Hayward Holdings, Inc. (NYSE:HAYW) Q3 2023 Earnings Call Transcript

Hayward Holdings, Inc. (NYSE:HAYW) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Welcome to Hayward Holdings Third Quarter 2023 Earnings Call. My name is Svangel and I will be your operator for today’s call. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Kevin Maczka, Vice President Investor Relations. Mr. Maczka you may begin.

Kevin Maczka: Thank you and good morning everyone. We issued our third quarter 2023 earnings press release this morning, which has been posted to the Investor Relations section of our website at investor.hayward.com. There you can also find an earnings slide presentation that we will reference during this call. I’m joined today by Kevin Holleran, President and Chief Executive Officer; and Eifion Jones, Senior Vice President and Chief Financial Officer. Before we begin, I would like to remind everyone that during this call, the company may make certain statements that are considered forward-looking in nature, including management’s outlook for 2023 and future periods. Such statements are subject to a variety of risks and uncertainties including those discussed in our most recent Form 10-K and Form 10-Q filings with the Securities and Exchange Commission that could cause actual results to differ materially.

Aerial view of a swimming pool with outdoor furniture surrounding it.

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 Holler.

Kevin Holleran: Thank you, Kevin and good morning everyone. It’s my pleasure to welcome all of you to Hayward’s third quarter earnings call. I’ll start on Slide 4 of our earnings presentation with today’s key messages. I’m pleased to report solid third quarter results consistent with expectations. The quarter was highlighted by continued execution in a challenging operating environment with strong profitability and cash flow generation. Gross profit margins expanded nearly 400 basis points through a laser-focused on management of manufacturing freight costs and a higher mix of technology products. We also demonstrated our robust cash flow generation characteristics again this quarter. Cash flow from operations increased approximately 50% on a year-to-date basis as we effectively reduced working capital.

This is a tremendous accomplishment by the entire Hayward team. End demand for Hayward products defined as channel sell-through met our expectations and exceeded our sales into the channel resulting in further normalization of distributor inventory. We are encouraged to enter the 2024 pool season with leaner inventory positions reported by our primary channel partners in the US and this sets up Hayward to return to a normal matching of sales with channel sell-through in this market. We are strengthening the business with investments in our industry-leading technology and operational capabilities. This includes the ongoing development of innovative IoT connected products and further footprint consolidation allowing Hayward to better support our customers and drive long-term profitable growth.

Overall, our team continues to execute in a challenging operating environment and I’m pleased with our performance during the quarter. Finally, we’re updating our guidance primarily to reflect the impact of more challenging macro conditions in certain international markets specifically in Canada, Middle East, and Latin America. Early buy orders in our primary US market increased year-over-year and are trending in line with expectations. However, recent in-season orders have been softer than previously anticipated, reflecting a cautious approach by channel partners ahead of 2024. For the full year 2023, we now expect net sales to reduce approximately 24% to 26% compared to last year and adjusted EBITDA of $245 million to $255 million. Longer term, we expect to resume a solid historical growth trajectory of mid to high single-digits.

Turning now to slide 5, highlighting the results of the quarter. I’m pleased to report net sales in line with expectations driven by stronger execution in the US and Europe. Net sales in the third quarter reduced 10% and year-over-year to $220 million largely due to channel inventory movements and softer market conditions. By geography, net sales reduced by 9% in the US and 15% in international markets. Europe reduced 6% with larger declines of 16% in Canada and 23% in Rest of World. I’m encouraged to see sales trends stabilizing in our largest markets of the US and Europe with each down less than 10% in the quarter. Aftermarket maintenance and repair remains resilient whereas demand for discretionary product categories has been more impacted by the challenging macro conditions particularly in the retail and online channels and certain international markets.

Commercial pool sales increased double-digits again in the quarter. We are focused on driving growth in these markets that are pleased with the continued robust demand. Our gross price list increased 5%, but was more than offset by the comparative changes in the earned annual distributor rebate and dealer incentive programs, which are finalized in the fiscal third quarter for the seasonal year end. In other words, more distributors earn rebates this year while fewer achieve rebate thresholds last year. This is a positive outcome and reflects channel partner increased target attainment and a higher mix of premium dealers in our results. Importantly, this is a third quarter dynamic and we expect positive net price realization on a full year basis.

As I mentioned, the gross margin performance was strong again in the third quarter despite lower volumes and net pricing. Gross profit margins expanded nearly 400 basis points year -over-year to 47.8%. The improvement is a result of continuous operational improvements, a moderating rate of inflation in certain purchased material and freight costs and a higher mix of technology products. This has allowed us to continue expanding gross margins at lower production volumes, while positioning for future growth. Adjusted EBITDA in the third quarter was $47 million with a margin of 21.4%. We continue to deliver the expected $25 million to $30 million in annual SG&A savings under our prior enterprise cost reduction program. These savings were partially offset in the third quarter by an increase in our field service warranty costs to accommodate higher labor cost per service call as well as our commitment to the consumer to replace with a whole good if a spare part is not available.

Importantly, our first-time quality metrics are consistent with prior periods and our production of spare parts has increased in response to a significant increase in early buy demand for parts. Consequently, we expect field service warranty costs to moderate going forward. Adjusted diluted EPS in the quarter was $0.09. Turning now to slide 6 for a business update. End demand for Hayward products was consistent with our expectations in the quarter with our largest markets US and Europe performing solidly. Non-discretionary aftermarket demand remains resilient, but demand for products used in discretionary new construction upgrades and remodels has been impacted by current economic conditions and rising interest rates. As a result customers are participating in the early buy program as expected by taking a cautious approach ahead of 2024 for in-season orders.

However, we are encouraged to see signs of stabilization in demand for new construction in the US particularly in the higher end of the market. Further, we continue to see compelling opportunities for upgrade and remodel given the record age of the installed base. We continue to see strong market acceptance of the connected suite of products within our Omni IoT automation ecosystem. Adoption of the Omni platform continues to grow with one of the largest builders in the US, now standardizing on Omni. Our Omni app is highly rated on both Apple and Google Play stores and we have seen an increase to 94% of all Omni’s activity used by homeowners via the app. We are also excited by the uptake of our Omni retrofit kit, which provides a simple upgrade path from legacy ProLogic controls to the latest technology.

As expected during the quarter, our channel partners continued to rebalance the level of inventory relative to the current economic outlook, normalized OEM lead times and higher cost of carrying inventory. Our primary partners in the US are reporting leaner inventory levels in the channel entering the new pool of season, whereas some partners and regions are still recalibrate. Turning to the price versus cost dynamic. We are maintaining price cost neutrality and driving solid gross margin expansion through disciplined cost control and manufacturing productivity improvements. We continue to evaluate our global manufacturing footprint as part of our operational excellence initiatives. Given the merits of our newest manufacturing facility in Barcelona, we initiated a plan during the quarter to consolidate our facility near Madrid into Barcelona.

This change will allow us to better leverage the benefits of a modern facility more closely align manufacturing, engineering and product management and support margins. We continue to prioritize working capital management and deliver significant improvements. Total working capital declined by $139 million on a year-to-date basis, contributing to the positive cash flow performance. With that I’d like to turn the call over to Eifion, who will discuss our financial results in more detail.

Eifion Jones: Thank you, Kevin and good morning. I’ll pick up on Slide 7. All comparisons I’ll make will be on a year-over-year basis. As Kevin stated, we are pleased with our third quarter financial performance. Net sales modestly exceeded expectations for the quarter and reflected a return to normal seasonality coupled with a progressive rightsizing of channel inventory. We delivered outstanding gross margin expansion to 47.8% and we’re realizing our SG&A cost reductions in line with the plan. Our balance sheet is strong and we generated good cash flow. Looking at the results in more detail, net sales for the third quarter decreased 10% to $220.3 million. This was driven by an 8% reduction in volume and 3% reduction in net price.

The volume decline during the quarter was primarily driven by the expected distribution channel inventory movements and moderating demand trends in discretionary elements of our markets like new construction and through the retail channels, as well as weaker performances in Canada and certain other export markets. Gross price increased approximately 5% but was reduced in the quarter by comparably higher annual rebate settlements and dealer incentives resulting in a net price decrease of 3% for the quarter. This is an end of seasonal year performance calculation quarter for us and can result in some swings to our rebate and incentive calculations based on final target achievements. Last year’s final calculation for the seasonal year performed in the third quarter resulted in a favorable adjustment to income, whereas this year the rebates are more normal.

This dynamic is generally limited to the third quarter. The key point is our price increases are holding and our incentive programs are yielding solid volume results with strong margins. Gross profit in the third quarter was $105.4 million. Gross profit margin increased 390 basis points year-over-year to 47.8% compared to 43.9% in the prior year period and a record 48.1% achieved in the second quarter of 2023. Disciplined manufacturing cost control and moderating input material and freight costs, more than offset the impact of reduced production volumes. As we have discussed before, Hayward has a long-standing commitment to lean manufacturing and continuous improvement. And I’m excited about our plans to deliver further productivity gains across our manufacturing and supply chains.

Selling, general and administrative expenses increased modestly on a sequential basis to $59 million in the third quarter. We are delivering on the annual run rate savings of $25 million to $30 million, targeted under our prior enterprise cost reduction program. However, we increased our field service warranty accrual rate in the quarter, primarily to account for higher service labor costs and reduced spare parts availability. We have taken proactive actions to address this and limit the impact going forward, including ramping production of spare parts and we expect these costs to moderate going forward. The increase in the accrual rate was partially offset by reduced variable compensation expense. In the quarter, we took a restructuring charge of $3.3 million, primarily related to the exit from our manufacturing facility near Madrid, a movement of that manufacturing to our newer facility in Barcelona.

This will yield an annual cost savings of approximately $2 million, once the move is complete. Adjusted EBITDA are $47.2 million in the third quarter and adjusted EBITDA margin was 21.4%. We are positioned to drive solid margin expansion as volume growth returns. We recorded an income tax benefit of $2.3 million in the third quarter related to favorable discrete tax items. We continue to expect an effective tax rate of 25% for the fourth quarter. Adjusted diluted EPS in the quarter was $0.09 on a fully diluted share count of 221 million shares. Let’s turn now to slide eight for a review of our reportable segment results. North American net sales for the third quarter declined 9% to $185 million, driven by 5% lower volumes and 4% unfavorable net price impact.

The reduction in volume was largely due to both the expected rightsizing of channel inventories and moderating end demand trends as previously communicated. Sales in Canada declined 16% in the quarter. This market is going through a tougher macro period. Relative to the US, it’s a very short season and now closed for 2023. And there is a higher concentration of lower-cost in-ground pools and above ground pools in that market, where demand is more significantly impacted by economic condition and financing costs. Despite the temporary net pricing dynamic I previously mentioned, gross profit margin in the quarter expanded 430 basis points year-over-year to a solid 49.4%. For two quarters in a row now, the NAM segment has posted greater than 49% gross margins.

Adjusted segment income margin was 24.9%. We were pleased with the margin performance in the quarter. Turning to Europe and Rest of World. Net sales for the third quarter decreased 15% to $35 million. Net sales benefited from net favorable price realization 4% and foreign currency translation benefited 3%, offset by a 22% decline in volume. We were pleased with the performance in Europe, where sales declined 6% overall and increased 1% in Southern Europe. In contrast, Rest of World declined 23%. We continue to invest in our expansion campaigns into Asia markets where we have established a solid share position, but we’re seeing a tempering of demand in that region, as well as increased macro pressure in the Middle East and Latin America. Overall for the segment, gross profit margin expanded 130 basis points year-over-year to 39.6% and adjusted segment income margin was 18.9%, again solid margin performances.

Turning to slide nine for a review of our balance sheet and cash flow highlights. Net debt to adjusted EBITDA was 3.9 times at the end of the third quarter compared to 3.8 times in the second quarter. We continue to prioritize deleveraging to our targeted range of two to three times. I’ll discuss this a little further shortly. Total liquidity at the end of the third quarter was $402 million, including a cash and cash equivalent balance of $244 million, and availability under our credit facilities of $158 million. We have no near-term maturities on our debt or interest rate swap agreements. Term debt of $1.1 billion matures in 2028, and the undrawn ABL matures in 2026. This attractive maturity schedule provides financial flexibility as we execute our strategic plans.

Our borrowing rate continues to benefit from the $600 million of debt currently tied to fixed interest rate swap agreements maturing in 2025 and 2027, which limits our cash interest rate on our term facilities to 6.7%. Our average earned interest rate on global cash deposits for the quarter was 4.6%. Overall, we are pleased with the quality of our balance sheet. We have a strong, but seasonal cash flow generation characteristic driven by high-quality earnings. Cash flow from operations was a robust $217 million year-to-date in 2023, compared to $144 million in the prior year period, reflecting the effect of working capital management. We made great progress reducing working capital by $139 million year-to-date. CapEx of $23 million year-to-date was consistent with the prior year period.

Year-to-date free cash flow generation of $194 million increased 62% compared to the prior year period last year. For the full year 2023, we expect free cash flow generation of approximately $125 million to $150 million depending upon the mix of standard versus early by final order activity. With the return to normal seasonality the company will typically use cash in the first and fourth quarters and generate cash in the second and third quarters. This year, larger early buy orders with extended payment terms will push the collection of some receivables into the first half of 2024. Turning now to capital allocation on Slide 10. As we’ve highlighted before, we maintain a disciplined financial policy and take a balanced approach emphasize strategic growth investments and shareholder returns, while maintaining prudent financial leverage.

In the near term, we are prioritizing CapEx growth investments and reducing net leverage within our targeted range of two to three times. We continue to consider tuck-in acquisition opportunities to complement our product offering, geographic footprint and commercial relationships in addition to opportunistic share repurchases. Turning now to Slide 11 for our outlook. We remain very positive about the long-term health and growth profile of the pool industry, particularly the strength of the aftermarket and in Hayward’s leadership position within the industry. We are updating our outlook for 2023 to reflect primarily a reduction in outlook for the Canadian and Rest of World markets. Our outlook for the US and Europe is moderately tempered by the more cautious stocking by our channel partners in the fourth quarter.

It’s clear some of our partners increasingly favor in-season purchasing rather than stocking ahead of the 2024 season, and we’ll continue to use current albeit increasingly normalized inventories to service remaining in-season 2023 business. Consequently, we now anticipate a decrease in consolidated net sales of 24% to 26%. We now expect adjusted EBITDA to be between $245 million and $255 million, with free cash flow in the range of $125 million to $150 million. Our interest expense expectation is approximately $75 million, reflecting the current interest rate environment on borrowing levels. The effective tax rate forecast remains approximately 25% for the fourth quarter and our CapEx spending forecast for the full year is approximately $30 million.

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

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

As a leader in this attractive industry, I’m excited about the opportunities to leverage Hayward’s competitive advantages and drive profitable growth and shareholder value creation. With that, we’re now ready to open the line for questions.

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Q&A Session

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

Jeff Hammond: Hey. Good morning, guys.

Eifion Jones: Good morning.

Kevin Holleran: Hey, Jeff.

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

Kevin Holleran: Sure. Good morning, Jeff. As we said in the prepared remarks, we’re obviously very pleased with the 47.8% gross profit margins posted up in the third quarter. Again that was up nearly 400 basis points with net sales down 10%. Maybe even more impressive is, knowing that that’s within 30 bps of the record gross profit last quarter with net sales down sequentially 22%. But your question is really getting at the pricing impact while posting those margins. And I would just want to point out that this is not a reflection on giving back list or invoice price. That was up 5% in the quarter. The realization — we’ve realized positive year-to-date and we fully expect to post positive price on a full year basis. In third quarter, it’s a bit of a unique period for us as this wraps up the end of the seasonal year and true-ups occur as the curtain drops on the full year and that’s really what occurred here.

I’ll turn it over to Eifion to maybe walk through some of the accounting of that in just a moment. But again, it does not reflect the loss of market pricing, or the stickiness of past price increases or give back there. It’s really related to two things, and I’ll turn it over to Eifion in just a moment. This end-of-season performance calculation occurs, which can result in some swings to our rebate and incentive calculations. Last year’s final calculation resulted actually in a favorable adjustment to income in third quarter whereas this year the rebates are more normal. And then secondly was a higher mix this year of some qualifying dealers primarily higher-end builders that earn incentives based upon volumes. So, again, with the destock that’s occurring and the fact that kind of the mid-level or the higher-end pools continue to perform well in a more destock lower sales out environment that became a bigger percentage of our overall mix.

Anything to add Eifion?

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

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

Kevin Holleran : Yes. I mean, the 160 that you just referenced that is our best estimate at this point. We’ll be in a better position to validate that at year-end. But again, we don’t have perfect information globally, but we do get input. We did make great progress — have made great progress through September. No doubt you’ve heard others in the industry talking about getting leaner on inventory and we agree. That said, there’s still some pockets or some regions that need some additional recalibration, but it’s largely behind us now. As for 2024, obviously, you’re not asking for guidance at this point, but we kind of look at it, as we work through the budgeting process here looking — there’s certainly some positives that we’ll be able to comp off of.

But there’s obviously some things that we’re needing more time to better understand. The three things, I would say, around the positives, the headwind from the heavy destock as we just — as I just spoke on is largely behind us here in 2023. Your prior question was around pricing. We expect to have positive net pricing. Again, we announced increase that took effect on October 1st that are now on the price list and out into the marketplace. And then thirdly, around this aftermarket resiliency. It continues to be resilient here in 2023, we’d expect it to play out again as always in 2024. We don’t know where new pools are going to land, but if current estimates play out and it’s in the 70,000 range, again, that’s going to add more pools to the installed base than we had ending 2022 that we’ll be needing service and maintenance and repair and remodel into the future.

On the more concerning side, certainly the macro is giving us all some pause. We spoke about some of the interest rates that are hitting all markets and particularly — in particular Canada and some of the export markets. And frankly at this point we don’t see a tailwind that’s going to meaningfully recover new construction going into 2024 particularly at that entry-level which is much more finance-based or interest rate based. So those are some of the factors that we’re overlaying as we look out into 2024. And we’ll be back in February with our firm outlooks for 2024, Jeff.

Jeff Hammond: I appreciate the color guys.

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

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

Kevin Holleran: Yeah. So I would say the sell-through was kind of on expectations. There’s a large distributor who’s already reported earnings. I would say what they reported for their equipment sell-through is on par with what we saw, being sold for the Hayward products into the marketplace which is again, sort of on expectation for what we saw rounding out the season here. And as for the first part of the question, we saw really in — throughout the third quarter and frankly we’re calling forward in the fourth quarter to just have some more tempered expectation around what we call in-season orders. And what I mean by that it’s not an early buy. The order flow in advance of the early buy season was not quite to expectation.

I think that that probably highlights continued diligence around inventory utilization and balance sheet considerations. So that’s really what the commentary gets at is overall we’ve seen nice response. We’re still not yet complete with the early buy season, but we’ve seen on expectation ordering there. But when you look at it combined with what the expectation was around in-quarter flow orders we didn’t quite see that in the third quarter and that’s giving us some pause as we look out in the fourth quarter and look at the full year guidance.

Eifion Jones: I think James — this is Eifion. I think James the channel is being very cautious in what they’re taking to inventory, given the macro dynamics that you see right now, particularly around interest rates and the cost to carry inventory. So they’re buying it when they need it and not earlier. And we see that I think across the entirety of our channel footprint. As we said in our prepared remarks we think that the result of that is they’re moving the purchasing of the 2024 season, much closer to the in-season demands they have. So given our interest rates are the channel has just been super cautious I believe, in what they’re taking in.