Resideo Technologies, Inc. (REZI) Q3 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, at this time I would like to welcome everyone to the Resideo 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. [Operator Instructions] It is now my pleasure to turn today’s call over to Mr. Jason Willey, Vice President of Investor Relations. Mr. Willey, you may begin.

Good afternoon, everyone. And thank you for joining us for Resideo’s third quarter 2022 earnings call. On today’s call will be Jay Geldmacher, Resideo’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.resideo.com. We would like to remind you that this afternoon’s presentation contains forward-looking statements. Statements other than historical facts made during this call may constitute forward-looking statements and are not guarantees 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 Resideo’s filings with the Securities and Exchange Commission. The company assumes no obligation to update any such forward-looking statements. We identify the principal risks and uncertainties that affect our performance in our annual report on Form 10-K and other SEC filings. With that, I will 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 with 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 & 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 remained healthy in air products, driven by connected thermostats strength in both retail and distribution channels. We see positive demand trends in the HVAC market, supported by sell-through data and conversation 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 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 remained strong and our ability to support customers over the past 18 months is creating new opportunities. Our traditional security business has seen headwinds across several fronts, including product transition in Europe, the run-off of 3G radio conversions 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 & 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 in fire and video surveillance. Demand indicators remain positive across most of ADIs 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 audio visual 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 omnichannel 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 resideo.com/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 $0.42 per share, compared with $0.46 in Q3 of 2021. Included in our third quarter results was an $8 million benefit associated with the tax indemnification accrual release and $17 million of costs related to a litigation matter that arose prior to our spin-off from Honeywell, as well as the impact of the sale of ADI’s India operations. Products & 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 & Solutions revenue declined by approximately 1% compared to last year Q3. Price realization added approximately $60 million to revenue year-over-year, while aggregate volumes declined by approximately 10%. Order activity slowed across Products & Solutions as the quarter progressed, as some customers and channels work to reduce inventory levels. We believe channel inventory normalization has further to go and this is reflected in our fourth quarter outlook. Products & Solutions gross margin in Q3 was 36.2%, down from 41.5% in the third quarter of 2021. Persistent inflationary pressures, need to source material from brokers and the effect of lower volumes and 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 & 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 & 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 investments, 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 and operating income of $4 million in Q3. Like the rest of Products & 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. ADI 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 brand’s 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 at 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 with our manufacturing footprint. Additional outlook details can be found on page 11 of our earnings slides. I will now turn the call back to Jay for a few concluding remarks before we take questions.

Thanks, Tony. While we are just satisfied 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 & 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 and 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, reductions of factory shifts, reduced third-party spend, launch of factory optimization initiatives and further laser focused on headcount. As we tightened the focus on controllable cost, 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 am 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 products 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. [Operator Instructions] Our first question will come from Ryan Merkel 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 streak by about 5%, but operating profit is going to miss by about 23%. Can you just unpack why the fall through is so big, 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 have seen and our FX -- our OpEx run rate is pretty firmly established at this point for Q4. So we are 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 the -- of what you are 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 $15 million sequentially, is that the right way to think about it?

Roughly, something that zipcode, sounds right.

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

So the time -- the timing of what we saw in Q3 was -- it evolved through the quarter. So we have seen more and more of those efforts as we have 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. 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 have 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.

Yeah. I would just add that, when you do get changes in the market like this, which we all understand pretty good idea of what’s going on. The standpoint the macros and inflation what have you been it’s just very natural. You get into an inventory correction standpoint. And to your question, when that will be? We are not 100% sure. But I think it’s definitely going to continue and through Q4.

Okay. May just sneak one more in, if I could, so it sounds like the POS is actually decent. So as the channel destock more about taking out safety stock as lead times have improved and then is the destock mainly water heaters or it impacting air and security too?

It’s fairly broad based. I wouldn’t say it’s everywhere. I mean, clearly the OEM channel of 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 are out over their skis. I mean, one of the things I want to comment on too is, this is an unexpected. We got questions going all the way back to -- all the way back to Q1, when interest rates started to tick-up and the conversations around a potential recession started to crop up. We talked to investors about the reality that if interest rates double or more, which they have done, that’s likely to impact the behavior in some of our markets and I think that’s a fair bit of what we are seeing. We can never predict the timing exactly. But the expectation for the way things have played out, I guess, from that context I wouldn’t put it into a surprise category.

Yeah. The other dynamic as you know, I mean, in -- many companies in the electronics industry in particular with their customers dealt with the supply chain constraints and so as part of that they are 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 it naturally happens. And as I indicated in my remarks, the supply chain still is a challenge. It’s better in certain places and I am -- which I am pleased about, but there are semicon suppliers of ours are still problematic and we will continue into 2023. So anyway it’s inter-related to that and then now with the various customers of ours are going into an inventory correction. And my experience in the past is that, in this type of situation is they maybe a little extra conservative to start with and watch the market move forward after making those corrections.

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

Yeah. Makes sense to me. Thanks guys.

Yeah. Thank you, Ryan.

Our next question comes from Amit Daryanani with Evercore. Please go ahead.

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

Yeah. So what we called traditional security doesn’t include First Alert. And 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 radio -- of 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 are also in the middle of a product transition in Europe that has caused our European traditional security business, if you will, to be soft as well. Those are the two biggest drivers.

I will just add to that. If you remember the cut over the sunset out there on three GPs have been. Today they weren’t exactly sure when that was going to happen. It was scheduled for February of 2022 and there had been some discussion on whether that’s going be pushing out, bottomline it was not pushed. But so everybody in Q3 of last year and even in Q4 were driving as much of the radios they could to get the convergence completed. And as Tony said, and the comparison to this Q3 is that 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. And then in terms of this inventory correction that you are seeing channel optimization up, I am curious, I mean -- and you said, it started in Q3 should happen in Q4. I mean, how long does that extend or at least historically have a perspective on how long these corrections have happened and how much extra inventory the channel has, anything over there to understand the timeframe of this inventory correction would be helpful?

Yeah. Tony said before and I probably pretty much stayed consistent with that. I mean, it really started in Q3, as an increased pace of these inventory corrections that we spoke of. And so -- and it will take, I don’t know we want a good number for you in terms of what’s traditional especially in all the dynamics that happened in this market over the last year and really over the last two years. But it’s going to definitely continue to the rest of Q4, I think, in terms of getting to the correction through and then we will 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 are seeing very strong performance in that business and that’s one of the indicators that I’d point to in terms of our view is that the work that we have done over the last couple of years is bearing fruit even in what is now a more difficult environment.

Got it. And if I could just ask you one more, I guess. It sounds like maybe I am reading too much into this, but suddenly you are going to look at doing some sort of cost optimization, cost control initiatives towards the end of the year. I am wondering does that change your framework around some of the fiscal 2024 operating margin targets you have talked about at all? Thank you.

No. Not at this point. I mean we are -- we had a conversation about that in our last earnings call. We are focused right now on responding to the market dynamics that we are 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 and then but the other thing I’d add and Tony kind of alluded to it. There were some things in the factory optimization side that we -- we have had actually on our drawing board for a while and between the managing to the supply chain issues. So we didn’t get caught ourselves with not enough supply, as we manage through this crazy time of this 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. I think we are going to move forward on it. If I not think -- we would have moved forward on some of these in either case and with the situation at hand we were accelerating some of those.

Perfect. Thank you.

Thank you, Amit.

[Operator Instructions] Our next question will come from Erik 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, so if we look at 3Q, 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 true or slower demand versus inventory correction? Maybe just to better understand if some of these more temporary factors like the inventory thing were large -- a larger part of that headwind or a smaller part and then I have a follow-up as well.

So, like I said, we don’t have -- as you know, Erik, we have got a pretty broad array of markets. So we don’t have comprehensive kind of sell-through/point of sale data. But, frankly, pretty much every data point I have seen is sell-through, not everyone but almost everyone showed pretty healthy activity at point of sale, up mid-to-high single digits, some even up in the double digits year-over-year. So the -- I think the inventory behavior change is 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 I think that’s probably -- it’s probably the totality of it. And then, sorry, what was the other part of your question? Oh...

No. No.

Yeah. So we do…

Yeah. Correct.

So we gave the numbers in terms of the year-over-year change and compared to our guide, it wasn’t a particularly significant driver though.

Okay. Okay. And then you had really nice performance on the ADI side, e-commerce growth, I think you called out was 22% private brands sales grew 23%. Is there any way that you can help us kind of better understand how big those opportunities are in terms of what percentage of mix, either one of those are for ADI and maybe where those were one year 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 for the plus 24 -- plus 22 for the quarter.

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

And we would approach that, sorry, go ahead.

No. Go ahead.

We have 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 are going effectively product category by product category, focused in areas that are relatively low tax, relatively straightforward for us to bring a brand in without creating meaningful disruption kind of across all of our third-party brands.

Yeah. I was going to add to that. And as part of their strategy, it is an important part of the future and they are making good progress as you pointed out. So but they are 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 will sneak 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 in 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 from me. Thanks.

We are…

Yeah. I mean we haven’t guided to the individual segments historically and we won’t. But we will see good growth again at ADI and the growth at P&S is going to be driven by the acquisitions.

Okay. Fair enough. Thank you guys.

Thanks, Erik.

Thanks, Erik.

And our next question will come from Ian Zaffino with Oppenheimer. Please go ahead.

Hi. Thank you very much. Just wanted to ask you a question just on margins, as you think about like as revenue has come down, if they do, given the macro environment. What do you think like maybe a decremental margin might be? 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 tends to kick in, let’s just say, after maybe a sales decline of a certain amount. And if we do see some type of decline, what type of margins we are looking at, maybe as a trough and then maybe as sort of a midpoint? Thanks.

Boy, I wish I could -- I wish I had all those details to give you and being able to forecast the world that accurately and predict exactly how it’s going to unfold. A couple of things you got to bear in mind about our margins. There is again with the breadth of products that we have and the breadth of factories that we have. The -- it’s hard to just sort of look at it from the standpoint of one straightforward analytic that’s going to give you kind of decremental margin -- a detrimental margin number. And 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 is more to come on that. But I can’t give you just kind of an algorithm that drives a decremental margin dynamic for us.

Yeah. Not just on the cost side either, may be like we are talking about factory optimization and variety of other things that Tony and I had talked about there. But also from a long range plan standpoint that we have provided to all you guys ties a lot to also what we are doing on our NPI roadmap with our products. So it’s a combination there, and I agree with Tony, we will 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 Kearney with Gabelli Funds. Please go ahead.

Hi, guys. Good afternoon. Thanks for taking my question.

Hi. You bet, Brett.

Provided a lot of helpful commentary in the prepared remarks, but I was just curious if you could, I guess, elaborate a little more, 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 functionalized a lot of that organization. We got it aligned with a lot of our traditional security business in terms of product development. But we have really functionalized it. I think the teams are working really seamlessly together. We originally, I mean, that -- I would say that -- I will say, I mean, we originally had a view that there was an opportunity to take out some costs at senior levels at First Alert. We end up keeping more of those folks. We have ended up keeping them, because frankly they have been really valuable in terms of not just providing insight around First Alert, but really being an integrated and involve part of the overall Resideo team. We still got work to do there in terms of the, what I will call, the operational integration and the manufacturing integration and those kinds of things. But I think, I’d argue, we are probably furthest along in terms of that, that culture and team integration.

I would add, I am very excited about what -- is it came into the family. What they have 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 particularly for the future. And those are the things like kind of a -- at a very high level mentioned, I am going to be excited to be able to share more things with you guys as we move forward. But I think overall the business plan that we put in place is part of doing that deal. I think Tony had mentioned that, I think, we are on plan to what we wanted to do for this year, and as well as what we are -- where we believe will be by the end of the year next year.

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

Terrific. Thanks so much guys.

Thank you.

[Operator Instructions] Our next question comes from Paul Chung with JPMorgan. Please go ahead.

Hi. Thanks for taking my questions. Most of them have been answered. But I just noticed a reduction in CapEx, where you are scaling back and is it kind of right level of CapEx to kind of models moving forward and how do we think about working cap dynamics during the year and overall free cash flow outlook and what are your…

Yeah.

… initial expectations for working cap investments for fiscal year 2023, sounds like the pace of inventory spend should come down here, any initial thoughts there? Thanks you.

So a few things, Paul. First of all, we are 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 we talked about doing the appropriate things in terms of cost management in an environment like this, versus making sure that we don’t cut muscle in terms of future opportunities. So, you are right, CapEx, is down, but I think that has more to do with the cadence and timing than it does with anything we are doing to pair it back, because we are not and we don’t intend to. In terms of working capital there is 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 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 AP came down. And then you can see there are a couple of cleanup items and again like other assets and that sort of stuff, there were some cleanup items that we funded through that, that probably won’t recur. So there is a little bit of -- I won’t 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. So we are -- I would say that, we have heightened our focus particularly on making sure that we are carefully managing inventory 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.

Hey. 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.