Mayville Engineering Company, Inc. (NYSE:MEC) Q4 2023 Earnings Call Transcript
Mayville Engineering Company, Inc. (NYSE:MEC) Q4 2023 Earnings Call Transcript March 6, 2024
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Operator: Hello, everyone, and welcome to the Mayville Engineering Fourth Quarter and Full Year 2023 Result Conference Call. My name is Nadia, and I'll be coordinating the call today. [Operator Instructions]. I will now hand over to your host Stefan Neely at Vallum Advisors to begin. Stefan, please go ahead.
Stefan Neely: Thank you, operator. On behalf of our entire team, I'd like to welcome you to our fourth quarter and full year 2023 results conference call. Leading the call today is MEC's President and CEO, Jag Reddy; and Todd Butz, Chief Financial Officer. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the Securities and Exchange Commission. Except as required by law, we undertake no obligation to update our forward-looking statements. Further, this call will include the discussion of certain non-GAAP financial measures.
Reconciliation of these measures to the closest GAAP financial measure is included in our quarterly earnings press release which is available at mecinc.com. Following our prepared remarks, we will open the line for questions. With that, I would like to turn the call over to Jag.
Jag Reddy: Thank you, Stefan, and welcome to those joining us on the call and webcast. 2023 was a year of significant progress for the entire MEC organization as we continue to advance a multi-year business transformation journey. Our entire team came together under a One MEC One mission mindset that emphasizes performance excellence and a collaborative customer-first approach. Last year, we sharpened our commercial focus expanding within higher value market adjacencies while improving our operational discipline leveraging automation and process efficiencies. We introduced a balanced capital allocation strategy investing in innovation and robotics, prioritizing high return capital-light advancements with payback periods of less than 18 months and inorganic growth while returning capital to shareholders through $2 million worth of opportunistic open market share repurchases.
Our fourth quarter performance was a solid finish to the year, one highlighted by continued organic revenue growth, substantial year-over-year margin expansion, improved profitability and the second consecutive quarter of record free cash flow generation. During the fourth quarter, demand conditions were generally favorable primarily driven by new project launches in our powersports, commercial vehicle and other end markets. Continued strength in our military end market coupled with tailwinds from public infrastructure-driven demand in our construction and access market. Importantly, our operational and commercial self-help initiatives are continuing to deliver improved profitability and cash generation to improve the cost absorption, value-based pricing and enhanced working capital efficiency.
As expected and as previously communicated, our fourth quarter results were impacted by the UAW strikes that were resolved in November together with the ongoing ramp up of production at our Hazel Park facility. In combination, these factors impacted fourth quarter adjusted EBITDA by 2.9 million. During the fourth quarter, we generated a second consecutive quarterly record 19.9 million of free cash flow. Consistent with our capital allocation priorities, we reduced our outstanding borrowings by more than 21 million in the fourth quarter bringing our ratio of net debt to trailing 12 months adjusted EBITDA to 2.1x. As we have stated in the past, our goal is to reduce our leverage to be between 1.5x and 2x by the end of 2024 and we are well on track to do so.
In our press release issued after market closed yesterday, we introduced 2024 financial guidance which consists of net sales in the range of 620 million to 640 million, adjusted EBITDA in a range of 72 million to 76 million and free cash flow in a range of 35 million to 45 million. Our financial guidance assumes continued positive momentum in our business even amid some transitional cyclical demand softness in select end markets. As we move through the year, we expect that new customer project launches and further optimization of our existing plant capacity will position us to deliver on our forecast. While Todd will provide specific assumptions around our '24 guidance shortly, the key takeaway for everyone on the call is that we have a high degree of confidence in this forecast, one that puts us well on pace to deliver on the multi-year targets we introduced at our Investor Day in late 2023.
Recall that by year-end 2026, we expect to deliver between 750 million and 850 million in revenues, expand adjusted EBITDA margins to between 14% and 16% and generate free cash flow between 65 million and 75 million. We believe these targets accurately underscore the significant value creation potential of our business over the coming years, consistent with our unwavering focus on total shareholder returns. I would emphasize that given discussions with our customers on the trajectory of utilization improvement, we expect to see balanced organic growth and margin improvement throughout 2024. We are expecting demand headwinds in key end markets throughout the year but will be mitigated by our continued new project launches at Hazel Park and continued market share gains.
Furthermore, we continue to expect that our Hazel Park facility will achieve 100 million of annualized sales by the end of 2024, consistent with our prior commentary. Even so, we do believe that the facility will still experience cost under absorption this year, albeit at a lower rate than in 2023. In the context of the multi-year growth targets we introduced during our Investor Day this past September, we expect the macro demand environment will mask some of the tangible improvements we are making in the business while positioning us for mid-single digit to low-double digit organic growth in 2025 and 2026, as demand recovers, new projects reach full volume ramp and our MSA acquisition begins realizing substantial cross-selling synergies. Let's now turn to a review of market conditions across our five primary end markets.
Let's begin with commercial vehicle market which represents approximately 38% of our trailing 12-month revenues. During the fourth quarter, commercial vehicle revenues decreased by 1% on a year-over-year basis primarily due to $5 million of estimated net sales impact of the UAW strikes. While normalizing for the impact of the labor union strikes, sales to our commercial vehicle market would have been up 8.4% year-over-year during the quarter. Our performance during the quarter reflects softening overall demand as the industry navigates regulatory changes as well as a general slowing in the economic activity, but was offset by new project launches which we expect will be a tailwind for MEC throughout 2024. Currently, ACT Research forecasts the Class 8 vehicle production to decrease 16.2% year-over-year in 2024 to 285,000 units.
The current projection indicates that build rates will reach peak levels for the year during the first quarter, stable to the fourth quarter of 2023. ACT expects build rate declines through the second and third quarter of over 20% year-over-year and then recovering modestly during the fourth quarter. For MEC, we expect our new CV project launches to continue ramping in the first and second quarter and completing around mid-year which will help us maintain comparable sales to this end market relative to 2023. It is also worth highlighting that ACT currently expects Class 8 production to recover in 2025, growing 7.7% compared to 2024 with continued growth of 18.4% from 2025 to 2026 which supports our organic growth expectations over the next two years.
Next is the construction and access market, which represented approximately 18% of our trailing 12-month revenues. Construction and access revenues increased 1.7% on year-over-year basis in the fourth quarter as steady demand in non-residential and public infrastructure markets more than offset softness within residential markets. We expect this trend to continue through 2024, particularly as public infrastructure spending begins to drive incremental demand in this end market resulting in our expectation of relatively flat growth for the year in this market. The powersports market represented approximately 17% of our trailing 12-month revenues and increased by 27.7% on a year-over-year basis in the fourth quarter. We continue to benefit from market share gains, which include new customer programs and we're partially offset by a cooling in consumer discretionary spending.
Fourth quarter growth in this market was also aided by customer supply chain disruptions that occurred in the fourth quarter of 2022, but have since normalized. Given current market conditions, we anticipate customers slowing demand as higher interest rates curb discretionary consumer spending but we expect these dynamics will be more than offset by an ongoing new project launches at MEC, resulting in our expectation of high single-digit growth in 2024. I would note that our new project launches relate to high-end models where demand has been fairly insulated from the impacts of higher interest rates. Our agricultural market represented approximately 10% of trailing 12-month revenues and increased 15.2% on a year-over-year basis during the fourth quarter.
The increase during the quarter was primarily driven by market share gains which offset continued overall softness in our legacy business. In regards to 2024, we expect our market share gains to offset slowing end-user demand in the overall ag industry and excess levels of dealer inventory within large ag, maintaining comparable sales to this end market relative to 2023. Our military market represented approximately 6% of trailing 12-month revenues and increased 12.9% on a year-over-year basis in the fourth quarter driven by new program wins and bill rate increases. Our customers have solid contractual backlogs with the U.S. government and we continue to see good volumes based on new vehicle introductions and related programs. However, our fourth quarter results do not represent our declining volumes we expect in 2024 due to final fulfillment of expiring projects at the end of 2023.
I would also point out that the majority of the revenues from the recently acquired MSA business are represented within our other end market category, which grew by nearly 12 million year-over-year in the fourth quarter. This end market also saw solid organic growth during the quarter as a new project with a battery thermal management customer continued to ramp up. As I mentioned a moment ago, the MSA integration has gone very smoothly. However, our fourth quarter revenues were modestly impacted by the broader UAW strikes. Nonetheless, we continue to see strong coding activity from existing customers as we make headway on our cross-selling efforts. In 2024, we see MSA generating between 20 million to 30 million of incremental net sales with the revenue synergies beginning to ramp up in the second half of the year.
Long term, we continue to expect MSA to achieve 100 million of sales by 2026 with at least 25 million coming from revenue synergies with legacy MEC customers. During the fourth quarter, we continue to progress in the implementation of our MBX value creation framework, further positioning us to deliver above market growth through the cycle. Commercially, we are targeting expansion within higher value, high growth adjacent markets including fleet electrification as well as energy transition while expanding our share of wallet among our current customer base. Demand for lightweight materials fabrication remains a significant market opportunity for MEC entering 2024. While steel fabrication has been our core area of focus for much of our history, recent customer investments in the aforementioned energy transition-related technologies require solutions expertise with comparably lighter weight materials such as aluminum and composites.
Our recent acquisition of MSA puts us in a strong position to capitalize on this market more fully. We also remain highly focused on deploying value-based pricing models across our customer programs. Year-to-date the teams have been working tirelessly to implement a programmatic pricing model and we expect these initiatives to drive meaningful financial results in 2024. We had some strong new wins in the fourth quarter including the following. Starting out, we were able to win significant content with one of our top customers across turf agriculture and construction markets. Many of these new awards were a result of the capacity we have installed in Hazel Park and we look forward to launching these next generation products. During the fourth quarter we continue to expand share supporting the expansion of our customer relationship with supplying battery thermal management products to multiple end customers.
This relationship will continue to expand as our customer grows their electric vehicle battery systems while we are also working on significant outsourcing programs with this customer. In the quarter we expanded share with our access customer as they expand their capacity utilizing MEC as a supplier of choice to support their growing production. We made progress in filling our new aluminum extrusion capacity with an award from a construction product customer. We expect further wins through synergies with this account and we are very happy to see where our sales pipeline is on extrusions as we continue our cross-selling focus. We have continued to gain additional market share as our commercial vehicle customers plan for their vehicle updates both on next generation products and battery electric vehicle platforms.
We expect to continue to grow share over the next two years with the amount of change that will occur in this industry. Operationally we are focused on driving further productivity and utilization enhancements including the centralization of management functions to optimize our performance across our manufacturing footprint. To that end we restructured our operations management team during the fourth quarter which we expect to help further streamline the implementation and oversight of our MBX initiatives. As before we have continued our rigorous implementation approach centered around our quarterly presence Kaizen’s implemented by monthly operational and commercial excellence Kaizen’s. Overall our team has performed over 125 MBX lean events through the end of 2023 with a focus on implementing lean inventory management processes improving our inventory returns from approximately 6x times to approximately 8x and sustainability of cost-saving measures identified.
Going into 2024 our financial guidance reflects contribution from our initiatives in the areas of business process efficiency, asset optimization, productivity, and operational standardization. In addition, the execution of these initiatives puts us on track to achieve the 100 basis points to 150 basis points of margin improvement we expect by 2026. In summary we expect that for the full year 2024 we will deliver 2 million to 4 million from our MBX lean initiatives and another 1 million to 2 million from our commercial pricing initiatives net of inflationary pressures in adjusted EBITDA. In terms of capital allocation we remain very focused on aggressively reducing our outstanding borrowings putting us on pace to achieve a net leverage ratio of between 1.5x to 2x by the end of 2024.
Our expected 35 million to 45 million in free cash flow generation this year will be used predominantly for this purpose along with our opportunistic share repurchases under our existing 25 million authorization. Opportunistic M&A remains a key part of our multi-year growth and business transformation strategy as we look to expand into high growth adjacent end markets. To that end while we are aggressively reducing our leverage our team is building a backlog of potential acquisition targets that will meet our criteria. As we are able to achieve our targeted net leverage levels we will be opportunistic in pursuing M&A that continues to build on our market leading capabilities and position the company to further capitalize on multi-year secular growth trends in energy transition and OEM outsourcing.
In summary as I have highlighted today our fourth quarter results capped off a successful year in our multi-year transformation efforts. 2024 will be a year of transition for MEC as our organic growth initiatives take hold and set us up for significant multi-year growth exiting the second half of this year. As a team we remain highly focused on delivering a high say/do ratio one where we continue to focus on program execution is at the center of all we do. Collectively we remain focused on delivering a superior return on invested capital whether through organic investments acquisitions or the repurchase of our own common equity. As we look forward to the coming year we will continue to hone and refine our approach to capital allocation as we seek to maximize value for all our shareholders.
With that, I will now turn the call over to Todd to review our financial results.
Todd Butz: Thank you, Jag. I'll begin my prepared remarks with an overview of our fourth quarter and full year financial performance followed by an update on our balance sheet and liquidity that will conclude with a review of our 2024 financial guidance. Total sales for the fourth quarter increased 15.6% on a year-over-year basis to $148.6 million driven by a combination of the MSA acquisition and improved organic sales volumes partially offset by the $5 million impact from the UAW strikes, which was primarily in our CV market as well as softening demand in our agricultural end market. When excluding the MSA acquisition organic net sales growth was 6.1% on a year-over-year basis. Our manufacturing margin was $18.2 million in the fourth quarter as compared to $13 million in the same prior year period.
The increase is primarily driven by increased organic volumes, MBX initiatives, and the acquisition of MSA. These tailwinds were partially offset by the impact of unobserved fixed costs associated with the new project launches, operational restructuring expense, and the impact of the UAW strikes. Our manufacturing margin rate was 12.3% for the fourth quarter of 2023 as compared to 10.1% for the prior year period for an increase of 220 basis points. Profit sharing bonus and deferred compensation expenses decreased by $500,000 to $3.6 million for the fourth quarter of 2023 which is driven by stock forfeitures related to restructuring of our operations team. Other selling, general and administrative expenses were $7.2 million for the fourth quarter of 2023 as compared to $6 million for the same prior year period.
The increase was primarily driven by an additional $1.1 million of legal expenses relating to our former fitness customer. Interest expense was $3.6 million for a fourth quarter of 2023 as compared to $1.2 million in the prior year period due to higher interest rates and higher borrowing under our credit facility. The increase in borrowings is due to the acquisition of MSA, which closed on July 1st, 2023. We continue to expect debt reduction during 2024 that may provide for further interest rate step downs as we achieve our net leverage goal of between 1.5x to 2x by year end. Additionally, as we go into 2024, we expect that the applicable interest rate will be approximately the same as the fourth quarter pending any reductions in that Fed policy rate.
Adjusted EBITDA increase to $17.7 million versus $11.6 million for the same prior year period. Adjusted EBITDA margin percent increased by 290 basis points to 11.9% in the current quarter as compared to 9% for the same prior year period. Increase in our adjusted EBITDA margin was primarily due to the increased organic volumes, the MSA acquisition, MBX initiatives, and a $500,000 improvement in our fixed cost absorption at Hazel Park, partially offset by the $1.6 million impact from the UAW strikes. Adjusted EBITDA margin progression is evident and demonstrates early advancement towards our 2026 goal of 14% to 16%. Now I'd like to provide a brief summary of our full year 2023 results. Net sales for the full year were $588.4 million, an increase of 9.1% as compared to the full year 2022.
Our full year 2023 net sales growth includes organic net sales growth of 4.3%. Our full year 2023 manufacturing margin was $69.7 million as compared to 61.1 million in 2022. This reflects a manufacturing margin rate of 11.8% of net sales, which is an increase of 50 basis points as compared to 11.3% in 2022. The full year 2023 adjusted EBITDA was $66.1 million as compared to 60.8 million in 2022. Our adjusted EBITDA margin percent during 2023 was 11.2%, which was comparable to 2022, but note that our 2023 results include $6.2 million of losses associated with the ramp up of production at our Hazel Park facility and the $1.6 million impact from the UAW strikes. Turning now to our statement of cash flows and balance sheet. Free cash flow during the fourth quarter of 2023 was a positive $19.9 million as compared to a negative $690,000 in the prior year period.
As Jag mentioned, this is our second consecutive quarter of record free cash flow generation since the IPO. The improvement free cash flow year over was primarily due to the $13 million decline in capital expenditures resulted from the completion of the Hazel Park facility and improved inventory terms as we continue to implement lean inventory management processes. As of the end of the fourth quarter of 2023, our net debt, which includes bank debt, financing agreements, finance lease obligations, and cash equivalents was $149.5 million as compared to $74.9 million at the end of the fourth quarter of 2022 and resulted in a net leverage ratio of 2.1x as of December 31st. As we have stated previously, it is our intention to use free cash flow generation to reduce our net leverage ratio to between 1.5x to 2x by the end of 2024.
During the fourth quarter alone, we repaid $21.8 million in borrowings using available free cash flow. Turning out to a discussion of our 2024 financial guidance. For the full year 2024, we expect the following. Net sales of between $620 million and $640 million. Adjusted EBITDA of between $72 million and $76 million and free cash flow of between $35 million and $45 million. Please note that risk-adjusted outlook takes into account the expected macro softening in the second half of the year, stable raw material and scrap income pricing, as well the under-absorbed fixed overhead costs associated with the Hazel Park facility as we ramp up to the $100 million run rate by year end. Our current full year 2024 net sales guidance reflects organic net sales growth of between 1.5% and 2.5% driven by new project wins associated with the ramp up of production at our Hazel Park facility.
Additionally, our guidance reflects the Hazel Park facility achieving an annualized run rate of $100 million of sales entering into 2025, which is in-line with our previous expectations and will have no material impact to adjusted EBITDA as we're expecting this facility to achieve a break-even return in 2024. Our 2024 net sales guidance also reflects a pro-rata contribution from MSA of between $20 million to $30 million in the first half of the year, and we expect to achieve revenue synergies in the second half of the year, which are in line with the expectations we articulated at our Investor Day in September of 23. Furthermore, embedded within our 2024 adjusted EBITDA guidance is a $2 million to $4 million reduction in cost associated with our MBX operational excellence initiatives, $1 million to $2 million of strategic value-based pricing initiatives, net of inflationary pressures, along with a $4 million to $6 million pro-rata contribution from the MSA acquisition.
In regards to SG&A, we expect that our SG&A expenses will grow to the high end of our near-term SG&A target of 4.5% to 5.5% of net sales during 2024. This increase is due to the higher compliance costs associated with SOX implementation, a full year of MSA SG&A expenses, and general inflationary costs. This increase was contemplated in the guidance we provided at our Investor Day in September, and we continue to target reducing our SG&A at a percentage of net sales to between 4.5% and 5% by 2026. Regarding our 2024 free cash flow guidance, we currently expect that our capital expenditures for the full year will be in the range of between 15 and 20 million dollars, focusing the high return capital aid automation advancements with payback periods of less than 18 months, such as recently implemented Cobot technologies and other investments to support organic growth.
Based on our free cash flow guidance, we expect to achieve our target of between 1.5x and 2x net debt leverage by year-end. Please note that our organic growth assumptions for 2024 are risk adjusted to reflect the degree of macro uncertainty that currently exists across some of our key end markets and the impact that this uncertainty may have on the demand for new projects as they launch throughout the year. Lastly, I would like to reiterate that 2024 will be a transitional year, one that positions MEC to deliver mid-single digit to low double digit organic growth in 2025 and 2026 as the macro demand environment rebounds, new project wins reach their full run rates, and our MSA acquisition continues to realize cross-selling synergies. With that, Operators, that concludes our prepared remarks.
Please open the line for questions as we begin our question and answer session.
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