Greetings. Welcome to the Holley Third Quarter 2023 Earnings. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Ross Collins, Investor Relations. You may begin.

Thank you, operator. Good morning, and welcome to Holley's Third Quarter 2023 Earnings Conference Call. On the call with me today are President and Chief Executive Officer, Matt Stevenson; and Chief Financial Officer, Jesse Weaver. This webcast and the presentation materials including non-GAAP reconciliations are available on our Investor Relations website. From time-to-time we post new information that may be of interest or material to investors on this website. Our discussion today includes forward looking statements that are based on our best view of the world and of our business as we see them today and are subject to risks and uncertainties including the ones described in our SEC filings. This morning, we will review our financial results for the third quarter and share our guidance for the full year 2023. As always, we'll leave time for your questions at the end. And with that, I'll turn the call over to our CEO, Matt Stevenson.

Thank you Ross and good morning, everyone. This is now my fifth month at Holley and I continue to remain extremely impressed by the team and the incredible opportunity that exists with this great company. Not only there are tremendous prospects for growth, but we're also finding ways to be more efficient while we're also enhancing our service levels to both consumers and distributors. We are undergoing a comprehensive transformation of the company to unlock all these opportunities and prepare organization for extensive growth. During this call, I will highlight some of the transformation that is underway including a new organizational structure on focus on becoming even more consumer centric. The development of a robust product development cycle, increasing the engagement levels with our customers, including our great distribution partners, lowering our cost to serve by taking a holistic look at our operations and adding new leadership talent to the team. Plus while transforming the company for the long term, we are also continuing to deliver in the short term through strong alignment of internal resources and intense daily focus on meeting our commitments. All of this hard work continued to pay off as we delivered a solid third quarter. Now let's take a look at some of the highlights from the quarter. On Slide 5 we've highlighted the key takeaways. Due to seasonality, the third quarter is historically our lowest for order demand. But even under those circumstances, we continue to build a path forward of our goal of gross margins of approximately 40% in EBITDA margin, is greater than 20%. Year-over-year for the third quarter, we dramatically improved gross margins by 600 basis points and increased EBITDA margins by 840 basis points. We also continue the progress of bringing down inventory and pass throughs through forecasting and operational…

Thank you, Matt, and good morning, everyone. Matt and I were extremely pleased with the results the team was able to deliver in the third quarter. We ended the quarter with year-over-year net sales growth and strong improvements in profitability across both gross margin and adjusted EBITDA. As Matt already alluded to, we believe our team's efforts to transform the organization and optimize our operations are taking hold and are driving improved financial performance. These efforts have had a positive impact on our ability to generate strong free cash flow and pay down debt. As a reminder, on Slide 12, our key financial priorities for the year have been restoring profitability, improving free cash flow, optimizing working capital, and deleveraging our balance sheet. These initiatives are firmly on track and are evident in our year-to-date results. So far for fiscal 2023, our cost initiatives are ahead of schedule and have delivered $30 million of year-over-year savings, which is in line with our original target, and we are now expecting to capture approximately $35 million in total for the full year. We have also delivered significant improvements in free cash flow. Year-to-date, we have generated $54 million of free cash, which is up $53 million compared to the free cash generated year-to-date in 2022. Supporting our free cash flow initiatives, the efforts to optimize working capital are also taking hold as we stabilize inventory returns from the significant headwinds we experienced in 2022. Lastly, as we have highlighted in prior calls, Holley is intently focused on paying down debt and reducing leverage. In line with this commitment, we were pleased to pay down $25 million in principal against our first lien term loan facility in September. On Page 13, we've laid out a summary of key income statement line items. As…

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] Our first question comes from the line of Brian McNamara with Canaccord Genuity.

First, I'm curious how Sniper 2 has been received, particularly at SEMA last week, given as I believe it was the first time you did new product seminars with it. And if you care to share how revenues are trending on the product relative to your expectations.

Brian, this is Matt. I mean we're very excited about Sniper 2. As you saw in the prepared remarks, won those global media awards and received a ton of attention at the show relative to our training sessions and both with the consumers that attended the show towards the end of the week and our distribution partners in the beginning half of that week. And it's a product that really is going to example how we move forward on product launches in the future by really partnering with the market getting it ahead with a proper launch calendar, partnering with our distribution to make sure we have inventory in stock and are driving the right promotional and consumer engagement efforts around it. So very excited about where that's trending. As right now, we're going to give specific revenue on products, but we're very excited about where it's headed.

And then secondly, I mean, I know Jesse kind of covered this a bit a few moments ago. Your implied Q4 guidance on the top line is pretty wide, I think minus 9% to plus 11%. I know the benefit of past dues lining down as part of that. But are there any other puts and takes we should be aware of?

No, Brian. I think that the main thing on the top line piece that we're continuing to focus more and more on is we've done a great job on the past due side is just what the order trends look like. And I would say that in the guidance, we're looking at flat to slightly positive on order trends. And on the past due side, we're looking to make continued progress there. And hopefully, based on the path that we have as a team internally, get that down to $4 million by the end of the year. And so I think one of the things that we called out in this is we feel like really good about the work the team has done on cost to serve and the continued opportunities there to be able to prop up the EBITDA margin even in light of any headwinds in the range on the top line. But this is, hopefully, that gets you what you need on sort of the drivers there.

Our next question comes from the line of Joe Altobello with Raymond James.

This is Martin on for Joe. I was just wondering if we can get a little more color around gross margin expansion? I know you said 600 bps and it included a meaningful price, some mix and lower warranty costs. Just wondering if we can get some idea around what those numbers are that bridge and whether that's sustainable going into the New Year?

This is Jesse. The big part of this on the gross margin side, just to kind of give you some rough numbers, about nearly 550 to 600 basis points of it alone is just from freight and with the next piece of it really largely being the warranty expense. I think as a reminder, Q3 of last year, we had a pretty meaningful warranty charge as it relates to one of our key suppliers actually sending us a lot of warranty claims a little late in the process versus what we're typically used to. So those are the big drivers. We did call out a slight benefit from product mix, but the 2 biggest ones, like I said, were freight and warranty expense.

I know you mentioned you want to get down to about $4 million in past dues. Just wondering if this is evenly spread around your segments or is it going to be particularly electronics? Just trying to get an idea of that mix?

Yes. I mean I think you can see in the mix, electronics versus non-electronics. We ended the quarter with electronics at about $5.5 million. We have to make progress on all of them. We've traditionally seen that in Q3, Q4, we do make good progress on those. And I think one of the areas that we called out thus far in the call, that's always been for at least a while, not always, but for the last several quarters, question mark is on the electronics procurement for chips. So seeing that, we've got that chip supply procured and the team is actively working very quickly to get these products created and out the door and the visibility we have on the inventory side and non-electronics, we feel like we should make progress across both big buckets to be able to get us down to [$4 million], which is generally what we would expect is an ongoing sort of sustainable level with some slight improvement from there kind of at some point next year.

Our next question comes from the line of John Lawrence with Benchmark.

Quickly, Matt, as you talk about redesigning the organizational structure, and I know Sean has moved up into that product development. Can you talk a little bit about now that you've had a little bit more time to put that together. What's the real benefit? Is it better speed to market? Is it a broader sense of priority of like the Sniper 2 of something coming to the forefront quicker to get to market, explain the process a little bit and how you think that benefits you in the next couple of years?

We're really excited about this direction we're headed in the organization. And I think you touched on a number of the major points. It's really about unlocking growth and driving that speed and growth. And when you look at where Holley has been really successful in the past around classic truck, classic muscle and modern muscle, there are segments that range from really about $1 billion to $2.5 billion each in the SEMA data. When you look at really where some of the large growth opportunities are like modern truck, that's over $14 billion. You look at euro, Asian imports, which are both over $7 billion, then off-road, which is about $6 billion. Now it's really setting up our vertical leaders to unlock growth in these other categories, which I'd say, have not been primary focuses in the past. And at the same time, within those verticals, there are certain platforms that really people want to modify and that are the picks of the enthusiasm. And we want to make sure we're bringing comprehensive solutions to the forefront of the market quickly to go after those platforms. And so with those changes as well as this highly structured phase gate system in the organization, we can now uncover the product innovation faster and make sure we're resourcing it to bring it to market more quickly and prioritize those opportunities. So we're really excited about the focus this is going to bring, bring us closer to the consumers and drive the growth.

Our next question comes from the line of Phillip Blee with William Blair.

This is Sabrina [ph] on for Phil. How did the direct-to-consumer business performed during the quarter? And what was the percent of sales?

This is Matt. As we talked about on our last earnings call, our goal is to meaningfully grow D2C as well as a number of other channels in our business. But with that said, throughout our business, there's going to be a lot of ebbs and flows relative to that D2C percentage as a total percentage of our business. And we just don't think that indicating on a specific percentage is the best indication of the performance of the overall business. We encourage you to look at the top line and bottom line growth of Holley in the future.

Our next question comes from the line of Christian Carlino with JPMorgan.

My first question is on what's your general view on the current health of the enthusiast customer? Are you seeing any increased caution from either resellers or the end customers later in the quarter and quarter-to-date? And that's my first question.

As I had in my prepared remarks, Q3 for us is typically our lowest order demands from a seasonal perspective. And we're seeing those order demands normalize, as we've talked about in previous quarters, there's a lot that happens in the fourth quarter in terms of as our enthusiast consumers start to buy products, they prepare for their builds that they begin in the winter, ultimately to have those cars on the road in the late spring and the summer. So there's a lot that goes on in the fourth quarter for us and various historic promotions and things of that nature. So really looking forward to seeing how the demand shakes out over the fourth quarter to get a better gauge of what we're going to see going into '24.

And I guess, depending on the top line. But as you look ahead, how should we think about the path to the 40% gross margin and 20% EBITDA margin targets? Is there enough self-help and cost savings that you can get there without hitting the 6% to 7% top line growth?

I think that as Matt has been here, and we've talked about the cost to serve project and the work that we've done that I think you can see some of the results in Q3 and Q4, we do think that there's still opportunity for us to drive further efficiencies in the operations in our cost overall to yield even better margins at comparable sales levels. I think it's a little early for us to say exactly when we would hit the 40%-20% as it relates to growth, I mean, growth would be a part of that equation. But long term, this industry has demonstrated resiliency in most markets. And as we get into '24, we'll have a better sense as we see Q4 and the first few weeks of Q1 of '24, to be able to give you a sense as to that 40%-20%, something that we would be able to achieve in the next 12 months or what does the timing look like? But nothing has changed structurally. Like we said before, in the industry. There's no Netflix moment in the auto aftermarket that gives us any caution to say anything other than getting back there is definitely achievable from what we can tell today.

Our next question comes from the line of Joe Feldman with Telsey Advisory.

I wanted to just kind of follow up on that last question about the gross margin. Like I get the 40%-20%, longer term, it will take some time. But what about in the near term? Like should we assume you guys can sustain this kind of high 30s, 37% plus in the next 12 months or so? Or like should we start to see a more steady rate over the coming months?

I think it's important to kind of look back at historical trends in the quarterly seasonality of this margin, not to get into the accounting nature of our business being a manufacturer business with cap variants and all those fun things. But when you look at sort of Q1, Q2, it's typically when we see our higher gross margin rates as we get leverage on fixed costs and then Q3, Q4, I mean, I think it's pretty sequential as you can see, we dropped from a revenue perspective due to seasonality, about $20 million from Q2 to Q3 with 50% flow-through in any given short period of time, that explains sort of that drop quarter-to-quarter. And what we're targeting when we say 40%-20% is not necessarily any given quarter. Otherwise, we would have probably rung the bell in Q2, but rather a full year view of what the margin profile would look like for gross margin and EBITDA. And so that, to Christian's earlier question is what we are trying to get our arms around for what is the timing of being able to achieve that. And I think to what Matt said and I repeated, seeing how Q4 shakes out in the early parts of Q1, we'll have a better indication as we finish up our planning for next year.

And then another question on just capital allocation. How should we think about capital allocation now? You've done a great job managing the balance sheet and we have made some [indiscernible]. Should we assume there's more to go there? Or will it be more continuing to invest in growth of the products? How will you allocate capital?

We've repeated throughout the year that getting our balance sheet in line and paying down debt with excess free cash flow, which we've generated a pretty meaningful amount this year and demonstrated our commitment to that with what we did in Q3 is our primary focus from an excess cash perspective. I think as a reminder, this is a capital-light business. I mean, to be spending roughly $6 million to $8 million in capital in the year with a business that's generating this level of revenue, I think it shows you it doesn't take a lot of capital to grow the business overall. So I wouldn't suspect if that's kind of what you're looking for. Could there be investments on the capital side that would get in the way of us meeting our debt commitments? That is not at all something that we view as a real issue here as we drive for growth.

So we should expect a little bit more of excess cash being used to pay down debt, I guess, in the near term?

Well, as we see how the cash profile looks throughout Q4, it's something that, as we said in our last call for Q3, we were looking at, but we're not going to make any commitments at this time on what we would do with that. We just need to really see how the cash profile looks and have a discussion internally and with our board about what the right moves are.

Our next question comes from the line of Michael Baker with D.A. Davidson.

So one clarification and then one follow-up question. The clarification, just to be sure I heard it right. So you raised your full year sales guidance towards the middle to high end, but you're saying the fourth quarter should be towards the low end of the implied guidance. I just want to make sure I heard that right?

Yes. I think whenever you do those squeeze, Michael, that is exactly what we're saying is whenever we take a view of the range, we feel like it's -- based on what we've talked about seeing the revenue come in towards the mid to low end of the range for the Q4 implied number and the EBITDA being at the midpoint to slightly above and based upon what we talked about, which is feeling good about the cost savings that have been put in place and the efficiencies that we are seeing to kind of make the shape of that relationship work is where we would point investors for this call.

So maybe I'll try to squeeze 2 questions into the follow-up. One, last quarter, you said third quarter and fourth quarter combined would be about 48%-52% split. It seems like, I think if I'm doing my math right, that might be a little different now. So what's changing? And then the real follow-up question is there's been no comments on like sell-in versus sell-through, what you're seeing from your customers in terms of stock levels, destocking, et cetera? Any color you can provide on sell-in versus sell-through or those kind of metrics, I think, would be helpful.

Yes. It's a good question. And I would say, to your point, you're reading what we talked about and what we're guiding to right now, just right on where from a shipment perspective, I think what we are seeing based on our imputed guide here is about a 50%-50% split between Q3 and Q4. The order split, I think, is really kind of what has changed there where we've seen the order trends that we're taking a look at and the promotions that we're putting in place, fully expecting these to be big drivers for Q4. But I think it's the question of the timing of when those come in and our ability to get those out because a lot of these orders come in, in December and needing to kind of put all cylinders in gear, if you will, to get those out would really make the difference on how we're able to get more to that 48%-52%. But based upon what we're seeing now and what we're in this call, we feel like the guide kind of gets you more to the 50%-50% split. Can you repeat your second question because that's a lot of questions.

Just sell-in versus sell-through, anything you can tell us about what you're seeing in terms of POS from your customers?

Yes. I mean this is something that we do look at. I would say that we've talked about it a bit in the previous calls. We're not giving those specific numbers. But I would say that trends improved between Q2 and Q3, but certainly something that we continue to look at. And I would say that what we're seeing is imputed in our guide here.

It looks like we have reached the end of question-and-answer session. I'll now turn the call back over to Matthew Stevenson for closing remarks.

Thank you. Slide 24 highlights the compelling thesis around Holley. This is an incredibly attractive market, driven by automotive enthusiasts. And this is not just a hobby for our customers. It's their passion and it's a lifestyle. And because it's more than just a hobby and trend, it weathers economic cycles extremely well. We have a massive addressable market, nearly $40 billion that has seen decades of uninterrupted growth. Holley is the industry powerhouse with a portfolio of iconic brands with a history of innovation. Plus, we have a track record of successful acquisitions and creating value through integrations and 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 our brands. This will create a competitive advantage and drive growth. All this leads to an attractive investment thesis with the business focused on delivering consistent organic growth of at least 6%, 40% gross margins, 20-plus percent EBITDA margins, sustainable free cash flow and a platform that enables value to be unlocked in strategic acquisitions. The combination of the attractiveness of our automotive and enthusiast marketplace and the great portfolio of Holley brands offers a fantastic investment opportunity. Before we close, I want to thank all our teammates for everything that they do every day to deliver for our customers. I want to thank our incredible group of consumer enthusiasts who support our brands as well as our distribution partners, many of whom have been with us for decades. And I want to thank you for your time today on the call. We look forward to continuing to update you on our progress in future quarters. I hope everyone has a great holiday season that's in front of us, and we look forward to talking with you in the New Year. Thank you, and have a great day.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.