MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the virtual fireside with MSA Safety Management. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Stanley Elliott. Sir, the floor is yours.

All right, Matthew. Thank you for the introduction, and thanks to everyone for joining us here today. We are very pleased to have the management team of MSA joining us for a virtual fireside chat and -- during these interesting times. And MSA has been one of our selectless picks for quite some time, and we think that this is a timely call to discuss how they are managing through this pandemic and the outlook, which we believe is encouraging going forward. With us today, we have Chairman and CEO, Nish Vartanian; we have CFO, Kenneth Krause; and we also have Elyse Lorenzato, who's heading up their IR group. The format for today will be pretty informal. I'm going to turn it over to Nish here in a second for a quick update. I'll follow in with a bunch of questions. There should be an opportunity for any one on the webcast to send in questions directly to me. We will not be opening it up to Q&A, given the time limitations here today, kind of looking at about a 45-minute call. So with that, thanks again for joining us. And Nish, the floor is all yours.

Thanks, Stanley, and thank you for having us. Before we get into the Q&A session, I'll provide a brief overview of our business conditions. But first, I want to express my appreciation to the associates of MSA. As I've said many times before, our mission of protecting the world's workers is the foundation of our success. The importance of our mission and our employees' dedication to it is really remarkable. Our team's reaction to the COVID crisis has been a reflection of a highly engaged workforce. We've worked with speed and agility to ensure operations continue through the crisis with minimal disruptions to providing essential product, service and support for our customers. And as a leader in safety, we've taken great care to ensure the safety and health of our own workforce by implementing enhanced safety measures in our plants across the world. In speaking of MSA's safety culture, the team has made great progress across the entire ESG landscape in 2020. In fact, we published our first ever stand-alone sustainability report earlier this year. The report includes enhanced disclosures around our environmental metrics and goals, workforce demographics and community partnerships. Our approach to ESG centers around continuous improvement, mirroring the approach that we've taken the rest of our business with the MSA operating system. For both the COVID response and the continuous improvements in ESG disclosures and processes, I'm proud to say that our entire MSA team is -- would be an understatement in the work that they've done. So now in terms of the business update. The story remains mixed, and our macro environment remains challenging. But we continue to control the controllables. So first, a look at what's going well. Our -- across our business lines, our market share continues to be very healthy, and we're winning customers. Our pricing is holding up nicely, and we continue to closely manage our operating expenses and execute on our restructuring programs aimed at improving the efficiency of our business model. The firefighter safety business is relatively healthy, and it's great to see the AFG funds flowing and the activity starting to pick up as we move into the fall. Fixed Gas and flame detection continues to perform as expected, and reoccurring revenue streams in that business are providing very good support as we anticipated. On the other hand, we've seen some challenges in a few areas. For example, our industrial PPE business continues to be weak as unemployment remains high. We managed through the virus resurgence and related disruptions in key markets this summer. And like the Southeast and Gulf area, we're hopeful that we bottomed through the summer months of July and August, but we have yet to see substantial improvement in the PPE space. As you know this area reflects about 30% of our overall business. As we discussed back on our call in July, the order pace tapered in our respiratory business over the summer. We continue to work through existing backlog and should see healthy revenue growth in the quarter as a result, but the incoming order pace has moderated a bit. While we're hopeful that we've reached a bottom in the summer months, we're focused on executing long-term margin expansion programs, and we're well positioned to use the balance sheet to drive value with M&A and organic investments. MSA's business model is showing resilience, and we're being very proactive to push forward with structural cost takeout to position MSA for improved incrementals as we emerge from this pandemic. I'm sure we'll get into all of this during the Q&A session, but that's just a brief update on what we've seen recently. So Stanley, back to you for some Q&A.

Perfect. I guess, let's start with the cost takeout. It sounded like, coming out of the calls, that you've been more focused on the discretionary cost side of the house. I think it's kind of -- have to go back to kind of the '15, '16 time period, where you had kind of a more "formal restructuring program." Is there a way to update us on has the thought process changed? Have you been more aggressive with the cost-out given the environment? And then is there any way to put a dollar figure or time frame to realize some of those savings?

I'll lead in, Stanley, and then have Ken add some more color for us. So yes, first and foremost, we did, obviously, with -- from an operational SG&A standpoint and some of the discretionary expenses, we did a really good job on clamping down on those expenses and making sure that we were careful with the business and maintain good profitability profile, as we talked about in the past. And we have known along that that's really short-term and short-term thinking. As we got into the year and we looked at the impact of COVID, and as you saw, the business has been really choppy, and we've talked about this a bit. Our incoming business in the month of April was really robust. It was really strong. And then May was soft, and then June kind of bounced back again, and it was fairly strong. And then as we saw COVID spike up again, especially down in the Sun Belt, when you look at the Southeast and the Gulf Coast where we have real good business, we saw the business fall off again as we were concerned with and anticipated. So that's really take -- made us take a hard look at some significant restructuring in the organization and really ratchet up the work around that. So I think your view of this is very good when you look back to '15 and '16. '15 and '16 is similar to what we're seeing today where we had that downturn in oil and gas, and we repositioned ourselves from a cost structure standpoint. And we -- when we came back out of that, that really happened in the latter part of 2016. I think August '16, we saw a turning point there. We saw our margins really come back because we do a good job of making sure we don't let those expenses come in at the rate that the business picks up. So we get some good leverage as we go forward. So you're looking at it the right way. Ken, you want to add something to that?

Yes. The only thing I would say is historically, Stanley, you know, and those who are on the call most likely know that a lot of our focus in the last 12 to 18 months has been in Europe and spending a lot of time in the International segment of our business. What we're doing now is not just Europe, but we're really looking across all aspects of our business and challenging each and every cost that comes into the business but also our overall approach to our business model. And so we continue to look at that, we continue to evaluate cost reduction and cost take-out opportunities. And we feel like we're at the point in the cycle where we should be focused on those things. As Nish indicated, '15 and '16, in 2015 and 2016, we were very active, and we took out a significant amount of cost from our cost structure and improved our incrementals. And we feel like this action that we're taking now will help us improve our incrementals even further, especially when the business starts to come back in the future. And so we feel like we're doing some things now that will enable us to see nice improved margins going forward as we -- when we bring on the additional revenue growth.

And in terms of sizing, should we think about it similarly to the '15, '16 period or is that too much detail? I know that you guys have been very focused on cost on a continuous basis, but just trying to kind of...

Yes. We have yet to establish that target or share that target publicly, but I'll tell you that we're focused on significant cost reductions. And those cost reductions aren't just in SG&A, maybe like they were back in '15 and '16, but they're also focused on manufacturing operations as well as SG&A and some of the more support corporate functions. And so it's really up and down the spectrum, and we're really looking to continue to position this business for success in the years to come.

Yes. And that makes sense. And I was kind of trying to highlight that with the kind of $1.3 billion, $1.4 billion sort of revenue company that you -- it's easy -- well, not easy, but there's an ability to get a pretty meaningful margin accretion on the upside when that occurs from the cost takeout.

Sure. And you saw that in '17 and '18, '19.

And how does -- how should we think about incrementals? I mean you kind of a 35%-plus, 40%-plus sort of a business. You -- where do you envision yourself when ultimately that the market finally starts to recover that these cost actions can end up pushing those numbers?

Well, the one thing that I would say is it's hard to put a time line on this or a specific target. But I'll tell you, and we talked about this back in our Investor Day in November, top quartile performance in our proxy peer group has operating margins with a 2-handle on it. And so we feel like that, that should be our longer-term goals. As we think about emerging from this pandemic, emerging from this recession and improving the business, we feel like that's a realistic target for us. Again, we're not putting a time line on it or a specific target out there, but we feel like it's reasonable to have expectations of that level.

Yes. No, and I would agree with. I think you have certainly the portfolio. When you think about kind of moving ultimately into that higher sort of a margin profile, we talk to a lot of investors, and they seem to think that the European restructuring is kind of the magic bullet, if you will. I'd love to get you to talk about the improvement that you made in Europe or the International segment here in the second quarter, and then also some of the other things you're working on to continue to expand margins to that kind of new level.

Yes. I mean, we were -- it was good to see that margin improvement. It's not just the second quarter, but it was consistent over a number of quarters that we continue to see that margin improvement. And we don't think we're done yet. We certainly aren't done yet. We've got a number of additional actions that we're executing on. And I think Bob Leenen, the group -- the President of that segment, is positioned very well. He's got a great background. He's got a great perspective when it comes to these sorts of things, and I think the team under him is executing extremely well as well. And so I think -- we feel like we have room to go. We continue to see opportunities from a shared service perspective, from a manufacturing operations perspective, but also from an end market channel partner perspective and how we go-to-market with some of our products. And so we -- again, we feel pretty well positioned in International. It won't be a consistent up into the right trend line. I mean you've seen us in the past -- in years past, where we'll see a couple of hundred basis points, and then you'll consolidate maybe for a period, and then you'll see further improvement going forward. I feel like that's the right cadence, and that's the right direction, and that's where we're headed with that business.

When you look at Q2, Stanley, the op margin of 15% for International, it just gives us a real good view that we can operate there. We can get there. So it will take us some time to get there, but we're showing a good improvement. That shared services facility in Poland is a nice step forward, and we're starting to build that and move positions there. And Bob just making all -- taking all the right steps, we're getting some pricing in the international market, which we haven't enjoyed in the past, which is really helping on the margin piece. So as we take the cost out and improve the efficiency of the business and get that margin improvement around selling, we should continue to see some nice improvement for that business. So we're confident about that.

No doubt. And kind of switching back to the top line environment. Have you seen better trends in economy that have reopened or a bit earlier to reopen? I'm just trying to get a sense for -- when you're talking about the softness in the industrial PP&E, how much of that was COVID-related, especially since some of those markets are coming back? But on the flip side, you've had all the storm activity to the Gulf Coast. Just trying to get a sense for what could potentially be on the horizon for some of those markets.

So China, for instance, if you look at the China business, the China business has returned to what, pre-COVID, kind of normal levels of improvement. That's our best growth area around the world today, and that business came back nicely. And that's what we are hoping for. We are hoping for that type of bounce back here in the U.S. and in Europe. And unfortunately, because of the reemergence of COVID in the south and then obviously, the storm was kind of a temporary step back, we saw some of those things come through. But we're optimistic that we'll -- hopefully, we don't get another COVID emergence here in the fall with the flu season. If we don't see that, we think that we'll start to see some pretty good improvement with the PPE products as we get through September, October, and then November, and then we get some seasonality, as you know, typically for the winter months, but we feel pretty good about coming out of this moving forward.

Yes. I mean, given the short-cycle nature there. How are you all positioned yourself either from inventory position, trying to get more shelf space, pricing, whatever it may be, how are you positioning yourself for a rebound in that business because ultimately, when that does turn, it will turn pretty fast?

So when you look at the different product lines, we can respond really quickly around head protection. Head protection is a space that we can really bounce back quickly because of the scale that we have in our facilities in the way we execute on driving through -- product through the warehouses and work real well with our big channel partners to make sure that they're positioned well as we see things turn, and we communicate closely with them. With fall protection, because we don't have the scale and the market share, that's where we take on a little bit of risk and build some inventory for that snapback so we can possibly take advantage of that. So obviously, we've got a strong balance sheet. We performed well from a financial standpoint. So we've built some inventory hoping that the fall turnaround season would be strong for us, and we've done well there. And on portable gas detection, we can respond very quickly because our scale is really solid in that area. So we're in good shape there. And if we see the APR business snap back with some big orders, we talked about that business moderating over the summer months. And if that does snap back with another outbreak, so to speak, we're really well positioned there with the investments that we've made in our Jacksonville, North Carolina facility with MSA LLC. So we're in a pretty good position from that standpoint. And we've aligned ourselves really well for the AFG funding and the grants that have been released. That business, it's really nice to see that start to flow again. So we feel like we're well positioned to be able to respond as that business comes back here over the fall.

And kind of on that APR business, you all should be finished with the Jacksonville expansion, I believe, coming up fairly soon. Can you talk about what that does in terms of improvements to margins or improvements to serve a larger community? And can I talk about some of the products that you all have out there, whether it's national stockpiles or whether it's kind of end-user demand right now and really what's driving that business?

Well, from a productivity standpoint, you're right. So we should -- we'll probably wrap up that work in the Jacksonville facility in the October time frame, which we've communicated in the past, and that's really done a nice thing. And pulling forward some of the improvements we had planned 3 and 5 years out, so this was a real nice opportunity to upgrade our equipment that was long in the tooth, and it was a good opportunity to make some improvements from that standpoint. So we can respond really well with some spikes in demand if we see that going forward. And really, we saw that the big thrust of the increase we saw in business was from industrial customers we've had in the past, which was good to see, and so we were able to respond to that and respond to their needs. And there are some other opportunities within the health care market. We've picked up some orders from some hospitals who have decided to use elastomeric respirators to supplement what they're doing with the N95 type respirators. So as you know, with a half-mask elastomeric base piece, you can catch an N95-type filter or a P100-type filter, which is a higher level of efficiency when it comes to filtration. So there's some flexibility in that. And there's a lot of communication within the medical community, the hospitals and some discussion about the possibility of adding elastomeric half-mask respirators to the national stockpile. So that hasn't been done yet. But -- so there's some discussion around that. So there's potential that we could possibly see some business from that as we go forward.

You mentioned the orders dropping off. I mean it would seem that they would drop off just given the impressive order rates you were seeing at the beginning of the year. But you still are implying that they're running positive through the back part of the year. I don't want to get too granular on you, but I was just curious to kind of parse that out.

Yes. Certainly, you're going to see double-digit growth. You're not going to see 60% growth over the back half of the year, but you're going to see double-digit growth over the back half of the year. We're still working through the backlog, and -- we don't have any concerns of canceled orders. In fact, customers continue to press us for delivery on products. And while we're working through that backlog, the pace of business has moderated back to what I would refer to as more normal type business for air-purifying respiratory business. So you'll probably see double-digit growth through the back half of the year with that business.

Yes. Yes. Then let's switch gears to the fire business. You mentioned pretty stable and encouraging trends there. I think especially given concerns, I guess, with the investment world about what's happening in state and local budgets. Can you talk about what's driving the improvement there? You mentioned the AGF funding, there was -- I guess it was -- I don't remember if it's the CARES or the Heroes Act earlier in the year, if that had some additional funding, but I would love to get some thoughts there, too.

Sure. First and foremost, it's really important to frame the fire -- our fire service business. Our business that goes into the fire service is mission-critical. It's protecting the firefighter, is as important having wheels on a fire truck. A firefighter can't even respond to a car fire because of the off-gassing, with carcinogenic material from a car fire. They have to have a self-contained breathing apparatus. And typically, when those breathing apparatus are 2 NFPA cycles out of compliance or the cylinders on those breathing apparatus have a 15-year life, useful life, municipalities have to replace those devices, and that's exactly what we're seeing. With the budgets being tight, they're holding off on capital improvements, such as resurfacing a parking lot at a fire station or maybe holding off on reroofing a fire station or buying some other type equipment that isn't mission-critical. But these products are mission-critical. And as you know from the replacement cycle, that was really created post-9/11. There's a large number of breathing apparatus that remain from that cycle that are getting into that 13- to 15-year age, and those need to be replaced. And so now that these grants have been let, there are some departments that have -- they realize that they're not going to get a grant, so they're using their own money or departments that get the grant place their orders. So we're really starting to see that business build over the last part of August and here in the first few days of September. We've picked up some real nice orders, and it's really encouraging to see. The turnout here remains solid. That was an area that I thought might slow down a bit, but we continue to see that business do really well. Our challenge with turnout here, quite frankly, is getting the product through our factory. And -- because we do have quite close working quarters within that plant in Pittsfield, North -- New Hampshire and obviously, we've done a real good job of spacing the employees, so that's slowed us down a bit. And so we're not getting the productivity levels that we have had in the past, and we continue to work through that. But from a booking standpoint, the incoming business for that turnout gear business, the breathing apparatus business and fire helmets, that all remains really solid for us. So we're encouraged by that, and the outlook for that remains pretty good. The replacement cycle, I'm comfortable to say will continue through '21, into '22 and maybe even longer.

Yes. That was going to be my next question. If you kind of threw out kind of a 13- to 15-year range, that would imply that we should have at least another maybe 2 years of some decent replacement opportunities for you all on a go-forward basis.

Yes, the last -- yes, no question. There's absolutely some opportunity, next 2 or 3 years.

Have you seen anything in the competitive landscape? You've done such a phenomenal job with the G1 in terms of addressing market need. Is anything, from your competitors, your peers, doing anything to disrupt kind of the market share gains that you've seen to date?

Sure. Absolutely. We -- as you know, the one big difference is, is the G1 breathing apparatus was an entirely new platform, right? So we started with a blank sheet of paper. It's been 5 years and over $50 million in developing the G1 breathing apparatus, which was the first time we really redeveloped the ground up breathing apparatus. And so that's left a number of our competitors, as you would imagine. We continue to talk about half of our business comes in from competitive conversions. So I think originally, we caught our competitors flat-footed and really took the market by storm, and we continue to do quite well, and they're responding to that. They're trying to play catch-ups, but what their changes are, Stanley, there are really more incremental changes to where maybe they'll make some adjustments to their face piece or adjustments to their regulator and some incremental change to their breathing apparatus to try to compete in some of these evaluations more effectively. To this point, we continue to compete really well. We're comfortable with our market share position. Just last night, we picked up 2 nice-sized municipal fire departments that are competitive conversions. And the fire service sales team continue to have a lot of confidence around that product and how we compete in the marketplace. And then the M1 continues to do well in the international market. We've made some nice gains in France. We talked about Hamburg, Germany. We picked up some nice business in the German market, made some real nice gains in France, and there's some other opportunity as we go forward in Europe and other parts of the world with the M1 breathing apparatus. So we think we're well positioned there.