HAYW - NYSE

Welcome to Hayward Holdings First Quarter 2023 Earnings Call. My name is Jordan, and I will be the 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, Investor Relations. Mr. Maczka, please go ahead.

Thank you, and good morning, everyone. We issued our first quarter 2023 earnings press release this morning, which has been posted to the Investor Relations section of our website at investor.hayward.com. There, you can also find an earnings slide presentation that we will reference during this call. I'm joined today by Kevin Holleran, President and Chief Executive Officer; and Eifion Jones, Senior Vice President and Chief Financial Officer. Before we begin, I would like to remind everyone that during this call, the company may make certain statements that are considered forward-looking in nature, including management's outlook for 2023 and future periods. Such statements are subject to a variety of risks and uncertainties, including those discussed in our most recent Form 10-K and Form 10-Q filings with the Securities and Exchange Commission that could cause actual results to differ materially. 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 first quarter earnings call. I'll start on Slide 4 of our earnings presentation with today's key messages. I'm pleased to report first quarter results in line with expectations, reflecting strong execution in a challenging operating environment, including adverse weather conditions in certain key markets that we successfully offset with market share gains. Sales out of the channel were stronger than sales into the channel as our partners made further progress recalibrating the level of inventory on hand. We maintained disciplined cost control by reducing production levels to align with current market conditions and delivering on our previously communicated commitment to reduce SG&A costs. Price realization remains favorable, offsetting inflation. These efforts resulted in a robust profitability as we delivered excellent structural margins at lower volumes. I'm especially pleased with sequential gross margin expansion of over 400 basis points despite lower net sales. As we proactively manage costs, we continue to invest in the business to support customers with innovative new solutions and superior service and drive future growth. To that end, we continue to launch exciting new products, and I'll highlight some examples in a moment. We also hosted 2 significant customer events, our first-ever Partner Summit in Nashville and a large builder event in Phoenix. These events showcased our technology leadership and provided value-added training opportunities. The dealer response was exceptional, and we expect these unique customer engagements to drive brand loyalty and increase demand for Hayward products and services going forward. Overall, I'm proud of our performance during the quarter. Finally, we are maintaining full year guidance. For the full year 2023, we continue to expect net sales to reduce approximately 18% to 22% and adjusted EBITDA of $265 million to $285 million. Looking out beyond 2023, we have every expectation of resuming a solid historical growth trajectory of mid- to high single digits. Turning now to Slide 5, highlighting the results of the quarter. Net sales in the first quarter reduced 49% year-over-year to $210 million, largely due to channel inventory movements and softer market conditions related to global economic uncertainty. This compares to a period of extremely strong growth of 23% in the first quarter of 2022 and 96% in the first quarter 2021. We are seeing a return to more normal seasonality with Q1 expected to be the low point for total net sales. We are encouraged by continued positive price realization to offset inflation and the success of our innovative new solutions. As I mentioned, the gross margin performance in the quarter was exceptional. Despite reduced net sales, gross profit margins expanded 20 basis points year-over-year and 430 basis points sequentially to a robust 46.6%. Our operations teams have done an outstanding job to start the year with a rightsized manufacturing cost base, and we are encouraged by this ability to maintain gross -- strong gross margins and much lower production volumes. Adjusted EBITDA in the first quarter was $45 million with a margin of 21.4%. We realized the expected SG&A savings under our cost reduction program. Adjusted EPS in the quarter was $0.07. Turning now to Slide 6 for a business update. We estimate that Hayward captured significant market share over the last 3 years. This was most notable in the strategically important U.S. Sunbelt and in critical products like IoT controls, variable speed pumps, water sanitization and LED lighting. Our IoT digital leadership position is clear. The market is responding favorably to the connected products within our omni automation ecosystem, and we continue to gain traction with dealer additions in our totally Hayward loyalty program. Underlying end consumer demand trends continue to moderate in North America with the Sunbelt an area of relative strength. Weather was historically unfavorable in the Western markets, and we were pleased to offset this with further market share gains in the West and the Southeast. Overall, Europe and Rest of World exceeded our expectations in the quarter, and I'm very pleased with the performance of our team, particularly in targeted new Asian markets where we've realized growth year-over-year. Our channel partners continue to recalibrate the level of inventory to be appropriately positioned relative to a softer global economic outlook, normalized lead times and higher cost of carrying inventory. This played out generally as expected in the first quarter as we continue to believe the channel will trend towards the low end of historical ranges for inventory days on hand over the course of the year. Turning to the price versus cost dynamic. We implemented a price increase of 4% to 5% at the beginning of January to maintain price cost neutrality, and we are realizing this pricing as expected. As you know, we took a number of proactive actions in recent quarters to streamline the organization, optimize the cost structure and support margins. This included a reduction of variable costs in our manufacturing cost base and supply chain as well as structural SG&A savings of $25 million to $30 million on a full year basis. These actions are intended to maintain a healthy margin profile with full year gross margins in the mid- to high 40s and adjusted EBITDA in the high 20s. We are delivering on these commitments. Finally, we continue to make great progress on our ESG journey. I'm pleased to report that Hayward received a 2023 Regional Top-Rated Award for ESG performance by Morningstar Sustainalytics, a leading ESG research, ratings and data firm. While still very early in our journey, we are proud to be recognized with one of the best ESG ratings for all companies in the U.S. and Canada. Turning now to Slide 7. Last quarter, I detailed our new product development strategy and shared some of the recent innovations driving our technology leadership in the industry. Today, I would like to highlight 2 new product launches. SmartPower is the first-to-market technology, which revolutionizes multi-zone lighting in the backyard, encompassing the pool, spa, water features and landscape lighting. This dramatically reduces component and labor costs while increasing reliability and ease of use for the homeowner. Next, the TracVac Suction Cleaner. This new cleaner outperforms its peers and superior pool surface coverage, speed of cleaning and ability to handle any obstacles it encounters. We continue to prioritize investments in the development of new products like these to further strengthen our competitive positioning and support customers with industry-leading products and technologies. Turning now to Slide 8. I'd like to reemphasize the attractive long-term fundamentals of the pool industry and Hayward. 2023 is a year of normalization. Softer market conditions related to global economic uncertainty, channel inventory reductions and comparisons to periods of strong growth are impacting near-term results. we view this as a temporary dynamic in a resilient industry characterized by consistent growth, driven by an ever-growing aftermarket. I would like to revisit the solid long-term fundamentals and growth outlook. A number of secular tailwinds, including the appeal of outdoor living, Sunbelt migration, connected smart home technologies and environmentally sustainable products are here to stay, and the pool industry is a beneficiary of each of them. More specific to the industry, the large installed base of over 5 million in-ground pools in the U.S. and 25 million pools globally increases each and every year as new pools are built and the average age is highest on record. This provides significant opportunity for aftermarket sales as pool owners maintain and modernize their pools with new IoT-enabled technologies to enhance enjoyment, ease of use and cost of ownership. As we've discussed in the past, Hayward enjoys deep rooted competitive advantages that strengthen our market position and drive compelling long-term growth for our shareholders. We have an incredibly strong and trusted brand, nearly a century in the making and one of the largest installed bases that comes from having a complete product line across all pool types. Proven technology leadership, operational excellence and multichannel strength are meaningful differentiators for Hayward. To summarize, we are proactively managing through this year of normalization, controlling what we can control to position the company for robust growth and profitability over the long term. As a leader in this very attractive industry, I'm optimistic about Hayward's long-term growth outlook. With that, I'd like to turn the call over to Eifion Jones, who will discuss our financial results in more detail. Eifion?

Thank you, Kevin, and good morning. I'll pick up on Slide 9. All comparisons I'll make will be made on a year-over-year basis. We are pleased with our first quarter financial results. Net sales were in line with expectations and reflected a return to normal seasonality, coupled with the progressive rightsizing of channel inventory. We delivered exceptional sequential gross margin back into the high 40s, and we're realizing our SG&A cost reductions in line with plan. Our balance sheet is strong with first quarter seasonal use of our revolving credit facility now fully repaid as of today with expected strong cash flow for the balance of the year. Specifically, our net sales for the first quarter decreased 49% to $210 million. This was in line with our expectations and driven by a 54% reduction in volume, partially offset by positive price realization of 5%. It's important to understand that the volume decline during the quarter was primarily driven by distribution channel inventory movements in addition to moderating in demand trends in discretionary elements of the markets, namely new construction and larger remodels. Despite the reduction in sales in the quarter, we've delivered a 3-year CAGR of 7% when compared to the first quarter of 2020, the last pre-COVID quarter. That's a 3-year stack growth of approximately 24%. Gross profit in the first quarter was $98 million. Gross profit margin increased 20 basis points year-over-year and 430 basis points sequentially to a strong 46.6%. Disciplined manufacturing cost control, continued price realization and moderating input cost inflation more than offset the impact of reduced production volumes. We have worked hard to achieve price cost neutrality and recalibrate our manufacturing cost base to deliver this strong gross margin performance. It sets the business up well to deliver robust profitability for the remainder of the year and beyond. Selling, general and administrative expenses declined 20% year-over-year to $55 million in the first quarter. As a reminder, we took proactive actions during the fourth quarter of last year to streamline the organization and optimize the SG&A cost structure, and we're delivering on the targeted run rate savings of $25 million to $30 million annually. Adjusted EBITDA was $45 million in the first quarter and adjusted EBITDA margin was 21.4%. We're pleased to maintain adjusted EBITDA margin more for 21% at these reduced volume levels, and we're positioned to drive solid margin expansion as volume growth returns. Despite the year-over-year reduction in the quarter, we delivered 3-year net sales and adjusted EBITDA CAGR, 7% and 8%, respectively, when compared to the first quarter of 2020. Our effective tax rate was 9% in the first quarter compared to 24% in the prior year period. The year-over-year change was primarily due to the timing of the discrete tax benefit. Adjusted EPS in the quarter of $0.07 on a fully diluted share count of approximately 221 million shares. Diluted share count decreased approximately 23 million shares or 9% year-over-year as a consequence of share repurchase activity in the prior year. Let's turn now to Slide 10 for a review of our reportable segment results. North America net sales for the first quarter declined 53% to $163 million, driven by 59% lower volumes, partially offset by a favorable 5% price impact. The reduction in volume again was largely due to the anticipated rightsizing of channel inventories and a moderation in end market trends. Gross profit margin was 48.6%, a sequential improvement of 560 basis points and adjusted segment income margin was 24.1%. Again, we are pleased with the margin performance in the quarter and frankly, very proud of the operations team in that success recalibrating our manufacturing cost base, a tremendous achievement. Turning now to Europe and Rest of World. Net sales for the first quarter decreased 26% to $47 million. Net sales benefited from a favorable pricing increase of approximately 5%, but we were adversely impacted by a 28% decline in volumes due to channel inventory reductions and the impact of geopolitical circumstances in Northern Europe, as well as a 2% headwind from unfavorable foreign currency translation. Gross profit margin was 39.8%, and adjusted segment income margin was 21.2%. Turning to Slide 11 for a review of our balance sheet and cash flow highlights. Total liquidity at the end of the first quarter was $263 million, including a cash and cash equivalent balance of $41 million and availability under our credit facilities of $222 million. Net debt to adjusted EBITDA was 4.1x compared to 2.9x at year-end 2022. The increase reflects reduced EBITDA and a seasonally soft period for cash collections in the first quarter. A large part of our accounts receivable at the end of Q1 is early by business sold on extended terms to be collected in Q2. We expect net leverage to be closer to 3x by the end of the year. As of today, our ABL is undrawn. Additionally, we will not make any excess cash flow payment in 2023, given our credit agreements permit deductions for CapEx, share repurchases and M&A. We plan to complete the transition from LIBOR to SOFR on Term Loan B borrowers during the second quarter. This change will not materially impact our financial position. Our borrowing rate continues to benefit from the $600 million of debt currently tied to fixed interest rate swap agreements. Cash flow from operations was a use of $91 million in the first quarter, reflecting the increase in the accounts receivable driven by early by order tenants. Inventory decline sequentially in the quarter after peaking in the third quarter of 2022 and is down $39 million since then. CapEx was $6 million in the first quarter, was consistent with the prior year period. And consequently, free cash flow was a use of $97 million. We have strong free cash flow generation characteristics driven by high-quality earnings, but cash flows are seasonal. With the return to normal seasonality, the company will typically use cash in the first quarter and generate cash in the balance of the year. We expect free cash flow conversion of greater than 100% of net income with free cash flow exceeding $150 million in 2023. Turning now to capital allocation on Slide 12. As we've highlighted before, we maintain a disciplined financial policy and take a balanced approach, emphasizing strategic growth, investments and shareholder returns while maintaining prudent financial leverage. We continue to consider tuck-in acquisition opportunities to complement our product offering, geographic footprint, commercial relationships and opportunistic share repurchases. However, in the near term, we're prioritizing organic growth investments and reducing net leverage within our targeted range of 2 to 3x. Turning now to Slide 13 for our outlook. We remain very positive about the long-term health and growth profile of the pool industry, particularly the strength of the aftermarket. Our outlook for 2023 is unchanged as we continue to anticipate a decrease in consolidated net sales of 18% to 22%. This outlook reflects resiliency in the North American nondiscretionary aftermarket and reductions in new construction and discretionary remodeling upgrade. In Europe and Rest of World, we expect reductions of approximately 25% as geopolitical circumstances negatively impact consumer sentiment in that region, although we are seeing green shoots in this segment. These decreases will be partially offset by a 4% to 5% net sales contribution from price increases initiated at the beginning of the year. Our unchanged guidance contemplates additional reduction of channel inventory in 2023 as a consequence of the reduced consumer demand, a reversion to normal supply chains and a higher cost of capital. Channel partners are adopting a lean inventory position given these dynamics and they're moving to the lower end of their desired days on hand target. We expect gross profit margin to continue to increase over the balance of 2023. We're holding our anticipated full year 2023 adjusted EBITDA in the range of $265 million to $285 million. As discussed, we also expect a strong improvement in free cash flow in 2023 as we reduce our own inventory levels with free cash flow exceeding $150 million. Our interest expense expectation remains unchanged at approximately $78 million, reflecting the current interest rate environment and borrowing levels. The effective tax rate forecast remains approximately 25% for the remainder of the year, and our CapEx spending forecast also remains unchanged, a $25 million to $30 million. I'll close on the same point that I started. I am proud of the Hayward team's ability to rapidly recalibrate, delivering net sales in line with expectations and a significant improvement in gross margin back into the high 40s, realizing SG&A cost savings in line with the plan and managing cash flow in line with normal seasonality. And with that, I'll now turn the call back to Kevin.

Thanks, Eifion. I'll pick back up on Slide 14. Before we close, let me reiterate the key takeaways from today's presentation. We delivered first quarter results consistent with expectations and reaffirmed our outlook for the year. Our team executed well in a challenging environment, maintaining disciplined cost control, demonstrating our agile manufacturing capabilities and offsetting weather-related headwinds with share gains. We're very pleased with the strong gross margin performance in the quarter. We continue to invest in our business to drive future growth and believe the actions we are taking today are strengthening our position as a premier company in the attractive pool industry. Finally, I'm confident 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.

[Operator Instructions] Our first question comes from Jeff Hammond with KeyBanc Capital Markets.

Really, I just want to dig in on this gross margin, I mean, really impressive sequential improvement here given the sales drop. And maybe just to unpack the moving pieces to really drive that. And then it sounds sustainable, maybe just talk about what's to come on the gross margin line.

Yes, great. Yes, I mean, I would say that we saw great execution from our operations and supply chain teams to see over 400 basis point improvement sequentially and a more modest improvement year-over-year when obviously, volumes were significantly different first quarter last year versus this year, is a great accomplishment. I would say the price increase that took effect of 1st of January, again, delivered price cost neutrality. We're seeing a moderation in inflation by no means deflation, but a moderation. If supply chains, by and large, are back to normal, no longer requiring us to venture into the spot by market air freighting or working over time. So all of those are obviously headwinds that we no longer face from a gross margin standpoint. So I think I would just close, Jeff, by saying as we've shown over the last 2 years, we have installed capacity that can fuel future growth with very modest to no CapEx. So I think we're well positioned as volumes improve, that we can continue driving higher gross margins through the business.

Okay. Great. And then just kind of on the North America business, maybe just level set us on where you think the progress is in the destock versus maybe how you thought it would be exiting 1Q? And then the weaker kind of guide for North America, is that just a function of kind of the early weather? Or is there something more broad than that?

Yes. I'll take the channel side. I'd say that Q1, we expected and called for channel destock in Q1. It was reflected in our guidance. And it largely played out to our expectations. The -- our retail and channel partners data coming back to us would reflect sort of mid-teen to high-teen sell-out decrease year-over-year, which I think is consistent really industry-wide. And then the balance is really channel destock. So we made great progress. We would call for the channel to be back to normalized levels by the end of the season latest, if not sooner. Yes, so we feel a good progress was accomplished here in the first quarter, Jeff.

Jeff, it's Eifion. In terms of the guidance for North America, we launched new construction decrement up a little bit. We're seeing permit declines in the first quarter here. It has leveled off a little bit as we exit Q1 into Q2, but we have taken the current new construction environment as an indicator that maybe we need to move up to minus 30% in terms of new construction decrement year-over-year. I would say we have some balancing attributes in the other parts of the business, and that's enabled us to keep guidance for Hayward totality in that 18% to 22% range down year-over-year at the net sales level.

Our next question comes from Ryan Merkel with William Blair.

Two questions for me. First off, you mentioned the weather. I'm just curious if you could quantify the impact in the quarter because your sales were better than I was thinking. And then in areas where you saw better weather in the quarter, did you see better sell-through?

Yes. The -- I would say weather probably impacted a couple of points. I think probably it had an impact on what could have occurred in the first quarter. As I think you've heard from some others before us, West Coast, both very wet and very cold. We rely on some sellouts in that California, Arizona region, which was certainly impacted in the first quarter. I think the impact there on us is maybe the sellout is a little less than that it could have been in those regions, and that may impact on the timing of some reorders back into those regions of the country. Conversely, if you really look sort of Texas, East and particularly in the Southeast, we had strong weather patterns, both from a precipitation and at a temperature standpoint, and we saw really strong performance in those regions, particularly Florida and the Southeast, where Q1 was very warm. And in the case of Florida, had very minimal precipitation and more normal precipitation in the Southeast U.S. So yes, we would say that where weather was not a headwind that the performance was much more in line to maybe even better than we initially expected.

Got it. That's helpful, Kevin. And then I wanted to follow up with a question on the nondiscretionary part of your business. There's some fears out there that, that might not hold up as well. People might repair equipment versus replacement. There could be some trade down. I know it's the first quarter, it's a small part of the season, but are you seeing any fears there that, that could be worse? Or is that part of the business tracking as expected?

Yes. I mean, as Eifion said, I think that we ticked down the range, maybe 5 points from our initial guide, specifically around new construction and some of the renovation or the upgrade activity. So I would say it's generally playing out the way we initially guided. I mean, certainly, our input from our builders and our large renovators is that they're not quite as busy as they were in the past few years. But again, this is an industry that's known for 50-plus percent, very resilient, very nondiscretionary aftermarket. That's holding up extremely well. And we're just keeping close tabs on, call it, that 40%, 40-plus percent of the business that's more discretionary in nature, whether that's the decision to build a new pool or to take a pool off-line and renovate it. We're keeping close tabs on that here in 2023 as certainly monetary policy is having an effect on some of that consumer discretion right now, Ryan.

Our next question comes from Saree Boroditsky with Jefferies.

Just following up on that question. Obviously, you updated the outlook for new construction and remodels you went through that. But could you quantify how you're thinking about that more resilient aftermarket demand piece of the business?

Yes. Saree, it's Eifion. In terms of the aftermarket, we're basically calling it flat year-on-year. We're beginning to see some positive momentum in markets that we've targeted, the market share gain. We're seeing some good results coming out of the West Coast, even though that had some weather impacts in that region, we still performed very well comparably against expectations. In terms of the Southeast and the Florida markets in the U.S., we saw some great momentum there in those markets as the warm weather enabled maybe an earlier start to the season there, which is great to see, and that's predominantly aftermarket. And then as I mentioned in my prepared remarks, we're beginning to see some green shoots in the aftermarket in Europe which has kind of been hunkered down for the last year. We're beginning to see some positivity coming out of Northern Europe. And again, in new markets that we're targeting on the export side, particularly in Asia. So I'd say right now, we're feeling positive about the aftermarket. As Kevin said, it's resilient. We're seeing that resiliency come through in our Q1 results where we're very pleased with the sales out of the channel in Q1.

I appreciate the color. You mentioned destocking lasting potentially through the end of the season. So this mean you would not expect sales to turn positive until potentially 4Q because you do have that easier comp head into 3Q. So just any color on the cadence of sales growth for the year.

Yes. So that's exactly kind of how we see the year. This return to normal seasonality will mean the comparison in Q2 will be tough given where we were this time last year, but it will be an elevated sequential period over Q1. We'll probably go to an even position in Q3 and then start to see a normal early buy in Q4, which will be the positive comp year-over-year. We don't give specific guidance on each quarter, but that's kind of the cadence we see within the year.

Our next question comes from Rob Wertheimer with Melius Research.

I think you touched on this in the prepared comments, but just to clarify, what's your best guess on where as we get through the destock event, where channel inventory sits days versus normal kind of as we exit the year? And then if I missed it, how much destock is embedded in your revenue guide explicitly.

Okay. So we don't specifically call out the specific number, but it's approximately 9% to 11% of the decrement year-over-year is associated with channel inventory reduction. I'll remind you that every time we see a decrement on the sellout, we take a little bit more inventory out of the channel and vice versa, when we start to see recovery year-over-year in channel sell-through, there'll be a pull-through of inventory back into the channel. But it's approximately 9% to 11% of the year-over-year decrement associated with channel destock. We do believe we made great progress in Q1 in that reduction in the channel. We do believe it will be complete by the end of the pool season or sooner, given we started this recalibration maybe a little bit earlier than some of our peers, but we expect to be fully complete by the end of the season. And at that point, to answer the first part of your question, we believe the channel will be down to the lower end of where it has been traditionally in months on hand. So somewhere between 3 to 3.5 months on hand in the channel, some higher and some distributors lower.

And [indiscernible] there's is really -- we're referencing 2019, which was the last, call it, normal year pre-pandemic as our benchmark for those metrics that Eifion just mentioned. So based upon these couple of factors, whether it's cost of carrying the inventory or the OEMs having much more normal lead times, coupled with some market dynamics. I think those 3 forces are maybe pressing down to slightly below normal by 2019 standards. So that's really what we measure against.

Our next question comes from Andrew Carter with Stifel.

First thing I wanted to double-click on. I think you said price cost through the line. Is -- first off, is that -- are you -- is pricing ahead of material cost? And is that different by region, i.e., North America and Europe, Rest of World? Has that benefit improved from 4Q? And I would suspect if it has, does that tailwind increase through the remainder of the year?

Yes. We would say, in Q4 last year, the margin was compressed because of the acquired cost of raw materials in Q3 last year. So we were a little bit behind the curve and price/cost dynamics in Q4 last year. We announced a price increase for Jan 1, that went into effect, 4% to 5%, depending upon the region. That then brought us back to price/cost neutrality. We don't believe there's very much inflation within the current year. We believe the actions that we're taking to combat some of the more elevated elements of the inflation of the prior 2 years like spot buying, expedited freight, that will come off. If there's any residual inflation, it will be covered by the better discipline we have in the business. So right now, we believe we're a price/cost neutrality. That will continue. But the important point is if we do see inflation return back to the business, then we're prepared to be agile and move price back into the marketplace. We've got to be cautious about that, given the level of price that's gone into the market over the last 2 years, but we're prepared to protect the margin.

Yes. On that note, so the level of pricing that's kind of gone in the market, do you see anything out there in terms of risk at holding it? Are you seeing any incremental promotions by any of the distributors, any demands on your end? I'm not sure exactly what their demands would be? Or is it -- or just anything that risks the pricing environment really down to the channel level?

I mean, as you know, Andrew, it's a very disciplined industry. There has been a lot of price out of necessity put into the marketplace. I'd say that what we're currently seeing in this environment is maybe a more -- a return to normalcy around traditional promotion activities, where there wasn't much need for that over the prior 2 years. Given the demand environment, I'd say it's more of a return. We really look at it. And what gives us confidence is, and I think that there is good value-based pricing with really strong payback for what the equipment costs. Overall, the equipment is still a very low percentage of a project, whether that's a renovation or a new construction. And obviously, there's a very nondiscretionary purchase, which gives very inelastic opportunities based on the infrequency of the equipment replacement. So really for all of those factors, we feel very confident that the industry and us will be able to maintain pricing that's been put into the market.

Our next question comes from Nigel Coe with Wolfe Research.

So I think you said sell-through in sort of the mid- to high-teens decline in North America. So obviously, that would include price. So it looks like units down maybe 20%, 25%. So when we think about the gap between the down 59% and the down 20%, 25%, that's all inventory. So we took out a lot of inventory in 1Q. Would you expect the magnitude of that inventory headwind to be similar in 2Q? Or does it start to narrow here from here on?

Yes. So we don't expect the headwind to be as severe in Q2. I mean the majority of the comp decrement is going to be in Q1. So we're pleased with the channel destock that we saw in Q1, we'll see a little bit more come through in Q2. It's a natural sellout period in the Q2 period as the distribution channel service the season. So you expect channel inventory to be reduced during this time period. We'll sell in, obviously, to keep up with that demand, but we do expect to see a moderation downwards in overall channel inventory. And then as I mentioned, by the end of Q3, the heel of the season will be fully back to normal in terms of months on hand days on hand.

Okay. And there's no concerns about shadow inventory held by contractors and dealers at this point?

Concern, no. I mean, I think there is some. We know there's some is a better way of stating it Nigel. But I think a good deal of it was burned off last year. There was some carryover, which is working its way through the system. Part of the -- the figure that Eifion gave a few moments ago in that 10%, 11% of our overall year-over-year reduction is related to channel. There is a portion of that, that would be considered a shadow. So we think that, that's accounted for in our guidance of a couple of percent that has burned off from the dealer base.

Great. And then my follow-on question is really around maybe some of the competitive dynamics in the market. Obviously, we heard from Pentair last week and their pool sales were, I think, down mid-teens. So I understand that there's some prior year market share and supply chain differences between yourself and them. But is there any difference in behavior with competitors? Are they taking a different approach to managing channel inventories? And any sense on that would be great.

I don't know if I have much on that, Nigel. Not exactly sure what their position in terms of channel stock was when the market demand started softening. As you know, we were pretty early in our ability to respond to the surge in demand, ramping production and really solving the order file fairly quickly, not as fast as anybody wanted, but I'd say relatively speaking pretty quickly. So I think that, that's what we're facing as a large part of this Q1 decrement is obviously some market slowdown on the discretionary side, but a much bigger piece of it is the recalibration and the restocking that our channel is burning off.

Our next question comes from Josh Pokrzywinski with Morgan Stanley.

Just apologies, I jumped on a little bit late with all the calls on this morning. But could you give us mind walking through maybe category or mix changes. Obviously, a lot of inventory coming down in the channel, which is good to see. But maybe not totally homogenous. So any categories where you were surprised by results and kind of overall comment on mix would be helpful.

Yes. We haven't seen a tremendous mix shift in what we're selling into the channel. Clearly, if you go back a year ago, there was probably some more heat being sold into the channel than there is currently. But generally speaking, as we see today, it's a full complement of products going into the channel. So that's very positive. It reinforces the new product programs that we've put into place. We've mentioned our new product introduction program, Vitality Index in Q1 was 20%, which is sequentially up from Q4. But at this time, it's a full complement with maybe a little bit less heat than we saw a year ago. There's still a high demand for IoT and controls. We continue to expand our production capabilities in our Rhode Island facility to make sure we're keeping up with that particular demand. So that's a very positive indicator of the adoption rate in controls. Regionally, the mix, a little bit more in Europe and Rest of World than we were expecting in Q1. So there's a bit of a regional mix effect. So that -- we see that as a positive, right? We were a little bit less bullish about Europe coming into the year. That's actually percolating a bit more positively than we expected and elsewhere in Rest of World as well. We need the seasonal markets in North America next to start opening up, and our guidance reflects a robust sequential improvement in sales from Q1 to Q2 as well as channel destock in Q2.

I would just add, Josh, that there are some products. Eifion has mentioned a few more, I think of the electronic products, whether it's salt chlorine, LED lights or automation and controls where we were much more hand to mouth up until very recently. So we just weren't in a position to really overstock or the channel wasn't in a position to really overstock there. So more of the products that we caught up on sooner would be the product categories that we collectively are working hard to get down to more normal days on hand.

Got it. That's helpful. And then just on the destock side, we covered a lot of ground, but I just wondering if higher interest rates and kind of the sensitivity around seasonal working capital lines of credit is maybe causing distributors to throw the switch a little harder than usual on inventory. And I guess what I mean is when we get through this, will they potentially be far too low just because the carrying cost is high.

I certainly think that the interest rate carrying costs are impacting some channel partners decisions on inventory. I think that decision is perhaps made a little easier given the fact that lead times from the OEMs are back to normal levels. So yes, I mean, we're keeping close tabs on understanding what the service levels are, what the inventory levels are as we really open all markets heading into the pool season here. And while we've resized our factories based upon the demand environment, we will do everything possible to be able to respond. If by chance we have maybe lowered inventory in some regions or some product categories lower than us as a channel want.

Our next question comes from Brian Lee with Goldman Sachs.

This is Miguel on for Brian. I think all our -- most of our questions have been asked, but I just had one, if I could. You guys talked about green shoots in the Rest of World. And then in the slides, you called out Rest of World is exceeding expectations. So just wondering, could you maybe give more color on that? What markets, what's driving those regions and whether that's market share gain or just better underlying demand or anything notable?

So the short answer is yes and yes. We targeted certain markets in Rest of World. We've put some sales teams into those regions. We'll call them new regions. We've always serviced them at arm's length, but now we've got personnel, particularly in the Asian market. And we've seen a great response to the Hayward brand in that region, and it's been very positive in Q1. In terms of Australia, which is another big pool market, it's also better than expectations, and that's good to see. The Middle East is a little bit off, but more than compensated by the other regions. And when we get into Continental Europe, Northern Europe, again, we've started to see some green shoots, particularly in the key German market where they have a high attachment to controls and technology, we're beginning to see some percolation there.

I would add domestically, the commercial pool market has been strong. That's been an area of relative strength in the U.S. Obviously, that was more impacted in the early days of COVID, but it's performed extremely well since then, Miguel.

This concludes the question-and-answer session. I would like to turn the conference back over to Kevin Holleran for closing remarks.

Thank you, Jordan. 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 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. So please contact our team. If you have any follow-up questions, and we look forward to talking to you again on the second quarter earnings call. Thanks, Jordan. You may now end the call.