Hayward Holdings, Inc.

Welcome to Hayward Holdings Third Quarter 2022 Earnings Call. My name is Adam and I will be your operator today. At this time, all participants are in the 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 1 on your touch-tone phone. Please note that this conference is being recorded. I will now turn the call over to Kevin Machka, Vice President of Investor Relations. Mr. Machka, you may begin.

Thank you and good morning, everyone. We issued our third 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 Halloran, 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 in our Form 10-K and Form 10-Q filings 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 the appendix to the slide presentation.

I would now like to turn the call over to Kevin Halloran. Thank you, Kevin, and good morning, everyone. It's my pleasure to welcome all of you to Hayward's third quarter earnings call. Before we begin, I'd like to say that our thoughts are with everyone that was impacted by natural disasters in the southeastern United States and Australia, and those in Europe impacted by the ongoing war in Ukraine. We are doing what we can to assist during this extremely difficult time. I'll start on slide four of our earnings presentation with today's key messages. First, our third quarter performance was in line with our expectations. During the quarter, we continue to leverage our competitive advantages, increase market share, and capitalize on the sustainable secular trends in our industry. I am pleased to see our primary channel partners report continued growth and channel sell-through for Hayward products in our core U.S. market. However, consistent with the expectations we communicated a quarter ago, we saw a meaningful divergence between channel sell-through and our net sales into the channel as our partners reduced the level of inventory on hand in response to normalized lead times and safety stock requirements. We are making significant progress on this recalibration necessary to support 2023 with the normalized level and mix of product in the channel. Second, we're winning in the marketplace. We continue to see positive adoption of our innovative, best-in-class products, and we are actively converting target accounts to Hayward loyalty programs. I am encouraged to see this result in further market share gains during the third quarter. Third, we are taking proactive steps to realign our cost structure to current conditions while prioritizing our strategic growth investments and productivity initiatives. We expect these actions to result in substantial variable cost savings and a structural SG&A reduction of approximately 10% on an annual basis. I'll provide additional details on our cost plans in a moment. Fourth, we are refining our full year 2022 guidance to reflect higher than expected inflation impacting Q4, continued normalization of channel inventory, and the consequence of geopolitical events in Europe. We have addressed inflation with additional price announcements in the fourth quarter to be fully realized in 2023. We now expect full year 2022 net sales to decline approximately 6% and adjusted EBITDA of 365 to 370 million. Finally, ESG is very important to Hayward and our shareholders. So I am pleased to report continued progress on our journey. Following the development earlier this year, of our ESG strategy and framework, which aligns to products, people, planet, and principles, we completed our first Scope 1 and 2 emissions inventories in partnership with a third-party expert. These results and other SASB-aligned reporting metrics are included in our first standalone disclosure, the Hayward ESG Data Sheet, which we published on our website during the third quarter. I would encourage stakeholders to review these disclosures and I look forward to updating you on our accomplishments going forward. Turning now to slide five to discuss the results of our third quarter. Net sales declined 30% year-over-year to $245 million, largely due to channel inventory correction and softer conditions in certain markets, such as Europe and Canada. We are encouraged by continued price realization, market share capture, and resiliency of our core U.S. markets. As I mentioned, sell-through in the U.S. increased during the quarter, reflecting continued underlying demand in the market. Adjusted EBITDA in the third quarter was $60 million, yielding a 24.6% margin. Decremental EBITDA margins for the quarter were 36% as we initiated manufacturing and SG&A cost reduction plans and realized lower costs associated with incentive compensation and sales rebates. Turning now to slide six for a business update. Our consumer demand varies significantly by region. Within North America, the U.S. Sunbelt continues to be an area of strength, with softer trends in the Northeast U.S. and Canada following the unfavorable weather earlier in the season. Year-to-date, Sunbelt markets have grown 36% faster than seasonal markets. Within Europe and the rest of the world, economic conditions are especially challenging in Europe, whereas we continue to see solid growth in the Middle East, Southeast Asia, and Australia. We estimate that Hayward captured approximately 130 million or 200 basis points in share since 2019, which we believe is more structural than transitory. We saw evidence of further gains in the third quarter, most notably in the strategically important U.S. Sunbelt region and in critical products on the pool pad like controls, variable speed pumps, and water sanitization. I'll speak in more detail on this in a moment. We continue to see growth in our Totally Hayward partner base and strong adoption of our innovative new products. We added another 1,800 Totally Hayward partners year to date after approximately 1,500 in full year 2021. We believe these dealer additions are key to our long-term growth through their dedication and advocacy of Hayward products and evidence of stickiness of share gain. Further, in the past 12 months through September, the U.S. sales team signed new accounts with annual sales value of approximately $80 million, with over 80% being larger account conversions. This new business is overweighted in the Sunbelt markets. Our strengthening IoT digital leadership position is driving the development of connected products within our Omni automation ecosystem, resulting in 17% growth in our new product vitality index. Turning to the price versus cost dynamics, A series of out-of-cycle price increases were required over the last few years to combat inflation and protect the structural margin profile of the business. While we have seen some commodity and freight costs start to ease, our total cost of goods sold continues to increase. As a result, we announced an additional 4% to 5% price increase in the fourth quarter to take effect at the beginning of 2023. The pool industry has been very disciplined on price historically, and we expect the recent price increases to hold. As noted earlier, we're making progress on recalibrating the level of Hayward inventory held by our channel partners. Distributors are reducing safety stocks built up during the period of strong demand and significant supply chain disruption, and we estimate a reduction of approximately 80 million occurred in the third quarter of 2022 compared to a meaningful inventory build in the prior year period. After adjusting for these changes in channel inventory levels are sell through the channel increased year over year. We are working with our channel partners to be appropriately positioned entering 2023 Finally, we are taking proactive and responsible actions to streamline the organization and optimize the cost structure to support margins. This includes a reduction of variable cost with specific attention to eliminating cost inefficiencies on our supply chain and reducing variable labor in our manufacturing cost base to maintain attractive gross margins in the mid to high 40s. In addition, we are targeting a structural SG&A reduction of approximately 10% on an annual basis or 25 to 30 million when fully realized in 2023 with initial savings of approximately 8 million to be realized in 2022. We are taking actions to maintain a high 20s adjusted EBITDA profile. Turning now to slide seven, I'd like to share some perspective on the company's transformation and strong financial and operating performance over the last three years. Based on our 2022 guidance, we will have grown net sales and adjusted EBITDA by approximately 80% and 115% respectively from 2019 to 2022. This represents CAGRs of 22% for net sales and 29% for adjusted EBITDA. We are extremely proud of these accomplishments. This period was characterized by strong demand across the industry, and we substantially outperformed following a successful transformation under a new and experienced leadership team that included several initiatives. We accelerated new product development and introduced innovative best-in-class products in the industry's top growth category. I will provide some additional product detail in the following slide. We also revamped our go-to-market model to drive growth. This included restructuring the sales force and introducing dedicated business development teams focused solely on new customer acquisition. The result has been an impressive signing of pool builders, remodelers, and servicers. We also introduced a unique e-commerce approach that resulted in true multi-channel capabilities across distribution, retail, and online. Hayward has a long-standing commitment to lean enterprise and continuous improvement, and we substantially improved our manufacturing and supply chain capabilities, resulting in a doubling of production within the existing manufacturing footprint. We also established two new distribution centers in the U.S., and invested in automation where appropriate to drive productivity. As a result, we far outpaced the industry, delivering robust growth and margin expansion, and this transformation has laid a strong foundation for profitable growth longer term. Turning to slide eight, I'd like to provide some additional detail on our new product development strategies. Here we highlight the rich source of opportunity for technology upgrades in the U.S. aftermarket. As we've discussed in the past, the existing 5.4 million in-ground pools have an average age approaching 25 years. These pools have significantly less technology installed when compared to a new pool being built in 2022. This slide highlights the three key technology product segments of IoT-enabled controls, salt chlorinators, and energy-efficient variable speed pumps. When building a new pool, consumers are educated to the benefits of these products, which deliver ease and convenience of use, as well as a more affordable and enjoyable swimming experience. The take rate of these technologies when compared to penetration on existing installed pools is significantly different. The opportunity gap presents compelling opportunity for the industry to provide a runway for growth. In these three segments alone, we see a potential revenue opportunity for the industry of approximately $6.5 billion. In recognition of this opportunity, we have focused our new product development priorities to deliver exciting IP-rich products, attracting consumers and trade professionals to upgrade the installed base. Our success is evidenced in the blue column, which highlights Hayward's very strong growth over the last three years in these critical product categories relative to industry growth resulting in share gains. recent new product introductions extending our omni line of iot enabled control products our new s3 low salt chlorination system and xc ultra high efficiency doe compliant pumps are just the start of several new impact products being released to support hayward's position as the equipment supplier of choice in fact our new operoid s3 and S3 Omni salt chlorine generators are uniquely able to operate at just 800 parts per million of salt, roughly a quarter of the salinity required by most commercially available systems. This opens up significant markets in certain southern states, such as Texas, where the adoption of salt chlorine generators has been more limited. Further, our new industry-leading high-efficiency TriStar XL variable speed pump An XC multi-speed pump ranges are great examples of product leadership, resulting in shared gains in a critically important category. This work was recently recognized by the United States Environmental Protection Agency with Hayward receiving its 2022 Energy Star Partner of the Year Award. With that, I'd like to turn the call over to Ivian Jones, who will discuss our financial results in more detail.

Thank you, Kevin, and good morning. I'll start on slide nine. All comparisons will be made on a year-over-year basis. Net sales for the third quarter decreased 30% to $245.3 million. This decrease was in line with our expectation and primarily driven by a 44% reduction in volume and 1% unfavorable foreign exchange impact, partially offset by 12% price realization and a 3% contribution from acquisitions. The net price realization reflected the full cumulative impact of our previously announced price increases to mitigate the escalating inflationary cost pressures. The volume decline during the quarter was primarily driven by distribution channel destocking, which we anticipated stepping into the quarter. Our lead times have now normalized, and most supply chain constraints have eased outside of some specific electronic-based material shortages. This improvement gives us the confidence to communicate normalized lead times to the channel and relieve their need to hold excess safety stock. It's important to understand in our primary U.S. market, we have positive channel sell-through, and the volume reductions we experienced compared to last year are due entirely to channel inventory movements. In the comparable quarter, the channel pulled in inventory, whereas this quarter, as Kevin mentioned, the channel destocked approximately $80 million. In addition, global uncertainty and geopolitical events continue to weigh on certain European markets. Our other markets in the rest of the world segment performed well as those markets continue to open up post-pandemic. Despite this unfavorable channel dynamic, we continue to experience good adoption of new products, particularly controls, sanitization, energy efficient variable speed pumps, and lighting. Gross profit in the third quarter was $107.8 million. Gross profit margin declined 239 basis points to 43.9% as continued strong price realization was offset by inflation and lower operating leverage on reduced volumes. Our pricing initiatives have enabled us to successfully offset the majority of inflation. In addition, the adverse one-time impact of purchase accounting related to the acquisition of the specialty lighting business from Halco in the quarter two period impacted gross profit margins by over 100 basis points in the third quarter. Adjusting for this purchase accounting entry Gross profit margin was 45.1% in the third quarter. Selling general and administrative expenses during the third quarter decreased 27% to $50.5 million, primarily driven by lower performance-related compensation and warranty expenses. As a percentage of net sales, SG&A increased modestly to 21%. Adjusted EBITDA was $60.4 million in the third quarter. Adjusted EBITDA margin was 24.6%, with the decremental margins limited to 36%. We implemented significant manufacturing cost and actions during the third quarter to support gross profit margin, as well as an initial structural cost savings in SG&A. The quarter also benefited from lower incentive compensation and lower sales rebates. Our effective tax rate was 13.3 percent in the third quarter compared to 22.2 percent in the prior year period as we benefited from discrete items resulting from certain state legislation changes and the tax benefit resulting from the exercise of stock options. Adjusted EPS was 14 cents. We deployed 50 million to repurchase 4.8 million shares during the third quarter. Our cumulative share repurchase activity resulted in a year-over-year reduction in share count of approximately 23 million shares, or 10% of shares outstanding. Now I'll discuss our reportable segment results for the quarter. Beginning on slide 10, North American net sales for the third quarter declined 32% to $203.7 million. The year-over-year change was driven by 47% lower volumes, partially offset by a 12% favorable price impact and 3% contribution from acquisitions. The reduction in volume was due to the channel inventory destocking in the quarter compared to channeled pull-in during the comparable quarter last year. As I mentioned, this D stock was expected in the quarter, and we do project continued normalization of inventory in the channel in the fourth quarter. Gross profit for the third quarter was $91.9 million, yielding a gross profit margin of 45.1%. Adjusting for the purchase accounting entry I mentioned, gross profit margin was 46.4% in the third quarter. Adjusted segment income was $56.9 million, with an adjusted segment income margin of 27.9%. Turning to Europe and the rest of the world on slide 11, net sales for the third quarter decreased 21% to $41.6 million. Net sales benefited from a price increase of approximately 10%, but were adversely impacted by a 23% decline in volume. In addition to Channel D stocking, geopolitical circumstances in Europe have negatively weighed on consumer sentiment, particularly in northern Europe. We also experienced a 7% headwind from unfavorable foreign currency translation, primarily related to the euro, which dropped below dollar parity in the quarter. Gross profit for the third quarter was $15.9 billion, yielding a gross profit margin of 38.3%. Adjusted segment income was $8.6 million, with an adjusted segment income margin of 20.8%. Turning to slide 12 for a review of our balance sheet and cash flow highlights. We are pleased with the quality of our balance sheet and the strong cash flow generation characteristics of the company. Our cash and cash equivalent balance at the end of the third quarter was $73 million, and total liquidity was $128 million. Our ABL matures in 2026 and our term loan matures in 2028, and this attractive maturity schedule provides financial flexibility as we execute our strategic plans. Net debt to adjust to EBITDA for the last 12 months was 2.4 times compared to 2.3 times in the second quarter 2022. The modest sequential increase in leverage reflects the capital deployment in the quarter, which included $50 million in share repurchases. At the end of the quarter, diluted shares outstanding was 222 million shares. Cash flow from operations was a source of $80 million in the third quarter compared to a source of 76 million in the year-ago period and 144 million year-to-date. Working capital use year-to-date has been comparably higher as we took safety stock positions in certain raw materials and finished goods. Inventories peaked at the end of the second quarter and are moving down as we ourselves reduce our safety stock positions. CapEx was $8 million in the third quarter compared to $9 million in the year-ago period. Free cash flow was $72 million in the quarter and $120 million year-to-day. This represents a net income conversion of 312% in the third quarter and 73% year-to-day. The business has strong free cash flow generation characteristics, indicating high quality earnings and supporting our growth investments. Turning now to capital allocation on slide 13. We intend to maintain a disciplined financial policy going forward. Our capital allocation priorities will be balanced, emphasizing strategic growth initiatives and shareholder returns while maintaining prudent financial leverage. We intend to continue investing in new product development, operational excellence, commercial programs, and productivity initiatives to drive growth in the business. We also remain an acquisitive company and seek to augment organic growth with tuck-in opportunities that enhance our product offering, geographic footprint, and commercial relationships. We are building a successful M&A track record after integrating four companies in the last 12 months in controls, water features, and lighting, which collectively contributed 3% sales growth in the quarter. Finally, the strong free cash flow generation supports continued opportunistic return of cash to shareholders. We deployed $50 million to repurchase 4.8 million shares in the open market in the third quarter, and $343 million to repurchase 23 million shares year-to-date. Our year-to-date share repurchase activity is accreted to adjust the DPS by approximately 10%. At the end of the third quarter, we had $400 million remaining on the existing $450 million three-year share repurchase authorization. And with that, I'll now turn the call back to Kevin.

Thanks, Ivy. I'll pick back up on slide 14 and 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 and adopt new technologies. 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. We also remain very encouraged by the execution of our teams, which continue to deliver solid market share gains and price realization while implementing our cost reduction programs. With that said, the current operating environment is increasingly uncertain, especially in Europe. Inflation remains persistent, and we are working through the reset of channel inventories. As a result, for the full year 2022, the company now anticipates a decrease in consolidated net sales of approximately 6% and adjusted EBITDA of 365 to 370 million. I am confident in our ability to successfully execute in this dynamic environment and remain very positive about the long-term growth outlook. Turning now to slide 15. Before we close, let me reiterate key takeaways from today's presentation. Our third quarter results were consistent with our expectations. We continue to win in the marketplace as we introduce new products, convert target accounts to Hayward, and increase our market share. We are controlling what we can control, optimizing our manufacturing base and taking proactive steps to realign our cost structure to current conditions while positioning for future growth. I have every confidence that these efforts will drive compelling financial results and shareholder value creation. With that, we're now ready to open the line for questions.

Thank you. As a reminder, if you'd like to ask a question today, please press star followed by one on your telephone keypad now. If you wish to withdraw, that's star followed by two. When preparing to ask your question, please ensure your headset is fully plugged in and unmuted locally. And our first question today comes from Jeff Hammond at Key Corp. Jeff, please go ahead. Your line is open.

Yeah, hi, good morning. Good morning, Jeff. Good morning. So just I guess on, you know, these SG&A cuts, maybe just frame how you're starting to think about, you know, demand destruction or some of the consumer weakness lingering into 2023.

Yeah, I think let me just start off with the cost actions in terms of Kevin's talk about the latter part of your question. We began the cost actions, Jeff, in Q3 with initial actions taken across primarily our manufacturing base. Later on in the course, we started to address our SG&A through specific cost actions there that will start to primarily affect Q4 and then have a full effect in 2023. We have announced, as of today, further actions both across our manufacturing cost base and across our SG&A base. We're focused really on light-sizing our factories to the current production levels that we see. And as we mentioned in our prepared remarks and in the release, reduce about 10% of our SG&A base, which is approximately 25 to 30 million. We'll continue to update you as we go forward and give you a fulsome update as we step into 2023. I mean, at the end of the day, these actions are to support and protect as we've become accustomed, mid to high 40s gross margin and protect our adjusted EBITDA in the high 20s.

As for the demand environment, Jeff, we're seeing still high single-digit retail pull-through out of the channel. That's obviously coming off some incredibly high comps from last year. We're really encouraged that that data indicates a continued share gain uh into the retail marketplace uh which has been you know really our top level priority um for the last several years running uh there's been you know quite a bit of discussion during this earnings season around new construction um we agree that based upon permit data um that that likely will be softer uh when the year closes out 2022 um you know i guess the positive or part offset there on the new construction side is you know it's really impacted the entry level and there's still a net higher values coming across the pad but you know again what's really driving this industry um is the aftermarket and you know the uh the break fix repair, replace, you know, some of the technology upgrading, you know, is still very optimistic. And the data shows that there's still great retail pull through out into the marketplace. So, you know, I'll just close. Obviously, there's been a lot of pricing. We spoke about it in our prepared remarks. You know, the market is accepting those prices. There's been a lot of it put into the marketplace. because of inflationary headwinds, and we expect that to continue to hold through the latter half of this year and into 2023.

Okay, good color there. So just on the kind of implied fourth quarter guide, you know, Decker Metals I thought were quite good in the third quarter. It seems like you take a pretty big step down into the fourth quarter, you know, any kind of moving pieces there, and then just, you know – What are the expectations around any early buy, if any, in the fourth quarter guide? Thanks.

Yes, I'll lead off, and again, like Kevin said, I'm on the latter point. I mean, it's pretty clear, based upon the full year guidance that we've given, sales in the fourth quarter are expected to be in the range of high 250s to low 260s, call that mid-point 260. We expect EBITDA to be between $51 million to $56 million. As you point out, structurally, the margin is around 21% of the midpoint adjusted EBITDA margin. Gross margins will be impacted in the fourth quarter by lower absorption. We're really focusing, Jeff, in the fourth quarter on the destocking on our balance sheet, in addition, obviously, to continuing to work with the channel on their destock. So production in the fourth quarter will be limited. We are continuing to right-size the manufacturing cost base but production will be down sequentially in Q4. We will have, as we talked about, continued inflation. Our acquisition cost in Q3 was higher than expected. It did necessitate us to put in another price increase. That price increase will be effective in January of 23, so we'll still have a bit of pinch in inflation also in Q4.

You know, as for early buy, Jeff, we did run a program this year. I would say, you know, as it's closed out here in the month of October, it's a more normalized early buy, kind of back to pre-pandemic expectations. Admittedly, we put a slightly lower expectation on it, given the channel stock position that But we hit that expectation, which I find encouraging and a great sign that the channel remains confident in that end market demand. And, you know, the expectation that we're going to get inventories down to the correct level, correct days on hand by year end. So we're working with the channel on getting that shipped. As we continue to deplete, we also want to make sure the inventory is in the right position and we got the right mix as the season kicks off into 2023. OK, thanks, guys.

The next question comes from Ryan Markle of William Blair. Ryan, your line is open. Please go ahead. Hey, guys.

Thanks for taking the questions. So picking up on that last comment you made, Kevin, it sounds like you think the channel destock is going to be done by the end of 2022. And then can you update us on how much you're assuming for the total destock now? I think the prior estimate was $150 million.

Yeah, so, you know, I would say on the chain, you know, what we discussed on last quarter, I'd say it's playing out, you know, as expected. We had nice D stock, hit expectation through Q3, more work to be done in Q4. But, you know, with the assumption of current demand trends continue, we think that we will largely be done and have inventory in the right balance. as we turn the year into 2023. And I would say, as you compare year over year, there was some inventory build, as I said in my prepared remarks, in 2021. And this year, we saw a nice reversal of that as our share continued to grow into the marketplace. So where there was some inventory building Q3 last year, we've actually depleted it by that $80 million or so that we had in the prepared remarks. So, you know, in terms of overall, we had kind of put a range of about 120 to 150 on it. And like I said, as of now, based upon retail pull-through and our expected Q4 ship back into the channel, we would say that we expect to be largely done and reset and balanced coming out of Q4. Great.

Okay, that's encouraging. And then on pricing, how much will price contribute in 2023, just given the recent increase you talked about? And I think there'll be some carryover. That would be helpful. Thanks.

There will be some carryover. I'll ask Ivan to give some more detail. There is carryover from an announcement called in the mid-year mark when it took effect. And then, of course, this most recent announcement here in Q4, which will start to impact Q1 shipments. So We're probably going to get a range now until we come in with our 2023 or formal guidance.

Yeah, Ryan, obviously we're not giving definitive guidance on price carry at this point. But what I would say is, as I mentioned earlier, we have now recently announced a 4% to 5% price increase, which is consequential to the inflation we saw coming through Q3. That will take effect in January, so we'll get a full year's benefit of that 4% to 5%. And then additionally, as you know, we did announce this past year in 2022 a mid-year price increase of approximately 4% to 5% as well. So we can take a half year of that and layer that on. So somewhere in the 7% range will be carried into next year.

Appreciate it. Thanks.

The next question comes from Brian Lee at Goldman Sachs. Brian, please go ahead. Your line is open.

Hello, everyone. This is Miguel on for Brian. Thanks for taking the question. My first one was just maybe going back on the updated revenue growth guidance. I guess maybe could you just decompose a bit the change in the guidance? Was that all related to channel inventory or maybe could you talk through how much of that was perhaps lower expectations on volumes maybe in Europe versus other regions. And then I'm assuming price is going to remain a headwind and an offset to those things. But just wondering if you could just maybe give more color on the change of the guidance versus prior. Thanks.

Yeah, so let me just talk about sales. Last time we talked around $200 million at the midpoint from original guidance to our revised guidance coming out at Q2. Now we expect it to be around $230 to $240 million would be the takedown from our original guidance stepping into 22. And that really is centric around three central themes. One, the channel correction, as Kevin mentioned. We said 120 to 150. We're kind of trending up into that mid-range right now. 130 to 135 is the channel correction. We think we're done at the end of the year. We identified it earlier. We got after it earlier. So I think we're in a good position now to get through that channel correction by the end of 22. In terms of Europe and the rest of the world, I think you're aware that market remains, let's say, complicated. Originally, we had... taken down our view on Europe and the rest of the world by 60 million. I think we're now at 70 million in our guidance. And then in terms of the seasonal markets, they've got a slow start. So this is the upper Midwest and northeastern Canada. They have a slower start this year. We've seen no improvement throughout the summer. And those markets now are essentially closed down for the season. And we expect better things next year. But in terms of this year, The seasonal market decrement is around $55 million to our previous expectations coming out of Q2 of only $40 million there. So really it's centric around slightly higher channel correction, a little bit of deterioration in Europe and the rest of the world, including the FX consequence, and recognition that the seasonal markets now have had a soft 22 period.

He also mentioned pricing, I believe, at the end of the question there, Miguel. I think you said headwind. We actually see pricing as a benefit, tailwind, kind of working through the next several periods.

Okay, got it. I meant tailwind. I had that reversed when I said it, but yeah, great. Awesome, I appreciate all that additional color. Second question, and I'll pass it on. maybe just on costs in general, you know, looking at the spot prices on sort of freight and metal, you know, we're hearing, you know, all those have come down, and then we're hearing from others, and you've noted in your prepared remarks that, you know, there might still be a bit of challenges around the electronics. But can you just maybe talk about the state of the state in terms of supply chain in general, and then specifically maybe, one, how we should think about the timing of when those – prices in the market start to translate and potentially more upside on margins? And then number two, maybe on the supply constraints, what's gotten easier and what's still a bit more challenging? Thanks.

Yeah, let me come at it in reverse order. I think it sets the response up correctly here. So in terms of sourcing, we have seen a nice improvement in sourcing. When I look at our key main commodity raw materials and other component items, we really are now only constrained from a sourcing perspective in electronics, namely PCBA components and microprocessors. We continue to work with our suppliers to get those materials, but that remains the only, let's call it, red traffic light on our commodity dashboard. Everything else from a supply quantity perspective has improved. In terms of cost, costs still remain elevated in our purchase costs. You have to recognize that we operate on a lag. So the raw materials that we purchase in any given queue are on a three-month lag. And obviously then any cost of sales that we sell in the quarter are really based upon prior quarter's acquisition. So we can be dealing with a lag of anywhere between three to six months from the market price of a commodity through that being recognized in our cost of sales. And so when you look at the year-to-date inflation in commodities, we still see resins elevated in our purchase price. We have seen some abatement in steel costs. We've got some specialist metals which still are high, and copper, based upon some contractual hedging we did, is higher. But we do expect that these will start to cool off here and possibly now start to provide a tailwind into next year. For me, it's a little bit too early to call definitively where we'll be in terms of inflation in 2023, and we've reacted accordingly on our 30s costs with a further price increase.

Understood. Yeah, thanks a lot for the additional color. I'll pass it on. Thank you.

The next question comes from Nigel Coe at Wolf Research. Nigel, please go ahead.

Thanks. Good morning. Thanks for the question. I think this one's for you. Good morning. How long do you think it'll take to work down inventories to the right level? And I'm just thinking about how much within your plan, within the margin guide you've got for 4Q, what sort of inventory benefit do you expect to achieve? And kind of, I guess, So adjacent to that question is, you know, normally you burn cash flow in 4Q. I'm assuming this time is different, but if you can just maybe talk about cash flow as well.

Sure. In terms of inventory, we say, just so I'm clear, you talked about Hayward balance sheet here. Exactly, yes. Yeah, okay. So inventory peaked in Q2. It is now beginning to come down modestly in Q3. uh but it will be lower at the end of the year as i mentioned we are reducing production uh to allow us to to get through that to finish good inventory uh more quickly and we expect that to continue actually uh into 2023. we will generate cash from a reduction in inventory in the fourth quarter but as you know the fourth quarter also has some early buy sales in the which are on extended terms. So I don't expect the quarter from a net working capital position to be a material cash flow period, but we will get some from inventory reductions. When you think about the days on hand, we have somewhere at the end of Q3 around about four and a half months of inventory of raw materials and about three and a half months of finished goods. That's about six weeks higher than normal. By the end of the year, we expect it to only be about two to three weeks higher than normal. And provided we see continued supply, normalization from our raw material suppliers, then we will continue to relieve our own balance sheets and destock that strategic inventory that everybody has taken. We're aiming now to get our cash conversion cycles back in the 90 to 100 days, which takes our raw material and finished goods down to about three and two months, respectively.

Okay, that's really helpful. Thanks, Fabian. My following question is really just maybe just a slightly crisper view on sort of how we view the outlook here. So 60% of the, you know, kind of the run rate replacement demand remains, you know, probably remains very solid even in a consumer recession. 20% new build will almost certainly be down, pick a number. What about the other 20%, the remodel? How do we view that going into 23?

Yeah, I think that's a potential... I think it's a potential offset on the construction side. As you know, Nigel, you know, our dealers, builders also do the remodeling. We know that new construction has been prioritized for the last two to three years. Average age continues to push to the right, approaching 25 years. So, you know, as we've been talking about for a few quarters, we think that that could be an opportunity to help offset some of the new construction. So, you know, you're looking at it the way we are, as we're, as we're looking into 2023, what's our expectation around new and remodel, which frankly, we view remodel as part of the aftermarket, you know, that, that 80% of our business that really is serving the installed base out there, um, you know, with, uh, with the pricing expectations. So those are all the factors that we're weighing. here through the fourth quarter, and will ultimately lead to our guidance when we talk again in first quarter.

That's very helpful. Thank you.

The next question comes from Sean Cowan of Bank of America, Maryland. Sean, please go ahead. Your line is open.

Hi, guys. Thank you for taking my question. We had a couple on pricing first. With the more normalized supply chain, some easing in commodity prices, and a balanced channel inventory heading into 2023, are you guys expecting any more price competition and promotional activity next year? And then the second one is, I believe you guys had a 4% surcharge in place the last couple of months. Is that still in place? And do you expect to pull that back with some relief on freight and commodity inflation?

Yes, I'll answer the second part. So the 4% surcharge now has become institutionalized in our pricing structures, and so that remains now in the price list, and the go-forward expectation is there'll be no giveback in terms of that, given where we've seen structural freight costs rest at over the last four months here.

As for the promotion, you know, the last two years, the industry really hasn't had to promote product given the demand profile. You know, what I would expect, you know, into 2023 is maybe is a return to normalcy with sort of standard levels of sales promotion activity that has long existed in the industry so we don't think it's incremental to historical trends sean but uh you know we would expect it to maybe be a bit of a step up from the fact that there was very little uh over the last call it two years or so okay just to clarify uh is the four to five percent increase is that just you guys turning the surcharge into a permanent price increase or is that in addition

That's in addition. Essentially, the surcharge became institutionalized over Q3, and the most recent announcement is a further price increase. As I mentioned, the freight costs in the business now have normalized. We've seen some reduction in container costs coming out of Asia, but the reality is inland transportation, LTL, FTL, freight costs, consequential to gas costs, diesel costs, are now structurally higher than they were 18 months ago.

Okay, got it. And then I think you mentioned that the sell-through grew high single digits year over year. Do you have a breakout of how much of that growth was price versus volume?

Sorry, can you just repeat the question again?

Of the high single-digit sell-through, what was the factors between price and others?

So we don't know exactly the channel price position year over year. It probably includes, let's say, negative low single-digit volume offset by mid to high single-digit pricing. Maybe a little bit of mix in there.

But the big component, Sean, would be volume probably off some single-digit, low single-digit percentage price. considerable price, and then mix, they have a little bit positive contribution.

Okay. Thank you.

The next question comes from Josh Pokrzewinski from Morgan Stanley. Josh, please go ahead. Your line is open.

Hi. Good morning, guys.

Hi, Josh.

If we could just talk a little bit about some of the categories here. If I think about that sell-through in the third quarter, it sounds like volumes were down a little bit, but any difference between what you're trying to actively destock in terms of categories or maybe what the channel's trying to destock versus the categories that have been more resilient or kind of drove some of that sell-through performance?

Yeah, I guess what I would say there, Josh, is where the channel has increased inventory, I think we've done particular categories that are more highly inventory. I think we've made nice progress getting some of that out. There's still some products out there, as we've been talking now for several quarters. There's some product categories that the industry, ourselves included, have just not been able to really you know, get back to full supply of, you know, namely, you know, products that require some of the electronic componentry, as Ivan said, that's still in shorter supply. So, you know, I think the channel did a nice job of addressing, you know, some of the heaters, you know, but we're still in short supply, I would say, net across some of the variable speed pumps, some of the automation and controls.

Got it. That's helpful. And then I know we've kind of approached this inventory question a million different ways and maybe just want to be crystal clear because I'm not that smart. On this $130, $135 million of kind of total destock that you're targeting here, does that include Hayward inventory or is that all channel facing? And I guess maybe if it is just channel facing, what's kind of the total number that you would put on that?

Josh, just to be clear, you're talking about Hayward product in the channel. That is the $135 million that we're referencing. So we expect our distributor's Hayward inventory to be reduced to $135 million over the second half of this year with substantial progress on that in Q3.

Okay, but you also have your own balance sheet inventory you're trying to work down. What numbers should we think about for that?

Yeah, so right now, when you look at the end of September, let's call it, rounded up $315 million on the balance sheet. We, by the end of mid to third quarter next year, expect that to be down to around about $220 to $225 million. Again, that's returning... Returning hour days on hand or months on hand for raw materials to about 90 days or three months and finished goods down to 60 days or two months. Again, preface the assumption that no further supply chain disruptions consequential to any macro events next year.

Got it. That's helpful. And then if I could just sneak in one more in, any comments that you would make on, I guess for lack of a better term, industry backlog, what your dealers know about and have queued up for next year? I would imagine that with these longer lead times between remodel and new pools that they're kind of booked out a little bit farther than usual. Is that starting to normalize? Is it still stretching out pretty far? Any cancellations? Mostly anecdotal, I know, because it's not really the way the industry works, but anything you can share would be helpful.

Yeah, I would say we're hearing very little negligible cancellations, so I don't think that's a contributor, Josh. I would say that the conversations we have with our dealers and our dealer counsel are it feels like it's returning to a more normal profile. You know, we did talk about the permitting on the new construction, but frankly, new construction gets too much attention. You know, this industry is driven by the aftermarket. So that remodel and that upgrade and that break fix is really what's driving the future outlook more than anything. And I would say, you know, as the inventory has been, you know, You know, the OEMs have done a nice job being able to fulfill and solve the backlog. Inventory is in the channel, and I think the availability is in a much better position. You know, in terms of their books, you know, new permits, new construction, we're calling for that to most likely be down this year, and then we'll take a harder look at 2023. But net-net, I think all that kind of adds up to its returning to more of a normal state. as we finish 2022 and prepare for the new 23 season.

Got it. That's helpful. Best of luck, guys.

The next question comes from Michael Halloran from Baird. Michael, your line is open. Please go ahead.

Hey, morning, everyone. Just one for me. When you look at the margins fourth quarter, obviously low 20s, I think, is kind of the implied range. How should I think about what the normalized margin levels look like? Obviously, there's some artificial downside of the quarter, given what's happening on the inventory side, given some of the inflationary things that you're talking about, plus you're implementing some cost containment programs. But as we look to next year, what's the right run rate should we be thinking about when we try to adjust for a lot of those pieces?

Yeah, good morning, Fabian. As we mentioned, Q4 is going to be impacted by some underabsorption. If I was to quantify that, it's around 175 to 200 bps. We think about the pricing initiatives that won't be in effect until January that will contribute another couple of hundred bps, possibly up to 250 bps. And so the aggregate of those to start to move the gross margin back into the high 40s. We've instituted The cost actions, which will eliminate 10% of our SG&A costs, some tough actions in there that we've got to get through to right-size that cost base. But once completed, that will allow the business to return our margins back into the high 20s.

Appreciate it. Thank you.

As we have no further questions, I'll hand back to Kevin Hollerin for concluding remarks.

Thank you, Adam. In closing, I'd like to thank everyone for their interest in Hayward. Our business is very well positioned to navigate the near-term challenges and deliberate 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 fourth quarter earnings call. Thank you, Adam. You may now end the call.

Thank you. This does indeed conclude today's call. Thank you all very much for your attendance. You may now disconnect your lines.