Earnings Call Transcript
Dorman Products, Inc. (DORM)
Earnings Call Transcript - DORM Q4 2025
Operator, Operator
Good morning, and thank you for standing by. Welcome to the Dorman Products Fourth Quarter 2025 Earnings Conference Call. Please note that this conference is being recorded. I would now like to turn the conference over to Alex Whitelam, Vice President of Investor Relations. Thank you, sir. Please go ahead.
Alexander Whitelam, Vice President of Investor Relations
Thank you. Good morning, everyone. Welcome to Dorman's Fourth Quarter 2025 Earnings Conference Call. I'm joined by Kevin Olsen, Dorman's Chief Executive Officer; and David Hession, Dorman's Chief Financial Officer. Additionally, Charles Rayfield, who will officially step into the role of Chief Financial Officer following our upcoming filing of the 2025 10-K, is in attendance. Kevin will provide a quick overview, along with an update on each of our business segments and their respective markets. Then David will review the consolidated results before turning it back over to Kevin for our outlook and closing remarks. After that, we'll open the call for questions. By now, everyone should have access to our earnings release and earnings call presentation, which are available on the Investor Relations portion of our website at dormanproducts.com. Before we begin, I'd like to remind everyone that our prepared remarks, earnings release and investor presentation include forward-looking statements within the meaning of federal securities laws. We advise the listeners to review the risk factors and cautionary statements in our most recent 10-Q, 10-K and earnings release for important material assumptions, expectations and factors that may cause actual results to differ materially from those anticipated and described in such forward-looking statements. We'll also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the schedules attached to our earnings release and in the appendix to this earnings call presentation, both of which can be found on the Investor Relations section of Dorman's website. Finally, during the Q&A portion of today's call, we ask that participants limit themselves to 1 question with 1 follow-up and to rejoin the queue if they have additional questions. And with that, I'll turn the call over to Kevin.
Kevin Olsen, CEO
Thanks, Alex. Good morning, and thank you for joining our Fourth Quarter 2025 Earnings Call. As Alex mentioned, I'll start with our achievements in 2025, a high-level review of the results for Q4 and updates for each of our segments before turning it over to David. Let me start on Slide 3. As you'll recall, in last year's Q4 earnings call, we laid out a clear set of strategic priorities for 2025, critical areas where we planned to commit time, resources, and investments to advance our long-term goals. I'm pleased to report that we delivered on what we said we would do. First, innovation. We had an exceptional year with record sales from new products, launching thousands of new SKUs, including some home runs like the electronic power steering rack, along with many singles, doubles, and triples. We also made meaningful investments in our product development function. Our current new product pipeline is as strong as it's ever been, with a growing mix of opportunities involving complex electronic solutions, an area where we believe we have a distinct competitive advantage. Innovation remains the lifeblood of Dorman, and the progress we made this year positions us extremely well for the future. Second, operational excellence. We advanced productivity across the organization, including deploying new automation technologies in our distribution centers. These initiatives improved service levels for customers, enhanced availability for end users, and generated tangible savings. We see continued opportunity here, and we'll keep driving efficiency and performance across our facilities. Third, supply chain excellence. Despite a complex tariff environment, we executed as planned. In 2025, we further diversified our global sourcing footprint, meeting our goal to reduce supply from China to below 40%. Strengthening supply chain resilience remains a key priority, and we continue to build deep strategic relationships with suppliers around the world. In 2026, we expect our supply from China will further be reduced to approximately 30% of our total spend. Fourth, channel expansion. In both heavy-duty and specialty vehicle segments, we expanded our reach and won new business. With Dayton, we drove wins by leaning into categories where we had competitive advantages. And with SuperATV, we expanded our dealer network and nondiscretionary portfolio. Finally, strategic growth. While M&A activity in the aftermarket was quiet overall in 2025, we capitalized on organic growth opportunities across each of our segments and end markets with category and customer wins. On the M&A front, we deepened relationships with potential sellers and continued to evaluate new opportunities. We're hopeful that the coming quarters will bring more activity to the M&A market. Overall, our priorities were clear, and we executed with discipline. We're proud of what we achieved in 2025 and even more confident in the foundation we built for continued growth and value creation. Turning to Slide 4, these accomplishments translated into outstanding financial performance for the year. Let me cover a few of the highlights. Net sales reached $2.13 billion, up 6% year-over-year. Growth was driven by strong demand in our light-duty segment during the first half, as well as successful execution of our tariff-related pricing initiatives in the back half. While broader market conditions presented some headwinds for heavy-duty and specialty vehicles, the teams executed on their commercialization initiatives during the year. We also delivered meaningful margin expansion and earnings growth for 2025. Although cash flow was impacted by increased tariffs, our earnings strength and cash management strategy allowed us to continue investing in the business, further strengthen the balance sheet, and return capital to our shareholders. Our achievements and performance in 2025 are the direct result of the hard work and dedication that our contributors bring to Dorman every day. So I'd like to take a minute to thank and recognize everyone across the organization who worked tirelessly to navigate through the dynamic changes and challenges faced throughout the year, all while driving innovation, delivering operational improvements, and putting our customers and end users at the forefront of everything we do. I'm proud of the talented team we have at Dorman and what we've accomplished together. I look forward to building on the success in 2026. Speaking of talent, I also want to welcome Charles Rayfield as our new CFO. Charles comes to Dorman with extensive CFO experience in both privately held and publicly traded companies. I know a few of you have had the opportunity to make quick introductions, and we're looking forward to having Charles on our future calls and getting out on the road in the coming quarters. Next, on Slide 5, let me touch on the high-level results for the fourth quarter. Consolidated net sales were $538 million, up slightly from Q4 2024, but below our internal expectations. Our tariff-related pricing actions supported modest growth. However, shipment volume was down year-over-year due to a larger customer adjusting their ordering patterns in the quarter, which I'll cover in a moment. Despite lower-than-expected net sales in the fourth quarter, gross margins exceeded our expectations, allowing us to deliver adjusted diluted EPS for the year at the high end of our guidance range. A couple of factors I'll highlight contributed to this result. First, we shipped more pre-tariff, lower-cost inventory, driven in part by lower-than-expected volume in the quarter. Second, our team did a nice job managing expenses across the organization. Together, these drivers allowed us to report adjusted diluted earnings per share of $2.17 for the quarter. As we anticipated, cash generation improved sequentially with $42 million in operating cash flow in Q4. Additionally, we further strengthened our balance sheet and returned $25 million to shareholders through share repurchases. Finally, we are issuing 2026 guidance that demonstrates our confidence in delivering strong top-line growth through innovation and commercialization initiatives and reflects the timing impacts relating to tariffs. I'll walk through that outlook in more detail shortly. So while there are several moving parts in the quarter, I'm pleased with our year-end results and have confidence in our team's ability to continue executing on our strategy and drive strong long-term profitable growth. Next, let me provide our results and market observations for each of our business segments while highlighting some of our recent accomplishments in each. Turning to Slide 6, I'll begin with our light-duty business. Net sales in the fourth quarter were $429 million, up slightly over the same period in 2024. We estimate that POS at our large customers was up mid-single digits year-over-year for the fourth quarter. And when you look at POS over the entirety of 2025, it directionally aligned with net sales. As I just mentioned, the team did an excellent job executing on our pricing initiatives. This helped offset lower shipment volume resulting from a larger customer that significantly shifted their ordering pattern during the quarter to reduce inventory. Also, keep in mind that last year's fourth quarter was exceptionally strong with execution on a number of large programs. As it relates to the specific customer ordering change, we expect to see continued order fluctuations in the first quarter of 2026, with stabilization returning in the second quarter. Overall, we believe the nondiscretionary nature of our product portfolio and our new product development strategy will allow us to drive outperformance over the long term. Next, we drove stronger-than-expected gross margin, given more lower-cost pre-tariff inventory shipped during the quarter, partially as a result of lower-than-expected volume. We also drove continued savings with our ongoing supplier diversification and productivity initiatives. Operating margin was down slightly year-over-year, largely because of the higher factoring costs related to tariffs. Looking more broadly at the light-duty market, macro trends continue to remain positive, with VIO and vehicle miles traveled increasing year-over-year. Additionally, OEM platform changes continue to present opportunities for our new product development strategy, especially in complex electronics. On this point, we continue to invest in our complex electronic capabilities as EV, hybrid, and ICE vehicles are increasingly being equipped with more digital systems. We have the infrastructure and expertise to address complex electronic failures with more than 15 years of experience with data logging, electronics design, and co-development to provide our customers with sophisticated software-enabled solutions. Our current new product pipeline includes the highest proportion of complex electronics in our history. As an example of this, we recently launched a fuel pump driver module for a wide range of Toyota and Lexus models. Assembled in the U.S., this solution is precision engineered to replace the original equipment module, which can fail after exposure to heat and environmental elements. The fuel pump driver module showcases Dorman's ability to apply OEM-level electronics engineering and manufacturing in high-volume applications, with more than 2.5 million vehicles in operation across Toyota and Lexus platforms. This module allows us to bring our advanced power electronics capabilities to drivers looking for extended vehicle life with an easy-to-install and cost-effective solution. Great job by our product development team for identifying and bringing this opportunity to market. Next, let me turn to Slide 7 for our heavy-duty business. Net sales grew 6% year-over-year in the fourth quarter despite continued pressure in the trucking and freight industry. The heavy-duty team did a nice job executing on the pricing front while also driving more business wins. Operating margin expanded 130 basis points year-over-year as a result of the timing around tariffs, similar to our light-duty business. We remain focused on improving both our commercial and operational execution in the heavy-duty segment to achieve our long-term goal of mid-teens operating margin. Looking across the sector, the great freight recession continued in the fourth quarter, where tariff and general market uncertainty continued to add pressure on the trucking and freight industry. That said, softer new vehicle sales across the last several years have led to an increase in the average heavy-duty vehicle age, a trend which we expect to continue for the next several years. All in all, there continue to be mixed signals within the market, making it hard to predict the timing of a rebound. But we're tracking it closely, controlling what we can control and investing where appropriate to capitalize on business wins. One example of this would be the recent expansion of our medium-duty product offering and omnichannel approach. Medium-duty vehicles are typically part of larger fleets focused on last-mile delivery, used in ports, large campuses, industrial settings, and for deliveries to our homes and businesses. These are high-mileage vehicles, making many stops, so they experience quite a bit of wear and tear. Historically, fleet managers would rely on their dealer relationships for key repairs in their medium-duty fleet. However, through our wholesale distribution network and direct sales relationships, we're approaching this channel with an improved focus to provide fleet managers with more options and cost savings while maintaining these critical assets. On Slide 8, I'll provide an overview of the Specialty Vehicle segment. Top-line growth in the fourth quarter was flat year-over-year, with pricing initiatives on certain categories offsetting softer spending in the overall segment. Operating margin was down year-over-year in the fourth quarter, primarily due to increased wage and benefit expenses. I'd note that the overall change in profit dollars is relatively low, and the team did a nice job managing expenses in specific areas of the business that are more controllable. Again, longer term, we are targeting a high-teens margin profile for the business, supported by expanding new product pipeline, especially with nondiscretionary parts. While market challenges persist, UTV and ATV ridership remains strong. This condition remained consistent through 2025, so we're not seeing an impact on overall end-user demand for these products, just timing delays in purchases. New machine sales are also rebounding to 2024 and 2025 levels, and dealers have generally rightsized their vehicle inventory positions. We expect that as economic conditions improve, riders will resume enhancing and repairing their vehicles. On the new product development front, SuperATV continues to demonstrate its speed and agility in bringing solutions to the evolving aftermarket. We recently launched a 4-inch and 6-inch portal gear lift for the CF Moto UForce U10. As CF Moto's newest high-demand UTV hit the market, SuperATV was the first and currently the only manufacturer to deliver portal lift solutions for this model. Our portals enable riders to customize and elevate performance with the durability and capability SuperATV is known for. This patented early-to-market position reinforces our strategic advantage, the ability to evaluate new vehicle platforms quickly, engineer high-quality components, and release fully tested products ahead of competitors. Congrats to the SuperATV team on another successful launch. With that, I'll turn it over to David to cover our results in more detail. David?
David Hession, CFO
Thanks, Kevin. Turning to Slide 9, let me provide more detail on our consolidated results. Net sales in the fourth quarter were $538 million, up $4 million or approximately 1% year-over-year. As Kevin highlighted, our net sales performance across the enterprise was largely driven by our pricing initiatives. In addition to the tough comparison we had in Q4 2024, where we had strong growth, volume this year was impacted by a larger customer that significantly changed their ordering pattern during the quarter to reduce inventory. That said, we believe these timing shifts will normalize through the second quarter of 2026. Adjusted gross margin came in higher than expected for the quarter at 42.6%. This was a 90 basis point increase compared to last year's fourth quarter. As Kevin mentioned, this margin expansion was driven by more pre-tariff, lower-cost inventory shipped during the quarter, partially as a result of lower-than-expected volume. Supplier diversification and productivity initiatives across the organization also contributed to our strong margin performance. Adjusted SG&A expense as a percentage of net sales was 25.2%, up 100 basis points compared to the same period last year. The uptick was largely tied to increased expenses related to funding the higher tariffs, along with higher wage and benefit costs in the quarter. Adjusted operating income was $93 million and flat compared to last year's fourth quarter. Adjusted operating margin was 17.4%, down slightly compared to the same period. As we discussed in prior quarters, there has been continued pressure on the trucking and freight industry impacting our heavy-duty segment. As a result, we recorded a non-cash goodwill impairment charge in the fourth quarter of approximately $51 million after taxes. This is reflected in our GAAP results included in our press release, but has been adjusted out in adjusted diluted EPS. With that, adjusted diluted EPS in the fourth quarter was $2.17, down 1% year-over-year, but up against a very strong fourth quarter 2024. Interest expense was lower on debt reduction, and our tax rate was lower in the fourth quarter of 2024 due to discrete items that did not repeat this year. Let me quickly cover our full year results on Slide 10. As Kevin mentioned in our 2025 highlights, net sales increased 6% year-over-year with the first half driven by strong demand in our light-duty business and our pricing initiatives related to tariffs driving our performance in the second half. New products saw a record year of sales, and the commercialization initiatives we've discussed throughout the year were positive drivers of our top-line results. Operating income increased 17% over 2024, and operating margins were up 170 basis points to 17.8%. Again, this margin performance was driven by tariff-related timing dynamics, along with the supplier diversification and productivity initiatives driven by our segments. Let me also provide some additional color on our earnings. Adjusted diluted EPS was $8.87 for 2025, a 24% increase compared to the year prior. Now with full visibility of the impacts that the additional tariffs had on our results for the year, we thought it would be helpful to quantify this impact for the investment community. When including the timing dynamics of price and costs, along with the one-time miscellaneous expenses associated with tariffs, we estimate a full-year impact of approximately $1.25 to our adjusted diluted EPS. While this is purely an estimate, we thought it would help contextualize pre-tariff comparison to 2024 and set a framework for our 2026 guidance, which Kevin will cover in a moment. Turning to our cash flow on Slide 11. As we expected, cash generation improved sequentially from Q3 to Q4. While tariffs continue to impact our inventory spend, we drove $42 million in operating cash flow during the quarter, a $30 million improvement from Q3. This allowed us to repay $16 million of debt and resume our share repurchases with approximately $25 million deployed in the fourth quarter. While we covered this extensively throughout the year, our full-year operating cash flow was down 51% in 2025 compared to 2024. With capital expenditures essentially consistent, free cash flow was down 61% year-over-year. Again, the majority of this decline was tied to higher cost inventory as a result of tariffs. Looking ahead in 2026, we expect operating and free cash flow to continue improving before normalizing in the back half of the year. I'll reinforce that we ended 2025 with a strong balance sheet and liquidity position. Throughout the year, we successfully managed tariffs and higher cost inventory with our asset-light operating model and cash management, all while investing in key organic growth opportunities for the organization. As you can see on Slide 12, net debt was $391 million at the end of the year, which was down $42 million compared to the same time the year prior. Our net leverage ratio was 0.89x adjusted EBITDA compared to 1.12x at the end of 2024. And finally, our total liquidity was $648 million at the end of 2025, up from $642 million at the end of the prior year. I'll conclude by commenting how proud I am of the work our team has done to build the financial foundation that the company sits on today and look forward to seeing where Kevin, Charles, and all my fellow contributors take Dorman into the future. To the analysts and investors that I've had the pleasure of working with over the past 7 years, thank you for all of your support and confidence in our team. With that, I'll turn it back to Kevin to cover guidance before we get into the Q&A.
Kevin Olsen, CEO
Thanks, David. Let me dive into the guidance we are providing for 2026 on Slide 13. As we discussed in our Q2 and Q3 earnings calls, tariffs created timing nuances related to when price and costs took effect on our results. This created a tale of 2 halves in 2025, where the first half was on a typical price and inventory cost schedule and then pricing took effect in the second half without the associated higher cost inventory selling through. As we discussed today, this continued into the fourth quarter as we shipped out less inventory with the highest levels of tariffs. Therefore, we expect to see the higher cost inventory hit more in the first half of 2026 before normalizing later in the year. Starting with the top line, we expect total net sales growth to be in the range of 7% to 9% for the year and directionally the same range for each of the segments. This growth target reflects both a modest level of volume improvement over 2025, along with the impact of pricing. Two factors to keep in mind. First, we had a strong first half of 2025 from a volume perspective. Second, as we've covered in our last several calls, 2025 only saw increased tariff pricing begin to take effect in Q3. So the full-year impact is a positive. Let me provide a bit of additional color around cadence for the year. From a margin perspective, we expect operating margin to reduce temporarily in the first quarter, but we expect our margin profile will meaningfully improve through the back half of the year. This is because of the FIFO lag on reduced costs from lower tariffs, along with our continued supplier diversification, productivity, and automation initiatives driving more savings throughout the year. For the full year, we expect to deliver an operating margin in the range of 15% to 16%, with a more normalized high-teens rate as we exit 2026. As a reference point, if you look back to our performance in 2023, with the inflationary environment following the global pandemic, we had a similar situation where the business began the year with subdued margins and finished the year strong. We're expecting a similar cadence with operating margins this year. The point is we've managed through inflationary cycles before, and we have the playbook to handle the timing nuances. Next, for 2026, we expect a full year tax rate of approximately 23.5%. This could vary from quarter to quarter as discrete items are recognized. Finally, for adjusted diluted earnings per share, we expect 2026 to be in the range of $8.10 to $8.50. Let me provide some additional context around this range. As David mentioned, we estimate that the additional tariffs that took effect in 2025 had an impact of $1.25 on our full year adjusted diluted EPS. Excluding this benefit, our adjusted diluted EPS would have been approximately $7.62 or a 7% increase over 2024. And our 2026 EPS guidance range represents a growth rate of 6% to 12% on a comparable basis. Again, this is purely an estimate, but we felt it was important to help outline the overall impact tariffs have had on the business. From a cadence perspective, we expect that EPS will see the toughest year-over-year comparison in the first quarter, with growth rates normalizing towards the end of the year. I'll mention that this is more color than we ordinarily provide. But given the complexities and nuances with the timing impacts of tariffs and price, we hope it might be helpful context as we think about 2026. All this said, we continue to live in an environment with significant uncertainty as it relates to tariffs and global trade dynamics. The recent IEEPA ruling by the Supreme Court last week and the new Section 122 global tariffs announced over the weekend have added additional complexity and uncertainty. For clarity, our guidance today reflects an assumption that future tariff levels will remain generally consistent with those that were in place prior to the IEEPA ruling, and therefore, we expect the overall impact on our business will likely be directionally the same. Additionally, our guidance does not reflect any potential IEEPA-based tariff refunds that may be issued or claimed in the future. Should any material changes to tariffs or trade disruptions significantly impact our business or alter our expectations, we may look to update our guidance. Just to finish up on Slide 14, I'd like to reiterate my congratulations to our entire team for delivering strong performance in 2025 and operationally executing exactly what we said we would do. While there are a number of moving parts in 2026, our guidance reflects our ability to navigate through the challenges tariffs have presented and deliver strong long-term growth for our shareholders. We'll continue driving innovation for our customers and end users, further improving our commercial and operational execution, and strategically investing in opportunities where we can win in our respective markets. We value your partnership, and thank you for your support. Finally, I wanted to take a moment to thank and recognize David as this will be his last earnings call. Since joining the company in 2019, David has played an integral role in our success, helping lead through a global pandemic, supply chain disruptions, and 2 rounds of tariffs. Now I understand why you're retiring. In all seriousness, David, your mark on Dorman will be felt for a long time. So thank you for your service, and we wish you all the best in retirement. With that, I would like to now open the call up for questions. Operator?
Operator, Operator
Our first question comes from Scott Stember from ROTH Capital.
Scott Stember, Analyst
David, congrats on your retirement, and it was great working with you.
David Hession, CFO
Thanks, Scott. It's been a pleasure. I appreciate it.
Scott Stember, Analyst
So beyond the tariff noise within the guidance, I'm just trying to make sure I get a sense of how, I guess, the light-duty business is doing. It sounds like mid-single-digit POS growth. There was a lot of pricing in there as well. But I know you typically don't parse this out, but I'm just trying to get a sense of what volume looks like on a POS basis. Just trying to get a sense of how you guys are matching up with what the O'Reilly's and the AutoZone's are saying.
Kevin Olsen, CEO
Yes, Scott. Thanks for the question. Good question. Look, the light-duty business, the macros remain very strong. I mean the sweet spot of the vehicle, the 7- to 14-year-old vehicle continues to increase. Miles driven continue to go up. The age of the vehicle now is approaching 13 years. So overall, we see a very constructive environment as we go into 2026. As you said, our POS was up mid-single digits in the quarter, very similar to what we saw in the third quarter. So not a lot of change there. The one dynamic, obviously, that we pointed out in our prepared remarks was, obviously, sales were down a bit as it related to POS because of the one customer who changed their order patterns in the fourth quarter. But other than that, we remain really constructive on the aftermarket here as we move into 2026.
Scott Stember, Analyst
Got it. And your guidance for 7% to 9% growth for the year, very robust. Obviously, it sounds like there'll be some additional pricing actions coming through. But maybe talk about POS versus sell-in. Are we basically saying that you would expect that POS would be up in that mid- to high-single-digit range for the year?
Kevin Olsen, CEO
Yes. We are expecting roughly mid-single-digit growth in point of sale as we move through 2026. Regarding new pricing, I want to clarify that it’s more about the comprehensive effect of the pricing changes we implemented in 2025, which will have a favorable impact. Beyond that, we anticipate point of sale growth will drive our overall sales growth alongside new products. As we noted, we had an exceptional year in 2025 from a new product perspective, achieving record sales in that category, which will benefit us going forward. We also expect another strong year for new product sales.
Operator, Operator
Our next question comes from Bret Jordan from Jefferies LLC.
Bret Jordan, Analyst
When we look at the inventory growth year-over-year, could you sort of parse out what of that is in tariff price, units versus cost in that inventory?
Kevin Olsen, CEO
Yes, Bret, the largest proportion of inventory growth that you've seen really starting at midyear at Liberation Day is the higher tariff cost. There is some additional lift there just because volume was up, but also we did purchase ahead of the tariffs that temporarily lifted our inventory levels as well. But the largest component is increased cost from tariffs.
Bret Jordan, Analyst
Okay. And then I guess when you think about the customer base ex the advanced math, about the POS, the cadence through the quarter, and I guess maybe if you could give us any color on early '26. Are you seeing the underlying traction improving at the sort of end-user demand?
Kevin Olsen, CEO
Yes. So as we mentioned, Bret, POS was very similar in the fourth quarter that we saw in the third quarter. And as we rounded into 2026, January was essentially in line with what we saw in the fourth quarter, and we did see a modest uptick in February. As you know, March is a pretty key month for the aftermarket as we get ready for the spring selling season. So obviously, we're hoping that, that continues that progress that we saw in February.
Operator, Operator
Our next question comes from Jeff Lick from Stephens Inc.
Jeffrey Lick, Analyst
David, best of luck.
David Hession, CFO
Thanks, Jeff.
Jeffrey Lick, Analyst
If you examine the sales exit rate, light-duty remained flat, heavy-duty increased by 5%, and specialty showed no change. What gives you confidence? Your forecast of 7% to 9% suggests there will be significant growth. Could you provide more detail? Also, am I correct in understanding that you'll still benefit from tariffs in the first and second quarters? Additionally, regarding your comment, Kevin, about point-of-sale sales and the change in customer order patterns, did those sales actually decline? It would be helpful to get more insight into what supports the projection of 7% to 9%, which suggests an acceleration.
Kevin Olsen, CEO
Certainly. Full-year sales growth for 2025 was approximately 6%. In the fourth quarter, one of our largest customers changed their ordering patterns due to supply chain and distribution center consolidations. Had we seen order rates continue as they did in the third quarter, we would have remained within our guidance. Specifically, orders from that customer decreased nearly 40% compared to the third quarter. This situation is not expected to persist as we move through 2026. We anticipate some disruptions early this year, but they are starting to normalize, and we expect to return to more typical ordering patterns by the end of the first quarter. When you combine that with new product introductions, which consistently drive above-market growth for us, as seen historically, and a full year of the pricing effect, which didn't take full effect until the latter half of the third quarter in 2025, we are quite confident in the sales guidance we provided.
Jeffrey Lick, Analyst
As a follow-up on gross margin, if I remember correctly, you have implemented pricing increases that affect the dollar amount directly rather than the percentage. This means you will recover the gross profit dollars, but your gross margin is likely to decrease with this pricing strategy. Am I right to say that the most significant impact as the cost of goods sold aligns will be in the first and second quarters, with margin decline in the third and fourth quarters, but not as much? Is that accurate?
Kevin Olsen, CEO
We provided additional clarification on the margin outlook, which is something we haven’t typically done. You are correct that when we implemented tariff pricing, it was dollar for dollar, which will affect margin percentages but not margin dollars. We are guiding for an operating margin percentage of 15% to 16% for the full year 2026, with expectations of finishing at a higher rate in the high teens. For context, in 2024, before tariffs took effect, our operating margin was 16%. As we manage through the higher tariff inventory in the first half, we can see the costs that have accumulated in our inventory. Additionally, after Liberation Day, we promptly started negotiating better prices with our suppliers, further diversifying our supply chain from higher tariff areas to lower tariff regions, and enhancing productivity initiatives. These savings are factored into the inventory and will manifest in the latter half of the year. It's important to note that any increase or decrease in input costs typically takes about 7 to 8 months to reflect in our inventory due to FIFO accounting, which is causing some confusion with our figures. Furthermore, if we set aside the timing aspects for 2025 and 2026, our implied guidance indicates a 15% two-year growth rate for 2026 compared to 2024, with a two-year EPS growth of about 16.5% over 2024. Taking everything into account, these are the growth levels we've historically achieved, and we remain confident in our ability to sustain them moving forward.
Operator, Operator
Our next question comes from Tristan Thomas-Martin from BMO Capital Markets.
Tristan Thomas-Martin, Analyst
A broader kind of question. You called out complex electronics growth. How should we think about kind of like your content TAM on an EV versus an ICE vehicle?
Kevin Olsen, CEO
Okay. I'll start with your question, Tristan. We consider ourselves indifferent regarding ICE vehicles or pure plug-in electric vehicles, which I believe you refer to as EVs or hybrid vehicles. We have the ability to develop parts compatible with any drivetrain. As we examine complex electronics, they increasingly represent a significant part of our portfolio across ICE, plug-in electric, and hybrid vehicles. Looking ahead over the next three years, the opportunities for new products in complex electronics are greater than ever, which we believe gives us a competitive advantage in the aftermarket. This situation is quite favorable for us, especially since complex electronics typically have a much higher average selling price compared to purely mechanical parts.
Tristan Thomas-Martin, Analyst
Yes. And then just switching to specialty vehicles. I think you used the term rebound in your kind of slides and script. So how are you thinking about kind of new vehicle kind of end market sales in '26?
Kevin Olsen, CEO
Yes, that's a good question. We didn't predict a market rebound, but we noted that new vehicle sales have seen a slight increase, which is positive. We hope that this trend continues. Inventory levels in the dealer channel have stabilized and are at healthy levels. We're not relying on a significant market rebound; instead, we are focusing on factors we can control, such as expanding our presence, especially on the West Coast where we've seen considerable success, and driving growth in new product development, particularly in nondiscretionary repairs, which is a key initiative for us. We're also managing our costs effectively. The market will fluctuate, and that is beyond our control, but we are confident in our strategies to drive growth. When the market does rebound, we believe we will be well-positioned to benefit.
Tristan Thomas-Martin, Analyst
Got it. David, enjoy the retirement.
David Hession, CFO
Thank you, Tristan. Appreciate it.
Operator, Operator
Our next question comes from David Lantz from Wells Fargo.
David Lantz, Analyst
David, congratulations again.
David Hession, CFO
Thank you. I appreciate it.
David Lantz, Analyst
So light-duty order fluctuations are expected to continue in Q1, but I just wanted to make sure the message is that segment sales should still grow in the quarter and then accelerate through the year from there. And then within the 7% to 9% top line sales for the year, curious if you can parse out how you think your sub-segment performance will shake out relative to each of the broader categories.
Kevin Olsen, CEO
Yes. I mean, David, I'll say that we didn't break out how much is going to be price and volume in the 7% to 9%. I think I've covered, in general, why we're comfortable with the growth guidance that we put out there. Look, I mean, not a lot has changed. I mean we feel that we've got good growth opportunities in all 3 segments. Light-duty, new product development, as I said before, we had a record year in 2025. We think we're going to have another strong year in 2026. Ordering patterns from our large customer will come back into line. We see very solid growth in the LV business in 2026, and we got the pricing ramp that I mentioned earlier. You have some similar dynamics, frankly, in the other 2 segments. In heavy duty, I'll just kind of remind everyone that heavy duty is probably the least exposed to tariff. But we've seen a couple of good quarters of growth. We had 6% growth in the fourth quarter. Again, we're not calling a rebound in the market for sure. We're just going to focus on the things that we can control and continue to take market share and deal with any tariff pricing that we're exposed to in that market, too. So that will drive a little bit of the uptick. And the same with specialty vehicle. I kind of covered that on Tristan's calls, but we continue to drive further market share gains as we expand in underserved regions in the country and continue to drive new product development growth, which we've been successful with. So that's what gives us the confidence to hit the guide that we put out there.
David Lantz, Analyst
Got it. That's helpful. And then on the balance sheet, it's really healthy. So curious if you can walk through how you're thinking about M&A in 2026 between potential tuck-in opportunities and geographic expansion and then balancing that with share repurchases.
Kevin Olsen, CEO
Our capital deployment strategy remains consistent. Firstly, we will assess our debt levels. We have significantly reduced our debt since our major acquisition of SuperATV, and our leverage ratios are currently quite moderate. Secondly, we aim to invest in organic growth and new product development, which provide our highest returns. We will continue to focus on this area. Thirdly, we intend to allocate capital for mergers and acquisitions. Our financial situation is strong given our current debt structure and cash flow, which has shown improvement in the fourth quarter compared to the third quarter. Last year, we generated approximately $76 million in free cash flow in 2025, which was below our usual performance due to tariffs. However, as we look ahead to 2026, we expect free cash flow to return to more normal levels, reflecting closer to the nearly $200 million we achieved in 2024. If M&A opportunities do not arise, we plan to return capital to shareholders, as we have done historically through share repurchases, which we resumed in the fourth quarter of 2025. Overall, the M&A landscape was quiet in 2025 due to uncertainties with tariffs, but as those issues subside, I anticipate increased activity in 2026.
Operator, Operator
Our next question comes from Gary Prestopino from Barrington Research.
Gary Prestopino, Analyst
Kevin, you're doing real well with Complex Electronics, new products, and all that. And at times, I think you've been a little bit reticent to talk about just the growth that's being contributed there by the new products. But if you could give us an idea on your top line, is it 50 basis points, 100 basis points, 200 basis points? It seems that is going to be, I think, a key driver of growth going forward. And then I have a follow-up on Complex Electronics.
Kevin Olsen, CEO
Yes, Gary, I want to emphasize that historically, we have not disclosed specific details for competitive reasons, but we believe our Complex Electronics portfolio provides us with a significant competitive advantage that we aim to protect. Regarding new products, we continue to launch thousands of SKUs, which will be reflected in the 10-K being issued tomorrow. You will see strong growth in SKUs. Notably, our new product sales growth reached a record in 2025, and we are focused on increasing throughput. Our forward-looking repair opportunity funnel is at its highest point historically, which gives us confidence. Looking back over the past 5 to 7 years, we are comfortable that we can achieve growth that outpaces the market. Historically, the aftermarket has grown between 3% and 4%, while we have delivered growth of 7% to 8%, and we believe we can maintain that trend.
Gary Prestopino, Analyst
Okay. That's fair. In the context of the total addressable market for complex electronics, particularly regarding electric vehicles, what is your outlook on the overall vehicle fleet? Are you anticipating a need to double your offerings in complex electronics as vehicles become more technologically advanced?
Kevin Olsen, CEO
Yes, Gary, that's a great question, and it's related to what I mentioned earlier. Looking ahead at repair opportunities, we have a good understanding of what's failing in the marketplace. Within that landscape, complex electronics are becoming an increasingly significant part. This trend is set to continue. The technology in vehicles today is very different from what it was five or ten years ago. Therefore, these repair opportunities will keep growing. While I won't comment on the possibility of doubling, I can tell you that a key focus for us is how to improve our throughput and reduce development time for complex electronics. We expect to see an increasing number of electromechanical part opportunities in the future.
David Hession, CFO
Okay. David, best of luck and hit them straight in your retirement. Thanks, Gary. I appreciate it. I've enjoyed working with you.
Operator, Operator
Our next question comes from Justin Ages from CJS Securities.
Justin Ages, Analyst
Congrats on the retirement, David.
David Hession, CFO
Thanks. I appreciate it.
Justin Ages, Analyst
Question on heavy duty. It's been a few quarters since you've mentioned some new business wins. I would like to know what is driving these new business wins. Should we consider them as gains in market share, or are they the result of new products? I am looking for a bit more insight on this.
Kevin Olsen, CEO
Yes, that's a great question, Justin. It's a mix of both factors. We mentioned that there's been a slight lift in the fourth quarter from tariff pricing, but the bulk of that increase comes from competitive wins. This is reflected in our ability to gain market share and also through new product development. One of the reasons we're excited about the heavy-duty platform and specifically Dayton products is our capacity to leverage our new product development process to achieve significant growth in that area. It does require some time to get the momentum going, which we have been working on. Therefore, we feel confident about our growth prospects as we continue to expand our portfolio and categories with above-frame products. This is a key reason why we are so enthusiastic about the heavy-duty business and the potential for growth through new product development.
Justin Ages, Analyst
Great. And then on margin, in '25, you highlighted outside of pricing increases, some productivity initiatives that helped margins expand. And you mentioned them into '26 as well. So I just wanted to get a little more color on what some of those productivity and automation initiatives are that you're looking towards.
Kevin Olsen, CEO
Yes, definitely. There are several factors to consider. First, as tariffs have become relevant again, we are focusing on securing the best acquisition costs globally, which involves ongoing negotiations with our manufacturing partners worldwide. Additionally, we have established a strong global supply chain team capable of identifying optimal manufacturing locations that offer the best overall value in terms of cost, quality, and pricing. Furthermore, we’ve made significant investments in automating our distribution centers, which has been a substantial cost for us, but these investments have proven successful as we've seen increased productivity in direct labor. We see this as just the beginning regarding our automation journey, and we will keep concentrating on this area. We are also continuously seeking ways to enhance productivity across all business functions. For example, we've achieved substantial growth in new product development and SKU expansion this year without needing to increase our resources significantly. This has been made possible through process improvements, better tools, and an improved organizational structure. We will keep pursuing such strategies to enhance productivity.
Operator, Operator
Our next question comes from Bret Jordan from Jefferies LLC.
Bret Jordan, Analyst
Just a quick follow-up on Complex Electronics. You talked about the ASP being higher. Given the lack of aftermarket competitors in that space, is the gross margin substantially higher as well?
Kevin Olsen, CEO
Yes, good question, Bret. I think we've discussed this before. It really depends on the average selling price. However, in most situations where we're competing against the original equipment manufacturers, that tends to yield our highest gross margin percentage, regardless of whether it's Complex Electronics or not. Therefore, we aim to maximize margins in areas where we have made significant investments, like in Complex Electronics, and we certainly want to ensure we achieve appropriate returns as well. So yes, in many cases, it is a high gross margin.
Operator, Operator
That concludes the question-and-answer session, and this concludes today's conference call. Thank you for joining. You may now disconnect.