Mayville Engineering Company, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. All dollar amounts below are in millions unless otherwise indicated. MEC manufactures metal components and provides tooling, fabrication, coating, assembly, and related services to customers in commercial vehicles, construction, powersports, agriculture, military, and other markets.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $108.6 | $143.7 | Down 24.4% |
| Manufacturing margin | $11.8; 10.9% | $19.6; 13.6% | Down $7.7; 270 basis points |
| Operating income | $1.6; 1.4% | $6.1; 4.2% | Down 74.1% |
| Net income | $0.05 | $2.46 | Down 98.0% |
| Basic and diluted EPS | $0.00 | $0.18 | — |
| EBITDA | $9.8; 9.1% | $13.7; 9.5% | Down 28.2% |
| Adjusted EBITDA | $11.4; 10.5% | $16.8; 11.7% | Down 31.9% |
| Operating cash flow | $2.6 provided | $1.5 used | Improved $4.1 |
| Capital expenditures | $2.4 | $8.2 | Down $5.8 |
At March 31, cash and cash equivalents were $13.0, compared with $0.001 at year-end 2019. Current assets were $113.8 and current liabilities $46.1. Revolver borrowings were $87.8, up from $72.6 at year-end; the reported borrowing rate was 3.125%. MEC reported $112.2 of availability under its $200.0 revolving facility, plus a $100.0 accordion feature. Capital lease obligations totaled $3.1. The company complied with its credit covenants: interest coverage was 9.21x against a 3.00x minimum, and leverage was 1.84x against a 3.25x maximum.
Material changes and management commentary
- Sales declined amid market-demand weakness and customer destocking that began in late 2019, particularly in commercial vehicles, agriculture, and construction. Customer shutdowns related to COVID-19 reduced late-March sales by approximately $5.0.
- Lower volumes reduced overhead absorption. Manufacturing margin also included approximately $0.9 of inventory-obsolescence and healthcare accruals associated with estimated COVID-19 impacts. Management cited strong labor productivity as a partial offset. Manufacturing margin percentage improved 700 basis points sequentially from Q4 2019.
- Management drew $13.0 on the revolver in March and placed the proceeds in a money-market account as a precaution amid COVID-19-related uncertainty. The company said it would continue to evaluate this liquidity position.
- Operating cash flow improved year over year, primarily due to a smaller increase in receivables. Lower capital spending reflected the timing of technology and automation investments shifted to Q4 2019. Financing cash flow included revolver activity and $2.4 of treasury-stock purchases.
- Interest expense fell 70.8%, attributed to lower borrowings during the comparable quarter and more favorable credit-agreement terms. A discrete $0.5 deferred-tax-asset removal related to loan-fee amortization materially affected the Q1 2020 effective tax rate.
Outlook, risks, and unusual items
- Management expected 2020 capital expenditures of approximately $12–$15, with spending nearer the low end if COVID-19’s adverse business impact increased. It believed operating cash flow and available borrowings would fund 2020 operations and expected covenant compliance, based on information available at filing time.
- The pandemic had negatively affected and was expected to continue affecting business, financial condition, cash flows, and results; the duration and full extent were uncertain. The company reported forced vacation, temporary and permanent layoffs, and other cost actions, and said further measures could be considered.
- Key risks include further demand reductions, customer or supplier disruptions, collection and liquidity pressures, variable interest rates, raw-material costs, and dependence on customer forecasts. A 100-basis-point interest-rate increase was estimated to add $0.2 of annualized interest expense based on quarter-end variable-rate debt.
- Disclosure controls and procedures were reported ineffective due to a material weakness involving inconsistently documented accounting policies and insufficient formal controls for complex or unusual transactions. Management had begun remediation, but stated the actions might not be sufficient. Management’s internal-control evaluation under Section 404 was expected to begin for the 2020 annual report.
- MEC reported no material litigation proceedings and no material changes to previously disclosed risk factors other than the added COVID-19 risk. It reported no goodwill impairment in the quarter.
Important facts for investors to verify
- Subsequent-quarter sales, customer production schedules, and the degree to which COVID-19 shutdowns and destocking persist.
- Whether margins and cash generation hold up as volumes change, including the assumptions behind COVID-19-related inventory and healthcare accruals.
- Revolver usage, remaining borrowing availability, covenant headroom, and whether management’s liquidity and 2020 capital-spending expectations remain achievable.
- Progress remediating the material weakness and whether disclosure and financial-reporting controls become effective.
- Customer concentration: four customers each represented at least 10% of Q1 sales; the largest accounted for 16.2%.