Good morning. Thank you for attending today's Mayville Engineering Company Fourth 2022 Earnings Conference Call. My name is Alisha and I will be your moderator for today's call [Operator Instructions]. I would now like to pass the conference over to your host, Noel Ryan with Vallum. You may now proceed.

Thank you, operator. On behalf of our entire team, I'd like to welcome you to our fourth quarter '22 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 risk 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'll open the line for questions. And with that, I would like to turn the call over to Jag.

Thank you, Noel all and welcome to those joining us. Today, I will provide a high level review of our fourth quarter and full year performance. This will be followed by an update on demand conditions across each of our end markets and a progress update on our MBX initiative. During the fourth quarter, we continue to build on the momentum evident across our business, highlighted by 13.8% year-over-year net sales growth and 26.2% year-over-year adjusted EBITDA growth. Total sales volumes increased 13.3% on a year-over-year basis in the fourth quarter, driven by broad-based demand across most end markets, but partially offset by continued disruptions in our customer supply chains. We also benefited from targeted commercial price increases in the period, which more than offset general inflationary pressures on labor and other product content. For the fourth quarter, our adjusted EBITDA margin increased 240 basis points to 10.5% when compared to the year ago period, when excluding the impact of the planned production ramp at our Hazel Park facility. For the full year 2022, we delivered significant year-over-year growth in net sales, adjusted EBITDA and net income. These improvements were driven by a combination of volume growth, fixed cost absorption, commercial price discipline and operational improvements. We achieved these strong full year results despite the continued supply chain disruptions impacting our customer's production schedules, which resulted in deferred sales volumes for MEC throughout 2022. Our team remains committed to improving business transparency through robust external reporting. Following recent discussions with coverage analysts and investors, we have begun to provide revenue mixed data by end market, detailed revenue and EBITDA bridges that highlight our period-over-period performance and broken out the revenue impact of raw material pass-throughs. We believe these incremental disclosures should prove helpful to understand our business and performance better.…

Thank you, Jag. I'll begin my prepared remarks with a detailed overview of our fourth quarter and full year financial performance, an update on our balance sheet and liquidity, and conclude with an overview of our financial guidance for the full year 2023. Total sales for the fourth quarter increased 13.8% on a year-over-year basis to $128.5 million driven by a combination of improved sales volumes and continued price discipline. Our manufacture margin was $13 million in the fourth quarter as compared to $9.4 million in the prior year period. The increase was driven by improved demand, increased commercial pricing and better absorption of manufacturing overhead costs, offset by a $900,000 decline in scrap income. Our manufactured margin rate was 10.1% for the fourth quarter of 2022 as compared to 8.3% for the prior year period. The increase of 180 basis points was primarily due to the reasons discussed above. Profit sharing, bonus and deferred compensation expenses were $4.1 million for the fourth quarter of 2022, which was above the $3.5 million recorded for the same prior to your period, primarily due to the decision to provide additional profit sharing to employees versus contributions to the ESOP plant. Other selling, general and administrative expenses were $6 million for the fourth quarter 2022 as compared to $5 million for the same prior year period. The increase is primarily due to increased professional fees, wages, and other expenses. Interest expense was $1.2 million for the fourth quarter of 2022 as compared to $440,000 in the prior year period, primarily due to higher interest rates. We anticipate that at current interest rates, interest expense should remain a similar quarterly level for the foreseeable future. Adjusted EBITDA increased $11.6 million versus $9.2 million for the same prior year period. Adjusted EBITDA margin percent increased…

[Operator instructions] The first question comes from the line of Mig Dobre with RW Baird. You may now proceed.

Hey. Good morning, guys. It's Joe [ph] on for Mig this morning. I wanted to -- hey, good morning. I wanted to mention the slide deck and the new disclosures were very helpful, so thank you very much for that. I guess my first question would be, and again with the slide deck there was a waterfall reconciling Q4 EBITDA with the prior year, I was wondering if maybe directionally you could talk about Q4 EBITDA versus Q3 EBITDA. Because, the way I look at it, the revenues quarter-over-quarter were down $7.7 million, but the EBITDA was down $4.6 million and I know there's a lot of moving pieces in there, but what was kind of the delta again with the EBITDA, Q3 versus Q4, which maybe left the margin a little below where we were expecting?

Yeah, so I'm going to let Todd jump in. Joe, I think one of the challenges we had in Q4 was customer supply chain disruptions. We had multiple customers that took unexpected line down days that obviously resulted in us under absorbing and last minute, we can't just take the cost out, right? So that's, I would say primarily one of the reasons why Q4 EBITDA margins we're all softer, but overall, I'm going to let Todd to help you with the bridge, but, I'm really proud of the team that executed exceptionally well in a really challenging environment in 2022. Overall, as we indicated, right, we had a tremendous performance both in top line and EBITDA margin improvement and also EBITDA dollar improvement, right? And we were able to transform our business in the second half into a better performing business coming into 2023 and more importantly, right, trying to ramp up Hazel Park and repurpose Hazel Park after what happened in late 2021. So, with that, let me turn over to Todd.

So, certainly Joe, and when you think of Q3 to Q4 sequentially, just in the normal course, the fourth quarter does have the holidays. You do end up with a little under absorption. So naturally, even if volumes would say are similar, you're going to see a little bit of dilutive impact because of fewer working days. You couple that with what Jag mentioned on the supply chain issues within our customer base and taking out a few extra days that adds a little more pressure to under absorption. We also ramped up quite a bit of headcount as it relates to Hazel Park. And so as you saw between Q3 to Q4, those costs, went up. It was about $2 million impact in Q4 versus about half of that in Q3, and then you couple the scrap income decline. So, you factor in those three things and that's really what drove down, the dollars and the percentage when you think of Q4 to q3.

Got it. Okay. Great. Thank you. That's very helpful. I guess my next question, your sales guidance is for 2023 sales would be anywhere from flat up $40 million. I guess kind of two questions related to that. First of all, you mentioned Hazel Park is a $100 million run rate exiting the year, but how much do you think through the course of the year Hazel Park will contribute? And then related to that, any thoughts on quarterly guidance or I'm sorry, quarterly cadence for the top line through the year?

So let me, let me take that, Joe. First of all, let me correct your statement that the $100 million dollar run rate exiting the year is for 2024, not 2023, for Hazel Park. That's number one. We are actively ramping, as we said in Hazel Park, right? The biggest challenge for us is really customer qualifications. Every single part we have to put through Hazel Park needs to go through detailed QP [ph] and other quality certifications by our customers. That's the biggest bottleneck. Having said that, we expect that revenue approximately between $25 million and $30 million for 2023 in Hazel Park. So that's number one. Number two, the guidance, $540 million to $580 million that we're providing on our top line for 2023 includes couple of things, right? Number one, it is risk adjuster, right? What does that mean? Well, the midpoint is risk adjuster. If the economy continues to be soft and the supply chain continues to be disrupted to our customers, will end up at the lower end of that range. If things, improve dramatically in terms of supply chain disruptions go away and economy is stable, volumes are stable, we could be at the higher end of that guidance. Also, as Todd mentioned in his prepared remarks, right now, the raw material of pass throughs are 4% to 5% down in 2023. So what that means is, take your $540 million-ish in 2022 and take out between 4% and 5% of that sales and then add back, right, our volume growth on top of that. Right? So hopefully that answers your question.

It does. That's very helpful. And then I guess my final question this is the first time I remember, are you guys talking about scrap income? Maybe I'm just not remembering correctly, but can you kind of talk about the dynamics around scrap income and how it kind of flows through the P&L?

Certainly. So that ends up being a contra expense. So it doesn't end up in our revenue lines. And the reason why we called that out, and you are correct, we have not historically called that out directly, but it changed so much and so quickly we felt it was prudent to, to kind of isolate that incident in the second half because it went from over $0.20 some a pound and almost half that in the third and fourth quarters. And it was a very steep and precipitous decline. In a normal course, scrap income was probably more than that. I call it $0.14 to $0.16 a pound. So we were unusually high in the beginning half of the year, but then it dropped really below what we would call normal market conditions in the second half. So that's why we felt that it made sense to call that out specifically in the last quarter.

Got it. Okay. Thanks for taking my questions. Good luck the rest of the quarter.

Thank you Mr. Joe. The next question comes from the line of Andy [ph] with Citigroup. You may now proceed.

I just want to understand more of what you're saying, at an end market level, you've said you expect powersports to be a higher percentage of sales in '23 versus '22 in construction Ag. I think you have down a little bit in terms of percentages, yet. The powersports market down construction flat ag up. Are you basically saying you expect customers to grow much higher than the market given the share gains you've had, maybe construction we should model conservatively and I'm not sure sort of what to make from the Ag comments because I think you talked about small Ag being down and large Ag being up, so more color would be helpful.

Yeah, So absolutely. So powersports as we indicated last time, Andy the market is driven -- or rather market has significant impact on discretionary spend and given interest rates, right, we expect the market as a whole to be down. But we have had significant program wins with a couple of our major customers. We also added a new customer in 2023 that will come online in second half of 2023. Given the new program wins, we're gaining significant share in the sports market and that's the reason why we expect that market -- that the sales in that segment to be up in 2023. In regards to construction, construction, most of our exposure right is in construction access. Residential is going to be down as we indicated. But we are seeing green shoots if you will, in non-residential construction areas and applications particularly with some of the infrastructure investments flowing through. So that gives us a little bit of confidence on the construction market that even though residential might be down, it might be partially offset by non-residential construction impact. Back to agriculture, we have approximately 50% of our sales in large Ag and approximately 50% of our sales in small Ag including turf care, right? So small Ag and turf care as you have seen industry reports and our customers talk as well talking about these sub-segments, there's significant inventory in the channel and we're seeing that softness come through in the small Ag and turf care applications, whereas large Ag continues to be strong, our customers are indicating strong demand signals and we continue to expect that sub segment to grow for us.

Got it. Very helpful. Okay. And then just flipping over to margins for a second, maybe a little more color about incremental margins in '23 and what MBX can and is contributing. I know you gave us, that 40 basis points to 70 basis points, but you cited, fair amount of headwinds on the business yet I think you're still going to high 20% incrementals at the midpoint. You can correct me if I'm wrong, but maybe how are you thinking about with MBX contributing now? Like what that means for your normalized incrementals because I think, Todd, you had talked about load 20s is normalized in the past.

Yeah. Really good question. As, as you have seen and in your past as a program like MBX takes some time to get really rooted as our daily operating system. So we've been on this journey for about six months now. And I can tell you the entire organization is excited, enthused this year, we'll -- in 2023, we'll probably do between three times to four times as many Kaizens as we would've done in 2022, right? Just the scale of our activity has significantly increased within the company. Having said that, right, the biggest concern I have after living through this type of programs for 20-plus years in my own almost 30 years in my career, right, the sustainability of those improvements is really where I am focused on. It's not the number of Kaisers we're going to do. It's really how much of those improvements can we sustain over long periods of time, right? So given that we're being really conservative on our margin impact in 2023, because I really need to see our, we as a company, right, sustain those improvements. That's why when we say 40 basis points to 70 basis points of accretion, EBITDA margins for 2023, that's a really risk adjusted conservative number that we're putting out there, right? We're going to really stand by that range with the expectation that we want to continue to push that number higher as we see the MBX program really take root in every plant, in every function, including finance and sales and marketing and supply chain, right? So I think that's where we are in terms of our MBX drive within the company. Todd, do you want to talk about the incremental margins?

Yeah. So historically you are correct. We've been in that 21.5% range historically, and like Jag mentioned, we would expect in the longer term, once the MDX really takes hold, that that incremental margin should improve. And certainly when you think of next year, we're very happy with the fact that you look at the midranges, the incrementals are, are very strong despite some continued expected headwinds. When you think of next year, we did talk about, continued potential for supply chain issues. We have the Hazel Park launch that is ongoing throughout the year that'll have a negative, $4 million to $6 million impact, and then you couple that in with the scrap decline, right? So despite all those kind of headwinds, we're still seeing nice progression on our incremental margins year-over-year at the midpoint.

Right. And Todd, you're to be clear, you're talking about '23 when you say next year, right? Just to be clear.

Yeah. Correct.

So let me just ask one other follow up on Hazel Park. So Jag, I think you mentioned the ramp up, the run rate exiting '24, just thinking about the $4 million to $6 million of incremental costs this year, is that sort of front end loaded so that by the end of the year, you're probably at breakeven or better, or like how do we think about that sort of improvement possibility?

Yeah, so if we were to think about it, right, it's probably 60-40 split Andy between first half and second half. It's sitting here, right? That's how our current estimate.

Yeah, I would completely agree with that. It is a little more front unloaded, but you still have that ramp happens throughout the year and then you get into Q4, certainly volumes in timing of days has a little bit of an impact there. So, I think the 60-40 split is a fair number.

And then for the $25 million to $30 million revenue, we're pushing to get through Hazel Park this year, right? We might be, slightly negative, right? So our goal obviously used to be at least EBITDA positive at least breakeven rather but that'll be a bit of a challenge in 2023.

There are no further questions registered. So at this time I'll pass the conference back to Mr. Jag Reddy? Excuse me. We do have a question from the line of Larry De Maria with William Blair. You may now proceed.

Just, I want to stay with Hazel Park for a minute here. So the $25 million to $35 million in '23 breakeven it may be fairly negative EBITDA growth in '24 and then a $100 million plus presumably in 2025. Can you help us on sort of the margin bridge, '24, we swing positive presumably on some number in between those sales brackets and what does it, what does it look like at a $100 million the EBITDA margin, and are we cannibalizing any other plants or is this all incremental? And, finally, how much of this is go get versus what you have visibility on?

Yeah. Okay. Thank you, Larry. On the a $100 million exit where we talked about in 2024 obviously, right? We're not providing any guidance for 2024. Having said that, we expect Hazel Park to be EBITDA accretive or positive rather in 2024. We expect perhaps approximately $65 million is $70 million-ish in revenues for 2024 out of Hazel Park with an exit run rate of $100 million and it'll be EBITDA positive. And in 2025, obviously a $100 million or more as you mentioned, we agree with that. In terms of out of the $100 million, approximately 50% of that $100 million will be new customers and new programs that we currently do not have. And then approximately 50% of the revenues would be current customers with some new programs and some existing programs, right? So what that means is, out of the $100 million, let's say approximately 25% or so of that number is some of the, the volume that we we're moving from other plans into Hazel Park to optimize our plant network, right? So hopefully that answers your question.

The other comment I would make, Larry when we think of the margin profile, when we get to the 2025 and we're at a $100 million run rate, our expectation would be that, that EBITDA margin would be in line with our expectation of the 15% or even hopefully even accretive from there. So that is our goal, our expectation. And, as Jack mentioned, keep in mind there isn't really cannibalization happen at plant. It's opening up capacity that was needed for us to bring in incremental business. So when you think of that $100 million, that will be all incremental business.

Okay. That's very clear and that's what I was looking for. And then the second question, I think is recently is December, you guys talked about the 15% EBITDA margins that you just referenced. If we look at the guidance for '23, and we have presumably obviously a much more stable year, I think the material pass throughs, you get some benefit there. But then even if we adjust out some of the under absorption and Hazel, some of the headwinds from Hazel, we're still nowhere near the 15%. So can you sort of help us bridge the gap between 15% target, which is it realistic or not, and timeframe, and then where we're entering now, even if we adjust for some of those headwinds. What's the gap?

Yeah, yeah. So we stand by our medium term goal of 15% of adjusted EBITDA margins. The bridge to where we are in 2023, our guidance and where we would like to be in couple of years is really, threefold, right? And it's approximately 70 basis points to 90 basis points, 70 basis points to 100 basis points of each of those items. One is his little pork, as we indicated. Other is scrap income as we indicated. And the third one is customer supply chain disruptions, right? We continue to see that, that's being, we talked about even in Q4 and in 2023 right? So those are the three items. Approximately 70 basis points to 100 basis points each is what we're battling to get to that 15% adjusted EBITDA launch target.

And the other comment I would make is, you look at the low end, the low end of the guidance kind of reflects about 11%, 11.2%. Yeah, as Jack mentioned, you have probably about 200 basis points to 300 basis points of headwinds and we're at 12% to 12.5%. So when you really factor that in, that potentially gets us near that 15% goal.

Okay? So realistically, medium term is probably around 2025 when we're operating at a much more productive run rate in Hazel Park

Without, really -- providing for further guidance at this point, I would say that's fair to say at some point, potentially in '24 or '25. We are expecting to have an Analyst Day later this year. And our expectation within that meeting would obviously be providing a bridge to our future EBITDA margins.

Okay. Pretty helpful. Thank you very much. Good luck.

Larry. Thank you, Mr. De Maria. [Operator instructions] There are no further questions registered at this time. So I will pass the conference back to Mr. Jag Reddy. You may now proceed.

Thank you, Alicia. Once again, thank you for joining our call. Should you have any questions, please contact Noel Ryan or Stefan Neely at Mayville, our Investor Relations Council. This concludes our call today. You may now disconnect.

That concludes today's conference call. Thank you for your participation. You may now disconnect your line.