Earnings Call Transcript - HAYW Q2 2023

Operator, Operator

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

Kevin Maczka, Vice President, Investor Relations

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.

Kevin Holleran, President and CEO

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% compared to last year, primarily due to leaner channel inventory positions at the end of Q3 ahead of expected robust early buy participation in Q4. It's important to understand our outlook for channel sell-through in 2023 is unchanged. Looking forward, we have every expectation of resuming a solid historical growth trajectory of mid- to high single digits with our sales into the channel aligned with channel sell-through of Hayward products. Now turning to Slide 5, highlighting the results of the quarter. Net sales in the second quarter reduced 29% year-over-year to $283.5 million, largely due to channel inventory movements and softer market conditions related to global economic uncertainty. This compares to a period of extremely strong growth of 10% in the second quarter of 2022 and 66% in the second quarter of 2021. As I mentioned, based on data from our primary channel partners, sales out of the channel exceeded our expectations in the quarter. We are now seeing a return to more normal seasonality, with Q2 seasonally strong and Q3 typically lower sequentially as we exit the summer pool season. We are encouraged by continued price realization to offset inflation and the success of our innovative new solutions. The market is responding favorably to the connected suite of products within our Omni automation ecosystem, with sales of IoT controls and lighting increasing in the quarter. Commercial pool sales also increased double digits in the quarter. We are increasingly focused on driving growth in these markets and are pleased with the continued robust demand. As I mentioned, the gross margin performance was again exceptional this quarter. Gross profit margin has expanded 70 basis points year-over-year to a record 48.1% despite reduced net sales and 150 basis points sequentially. Having achieved price-cost neutrality, the improvement in our gross margin is the result of multiyear operational improvements, including consolidation of our manufacturing footprint, removing inefficiencies, realizing value engineering savings and driving continuous improvement. This has allowed us to continue expanding gross margins at lower production volumes while positioning for future growth. Adjusted EBITDA in the second quarter was $79.5 million, with a healthy margin of 28%. We continue to deliver the expected SG&A savings under our cost reduction program. Adjusted diluted EPS in the quarter was $0.19. Turning now to Slide 6 for a business update. We estimate that Hayward captured significant market share over the last 3 years, and our teams are working hard to gain share going forward. As discussed in recent quarters, our new product development strategy is a key driver as we increase investments in innovative new products to further advance our technology leadership in the industry. Another important driver is the evolution of our go-to-market strategy, prior restructuring of the sales force and the establishment of dedicated business development teams focused solely on new customer acquisition, resulting in solid growth in the number of new dealers converting to Hayward. To further improve the customer experience, we are enhancing the organizational structure in an important strategic region, integrating sales, technical service, support and training under common leadership. This touches all aspects of customer engagement from new dealer orientation and training to post-sale support. We're also enhancing our marketing campaigns for the service trade to incentivize conversion to Hayward products. This evolution will drive customer intimacy and deliver incremental demand for Hayward. Further, in international markets, we are reallocating resources to higher-growth regions, notably Southeast Asia, Australia and Middle East. Early success of these programs is encouraging and supportive of continued market share gains and establishing Hayward as a leading brand in these regions. Channel sell-through exceeded expectations in the quarter. Our channel partners continue to recalibrate the level of inventory as expected relative to the current economic outlook, normalized OEM lead times and higher cost of carrying inventory. We continue to anticipate further reductions as we close out the pool season to a leaner position at the end of Q3 as distributors prepare to participate in the 2024 early buy program. Turning to the price-versus-cost dynamic. We implemented a price increase of 4% to 5% at the beginning of the year to achieve price/cost neutrality, and we continue to realize this pricing as expected. As a reminder, we took proactive actions in recent quarters to streamline the organization, optimize the cost structure and maintain a healthy margin profile, with full year gross margins in the mid- to high 40s and adjusted EBITDA margins in the high 20s. We are delivering on these commitments. Our team continues to prioritize working capital management, and we delivered significant improvements during the quarter. On a year-over-year basis, balance sheet inventory and total working capital declined by $78 million and $135 million, respectively, contributing to the strong cash flow performance. Finally, we continue to make great progress on our ESG journey and are pleased that our performance is being recognized. Since receiving a 2023 regional top-rated award from Morningstar Sustainalytics last quarter, MSCI upgraded our ESG rating from BBB to A. Additionally, I'm proud to report that our full suite of variable speed pumps is now ENERGY STAR-certified by the U.S. Environmental Protection Agency. Hayward is dedicated to develop the industry's most energy-efficient, high-performance products to drive market share gains, particularly in high energy cost markets like California. This achievement further demonstrates why we continue to be the number one rated products brand by U.S. pool professionals. With that, I'd like to turn the call over to Eifion, who will discuss our financial results in further detail.

Eifion Jones, Senior Vice President and Chief Financial Officer

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 deliver the strong gross margin performance. Over the last 5 years, we have improved capacity utilization with the rationalization of a manufacturing footprint, including the exit from one larger underutilized facility and the integration of three acquired manufacturing facilities. Hayward has a long-standing commitment to lean manufacturing and continuous improvement, and the business is well positioned to deliver further productivity gains and robust profitability going forward. Selling, general and administrative expenses declined 16% year-over-year to $58 million in the second quarter. We took proactive actions in late 2022 to streamline the organization and optimize the SG&A cost structure. And we are now delivering on the targeted annual run rate savings of $25 million to $30 million. Adjusted EBITDA was $79.5 million in the second quarter, and adjusted EBITDA margin increased 660 basis points sequentially from 21.4% to 28%. We are pleased to report adjusted EBITDA margins in the high 20s at these reduced volume levels, and we're positioned to drive solid margin expansion as volume growth returns. Our effective tax rate was 32% in the quarter compared to 24% in the prior year period. The change was primarily due to the timing of a discrete tax item. Adjusted diluted EPS in the quarter was $0.19 on a fully diluted share count of 221 million shares. Diluted share count decreased approximately 8 million shares or 4% year-over-year as a result of share repurchase activity in prior periods. Let's turn now to Slide 8 for a review of the reportable segment results. North America net sales for the second quarter declined 31% to $237 million, driven by 36% lower volumes, partially offset by a 4% favorable price impact. The reduction in volume was largely due to both the expected rightsizing of channel inventories and the moderating end demand trends as previously communicated in new construction and remodel. Gross profit margin expanded 110 basis points year-over-year and 130 basis points sequentially to a very solid 49.9%. And adjusted segment income margin was 32.4%. Again, we are pleased with the margin performance in the quarter. Turning to Europe and Rest of World. Net sales for the second quarter decreased 20% to $46 million. Net sales benefited from favorable price realization of 4% but were adversely impacted by a 25% decline in volumes due to channel inventory reductions and the impact of geopolitical circumstances in Northern Europe. We are pleased with the results of our expansion campaigns into Asian markets where we have established a solid share position. Overall, the segment gross profit margin was 39.1%, and adjusted segment income margin was 20.8%. Turning to Slide 9 for a review of our balance sheet and cash flow highlights. Net debt to adjusted EBITDA was 3.8x, down sequentially from 4.1x in the first quarter as a result of strong cash flow generation. Q2 is a seasonally strong period for cash collections as the receivables related to early buy business sold in Q4 and Q1 on extended terms are collected in Q2. Additionally, we made great progress on the reduction of our own inventory, sequentially decreasing $40 million from the ending Q1 position. We expect net leverage to be closer to 3x by the end of the year. Total liquidity at the end of the second quarter was $437 million, included in the cash and equivalent balance of $205 million and availability under our credit facilities of $232 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. 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. And our average earned interest rate on global cash deposits for the quarter was 3.8%. This attractive maturity schedule provides financial flexibility as we execute our strategic plans. We completed the transition from LIBOR to SOFR on Term Loan B borrowings during the second quarter, with no material impacts on our financial position. Overall, we are pleased with the quality of our balance sheet. We have strong but seasonal cash flow generation characteristics, driven by high-quality earnings. Cash flow from operations was a robust $167 million in the first half of 2023 compared to $64 million in the first half of 2022, reflecting robust cash collection of prior early buy shipments and a reduction in our own inventory. We have been successful in managing our working capital inventory levels. Inventory has declined $49 million year-to-date and is now down $97 million since peaking in the third quarter of 2022. CapEx of $16 million in the first half was consistent with the prior year period. Free cash flow more than tripled in the first half to $151 million. With a return to normal seasonality, the company will typically generate cash in the second and third quarters and use cash in the first and fourth quarters. For the full year 2023, we expect free cash flow conversion of greater than 100% of net income, with free cash flow now exceeding $175 million. Turning now to capital allocation on Slide 10. As we've highlighted before, we maintain a disciplined financial policy and take a balanced approach, emphasizing strategic growth investments and shareholder returns while maintaining prudent financial leverage. We continue to consider tuck-in acquisition opportunities to complement our product offering, geographic footprint and commercial relationships in addition to opportunistic share repurchases. However, in the near term, we're prioritizing growth investments and reducing net leverage within our targeted range of 2 to 3x. 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 refining our outlook for 2023 to reflect incremental reductions in channel inventory levels. Our view of underlying consumer demand for Hayward products is unchanged, but the broad channel network is adopting a very lean inventory position. We now anticipate a decrease in consolidated net sales of 20% to 23% due to modest incremental reductions in channel inventory levels. Our outlook for end demand, defined as channel sell-through, remains unchanged. In North America, the nondiscretionary aftermarket is resilient, but we expect new construction to be down approximately 30%, with remodel and upgrade down approximately 25%. In Europe and Rest of World, we continue to anticipate a broad reduction of approximately 25% as geopolitical circumstances weigh on consumer sentiment in Northern Europe. These decreases will be partially offset by a 4% to 5% net sales contribution from price increases initiated at the beginning of the year. We expect gross profit margin to modestly increase in the second half of 2023. Given the solid margin performance, we are maintaining the low end of our prior range, with the expected adjusted EBITDA to be between $265 million and $280 million. As discussed, we also expect strong cash flow generation in 2023, with free cash flow exceeding $175 million. Our interest expense expectation is approximately $75 million, reflecting the current interest rate environment and borrowing levels. The effective tax rate forecast remains approximately 25% for the remainder of the year, and our CapEx spending forecast is also unchanged at $25 million to $30 million. I'll close with this summary. 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 record gross margins at reduced sales volumes. I am also very pleased with the strong cash flow generation and reduced balance sheet leverage. With channel inventory reducing to lean positions, increased market share over 2019, structural gross profit and adjusted EBITDA margins returning to our target levels and a strong balance sheet, we're in good financial position as we enter the second half of the year and the commencement of the 2024 pool season.

Kevin Holleran, President and CEO

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, Operator

Your first question comes from Andrew Carter of Stifel.

Andrew Carter, Analyst

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.

Kevin Holleran, President and CEO

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 has 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 overtime in our facilities to satisfy demand have all been key elements of what's driven the margin performance more recently.

Eifion Jones, Senior Vice President and Chief Financial Officer

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 two 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 three years to rightsize our manufacturing facilities. And since the end of 2019, we've exited four 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 four 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 three years because of all the inflation noise.

Andrew Carter, Analyst

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?

Eifion Jones, Senior Vice President and Chief Financial Officer

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 on our current outlook today.

Operator, Operator

The next question comes from Jeff Hammond of KeyBanc Capital.

Jeffrey Hammond, Analyst

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?

Kevin Holleran, President and CEO

Yes, I would say it was better than expected. In our original guidance, we estimated a net price decrease of around 10%. We are currently observing a year-over-year decline of about 10%, but the situation is slightly better in the second quarter, although still negative. Our sell-through has remained strong based on the data we gather and our collaborations with channel partners. As we approach the end of the pool season in the third quarter, we anticipate further destocking. As mentioned in my prepared remarks, we expect to be at lower-than-expected inventory levels, which has led to some updates to our guidance presented this morning. This situation also offers us an opportunity for early buying to position ourselves effectively for the 2024 pool season.

Jeffrey Hammond, Analyst

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?

Kevin Holleran, President and CEO

Yes, from a seasonality perspective, I would say it’s returning to a more typical pattern that we've observed historically. I would estimate that the first half will be in the high 40 percent range and the second half in the low 50 percent range, with the first and third quarters appearing quite similar to one another. The second quarter is expected to be a slight increase from what we usually experience in the fourth quarter, given that we're able to collect those early buy orders for shipment at our discretion. Overall, we are seeing a return to a more normalized quarterly seasonality. I apologize, I forgot the second part of your question.

Jeffrey Hammond, Analyst

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

Kevin Holleran, President and CEO

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.

Operator, Operator

The next question comes from Rob Wertheimer of Melius Research.

Robert Wertheimer, Analyst

So it seems like you and others in the industry have kind of the same view that the channel destock will be completed at the 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.

Eifion Jones, Senior Vice President and Chief Financial Officer

Sure. While we don't capture every detail of inventory data, we obtain reliable information from our major U.S. trading partners, distributors, and some retail channels. We've observed a gradual reduction in stock levels since the end of Q2 2022, which has intensified throughout the first half of this year, particularly in the second quarter. The feedback from the channel indicates a desire to maintain this trend as we enter the peak of the season in Q3, with the expectation that they will keep their balance sheets lean leading into the early buying period. This aligns with the data we are receiving.

Robert Wertheimer, Analyst

Okay. Perfect. I apologize if I missed it. I believe I saw one of your competitors quantify the destock impact on their revenue this year. Do you have a similar quantification? When you mention being lean for the channel, do you expect to end the year within normal ranges, or will channel inventory be a bit lean or a bit high compared to underlying sales levels? I will stop there.

Eifion Jones, Senior Vice President and Chief Financial Officer

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 embedded within our guidance is approximately $160 million.

Operator, Operator

The next question comes from Saree Boroditsky of Jefferies.

Unidentified Analyst, Analyst

I wanted to ask about pricing as we move into 2024, especially since other players in the pool industry are indicating that they expect higher than usual prices.

Kevin Holleran, President and CEO

Yes, we are still addressing that issue. We typically align pricing with the development of our early buy program. We anticipate inflation next year to be in the range of 3% to 4%. We will continue to face wage inflation affecting various components, including some of our suppliers. We are focused on maintaining price-cost neutrality, especially considering the price increases implemented over the past three years, which may affect demand. Given current inflation estimates, we are planning to implement additional price changes in 2024.

Operator, Operator

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

Rafe Jadrosich, Analyst

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?

Kevin Holleran, President and CEO

Yes, I believe there will be participation in the early buy program. It's still in the design phase for the 2024 season. Historically, early buy has not been very successful for our industry across all markets, whether seasonal or in the Sun Belt. Typically, there is a pricing announcement at that time, often including discounts and specific payment terms as incentives. These factors can help OEMs manage factory operations, balance production fluctuations, and ensure products are ready in the channel in case spring starts early, allowing us to respond quickly if the season begins sooner than expected.

Operator, Operator

The next question comes from Robert Wertheimer of Melius Research.

Robert Wertheimer, Analyst

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.

Eifion Jones, Senior Vice President and Chief Financial Officer

It's not a perfect process to collect every single inventory data point, but we obtain valuable information from our main U.S. trading partners, distributors, and some from retail. We have observed a steady destocking trend since the end of Q2 2022, which notably intensified during the first half of this year, particularly in the second quarter. Feedback from the channel indicates they aim to maintain this trend as we move into the peak of the season in Q3, with a strong desire to keep their balance sheets lean as we approach the early buying period. This is what we are hearing, and the data we are receiving supports this observation.

Operator, Operator

The next question comes from Saree Boroditsky of Jefferies.

Unidentified Analyst, Analyst

I wanted to discuss the pricing as we approach 2024, considering that other players in the pool industry are indicating that prices will be higher than usual.

Kevin Holleran, President and CEO

Yes, I would say we are still addressing that. We typically assess pricing while we are simultaneously developing the early buy program. Our expectations for inflation next year remain intact, and various sources suggest it will be around 3% to 4%. We anticipate continued challenges with wage inflation affecting various components and even some of our suppliers. Our goal is to maintain price-cost neutrality. We recognize the amount of pricing introduced into the market over the past three years, considering the potential for demand disruption. However, based on current inflation estimates, we are planning to implement further price adjustments in 2024.

Operator, Operator

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

Rafe Jadrosich, Analyst

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?

Kevin Holleran, President and CEO

Yes, I believe there will be participation in the early buy program, which is still being designed for the 2024 season. Traditionally, early buy has been less effective in our industry across all markets, whether they are seasonal or in the Sun Belt. Historically, there is a pricing announcement at that time, with some discounts and payment terms included in the early buy program as incentives. These elements are part of your question, Rafe. There's also significant benefit for the original equipment manufacturers in our capacity to operate our factories efficiently, helping to smooth out production fluctuations. Additionally, it's crucial to have products ready in the distribution channel in case we experience an early spring, allowing us to respond effectively to an early start to the season.

Operator, Operator

The next question comes from Robert Wertheimer of Melius Research.

Robert Wertheimer, Analyst

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.

Eifion Jones, Senior Vice President and Chief Financial Officer

It's not an exact science when it comes to gathering every detail of inventory data, but we do obtain valuable insights from our main U.S. trading partners, distributors, and some from the retail sector. We have observed a consistent trend of destocking since the end of Q2 2022, which intensified during the first half of this year, particularly in the second quarter. Feedback from the channel indicates they intend to maintain this trend as we approach Q3, aiming to keep their balance sheets lean ahead of the early buy period. This is the information we are receiving, and it aligns with the data reported back to us.

Operator, Operator

The next question comes from Saree Boroditsky of Jefferies.

Unidentified Analyst, Analyst

This is Saree Boroditsky from Jefferies. I wanted to discuss pricing. How are you planning to approach pricing in 2024, especially since other players in the pool industry are indicating they will be raising prices above normal levels?

Kevin Holleran, President and CEO

Yes. I would say we're still working through that. We typically align pricing with the development or design of the early buy program. We continue to expect inflation next year to be around 3% to 4%, depending on the source. We also anticipate ongoing wage inflation that affects various components, including our suppliers. Our goal is to maintain price-cost neutrality. We're conscious of the amount of pricing that has been introduced into the market over the last three years, considering the potential for demand disruption. However, based on the inflation estimates available, we are planning to implement additional price actions in 2024.

Operator, Operator

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

Kevin Holleran, President and CEO

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.

Operator, Operator

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.