Resideo Technologies, Inc.

Ladies and gentlemen, at this time, I would like to welcome everyone to the Residio Technologies third quarter 2022 earnings conference call. Today's call is being recorded, and all participants will be in a listen-only mode until the formal question and answer portion of the call. If you would like to ask a question during that time, please press star 1 on your telephone keypad. If you would like to withdraw your question, please press star 1 again. It is now my pleasure to turn today's call over to Mr. Jason Willey, Vice President of Investor Relations.

Mr. Willey, you may begin.

Good afternoon, everyone, and thank you for joining us for Residio's third quarter 2022 earnings call. On today's call will be Jay Geldmacher, Residio's chief executive officer, and Tony Trenzo, 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 Residio'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 now turn the call over to Jay.

Thank you, Jason, and good afternoon, everyone. Q3 was a mixed quarter for Resideo in a dynamic environment. ADI again delivered solid revenue growth and profit expansion. Driven by strong performance in security and fire categories, serving commercial markets. At P&S, we had 14% year-over-year growth in air products that experienced headwinds across other product areas, particularly in security and OEM components for water heaters. Order rates slowed during the quarter, and customers have begun to normalize inventory as macro uncertainty grows. In the third quarter, products and solutions delivered 12% year-over-year growth and we made significant progress on a number of key strategic initiatives. This includes advancing software platforming work, growing content with builders and service providers across single and multifamily construction, and enhancing our energy management offerings to improve user experience. These initiatives are central to our strategy of expanding the business into attractive growth areas. In the quarter, sales and orders remain healthy in air products, driven by connected thermostat strength in both retail and distribution channels. We see positive demand trends in the HVAC market, supported by sell-through data and conversations with customers. However, these conversations also indicate uncertainty around the macro outlook and a heightened focus on managing channel inventory levels. Within energy products, the OEM channel is experiencing a normalization of order rates after a period of historically high demand. This was most evident in products serving the gas water heater market, where the channel is actively reducing inventory levels. In the boiler and furnace markets, customer indications remain positive for activity in the upcoming heating season. We believe our competitive position across the OEM channel remains strong and our ability to support customers over the past 18 months is creating new opportunities. Our traditional security business is seeing headwinds across several fronts, including product transition in Europe, the runoff of 3G radio convertings, and slower overall activity levels in our North American business. We expect these trends to remain present through at least early 2023. The First Alert acquisition has been an important contributor to our year-over-year revenue growth, and integration is progressing well. The feedback from key retail and home builder customers has been extremely positive. We are encouraged by the opportunities we are already seeing in expanding First Alert products into the HVAC channel and with new residential construction customer wins. These dynamics within products and solutions are against the backdrop of ongoing supply challenges with our core semiconductor components. While backlog has moved lower from historically elevated levels, we remain supply limited in certain areas. Supply constraints continue to create inefficiencies within manufacturing and necessitate sourcing components in the broker market, resulting in margin and inventory headwinds. Outside of certain semiconductors, we are seeing signs of improvement in other materials and freight markets. At ADI, revenue grew 5% in the third quarter, driven by commercial sales in North America and fire and video surveillance. Demand indicators remain positive across most of ADI's categories. ADI is executing on key initiatives around e-commerce and private brands, both of which saw over 20% growth in the quarter. As we discussed on our last earnings call, in early July, ADI completed the acquisition of Electronic Custom Distributors, a leading regional distributor of residential audio, video, automation, and telecommunication products. We continue to look at opportunities to expand ADI's presence in adjacent categories of audiovisual and data communications. ADI's execution remains best in class. Digital and system investments made over the past two years are significantly enhancing ADI's omni-channel capabilities and ability to serve customers. The business is well positioned to continue to grow sales and expand margins. As we manage the day-to-day challenges of the current environment, we remain focused on positioning Resideo for long-term success. A key aspect of this is our ESG efforts. Many of our products are designed to help address the environmental challenges facing our planet. Resideo took an important step in our ESG journey with our inaugural ESG report published last week. This report is the culmination of a company-wide effort to identify our most pressing ESG priorities and opportunities. As we look forward, we are focused on providing greater transparency to our stakeholders regarding our ESG journey. The report is available on our investor relations page, and you can learn more at residio.com slash sustainability. With that, I will turn the call over to Tony to discuss third quarter performance and outlook in more detail.

Thank you, Jay, and good afternoon, everyone. Third quarter revenue of $1.62 billion was up 8% compared to Q3 last year, excluding $135 million from acquisitions and approximately $50 million of negative foreign exchange impact, revenue increased by approximately 3%. Gross margin for the quarter was 26.6% compared with 28.1% in last year's third quarter. Consolidated operating expenses grew by $21 million, or 8%, due entirely to $26 million of first alert operating expenses. Operating income of $155 million declined 7% compared to last Q3. and diluted earnings were 42 cents per share compared with 46 cents in Q3 of 2021. Included in our third quarter results was an $8 million benefit associated with a tax indemnification accrual release and $17 million of costs related to a litigation matter that arose prior to our spinoff from Honeywell, as well as the impact of the sale of ADI's India operations. Products and solutions third quarter revenue of $707 million was up 12%. Excluding $112 million from acquisitions and approximately $30 million of unfavorable foreign exchange impact, products and solutions revenue declined by approximately 1% compared to last Q3. Price realization added approximately $60 million to revenue year over year, while aggregate volumes declined by approximately 10%. Order activity slowed across products and solutions as the quarter progressed, as some customers and channels worked to reduce inventory levels. We believe channel inventory normalization has further to go, and this is reflected in our fourth quarter outlook. Products and solutions gross margin in Q3 was 36.2%, down from 41.5% in the third quarter of 2021. Persistent inflationary pressures, the need to source material from brokers, and the effect of lower volumes on factory efficiency all negatively impacted gross margin in the quarter. In addition, the inclusion of lower margin first-alert revenue reduced gross margin by approximately 200 basis points in Q3. Products and Solutions operating profit was $124 million, or 17.5% of sales, compared with $157 million, or 24.9% of sales last year. Operating expenses for products and solutions were up $27 million year-over-year due to the $26 million in First Alert costs as well as planned increases in R&D investment offset by lower other SG&A. We are actively managing operating costs while ensuring we continue to invest in key growth and innovation initiatives. First Alert contributed revenue of $112 million in operating income of $4 million in Q3. Like the rest of products and solutions, first alert gross margin was negatively impacted by inflationary cost pressures. We remain on track to exit 2022 at an annual cost synergy run rate of $10 million and to achieve run rate annual cost synergies of $30 million by the end of 2023. KDI continued its strong performance in Q3 with revenue up 5% to $911 million. ADI again saw strong activity in categories serving commercial markets, including fire, video surveillance, and access control. $23 million of revenue from acquisitions and approximately $22 million of unfavorable foreign exchange impact effectively offset each other during the quarter. ADI gross margin in the third quarter was 19.3%, up from 18.6% last year, reflecting improved product line margin increased private brands' contribution, and the strong pricing environment. ADI Q3 operating profit of $78 million was up by $5 million, or 7%, versus last year. In October, we completed the sale of ADI's operations in India, which comprise all of ADI's APAC business. Proceeds from the sale were immaterial, and the transaction generated a $4.5 million goodwill impairment that was recorded in other expense in Q3. Corporate costs were $47 million, down from $63 million in the prior year. In Q3 of 2021, impairment charges on our former headquarters added $9 million to corporate costs, while this year's corporate costs benefited by $8 million due to a tax indemnification accrual release. Excluding these items, corporate costs were relatively flat year over year. Our 2022 corporate spending is tracking below prior year levels and below our forecast when we entered 2022. Turning to our outlook for the fourth quarter, we expect revenue to be in the range of $1.55 billion to $1.6 billion. Consolidated gross margin is expected to be in the range of 26.5% to 27.5%. and GAAP operating profit is expected to be in the range of $130 million to $140 million. For the full year 2022, we now expect revenue to be in the range of $6.36 billion to $6.41 billion, implying year-over-year growth of 9% at the midpoint. Consolidated gross margin is expected to be in the range of 27% to 28%, and GAAP operating profit is expected to be in the range of $645 million to $655 million, implying 16% annual growth at the midpoint. Our full-year outlook includes First Alert revenue of approximately $340 million and operating profit of approximately $15 million. For the fourth quarter, we expect First Alert to contribute revenue of approximately $115 million and operating profit of approximately $4 million. Included in First Alert's full-year outlook is approximately $25 million of costs associated with integration, intangible amortization, and inventory step-up. We continue to actively review our cost structure, including initiating manufacturing optimization activity. These initiatives may result in a charge to our Q4 results that is not included in the outlook provided above. we believe there remains significant opportunity to drive operational and cost efficiencies within our manufacturing footprint. Additional outlook details can be found on page 11 of our earnings slides. I'll now turn the call back to Jay for a few concluding remarks before we take questions.

Thanks, Tony. While we are dissatisfied with our Q3 financial results and outlook for the fourth quarter, We remain on track to deliver over 15% operating income growth and earnings per share expansion in excess of 20% for 2022. We believe both ADI and products and solutions are performing well relative to competition across almost all key product categories and markets. The work of the entire Resideo team over the past two years to build and reestablish relationships with key stakeholders is paying dividends in our relative performance in the market and positions us well for 2023 and beyond. With an uncertain short-term market backdrop, we are taking actions to ensure we protect profitability and drive improved cash generation. This includes additional targeted pricing actions to offset input inflation, reduction to factory shifts, reduce third-party spend, launch of factory optimization initiatives, and further laser focus on headcount. As we tighten the focus on controllable costs, we remain committed to strategic investments across both businesses to ensure we are positioned to capitalize on the meaningful long-term opportunities we continue to see. I'm excited by our growing momentum on a number of major innovation and technology initiatives. While not all clearly visible externally, we have made substantial progress around software platforming work, intelligent sensor innovation, and positioning the business for long-term energy transition trends around electrification and hydrogen. Much of this work is being driven by our innovation and business development organizations. As we move into 2023, we will have more to share on each of these areas and other work that will enable product and services differentiation. I want to thank the entire Resideo employee base for their efforts in the quarter and a continued focus on delivering for our customers. This concludes our prepared remarks. Operator, we are now ready for questions.

Thank you. And as a reminder, that is star one if you would like to ask a question. Our first question will come from Ryan Merkle with William Blair. Please go ahead.

Hey, good afternoon, and thanks for taking the questions.

Hey, Ryan.

So I wanted to start on the 4Q guide. it looks like sales are going to miss the street by about 5%, but operating profit is going to miss by about 23%. Can you just unpack why the fall through is so big to the operating profit line?

Yeah. So, hey, Ryan, a couple of things.

I mean, we talked about the deleveraging effect of lower volumes that we've seen. And our OPEX run rate is pretty firmly established at this point for Q4. So we're not going to see a dramatic decline in operating expenses during the quarter. And I guess I haven't looked at the exact bridge of what you're laying out, but I suspect that those are probably the primary drivers.

Yeah, I mean, it looks like if I put a 27% gross margin in there, it looks like OPEX is up, you know, 15 million sequentially. Is that the right way to think about it?

Roughly something in that zip code. Sounds right. Okay.

Okay. And then can we talk about the software orders in P&S? I guess first off, how much inventory do you expect the channel is going to destock in 3Q and 4Q?

So, you know, the timing of what we saw in Q3 was, you know, it evolved through the quarter. So we've seen you know, more and more of those efforts as we've rolled into Q4. I think it's going to continue through the quarter. I don't think we have a clear view as to exactly when that's all going to ultimately play out. You know, one of the things that's important to recognize is we haven't yet seen a significant downtick in the point of sale data that we've been able to see. Now, that's not comprehensive, but at our point of sale and our conversations with customers, The sale at the end customer level continues to be strong and continues to grow in many areas. So we do feel like the overall demand dynamic is probably being understated right now because of this destocking effort that's going on.

And I would just add that when you do get changes in the market like this, which we all understand, pretty good idea what's going on. from the standpoint of the macros and inflation, what have you, then it's just very natural you get into an inventory correction standpoint. And to your question, you know, when that will be, you know, we're not 100% sure, but I think, you know, it's definitely going to continue through Q4.

Okay. Let me just sneak one more in if I could. So it sounds like the POS is actually decent. So is the channel D stock more about taking out safety stock because lead times have improved? And then is the D-Stock mainly water heaters or is it impacting air and security too?

It's fairly broad-based. I wouldn't say it's everywhere. I mean, clearly the OEM channel and the water heaters market is one of them. But I think pretty clearly people are pulling in the reins on inventory and not wanting to feel like they're out over their skis. I mean, one of the things I want to comment on too is this is an unexpected situation. You know, we got questions going all the way back to, you know, all the way back to Q1 when interest rates started to tick up and conversations around, you know, a potential recession started to crop up. You know, we talk to investors about the reality that, you know, if interest rates double or more, which they've done, that's likely to impact the behavior in some of our markets. And I think that's a fair bit of what we're seeing. We can never predict the timing exactly. But the expectation of the way things have played out, I guess from that context, I wouldn't put it in the surprise category.

Yeah, and the other dynamic, as you know, I mean, many companies in the electronics industry in particular, with their customers, dealt with the supply chain constraints. And so as part of that, they were driving as much inventory as they thought was necessary to protect themselves. And then when you get the change in the market demand, then this is what naturally happens. And as I indicated in my remarks, the supply chain still is a challenge. It's better in certain places, which I'm pleased about, but there are Semicon suppliers of ours that are still problematic and will continue in 23. So anyway, it's interrelated to that. And then now the various customers of ours are going into an inventory correction and My experience in the past in this type of situation is they may be a little extra conservative to start with and watch the market move forward after making those corrections.

And Ryan, I'll make one more comment too. I know this wasn't the root of your question, but I really want to make this point. We're not surprised by this destocking activity. We were not able to predict the timing exactly, as Jay said, but we're not surprised by it. And we're doing what we said we were going to do. We're tightening our belt on spending. We're focused on reinitiating some of the cost initiatives around factory optimization that we had delayed because of the dynamics in the supply chain market. And we're continuing to invest for the future. There's no change to our view of the long-term or even intermediate-term opportunity at Resideo. It feels to us like we're picking up market share in this difficult market. So what we see is a cyclical event driven by, you know, a rising interest rate environment and, you know, some economic uncertainty with some of our customers that really is, we think, temporary.

Yep. Makes sense to me. Thanks, guys. Yeah, thank you, Ryan.

Our next question comes from Amit Daryani from Evercore.

Please go ahead.

Thanks for taking my questions. I guess maybe to start off with, can you just sort of help understand the divergence that you're seeing between security products, which seems to be down a fair bit, versus energy? And then maybe you can just talk about air in terms of how that's stacking up as well on an organic basis, because I think the up 14 might include the first alert.

Yeah. So what we called traditional security doesn't include first alert. And the The two biggest drivers are we had a, I hate to call it a tough comp, but we had a significant level of sales of 3G radios because of the 3G radio conversion in Q3 of last year that dropped off pretty dramatically in Q3 of this year, which was expected. We're also in the middle of a product transition in Europe that has caused our European market traditional security business, if you will, to be soft as well. Those are the two biggest drivers.

And I just added that if you remember, you know, the cutover, the sunset out there on 3G piece, you know, had been debated. They weren't exactly sure when that was going to happen. It was scheduled for February of 2022, and there had been some, you know, discussion on whether that was going to get pushed or not. The bottom line, it was not pushed. But so everybody in Q3 of last year and even in Q4, we're driving as much of the radio as they could to get the conversions completed. And as Tony said, the comparison to this Q3 is one of the big drivers of that change.

Got it. Okay, that's helpful because the traditional security did look down a fair bit, but that helps. In terms of this inventory correction that you're seeing, channel optimization, I'm curious, you said it started in Q3, should happen in Q4. How long does that extend, or at least historically, do you have a perspective on how long these corrections have happened or how much extra inventory the channel has, anything over there to understand the time frame of this inventory correction would be helpful.

Yeah, you know, what Tony said before, I pretty much stayed consistent with that. I mean, it really started in Q3 at an increased pace of these inventory corrections that we spoke of. And so it'll take, you know, I don't know. We don't have a good number for you in terms of what's traditional, especially in all the dynamics that have happened in this market over the last year and even really the last two years. But it's going to definitely continue through the rest of Q4, I think, in terms of getting it to the correction and then we'll see where it goes from there.

And by the way, I also, I didn't answer your question about the air business. I guess the point I want to make there is our connected thermostats business is doing really well. We're seeing very strong performance in that business, and that's one of the indicators that I'd point to in terms of our view that the work we've done over the last couple of years is bearing fruit even in what is now a more difficult environment.

Got it. If I could just speak in one more, I guess. It sounds like maybe I'm reading too much into this, but it sounds like you're going to look at doing some sort of cost optimization, cost control initiatives towards the end of the year. I'm wondering, does that change your framework around some of the fiscal 24 operating margin targets you've talked about at all? Thank you.

No, not at this point. I mean, we had a conversation about that at our last earnings call. We're focused right now on responding to the market dynamics that we're seeing without compromising our long-term outlook. And that's the balancing those two is our critical sort of focus right now.

I would agree with Tony on that, but the other thing I'd add, and Tony kind of alluded to it, you know, there were some things in the factory optimization side that we've had actually on our drawing board for a while in between the managing through the supply chain issues so we didn't get caught ourselves with not enough supply as we managed through this, the crazy time of this, the last 18 months, and also some COVID-related things going back 18 months ago. So we waited. The good news is we have plans in place to do some of these types of things, and now we can move forward on it. I think we would have moved forward on it. As a matter of fact, I think we would have moved forward on some of these in either case. And with the situation at hand, we're accelerating some of those.

Perfect. Thank you. Thank you, Matt.

And as a reminder, it's star one to ask a question.

Our next question will come from Eric Woodring with Morgan Stanley. Please go ahead.

Hey, guys. Good evening. Thank you for taking my questions. Maybe just to ask about the inventory side of things. Again, maybe, you know, so if we look at 3Q, you know, you missed the midpoint of your guide by, call it, 77 million, all on the P&S side. Maybe if we use that as the starting point, is there any way that you can help us understand what the headwinds were or to size the headwinds kind of between any incremental FX impact that you hadn't assumed versus just like truer, slower demand versus inventory correction? Maybe just to better understand if some of these more temporary factors like the inventory thing were a larger part of that headwind or a smaller part. And then I have a follow-up as well.

So... You know, like I said, we don't have, you know, as you know, Eric, we've got a pretty broad array of markets. So we don't have comprehensive kind of sell-through slash point-of-sale data. But frankly, pretty much every data point I've seen at sell-through, not everyone, but almost everyone, showed pretty healthy activity at point-of-sale. You know, up mid to high single digits, some even up in the double digits year over year. So, you know, I think the inventory behavior change is, you know, from the standpoint of if you look at it purely, I think the inventory behavior change is probably the totality of those two buckets. It's hard to pull it out, but, you know, I think it's probably the totality of it. And then, sorry, what was the other part of your question? No, no. Yeah. So we gave the numbers in terms of the year-over-year change. Compared to our guide, it wasn't a particularly significant driver, though.

Okay, okay. And then, you know, you had really nice performance on the ADI side, e-commerce growth. I think you called that was 22%. Private brand sales grew 23%. You know, is there any way that you can help us kind of better understand how big those opportunities are in terms of, you know, what percentage of mix either one of those are for ADI and maybe where those were, you know, one or two years ago, just to kind of understand how that each of those efforts have progressed over the last few years.

So, Jason, keep me honest. We do give the e-commerce sales number, and that was, was it plus 24? Plus 22 for the quarter.

Yeah. So, Eric, this is Jason. So, yeah, you're right. E-commerce grew 22%. It's 18% of total sales now. runs through the e-commerce channel. I mean, that's up from, you know, last year at this time, it was around 15, 16%. If you go back, you know, two years, it was, you know, very low, very low double digits. So it's a nice acceleration, particularly since the beginning of 2020. We haven't broken out specifically the private brands, you know, as a percentage of the total business. I think we have kind of indicated it remains a, you know, single digit, you know, mix. as part of ADI has, you know, grown very nicely off of a small base as you've seen from the growth rates in the last, you know, 18 months or so.

And we've approached that. Sorry, go ahead. We've approached that, the private brands business, strategically and carefully while also trying to be aggressive in terms of the growth opportunity that's there. We're going effectively product category by product category, focused in areas that are, you know, relatively low tech, relatively, you know, straightforward for us to bring a brand in without creating meaningful disruption kind of across all of our third-party brands.

I was going to add to that. And as part of their strategy, it is an important part of the future. And they're making good progress, as you pointed out. But they're being very careful in their selections. And I think that's paying off, too, in terms of picking the right types of categories for private label.

Okay. That's super helpful. And maybe I'll sneak it in a third one as well. And just any incremental comments or color you can share on how to think about P&S growth versus ADI and 4Q. Obviously, you have a tailwind in P&S from first alert, but any incremental color you can share would be super helpful. And that's it for me. Thanks. Yeah.

I mean, we haven't guided to the individual segments historically, and we won't. But we'll see good growth again at ADI. And you know, the growth at P&S is going to be driven by the acquisitions.

Okay. Fair enough. Thank you, guys. Thank you, Aaron. Eric. Eric. That was Eric.

And our next question will come from Ian Zafino with Oppenheimer.

Please go ahead.

All right. Thank you very much. So I wanted to ask you a question just on margins. Don't you think about, like, as revenues come down, if they do, given the macroenvironment, what do you think like maybe a decremental margin might be? You know, and then how long until you can maybe stabilize that margin? Meaning, I know you talked about some of the optimization of the business, et cetera. How long does that tend to kick in? Let's just say after maybe a sales decline of a certain amount, you know, and if we do see some type of decline, you know, what type of margins are we looking at? Maybe it's a trough. and then maybe a sort of a midpoint. Thanks.

Boy, Ian, I wish I had all those details to give you and be able to forecast the world that accurately and predict exactly how it's going to unfold. A couple of things you've got to bear in mind about our margins. I mean, there's, again, with the breadth of products that we have and the breadth of factories that we have, you know, it's hard to just sort of look at it from the standpoint of, you know, one straightforward analytic that's going to give you kind of a decremental margin, a decremental margin number. And, you know, we haven't yet finished our budgeting process for 2023, so it's really kind of difficult for us at this point to have any commentary in terms of what we see from a margin perspective. So I think there's more to come on that, but I can't give you just kind of an algorithm that drives a detrimental margin dynamic for us.

And it's not just on the cost side either. I mean, like we were talking about factory optimization and a variety of other things that Tony and I talked about there, but also from the long-range plan standpoint that we've provided to all you guys, it ties a lot to also what we're doing on our MPI roadmap with our products. So it's a combination there, and I agree with Tony. You know, we'll be able to share, of course, much more when we talk to you guys next about that.

Okay. Thank you very much.

And our next question will come from Brett Carney with Gabelli Funds.

Please go ahead.

Hi, guys. Good afternoon. Thanks for taking my question. You bet, Brett. provide a lot of helpful commentary and prepared remarks. But I was just curious if you could, I guess, elaborate a little more. You know, it's probably been about seven months with the team from First Alert at Resideo, how that's progressing integration-wise, and then more recently on the other side, the electronic custom distributors, how those teams are kind of integrating into the organization at this point.

So I would say... on the first alert side, the team integration has progressed quite far at this point. We have, we've functionalized a lot of that organization. We've got it, you know, aligned with a lot of our traditional security business in terms of product development, but we've really functionalized it. And I think the teams are working really seamlessly together. We originally, I mean, I'll just say it, you know, I'll say it. I mean, we originally had a view that there was an opportunity to take out some costs at senior levels at First Alert. We've ended up keeping more of those folks. We've ended up keeping them because, frankly, they've been really valuable in terms of not just providing insight around First Alert, but really being an integrated and involved part of the overall Residio team. We've still got work to do there in terms of the what I'll call the operational integration and the manufacturing integration and those kinds of things. But I think, you know, I'd argue we're probably furthest along in terms of that culture and team integration.

I'd add that, you know, I'm very excited about what, you know, as they came into the family, what they've done in the business development area, also in terms of innovation and technology and what that brings in is the total product offering today and in particular for the future. And those are the things I kind of at a very high level mentioned I'm going to be excited to be able to share more things with you guys about as we move forward. But I think overall, though, the business plan that we put in place as part of doing that deal, I think Tony may have mentioned it, I think we're on plan to what we want to do for this year and as well as what we believe will be by the end of the year next year.

And on ECD, it's obviously much more recent. And That particular business, as most of the businesses that we've acquired at ADI, we've acquired them sort of for their specific capability. And ECD brings some specific capabilities that we're working to leverage across the totality of the ADI business. So from a team integration standpoint, I think we're more in a learning mode in terms of what their capabilities are so that we can leverage across the organization than it is really bringing them sort of directly into the functional organization at ADI.

Terrific.

Thanks so much, guys. Thank you.

And as a reminder, that is star one.

If you would like to ask a question, our next question comes from Paul Chung with J.P. Morgan. Please go ahead.

Hi. Thanks for taking my questions. Most of them have been answered, but I just noticed a reduction in CapEx. You know, where are you scaling back? And is this the kind of right level of CapEx to kind of model moving forward? And how do we think about working cap dynamics to end the year and overall free cash flow outlook? And what are your initial expectations for working cap investments for fiscal year 23? Sounds like the pace of inventory spend should come down here. Any initial thoughts there? Thank you.

So a few things, Paul. First of all, we're not paring back on CapEx. In fact, one of the things that we as a leadership team have tried to communicate is we will fund high return, logical value creating CapEx. That's not, you know, we talked about doing the appropriate things in terms of cost management in an environment like this versus making sure that we don't, you know, cut muscle in terms of future opportunities. So, you know, you're right, CapEx is down, but I think that has more to do with the cadence and timing. than it does with anything we're doing to pare it back because we're not and we don't intend to. In terms of working capital, there's a few dynamics. I mean, as I said earlier, we don't have anything to share with you today with respect to 2023, but we did see, you know, meaningful build of inventory in the first half of the year. In Q3, the inventory build wasn't all that big. So in some ways, it's kind of interesting. What we ended up doing was paying for some of the inventory that we bought in Q2 and Q3, which also had a negative effect on Q3 cash flow because our RAP came down. And then you can see there were a couple of cleanup items, and you get into other assets and that sort of stuff. There were some cleanup items that we funded through that that probably won't recur. So there's... You know, there's a little bit of, I don't want to say noise, but this quarter's cash flow is not representative of what we expect in terms of cash flow conversion. We still expect Q4 to be meaningfully stronger, but I would say that we have heightened our focus particularly on making sure that we're carefully managing inventory, you know, heading into a bit of a softer environment.

Okay, great. Thank you so much.

And with no further questions, I'd like to turn the call back to Mr. Willey for closing remarks.

Thank you, everyone, for your participation and your questions today, and we look forward to speaking with you over the coming weeks and months. Have a good rest of your day. Thank you.

And that will conclude today's conference. Thank you for your participation, and you may now disconnect.