Hayward - Q2 2024

Transcript

Operator (participant)

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. At this time, all participants are in a listen-only mode. Later, we will conduct a Q&A session. During the Q&A session, if you have a question, please press Star, then the one on your touch tone phone. Please note that this conference is being recorded. I will now turn the call over to Kevin Maczka, Vice President in Investor Relations. Thank you, sir. You may begin.

Kevin Maczka (VP of Investor Relations)

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.

Kevin Holleran (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 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 multi-channel 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 of 2024, we now expect net sales to increase approximately 2%-5% and adjusted EBITDA to increase approximately 3%-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 continue to increase on an organic basis, following a multi-year 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 product was consistent with our expectation in the quarter, with North America and Europe outperforming the rest of world.

Aftermarket repair and replace remains 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 US 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 position, furthering 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 focus 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 life cycle 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 to Hayward. 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 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 three key roles. This included the appointment of Ray Lewis as Chief Human Resources 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 seven. As I mentioned previously, we are excited about the opportunities to develop our commercial pool business, and a 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 salt 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 other Hayward products. Similarly, Hayward's domestic and international scale afford 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.

Eifion Jones (SVP and CFO)

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 +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, and 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 nine, North American net sales for the second quarter increased 2% to $241 million, driven by favorable pricing. Net sales increased 1% in the US and 5% in Canada.

We were pleased to see increased orders in 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 is encouraging, but certain Middle East and Asian 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 the 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 buyer 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% 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 increase in 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 maintain 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%-5% to a range of $1.01 billion-$1.04 billion, including a contribution from the ChlorKing acquisition of approximately 1%.

We now expect Adjusted EBITDA of $255 million-$270 million or an increase of approximately 3%-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 CrowdStrike outage had no material impact on the company. And with that, I'll now turn the call back to Kevin.

Kevin Holleran (CEO)

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.

Operator (participant)

Thank you. At this time, we'll be conducting a Q&A session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Ryan Merkel with William Blair. Please proceed with your question.

Ryan Merkel (Analyst)

Hey, everyone. Thanks for taking the questions. I wanted to start off with the acquisition of ChlorKing. Sounds like a really nice business. What are, what are the one or two bigger opportunities, Kevin, that you see there?

Kevin Holleran (CEO)

Yeah, good morning, Ryan. Yeah, this is a really, it's a great company, and we're really excited to welcome them to to Hayward. It positions us really well in the commercial market. You know, commercial has performed extremely well, aside from 2020, when, you know, so many of the commercial pools were not allowed to open. But we've seen great double-digit growth in the years since then. You know, what I think the strength. There's many, you know, when it comes to ChlorKing, but, you know, when you, when you look at their leadership in the commercial sanitization category, they've experienced a nice growth trajectory, over the recent past, great margins.

You know, but what they really bring to to the company is a real stronghold in the Class A segment of the commercial market. Commercial is really defined by two categories, Class A and Class B. Class A is really defined as more of those larger bodies of water, greater than 100,000 gallons, competition pools, water parks, et cetera. That's really where their sweet spot is. Hayward, you know, really participates in the Class B, which is, you know, the mix is about 15% Class A, 85% of the market, Class B, and we really refer to that by the acronym of HMAC, which is Hotel, Motel, Apartment, Condos.

We have a nice product line that speaks and plays well in the Class B, but ChlorKing really gives us some added, added exposure, and a product line to be able to, to leverage more broadly in the Class A. There's all kinds of cross-selling opportunities for some of ChlorKing's products to be introduced more so into the Class B, where we're already participating, and likewise, some of the Hayward product into the Class A segment. So lots of great, as I mentioned in my prepared remarks, great relationships that frankly, we don't, we don't have today around the pool architects and designers, builders, operators, specialty distribution. So, you know, Steve, we've actually had a relationship with Steve and the ChlorKing team for, for several years.

We actually private label and have for many years a water sanitization that we sell into the Class B. So we know each other, have a high level of intimacy with each other, and really looking forward to integrating and continuing our growth trajectory in the commercial space.

Ryan Merkel (Analyst)

That's great. Thanks for that. And then for my follow-up, I was curious on the longer-term outlook for new pools. Obviously, this year is gonna be pretty weak. Do you still think that we can do 90,000, 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?

Kevin Holleran (CEO)

Yeah, you know, I mean, you're familiar with the long-term new construction profile, and you know, this year, you know, most of us in the industry are sort of coalescing around this, you know, 60,000 or so, which would be another 15% decline off of last year's 25% decline. You know, there is heavy reliance upon interest rates. I do think, though. You know, I'm well, I'm not sure I can, I can predict 90,000 there. I do think that this is absolutely a low watermark, and as we do get some relief around interest rates, that the long-term viability and the desire to have a pool in the backyard is still highly desirable. You know, our single-family home starts has not really kept up with the family formation over the last several several years.

You can really say dating back to the GFC. So that's gonna be addressed at some point, which is a, which is a strong correlation point for new pool construction. So, you know, those secular trends around migration, as well as time at home, interest in having a healthy outdoor lifestyle, I think these—this is all tailwind for when interest rates, you know, finally start to abate. And we're looking forward to to hopefully 2024 being a low watermark, and we can get back tto o new pool construction in the near future.

Ryan Merkel (Analyst)

Got it. Thanks. I'll pass it on.

Operator (participant)

Thank you. Our next question comes from the line of Nigel Coe with Wolfe Research. Please proceed with your question.

Nigel Coe (Managing Director)

Oh, thanks. Good morning, everyone.

Kevin Holleran (CEO)

Good morning. Thanks for the question.

Nigel Coe (Managing Director)

Good morning. Just looking at the full year outlook, I think we're now sort of 1%-4%, excluding the impact of, of the, of the acquisition. So maybe just if you just unpack the kind of, you know, the sort of the adjustment you're making to sell-through versus maybe a bit more pressure from inventories. That would be helpful. And, you know, obviously, we saw from Pool Corp that equipment was down 2% in their numbers. You you obviously had +2% in North America. We're just wondering what you saw on sell-through in in the second quarter as well.

Kevin Holleran (CEO)

Yeah, sure. Let me, let me start that one. Let me first address the narrowing or what contributed to the narrowing of the, 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 2% 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 +10% range overall. What has changed is what we'll call just market market volume.

Originally, we laid out in North America the 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 is 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 at the -20%. Similarly, we're increasing that an extra 5% to a 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, you know, the +1% in the, in the second half from the ChlorKing acquisition would really get us to, to that midpoint revision of around 3.5%, with the range of 2%-5%.

Nigel Coe (Managing Director)

Okay, great. Thank you.

Kevin Holleran (CEO)

And second part of the question-

Eifion Jones (SVP and CFO)

Go ahead, Nigel.

Nigel Coe (Managing Director)

Just just, just the sell-through for second quarter, but that was a very fulsome answer. So thanks for that. But just on the, so just this sounds like ChlorKing is about $20 million of annualized revenue. Just want to make sure that's the case. And then just you talked about some of the share initiatives on the West Coast, in particular, the Sunbelt states. Maybe just talk about, so give an update in terms of, you know, the initiatives in train and then perhaps some of the success, you know, success you've seen with those, with those dealer conversions.

Eifion Jones (SVP and CFO)

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

Kevin Holleran (CEO)

Yeah. On, you know, dealer conversion, we have a lot of great initiatives underway. You know, I would say in some of those markets where, you know, we would say we have shared growth opportunities, specifically the West, as you mentioned, and then also, you know, what we call the South Central, around some, additional, on the street selling resources with marketing support, coming out, coming out of North Carolina. Obviously, the hub which I spoke about in my prepared remarks, is really a pilot. You know, we would like to see that proof of concept play out.

And you know, it'd be our expectation that we'll continue to roll that out in some additional markets going forward to really be that that one-stop shop for our dealers from a service and a support and a training standpoint. You know, and then we've spoken in the past, there are some nuanced differences from a product standpoint. You know, products that maybe sell in the Northeast or in Florida, you know, small footprint heater, 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 need to get the equipment set on a, on a smaller square foot pad.

So you know, lots of lots of attention being paid and resources being allocated inside our organization to continue focusing on those lower share markets, where, frankly, we have opportunity for growth, and we see nice, nice trend line occurring for us in those markets.

Nigel Coe (Managing Director)

Great. Thanks, Kevin.

Kevin Holleran (CEO)

Thanks, Nigel.

Eifion Jones (SVP and CFO)

Thanks, Nigel.

Operator (participant)

Thank you. Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please proceed with your question.

Jeff Hammond (Managing Director and Equity Research Analyst)

Hey, good morning, everyone.

Kevin Holleran (CEO)

Good morning, Jeff.

Jeff Hammond (Managing Director and Equity Research Analyst)

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

Kevin Holleran (CEO)

Yeah. From an inventory standpoint, you know, I would say we don't have perfect information, but, you know, talking in generalities, you know, when I was walking through the bridge just a moment ago on, on guidance, I would say that +10 was laid out. You know, I think that that still allows us to contemplate what we're seeing with the, with the channel in terms of overall inventory held. We you know, and I think our assumption still holds there. I would say in the first half, you know, we've probably seen a little bit more aggressive movement on the channel inventory, which frankly, is not unexpected when you really look at the environment that we're operating in.

You know, less sales out the door obviously would require less inventory to maintain days on on hand. You know, by this point, I think we were all assuming or at least hoping for some interest rate reductions, which have not occurred, so carrying costs across the broad channel has not reduced at all, you know, creating that incentive for less inventory carry. And frankly, us OEMs, you know, I think are pretty responsive right now from a, from a lead time standpoint to be able to serve the demand as it comes.

So, you know, we've seen, you know, some movement down per our original expectations, and as we play through the second half of the year, we still think that that assumption around the positive 10 will play out for us in full year 2024. As for early buy, you know, it's a bit early on that, so we're still defining and writing the plan, but we are definitely intending on offering early buy later this year into the 2025 season. You know, based on conversations that we've had, we would expect solid participation in the program as we roll it out. I know you know this, but for the broader audience, you know, early buy is really designed as a win-win for both distributors and us manufacturers.

Elements of that program, you know, is is avoidance of some future price increases and allows us to level load our factories and ship at our discretion. So, you know, based upon the inventory, obviously, these two questions are linked together, you know, with inventory reduction working through the end of the season here, what we would expect is a strong response to the early buy program that will roll out in the next, you know, call it a month or so, to the channel.

Jeff Hammond (Managing Director and Equity Research Analyst)

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

Kevin Holleran (CEO)

Yeah. You know, I think, you know, as I look, I spent some time describing Class A and Class B there. You know, we have, we had some products that we sold into Class A, but, you know, ChlorKing really does increase, you know, the catalog that we can now offer to to Class A. That said, there's still some some important higher volume products in the Class A that that us nor ChlorKing have, that presents opportunity for us, either from an organic or an inorganic standpoint, like some larger horsepower pumps, for example, or higher capacity filters or heaters would be some that I think are future opportunities that we'll continue to solve for. You know, but Class B, you know, we're,

Really happy, really pleased with what our, what the catalog looks like there. We've been seeing, you know, for years, running double-digit growth. But this is really not—commercial is really not a market that Hayward focused on historically. This is, this is, this a relatively new development for us over the last, you know, five to eight years or so where we focus. So, you know, we're excited, and there's other opportunities, organically and inorganically, to now leverage a broader set of relationships that ChlorKing brings to us, and we're anxious to get on with this and keep growing this, this, this commercial business, Jeff.

Jeff Hammond (Managing Director and Equity Research Analyst)

Okay, great. Thanks.

Operator (participant)

Thank you. Our next question comes from the line of Andrew Carter with Stifel. Please proceed with your question.

Andrew Carter (VP and Senior Equity Analyst)

Hey, thanks. First question I wanted to ask, looking at your free cash flow outlook for the year, at $160, 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 if onto cash flow, if pre-buy doesn't work, or something else in the inventory purchase levels? Thanks.

Eifion Jones (SVP and CFO)

Yes. Good morning, Andrew. We do expect a robust early buy that that will raise the accounts receivable position at the end of the year, year-over-year. So that's contemplated in our guidance. Additionally, our inventory position, which we, which we have worked very diligently to reduce both year-over-year and 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, included that within the ending balance sheet forecast.

Andrew Carter (VP and Senior Equity Analyst)

Thanks. And I know that, you're not gonna really give any commentary around future pricing decisions today, but kinda regarding, number one, kind of the pricing you've taken, is there anything you've seen that prices are too low, too, or too high for, for your products? I mean, equipment's been pretty resilient. And the second thing is, I know you mentioned earlier on about kinda SKU optimization value. Would you lean on that, would you potentially lean on that heavier, and, and if you had to take a year off from pricing or something like that, or, or would it give you the option to take a year off? Just anything you can, help us with there. Thanks.

Kevin Holleran (CEO)

Yeah, SKU rationalization has certainly received a lot more attention in the last year or so. We had some meaningful rationalization flow through product management, operations, and engineering last year. That said, there's there's plenty more to be, to be done there, that you know, we're conscious that this isn't really you know, done in episodes, but this is something that's ongoing throughout our organization and continue to to tighten up that that product catalog, which then allows us to obviously look at what the value creation is within each product line, and you know, go through that process of looking very objectively at the value, the life expectancy, some of the functionality that you get from you know, from the, from the equipment that we offer through the channel to the homeowner.

So, either they're absolutely linked. I'm not sure if I, you know, if I see it as one replacing the other, in and off here, I think we can, I think we can do both. But to your point, you know, I think that historically, pricing has really been sort of to offset inflation. This market has been able to do that, and it's stuck, but we're certainly spending a lot more time looking from a, from a SKU count standpoint, and then also from a value creation. Frankly, I think that there's still plenty of products in the, in the lineup that are not priced commensurate with with value given.

So I think there's there's plenty of opportunity not just to offset inflation, but to take a real objective look and see what kind of maximization we can get in future pricing.

Andrew Carter (VP and Senior Equity Analyst)

Thanks. I'll pass it on.

Operator (participant)

Thank you. Our next question comes from the line of Saree Boroditsky with Jefferies. Please proceed with your question.

Saree Boroditsky (Equity Research Analyst)

Hi, good morning.

Eifion Jones (SVP and CFO)

Good morning.

Saree Boroditsky (Equity Research Analyst)

I guess first, building on your last discussion, you know, could you quantify the potential for SKU rationalization and just, like, how that impacts margin performance as we think about the out years?

Eifion Jones (SVP and CFO)

Sorry, could you just repeat the question, Saree? Which call is it?

Saree Boroditsky (Equity Research Analyst)

Could you quantify the potential for SKU rationalization and how that impacts margin performance in the outyears?

Eifion Jones (SVP and CFO)

Yeah, 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 count of SKUs that we're rationalizing, but it's been a meaningful reduction through the end of, end of Q2 here. As it implicates, both 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 honed-in SKU range. It will continue to enable our manufacturing locations, manage the throughput in a much more efficient way, so that will be a, a positive there.

It will continue to allow us to have best-in-class procurement programs and manage the inflation through the business. And then additionally, as we think about developing the product line into the future, we're more focused on on on the key platforms across the business. So, all that said, 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 well as the channel's working capital.

Saree Boroditsky (Equity Research Analyst)

I appreciate the color. Then on the lower channel inventories, you know, you talked about distributors relying on your lead times for inventory this year. Is it 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? Thank you.

Kevin Holleran (CEO)

Yeah, I mean, I think we'll continue to work very closely with our, with our channel partners to ensure right inventory, right time, at 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 manufacturing standpoint. So, you know, I think, I think our channel partners can continue to look to us to be able to respond timely to to whatever changes may be occurring in the, in the marketplace. But, you know, obviously, there is keen interest with the channel to have product ready at the point of sale when when the dealers come in the front door.

So we're gonna continue to work closely with them to make sure that our, that our demand signals out to our supply chain and our factories, you know, are commensurate and well coordinated with the channel. And you know, I mean, we're we feel really good that when the destock, you know, really ended late last year. You know, I like being in this position of having the right days on hand and, you know, being able to respond very timely and our sales in to match what their sales out into the retail marketplace. So, you know, I think that that's been a great development here in 2024, and we'll look to to continue that into the future.

Saree Boroditsky (Equity Research Analyst)

Thanks for taking the questions.

Operator (participant)

Thank you. Our next question comes from the line of Mike Halloran with Baird. Please proceed with your question.

Speaker 10

Hey, good morning, everybody. This is Paz on for Mike. I want to follow up on Saree's questions. You know, obviously, margin performance here is healthy against lower volumes and challenged end markets. You called out a little bit of mixed 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?

Eifion Jones (SVP and CFO)

Yeah, good morning. Do we think we are sustainable? Absolutely. I mean, we've done a lot of work over the course of the last four years to improve the quality of our gross margin. Obviously, we were fighting for a period of time, inflation. That's firmly in the rearview mirror in terms of price cost management of inflation. And what you're seeing now as, as margins continue to accrete positively, is a result of the very hard work that we've done to continuously improve the productivity in our manufacturing footprint. We've gone through a period of site rationalization over the course of the last four years. We will always have that opportunity as we continue to inorganically grow.

Pretty much every facility that we've acquired over the last couple of years, we've been able to collapse that production into the existing Hayward footprint. We'll not do that with the, the most recent acquisition. That's a very self-sufficient business, operating very excellently. But as we go forward, we can platform other businesses into our manufacturing location. We have a long legacy of Six Sigma Kaizen improvements across our facility, a lean manufacturing culture that continues to produce here in the, in the medium term. So all that saying, we feel very comfortable that we can sustain the gross margin as we continue to grow. We have tremendous capacity utilization available to us today. We're probably around approximately 60% cap utilized, so we can continue to grow this business without having to add any additional CapEx.

In terms of the cadence for the balance of the year, yes, we do get a little bit of decrement in Q3. Q3 looks very similar to Q1 in terms of the size of our sales in the business, and consequently, when we step from Q2 down to Q3, we get a little bit of leverage penalty. But then as we step up in Q4, we get that leverage back. But as you know, Q4 tends to be the early buy discount period, so that that will have to wait and see how that margin opens up. We have a price announcement that goes into effect October first. We have discounts that go into effect October first on early buy, and then we'll be able to evaluate the net position and its impact on margin.

But we feel comfortable with where we're at. We're very pleased with the year-to-date performance of gross margin, greater than 50%. That's a phenomenal result for us, and as a management team, we continue to to cement that in over the course of time.

Speaker 10

That's super helpful. Thank you. Maybe switching gears to capital deployment. You know, it sounded like inorganic maybe moved its way up the priority list in the prepared remarks, but maybe, 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, that you're trying to prioritize or highlight as you, as you filter through your funnel?

Eifion Jones (SVP and CFO)

Let me, let me just touch on our standard capital allocation for us, because we have not deviated from that. You know, we'll always take 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 growth funnel between 2%-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 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 4, just over 4 times now to to 2.8 on an organic basis. Taking into consideration ChlorKing, we're at 3.1 times, and we'll continue to move into our target range of 2-3 times over the balance of the year. And then thirdly, our inorganic activities, so 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 nurture a pipeline that covers both residential and commercial in in focus. And then finally, as I mentioned, our cash profile does afford us the opportunity to also think about return to shareholder.

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.

Kevin Holleran (CEO)

I would just add, as Eifion 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, the product catalog. But, you know, I'd say in terms of technology, I mean, we're very strong with what we call core pad equipment, pumps, filters, you know, cleaners, et cetera. So things around automation and around more the lifestyle products will continue to be key points of emphasis for us, both organically and as we contemplate inorganic opportunities going forward.

Speaker 10

Thank you. I'll pass it on.

Operator (participant)

Thank you. Our next question comes from the line of Rafe Jadrosich with Bank of America. Please proceed with your question.

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

Hi. Good morning. Thanks for taking my questions.

Eifion Jones (SVP and CFO)

Good.

Kevin Holleran (CEO)

Great.

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

I wanted to ask on the some of the comment or just follow up on some of the comments on the permits trend that you're seeing on the new construction side. Can you remind us the typical lag between your, your business and permits? Like, how do we think about when--whenever new construction bottoms and starts to inflect at some point, like, when would that actually flow through into your revenue?

Kevin Holleran (CEO)

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

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

Got it. Okay, so it's a pretty quick, it's pretty quick turnaround from the permit to your sale. Okay. And then the-

Kevin Holleran (CEO)

Now it is. I would say that wasn't as, you know, we were having to ask that question during during COVID, that would have been a longer tail on that. But I think in general, you're, you know, you're kind of talking, you know, two months or so.

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

Okay. That, that, that's helpful. And then if, if we step back and look at the commercial market, you know, relative to, to, to resi, can you talk about, I mean, resi is pretty consolidated with you and the two other large players controlling the, the majority of the market. How is commercial set up competitively, in terms of, like, the consolidation of, of that size? What is the relative size of commercial versus resi, and then what's the margin profile of that business compared to, like, your, your kind of legacy core business that you have today?

Kevin Holleran (CEO)

Yeah, I think from a margin standpoint, I'll let Eifion add at the end here, but it's, but it's strong margin business. And one of the real benefits of ChlorKing is pretty similar margin profile as as the business that it's joining at Hayward. In terms of competitive landscape, I would say, you know, the big three, as we're often referred 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, I guess, than 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, it's a bit more fragmented, I would feel, than maybe the the residential business, as we know it.

Eifion Jones (SVP and CFO)

Yeah, in terms of margin comparability, I'd say generally speaking, we don't see a major difference at the EBITDA line between the residential and commercial business. Maybe they have a slightly different profile within the income statement between gross margin and SG&A, but at the bottom line, it's very comparable. The nice thing about these type 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 costs. And so, we look to continue to expand the ChlorKing acquisition over the course of time. And, you know, same applies to future acquisitions, that type of attribute that we can bring.

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

Good. Thank you. That's helpful.

Operator (participant)

Thank you. Our next question is a follow-up from the line of Nigel Coe with Wolfe Research. Please proceed with your question.

Nigel Coe (Managing Director)

Oh, thanks for the follow-up. I think a couple quick ones for, for you, Eifion. I think you mentioned, factory utilization right now is about 65%. What would you say is a normal level? Because I'm, I'm assuming that's about two points or so, gross margin under absorption. So I'm just wondering if, number one, if you agree with that, that view and, and, you know, what is a normal level?

Eifion Jones (SVP and CFO)

Yeah. So for us, just to correct you, I said 60% is where we're-

Nigel Coe (Managing Director)

Okay

Eifion Jones (SVP and CFO)

... approximately utilized today. And when we say normal, we would say that is probably trending back to where we would normally operate in these units, pre-pandemic level. During the pandemic, we accelerated shifts within the facilities to take, 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 over the pandemic period, to be able to tap into that latent capacity, to get more shifts on, to get access to those machine hours, and those additional shifts in the, in the week and over the weekend. And so that's always there now as an 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, we've got good absorption. It's appropriate level absorption to the cost base we're incurring. And as we continue to grow volume, we will right-size labor to keep lockstep with that absorption profile we need in the business.

Nigel Coe (Managing Director)

Oh, okay. I misread the comment, so thanks for the clarification. And then just a quick one on free cash flow. You know, accounts receivable fell quarter-over-quarter from $351 million down to $148 million, and I know normally we do see that draw down in AR, but not to this degree. So I'm just wondering, you know, is that all organic or was there some help from factoring in the quarter? Just, you know, any thoughts there?

Eifion Jones (SVP and CFO)

Yeah. 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 six months extended payment terms. And so most of our cash in in in early buy for early buy receivable 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.

Nigel Coe (Managing Director)

But no big factoring impact there?

Eifion Jones (SVP and CFO)

No, no, not at all.

Nigel Coe (Managing Director)

Okay, great. Thanks, Eifion.

Operator (participant)

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

Kevin Holleran (CEO)

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.

Operator (participant)

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