Welcome to Hayward Holdings Third Quarter 2023 Earnings Call. My name is Svangel and I will be your operator for today's call. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. 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 third 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 third quarter earnings call. I'll start on Slide 4 of our earnings presentation with today's key messages. I'm pleased to report solid third quarter results consistent with expectations. The quarter was highlighted by continued execution in a challenging operating environment with strong profitability and cash flow generation. Gross profit margins expanded nearly 400 basis points through a laser-focused management of manufacturing freight costs and a higher mix of technology products. We also demonstrated our robust cash flow generation characteristics again this quarter. Cash flow from operations increased approximately 50% on a year-to-date basis as we effectively reduced working capital. This is a tremendous accomplishment by the entire Hayward team. End demand for Hayward products, defined as channel sell-through, met our expectations and exceeded our sales into the channel, resulting in further normalization of distributor inventory. We are encouraged to enter the 2024 pool season with leaner inventory positions reported by our primary channel partners in the US, and this sets up Hayward to return to a normal matching of sales with channel sell-through in this market. We are strengthening the business with investments in our industry-leading technology and operational capabilities. This includes the ongoing development of innovative IoT connected products and further footprint consolidation, allowing Hayward to better support our customers and drive long-term profitable growth. Overall, our team continues to execute in a challenging operating environment, and I'm pleased with our performance during the quarter. Finally, we're updating our guidance primarily to reflect the impact of more challenging macro conditions in certain international markets, specifically in Canada, the Middle East, and Latin America. Early buy orders in our primary US market increased year-over-year and are trending in line with expectations. However, recent in-season orders have been softer than previously anticipated, reflecting a cautious approach by channel partners ahead of 2024. For the full year 2023, we now expect net sales to reduce approximately 24% to 26% compared to last year and adjusted EBITDA of $245 million to $255 million. Longer term, we expect to resume a solid historical growth trajectory of mid to high single-digits. Turning now to slide 5, highlighting the results of the quarter. I'm pleased to report net sales in line with expectations driven by stronger execution in the US and Europe. Net sales in the third quarter reduced 10% and year-over-year to $220 million, largely due to channel inventory movements and softer market conditions. By geography, net sales reduced by 9% in the US and 15% in international markets. Europe reduced 6%, with larger declines of 16% in Canada and 23% in Rest of World. I'm encouraged to see sales trends stabilizing in our largest markets of the US and Europe, with each down less than 10% in the quarter. Aftermarket maintenance and repair remains resilient, whereas demand for discretionary product categories has been more impacted by the challenging macro conditions, particularly in the retail and online channels and certain international markets. Commercial pool sales increased double-digits again in the quarter. We are focused on driving growth in these markets and are pleased with the continued robust demand. Our gross price list increased 5%, but was more than offset by the comparative changes in the earned annual distributor rebate and dealer incentive programs, which are finalized in the fiscal third quarter for the seasonal year end. In other words, more distributors earn rebates this year while fewer achieve rebate thresholds last year. This is a positive outcome and reflects channel partner increased target attainment and a higher mix of premium dealers in our results. Importantly, this is a third quarter dynamic, and we expect positive net price realization on a full year basis. As I mentioned, the gross margin performance was strong again in the third quarter despite lower volumes and net pricing. Gross profit margins expanded nearly 400 basis points year-over-year to 47.8%. The improvement is a result of continuous operational improvements, a moderating rate of inflation in certain purchased materials and freight costs, and a higher mix of technology products. This has allowed us to continue expanding gross margins at lower production volumes while positioning for future growth. Adjusted EBITDA in the third quarter was $47 million with a margin of 21.4%. We continue to deliver the expected $25 million to $30 million in annual SG&A savings under our prior enterprise cost reduction program. These savings were partially offset in the third quarter by an increase in our field service warranty costs to accommodate higher labor costs per service call, as well as our commitment to the consumer to replace with a whole good if a spare part is not available. Importantly, our first-time quality metrics are consistent with prior periods, and our production of spare parts has increased in response to a significant increase in early buy demand for parts. Consequently, we expect field service warranty costs to moderate going forward. Adjusted diluted EPS in the quarter was $0.09. Turning now to slide 6 for a business update. End demand for Hayward products was consistent with our expectations in the quarter, with our largest markets, US and Europe, performing solidly. Non-discretionary aftermarket demand remains resilient, but demand for products used in discretionary new construction upgrades and remodels has been impacted by current economic conditions and rising interest rates. As a result, customers are participating in the early buy program as expected by taking a cautious approach ahead of 2024 for in-season orders. However, we are encouraged to see signs of stabilization in demand for new construction in the US particularly in the higher end of the market. Further, we continue to see compelling opportunities for upgrade and remodel given the record age of the installed base. We continue to see strong market acceptance of the connected suite of products within our Omni IoT automation ecosystem. Adoption of the Omni platform continues to grow with one of the largest builders in the US now standardizing on Omni. Our Omni app is highly rated on both Apple and Google Play stores, and we have seen an increase to 94% of all Omni’s activity used by homeowners via the app. We are also excited by the uptake of our Omni retrofit kit, which provides a simple upgrade path from legacy ProLogic controls to the latest technology. As expected during the quarter, our channel partners continued to rebalance the level of inventory relative to the current economic outlook, normalized OEM lead times, and higher cost of carrying inventory. Our primary partners in the US are reporting leaner inventory levels in the channel entering the new pool season, whereas some partners and regions are still recalibrating. Turning to the price versus cost dynamic. We are maintaining price-cost neutrality and driving solid gross margin expansion through disciplined cost control and manufacturing productivity improvements. We continue to evaluate our global manufacturing footprint as part of our operational excellence initiatives. Given the merits of our newest manufacturing facility in Barcelona, we initiated a plan during the quarter to consolidate our facility near Madrid into Barcelona. This change will allow us to better leverage the benefits of a modern facility more closely align manufacturing, engineering, and product management and support margins. We continue to prioritize working capital management and deliver significant improvements. Total working capital declined by $139 million on a year-to-date basis, contributing to the positive cash flow performance. With that, I'd like to turn the call over to Eifion, who will discuss our financial results in more detail.

Thank you, Kevin and good morning. I'll pick up on Slide 7. All comparisons I'll make will be on a year-over-year basis. As Kevin stated, we are pleased with our third quarter financial performance. Net sales modestly exceeded expectations for the quarter and reflected a return to normal seasonality coupled with a progressive rightsizing of channel inventory. We delivered outstanding gross margin expansion to 47.8%, and we're realizing our SG&A cost reductions in line with the plan. Our balance sheet is strong, and we generated good cash flow. Looking at the results in more detail, net sales for the third quarter decreased 10% to $220.3 million. This was driven by an 8% reduction in volume and a 3% reduction in net price. The volume decline during the quarter was primarily driven by the expected distribution channel inventory movements and moderating demand trends in discretionary elements of our markets like new construction and through the retail channels, as well as weaker performances in Canada and certain other export markets. Gross price increased approximately 5% but was reduced in the quarter by comparably higher annual rebate settlements and dealer incentives resulting in a net price decrease of 3% for the quarter. This is an end of seasonal year performance calculation quarter for us and can result in some swings to our rebate and incentive calculations based on final target achievements. Last year's final calculation for the seasonal year performed in the third quarter resulted in a favorable adjustment to income, whereas this year the rebates are more normal. This dynamic is generally limited to the third quarter. The key point is our price increases are holding, and our incentive programs are yielding solid volume results with strong margins. Gross profit in the third quarter was $105.4 million. Gross profit margin increased 390 basis points year-over-year to 47.8% compared to 43.9% in the prior year period and a record 48.1% achieved in the second quarter of 2023. Disciplined manufacturing cost control and moderating input material and freight costs more than offset the impact of reduced production volumes. As we have discussed before, Hayward has a long-standing commitment to lean manufacturing and continuous improvement, and I'm excited about our plans to deliver further productivity gains across our manufacturing and supply chains. Selling, general, and administrative expenses increased modestly on a sequential basis to $59 million in the third quarter. We are delivering on the annual run rate savings of $25 million to $30 million targeted under our prior enterprise cost reduction program. However, we increased our field service warranty accrual rate in the quarter, primarily to account for higher service labor costs and reduced spare parts availability. We have taken proactive actions to address this and limit the impact going forward, including ramping production of spare parts and we expect these costs to moderate going forward. The increase in the accrual rate was partially offset by reduced variable compensation expense. In the quarter, we took a restructuring charge of $3.3 million, primarily related to the exit from our manufacturing facility near Madrid, which will yield an annual cost savings of approximately $2 million, once the move is complete. Adjusted EBITDA was $47.2 million in the third quarter, and adjusted EBITDA margin was 21.4%. We are positioned to drive solid margin expansion as volume growth returns. We recorded an income tax benefit of $2.3 million in the third quarter related to favorable discrete tax items. We continue to expect an effective tax rate of 25% for the fourth quarter. Adjusted diluted EPS in the quarter was $0.09 on a fully diluted share count of 221 million shares. Let's turn now to slide eight for a review of our reportable segment results. North American net sales for the third quarter declined 9% to $185 million, driven by a 5% lower volume and a 4% unfavorable net price impact. The reduction in volume was largely due to both the expected rightsizing of channel inventories and moderating end demand trends as previously communicated. Sales in Canada declined 16% in the quarter. This market is going through a tougher macro period. Relative to the US, it's a very short season and now closed for 2023. There is also a higher concentration of lower-cost in-ground pools and above ground pools in that market, where demand is more significantly impacted by economic condition and financing costs. Despite the temporary net pricing dynamic I previously mentioned, gross profit margin in the quarter expanded 430 basis points year-over-year to a solid 49.4%. For two quarters in a row now, the NAM segment has posted greater than 49% gross margins. Adjusted segment income margin was 24.9%. We were pleased with the margin performance in the quarter. Turning to Europe and Rest of World. Net sales for the third quarter decreased 15% to $35 million. Net sales benefited from net favorable price realization of 4%, and foreign currency translation benefited 3%, offset by a 22% decline in volume. We were pleased with the performance in Europe, where sales declined 6% overall and increased 1% in Southern Europe. In contrast, Rest of World declined 23%. We continue to invest in our expansion campaigns into Asian markets, where we have established a solid share position, but we're seeing a tempering of demand in that region, as well as increased macro pressure in the Middle East and Latin America. Overall for the segment, gross profit margin expanded 130 basis points year-over-year to 39.6%, and adjusted segment income margin was 18.9%, again solid margin performances. Turning to slide nine for a review of our balance sheet and cash flow highlights. Net debt to adjusted EBITDA was 3.9 times at the end of the third quarter compared to 3.8 times in the second quarter. We continue to prioritize deleveraging to our targeted range of two to three times. I'll discuss this a little further shortly. Total liquidity at the end of the third quarter was $402 million, including a cash and cash equivalent balance of $244 million, and availability under our credit facilities of $158 million. We have no near-term maturities on our debt or interest rate swap agreements. Term debt of $1.1 billion matures in 2028, and the undrawn ABL matures in 2026. This attractive maturity schedule provides financial flexibility as we execute our strategic plans. Our borrowing rate continues to benefit from the $600 million of debt currently tied to fixed interest rate swap agreements maturing in 2025 and 2027, which limits our cash interest rate on our term facilities to 6.7%. Our average earned interest rate on global cash deposits for the quarter was 4.6%. Overall, we are pleased with the quality of our balance sheet. We have a strong, but seasonal cash flow generation characteristic driven by high-quality earnings. Cash flow from operations was a robust $217 million year-to-date in 2023, compared to $144 million in the prior year period, reflecting the effect of working capital management. We made great progress reducing working capital by $139 million year-to-date. CapEx of $23 million year-to-date was consistent with the prior year period. Year-to-date free cash flow generation of $194 million increased 62% compared to the prior year period last year. For the full year 2023, we expect free cash flow generation of approximately $125 million to $150 million depending upon the mix of standard versus early buy final order activity. With the return to normal seasonality, the company will typically use cash in the first and fourth quarters and generate cash in the second and third quarters. This year, larger early buy orders with extended payment terms will push the collection of some receivables into the first half of 2024. Turning now to capital allocation on Slide 10. As we've highlighted before, we maintain a disciplined financial policy and take a balanced approach to emphasize strategic growth investments and shareholder returns, while maintaining prudent financial leverage. In the near term, we are prioritizing CapEx growth investments and reducing net leverage within our targeted range of two to three times. We continue to consider tuck-in acquisition opportunities to complement our product offering, geographic footprint, and commercial relationships in addition to opportunistic share repurchases. Turning now to Slide 11 for our outlook. We remain very positive about the long-term health and growth profile of the pool industry, particularly the strength of the aftermarket and in Hayward's leadership position within the industry. We are updating our outlook for 2023 to reflect primarily a reduction in outlook for the Canadian and Rest of World markets. Our outlook for the US and Europe is moderately tempered by the more cautious stocking by our channel partners in the fourth quarter. It's clear some of our partners increasingly favor in-season purchasing rather than stocking ahead of the 2024 season, and we'll continue to use current albeit increasingly normalized inventories to service remaining in-season 2023 business. Consequently, we now anticipate a decrease in consolidated net sales of 24% to 26%. We now expect adjusted EBITDA to be between $245 million and $255 million, with free cash flow in the range of $125 million to $150 million. Our interest expense expectation is approximately $75 million, reflecting the current interest rate environment on borrowing levels. The effective tax rate forecast remains approximately 25% for the fourth quarter, and our CapEx spending forecast for the full year is approximately $30 million. And with that, I'll now turn the call back to Kevin.

Thanks, Eifion. I'll pick back up on slide 12. I'll close with the summary. We delivered third quarter 2023 results in line with expectations. I'm proud of the Hayward team's ability to execute throughout this challenging period for the industry, delivering net sales ahead of expectations for the quarter with strong gross margin expansion at reduced sales volumes and further cash flow generation. With channel inventories reducing to leaner positions, increased market share over 2019, healthy structural margins, and a strong balance sheet, we are well positioned as we enter the 2024 pool season. Longer term, this is a resilient industry characterized by consistent growth and ever-growing aftermarket and a number of secular tailwinds including the appeal of outdoor living, Sun Belt migration, connected smart home technologies, and environmentally sustainable products. As a leader in this 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.

Thank you. We will now be conducting a question-and-answer session. The first question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hey. Good morning, guys.

Good morning.

Hey, Jeff.

Yes. Just wanted to go back to this negative pricing. I guess what's a little confusing to me is, given all the destocking and the weaker demand, why rebates are higher and just maybe help me understand if there's other discounting in there or maybe how the rebate true-up works that maybe obfuscates kind of the underlying price?

Sure. Good morning, Jeff. As mentioned in our prepared remarks, we are very pleased with the 47.8% gross profit margins reported in the third quarter. This reflects an increase of nearly 400 basis points, even with net sales down 10%. What's even more noteworthy is that this margin is just 30 basis points shy of our record gross profit last quarter, despite a sequential net sales decline of 22%. Your question addresses the impact of pricing on these margins. I want to emphasize that this is not due to giving back list or invoice prices, which increased by 5% this quarter. We have seen positive year-to-date realizations and expect to maintain positive pricing for the full year. The third quarter is somewhat unique for us, as it marks the end of our seasonal year when true-ups happen, which is what we experienced this time. I’ll let Eifion explain some of the accounting aspects shortly, but to clarify, this situation doesn’t indicate a loss in market pricing or any reduction in past price increases. It relates to two main factors. First, the end-of-season performance calculation can cause fluctuations in our rebate and incentive figures. Last year, this calculation brought a favorable adjustment to our income in the third quarter, while this year, the rebates are more standard. Second, there’s been a higher mix of qualifying dealers this year, mainly high-end builders who earn incentives based on volume. With the destocking occurring, mid-level and higher-end pools are performing well in a lower sales environment, making this segment a larger part of our overall mix. Eifion, did you want to add anything?

Yes. I'd say, Jeff, it's very much limited to the third quarter. Last year's final calculation resulted in a favorable adjustment to income. So we're stepping over that favorability year-on-year. This year we have more normalized rebates as a percentage of sales. So it's strictly limited to final accounting on a seasonal year rebates, and we expect positive price realization as we go forward here.

Okay. That's very helpful. And then just as we look into 2024, maybe any update on that destocking number 160? And then just how are you seeing markets starting to shape up as you look into 2024 and kind of your confidence you recapture on sell-through that destock impact or most of it.

Yes, the 160 figure you mentioned is our best estimate at this time. We'll have more clarity on that at year-end. While we don't have complete information globally, we do receive some insights. We have made significant progress up to September, and many in the industry are focusing on reducing inventory, which we support. However, there are still some areas that require further adjustment, although most of this is behind us now. Regarding 2024, while you're not asking for specific guidance, we view it as we navigate the budgeting process, identifying certain positives we can build on. However, there are still elements that need more time for better understanding. The positives include the fact that the heavy destocking challenge we faced is mostly resolved in 2023. You asked earlier about pricing, and we anticipate positive net pricing. We announced a price increase that took effect on October 1st, which is now reflected in the market. Additionally, the aftermarket continues to show resilience in 2023, and we expect this to continue into 2024. We are uncertain where new pool installations will land, but if estimates suggest around 70,000, that will increase our installed base beyond what we had at the end of 2022, requiring service, maintenance, repair, and remodel in the future. On a more concerning note, the macroeconomic conditions are giving us pause, particularly with interest rates affecting all markets, especially in Canada and some export regions. Currently, we don't foresee a significant tailwind that would meaningfully boost new construction heading into 2024, especially at the entry-level, which is heavily influenced by financing and interest rates. These are some of the considerations we are factoring in as we look towards 2024. We'll provide a more definitive outlook in February.

I appreciate the color, guys.

Thank you. Next question comes from the line of Saree Boroditsky with Jefferies. Please go ahead.

Good morning. This is James on for Saree. Thanks for taking questions. So I wanted to talk about your commentaries on softer than previously expected in-season orders. Can you provide some more color on this and how the sell-through was like in the third quarter and into October?

I would say the sell-through met our expectations. A large distributor has already reported earnings, and their equipment sell-through aligns with what we observed for Hayward products in the market, which was expected as we concluded the season. Regarding the first part of your question, we noticed throughout the third quarter and are projecting for the fourth quarter that we need to have more realistic expectations regarding in-season orders. This isn't about early buys; the order flow prior to the early buy season didn’t meet expectations. This likely reflects ongoing concerns about inventory management and balance sheet factors. Overall, we've seen a positive response and although we are not finished with the early buy season, the ordering has been as expected. However, when combined with our initial expectations for in-quarter orders, we didn't see those results in the third quarter, which raises some concerns as we prepare for the fourth quarter and finalize our full-year guidance.

I think the channel is being very cautious about what they're adding to their inventory due to current macro dynamics, especially related to interest rates and the cost of holding inventory. They are purchasing items as needed rather than in advance. This trend is evident across our entire channel footprint. As we mentioned previously, this cautious approach has led to a shift in purchasing for the 2024 season, bringing it much closer to the actual in-season demands. Given the interest rates, the channel has been particularly careful in their inventory decisions.

Got it. Thanks for the color. Then as a follow-up, you guys talked about resilient aftermarket demand and even going into 2024, but I believe one of your competitors talked about the aftermarket coming in weaker given higher interest rates. So can you provide more color on what you mean by resilience here?

Yeah. I mean when we define the aftermarket, broadly speaking that's everything but new construction, and that certainly gets a lot of attention. But the aftermarket is a combination of that classic break-fix remodel activity, and then just some upgrading where we define that as if the heater wasn't there on the pad last year and it's added this year that's an upgrade. So I do think that the break-fix, when we're talking about really resilient and nondiscretionary, that's the piece of the aftermarket that we're really referring to. The other elements of the aftermarket, whether it's the remodel or some of the upgrading activity is certainly impacted by the current macro environment and the interest rates in the environment. But again, we view that break-fix as something in the 50% range of our overall business. And by and large that stayed very resilient through this macro environment that we're experiencing.

Great. Thanks for taking my questions.

Thank you. Next question comes from the line of Ryan Merkel with William Blair. Please go ahead.

Hi, everyone. Thanks for taking the questions. I wanted to start off with 4Q just coming in a lot lighter than we were expecting. What's really the headline there? Is it the international business that's weaker, or what else is in there?

It is Canada and some of our export markets. We were in Canada last week, and I would say there is still some destocking that needs to occur in the Canadian market. The mortgage rate environment there is quite different, with shorter lock periods, and there has been considerable media coverage recently about the adjustments homeowners will face in the coming years. This presents a significant challenge and is causing a lot of anxiety among homeowners in Canada, which is affecting their discretionary income and household spending. Over the past three to four years, the response during the early stages of COVID-19 in Canada was even stronger than what we observed in our core US market. Now, as macro factors come into play, the recovery seems to be outpacing what we're experiencing in the core US market. Therefore, Canada is the main factor influencing our Q4 outlook.

I think what's important Ryan to also understand is the demand channel sell-through that we've seen in our core markets, US and Europe actually is in line with our expectations. And we have a similar expectation for channel sell-through in Q4. But as I just mentioned in the previous response, what the channel is taken in in Q4 is going to be lighter than we expected as they shift their buying patterns to be more juxtaposed to their needs in the 2024 season. I just think it's a general cautious approach to managing their balance sheets as we continue to wrangle as an economy here with high interest rates.

It was probably implied, Ryan. We know you may not, but we have a strong presence in the Canadian market, which is why it is significantly affecting the Hayward outlook right now.

Got it. Okay. That's actually really helpful. Thank you for walking through that. And then for my follow-up, can you just talk about price in 2024? I think you've come out with a list price increase. And then any change to incentives for the early buy? Or would you call them normal?

Tackling the first one, yes, we did announce a price increase for the 2024 season. The actual wording on the price increase up to 5% on the whole goods, slightly more on parts, and that's a US-centric comment. It does vary a little bit as you go around the hall and around the rest of our business. But generally speaking, once you put all of that into the calculation of the SKU range, we'd expect probably an average price increase of about 3% to 4% globally next year on a weighted SKU basis. And really that's to protect against where we see inflation dynamics and most of those inflation dynamics are consequential to labor cost increases in the business. In terms of the early buy, we have given an extended discount more in line with history, on the early buy. And in terms of terms, we have gone to a more standardized approach on payment terms of 180 days in the main. Some customers have slightly different, but generally speaking, 180 days with a 2% discount to pricing.

Perfect. Thank you.

Thank you. Next question comes from the line of Andrew Carter with Stifel. Please go ahead.

Hi. Thank you. I just want to go back to this vendor incentive issue in the quarter. I guess number one, why was this so abrupt and kind of not telegraphed in the quarter given the focus on pricing here? And I'm still a little confused about how the rebates could be up this year, given I know you said it was a tailwind last year, but I would assume you probably had a better volume sell-through last year than this year than what's implied. Can some individual customers outperforming drive the mix that much? Just some incremental clarity there. Thank you.

Yes. It is a limited Q3 dynamic, Andrew. This time last year, when we performed seasonal rebate calculations, the final calculations resulted in a positive adjustment back to income given the aggregate misses across the channel. Our rebate structures are based on channel sell-in in the main, and last year, they were limited based upon channel performance. This year, we've restructured our programs. In the US, we've actually gone to a more quarterly based program structure, that's in recognition of the dynamics we were assisting the channel with in terms of destock, and we've had a slightly higher rebate percentage payments this year than we have had last year. But given it all gets accounted for in Q3, you can have a year-over-year swing dynamic that has no implications for the overall gross price. Gross price still remains positive year-over-year, and this adjustment really is a Q3 dynamic.

So quickly, so was one more incremental thing this year a change in the program relative to last year? Did I hear that correctly?

We changed in the US. We changed our programs to a more quarterly based program incentive. Last year was a typical seasonal approach. So you're accruing for seasonal rebates; you get to the end of the season, you evaluate where the channel is, and then you make your adjustments accordingly. This year it's been more quarterly adjustments.

Second question about your year-end leverage. I'm calculating right off your updated guidance, I'm getting like a 3.7 to 3.4. That would assume best on best, worst on worst. Is that fair because the pre-buy will dictate cash flow. Within that, what are the implications for where leverage will go into kind of first quarter. I know that debt paydown is your highest priority. Help us understand that and what the dynamics are and how much aggressively you're wanting to pay down debt? Thanks.

Sure. Yes. The range that you recount there is broadly correct. And it, as you said, is heavily dependent on the mix of business as we step through the final nine, ten weeks of the year here. As we mentioned, lower flow orders, as the channel moves their flow in-season terminology we're using here. As they ship those orders to closer to the 2024 season, you push that cash collection into that time period and you actually exit this year with slightly higher inventories. So we do expect to deleverage as we step into the new year. We expect to get back into our targeted range of two to three times in 2024, once we collect the early buy cash and we see these in-season orders go through in the back end of Q1 and Q2 of next year. We feel really good about our liquidity position. Right now we've got significant cash on the balance sheet. We remain undrawn on our ABL facility. We've done a good job on our own here reducing our own inventory levels on our balance sheet, which has been a great source of cash this year. So from my perspective, we feel – I feel very comfortable with the liquidity position in the business and recognize that with the shift in order mix, it will defer a little bit of cash collection into next year whereas we had anticipated this year, but that's just a timing issue.

Thanks. I’ll pass it on.

Thank you. Next question comes from the line of Mike Halloran with Baird. Please go ahead.

Hey, good morning, guys. Paz on for Mike. A quick one for you. So obviously, a lot of moving pieces, given the destocking, the pricing discounts impacting EBITDA margins. But can you maybe help us understand what you think the right run rate exiting this year looks like? Obviously, a little bit wider range of expectations or possible outcomes going into 4Q and into next year than we were initially anticipating. So if you could touch on that a little bit on exit rate expectations that would be helpful.

Yes. Let's – in terms of the quality of the income statement, we still expect to exit out this year at high 40s gross margin and slightly over mid-20s adjusted EBITDA, when you calculate our results at the midpoint. So we're very pleased with the quality of our income statement, despite the year-on-year net sales decline as we go through this channel destocking period. So that's come as a consequence of a lot of hard work in the business to protect our margin, and as we indicated we look forward to next year to see that leverage opportunity lift both of those margin dynamics both on the gross profit line and more importantly at the adjusted EBITDA line. But as we exit this year, we're still going to post up high 40s gross margin and slightly over mid-20s adjusted EBITDA margin.

Got it. That's super helpful. And maybe at a high level, can you just dig into the diverging trends of the gross margin and the adjusted EBITDA margin that we saw in this quarter? And maybe help us with the puts and takes that drove the gain in gross margin with the weakness in adjusted EBITDA margin?

Yes. I think it just strictly comes down to, as we've discussed before, Q1 and Q3 tend to be the low part of our year. And then when you look at the coverage you have across your SG&A base, you have less coverage in Q3. So you'll see healthy margins throughout the year at the gross margin level, but less leverage across the SG&A base in Q1 and Q3. And that's what limited the adjusted EBITDA margin in this particular quarter. It will lift again in Q4 as we get more leverage across that SG&A base. We had, as we mentioned, a little bit of a sequential increase in SG&A costs consequential to field service warranty costs; that's a true-up of the pricing in recognition of higher field service inflation costs rolling through. But again that will moderate as we go forward here. But it strictly comes back to leveraging across the SG&A base in a seasonally light sales period.

Thanks. I appreciate the color. I will pass it on.

Thank you. Next question comes from the line of Nigel Coe with Wolfe Research. Please go ahead.

Hi, Eifion.

Thanks. Hi, Nigel. How are you doing?

Good. Thanks. Good. All right. So Canada – just about Canada. Can you remind us how big is Canada? What percentage of your North American segment is Canada? And is there any material difference in margins between Canada and your North American business?

Canada on a comparison basis was nearly 10% in 2022, and it's about two-thirds of that in our overall mix this year. Historically, there had been more of a margin decrement in Canada. But I'd say the team has done a great job over the last handful of years working the price less value basing our pricing, and it's gotten much closer to our standard, call it, US margin rate, Nigel.

Okay, that's great. Given that distributors are being cautious, I’m not surprised, but I’m curious if you’ve noticed any significant differences in behavior between smaller distributors and larger ones like Pool. I would imagine that the costs of holding inventory in the current rate environment are challenging for some smaller players. So, I’m wondering if you’re seeing any differences out there. Is this purely an end market issue, or is it also related to the rates?

I haven't really observed any irrational behavior among our distributor partners. As mentioned earlier, they seem to be more cautious with their reorder rates. As they work to reduce their inventory levels, that’s what we’ve noticed rather than any irrational pricing strategies in the market.

Yes. It wasn't a pricing comment. But just my final comment is really actually on pricing the adjustment. So, Eifion, I think you said you've gone to a quarterly basis now as opposed to a seasonal basis. Is this true up really just purely a 3Q issue? I just want to make sure this isn't going to be during the fourth quarter as well.

Yes, I want to clarify that this is indeed a Q3 issue, and it stems from not repeating a strong performance from last year. We anticipate positive price realization in the fourth quarter compared to last year. Unfortunately, we experience year-over-year seasonal adjustments in the third quarter. As you noted, we have transitioned to a core fee program this year and have modified our rebate structure to operate on a calendar year instead of the traditional seasonal year ending in Q3. We will shift to quarterly adjustments for the remainder of the year and continue with a calendar year basis starting in 2024.

Okay. I just killed a horse on that one. So, thank you very much.

Thank you. Next question comes from the line of Sean with Bank of America. Please go ahead.

Hi guys. Thanks for taking my question. Despite the pricing headwinds, the gross margin was near record levels. So, can you talk about what you're seeing on inflation for materials and labor and what your expectations are heading into 2024?

So, we have seen moderating inflation in some commodities. The overall basket of raw materials including purchased items still remains moderately inflated over last year, but the rate of inflation is certainly decreasing. I think when it comes to labor costs we are seeing labor costs now move positive move higher, and that was one of the main implications reasons why we increased our price list as we move into 2024. But just again to come back to the price dynamic, price list in the quarter was positive year-over-year. You've just got this one-time rebate anomaly which is unfortunately affecting Q3. But as you step into Q4, you'll see the fullness of price year-over-year. And for the full year, we still expect very positive price realization, and margins will continue to hold into the high 40s as we step through Q4.

Great. Thank you.

Thank you. Next question comes from the line of Nick Cash with Goldman Sachs. Please go ahead.

Hi everyone. This is Nick Cash on the line for Brian Lee. Just had a quick question regarding destocking. It seems that you guys still are having some destocking issues in Canada but I just really wanted to know can gauge how you guys are seeing the rest of North America and the rest of the world? And if you have any visibility on being fully destocked in 2024 in any of these other markets? You also mentioned buyers being a little bit more cautious, and that's, I guess, the new base case? Or do you happen to see or expect any restocking period that could possibly be a tailwind going into 2024? Thank you.

Yes, we've made significant progress through September. However, there are still some specific channel partners and regions, including Canada, that need some adjustment. Overall, we feel positive about the progress made as we conclude the seasonal year in September. The typical inventory cycle, due to early purchases and winter stocking programs, involves reducing inventory during Q3, with Q4 and Q1 usually being restocking phases, followed by working off that inventory in Q2 and Q3 as markets open up. That's the situation regarding destocking. I neglected to address the second part of the question.

Going into '24?

I think when it comes to the rest of the world, it's a bit of a wait and see. Some of those markets have got a bit more macro sensitivity than our primary US and European markets. So we'll continue to monitor that situation and work with those channel partners to get that pull-through to help them move that material through those channels, but it's something that we want to have full visibility up until we actually step into the 2024 season.

Yes. I mean with our supply chain capabilities, as we exhibited through the COVID experience, whether the orders come in through an early buy program or whether they're more in season, we'll be partnering with our channel folks to respond what we believe is best-in-class to be able to respond to the market dynamics, as they play out here into 2024.

Awesome. Thank you guys. Appreciate the color.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Kevin Holleran for closing comments.

Great. Thank you. In closing, I'd just like to thank everyone for their interest in Hayward. Our business is well positioned to navigate the near-term challenges and deliver value to all stakeholders in the year ahead. This wouldn't be possible without 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 fourth quarter earnings call. Thank you, operator, you can now end the call.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time.