Greetings and welcome to the Holley Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ross Collins, Investor Relations. Thank you, Ross. You may begin.

Thank you, operator. Good morning and welcome to Holley's fourth 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 businesses 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 fourth quarter and share our guidance for the first quarter and full year 2024. As always, we'll leave time for your questions at the end. With that, I'll turn the call over to our CEO, Matt Stevenson.

Thank you, Ross, and good morning, everyone. Since joining Holley nine months ago, it has become increasingly clear to me that we have only just begun to uncover the vast potential for growth that this remarkable company possesses. During today's call, we will delve into the details of our organization's comprehensive transformation and the key areas we are focusing on to unlock this growth. We will also highlight our emphasis on the consumer verticals and how we plan to position our offerings in the market. But first, I'll discuss the results of the fourth quarter. I'm incredibly proud of the Holley team and the effort they put forth in 2023, a tremendous amount of change and hard work to deliver a year that was pivotal in the stabilization of the company. All this effort paid off as we delivered a solid Q4 and came in at the top end of our guidance for the year on adjusted EBITDA. Now let's take a look at some of the highlights from Q4 on Slide 5. If you take away one thing from our presentation today, it should be that we are laser-focused on unlocking growth while delivering annual gross margins of 40% and adjusted EBITDA margins of 20% or greater. For Q4, on the top line, we delivered another quarter of year-over-year revenue growth, which makes two in a row for us. Although that growth engine is not yet where we want it to be, it shows we are headed in the right direction. Our margins have also significantly increased year-over-year, thanks to improvements in our cost to serve efforts and effective management of our discretionary spending. Free cash flow was up substantially over the prior year, and with such strong cash flow generation, we were able to prepay another $25 million…

Thank you, Matt, and good morning, everyone. We are pleased with our fourth quarter results, which capped off a year of many accomplishments. On Slide 14, we've highlighted our fourth quarter results and key financial metrics, which include a second consecutive quarter of year-over-year sales growth and meaningful improvements in both gross margin and adjusted EBITDA margin. Our team has done a fantastic job boosting sales and margin by cutting costs as we planned early this year and improving operations through our cost-to-serve efforts in the back half. Gross margin for the quarter was up 800 basis points from 30.7% in the fourth quarter of ‘22 to 38.7% in ‘23. After adjusting for the product rationalization in Q4 of ‘22, gross margin for the quarter improved approximately 500 basis points year-over-year in ‘23. It was primarily driven by a combination of efficiencies coming from freight management, improved production management, and lower fixed costs from facility consolidations outlined at the beginning of the year. SG&A for the quarter was down $17.7 million versus the prior year. Approximately $13 million of the year-over-year improvement is coming from equity compensation, which was primarily driven by a one-time accelerated grant in Q4 of ‘22. The remaining year-over-year improvement was driven by a combination of outbound freight-related efficiency improvements and improved cost management efforts that were outlined earlier this year. Improvements in both gross margin and SG&A supported significant year-over-year growth in adjusted EBITDA margin for the quarter, which was up 850 basis points to 18.3% in the fourth quarter of 2023 versus 9.8% in ‘22. As shown on Page 15, we maintained our strong adjusted EBITDA performance and generated cash from enhancing our working capital strategy and inventory management. This led to free cashflow for the quarter of $29.9 million. This is consistent with…

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.

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Brian McNamara with Canaccord Genuity. Please proceed with your question.

Hey, good morning, guys. Thanks for taking the questions. I guess firstly, past dues came down $5 million sequentially. I think you guys had anticipated $10 million. Anything worth calling out there?

Yeah, Brian, I think when we were giving our guidance before, we were expecting a little softer order growth and more past due improvement. And it kind of came in flip-flops here with the work the team had done to really reengage some demand in the past dues actually. Unfortunately, on the mechanical side, we've got some work we're doing on the inventory improvements that we really need some more time to work through that. So that's an area that we see there's more improvement to come, but we weren't able to sufficiently get it through in Q4.

Great, and then to that point, orders are up nicely, I think up 7% in Q4, and obviously sales in Q1 are expected to be weak. I know you touched on this briefly. Can you kind of reconcile the difference between the two in order strength and maybe lower than expected out-the-door consumer demand and what gives you confidence that that improves as the year progresses?

Yeah, so the order strength, I think what we were seeing there is our resellers were coming into the quarter, really the back portion of the quarter, expecting to see much stronger demand on their out the door than they actually realized. So it's a little bit of they have to have the inventory in place to fulfill the demand and it just didn't play out the way they had anticipated. That is kind of bleeding into, obviously, Q1. And we talked about -- we haven't typically given a quarterly guide, but given the uncharacteristic nature of how Q1 is coming in, we felt it was important to. And as we've seen the quarter progress, here in the back half of February, we really started to see that trend improve pretty meaningfully to just give us confidence that as we get further into the year, Q2 and beyond, particularly in the back half, that the out-the-door trends at our resellers are actually improved and the initiatives that we've got in place to drive product launch effectiveness, the products we've got going on, the promotional strategies that we've got in place will actually really start to take off.

And if I could just squeeze in one final one on margins. The midpoint of your guidance calls for nice improvement on margins on flat sales. There's a school of thought out there that most of the benefit of your turnaround efforts are already flowing through the P&L. Anything worth calling out here in terms of maybe what's being underappreciated about the durability of margins in your business? Thanks a lot, guys.

Certainly. That's -- the biggest driver of that, Brian, is just going to be, we're able to maintain just general margin through pricing on the gross margin line, but we found additional cost savings efforts producing fruit particularly on how we're handling our returns and further efficiencies in our freight expense. That's the $5 million to $10 million that we called out.

Our next question is from Mike Swartz with Truist Securities. Please proceed with your question. Mike, is your line on mute? Hello, Mike? Our next question is from Joe Altobello with Raymond James. Please proceed with your question.

Thanks. Hey, guys. Good morning. So first question for you, Jesse, if you could quantify for us maybe the amount of excess inventory in the reseller channel right now and how confident are you that this is a one-queue phenomenon and doesn't bleed into the second quarter?

Well, Joe, we don't actually have the direct numbers of their actual inventory excess, but what we do track is where do they stand relative to where they should be on a comparable basis year-over-year. And when we look at last year, they were really well under-inventoried where they should have been, and this year we're saying they're $10 million to $15 million above where they should be. So hopefully that gives you -- at the end of Q4 obviously, hopefully that gives you what you need.

No, it does. I appreciate that. Maybe on a second topic, M&A, given the progress you guys have made on the balance sheet, it sounds like you're pivoting a little bit to a more aggressive stance. Could you speak to the pipeline right now in terms of quality of the assets that are for sale and maybe the valuations that you're seeing?

Yeah, I'll comment, Joe, relative to kind of the pipeline. I mean, we remain opportunistic with M&A for the right opportunities. In my prepared remarks, I commented that we're really using the market segmentation to inform our direction relative to our targeted categories and verticals that we're going after. So I think, a little too early to comment on specific multiples we're seeing in that pipeline. But a lot of great work's going on relative to unlocking our long-term growth strategy and making sure we have the right M&A to support that.

Okay, great. Thank you, guys.

Our next question is from Christian Carlino with JPMorgan. Please proceed with your question.

Hi, good morning. Thanks for taking our question. First, could you -- given the focus on strategic pricing, could you talk about how you're thinking about price realization and unit volume demand in ‘24?

Yeah, I think good question, Christian. I think from a unit volume demand in ‘24, just given that our current model would estimate we're going to do about 3% to 4% in price with flat sales, I think that kind of gets you there on where the units would go. I think with the efforts that we're putting in place to actually supercharge these launches, one of the things that we have yet to really realize and fully appreciate is the power of launching effectively. I think through some of the new product launches that we've got coming and the way that we're going to go to market, we anticipate there's potential upside there to get volume growing at a much faster pace than we've seen historically, but we're not baking that into the guide because we feel like it's important for us to fully understand it first.

Got it. That's helpful. And, could you talk about your channel expansion efforts? And is there any way you can quantify this, whether it's number of resellers you've been adding or the lift of sales from the new resellers, just to help us better understand the work you're doing there and maybe what inning we're in?

Yeah, Christian, I'll comment on that and thanks for the question. So relative to how we're looking at these verticals, we're taking a much more external than internal look in saying, hey, who are the top distribution partners within each of these verticals? And do we have the share and the relationship that we expect, given our great brands and our great products. So, I’d still say it's early innings, but we know who the leaders are in the segment. We know who we have great relationships with, and those that we have relationships are just embarking on. But it's just making sure we're using the market data and the segmentation to drive the directional growth versus just looking inwardly at where we've been historically in the past.

Got it. Thank you very much. Best of luck.

Thanks, Christian.

Our next question is from John Lawrence with The Benchmark Company. Please proceed with your question.

Great, thanks guys. Can you talk a little bit about, when you think about the new products that you've, the racing helmet, et cetera, can you just walk us through a little bit about how that path started, what led you to that product, and just sort of that pathway of introducing these new products? And I assume the new engine products that were released in the summer continue to add gains and help the profile.

Yeah. Good morning, John. Thanks for the question. Yeah, I think that is a great example of the collaboration we're driving internally between our various business units and consumer verticals. So for example, we have a gentleman that leads our off-road division and he's an adamant off-road enthusiast and he saw a gap relative to helmets in the market and then we had our safety division under Simpson of course does class-leading helmets and those two work together with their respective teams to say, hey what is missing in the features and benefits customers are looking for in a helmet, and then how do we best bring that to market? So things like that start a lot with the market knowledge our team brings. And then we have stood up a product phase gate system. Now we validate all the opportunities based on market potential, differentiation in the market, who we're competing with, what distributors we're going to partner with to bring it to market. So it's a much more sophisticated process than been in the past.

Great, thanks. And just a follow-up, Jesse, what's the cost of maintaining -- you're talking about shrinking inventory levels and 10,000 SKUs or whatever. What is the cost savings of reducing that inventory from a holding standpoint, et cetera?

Yeah. So good question, John. I think the net sales impact, like we pointed out here, is less than 1%. There is some cost savings as we kind of reduce complexity in the business and certainly carrying this inventory. I mean, in some cases, John, I mean, we're talking things that turn at well under half a turn a year. So you can kind of calculate the actual carrying costs from a cost to capital perspective. But then, one of the things that we talked about is, making investments in the organization and key capabilities. And we recently just executed a reduction in force to reallocate those savings that were associated with complex work that wasn't value add to help invest in some of these key capabilities. So, we've kind of done all this holistically in order to reduce complexity and put the right people in place here.

Great, thanks, good luck.

Thanks, John.

Our next question is from Joe Feldman with Telsey Advisory Group. Please proceed with your question.

Thank you. Good morning, guys. Question on the late fourth quarter slowdown in demand that your partners had saw. What was driving that? Was that because it was -- like, was that weather-related issues where it gets too cold to go outside and work on the car? Or was there something else at hand? Was it just, people weren't buying these products for holiday season, I guess? But maybe you could share a little more color there if you know anything.

So, Joe, we don't get a lot of intel beyond sort of what their actual out-the-door sales were in the quarter. We do get it monthly. What I can say is I think there was a bit more optimism going into Q4 just overall. And the trend didn't kink or anything in out-the-door sales for any of the given months in the quarter. It's just that they were looking for it to be a bit bigger than it turned out to be for them.

Got it. Got it. And as you started…

Let me build on that for a second. Let me build on that for a second. I would say for us, as we look at our best analog is our internal D2C, which we're not giving that specific numbers. We don't want to focus on it too much. We actually saw improving trends in the back half of the quarter. So that was actually encouraging just overall.

That's very helpful info. Thank you. And then maybe my follow up, I guess more for Jesse. I think I heard you right, if I heard you correctly, you said first half of the year sales would be 51% to 52%, which I think is consistent with historical. But after lowering the first quarter number, is it fair to say you're putting a pretty solid amount of emphasis on the second quarter now to come through? And it seems like a little bit above trend for the second quarter. So I just want to make sure I heard that right and maybe you could share a little more color on the thinking on that.

Nope, you're spot on. That is the implication. And we did see, out-the-door sales in April of last year were really weak. So we're rolling over a pretty easy comp for our resellers on that. And we've also got some efforts going into Q2 this year as we streamline this promotion and product launch strategy that should really start to help make Q2 a stronger quarter than last year.

Got it. Okay. That's helpful. Thank you and good luck, guys.

Thank you.

Thank you. Our next question is from Phillip Blee with William Blair. Please proceed with your question.

Hi. This is Sabrina on for Phil. Thanks for taking our question. How has the segment reorganization of new verticals affected your internal team's operations or go-to-market strategies for new products?

Yeah, Sabrina, quite substantially. As I mentioned in my prepared remarks, Holley has done really well in kind of the traditional segments and verticals of domestic muscle. And meanwhile, the largest segments of the market are actually in that modern truck and off-road, [your own] (ph) import, and large market and safety and racing. So internally, we're dedicating sales, marketing, and product planning resources, kind of each of those four major categories to make sure we continue our great success in domestic muscle, but at the same time, we're really unlocking growth in these other three categories. So now there's distinct teams that work together to make sure we're identifying the market opportunities, bringing the right things to market. And as Jesse touched on, really improving our execution relative to product adoption by really enhancing our product launch strategy and making sure all the elements of product planning, marketing, and sales are connected when we launch those products.

That's helpful. Thanks. Best of luck.

Thanks, Sabrina.

[Operator Instructions] There are no further questions at this time. I would like to hand the call back to Matt for closing comments.

All right. Thank you. Now Slide 22 highlights the compelling thesis around Holley. 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. Because it's more than just a hobby or a trend, it weathers the economic cycles extremely well. We have a massive addressable market, nearly $40 billion, that has seen decades of uninterrupted growth. And 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 in unlocking growth. We have a unique opportunity to create a transformative 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 a business focused on delivering consistent organic growth of at least 6%, 40% gross margins, 20% plus 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 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 they do to deliver for our customers every day. And 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 and look forward to continuing to update you on our progress in future quarters. Thank you and have a great morning.

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