Welcome to Hayward Holdings' Second Quarter 2023 Earnings Call. My name is Michelle, and I will be your operator for today's call. [Operator Instructions]. I will now turn the call over to Kevin Maczka, Vice President, Investor Relations. Mr. Maczka, you may begin.

Thank you, and good morning, everyone. We issued our second quarter 2023 earnings press release this morning, which has been posted to the Investor Relations section of our website at investor.hayward.com. There, you can also find an earnings slide presentation that we will reference during this call. I'm joined today by Kevin Holleran, President and Chief Executive Officer; and Eifion Jones, Senior Vice President and Chief Financial Officer. Before we begin, I would like to remind everyone that during this call, the company may make certain statements that are considered forward-looking in nature, including management's outlook for 2023 and future periods. Such statements are subject to a variety of risks and uncertainties, including those discussed in our most recent Form 10-K and Form 10-Q filings with the Securities and Exchange Commission that could cause actual results to differ materially. The company does not undertake any duty to update such forward-looking statements. Additionally, during today's call, the company will discuss non-GAAP measures. Reconciliations of historical non-GAAP measures discussed on this call to the comparable GAAP measures can be found in our earnings release and the appendix to the slide presentation. I would now like to turn the call over to Kevin Holleran.

Thank you, Kevin, and good morning, everyone. It's my pleasure to welcome all of you to Hayward's second quarter earnings call. I'll start on Slide 4 of our earnings presentation with today's key messages. I'm pleased to report second quarter results exceeded expectations, with continued strong execution resulting in robust margin expansion and cash flow generation. Our team is performing remarkably well and driving structural improvements in the business during a challenging operating environment. Channel sell-through exceeded both our expectations and our sales into the channel, resulting in further normalization of distributor inventory. We expect the channel destocking to be fundamentally complete by the end of the third quarter, positioning the channel at leaner levels entering the 2024 pool season. This sets up Hayward to return to a normal matching of sales with channel sell-through. We achieved record gross profit margins in the quarter through operational excellence and necessary price realization to offset inflation. This is a tremendous accomplishment, and I'm very proud of the Hayward team. We also demonstrated our strong cash flow generation characteristics. Cash flow from operations more than doubled on a year-to-date basis as we effectively reduced working capital. As we proactively manage costs and working capital, we continue to invest in the business to advance our technology leadership position, support our customers and drive future growth. We continue to execute in a challenging operating environment, and I'm pleased with our performance during the quarter. Finally, we are refining our guidance. For the full year 2023, we now expect adjusted EBITDA of $265 million to $280 million, with the high end modestly reduced by $5 million, and the low end maintained as a consequence of strong margin performance. We now expect net sales to reduce approximately 20% to 23% and compared to last year, primarily due…

Thank you, Kevin, and good morning. I'll pick up on Slide 7. All comparisons I make will be on a year-over-year basis. We are pleased with our second quarter financial results. Net sales exceeded expectations for the quarter, both sales into the channel and channel sell-through, and reflected a return to normal seasonality, coupled with the progressive rightsizing of channel inventory. We delivered outstanding gross margin expansion to a record 48%, and we're realizing our SG&A cost reductions in line with plan. Our balance sheet is strong, and we had an excellent quarter for free cash flow generation, enabling us to reduce leverage to 3.8x net debt to EBITDA. Looking at the results in more detail. Net sales for the second quarter decreased 29% to $283.5 million. This was driven by a 35% reduction in volume, partially offset by positive price realization of 4%. It's important to understand the volume decline during the quarter was primarily driven by distribution channel inventory movements in addition to the expected moderating end demand trends in the discretionary elements of our markets like new construction. Unfavorable weather in certain U.S. markets at the start of the pool season had a modest impact. Despite the reduction in sales in the quarter, we delivered a 3-year growth rate of 9% when compared to the second quarter of 2020. That's a 3-year stacked growth of approximately 29%. At the channel sell-through level, this growth rate was even higher. Gross profit in the second quarter was $136.5 million. Gross profit margin has increased 70 basis points year-over-year and 150 basis points sequentially to a record 48.1%. Disciplined manufacturing cost control, continued price realization and moderating input cost inflation more than offset the impact of reduced production volumes. We achieved price-cost neutrality and recalibrated our manufacturing cost base to…

Thanks, Eifion. I'll pick back up on Slide 12. Before we close, let me summarize the key takeaways from today's presentation. We delivered second quarter 2023 results ahead of expectations. Our team executed well in a challenging environment, maintaining disciplined cost control and achieving record gross margins and strong cash flow, all while investing in the business to drive future growth. 2023 is a year of normalization as the industry navigates global economic uncertainty and channel inventory recalibration. We view this as a temporary dynamic in a resilient industry characterized by consistent growth and ever-growing aftermarket and a number of secular tailwinds, including the appeal of outdoor living, Sunbelt migration, connected smart home technologies and environmentally sustainable products. Each of these are here to stay, and the pool industry is a beneficiary of each of them. As a leader in this very attractive industry, I'm excited about the opportunities to leverage Hayward's competitive advantages and drive profitable growth and shareholder value creation. With that, we're now ready to open the line for questions.

[Operator Instructions]. Your first question comes from Andrew Carter of Stifel.

First question I wanted to ask, the gross margin performance ahead of your expectations. As you think about the price cost, I know you said neutrality, but I would assume prices are well ahead of input cost inflation. And you start to see some real easing like peak, I know that days inventory have actually continued to increase. So anything you can help us on cadence of gross margins.

Yes. Andrew, this is Kevin. I would say from a price/cost, achieving that neutrality here in the second quarter, as you know, this has been many quarters in the making to get to this neutral position. And I think the organization has done a great job of really implementing pricing initiatives to protect those margins. In terms of inflation, I think it's safe to say we've seen some moderation in the rate of inflation, particularly in some highly volatile commodities that we've dealt with historically. But we've not yet seen a wholesale deflation. Frankly, we're not calling for that in the immediate future. So that's really informing some of our thoughts heading into 2024, which we're certainly not guiding. We're in process of really determining what kind of pricing actions to offset inflation will be contemplated heading into 2024. But again, at this point, we're not seeing deflation really, just more moderation. Other things that have helped the gross margin, certainly, the raw material supply coming back to near normal is certainly -- presented a bit of a tailwind for us and no longer having to do some of these spot buys, air freighting or really working over time in our facilities to satisfy demand have all been key elements of what's driven the margin performance more recently.

Yes, I would just add, Andrew, when you think about the 48%, which is an improvement, obviously, you've got to split the margin into 2 pieces, the margin benefit. One is price-cost neutrality. We're ticking that box. The second element has been the progressive background story over the last 3 years to rightsize our manufacturing facilities. And since the end of 2019, we've exited 4 facilities all within the U.S. One was on the West Coast. Three were acquired facilities. And all of that has been synergized into the remaining existing 4 walls of our facilities. And that has been additive to the margin, which is really now being visible inside the margin, probably masked still over the last 3 years because of all the inflation noise.

One other question. So the free cash flow guidance has gone higher by just $25 million. You generated $150 million. That means $25 million in the second half. But then if I look at your leverage target, that implies that you've got a lot more free cash flow. Could you square that with us? And also, if there's any kind of downside to your expectations around prebuys, could that be a stronger fundamental performance for the year?

Sure. It's a great question. Obviously, you can see in my, let's call it, conservatism inside the cash flow forecast. We've done $151 million year-to-date in free cash flow. We're calling greater than $175 million, and I do believe it will be greater than $175 million to achieve closer to the 3.0 leverage. We've still got to get through the announcement of our early buy program. As you know, under the early buy program, it does include extended terms. We have to see the offtake level to that early buy, and that may change the outlook for free cash flow as we get into the second half of the year. But we feel very good about our ability to continue to reduce leverage in the business down to about 3x based upon our current outlook today.

The next question comes from Jeff Hammond of KeyBanc Capital.

I was interested in your comment about sell-through exceeding expectations. And I'm just wondering if that's a market dynamic or market share dynamics. And then I guess, if sell-through is coming in better, what's kind of informing the bigger destock?

Yes. I would say it was better than expectations. In our original guide, we laid out net of price, something in the 10% range. We're seeing negative 10% that is year-over-year. We're seeing something slightly better than that here in the second quarter but not massively better than that. It's still negative. I think our sell-through, Jeff, has continued to be really strong based upon data we collect and working with our channel partners. So we -- as we work through the end of the pool season here, Q3, we are calling for additional destock. But as I said in my prepared remarks, we expect to really be there. At lower than originally expected inventory levels, I think that that's really what prompted some of the update to the guide that we presented here this morning. And I think it also presents us with an opportunity around early buy to really position ourselves well heading into the 2024 pool season.

Okay. And then just maybe level set us on how you're thinking about 3Q, 4Q seasonality. And then I think you mentioned the word robust in terms of early buy. Like just what's your level of visibility and communication with your distributor partners around just the size and magnitude of early buy?

Yes, from a seasonality standpoint, I'd say it's trending back to a more normal seasonality that we've seen historically. That kind of call it, first half would call it high 40%, second half kind of low 50%, with Q1 and Q3 looking pretty similar to each other, Q2 being -- I should say, Q4 being a tick up from what we historically see in Q2 based upon kind of collecting those early buy orders and being able to ship them at our discretion. So we really see that returning to that more normalized quarterly seasonality. I'm sorry. The second part of the question, I forgot what that was.

Just the visibility on early buy and communication with the distributors.

Yes. We have had conversations. And I think based upon the desire here to maybe take inventory to an incrementally lower level exiting Q3, I think, positions all stakeholders, OEMs as well as channel partners to really lean into early buy for the 2024 season. We haven't had what I'd call a normal early buy now for several years. So I see it really kind of returning to a more normal early buy expectation, with maybe a little bit of tailwind given the fact that inventory levels we expect to be even healthier than they have been historically.

The next question comes from Rob Wertheimer of Melius Research.

So it seems like you and others in the industry have kind of the same view that the channel destock will be completed at 3Q. And I wondered if you could just share like your investigation around what you've done, any industry metrics you can sort of see to give us background of how confident you are in that estimate.

Sure. So it's not a perfect science in terms of collecting every single inventory data point, but we get good information on our primary U.S. trading partners, distributors and some from the retail side of the channel. And what we've seen is a progressive destock. Since Q2 -- end of Q2 2022, there has been a progressive level of destocking taking place. And it really accelerated over the first half of this year, with a great level of destocking occurring in the second quarter. What we're hearing from the channel is that they want to continue that trend as we get into the heel of the season, Q3, with every expectation they want to have their balance sheet at a lean position as we enter the early buy period. So that's what we're hearing. And based upon the numbers that are being reported back to us, that's what we're seeing.

Okay. Perfect. And then I apologize if I missed it. You -- I'm sure I saw one of your competitors sort of quantified the destock impact on revenue for them this year. Do you have a similar quantification of that? And then when you say lean for the channel, do we end up the year sort of normal ranges or a little bit lean or a little bit fat on channel inventory versus underlying sales levels? And I'll stop there.

Sure. So what we've effectively included within our guidance is a channel destock on the full year of approximately $160 million, a little bit less than that. And that's really both at the primary channel level. And a little bit associated with what we're hearing could be held at the dealer level as well. But in the entirety, the full year channel destock embed within our guidance is approximately $160 million.

The next question comes from Saree Boroditsky of Jefferies.

This is [indiscernible] on for Saree. And I wanted to touch on the pricing. So how are you thinking about the pricing like going into 2024 as other like pool industry players are suggesting like higher than normal pricing?

Yes. I mean we -- I'd say we're still working through that. It's -- we normally work through the pricing same time that we're developing or designing the early buy program. What we see, we still really see an expectation around inflation next year. Depending upon the source, I think it's somewhere between 3% and 4%. I think we'll continue to battle wage inflation as that works through the components and even in some of our own suppliers. So we're intent on continuing to maintain price-cost neutrality. Obviously, we are aware of how much price has been put into the marketplace over the last, call it, 3 years or so with an eye to potential demand disruption. But again, given the inflation estimates that are out there, we are looking at implementing additional price actions into 2024.

The next question comes from Rafe Jadrosich of Bank of America.

It's Rafe. Just following up on the comment on the pricing expectation for next year and then the early buy expectation for the kind of having it in line with normal trends. So what like incentivizes dealers and distributors to participate in that early buy? You're kind of talking about them working hard to get their inventory lower than normal. Like is there potential that they just continue to operate with these lower levels of inventory? Or do you expect kind of the return to normal pricing cadence to get them to pull forward their orders?

Yes. I mean I think that there will be participation in early buy. Again, it's still being designed for the 2024 season. But traditionally, early buy has been a poor element of our industry, both -- really in all markets, whether that's seasonal or more the Sun Belt markets. Historically, there has been a pricing announcement at that time, with some discounts incorporated into the early buy program along with some payment terms. So those are the enticements that I -- that you -- that was in your question there, Rafe. And obviously, there's great benefit to the OEMs in our ability to run our factories, smooth out some of the production peaks and valleys. And as important, get products staged into the channel should we have an early break to spring so that we're ready to respond if there's an early start to the season.

That's really helpful. And then kind of stepping back and thinking longer term, I think you described 2023 as your normalization after really exceptional growth the prior 2 years. How do we think about when we could sort of get back to that long-term algorithm for the industry of mid- to high single-digit growth with like consistent pricing? When do you think we will sort of get -- that the industry is going to hit this like normalization stage?

Yes, I'm not sure we're ready to call 2024 yet. We as well as all of our participants and peers in the industry here really do expect the industry to get back on this traditional, mid- to high single-digit growth rate. I think it really comes down to more the macroeconomic, the interest rate environment, the inflationary environment, I think all of these over the last call it, 12 months or so has had a bit of an impact. That was in our original guide. And I think others are aligned around the impact that that's having on some of the more discretionary aspects of our industry. It's a great attribute in our industry, this largely nondiscretionary a reliable aftermarket. But there is an aspect, whether it's new construction, whether it's the decision to remodel or even upgrade some of the technology on your pad that does have a bit of a discretionary aspect to it. And we've seen some softness there in 2023. So I think that as we work through the second half of the year, Rafe, and get more confident in our forecast or budget for 2024, we need to make some assessments around what that macro environment is going to be into 2024.

[Operator Instructions]. The next question comes from Brian Lee of Goldman.

This is [indiscernible] on for Brian. I guess, first question on gross margin, kudos on the execution. You mentioned maintaining price-cost neutrality in '24. And it sounds like there's more optimization measures and streamlining, you can squeeze out more margins. So I just wonder, how should we think about like the long-term gross margin trajectory here? Should we see a path heading in -- see a path towards like 50% gross margin in the next couple of years?

Look, so we're really pleased that we've been able to now wrestle inflation to the ground and get to price-cost neutrality. And we'll continue to monitor inflation as we step into 2024 and take the requisite actions to protect the margin if we see inflation start to circulate again. But our current view for the forward 2024 year is that inflation will probably normalize back down to this maybe 3.5% level, and I think we're aligned with where the economic outlook there is as well. But the bigger benefactor to margin growth over the next couple of years is going to come from continued lean operational focus. We've got plans and ambitions to continue to improve our facilities. We have a tremendous track record of being able to lean up our facilities, drive process improvements in those facilities. And we're going to make the requisite investments to continue along that path both in terms of process improvement as well as CapEx improvements. I'd say the third attribute to our margin is products. And we've had a great 3 years in terms of new product introductions that have great margin profiles, and it's a win-win for the consumer with gray energy savings and other attributes that they're looking for. So as long as we continue to do that for the consumer, then I think we'll continue to see margin accretion over the course of time.

Yes, I was just going to add. In our presentation today and our script and some of the questions, there's a lot of good information there around things like gross margin and channel destock, and that's obviously all work in progress. But I think it's important to kind of step back and just give a little bit of perspective on where we sit as an organization. Over the last 3 years, we've gained share. We've realized pricing against inflation. But as Eifion just said, more importantly, we've expanded gross margins due to the tremendous work of our operations team to optimize footprint, lean out our facilities and then really match variable cost to our production volumes. We haven't spoken about it today much, but we are hitting our expectations around rightsizing the SG&A cost out between $25 million and $30 million, which is really enabling these high 20% adjusted EBITDA margins. And I think it will provide margin tailwind as volume returns. We've spoken about the channel destock. We've worked hard with our channel partners to get that down to healthier levels as we enter the 2024 pool season, and there's been obvious strengthening on the balance sheet from a working capital standpoint. But what we are laser-focused on as an organization as we head -- move through 2023 and enter 2024 is really the top line. That is around gaining further share, particularly in historically underrepresented markets for Hayward to continue delivering on best-in-class technology and product solutions for the pool owner and to be a great supply partner to our trade professionals and channel partners as well as an employer of choice and, of course, an investment of choice. So I just wanted to kind of give some perspective on what we've been working hard on and what our focus is heading forward as an organization.

Just a follow-up to one of the prior questions on growth. It sounds like all these inventory destocking could be a tailwind in '24. So I just wonder if you can quantify how much of that tailwind could be. And also, directionally, how should we think about 2024 growth versus the historical, let's say, 6% growth rate in the industry?

Yes. So as I mentioned, we -- destock for this year is approximately $160 million. We've seen substantial progress with that destock through the first half of the year, more than 75% based upon our calculations. There's been a tick up in the first half, with the balance now in Q3. And as we enter the 2024 pool season, which commences October 1, we expect that destock to be no longer a headwind as we head into next year. And that's when we start to -- on an annualized basis, start to achieve to . So I don't think we want to get finite here on 2024, but we certainly think the $160 million is unlikely to repeat, obviously, next year. So that headwind is fully removed. In terms of the second part of your question, which is, I think, been asked a couple of times so far is, what does the longer-term growth algorithm look like in the business and when do we get back to it, look, I still think we're super excited about this industry. This industry has got a fundamental attribute that many other industries don't have, which is a tremendous aftermarket installed base that we're servicing. Every year, that installed base grows with the addition of new pools. Over the last 3 years, a tremendous amount of new pools have been additive to that installed base. And that installed base will continue to be serviced over the next several years. Coupled with that is the adoption of new technologies. Coupled with that is continued adoption of increased attributes to the pool pad and in the pool. So we think we're moving into positive cloud environment. Now we're looking at green -- blue skies and green fields as we go forward, and we're super excited. Whether it gets to the algorithm in 2024 is to be determined. But we do need the macro environment to improve a little bit, all the noise around recession to abate, inflation to normalize, the Federal Reserve to be pleased with the work effort so far. And then I think we will get much better visibility. But the headwind on channel destock, we're going to say basically, no longer does it exist as we enter 2024.

The next question comes from Nigel Coe of Wolfe Research.

Can you hear me?

Yes.

This is [indiscernible] from Wolfe Research on behalf of Nigel. What I wanted to really begin to was kind of wanting to understand kind of how did the sell-through compare by region in North America and what impact did weather have overall.

Was the last part of the question weather?

Yes.

Yes. I mean I'd say whether, as you look over the first half, has had a bit of an impact but more so, I would say, in Q1 than what we saw overall in Q2. I think it's pretty well understood some of the issues on the West Coast in Q1. I think that that's largely improved in second quarter. Some of the more high-share regions for Hayward have actually performed well in the second quarter. So I mean we're not going to necessarily break out how we did region by region. But I would say weather has had a bit of an impact through the first half. It's in a much better -- it's more cooperative right now as we work through the summer and hopefully finish out the pool season here and will continue to allow us to hit those channel inventory levels as we work through the end of the third quarter here.

There are no further questions. I will turn the call back over to Kevin Holleran.

Thank you, Michelle. In closing, I'd like to thank everyone for their interest in Hayward. Our business is very well positioned to navigate the near-term challenges and deliver value for all stakeholders in the years ahead. This would not be possible with the hard work, dedication and resilience of our employees and partners around the world. Please contact our team if you have any follow-up questions, and we look forward to talking to you again on the third quarter earnings call. Thanks. Michelle, you can now end the call.

Thank you. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.