Resideo Technologies, Inc.

Ladies and gentlemen, at this time, I'd like to welcome everyone to the Resideo Technologies third quarter 2021 earnings conference call. Today's call is being recorded. All participants will be in a listen only mode until the formal question and answer portion of the call. It is now my pleasure to introduce Mr. Jason Willey, Senior Director of Investor Relations. Mr. Willey, you may now begin.

Good afternoon, everyone, and thank you for joining us for Residio's third quarter 2021 earnings call. On today's call will be Jay Gelmacher, Residio's chief executive officer, and Tony Trunzo, our chief financial officer. A copy of our earnings release and related presentation materials are available on the investor relations page of our website at investors.residio.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 of 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 residual 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 now turn the call over to Jay. Thank you, Jason, and good afternoon, everyone. Our Q3 performance demonstrates strong operational execution and progress on our business transformation. This performance is against the backdrop of healthy in-market demand that continued global supply chain challenges. We grew revenue 10% year over year in the quarter. This growth was tempered by expansion of products and solutions backlog, which remains well above historical levels. We also experienced supply chain constraints within certain categories at ADI. Our supply chain team and executive leadership continues to spend significant time engaging with key supply partners. We believe this proactive and direct engagement has enabled us to better deliver for customers and is benefiting our financial performance. Against this dynamic macro backdrop, we continue to make significant progress on our transformation work. We are driving margin benefit at ADI from investments in pricing tools and digital initiatives. Within products and solutions, value cost engineering efforts are delivering to plan. Additionally, we are seeing benefits within the sales organization from consolidating systems, Miller-Hyman training, and sales operations build-out. Each of these initiatives have helped enhance our relationship with and visibility into key customers. The results of this work and targeted investments are visible in our operating income and 160 basis point expansion and operating margins. Within ADI, investments in digital and pricing initiatives help drive a 200 basis points year-over-year gross margin improvement. As more transactions flow through digital channels, ADI can free up sales associates for more value-added selling. This allows for better leverage of these high-value individuals as ADI executes on this long-term growth strategy. At the same time, day-to-day execution at ADI remains strong, with average daily sales up 9% year-over-year. The business has done an excellent job managing through an increasing tight supply environment. This execution positions ADI to remain the go-to source for customers across its product categories. Early results from the recent Shoreview and North Polk acquisitions are encouraging. and integration is progressing according to schedule. We are actively looking at further inorganic opportunities to expand ADI's offerings, particularly in the datacom and AV markets. Within products and solutions, demand remained healthy across key channels. As the quarter evolved, it became clear that supply chain and global logistic challenges were not easing, and in some cases, worsened. The team has done an excellent job navigating these challenges. We remain aggressive in engaging with key suppliers and partners to ensure we are doing everything possible to deliver for customers. Semiconductor components remain the largest bottleneck. While we navigate through these supply chain challenges, we remain focused on driving our innovation engines. During the quarter, our partner Amazon announced an exciting collaboration to bring a differentiated entry-level connected thermostat to the DIY market. This is an example of our strategic focus on partnering with leaders in the market, specifically opportunities where we can leverage our strengths with those of other players to create enhanced value. We are also making investments in areas offering exciting long-term opportunities. This is true from a revenue growth perspective and as we work to support a more sustainable future. An example of this is hydrogen. Today we have a strong presence and portfolio in the traditional boiler components and subsystem market. This positions us particularly well to be a partner to OEMs as they begin the process of transitioning their products to support hydrogen. This includes supporting partners as they move towards qualifying and launching boilers that address hydrogen blends up to 30% and 100% hydrogen. Earlier this year, we completed a facility investment in Lotte Germany to support our hydrogen technology efforts. We are excited to be working with several leading manufacturers on their projects to serve the long-term hydrogen opportunity in Europe. While it is early stages of this market opportunity, we are actively engaged in technology development internally and with key partners. As we focus on ensuring we are doing all we can to drive a sustainable future for our business and end customers, we are pleased that Megan Murphy has joined the Resideo team to lead our ESG activities. She'll be responsible for Resideo's ESG strategy, communications, and reporting. This means working closely across the organization on alignment of stakeholders and on execution of key milestones along Resideo's ESG journey. With that, I'll turn the call over to Tony to discuss our third quarter performance and 2021 outlook in more detail.

Thanks, Jay, and good afternoon, everyone. Q3 was another strong quarter for Resideo with revenue of $1.5 billion. up 10% compared to Q3 last year. Gross margin for the quarter was 27.8%, up 60 basis points compared to Q3 2020. Consolidated operating expenses increased by 4% from last year, but declined 90 basis points relative to sales, demonstrating continued operating leverage. Operating income increased 27%, and operating margin improved by 160 basis points. Products and Solutions' third quarter revenue of $631 million was up 10% due to continued healthy demand and the impact of recent price increases. Third quarter results also benefited from a customer rebate reserve credit of approximately $12 million, which positively impacted both revenue and gross margin. Revenue and gross margin were negatively impacted in the quarter by higher costs for materials and freight, as well as shortages for many semiconductor components. Supply challenges are having the largest impact on revenue and margin in our trade and security channels. Products and solutions gross profit margin in Q3 was 40.9%, down from 42.3% in the third quarter of 2020. The decline in gross margin was primarily due to materials price inflation of approximately $30 million, as well as $14 million of higher freight costs year over year. These impacts were partially offset by price realization of approximately $17 million, and the previously mentioned rebate credit. We instituted an additional round of price increases in September, which had limited impact on Q3 results, but are expected to benefit Q4 and beyond. E&S segment operating profit was $157 million, or 24.9% of sales, compared with $141 million, or 24.7% of sales last year. Operating expense for products and solutions was flat year over year, reflecting solid cost management and reduction in restructuring costs. ADI Q3 revenue of $865 million increased 9% year over year, reflecting a combination of volume and pricing expansion. ADI saw better commercial activity in the quarter with strength in fire, access control, and wire categories. while AV and intrusion categories were constrained by product availability. ABI again drove strong growth in digital channels, with e-commerce sales up over 40% and accounting for 16% of total ABI revenue in the quarter. ABI also continues to make progress in expanding its private brands offerings to complement its extensive third-party vendor offerings. ABI gross profit margin in the second quarter was 18.5%, up two percentage points from 16.5% last year. This increase in gross margin was a result of improved product line margin as ADI benefits from pricing initiatives and increased private brands' contribution. Margins also benefited from positive industry pricing dynamics. ADI is seeing improvements in product line margin from the investment and rollout of pricing optimization tools that enable its sales teams to make more data-driven pricing decisions in real time. We intend to deploy these tools beyond the United States and expect them to be a key driver in achieving the 2024 growth and margin targets we outlined at our investor day in March. ADI Q3 operating margin increased 130 basis points from last year. We continue to direct investment toward ADI especially in the area of digital channel improvements and sales tools, which is reflected in higher operating expenses. ADI's two recent acquisitions contributed $16 million to Q3 revenue with no impact on operating profit. Integration is progressing to plan with both acquisitions on track to be fully integrated by year-end. Corporate costs for the quarter were $63 million, or 4% of sales, compared with $66 million, or 5% of sales, in the third quarter of 2020. This reflects a reduction in spin and restructuring-related costs of approximately $19 million, as well as $9 million of impairment costs this year related to our Austin office space. We do not expect any further charges this year related to Austin. In August, we refinanced our senior unsecured notes, further strengthening our balance sheet. The new $300 million of notes mature in 2029 and carry a 4% coupon as well as an investment-grade covenant package. Proceeds from the offering were used to redeem our 6.8% notes that were due in 2026. Included in Q3 other expense was $18 million of debt refinancing costs related to this transaction. The new bonds, together with the refinancing of our senior secured credit facilities in the first quarter, will result in approximately $8 million in annualized interest expense savings. Over the past 12 months, we've made significant improvements in our capital structure. We ended Q3 with cash and cash equivalents of $686 million and total outstanding debt of $1.2 billion. Net debt stood at $546 million compared to $1.1 billion at the end of Q3 2020. During the quarter, we generated $104 million of cash from operations, and for the first nine months of the year, operating cash flow exceeded $200 million. In terms of our outlook, fourth quarter revenue is expected to be in the range of $1.44 billion to $1.49 billion. Consolidated gross margin is expected to be in the range of 27 to 28 percent, and GAAP operating profit is expected to be in the range of $140 million to $150 million. For the full year 2021, we now expect revenue to be in the range of $5.83 billion to $5.88 billion, implying year-over-year growth in the range of 15 to 16 percent. Consolidated gross margin is expected to be in the range of 26.5% to 27%, and GAAP operating profit is expected to be in the range of $558 million to $568 million. Our revised outlook anticipates a further increase in products and solutions backlog in the fourth quarter due to shortages of certain components, additional component inflation of approximately $35 million, and approximately $10 million of additional year-over-year freight costs. Offsetting these higher costs are expected pricing benefits above our typical baseline of approximately $45 million. Corporate expenses for the year are expected to be approximately $260 million compared with $290 million in 2020. This includes the $16 million litigation settlement in Q2 and the $9 million Austin impairment costs this quarter. Additional outlook details can be found on page nine of our earnings slides. As a reminder, ADI has five fewer selling days in the fourth quarter compared to Q4 of 2020. I'll now turn the call back to Jay for a few concluding remarks before we take questions.