MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Morning, everyone. This is Mike McGinn, Senior Analyst, Wells Fargo Industrials. For those investors on the line and webcast, if you have any questions you haven't already submitted, you can e-mail me at [email protected], and I'll do my best to fit those in. So without further ado, we're delighted to have MSA Safety. With us is Ken, CFO; and Elyse, Director of Investor Relations, who I believe have a brief slide presentation, then we'll follow-up with Q&A. Ken?

Great. Well, thank you. Thank you, Mike. I'll just turn it over to Elyse. Let her walk through a few slides here. I'll talk a bit as well here shortly, and then we'll open it up for Q&A. So Elyse?

Thanks, Ken, and thanks, Mike, and the Wells team for having us. As we go through the slides this morning, as always, please be mindful of the safe harbor. So it's my pleasure to introduce MSA Safety to you. And for those that don't know about our company, we are a $1.35 billion manufacturer of safety products and solutions across a really diverse range of end markets and geographies. Safety is all we do. We live and breathe it every day. We have about 55% of our business here in the U.S., the remaining 45% in markets like Europe, Latin America, the Middle East and China. And from an end market perspective, our largest single market is firefighter safety. We also play in a number of industrial-oriented markets, like energy, construction, utilities and other markets. And we've been executing on our mission of protecting the health and safety of workers for more than 105 years. So every day, our products protect tens of millions of workers around the world. And safety has really never been any more important or relevant than it is today. Before the pandemic, through the pandemic and I'm sure afterwards, organizations of all sizes are investing resources into their safety programs and equipment and protocols. And there are a lot of unique mega trends that are really relevant to our business, from fire service to fall protection and the connected worker, our product development portfolio really leans into those mega trends. And one trend that's certainly very relevant to the investor community and others is ESG. And our mission is really ESG-oriented. We help our customers achieve their ESG goals with our safety solutions. And from an internal perspective, we focus on our ESG programs as well, and we've expanded our disclosures in recent years around that area to really bring more transparency to our internal efforts. So I'll hand it over to Ken to talk about our market positions. Ken?

Great. Thanks, Elyse. Two -- actually 3 things I want to talk to you about here this morning. First is our market positions; the second is I'll touch upon the execution that we've seen across the portfolio going back over the last several years; and then the third thing I'll do is provide a quick update on what we're seeing here as we go throughout in 2021. And so starting first and foremost on leadership positions here on this first slide. At MSA, it really all starts with our R&D investments and our effort around launching innovative new technologies. We're continuing to launch some of the most exciting safety technologies that not only provide customers with a high -- the highest level of technology, but it also oftentimes provides our customers with productivity opportunities and allows them to go to work in a more productive manner. In 2020, we invested nearly $70 million in R&D to bring the most advanced safety solutions to our customer base. As a result of investing in this area, 35% of our revenue over the last 12 months is from -- are from products that we invested in and launched over the last 5 years. Normally, when we launch products -- launch new products, they are accretive to the overall margin profile. And if they're not, we've got a heavy focus on value engineering, to go in and to continue to make the product better and more efficient. We play in a $9 billion addressable market, which we've expanded over the years through M&A and organic R&D investments. And in January of this year, we expanded our addressable market to include the international firefighter PPE space through the acquisition of Bristol Uniforms. Our market positions reflect a very large installed base. Our strategy has been to seed the market very heavily with MSA hardware and then layer in bolt-on technologies and software solutions. What we're doing with the G1 and LUNAR is a good example of that or the ALTAIR 4XR and Safety io. We've continued to invest about 4% of revenue in R&D, which sustains our market position and very healthy gross margin profile. Moving on to the next slide here and spending a little bit of time on execution. Our value-creation formula or growth algorithm is to drive mid-single-digit revenue growth through organic R&D investments and bolt-on acquisitions. Our continuous improvement culture has been yielding strong results across our business over the last several years. It is particularly evident more recently in our international segment, where we've been executing a margin improvement road map for several years. We've expanded margins 400 basis points in this segment from 2016 to 2020. We aim to grow profitability at a multiple of revenue for MSA as a whole. And over the last several years, we've been successful in doing this and driving an incremental margin profile that is very accretive. We also use our balance sheet as a competitive advantage and deploy capital to drive growth and return value to our shareholders. We closed out Q1 with leverage of less than 1x on a net basis. Growing our business both organically and through acquisitions is our top priority for capital deployment. Our acquisition pipeline is very active, and we are evaluating assets across our core markets, geographies and technologies. We announced the dividend increase earlier this week, which builds on a long legacy of more than 50 years of consecutive increases. So we remain well positioned to continue our balanced approach to capital allocation. Looking more closely at more near-term results in Q -- in 2021 here on the business update. The first quarter revenue certainly was a challenge. January and February started slow. It was a tough quarter. But what was really good to see was our incoming order pace and how it strengthened so well in March and remained into April. Backlog levels are healthy as we start executing throughout the second quarter. Operating cash flow was up tremendously from a year ago, and we deployed $63 million for the acquisition of the U.K. turnout gear company I spoke about previously. We invested almost $10 million for strategic CapEx, most notably around our facility here in Pittsburgh, Pennsylvania, where we're building out our gas detection center of excellence, and we also funded $17 million of dividends to our shareholders. Looking ahead and looking at some of the trends as we move forward, the more recent uptick in order activity provides a sense of optimism and a level of confidence as we start to enter Q2. We think the worst is behind us, but we're also mindful that we're continuing to operate in a very dynamic environment. And probably the one area that presents some of the more significant challenges to many of us were just the overall supply chain challenges that we're all seeing, as we've ramp up, as we turn the light switch back on the economy and ramp up demand levels to where they were back in 2019. We've made adjustments to certain pricing actions, and we're actively evaluating additional actions. We've always been able to pass along our pricing increases. We're not a price-sensitive market. We really focus on providing value and appropriately charging for that value to our customer. We expect to deliver continuous improvements big, too, and we expect to to deliver about $15 million of cost savings in our income statement in 2021. If you have been following us over the last 12-or-so months or even going back longer than that, you'll know we have a constant focus on continuous improvement in restructuring our business and driving towards best-in-class margins, and we continue to do that. We expect annual savings after 2021 of about $20 million associated with the activities we actioned over the last 12 or so months. These actions and savings will help to offset some of the variable costs that will come back in the business as a result of returning to the office and turning the economies back on, but it also help structurally improve our business. And so we think we're excited about some of the programs that we've executed over the last year or so. Finishing here with key messages. Workplace safety is more important than ever. The pandemic really brought -- shined a bright light on safety. And our business is positioned extremely well with a focus on safety to benefit here as we move forward. The uptick in our orders in March and April certainly provides a lot of confidence as we enter Q2. At the same time, it's a dynamic environment, and we're certainly mindful of all the challenges. And the overall algorithm with respect to growth, profitability and cash flow remains unchanged. Our focus is continuing to grow this business, maintain our leadership positions and grow those leadership positions, drive improvements in cash flow, share that cash flow with shareholders, but also reinvest in our business so that we can continue to grow. With that, I'll open it up for any Q&A there might be.

Yes. That was very comprehensive. I guess starting with the downturn and where we just were a few months ago given there's this -- been this value rotation theme playing out in the market, most people would see your performance and Peggy was one of those "COVID winners," but that's really only the air purifier piece of your portfolio. Can you talk about the demand indicators for the bulk of your remaining business and the differentiation between other goods? Or like are you more employment based? Any color there would be great.

Sure, Michael. We did -- as you just indicated, we did benefit from the respirator sales in 2020. But you're exactly right, that's less than 10% of our portfolio. About 1/3 of our business is related to fire service, 1/4 of it is related to energy, and the remainder is really split across a number of end markets from construction to utilities, the general industrial and even the military over in Europe. So it's a very broad, diversified and defensive portfolio. And speaking of defensive, fire service is really probably the most defensive of markets. It really is not attached to an economic cycle. But it's attached to providing firefighters with products they need to continue to do their jobs on a daily basis in a very safe manner. And so fire services has been very defensive through the downturn and has been very resilient through a number of economic cycles. On the industrial side, there are 2 items, 2 major aspects of the portfolio in the industrial. One is employment-related products, like hard hats, portable gas detection and fall protection. The others is FGFD, fixed gas and flame detection, which is more project-based, more asset-intensive, but what I can say is you did see the turn down in a number of industrial businesses last year. However, as we've talked about sometime, we expect that to come back quickly as economies reopen, and that's exactly what we're seeing in March and April. The hard hat portable gas and fall protection business showed very nice growth to finish the first quarter and to start the second quarter. And so we feel pretty good about the position of the portfolio as we start to execute here in 2021.

Great. So stepping back and I look at your model, new product development clearly stands out as a big theme. You also have some large competitors in the space. When you put that amount of R&D to work, what has been the net benefit to share gain, gross margin and product vitality over time?

Sure. I'll start with a focus on product vitality. As I mentioned in my comments earlier, 35% of revenue is generated from products we developed and launched in the last 5 years. So a really strong product vitality, and that's an important metric for us in our business. When we look at share gain, when we think about the share gain that we've had in our business, it's been very meaningful. The one product that comes to mind is the SCBA here in the U.S. We launched the G1 SCBA over 5 years ago. Now we moved from a #2 position to a very strong #1 position here in the U.S., gaining significant amounts of market share through the launch of the G1. And then what we've been able to do with that is continue to introduce new technologies, like LUNAR, bring on new acquisitions, like Globe, and invest in international growth platforms, like the M1 SCBA, and then more recently the Bristol acquisition. So it's really -- it's interesting. We've done a similar thing with fall protection with the launch of the V-SERIES. If you go back pre-pandemic, we were seeing 20-plus percent growth in fall protection, seeing good, strong share gains. And we continue to maintain and its interesting, we looked at that one key metric that we continued to focus on during the pandemic and as we exited 2020, we shared data and what our shared data told us was that we continued to grow our share position despite the challenges associated with COVID. And We exited 2020 with a strong -- probably the strongest share position we have across our portfolio than we've ever had. And so it's great to see that, and that's all enabled by R&D. The last area is margin profile. And generally, when we launch a product, it's accretive to the overall margin profile. And if it's not, we go through value engineering to take out costs to reengineer it to make it more profitable for our business. And so the G1 was a good example of that. When we launched the G1, it actually was dilutive to margins. But as we went through the launch, and as we looked at the device more closely, we were able to take certain things out, do things more efficiently and improve those margins tremendously.

Okay. Great. So engineered efficiencies. So with distribution a large source of your sales, how do you gather voice of the customer? Are you proactively pushing new product or pulling information from the channel for that next commercial-grade idea that fits an existing need?

Voice of the customer is incredibly important to us. And that voice of customer activity is enabled from strong partnerships we have with our distributors and a great deal of direct interaction with the end user customer. We've got a large sales force in addition to selling through channels. Part of that is to be able to have this nice balance between push and pull. And so when we look at the voice of customer work, that voice of customer work is incredibly important to our new product development engine and is a key input to that. And so this combination of push and pull allows for that to occur. We create demand with end users and source that voice of customer feedback from them. And we use distribution -- we use the distribution channels to really expand our reach and go-to-market more efficiently. And so it's a really nice model that we've been following for quite some time and seems to be working well for us.

Got it. So I wanted to switch gears and touch base on ESG. It comes up a lot in general among investors, but your company seems to be embracing it now. Maybe your end markets don't necessarily fit the traditional E component of that given some mining and energy exposure. But can you walk us through how you approach ESG with your business, your markets and your end consumer?

Sure. We -- as I think Elyse had commented on in the presentation, we embrace it. We look at ESG both from an external and an internal standpoint. Externally for MSA, our mission and the overall product development process serves a critical ESG function because our products protect the lives of millions of workers each and every day. We help our customers achieve their safety goals in the most productive manner or the most efficient manner possible. Internally, ESG is incredibly important to us, and we approach it through a continuous improvement lens. When we think about ESG, we think about what's material to our business and what's material to the world with respect to our business. And so it's a really nice balance between the external, internal focus. One of the key supporting pillars that enables our ESG mission is attracting and retaining talent. I mean we invest in development throughout -- through tuition reimbursement, leadership development programs and other benefits. Our culture has also certainly been a differentiator for us here. Our people have executed well despite hurdles that we've all faced. And that's a good example of how we focus our ESG has -- and how it has contributed to being a better business and better business outcomes.

Great. So LUNAR came up earlier, and I was wondering how do you view the connected worker. IoT seems like it a differentiator for you guys. Looking at these technologies, can you talk about pricing product and service strategy? Is this something that's bundled and gives you a chance to win more business with other equipment as customers upgrade or retrofit? Or is this something more standalone?

Sure. MSA has taken -- historically has taken a hardware approach to the business where we've launched portable gas detectors, we've launched SCBAs and the like. But as we think about how we pivot into the future, we've started to launch more software-oriented products, which allow or -- that afford the opportunity to create a more recurring revenue model. And so as we think about LUNAR, as we think about some of the work we're doing with Safety io in the portable gas detection area, we're really seeing a step towards a potential for bundling certain contracts. So we might sell hardware, have an embedded software incorporated in that hardware, which we can charge for over an extended period of time. And so we're taking a closer look at that. Today, that's a very small part of the portfolio. But as we go forward, it's a really big area of focus and opportunity for us. We have such a large installed base that uses our products each and every day. We're trying to understand how we might provide a recurring service associated with those products that our customers would benefit from. And so we have a number of initiatives that are aimed towards that. And we think that we'll be making -- we expect to make more progress in that area as we go forward.

Certainly, yes. Installed base is a topic that comes up a lot in my industrial coverage. So do you have a sense of kind of this branch out IoT, what that does for your TAM? How it varies across certain geographies where you share higher or maybe lower and you have some more runway?

Yes. It's interesting. We think there's runway across all the geographies with respect to the total addressable market from the U.S. to Europe to the strategic emerging markets, like China, Latin America and the Middle East. It's in terms of identifying intersections where the TAM is largest and our share is smallest. There are a few that really stand out from a geographic product and market standpoint. The first is the emerging markets that I just mentioned. Typically, these markets grow at a faster clip in our share opportunity is largest there. The opportunity in that area is more around -- at least our view is it's not as much focused on the connectivity at this point, but it's more around the hardware. It's more around seeding the market and really play creating that installed base with our hardware. From a product standpoint, fall protection has a $2 billion market size, and we're #3 player globally and gaining as we execute. From a market standpoint, the IoT market is, as I said earlier, at a very early stage of adoption but -- and we're on the ground floor, and we see opportunities there. I talked earlier about emerging markets. I think the biggest opportunity in the near term is in areas like the United States where you're seeing people lean into those technologies. And we feel like, based upon our market position especially in the U.S., we're positioned extremely well to benefit over time. We've also focused on expanding this TAM and the total addressable market. The Bristol acquisition helped us do that in the international turnout gear market. The Globe acquisition certainly helped us do that. Latchways acquisition a few short years ago helped us do that and then going clear back to General Monitors. And so we have a focus on continuing to expand that addressable market opportunity for us, and we're excited about the opportunities that we have to do that.

Certainly. So keeping with that theme of the acquisitive side of the equation, you've added a couple of bolt-ons you just alluded to. 2015, '17, it looks like some pretty big years in terms of cash outlays. Your balance sheet is certainly at an attractive place. What does the acquisition playbook look like for you? Do you have a product-first mindset? Or maybe how much variation is there in your integration for something newer and more greenfield versus something that's a product line expansion?

We evaluate -- and I mentioned just on the conference call last week. We evaluate assets across core markets, core geographies and core technologies or even new and innovative technologies. Many of our growth investments that we've made really check a number of these boxes. It's not just a geography or a market, but it really cuts across all 3 of these major areas. Bristol was a good example of that. It gave us an opportunity to expand into the U.K. fire service. The fire service is a core market. U.K. is a core geography. And so you could see how it cuts across. And CRM monitors was similar. It provided core technologies that accelerates our connected worker efforts. We've done some of our best acquisitions as we've come out of recession. If you go back to General Monitors, that was a really good example of how we used our balance sheet to grow our business and to invest in geographies like the Middle East. The General Monitors acquisition gave us an opportunity to expand into the Middle East, especially in that oil and gas area. It gave us some new technologies, which were very appealing as well. And so it was a really great acquisition for us. And our balance sheet is in great shape today, just like it was back then. We're certainly a lot larger today than we were then. And so we're well positioned to use the balance balance sheet for the right opportunity, and the right opportunity is something I think that's around our core space. It's around our core competencies. And so we're looking at how we can leverage those core competencies going forward. The integration playbook, as we pivot into the integration inside, it varies based on the specific acquisition, whether it's greenfield or product-line expansions, whether there's common enterprise-wide systems, ERP systems, the general size of the acquired organization and the like. So it really changes. But what we do is we use the -- an integration champion as part of that effort and that's worked well for us. We've been able to hit or exceed many of all -- many, if not all, of our targets around our acquisitions. So we feel like we've got a good approach on that side.

Yes. On the costs front, are -- do you use technology in any way to predict supplier price increases or protect hardware margins? Thinking how much sourcing and pricing do you push down in a centralized versus decentralized model? And what metrics are you honing in on in terms of like commons part percentage, low-cost [indiscernible], PPV, anything like that?

It's really -- there's not one metric or one process or one focus area that we execute. We -- when we think about pricing, we think about managing our margins. It's all about looking at the value that our products provide our customers and making sure that we're appropriately charging for the value that we're providing to our customers. We also look at macroeconomic factors, and that informs our decision as well on prices. And when we would raise a price, when we would not raise prices. Tariffs were a great example of how we applied macroeconomic or macro level data. It informed our decision to raise prices. You go back, when we saw tariffs ramping, we had a price increase, and we introduced an off-cycle price increase. And so we were -- and that stuck in the market. So we were very proactive at managing that. So we continue -- every month, our marketing and pricing groups are looking at our positions in our markets. They're looking at our -- the products we're providing. They're using a number of different technologies. We continue to make strong investments in our marketing functions and our pricing functions because when we started this, we saw a great opportunity. And I think that you're seeing that benefit come into our portfolio. Some of it's masked over the last year or so because of the pandemic-related issues and the volume issues yet to have and how that impacts your overall gross margin profile from just some inefficiencies in the plants. But we're seeing good improvement, good take on the pricing side, and we feel like we can continue -- we're positioned well to continue to navigate the supply chain challenges and inflationary pressures that we're all seeing and talking about.

Great. So I believe that is all the time we have. I'd like to thank the MSA team, Ken and Elyse, and their investors on the line.

Thank you. I appreciate it. No it's great to be with you, Michael, and great to be at the conference today. Thanks for having us. We really appreciate being able to participate.

Very welcome.