Q3 2022 Holley Inc Earnings Call
Good afternoon, and welcome to the Holly third quarter 2022 earnings call.
At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
Please note this conference is being recorded.
I'll now turn the conference over to our host Ross Collins with Investor Relations. Thank you you may begin.
Thank you Diego good morning, everyone. Thank you for taking the time to join us today.
On the call with me today are Tom Tom Watson, President and Chief Executive Officer, Steve Trussell.
President of Finance and insurance Finance, Chief Financial Officer, Daniel <unk> Executive Vice President of corporate development and new ventures.
After their prepared remarks, we will open the call for questions now I will reference the safe Harbor provisions under the private.
Private Securities Litigation Reform Act of 1095. 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 materially from those reflected in the forward. Looking statements are included in the company's recent 10-Q S for an S. One 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 all.
Or does it at a later time Holly 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 would like to turn the call over to Tom Tomlinson, Holly's Chief Executive Officer Tom.
Thanks, Ross good afternoon, everyone and thanks for joining us today.
As part of the call today, we will be referring to a slide deck titled third quarter 2022 supplemental earnings information.
This deck is available for download on our IR website, investor Dot Holly Dot com.
As we stated in our press release. This afternoon, while we are encouraged by the sequential improvement we saw during the quarter our earnings fell short of expectations.
After decreasing further in July sales improved in August and September as we began to overcome supply chain related challenges.
Although sales for the quarter were down year over year, our shipment rates progressively improved within the quarter and sales in September were above prior year as highlighted on slide three.
Supply chain constraints peaked in July and then began to ease increased receipts of components from global suppliers allowed us to steadily produced and shipped more product in August and September . These.
These improving run rates in Q3 are illustrated on slide four.
Our suppliers of certain automotive grade micro chips also began to resume shipments during the quarter, which allowed us to progressively build and ship more of our popular electronic products. These suppliers have also provided improved visibility to future shipments.
As discussed last quarter, we acquired a large quantity of automotive grade micro chips on the spot market that were unusable. Upon initially receiving the weed.
We've now developed and validated a process to reprogram those chips restoring them to full functionality and enabling us to begin consuming them in production.
Challenges remain in the supply chain, we're focused on improving availability of components and increasing shipments.
Profitability was negatively impacted by lower production volumes that drove negative operating leverage and manufacturing inefficiencies, especially earlier in the quarter.
We also saw higher input costs from both inflationary pressures as well as scarcity related cost escalation in connection with automotive grade microchips.
Warranty costs were higher as resellers caught up on our backlog of warranty returns and higher inbound freight and other overhead costs are continuing to work their way through inventory.
Pricing actions taken midyear, partially offset these cost headwinds.
As sales increased in August and September we saw operating leverage turned positive resulting in progressively improving earnings although still below historical levels as a result of the aforementioned cost headwinds.
Channel inventory decreased by $8 $4 million in the quarter, although stronger shipments to resellers in September allowed us to begin rebuilding channel inventory, partially offsetting the decreases that occurred in July and August these.
These monthly channel inventory changes are set forth on slide five.
Underlying demand has remained solid despite our supply chain challenges.
<unk> do orders represent demand that we have not yet been able to convert to sales by shipping against orders placed by consumers and resellers.
Past due orders have remained elevated throughout the year.
As shown on slide six our steadily improving sales run rates in August and September allowed us to reduce excess past due orders by $11 $1 million in the quarter.
At the ended the quarter excess past dues remained elevated and were $36 million were looking forward to eliminating excess past due orders as supply chain conditions continue to improve.
We're pleased with the solid demand we've seen for our products at a time when consumers are stressed by inflationary pressures.
Our direct to consumer sales were up 11% and we saw enthusiast engagement continue to accelerate at our Holly owned events.
As highlighted on slide two DTC sales were up year over year, despite supply chain challenges that left us out of stock on many of our popular products.
DTC sales provide us with visibility into consumer behavior and insight into underlying consumer demand because DTC sales are not influenced by reseller purchasing decisions are.
Our DTC strategy is core to what we do and the growth in our DTC channel continues to be driven by innovation strong performance marketing content and social media engagement event expansions and new brand integrations.
Growing DTC sales remains a priority for our team.
With the improvements we realized within the quarter. We believe we're now better positioned to convert more of the demand we've seen into sales and supply chain conditions continue to improve and as we continue to execute operationally.
There is a lot more work to do to lower our cost and reduce our inventory levels and we see numerous other opportunities for further operational improvements.
Our team is aggressively pursuing strategies to drive higher productivity and lower our cost structure and we're continuing to make progress integrating acquired businesses in order to drive further synergies.
With so much work to do we're pleased to announce the appointment of Brian Applegate as interim Chief operating officer.
Ryan who has advised Holly on M&A since 2018 is a performance aftermarket industry veteran with a wealth of operating experience. He's a known quantity to our team and we're excited to partner with Brian to drive near term improvement in our operating performance.
As interim CEO COO, he will be focused on our highest priorities and largest near term opportunities in supply chain manufacturing and engineering.
Efforts in these areas will help accelerate our improvement initiatives and allow us to realize the benefits of these improvements more quickly.
We remain confident in the underlying profitability and cash flow generation potential of our business and we firmly believe that <unk> position as an industry leader with ample runway for long term profitable growth is unchanged.
I'll now turn it over to Vince to discuss recent M&A activity and consumer engagement.
Ginny.
Thank you Tom and good afternoon to everyone on the call that we did not complete an acquisition during the third quarter. We are progressing on integration as we have said on prior calls driving synergies from our past acquisitions enables holly to continue to maximize value creation within the year as we realize these savings on an.
MS basis, we will enhance our balance sheet strength and further improve our liquidity position and support of long term growth.
As a reminder, over the past 12 months, we have completed five acquisitions that were highly strategic and expanded our wide range of products during the quarter. We further integrated several of our acquired companies onto our internal ERP system, reducing overall costs and increasing operational efficiencies.
To provide an example, we closed on rates clip in late Jan and I am proud to report the team's success in completing our integration in early September to that and raise clip safety products are now seamlessly offered to resellers alongside our existing performance and safety offering and for the first time, so I'll direct to consumer through Holly Dot com.
Our existing digital platform.
I would now like to shift to our Holly owned consumer events.
As we have just completed a very productive event season highlighted by positive consumer engagement during the quarter Holly hosted its 13th annual <unk> East event in our hometown of bowling Green, Kentucky as.
As well as Holly Moe Party and Holly's Intergalactic Ford Festival in total our 2022 event attendance is up 12% from the prior year's events.
The growth in popularity of Holly's company owned events allows our team the opportunity to make an emotional connection with our enthusiast community learn more about our consumers and further bolster our idea bank for new products.
In addition, our events hosted in the bone in bowling Green continue to make a positive local impact in our community.
Last we are continuing to leverage content marketing as a way to engage and inspire and support our enthusiasm customers.
During our fall 2022 event season, Holly experienced a 52% increase in social engagement and our social media platforms experienced $6 4 million video views with that overview I'd now like to hand, the call over to Steve who will discuss our third quarter financial results in greater detail Steve.
Thank you Danny and good afternoon, everyone.
Holly delivered net sales of $154 8 million in the third quarter, a three 1% decrease from $159 $7 million in the third quarter of 2021.
Non comparable sales associated with acquisitions contributed $7 7 million or four 8% of year over year growth. The remaining comparable sales decreased by $12 6 million.
Or seven 9% compared to the prior year quarter offsetting the impact from the acquisition.
As we have stated in the past, we typically don't disclose monthly facing a result, but we believe it is important to illustrate how sales trends improved as the quarter progressed, we had lower sales early in the quarter with July seeing the worst of the impact we began to see improvements late in August and we saw a meaningful turnaround in sales performance in September .
As sales grew 31% year over year.
The headwinds that Tom discussed were the main reason for the weakness.
In July and August sales, although as the quarter progressed, we saw shipments improved.
Gross profit for the third quarter of 2022 decreased $16 $8 million or 25, 8% to $48 $4 million when compared to $65 2 million for the third quarter of 2021.
Gross margin for the third quarter of 2022 was 31, 3% compared to a gross margin of 48% for the third quarter of 2021.
Of the 960 basis point decrease in gross profit 510 basis points were driven by inflationary pressures in 290 basis points came from higher expenses associated with warranty costs. The remaining decrease came from loss leverage due to the lower sales volume.
Total selling general and administrative expenses increased by <unk> 3 million or 10, 5% in the third quarter. The increase in SG&A was driven by a $2 6 million increase in outbound shipping and handling cost related to inflationary pressures from domestic shipping companies and an increase of $1 million attributable to <unk>.
Acquisitions, partially offsetting these increases was a decrease of $1 6 million and add administrative and sales personnel costs, reflecting the company's implementation of recent cost saving initiatives.
Interest expense increased by five 9% from the third quarter of 2021 to $10 4 million, reflecting a higher level of debt and a higher effective interest rate.
We recorded net income of $31 6 million in the third quarter of 2022 net income for the third quarter of 2022 was favorably impacted by a $37 6 million.
Noncash decrease in liabilities for warrants and earn out shares on.
On an adjusted basis net loss was $4 $1 million versus net income of $4 6 million from the third quarter of 2021.
Adjusted EBITDA decreased to $16 4 million in the third quarter down from $35 $5 million in the third quarter of 2021. The issues. We have discussed which include supply chain challenges that disrupted sales and costs operational inefficiencies elevated.
<unk> expense and higher shipping expenses, where the core headwinds to our EBITDA performance during the quarter.
Turning to our balance sheet, we have seen a significant increase in inventory during 2022 inventory increased by $45 million from the end of 2021 to the end of the third quarter of 2022.
The largest factor in this increase is the higher cost of the items in inventory from inflation and higher freight costs. In addition, as the supply chain became more unreliable, we're holding additional safety stock in components for product, we cannot yet ship.
We are focused on improving financial performance and working capital management towards the goal of healthy cash generation.
We have maintained ample liquidity as we ended the quarter was $16 6 million in cash and have the full capacity of our undrawn revolver. Additionally, our leverage ratio remains below the level, where restrictive covenants apply and we fully expect that to hold true through our current outlook.
Summary of our liquidity profile can be found on slide seven of the investor deck.
Moving to our outlook for 2022 as you saw on our press release, we are updating our guidance, which now calls for annual net sales in the range of $695 million to $710 million and adjusted EBITDA between $118 million and $124 million.
We also adjusted our Capex expectations to be in the range of $14 million to $15 million, while we are maintaining our depreciation and amortization and interest expense guidance, which are between $24 million to $26 million and 33% to $35 million respectively. This guidance includes reduced spending to reflect the chat.
<unk> environment in the months ahead and takes our leverage ratio into consideration.
That concludes our prepared remarks and I'll now.
Now I'll turn the call over to Ross. So we can address your questions.
Yes.
Thank you.
And at this time, we will be conduct related.
Okay.
Absolutely Steve.
As a reminder, we said please limit yourself to one question with one related follow up as needed Diego. Please open the line for questions from our participants.
Thank you.
And at this time, well conduct a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue you.
You May press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
Our first question comes from Joe <unk> with Raymond James Please state your question.
Thanks, Hey, guys. Good afternoon, I guess first question I wanted to follow up on the commentary.
Regarding September it looks like trends did improve in the months and I look at your your guidance in at least the sales guidance assumes a further decline in sales in the fourth quarter. It looks like it worsened a little bit from Q3, So I'm curious I guess how October .
First half of November look did you see continued improvement.
And and and.
And do you think those issues that you saw on the supply chain side are going to continue throughout 'twenty, three or could we see them continuing to get better next year.
So from from the standpoint of the question around supply chain.
I would I would say that while we made improvements saw improvements on the supply chain there continue to be risks around supply chain.
One of the specific areas of risk I would mentioned is just in the availability of micro chips and while we have seen that improve when.
When we talk to the <unk>.
Manufacturers and distributors of those.
Those micro chips, there is still scarcity and when we talk about the fact that our receipts of microchips have improved.
Those specific microchip, we're talking about there is.
One that is used in our largest <unk>.
Electronic product line that uses those types of chips.
The second largest category.
Our product category or product line is where we are still seeing constrained chips and.
There is risk that we receive less chips.
And the remainder of the year then than.
And then we did in the second and third quarter.
And so you know.
Obviously this category.
Yeah.
A larger overall impact on our sales and so we're looking at.
The risks as well as the opportunities as we set our guidance going forward.
Okay. So just to be clear it doesn't sound like you're you're seeing anything getting worse in October and November .
But it sounds like you're just trying to lay out a more.
Our conservative outlook at this point.
Yes, Yes, I think we think that's fair.
Okay.
Okay. Thank you guys.
Our next question comes from Ryan Sundby with William Blair. Please state your question.
Hey, guys.
Thanks for the question.
Wanted to ask a little bit more on the warranty cost.
Kind of a onetime hit this quarter or should we expect that you had.
It continues to happen moving forward.
So we believe there was a backlog of warranty claims are warranty returns that were sitting at our resellers and a lot of those came in in in the quarter.
We.
We have provided for.
An increase in warranty.
Throughout the remainder of the year to ensure that.
That was our effort to to make provision for any additional warranty that would come in.
Okay got it.
And then thanks.
Thanks, Rob.
Progression that you provided.
Slides here.
Sticking on the retailer Destocking.
We did start to see that improve in September could you talk a little bit more about where inventory levels are today, how comfortable are you with them.
Should we expect to see more refill taking place in Q4 or is that kind of correct.
When you so we don't have perfect visibility to channel inventories.
But we're able to track the increases and decreases in channel inventories with our largest.
Resellers and basically win.
In this environment when you see channel inventory go down specifically in July and August .
That is primarily driven by our inability to ship our excess past due orders.
And as we saw our ability to ship improve in September .
There was an immediate improvement in terms of the channel the channel inventory.
So.
We're certainly working hard to drive continued improvement from a supply chain standpoint from a manufacturing operation standpoint, So we can get more throughput and ship more product.
And at this point, we believe that that will allow us to improve the channel inventory position.
Got it great. Thanks, I'll jump back in queue.
Okay.
Our next question comes from Christian Carlino with J P. Morgan. Please go ahead.
Hey, good evening guys. Thanks for taking my question.
So.
Not asking you know you're not guiding to 'twenty three but you've had a few events recently as well as the industry trade show. So I guess could you give us an update on some of the learnings.
Youre hearing going on in the industry what are your peers, saying.
And can you speak to any level of promotion ality or softness.
At least it for your peers or the industry more broadly.
So I mean, I think one of the things that.
Would be good to talk about here is the discussions that we have with many of our resellers.
<unk>.
They have indicated us that are to us that our competitors are also struggling with supply chain issues and they've indicated that our our performance is at the top of the performance that they're seeing from.
From our competitor among us and our competitors.
So.
We continue to see demand.
That is solid.
Solid our DTC sales continued to grow and again that's against the backdrop of.
Just being out of stock on so many of our most popular items and when you. When you don't have them in stock most consumers don't.
Don't buy them.
So.
That represents a <unk>.
Missed opportunity there.
I mean, I think there is a.
A lot of optimism this industry has historically grown year over year over year.
And.
We're just looking forward to being able to take advantage of that by.
Improving our shipping performance.
Got you that's all really helpful color and then I guess on the on some of the cost cutting measures.
Most of the margin decline is from just fixed cost deleverage, but.
Yes.
Do you have to get back to the price like prior trend of sales to return to mid mid Twenty's EBITDA margin or are there other areas of self help that you haven't implemented yet you have visibility to.
Well, we have visibility to opportunities in.
We have some extra help now with Brian Applegate coming on board as our.
Interim COO, so that gives us more bandwidth to go after these and so that's very much it's going to be our focus and that will allow us to drive sales higher.
As we improve our operations and then.
As we get the leverage associated with the higher sales and then as we reduce.
The various costs, we've talked talked about obviously that will further enhance profitability.
Got you, so youre not cutting into the meat of the business you're right.
All right sizing, our operations and Youll benefit from leverage on the other side of this as well.
That's correct and one of the things to think about is that we have a number of recent acquisitions.
There is more work to do there in terms of integrations and capturing synergies and the net debt.
That's just an ongoing effort.
Within the company to see.
See those costs come out and that will improve our position from a fixed cost standpoint.
Thank you.
Our next question comes from Alex Perry with Bank of America. Please go ahead.
Hi, Thanks for taking my questions.
Just first on slide three which I think shows sort of sell and can you maybe help us think about the sequential point of sale trends at retail in the quarter. I think you said retailer Destocking continued in July and August before recovering.
Your shrunk shipments in September , but does that imply that the point of sale trends didn't change given it just sort of led to rebuilding up inventory or did you also see.
The point of sale trends improve in the retailers that you have visibility into thank you.
So that the visibility that we have.
As.
Around our products and.
We because of our inability to ship.
The sell through the out the door sales have been.
Below what they could have otherwise been if we were shipping as we've seen shipping.
Our shipping rates improved we have seen the sell through and we have seen resellers now start to report it.
Increases year over year increases in their out the door sales.
That's very helpful. And then my follow up question was on <unk>.
Gross margin. So I mean, how should we think about <unk> gross margins here should we expect a similar level of compression as we saw in the third quarter.
What would be the sort of puts and takes here for looking at trying to model out for Q gross margins. Thanks.
Yes, you should expect to see similar type.
Compression in the fourth quarter as some of the factors that hit us in the third quarter are going to continue.
Higher freight costs continued inflationary pressures.
On our component costs.
Perfect. That's really helpful best of luck moving forward.
Thank you.
Thank you just a reminder to ask a question press star one on your telephone keypad.
Our next question comes from Joe Feldman with Telsey Advisory Group. Please state your question.
Yeah, Hey, guys. Good afternoon, I actually wanted to follow up on that last question too.
We think about.
A new level of gross margin going forward or I mean is there any reason you shouldnt get back to the historic.
Historical percent nor.
Normally have or.
Are we going to see this kind of pressure for the next few quarters into 'twenty three as well.
It's our it's our intent to.
To restore.
Margins to historical levels.
So I mean, we.
We see.
An opportunity to do that and Theres a lot of work to do I think to do that but the team is very committed to making that happen.
Sure.
Okay got it thanks.
Just.
I was thinking.
With regard to inflation I know you called it out on the cost side, but I'm just wondering how much inflation is baked into the on the price.
At this point at retail is that.
Been much of an impact on driving sales.
So it is it has been pretty significant.
In terms of.
Over the last two or three years, we have adjust typically we make price adjustments once a year about mid year and last year in particular, we did three we did our increase.
This year.
In the in the mid June timeframe and that increase was about mid single digits. So.
We were able to get price. We're also mindful that our consumers are stressed so we've been careful not to push that lever to pull that lever too hard.
Sure.
Thanks, guys. Good luck with this quarter.
Thank you.
Thank you there are no further questions at this time I'll turn floor back to Tom Tomlinson for closing remarks. Thank you.
Thank you Diego demand has remained solid throughout the quarter demonstrating the resilience of our enthusiast consumers as supply chain pressures eased during the quarter, we saw sequential improvement in our production levels, which in turn drove higher sales and earnings. We are intently focused on driving further improvement in these areas in the <unk>.
Coming months and fully committed to the aggressive pursuit of near term opportunities to streamline our cost structure.
We remain confident in the underlying profitability and cash flow generation potential of our business and as an industry leader. We firmly believe Holly is positioned to capitalize on the long term favorable demand trends and the performance automotive aftermarket.
This concludes our remarks remarks for the day. Thank you for joining us and we will now end the call Goodbye everyone.
Thank you all parties may now disconnect have a great evening.