Mid-States Aluminium Corp. (MEC) Earnings Call Transcript & Summary

Hello, and welcome to the Mayville Engineering Company to acquire Mid-States Aluminum Corporation Conference Call. My name is Alex. I'll be coordinating the call today. [Operator Instructions] I'll now hand over to your host, Stefan Neely of Vallum Advisors. Please go ahead.

Thank you, Alex, and good morning, everyone. Thank you for joining the call this morning to discuss Mayville Engineering Company's planned acquisition of Mid-States Aluminum Corporation or MSA, which was announced in a press release earlier this morning. Leading our 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. Following our prepared remarks this morning, we will open the line for questions. In supplement to today's discussion, we have also provided presentation materials, which can be found in the Investor Relations portion of our corporate website at ir.mecinc.com. With that, I would like to turn the call over to Jag.

Thank you, Stefan, and welcome to those joining us on the call and webcast. Earlier this morning, we announced the acquisition of Mid-States Aluminum Corp., a privately held, vertically integrated manufacturer of custom aluminum extrusions and fabrications for a total cash consideration of $96 million plus ordinary and customary adjustments. Over its nearly 60-year history, Wisconsin-based MSA has built a strong reputation as an industry-leading aluminum extrusions manufacturer for major OEMs in the building and construction, recreation, medical, agriculture and transportation sectors, offering value-added services that include design, engineering, fabrication, anodizing and finishing, assembly and packaging. Among MSA's largest customers are John Deere, Postle Aluminum, Inalfa Roof Systems, Bruno and Krueger International. MSA is family-owned and operated with approximately 250 nonunion employees located at MSA's 2 manufacturing facilities in Fond du Lac, Wisconsin, which are conveniently located 30 minutes from MEC's headquarters in Mayville. Importantly, given the minimal capabilities overlap between our 2 businesses, we intend to retain MSA's skilled employee base and leadership team. MSA is a performance-driven organization, one whose history of growth and innovation, domestic manufacturing presence, attractive margin profile, deep customer relationships and complementary end market exposure are highly advantageous to our existing business. The proposed acquisition is expected to close during the third quarter of 2023, subject to the satisfaction of customary closing conditions. Importantly, at closing, the acquisition of MSA will be immediately accretive, excluding transaction costs to MEC's EBITDA margin, free cash flow and earnings per share. Given the close proximity of our combined operations, we anticipated seamless integration process over the next 6 months with no anticipated impact to MSA's ongoing operations. Before I turn the call over to Todd, I would like to discuss the strategic rationale for this transaction and specifically how the acquisition of MSA will contribute to the execution of our ongoing business transformation, consistent with the priorities outlined within our MBX value creation framework. Since arriving at MEC nearly a year ago, I have outlined how over the coming years, we intend to drive ratable margin expansion through a combination of commercial expansion with higher-value specialty markets, improve operational efficiencies across our plant operations and disciplined capital allocation, including an emphasis on accretive acquisitions that accelerate our entrance into higher-growth complementary verticals. Let's discuss why MSA helps accelerate our execution of these strategic objectives. First, at a commercial level, MSA will serve to materially enhance MEC's light-weight material fabrication capabilities, which are in high demand across our existing customer base. While MEC has been the largest steel fabricator in the U.S. for more than a decade, MSA's expertise with aluminum extrusions and fabrications will position MEC to better capitalize on rapidly growing demand for light-weight materials used within energy transition and emerging technologies applications, such as battery electric vehicles. Second, given the minimal capabilities overlap between MEC and MSA, we expect MSA will provide MEC with new cross-selling opportunities to grow our share of wallet with existing customers. Through the MSA acquisition, MEC will be able to actively meet this existing customer demand, creating attractive revenue synergies. Third, we see this acquisition as an opportunity to penetrate new adjacent markets. As outlined previously, we remain committed to concentrating our market expansion activities within emerging technologies where demand for light-weight materials, additional -- light-weight materials continue to accelerate. The addition of MSA's aluminum fabrication capabilities will position MEC to become an early mover of scale within these vertical markets. Fourth, as Todd will speak to shortly, MSA brings a high-margin book of business to MEC, one that currently exceeds our average. During the 3 years ended 2022, MSA has generated an average adjusted EBITDA margin of 15.6% or 530 basis points of our MEC's adjusted EBITDA margin during the same period. Importantly, we see the potential for further improvement as we implement our MBX lean manufacturing processes across MSA's facilities. Finally, we really like MSA's complementary domestic manufacturing footprint, which closely aligns with our own. Our combined facility footprint will allow for close collaboration across our existing network and process flow. In summary, this transaction checks all the boxes, positioning MEC to drive growth within new higher-margin market verticals while expanding our share of wallet with existing customers. Within our existing customer base alone, we currently anticipate more than $25 million to $40 million in revenue synergies over the next 3 to 5 years, given known demand within our commercial vehicle, power sports, agriculture and construction and access markets, as well as $1 million to $2 million in cost synergies. As MSA is currently utilizing approximately 70% of their existing manufacturing capacity, we are confident that they will be able to meet the growing demand for their services. The MSA acquisition represents an exciting and transformational moment for MEC. We are excited to welcome the employees of MSA to the MEC family, and look forward to driving superior returns for our shareholders as one combined team. With that, I will turn the call over to Todd.

Thank you, Jag, and thank you, everyone, for joining us to discuss today's historic transaction. As Jag mentioned, MSA is a well-operated business whose commitment to quality, deep product expertise and integrated solutions have contributed to a stable portfolio of long-term OEM customer relationships. Over the years, they're focused on high-margin specialty solutions, product innovation, strategic pricing and disciplined expense management has translated to consistent profitable goal that aligns well with our own strong track record at MEC. We are acquiring MSA for $96 million of cash, plus ordinary and customary adjustments or 6x MSA's full year 2022 adjusted EBITDA. On a post-synergy basis, we estimate this acquisition will deliver internal rate of return of approximately 15%. During fiscal year 2022, MSA delivered $86 million of revenue, $16 million of adjusted EBITDA, resulted in adjusted EBITDA margins of approximately 18.6%. MSA as historically has required less than $3 million annually of maintenance CapEx, positioned it to be highly cash generative. As such, we expect the transaction will be immediately accretive, excluding transaction costs and will contribute between $30 million to $35 million of revenues in the second half of 2023, and between $4 million to $6 million of adjusted EBITDA. We intend to fund the transaction with an amendment to our existing credit agreement that increased the revolving credit facility size of $250 million. Pro-forma for the acquisition, our net leverage, defined as net debt divided by pro-forma trailing 12-month adjusted EBITDA will be approximately 2.5x to 2.8x. Over the next 18 months, we will prioritize free cash flow generation of the combined company to repay the borrowings under our credit facility. At this time, we expect to reduce net leverage to 1.5x to 2x by the end of 2024. Operationally, this transaction will bring our total number of facilities to 22 with the addition of MSA's approximately 325,000 square feet of manufacturing space. And the total number of our employees will increase from 2,300 to 2,550. With that, operator, we'd like to open the call up for questions.

[Operator Instructions] Our first question for today comes from Tim Moore of EF Hutton.

Congratulations on the terrific transaction. The financial data you supply seems very interesting and compelling. Maybe I'll just start off with a combined question. It's very interesting that the adjusted EBITDA margin has been 15.6%. Could you give us a sense of maybe what type of OEMs they have? And maybe how they're achieving that higher EBITDA margin?

Tim, thank you for the call. Their customers are in agriculture, medical, machinery and equipment and construction -- building construction markets. I will let Todd jump in on the margin profile of some of these product lines. But our belief is that aluminum extrusions are a highly in-demand components as the industry is transitioning to energy savings and electrification and energy transition. These products are in high demand, but also there is a supply constraint in the marketplace. And hence, MSA is able to extract higher pricing and higher margins for their products and services. Also, in the last couple of years, MSA invested in a case of manufacturing capability for aluminum extrusions, they invested in one of the largest presses in the country that gives them a cost advantage in terms of how they can extrude and produce these products that are in high demand.

Yes. And to add on, Tim, to Jag's comments, not only the demand and certainly the new capability to have with the new press. But just like MEC, they have the ability to pass through aluminum price changes. And so they've been very good on their pricing strategy to make sure that all the inflationary pressures that everyone is seeing gets passed through to the customer and all the pricing may have done is sticky. And so we feel really good about their margin profile. They've demonstrated over the last 2 to 3 years, they can hit 18% to 19% adjusted EBITDA and all the reasons that Jag just spoke of and then the protection they have in their contracts.

That's terrific and helpful color. I appreciate that. My next question is for the time line on the 15% IRR, I'm assuming how long do you think that would take? And does that incorporates both the revenue and the cost synergies you just mentioned in your prepared remarks?

Yes. That's including -- the 15% has all those factors already baked into it. We used the weighted average cost of capital of about 13%, didn't get overly aggressive on the growth factors and perpetuity 2.5%. So I think we've been conservative when we came to that 15%. Certainly, year 1, we're going to have some negative synergies. There's transaction cost out of the gate that comprised of legal and consulting, accounting and some tax work. We'll have some start-up costs and integration costs on the IT front. Certainly, they'll be part of a public company of the set of control environment and things of that nature. But when you get into next year, that's when we start to really start to see the positive impact of all the accretive impacts when you think of all these synergies. When we think of purchasing, we have the sales and cross-selling, we have MBX initiatives, We've already identified insurance and benefits. So there's a host of synergies that we feel very confident that we could execute upon. Again, this year, sort of the transaction and start-up costs. But as we get into next year, that $1 million to $2 million annually surely fall through the bottom line to be rapidly.

That's very helpful color. And my last question is, I noticed the release said and you mentioned it to close during the third quarter. But can you give us a sense of maybe how long you've been in discussion with them? And is it possible that you could close sometime early September? Or do you think it will be more like a late September timing?

Let me address that. We have been -- let me actually step back and then say, I have been here 11 months exactly, Tim. And one of the first efforts we made as a team when I joined was to laser focus on light-weight material and potential targets in that space with aluminum, plastics and composites in that order. So when we found MSA, which happens to be 30 minutes away from where our headquarters is, we got excited. We met with them, I don't know, almost 6 to 9 months ago. And it's a private sale. It is not an auction. This was a relationship that Todd and Ryan and the team had from many years ago, so we were able to immediately get into cultivating that relationship and continue on with that process. So we've been in good discussions for a good 6 months. I suspect that we can close in early part of Q3 rather than later part of Q3.

Our next question comes from Larry De Maria from William Blair.

Congratulations. Two questions. First, can you talk about if there's any kind of customer overlap there is? And related to that, you've talked about the end markets building construction, medical, transport et cetera. Can you sort of size some of those or percentage them or lengthen maybe in terms of bring the importance?

Yes. So I would say the only that we have one major customer that has an overlap, Larry, and that's John Deere. Outside of John Deere, we don't have much of a customer overlap, but we're happy to share that this capability we're acquiring through MSA acquisition will actually open up cross-selling opportunities into our existing verticals such as commercial vehicles, power stores, construction access and agriculture. So that's really where we are focused on. In terms of end market exposure, Todd is going to jump in and then provide some numbers here.

So when you look at the end market, about 19% of their sales are comprised of that end market. Building Construction is about 33%. Medical represents about 16% of sales. Recreation and Transportation is about 21%. And in the other categories was the additional 10%. So it's very diverse markets. And as Jag mentioned, not much other than dear relationship. And in fact, at a consolidated level, it reduces our exposure to deal as a percentage of our total sales.

Okay. That makes sense. And second question, I think you gave 2022 EBITDA, is there a trailing 12-month number? And can you just sort of talk about your line of sight on new business? Are they working on stuff and you feel like they can close together you can close some other stuff? Or is there a lot of -- okay, just sounds good, let's go get business?

No. I would characterize it's booked business. In '23, and we'll have certainly numbers after we close and file the necessary filings. But in '23, they are seeing all the markets up except for recreation and that's primarily the postal aluminum, which is in the RV space, which is an expected kind of pullback this year being that dealer inventories are at a peak and that gets back in 2024 to a more normalized level. So as we look at and characterize '23, EBITDA margin percentage is very similar. So they're still executing very well. Sales are down a little bit and it's all in the RV market. All of the other end markets are up with high single digits.

Okay. Well, that's good. But I think I was sort of more towards some of the revenue synergy numbers, which I guess, a couple of years out, but kind of the line of sight and capturing some of that is already in discussions, and there's a good sort of pipeline [indiscernible] continue to develop there.

Yes. Great question, Larry. As part of the diligence process, we were able to vet MSA's capabilities with a couple of our large customers, in terms of manufacturability, cost competitiveness and all of that. That's one of the themes that we took was that it's got to be 1 plus 1 has to be greater than 2. So we we're very confident that the capabilities we're bringing to MEC will help us quickly capture the revenue synergies we have laid out in our existing markets that are rapidly transforming into energy transition, battery electric vehicle platforms.

And certainly, Larry, as you think of -- as we've talked in the past, Jag has certainly mentioned that is a capability that we've heard over the last 12 months from almost every single one of our customers is in need for an aluminum capability within MEC's. And so as Jag mentioned, as part of that diligence process, we actually worked with the MSA management team and this performed quotation activity on a number of large OEMs. So we feel very good that one; the capability that we're bringing on aligns with their needs; and two, that we're price competitive.

Okay. Can I -- I'm sorry to ask one more question, if I can. First, related to that, the aluminum, obviously, I get that you talked about the other areas you've been looking for. Just to clarify, your existing core business, not having those capabilities. Did you see any of that business at risk? Or is this or more about opening up a new line of sight? Or is there any risk to the kind of the core?

I mean, I would characterize -- yes, as more of opening up additional opportunities rather than any of our existing business at risk.

Our next question comes from Vlad Bystricky of Citigroup.

Congratulations on the announcement here today. So I just wanted to ask you on MSA's margin profile. It looks like there's been material expansion in the company's adjusted EBITDA margin over the past 4 years that you've got on the slide deck there. So can you talk about what's changed? Has there been something structurally that's changed in the business to drive these higher margins? And how you're thinking about sort of the sustainability of margins where they are today?

Sure. What materially changed, as you can see from Slide 6, right. From 2020 and before, right, they're in the $45 million to $46 million in sales. In 2021, there were in the -- almost $71 million and '22, $86 million. That step change is a direct result of a large investment MSA made in extrusion capability, being invested in a 3150 ton press that can extrude over 8 inches -- up to 8 inches of aluminum. So that state-of-the-art press capabilities is one of the largest in the country, if not the largest in the country, and that gave them immediately an opportunity to change their cost profile. And more importantly, attract a different set of customers to the company, right? So that's really why their margin profile changed, their revenue profile changed and that's why we're interested and excited about because there's still a bunch of capacity left on that press, and we can take that capacity to our existing customer base.

As we mentioned, Vlad, material is a path has set for them -- sorry, in a little bit in '22, there was probably $4 million to $6 million of raw material pass-through, but aluminum isn't as volatile as steel. There is still fluctuation in the market, but the pricing has not been quite erratic. But again, they're protected on the upside and downside with steel prices do fluctuating.

Okay. Great. That's helpful. And Jag, you kind of answered my other question, which is the revenue growth that we see here is just to be clear, that it's really organic through the step-up through the investment in that additional capacity. Is that fair to say? In other words, they haven't done significant M&A?

Yes.

Okay. Great. And then maybe just one last one for me. If -- so you mentioned their exposure to the building and construction end markets here. Can you give us any more color on what they do in building and construction and what sort of within building construction? Are there particular exposure to areas like non-resi versus resi versus infrastructure? Any sort of color you could give on what's driving that portion of the business for them?

They have in building and construction is probably a broad description. They have some medical and lab furniture, commercial door infrastructure -- commercial door hangers. Think of it as an office building, right, large glass doors when you push bar, right, the doors open up. See, that's all aluminum, right? So there's a lot of stuff like that they do. Similarly, they have a lot of LED lighting components and so on, right? So there's quite a diversified set of applications, very little in residential applications. So that's why I will describe the building and construction market.

Got it. Got it. And sorry, maybe I don't know if I missed it earlier on the call, but did you mentioned your largest customers is 17% of revenue? Any sort of information on customer concentration outside of that, number one? Any other sort of concentrate top 5 overly concentrated to any particular customers that we need to think about?

Well, postal aluminum is certainly their largest customer and that's in the RV space. They make products for core. John Deere would probably be the second and it represents about 10% of their sales. So outside of that, they're low single digits. And again, they have a -- we described the top 5, but after that, there are number of other customers in the portfolio.

[Operator Instructions] Our next question comes from Mig Dobre of Baird.

Just to follow up on -- yes, just a follow-up on the discussion you had with Vlad a moment ago. So again, looking at Slide 6. The revenue growth relative to '19 and '20 pretty significant obviously, but it doesn't look like the business mix has changed all that much. So I'm sort of curious if -- how this growth has manifested itself, is it just sort of a function of new customers that just happen to be sort of very similar to what this business had back in 2020? Or is there sort of an inflation sort of component to this that we have to keep in mind, yes, any additional color would be helpful there.

Well, thanks, Mig. And as Jag mentioned, really, the impetus was that new investment in the press line. They were kind of at a full capacity, let's call it, without that additional press line they put in. And that new press line opened up the number of customers to them. And so they really were able to take organically expand relationships they already had and do more work with their customer base and more efficiently. And so they didn't have to add a lot of head count or people. It was really technology driven. And it is one of the largest in the North America. And it will also quick change over, really highly efficient. So it really opened the door for their capacity and this expanded their organic relationship. So there hasn't been any real new customers coming into the fall, but let's say, in the last few years. No acquisitions that drove that sort of growth. It really was that investment data cited about 40 years ago. The press took about 2 years for it to get in place and operating. So that was the game changer for the business.

Can you give us any color in terms of the level of investment that was made here? And excuse my ignorance, but I don't really understand what's special about this press? And what sort of product it would make that maybe somebody else would not be able to do?

So the original investment, which we made in 2019 was about $8 million to $10 million. The press, we took about 18 months to construct and build. And what it really allows for us what Jag said, it's just a faster rate. You put an aluminum build it into the machine. It's able to press it, form it in a very rapid fashion and the changeover from a -- to a different dye is very quick. So there isn't this an older technology, it might take you a few hours to change that dye, now you can do it in a minutes. So that technology and the ability now to shift and be more nimble, let's call it agile, really opened the door for them to do quick run, short run. Historically, they'd always look for high volume or not automotive level, but I would say more mid level volume and long-running jobs in order to be efficient. This -- again, this technology is so much faster. The quality is much improved. It melts that billet in a much more rapid fashion and it pushes into extrusion line. So it is one of the first in North America and certainly it was a sizable investment that, again, just change the profile of their business.

Okay. On Slide 5, you have a table here outlining revenue and cost synergy rather a chart. And wondering if you can maybe help me better understand this chart. What sort of revenue versus cost in these bars? And what level of visibility do you have on the revenue component of all of this? I mean, how are you going to go about implementing it?

So as we mentioned, Mig, in my earlier comments, through the diligence process, we actively worked with a couple of our large customers to evaluate MSA's capabilities and cost competitiveness. So we took real world big packages from a couple of our customers and ran it through the MSA team, right? And let them price it as they normally would. So -- and then we're able to then confirm not only the capabilities of this new technology and the new press, but more importantly, their ability to take those extrusions and then fabricate, i.e., machine, weld, assemble, just like what MEC does in the back end of the operations and go back to our customers and then say, "Hey, this is what MSA could provide if they're part of the MEC family, right?" So that gave us high confidence that within a 12- to 18-month period, we can win some large business with some of our existing customers who currently procure these materials from other players and having difficulty procuring because of the constrained capacity in North America. And more importantly, increased demand for lightweighting materials across the spectrum of many industries that want this sort of materials and there's a capacity constraint currently. So that's really how we're thinking about revenue synergies. And I would say that what we laid out here is time, I guess, contingency later. So that means that we -- if we can get some of these opportunities landed, these revenue synergies could materialize quicker. We're going to go through them systematically, opportunity by opportunity, customer by customer. Ryan and I are going to get on calls today, talk to all of our large customers. Now just to let them know the new capabilities we have and continue to drive that business development opportunities to realize these revenue synergies in the coming years.

And just to clarify, Mig, that what's depicted on Slide 5 is only the revenue synergy. On the cost synergy side, again, we've identified some -- obviously, the cross-selling opportunities, but insurance and benefits, there are IT subscriptions and a whole host of back office type of things that we feel we can drive $1 million to $2 million annually in cost savings. Now again, we'll have some negative transaction costs and start-up costs in year 1 or, I would say, the first 6 months, but as you look into 2024 and beyond, we think we can improve their bottom line as it stands today by 10% to 15%.

Understood. That's helpful. And my final question, you mentioned here that the transaction is going to be accretive to EPS. Just looking to clarify how you're thinking about that accretion? Is it cash EPS that you're talking about? Is it EPS in the form that you're reporting it right now? And in terms of the debt, can you remind us what sort of rate or expense will be associated with this financing?

Yes, certainly. So when you think of accretion, is certainly accretive day 1, not excluding transaction and start-up costs. For this year, we think it will be neutral to EPS but it'd be about $0.10, if you talk about transaction and other costs. And then certainly, as you mentioned, interest costs will go up a little bit on our leverage profile. Interest of 5% in that 7% to 7.5% for the short term. We've already factored those items into it but they've been highly cash generative. Their free cash flow conversion rate has been above 80% over the last 1.5 years. And as we mentioned, $3 million in maintenance CapEx annually. I mean outside of the large investments they made a few years ago, historically, and since that point, it's in that $2 million to $3 million range. So we feel cash generation from this will generate, obviously, positive cash flow outside of the kind of the impact we talked about when you think of the legal and consulting and then also the increased interest expense. And I get it, we're paying a little higher interest rate today. But the nice thing is we're paying 6x EBITDA -- in trailing EBITDA. A year ago or even 18 months ago, a company like this coming to market. It wasn't to market, but a company like this that gained market. We'd probably be in that 10x to 12x range and we would add a much higher purchase price. So we feel like even though the short-term impact of interest costs isn't insignificant, that's short term. In the long term, I think we're really going to benefit because, again, that purchase price was at that 6x trailing 12x.

Yes. And I want to pick up on that comment that you provided, Todd, in terms of the multiple itself 6x versus 10x to 12x a few years ago. I'm sort of curious as to why you think that is because, obviously, the margin profile and the revenue is looking very different than it did 3 years ago. And I think a lot of us are sort of trying to get at whether or not there is something from a cycle standpoint or end market dynamics that's going unique that is catalyzing this transaction on the part of the seller?

So I can't speak for anyone's motivations on why and when anyone would want to sell their business, right? That's not our business to talk about. But as we described, Postle Aluminum being part of RV industry, those sales are down year-over-year, right? So we knew that going into this year -- actually coming into this year, late last year, we knew that 2023 is going to be a down year for RV industry. We expect that to stabilize going into 2024, but that's not why we're buying this company, right? Why we're buying this company is to leverage their existing capabilities that we can take into other industries that they don't have today access to. So commercial vehicles, power sports, construction access and agriculture, all industries where we are, we MEC are a large Tier 1 supplier, right? That's where our customers are asking for these capabilities. When you look at this business and then you say, all right, there are $86 million in 2022. They're going to be down this year and that means there's an existing capacity that we can take into new verticals and new customers that's the attractive part, right? The current ownership may not be able to realize those revenue synergies because they don't have access to those customers. A large company that currently does business with us is CV or power sports customer will not go and seek out a small company like MSA. Once they're part of MEC, that opens up the opportunities because we have the quality systems, we have the quality certifications. We have existing supplier cores, existing relationships with our customers, right? That's the opportunity here. It's not that their revenues are down, they're selling for less, and we're buying for less, it's that we saw the opportunity to take existing capacity and capabilities and drive additional growth for MEC and MEC shareholders. That's the game here. That's the play here.

At this time, we currently have no further questions. So I'll hand back to Jag Reddy for any further remarks.

Once again, thank you for joining our call. We believe this is a very exciting moment for all MEC shareholders and we look forward to providing an update on our entire business on our second quarter earnings call in early August. Should you have any questions, please contact Noel Ryan or Stefan Neely at Vallum our Investor Relations Council. This concludes our call today. You may now disconnect.

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