Good day, and welcome to the Mayville Engineering Third Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Nathan Elwell. Please go ahead. .

Thank you. Welcome, everyone, and thank you for joining us on today's call. A few quick items before we begin. First, please note that some of the information that you will hear during this call will consist of forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended.

Such statements express our expectations, anticipations, beliefs, estimates, intentions, plans and forecasts. Because these forward-looking statements involve risks, assumptions and uncertainties, our actual results could differ materially from those in the forward-looking statements.

For more information regarding such risks and uncertainties, please see our filings with the Securities and Exchange Commission, including our Form 10-K for the period ended December 31, 2019, and our filing on Form 10-Q for the period ended June 30, 2020.

We assume no obligation and do not intend to update any such forward-looking statements, except as required by Federal Securities Laws. Second, this call will involve a discussion of certain non-GAAP financial measures.

Reconciliation of these measures to the closest GAAP financial measure is included in the earnings press release, which is available at mecinc.com. .

Joining me on the call today is Bob Kamphuis, Chairman, President and Chief Executive Officer; Todd Butz, Chief Financial Officer; and Ryan Raber, EVP of Strategy, Sales and Marketing. .

First, Bob will provide an overview of our performance, then Todd will review our financial results. Bob, please go ahead. .

Thank you, Nathan. Good morning, everyone. Before we discuss our third quarter results, I wanted to provide a brief update regarding the health and well-being of our employee shareholders.

We've been operating effectively under pandemic conditions for several months, and I'm pleased to report we've done a good job of creating a safe environment for our workforce and have avoided any widespread outbreaks at any of our facilities so far.

We're certainly not taking this for granted and remain vigilant with our protocols to do everything we can to ensure the health and safety at all of our facilities. With that said, let's now turn to results.

After navigating a very challenging second quarter when many customers were shut down, we delivered improved results during the third quarter as customers started to get back to work. All things considered, we're pleased with our performance.

Despite ongoing COVID risks and challenges, we delivered encouraging top line results as many of our customers ramped up production during the quarter, which led to volume returning for MEC..

From a cost management perspective, we're pleased with the progress we've made in optimizing our manufacturing operations. We continue to implement measures to maximize our efficiency, productivity and the impact of these initiatives and beginning to flow down to our bottom line.

For the third quarter, we generated net sales of $91.1 million and adjusted EBITDA of $9.8 million. While we're encouraged by the sequential improvement of our financial performance, we see even more improvement potential and continue to strive to improve our results going forward..

first, by realizing full year benefits from the acquisition synergies with DMP; second, by realizing efficiencies from our recent investments in technology and automation; and third, from the recent consolidation of our Greenwood South Carolina capacity footprint, which I'll explain in more detail.

As a reminder, our DMP acquisition has now been fully integrated into our organization for several months. We're seeing the expected synergies manifest themselves and are excited to see this business continue to trend positively over the coming quarters.

On the Greenwood topic, led by our new CEO -- our COO, Rand Stille, our highly skilled team of planners and engineers did a fantastic job of implementing the transition and ensuring that everything went according to plan..

Our inventory management initiatives were executed perfectly, guaranteeing we did not miss a beat with our customers. All the former Greenwood based programs have now been moved to 5 other manufacturing facilities around the country and are now fully up and running.

All of the necessary equipment from this facility have been transferred to other locations, we have sold excess equipment and are preparing the facility for sale. As a reminder, we have reduced overhead costs as well by maintaining our overall manufacturing capacity despite this reduction in footprint.

For the former Greenwood manufactured parts, we have also reduced related working capital and expect improved margins at the new manufacturing locations over the long run. All in all, the process went according to plan, and the timing could not have been better.

Coupled with the contributions that our investments in automation are generating, we are pleased with how well we've been able to manage our cost structure this year..

That brings us to our end markets and what are we seeing throughout the industry.

After many of our customers experienced pandemic-related shutdowns near the end of the first quarter and into the second quarter, there were far fewer disruptions during the third quarter and operational ramp-ups progressed slightly better than planned across the board..

Our customers are continuing to get back towards more normal production schedules albeit at lower volumes for some and the relative calmness compared to previous quarters has certainly been welcome. We are encouraged that the tides are beginning to turn for many of our major end markets, which are showing early signs of stabilization and improvement.

In our commercial vehicle markets, especially based on industry data and customer feedback, we believe the pullback seen over the past 12 months are mostly behind us.

Our orders during the quarter were in line or above industry forecast, with more robust freight rates returning as a result of increasing orders from carriers and large fleets, we anticipate that the market will continue to improve in the near term. Throughout the pandemic, the powersports market has displayed significant relative strength.

With people unable to travel fire, they have increasingly engaged in forms of local outdoor recreation. And we continue to believe that this will be an area of strength for our business near term, as these MEC customers rebuild dealer inventory and meet consumer demand..

As we have consistently noted that construction and access and our agricultural end markets have been challenging over the past 12 months, with inventory destocking being a notable issue. We are cautiously optimistic that the worst of the destocking is behind us at this time.

And we are hopeful that the situation will continue to slowly improve going forward. As the world has rapidly changed since March, there are increasing questions as it relates to the nonresidential construction market. While we are hopeful that this business picks up in the future, the timetable and magnitude are certainly unknowns at this point.

We continue to be in close contact with our customers in this segment as everyone continues to adapt to the challenges of this new environment..

Finally, our Military segment has continued to be a steady market for us. We continue to be encouraged with our business for this market, and we'll look for it to be an ongoing source of strength for us in the coming years. Our efforts relating to capturing additional market share are progressing well.

Despite the headwinds we have faced in the last months, I want to reiterate that no contracts or customer relationships have been lost this year. This means as our customer volumes return our volumes will also return, and we are ready to deliver.

Overall, we're encouraged by the broader trends that we are starting to see across our end markets as some of the headwinds that we have faced over the past 12 months are starting to dissipate.

In addition to the advancements that we've made in our current operations, we are diligently seeking out new projects and takeover business in both our current markets that we serve and attractive new lines of business..

In recent months, we have been able to secure market share growth across multiple product lines for one of our important commercial vehicle customers. This was done through product development activities with the new programs launching next year as our customer brings on their new models of trucks.

In the ag market, we recently secured new contracts for a tractor platform at an existing customer that continues to bring new technology to the market. This highlights our ability to build long-term relationships and grow alongside our customers..

We've seen a very active Power Sports market this year. We've secured both volume expansion and added new products with existing customers. We are also pursuing potential awards with multiple new customers in this market.

With our ability to ramp up capacity to support rapid expansion of products in both takeover and product development cycles, we are well positioned to help customers meet their growing demand. In previous calls, we've also mentioned the work we are doing in the warehousing and package management space.

We launched programs with a new customer earlier in 2020, which has continued to see sequential growth both due to increased volumes and the customer's expansion of market share as we continue to build this promising partnership..

Overall, we believe that there are multiple interesting opportunities for new projects and take over business in our pipeline, and we are excited to explore these new avenues in the weeks and months ahead.

So despite the challenges faced in the past year, we continue to generate strong cash flow, which has allowed us to opportunistically pay down debt. Todd will discuss this topic in more detail in his section but suffice it to say, we're pleased with our current financial position..

In addition to making ongoing organic investments in our business growth, we are constantly surveying the market for intriguing acquisition opportunities that will help us achieve long-term growth.

While the market remains relatively quiet, we are still looking for opportunities that help expand and diversify our product offering, gain exposure to new industries and establish relationships with new blue-chip customers.

Unlike many of our competitors today, should the right investment become available, we have the flexibility and meaningful capacity to pursue them given our fortified finance position..

Overall, this quarter featured many positive developments, and we're doing a good job of adapting our business to meet our customers' market needs and realities. We are very glad to see that most of our customers are progressing in their ramp-up of production and encouraged by the overall direction that our end markets are heading..

In 2020, we recognized their 75th anniversary. And on our heritage as we continue to be focused on executing on everything in our control. And delivering the highest quality value and service to our customers when they need it the most.

While some level of uncertainty will undoubtedly be part of the story in the near term, we are more optimistic today that at any point in the past 12 months and believe we are well positioned for the future..

With that, I will pass on the call to Todd, so he can discuss our financial performance.

Todd?.

Thanks, Bob. I'll begin with a look at our third quarter financial performance before providing commentary on our balance sheet, liquidity and our thoughts on guidance. As noted in our press release, we recorded third quarter net sales of $91.1 million, as compared to $128.5 million for the same prior year period, a decrease of 29%.

The decline is due to manufacturing volume reductions driven by the pandemic and continued customer destocking activities, particularly in the agriculture and construction access equipment end markets. Despite the lower volumes, it is important to note that all customer relationships, manufacturing programs and components produced remain intact.

Manufacturing margins were $9.7 million for the third quarter of 2020 as compared to $14.6 million for the same prior year period, a decline of 33%. The comparative decline was mostly driven by the aforementioned volume declines.

Although our cost reduction efforts helped realign our business, volume reductions resulted in under-absorbed fixed overhead..

Additionally, the company incurred a $0.7 million charge, the cost of sales during the quarter related to the finalization of the Greenwood facility closure. Manufacturing margin percentages were 10.7% for the third quarter of 2020 as compared to 11.3% for the 3 months ended September 30, 2019, a decline of 60 basis points.

On its own, the volume declines negatively impacted the manufacturing margin percentage results by approximately 300 basis points.

The good news is that a significant portion of this decline was offset by a combination of cost-cutting measures associated with our continuous improvement initiatives, investments in new technology and automated that requires less direct labor and the full impact of the finalization of the DMP synergies.

Based on the aforementioned improvements, manufacturing margin percentages are expected to improve beyond historical averages when volumes return to prepandemic levels..

Profit sharing bonus and deferred compensation expenses were $2.3 million for the third quarter of 2020 as compared to $0.7 million for the same prior year period.

The $1.6 million increase is due to the reestablishment of discretionary employer 401(k) contributions and some discretionary bonuses that had been eliminated in the second quarter of this year.

Other selling, general and administrative expenses were $4.5 million for the third quarter of 2020, as compared to $6.1 million for the same prior year period, which included $0.9 million of onetime IPO and DMP acquisition-related expenses.

Excluding the onetime charges from last year, these expenses decreased $0.7 million due to synergies achieved through the integration of DMP, lower travel expenses due to the pandemic and other cost savings initiatives. Interest expense was $0.6 million for the third quarter of 2020, as compared to $1 million for the same prior year period.

The $0.4 million decline is due to our lower debt levels this quarter as compared to 2019 and securing lower interest rates through the amended and restated credit agreement, which was entered into in September of 2019..

For the third quarter of 2020, income tax expense was $0.7 million on a pretax loss of $0.4 million. This unique circumstance was driven by a discrete tax adjustment due to the timing requirement to revalue certain stock-based compensation awards for tax purposes.

The company will always be subject to discrete tax adjustments such as these, which are permanent, however, the impacts of which are not expected to be material.

Our federal net operating loss carryforward was approximately $23 million as of quarter end, which was driven by the current year and prior year pretax losses generated mostly from the onetime IPO and DMP acquisition-related expenses. The NOL does not expire and will be used to offset future pretax earnings.

We continue to anticipate a long-term effective tax rate to be approximately 26% going forward..

Adjusted EBITDA was $9.8 million for the third quarter of 2020, as compared to $14.2 million for the same prior year period.

Adjusted EBITDA margin percentage declined by just 20 basis points to 10.8% in the current quarter as compared to the same prior year period and represents a decremental margin of only 11.6% as compared to our historical average of 17.5%.

Additionally, as compared to our second quarter 2020 adjusted EBITDA of $2.3 million, our incremental margin percentage was 26.6% for the third quarter. As compared to our historical average of 22.5%, evidencing our ability to quickly adapt to market conditions.

Again, the business realignment and cost adjustments are permanent, providing a clear path to a 15% adjusted EBITDA margin expectation when volumes return to pre-pandemic levels..

Now, let me address our balance sheet and liquidity figures. Despite a very challenging year, I'm very pleased with our financial results and our ability to generate cash flow, which has directly resulted in the year-to-date pay down of approximately $13 million as debt finished the quarter at $62.8 million.

Capital expenditures were $5.4 million for the 9 months of 2020 as compared to $22.8 million for the same prior year period, a decrease of $17.4 million. The decline was driven by a 2019 investment cycle that focused on new technology and automation versus leveraging those investments in the current year.

Capital expenditures for 2020 are still expected to be in the range of $10 million to $13 million.

As discussed last quarter, the company amended its credit agreement at the end of the second quarter in order to provide an added level of insurance against future macroeconomic events, allowing us to remain focused on serving our customers and growing the business..

The amendment increased the maximum ratio from 3.25x to 4.25x through the fourth quarter of 2020, adjusting quarterly thereafter until returning to the original 3.25x in the fourth quarter of 2021. This relief was provided in exchange for modest adjustments to pricing, along with other usual and customary negative covenants.

The debt capacity and maturity of the credit agreement were not impacted. As of September 30, 2020, total outstanding debt, which includes bank debt and capital lease obligations, was $62.8 million, resulting in a leverage ratio of 2.2x, which is significantly lower than our covenant threshold of 4.25x. .

Now, I'd like to briefly discuss our outlook for the remainder of 2020. Based on the current COVID pandemic and related economic uncertainty and consistent with most of our top customers, we are not providing a specific financial outlook.

However, we believe that we should be able to build upon our improved third quarter performance and deliver similar results in the fourth quarter after giving consideration for fewer working days due to the holiday season..

With that said, I will turn the call back over to Bob for closing remarks. .

Thank you, Todd. While familiar challenges have continued to affect us, we are very proud of the progress that we have continued to make over the past 3 months. We've learned a great deal during these difficult times and are confident that we are coming out of this situation, a stronger company.

We are encouraged that the volumes are returning with many of our key customers and are glad to see signs of stabilization across many of our end markets. As I said before, we believe that we are positioned to end the year on a high note. And if the economy doesn't deteriorate, it should be able to sustain this momentum heading into the new year..

Before I open up the call for Q&A, I just wanted to take a moment to thank our employee shareholders for the performance they have delivered to our customers over the past several months.

Everybody has played a role in helping our organization respond to the challenges we face by displaying ingenuity, adaptability, consistency, grit and determination to win. It has never been clear to me that the future for MEC looks bright and the best is certainly yet to come. With that said, operator, we'd like to open up the call for questions. .

[Operator Instructions] The first question today comes from Mig Dobre of R.W. Baird. .

It's Joe Grabowski on for Mig this morning.

Can you talk about how demand and perhaps capacity utilization trended during the quarter? Was there sort of an improvement through the quarter? And then maybe any color you can give in October?.

Well, I guess we're withholding our forecasting for October, but -- and for the quarters going forward at this time. But suffice it to say that we have seen continued strengthening. We -- our third quarter, I think, brought us into a range of somewhere around a 60% to 65% utilization of our capacities.

So we -- and more towards the end of the quarter than the beginning of the quarter. So we're continuing to see that build. And we've got a shortened quarter because of days in the fourth quarter. But we're moving in the right direction. We're cautiously optimistic. And I think that's the right position to be in at this time. .

Got it. Okay. And then maybe switching to ag equipment demand. Other component suppliers that we follow have talked about seeing some recent strength in the ag equipment channel.

I guess, do you think maybe demand for components in the Ag equipment is going to pick up shortly, kind of specifically, what are you seeing in that end market?.

I'll make a couple of general comments, and then I'll ask Ryan to comment. Generally, we're seeing some very modest strengthening. But I think there's there's more potential out there, just we haven't seen that show itself yet.

Ryan, do you have anything to add to that?.

Yes. I think kind of, Joe, the smaller ag & turf segment for hobby farmers maybe a similar demand profile to what we would see in the powersports market with stronger retail sales, certainly coming into the year, there needed to be some pretty extensive destocking on small ag.

And as we exited, I'll say Q2, a lot of that work was kind of behind, and the retail environment was pretty good on the large side.

And we see that fairly stable for us, our bigger tasks have been capturing market share just through a lot of the technology advances that our customers are making to continue to grab additional products and share that will benefit revenues in the years ahead. .

Got it. Okay. And then maybe switching to powersports. I assume there's sort of a seasonal pattern to powersports demand? Maybe not, but I'm assuming there's more demand over the summer.

Do you think maybe that season is going to get elongated this year just based on the consumer demand and where dealer inventory levels are?.

Yes. It's been an unusual year because of the inventory reductions at our customers' dealerships. So at this point, they're not only rebuilding inventory, they're meeting pretty robust demand. We would likely see that the inventory will be getting to better position sometime next year.

And then the consumer demand will be what's driving our production volume. .

Got it. Okay. And then if I could just maybe sneak in one more.

CapEx about $5.5 million year-to-date, the guidance is for $10 million to $13 million for the year? Just wondering what is driving the pickup in Q4?.

Todd, do you want to take that one?.

Yes, certainly. So as you know, the second quarter was definitely our role point. And we did preserve cash flow at that time to preserve the balance sheet with things relatively uncertain at that point. Now that we're seeing a little more clarity into this year in a little more stabilization.

We're just rebuilding upon the plans we had earlier this year and executing on our continued theme and investment, new technology and automation. And so in the fourth quarter, I do expect it to be a little more robust on the spending side. .

The next question today comes from Andrew Kaplowitz of Citi. .

This is Eitan Buchbinder on for Andy. So adjusted EBITDA margin was down only 20 basis points despite a 29% decline in sales.

And given the benefit from cost actions that are still layering in and revenue that could be similar between Q3 and Q4 would it be fair to assume adjusted EBITDA margin improving sequentially from 10.8%? Or would there still be a seasonal dip in Q4?.

We would expect a bit of a seasonal dip because yes, fewer working days and you couple that with the holiday pay that also occurs. But otherwise, we're very pleased with the progress we've made on the cost-cutting side and what we're seeing on the financials. .

That's helpful. And free cash flow generation of $14.5 million was up significantly both year-over-year and sequentially.

So how are you thinking about free cash flow conversion for 2020 potentially coming in above 50% conversion on adjusted EBITDA? And is that still the right long-term expectation for the company now that 2019's investments in automation have been completed?.

Yes. I mean, if you look at historical averages, it's been around 50%, in some years, a little better than that on conversion rate. So I do expect this year to be above 50%. And as we look forward, I would expect that same sort of conversion going forward. .

[Operator Instructions] Showing no further questions. This does conclude our question-and-answer session. I would like to turn the conference back over to Bob Kamphuis for any closing remarks. .

All right. Well, thank you for your time today. We appreciate your interest in MEC, and we'll look forward to seeing some of you at the Baird Virtual Conference next week. Have a great day today and make sure you get out there and vote. Thank you. .

The conference has now concluded. Thank you for attending today's presentation..