MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good afternoon, everybody. Thank you for joining the MSA Safety presentation. I'm Larry De Maria, Research Analyst here at William Blair, required to inform you that for full list of research disclosures and potential conflicts of interest, you can visit our website at www.williamblair.com. Today from MSA, we have Nish Vartanian, Chairman and President and CEO; and Ken Krause, CFO. As you're probably well aware, MSA Safety is a global manufacturer and leader of sophisticated safety equipment. It helps protect workers in building infrastructure. They have a variety of core products, including gas protection, firefighter helmets and apparel, fixed gas line detection, industrial head protection and fall protection. The company is founded in 1914 and based in Cranberry Township, Pennsylvania. So we're going to do a discussion in a little bit. But Nish, first if you can add some comments and we have a presentation, which hopefully you can see on your screen. And then we'll do some Q&A afterwards. If you have any questions, feel free to use the app to shoot it to me and I'll be happy to ask them. Thanks very much, and thank you, guys, for being here. Please go ahead, Nish.

Great. Thank you, Larry. And again, I want to thank everybody for your interest in MSA today. What I'll do is take you through a short presentation. And then, of course, Ken and I will answer some questions from Larry as we go forward. Just a reminder on safe harbor. I want to remind everybody to -- it'll take time to read through this and just need to cover that before I get into the presentation. So our mission at MSA is, as Larry mentioned, founded in 1914. Our mission that men and women may work in safety has been unchanged in our 105-year history of the company. And that mission today is more important than ever. It resonates with our customers, with our communities, with our employees. And we use that as part of our recruitment tool with our employees and the engagement of those employees. And we'll talk a little bit more about that as I go forward in the presentation. Just a quick overview. We're traded on the New York Stock Exchange, revenue of $1.4 billion, about 5,000 employees. We have good diversity from a geographical standpoint in our business. We're approximately -- 1/3 of our business comes from our International segment and 2/3 from the Americas segment. And then we also have some good diversity in the markets we serve in our business, with firefighter safety representing about 35% of our business, equipment based around PPE, industrial PPE, represents about 30%. And in fixed gas and flame detection, 20%. And air purifying respirators, which has been in the news, represents about 8% of our business. And then the other products, about 7%. We've had strong shareholder return over the last 5 years, some good performance in our margin improvement and mid-single-digit growth in our business. From a secular standpoint, safety, obviously, is very important when it comes to global brands, whether it's ESG or the unfortunate events here with COVID-19. Safety, whether it's protecting workers or our communities, is top of mind with any business owner or in our communities. And so this has become a key area of focus for a number of our customers. And when you're considering safety products and protecting workers in the workplace, there's an awful lot of CEOs who are cutting corners in this area. So it obviously, from a secular standpoint, creates a nice opportunity for MSA as we move forward. We have leading positions in attractive markets around the world. As I mentioned, the fire service safety. Just think of the firefighter and how you outfit and protect that firefighter, being a self-contained breathing apparatus, turnout gear, fire helmets and boots. In the gas detection segment, which is used predominantly in the industrial environment, we have fixed gas and flame detection systems, and then portable gas detection, which you would attach to the worker to go into confined spaces or to monitor that worker as they're working in an environment. And then, of course, personal protective equipment, being industrial head protection and fall protection. We have leading positions around the world in those product categories, and our addressable market is in that $8 billion to $9 billion range. All of those products are specified by our users. So we do a nice job of specifying products and bring those solutions to the markets. And we invest in a significant portion of our revenue in R&D. Approximately 4% a year spent in R&D in our business. And the payback for that has been quite rewarding for our shareholders. We have about 35% product vitality, being 35% of our products that we sell today were developed in the last 5 years. And that really translates into a fairly robust gross margin profile for the organization. First quarter 2020, about 46%. We continue to have a nice pipeline of industry-leading products that we're developing and introducing in the marketplace. Some recent products that we brought to market were the M1 SCBA for the international fire service market, the ALTAIR io360, the X and S5000 gas monitors, which have been very successful within the oil and gas industry. And of course, we've had some real strong growth around fall protection, and there's been a number of fall protection products we've brought to market. So pretty excited about the pipeline and the products that we've introduced and then some products that we have coming in the future. One of them is fire grid, which is around connected firefighter with a product called LUNAR that we're introducing for the fire service later this year. So we've had strong incremental margin improvement for the organization, and we continue to see some good improvement as we go forward. Our incremental margins have been in the range of 30% to 40%. And as you can see, we've improved our margin steadily dating back to 2010, but in particular, since 2015, we've had about 500 basis points of margin improvement for the overall business. But we're showing good improvement in the Americas and in International. The International segment has been a real focus for us to show some improvement there. And that improvement that we've had continues through the first quarter of 2020, and we continue to have a pipeline of opportunity to improve margins as we move forward. The overall cost structure of the organization. When you look at our cost, a big part is raw materials. So we look at the pipeline and we look at our supply chain of products to improve the cost of our raw materials. The indirect overhead and of course, SG&A expenses all contribute as part of the cost. And all those areas are somewhat actionable for us to improve our cost as we go forward. So we continue to look for some investment and opportunity to reduce our cost overhead. And we have a nice pipeline that we've executed on in Europe and continue to develop that. But also in this situation we're in with COVID-19, we continue to look for opportunities in our cost structure overall as an organization as we go forward. So we've got a real good track record of disciplined execution as an organization. Our mid-single-digit growth has really translated into nice operational margin improvement in the organization. And we're committed to our capital deployment on a very diversified basis, whether it's the R&D expense to produce, from an organic standpoint, new products to gain market share and improve our margins, the CapEx deployment and of course, the dividend that we've paid out -- increasing dividend of over 50 years. So we have a real strong track record of how we invest that going forward. And a question we'll get into a little bit later is how that pipeline looks for -- from an acquisition standpoint, from an inorganic investment, from a balance sheet standpoint. And our balance sheet is in pristine condition. We're in really good shape to get through this economic situation we're in today and obviously come out the other side, and looking for some opportunities from -- to add to our product portfolio as we go forward. We've had some excellent success in the past, whether it's Sierra Monitors, our most recent acquisition, Globe for the turnout gear, or Latchways with fall protection. We have a real strong track record of adding to our product portfolio to create some value for our shareholders. So today, we have 4 key priorities around COVID-19. First and foremost, our priority has been protecting the health and safety of our workforce. And we've done a fantastic job of that, maintaining the operations of all of our facilities and really working hard to ensure that our supply chain has been in good shape. Around business continuity and ensuring supply chains stay up and running, we have not had any issues around those areas. You heard us talk in the first quarter about expanding manufacturing capacity of our existing air purifying respiratory portfolio. That activity continues. That will be a multiple month project that will take us into the summer, where we're looking to expand our production of air purifying respirators to keep up with the demand that we see today and into the future for those products. So we're on track with the investment there, and we look for some improved output as we get into the third and fourth quarters of this year. And of course, managing the operating expenses and the liquidity of the organization going forward. As I mentioned, we're in a great position from a balance sheet standpoint and liquidity, and we continue to actively manage our operating expenses to maintain that margin profile and improve upon it as we move forward with the business. So why invest in MSA? Superior innovation is #1. We do a great job in listening to our customers and finding solutions to our customers' needs. And that really comes through in the strong margins we have with the products that we sell today, and new products that we introduce going forward typically have a little higher margin profile than the older products they replace. Or as we get into white space, whether it's with LUNAR or the ALTAIR [ 8-360 ], those products typically have very high-margin profiles for us. We have real strong diversification across our product portfolio in the markets that we serve and also from a geographic standpoint. We've been pretty effective in growing our business about 2x GDP. So when you look at our focus around mid-single-digit growth for our business and trying to pull 1.5 to 2x that to the bottom line, we've been very effective with that from a historical basis. And of course, as I mentioned previously, a strong track record around strategic acquisitions to enhance our competitive profile in the business. So we continue to focus on the growth and margin expansion opportunities, really a high focus on that around our European segment and International segment of our business. You saw some good growth in the margin expansion in International during the first quarter. And that's really indicative of some of the investments that we have made in 2019, where we saw some nice improvement. And that carries on into 2020, and we continue to look for those opportunities going forward. And as I talked about the balanced capital allocation through our balance sheet, we're really committed to driving superior returns for our shareholders as we go forward. So with that, I'll open up things to questions with Larry. And Ken will join us to go through some Q&A you may have.

Great. And as a reminder, feel free to shoot us some questions into the system. Thanks for that update, Nish. Maybe just -- I know there's some very good, obviously, long-term story. A little bit of a new near-term disruption, obviously, for everybody. Can you give us an update on -- I know you had reported recently, April probably is not great. But how is the business, orders, backlog, et cetera, trend from April to May? Now we're into June. Can you give us any kind of color on the current trends? What changed orders, backlog? And what kind of visibility you have at this point?

So I'll kick it off, and then flip it over to Ken to add a little more color, if he'd like. So first and foremost, the backlog remains robust for us. So we've got a very strong backlog in the overall business. In fact, our backlog is at record levels. It's elevated significantly from a year ago. So we have some nice opportunity to shift that backlog over the next 2 and 3 quarters for the business. And what's driving that backlog, you have a couple of areas that are fairly strong. Air purifying respirators, obviously, from the COVID-19 pandemic. Number 2 would be fixed gas and flame detection, really driven predominantly from the Middle East and opportunities in that area that we need to ship over the next several quarters. And then breathing apparatus. The breathing apparatus backlog remains healthy from where we were a year ago. And those are the primary areas. Got a bit of a spike up in backlog with Globe, but we expect to ship that probably over the next quarter or 2. So the backlog remains healthy. What has not changed from what we discussed in our quarterly call is the strong demand around air purifying respirator products. That continues, and we do have a fairly optimistic outlook for that business as we go forward. What has changed a bit, specifically to the month of May, is business became somewhat choppy in May around, number 1, breathing apparatus and the fire service. That was really a result of municipalities not being able to meet and our fire service sales team not being able to get in front of customers to do presentations. Now as the municipalities get back up and running and people get back to work, we expect that business to come back. As we look at the fire service pipeline, a pipeline for breathing apparatus and the balance of the products look exactly the way they look from 2018 and '19. So the opportunity pipeline in those areas remains strong, and we're optimistic about that business as we go forward. What became very choppy for us, as you would imagine, is that other PPE-type equipment, being portable gas detection, head protection and fall protection products. Obviously, as construction sites and work sites closed down, the demand for those products dropped off significantly. And we are seeing some green shoots of optimism coming through, where as the economy opens back up, some of those products begin to return back to normal levels of bookings. But that's all shortsighted business, right? So that has very much -- we book and bill a lot of that product in the same month for and a month thereafter. So we don't have a lot of line of sight to that business. But there is some optimism around the fact that, that will come back. And if we follow what we've seen in China, that business in China has come back and is very strong at this point. So hopefully, what we'll see is that business open up as our -- come back as our economy opens up as we go forward. And Ken, do you want to add to that?

Yes, just adding a little bit of color to the -- to what we're seeing. When we finished the first quarter in April, we had -- we said in our public documents that we expected at Q2 that the quarter would be a little bit more challenging than Q1 was for us, that we expected potentially a sequential slowdown in our business because we were expecting to ship our backlog more so in the second half of the year. So that continues to hold. But what we -- as Nish had indicated, what we did see was probably a little [ dip as ] we were hopeful that the economy would reopen in May. And really, we didn't see that. And so as Nish indicated, those products that go on the people, the fall protection, the head protection, the portable gas detection, all were really challenged in the month of May. We're hopeful that, that will come back as we see employment improve and unemployment markets improve and metrics. And so we're hopeful we'll see that just as we have in China. As Nish indicated, it's really important is to note that we are seeing some nice robust demand coming out of China. Things are coming back online. We're not seeing any additional distractions or disruptions in that business. So we're -- we feel like we're positioned pretty well. But that's probably -- that employment-related products are challenged. And just getting in front of customers, getting out there and getting in front of customers to demo and to sell our products has been a challenge for us here in Q2.

So it sounds like pretty healthy business overall. But obviously, some near-term choppiness, which is part of what you guys had expected, but some green shoots out there as well. So no major dislocation, I don't think. So we have a few -- let's talk about your M&A outlook, if you will. Most companies are not doing too much in the next couple of weeks, if not quarter. But how do you think about the timing, the size? How eager are you guys? And also, if we stepped aside, what other categories could you be looking at that would make some sense? I mean, I'm thinking safety software, training software, quality management, things like this. Is that an area where it could be more recurring? It could be a higher value add that you'd be looking at?

So first and foremost, from a balance sheet perspective, as you know, we're in really -- a really strong position. So we're very in a strong position to make acquisitions as we go forward. We're very active, and we have an active pipeline around opportunities for acquisitions. So across all of our core product areas, I would say, maybe with the exception of self-contained breathing apparatus because we've done so much from an organic standpoint investment in those areas, we have opportunity across the entire portfolio. And we're also -- we also look outside of our current core product portfolio. As we did with the Globe acquisition, we will look at some adjacent areas where we have some markets that we serve to look for some other opportunities. So software as a service, so to speak, those are areas that we have looked at. And several other areas. So there's a lot of opportunity. The pipeline is robust. We continue to evaluate and stay in contact with those opportunities. And just as we did in 2010 and later with Latchways around 2015, we're not shy about making an acquisition coming out of an economic downturn. We levered up quite significantly coming out of the Great Recession in 2010, making the acquisition of General Monitors. We levered up to 3.5x our EBITDA in that acquisition and did a nice job of integrating that, along with several other acquisitions. So with that, I'll flip it over to Ken for any additional color.

Yes. No, I'd just emphasize that we are positioned really well, positioned from a balance sheet perspective better than we've ever been and in order to be on the offensive at the appropriate time. The challenge you have is valuing businesses today and really understanding and forecasting what these businesses might do in the next 12 to 24 months. With that said, we've dealt with uncertainty in the past, maybe not as severe as the uncertainty we're dealing with right now. But we certainly have dealt with uncertainty, and we've acquired coming out of recessions in the past, and we're certainly focused on doing that. And we're developing relationships, but staying close with some of our more strategic targets and the like. So I would say stay tuned. I think you -- Larry, I think your comments around in the coming weeks or coming months is probably spot on. I think it's right now, let's get through this, the recent downturn, let's get through this uncertainty. Let's see how things come out here maybe in the second half and at some point, go on the offensive.

Got you. We get a lot of question on the CARES Act and the potentially Heroes Act. Can you discuss -- I know it was 100, 150, I think, that went to the CARES Act. Is that already being allocated? Are you seeing that? And then the Heroes Act, that's another $500 million to $520 million. Can you just parse through how likely or if you think that will come through? And when does the rubber hit the road, so to speak, on some of these things?

Sure. So today, we have approximately $350 million in assistance to firefighter grant funding. So that's a federal funding that we've seen year in and year out. And they're beginning to allocate those dollars. So that's where you see that pent-up demand for breathing apparatus and fire departments making their decision and purchase on breathing apparatus. We typically see those dollars let from June typically through August or September. And then shortly thereafter, we start to see some orders come through. And then, of course, that builds up opportunity for us, and we ship that typically fourth quarter or first quarter as we see through that normal cycle. So we expect that normal cycle to occur with the assistance to firefighter grant money. The CARES Act funding, that was approximately $100 million. That money is flowing through the system today. So that money was for fire departments to buy COVID-related products. And we do benefit from part of that with something called an APR adapter. An APR adapter is a device that -- an accessory that snaps onto the face piece of a breathing apparatus. And they can then attach cartridges and use that for an air purifying-type respirator. So we have approval of that for our M7 breathing apparatus, which is the device that predates the G1 breathing apparatus; and of course, the G1 breathing apparatus. So we have been seeing some orders for those. But more importantly, when you consider municipal fire department budgets, they've been put under some pressure to buy some products to protect the firefighters from COVID, and those were unexpected purchases that they had to make. So whether it's product or MSA-related type product, breathing apparatus, turn out gear, et cetera, those funds will help to purchase those other products, whether it's our APR adapter or some other product, and that will keep the remaining budgets intact for those fire departments. So that helps us in 2 ways, whether they're buying our products directly or they're helping to offset some additional expenses that they have related to COVID-19. Now the Heroes Act, that remains to be seen. That's an additional $500 million, $0.5 billion for the fire service, that's built in. We just don't know where that stands. What is important is that the fact that the federal government does see the need to continue to fund those first responders, the first responders and the need. And we depend upon them to respond to our communities, making sure that they're funded from an employment headcount standpoint, so they can afford that, and then also on an equipment standpoint is obviously top of mind. So it's good to see that there is some funding there for the fire service. I'm not quite sure if it'll come in at $500 million or some other number. But certainly, there'll probably be some federal funding for our fire service, just as we saw post 9/11. Post 9/11 -- or pre 9/11, funding for the AFG was in that $100 million range. Post 9/11, those funds for AFG funding ramped up to $750 million a year. As the federal government recognized fire departments needed to update their equipment and ramp up to protect firefighters, you may see something very similar this year as funding ramps up from a federal standpoint. So whether it comes to the Heroes Act or another avenue, there'll probably be some funding as we go forward.

Okay. So we're optimistic that hopefully something else comes through, which would be incremental. And obviously, it's politics at play.

Correct.

We had a question to me around the product liability expenses. Is this a manufacturing issue that can be eliminated or minimized? Or is this more of a recurring type of expense that should be looked at as part of doing business?

I'll let Ken answer some of that. But before he does, I just want to mention that the vast majority of the product liability expense was around products that we stopped selling about 20 years ago. There are a lot of legacy products involved, and it's something we manage through quite effectively from an expense standpoint. So with that, I'll flip it over to Ken.

Yes. I mean product liability is inherent in our business. We're providing products that save lives and are used on the front lines each and every day. With that said, as Nish indicated, probably the expense that you see in our P&L, for the most part, is related -- are related to products we sold decades ago and no longer sell, and even in the markets that we no longer participate. And so we've moved away from that quite considerably. But overall, we have an IBNR, an incurred but not reported liability. It goes out to 2050 or 2060 on the curve. We feel like our liability is complete as appropriate. We actually have a net asset recorded when it comes to product liability right now, when you look at the difference between the insurance and the overall liability. So from an enterprise value perspective, it's relatively neutral. And we feel like it's very well controlled and managed. And we feel like we're in a position, again, from a capital structure perspective to continue to manage through the uncertainty we all deal with on the product liability side.

We have about 3 minutes left. So I wanted to ask, you talked about your long-term organic growth history and how you're thinking about things. Any change to how you're thinking about the long-term story going forward, given where we are in oil and gas markets? Can you just tie the oil and gas markets to your long-term growth story, how impactful that will be? And if that would suggest any change to how you're thinking about through-the-cycle business moving forward?

Sure. Sure, Larry. The -- so when you look at the oil and gas business, it represents about 30% of our overall business. And we've gone through periods in the past where oil and gas has been in a downturn, goes through some cycles as we've seen several times over the last 20 and 30 years. Clearly, it will come back at some point. We'll see. The price of oil, surprisingly, is back up to $40 in a relatively short period of time. So certainly, we expect that, that business will come back with some real strong demand as we go forward. So we're really optimistic about the business. As you look out into the back half of '21 and into '22, we think that we'll see some real strength from an oil and gas standpoint as that business comes back. And the overall business and the outlook for that looks fine. But we feel pretty confident about the growth of the overall business to maintain the profile of mid-single-digit revenue growth on the top line and some leverage of 1.5 to 2x that on our operating profit margin. We've done a nice job of executing that from a historical standpoint through organic growth with the launch of new products and gain in market share, pricing profile. And then obviously, there's been some inorganic growth through some acquisitions. So we have a high degree of confidence in returning to that once we get through the other side of COVID-19.

Great. We have about 1 minute left or so. Maybe just worth reminding investors, how do you think about incremental margins and decremental margins? And a quick reason why they're so good, especially on the decremental side? Because I guess you're taking some costs out, but is it structural versus variable? But I think it's maybe lost on people, if it's worth mentioning. And then that will be the last question for me.

Sure. Ken?

Yes, sure. When we think about incremental, so on the incremental side, we've been fortunate to take cost out and drive growth in our new products and pricing and get incrementals of 30% to 40% pretty consistently. On the decremental side, we feel like we can do much better than that on our business. If we were to see a prolonged [indiscernible], we feel like that we could do better with more structural change in our business. At this point, we haven't made any significant change. We've started to accelerate some restructuring programs that we already had in place. But we haven't made any wholesale changes per se in the business. We feel like, though, that we could improve the business and deliver decremental or better than the overall incremental. It may take a quarter or 2 to action some of those initiatives and levers. But we feel like we could certainly improve the decremental margin versus what we see on the incremental side.

Great. All right. Thank you, Nish and Ken. I appreciate your time. Best of luck the rest of the day. And thank you all for joining. We're going to conclude there. Thanks, and have a great day, everybody.

Thank you. Have a great day.

Thank you. Appreciate it, Larry.