Hayward Holdings, Inc. (NYSE:HAYW) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Welcome to Hayward Holdings First Quarter 2023 Earnings Call. My name is Jordan, and I will be the operator for today’s call. [Operator Instructions] Please note this conference is being recorded. I will now turn the call over to Kevin Maczka, Vice President, Investor Relations. Mr. Maczka, please go ahead.

Kevin Maczka: Thank you, and good morning, everyone. We issued our first 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 : Thank you, Kevin, and good morning, everyone. It’s my pleasure to welcome all of you to Hayward’s first quarter earnings call. I’ll start on Slide 4 of our earnings presentation with today’s key messages. I’m pleased to report first quarter results in line with expectations, reflecting strong execution in a challenging operating environment, including adverse weather conditions in certain key markets that we successfully offset with market share gains. Sales out of the channel were stronger than sales into the channel as our partners made further progress recalibrating the level of inventory on hand. We maintained disciplined cost control by reducing production levels to align with current market conditions and delivering on our previously communicated commitment to reduce SG&A costs.

Price realization remains favorable, offsetting inflation. These efforts resulted in a robust profitability as we delivered excellent structural margins at lower volumes. I’m especially pleased with sequential gross margin expansion of over 400 basis points despite lower net sales. As we proactively manage costs, we continue to invest in the business to support customers with innovative new solutions and superior service and drive future growth. To that end, we continue to launch exciting new products, and I’ll highlight some examples in a moment. We also hosted 2 significant customer events, our first-ever Partner Summit in Nashville and a large builder event in Phoenix. These events showcased our technology leadership and provided value-added training opportunities.

The dealer response was exceptional, and we expect these unique customer engagements to drive brand loyalty and increase demand for Hayward products and services going forward. Overall, I’m proud of our performance during the quarter. Finally, we are maintaining full year guidance. For the full year 2023, we continue to expect net sales to reduce approximately 18% to 22% and adjusted EBITDA of $265 million to $285 million. Looking out beyond 2023, we have every expectation of resuming a solid historical growth trajectory of mid- to high single digits. Turning now to Slide 5, highlighting the results of the quarter. Net sales in the first quarter reduced 49% year-over-year to $210 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 23% in the first quarter of 2022 and 96% in the first quarter 2021. We are seeing a return to more normal seasonality with Q1 expected to be the low point for total net sales. We are encouraged by continued positive price realization to offset inflation and the success of our innovative new solutions. As I mentioned, the gross margin performance in the quarter was exceptional. Despite reduced net sales, gross profit margins expanded 20 basis points year-over-year and 430 basis points sequentially to a robust 46.6%. Our operations teams have done an outstanding job to start the year with a rightsized manufacturing cost base, and we are encouraged by this ability to maintain gross — strong gross margins and much lower production volumes.

Adjusted EBITDA in the first quarter was $45 million with a margin of 21.4%. We realized the expected SG&A savings under our cost reduction program. Adjusted EPS in the quarter was $0.07. Turning now to Slide 6 for a business update. We estimate that Hayward captured significant market share over the last 3 years. This was most notable in the strategically important U.S. Sunbelt and in critical products like IoT controls, variable speed pumps, water sanitization and LED lighting. Our IoT digital leadership position is clear. The market is responding favorably to the connected products within our omni automation ecosystem, and we continue to gain traction with dealer additions in our totally Hayward loyalty program. Underlying end consumer demand trends continue to moderate in North America with the Sunbelt an area of relative strength.

Weather was historically unfavorable in the Western markets, and we were pleased to offset this with further market share gains in the West and the Southeast. Overall, Europe and Rest of World exceeded our expectations in the quarter, and I’m very pleased with the performance of our team, particularly in targeted new Asian markets where we’ve realized growth year-over-year. Our channel partners continue to recalibrate the level of inventory to be appropriately positioned relative to a softer global economic outlook, normalized lead times and higher cost of carrying inventory. This played out generally as expected in the first quarter as we continue to believe the channel will trend towards the low end of historical ranges for inventory days on hand over the course of the year.

Turning to the price versus cost dynamic. We implemented a price increase of 4% to 5% at the beginning of January to maintain price cost neutrality, and we are realizing this pricing as expected. As you know, we took a number of proactive actions in recent quarters to streamline the organization, optimize the cost structure and support margins. This included a reduction of variable costs in our manufacturing cost base and supply chain as well as structural SG&A savings of $25 million to $30 million on a full year basis. These actions are intended to maintain a healthy margin profile with full year gross margins in the mid- to high 40s and adjusted EBITDA in the high 20s. We are delivering on these commitments. Finally, we continue to make great progress on our ESG journey.

I’m pleased to report that Hayward received a 2023 Regional Top-Rated Award for ESG performance by Morningstar Sustainalytics, a leading ESG research, ratings and data firm. While still very early in our journey, we are proud to be recognized with one of the best ESG ratings for all companies in the U.S. and Canada. Turning now to Slide 7. Last quarter, I detailed our new product development strategy and shared some of the recent innovations driving our technology leadership in the industry. Today, I would like to highlight 2 new product launches. SmartPower is the first-to-market technology, which revolutionizes multi-zone lighting in the backyard, encompassing the pool, spa, water features and landscape lighting. This dramatically reduces component and labor costs while increasing reliability and ease of use for the homeowner.

Next, the TracVac Suction Cleaner. This new cleaner outperforms its peers and superior pool surface coverage, speed of cleaning and ability to handle any obstacles it encounters. We continue to prioritize investments in the development of new products like these to further strengthen our competitive positioning and support customers with industry-leading products and technologies. Turning now to Slide 8. I’d like to reemphasize the attractive long-term fundamentals of the pool industry and Hayward. 2023 is a year of normalization. Softer market conditions related to global economic uncertainty, channel inventory reductions and comparisons to periods of strong growth are impacting near-term results. we view this as a temporary dynamic in a resilient industry characterized by consistent growth, driven by an ever-growing aftermarket.

I would like to revisit the solid long-term fundamentals and growth outlook. A number of secular tailwinds, including the appeal of outdoor living, Sunbelt migration, connected smart home technologies and environmentally sustainable products are here to stay, and the pool industry is a beneficiary of each of them. More specific to the industry, the large installed base of over 5 million in-ground pools in the U.S. and 25 million pools globally increases each and every year as new pools are built and the average age is highest on record. This provides significant opportunity for aftermarket sales as pool owners maintain and modernize their pools with new IoT-enabled technologies to enhance enjoyment, ease of use and cost of ownership. As we’ve discussed in the past, Hayward enjoys deep rooted competitive advantages that strengthen our market position and drive compelling long-term growth for our shareholders.

We have an incredibly strong and trusted brand, nearly a century in the making and one of the largest installed bases that comes from having a complete product line across all pool types. Proven technology leadership, operational excellence and multichannel strength are meaningful differentiators for Hayward. To summarize, we are proactively managing through this year of normalization, controlling what we can control to position the company for robust growth and profitability over the long term. As a leader in this very attractive industry, I’m optimistic about Hayward’s long-term growth outlook. With that, I’d like to turn the call over to Eifion Jones, who will discuss our financial results in more detail. Eifion?

Eifion Jones : Thank you, Kevin, and good morning. I’ll pick up on Slide 9. All comparisons I’ll make will be made on a year-over-year basis. We are pleased with our first quarter financial results. Net sales were in line with expectations and reflected a return to normal seasonality, coupled with the progressive rightsizing of channel inventory. We delivered exceptional sequential gross margin back into the high 40s, and we’re realizing our SG&A cost reductions in line with plan. Our balance sheet is strong with first quarter seasonal use of our revolving credit facility now fully repaid as of today with expected strong cash flow for the balance of the year. Specifically, our net sales for the first quarter decreased 49% to $210 million.

This was in line with our expectations and driven by a 54% reduction in volume, partially offset by positive price realization of 5%. It’s important to understand that the volume decline during the quarter was primarily driven by distribution channel inventory movements in addition to moderating in demand trends in discretionary elements of the markets, namely new construction and larger remodels. Despite the reduction in sales in the quarter, we’ve delivered a 3-year CAGR of 7% when compared to the first quarter of 2020, the last pre-COVID quarter. That’s a 3-year stack growth of approximately 24%. Gross profit in the first quarter was $98 million. Gross profit margin increased 20 basis points year-over-year and 430 basis points sequentially to a strong 46.6%.

Disciplined manufacturing cost control, continued price realization and moderating input cost inflation more than offset the impact of reduced production volumes. We have worked hard to achieve price cost neutrality and recalibrate our manufacturing cost base to deliver this strong gross margin performance. It sets the business up well to deliver robust profitability for the remainder of the year and beyond. Selling, general and administrative expenses declined 20% year-over-year to $55 million in the first quarter. As a reminder, we took proactive actions during the fourth quarter of last year to streamline the organization and optimize the SG&A cost structure, and we’re delivering on the targeted run rate savings of $25 million to $30 million annually.

Adjusted EBITDA was $45 million in the first quarter and adjusted EBITDA margin was 21.4%. We’re pleased to maintain adjusted EBITDA margin more for 21% at these reduced volume levels, and we’re positioned to drive solid margin expansion as volume growth returns. Despite the year-over-year reduction in the quarter, we delivered 3-year net sales and adjusted EBITDA CAGR, 7% and 8%, respectively, when compared to the first quarter of 2020. Our effective tax rate was 9% in the first quarter compared to 24% in the prior year period. The year-over-year change was primarily due to the timing of the discrete tax benefit. Adjusted EPS in the quarter of $0.07 on a fully diluted share count of approximately 221 million shares. Diluted share count decreased approximately 23 million shares or 9% year-over-year as a consequence of share repurchase activity in the prior year.

Let’s turn now to Slide 10 for a review of our reportable segment results. North America net sales for the first quarter declined 53% to $163 million, driven by 59% lower volumes, partially offset by a favorable 5% price impact. The reduction in volume again was largely due to the anticipated rightsizing of channel inventories and a moderation in end market trends. Gross profit margin was 48.6%, a sequential improvement of 560 basis points and adjusted segment income margin was 24.1%. Again, we are pleased with the margin performance in the quarter and frankly, very proud of the operations team in that success recalibrating our manufacturing cost base, a tremendous achievement. Turning now to Europe and Rest of World. Net sales for the first quarter decreased 26% to $47 million.

Net sales benefited from a favorable pricing increase of approximately 5%, but we were adversely impacted by a 28% decline in volumes due to channel inventory reductions and the impact of geopolitical circumstances in Northern Europe, as well as a 2% headwind from unfavorable foreign currency translation. Gross profit margin was 39.8%, and adjusted segment income margin was 21.2%. Turning to Slide 11 for a review of our balance sheet and cash flow highlights. Total liquidity at the end of the first quarter was $263 million, including a cash and cash equivalent balance of $41 million and availability under our credit facilities of $222 million. Net debt to adjusted EBITDA was 4.1x compared to 2.9x at year-end 2022. The increase reflects reduced EBITDA and a seasonally soft period for cash collections in the first quarter.

A large part of our accounts receivable at the end of Q1 is early by business sold on extended terms to be collected in Q2. We expect net leverage to be closer to 3x by the end of the year. As of today, our ABL is undrawn. Additionally, we will not make any excess cash flow payment in 2023, given our credit agreements permit deductions for CapEx, share repurchases and M&A. We plan to complete the transition from LIBOR to SOFR on Term Loan B borrowers during the second quarter. This change will not materially impact our financial position. Our borrowing rate continues to benefit from the $600 million of debt currently tied to fixed interest rate swap agreements. Cash flow from operations was a use of $91 million in the first quarter, reflecting the increase in the accounts receivable driven by early by order tenants.

Inventory decline sequentially in the quarter after peaking in the third quarter of 2022 and is down $39 million since then. CapEx was $6 million in the first quarter, was consistent with the prior year period. And consequently, free cash flow was a use of $97 million. We have strong free cash flow generation characteristics driven by high-quality earnings, but cash flows are seasonal. With the return to normal seasonality, the company will typically use cash in the first quarter and generate cash in the balance of the year. We expect free cash flow conversion of greater than 100% of net income with free cash flow exceeding $150 million in 2023. Turning now to capital allocation on Slide 12. 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, commercial relationships and opportunistic share repurchases. However, in the near term, we’re prioritizing organic growth investments and reducing net leverage within our targeted range of 2 to 3x. Turning now to Slide 13 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. Our outlook for 2023 is unchanged as we continue to anticipate a decrease in consolidated net sales of 18% to 22%. This outlook reflects resiliency in the North American nondiscretionary aftermarket and reductions in new construction and discretionary remodeling upgrade.

In Europe and Rest of World, we expect reductions of approximately 25% as geopolitical circumstances negatively impact consumer sentiment in that region, although we are seeing green shoots in this segment. These decreases will be partially offset by a 4% to 5% net sales contribution from price increases initiated at the beginning of the year. Our unchanged guidance contemplates additional reduction of channel inventory in 2023 as a consequence of the reduced consumer demand, a reversion to normal supply chains and a higher cost of capital. Channel partners are adopting a lean inventory position given these dynamics and they’re moving to the lower end of their desired days on hand target. We expect gross profit margin to continue to increase over the balance of 2023.

We’re holding our anticipated full year 2023 adjusted EBITDA in the range of $265 million to $285 million. As discussed, we also expect a strong improvement in free cash flow in 2023 as we reduce our own inventory levels with free cash flow exceeding $150 million. Our interest expense expectation remains unchanged at approximately $78 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 also remains unchanged, a $25 million to $30 million. I’ll close on the same point that I started. I am proud of the Hayward team’s ability to rapidly recalibrate, delivering net sales in line with expectations and a significant improvement in gross margin back into the high 40s, realizing SG&A cost savings in line with the plan and managing cash flow in line with normal seasonality.

And with that, I’ll now turn the call back to Kevin.

Kevin Holleran : Thanks, Eifion. I’ll pick back up on Slide 14. Before we close, let me reiterate the key takeaways from today’s presentation. We delivered first quarter results consistent with expectations and reaffirmed our outlook for the year. Our team executed well in a challenging environment, maintaining disciplined cost control, demonstrating our agile manufacturing capabilities and offsetting weather-related headwinds with share gains. We’re very pleased with the strong gross margin performance in the quarter. We continue to invest in our business to drive future growth and believe the actions we are taking today are strengthening our position as a premier company in the attractive pool industry. Finally, I’m confident we have the right strategy and talent in place to drive compelling financial results and shareholder value creation. With that, we’re now ready to open the line for questions.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Jeff Hammond with KeyBanc Capital Markets.

Operator: Our next question comes from Ryan Merkel with William Blair.

Operator: Our next question comes from Saree Boroditsky with Jefferies.

Operator: Our next question comes from Rob Wertheimer with Melius Research.

Operator: Our next question comes from Andrew Carter with Stifel.

Operator: Our next question comes from Nigel Coe with Wolfe Research.

Operator: Our next question comes from Josh Pokrzywinski with Morgan Stanley.

Operator: Our next question comes from Brian Lee with Goldman Sachs.

Operator: This concludes the question-and-answer session. I would like to turn the conference back over to Kevin Holleran for closing remarks.

Kevin Holleran : Thank you, Jordan. 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 without the hard work, dedication and resilience of our employees and partners around the world. So please contact our team. If you have any follow-up questions, and we look forward to talking to you again on the second quarter earnings call. Thanks, Jordan. You may now end the call.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.