Good morning, everyone, and welcome to the Mayville Engineering Company First Quarter 2024 Earnings Conference Call. My name is Chad, and I'll be your moderator today. [Operator Instructions] I'd now like to pass the conference over to your host, [ Stefan Neely ], to begin. Stefan, please go ahead.

Thank you, operator. On behalf of our entire team, I'd like to welcome you to our first quarter 2024 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.

Thank you, Stefan, and good morning, everyone. Thank you for joining us today. The first quarter was a strong start to the year for our team, one highlighted by a robust net sales growth, margin expansion, and free cash flow generation. Our first quarter results continue to reflect the success of our MBX framework and the impact of our culture of continuous improvement. Demand within our end markets remains healthy, supporting organic sales growth, while our teams execute on new project startups in our commercial vehicle, powersports, and other end markets. Over the last year, our team has demonstrated measurable progress with sourcing optimization and our labor utilization, resulting in $1.6 million of year-over-year self-help adjusted EBITDA improvement during the first quarter alone. We continue to see significant opportunities to further increase plant utilization, while driving improved operating leverage. For example, at our Hazel Park facility, we expect to achieve a $100 million annual revenue run rate by year-end 2024, consistent with our prior expectations. Looking to the remainder of 2024, I am encouraged by the opportunities we see to further improve our commercial reach and operational productivity. However, given broader market volatility, we continue to manage our business with discipline and conservatism. Through this lens of cautious optimism, we anticipate a steady, ratable cadence of growth and margin improvement through the balance of the year, all of which reflects the expected timing of new project starts, together with pockets of demand softness in select end markets. With that in mind, we are reiterating our 2024 financial guidance, which projects full year net sales growth of between 5% and 9%, and growth in total free cash flow of between approximately $11 million to $21 million when compared to 2023. Turning now to a review of market conditions across our 5…

Thank you, Jag. I'll begin my prepared remarks with an overview of our first quarter financial performance, followed by an update on our balance sheet and liquidity. Total sales for the first quarter increased 13.1% on a year-over-year basis to $161.3 million. This increase was driven by a combination of the MSA acquisition and improved organic sales volumes, partially offset by expected softening demand in our legacy agriculture end market and the expected falloff of certain military aftermarket programs at the end of 2023. When excluding the MSA acquisition, organic net sales growth was 3.3% on a year-over-year basis. Our manufacturing margin was $20.9 million in the first quarter as compared to $16.4 million in the same prior year period. The increase was primarily driven by increased organic volumes, MBX, commercial pricing initiatives, and the acquisition of MSA. Our manufacturing margin rate was 13% for the first quarter of 2024 as compared to 11.5% for the prior year period for an increase of 150 basis points. Other selling, general, and administrative expenses were $7.8 million for the first quarter of 2024 as compared to $7 million for the same prior year period. The increase was primarily driven by an additional $0.3 million of legal expenses related to our former fitness customer, incremental costs related to the acquisition of MSA, increased costs related to compliance requirements, and annual wage inflation. Interest expense was $3.4 million for the first quarter of 2024 as compared to $1.7 million in the prior year period due to higher interest rates and higher borrowings 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, which may provide for further interest rate stepdowns as we achieve our net…

[Operator Instructions] The first question comes from Mig Dobre from Baird.

It's Joe Grabowski on for Mig this morning. I guess, my first question, 3% organic sales growth in the first quarter. Maybe how does that break down between -- you've got Hazel Park ramping up, you've got new customer and project wins, but then maybe some end market headwinds. How does kind of the moving pieces split out to get to the 3% organic sales growth you had in the first quarter?

Thanks, Joe. Yes. So when you look at the 3% organic growth, a big driver of that certainly is a continued strong CV market relative to the last year, and then powersports wins. We really started launching those in the back, in the fourth quarter of last year, and we've seen the benefit of it. You can see that a pretty significant year-over-year incremental lift in sales as it relates to powersports of 25-plus-percent in the quarter versus last year. So, it's really a new project wins, and the market itself is kind of behaving as we had expected in the first quarter. So there wasn't many surprises that occurred. In fact, I think things are, as we look forward, are really shaping up as we expected when we came up with guidance just a few months ago.

Yes. Just to add to that, Joe, CV market is expected to be down over 10% this year. It's a huge testament to our commercial team and our operations teams that we're basically flat in CV in Q1 versus a market decline of 10% for the year, right. Similarly, powersports, as Todd mentioned, our significant wins and startups and ramp-ups in powersports are continuing to propel our sales forward in the quarter.

Great. Maybe I'm going to ask a similar question for the remainder of the year. Your assumption is that organic sales moderate a little bit the final 3 quarters of the year but stay positive in aggregate over the 3 quarters. So, again, as you look through the remainder of the year, how much do new project wins in Hazel Park offset maybe some, as you mentioned in the slide deck, some selective softening of end markets?

Yes. I think that ag market, as an example, right, that demand in that market continues to be fluid. We do expect that uncertainty to continue the rest of the year. In terms of powersports, we feel pretty good about the trajectory of the ramp. And similarly, in access and construction, mostly it's access that we're seeing a good uptick in demand, and construction continues to be driven by mostly nonresidential and infrastructure demand even though the residential continues to be soft, right. So given all those dynamics, right, we feel pretty good about these end markets. For CV in particular, we expect CV to soften somewhere as a market in the middle of the year and pick back up in Q4 as an end market. But given our product launches and ramp-ups throughout the year, we continue to expect to remain flat to last year in the CV end market.

Okay. And if I could sneak in 1 more on EBITDA margin, really nice EBITDA margin from MSA. It looks like from the waterfall maybe mid-20% EBITDA margin from MSA. If you back out MSA, maybe 40, 50 basis points of year-over-year EBITDA margin improvement. So, maybe any headwinds in the quarter that maybe limited the core EBITDA margin expansion that maybe dissipate as we progress through the year?

I wouldn't call that any headwinds in remaining non-MSA core businesses. Also, let me remind you that MSA is fully integrated. So, yes, we're calling it out separately as we roll through the second quarter. Then we'll lap that and then we'll continue to show remaining core business margin expansion. Yes, MSA had a fantastic Q1, no doubt about that. At the same time, every single one of our other parts of the business continue to show margin progression. Even Hazel Park, yes, it was a slight headwind in Q1, but that's much better than the last couple of quarters last year. We continue Hazel Park to continue to get better. The rest of the businesses continue to expand margin. Sitting here, we feel very good about our core business and how we're performing and how we continue to expand margin and remain on track to our 14% to 16% margin target in the coming years.

The next question is from Vlad Bystricky from Citigroup.

Thanks for all the color here today. I thought the commentary and updates around the value-based pricing initiatives were quite positive. So, can you talk about -- is there a way to think about how much of your overall portfolio today has made that transition to value-based pricing and sort of the runway that you see for continued value-based pricing tailwinds going forward, if you will?

Yes. I would say, it really took root probably mid to third quarter of last year where we started really implementing that. It took us a while to get going, to be honest. So I would say that in the last 6 months or so, every new program win would be under that framework. So, a lot of those wins, we haven't really started producing those products. So that means we haven't really seen that impact in our margin profile. So what that means is, less than 5%, I would say, or maybe 10% at max, is under that framework. It will take some time for rest of the business to catch up to that framework. These are annual wins that will continue to lap, and maybe it takes a couple of years for us to continue to implement that value-based pricing framework across our portfolio. Having said that, for 2024, we expect $1 million to $2 million of pricing -- price capture, a net of inflation. So it's a really good start, a net of inflation, $1 million to $2 million in this environment, is a pretty good start for us on that journey. And I expect that to continue to get better as we progress.

That's really helpful color. I appreciate it. And then, just on the capital allocation side, can you talk about the $7 million to $10 million of investment in high-return capital-light growth advancements that you've called out on the slide? Can you give some examples of what these investments entail and how we should think about the potential pace of these kinds of investments looking beyond 2024?

Yes, I'll give you a couple of examples. This year, in particular, we are focusing on cobots, right? Cobots are -- they are similar to robots, but they sort of work with humans a lot more flexibly than a regular robot. So when we think about automation, we're looking to deploy numerous instances where we could actually use a cobot, and that could eliminate not only a human operator, but also the cobot can run lights out 24/7. So, we're trialing that technology in multiple locations, in multiple plants, in multiple applications. That would be 1 example. The second example would be, as we look to replace old equipment, we will look to automate, use newer technology, and continue to look for productivity improvements in terms of labor, but also in terms of capacity utilization. How can we run the machine 24/7 is really how we think about these automation investments. Many times, these are not expensive. A cobot, just the gear itself, is like $70,000, and fully implemented, maybe $100,000 to -- you push it $120,000, right? If that $120,000 cobot can eliminate 1 operator in 3 shifts, it's a quick payback. So that's how we think about these automation investments, and then continue to deploy automation to drive productivity and expand capacity.

[Operator Instructions] Our next question is from Ted Jackson of Northland Securities.

Congratulations on the quarter. My kind of easy questions were all asked, or actually have been answered in your presentation, so let's ask more like kind of conceptual things. So let's start with MSA. And you did talk a bit about the customer cross-pollinization, but can you give us an update in terms of the capacity utilization at MSA today? I mean, when you bought the company, it was at 80%. You had about 20% of that to fill. Where does that stand now? When do you think you'd get that at 100%?

Yes. When you think of MSA, initially that utilization rate was around that 80%. We've opened up excess capacity through our MBX over the last, let's call it, 3 quarters. So I would say today that's more like 70%. So it provides us even more opportunity to cross-pollinate that facility. Our pipeline remains very strong. We're very encouraged by the number of opportunities that we're seeing. And it unfortunately takes a little more time in some circumstances when customers model changeovers, and just their timing of launch doesn't always align with where we'd like it to see it. But generally speaking, everything there is really shaping up as we expected. And again, you can see by the performance in the quarter, they're all performing given our initial expectation. And a lot of that is surrounded by really adapting that MBX culture.

Okay. Then getting away from MSA and also Hazel Park, the rest of your facilities, can you give us an update in terms of where utilization rates are in there and where you think you can get them in the next 1 year and 2 years?

Yes. As we discussed, Ted, Hazel Park will be a $100 million revenue plant for us in 2025. We have the demand to fill that plant, and we continue to ramp our product launches in the plant. And we are optimistic that we'll hit that target by end of this year going into 2025 to make Hazel Park a $100 million plant for MEC in 2025 and beyond. And after that, how much more can we expand capacity at Hazel Park with MBX and productivity initiatives? We'll focus on that once we get into 2025. But at this point, we're focused on ramping the plant to hit our targeted revenue for 2025.

Jag, actually I was asking for the non-Hazel Park plants, the ones that you've been very upfront with regards to Hazel Park itself, although it does take a question. I think I recall with -- maybe it was, I think it was the last call, you were on track for $100 million, you had $75 million of what you expected to run through there, like in the books, and you had $25 million more to go. So just since we're on Hazel Park, is it fair to assume that you've kind of circled on the rest of that business that you needed to fill that plant in terms of your guidance? And then again, kind of more a question in kind of where is capacity outside of Hazel Park and MSA and kind of where you see the trend lines for that?

Yes. We continue to fill that $25 million pipeline, if you will. Our pipeline is very strong. Going into 2025, I am confident that we will be able to fill that revenue gap in Hazel Park -- outside of Hazel Park, Ted. The demand continues to be strong. We continue to open capacity, even on push shifts. If you recall, we were full on push shifts. We were approximately 79% full on second shift and third and fourth shifts, right, much lower. So, what we've done over the past year is to continue to open up capacity with MBX initiatives. We have done about 150 kaizen events in the last 12 months -- sorry, last 5 quarters. With all of those activities, we continue to expand capacity and productivity both on first and second shifts. So given that, we continue to go after new business for every single plant. I can't think of any plant that we're not able to fill at this point. So given even in a softer end market year, we continue to grow. That's a testament to our pipeline. That's a testament to the value we provide to our customers and our ability to continue to grow with not only existing customers, but also continuing to bring in new customers to MEC.

So I have 1 more question, but before I ask it, I'm going to summarize what you just said to make sure I listened to it correctly. What you're telling me is that essentially I would say that maybe utilization rates today are not a good metric because your utilization, your capacity across your network of facilities is increasing as you're making them more efficient, which means that your fixed cost is staying the same. You're improving margins, but you even have more room for margin improvement as you fill this capacity because you have more capacity with the same fixed cost and you have a better runway in terms of realizing your goals as we think about your longer-term forecast. Is that kind of what you're telling me, Jag?

I think you summarized it better than I could have, Ted. Just 1 more comment on that, right? Some of our large plants, such as Mayville and Defiance, have had just historically impressive volumes, revenues, and EBITDA margins and EBITDA dollars in our history of 79 years, right? So that's a testament to how we're continuing to put additional volumes into our plants, but also were able to take cost out and make these large, what we call as battleships, right, continue to be more efficient and being able to produce more. And back to your point of, yes, it's the same fixed cost, right? If we can stuff more into some of these large plants, right, the drop-through is just incredible. So that's where majority of our MBX initiatives are focused on is to continue to expand productivity, expand capacity in some of our large plants so that we can show to our customers that we can take more volume, even when we're ramping up new capacity at Hazel Park, we continue to fill our existing plants with a lot more volume.

Great. And now my last question, because I'm taking up too much time. I want to circle back to the M&A strategy and progress. And I know that in the ideal world, what you really want to do is pay off MSA, get the de-levering in place, and then be able to go and pick up whatever it might be, something in plastics, composites, or new customers in the existing businesses. That being said, when you think about M&A, it's not necessarily you get to pick your timing when your opportunities come, they come, then you've got to have to just sort of dance for the dance. Where are you in terms of your funnel? Is there anything that -- you don't have to get into too much of specifics, but is there any chance that any of the opportunities that you are in discussions with or evaluating could come into play during this fiscal year and next? And that's my last question.

Yes. Great question, Ted. We continue to prioritize debt reduction for 2024. As you've seen the free cash flow generation in Q1, we continue to focus on inventory reduction, improving inventory turns, reducing our working capital. With all of these activities, we're confident that we can reduce our debt and our leverage by end of this year. We will target the low end of that range, to be honest, to get to before end of this year with our increased focus on free cash flow generation. Having said that, we have not slowed down on our approaches, evaluations of potential M&A targets. We have a list of targets that what we call as must-dos. We will continue to engage with those targets. We'll continue to wait for the appropriate time for these transactions to materialize, but with the first priority on debt reduction to get down to 1.5x leverage by end of this year. As we approach that low end of that range, 1.5x to 2x as we laid out, we will get more active in terms of what we can do next with our M&A capacity. Having said all that, the chance of a transaction closing in 2024 is small. You never say never, but it will be small because we're laser-focused on our debt reduction. But we will continue to engage with potential targets. We will continue to look for ways to fill our skills gap and our offerings to our end customers.

Congrats on the quarter, and I was impressed with your free cash flow. I mean, I kind of like free cash flow. Talk to you later.

The next question is from Tim Moore of EF Hutton.

I just want to reiterate, it's always nice to see free cash flow, and it's really what I think stocks are based on in the long-term. So, great work there. It's nice to see an organic sales growth be to maybe 2%. Powersports is very impressive. Jag, I was wondering maybe if you can give 1 or 2 examples of maybe wins over the last year or so or incremental work from current customers where you're doing more of the value-added steps in the processes like painting, coding, and tackling some more of the complex assemblies, which are higher margin. Do you remind me -- if I think from maybe a year ago when we met up for lunch, I might have written this down wrong, but I thought maybe like 75% of your value-added steps -- processes were being done at only 2 of your Plans. Is that still the case? And kind of what's the plan for that?

Thanks for the question, Tim. We continue to look for opportunities where we can do more complex fabrications for our customers. We continue to look for where we can do more, whether it is finishings, sub-assemblies, logistics, aftermarket. So, all of those activities is something at the forefront of our commercial processes and approaches. So I would say that every single opportunity that we look for, and more importantly, one in our prepared remarks where we talked about quite a number of wins in the quarter, I would say pretty much all of them have multiple offerings, not just metal fabrication, but also finishing and sub-assemblies, et cetera. So, every opportunity we look for will continue to have a lot of value addition, and that's how we can show to our customers that we're the preferred supplier to our end markets.

That's helpful. Maybe just switching here to kaizens, which never stops -- continuous improvement definition, but it seems like -- have you uncovered a noticeable amount of extra capacity or maybe worker shift optimization in a major tour to all the plants the past year. I've got to imagine some of those supervisors and managers we met a year ago were thinking they were at full capacity, but they weren't. I'm just wondering if you could talk about that for maybe incremental margins and unlocking capacity.

As I just talked about, Defiance and Mayville as an example, we continue to find great opportunities to reduce our labor content, increase our capacity, and continue to grow in every single plant. So, a lot of that comes from our focused efforts in operations to standardize, to take cost out, and have really good discipline, whether it's lean daily management, whether it is the supervisors and the ops managers and the plant managers running kaizen. Me and my leadership team, we spent 2 weeks ago a full week on the plant floor. I was in jeans and steel toe shoes and safety glasses all week working on a plant kaizen where we moved machines around, we relaid out the workflow, we did time studies. And in the end, each shift needed pre-kaizen, each shift needed 3 operators post-kaizen. We were able to consolidate all the steps, and we were able to eliminate 1 operator and we can still run the cell more efficiently, more throughput than pre-kaizen with only 2 operators. I mean, that is the focus that we have in every plant and every cell. We're driving that level of discipline. So, we did 6 kaizens during that week in Wisconsin. I won't give you the numbers, but a significant amount of savings that we were able to unlock. But at the same time, the key is not what we did during that week, Tim, as you know. The key is to sustain those savings for the rest of the year and then beyond. So, we have also put in pretty disciplined processes where we're able to monitor those savings on a monthly basis. And if they continue to remain strong, we'll continue to monitor. If they fall back, then we have countermeasures to get those savings back online. So, it's a very focused effort across the company. And I'm really proud of our MBX team. I'm really proud of the entire MEC team who is energized by our MBX program, but more importantly, driving day-to-day, not just when me and the leadership team are on the plant floor, but day-to-day driving improvements, and that's reading out in our results.

Great, Jag. That's really helpful. I'm going to save my final 3 questions for offline when we talk in an hour, but thank you.

We have no further questions. I'd like to hand back to Jag Reddy for closing remarks.

Once again, thank you for joining our call. We appreciate your continued support of MEC, and we look forward to updating you on our progress next quarter. Should you have any questions, please contact Noel Ryan or Stefan Neely at Vallum, our Investor Relations Council. This concludes our call today. You may now disconnect.

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