Mayville Engineering Company, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. MEC manufactures metal components and provides fabrication, coating, assembly, tooling and related services for customers in several industrial markets. The company acquired Defiance Metal Products (DMP) in December 2018 and completed its IPO in May 2019.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $145.1 million | $91.5 million | $288.9 million | $178.8 million |
| Manufacturing margin | $20.5 million; 14.1% | $15.5 million; 17.0% | $40.1 million; 13.9% | $27.4 million; 15.3% |
| Operating income (loss) | $(16.7) million | $9.5 million | $(10.6) million | $14.9 million |
| Net income (loss) | $(15.3) million | $8.1 million | $(12.8) million | $12.5 million |
| Adjusted EBITDA (non-GAAP) | $17.8 million; 12.3% | $14.4 million; 15.8% | $34.6 million; 12.0% | $24.8 million; 13.9% |
| Operating cash flow | Not separately stated | Not separately stated | $6.5 million | $16.8 million |
Q2 diluted loss per share was $0.91, versus earnings of $0.56 per share a year earlier. Q2 GAAP EBITDA was $(8.1) million, compared with $13.9 million. Adjusted EBITDA is a company-defined non-GAAP measure; MEC cautions that it should not be viewed as a substitute for GAAP results.
Liquidity, debt and cash flow
- At June 30, 2019, cash was $1 thousand, current assets were $121.7 million and current liabilities were $88.8 million.
- Debt principal comprised $41.5 million drawn on a $90 million revolver and $48.1 million of other long-term debt. Capital lease obligations were $1.8 million. Revolver availability was $48.5 million; the company reported compliance with debt covenants.
- The IPO proceeds were used substantially to repay debt, including $25 million of subordinated debt and $43 million of Term A debt; the revolver was also reduced. The subordinated loan was paid off.
- For the six months, investing cash use was $19.0 million, including $16.6 million of capital expenditures and $2.4 million for the DMP working-capital true-up. Financing cash flow was $9.4 million, and cash declined by $3.1 million.
Changes versus prior periods and notable items
- Q2 sales rose 58.6%; management attributed the increase primarily to DMP, while MEC’s legacy-business sales were described as comparable to the prior-year quarter. For the first half, DMP contributed $103.7 million of the $110.1 million sales increase.
- Manufacturing margin percentage declined, which management attributed to DMP-related mix dilution and shifts in the legacy customer mix.
- Reported losses included substantial IPO-related compensation charges: Q2 profit-sharing, bonus and deferred-compensation expense rose to $22.8 million, including approximately $10.2 million of deferred-compensation expense and $9.9 million of LTIP expense associated with the IPO. MEC also recorded $3.0 million of Q2 IPO expenses and a $2.7 million Q2 loss from revaluing DMP contingent consideration.
- The IPO ended the legacy business’s S-corporation status; MEC became subject to corporate income taxes from May 2019. Q2 included a $3.5 million income-tax benefit.
- DMP contingent consideration was valued at $9.6 million at June 30. An additional payment of up to $10 million may be due based on DMP’s EBITDA for the year ending September 30, 2019.
Outlook, risks and controls
- MEC budgeted approximately $20 million of capital expenditures for full-year 2019, unchanged from its prior budget. Management said operating cash flow and available borrowings were expected to be sufficient to fund 2019 operations, while noting that cash needs and future access to capital remain subject to uncertainty. No formal revenue or earnings guidance is provided in the filing.
- Key risks include dependence on large customers and their industries, limited firm customer production commitments, raw-material and tariff exposure, labor and manufacturing-capacity constraints, acquisition integration and capital requirements, and interest-rate sensitivity. Management estimated that a hypothetical 100-basis-point rate increase would add $0.4 million of interest expense for the first half.
- Disclosure controls were deemed ineffective at the reasonable-assurance level because of previously identified material weaknesses involving IT general controls and financial reporting processes, including journal-entry controls, documented procedures and staffing. Remediation efforts were ongoing.
- MEC reported no material litigation proceedings and stated that reasonably possible losses from ordinary-course claims were not expected to materially affect the financial statements.
Important facts for investors to verify
- How much of sales growth and adjusted EBITDA improvement is sustainable apart from DMP, and whether DMP meets the earn-out performance threshold.
- The ongoing cost base after IPO-related compensation and transaction charges, and the effect of lower manufacturing margins.
- Cash conversion and working-capital needs, given first-half operating cash flow of $6.5 million, capital spending of $16.6 million and minimal period-end cash.
- Debt repayment capacity, revolver availability, covenant headroom and exposure to variable interest rates.
- Progress remediating material weaknesses and the timing of effective disclosure and financial-reporting controls.
- Customer concentration and potential share sales as ESOP participants become eligible to diversify or receive shares.