Hayward Holdings, Inc.

Welcome to Hayward Holdings' second quarter 2022 earnings call. My name is Sam, 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 question and answer session. During the question and answer session, if you have a question, please press star, then one on your touchtone phone. Please note that this conference is being recorded. I will now turn the call over to Kevin Maska, Vice President of Investor Relations. Mr. Mazka may begin.

Thank you and good morning everyone. We issued our second quarter 2022 earnings press release this morning, which has been posted to the investor relations portion 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 Ivian 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 constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about future expectations, anticipation, beliefs, estimates, forecasts, plans, and prospects. Such statements are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in the company's earnings release posted on the website, and will be provided in our Form 10-Q for second quarter 2022 as filed with the Securities and Exchange Commission. 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, which we believe can be useful in evaluating our performance. The presentation of this Additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations of net income calculated under U.S. GAAP to adjusted EBITDA as well as reconciliations for other non-GAAP measures discussed on this call can be found in our earnings release and will be included in Form 10-Q. I would now like to turn the call over to Kevin Halloran.

Thank you, Kevin, and welcome to the team. Good morning, everyone. It's my pleasure to welcome all of you to Hayward's second quarter earnings call. I'll start on slide four of our earnings presentation with some highlights from the second quarter. We delivered another solid quarter marked by net sales growth of 10% year over year to $399 million, which was on top of exceptional growth of 66% in second quarter of 2021. In our core North American market, net sales increased 17%. Adjusted EBITDA in the second quarter grew 16% year-over-year to 128 million, yielding a 32% margin. This represents an increase of 166 basis points over the prior year level, despite the sustained inflationary headwinds. Later in the presentation, we'll discuss our outlook for the year, which we have revised to reflect current channel inventory dynamics and macroeconomic conditions. Before we do that, I'd like to take you through why we're so confident in the long-term growth model for Hayward and the industry. As outlined on slide five, our performance continues to be driven by our ability to execute on the core drivers of growth, including digital leadership, dealer conversions, new products, operational excellence, and broad channel access and environmental sustainability. Importantly, this resulted in solid net sales growth of 28% over the last year. Notably, I'd like to highlight continued strength in our OmniLogic IoT-enabled pool controller installations, which have grown over 60% in the last 12 months. We also see continued strong momentum with our sales team, who have added over 1,000 Totally Hayward partners year-to-date after approximately 1,500 in full year 2021. These dealer additions are key to our long-term growth through their dedication and advocacy of Hayward products. Finally, I'd like to draw your attention to our new product vitality index, which increased 29% due in large part to our market success with the industry's most efficient variable speed pumps, omni-logic controls, and sanitization products. On slide six, Our focus on strengthening our IoT digital leadership position through smart pad conversions is continuing to take place with the ongoing development of new products that pair with our Omni automation systems. The industry's top growth categories include energy efficient variable speed pumps, controls, and LED lighting. Hayward has made significant investments across all these categories through innovation, new product development, and acquisitions. Our ability to enhance and expand our offering provides diversification, strengthens brand recognition, and overall market penetration. This has allowed us to fully participate across our key end markets of aftermarket upgrade, repair and replace, remodeling, and new pool construction. Moving to slide seven, I'd like to revisit an important slide that we've highlighted before with some updated market trends reflecting an ever increasing total addressable market opportunity. A key driver in our industry is the technology upgrade conversion occurring in the aftermarket with opportunities for digital, chemical, and energy. For each of these three categories of IoT enabled controls, salt chlorination, and variable speed pumps, we compare the take rate at time of new pool construction to the current level of aftermarket penetration. We believe in the premise that existing pool owners If educated as to the merits of these compelling technologies as consumers building new pools are they would desire the same benefits. First is digital conversion with controls and automation replacing manual time clocks adding iot enabled controls delivered what we call the smart pad. Individual equipment components dynamically controlled to make pool use easier and more enjoyable, while lowering the cost of ownership. Second is conversion to non-chemical forms of water sanitization as chemical chlorine is replaced with salt chlorine generators and UV ozone products, making a safer, more natural swimming experience. Finally, a conversion to more energy efficient products, notably variable speed pumps replacing single speed pumps and color LED lights replacing white incandescent lights. Our sales teams are working with trade professionals to promote these exciting new technologies as aftermarket upgrades. Moving aftermarket to new construction penetration levels in these three categories alone affords a market opportunity of well over $6 billion. On slide 8, as I mentioned, at the time of new construction or full remodel, homeowners have several great new technologies available to deliver comfort, ambiance, and convenience of pool ownership. These technologies also offer a compelling cost of ownership benefit when compared to older legacy equipment. As you see here, reimagining the backyard with the pool as the central feature both day or night is now a reality. These technologies provide a real win-win for both the pool owner and Hayward. At the point of construction, a smart pad pool on average has $7,000 more OEM content when compared to a legacy non-smart pad pool. Given most pools have a typical lifespan of 30 years and equipment typically needs replacing every 10 years, there will be two replacement cycles yielding a $21,000 lifetime incremental value per pool. Turning now to slide nine. While new construction is a key part of the industry, the core driver of our business is the resilient aftermarket. Through various economic cycles over the last 50 years, shown here in orange, The installed base has always grown and is now approximately 5.4 million in-ground pools in the United States. This creates a lifetime need for repair, replace, remodel, and upgrade. On slide 10, I'll briefly discuss our M&A activity focused on core pool product or technology tuck-ins as well as backyard adjacencies. During the quarter, we completed the acquisition of J&J Electronics and Solos, which represent the specialty lighting business of Halco. As discussed earlier, lighting is one of the top growth categories in the industry, highlighting pool owners' desire to increase the function and ambience of their outdoor living space by leveraging the Omni app. We are pleased with the progress made to date into integrating these businesses, as well as the other businesses we added to the Hayward family late last year. These technologies and products will increasingly differentiate our leading lifestyle product portfolio. With that, I'd like to turn the call over to Ivan Jones, who will discuss our financial results in more detail.

Thank you, Kevin, and good morning. I'll start on slide 11. All comparisons will be made on a year-over-year basis. We delivered another quarter of growth and profitability with performance supported by operational agility, new product adoption, and successful management of ongoing inflation. Net sales for the second quarter increased 10% to $399.4 million. The growth during the quarter was driven by 17% price realization and 1% contribution from acquisitions, partially offset by a 6% decline in volumes and unfavorable exchange rate impact of 2%. The net price impact over the prior year period reflected the full accumulative impact of our previously announced price increases over the last 18 months to mitigate the escalating inflationary cost pressures. During the quarter, we also saw the initial contribution from the recently announced acquisitions, notably the specialty lighting acquisition from Helco. The volume decline during the quarter was primarily driven by a sharp reduction in our European sales, the result from the war in Ukraine, which required us to exit certain businesses in that area, and it has led to a general reduction in consumers' confidence across the region. We also experienced the initial impact of the poor weather in our seasonal markets, namely the US Midwest, Northeast, and Canada. These markets suffered from unusually cool and wet conditions throughout the quarter. These conditions delayed pool construction and remodel projects, as well as the openings of existing pools, all of which drive equipment demand. Consequently, channel inventory serving these regions were higher than usual at the end of the quarter. Despite these volume challenges, we experienced good adoption of new products, as evidenced by an increased sale mix of controls, sanitization, energy-efficient variable speed pumps, and lighting. Growth in these product categories offset the expected decline in demand for heaters. Gross profit in the second quarter increased to $189.4 million, an increase of 13% year-on-year. We were very pleased to improve gross profit margin to 47.4%, an increase of 130 basis points, primarily resulting from price increases offsetting inflation. Our pricing initiatives and supply chain capabilities have been successful in protecting the structural margin profile of our business. While the price of pool equipment has increased meaningfully over the last few years, it remains a relatively small component of the overall cost of a pool project compared to labor, construction, and other raw materials. Selling general and administrative expenses during the second quarter decreased 4%, to $68.9 million, primarily driven by lower volume-related incentives, warranty expenses, and stock-based compensation. As a percentage of net sales, SG&A decreased to 17.3%, a decrease of 244 basis points, reflecting the leverage we have achieved as the business has grown and we continue to achieve operational improvements. Operating income increased 27%. to $102.7 million in the second quarter. This increase in operating income was driven by higher net sales and conversion to profitability. Net income increased 25% to $66.3 million. Adjusted EBITDA increased to $127.6 million at the second quarter, representing an increase of 16% driven by higher net sales and operating income. Adjusted EBITDA margin of 32% was increased 166 bps compared to the prior year period, reflecting an incremental margin of 49%. Now I'll discuss our reportable segment results for the quarter. Beginning on slide 12, North American net sales for the second quarter increased approximately 17% to $342.1 million, The increase was primarily driven by a 19% favorable price impact, a 2% contribution from acquisitions. Sales volumes declined 3% as demand into the channel began to moderate following the strong water flow we saw at the start of the year, initial impacts of the poor weather in seasonal markets, and the beginning of a channel inventory recalibration. Distributors started reducing safety stocks as a result of improved supply chains and shorter lead times for specific products. Gross profit for the second quarter increased 19% to $166.8 million. Adjusted segment income increased 24% to $122.5 million, while adjusted segment income margin increased 203 basis points to 35.8%. Turning to Europe and the rest of the world, on slide 13, net sales for the second quarter decreased 19% to $57.4 million. Net sales benefited from approximately 8% net price increase, but were adversely impacted by a 20% decline in volumes, as geopolitical circumstances in Europe have negatively weighed on consumer sentiment, in addition to a 7% headwind from unfavorable foreign currency translations. Adjusted segment income decreased 27% to $13 million, yielding an adjusted segment income margin of 22.7%, or a decrease of 234 basis points. For the six months ended July 2, 2022, cash flow from operations was a cash source of $63.7 million, compared to a cash source of $123.4 million during the prior year period. Working capital use year-to-date has been comparably higher as we took safety stock positions in certain raw materials and finished goods. Cash used in investing activities was $77.2 million compared to $9.7 million in the prior year period. This includes acquisition expenditures of $61.3 million primarily for the specialty lighting business acquired from Helco. Total liquidity at the end of the second quarter was $239 million inclusive of $109 million of cash on hand. Net debt to adjusted EBITDA for the last 12 months was 2.3 times compared to 1.7 times as of December 31st, 2021. The increase in leverage reflects the closing of the acquisition I just mentioned and the share repurchases we've completed in the second quarter for $212 million. At the end of the quarter, our outstanding count of common stock was 216 million shares. And with that, I'll now turn the call back to Kevin Holleran.

Thanks, Ivian. I'll pick back up on slide 14. At Hayward, ESG has always been important to us, and we know that it's important to our shareholders as well. We've continued to focus on the energy consumption throughout our operations, as well as making sustainable products a key focus of our new product development roadmap. The development of such products and technology was recognized by the United States Environmental Protection Agency with Hayward earning the 2022 Energy Star Partner of the Year Award. The award recognizes industry leadership, product innovation, and an overall commitment to environmental protection through energy efficiency. We appreciate the agency's acknowledgement as we continue to develop technology and products to help make pools more environmentally sustainable. In addition, we are pleased to announce that we will be publishing Hayward's first ESG tear sheet during the third quarter. On slide 15, I will address the main trends supporting our outlook. We remain very positive about the long-term health of the pool industry, particularly the strength of the aftermarket. It continues to grow every year with the addition of new pools to the installed base and provides a rich upgrade and remodel opportunity as this base continues to age. The aftermarket has proven to be resilient across economic cycles. We firmly believe there has been a significant increase in the appreciation for the backyard as a consequence of numerous favorable secular trends. With that as the long-term backdrop, let me now describe the current operating environment. As we all know, macro conditions are especially dynamic in Europe, where the continent is dealing with an ongoing war, declining consumer sentiment, and a more challenging foreign exchange environment. As a result, we now expect sales in Europe to decline in 2022. turning to our core North American markets. Operational agility and supply chain capabilities have enabled us to deliver on a robust backlog of orders in 2021 and the first half of 2022. Market growth has been positive in 2022, primarily in the U.S., but has softened due to economic uncertainty and unfavorable weather in seasonal markets where we have leading market share. All of this resulted in elevated channel inventories at the end of Q2 2022 and reduced the level of in-season restocking orders we would typically deliver in late second quarter and third quarter. With the close of the season approaching, we've elected to reset and work with our channel partners to normalize inventory levels and prepare for 2023. With distributors' increased confidence in OEM supply chains and shorter lead times, they don't require the same level of safety stock, resulting in a recalibration of four to six weeks less channel inventory. We are planning for reductions in channel inventory from over four months of inventory on hand to closer to three months by the end of the year. We believe this will enable us and our channel partners to start 2023 with the right level and mix of product for the 2023 pool season. As a result of this and the lower sales forecast for Europe, The company now anticipates a consolidated sales decline of two to 6% and adjusted EBITDA of 385 million to 400 million. We are taking proactive steps to manage production levels and cost structure. I'm confident our operational efforts and pricing initiatives will enable us to manage margins through this period. Based on the revised 2022 guidance, we will have grown Hayward net sales and adjusted EBITDA by 84% and 228% respectively since 2019, while enhancing our market position with new SmartPAD technology products and positioning Hayward for long-term growth. My board and I have confidence in the resiliency of the business, cash flow generation, and growth outlook. As a result, we are reloading the share repurchase program back to $450 million over three years. Turning now to slide 16. Before we close, let me reiterate the five key elements of our value proposition. We are a pool pure play where over 95% of net sales is derived from this outdoor living category. We have layers to our competitive mode that defend our position and deliver growth. Hayward is leading the way as pool owners convert smart pads with our leading IoT enabled Omni controls and connected products. Conversion strategies are actively growing the addressable market within the resilient and growing aftermarket. Finally, we're also delivering our shareholders best-in-class financial performance driven by operational leverage, disciplined capital allocation, underpinned by strong free cash flow generation. With that, we're now ready to open the line for questions.

Thank you, Kevin. We will now begin the Q&A session. If you'd like to ask your question, again, it is star 1 on your telephone keypad. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We'll pause here for just a moment to compile the Q&A roster. Our first question comes from the line of Jeff Hammond with KeyBank Capital Markets. Jeff, your line is open.

Hey, good morning, guys. So just really want to hit on the D stock and just understand, it seems like the magnitude is quite stark, particularly given that price is going through and what you had in the first half. So just kind of level set us on how you got comfortable with the level of declines and do we It looks like Europe's a little more weak. Do we hold flat for the year in North America, or is that also negative?

Let me start there, Jeff, and I may add to it. I'd say more than half of the new guidance is related to the channel inventory, as I mentioned, in prepared remarks. That's somewhere around four to six weeks. is really more than half of what the overall re-guide is. The balance would really be comprised of a number of things from the shortened season in the weather-impacted areas like Canada, Northeast, Midwest. Some demand moderation. We're still seeing year-over-year growth, but it is not to our original expectation when we laid out earlier in the year guidance. then as you mentioned you know europe and ukraine uh related consequences fx is clearly a headwind with a slight offset around acquisitions so that's sort of the bridge of all the contributing factors uh you know how did we get here and as we discussed uh in in our q1 call the the macro economic environment uh is it's clearly uncertain in north america uh and especially so in europe where we've seen a deterioration deterioration due to the continued war and its consequential effect on on consumer sentiment and their economies you know we expected to sell less into the channel um versus sell out due to the strategic positions that many of our channel partners took at the end of 2021. As Q2 occurred, inventories remain high. And we're now actively working with the channel to try and reduce those inventories. As I said, supply chains have clearly improved. Our published lead times have substantially improved. So there's that reduced need to hold these higher safety stock levels. And we'd like to work with our channel partners to destock and have fewer months of forward-looking sales, you know, in the channel so we can be more responsive. So, you know, that's what's kind of gone into our thinking and what played out in Q2. Anything to add?

No. As you think about the balance of the year, Jeff, I would say both regions will have a stocking recalibration program. It will be larger in North America. That's where the balance sheets were stronger for our channel partners. We probably saw some destocking in the first half in Europe, but there will still be further destocking. Both regions will take that correction in the second half, but the correction will be higher in North America than it will be in Europe.

Okay. And then just one quick follow-on on the D-stock. It seems like a third of your products, like the variable speed, the controls, the salt chlorinators are still in short supply. So I don't know if it's skewed differently. And then just secondly, talk about decrementals as you D-stock and what you think you can hold them to and what actions you're taking to kind of mitigate that margin decline. Yeah.

Yeah, I mean, as you said, I think most OEMs are, you know, trying to address short supply and some supply chain challenges around the same type of products. Things with chips continue to be a little hand-to-mouth, and that affects things like controls and salt cells from a specialty metal standpoint, maybe to a lesser extent variable speed pumps. But You know, those are the things where there's not, we still have healthy backlogs overall, but particularly in those categories and the channel is anxious for us and others to solve that. You know, we're working very aggressively, have been for some time here at the end of the second quarter, into the early third quarter to reset production levels and taking the appropriate actions to resize the facilities to get the variable costs out. As we've highlighted in prior quarters, we've been able to ramp up largely, you know, through variable cost structure. And, you know, we'll be doing the same as we reset. And we'll look, you know, more broadly than just our facilities across our entire cost base and size the business to the current forecast.

Okay. Thanks, guys.

Thank you, Jeff. The next question is from Brian Lee with Goldman Sachs. Brian, your line is open.

Hey, guys. Good morning. Thanks for taking the question. A couple questions from my end. First on demand, it does sound like you guys are alluding to beyond channel inventory build, there's some moderation in demand. Can you kind of give us additional color around the different segments, whether you're seeing that with new pool builders, whether it's in the aftermarket, and is this an affordability issue with all the price increases? I'm just trying to get a sense for maybe where you're seeing some of the demand softening, and maybe where you guys have been more bullish coming into the year, and that's where you're seeing some downside risk here.

Yeah. Yeah, there's a lot there. But let me try and address it as we see it. You know, overall, you know, when we set coming into the year, You know, with last year's retail pull through in front of us, we expected some moderation off a very, very high, you know, pull through the channel last year. And at the halfway point, I would say while there's still, you know, growth clearly year over year, the volume has not quite been what we expected. Lots of prices. There are some areas where mix is contributing to it, but that's kind of the equation there. Price and a little bit of mix, but not quite on the volume side. From a regional basis, there are some regions that are doing extremely well that haven't been affected by weather or some of the geopolitical. But in general, the economic uncertainty is certainly there. And I think that that's what we would attribute some of the volume not playing out as we originally expected. New construction, our builders are still extremely busy. They're saying that the leads and the quotes, and we see it with the permitting, You know, is not quite what it was this time last year, but they're still extremely busy and their books are full. We lost some building days for sure in some of these regions affected by the weather. And, you know, if we have a late summer or late fall, you know, we may be able to make some of that up, but that was probably lost time based upon weather. MOTHER NATURE NOT COOPERATING THIS YEAR. SO WE CONTINUE TO SEE LOTS OF FOLKS FROM A TECHNOLOGY STANDPOINT, YOU KNOW, OPTING TO BRING OMNICONTROLS ON AND TAKE CONTROL OF THAT BACKYARD. SO, YOU KNOW, THAT TREND IS STILL VERY POSITIVE FOR US. AND THAT'S REALLY HOW WE SEE IT.

OKAY. THAT'S GREAT. APPRECIATE THAT. And then maybe just secondly on this whole channel inventory reset, you know, it sounds like it came here sort of real time in terms of how you guys saw it evolve. What's your sort of, you know, whether it's based on historical precedence or what you're hearing from the channel itself, like is this a one to two quarter reset? What's sort of your thought process around the timing of kind of recalibrating the THE CHANNEL TO THE DEGREE WHERE MAYBE YOU'VE GOT A MORE NORMALIZED BACKDROP HEADING INTO THE 23 PULL SEASON.

YEAH, THAT'S EXACTLY THE TIMING THAT WE'RE LOOKING TO ADDRESS THIS, BRIAN. YOU KNOW, CLEARLY THE PULL THROUGH IS ULTIMATELY WHAT AFFECTED THIS. YOU KNOW, WE'VE BEEN SHIPPING FOR 18 OR 24 MONTHS AT A REALLY STRONG CLIP We want to make sure that, you know, with all the uncertainty flying around the economy and the various markets, that the responsible thing to do is to look into the channel, work closely with them to get these days on hand, you know, down to a more healthy level, which will give us, which will allow us to really address whatever 2023 has in store for us. and be in a much better position to be able to accommodate a wide range of 2023 outlooks.

All right, fair enough.

I'll pass it off. Thanks, guys. Thank you.

Thank you, Brian. The next question is from the line of Ryan Merkle with William Blair. Ryan, your line is open.

Hey, guys. Good morning. Good morning. So I wanted to start off with the demand trend through the quarter, if I could. I know weather was a factor for South in April and May, but it would be helpful to understand with demand and then what you're seeing in July.

You broke up a little bit. I think you were asking, you know, how it looked maybe later in the quarter and early into july but frankly we don't have visibility um specifically for july yet i would say we're seeing uh it's based upon conversations you know as we guided um for the for the second half here you know there were some there were some markets um later in the quarter uh who had that had some nice uh pull through the warmer climates um we saw a bit of recovery in the weather affected regions. But, you know, in general, when you look at Q2, it was not to our original expectations on the retail pull through. And clearly with the volume being net down year over year, that's really what informed us as we looked hard at the second half of guidance.

Got it. Okay. That's helpful. And then can you quantify the impact to 22 sales from the D stock? It sounds like you're being conservative. I guess the harder question that I want to ask is, as you think about 23, could there be more D stock? I think you mentioned you're gonna go to three months of inventory for the channel. I mean, could that go to two months? I know it's hard to call at this point, but just how are you thinking about that? And are you being conservative?

Hi, Ryan. It's Ivy. I'd say more than half of the reduction in the guidance at the top line is related to channel inventory reduction. It's a takedown of four to six weeks. The channel has the ability to hold between four to four and a half at the top end and can go down to three before it starts to feel short. We have taken the channel inventory reduction forecast down to the low end of the three, so basically around about 3.25 months on hand. And we believe that's a very healthy position to start the fiscal 23 time period. Outside of the channel imagery takedown, the balance of the takedown is really related to the consequential impact of the shortened season in the seasonal markets in the U.S. and Canada. Some demand moderation that Kevin alluded to. Obviously, the situation in Europe, which is impacted by the events in the Ukraine as well as the FX, and there is a slight offset for the four-year impact of the newly acquired business, the lighting business from Helco. But two-thirds of the, or actually just over half the takedown is associated with the reduction in the channel inventory. And we believe that is the right place to exit the just over three months of inventory on hand in the channel.

Very helpful. Thank you.

Thanks, Ryan.

Thank you, Ryan. The next question is from the line of Michael Halloran with Baird. Michael, your line is open.

Hey, thank you. Morning, everyone. So just some thoughts on pricing. How is pricing holding in all of SQL? And as you think about the destocking, any concerns that there's going to be some price bleed here or has there been pretty good discipline across the players in the industry at this point?

Yeah, look, I mean, we've instituted now cumulative price increases since January of last year, around 24% globally, 25% in North America. That still includes a surcharge of 4%. That aggregate cumulative price there matches up with our cost of goods sold index of around 25% increase since December 2020. The guidance that we've given, like always, or at least more recently, does not include the continuation of or the inclusion, I should say, of the surcharge. It's not institutionalized at this point. It gives us a little bit of flexibility if we see some decrease in certain commodity raw materials. But as you've witnessed over the last 12 to 18 months, this industry has great pricing power. We believe it's sticky. It's always had this type of pricing power. But saying that, we're conscious that we've put a close to 25% price into the industry over the last 18 months. We're very mindful that's a lot of price, and we have not contemplated any further pricing action in the balance of this year. But we will continue to monitor costs, and we do believe if costs warrant it, we can get further price. And we don't necessarily see inflation moving into a deflationary period over the next six months. In terms of, I think, where maybe the second element of your question was going, do we believe that these stocking actions in the channel will cause some price pressure? We do not believe that is the case. Pool equipment still remains a relatively low cost of the overall pool installation value. We've brought products to market which have great win-wins for the consumer if we look at the categories. that have been climbing in terms of a demand of variable speed pumps and multi-speed pumps coupled with controls. These are high-priced products going into the market and very clearly reflecting strong consumer demand for win-win and value-creating products. So we don't believe there will be price pressure decreasing or price pressure increasing leading to decreases, we believe price is sticking. Margins, therefore, will hold up. And as far as our ability to manage our cost base in the business, we've talked about how we've grown this organization within the four walls of our existing manufacturing footprint over the last 18 months. That's a lot of variabilization of costs going into the business. We're now addressing that on the takedown. So we believe our absolute gross margins will will hold in the high 40s, and we're setting our targets to hold our growth, sorry, our adjusted EBITDA margins at that 30% level as we close out the year.

Thanks for that, Adrian. So then second question is just on the willingness to deploy capital here. I know you mentioned, I forget the exact terms you used, but essentially reinvigorating the share buyback side of things. Maybe just talk about the willingness in the short term to use that as a lever as well as what kind of M&A pipelines, what the M&A pipeline looks like from your perspective.

I mean, right now we're concentrated on the organic side of the business. We've got management actions right now to address the reduction of manufacturing cost base that we've variableized up over the last 18 months. If there is an interesting and accretive M&A opportunity, certainly we continue to look at those deals, but the priority right now as the management team is to continue to focus on the organic business as we close out this fiscal year. In terms of the announcement to replenish our share repurchase program, look, we believe at the current price points, The Hayward share price is an attractive buy. We believe in the long-term fundamentals of this organization, high-margin business with a strong cash flow generation profile that affords this business with a very enviable opportunity to deploy capital across all of the organic M&A and share repurchase opportunities that we may have. But we want to remain agile and use our cash wisely. But certainly at the current price point, the Hayward stock price could provide an interesting opportunity and be an attractive repurchase.

Much appreciated. Thanks, everyone.

Thank you, Michael. The next question is from the line of Suri Boroditsky with Jefferies. Suri, your line is open. Three, can I confirm you're not muted?

Sorry about that, I was. So this guidance change is rather abrupt. So can you just talk through your visibility into sales and how this visibility gets you comfortable with inventory levels heading into 2023? Yeah.

I mean, again, what we see, excuse me, is, you know, from a New construction standpoint, healthy demand there. We still see upgrading occurring to, you know, IOT and connected products. We continue to believe that renovation, which has been deferred over the last couple years, is an opportunity that will play out over the next couple years. And that the aftermarket will continue to be extremely resilient as it has been in prior economic down cycles. With the great financial crisis being the most recent, new construction certainly was impacted by that. But overall, the aftermarket held up due to its non-discretionary or semi-discretionary nature. We continue to feel... that that's very good. I mean, overall, this industry is still experiencing growth, which is great news. And it's experiencing growth that is greater than what the historic mid to high single digit growth algorithm has been, coming off a couple of years of extremely great growth performance. You know, that's very encouraging for us and for the industry. So we continue to remain bullish. We did an exceptional job of getting after our backlog over the last 18 months. The inventory is in the channel, and we just want to make sure that it's properly sized for what the market consumption is now and what we expect it to be in the future.

Great, thanks. And then you talked about some end customer demand moderation. Could you just talk about if you've seen this in certain products versus others?

You know, we do see both wholesale shipment data across the industry. And, you know, we've done really, really well there. You know, from a product standpoint, You know, we feel good about our share performance around many of these products related to the conversions that I spoke about in the prepared remarks, whether that's energy efficient, variable speed pumps, controls continue to perform extremely well. You know, perhaps You know, what we're very curious about is will these upgrades continue at the rate that we have seen more recently? But thus far, you know, the upgrading is still occurring, and we're very anxious to see what the new construction profile looks like going forward.

Great. Thanks for taking my questions today.

Thank you, Siri. The next question comes from the line of Dan Oppenheim with Credit Suisse. Dan, your line is open.

Thanks very much and appreciate all the color on this. I guess wondering about some of the comments in terms of the new expectations for the full year in terms of sales based on the destocking and such would seem to imply sort of based on the full year sales sort of a sharp decline than obviously in the second half. Is your assumption then that much of that destocking occurs here during the third quarter. And I guess looking at the second half, what the full year implies, it's sort of a 25% decline there. So are you thinking that the third quarter is worse than that, potentially sort of 30% to 40% decline in sales?

Yes, your second half numbers are directionally correct there. Yes, we would expect to take more of the channel inventory correction in the third quarter. It's naturally a period in the pool season as it comes to a close when inventories are reduced. We're working actively with the channel through this quarter to reduce those inventories. So the majority of that channel inventory correction will occur in the third quarter.

Got it. Okay, thanks. And then in terms of the, you talked about sort of the business development in terms of adding dealers and such, how much do you think you can do in that area to offset some of the easing of demand during this time and sort of what efforts are taking place there?

Yeah, I mean, that's been a key focus of our commercial teams is, you know, as we've had some great product launches, over the last couple of years, recruiting and bringing more service dealers and builder remodelers into the Hayward camp. And that's going to continue to be a key focus as we've been able to meet the swelling demand, married with some great innovative products that are enabling the SmartPAD upgrade Um, there's a lot, uh, there's a lot to offer. There's a lot to, uh, uh, um, that we're arming our, our sales team with to recruit, uh, additional totally Hayward, uh, folks into our families. So, um, you know, that's, that's, that's a key focus of our commercial team right now is to continue that effort of bringing folks, uh, over to the Hayward team.

Great. Thank you.

Thanks.

Thank you, Mr. Oppenheim. Our final question today comes from the line of Rafe Jadrzicz with Bank of America. Rafe, your line is open.

Hi, good morning. Thanks for taking my questions. On the updated sales outlook for the year, can you talk about what that implies for volume in the second half of the year, just given the fact that there's been so much put in place and there's a lot of moving parts? just trying to get a better understanding of what the volume assumptions are.

Yeah, the majority, obviously, of the takedown in net sales value is a consequence of volume reduction. Pricing will still be comparatively higher in Q3 and to a lesser extent in Q4. We still expect, obviously, a little bit of further headwind on FX in Q3, maybe slightly moderating comparatively in Q4. And we'll get a positive contribution in the second half from acquisitions. But the majority of the second half takedown is volumetric based.

Just the 18% price that I think you highlighted, I think that was year to date. What would that outlook be in the second half of the year? How much price are you expecting to realize in the second half?

The average price over the second half is going to be closer to around 7% to 8% comparatively over the second half of last year.

Okay, that's helpful. And then when you look at your inventory levels, like not within the channel, but the inventory on your balance sheet, how much of that increase every year is related to price versus volumes?

So our COGS index has increased just under 24% since the beginning of last year. So I would say year over year, we're dealing with probably somewhere in the magnitude of about 15 to 16% COGS index increase in our balance sheet, or raw material index increase within the balance sheet.

Okay. And then just the With volumes coming in the second half of the year, I think the guidance implies a little bit lower margins compared to what you were expecting earlier, but still pretty resilient. Can you just give a little bit more color on how you're going to be able to your margins with such a kind of sharp decline in volumes in the second half of the year? You talked earlier about some of the leverage you have to pull and the variable cost model, but margins are up a lot in the last two years. So have there been structural changes in the business that we've seen kind of post-COVID that are going to allow you to hold margins at these higher levels?

Yeah, I think there's a couple of key factors to consider here. Let's just talk about price. We announced a further price increase. in the second quarter, which will have full benefit within the second half of this year. So that will be a contributing factor to our top line. Secondly, what's really important to understand is we generally have a very low fixed cost base within our business. When you look at our cost of goods sold structure, slightly over 70% of it is raw materials, about 10% is 80% variable within our cost structure. We have been able to increase our production and our sales out into the channel or sales into the channel over the last 18 months by containing that growth within the existing four walls of our manufacturing facility. We've always maintained a very agile workforce with a large degree of temporary labor, and we are now and have been over the last four weeks removing that temporary labor from the cost base. We have a little bit more work to do, Rafe, clearly, to fully protect the margin, but we're confident over the balance of the year that we will be able to reduce our cost base within the factory, given it was highly variable at the raw material level and variable at the temp labor level. We'll be able to get that out of the cost space over the course of the next three months. And I'm confident as we move into Q4, we'll see margins start to level out and thereafter recover. SG&A obviously is another focal point. We want to continue to make sure that we are right-sized in our SG&A base. We have opportunities there to do some improvement, but we also want to make sure that we continue to invest within the sales force and the new product introduction and development programs that we have over the course of the balance of this year and obviously into next year. But we do feel comfortable with the effective margin forecast that we've given implicit within our guidance.

Thank you for all the comments. One more in. How do we think about capital allocation and your approach to M&A and sort of this more challenging macro environment?

Yeah, I mean, I think I've said it well a couple of questions ago. I mean, we're really internally focused right now. We want to make sure that we continue funding the organic projects, you know, that continues to generate top line growth for us and serve our customers. We'll continue, you know, from an M&A standpoint, staying in contact with folks and progressing some of those conversations, but that's really not a focus for us in the more immediate term. It's much more internal organic focused from a capital allocation standpoint, right?

Thank you. That's very helpful.

Thank you. Thank you, Rafe. That concludes our Q&A session for today. So, at this time, I'd like to hand the call back to Kevin Halloran for closing remarks.

Thanks. In closing, I'd just like to thank everyone for their interest in Hayward. Our business is very well positioned to navigate any near-term challenges while continuing to generate growth 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. 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 to be held the week of October 24th. Sam, you can end the call now. Thank you.

That concludes the Hayward Holdings second quarter 2022 earnings call. Thank you all for your participation. You may now disconnect your lines.