Participants

David Hession; Chief Financial Officer, Senior Vice President, Treasurer; Dorman Products Inc

Kevin Olsen; President, Chief Executive Officer, Director; Dorman Products Inc

Scott Stember; Analyst; MKM Partners

Bret Jordan; Analyst; Jefferies

Presentation

Operator

Good morning, and thank you for standing by. Welcome to the Dorman Products first-quarter 2024 earnings conference call. (Operator instructions) Please note that this conference is being recorded.
I'd now like to turn the conference over to David Hession, Dorman Chief Financial Officer. Thank you, sir. Please go ahead.

David Hession

Thank you. Good morning, and welcome to Dormanl's first quarter of 2024 earnings conference call. I'm joined today by Kevin Olsen, our Chief Executive Officer. First, Kevin will provide a business update, and I will review the quarterly results followed by closing remarks from Kevin. After that we'll open the call for questions.
By now, everyone should have access to our earnings release and earnings call presentation, which we published earlier today. These documents are available on the Investor Relations portion of our website at dormanproducts.com.
Before we begin, I would 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 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.
I will 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 the appendix to this earnings call presentation, both of which can be found on the Investor Relations section of Dorman's website. And finally, during the Q&A portion of today's call, we ask that participants limit themselves to one question with one follow-up and rejoin the queue if they have additional questions.
And with that, I will turn the call over to Kevin.

Kevin Olsen

Thanks, David. Good morning, and thank you for joining us on our first-quarter 2024 earnings call. Today, I will discuss the highlights of the quarter across our three operating segments and provide a deeper dive into dormancy due to the aftermarket innovation engine. It is the core capability that links our three segment strategies together.
Turn to slide 3, if you're following along with our deck, Q1 was another consecutive strong quarter for Dorman as we delivered financial results in line with our expectations. We delivered net sales of $469 million, achieved a 660-basis-point improvement in adjusted operating margin led by the consistent gross margin recovery that we have driven over the last few quarters. As a result, adjusted diluted EPS increased 134% over prior year free cash flow of $41 million was very strong. So we deployed cash to repay $50 million of debt and repurchased $27 million of our shares. And finally, a new product teams across all three segments, continuing to churn out new product growth by introducing over 1,400 new products to the market many as aftermarket exclusives.
Moving on to slide 4, I'll dig into some segment observations. In the light duty. We continue to be encouraged by a positive overall market trends, vehicle miles driven, and the average age of vehicles continues to increase. Both are significant tailwinds for the aftermarket. We believe USVIO vehicles aged 8 to 13 years. What we call the prime VIO. for Dorman is in the early innings of substantial growth and has fully lapped the great recession period for fewer new vehicles.
Entered the market POS growth accelerated through the quarter, finishing march up high single digits after starting the year off slow with new products continued to benefit the business, including our patented oil filter housing, which proved to be a top performer for the quarter.
Finally, our operations initiatives continue to drive significant value. Our investments in automation and automation enabled our contributors to move product through our DCs, more efficient. While our investments to diversify our global supplier base have enhanced the resiliency of our supply chain.
Turning to heavy duty, the freight industry continued to be challenged. Many industries have reduced their shipping volumes over the last several quarters as the economy has slowed down from its post-COVID fever pace. This naturally leads to fewer vehicle repairs as expected, we also saw the destocking of inventory that started in the second half of 2023 continue into the first quarter of 2024. This environment, coupled with a strong Q1 2023, compares to negative first quarter growth versus prior year sequentially. However, Q1 sales slightly higher than Q4 2023. While we take this sequential improvement is a positive sign, we remain cautious in our outlook for the remainder of the year.
In terms of initiatives, we're seeing good traction in the implementation of Dorman's new product fundamentals from the light duty business to the heavy duty business. We're also taking actions that we expect will result in more efficient operations in our plants and distribution centers.
Finally, in specialty vehicle for pleased to have generated modest growth as initiatives to drive dealer penetration and new non-discretionary product introductions have more than countered a soft end market for new machines. We believe that these market share growth initiatives will yield solid returns net sales of accessories for new vehicles will increase once financing rates for new vehicles and consumer sentiment improve over the long term, we're confident that demand for new vehicles, accessories and repair parts remains robust.
On slide 5, as I mentioned in my opening remarks, we're going to take the opportunity to focus some discussion and what we consider to fuel for Dorman's growth engine, our new product innovation capabilities. We're proud of our innovation model and the value it creates for our contributors, customers and our shareholders. As we discussed during our Q4 call, it all starts with ideation, which means being the first to identify failure prone part first to imagine and reengineer solution that yields not only repair parts, but also a solution simplifies repair challenges of the technician gets the vehicle back on the road quickly. Our approach to redesign of often allows us to fix the original plus, generate intellectual property around the novel aspects of our solutions.
Our operating model also allows us to be one of the first to deliver OE all carrier products to market. We have both advanced in-house capabilities in all vehicle systems, which allows us to quickly engineer solutions and a vast network of supply bar, which provides us with the ability to scale volume in high demand parts quickly, maybe most importantly, we've systematized our new product development in such a way that it allows us to export these capabilities from dormant light duty legacy business to the other parts of our business as you'll see we've had great success implementing our innovation approach in our heavy duty and specialty vehicle business.
We view our new product innovation engine as a competitive advantage that we can use to drive value through synergies from current and future acquired companies. Our new product innovation engine is yielding results. Over the last three fiscal years. We brought over 19,000 new SKUs to market across our three segments with roughly 30% of those parts new to the aftermarket mini at launch, they were only available from dormant or the OEMs.
Next on slide 6, we'd like to highlight some recent examples of new to the aftermarket success stories. Starting on the far left, you'll find our patented oil filter housing, which has quickly become one of the most successful products with governments, history ideation team discovered that the original Park had a high failure rate, high deployment in the field. Most importantly, several points of failure that were fundamental to the original product design.
Our engineers redesign that part to address the failure points in their work has led us to being awarded several patents on our proprietary design. The original value for an oil filter housing can be found on over 10 million vehicles on US roads today.
Our next example is the heavy duty clutch shoulder ideation team discovered that this part was being sold at rates in excess of its predicted replacement rate. Prompting the product team to investigate heavy duty product team evaluated that apart from determined its failure modes and also discovered that the part is so difficult to service that technicians for replacing it prior to failure as a preventative maintenance action, our team redesigned the far higher quality components and built a fully operational test transmission quality test and prove that the doorman are lasted beyond the OE parts listed performance as a result of the team's innovation truck orders are now able to reduce number of replacement over the truck's life, saving substantial repair time and money.
Next is an example of our innovation deployed to create a feature set that better fits a product application than the incumbent part UTV riders and certain driving conditions for glass windshields because they are more resistant to scratches and less attractive to dirt and dust. However, while the fix are manual opening glass windshields that are available today have their place, consumers have quickly embraced the improved fit, finish and function of the newly released power actuated windshield from the driver seat. This windshield can be easily adjusted as weather conditions or terrain changes. Modular design can be retrofit to many UTV. applications already in service.
Finally, I'd also like to highlight an electronics module that we redesigned from scratch that incorporates proprietary electronics designed by our engineers, the software code written by our engineers. This fuel injector driver module has found a widely deployed engine and has design issues. It's housing electronics that can lead to high failure rates ROE six-product upgrades, the electronics and provides a weatherproof case that extends the lifecycle of the parts. We provide this module as a new not rent remanufactured parts and are the exclusive aftermarket provider for this product in a new form. We believe that there are very few aftermarket competitors that are capable of releasing a completely new electronic module, including proprietary electronics, designing software code. These are just a few examples of the thousands of new parts that we release every year, but we think they provide a strong cross sample of our new product innovation capabilities that power dormant growth engine and provide Gorman with competitive advantages today and into the future.
Now, I'll hand it off to David to review our Q1 financial performance.

David Hession

Thanks, Kevin. Turning to slide 7, Q1 net sales were $469 million, up modestly year over year. This growth was accomplished in the face of the market headwinds that Kevin described in his remarks and was primarily driven by the growth of new products recently introduced mark.
Moving to gross margin. Our Q1 adjusted gross margin was 38.7%, a 630-basis-point increase compared to the same quarter last year. The year-over-year margin improvement follows the last few quarters, trend of improvement from lower cost inventory, cost savings initiatives and pricing actions to offset inflation.
Shifting to SG&A. Adjusted SG&A expense was 24.9% of net sales, an improvement of 30 basis points compared to Q1 of 2023. Cost-savings initiatives were the primary driver of the improved. Our Q1 adjusted operating income was $65 million, a 92% increase from the same quarter last year. Adjusted operating margin was 13.9%, up 660 basis points year over year. And finally, adjusted diluted EPS in Q1 was $1.31, a 134% increase versus last year. The growth was mainly due to the increase in adjusted operating income, coupled with a lower interest expense after four consecutive quarters of debt prepayments, partially offset by a higher tax rate.
Let's move on to a review of our segment results starting on slide 8. Q1 light duty net sales were $359 million, a 3% increase year over year. Sales started the year soft, but strengthened through the quarter as customer POS growth accelerated while the gap between POS and shipments narrowed. We also saw some customer destocking in the quarter as they continued to reduce their inventory after loading up during the pandemic. As Kevin highlighted, new products, including the oil filter housing product, had a very strong. Fourth light duty adjusted operating margin was 16.1% in Q1, 990-basis-point improvement year over year. As I described for the overall business sales of lower cost inventory and a result of cost saving initiatives contributed to the margin improved.
Moving on to heavy duty on slide 9, net sales were $58 million in Q1, a 15% reduction year over year. Q1 was up against a strong prior year comparable. That was driven by the tailwind. The COVID-driven inventory restocking by customers has in the light duty business, the trend was positive through the fourth with the year over year sales gap in March, small and in June, we believe we're beginning to see signs of abatement of some of the headwinds we're facing, including customer inventory destocking and have cautious optimism for a second half recovery in trucking demand. Heavy duty adjusted operating margin was breakeven down from 7.9% in Q1 of last year. Heavy duty margin was affected by the sell through of high cost inventory. The deleverage of fixed costs on lower net sales volumes and the impact of investments we have made to grow sales and improve margins long term.
Shifting to specialty vehicle on slide 10, our Q1 net sales were $52 million, an increase of 1%. We continue to see consumers putting off the acquisition of new vehicles has financing interest rates remain high and economic confidence remains mixed. This dynamic impacts the dealer channel, which remains a challenging market, particularly for accessories and first-fit upgrades. We remain confident in the prospects for steady long-term growth in the overall vehicle park as enthusiasm for alternative transport vehicles remains high, so we believe this is a temporary challenge for the market.
Overall, despite this end market challenge, our specialty vehicle business was able to deliver the growth we believe that our initiative to expand our dealer footprint and drive sales to new dealers enabled us to capture share in a flat market. Further, our initiative to drive new product sales, particularly our focus on non-discretionary repair parts and parts for utility vehicles were spending less discretionary remains very much on track. Q1 specialty vehicle operating margin was 13.9%, flat year over year.
Please turn now to slide 11, where we will discuss cash flow. Q1 free cash flow was $41 million, an increase of $26 million from prior year. The improvement was largely attributable to a $27 million increase in net income, countered slightly by timing, driven movements of some working capital, which in line with our capital allocation strategy during the first quarter, we made capital expenditures of $11 million, consistent with prior year. We also repaid $15 million on our credit facility, and we returned $27 million to shareholders through the repurchase of our shares at an average price of $85 per share.
I'll turn next to our balance sheet and liquidity on slide 12. As of March 30, our net debt was $528 million, a reduction of $12 million from Q4, and our net leverage ratio was 1.61 times. Adjusted EBITDA down from 1.87 times in Q4. Our current leverage is comfortably below our longer-term target ceiling of two times or less than three times in the 1st year following an acquisition additional, we had $552 million of total liquidity, including cash on hand. We remain confident in the strength of our balance sheet and the capacity we have available to execute our strategic initiatives.
Now, I'd like to discuss our previously provided 2024 guidance included on slide 13. Our first-quarter performance was in line with our expectations light duty experienced 3% growth, but shipments still lagged customer POS, the gap we expect to align more closely over the remainder of the year. Our heavy duty business is still negatively impacted by a soft trucking market. We expect this softness to continue into the second quarter for a modest rebound in the second half of the year.
And finally, specialty vehicles end markets will continue to face challenges, but the team is focused on taking share from new product launches, geared around nondiscretionary repair parts at a new direct to consumer customers and building new dealer relationships. Based on these expectations, we are confirming our consolidated full-year net sales growth guidance of 3% to 5%.
We also confirm our 2024 adjusted diluted EPS range of $5.40 to $5.70 a share, our 19% to 26% increase over the prior year. The savings from the Q1 reduction in workforce programs and other cost savings initiatives are on track to hit plan. We still expect these savings to be partially offset by investments we're making to further diversify our supply chain as well as higher inflationary costs such as ocean freight and employee benefit costs.
With that, I'll turn it back over to Kevin to conclude. Kevin?

Kevin Olsen

We're proud of our first quarter results and our start to the year for countering headwinds in our markets by doing what we do best, delivering new and innovative product solutions that our customers rely on to profitably grow their business and the end user end users rely on freight, satisfying repair or upgrade experience. There will continue to be challenges in our markets in the next three quarters. I'm confident that the initiatives we have underway and the doorman contributors who are leading them to be able to execute and drive success in any environment.
I would now like to open the call for questions. Operator?

Question and Answer Session

Operator

(Operator instructions) Scott Stember with MKM Partners.

Scott Stember

You guys have basically two questions for Laura. David, you were talking about there being some destocking in the quarter in light vehicle, but it sounds like end demand is still very, very strong. When do you expect to be back to a one for one set up sell into sell through in light duty?

Kevin Olsen

Hey, Scott, it's Kevin. I'll handle that one. We definitely saw we had a difficult start to the year for sure, January, we saw POS kind of in that low single digit range, but we did see that pickup as we move through the quarter. And as we said in the prepared remarks, we exited March in the high single digit range. And yes, overall shipments still lag POS for the entire quarter, and we did see some inventory rebalancing as expected. However, the gap was certainly a lot tighter in March than we saw in January. We continued to see that into April. So I would characterize it, Scott as needed. You guys are having that gap.

Scott Stember

And then next question on the specialty vehicles, you can talk about your break fix initiative, I guess trying to sell more pure aftermarket sales. Can you just give us an update about the percentage of sales that break fixes where it was when you first acquired two three TV show literally acquired two great TV.

Kevin Olsen

Scott, we saw the opportunity to not only build out no kind of nondiscretionary repair parts, but also expand the business geographically. And I would characterize the last 18 months is that we've executed on those initiatives and we've actually exceeded what we had laid out pre-acquisition in terms of the executing on those. And roughly right now, Scott, about half the business, we would characterize as nondiscretionary repair parts and that is up from pre-acquisition.

Scott Stember

Got it, thanks. I'll jump back in the queue.

Kevin Olsen

Thanks.

Operator

Bret Jordan, Jefferies.

Bret Jordan

Hey, good morning, guys. Dave, could you talk about inflation in the period, how much pricing impacted, particularly on the, um, on the light duty side and then sort of what you're expecting for the year?

David Hession

Yeah, Bret. As you know, we don't disclose the breakout of price volume, but I would characterize is, as you know, we definitely saw some price. The overall market growth in last year in 2023, which continued into 2024. And however, we do expect modest unit growth here in 2024, but there will be a component of price and the overall growth equation this year in the industry.

Bret Jordan

Okay, great. And then I think on slide 4, you talked about signs of market reset. I think in the specialty vehicle. Is that something that you see coming as far as the OE production levels? Or is that something that's sort of already reflected in what's going on in specialty vehicle sales?

Kevin Olsen

Well, I would say, Brett, that we see it coming in terms of new vehicle sales is there's still a meaningful portion of our sales that go on vehicles that are less than two years old. So obviously, when new unit sales are depressed, that is going to be a headwind for us that we did see that unit sales were down in 23 versus 22. We believe that as inventory levels in the channel have really increased and are at probably over optimum levels. And that discounting will ensue and so we do expect that machine set new machine sales will start to accelerate here as we move through the year.

Bret Jordan

Okay, great. Thank you.

Kevin Olsen

Thanks, Brett.

Operator

Scott Stember, MKM Partners.

Scott Stember

Yes. Just secondly, back to heavy duty, you guys made comments about, I guess that there's signs that we could be hitting a bottom cautiously optimistic about A 2H rebound? Or is that just based on restocking completing itself and getting past the tough comparison? Or is there other signs that actual end demand in the aftermarket there are rebound.

Kevin Olsen

I think it's a combination of both, Scott. And clearly we we believe that the inventory kind of reductions are starting to ease. We're seeing that the our sequential sales were up from Q1 from Q4, but and frankly, still a lot of market intel. We talk a lot to our customers and then they'll feel that we're getting is the second half will be a slight rebound over the over the first half. But the honest, we're being very cautious in our approach, and we're really focused on cost initiatives, efficiency and productivity initiatives and taking share initiatives on the commercial front. So we're well positioned when it does rebound.

Scott Stember

And this last question on capital deployment it looks like you guys are back in the market buying back stock, but also paying down debt. What's your optimal leverage ratio that you want to be at? And should we expect our share repurchase is to increase as you get closer to that optimal leverage ratio?

David Hession

Yeah, Scott. The capital allocation strategy has been pretty consistent with where we've been historically. So the first thing we'll look at is leverage at the end. The quarter we finished at 1.61 down from 1.87 last quarter. The first place will look, second places, internal investment. We invested in cash and CapEx there in the quarter. M&a next, no M&A this quarter. And then we'll look to see where do we what do we do with the excess cash, we'll look at our models and we thought it was a good opportunity this quarter to invest some money in on share buyback. We bought $27 million back at about 310,000 shares at $85, but that was a pretty good return for our shareholders. So we look for a balanced approach Scarlett's what we did in the quarter as we move forward, please, same approach.

Scott Stember

Got it. That's all I have. Thank you.

Kevin Olsen

Thanks, Scott.

Operator

Bret Jordan, Jefferies.

Bret Jordan

I think you commented about investing in supply chain diversification as well. Could you maybe give us an update on what you're seeing there and what markets are seeming attractive and where you might begin to sort of go source from markets outside of your traditional channel?

Kevin Olsen

Yes, Bret, good question. It's Kevin. Yeah, we would we took on that initiative, Bret, a few years ago where we really started to look strategically at our supply chain. Obviously, COVID and the supply chain disruptions really accelerated our efforts there. And we are I would characterize it still is early innings in terms of diversifying our supply chain. We've made significant progress and really there are no there isn't any one area that we're focused on. It's really around the globe. So other Pac Rim countries, Eastern Europe, Mexico, India, there's a lot of places that we have successfully moved supply to some but it's going to be a it's going to be a long, a long haul. But I would tell you that today, we're very pleased with the progress that we've made.

Bret Jordan

Greg appreciate it. Thank you.

Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.