Good morning. Thank you for attending the Mayville Engineering Company Third Quarter 2024 Earnings Conference Call. My name is Bridget, and I'll be your moderator today. All lines will be muted during the presentation portion of the call with an opportunity for question-and-answers at the end. I'd now like to pass the conference over to your host, Stefan Neely, with Vallum Advisors. Thank you, Stefan. You may proceed.

Thank you, operator. On behalf of our entire team, I'd like to welcome you to our Q3, 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. During the Q3, we continued to advance our strategic priorities despite a marked near-term deceleration in customer order activity. This demand softening materialized at the beginning of August as customers took destocking actions to manage their high levels of dealer inventory. In response to the shifting demand conditions, we introduced a series of cost rationalization initiatives during the Q3. This includes the reduction of production days, a 12% reduction in our labor force, the decision to permanently close our Wautoma facility in the 4th quarter and other cost reduction actions. The combination of these items are expected to result in an estimated $600,000 of restructuring expenses in the Q4 and $1 million to $3 million in annualized cost savings. In combination, these cost actions positioned us to deliver a 50 basis point increase in adjusted EBITDA margins as compared to last year. This demonstrates our ability to quickly navigate through a down cycle and execute in a challenging environment even as net sales declined by more than 14% versus the prior year period. While demand conditions have begun to stabilize during the Q4, order rates are below our expectations. Our outlook for the year has always reflected a softening demand environment in the second half of the year, particularly in the commercial vehicle market. However, the pace of demand weakness in our powersports, agriculture and construction end markets were greater than expected. Many customers cut production in response to lower order intake and to destock channel inventories. Given the current demand environment, we have opted to reduce our full year 2024 net sales, adjusted EBITDA and CapEx guidance. Our revised guidance accounts for reduced order activity during the second half of 2024, partially offset by recent cost…

Thank you, Jag. I'll begin my prepared remarks with an overview of our Q3 financial performance, followed by an update on our balance sheet and liquidity, and conclude with a discussion of our updated 2024 guidance. Total sales for the Q3 decreased 14.4% percent on a year-over-year basis to $135.4 million. The decrease in net sales reflects softening customer demand across all our key end markets due to channel inventory rationalization and softer customer demand, partially offset by ongoing new project ramp ups. Our manufacturing margin was $17.1 million in the third quarter as compared to $19 million in the same prior year period. The decrease was primarily driven by the corresponding decrease in net sales. Our manufacturing margin rate was 12.6% for the Q3 of 2024 as compared to 12% for the prior year period or an increase of 60 basis points. The improvement in our manufacturing margin rate reflects the impact of our ongoing MBX and pricing initiatives, labor force reduction decisions and other cost reduction actions. Other selling, general and administrative expenses were $7.6 million for the Q3 of 2024 as compared to $8.6 million for the same prior year period. The decrease was primarily driven by a reduction in legal expenses relating to our former fitness customer and non-reoccurring costs incurred in the prior year period associated with the MSA acquisition. Interest expense was $2.7 million for the Q3 of 2024 as compared to $3.9 million in the prior year period due to a reduction in borrowings and lower interest rates relative to the Q3 of last year. The decrease of $57.7 million in the borrowings since the Q3 of the prior year reflects our continued strong free cash flow generation over the past year. Adjusted EBITDA for the Q3 was $17.1 million versus $19.2 million…

[Operator Instructions] The first question comes from the line of Mig Dobre with Baird. Mig your line is now open.

Thank you, and good morning, everyone. My first question. Digging into your fourth quarter outlook, can you maybe break it down a little bit in terms of what your expectations are for manufacturing margin and how you think about SG&A sequentially?

Yes. So maybe as you think about the fourth quarter sequentially, we would expect manufacturing margin to be down slightly again as compared to Q3. Keep in mind that when you think of our fixed versus variable cost, fixed represents about 55% of our total cost makeup. And so, given the low expectation of $120 million to $130 million volume in Q4, I think we're doing everything we can to get the variable cost out, but that will lead to and drive under absorption. So, SG&A, we did make some changes within SG&A, and that was part of our other cost reduction activities. So, we will see a favorable impact on that as we look into Q4. And then you can see that the expected EBITDA margin profile isn't that 7.5%, 8% to maybe 9% to 10% range. So certainly, it's a low point in the cycle, but we feel like we've done everything right to position ourselves as the markets rebound to really take advantage and scale up. I think more importantly is as we enter 2025, I think we've cost position the business well that when we come out of the quarter, we can see incremental margin rates that are in that low to mid 20% range. So, I think again, this is a low point and we'll come out of it very quickly.

Yes, just to add to that, Mig, we have made the decision to extend shutdowns during Thanksgiving week, Christmas holidays, pretty much every single one of our plants. And we have informed our customers that we'll be shutting down for extended periods and gave them almost 60-day notice, so that we could continue to produce and ship for them outside of those shutdown days, right. So, this is first time in a very long time as a company, we have pulled every lever possible to reduce our cost structure, take out variable costs as much as we can and also resize our SG&A and other elements of our fixed costs as well. So, as the demand comes back going into first half, we are really well positioned to take advantage of that reduced cost structure and continue to drive better margin profile for the business going forward.

But just to put a finer point here, looking at my model here, I'm guessing that manufacturing margin is going to be somewhere around 8%, 8.5%. Is that a fair way to think about it?

Yes. I would say it's a fair way to characterize it, yes.

So, when you look at the revenue for the 4th quarter, I think the midpoint implies something like $125 million, is that in line with the orders that you're getting from the customers? Meaning, are you your book to bill in terms of that revenue, is it 1? Is it less than that? Are you still burning through some backlog of business? Or how should we think about that?

Yes. I would say that is firm in orders, right? It's not backlog, it's not anything else that we need to go get or fill, and really represents what we see today as our Q4 volume at that midpoint. And again, we've restructured and positioned well. We have not lost any orders. I think that's a very important point as Jag mentioned earlier. And we really stand in good position as we look to 2025

Yes, let me reinforce that. We have not had any material market share losses. We kept pretty much all of our existing business. We continue to add new business as I mentioned in my prepared remarks. Year-to-date, we have won 80 million of new business. Our run rate for the last couple of years has been 80 million to 90 million of new business on an annual basis, ending Q3 at 80 million of new business. Really is a very good book of business for booking and more importantly preserving our share and in many cases expanding our share within our customer base.

Okay, so the fourth quarter, you're basically producing at the sort of levels that the market allows from a demand standpoint. I guess my final question is, as you think about 2025, and I recognize we'll get to specific guidance later on, but as you think about 2025, at least to me, it's not evident that the fourth quarter marks the trough or that you're going to see significant improvements sequentially in at least in the first half of the year, because virtually every vertical you have here, commercial vehicles, so it's got production issues. Agriculture, we heard from ADCO the other day, production cuts are stretching into 2025. We're probably going to hear the same from CNH and Deere construction and access, Oshkosh is cutting production in area work platforms and tele handlers. So, it seems like this is an issue that stretches into 2025. I'm curious as to what your perspective is on that, and then if I'm correct in my assertion that this is stretching into ‘25, what tools do you have at your disposal to get manufacturing margin or overall margin to improve relative to what we're seeing in the fourth quarter? Thank you.

Yes. A significant end user demand issues that you raised, related to financing rates and excessive dealer inventories that many of our publicly traded customers have talked about extensively in their earnings calls or the past few months. So, we have appropriately adjusted our cost structure and our capacities to reflect that going forward. Our expectation, MEC, is that power sports would be the first end market to recover as interest rate cuts take hold, right after Powersport, we expect powersport to recover sometime in the first half, call it late Q1, early Q2 or sometime in Q2. Construction access is probably Q2 time period is where we expect construction access market to start seeing an uptake back. Our at least normalization levels, CV market the data is well known and well published, as we mentioned, based on ACT research. Second half we'll start to see a pickup even though sequentially, quarter-over-quarter next year CV will continue to step up. And then Ag, I think is in a longer cycle of a downturn, and we don't expect ag to recover in 2025. Having said that, Ag is only 8% of our total revenues, so we can just beat up on Ag and market all day long, but it's only 8% of our total revenues, right? So, we're still 38% in CV, 15% to 18% in other two end markets I just mentioned. So, I think we just need to think about, right, yes, ag is in a downturn and that's the news we hear all day long, but that's only 8% of our overall sales.

The next question comes from the line of Ted Jackson with Northland Securities. Ted, your line is open.

So, a couple of questions. So, let's just start, like, most of it's pretty easy. The $600,000 charge, just out of curious, are we going to see that above or below the operating income line in the Q4? And will it be called out as far as a singular line item or will it just be inside of your SG&A expenses?

No, it'll be above and it will be called out separately. Certainly, as we mentioned in the Q4, we will be shutting that facility down, preparing it for an ultimate potential sale as we look into early part of 2025. So those items will be construed as restructure costs and be called out separately and clearly defined in our KA.

Okay. And then on the $1 million to $3 million in annual savings, is that something that we should expect to see beginning in, I don't know, the Q1 of '25 or that happened in the Q4 of '25? And then will it I assume it will be something that builds over time or is it will be kind of a onetime shot?

No, I think you'll see that right away coming into Q1 of next year, but let's call it mid quarter. Because again, our expectation is to have that facility completely closed and positioned for sale. And hopefully, we've seen good interest and so hopefully we can exit that completely in the Q1 and have that savings. And so again, we should see that beginning in the first part of 2025.

And then when we think about those savings, would we see that more on the cost of goods sold line or more within the OpEx lines?

Yes, it will be mostly in the cost of sales line. We did some reposition like we mentioned on SG&A, which will be savings. But the bulk of that really is all of the fixed costs that related to the plan and then other some direct headcount reductions that we've made.

And then, with the Peloton settlement, a couple of questions there is where will we see that on the free on the cash flow all line? Will that show up in, in kind of the investing side of things? Will it show where will it show up in there? And then you mentioned in your presentation that you used those funds already to pay down debt and to repurchase stock in the quarter. Could you tell us how much stock you repurchased with it and how much of it went to debt production?

At this point, obviously, as you know, we have a line of credit, it's a sweep account. So, any collections on a daily basis that we receive go in and reduce debt overnight. So, we have yet to deploy, share repurchase at this point. All that was used for debt reduction on the intraday. But we, as Jag mentioned, we are looking to have a more programmatic stock repurchase. And we will expect in the Q4 to allocate some of those proceeds, to stock repurchase. As it relates to free cash flow, that will show up in the operational line. But when you think about our annual disclosure and our 10-K, that will be clearly delineated as to where in the financial statements as well as where in the cash flow line that those proceeds went through.

But you're saying that'll show up with an operating activity? I would a little surprised by that, but okay.

Yes. From the free cash flow, yes.

And then going back into some of the guidance and stuff, I mean, you've got some tough comps in the first half of the year. Is it fair to assume as we think about given the fact that you're going to have a relatively weak second half of ‘24, that the way you're laying it out, that just because of the comps that we should see growth return in the second half, just be you see what I'm saying? Just as we roll through your guidance, that starting with probably the third quarter and then with the fourth quarter, that we should see revenue growth from the prior year and then it sounds like you're viewing it as something that would accelerate maybe in terms of actual growth in 2026.

Yes, I would say that's a very fair depiction of what we would expect.

The next question comes from the line of Natalia Bak with Citi. Natalia your line is open.

Good morning. This is Natalia Bach from Citigroup on behalf of Andy Kaplowitz. I guess my first question, you revised your ‘24 guidance setting stops and customer demand, but in the presentation, I noticed you kept your organic net sales growth of 1.5% to 2.5% for the year. Can you help reconcile why that is?

That is without, so we kind of separated the two meaning organic growth, that is new wins and opportunities we've done. And we try to separate that slightly from when you look at the market and destocking, and the impact that that has had. So, we still feel like we're on pace to continue to have, year-over-year it will be kind of flat potentially up slightly. So, we might see that year-over-year be a little better, but we were trying to exclude a little bit of the impact of destocking.

And then maybe just focusing on a specific end market, particularly power sports. You cited that you're gaining slash growing market share, but can you talk about who you're taking market share from, and despite the software macro outlook what initiatives are you implementing or taking actions to gain this market share?

Yes, Natalia, we talked about bringing on brand new customer in the power sports market at the beginning of the year. That customer program went into production earlier this year. That is what, mostly we're talking about a new customer win and a market share gain. Similarly, we have also picked up new programs with existing customers as well. These are both of these customers produce side-by-side and vehicles in that nature, so those are the two customers where we have gained a pretty good share this year.

Okay, helpful. And my last question, just on free cash flow, you had pretty good free cash flow generation year-to-date, and you maintained your guidance for the year. I'm just curious from your perspective, what's going right there. What are you like optimizing in terms of working capital or what initiatives are you doing to continue to generate the strong free cash flow?

Absolutely. As we publicly discussed in the past couple of quarters, our MBX program and our intense focus on reducing our working capital, reducing our inventories, collecting our outstanding receivables faster and adjusting our payable terms with our suppliers. We pulled all of those levers. Since 2022, we ended 2022 at 6.2 turns of inventory. We ended Q3 around 9 turns of inventory. So, you can see that level of improvement in how we're managing our business and how we're managing our working capital, all of that is reading out in our free cash flow generation.

There are currently no questions registered. [Operator Instructions]. There are no additional questions waiting at this time. I would like to pass the conference over to our management team 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 Valem, our Investor Relations Counsel. This concludes our call today. You may now disconnect.

That concludes the Mayville Engineering Company Third Quarter 2024 Earnings Conference Call. Thank you for your participation and enjoy the rest of your day.