Holley Inc. (NYSE:HLLY) Q4 2023 Earnings Call Transcript
Holley Inc. (NYSE:HLLY) Q4 2023 Earnings Call Transcript February 28, 2024
Holley Inc. beats earnings expectations. Reported EPS is $0.01005, expectations were $. Holley Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: 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.
Ross Collins: 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.
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 in debt during the fourth quarter. Considering our $25 million debt paid out at the end of September, we have prepaid a total of $50 million in debt in just the last four months of 2023. As we discussed last quarter, Philip Dobbs, the former Chief Marketing Officer of Bridgestone, joined our team last fall. Under Philip's leadership, the team has identified numerous short-term opportunities to capitalize on, contributing to our positive year-over-year growth. While prioritizing quick wins in our operations, we're also fully immersed in a transformative journey to unlock sustainable, profitable growth by building best-in-class capabilities with experienced leaders, which we will discuss later in the call.
On Slide 6, you can see some of the high-level financial results for the quarter, in addition to some of the key business highlights. As I mentioned, net sales were up year-over-year and came in at nearly $156 million. Gross margins and EBITDA margins are up substantially year-over-year, 800 basis points and 850 basis points, respectively. Free cash flow was just under $30 million, which was dramatically up year-over-year, when cash flow was actually negative for this quarter in 2022. On the right side of the slide, you can see some of the business highlights for Q4. The product innovation pipeline continues to be robust, with many new products launched during the quarter. In the domestic muscle vertical, we launched the Flowmaster 2024 Ford Mustang Outlaw Axle-back exhaust, which enhances the sound, appearance and performance of both the 2.3-liter Ecoboost and the 5-liter engines.
In the off-road vertical, we introduced the Simpson Racing SD1 lightweight helmet, an engineered solution that combines our popular Simpson helmet styling with features specifically designed for dirt racing enthusiasts, such as an intake, exhaust ports, and improved cheek pad design for hydration and communication. In the Euro and Import vertical, our Dyna brand launched another popular cold air intake solution for the BMW M240, M340, and M440 platforms, all which share the B58 engine. Earlier in the year, we introduced a premium carbon fiber intake. And in Q4, we released a more affordable PEX version, allowing more Dyna fans to enhance performance, style and personalization of their BMWs. We have also improved our promotional capabilities.
One thing that we lacked before in our business was a thorough external communication strategy. With some outside support, we have created a media strategy to increase awareness of our products. In just the fourth quarter, we achieved 670 million media impressions with this strategy, which we believe is a very economical way to spread the news about all the excellent brands and products that we have to offer. In addition, we have made improvements to our sales promotion. Previously, our distribution partners were not included in our promotional efforts. This resulted in them not promoting our products as desired during these time periods, and in some cases even promoting our competitors' products to preserve their margins. We have addressed this issue in our new approach.
After involving our partners this year, we have witnessed the sales increase of more than 10% year-over-year during our Holley Days sales, which launched right before Black Friday, and a 7% increase during our promotion that supported the performance racing industry event in early December. Now, our operations team works hard to ensure we have the right products at the right time, at the right place. This requires a lot of coordination, including managing our forecasting process, supply chain, manufacturing footprint, and our distribution center. All that has to work together to be successful. Through better forecasting and improved [sign-off] (ph) process, we are advancing and having better inventory availability of our top products. We also lowered past dues by $5 million this quarter.
And a major reason for that was increasing the availability of our top 2,500 SKUs by almost 5%. Thanks to the improvements in our processes, we generated an additional $14 million in free cash flow by reducing our inventory levels. On the left side of Slide 7, you can see the three core steering principles that guide us. We aim to turn these principles into reality by concentrating on the four main areas on the right. The first one is about our teammates and making Holley a great place to work. The second area is about improving our operations to not only eliminate unnecessary activities that increase costs, but also ensure we have the right products in stock and the right inventory levels to meet the market demand. Moreover, we must provide our enthusiast consumers and distribution partners with the best omni-channel customer experience in our industry.
The third key area is optimizing our acquisitions. Holley has added some great brands and businesses to our portfolio in recent years, and we appreciate their distinct characteristics. We must support these differences to help them succeed in their particular markets. We strive to ensure that there is no one-size-fits-all approach and that the appropriate structure is in place with leadership and accountability to help these businesses reach outstanding market growth in their respective areas. And finally, we are focused on putting all customers first. This includes not only our wonderful base of consumers, but also our loyal distribution partners. We are looking for ways to grow and extend our sales channels in an effort to reach and serve a wider range of enthusiasts.
In previous calls, we briefly mentioned the transformation taking place at Holley. During this call, we will delve deeper into the details of our progress and the key elements we are focusing on in this journey. Now Slide 8 shows this journey and the four major building blocks in making this transformation a reality. We're about midway through the process with more work ahead. We started by enhancing the core elements of accountability and empowerment such as improved communication, KPIs by function, and a daily rhythm of reporting and reviewing results, and the practice of major project and program reviews. We also define additional requirements of our leaders and what we expect from them. Then we started to sharpen our focus in the organization by segmenting the market and ranking the opportunities with the highest growth potential.
We brought more discipline into the business and used different data sources to identify quick wins and key priorities for the next 12 months. We then launched specific projects and programs aimed to take advantage of those opportunities. We also began partnering with our distributor to find ways to grow our collective business and brought in some new talent to help drive change. We are currently at the core of the transformation, where we are not only investing time in training our leaders in various aspects, but we have also recently completed a restructuring event that will help propel our organizations to new heights. This restructuring has enabled us to realign our company's go-to-market strategies around our customer verticals and bring in expertise and critical leadership functions, which will help drive our transformation and unlock key elements of our growth strategy.
Growth is at the center of everything we are focused on, and we believe there are four keys to unlocking this growth. Let's look at those in more detail on Slide 9. The keys to unlock growth for us include product innovation, promotional excellence, strategic pricing, and targeted M&A. As a leading consumer automotive enthusiast platform, we are focused on the needs of our customers in directing our resources towards the growing segments and categories of the market. To achieve this, we remove slow moving products from our portfolio and focus our resources on what matters. By implementing our product phase gate system, we are prioritizing innovation and focusing on high impact projects, accelerating their time to market. We're also revamping our product launch capabilities, which will ensure that all key elements of sales and marketing are aligned with the necessary resources to drive faster market adoption in both our B2B and D2C channels.
In terms of promotional capabilities, our aim is to be at the forefront of the industry. And in today's world, that means excelling in digital marketing. We are upgrading items such as our product data structure, SEO, paid search, and digital assets, which will ensure maximum awareness and adoption of our products. Now, enhancing engagement with our customers is always a top priority. For instance, in our customer engagement center where consumers call for advice and product information, we have significantly improved our answer rates and overall customer experience. Soon, we will launch a CRM system that will enable our team members to better serve our customers with more detailed information on their purchase history and the vehicles in their garages.
We continue to value our relationship with our distribution partners and strive to work together to increase sales of our products. For the first time in many years this past quarter, we involved them in our promotional programs and saw a significant year-over-year improvement compared to the same time period last year. Strategic pricing is another crucial factor in locking our growth potential. We strive to ensure that our products are priced competitively in each category and vertical relative to their respective value propositions. By utilizing the right analytical tools to maintain our competitiveness while taking into account the total consumer costs, including shipping to various locations around the country, we believe we can drive growth.
Additionally, we are currently developing programs with our distribution partners to increase market share and overall profitability, something that was not previously considered. M&A is an important part of our growth strategy. In future acquisitions, we'll be informed by our market segmentation and targeted towards the growth segments of the market where we feel there are gaps in our portfolio. In addition to expanding our product line, we will also consider potential acquisitions that provide additional capabilities. We believe that these key elements will unlock growth by enabling us to bring the right products to the market with faster adoption. We have frequently referred to our consumer verticals and have refined our internal view of them.
On Slide 10, you can see those consumer verticals. At Holley, we have been traditionally focused on the domestic muscle vertical and have achieved great success in that area. However, this vertical represents one of the smallest parts of the total $40 billion total addressable market. We have a portfolio of strong brands and products that should be well positioned in these other consumer verticals such as modern truck and off-road, euro import, and safety and racing. As previously mentioned, we are dedicating resources in sales, marketing, and product planning to foster growth in each of these. Part of our growth strategy involves positioning our product lines as comprehensive solutions for customers, rather than individual pieces and parts within each of those consumer verticals.
The automotive performance aftermarket can be a confusing landscape, and customers seek out experts on their vehicles to find all the key elements of performance. On slide 11, you can see two examples of how we are beginning to merchandise our products, transitioning from individual pieces and parts to complete customer solutions. The example on the left serves the off-road vertical, where we have numerous products under different brands to target the consumer's needs. We put those offerings under the umbrella of Holley off-road to provide the platform to market those solutions. In some verticals, we have brands that span multiple product categories. Under our Dyna brand, which targets BMW enthusiasts, you can get exhaust, intakes, tunes, suspensions, and many other components.
The example on the right is of our Dyna brand grouping products into performance packages, offering turnkey solutions for our customers. Given the extensiveness of the Holley portfolio of products and brands like these examples we just talked about, we felt that company’s naming needed a slight modification that you can see on Slide 12. Going forward, we'll be conducting business under the name Holley Performance Brands. We believe that this name better represents our identity in the breadth and depth of our market presence, which we believe is unmatched by any other company. Our focus is on growing in all market segments by providing customers with powerful solutions, not just individual parts. Now, I'd like to turn the presentation over to Jesse, who will discuss our Q4 and full year 2023 results, as well as our outlook and guidance for 2024.
Jesse Weaver: 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 the robust cash generation we have achieved throughout the year, and it is about a $31 million improvement compared to the same quarter last year. As you can see on Slide 16, our remarkable cash flow has allowed us to keep reducing our leverage. We ended the quarter with a net leverage ratio of 4.21 times, which is meaningfully below the covenant that is outlined in our amended credit agreement and down from 5.67 times at the end of the first quarter. This is also below the original debt covenant of 5 times.
As was announced in our December press release, we were pleased to prepay an additional $25 million in principal against our first lien term loan facility during the quarter, which when combined with the $25 million prepayment in September of ’23, allows Holley to recognize up to an estimated $2 million in annualized net interest savings. Now, taking a step back and looking at our full year ‘23 performance on Slide 17, our cost reduction efforts, improved working capital management, and significant improvement in past dues helped deliver an incredible year of EBITDA and free cash flow growth. Profitability significantly improved on both gross margin and adjusted EBITDA margin by 200 basis points and 300 basis points respectively, which supported meaningful improvements in free cash flow, which was up $84 million compared to ‘22.
Moving to Slide 18, early last year we laid out four key financial priorities for the year, restore historical profitability, improve free cash flow, optimize working capital, and de-lever the balance sheet. I'm proud to say we've accomplished these goals, which are evident in our full year results. As we enter ‘24, we will continue to focus on increasing total profit, free cash flow, and reducing debt as our main financial goals. Now I'd like to cover our Q1 and full year ‘24 outlook on Slide 19. For the full year 2024, we are projecting net sales in the range of $640 million to $680 million and adjusted EBITDA in the range of $125 million to $145 million. We expect ‘24 results to include capital expenditures of $8 million to $12 million, depreciation and amortization between $24 million and $26 million, and interest expense in the range of $50 million to $55 million.
As we remain focused on continued improvements in leverage, we are also providing a year-end net leverage target of between 3.5 times to 4 times. As a reminder, the significant improvement we achieved in lowering past dues in ‘23 helped our sales performance in ‘23. With past due balances now much closer to normal levels, our revenue guidance includes 2024 headwinds associated with past due shipments which were much higher in ‘23 and not expected to repeat at the same level in ‘24. I would also like to note that the midpoint of our 2024 sales and EBITDA range assumed the exit of unprofitable business lines and the rationalization of approximately 10,000 non-performing SKUs, which represent less than 1% of sales. In addition, we continue to drive efficiency in our business and expect to save another $5 million to $10 million in ‘24, above the savings generated in 2023, from improvements in return handling and reduced shipping fees.
These factors make us optimistic about improving the adjusted EBITDA margin as shown in the full year guidance. Specific to the first quarter of this year, we are expecting net sales in the range of $150 million to $160 million and adjusted EBITDA in the range of $27 million to $33 million. Several factors, both internal and external, helped inform our first quarter and full-year guidance ranges. Notably, our distribution partners experienced lower-than-expected consumer demand in late ‘23 that led to higher inventory levels at several of our key distribution partners. Distribution partners' elevated inventory levels have had an impact on orders and shipments in January and early February, with overall order and shipment trends improving throughout the quarter.
While these developments will likely impact our Q1 results, we believe that our sales and marketing initiatives, particularly improvements to our product launch effectiveness, will help lead to growth in the second half of the year. For the year, we're currently anticipating first half sales to account for 51% to 52% of total sales for the year, with year-over-year adjusted EBITDA margin improvement occurring after Q1. We expect to see a modest increase in our leverage ratio at the end of the first quarter, which is largely a result of slightly lower covenant-adjusted EBITDA in Q1 of ‘24 compared to the prior year. As year-over-year top line improves and margins expand throughout the year, leverage is expected to begin declining again starting in Q2 and reach 3.5 times to 4 times by year-end.
In the medium term, we are targeting a range of 3 times to 3.5 times, driven solely by the expected cash generation of the business. In periods where we are making significant acquisitions, we would expect to finance them with an accretive mix of equity and debt, and as a result, post-acquisition leverage may exceed our targets for a short period of time while we continue our efforts of making progress towards a 3 times leverage target in the long term. In closing, while we have seen some softness in Q1, we are confident in the resilience of this enthusiast-based industry. Plus, as you heard from Matt today, we are extremely focused on transforming the growth engine in ‘24 while simultaneously refining our cost to serve. We remain very bullish on the free cash flow generation of this business and are firmly on track to achieve our long-term gross margin and EBITDA margin targets of at least 40% and 20% respectively.
This concludes our prepared remarks. We would now like to open the line up for questions.
Ross Collins: 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: 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.
See also 15 Countries with the Most Beautiful Castles in the World and 20 Countries That Read the Most in the World.
To continue reading the Q&A session, please click here.
