Hayward Holdings, Inc. Q2 FY2024 Earnings Call

Greetings, and welcome to the Hayward Holdings Second Quarter 2024 Earnings Call. My name is Melissa, and I will be your operator for today's call. Please note that this conference is being recorded. I will now turn the call over to Kevin Maczka, Vice President, Investor Relations. Thank you, sir. You may begin.

Thank you, and good morning, everyone. We issued our second quarter 2024 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 2024 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 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 consistent with expectations. We executed well again this quarter in a challenging industry environment, delivering strong profitability, increased cash flow, and an improved balance sheet. We continue to advance our growth strategy, centered around technology leadership, brand and multichannel strength, and operational excellence, and expect this to result in above-market growth and shareholder value creation. I'm proud of the performance of the entire Hayward team during the quarter. Net sales increased modestly year-over-year as positive net price realization was offset by lower volumes. Gross profit margins expanded 290 basis points to a record 51%. This represents the sixth consecutive quarter of year-over-year gross margin expansion. Cash flow generation was also solid during the seasonally strong period for collections with cash from operations increasing 26% year-over-year in the first half. Strong profitability and cash flow enabled us to further strengthen the balance sheet and fund our growth initiatives. During the quarter, we reduced net leverage by more than a full turn sequentially on an organic basis from 4x to 2.8x excluding the use of cash to acquire ChlorKing at the end of the quarter and paid down our entire incremental Term Loan B on a voluntary basis. ChlorKing, a leader in commercial pool water sanitization, is a great strategic fit with a strong financial profile, advancing our position in the commercial pool market. We're very excited to welcome the ChlorKing team to Hayward, and I'll share additional details on the business later in the presentation. Finally, as we enter the second half of the year, we are narrowing our full year guidance, reflecting better-than-expected margins offset by a more challenging demand environment, particularly in new construction and remodels and certain international markets. For the full year 2024, we now expect net sales to increase approximately 2% to 5% and adjusted EBITDA to increase approximately 3% to 9%. Turning now to Slide 5, highlighting the results of the quarter. Net sales in the second quarter increased modestly year-over-year to $284 million, consistent with expectations. By segment, net sales increased 2% in North America and declined 6% in Europe and Rest of World. Europe outperformed with 7% sales growth in the quarter, whereas Rest of World sales declined 21%. We are focused on driving growth in the commercial segment of the market, both organically and inorganically through acquisitions like ChlorKing. Commercial pool sales in North America continued to increase on an organic basis following a multiyear trend of robust growth. As I mentioned, gross profit margins expanded 290 basis points year-over-year to a record 51% in the second quarter. Adjusted EBITDA margin in the second quarter increased 100 basis points year-over-year to 29% and adjusted EPS increased 11% to $0.21. Turning now to Slide 6 for a business update. In-season demand for Hayward products was consistent with our expectation in the quarter with North America and Europe outperforming the Rest of World. Aftermarket repair and replacement remain resilient, but demand for the majority of new construction and remodel continues to be impacted by current economic conditions and higher interest rates. While we see the number of U.S. permits down in the mid to high teens, the value of permits also remains resilient, indicative of relative strength in the high-end new construction and remodel segments of the market. We expect similar trends in the second half of 2024. We continue to execute many important strategic initiatives to strengthen our business and drive profitable growth. This includes introducing innovative new products to advance our technology leadership, further developing our go-to-market capabilities, and improving channel and dealer support. On the fourth quarter earnings call, we introduced the new microchannel temperature control unit, a first-of-its-kind product, providing the ability to both heat pool water and cool to 40 degrees with a single unit. Customer response has been extremely positive, with pool owners excited about the ability to utilize the spa for a cold plunge. Differentiated innovative products like this add value to our customers and drive engagement with target accounts. We continue to expand in key U.S. markets like the West and South Central through investments in focused teams working under common leadership to both support existing customers and target successful dealer conversions. These teams comprise business development managers working side-by-side with sales and technical service. This structure is key in managing the lifecycle for newly acquired accounts from engagement to education, conversion, and ongoing long-term support. One specific initiative of note is the launch of the Hayward Hub DFW in Texas. This first-of-its-kind Hayward facility will serve as a training, service, and support center for dealers and trade professionals in this important growth market, driving customer intimacy and loyalty behavior. Since the opening in mid-Q2, nearly 200 individuals from more than 30 companies have already attended training sessions on the latest Hayward technology at the hub. We believe this will be a winning formula as we grow in this key market. To further support our existing dealers, we introduced the new OmniPro app earlier this year, providing significant value to trade professionals in the form of real-time remote monitoring of a homeowner's pool and equipment configuration via the cloud. Builders see the value of proactive remote monitoring of pools, particularly through the construction completion and warranty period of their installations. Similarly, large professional service organizations benefit from this business efficiency tool, allowing them to prioritize and respond to service needs. We are pleased with the progress of these initiatives and are well-positioned to drive future growth. Moving on to the channel. Our partners are pursuing leaner inventory positions as they work to achieve increased efficiency goals. We continue to work with them to optimize the level of Hayward inventory on hand and the SKU mix by facility to reduce the occurrence of inventory stockouts. The pool industry has always been very disciplined on price, and we previously implemented an annual price increase for 2024 to maintain price/cost neutrality. We continue to expect positive net price realization of approximately 2% for the full year, consistent with the contribution in the first half. We are implementing value-based pricing strategies and SKU rationalization to optimize pricing and ensure our products are priced appropriately relative to the exceptional value provided to pool owners. We expect to realize incremental benefits from these initiatives going forward. In May, we further strengthened our senior leadership team by filling 3 key roles. This included the appointment of Ray Lewis as Chief Human Resource Officer; Kevin Gallagher as Chief Engineering Officer; and Dario Vicario as General Manager of Europe and Rest of World. We were delighted to welcome these accomplished leaders to key positions within the organization. Our company is already benefiting from their diverse backgrounds and proven track record of success. Finally, we were honored that Green Builder Magazine recognized the Hayward TriStar XL variable-speed pump as a sustainable product of the year. This underscores our commitment to sustainability and environmental responsibility as we strive to produce the most energy-efficient solutions for our customers. Turning now to Slide 7. As I mentioned previously, we are excited about the opportunities to develop our commercial pool business, and the key building block is the addition of ChlorKing, nearly doubling our sales in the commercial market. Operating in Atlanta, Georgia, ChlorKing has grown into the leading natural water sanitization technology company in the commercial pool and recreational water space. This business, led by Co-Founder and CEO, Steve Pearce, and his team, brings a wealth of industry knowledge and experience, as well as relationships with pool designers, trade professionals, specialty distributors, and operators. Innovative technologies are patented with products specified into projects all over the world. Key products include high-capacity chlorine generators and ultraviolet disinfection systems. These technologies help lower annual operating costs and are environmentally sustainable, avoiding the need to handle and store large volumes of chlorine while enhancing water quality for our customers. These products are complementary to Hayward's existing commercial product range and technologies. Importantly, ChlorKing's sales organization and trade relationships expand the size of the addressable market for our other award products. Similarly, Hayward’s domestic and international scale affords ChlorKing product growth opportunities. Other operational synergies related to our manufacturing base, global supply chain, and distribution network present compelling financial opportunities. ChlorKing and Hayward's existing commercial pool business will integrate and operate out of Atlanta under Steve Pearce's leadership. We look forward to future reporting of our growth in this important vertical. 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 start on Slide 8. All comparisons will be made on a year-over-year basis. As Kevin stated, we are pleased with our second quarter financial performance. Net sales were in line with expectations for the quarter, and we delivered outstanding profitability. Cash flow generation was robust, enabling early debt repayment and the strategic acquisition of ChlorKing. Net leverage reduced meaningfully in the quarter. Looking at the results in more detail. Net sales for the second quarter increased modestly to $284 million. Net price realization of positive 2% was offset by 2% lower volumes. Gross profit in the second quarter increased 6% to $145 million, and gross profit margin increased 290 basis points year-over-year, a 180 basis points sequentially to a record 51%. This is a strong result, primarily driven by continuous improvement and efficiency gains in our manufacturing operations. Adjusted EBITDA increased 4% to $83 million in the second quarter, and adjusted EBITDA margin increased 100 basis points year-over-year and 780 basis points sequentially to 29%. Our effective tax rate was 20% in the second quarter compared to 32% in the prior year period. The change was primarily due to the timing of discrete tax items. Adjusted EPS in the quarter increased 11% to $0.21. Now I'll discuss our reportable segment results, beginning on Slide 9. North American net sales for the second quarter increased 2% to $241 million, driven by favorable pricing. Net sales increased 1% in the U.S. and 5% in Canada. We were pleased to see increased orders and sales in the quarter in Canada, despite the significant impact in that market due to economic conditions and higher financing costs. Gross profit margin increased 300 basis points year-over-year and 110 basis points sequentially to a robust 52.9%, representing the sixth consecutive quarter of year-over-year margin expansion. Adjusted segment income margin was 33.7%. Turning to Europe and Rest of World. Net sales for the second quarter decreased 6% to $43 million due to lower volumes. Net sales increased 7% in Europe and declined 21% in Rest of World. The increased sales in Europe are encouraging, but certain Middle East and Asia markets continue to feel the impact of current macroeconomic and geopolitical conditions. Gross profit margin increased 170 basis points year-over-year and 320 basis points sequentially to 40.8%. Adjusted segment income margin was 19.8%. Turning to Slide 10 for a review of the balance sheet and the cash flow highlights. We are very pleased with the balance sheet improvement and strong cash flow performance in the quarter. Net debt to adjusted EBITDA improved significantly on a sequential basis from 4x at the end of the first quarter to 2.8x at the end of the second quarter, excluding the impact of the ChlorKing acquisition; including the cash outlay for the acquisition, net leverage was 3.1x. Total liquidity at the end of the quarter was $448 million, including cash and equivalents of $215 million plus availability under our credit facilities of $233 million. We have no near-term maturities on our debt. The term debt 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 benefits from the $600 million of debt currently tied to fixed interest rate swap agreements maturing in 2025 through 2027, limiting our cash interest rate on our term facilities to 6.5% in the second quarter. Our average interest rate earned on global cash deposits for the quarter was 4.8%. The business has attractive free cash flow generation attributes with seasonal strength in the second quarter related to payment collection of early buy receivables. Year-to-date, cash flow from operations was $210 million, a 26% increase compared to the prior year period. This improvement reflects continuous improvement in working capital management primarily a 12% year-over-year reduction in inventory levels, excluding acquired inventories. CapEx of $11 million in the first half was below the prior year period due to project timing, resulting in a year-to-date increase in free cash flow of 32% to $199 million. We continue to expect free cash flow generation of greater than 100% of net income, with full year 2024 free cash flow of approximately $160 million. As previously discussed, we completed a voluntary early debt repayment in the second quarter given our increasing cash balance. Specifically, we used cash on hand to repay the full outstanding balance on our incremental Term Loan B of approximately $123 million. We expect this to result in annualized interest expense savings of approximately $10 million or $4 million net of interest income; expected net savings for fiscal year 2024 are approximately $3 million, reflecting the partial year impact. Turning now to capital allocation on Slide 11. As we've highlighted before, we maintained a disciplined financial policy and take a balanced approach, emphasizing strategic growth investments and shareholder returns while maintaining prudent financial leverage. In the near term, we are prioritizing organic and inorganic growth investments and debt repayment. We continue to consider other strategic acquisition opportunities to complement our product offering, geographic footprint, and commercial relationships, in addition to opportunistic share repurchases. Turning now to Slide 12 for the outlook. Entering the second half of the year, we are narrowing our full year guidance, reflecting better-than-expected margins, offset by a more challenging demand environment, particularly in new construction and remodels and certain international markets. The guidance range contemplates uncertainty in global macro conditions and consumer spending trends, coupled with our expectations regarding channel inventory levels. We continue to anticipate solid execution across the organization, positive price realization, and increased technology adoption. For the full fiscal year 2024, we now expect net sales to increase approximately 2% to 5% to a range of $1.01 billion to $1.04 billion, including a contribution from the ChlorKing acquisition of approximately 1%. We now expect adjusted EBITDA of $255 million to $270 million or an increase of approximately 3% to 9%. We anticipate full year free cash flow of approximately $160 million. Our net interest expense expectation of $63 million reflects the early debt repayment. The effective tax rate forecast remains approximately 25% for the remainder of the year, and our CapEx spending forecast is approximately $30 million. Looking out beyond 2024, we remain very positive about the long-term health and growth profile of the pool industry, particularly the strength of the aftermarket. We are confident in our ability to successfully execute our strategic growth plans. Finally, I'd like to note that the recent outage had no material impact on the company. And with that, I'll now turn the call back to Kevin.

Thanks, Eifion. I'll pick back up on Slide 13. Before we close, let me reiterate the key takeaways from today's call. We delivered second quarter results consistent with expectations in a challenging environment. Our team continues to execute, delivering record gross margins and robust cash flow, allowing us to fund our growth strategies and fully repay our incremental term loan early. We are excited about the addition of ChlorKing's innovative technologies and the many opportunities we see to leverage a broader commercial portfolio, better serve this growing market, and drive profitable growth. We added proven talent to the senior leadership team, and I'm confident that we have the right strategy in place to drive compelling financial results and shareholder value creation. With that, we're now ready to open the line for questions.

Our first question comes from Ryan Merkel with William Blair.

I wanted to start off with the acquisition of ChlorKing. It sounds like a really nice business. What are one or two bigger opportunities, Kevin, that you see there?

Yes. Ryan, this is a really great company, and we're excited to welcome them to Hayward. It positions us well in the commercial market. Commercial has performed extremely well, except for 2020 when many commercial pools were not allowed to open. However, we've seen great double-digit growth in the years since then. There are many strengths to ChlorKing, but their leadership in the commercial standardization category stands out. They have experienced a solid growth trajectory recently and have great margins. What they really bring to the company is a stronghold in the Class A segment of the commercial market. Commercial is defined by two categories: Class A and Class B. Class A includes larger bodies of water, greater than 100,000 gallons, such as competition pools and water parks, which is where their strength lies. Hayward primarily participates in Class B, which consists of about 15% Class A and 85% Class B, encompassing hotels, motels, apartments, and condos. We have a solid product line that fits well with Class B, but ChlorKing provides added exposure and a product line that we can leverage more broadly in Class A. There are numerous cross-selling opportunities for ChlorKing's products to be introduced into Class B, where we're already involved, and likewise, for some of Hayward's products to enter the Class A segment. There are many great relationships that we currently lack around pool architects, designers, builders, operators, and specialty distribution. We've had a relationship with Steve and the ChlorKing team for several years. We have privately labeled a water standardization that we sell into Class B for many years, so we know each other well, and we are looking forward to integrating and continuing our growth trajectory in the commercial space.

That's great. And then for my follow-up, I was curious on the longer-term outlook for new pools. Obviously, this year is going to be pretty weak. Do you still think that we can do 90,000 or 100,000 pools once interest rates come down? Are you hearing from contractors that it's really just a function of rates why the market is so weak?

Yes, you're aware of the long-term new construction outlook. This year, most of us in the industry are settling around approximately 60,000, which represents another 15% drop from last year’s 25% decline. We are heavily dependent on interest rates. While I can’t predict reaching 90,000, I believe this marks an absolute low point. As we start to see some relief with interest rates, the long-term appeal of having a pool in the backyard remains strong. Our single-family home starts have not kept pace with family formation over the past several years, particularly since the Great Financial Crisis. This will need to be addressed, which is closely linked to new pool construction. The trends regarding migration and spending more time at home, along with a greater interest in maintaining a healthy outdoor lifestyle, should provide a boost once interest rates stabilize. We are optimistic about 2024 potentially being a low point, allowing us to return to new pool construction soon.

Our next question comes from the line of Nigel Coe with Wolfe Research.

Looking at the full year outlook, I think we're now in the range of 1 to 4, excluding the effect of the acquisition. It would be helpful if you could explain the adjustments you're making to sell-through compared to the increasing pressure from inventories. Additionally, we noted that POOLCORP reported a 2% decline in equipment sales while you experienced a 2% increase in North America. I’m also curious about what you observed regarding sell-through in the second quarter.

Yes, sure. Let me start that one. Let me first address the narrowing what contributed to the narrowing of the guidance, Nigel. Let me start with what is unchanged from our original bridge that we talked through earlier in the year. We continue to expect price to flow through at a couple of percent for the year. We continue to assume a little bit of headwind, 1% or so on FX. And really, our overall expectation for the absence of the inventory destock felt in 2023, not to repeat in 2024. We would assume that to still be kind of in the plus 10% range overall. What has changed is what we'll call just market volume. Originally, we laid out in North America, the discretionary aspects of the market to be down 10%. We're now increasing that to down 15% based upon what we're seeing through permits as one data point, but also interactions with the channel and with our dealer partners. And then pivoting to Europe, Rest of World, where that assumption on the discretionary aspect was up to negative 20%. Similarly, we're increasing that an extra 5% to down 25%. So if you flow that through as a percent of our business, that would really take market volume from an original expectation of down, call it, 6.5% to now down 8.5%. And then as you mentioned, the plus 1% in the second half from the ChlorKing acquisition would really get us to that midpoint revision of around 3.5% with the range of 2% to 5%.

Go ahead, Nigel.

The sell-through for the second quarter was a thorough response. It seems that ChlorKing is about $20 million in annualized revenue, and I want to confirm that. You mentioned some share initiatives on the West Coast, particularly in the Sunbelt area. Could you provide an update on those initiatives and share any successes you've had with dealer conversions?

Just to calibrate you on the ChlorKing, it has an annualized revenue result of about $25 million. It's a little bit more weighted in the first half of the year than the second half of the year, around $12 million. About the dealer conversion, Kevin?

Yes. On dealer conversion, we have a lot of great initiatives underway. I would say in some of those markets where we would say we have share growth opportunities, specifically the West, as you mentioned, and then also what we call the South Central around some additional on-the-street selling resources with marketing support coming out of North Carolina. Obviously, on the hub, which I spoke about in my prepared remarks, is really a pilot. We would like to see that proof-of-concept play out. And it would be our expectation that we'll continue to roll that out in some additional markets going forward to really be that one-stop shop for our dealers from a service, support, and training standpoint. And then we've spoken in the past; there are some nuanced differences from a product standpoint. Products that may sell in the Northeast or in Florida, small footprint heaters, for example, is something we brought to market a couple of years ago that's doing extremely well in the West Coast where there's smaller lot lines and a need to get the equipment set on a smaller square foot pad. So lots of attention being paid and resources being allocated inside our organization to continue focusing on those lower share markets where we, frankly, have opportunity for growth, and we see a nice trend line occurring for us in those markets.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Just wanted to go back to inventory. It doesn't sound like you've changed the destock assumption, but I'm just wondering with the pool preannouncement and some of the softer dynamics on the discretionary what maybe you're seeing the same or different around the want to hold inventory at the channel level and then any early discussions about how early buy might play out the same or different.

From an inventory perspective, we don't have complete information. However, generally speaking, when I discussed our guidance, I mentioned a positive outlook. This still allows us to consider the overall inventory in the channel. In the first half of the year, we noticed a somewhat more aggressive movement in channel inventory, which isn't surprising given the current market conditions. Fewer sales mean that we need less inventory to maintain our stock levels. By this point, we were all expecting some reductions in interest rates, which haven't happened. As a result, carrying costs across the channel remain high, leading to less incentive to hold inventory. OEMs are currently responsive in terms of lead times to meet demand as it arises. We've adjusted our expectations down slightly. Looking ahead to the second half of the year, we believe that our positivity will still play out for the full year of 2024. Regarding early buy initiatives, it's a bit too soon to share details, as we are still developing our strategy, but we do plan to offer early buy options later this year for the 2025 season. Based on our discussions, we anticipate strong participation in the program when we launch it.

Okay. Just on ChlorKing, more critical mass with this deal in commercial pools. Maybe just talk about where you see the best opportunity for revenue synergies other than pulling you through, you pulling them through? And then just what's the market and pipeline look for other bolt-ons to continue to fill out the commercial pool space?

Yes, I spent some time discussing Class A and Class B. We have sold some products into Class A, but ChlorKing really expands the range of offerings we can provide to that segment. However, there are still key high-volume products within Class A that we and ChlorKing do not currently offer, such as larger horsepower pumps and higher capacity filters or heaters, which represent future opportunities for us, whether organically or inorganically. As for Class B, we are very pleased with our catalog there and have experienced double-digit growth for several years. Historically, Hayward did not focus significantly on the commercial market, but this has been a new development for us over the past 5 to 8 years. We are excited about the opportunities, both organic and inorganic, that ChlorKing provides to leverage a wider array of relationships, and we are eager to continue growing the commercial business.

Our next question comes from the line of Andrew Carter with Stifel.

First question I wanted to ask, looking at your free cash flow outlook for the year at $160 million. Given the year-to-date and what you're implying in the EBITDA, I'm implying a pretty heavy working capital drag more significant than the past couple of years. Is that predicated on a pre-buy, a pretty significant increase in the pre-buy, therefore, upside on to cash flow if pre-buy doesn't work or something else in the inventory purchase levels?

Yes. Andrew, we do expect a robust early buy that will raise the account receivable position at the end of the year, year-over-year, that's contemplated in our guidance. Additionally, our inventory position, which we have worked very diligently to reduce both year-over-year from the end of 2023. We will probably take a strategic position in finished goods as we enter 2025 in anticipation of some of the ERP developments we have planned for 2025. That is still to be determined exactly how we invest in that particular working capital position, the timing of that, but we have for now improved out within the earnings balance sheet forecast.

I understand that you may not provide any comments on future pricing decisions today. However, regarding the pricing you've implemented, have you noticed if any prices are too low or too high for your products? Equipment has remained quite steady. Also, you mentioned earlier about the value of SKU optimization. Would you consider relying on that more heavily if you had to pause pricing for a year or something similar? Or would it allow you to take a year off from pricing? Any insights you can share would be helpful.

SKU rationalization has gained significant attention over the past year. We made substantial progress through our product management, operations, and engineering teams last year. However, we recognize that there is still a lot of work to be done. This process is ongoing across our organization and is aimed at refining our product catalog. This allows us to assess the value each product line offers and go through that evaluation. We are analyzing the value, life expectancy, and functionality of the equipment we deliver to homeowners through our channel. These elements are interconnected, and I don’t see one overshadowing the other. We can pursue both paths. Historically, our pricing strategy has helped counteract inflation, which this market has managed to maintain. We are devoting more resources to analyzing our SKU count and assessing value creation. I believe there are still many products in our lineup that are not priced appropriately in relation to their value. This presents a substantial opportunity to not only counter inflation but to also take a thorough look at how we can optimize future pricing strategies.

Our next question comes from the line of Saree Boroditsky with Jefferies.

Could you quantify the potential for SKU rationalization and its impact on margin performance as we consider the future?

Yes, sure. So our SKU rationalization program initiated probably close to a year ago now; we've made very good progress. We're tackling the U.S. facilities first, and then we'll progressively roll it out. We don't give specifics on the exact SKUs that we're rationalizing, but it's been a meaningful reduction through the end of Q2 here. As it implicates all of our working capital initiatives as well as our margin initiatives, it will have a positive impact on our ability to price goods or a value-based pricing methodology. So we look to gain continued margin development through a more refined SKU range. It will continue to enable our manufacturing locations to manage the throughput in a much more efficient way. So that will be a positive there. It will continue to allow us to have best-in-class procurement programs and manage inflation through the business. And then additionally, as we think about developing the product line into the future, we're more focused on the key platforms across the business. So all of that saying, we think as we step into 2025, all of that will provide us with margin expansion opportunity and will also help our working capital as well as the channel's working capital.

I appreciate the color. Then on the lower channel inventories, you talked about distributors relying on your lead time for inventory this year. Is this a 2024 response? Or do you expect distributors to continue to get more efficient on inventory and rely on OEMs more? And does that impact working capital for you?

Yes. I mean, I think we'll continue to work very closely with our channel partners to ensure right inventory, right time at the right location. I think one of the real strengths of Hayward historically and will continue into the future is our responsiveness from a supply chain and a manufacturing standpoint. So I think our channel partners can continue to look to us to be able to respond timely to whatever changes may be occurring in the marketplace. But obviously, there is keen interest with the channel to have products ready at the point of sale when the dealers come in the front door. So we're going to continue to work closely with them to make sure that our demand signals out to our supply chain and our factories are commensurate and well-coordinated with the channel. And I mean, we feel really good that when the destock really ended late last year, I like being in this position of having the right days on hand and being able to respond very timely to our sales to match what their sales out into the retail marketplace. So I think that that's been a great development here in 2024, and we'll look to continue that into the future.

Our next question comes from the line of Mike Halloran with Baird.

This is Pes on for Mike. I want to follow up on Saree's questions. Obviously, margin performance here is healthy against lower volumes in challenged end markets. You called out a little bit of mix benefit, but then obviously, operational efficiencies as well that should prove a little bit more structural and sustainable. Maybe talk about how you think about margin sustainability and should we expect pretty normal seasonal margin cadence here in the back half.

Yes, we believe we are sustainable. We have put significant effort over the last four years into enhancing our gross margin quality. We've overcome a period of inflation that is now behind us in terms of price and cost management. The improvement in our margins, which are steadily increasing, is a result of our hard work to boost productivity in our manufacturing operations. We have also rationalized our sites during this time. As we continue to grow through acquisitions, we generally integrate the production of new facilities into our existing operations. However, our most recent acquisition operates very well on its own. Moving forward, we can integrate other businesses into our manufacturing locations. We have a strong history of implementing Six Sigma and Kaizen improvements within our facilities, fostering a lean manufacturing culture that will sustain production in the medium term. We are confident in our ability to maintain our gross margin as we grow. Currently, we have significant capacity available, utilizing about 60% of our capacity, which allows us to expand without needing additional capital expenditures. For the remainder of the year, Q3 may show some challenges similar to Q1 in terms of sales size, resulting in a slight leverage penalty when moving from Q2 to Q3. However, we expect to regain that leverage in Q4, although Q4 usually involves early buy discounts, so we will need to observe how margins perform. We have a price adjustment and discounts starting on October 1, and we will assess the resulting impact on margins. Overall, we are pleased with our year-to-date gross margin performance of over 50%, which is an excellent outcome for us, and we are committed to maintaining this performance over time.

That's super helpful. Maybe switching gears to capital deployment. It sounded like inorganic maybe moved its way up the priority list in the prepared remarks, but maybe I'm just leaning on the fact that we just finished on ChlorKing. Can you maybe talk about how you're thinking about prioritization of commercial versus traditional residential pool? And then are there any particular products or technologies that you're trying to prioritize or highlight as you filter through your funnel?

Let me just touch on our standard capital allocation process. We have not deviated from that. We'll always take our first priority as investment back into our business. We're an OEM; we're a manufacturer. We take care of our facilities, and we look to continue to upgrade those facilities with a capital expenditure profile between 2% to 3% per year. This year, we're calling for around $30 million. It's a little bit lower than we had originally said, and that's purely a consequence of the timing of some of the investments that we're putting into our U.S. facilities. Secondly, our priority in the short term here has been to delever our balance sheet, and we've done a really good job, we believe, sequentially. We've moved down from just over 4x now to 2.8x on an organic basis, taking into consideration the cooking; we're at a 3.1x though will continue to move into our target range of 2x to 3x over the balance of the year. And then thirdly, our inorganic activities or M&A. It's always been a growth attribute for this organization. It will continue to be a growth attribute given the very rich cash flow profile of this organization. ChlorKing was our most recent great acquisition. We do have a merger pipeline. That covers both residential and commercial in focus. And then finally, as I mentioned, our cash profile does afford us the opportunity to also think about returning to shareholders. Right now, no specific commitments there, but we do have remaining $400 million on our share repurchase program that's available for deployment at the appropriate time.

I would just add, as I've mentioned, I mean, we maintain a healthy pipeline. Our market position in residential is significantly stronger than where we are in commercial. So that may afford us more opportunity from a commercial standpoint as we look at building out the product catalog. But I'd say in terms of technology, I mean, we're very strong with what we call chlorine equipment, pumps, filters, cleaners, etc. So things around automation and around more of the lifestyle products will continue to be key points of emphasis for us, both organically and as we contemplate inorganic opportunities going forward.

Our next question comes from the line of Rafe Jadrosich with Bank of America.

I wanted to follow up on some comments regarding the trend in permits for new construction. Can you remind us of the typical lag between your business and permits? How should we interpret the timing of when new construction begins to improve and when that would reflect in your revenue?

Yes, I think it's probably a couple of months, Rafe, is how we would define what we see in terms of permitting. If you were to follow one specifically through the process, I think you'd be somewhere between kind of 45 to 60 days or so depending upon what the workload of the specific dealer is that's filing the permit.

Got it. It's a fairly quick transition from obtaining the permit to making sales.

Now it is. I would say that we haven't asked that question during COVID, which would have extended the timeframe. But in general, you're looking at about two months or so.

Okay. That's helpful. If we look at the commercial market in relation to the residential market, can you discuss how commercial is structured competitively, especially considering that residential is fairly consolidated with you and two other major players holding most of the market? What is the competitive landscape for consolidation in commercial? How does the size of the commercial market compare to residential? Additionally, what is the margin profile for the commercial business compared to your legacy core business?

Yes. I think from a margin standpoint, I'll let Eifion add at the end here, but it's a strong margin business. And one of the real benefits of ChlorKing is a pretty similar margin profile as the business that it's joining at Hayward. In terms of the competitive landscape, I would say the big 3, as we're often referring to, all participate in the commercial market globally to some extent. But as you do look around some of the individual product categories, it is a bit more fragmented than what you might see in the residential space from some of the larger horsepower pumps to some of the larger BTU commercial heaters to some of the regenerative filter brands out there. So it's a bit more fragmented, I would feel than maybe the residential business as we know it.

In terms of margin comparability, I'd say, generally speaking, we don't see a major difference in the adjusted EBITDA line between residential and commercial business. Maybe we have a slightly different profile within the income segment between gross margin and net impact. But at the bottom line, it's very comparable. The nice thing about these types of acquisitions for us over the course of time, we have an opportunity to progressively improve the margin with the purchase power that we can bring to the raw material acquisition cost. And so we look to continue to expand the ChlorKing acquisition over the course of time. And the same applies to future acquisitions, that type of attribute that we can bring.

Our next question is a follow-up from the line of Nigel Coe with Wolfe Research.

I have a couple of quick questions for you, Eifion. You mentioned that factory utilization is currently around 60%. What do you consider to be a normal level? I assume that's roughly a 2-point impact on gross margin and absorption. So first, do you agree with that perspective? And what would you say is the normal level?

Yes. So for us, just to correct you, I said 60% is where we're approximately utilized today. When we say normal, we would say that is probably trending back to where we would normally operate in these units pre-pandemic levels. During the pandemic, we accelerated shifts within the facilities to take advantage of the capacity in the machinery in the hours in the day. So we still have that opportunity as we continue to grow the business volumetrically. It was a great learning in the pandemic period to be able to tap in that latent capacity to get more shifts on to get access to those machine hours and those additional shifts in the week and over the weekend. And so that's always the awesome opportunity for us given we've proven out we can do that. We're not under-absorbing right now in our facilities. We balance, and this is a massive kudos to our operational team. They balance the variable cost labor in those facilities to match the current production level in those facilities. So we've got good absorption: it's the appropriate level of absorption to the cost base we're incurring. And as we continue to grow volume, we will right-size labor to keep up with that absorption profile we need in the business.

Okay. I must read the comments. And then just a quick one on free cash flow. Accounts receivable fell quarter-over-quarter from 351 down to 148, and I know we usually see that decline in annual recurring revenue but not to this extent. So I'm just wondering, is that all organic? Or was there some assistance from factoring in the quarter? Any thoughts there?

Yes. So in terms of the accounts receivable, it normally does decline from Q1 to Q2 as a consequence of all the early buy receipts that come into the business. As you know, early buy offers a discount and up to 6 months extended payment terms. Most of our cash from early buy comes in the second quarter, and that was the case that you saw this year. So we're very pleased with the cash collection period for early buy this year. Happy to report that the vast majority have paid exactly on time, which is great to see in the current climate. And as we step through the balance of the year now, accounts receivable will increase again as we ship in Q4 early buy for the 2025 season.

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Holleran for any final comments.

Thank you, Melissa. 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 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 third quarter earnings call. Thanks, Melissa, you can now end the call.

Thank you. This concludes today’s conference. You may now disconnect at this time. Thank you for your participation.