Mayville Engineering Q4 2023 Earnings Call Transcript

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Provided by Quartr
March 6, 2024

There are 8 speakers on the call.

Operator

Hello, everyone, and welcome to the Mayville Engineering 4th Quarter and Full Year 2023 Results Conference Call. My name is Nadia, and I'll be coordinating the call today. I will now hand over to your host, Stefan Neely at Valium Advisors to begin.

Operator

Stefan, please go ahead.

Speaker 1

Thank you, operator. On behalf of our entire team, I'd like to welcome you to our Q4 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.

Speaker 1

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 meckinc.com. Following our prepared remarks, we will open the line for questions. With that, I would like to turn the call over to Jack.

Speaker 2

Thank you, Stefan, and welcome to those joining us on the call and webcast. 2023 was a year of significant progress for the entire MEK organization as we continue to advance a multiyear business transformation journey. Our entire team came together under a 1 MEC, 1 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 $2,000,000 worth of opportunistic open market share repurchases.

Speaker 2

Our 4th 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 2nd consecutive quarter of record free cash flow generation. During the Q4, 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 Q4 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.

Speaker 2

In combination, these factors impacted 4th quarter adjusted EBITDA by $2,900,000 During the Q4, we generated a 2nd consecutive quarterly record $19,900,000 of free cash flow. Consistent with our capital allocation priorities, we reduced our outstanding borrowings by more than $21,000,000 in the 4th quarter, bringing our ratio of net debt to trailing 12 months adjusted EBITDA to 2.1 times. As we have stated in the past, our goal is to reduce our leverage to be between 1.5 times and 2 times by the end of 2024 and we are well on track to do so. In our press release issued after market close yesterday, we introduced 2024 financial guidance, which consists of net sales in the range of $620,000,000 to $640,000,000 adjusted EBITDA in a range of $72,000,000 to $76,000,000 and free cash flow in a range of $35,000,000 to $45,000,000 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.

Speaker 2

While Todd will provide specific assumptions around our 2024 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 multiyear targets we introduced at our Investor Day in late 2023. Recall that by year end 2026, we expect to deliver between $750,000,000 $850,000,000 in revenues, expand adjusted EBITDA margins to between 14% 16% and generate free cash flow between $65,000,000 $75,000,000 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 $100,000,000 of annualized sales by the end of 2024, consistent with our prior commentary.

Speaker 2

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 20252026 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 5 primary end markets. Let's begin with commercial vehicle market, which represents approximately 38% of our trailing 12 month revenues. During the Q4, commercial vehicle revenues decreased by 1% on a year over year basis, primarily due to $5,000,000 of estimated net sales impact of the UAW Strikes.

Speaker 2

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 MEK 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 Q1, stable to the Q4 of 2023. ECT expects bill rate declines through the 2nd and third quarter of over 20% year over year and then recovering modestly during the Q4.

Speaker 2

For MEK, 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 2 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 percent on a year over year basis in the 4th 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.

Speaker 2

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 Q4. We continue to benefit from market share gains, which include new customer programs and were partially offset by a cooling in consumer discretionary spending. 4th quarter growth in this market was also aided by customer supply chain disruptions that occurred in the Q4 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.

Speaker 2

Our agricultural market represented approximately 10% of trailing 12 month revenues and increased 15.2% on year over year basis during the Q4. 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 4th quarter driven by new program wins and build rate increases. Our customers have solid contractual backlogs with the U.

Speaker 2

S. Government and we continue to see good volumes based on new vehicle introductions and related programs. However, our Q4 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 $12,000,000 year over year in the Q4. This end market also saw solid organic growth during the quarter as a new project with a battery thermal management customer continue to ramp up.

Speaker 2

As I mentioned a moment ago, the MSA integration has gone very smoothly. However, our 4th 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 $20,000,000 to $30,000,000 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 $100,000,000 of sales by 2026 with at least $25,000,000 coming from revenue synergies with legacy MEC customers.

Speaker 2

During the Q4, we continued 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.

Speaker 2

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 Q4 including the following. Starting out, we were able to win significant content with one of our top customers across turf, agriculture and construction markets.

Speaker 2

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 Q4, 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 products customer.

Speaker 2

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 our next generation products and battery electric vehicle platforms. We expect to continue to grow share over the next 2 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 Q4, which we expect to help further streamline the implementation and oversight of our MBX initiatives.

Speaker 2

As before, we have continued our rigorous implementation approach centered around our quarterly presence Kaizens implemented by monthly operational and commercial excellence Kaizens. 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 turns from approximately 6 times to approximately 8 times 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 $2,000,000 to $4,000,000 from our MBX lean initiatives and another $1,000,000 to $2,000,000 from our commercial pricing initiatives, net of inflationary pressures in adjusted EBITDA.

Speaker 2

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 $35,000,000 to $45,000,000 in free cash flow generation this year will be used predominantly for this purpose along with our opportunistic share repurchases under our existing $25,000,000 authorization. Optionistic M and 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 and 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.

Speaker 2

In summary, as I have highlighted today, our 4th quarter results capped off a successful year in our multi year transformation efforts. 2024 will be a year of transition for MEK as our organic growth initiatives take hold and set us up for significant multiyear growth exiting the second half of this year. As a team, we remain highly focused on delivering a high C2 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.

Speaker 2

With that, I will now turn the call over to Todd to review our financial results.

Speaker 3

Thank you, Jay. I'll begin my prepared remarks with an overview of our Q4 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 4th quarter increased 15.6% on a year over year basis to $148,600,000 driven by a combination of the MSA acquisition and improved organic sales volumes, partially offset by the $5,000,000 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 $18,200,000 in the 4th quarter as compared to $13,000,000 in the same prior year period.

Speaker 3

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 unabsorbed 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 Q4 of 2023 as compared to 10.1% for the prior year period or an increase of 220 basis points. Profit sharing, bonus and deferred compensation expenses decreased by $500,000 to $3,600,000 for the Q4 of 2023, which is driven by the stock forfeitures related to the restructuring of our operations team. Other selling, general and administrative expenses were $7,200,000 for the Q4 of 2023 as compared to $6,000,000 for the same prior year period.

Speaker 3

The increase was primarily driven by an additional $1,100,000 of legal expenses relating to our former fitness customer. Interest expense was $3,600,000 for Q4 of 2023 as compared to $1,200,000 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 1, 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 1.5 times and 2 times by year end. Additionally, as we go into 2024, we expect that the applicable interest rate will be approximately the same as the Q4 pending any reductions in the fed policy rate.

Speaker 3

Adjusted EBITDA increased to $17,700,000 versus $11,600,000 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, MDX initiatives and a $500,000 improvement in our fixed cost absorption at Hazel Park, partially offset by the $1,600,000 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.

Speaker 3

Net sales for the full year were $588,400,000 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 $69,700,000 as compared to $61,100,000 in 20.22. This reflects a manufacturing margin rate of 11.8 percent of net sales, which is an increase of 50 basis points as compared to 11.3% in 2022. Full year 2023 adjusted EBITDA was $66,100,000 as compared to $60,800,000 in 2022.

Speaker 3

Our adjusted EBITDA margin percent during 2023 was 11.2%, which was comparable to 2022, but note that our 2023 results include $6,200,000 of losses associated with the ramp up of production at our Hazel Park facility and the $1,600,000 impact from the UAW strikes. Turning now to our statement of cash flows and balance sheet. Free cash flow during the Q4 of 2023 was a positive $19,900,000 as compared to a negative $690,000 in the prior year period. As Jake mentioned, this is our 2nd consecutive quarter of record free cash flow generation since the IPO. The improvement in free cash flow year over year was primarily due to the $13,000,000 decline in capital expenditures resulted from the completion of the Hazel Park facility and improved inventory turns as we continue to implement lean inventory management processes.

Speaker 3

As of the end of Q4 of 2023, our net debt, which includes bank debt, financing agreements, finance lease obligations and cash and cash equivalents was $149,500,000 as compared to $74,900,000 at the end of the Q4 of 2022 and resulted in a net leverage ratio of 2.1 times as of December 31. As we have stated previously, it is our intention to use free cash flow generation to reduce our net leverage ratio between 1.5x and 2x by the end of 2024. During the Q4 alone, we repaid $21,800,000 of borrowings using available free cash flow. Turning now to a discussion of our 2024 financial guidance. For the full year 2024, we expect the following: net sales of between $620,000,000 $640,000,000 adjusted EBITDA of between $72,000,000 $76,000,000 and free cash flow of between $35,000,000 $45,000,000 Please note that our 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 as the under absorbed fixed overhead costs associated with the Hazel Park facility as we ramp up to the $100,000,000 run rate by year end.

Speaker 3

Our current full year 2024 net sales guidance reflects organic net sales growth of between 1.5% 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 $100,000,000 of sales entering into 2025, which is in line with our previous expectations and will have no material impact to adjusted EBITDA as we are expecting this facility to achieve a breakeven return in 2024. Our 2024 net sales guidance also reflects a pro rata contribution from MSA of between $20,000,000 to $30,000,000 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 September of 'twenty three. Furthermore, embedded within our 2024 adjusted EBITDA guidance is a $2,000,000 to $4,000,000 reduction in costs associated with our MDx operational excellence initiatives, dollars 1,000,000 to $2,000,000 of strategic value based pricing initiatives net of inflationary pressures along with a $4,000,000 to $6,000,000 pro rata contribution from the MSA acquisition.

Speaker 3

In regards to SG and A, we expect that our SG and A expenses will grow to the high end of our near term SG and A target of 4.5% to 5.5 percent of net sales during 2024. This increase is due to the higher compliance costs associated with SOX implementation, a full year of MSA, SG and 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 and A as a percentage of net sales to between 4.5% 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 $15,000,000 $20,000,000 focusing on high return, capital light 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.

Speaker 3

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 Mac to deliver mid single digit to low double digit organic growth in 20252026 as the macro demand environment rebounds, new project wins reached our full run rates and our MSA acquisition continues to realize cross selling synergies. With that, operator, that concludes our prepared remarks. Please open the line for questions as we begin our question and answer session.

Operator

Thank And our first question go to Mig Dobre of Maybelle Engineering. Mig, please go ahead. Your line is open.

Speaker 4

Hey, guys. This is Peter Kalankarian on for Mig this morning. Thanks for taking my question. First, you mentioned $5,000,000 negative impact to sales in commercial vehicle in the Q4. Will there be catch up on this in the Q1?

Speaker 4

Is that embedded in full year guidance at all? Any color around that?

Speaker 2

Hey, good morning, Peter. Yes. Generally, I would have said, right, with order books pretty full and significant backlogs for most of OEMs in the CV market that $5,000,000 miss would carry forward into 2024. Having said that, that same customer continues to have, as they have publicly indicated, some supply chain challenges as well in Q1. So given that, it's possible that, that could just move into 2024, but also there's a general slowdown expected in 2024 for CD industry as a whole, as we mentioned.

Speaker 2

So it remains to be seen. Seen. So our forecast includes that potential carryover into 2024 in that market.

Speaker 4

Great. Thanks for the color there. This one might be a little more specific, but in your end market outlook, just looking at the slides, you now have the ag industry outlook down. It was revised from flat to down, I believe. But the company outlook for MEC to be flat was unchanged.

Speaker 4

I understand the share gain commentary, but with all the OEMs now talking about sizable declines in large ag, production cut probably going to end somewhere in the magnitude of 10%, 15%. What gives you confidence in your outlook for ag on the MEC side being flat year over year? And if it's all share gains, is there a way to add some color or even quantify what you're looking at there?

Speaker 2

Yes. That's a good question. You're absolutely correct, right? Most of our ag customers have indicated a decline in the range of 10% to 15%, both in large ag and small ag as well. As you recall, MSA that we acquired mid year last year also had some exposure to ag.

Speaker 2

I would say the incremental ag revenues from MSA, they'll lap right in 2024, it's approximately 4,000,000 So that's 1 plus significant share gains as we talked about and significant new project launches that we have mentioned in this call and previously, right, will continue to help us maintain a flattish growth in that end market. As you guys have seen from recent ag shows, some of our customers are highlighting some new technologies and new platform launches, right. We are on multiple of those programs. So that gives us confidence that as the market is slowing down, but with new project launches and new product launches from our Ag customers, right, we continue to benefit from that growth as well.

Speaker 4

All right. Great to hear. One quick last one for me actually. Any update on that the lawsuit, the fitness customer lawsuit, any changes to the time line there?

Speaker 2

Yes. Look, the lawsuit, I guess, the wheels of justice turned slow, all kidding aside, right? The parties have cross appealed the court's order on the motion to dismiss. Peloton appealed the portion of the order that denied the motion to dismiss the claim for breach and anticipatory repudiation of contract and MEC appealed a portion of the order that dismissed the claim for breach of the duty of good faith and fair dealing. Both appeals are pending.

Speaker 2

Additionally, Peloton filed a counterclaim alleging that Peloton was induced by fraud to enter into supply agreement and seeking possession of supply agreement and damages among other forms of relief. So we have answered Peloton's counterclaim as well, denying the allegations. So as we continue to pursue this claim, right, we continue to remain confident in the protections within our agreement. So that's a long way of saying, right, the lawsuit continues and we're confident in eventual outcome in the legal

Speaker 3

system. And Peter, this is Tyler. One comment I would make is in our guidance, we have reflected about $1,500,000 to $2,000,000 of legal costs as this case continues to develop. So just know that when we provided guidance we contemplated all those scenarios and included that already in our 2024 outlook.

Speaker 4

Great. Thanks for all that guys. A lot to digest there. I will jump back in the queue.

Speaker 2

Thank you.

Operator

Thank you. The next question goes to Tim Moore of EF Hutton. Tim, please go ahead. Your line is open.

Speaker 5

Thanks. And nice EBITDA guidance for this year and free cash flow generation was quite impressive in the 4th quarter. As you embark on that $200,000,000 cumulative free cash flow through 2026 goal, it was also nice to see the auto worker strike wasn't as bad as originally expected. And I just wanted to kind of reconcile one thing, Todd and Jag. For your sales guidance for this year, thanks for giving that organic growth guidance, that includes the $20,000,000 to $30,000,000 incremental sales until your anniversary on July 1 for the MSA acquisition.

Speaker 5

It seems about $10,000,000 like compared to what maybe I was forecasting, but your EBITDA of $4,000,000 to $6,000,000 was exactly what I had in my model. So how confident are you in that 20% EBITDA margin incremental? And I'm just wondering, is there any end markets that might be lighter in the first half of the year for MSA, which doesn't really have commercial vehicles, but you got the, don't know, 19% ag sales exposure it had. But RVs bottomed out. So I guess what I'm kind of getting at is, what's maybe the end market delta on sales for MSA in the first half of this year?

Speaker 5

And what gives you confidence on 20% EBITDA margin?

Speaker 2

Good morning, Tim. Look, I don't think that there's any particular end market that's kind of delta that we're forecasting against what we have indicated in the past. Todd, anything you want to add?

Speaker 3

Yes. Good morning, Tim. What I would say is within our guidance, certainly, we've contemplated numerous scenarios and we've risk adjusted. When you think of the Q1 sequentially coming out of Q4, we would expect to see a rise in volumes and sales about between 2% 4%. 2nd quarter, again, similar growth, but knowing that there's going to be a decline in the CV market that begins in the second half.

Speaker 3

Now we're highly confident we're going to be able to offer that through our new launches and other activities. But certainly we'll see a little bit of maybe top line deterioration just because of that offset, right? And Q4 certainly with just shortened, let's call it, working days and expected shutdown. So when you think of all these market dynamics happening, CV is primarily the largest change and that really begins in the second half. Ag, we've contemplated.

Speaker 3

Powersports, again, we're indicating that it's up year over year despite the macro environment showing it down. Margin progression, again, we could expect to continue to see that as Hazel Park comes online in a more significant way in the second half. So as Jake mentioned on the call, our degree of confidence in this forecast is very high. And we did look at it all end markets and really put a lot of thought into if things were to deteriorate slightly from where they are today, we're at the low end of that guidance. Certainly, if things improve, we're at the

Speaker 6

higher end.

Speaker 3

So I think we've encapsulated everything that we think could happen this year. And I would hope that this does reflect, when you look at our markets, our resilience. When you think of our historical ability to kind of offset declining markets and this is another demonstration of that that despite our markets and some of them being down double digit, we're expecting flat type of sales growth. That's because of our ability to reposition and gain market share during these times. And when you think of the progression to 25% and 26%, you get that multiplier impact.

Speaker 3

These markets are expected to rebound. And with that, we're going to get the top line sales, utilization and the nice margin progressions as we move forward.

Speaker 2

Yes. Let me hit on, Tim, the points that Todd made, right. When I was joining the company in 2022, I've talked to a lot of customers, a lot of shareholders and obviously investment community, right. One of the big concerns that was raised was that Mac tends to many of the end markets that Mac plays in, right, whether it's ag or commercial vehicle or construction, right, they tend to move in the same direction given the macro exposure, right? And that could be a challenge in a down year, right?

Speaker 2

So what we're saying here, as we have laid out clearly end market by end market, when CV is going to be down 16%, we're going to be flat. When ag is going to be down 10% to 15%, we're going to be flat, right? When Power Sports is going to be down, right, let's say mid single digits, we're going to be up, right? That demonstrates the significant work the MEC team has put in place for the last number of years to continue to grow our business, continue to gain share and continue to offset, right, potential downturns with the new program launches. And of course, right, bringing on incremental capacity, not only through AZER Park, but also through our MBX initiatives, we have unlocked significant open capacity in previous years where the sales team might have said, hey, we don't have capacity to bring on new business.

Speaker 2

Now we have completely opened that up, right? We have significant capacity we can bring on so we can confidently continue to sell, right, even though, right, the market may be up. So what that's helping us in a down year is that we have significant backlog that we're going to be able to deliver in 2024. And then when the markets come back up in 2025 and 2026, that's going to be a significant tailwind for us, right? So that's why we feel really confident about our end market exposure, but more importantly, how we have been able to offset any potential declines in a year where multiple end markets are going to be going in a downward direction.

Speaker 5

That's helpful. And made a really good point, Jag, on how construction could move with CVs. Because I was more obsessed with the MSA side and given that they have RVs at bottom, that shouldn't be a headwind for you this year. And they don't have any really CV exposure much now, but they have a construction access in agriculture. That's helpful.

Speaker 5

And it was really nice to hear about the open capacity points are really good point. I know we talked about it when it's launched a year ago. So I just got 2 more quick questions. They're pretty easy, maybe for Todd. Todd mentioned Hazel Park maybe breakeven this year.

Speaker 5

Todd, how are you thinking about how much under absorbed costs do you think in the 1st 9 months? Let's say you get to that $25,000,000 quarterly run rate Q4, you're looking like $3,000,000 drag through the 9 months, including launch and onboarding new customer costs?

Speaker 3

Yes. Good question, Tim. So really it's going to be more front end loaded. So in the first half, we would expect some under absorption of costs, I'd say $1,000,000 to $2,000,000 range. And then really that second half, when you think of 3rd quarter, you're starting to get you have some under absorption in Q3, but getting closer to that breakeven.

Speaker 3

And certainly Q4 would be in the green or the black, right? And really for the whole year that offsets what you'd see primarily in the first half. Again, most of these projects that we've been launching and working on over the last, let's call it 12 months to 18 months are really taking shape and hold and launching in the second of the year. So that's when we'll start to see the utilization happening. And again, breakeven for the year, but as we exit Q4 at that $100,000,000 run rate.

Speaker 5

Good. Good. Yes, I'll keep my $3,000,000 through 9 months. But do you expect the raw material pass throughs and scrap prices to be neutral this year? I know they were a drag last year.

Speaker 3

Yes, that is our expectation. And one of the items that Conte commented on was that our assumption is material pricing and scrap income pricing will be stable now. We don't expect any changes, but again, material pricing, keep in mind, is a pass through to our customers. So the risk of when prices rise or decline really is very minimal.

Speaker 5

Good, good. And just one last one for Jag, and I'll hand over the questions. Just on energy transition, I just think it's so interesting for you. You have that customer win that was pretty big for battery thermal management in Hazel Park. Could Jack just maybe elaborate maybe more on like some specific end markets and types of products you're working on for the lightweight deposits, aluminum, just the whole energy transition topic, if you can kind of give us a little sneak peek?

Speaker 2

Yes. Just a reminder, right, we do not play in passenger vehicles, right. So that's I want to put that out there, right. There was a lot of news over the last 6 to 9 months around the passenger end markets on EVs, etcetera, right. We have no exposure in that space.

Speaker 2

Our business development has been mostly around commercial vehicles, potentially powersports and potentially other end markets. We have taken 2 approaches, right. 1, we're directly working with a couple of CV customers and a powersports customers as they transition their platforms to battery electric vehicles. So we're directly supplying components to their BEV platforms. Secondly, the other customer we have mentioned in the past, right, who's got multiple systems that they're deploying into multiple vehicle platforms.

Speaker 2

And we're continuing to supply components to them. And then they're putting them together as sub assemblies or assemblies and then they're supplying to other end users and other OEMs. So we're participating in this energy transition both directly and indirectly. Coming back to some of our legacy customers, as our legacy customers, particularly in the CV market, right, as they refresh their platforms, they're looking to add more and more lightweight materials even in non battery electric platforms. But also as they transition to battery electric platforms, we're finding opportunities to supply aluminum extrusions, aluminum fabrications into the CV market.

Speaker 2

Just want to mention that we have gotten multiple customer codes. What that means is they have qualified MSA as a supplier. That's a first step. We have completed IATF certifications and other qualifications for the facilities that MSA operates. So all of this will help us continue to win.

Speaker 2

We did talk about last quarter a significant win in the CV market for MSA and we continue to pursue additional CV opportunities and powersports opportunities with MSA capabilities.

Speaker 5

That's terrific. And thanks. And I love the setup of possibly, hopefully, conservative organic sales growth guidance this year depending on macro. But that's it for my questions. Thanks.

Speaker 3

Thank you, Tim. Thank

Operator

you. The next question goes to Ted Jackson of Northland Securities. Ted, please go ahead. Your line is open.

Speaker 2

Good morning, Ted.

Speaker 6

Thanks very much. Good morning. Hey, so the fun questions I had have been asked, but I got a couple of small ones for you. The first one, just kind of switching back over to the commercial vehicle business and the guidance you gave. Are you expecting the second half of your sales in that category to be down relative to the first half?

Speaker 6

Is that what I when I listened, is that what I should be thinking about as I read foil my model?

Speaker 2

Yes, I think that's a fair assumption, Ted. I think the base business obviously is going to be down. The market is going to be down 16%. We're expecting the Q1 to be reasonably good, given the strong backlog and order rates. I think yesterday or so, ACP released another report saying that the February orders held, right.

Speaker 2

So I think Q1, we expect it to be pretty good. Q2 will be okay. And then we expect Q3 and Q4 for the base CV business to continue that decline, right? I mean, we can't really predict which month or which quarter exactly the downturn will be, but it will be second half. Having said that, right, we have launched our fuel tanks for one of our top customers, as we mentioned last time.

Speaker 2

So all of that will continue to ramp and should some of the declines in the second half with some of the new program launches that we have.

Speaker 6

Okay. Simple question for Todd. What do you think the tax rate what we should use for tax rate for 2024?

Speaker 3

Well, certainly, as we wrapped up our 2022 tax returns, which were filed in October, we had found some opportunities on research and development, some other credits that we can utilize. So we did have a little bit of benefit in the Q4 from those activities. And as you look into the forward guidance, you think at 24% and beyond, I would continue to say that it's 27%. We think of 21% federal and about your 6%, 7% state tax rate. So, you're working to drive and we can to hopefully minimize those impacts.

Speaker 3

But I think as you model that or look at it to try to go out on a limb and say we can beat the effective tax rate every quarter is probably a bit difficult.

Speaker 6

Okay. And then something maybe a little more entertaining, but just shifting over to the military segment in terms of top line. I mean, I know it's nothing really changing in regards to your guidance, but given the fact that the world is just increasingly a more dangerous place and we've got 2 wars of substance going on and all this concern with regard to Taiwan. Is there anything that you see on the horizon that would result in a shift in your guidance? I mean, is there if Congress was to actually get its act together and pass funding and actually give Ukraine money and Israel money, would that change anything here?

Speaker 6

Is there anything kind of out there that would say, oh, well, we have some wind in our sails or is there nothing that would change your outlook for that segment?

Speaker 2

Yes. I don't think even if there's a funding release for these 2 major conflicts get done in this year, right? I don't think we'll change our outlook. Specifically, we're already on 2 major programs, right? 1 is JLTV, other is Humvee, right?

Speaker 2

So those are 2 major programs that we're on. We had a significant program that came to an end at the end of last year that will not repeat. And that's the reason why we're being fairly prudent about our forecast in the military market. JLTV program is transitioning from one customer to another customer. And then AIM General is our Hamby producer, right?

Speaker 2

They're taking over the JLTV program. So we expect that's actually a tailwind for us. But given that we will have more content in the new OEM versus the current OEM, But that program doesn't kick in. The volumes don't kick in until sometime in 2025, right? So that's why 2024, I think, in our forecast is pretty stable and reasonable and where we sit here and then see how this market is going to perform in 2024.

Speaker 6

Okay. That's it for me. Thanks very much.

Speaker 5

Thank you, Doug. Thanks, Doug.

Operator

Thank you. The next question goes to Larry De Maria of William Blair. Larry, please go ahead. Your line is

Speaker 7

open. Thanks. Good morning, everybody.

Speaker 4

Hazel Park, obviously, you seem

Speaker 7

to have confidence in getting towards the $100,000,000 run rate. I guess, real question is how much of it is already booked versus go get? And I assume most of it at this point is sort of in

Speaker 3

the backlog?

Speaker 2

Yes. So as we indicated in the past, Larry, approximately $75,000,000 of that $100,000,000 is booked. And we feverishly continue to launch those programs. And we expect we'll be able to fill the other delta with new programs that we continue to win and pursue, but also potentially other transfers based on customer requirements where we may put a program, a new program in a different plant and then may end up moving some of that volume into Hazel Park based on customer requests and other factors. But otherwise, we feel pretty confident about filling that $100,000,000 pipeline with new business.

Speaker 7

Okay. But in other words, there hasn't been any change from the $75,000,000 over the $100,000,000 booked since the last time?

Speaker 2

No, we continue to win new programs and we'll continue to look at in a way to slot those programs. Okay. Thanks. And then, obviously,

Speaker 7

you discussed on this already in the call, but there's a lot going on this year with MSA, Hazel, some mixed end markets, but new wins in the outperformance. Can you give

Speaker 5

a little bit more maybe

Speaker 7

a finer point on the cadence of the year for sales and margins, even if it's 1st year or second half, obviously, because in the back half you have CV rolling off, but you have HaloPark ramping up and maybe that margin had been going away. So I don't know any kind of color around the actual cadence for the year, like I said, even if it's first half, second half instead of quarterly would be helpful.

Speaker 3

Yes. So Larry, when you think of first half sale from a top line perspective, we would expect sequentially coming out of Q4, Q1, like I stated being up 2% to 4%, 2nd quarter sequentially up a few percentage points versus 1st quarter. But then and again, your first half is up, right? As you look at the second half, certainly, we're going to see some declines in the CV market that 16% annualized reduction rate really begins in the second half. And so with that, even though we have new project launches buffering that, we do expect to see a little bit of sales decline in the second half.

Speaker 3

And then when you think of 4th quarter, just because it's shorter number of days and then planned shutdowns that customers do each year around the holidays, we would expect to see even a little more top line reduction. Now it doesn't matter volumes in the normalized course are really changing. It's just a matter of cadence and then certainly the CV market being a big driver of that. When you think about EBITDA margin progression, Q1 for the most part will be a little bit down as you compare it to Q4. And the reason is, I mean, some of it is, again, it's a risk adjusted budget.

Speaker 3

We are expecting our healthcare to have significant increases this year and that's been contemplated in the guidance as well as the compliance costs that we had mentioned earlier that really started Q1, day 1, when you think of not only SOX integration or migration, but also cybersecurity measures and other things that we're putting in place. So we will be at the higher end of SG and A percentage for 2024. And now when you think of that margin profile sequentially, it will begin to grow. And it's a little bit muted in the second half because keep in mind, even though Hazel Park will improve and we'll get better utilization there, with the CV market declining, some of our other plants will have less volume. And that's because there'll be an under absorbed position, but certainly it does put a little pressure and negate some of the impact of the Hazel Park launch.

Speaker 3

So again, sequentially after Q1, we would expect to see margins EBITDA margin percentage improve. And when you think of SG and A expenses, it's really a step cost. This is a kind of transitional year. As we look into 2025 and 2026, we expect to be in that low at 4.5% to 5% because we're not going to have that incremental step up going forward.

Speaker 7

Okay. And then just to clarify, we should expect Hazel Park to generate around $25,000,000 sales in 4Q. Is that about right based on obviously $100,000,000 run rate?

Speaker 2

That is the current plan, Larry.

Speaker 7

And will that be a kind of normalized margin or there will still be some friction in the Q4?

Speaker 3

There will be a little bit of friction in the Q4. Certainly, it will be a positive net income or EBITDA result, but it will be still progressing through the quarter. So as you think of the ending Q3, we'll still be going through the volume ramp up as we enter Q4. So there'll be a little bit of drag yet happen.

Speaker 7

Okay. Very good. Thank you. Good luck.

Speaker 3

Thank you. Thanks, Larry.

Operator

Thank you. Thank you. It appears we have no further questions. I'll now hand back to Jag for any closing comments.

Speaker 2

Quarter. Should you have any questions, please contact Noah Ryan or Stefan Neely at Valem, our Investor Relations Counsel. This concludes our call today. You may now disconnect.

Operator

Thank you. This now concludes today's call. Thank you for joining. You may now disconnect your lines.

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Earnings Conference Call
Mayville Engineering Q4 2023
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