Earnings Call Transcript - DORM Q1 2025

Operator, Operator

Good morning, and thank you for being here. Welcome to the Dorman Products First Quarter 2025 Earnings Conference Call. This conference is being recorded. I will now hand it over to Alex Whitelam, Vice President of Investor Relations. Thank you. Please proceed.

Alex Whitelam, Vice President of Investor Relations

Good morning, everyone. Welcome to Dorman's first quarter 2025 earnings conference call. I'm joined by Kevin Olsen, Dorman's Chief Executive Officer; and David Hession, Dorman's Chief Financial Officer. Kevin will share updates on the business and address the tariff situation. Then David will review our quarterly results and reaffirm guidance. Kevin will then close our prepared remarks before opening 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, including forward-looking statements within the meaning of federal securities laws. We advise 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 one question with one 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 first quarter 2025 earnings call. As Alex mentioned, I'll start with a high-level review of the results and then cover the actions we've taken over the last several years to position us well to address tariffs. I'll also touch on the observations we're seeing within each of our segments. Turning to Slide 3. I wanted to briefly touch on the quarter. David will provide more detail, but we had an outstanding first quarter with strong top and bottom line results. Consolidated net sales for the quarter grew 8% year-over-year to $508 million. Our team continues to do a great job on the new product development front, which contributed to our growth. We also delivered solid margin expansion in the quarter. Adjusted operating margin for Q1 2025 was 17%, expanding 310 basis points compared to the same period last year. This margin performance was again led by our light duty business, which drove solid margin improvement over last year's first quarter. Lastly, adjusted diluted EPS increased over last year's first quarter by an impressive 54% to $2.02 and free cash flow in the quarter was $40 million, allowing us to repay $20 million of debt and repurchase $12 million of our common stock. Overall, we began the year with strong results that support our expectations for continued growth this year. On Slide 4, we thought it would be valuable to discuss some of the investments we've made in our business over the last several years, which position us well to perform in situations of economic uncertainty like we currently face. I'd like to caveat that the situation has been highly fluid, as you all know, and we are following it closely. I've been extremely impressed with our team and their ability to pivot and navigate through the day-to-day challenges. It speaks to the level of talent we have across the organization. First, as we discussed on our last call, we've taken significant steps to diversify our supply chain since the Section 301 tariffs on Chinese imports went into effect in 2018 and 2019. Entering 2025 and before the new tariffs were put into effect, we have been executing a plan to continue to reduce our share of products sourced from China. In 2025, we estimate that approximately 30% to 40% will be sourced from partners in China, approximately 30% in the U.S. and the remainder from various regions around the world. We will continue to remain focused on optimizing our supply chain strategy. We believe this level of diversification gives us a competitive advantage. It's not just an effort to capture cost savings. Our asset-light manufacturing strategy and expertise stand out as competitive advantages, allowing us to identify and partner with leading manufacturers around the globe to drive redundancy, flexibility, and resiliency within our supply chain. The end result is better products at better prices for our customers and end users. Through our strategic sourcing investments, we developed strong relationships with our supply partners. Our scale often makes us a strategic customer for our vendors. In many instances, we're one of their largest customers. This scale and strategic position foster deep partnerships with our suppliers that ultimately benefit our customers and end users. Next, the products that we sell play an essential role in everyday life. Our products help people get to work, get their kids to school, take vacations, and visit friends and family. Our products also help businesses keep their goods flowing from Point A to Point B and provide everyday services to local communities. The majority of our product portfolio is nondiscretionary in nature. So if you are in need of one of our parts, odds are your vehicle is not operating or not operating safely. Nondiscretionary parts have historically done well in uncertain economic times. And for decades, we have successfully navigated various diverse economic environments. Furthermore, we believe our innovation strategy and the strength of our brands position us well to succeed. Our innovative solutions are core not only to our success but also to the success of our customers and technicians who rely on our new products for their own growth and profitability. We've also strategically invested in our brands over the last several years, which has led to the Dorman, Dayton, and Super ATV brands being sought after in their respective segments. And finally, our financial profile serves as a significant benefit to our investors and customers. We have a strong balance sheet and liquidity position, allowing us to manage higher costs from tariffs in the short term to invest in inventory to support our customer needs and to capitalize on strategic growth opportunities along the way. We expect our strong financial foundation will stand out as a key competitive advantage compared to our peers. In the end, we have the experience and playbook in the right set of solutions, suppliers, and customers, along with the financial strength to navigate the changing trade environment. Before I turn it over to David, let me touch on the observations we're seeing across our segments on Slide 5. These observations include what we've experienced leading up to the recent tariff announcements and what we see looking forward in the new trade and economic environment. Starting with light duty, as I mentioned, positive macro trends continued into the year. Vehicle miles traveled declined higher year-over-year, and we expect that used vehicles will continue to stay on the road longer, both of which are key contributors to the success of the aftermarket. During the quarter, customer demand was strong, a trend that followed through from the end of 2024. In particular, we had a strong season with our patented oil filter housing product that we've discussed in previous calls. This, along with the success of our other recent new products, were key contributors to our growth. In our heavy duty segment, the soft market conditions that impacted trucking and freight markets in 2024 continued through this year's first quarter. While the early signs of stabilization we spoke of on our last call continued in the first few months of 2025, the announcement of tariffs and the impact on demand for trucking and freight began creating additional uncertainty in the market late in the quarter. We're watching it closely, and we'll continue to position the business for long-term success through portfolio expansion and productivity initiatives. In the Specialty Vehicle segment, we remain encouraged with the enthusiasm in the UTV and ATV markets. The feedback we get from end users is that they are very engaged and positive; we're not seeing a pullback in ridership. However, consumer spending softened during the quarter and may be a headwind moving forward. We remain focused on expanding our portfolio of nondiscretionary parts, capturing share, and expanding the dealer network as the market rebounds. With that, I'll hand it off to David to review our Q1 financial performance.

David Hession, CFO

Thanks, Kevin. As we turn to Slide 6, I'd like to point out that we maintained our positive momentum from the fourth quarter. Consolidated net sales in the first quarter were $508 million, up 8% year-over-year driven by strong customer demand. Light duty again drove above-market sales growth on positive macro trends and the success of our new products. I'll cover each of our segments more in just a moment. Adjusted gross margin for the quarter was 40.9%, a 220 basis point increase compared to the prior year period. Margin expanded on the strong sales growth and favorable mix of new products coupled with cost savings generated from supplier diversification as well as productivity and automation initiatives. Adjusted SG&A expense as a percentage of net sales was 23.9%, down 100 basis points compared to the first quarter of 2024. Adjusted operating income was $86 million in the first quarter, up 33% compared to the same period last year. Adjusted operating margin expanded 310 basis points to 17%, largely from the gross margin improvement I just discussed. Finally, adjusted diluted EPS in the first quarter was $2.02, up 54% compared to last year's first quarter, along with increased adjusted operating income and lower interest expense as a result of our debt repayments over the last 12 months. Our effective tax rate benefited from a timing difference in the quarter. Finally, our share repurchase program activity over the last year contributed to positive EPS growth. Next, let me provide updates on each of our business segments, starting with light duty on Slide 7. Light duty's performance in the first quarter was outstanding, with net sales increasing 14% year-over-year. The growth was driven by strong customer demand, especially for our new products, with foundationally positive macro trends continuing through the first quarter. POS was up high single digits versus shipments that were up low teens in the quarter. Light duty also drove strong margin improvement, with segment operating margin increasing to 19.9% for the quarter, a 380 basis point increase compared to the same period last year. This margin expansion benefited from new product mix and cost savings from our ongoing automation and productivity initiatives, along with higher leverage on our volumes. Turning to Slide 8, heavy duty net sales were again impacted by continued market pressures in freight transportation and the trucking aftermarket. Net sales were down 11% year-over-year, and segment operating margin turned slightly negative as the business has a larger fixed cost manufacturing footprint in our U.S. manufacturing plants compared to our other segments. While the early signs of stabilization that we mentioned on our last call continued to play out through the first few months of the year, the uncertainty that tariffs inject into the trucking and freight market gives us further pause to call for a rebound in our business. That said, we'll continue to invest in new product development and commercialization initiatives to capture share and best serve our customers when the market does turn. Moving to Slide 9, UTV and ATV ridership in the Specialty Vehicle segment remains healthy. But in the first quarter, net sales declined 9% year-over-year, which proved to be a notable shift from the growth we saw at the end of last year. We expect this turn was a result of consumer sentiment changing after the holiday season and as uncertainty around tariffs took hold. This weakened confidence level in the economy will likely continue, given general uncertainty in tariffs, but we expect demand to return once the economy stabilizes. To best serve our customers and riders, we'll continue to invest in product offerings through our internal innovation funnel and through tuck-in acquisitions of value-added brands. We'll also continue to expand our dealer network to further broaden our market share. On the margin front, segment operating margin declined to 10.2% in the quarter. The main driver of this decline was the deleveraging of our fixed costs and sales decline. Similar to the heavy-duty business, we manufacture a portion of our products internally in the U.S. Within our operations, we are taking appropriate actions to mitigate margin degradation should the market softness continue in the future. Turning to our cash flow on Slide 10. Our cash flow in the quarter was solid and strong earnings growth offset by investments we made in inventory. Free cash flow in the first quarter was $40 million, essentially in line with the same period last year. During the quarter, we deployed $11 million in capital expenditures, repaid $20 million in debt, and repurchased $12 million of our common stock. The cash flow we've generated and our use of cash over the last eight quarters have positioned us well with the liquidity to manage increased costs as a result of the tariffs. I'll touch on our liquidity in just a minute, but I wanted to highlight that our capital allocation strategy has proved to be a key value driver for Dorman. As we look forward, our long-term strategy doesn't change. We will continue to look at our debt and leverage targets first and then utilize our cash to invest internally as that is where we get our greatest return. We'll then look to invest in strategic growth opportunities and opportunistically repurchase shares. That said, in the short term, we'll be utilizing a portion of our cash and balance sheet flexibility to fund the higher cost of inventory resulting from the tariffs. On Slide 11, we highlight much of what we've already covered, which is that we believe we have the balance sheet capacity and liquidity to help finance the cash needed for the significant increase in inventory costs we anticipate as a result of the tariffs. As you can see, net debt was reduced to $402 million, and our net leverage ratio was 1.01x adjusted EBITDA, down from 1.12x at the end of last year. Additionally, our total liquidity increased to $660 million at the end of the quarter, up from $642 million at the end of 2024. In the end, we expect the strength of our balance sheet will be a competitive advantage against the market conditions we currently face. Turning to Slide 12, I'd like to cover our guidance for 2025. Given our performance in the first quarter and the future outlook for our underlying business, we are reaffirming our 2025 net sales growth guidance of 3% to 5% and adjusted diluted EPS guidance range of $7.55 to $7.85. Please note that this guidance does not include any impact related to U.S. enacted or proposed tariffs in 2025 for any potential retaliatory measures from U.S. trade partners. As you know, the situation remains highly fluid, and negotiations between various countries and the administration are ongoing. Adding to the fluidity, our conversations and negotiations with our suppliers and customers are ongoing as well. With this level of uncertainty, we felt it was prudent to continue providing our positive view of the underlying business and not include any impact from increased pricing or higher costs associated with the tariffs. As the situation gains more clarity, both at the macro level and for Dorman, we'll look to provide an updated view with the impacts to our expected results. And finally, for modeling purposes, we continue to expect a 24% effective tax rate. With that, I'll now turn it back over to Kevin to conclude.

Kevin Olsen, CEO

Thanks, David. I'll just reinforce what we've said throughout. First and foremost, we had an outstanding first quarter that positions us well for growth this year. While there is a significant level of uncertainty that exists with tariffs, we have the experience and talent to address the challenges ahead. Additionally, we have a stronger supplier base, a more diversified customer base, and a stronger financial foundation than we've ever had before. We'll continue focusing on the needs of our customers and end users and look to capitalize on the opportunities we see in the marketplace. With that, I would now like to open the call up for questions.

Operator, Operator

And our first question comes from Scott Stember with ROTH Capital Partners. Your line is open.

Scott Stember, Analyst

Good morning, guys, and thanks for taking my questions. Very strong performance in heavy-duty, very strong high single-digit POS, a few ticks below the sell-in. So I guess the first question is, have you seen any of your bigger customers buying ahead to get ahead of tariffs? And if not, is this just a function of you guys gaining shelf space with some of your bigger, faster-growing partners that are expanding rapidly.

Kevin Olsen, CEO

Yes, it's Kevin. Good question, Scott. The light duty business performed very well this quarter, building on a strong fourth quarter. Our point of sale was up high single digits, similar to last year, driven by our new product performance, and the overall market conditions remain favorable. Our sell-in growth actually surpassed our point of sale growth this quarter due to an easier comparison. Looking back at the two-year performance, it aligns more closely with the point of sale growth we experienced, considering some timing issues last year between the first and fourth quarters of 2023. Regarding your question about customers purchasing in advance to avoid tariffs, we haven't observed any signs of that yet from our customers in terms of orders. It's a possibility, but as of now, we haven't seen significant evidence of it.

Scott Stember, Analyst

Got it. And on tariffs, obviously, I appreciate there's a lot of uncertainties here, and it's hard to predict anything. But clearly, with 145% as it stands right now, some folks are concerned about what impact it will have on your business. So it sounds like you're a lot better positioned than you were the last time around with tariffs, but could you just again remind us of some of the mitigation efforts that you have in place, and then timing of when we would actually start to see anything hit your results?

Kevin Olsen, CEO

Yes, it’s Kevin. It's quite early to assess the situation, especially since the 232 auto tariffs just began a few days ago. As we've discussed, our supply chain is much more diverse now compared to five or six years ago, which was intentional on our part. Approximately 30% to 40% of our sourcing is from China in 2025, depending on the product mix, with around 30% sourced in the U.S. and the remainder spread globally. It's important to note that most of our parts are non-discretionary and have historically been inelastic during similar situations. When these tariffs impact us, our FIFO inventory means we'll likely not see significant effects for about six months after they take effect. Regarding mitigation, we have addressed similar challenges before and have a solid strategy in place. We'll be negotiating with our suppliers for cost concessions, focusing on productivity initiatives, and seeking to offset any differences through price adjustments.

Scott Stember, Analyst

Great. That's all I have for now. I'll get back in the queue. Thank you.

Kevin Olsen, CEO

Thanks, Scott.

Operator, Operator

Our next question comes from the line of Bret Jordan with Jefferies. Your line is open.

Bret Jordan, Analyst

Hi, guys. Good morning. On that EBIT margin in light vehicle, you talked about product mix versus leverage on the volume, could you sort of break out what was product mix versus leverage on the volume? You talked about a lot of new to the aftermarket and the oil filter housing. And could you just sort of bucket where that pretty solid margin expansion came from?

Kevin Olsen, CEO

I mean, Bret, if you look back, we've been generating these types of operating margins in light duty for quite some time now. And really, it is mostly due to our product mix. We don't break out exactly how much is due to just core business, but a lot of it is due to the new product mix. And as we've talked about before, we've had some really successful new products come to market. But also the macros have improved, right? I mean, if you look at the sweet spot, the 7- to 14-year-old vehicle, which is where we really target, new product development that vehicle cohort has really grown over the last couple of years, and we see that cohort continuing to grow over the next three to four years. Those two factors have really enabled us to expand margin in the light-duty side.

Bret Jordan, Analyst

Okay. And then I guess when you think about the more commoditized mix in the portfolio of maybe chassis, and your supply chain footprint versus competition, is there any material difference? Or is everybody pretty much exposed in the same countries? Have you thought about yourself versus maybe the Tenneco chassis businesses or the MevoTech chassis businesses? Is there any risk that someone will be advantaged given their geographic mix or is pretty much be everybody the same?

Kevin Olsen, CEO

Yes, good question, Bret. I'm not going to comment on a specific category, but overall, you're going to see some impact depending on how the tariffs settle, which is uncertain at this point. There may be situations where one company is advantaged over another. Looking at our operations, our exposure to the highest tariff region is still heavily linked to China, but we believe our overall exposure is lower than many others. With our balanced global footprint, we see ourselves in a position of competitive advantage.

Bret Jordan, Analyst

Okay. Great. And then on pricing, in the event we do get tariffs and the conversations with your large retail customers, does it sound as if everybody is still expecting to be able to pass most of these through? Or is it just the magnitude of the tariffs, something that some place along the line of the supply chain or the retailers, they have to eat some of this higher cost?

Kevin Olsen, CEO

Yes, Bret, I won't speculate on our customers' actions. However, I feel confident that we can manage the net impact overall. It's important to remember that our portfolio mainly consists of essential repair parts and hard parts. We consider ourselves a strategic partner to all our customers, maintaining a strong brand presence with both them and the end users. We have a reliable strategy in place, as we have navigated similar situations before, particularly in 2018. Ultimately, we believe we will succeed regardless of how this unfolds.

Bret Jordan, Analyst

Great. Thank you.

Operator, Operator

Next question comes from the line of Gary Prestopino with Barrington Research. Your line is open.

Gary Prestopino, Analyst

Good morning, everyone. David, I have a few questions regarding the income statement. It appears that your interest expense has significantly decreased sequentially. I'm curious if the net interest was approximately $7.4 million. Should we expect this figure to remain consistent throughout the year on a quarterly basis, or was there a specific factor that contributed to this decrease?

David Hession, CFO

Yes, Gary, it's Dave. We've been focused, as you know, on paying down our debt since the acquisition, and we paid down close to $270 million over the last couple of years, which has brought our leverage down to 1x EBITDA. So the balance sheet is as strong as it's ever been. We feel really confident about our ability to navigate in this current situation. As far as the interest expense, Gary, I think using the current quarter is probably a good assumption for your model.

Gary Prestopino, Analyst

Okay, that's very helpful. Could you provide insight on the tariffs issue in comparison to what occurred in 2018 or 2019? Specifically, how much of your product was sourced from China during that time, and what lessons have you learned from that experience that you can apply to the current situation if tariffs significantly affect product prices?

Kevin Olsen, CEO

Yes, Gary, it's Kevin. Good question. About six or seven years ago, we disclosed that over 70 percent of our products were sourced from China and Taiwan, with most of that coming from China. We are now in a much different position as we evaluate Dorman today. Reflecting on our mitigation efforts, we learned from that previous experience and have focused on diversifying our supply chain to create a more resilient one. We've successfully built a solid understanding of other regions, including where capacity exists and how to source quality parts at competitive prices worldwide. Our team is experienced in these areas now. Additionally, we've dedicated significant time to enhancing productivity across our business. We've previously mentioned our automation initiative, which has modernized our distribution facilities, and we will continue to seek ways to reduce costs. Any remaining net costs will be addressed through pricing adjustments.

Gary Prestopino, Analyst

Okay. If I could ask one more question, it's a simple one. You mentioned that new products were a key factor in driving growth this quarter. Could you provide an approximate range of how much of the quarter's growth was attributed to new products, even if you can't specify the exact sales figures?

Kevin Olsen, CEO

Yes, Gary, we don't provide that specific breakdown, but I can tell you that when looking at the overall market growth in the industry, it’s showing low single-digit growth compared to the high single-digit growth in POS that we have experienced. This difference is primarily driven by new products. That has been our business model, and it will continue to be. Historically, we have been very confident in our ability to significantly outperform market growth due to our business model, and we believe this will persist. Thanks, Gary.

Operator, Operator

Next question comes from the line of Justin Ages with CJS Securities. Your line is open.

Justin Ages, Analyst

Hi, good morning everyone. I appreciate the insight on how much is sourced from China. Can you provide any details on how that is distributed across the segments? For instance, is the majority of that 30% to 40% going to light duty? Any information on that would be useful.

Kevin Olsen, CEO

Yes, Justin, good question. We're not going to get into the details or disclose the impact in our different segments, mainly because, frankly, it's too fluid at this point and for competitive reasons. I will make a couple of comments, though, on each individual segment. In light duty, as I mentioned before, we believe we have a very diversified supply chain and footprint. We have less exposure, as I mentioned before, to the overall hard parts market in the aftermarket. We think significantly so. So overall, we view that we have a competitive advantage in relation to the competitive set in light duty. If you look at heavy duty, very modest impact from tariffs. We believe, again, as we look around the competitive landscape that we're well advantaged there. In specialty vehicle, we do have some exposure to China, but we also have a large manufacturing footprint in the U.S. in Madison, Indiana. If we look at that entire industry, it's very heavily indexed to China. So again, we think we're well positioned as we look against the competitive set. And also keep in mind, Justin, that we do have a pretty good footprint here in the U.S. As I mentioned before, we do source roughly 30% of our products here in the U.S., some of that through our own plants. We do have six Dorman-owned manufacturing plants in the U.S. And obviously, we'll look to leverage them as much as we can where it makes sense. You got it, Justin. Thank you.

Operator, Operator

And we have a follow-up question from Scott Stember with ROTH Capital Partners. Your line is open.

Scott Stember, Analyst

Hi, everyone. I have a quick follow-up regarding the 232 tariffs. I'm trying to understand if there will be any exemptions and also the President's comments about potential clawbacks on auto parts. Is this specifically concerning the OEM and OEM production, or could there be any advantages or offsets for the aftermarket as well?

Kevin Olsen, CEO

Yes. Scott, we're still working through that. But in general, the auto part, the 232 tariffs is really tied to the HTS code, and where we have parts that fall into those codes, we're obviously subject to that tariff. And there's a bunch of other tariffs as well, and they all interplay. But for the most part, that exemption was for the OE, but we're still evaluating the impact on Dorman.

Operator, Operator

Ladies and gentlemen, that concludes the question-and-answer session. Thank you all for joining, and you may now disconnect.