Hayward Holdings, Inc. (HAYW) Q4 2022 Earnings Report, Transcript and Summary

Welcome to Hayward Holdings Fourth Quarter 2022 Earnings Call. My name is Daniel and I will be your operator for today's call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the call over to Kevin Maczka, Vice President of Investor Relations. Mr. Maczka, you may begin.

Thank you, and good morning, everyone. We issued our fourth 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 Eifion Jones, Senior Vice President and Chief Financial Officer. Before we begin, I would like to remind everyone that during this call, the company may make certain statements that are considered forward-looking in nature, including management's outlook for 2023 and future periods. Such statements are subject to a variety of risks and uncertainties, including those discussed in our most recent Form 10-K and Form 10-Q filings with the Securities and Exchange Commission that could cause actual results to differ materially. The company does not undertake any duty to update such forward-looking statements. Additionally, during today's call, the company will discuss non-GAAP measures. Reconciliations of historical non-GAAP measures discussed on this call to the comparable GAAP measures can be found in our earnings release and the appendix to the slide presentation. I would now like to turn the call over to Kevin Holleran.

Thank you, Kevin, and good morning, everyone. It's my pleasure to welcome all of you to Hayward's fourth quarter earnings call. I'll start on Slide 4 of our earnings presentation with today's key messages. As we continue to navigate a very dynamic operating environment, I'm pleased that our fourth quarter performance was in line with expectations. Consistent with the outlook we communicated a quarter ago, our results reflected the continued reduction of channel inventory days on hand. I'll make additional comments on our expectation for channel inventory in a moment. Second, we took proactive steps during the second half to realign our cost structure to current market conditions while maintaining our strategic growth investments and productivity initiatives. This includes successfully executing the previously announced enterprise cost reduction program, which was designed to drive substantial variable cost reductions and structural SG&A savings of approximately 10% on an annual basis. Under this program, we delivered approximately $9 million in SG&A savings in the fourth quarter and are on track to deliver the full annual savings of $25 million to $30 million in 2023. Third, Hayward has a long-standing commitment to lean manufacturing and continuous improvement. We view operational excellence as a significant competitive advantage. We demonstrated our agile manufacturing capabilities throughout the year, continuing to ramp production in the first half to deliver on a record backlog, then reducing production in the second half to support structural margins during a period of declining volume and reducing channel inventory days on hand. Fourth, we continue to strengthen Hayward's position as the premier company in the attractive pool industry. We are seeing positive market reception of our innovative new products and are actively converting target accounts to increase Hayward's dealer base. Finally, we are introducing full year 2023 guidance. Hayward delivered tremendous growth in recent years, building upon a strong installed customer base that we expect will drive aftermarket sales for years to come. Compared to 2019, the last pre-pandemic year, our 2022 net sales and adjusted EBITDA represent increases of 79% and 113%, respectively. Given current global economic conditions and difficult comparisons to this period of extremely strong growth, we now expect sales to reduce in 2023 before resuming a historic mid- to high single-digit growth trajectory. We see 2023 as a year of continued channel inventory recalibration with our net sales into the channel meaningfully below sell-through. This headwind will partially be offset by the adoption of innovative new products, disciplined price cost management and operational excellence. For the full year 2023, we expect net sales to reduce approximately 18% to 22% and adjusted EBITDA of $265 million to $285 million. Turning now to Slide 5, highlighting the results of the fourth quarter and full year. Net sales in the fourth quarter reduced 27% year-over-year to $259 million, largely due to lower volumes related to channel inventory movements and softer conditions in certain markets, especially Europe and Canada. We are encouraged by continued positive price realization during the quarter, more than offsetting inflation and the success of our innovative new solutions. Adjusted EBITDA in the fourth quarter was $53 million, with a margin of 20.6%. We realized manufacturing cost savings and the initial SG&A savings under our cost reduction program to support structural margins as production volumes declined. Adjusted EPS in the quarter was $0.11. For the full year 2022, net sales reduced 6% to $1.3 billion with adjusted EBITDA of $368 million, each consistent with our guidance. Despite our reduced net sales into the channel, our primary channel partners delivered record sell-through revenue of Hayward products into the core U.S. market in 2022. Adjusted EBITDA margin was a healthy 28%. Adjusted EPS for the full year was $0.98. Turning now to Slide 6 for a business update. End consumer demand continues to vary significantly by region. While underlying demand trends are moderating in North America, the sunbelt continues to be an area of relative strength, driven by secular trends related to demographics and outdoor living. We are seeing softer trends in more seasonal markets such as the Northeast U.S. and Canada. Within Europe and Rest of World, we continue to see solid growth in the Middle East and Southeast Asia, whereas conditions are especially challenging in Northern Europe. We estimate that Hayward captured significant market share over the last 3 years. We believe this trend is more structural than transitory. This was most notable in the strategically important U.S. sunbelt region and in critical products on the [pool pad] like controls, variable speed pumps and water sanitization. Our strengthening IoT digital leadership position is driving the development of connected products within our omni automation ecosystem. The market is responding favorably as we continue to gain traction with dealer additions in our Totally Hayward loyalty program. Turning to price versus cost dynamic. 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, total cost inflation remains elevated. As a result, we implemented the previously announced price increase of 4% to 5% at the beginning of January. The pool industry has been very disciplined on price historically, and we expect the recent price increases to hold. Our channel partners continue to recalibrate the level of Hayward inventory to be appropriately positioned, relative to current market conditions. In the second half of 2022, distributors reduced days on hand as expected after a meaningful inventory build during a period of strong demand and significant supply chain disruption. Based upon channel information, we estimate that our sell-through increased 11% in the U.S. on a full year basis to a record level. However, as I mentioned, we now believe the distribution channel will make additional reductions in 2023 as a result of a softer global economic outlook, lower safety stock requirements due to normalized lead times and higher costs of carrying inventory. We believe the channel will trend towards the low end of historical ranges for inventory days on hand over the course of the year, and we have reflected that in our outlook. Our 2023 guidance now contemplates an additional reduction in channel inventory days on hand with the first quarter impacted most significantly. We took proactive and responsible actions during the fourth quarter to streamline the organization and optimize the cost structure to support margins. This includes a reduction of variable costs in our manufacturing cost base and supply chain to maintain attractive gross margins in the mid- to high 40s. In addition, we expect to deliver structural SG&A savings of approximately 10% on an annual basis or $25 million to $30 million in 2023. These actions are intended to maintain a high 20s adjusted EBITDA profile. Finally, ESG is very important to Hayward and our shareholders. So I'm pleased to report continued progress on our journey. In 2022, we developed our ESG strategy and framework, which aligns to products, people, planet and principles and completes our first Scope 1 and 2 emission inventories in partnership with a third-party expert. These results and other reporting metrics are included in our first stand-alone disclosure, the Hayward ESG data sheet, which we published on our website during the year. I would encourage our shareholders to review these new disclosures. Turning now to Slide 7. I'd like to share some perspective on the company's competitive mode that strengthens our market position and drives growth for our shareholders. Starting at the 1:00 position on the pie chart, we have an incredibly strong and trusted brand decades in the making, and we're the largest installed base that comes from having a complete product line across all pool types. This provides ample opportunity to introduce new technologies into the aftermarket, which is the primary driver of our business at approximately 80% of sales. Next is our strength across multiple channels as we 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 continued growth in the number of pool builders, remodelers and servicers to our Totally Hayward loyalty program that state their reputation on Hayward products every day in the backyard. We also introduced a unique e-commerce approach that resulted in true multichannel capabilities across distribution, retail and online. Moving around the chart, Hayward is committed to operational excellence and continuous improvement. And we substantially improved our manufacturing and supply chain capabilities in recent years. We primarily manufactured domestically with approximately 85% of our production in the U.S. We are vertically integrated with shorter supply chains than others. Our facilities are highly automated and agile with the proven ability to flex up and down as appropriate with limited incremental capital. Finally, one of our biggest differentiators is our product and technology leadership, which I will discuss on the following slide. These important elements of Hayward sustainable competitive moat form a strong foundation for profitable growth longer term. Turning to Slide 8. I'd like to provide some additional detail on our industry-leading products and technologies. While operational excellence and customer service are ingrained in our culture, at its heart, Hayward as a product company. Recent launches have showcased Hayward's focused new product development strategy. Key product categories have been identified as must-win with the goal of delivering compelling products, capable of attracting both, new customers as well as expanding our total addressable market by driving incremental content into lower technology pools in the installed base. We prioritize investment into these product categories, leveraging in-house core competencies to deliver innovative, patent-protected solutions designed to make pool ownership easier, more affordable and sustainable. They are key to driving growth and market share gains. A few of these recent introductions are shown here on the slide. Our variable speed and XE pump, DOE-compliant platforms lead the way in energy efficiency and are responsible for our ENERGY STAR Partner of the Year Award. Omni continues to be the IoT automation platform of choice Our [app of cords,] effortless and simple use for both, the homeowner and trade professional. HydraPure is a novel 3-in-1 water treatment technology combining UV with Ozone and AOP to provide the safest, purest and clearest water. The new S3 AquaRite builds on our best-in-class salt chlorination platform providing the ability to operate at 1/3 the salt concentration of legacy designs and offering unique control capability. Our LED lighting solutions, [fan] pool, spa, water features and now landscape. Simplicity of installation and control was recently added through the introduction of SmartPower. Finally, the new universal HC heater offers dual fuel capability and combines efficiency and performance in the industry's smallest footprint, easiest to install heater. To summarize, technology leadership is central to our growth strategy, and we are very proud of our recent innovations. We continue to prioritize investments into new product developments to further strengthen our competitive positioning and support our customers with industry-leading products and technologies. With that, I'd now like to turn the call over to Eifion Jones, who will discuss our financial results in more detail.

Thank you, Kevin, and good morning. I'll start on Slide 9. All comparisons will be made on a year-over-year basis. Net sales for the fourth quarter decreased 27% to $259 million. This was in line with our expectation and primarily driven by a 36% reduction in volume and a 1% unfavorable foreign exchange impact, partially offset by 9% from price realization and 2% contribution from acquisitions. The volume decline during the quarter was primarily driven by distribution channel inventory movements, which were anticipated as we entered the quarter. Gross profit in the fourth quarter was $109.5 million. Gross profit margin declined 466 basis points to 42.3% as continued strong price realization was offset by lower operating leverage on reduced production volumes. Selling, general and administrative expenses during the fourth quarter were consistent with the prior year period at $60.5 million, representing 23% of net sales. As a reminder, the fourth quarter 2021 benefited from a $5 million favorable nonrecurring item, related to insurance proceeds from a property claim. And we realized approximately $9 million in structural cost savings in the fourth quarter of 2022. Adjusted EBITDA was $53.3 million in the fourth quarter, and adjusted EBITDA margin was 20.6%. Our effective tax rate was 30.2% in the fourth quarter compared to 18.4% in the prior year period. The year-over-year change was primarily due to the timing of discrete items. Adjusted EPS in the quarter was $0.11, fully diluted share count has decreased 25 million shares or approximately 10% of shares outstanding, primarily the result of the share repurchases completed during the first 3 quarters of 2022. Turning now to Slide 10 for a review of our full year results. Net sales for the fiscal year 2022 decreased 6% to $1.3 billion. This decrease was in line with our guidance and primarily driven by a 20% reduction in volume and 2% unfavorable foreign exchange impact, partially offset by 13% from price realization and a 2% contribution from acquisitions. Gross profit for the full year was $597 million. Gross profit margin declined $135 million basis points to 45.4% as strong price realization to combat inflation was offset by a lower operating leverage on reduced volumes in the second half. We invested $22 million in RD&E and engineering in 2022 to support our commitment to growth and innovation. SG&A expenses for the year declined 7% and to $249 million, driven by lower discretionary and volume-based expenses plus the initial benefits of our cost reduction program. On a full year basis, SG&A as a percentage of net sales was 19%. Adjusted EBITDA was $367.6 million with an adjusted EBITDA margin of 28% for the full year. Our effective tax rate was 23.4% in '22 compared to 21.7% in 2021. Adjusted EPS was $0.98 for the full year 2022. Now I'll discuss our report with segment results. Beginning on Slide 11. North America net sales for the fourth quarter declined 27% to $216.8 million, driven by 38% lower volumes, partially offset by 9% favorable price impact and 2% contribution from acquisitions. The reduction in volume was largely due to the anticipated rightsizing of channel inventories. Gross profit margin was 43%, and adjusted segment income margin was 21.8%. Turning to Europe and Rest of World. Net sales for the fourth quarter decreased 23% to $42.2 million. Net sales benefited from a net favorable price increase of approximately 7% but were adversely impacted by a 25% decline in volumes as well as a 5% headwind from unfavorable foreign currency translation. Gross profit margin was 38.8%, and adjusted segment income margin was 19.9%. Turning to Slide 12 for a review of our reportable segment results for the full year. North America net sales declined 5% to $1.1 billion, driven by 21% lower volumes, partially offset by a 15% of favorable price impact and 2% contribution from acquisitions. Gross profit margin was 46.4% and adjusted segment income margin was 30.7%. Turning to Europe and Rest of World. Net sales for the full year decreased 15% to $205.3 million, benefiting from a net favorable pricing increase of approximately 8%, but adversely impacted by a 17% decline in volumes and a 6% headwind from unfavorable foreign currency translation. Gross profit margin was 40% and adjusted segment income margin was 23.6%. Turning to Slide 13 for a review of our balance sheet and cash flow highlights. We ended 2022 with total liquidity at $268 million including the cash and cash equivalent balance of $56 million and availability under our undrawn credit facilities of $212 million. Net debt to full year 2022 adjusted EBITDA was 2.9x. We will not make an excess cash flow payment in '23, given our credit agreements permit deductions for CapEx, share repurchases and M&A activities. Cash flow from operations was a use of $28 million in the fourth quarter, reflecting an increase in accounts receivable driven by early by order terms. Cash flow from operations was $116 million for the full year. Working capital use in 2022 was comparably higher, primarily related for the higher safety stock positions we took in certain raw materials and finished goods. Inventories peaked at the end of the second quarter 2022 and declined by $29 million or 9% in the second half. CapEx is $6 million in the fourth quarter was consistent with the prior year period. For the full year, CapEx of $30 million compared to $26 million in 2021 as we continue to invest in highly efficient automation into our production facilities. Free cash flow was $86 million for the full year 2022. The business has strong free cash flow generation characteristics, driven by high-quality earnings, which support our growth investments. Turning now to capital allocation on Slide 14. We will maintain a disciplined financial policy. Our capital allocation priorities will be balanced, emphasizing strategic growth investments and shareholder returns while we maintain prudent financial leverage. We also remain an acquisitive company, having successfully integrated 4 acquired companies in the last 18 months, which contributed 2% to sales growth in the full year 2022. Finally, strong free cash flow generation supports opportunistic return of cash to shareholders. We deployed $343 million to repurchase 23 million shares in 2022. Entering '23, we had $400 million remaining on the existing $450 million 3-year share repurchase authorization. Turning now to Slide 15 for the main trends supporting our outlook. We remain very positive about the long-term health and growth profile of the pool industry, particularly the strength of the aftermarket. With that said, for the full year 2023, the company anticipates a decrease in consolidated net sales of 18% to 22%. This outlook reflects resiliency in the North American nondiscretionary aftermarket and reductions of approximately 20% to 25% in new construction and discretionary model and upgrades. Whereas in Europe and Rest of the World, we expect reductions more in line with 25% as geopolitical circumstances negatively impact consumer sentiment in that region. These decreases will be partially offset by a 4% to 5% net sales contributions from price increases initiated at the beginning of the year. Included in our guidance is an additional reduction of channel inventory as a consequence of the reduced consumer demand in 2023, a reversion to normal supply chains and a higher cost of capital. We expect our channel partners to adopt a lean inventory position, given these dynamics and moved to the lower end of their desired days-on-hand targets. We expect to revert towards more normal seasonality in 2023. However, we expect channel inventory rightsizing the impact the first quarter most significantly with net sales trending below the typical seasonality in this first quarter. We expect gross profit margin to increase in 2023 due to incremental positive price realization and executed productivity initiatives. We anticipate full year '23 adjusted EBITDA in the range of $265 million to $285 million. We are on track to deliver the targeted SG&A cost savings of $25 million to $30 million in '23 or an incremental $16 million to $21 million after achieving approximately $9 million in 2022. These savings will be partially offset by increasing wage inflation and variable compensation. We also expect a strong improvement in free cash flow in '23 as we reduce our own inventory levels. This should result in more typical free cash flow conversion of greater than 100% of net income with free cash flow exceeding $150 million. Finally, we expect interest expense of approximately $78 million, reflecting increase in interest rates and borrowing levels. We also expect a modestly higher effective tax rate of approximately 25% and CapEx spending consistent with the prior year at $25 million to $30 million as we continue to support the business and invest for growth. We are confident in our ability to successfully execute in this dynamic environment and remain very positive about the long-term growth outlook. And with that, I'll now turn the call back to Kevin.

Thanks, Eifion. I'll pick back up on Slide 16. Before we close, let me reiterate the key takeaways from today's presentation. We delivered fourth quarter results that were consistent with our expectations. 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. Our agile manufacturing capabilities provide a significant competitive advantage as we flex production as appropriate to satisfy demand and maintain margins. We continue to position Hayward as a premier company in the attractive pool industry as we innovate and support our customers with best-in-class award-winning products and technologies. Finally, our 2023 outlook reflects continued near-term headwinds related to macroeconomic conditions and channel destock, but I have every confidence that we have the right strategy and talent in place to drive compelling financial results and shareholder value creation. With that, we're now ready to open the line for questions. [Technical Difficulty] It appears that we're having a technical difficulty. If everyone could just stand by, we'll be right back to the Q&A session momentarily.

[Operator Instructions] The first question is from the line of Ryan Merkel with William Blair.

So Kevin, I wanted to start off with a high-level question on 2022. Can you talk about the bigger accomplishments and some of the bigger changes for the company in '22 as you address the changing market and then wanted to set up a stronger '23?

Sure. It's good to hear from you, Ryan. Thanks for the question. I think '22, we accomplished quite a bit to be proud of. The full year '22 performance finished in line with recent expectations from a sales and an adjusted EBITDA standpoint. I think importantly, that 28% adjusted EBITDA margin after an incredibly strong first half in a slower second half is something that we take great pride in. Also, as I mentioned in the prepared remarks, this record sell-through of Hayward product into the key U.S. market in that low double digit setting a record, I think it's a great accomplishment as well. In the process, providing share gains in some key categories like variable speed pumps controls, salt-alternate sanitizers, LED to name a few. So I think importantly, we saw the need for some channel destock and reduction of days on hand, we got after that in the second half of the year and got to really where we were expecting, which was getting back to year-end 2019 levels which was, as you know, the last pre-pandemic. So I think I would probably close with just returning over $340 million to shareholders during the year. I think all of those are great accomplishments and set us up well for 2023, which will be, I think, a bit of recalibration before we get back to that more historical mid- to high single-digit growth rate.

Got it. Then my follow-up, just on '23 revenue guidance. Can you talk about your assumption for U.S. retail sell-through? And then how much inventory destock are you estimating in '23?

Yes. As it pertains -- you did specifically ask about North America, right, Ryan?

Yes, right.

Around -- our assumptions for 2023, let's just talk about the key components from a revenue standpoint. From a remodel and upgrade standpoint, which is about 30% of our mix, we're seeing somewhere around 20% reduction in units. New construction, as I think most people are coalescing around, that's 20% mix, and we're calling for between 20% and 25% reduction there. I think on the nondiscretionary kind of this 50% of our mix, which is very resilient. I think that we would say that there's a potential for maybe 5% unit reduction there as maybe there's some deferred maintenance or as things break, not -- everyone may not upgrade to the most current version. So net of that, there's about 4% price. So I think that, that's about, call it, 10% or so headwind going into 2023. And then beyond that is what we would expect for additional channel destock, which gets us up into that, call it, 18% to 22% overall guide. I'll just mention Europe. I think we're taking a little bit more of a cautious view around new construction and discretionary upgrades. Of course, there's a little bit of FX headwinds in our expectations. So we're modeling somewhere between 20% and 25% for that segment.

The next question comes from Jeff Hammond of KeyCorp.

So really I want to get at the decrementals. It looks like in your guide, your decrementals are kind of 35%, and you're holding the line pretty well. And I guess, fourth quarter, it seemed like the decrementals were worse, and you got some of your SG&A savings. So I just want to understand kind of the confidence in holding the decrementals and what other offsets you're thinking about, whether it be disinflation or less disruption, et cetera, kind of built into that.

Yes. It's Eifion. Yes, you're right. But that [Indiscernible] that we're forecasting for next year at 35%, which is more in line with the historical movement we see on incremental decrementals. It was a bit more severe in Q4 last year. But as we've noted in the prepared remarks, it was really a period in which we recalibrated our cost base, both at the manufacturing level as well as the SG&A level. And as we enter 2023, we believe we're in a great shape in the cost base, both at the factory level and in SG&A to deliver those limited decrementals to 35%. We do have, obviously, upwind -- sorry, tailwinds and upside to the extent that we do see some further improvements in areas like freight costs, which have improved over the last 6 months, but that can be a tailwind to 2023. But at this particular point, we believe on the construct of our forecast, our manufacturing cost base and SG&A base are rightsized to deliver the outlook that we've provided.

Okay. That's helpful. Maybe just -- can we just talk about normal seasonality? Because it seems like '19, there was some destocking, 2022 was just odd. So I don't know if you can frame how to think about kind of normal seasonality in that first quarter in particular.

Yes, you're right. I mean, typically, when we think about a year -- if we go back pre-pandemic and look at the preceding 5 or 6 years, our first half was about 48% of the full year and second half, 52%. We believe that is going to be our reality in '23 with maybe a slight reduction in Q1, compensated by a little bit more in Q2. But we're trending back to a normal seasonality, which is low Q2 higher -- sorry, low Q1, higher Q2 as the season gets well underway, lower Q3 as the season comes to an end and a higher Q4 as we start to prepare for the forthcoming 2024 season.

The next question comes from Nigel Coe of Wolfe Research.

Just wanted to dig in a bit more to the '23, the build, and in particular, the repair and maintenance. I think Kevin, you said maybe down 5% in '23. Obviously, I understand the kind of the desire to be conservative. I think you commented that during the [GFC] that you saw maintenance to actually grow during that timeframe. So I'm just wondering with unemployment of 3% in the U.S., it feels like we're in a better position today than we were back then. So just wondering why the [Indiscernible], that's down 5%. And maybe there's been some pull forward, et cetera. So just any thoughts there would be helpful.

Yes. I mean, what we primarily saw in the great financial crisis as I understand, was really our new construction took the biggest impact at that point in time. I think to be pragmatic, looking into 2023 with some of the inflationary concerns, I think it's wise for us to kind of look at that 50% or so, that is very resilient and just say that as we get into the fourth quarter of this year, I think people have the ability to maybe defer some of the maintenance or maybe not fully upgrade to the current version and maybe do more of a like-for-like depending upon what their discretionary income looks like at that point in time. So I don't think that there's anything bigger at play, Nigel, than just trying to be a bit cautious with what might happen with this 50% of the -- of our revenue flow.

[Indiscernible] understand that. And then my follow-on question, again, digging a bit deeper into the inventory dynamics. So it looks like about 10 points of headwinds baked in for inventory in North America, that's about $100 million, I think, of headwind. Curious if you would expect to see the bulk of that to hit in 1Q and then perhaps a little less than 2Q? And then maybe just to frame kind of what impact you saw in the second half of last year?

Yes. So the second half of 2022, I would say, obviously, in the Q2 call is when we identified the need to take days on hand out as we were starting to end the 2022 season. Our objective was to get days on hand by the end of the year back to pre-pandemic levels, which was -- 2019 would be that marker, and we did that. We accomplished that in the -- by the end of December, kind of getting back to those days on hand, months on hand in the channel. As the second half played out and as we look to finalize our 2023 guide, I would say some of the discretionary outlook for 2023 continue to soften as I previously spoke around remodels and new construction and whatnot. So with that view, having done good work in the second half of 2022, I think that there's a couple of things contributing to a desire to have less inventory. Overall, if there's less retail activity, less inventory is required in the channel to service that. I think, secondly, us and most OEMs are back to normal lead times. So we're able to provide a more just in time now that the supply chain disruptions are largely behind us. And then thirdly, I would say, obviously, inventory carrying costs are more expensive today than they were during the pandemic. So for all those reasons, that's really what we accomplished in the second half of 2022, which I would say was a success and the need for additional [Indiscernible] work to be done in the start of 2023, Nigel.

The next question comes from Rob Wertheimer of Melius Research.

I had kind of a similar question to what Nigel just asked, but on the upgrade and remodel side. Can you contextualize the kind of rough outlook you gave for '23 versus prior recessions? And as a follow-on to that, is that a [tier 4] forecast at this point? Or do you already have enough channel commentary and install a commentary or whatever to have kind of the real look at it at this point in the year?

Yes, I'll jump in here. It's Eifion. When we think about the aftermarket, we would say typically 50% of our aftermarket is nondiscretionary resilient. However, we are given due recognition that it's very unusually [violent] right now with the interest rate environment and a lot of discussion around where the economy goes. So to be cautious and prudent, we've said that upgrading that takes place at a break fix time period. So when you see an end-of-life asset comes to the end of its life, typically people are spending money to go to the latest upgrade. And that may be deferred, and that's reflected in our guidance. We think it's a very cautious view, but we want to be cautious as we start the year off here in the beginning of '23. In terms of remodel -- we talked about remodels before. We do see the installed base. We do believe there's pent-up demand for remodeling. However, again, based upon the backdrop of the economy, we think very much similar to new construction that could be a case here for down remodels and additions [Indiscernible] rate in the region of 20% to 25% across our business base.

Fair enough. Kevin, I think you touched on it in your prepared remarks that this outlook brings channel inventory days towards the low end of prior ranges. I mean, eventually, that turns into a tailwind, I don't have that destock. What scenario could have another year of channel destock after this? So we don't assume the markets fall apart. I mean at the very bottom of the ranges of inventory, do you feel comfortable, or is there essentially room to go there? And I'll stop there.

Yes. Thanks, Rob. I would say that our expectation is that the channel correction in terms of days on hand will be completed in 2023. I don't think that based upon some of our conversations and again, all those factors that I mentioned just a moment ago, while answering Nigel's question, I think, plays into the fact that we can maybe just dip maybe below normal days on hand, and we can -- will serve the demand in 2023 with slightly less overall days on hand. And to your point, that may provide some tailwinds into 2024, but that seems a long way off at this point.

The next question comes from Saree Boroditsky of Jefferies.

So you highlighted some structural share gains. I think you've talked about that being around [2.5%]. What are you seeing now that supply chains have normalized, and how do we think about you maintaining that?

Yes. I mean, each year, our top priority is profitable growth, which implies share gains. I'd say over the last 2.5 to 3 years, we've experienced share gains across some critical product categories. We view that as more structural than transitory, for a number of reasons. I think product introductions plays into it as reflected with our Vitality Index, which is up over 20%. Some new dealer conversions into our Totally Hayward program with more folks in the backyard advocating Hayward product. I think we've seen great penetration, specifically in some of the year-round sunbelt markets. And I feel that we're still really in the early innings of some of the adoption of new technologies, be that controls or alternate sanitizers. And I think that we have great products to bring to the market. And we'll continue to see that upgrading opportunity with Hayward products into the market.

Great. And then could you just talk about the cadence of the remaining SG&A savings and how we should think about that impacting margins through 2023 and into 2024?

Yes. So we have essentially completed all of the rightsizing of our SG&A base as we closed out Q4. And so we entered 2023 in a very healthy position to start realizing the entirety of the run rate savings of $25 million to $30 million per quarter. And so you will see our SG&A base in each of the quarters, around $60 million beginning in Q1. So we're in great shape [into] the year with all of those savings back into our numbers, and we're realizing those as we come out of the gate.

The next question comes from Michael Halloran of Baird.

So 2 questions here quick. First one, when you look at the guidance back half of the year, it seems like you're assuming positive North American growth, which makes sense given the destock comps. How are you guys thinking about the underlying sellout in the channel as you get to the back half of the year? Is it still down year-over-year at that point? Or it's just the destocking comps that is driving the year-over-year gains? Or is there something else going on?

Yes. It's Eifion. Yes. So no, we expect the destocking to impact our sales into the channel, predominantly in the first half. We expect sell out of the channel to be fairly consistently down over each of the quarters but our sell-in to the channel to pick up in the second half as we start to build for the seasonal year '24.

And then how are you thinking about capital usage here? You just buy back in the fourth quarter, given where your guidance is leverage is a little bit higher here. Are you guys still contemplating buybacks as you think about capital usage in 2023, or are there other priorities?

Yes. Look, I would say we remain very disciplined on our capital allocation program. Our financial policy requires us to maintain leverage in the target range of 2 to 3x. At the end of '22, we were at 2.9x. And despite the lower guidance on EBITDA in '23 versus '22, we still do expect to close '23 out with leverage ratios of around 2.9 to 3x at the end of the year, driven by a meaningful cash flow generation. And the focus is going to be on meaningful cash flow generation from the business. We've got no particular plans now for use of capital other than to continue to pay down our net debt position throughout 2023 as well as the investor CapEx programs into the business.

The next question comes from William Carter of Stifel.

So first question I would ask is going back to your own kind of inventory. Your drawdown plan, I believe, last quarter was $90 million, you draw down some, that would imply an incremental [$50] million. But I would guess your volume assumptions for next year are now different relative to where they were before. And if I look -- if I read your free cash flow guidance correctly, you only got about $6 million to $15 million of working capital. So could you help us frame how much potential upside there is to that $150 million in free cash flow from drawdown, what you're planning, your own inventory, your own production, your own purchases?

Yes, sure. So as we previously communicated, inventory peaks in our own balance sheet, midyear last year, we -- around about $313 million. We reduced that down to $284 million by the end of the year. When you think about the year-over-year increase '22 versus '21, that was about a $50 million increase in working capital, about half of that was inflation. The other half is divided between safety stock positions we took and acquired inventory through the J&J acquisition. What we're forecasting for next year is to continue to reduce our inventory down to our target months on hand position of 3 months on hand for raw materials and 2 months on hand finished goods. We don't quite get there by the end of next year, but we're super plus. And we've got a lot of plans in place to drive it down there. In terms of the free cash flow figure that I quoted of $150 million, yes, there is upside to that if we can continue to drive inventory out of the balance sheet, which is our plan. We want to be cautious about that. We want to be fully prepared to support the '24 season. We recognize the guidance we have given is cautious, but we remain very optimistic about the start to next season. And we will gauge our level of inventory as we enter Q4 as being appropriate or not, to support '24. But at this time, Andrew, there is upside, the $150 million, that is predicated upon what we believe our inventory needs to close out at '23 prepared to the '24 season.

Second question I would ask is I believe last quarter, you said pricing net of material cost inflation was positive. That was in 3Q. I'm not sure if you said that today. So was it a positive? Did it accelerate? And kind of how are you thinking about gross margin pricing relative to your cost for next year? Also recognizing, I know you've got a very long inventory position. So we've seen some favorability in COGS that might take away [the] flow through.

Yes. That's exactly right. I mean when we think about -- let's talk about margins in Q4. They were impacted by the higher acquisition cost of raw materials at the back end of Q2 and into Q3. That roll through our cost of sales in Q4 and that's behind us. Now we did start to see some tempering of inflation. I want to be clear, we didn't see de-inflation, but we saw some tempering of inflation in Q4 which will start to benefit our 2023 period, because we've also instituted now a price increase of 5%, beginning January 1. So we believe based upon now the institution of that new price, the rightsizing of our manufacturing cost base, continued reduction in freight costs over this time period that our gross margins will start to elevate back into the high 40s by the time we get through the end of Q2, and it will carry at that level through the end of the full year. So we're very comfortable in the projections that we put forward for high 40s gross margin for this year, predicated upon their price and normalization of freight, coupled with a tempering of inflation in raw materials.

The next question comes from Rafe Jadrosich of Bank of America.

I just -- Kevin, I want to just follow up on some of your comments on sell out earlier. Just on the 11% for 2022, can you clarify if that was revenue or units? And then the same question for the 2023 outlook of, I think, in aggregate, you're expecting sort of down 10%. So can you just clarify between the revenue and volume?

On the 2022, that was the rate -- sorry, could you restate the second part of the question, Rafe?

Yes, so the sellout comments, you answered the first one that the 11% was on units, not revenue. For 2023, what are you expecting on revenue and units for sellout? I think you said 10%, was that a volume number or a revenue number?

So yes, to be clear, when we're thinking about the '23 guidance, all of the metrics we quoted 20% to 25% new construction, remodel and the discretionary element of the aftermarket, those were all unit-based figures. Those will be offset by the -- partially offset by the 5% price increase that we've put through beginning of 2021. When we think about -- [Indiscernible]. When we think about the full year sellout, we're guiding down high single digits as an aggregate in the business, and that is a revenue sellout reduction year-upon-year.

Got it. Okay. [Indiscernible]

Adding another -- I would add the difference to the guidance, the channels you saw.

Can you just remind us what 2021? Yes. Can you remind us what the 2021 sellout was? So we can sort of think about how you're sell-in versus sellout has trended over the last few years here?

Yes. I believe 2021, rate, was mid-20s. Sorry, sorry, sorry. That's wrong. No, no, no. That was rate, sorry. That was our expectation on sellout for 2022. We were actually mid-30s on sell-outs for 2020 -- for 2021. Sorry, yes, I want to correct the record there. We were calling for mid-20s in 2022 and actually realized kind of low double digits after [35] or so actual [Indiscernible] 2021.

That's really helpful. And just on the -- you commented that channel inventories, you're expecting them to get to sort of historically low levels versus where they've been in the past. Is there anything structural about that where you'd expect that to continue into 2024? Or as sellout kind of stabilizes and there's just more certainty around the economic environment, would you expect the channel to try to return to normal levels? Like could we see a restock at some point where sell-in starts to track ahead of sellout? And like how early could that happen?

Yes. I don't think that we're seeing or will experience a change forever more to lower days on hand. I think that this is in response to an interest rate environment, a macro economic environment that's causing carrying cost impacts that is impacted by an outlook for less discretionary purchasing in the marketplace. So I do think that for a period of time, we'll operate kind of less or lower than normal inventory levels, but I see ultimately that we'll get back to more historical days on hand. As we move through the different quarters of the year, that obviously changes how much you need. How much the channel wants on the shelf to start a season versus exiting a season are different numbers or different amounts. So I'm not sure I'm ready to call when that could occur. I think that for the time being, we're more focused on the destock, and we'll continue to work closely with our channel partners for when those historical levels will be restored.

Our final question comes from John Joyner of BMO.

So on the other 4% to 5% price increase that you implemented at the beginning of the year, I guess can you remind us how much of the price increase increases from last year carried over into this year? And then with things normalizing a bit, how much of the price increases have you historically realized in similar type environments, understanding that distributors are typically receptive of price hikes?

I'll start off by saying, John, that 4% to 5% which took effect in January, additive to that would be about 2% per half year wrapped from our announcement midyear of 2022. So that's what would be combined. I would just put the caveat that the contribution to revenue growth is lower given the reduced volumes in 2023. But those are the 2 pieces that go into our pricing expectation for 2023.

Can you repeat the last part of the question, please, John?

Yes, Eifion. So just with regard to things kind of normalizing and how much of price increases have you historically realized in similar types of environments with fully understanding that distributors are typically receptive of price hikes, but you're putting through 4% to 5%, how much of that would you expect to actually realize? I mean I know you probably had a 4% to 5%, but what has been the norm?

Yes. So we would -- based upon view of history and our analysis of history that there's never been any price kickback, John. I mean this industry has a disciplined pricing mechanism as instituted at the beginning of the seasonal year, typically October 1. It's been historically [1s or 2,] maybe slightly higher percent. This has been an unusual period over the last couple of years, but we've not seen any price pushback at this time. And nor do we expect any. Equipment tends to be at a very low cost element of the overall pool installed costs, typically 10%. As long as we can continue as an OEM to bring meaningful value-based products to the consumer, we believe price will remain very sticky as we go forward. Now we do recognize that promotional campaigns and rebates maybe a little bit lighter over the preceding 2 years, that will revert to a more normal rebate of promotional activity structure in '23, but core pricing will remain sticky.

Thank you. And with that, we will conclude the question-and-answer portion of today's call. I would now like to hand the conference back over to Kevin Holleran for closing remarks.

Thank you. I'd just like to thank everyone for their interest in Hayward. Our business is very well positioned to navigate the near-term challenges and deliver value for all stakeholders in the years ahead. This would not be possible without the hard work, dedication and resilience of our employees and partners around the world. Please contact our team. If you have any follow-up questions, and we look forward to talking to you again on the first quarter earnings call. Thank you, Daniel, and you may now end the call.

And with that, we will conclude today's conference call. Thank you for participating. You may now disconnect your lines.