Good morning, ladies and gentlemen, and welcome to the conference call to discuss the results from Holly's Second Quarter of 2023. [Operator Instructions] Please be advised that the reproduction of this call in whole or in part is not permitted without written authorization of Holly. And as a reminder, this call is being recorded and will be made available for future playback. I would now like to introduce your host for today's call, Mr. Ross Collins, Senior Managing Director of Alpha IR. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Thank you for taking the time to join us today. On the call with me today are Matthew Stevenson, President and Chief Executive Officer; and Jesse Weaver, Chief Financial Officer. After their prepared remarks, we will open the call for questions. We will be referencing page numbers from our second quarter 2023 quarterly earnings presentation, which can be found on our Holly Investor Relations website. Now, I will reference the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. In many cases, these risks and uncertainties are beyond the company's control. Although the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct, and actual results may differ materially from expectations. Important risk factors that could cause actual results to differ from those reflected in the forward-looking statements are included in the company's recent 10-Q, S-4 and S-1 filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that statements will remain relevant and operative at a later time. Holy undertakes no obligation to update any information discussed in this call in the future. Additionally, we will be discussing certain non-GAAP financial measures; a reconciliation of these items to U.S. GAAP are included in today's press release, which is also posted on our Investor Relations website. At this time, I'd like to turn the call over to Matthew Stevenson, Holly's President and Chief Executive Officer. Matt?

Thank you, Ross, and good morning, everyone. It is an absolute pleasure to be joining you on my first earnings call here at Holly. Not only did I join this company because I am an automotive enthusiast, but I also saw the remarkable growth potential in this organization. We have great brands, great products, great people and great customers. What more could you ask for? I joined the company in June of this year, and there was a lot of fantastic progress already underway from the leadership of our Board member and Interim CEO, Michelle Gloeckler. I want to thank Michelle for all her efforts in the 4 months prior to me joining Holly. On Slide 5, we've highlighted the key takeaways for the second quarter. It is clear we are continuing to build a path for gross margins of approximately 40% and EBITDA greater than 20% over the long term. We demonstrated that ability by delivering nearly 40% gross margins and 21.6% adjusted EBITDA for the quarter. Through forecasting and operational improvements, we brought down net inventory levels by more than $10 million in the quarter, boosting our year-over-year improvement in free cash flow. We also reduced past dues across both our electronic and mechanical categories by $4 million. And on the new product development side, we launched our all-new Sniper 2, the next evolution of our marquee fuel injection product line. The Sniper 2 features enhanced capabilities and greater compatibility with older vehicles, plus installation is a lot simpler, which greatly reduces install time for our customers. Also, our unique QuickStart feature allows users to get their Sniper EFI system running by answering only a few questions about their engine. No laptop or prior tuning experience is required. In addition, future product line extensions like wireless connectivity will…

Thank you, Matt, and good morning, everyone. Our second quarter results were encouraging as we continued to see sequential improvement in our financials. Despite the year-over-year decline in sales, we did see an improvement in sales and EBITDA from the decline seen in the first quarter. Improvement was driven by normalizing order growth, past due fulfillment and a continued realization of our cost savings initiatives that were implemented at the end of 2022. Results from these initiatives generated approximately $11 million in savings for the quarter. As a reminder, on Slide 9, our key financial priorities for the year are restoring profitability, improving free cash flow, optimizing working capital and deleveraging our balance sheet. And through the incredible efforts of the team, we were able to drive profitability in line with our long-term targets this quarter. With an organization focused on improving operations and capitalizing on go-to-market opportunities, we are on the right track to delivering these priorities for the year. On Page 10, we've laid out a summary of key income statement line items. I will cover the key drivers of our financial performance in the subsequent slides. However, as is highlighted on this slide, Holy delivered improved adjusted EBITDA and adjusted net income year-over-year despite the declines in net sales and gross margin. And as Matt already alluded to, our financial performance continues to be propelled by our team's tenacity and dedication to optimizing our operations while also remaining focused on engaging and inspiring our enthusiast customer base. These fundamental improvements over time will deliver market-leading results and lay the foundation for sustainable long-term growth. Turning to Slide 11; you'll see that we're comparing our second quarter net sales results to comparable net sales in 2019. We believe comparisons versus '19 are important for us as we focus…

As a reminder, we ask that you please limit yourself to one question with one related follow-up as needed. Operator, please open the line for questions from our participants.

[Operator Instructions] Thank you. Our first question comes from Brian [ph] with Canaccord Genuity.

Congrats on the strong quarter and the progress you guys are making. I guess I want -- not want to know about the early reception to Sniper 2, both with your customers and dealers and the like in the channel? And how we should think about revenue contribution from this product launch in the back half...

Brian, this is Matt Stevenson. I appreciate the question. I mean we're just seeing a tremendous amount of interest in the new type 2. And as I mentioned in my prepared remarks, we already saw $1.5 million of sales out through the end of July, which was pretty early because we just launched that at the end of the quarter. And we're also seeing some great stock orders by our major distribution partners. So overall, a lot of great excitement around this product for us.

And then, just a quick follow-up on kind of your 40/20 margin algorithm, but maybe for Jesse. It seems like you guys got back here pretty quickly, at least faster than maybe we had expected. And this is with sales down considerably. Like how should we think about that evolving when you guys actually start growing sales again?

Brian, it's a good question. And I think just to kind of clarify on the 40-20 for us, I mean the way we think about it for our internal goals is that 40-20, we need to deliver on a full year. And certainly, we've come out of the gate this year, moving in the right direction, I think, hopefully, reinstilling confidence that, that is achievable. And as we go into the back half, as I've noted in the prepared remarks, typically, you'll see a step down in margins. And so I don't see at this moment us necessarily being able to fully commit to that this year. But going into next year, it is a focus of the team.

Thank you.

Our next question comes from Mike Swartz with Truist Securities.

I think you made the comment in your preamble around -- you're now seeing normalizing order growth. So I just wanted to dig into that a little more. I guess what exactly does that mean? And I guess, how much more visibility do you have into distributor and retailer orders for the back half of the year?

Michael, it's Jesse. Good question. And the normalization of order growth, just to kind of remind the group is the concept that we came into the year as we were guiding for the year and just coming off of and the stimulus coming from '21 and '22 when we were seeing the decline in orders, we anticipated that the front half from an order growth perspective, would be soft but improving throughout the year. And so the declines we're seeing are sort of the anticipated declines but the trend is what we're looking for, which is an improvement. I think orders were down about 13% in Q1. We were running down 1.6% in Q2. And our guidance implies that in the back half, we start to see orders be positive. And so we're headed in the right direction there. And so that's the normalization. So just getting back to what we would call a pre-COVID normal rate. In terms of what we're seeing on the out-the-door sales is our best barometer in terms of consumer pull-through through some of our key resellers. We get about 50% of their data on what our out-the-door sales are. And I think they're seeing relatively stable out-the-door sales on their end despite our year-over-year sales. And I think we've communicated that, that's just due to they were heavily overstocked coming into the year. And the back couple of months that we've looked at have been pretty encouraging, reinforcing the guidance that we have in place.

Okay, great. And maybe just sticking on the topic of retailer and consumer demand. I guess, how did the direct-to-consumer business performed during the quarter? And what was the percentage of sales from that business?

Yes, it's a good question. And I'm going to start, and I'll let Matt kind of finish this as we kind of refocus our efforts as a team on what the overall best way to grow the business as a whole is. But as it relates to D2C. D2C as a percentage of gross sales was 21% for the quarter, which is about 100 basis points better than it was in Q2 last year. And on a growth rate perspective, we are seeing improving trends sequentially with D2C, where D2C was actually about flat where a business as a whole was down 2.3% versus Q1 where D2C was down 6% versus the overall business at 13%. And I will point out that, that down 6% in Q1 is an updated number based on a more direct-to-consumer sales comparable for the prior year. But on a year-over-year basis as a percentage of the overall business, we are seeing improving trends there. But I will say that D2C as Matt's come in and recognize that 80% of our business is reseller business. And I think as we've talked about before, when you look at the gross margin on D2C versus resellers, certainly accretive D2C, but you have to look at the full P&L there and sales between the 2 is relatively flat. And so we need to optimize, I think, the overall go-to-market channel that has the highest profit potential based across the categories. And certainly, the partnerships with the resellers has an opportunity to grow. So in terms of D2C long term, I don't -- I think we're still evaluating where that needs to be, but it's still an important part of our business.

Thank you. Our next question comes from Christian Carlino with JPMorgan.

Could you just help us bucket out some of the changes in the guidance at a high level, just how much was it versus the internal plan in the first half versus an updated look at the second half? And any color on the cadence of DTC through the quarter and quarter-to-date that helped inform your updated view.

Yes. It's a good question, Christian. And what I'll say is we've raised the guidance on the top end. I think modestly from the bot like raising the bottom end because of the trends that we started to see in the order growth and a lot of the coming into the year, the question mark was how are orders going to actually trend coming through the second -- through the first half. And so as we've raised that guidance, we've gotten, I would say, better at understanding where our past due balance is going to end up. And so what you're seeing in that back half guidance is some mid-single digit, mid- to high single-digit growth on orders with some continued improvement in past dues. I would say getting to the top end of the range would mean higher order growth, closer to double-digit order growth and then getting into the bottom end of the range, it would be closer to low single-digit order growth. So hopefully, that helps you understand what the key drivers are. We also include in that is just -- this is based on the visibility that we have on a risk-adjusted basis and chip availability, and I'll reinforce the team did a really good job coming into this quarter. And I think we mentioned it in the last call in securing chips on the spot market, but we're still taking a cautiously optimistic approach as it comes to setting guidance there. And if they're able to exceed what we've seen historically, we've been able to do there, that could be another tailwind on the revenue side.

Got it. That's helpful. And then I guess, how are you thinking about gross margin in the updated guidance? Yes, there's a step down in sales, but you should also benefit from the lower manufacturing costs to a greater degree as you turn through the inventory, plus you have the lag pricing in electronic mix benefits. So I guess, is there anything else we're missing in those big buckets? And how should we think about gross margin exiting the year?

Yes. So the key thing to remember is we have a fixed cost base in our gross margin that when sales comes down, there's a bit of deleveraging that happens there. We have pricing that kind of helps offset some of that. And then the other thing that we're kind of working through in the back half is just based upon our accounting method with manufacturing accounting, there are some costs on a year-over-year basis that are from previous periods that roll through at a higher rate. And so we think that the gross margin back half is something that we should probably see kind of be year-over-year positive on the gross margin line, but it could step down a little bit just given the sales leverage piece.

Thank you. Our next question comes from John Lawrence with Benchmark Company.

Congratulations on the quarter. Jessie, could you talk a little bit about maybe when you look at the slides with the business, Slide 7 and you talk about the new products launched in Q2. Where would that sit as you look sequentially over the past few quarters? I mean is this a major step-up in development as cash was tighter, et cetera? Or where would that sit in that progression?

Good question, John. And I mean this is pretty consistent with what the team has been doing. I would say that with Mac coming on board, we're going to continue to make sure that these products are -- innovation is one of the key product drivers of our consumers purchase intent. And so that as we continue to release new products, we want to highlight the great work that the team is doing, the awards that they're winning. And as we continue to shape the strategy around new product development, I think we'll be able to show more visibility into some of the areas that we're moving into that we haven't historically had focused on. But it's pretty consistent.

Great. And Matt, the slide before, the optimizing acquisitions, that's been a part of the team's sort of strategy. What -- as you moved around and visited these facilities, et cetera, where do you think you are in that category and aligning with that, the CapEx? Is it a return issue now that you want to set that bar a little higher before and then maybe about the pullback maybe in CapEx for the rest of the year?

John, I'll kind of break that into two there. So I travel is just visiting all these great brands and companies that are part of the Holly family, like there are just some tremendous opportunities there. So at the same time, they do have their nuances relative to -- do they have a retail component, a service component, the D2C component. So we're really going through and making sure we're preparing those business units for optimal growth going forward. And so really, over the next 6 months, we're going to spend time making sure we're providing those businesses, the resources for that growth going forward. In terms of the CapEx spend, just really, as I've come in, just want to make sure we're preparing the organization relative to the scope of some of our CapEx spend that is really going to take this company to the next level. So it's more just a pause, making sure we're looking at it with the full growth potential that we intend to make sure we're spending that capital appropriately.

Thank you.

Thank you. Our next question comes from Joe Altobello with Raymond James.

This is Martin [ph] on for Jon Altobello. I was just wondering, in terms of capital allocation, is your priority -- your first priority beyond investing in the business, is still debt reduction?

Sorry, Joe, can you say that again?

Yes. In terms of capital allocation, is your first priority beyond investing in the business, build debt reduction?

Yes. I think that's a good question. I mean you can see we generated a lot of cash in the quarter and sitting at $42 million, a lot of questions probably coming up on capital allocation at this point. And it's a great place to be when you can start to have those discussions. And it's one of the things that we internally are really focused on. But I would say that understanding, we got to understand a few more pieces of what we need to do for the business here in the next 6 to 12 months. But debt deleveraging the balance sheet continues to be a focus, but have any -- we're not in a position at this point to kind of give you any specifics on that.

Got it. And when you talked about the COVID-driven demand bump, what do you think it will take to lap that demand bump?

Well, based on the work that I had done kind of coming into the year and what we've shown in the appendix on normalization, my estimation is the back half, we should be lapping a period when there's probably a lot less stimulus tailwind and largely in Q4 is whenever I view that the number is relatively small. And then obviously, going into next year, that should be behind us unless there is some new stimulus that has been not in print thus far.

Thank you.

Thank you. Our next question comes from Alex Perry with Bank of America.

I guess just first, how should we be thinking about sort of 3Q versus 4Q sales cadence? Should we be thinking outsized growth in the fourth quarter, given the easier comp from last year?

It's a good question, Alex. And I mean we're not -- obviously, we're just giving full year guidance, so I don't want to be too prescriptive on it. But I think if you look at kind of what we've been seeing historically, pre-COVID time frame, you would see roughly 50-50 split between the two. Now that said, pre-COVID, D2C wasn't where it is today. And I think what we generally internally anticipate is a slight uptick in Q4 versus Q3. And largely, that's just driven to what we do with holidays and a B2C penetration. And typically, at that point, our distribution partners have less inventory in stock, and we have it available. So we often find ourselves in a position to fulfill what the consumer needs at that moment. But typically around 50-50, but you would see probably something more like 50% to 52% in Q4 on the back half split.

That's really helpful. And then could you maybe just help us think through the margin implications of the launch of your newer generation products like Sniper 2.0 versus prior generation products? Are these products generally higher margin for you guys?

These -- the way it's been priced and the work that the team has done is we're offering, I think, a really good -- a great product out there that's got all the features that consumers have been asking for on newer technology, and we've priced it at a way that we're able to be margin neutral to prior generation. So you shouldn't expect any meaningful margin bump from those products.

Perfect. That's very helpful. Best of luck going forward.

Our next question comes from Bret Jordan with Jefferies.

Could you give us a little more color on your comment about evaluating the direct-to-consumer longer term? Is that -- is the cost associated with that business, maybe something that you focus more on the reseller market? Or I guess, what color are there?

Yes, Brett, it's Matt. For us, being a leading consumer platform for automotive enthusiasts direct-to-consumer is absolutely core to our strategy, right? At the same time, we need to look at cost to serve, but also to -- we see tremendous potential in this business in a variety of sales channels, whether it's international, OE as well as a lot of growth with our distribution partners. So kind of when we think about pegging an arbitrary number around D2C, we don't think it's the best barometer of the level of engagement we're driving with our consumers.

Okay. And then I guess, last quarter, we talked a bit about sort of applications related to electric vehicles. Have you made, I guess, any more internal progress there or anything to discuss.

Yes. Nothing to discuss specifically today, Brett. But yes, progress continues and there's really two focuses for EV for us. One is providing aftermarket performance parts for EV vehicles that come out of the factory OE as well as looking at some retrofit applications for EV components for classic and modern cars. So some exciting things we're looking at, and I'd just say more to come in the future.

Okay. And then one real quick question. I think somebody asked earlier, but just -- do you have any color on the cadence of retail POS as the quarter progressed?

Yes. I mean we haven't given, Brett, historically the month-by-month or quarter-to-quarter, but I'll say the last couple of months that we've gotten and we just got the July numbers, we've seen positive growth on the out-the-door sales from our resellers. So it's headed in the right direction here as we go into the back half.

Thank you. Our next question comes from Michael Baker with D.A. Davidson.

Yes. Sorry, I was mute. I want to ask Matt just about -- well, to long-term top line growth algorithm and how you think about organic growth, I assume you think it'll grow at or above that 6% industry growth. But how do you think about acquisitions? Has that changed at all in terms of the benefit of acquisitions for the long-term top line strategy?

Yes. Thanks for the question, Michael. It hasn't changed; absolutely not. I mean we definitely remain opportunistic around acquisitions. It's key to our strategy going forward.

So based on the commentary previously on some acquisitions, should we expect the pace of acquisitions to be similar less more than what we've seen in the last few years?

Yes. Relative to that pace, I said, for the next 6 months or so, we're really focused on optimizing the great brands and businesses that have become part of our portfolio. But again, we remain opportunistic and looking at acquisitions that are part of our long-term strategy. In terms of the relative pace, we have to just look at that as part of our capital allocation strategy going forward.

Okay. Fair enough. A couple more questions, if I could, follow-ups. It's been asked a couple of times, but I'm going to ask also the direct-to-customer business. It does seem like a big change in tone, like when you demerged relative to the SPAC and the last few years, this has been like DTC has been the focus. This is a good direct even though it was only 2% of the business, the growth is all about direct to customer. Now it's like you've really mentioned it in the script, and it came up a couple of times in Q&A. So it seems like a pretty big change to me, which I get. I get why you're doing it. But I guess my question is, what do you need to change to do anything differently internally, different people, different focuses, whatever? Or is it just as easy as saying, hey, this is going to be less of a focus going forward in that stat [ph]?

Yes. I think, Michael, just to be clear, it's not a change of focus. Like I mentioned in response to the previous question, we're a leading consumer platform for automotive enthusiasts and direct to consumer as part of our core strategy. But pegging this percentage of our business relative to D2C, I just give you a hypothetical example, if we grow OE international by x number of millions. And then we're looking at the same percentage, the overall growth of the business keeps going up, but D2C may slightly go down quarter-over-quarter. So that's why we just don't want to get hung up on the percentage. We want to look at meaningful growth across all of our channels, especially D2C.

Yes. No, that makes perfect sense. It just seemed like a little bit of a different messaging to me, maybe not. Last one, if I could. Your back half, my math is the back half implied sales guidance at the midpoint is flat even down slightly. To me, that seems a little conservative seeing the momentum that you saw in the second quarter and just a commentary in the back half. Is it fair to call the back half sales implied sales guidance conservative at the midpoint being down about 50 basis points, I think.

I think the guidance that we've provided is a well -- based on what we know today, we feel like it is a good range that it kind of takes into account what we're seeing in order of trends, what we have to do on the past dues. And I think it's important as investors start to really understand and learn this business to understand this dynamic between orders and past dues and how those flow through to net sales. And if you look at last year, I want to say that we burned down about $20 million in past dues that really helped the order sort of declines year-over-year that we have to lap that this year. We don't have as much dry powder in the past due bucket right now to make that sort of up. So for our guidance here, we talked about mid-to-high single digits on order growth. I mean that's necessary. And while we're headed in the right direction, I feel like the guidance here sort of captures a risk-adjusted view as to what that could be. But that past due lap is a big part of this back half as to why you're not seeing as much on the net sales line as you might have expected.

Well, then if I could ask one more follow-up, sorry to hog the mic, but the past dues has definitely come down to $22 million, but still above where it was pre-code. I guess the question is do we expect that past due number to continue to all -- that $22 million go to now million, $18 million in the coming quarters? Or have you sort of hit the right level now or does it just go to zero [ph]?

Well, it won't go to zero. I think we provide that 2019 view in their pre-COVID to give you a benchmark for what it was prior to all of this.

I guess it was 2%, so close to zero?

Not zero, but close to zero. That is zero [ph] is the goal, but practically hasn't been done. So given where we are, you can see that we do have a lot of work to do there. I think Slide 13 in the presentation, you can see the work that's been done over the past several quarters is largely outside of electronics. So in our guidance, we assume that the past dues continue to improve outside of electronics. And then as we go into next year, the intent is to kind of work that down even further on the electronics side.

Got it. Okay, fair enough. Thanks for all the time. I appreciate it.

Thank you, Michael.

Thank you. There are no further questions at this time. I'll now pass the call back to Mike [ph] for a few closing remarks.

All right. Thank you, Lisa. Now Slide 22 highlights the compelling thesis around Holly. This is an incredibly attractive market, driven by automotive enthusiasts. This is not just a hobby for our customers. It's our passion and it's a lifestyle. And we are focused on being the leading consumer branded company for these automotive enthusiasts. And because it's more than just a high year of trend, this industry weathers the economic cycles extremely well. Plus we have a massive addressable market, nearly $40 billion. That has offered decades of uninterrupted growth. Holly continues to lead this industry through a powerhouse of iconic brands with a history of innovation. Plus, we have a track record of successfully integrating acquisitions where we have captured synergies while also unlocking growth. We have a unique opportunity to create a transformational digital experience that will redefine the way our consumers and distribution partners interact with brands. This will create a competitive advantage and drive growth. All this leads to an attractive investment thesis with a business focused on delivering consistent organic growth of at least 6%, 40% gross margins and 20%-plus EBITDA margins and sustainable free cash flow, all within a platform that enables value to be unlocked with strategic acquisitions. The combination of the attractiveness of our automotive enthusiast marketplace and the great portfolio of Holy brands offers a fantastic investment opportunity. Today, I hope you got a sense of my passion for this great company, the industry and the bright future ahead of this organization. I thank you for your time today on the call and look forward to continuing to update you on the progress in future quarters. I wish you all the best until we speak again. Thank you, and have a great morning.

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