gonna do a great job running these two separately. I think that different people will have different views on which business they're more attracted to based on their own personal preferences. I view them both as very good companies. I view them both as things that are worthy of taking a look at. Some folks are like, well, should I invest prior to? And I'm like, listen, that, that's your choice. Just look at each business, make your decision, and understand what each business represents. Listen to the investor days. Listen to what we're saying.
It creates the opportunity that we still think is there for people to, from a value creation standpoint, there's a lot of shareholder value creation that both companies can generate.
Sounds great. Mike, Chris, thank you.
Thank you, Adam.
Thanks, Adam.