Q3 2023 Holley Inc Earnings Call

Greetings and welcome to the Holly third quarter 2023 earnings call. At this time, all participants are in a listen only mode.

<unk> 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.

Now I'll turn the conference over to your host Ross Collins, especially relations you may begin.

Thank you operator, good morning, and welcome to Holly'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 week.

This webcast and the presentation materials, including non-GAAP reconciliations are available on our industrial 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, and as always we'll leave time for your questions.

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 Holly and I continue to remain extremely impressed by the team and the incredible opportunity that exists with this great company.

Not only their 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 of these opportunities and prepare organization for extensive growth.

During this call I'll highlight some of the transformation that is underway, including <unk>.

A new organizational structure focused on becoming even more consumer centric the development of rural bus product development cycle, increasing the engagement levels with our customers, including our great distribution partners.

Our cost to serve by taking a holistic look at our operations and adding new leadership talent to the team.

Plus we're transforming the company for the long term. We are also continuing to deliver in the short term through strong alignment of internal resources and an 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 five 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 continued to build a path toward our goal of gross margins of approximately 40% and EBITDA margins 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 continued the progress of bringing down inventory and past dues were forecasting and operational improvements.

Which has enabled us to improve our free cash flow and further pay down our debt.

The summer is always an exciting time for us regarding consumer engagement and it is the peak of our event season, and we had four amazing events in the third quarter that continued to show year over year increases in attendance.

As part of our transformation, we also rolled out a new organizational structure focused on unlocking growth in our consumer verticals and empowering our leaders in our product categories and brands.

We'll dive into this <unk>.

More detail in a few slides.

On slide six you can see some of the financial and ongoing business highlights from our third quarter.

Net sales were $156 million up 1% year over year for the quarter gross margins and EBITDA margins were both up significantly from the prior year.

Gross margins were 37, 3% and EBITDA margins were 19% as our lower fixed cost base and numerous operational improvements elevated the bottom line year over year.

Free cash flow was 21.7 million for the quarter.

A $32 million improvement versus the prior year.

This improvement was driven by solid operational performance and meaningful reductions in past due.

Inventory.

Now onto some of the business highlights for the quarter.

We continued our leadership in product innovation, introducing over 65, new products in the third quarter.

Including our new plug and play adapter kit for sniper one owners to upgrade the sniper too.

As you recall sniper too is our new electronic fuel injection system, which we discussed last quarter is a marquee product for us that as their mainstream EFI offering.

We also launched multiple accessories to enable dues is to swap the modern 7.3 leader Board Godzilla edge platform in the classic trucks and muscle cars include.

Including high Mount accessory driving oiling system, and a low profile cast intake manifold.

Plus we are expanding our offerings in modern truck new exhaust kids under our flow Master brand for the popular.

2022, it up Toyota tundra.

As the leading consumer platform for automotive performance enthusiasts, our events are critical for engaging consumers at the grassroots level.

Summertime is the height of our bad season, we held four major events this past quarter.

All four of those events were held on our home turf here in bowling Green, Kentucky.

First east Port fast deep experience in both party.

These events hosted over 75000 enthusiasts up over 12% year over year.

These events give us unparalleled direct connection with our consumers and allow us to understand firsthand, where the enthusiast automotive performance aftermarket trends are headed.

In addition to connecting with consumers in person digital engagement is critical to our success.

And through activating Aura Q3 events, we were also able to partner with popular social influencers with over 29 million followers, enabling us to continue to build out our digital community and social engagement.

To promote our sniper two launch we also worked with key digital media partners, such as Hot Rod garage H P Academy Motor trends engine masters afford muscle, which generated $4 8 million digital impressions.

We're also bringing in new leaders to continue to elevate our customer experience increased product innovation and drive growth.

We engaged a former chief marketing officer of Bridgestone to lead our customer experience marketing team.

That her efforts increased innovation to implement a comprehensive product stage gate system across our business.

We hired a new vice president of product manager with extensive experience at tier ones like Wabco.

We also see the OEM performance aftermarket as a growth vertical for us and hired a new leader with extensive OEM experience with major tire manufacturers and Fox factory to lead this for us.

As you'll see on slide seven we finished up last week with a strong presence at sema in Las Vegas.

We continued our leadership in product innovation by winning seem as best engineered wood products in the world with a new folly easy level fuel level Center, which uses lidar technology to precisely measure the depth of fuel remaining in your tank.

It prevents the need to set up flow type fuel level sensors, which saves time and improves the accuracy.

Pictured here accepting the award as Jamba cloud leader of a classic instrument in Detroit speed brands.

We also took home a number of global Media Awards. These awards our nominee by Premier journalists from throughout the world that come to the Sema show with a purpose of identifying of discovering what new products are likely to succeed in their home countries.

Included in that list were the following Holly performance products.

Our sniper to EFI system, our Detroit speed 1964 to 1970 Mustang Friedan kit in our Hooker Black car brands L. S swap stainless steel manifolds.

On the right side of the slide you can see another project, we're really excited about they debuted at sema.

Detroit speed brand, we are one of the Premier rescue my builders and that reputation gets recognized by some of the biggest celebrity names out there.

It gives us a platform to promote all the possibilities that hollie can provide on your next project.

At this year's Sema, we displayed a project we've been working on for comedian and actor Kevin Hart.

As an avid auto enthusiasts, we're delighted Kevin chose us further build on this 1969 Pontiac G T O.

In addition, our E P. Our brand which focuses on European platforms. Also wanted innovation award at Sema from one of our major customers for its direct turbo replacement kit for the Audi three point leader engine found on many 2000 eighteen's enough platforms.

Last quarter, we introduced you to our three fundamental steering principles you can see those on the left side of slide eight.

We expect to make these principles reality by focusing on four key areas to the right.

The first centers around our teammates and making Holly great place to work.

The second area, we focused on is enhancing your operations did not only remove non value added activities, but also ensure we have the right products available.

And the right inventory levels to serve the market.

Plus we must offer enthusiasm consumers and distribution partners, the best Omni channel customer experience in our space.

The third key area is optimizing acquisitions.

All he has acquired some amazing brands and businesses over the last few years, we realized that each of these has their nuances we miss fostered these differences to nail them to continue to deliver in their distinct markets. We are working to ensure that there's no one size fits all approach.

At the appropriate structures in place leadership and accountability to make sure. These businesses achieved outsized market growth in their respective areas.

Finally, we are putting our focus on all customers first.

This not only includes our fabulous based consumers, but also are loyal distribution partners were finding ways to grow and expand our sales channels in an effort to reach and serve a broader range of enthusiasts.

On to slide nine.

The transformation occurring in our organization is extensive as we work to grow the company both organically and Inorganically. There are four areas, we'd like to highlight for today's call and they include the marketing and sales evolution cost of serve it has product development and the rollout of our new organizational structure.

When it comes to marketing and sales capability, there's a comprehensive evolution happening we are aligning our resources around the goal of increasing our customer engagement with both our consumers and distribution partners and focusing on our key areas of opportunity with the greatest impact.

On the distributor side.

Many more ways to partner with key distributors in a consumer verticals to win a larger share of their business and identified mutual growth opportunities.

We've also refocused resources be even more customer focused and have advanced what was our call center into a new customer experience and engagement center. This new pass with additional resources. It was rooted in providing the highest level of customer support.

We are investing in our digital capabilities, so often leading experience in our space to attract and convert more customers through our own as well as third party consumer distributor platforms.

We're also focused on improving our cost position through a project we put in place call cost to serve.

With some outside assistance it by combining data sources that were previously previously not available.

We're able to identify by product category the cost to serve various customer types. The.

The focus of this project is on both the inbound cost of the sourcing of the components for our product as well as the internal and external distribution of the product and after sales support that's required for us to serve the various channels.

No not really refining low hanging fruit with inefficiencies in our operation but.

But at the same time, we were uncovering ways to improve our <unk>.

Customer service.

Now that's definitely a win win scenario.

Product innovation is key to our business with so many great brands and categories, we needed a more refined structure a process to manage our product development efforts. This is Matt installing seven new consumer verticals with leaders to steer that development across the key platforms in categories.

We're also creating a robust product development roadmap by category and implementing a product development phase gate system with the golf filter out low return projects and elevating the highest priority product launches in the organization to ensure they are receiving the necessary resources to have successful market adoption.

To help unlock the potential of this great company, we're instituting a new organizational structure. This new structure better focuses on the needs of the consumer accelerated product development enhances customer service and drives clear accountabilities and responsibilities in the company.

The new structure is intended to be as cost efficient as possible.

Through in depth input from our stakeholders, we settled on a matrix structure. It comprises 10 product categories there'll be focused on executing our business plan developed in conjunction with our seven consumer vertical leaders, who will drive this strategy across the business as to what platforms and what products, we are targeting to bring them.

Market.

Additionally, we do have valid the support structure at the home office that ensures we are providing our leaders with the right amount of functional support and resources to execute their strategies efficiently and effectively.

One of the goals of this organizational structures to drive empowerment within our brands with guardrails of support and direction.

All of this change is required an extensive change management focus with greatly enhanced communication across our company.

On Slide 10, you can see our new consumer verticals.

These consumer verticals like very closely with how cement and other organizations in our space look at the market.

Now legacy Hollywood focused on classic truck and muscle, which.

Which we've shown a clear leadership position it.

But the biggest areas of opportunity based on our consumer market segmentation exist in modern truck Euro and off road, which is informing much of our go forward strategy.

With our vertical leaders focusing more on the needs of consumers, which includes where they shop what vehicles, they've purchased and what products. They are interested in it allows us to become hyper focused on delivering platform solutions.

The world of the performance automotive aftermarket is vast and confusing and consumers do not want to spend hours and hours trying to uncover who has what for the newer used vehicle. They just purposes.

They are increasingly going to specialists, who understand the verticals and the respective platforms in them.

Few companies if any have the opportunity to Holly does to present, a comprehensive platform offering with all the product categories recover.

We have significant potential for growth by focusing and organizing our products in a manner that best resonates with the consumer.

More to come on this in the future.

Now I'd like to turn it over to Jesse to discuss our financial priorities and our Q3 results in more detail.

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.

Did the quarter with year over year, net sales growth and strong improvements in profitability across both gross margin and adjusted EBITDA.

Matt already alluded to we believe our team's efforts to transform the organization.

Optimizing our operations are taking hold.

They're 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.

Our key financial priorities for the year than restoring profitability, improving free cash flow optimizing working capital and deleveraging our balance sheet.

These initiatives are firmly on track are evident in our year to date results.

So far for fiscal 'twenty three our cost initiatives are ahead of schedule and have delivered $30 million a 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've 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.

It's to optimize working capital are also taking hold as we stabilized inventory turns from the significant headwinds we experienced in 2022.

Lastly, as we have highlighted in prior calls how he is intently focused on paying down debt and reducing leverage in line with this commitment we were pleased to pay down $25 million in principle against our first lien term loan facility in September.

On page 13.

Laid out a summary of key income statement line items as I mentioned earlier, we were pleased to see a return to year over year net sales growth.

They have to get improvements in profitability as measured by gross margin and adjusted EBITDA.

On page 14, we've highlighted net sales for the quarter.

Increased $2 million or 1% versus Q3 of 2022.

Our net sales growth was largely driven by strong growth within our electronics category, which increased approximately 13% as the team made tremendous progress on past dues in the quarter from their proactive efforts on chip procurement.

Net sales in the third quarter benefited from $8 million and a reduction of past dues across both electronics and non electronic categories, which can be found on page 15.

This marks the seventh consecutive quarter of pass through reductions overall since the peak of $56 million in the fourth quarter of 2021.

And for the first time since 2020, we made meaningful progress on electronics past dues, which were reduced by nearly 50% down to five and a half million dollars.

As of the end of Q3 past dues on electronics for the lowest we've experienced since Q4 of 'twenty 'twenty.

Turning to gross margin on page 16, you can.

Can see that our gross margin of 37, 3% is up 600 basis points compared to 31, 3% last year.

This strong increase was primarily driven by meaningful improvements in freight lower warranty expense and some favorable impact from product mix.

Moving to slide 17, adjusted EBITDA for the quarter increased $13 3 million, which is an increase of more than 80% over the prior year.

This resulted in an adjusted EBITDA margin of 19%.

Which is 800 basis points better than the 11% adjusted EBITDA margin from Q3 of 2022.

Our year over year adjusted EBITDA improvement was driven primarily by operating improvements as can be seen in our gross margin results as well as lower SG&A expenses.

But the third quarter of 2023 S. G&A, excluding equity compensation was $26 million down 3 million from $29 million in the third quarter of 2022 three.

$3 million reduction, primarily driven by our efforts related to cost to serve and optimizing freight.

SG&A, excluding equity compensation at roughly 17% of sales versus 19% of sales in Q3 of 22 remains in line with historical trends for Q3 and reinforces the team's original commitment to cost containment coming into the year.

As can be seen on page 18, our EBITDA results for the quarter combined with cash generation from improvements in inventory resulted in strong free cash flow of $21 7 million.

Fortunately this is a continuation of the solid cash generation, we delivered last quarter.

It presents roughly at $32 million improvement when compared to the third quarter of last year.

Moving to slide 19, our free cash flow has been a significant contributor to the reduction in net leverage we have experienced year to date.

We ended the quarter, but the net leverage ratio of 489 times.

Which is meaningfully below the covenant that is outlined in our amended credit agreement and down from 5.58 times at the end of last quarter.

This is also below the original debt covenant of five times.

Our previously announced debt pay down at $25 million directly in line with our commitment to prioritize near term debt reduction and.

And at current rates is expected to reduce our cash interest expense benefit free cash flow by roughly $1 million on an annualized basis.

While we no longer need the amendment given our net leverage ratio is below the covenant originally put in place we are keeping it in place to ensure we have the financial flexibility needed to continue making progress on all our strategic initiatives.

In the near term, we expect continued strong free cash flow to support further debt pay down and will be providing investors with more guidance on net leverage targets during our year end call in early 2024.

Moving to slide 20, as it relates to Holly's long term debt profile I would like to remind investors that we proactively entered into costless interest rate collar earlier. This year that hedge is $500 million of our debt against three months so for rate fluctuations through February of 2026.

Taking these steps earlier in the year combined with our efforts to prepay our debt is greatly reduced our exposure to fed interest rate policy and set us up to continue making progress on both cash flow and maintaining our leverage below our original net leverage covenant of five times.

Now I'd like to cover our revised 2023 outlook on slide 21.

Given our year to date results, we are raising the bottom end of our net sales and adjusted EBITDA guidance.

For the full year, we're now projecting net sales in the range of 645 million to $6 75, and adjusted EBITDA between $123 million to 128.

While the reduction in past due this year is encouraging.

It does provide a tailwind to results, but as we look ahead to the fourth quarter and next year will be more intently focused on order growth trends forgetting our perspective, our near term performance.

With that in mind, a likely scenario could be that our full year revenue could be positioned in the bottom half of the guidance range, while efforts on operating efficiency and cost containment support our full year adjusted EBITDA to be towards the top half of its guidance range.

And on a sequential basis adjusted EBITDA would normally be expected to come down in the fourth quarter, which is consistent with historical trends.

This is largely driven by the impact of our holidays promotion and the step up in outbound freight and SG&A from an increase in sales going through our D to C channel.

Because a higher percentage of small parcel freight charges.

We are also narrowing our capex guidance range to between six and $8 million from the prior range of $5 million to $10 million.

Our depreciation and amortization guidance range has been adjusted to between $24 million and $26 million and our interest expense expectation, excluding the mark to market on the collar.

Unchanged and remains 58 million to $62 million in closing we are encouraged by the return to topline growth. We saw in the quarter supported by the significant reduction in past dues and most notably on electronics.

Year to date performance has been strong highlighted by our gross margin and EBITDA margin performance cash generation working capital management and focus on reducing leverage.

In addition, I'm, even more excited about the opportunities that lie ahead, and our long term growth prospects of Holly and the industry as a whole armed with leading brands and a strong focus on operational excellence, we look forward to continuing to build a path towards gross margins of approximately 40% and adjusted EBITDA margins greater than 20%.

This concludes our prepared remarks, and we'd now like to open up the line for questions.

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 again at this time, we will be conducting a question and answer session. If you'd 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 May also 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.

Handset before pressing the star.

Our first question comes from the line of Brian Mcnamara marrow with Canaccord Genuity.

Please proceed with your.

Yeah.

Hi, Good morning, guys. Thanks for taking our questions first I'm curious on sniper tier has been received particularly I've seen all of last week given all this 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.

Hey, Good morning, Brian This is Matt Yeah, I mean, we're very excited about our sniper too and as you saw in the prepared remarks, you know one one of those global Media Awards and I 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 are towards in the beginning half of that week and it's a product that really is Gonna example, how we move forward on our product launches in the future, but really partnering with the market.

Getting it a head 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 not going to give specific revenue on products, but we're very excited about where it's headed.

Great and then secondly, I mean, I know just you kind of covered this a bit a few moments ago. Your implied Q4 guidance on the topline is pretty wide I think minus 900, plus 11, I know the benefit of past dues winding down as part of that but are there any other puts and takes we should be aware.

No, Brian I think that the.

One thing on the topline piece that we're continuing to focus more and more on is we've done a great job on the past dues side is just what the order trends look like and I would say that in the guidance. You know, we're looking at flat to slightly positive on order trends and you know.

On the past dues side, we're looking to make continued progress there to hopefully.

Based on the path that we have as a team internally to get that down to 4 million by the end of the year and so you know I think one of the things that we called out and 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 you know.

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.

Got it thanks, a lot guys best of luck.

Thanks, Brett.

Our next question comes from the line of Joe <unk> with Raymond James. Please proceed with your question.

Good morning. This is Martin on for Joe I was wondering if we can get a little more color around gross margin expansion. I know you said, it's 600 bps and I included meaningful right some mix and lower warranty cost I just wonder if you can get some idea around what those numbers are that bridge and whether that's sustainable going into the new year.

Yes, Martin this is Jesse the big part of this on the gross margin side, you know 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 says.

Sending us a lot of warranty claims a little late in the process of 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 two biggest ones like I said were freight and warranty expense.

Got it. Thank you and 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 can be particularly electronics, just trying to get an idea of that mix.

Yes, I mean, I think you can see in the mix you know electronics versus non electronics, we ended the quarter with electronic said about five and a half million. We 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.

On the call, it's always been for at least a while not always but for the last several quarters. A question Mark is on the electronics procurements for chips and so seeing that that we've got that chip supply procured and the team is actively working very quickly to get these products created an 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 are to be able to get us down to four.

Which is generally what we would expect as an ongoing sort of sustainable level with some slight improvement from there kind of at some point next year.

Great. That's helpful. Thank you very much.

Yeah.

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

What's your question.

Hey, good morning, guys.

Quickly, Matt as you talk about redesigning and the organizational structure and.

Sean's 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 this is a better speed to market is it a broader sense of.

Priority of like sniper to something coming to the forefront quicker.

To get to market explain that process, a little bit and how you think that benefits us in the next couple of years.

Sure sure John and good morning, Yeah, we.

We're really excited about this.

Direction, we're headed in the organization and I think you you touched on on a number of the major points, it's really about unlocking growth and driving that speed and growth and when you look at.

Holly has been really successful in the past around classic truck you know classic muscle and in modern muscle. There. There are segments that range from really about 1 billion to 225 billion. Each in sema data. When you look at really where some of the large growth opportunities are like modern truck.

That's over 14 billion and you look at Euro Asian imports, which are both over 7 billion in off road, which is about 6 billion notes.

Really setting up our vertical leaders to unlock growth in these other categories, which I'd say have not been primary focus is in the past and at the same time.

Within those verticals there are certain platforms that really people want to modify and that are that are the picks of the enthusiast 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 you know this.

A 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 it bring us closer to the consumers and drive the <unk>.

Rose.

Great. Thanks, Good luck.

Thanks, John.

Yeah.

Our next question comes from the line of.

I believe with William Blair. Please proceed with your question.

Good morning.

Sabrina on for Phil Thanks for taking my question, how did the direct to consumer business performed during the quarter and what was that as a percent of sales.

Okay.

Hi, Sabrina this is Matt you know as we've talked about on our last earnings call. Our goal is to meaningfully grow D to C. As well as a number of other channels are in our business, but with that said you know there is through the router business youre going to be a lot of ebbs and flows relative to that DTC percentage.

As a total percentage of our business and we just don't think that you know, indicating on a specific percentage is the best indication of the performance of the overall business.

Encourage you to look at the topline and Bottomline growth of Holly in the future.

Okay. Thank you that's helpful.

Our next question comes from the line of Christian Carlino with J P. Morgan can you proceed with your question.

Hey, good morning, guys.

My first question is on you know what what's your general view on the current health of the enthusiast customer are you. What are you seeing any increased caution from either resellers or the end customers.

Later in the quarter and quarter to date and Oh that that's my first question.

Hey, Christian how are you doing this Matt good morning.

Hey, you know Christian is that as I had in my.

Prepared remarks Q3 for us is typically.

Our lowest order demands from a seasonal perspective, and we're seeing that you know those order demand.

<unk> you know normalize as we've talked about in previous quarters no. There's a lot that happens in the fourth quarter you know in terms of it as our enthusiast consumers.

<unk> <unk> byproduct to prepare for their builds that they begin in the winter you know 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 in very various historic promotions in and things of that nature. So really looking forward to seeing how you know the demand.

Shakes out over the fourth quarter to get a better gauge of what we're going to see going into 'twenty four.

Got it that's helpful and I guess, you know dependent on the topline, but as you look to as you look ahead and how should we think about the path to the 40% gross margin and 20% EBITDA margin target is there is there enough self help and cost savings that you can get there without hitting the 6% to 7% top line growth.

Hey, Krishna to Jesse I, you know I think.

This is Matt has been here and we 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 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.

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 you know as we get into 'twenty four we'll have a better sense.

As we see Q4 in 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.

Got it that's helpful. Thanks best of luck. Thanks.

Sure sure.

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

Yeah, Hey, good morning, guys wanted.

I wanted to just kind of follow up on that last question about the gross margin line.

Get the.

You know 40 20 longer term, we will take some time, but.

What about in the near term you know like should we assume you guys can sustain this kind of high thirties 37, plus in the next you know.

Fixed 12 months or so or like should we start to see a more steady rate over the coming months.

Hey, Joe It's Jesse I think it's important to kind of look back at historical trends in the quarterly seasonality of this margin.

You know not to get into the accounting nature of our business being a manufacturer business with cat variance at all those fun things, but when you look at sort of Q1 Q2. Its 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, but about $20 million from Q2 to Q3 with 50% flow through you know in any given short period of time that explain sort of that drop quarter over quarter over quarter to quarter.

And what were targeting when we say 40 20 is not necessarily any given quarter otherwise, we would've probably you know 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 Christians earlier question is what we are trying to get our arm.

Around four.

For what is the timing of being able to achieve that and I think to what Matt said and I repeated seeing how Q4 shapes out in the early parts of Q1, we'll have a better indication as we finish up our planning for next year.

Got it got it that's helpful. Thank you and then.

Another question on just capital allocation.

How should we think about you know.

Capital allocation now you know you you've done a great job managing the balance sheet and we paid some debt should we assume there's more to go there or will it be more you know continuing to invest in growth of the product or how.

How would you allocate capital that's the question. Thanks.

Thanks.

Good question.

We've repeated throughout the year that are 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.

<unk> is our primary focus from an excess cash perspective, I think as a reminder, you know this is a capital light business I mean to be spending eight.

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.

Our debt commitments.

That is not at all something that we view as a real issue here as we drive for growth.

Got it that's helpful. Thank you. So 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 you know 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 in and have a discussion internally and with our board about what the right. The right moves are.

Thank you good luck with the fourth quarter. Thanks, guys. Thank you. Thank you Jim.

Yeah.

Our next.

From the line of Michael Baker with D. A Davidson. Please proceed with your question.

Hi, Thanks, 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 is.

I just want make sure I heard that right.

Yeah, I think whenever you do the squeeze Michael that that is exactly what we're saying is whenever we take a view of the range.

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 mid point to slightly above and based upon what we talked about which is you know feeling good about the cost savings that have been put in place and the efficiencies that we're seeing to kind of make that shape up.

That relationship work is where we would point investors for this this call.

Okay.

So maybe I'll try to squeeze two questions into the follow up one last quarter, you said third quarter and fourth quarter combined would be about a 48% 52% split it seems like I think if I'm doing my math right that that might be a little different now so what's changing and then the follow up real follow up question is.

You didn't really there's been no comments on like selling 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 are those kind of metrics I think would be helpful. Thanks, Yeah. It's a good question and I would say you know to your point, you're you're reading.

What we talked about and what we're guiding to right now just right on where you go from a shipments perspective.

What we are seeing based on our imputed guide here is about a 50 50 split between Q3 and Q4 are the order split I think is really kind of what has changed there where we've seen the order trends that were taking a look at and the promotions that we're putting in place fully expecting needs to be big.

Big drivers for Q4, but I think it's a 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 all cylinders and gear if you will.

To get 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 were you know it.

This call.

We feel like the guide kind of gets you more to the 50 50 split can.

Can you repeat your second question because it's a lot of question Yeah I apologize. It just just sell in versus sell through I mean, you can tell us about what you're seeing in terms of Pos from your from your customers.

Yeah. I mean this is something that we do look at I would say that we've talked about it a bit in the in the previous calls without giving the specific numbers, but I would say that trends improved between Q2 and Q3.

But certainly something that we continue to look at it and I would say that what we're seeing is imputed in our guide here.

Okay fair enough. Thank you.

And as a reminder, if anyone has any questions you May press star one on your telephone keypad to join the question and execute.

Yeah.

And it looks like we have reached the end of question and answer session. I'll now turn the call back over to Matthew Stevenson Politicos remarks.

Alright, thank you.

24 highlights the compelling thesis around Holly.

This is an incredibly attractive market driven by automotive enthusiasts and this is not just a hobby for our customers as their passion and it's a lifestyle and because it's more than just a hobby or trend or whether it's economic cycles is extremely well.

We have a massive addressable market nearly 40 billion that athene decades of honor interrupted growth.

Holly 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 their brands. This will create a competitive advantage and drive growth.

All of 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 and strategic acquisitions.

The combination of the attractiveness of our automotive enthusiast marketplace and the great portfolio of Holly 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 and I want to thank our incredible group of consumer enthusiast, 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.

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.

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