Mayville Engineering Company - Q2 2024

Transcript

Operator (participant)

Good morning. Thank you for attending today's Mayville Engineering Company Q2 2024 Earnings Conference Call. My name is Tamia, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I would now like to pass the conference over to your host, Stefan Neely, with Vallum Advisors. You may proceed.

Stefan Neely (Head of Investor Relations)

Thank you, operator. On behalf of our entire team, I'd like to welcome you to the Mayville Engineering Q2 2024 Results Conference Call. Leading the call today is MEC's President and CEO, Jag Reddy, and Todd Butts, 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. Reconciliations of these measures to the closest GAAP financial measure is included in our quarterly earnings press release, which is available at meinc.com. Following our prepared remarks, we will open the line for questions.

With that, I would like to turn the call over to Jag.

Jag Reddy (CEO)

Thank you, Stefan, and good morning, everyone. Thank you for joining us today. During the Q2, we continued to demonstrate strong strategic execution, which drove robust net sales growth, margin expansion, and free cash flow conversion. During the quarter, our teams successfully executed on new project startups in our commercial vehicle and power sports end markets. These new projects drove nearly 7% year-over-year organic sales growth, well above the growth trends in our end markets. Our teams continued to focus on implementing our MBX Lean initiatives, drove $0.9 million of year-over-year self-help adjusted EBITDA improvement during the Q2. Since the beginning of the year, our structured approach to operational excellence and lean manufacturing has resulted in approximately $2.5 million of sustainable year-over-year margin improvement.

As we move into the second half of the year, our team's continued successful execution on key commercial growth and operational excellence initiatives, combined with improving utilization at our Hazel Park facility, will be important catalysts for outperforming our end markets. While customer demand remained steady throughout the first half of the year, our customers' outlook for the second half of the year has softened in a few of our key end markets. However, with our robust strategic execution, combined with our market share gains, we continue to expect that we will deliver growth for 2024. With that in mind, we are reiterating our 2024 financial guidance for net sales and Adjusted EBITDA, which projects full-year net sales growth of between 5% and 9%, and growth in Adjusted EBITDA of between 9% and 15%.

As it relates to free cash flow, our strong performance in the first half of the year has outpaced our expectations. As a result, we are increasing our expected full-year 2024 total free cash flow guidance to between $45 million and 55 million. Turning now to a review of market conditions across our primary end markets. Let's begin with our commercial vehicle market, which represents approximately 37% of our trailing 12-months revenues. During the Q2, commercial vehicle revenue increased by 10.8% on a year-over-year basis. This is primarily due to strong strategic execution on new project launches and strategic pricing initiatives, which more than offset a 0.3% decrease in North American Class 8 production during the quarter.

Currently, ACT Research forecasts the Class 8 vehicle production to decrease 9.4% year-over-year in 2024 to approximately 308,000 units. ACT expects build rates to soften materially in the second half of the year, declining 17% in Q3 and 23% in Q4. For MEIC, we expect our new CV project launches to continue ramping into the second half of the year, which will help us maintain comparable sales to this end market relative to 2023. It is also worth highlighting that ACT currently expects Class 8 production to recover in 2025, growing 1% compared to 2024, and having continued growth of 11% from 2025 to 2026, which supports our organic growth expectations for the next two years.

Next is the construction and access market, which represented approximately 17% of our trailing twelve-month revenues. Construction and access revenue increased 2.7% on a year-over-year basis in the Q2.... This reflects the steady demand in non-residential and public infrastructure markets, which more than offset softness within residential markets. We expect this trend to continue through 2024, supporting our overall outlook for flat net sales to this end market due to infrastructure-related equipment demand and ongoing new customer wins. The powersports market represented approximately 18% of our trailing twelve-month revenues and increased by 26.3% on a year-over-year basis in Q2. We continue to benefit from market share gains, which include new customer programs on high-end models and were modestly offset by softening consumer discretionary demand.

As we have stated in the past, we believe that our growth rate in this end market will slow relative to the prior year comparisons, but the momentum from our market share gains in this end market will continue to drive growth for the year. Our agricultural market represented approximately 9% of trailing twelve-month revenues and increased 8.9% on a year-over-year basis during the Q2. Our Q2 results for this end market reflect contributions from the MSA acquisition, offset by softening demand within our legacy large ag market. The outlook for ag has been increasingly uncertain due to the impact of lower crop prices and elevated inventory levels. Given this uncertainty, we expect our markets to be soft in the second half of the year, but still outperform the overall ag market due to market share gains with key customers.

Overall, our Q2 net sales growth included nearly 11% growth associated with the Mid-States Aluminum acquisition, which closed early in the Q3 of last year. The majority of MSA revenues are represented in our other end market. For 2024 as a whole, we continue to see MSA generating between $20 -30 million of incremental net sales. On the commercial front, we continue to build our momentum, cross-selling MSA's capabilities to our existing customers. We expect that these efforts will be a significant catalyst for above-market growth in 2025. On the pricing front, our team's efforts continue to bear fruit, particularly as new project volumes ramp up. During the Q2, our commercial pricing initiatives drove $0.6 million in incremental Adjusted EBITDA year-over-year, net of inflationary pressures.

We continue to target between $1 and 2 million of Adjusted EBITDA growth from our pricing initiatives through the end of the year. Turning now to an overview of substantial new business wins during the Q2. We have continued to gain additional market share with our commercial vehicle customers as they plan their vehicle updates going into the emissions regulation changes. We expect to continue to grow share over the next two years with the amount of change that is expected to occur. During the Q2, we continued to expand share with one of our new powersports customers, supporting their next generation product lines. These wins support additional growth over the next year and expect additional organic opportunities in the quarters ahead. In the quarter, we expanded share within our primary military customer, expanding share on current product, bringing us additional diversification across platforms.

During the quarter, we received multiple awards for engine 2 products in the agriculture market, driven by model updates based upon regulatory emissions changes that will be occurring in the years ahead. We also grew share with one of our industrial customers, supporting material handling equipment in the quarter as they look to launch new products into the market. As part of our ongoing strategic success, our operations team has continued to build momentum with the execution of our MBX framework and the culture of continuous improvement that has begun to permeate the company. These initiatives have been driven by our rigorous approach to MBX lean implementation, highlighted by over 200 MBX Kaizen events since launching the MBX program in late 2022. In summary, the execution of our commercial and operational excellence initiatives has been quite successful, as represented by our financial performance thus far in 2024.

These results give us further confidence in our ability to drive ratable improvements to our financial profile and deliver sustainable long-term shareholder value. As you will recall, we expect to deliver between $750 and 850 million in revenues, expand adjusted EBITDA margin to between 14% and 16%, and generate free cash flow of between $65 and 75 million by the end of 2026. Given our strong strategic execution, it is evident that we are making meaningful progress toward achieving these goals.... In terms of capital allocation, our strong free cash flow generation has allowed us to reduce our net leverage by nearly one turn over the course of the last year. At the end of the quarter, our net leverage ratio stood at slightly below 1.7x.

Given the strong year-to-date cash flow generation, we now expect to be at the lower end of our targeted net leverage ratio range of between 1.5x and 2x by the end of 2024. Additionally, during the Q2, we repurchased $1 million worth of common equity under our $25 million share repurchase program, with $24 million remaining under the existing authorization. Going forward into the second half of the year, we intend to repay additional debt in order to further reduce our cost of capital. Additionally, we're also actively evaluating a more structured approach to our share repurchase strategy, which aligns with our existing authorization. Strategic M&A has always been a key part of our multi-year growth and business transformation strategy. Our top priorities include lightweight materials fabrication and complementary bolt-on acquisitions of accretive assets.

As we have been making solid progress towards our leverage goal, we are increasing our focus on evaluating key opportunities to build on our market-leading capabilities and further position the company to capitalize on multi-year secular growth trends in energy transition and OEM outsourcing. Ultimately, we are taking a philosophical approach to capital allocation that is centered on deploying capital in a manner that creates the greatest return for the company and for our shareholders. We believe the highest opportunities for return are through debt reduction, strategic M&A, and share repurchases, and we'll continue to allocate our capital prudently based on these opportunities. In summary, I am very proud of our team's ongoing commitment to excellence and strategic execution.

Their hard work and commitment have positioned us to navigate the impending softening of end market demand and to deliver above market growth with sustainable value creation, both in the near term and over the coming years. With that, I will now turn the call over to Todd to review our financial results.

Todd Butz (CFO)

Thank you, Jag. I'll begin my prepared remarks with an overview of our Q2 financial performance, followed by an update on our balance sheet and liquidity. Total sales for Q2 increased 17.7% on a year-over-year basis to $163.6 million. This increase was driven by a combination of the MSA acquisition, strong strategic execution, and continued organic sales growth, partly offset by ongoing softness in our legacy agricultural end market and the expected roll-off of certain military aftermarket programs at the end of 2023. When excluding the MSA acquisition, organic net sales growth was 6.9% on a year-over-year basis. Our manufacturing margin was $22.3 in Q2, as compared to 16.1 million in the same prior year period.

The increase was primarily driven by organic volume growth, execution of our MBX lean manufacturing initiatives, commercial pricing, and the acquisition of MSA. Our manufacturing margin rate was 13.6% for the Q2 of 2024, as compared to 11.6% for the prior year period, or an increase of 200 basis points. Other selling, general, and administrative expenses were $8.3 million for Q2 of 2024, as compared to $7.4 million for the same prior year period. The increase was primarily driven by an additional $500,000 of legal expenses relating to our former fitness customer, incremental expense associated with MSA, and increased costs related to compliance requirements.

Interest expense was $3 million for Q2 of 2024, as compared to $2 million in the prior year period, due to higher borrowings under our credit facility. The increase in borrowings is due to the acquisition of MSA, which closed on July 1, 2023. Our focus on reducing our debt leverage, combined with strong free cash flow through Q2 of 2024, has allowed us to achieve our net leverage goal of between 1.5x and 2x, which is ahead of our year-end target. Going into the second half of the year, we will continue to repay debt in order to reduce our interest expense, which is variable based on net leverage. Adjusted EBITDA increased to $19.6 versus 15.3 million for the same prior year period.

Adjusted EBITDA margin increased by 100 basis points to 12% in the current quarter, as compared to 11% for the same prior year period. The increase in our adjusted EBITDA margin was primarily due to the increased organic volumes, the MSA acquisition, MBX initiatives, and the benefit from our commercial pricing activities. Our Q2 results demonstrate the continued progress towards our 2026 adjusted EBITDA margin goal of 14%-16%. Turning now to our statement of cash flows and balance sheet. Free cash flow during the Q2 of 2024 was a positive $19.2 million, or $0.94 per share... as compared to a negative $3.7 million in the prior year period.

The improvement in free cash flow year-over-year was due to improved working capital efficiency, resulting from our MBX initiative and a one-time $17.6 million payment of deferred compensation expense in the Q2 of last year. Our strategic execution has been the primary driver of our improved free cash flow conversion thus far in 2024. As a result of our MBX winning initiatives, our day sales outstanding and inventory days have both declined by more than 15% as compared to a year ago. As of the end of Q2 of 2024, our net debt, which includes bank debt, financing agreements, finance lease obligations, and cash and cash equivalents, was $125.1 as compared to 89.7 million at the end of Q2 of 2023.

Our debt reduction resulted in a Net Leverage Ratio of slightly below 1.7x as of June 30, and will provide for a 30 basis point rate reduction in the Q3. In light of our Q2 results and our current outlook for the remainder of the year, we are reiterating our financial guidance for net sales and Adjusted EBITDA, while increasing our financial guidance for Free Cash Flow. For 2024, we continue to expect the following: Net sales of between $620 million and $640 million, and Adjusted EBITDA of between $72 and 76 million. For Free Cash Flow, we now expect full year Free Cash Flow will be in a range between $45 to 55 million, as compared to our original expectations of between $35 and 45 million.

Our outlook for the full year continues to reflect a risk-adjusted view of overall demand for the second half of the year. During the first half of the year, we have experienced strong growth and margin realization through our strategic execution. However, as Jag mentioned, we have seen softening demand in some of our end markets, particularly commercial vehicle, powersports, and agriculture. These end market dynamics are in line with the risk-adjusted view of the year, even as our growth and execution during the first two quarters outpaced our expectations. Overall, when combined with evolving end market dynamics, our guidance continues to reflect organic net sales growth as compared to 2023 of between 1.5% and 2.5% due to new product wins. With that, operator, that concludes our prepared remarks.

Please open the line for questions as we begin our question and answer session.

Operator (participant)

If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason at all, you would like to remove that question, please press star followed by two. Again, to ask a question, please press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. The first comes from Mircea Dobre with Baird. You may proceed.

Mircea Dobre (Managing Director)

Thank you. Good morning, everyone, and congratulations to the team on really good performance in a choppy environment. So that's, that's great to see. I guess my first question is on the free cash flow guidance. Todd, maybe you can help me better understand what prompted you to raise that guidance, even though the other elements have stayed unchanged. Is this just a function of kind of converting some of that inventory into cash? Are there any other working capital items we need to be aware of?

Jag Reddy (CEO)

Good, good morning, Mig. I'm going to quickly pass on to Todd here, but I just want to reiterate that, our sustained efforts in continuing to drive MBX across our enterprise, that's in both operations and the rest of the functions, and driving, better days in payables, better days in receivables, inventory reduction, better forecasting, SIOP implementation. All of these actions that we've been, you know, pursuing for the last year and a half, has shown, in the first half, right, you know, what the power, power of MBX is, and that is really what gives us the confidence, to raise our guidance for, for the year.

Todd Butz (CFO)

Yeah. Good morning. To Jag's point, it really is driven by the MBX initiatives. I mean, if you look back, you know, 12, 18 months ago, we were at, you know, six times, or terms rather. Today, we're at just over nine as we finish Q2. In addition to that, you know, we've been working very hard on, you know, our terms and conditions with customers, you know, our collection efforts. I mean, across the board, it's been very, very positive.

So when we looked into the back half of the year, which historically, the Q4, our Q4, is one of our strongest cash flow quarters, we do expect now, that again, be in that range of $45 -55 million, and, and that's why we, we feel confident that we can achieve that, and therefore, we raise the guidance.

Mircea Dobre (Managing Director)

But again, you know, looking back historically here, I think in 2021, you had a big cash drag from inventory—from an inventory build. I'm kinda searching through my memory here. I think that might have had something to do with challenging supply chain and all the disruptions that existed in the industry at the time. I guess my real question here is, you know, is there room to improve on the performance that you're delivering this year? Should we expect another, you name it, $5, $10 million worth of potential release of working capital as we think going forward?

Jag Reddy (CEO)

... so when you think of 2021, at the end, it was supply chain. We were also building inventory for the expected launch of our former fitness customers. So a bit of a unique situation there.

Mircea Dobre (Managing Director)

Right.

Jag Reddy (CEO)

As we move forward, definitely this year, we do expect to unlock continued working capital, whether it be through receivables, you know, payables, you know, our payments as well as inventory. But I, I will note that that rate of progression will moderate a bit when you think of, you know, going from six times or six turns rather, to nine, you know, there's a lot of, let's say, low-hanging fruit that we can get after. Going from nine to, to 10 or 10 to 11 is a little more difficult. Now, we still remain confident we can achieve that, but it'll take a little more time to do it. But in the near term, we do expect in the next six months that we'll continue to see good working capital progression and, and favorable free cash flow.

Mircea Dobre (Managing Director)

Okay. Okay, two questions on end market. I guess the first one is on commercial vehicle. In your prepared remarks, Jag, you talked about the setup here into the third and Q4, but as I understood it, you said that you still expect to be flat year-over-year from a revenue standpoint in commercial vehicle. I'm curious as to what gives you the confidence that you're gonna be able to hit that guide? And I understand that you outperformed relative to builds by about double digits in Q2, but the degree of outperformance, especially as we look into Q4 relative to builds, would be much more significant than what you've done thus far.

So is it that these customers are ramping through the year, these new contracts are ramping through, through the year, or is there, is there something else to be aware of here?

Jag Reddy (CEO)

Yeah, on commercial vehicles, the first half, our customer builds outperformed our expectations, and we do expect the second half to slow down, our customers to slow down their build rates, and that's what we have planned from the beginning. Our confidence in hitting our forecast for second half really relies on our customers' build rate projections and ACT forecasts of 308,000 vehicles for the year. Given that, even though we do expect some softness in the deceleration of build rates, given our new program launches and some of the share gains we've been talking about, those increased sales to our end customers gives us confidence that, you know, we can hit our forecasted targets.

Mircea Dobre (Managing Director)

But to be clear here, you expect to be flat revenue in commercial vehicle, even in Q4 on a 23% build decline?

Jag Reddy (CEO)

Let me, let me reiterate. We expect to be flat for the full year in 2024 to 2023 results in our CB market.

Mircea Dobre (Managing Director)

Okay. Thank you for clarifying. And then finally, on agriculture, you already mentioned that large agriculture is under pressure. I think small ag is under pressure as well. There's-

Jag Reddy (CEO)

Yeah

Mircea Dobre (Managing Director)

... pretty material production cuts that are coming across from all the OEMs, you know, somewhere in the high 20s, low 30s in some cases. So I'm sort of curious here as to how you think about this vertical specifically, especially as you differentiate between Q3 and Q4, because the pressure on build rates seems to be varying between these two quarters by OEMs. So based on your customers, I'm kind of curious as to how you're thinking about progression. Thank you.

Jag Reddy (CEO)

Yeah, that's a good question, Mircea. We expect the overall ag market to be down mid-teens based on the programs we're on and the visibility we currently have. That breaks down approximately, you know, 15% or so for large ag and approximately 10% or so for the small ag. That's for end market. For us, we're currently projecting we're gonna be down for the year, approximately 5% overall. That's because of some share gains we talked about. There is also a lapping of some MSA ag revenues that came into the first half. So you put all of that together, year-over-year, we will be down approximately 5% in the ag end market.

But also, let me remind you that, you know, overall, ag is only 9%, approximately 9%-10% max, of our overall sales. It is still one of our smaller end markets, slightly larger than our military market, which is approximately 6%. So, even though the headlines, we see the headlines, we read our customers' public comments, but given where we are in the cycle, given our program wins, given our share gains, we feel like we can continue to outperform the agriculture end market.

Mircea Dobre (Managing Director)

I appreciate it. If I can squeeze one more, I'm sorry, on the military. Just as a quick reminder here, is your exposure in military predominantly on the JLTV, or are there other programs that you have in there as well? Thank you.

Jag Reddy (CEO)

Yes, so we have JLTV, FMTV, are the two main programs we're on.

Mircea Dobre (Managing Director)

Great. Thank you. Good luck.

Jag Reddy (CEO)

All right, thank you.

Operator (participant)

Thank you. The next question comes from Ted Jackson with Northland Securities. You may proceed.

Ted Jackson (Senior Equity Research Analyst)

... Thank you very much. Congrats on the quarter, guys.

Jag Reddy (CEO)

Okay.

Ted Jackson (Senior Equity Research Analyst)

I got a handful of questions, I'll try to run through them really quick. First of all, on the commercial vehicle, when you were giving the market data for growth, I caught the 11% growth with regards to 2026, but I missed what you said for 2025. Can you, do you have that-

Jag Reddy (CEO)

Yeah-

Ted Jackson (Senior Equity Research Analyst)

In your head, Jag?

Jag Reddy (CEO)

Yeah, yeah. We expect the 2025 to be slightly approximately 1% up versus 2024.

Ted Jackson (Senior Equity Research Analyst)

Okay. And then when, when I think about that, I mean, that's market data. You know, you would expect at a minimum, to grow in line with market, you know? So I'm not saying that that's your guidance, I'm just saying, like, you know, if the, if the market data and the projections hold true, that it would stand to reason that you would expect to see some modest growth in commercial vehicle in 2025.

Jag Reddy (CEO)

Yeah, even though obviously we're not providing any guidance for 2025, with that caveat, we expect to outperform the commercial vehicle market in 2025.

Ted Jackson (Senior Equity Research Analyst)

Okay. My second question goes over into the power sports market. I mean, you just nailed it there. You know, I mean, it's the market's, you know, as weak as anything you could imagine, and, you know, the project wins for you have really allowed you to, you know, pull through on that. When, when we finish off this year and get into 2025, you know, I mean, would, would—is there more stuff that would allow you to continue to, let's just call it, outperform the market?

I'm not gonna ask for, you know, for you to, you know, talk about, you know, market share, kind of, market growth and stuff, but, you know, would you view 2025 of being at an arena where you would grow more in line with the market, or is there still some tail from all the new activity that you, you know, brought through your business in 2024 that will carry forward into 2025 and allow you to, you know, to continue to, say, grow faster than that market in aggregate?

Jag Reddy (CEO)

Let me first step back-

Ted Jackson (Senior Equity Research Analyst)

If I'm asking, because you've been ramping, you know what I mean? You're ramping a lot of this stuff-

Jag Reddy (CEO)

Yeah

Ted Jackson (Senior Equity Research Analyst)

... you know, through this year and kind of like, how does it tail into 2025, is where I'm going with this.

Jag Reddy (CEO)

Yeah. So, the discretionary nature of significant spend in the market and interest rates have had a effect on customer purchases. At the same time, our customers have built up significant inventory in the channels as well. It's been a really great first half for us in power sports market as we ramp up new customers. We do expect the second half to moderate a bit our growth rates in the market. We will still grow and outperform the market. It'll be interesting to see what happens with interest rates and channel inventories with our customers as we go into 2025. There is a good possibility that we will outperform the market, even in power sports next year.

But sitting here, it's a little challenging to predict, right, you know, how that is all gonna play out, given the interest rate environment, we're currently in.

Ted Jackson (Senior Equity Research Analyst)

Yeah, I mean, I listen to all those calls, and, there's, you know... I mean, the new product stuff they talk about is nice, but the market itself is just horrible. A question that I think will come close to your heart, Jag, and, maybe somewhat fun. You know, I wanna, maybe to have you unpack a little bit, about where you are on your journey for value-based pricing. You know, I mean, it's, you know, you highlight it a lot, you know, you've talked about how it's improving your margin structure. You know, so if we think about MEC and, you know, the revenue base that it has, you know, maybe like, you know, like, how much of your revenue have you converted over to, you know, this new pricing model?

You know, how far can you take it, I guess? You know, kind of, kind of what do you see it in terms of the trajectory as we roll through 2025 and beyond?

Jag Reddy (CEO)

As we indicated last time, Ted, probably 15%, maybe less than 20% of our total sales are probably under the quote-unquote "new pricing regime," i.e., value-based pricing. So what that gives us is a good, you know, three to four to 5-year runway to continue to convert existing core business to the new pricing model. So it's gonna, it's gonna have some legs at the same time, right? It's going to take some time as well. And, you know, it's both positive as well, given that we can continue to leverage our pricing for the foreseeable future.

Ted Jackson (Senior Equity Research Analyst)

Okay. My last question for you all is just maybe an update on the, you know, the sports equipment litigation, kind of, where are you with regards to that process? You know, maybe any change in terms of how you, you know, see it in terms of its resolution, just kind of an update on that front. Thanks.

Jag Reddy (CEO)

Sure. The discovery process continues with the litigation, and we expect the discovery phase to conclude in Q3, and you know, anticipate potentially a trial to begin either later this year or early 2025. We remain confident in a positive outcome for MEC. Beyond that, we will not comment on the pending litigation.

Ted Jackson (Senior Equity Research Analyst)

Okay, great. It was worth asking. Congrats again on the quarter. I'll talk to you guys soon.

Jag Reddy (CEO)

Thank you, Ted.

Todd Butz (CFO)

Thanks, Ted

Operator (participant)

... Thank you. The next comes from Ross Sparenblek with William Blair. Your line is open.

Jag Reddy (CEO)

Morning, Ross.

Todd Butz (CFO)

Morning, Ross.

Operator (participant)

Ross, your line is open. Please ensure you are unmuted. The following question comes from Natalie Back with Citigroup. You may proceed.

Natalia Bak (Analyst)

Hi, good morning. Can you hear us in the recorder? This is Natalie Bak on behalf of Andy Kaplowitz from Citigroup.

Todd Butz (CFO)

Good morning, Natalie.

Natalia Bak (Analyst)

My first question that I want to ask is, with leverage now slightly below 1.7 turns, and you raising your Free Cash Flow guidance for the year, how are you thinking about the potential for incremental M&A activity? And what impact does recent market volatility and current macroeconomic uncertainty have on how you and the board think about M&A in the current environment?

Jag Reddy (CEO)

Yeah, it's a really good place to be, Natalie. We are ahead of our schedule on our debt repayments, and as interest rates are working in our favor, as we indicated, 30 basis points of interest rate reduction in Q3 for us, given our leverage ratio, and potentially future interest rate cuts by Fed, gives us confidence that we can continue to pursue our capital allocation strategy. As indicated in our prepared remarks, we will put together a structured buyback program as well, as we continue to reengage with potential M&A targets. Our pipeline remains strong, and we continue to stay close to the market.

Given that the multiples have remained consistent, we expect to, you know, pursue some attractive targets in our adjacent markets to beef up our offerings to our end customers, either in lightweight materials, energy transition, and other attractive end markets that will also help us with the diversification in our end markets.

Natalia Bak (Analyst)

Okay, helpful. Then just honing in on your construction access end market, can you remind us of your mix of exposure to resi versus commercial construction equipment? How are you thinking about trends in resi versus commercial impacting your outlook for the construction order portion of your business going forward?

Jag Reddy (CEO)

Yeah, I don't think I can break down on the call resi versus infrastructure. We have not given that breakout in the past. Having said that, our access versus construction is approximately 45-55. That's the breakdown. In construction, though, we are seeing some modest signs of growth in our resi exposed to markets and infrastructure, particularly the government and public infrastructure could be a tailwind in the second half of 2024. But we need to watch our OEM inventories in the channel and then see how that continues to translate into sales and production for our end customers. Access market, though, continues to be strong. Our access customer has strong backlog which we expect to support our 2024 forecast.

Natalia Bak (Analyst)

Very helpful. And then, just focusing on power sports, can you just talk about what you're seeing and hearing from more of your consumer-facing customers in that end market?

Jag Reddy (CEO)

All of our end market customers have both consumer-facing products and also what we call as utility products. The utility demand has been stable and strong. We have gotten on new platforms and programs with, you know, multiple customers. As we discussed last time, we brought on some new customers to MEC this year. All of that is helping us stabilize and grow in this end market with a pretty sizable contraction in actual end market sales. We see that discretionary spend, i.e., the recreational side of the market, continues to be soft, and our customers continue to have excess inventory in the channel. We all can see the marketing programs they're running to clear the inventory channel, sorry, channel inventories. So we'll have to see how it plays out.

Our expectation is that if there are any movement in the interest rates in the coming quarters, that will only be a tailwind for us, either in Q4 or, going into 2025.

Natalia Bak (Analyst)

Okay, that's helpful color. And then one last question for me. You mentioned how the continued ramp-up of new project work should help offset some of the expected softness in a few end markets in the second half. Maybe, can you talk about how these new projects should help flow through the P&L over the coming quarters, and how we should think about that potentially impacting top line and reported profit, profitability over the next few quarters?

Todd Butz (CFO)

So when you think about the markets, right, we've said on the last call, we've made significant gains in power sports. We've made significant gains in CV-

Natalia Bak (Analyst)

Mm-hmm

Todd Butz (CFO)

... which will again, offset or mitigate, right, some of the declines that we're seeing on the end market demand. On the top line, you know, given that, you know, CV is, you know, 38% of our overall sales, we do expect sequentially, you know, going from Q2 to Q3, we will see about a maybe 6%-8% decline in top line revenue, you know, versus a seven, you know, 20%+ percent decline in that, you know, CV market alone. And then when you look at Q4, more of a modest decline, maybe 1%-3%. From a P&L perspective, you know, the fundamental building blocks that we've put in place already as it relates to MBX, other lean initiatives and commercial pricing are there, right?

And they're really, you can see the results in Q1 and Q2 to have a very positive impact on our, you know, bottom line financial performance. But as you enter the second half, given that CV does have a pretty sizable downturn, it that will impact, you know, some of our larger facilities. So we will, you know, have a little bit of a, maybe a tempered margin progression in the second half as these facilities will be, you know, slightly underutilized, you know, due to overhead absorption. But generally speaking, when we think about margin progression and our 14%-16% goal, we feel we have the pieces in place to build upon to continue margin progression, even in a down market, albeit it'll be very, you know, tempered, I would say, in Q3 and Q4.

Natalia Bak (Analyst)

Okay, got it. Very helpful. Congrats on the quarter, and thank you for taking all my questions.

Todd Butz (CFO)

Thank you.

Jag Reddy (CEO)

Thank you.

Operator (participant)

Thank you. The final question comes from Ross Sparenblek with William Blair. You may proceed.

Ross Sparenblek (Equity Research Analyst)

Hey, good morning, guys.

Todd Butz (CFO)

Good morning, Ross.

Jag Reddy (CEO)

Morning, Ross.

Ross Sparenblek (Equity Research Analyst)

All right, you can hear me. Apologies for technical difficulties there. Maybe sticking on the margins, you know, as we think about kind of the second half, maybe a little bit softer on the end market, but you have done excellent work with MBX. What would expectations be for maybe decrementals, given the work that has been done, if it's maybe a little bit worse than expected in the, you know, second half of the year?

Todd Butz (CFO)

No, I wouldn't characterize—I think the decremental will be a little bit—Our historical decremental is around 17.5%. And I would say that we're at or maybe slightly below that as we stand today. You know, I would expect, and we do expect to continue to see the positive impact of MBX and commercial pricing and other initiatives in the second half. But like I just mentioned, that will buffer or, you know, be mitigated by, unfortunately, the pressure of underutilization at a few of our larger facilities. But generally speaking, I would expect margin progression to continue in Q3 and Q4, but at a much lower pace than what we saw from Q2 to Q3.

Jag Reddy (CEO)

Just to add to that, Ross, we are actively looking at all the levers we have at our disposal, as we expect the volumes to come down, particularly in some large facilities, some significant operations. We're looking at every lever, including cutting back on overtime, you know, really following strict checkbook processes to make sure that our variable spend is down. We're looking at resizing our workforce in a couple of our facilities that are either seeing or are expected to see some significant volume reduction. So we're taking all the actions necessary for the second half for us to continue to drive the revenue and margin progression as we laid out.

Ross Sparenblek (Equity Research Analyst)

Okay. And maybe just on capacity, when we think about, you know, excess, I think maybe there's $10 million left to go get at Hazel Park. But just company as a whole, where do you guys stand today? And how should we frame, you know, all the wins in Q2 as, you know, contributing in the next four quarters to revenue, trying to support that margin outlook?

Jag Reddy (CEO)

Yeah. So the first point I would add is we're continuing to make good progress with the ramp-up of Hazel Park. That gap that you highlighted, we continue to work that gap down. The pipeline that our sales team has developed is really strong, and we are continuing to focus on closing those opportunities to be able to add to that gap that you mentioned. So sitting here, we feel pretty good about our exit rate out of Hazel Park in 2024.

Ross Sparenblek (Equity Research Analyst)

Perfect. And just one more, if I can, on Hazel Park. Is there anything that we should call out in the modeling as we think about the cadence of these four end markets ramping? Powersports is obviously, you know, having a good year this year. Is ag maybe at 2025, 2026, or is there anything, you know, with that cadence that we should be aware of?

Jag Reddy (CEO)

Yeah. I wish I could predict the ag market downturn or the, you know, duration of the downturn, right? So, we'll just have to watch it really closely, and then as we exit the year, right, we'll have a better idea where interest rates stand and where, you know, yields and crop prices stand at the end of the year. But also, I wanna remind everyone that ag is only 9% of our overall business, right? You know, yes, the headlines are very negative, but at the same time, right, it's still a small portion of our overall business.

Ross Sparenblek (Equity Research Analyst)

Okay. So the ramping of these programs isn't fully insulated from the overall market, is the takeaway, whereas Powersports, it clearly is.

Jag Reddy (CEO)

Yep, agreed.

Ross Sparenblek (Equity Research Analyst)

Oh, perfect. Awesome, guys. Well, yeah, congrats on the quarter. Thanks for the questions.

Jag Reddy (CEO)

Thanks, Ross.

Todd Butz (CFO)

Thanks, Ross.

Operator (participant)

Thank you. There are currently no other questions at this time. I will pass it back over to the management team for closing remarks.

Jag Reddy (CEO)

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 counsel. This concludes our call today. You may now disconnect.

Operator (participant)

This concludes the conference call. Thank you for your participation. You may now disconnect your line.