MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good morning, and welcome to the session for MSA Safety, and welcome to the first day of the Baird Industrial Conference. I'm Rob Mason, Senior Equity Research Analyst at Baird covering the Advanced Industrial Equipment Sector. MSA Safety is the leading provider and pure-play safety provider of sophisticated safety equipment and products globally. The company targets high end personal protection application in 6 core product areas in which it has leading market shares. In its markets, it has earned tremendous brand loyalty from its customers, safety regulations in developed countries are driving demand, while continued industrialization in developing regions offer MSA significant growth runway. So with us this morning, to tell us more about MSA, we have Nish Vartanian, who's Chairman, President and CEO; Ken Krause, CFO and Treasurer; and Chris Hepler, who overseas IR. So I think, gentlemen, Good morning.

Good morning, Rob.

Run through just a few slides, brief overview, and then we will take your questions. And just as a reminder, make sure you submit those questions through the portal, and I will weave those into the conversation. So with that, I will hand it off to Ken. You're going to take this?

I'll kick it off, Rob.

Okay.

Yes.

Great.

Rob, thank you so much, and thanks, everybody, for your interest in MSA. Just a quick reminder on safe harbor. I won't take time to read through this, but just want to make a reminder of this. So just to cover MSA and a quick overview on MSA is that we're a 107-year-old manufacturer. So we design, develop, manufacture safety equipment to protect people, critical infrastructure and the environment. Our mission that men and women may work in safety and that they, their families, and communities live in health throughout the world, that mission has been unchanged for over 107 years. When you think about our mission, today, it ties together with ESG better than ever. Protecting people's lives is really an ESG play, so to speak. We published an ESG report on an annual basis. We just recently published our second one and we're really proud about the progress that we've made around ESG. We continue to focus on areas of opportunity. Quite frankly, we look at ESG as an opportunity to make ourselves better as an organization. When you look at some of our diversity metrics and what we do as an organization, we certainly help ourselves by improving what we do around ESG. We focus on our mission in attracting, retaining and developing a workforce that's highly engaged. In fact, we measure our engagement on an annual basis and then we also are recognized for the work that we do around employee engagement and retention with some awards, that we have won several awards over the last couple of years. Most recently, we were recognized as a top employer for Western Pennsylvania by the Pittsburgh Post-Gazette. And we're really proud of that award because that award is -- as a result of our employees' input in some questions that the Pittsburgh Post-Gazette had. And one particular area that we're really proud of is the fact that our employees rated us #1 for a company that's open to new ideas. And it's something that we really encourage in the organization to get our workforce to participate in coming up with new ideas, new solutions and solutions for our customers. So we leverage that mission that we have in a very strong way to build out the organization. While we're dedicated safety and kind of a single play around safety technology, our business is really diversified by geography, by market and by product. So when you think about the diversity by geography, now the Americas, both North and South America represent about 66% of our business, about 2/3 of the business and 1/3 of the business is the balance of international. When you peel out everything outside of the U.S., the U.S. represents about 55% of the business. So we have a good geographical diversity in the business. And then when you look at the market segments that we represent, the fire service represents over 35% of the business. What we define as PPE industrial type business, personal protective equipment, protecting workers, that represents over 30% of the business. And then the fixed gas and flame detection business is a little over 20% of the business. It's a really resilient business model. We have some real strength in our balance sheet that allows for a balanced approach and capital deployment. We've paid an increasing dividend for over 50 years. We invest both from an organic standpoint and new product development, about 4.2% or 3% of our revenue on an ongoing basis, to develop new products. In fact, our product vitality metric runs around 35%. Those new products we bring to market provide greater solutions for some of our customers' most difficult problems. And typically, those products have higher-margin profile and continue to help us strengthen our position in the marketplace. Then we also allocate our -- some of our balance sheet to inorganic growth. We have a really strong track record around inorganic growth and deployment of that capital, the most recent acquisition was for Bacharach, which was really more of an environmental play. It's in that sweet spot of gas detection products that we know so well but it's really around the area of environmental protection when it comes to refrigerants or ammonia or some other hazards that we are pretty knowledgeable around the development of product in that area. So we're focused today from an organic standpoint on leveraging technology defined solutions for our customers greatest challenges and provide our customers with higher levels of protection and efficiency. So when you think of workforces trying to automate more and do more with less workers, some of the products that we have introduced have really helped our customers work through some of that. We can talk about that a bit more on the next slide, Chris. So on the left side of the slide, when you deliver our business, those are the 3 key areas, firefighter safety. So think of a firefighter from head to toe protection, fire helmet, turnout gear, the self-contained breeding apparatus, and of course, gas detection and a new product that we introduced called LUNAR. LUNAR is a connected device that allows for a firefighter thermal imaging camera, location via GPS and then accountability from firefighter to firefighter. And so that's a new technology that we introduced to continue to help fire departments with firefighter accountability. And as I mentioned earlier, that represents a little over 35% of our business and that business is really funded by municipal or federal funding, which is a real stable business. So that brings some real balance to our portfolio. A year ago, when we saw some of the markets around PPE industrial business drop off of the employment levels, that fire service business really remained stable for us. The funding remains very stable and bio departments continue to purchase those critical products to protect firefighters, not just here in the U.S. but around the world. Then the second part of the business is that industrial personal protective equipment products. That's where you get to our portable gas detection, industrial head protection and fall protection, which are our main products in those areas, which, again, like the fire service, those products were either #1 or #2 in the world and market position. And really, that -- those products are tied to headcount. When you think of infrastructure build in the U.S., you can't build anything without hard hats fall protection and of course, portable gas detection to go into those compliance spaces. Those products are used in a broad range of environments to protect workers from general construction type business or oil and gas industry, the heavy industrial type work. And then the last area is fixed gas and flame detection. That's -- those gas detection products that are installed and built into a larger infrastructure within facilities to look for, sell for, listen for gas leaks or fire, and that protects critical infrastructure and the environment. And that's another very attractive area of our business that, again, is -- it runs on a business cycle from the PPE industrial or the fire service business. So it provides a little more diversity in the business. And that part of business is where our Bacharach business fits in from an organic standpoint. So with that, I'll flip things over to Ken Krause, our CFO, who will take a look at a business update, looking ahead for the business. Ken?

Good morning, everyone. It's great to be with you yet again to discuss MSA Safety and as Nish had pointed out, the business remains very diversified and very resilient. Looking at the business update, we continue to see good strength across our core product portfolio. The demand is very much intact. We're seeing double-digit growth year-over-year, but also doing -- comparing ourselves back to 2019 through the first 40 or so business case here in the fourth quarter. So we're continuing to see good growth, good order growth. The challenge, of course, is with the supply chain. It hasn't gotten any better in the last week or so since we last spoke to you. And as we had mentioned on our call, we expect those supply chain headwinds to persist into 2022. With that, we continue to execute successfully with pricing initiatives, and we're seeing really nice improvement in pricing, and we're successfully executing on that price cost equation as you saw in our third quarter results. Albeit it continues to be a very challenging environment. Cash flow remains very much a focus for us, and we continue to generate significant amount of improvement in cash flow, allowing us to continue to invest in a number of new and exciting areas for the business. As we look ahead, we expect robust demand to continue into '22. We are currently carrying a very elevated backlog. Going back to a comparison to 2019, backlog is up almost $100 million versus that period now. When we reported on the call, it was up considerably and it continues to grow as we see demand improving, but also continuing to face some of the supply chain challenges that we're facing. When we think about our margin profile, we continue to target 30% to 40% incremental margins as we think about '22. And we have a laser focus on cash flow conversion at or above 100%. It's good to see at those levels in 2021 despite the growth, we continue to see nice improvements in cash flow, notably within our receivables portfolio. And our capital allocation priorities remain unchanged. We continue to focus on a combination of growth and returning capital to our shareholders. So with that, I'll turn it back over to Rob for any questions that we might want to walk through.

Yes. Thanks, Ken. And again, if you have any questions, submit those, and we'll try to work those into the conversation. Ken, just maybe -- I'll go real quickly just to the fourth quarter outlook. You've indicated some confidence that we'll see a little bit of lift in revenue, some of that seasonality, maybe some of that's your supply chain as well permitting that. But to the extent that sales can be up about 10% sequentially is what you've communicated, how should we think about that though as we move into 2022? Just with respect to seasonality and elevated backlog that you're carrying as well as the very strong demand. Should we think that there is more of a normal seasonal pattern that emerges? Or would the elevated backlog and trying to work that down, I suppose, supply chain permitting. Would that -- I guess what I'm getting at is 375-ish kind of the fourth quarter, that would be the 10% increase. Is that a jumping off point as we go into the first quarter?

Yes. It's a great question, Rob. And as we had talked in our earnings call, we still do expect about a 10% lift into Q4 versus Q3. We're not seeing supply chain challenges abate at this point, so it's really hard to provide a forecast for Q1 or the first half of next year. But we do expect to carry an elevated level of backlog into '22. And if we do see those supply chain challenges abate a bit here in the first quarter, we certainly would expect to see some nice year-over-year growth. Because as you recall, in Q1 a year ago, we did see some significant challenges prior to the vaccine rollout, prior to the effective rollout here in the U.S. The business was a bit challenged in Q1. And so we are hopeful that we'll see some nice growth as we go forward. We certainly are carrying the business. We're carrying the backlog, and we're seeing a robust uptick and order pace and demand patterns, presenting themselves to us as we execute through the fourth quarter.

Okay. And if I -- you referenced the comparisons, maybe the year-over-year comparisons can be a bit distorted just the way last year played out. But relative to 2019 being up as you are, does that include acquisitions? Or is that on an organic basis?

Yes. It includes acquisitions. However, the organic business is certainly doing very well versus 2019, and we're seeing some nice elevated levels of demand versus the 2019 level that we saw in the business. So the business is certainly different today with the Bacharach and the Bristol acquisitions, but the organic business, the hard hat business, for example, is doing exceptionally well. The SCBA business continues to see good demand levels as well, and our higher service positions have never been stronger. So it's a pretty healthy demand environment right now and a pretty strong position we have in the markets where we're competing.

You've had to be more aggressive on pricing, just given the backdrop. That doesn't always necessarily sync up perfectly with cost. But where do you think you'll end the year in terms of price realization? And what does that portend for next year, just what you'll carry into next year and does it -- to extend that question, does the current inflationary environment trends that you're seeing suggest you'll need to increase prices further next year.

Yes. It's -- when we look at the business here in the third quarter, for example, when we look at our core business, the core business is probably the best place to look at our price realization. But the core business on an organic basis year-over-year grew at about 9%. And what we have talked about was about a 5% price realization coming through the business in the third quarter. So we would expect us to continue to see price realization in those ranges. And it might even accelerate depending on what we see with inflation because if we continue to see the inflation challenges that we're all seeing, we are certainly going to be very proactive and introducing more price increases as we move forward. When we reflect on 2021, Rob, and we look at the areas where we've seen the most amount of price increase, it's been in the Americas, it's been in the U.S. But we've started to ramp up some of our focus in our international segments, especially in Europe. And so we're looking at those markets a little bit closer. That might present a bit of a tailwind as we go into '22 with respect to pricing. But we remain very proactive and very disciplined when it comes to price increases, not only price increases as we look across the portfolio, but managing those special price changes and SCRs, we call them here at MSA, a one off-price adjustments and things like that. We're very disciplined when we see those come across, especially considering all the inflation that we continue to experience in our supply chains.

Yes. Yes. And that's a good segue. I was going to see Nish or Ken, if you could just take us around the world just a bit because North America has been strong, maybe perhaps stronger than international, but I'm just curious if you're starting to see that international part of your business trend better as we go through the end of the year and into next year.

So all of the Americas have been very strong. So when you look at the business, both North and South America, the business has been robust. Our vaccination rates are really high, down through Latin America, and they've done a nice job in that area. And apparently, our customers have and those economies have held up quite well. So the business remains strong throughout the Americas, really -- real good demand for our product. Internationally, it's been really choppy. It's been a matter of COVID and Variant popping up in different parts of the world, that have not only impacted supply chain or product to us, but also our end-user markets in some of those areas. So we have seen some choppy business. We do see signs of that improving in some of those core product areas, the leading products that we see as employees come back to work. We're starting to see some improvement in those areas, and we hope that continues. But I think that's just going to be a matter of COVID and now seeing that winter spike up, so to speak, and COVID, hopefully, the numbers continue to trend down, and we'll see the business come back along with that. So we're encouraged by that as we go forward.

Since it's very near-term and topical, and I think you referenced it, how do you see the opportunities around the infrastructure bill that was recently passed in the U.S. impacting you? Presumably, that would be most directly in your headcount-oriented businesses. And maybe relatively, do you have any view just on how employment levels currently are? Where they could trend? It seems we are labor constrained, what is the opportunity for those parts of your business to increase over the next year?

Well, we don't have a final point on what's going to happen to the employment projection around infrastructure build and construction and from that whole piece. But suffice to say that you can't build anything without hard hats, fall protection and really portable gas detection fits in those areas. So we certainly expect to see good demand for those products as money spent on roadway, construction, bridges, other infrastructure type build. We do think we'll also see some uplift with fixed gas and flame detection. Some of that infrastructure is critical infrastructure, such as possibly pipelines, upgrading pipelines, greater protection around pipelines. So certainly, there's a lot of fixed gas and flame detection use in those areas. So we have some nice opportunity there. And President Biden is always -- and I've mentioned this in the past, he's a strong proponent of the fire service. The assistance of firefighter grants, he has been a strong advocate around that. In fact, he kicked off his presidential campaign here in Pittsburgh with local Union #1 of the local fire station here. So he's had a tight relationship with fire service. And I would imagine at the fire service, we'll continue to see some nice funding come through from the federal levels. So we're somewhat encouraged by that as we go forward.

Good. Nish, that plays into the next question that I had as well as just the industrial and maybe the headcount to the extent we have headcount constraints, companies need to be more productive. Your connected products that you've introduced over this year in a couple of areas are servicing now with MSA+. Does the MSA -- I'll start there because that's maybe the newer one that you just recently released. Does that -- I've kind of seen that's where you wanted ahead for some time with this MSA+ in the gas detection arena. But just maybe speak to the -- how you see that product being rolled out, the uptake. I'm not sure what the sales cycle necessarily looks like but how that could change the dynamic for you in gas detection.

Yes. We've really been focused on this. One of the key comments that we hear from customers is the labor intensity around gas detection. Some of the key areas that you have to focus on a gas detection is continuous calibration, make sure that the sensors are responding properly, the alarms go off at the appropriate time. Historically, that's always been somewhat labor-intensive or an individual would have to calibrate each instrument that they have 4 or 5 portable gas detectors and a facility. You have to go through and manually calibrate those devices on a regular basis. So several years ago, we started to build our sensors so that they would be more stable under life, reduced calibration times in between usage and so that was one step. And then the next step, which we've introduced here with some recent products and specifically around the io4 and the MSA+ program is when a worker takes a device for use during the day, there is no longer documentation, paper documentation to fill out in forms that allow to do this. It is full device out of the calibration module. Tap it to their badge, now that unit is a sign to that worker and all the documentation around that device is uploaded through the cloud, so they have continuous monitoring. Then at the end of the day, when a worker puts the device back into its station, it now self-calibrates, and we can also push any software updates to that device, just as you would to your iPhone or update an app on your phone. So this is really been well received by customers who have seen this because they see the reduced labor time that they have connected to each device that's on their worksite. So it really hits the heart of that making their employees more efficient and also raising levels of protection to ensure that all of the information that that gas detector sees is uploaded to the cloud. So think of it like a black box on the fire in an airplane, all that information is maintained. So that's something we've been working on for a period of time. And obviously, with the type of labor constraints, that certainly helps our customers. We introduced that product at the Safety Congress here a month ago and we'll start to see those get into the marketplace in early '22. So we see the uptake of that product being fairly strong through '22 and certainly into '23 as we go forward. We're excited about that product and some of the other offerings we have around the connected work platform.

Okay. That's great. And just to circle back to your commentary around the fire service business. Certainly, it seems like it has been strong domestically, remains strong, and I think your backlog is high there. What are the prospects for -- as you go into '22 around fire service? And maybe I'm speaking more internationally. Does that start to look a little bit better coming out of October?

Yes, we're really excited about that. When you look at the pipeline for business on an international basis, the business is really healthy. So we have a pretty good view of the pipeline of business and opportunities that we have around the world. So we're optimistic about that business as we go forward. Bristol certainly presents us with some nice opportunity to take a really strong line of turnout here and move that through our channels of distribution on a global basis and really leverage our channels of distribution around the world. So we think there's some nice opportunity around Bristol with some growth there at the top line and then breathing apparatus and continuing to see that business strength around the world.

How is the margin profile of Bristol trended since it's been under your umbrella for a bit now?

Yes. Sure. The Bristol margin profile has certainly been an area of focus for us, Rob. It's still not at the level that we would like it to be. But I think Bob and the team have a really nice plan that they're executing on to make that business a much more profitable business as we go into '22. But it has been a bit of a headwind on our margins, especially in the international segment. But the plan that Bob and the team have and they actually just -- we just discussed it last week. It provides us a sense of confidence that that business will recover and start to see some improvements as we execute on the integration plan that he has for the business.

And you had referenced in your earlier comments around the outlook, the 30% to 40% incremental margin objective. You think that can hold in 2022, just given all the dynamics that you may have -- will see with inflation. But your ability to get price as well. It looks like maybe you're getting perhaps an extra or another $5 million or so of savings out of your restructuring or potentially so. Is that fair?

Yes. When we look at that incremental margin profile for '22, Rob, we certainly expect to see some improvements from where we are this year. We had a number of headwinds coming back into the business with respect to variable compensation resets and other things that we just didn't do in 2020 because of the pandemic, but we're starting to see those things start to open up. So we saw a bit of a headwind here in 2021. As we look at '22, we do expect that business to get back to that more historical level of profitability that we've enjoyed. And as we move forward, there's certainly a lot of variables when we think about pricing and inflation and supply chain challenges. But we think the plan that we're putting together right now for next year provides a bit of a nice road map to get us back to those incremental -- the incremental margin profile that we've enjoyed over time. And so stay tuned on that, but we feel like the restructuring investments are paying off. Our focus on pricing, the volume that we're seeing and the improvements in volume that we expect to see should all provide a nice tailwind to the incremental margin profile.

We're almost out of time, but maybe get 2 quick ones in here. Just real quickly around your comfort on the balance sheet, maybe what the M&A pipeline looks like. You've had an active year this year, but are you -- I know you always want to stay active, but is there anything percolating in the pipeline that could be near-term?

We continue to look at that pipeline, Rob. Chris is doing a fantastic job from an M&A standpoint to really built out a nice pipeline of potential opportunities, and we continue to manage that pipeline. With that said, I think 2021 was a successful year for us, where it gave us the opportunity to make some significant investments in the business that will benefit us for years to come. With that, we continue to look at opportunities but our focus right now, at least for the next quarter or 2 is probably on integrating these acquisitions that we've been successful with this year. With that, we certainly are not out of the market when it comes to M&A, and we'll continue to look at new opportunities, but we are really focused on making these businesses better than we just bought in 2021.

I'll hit this one last question that came in via e-mail. It just noted there was a new disclosure in your 10-Q on the product liability side. Just what triggered the disclosure itself, is the nature of the question.

The disclosure, are we speaking to the accrual that we had in Q3?

Yes. In Q3 around the PFAS mentioned as well as your ability to get insurance, I think there as well.

Yes. As you look at all of our toward exposures and all of our liability exposures, the areas continue to evolve and continue to change. And so what we try to do with all of our disclosures like we have over a long period of time is of all those disclosures as facts and circumstances change. It's a major risk area for us, and that's why we devote a significant amount of our 10-K and 10-Q to the risks associated with product liability. And we will continue to evolve those disclosures and adjust our roles as facts and circumstances change. And so really, that's what led to the disclosures and how we continue to evolve those disclosures. It's just facts and circumstances change on an ongoing basis, and we want to make sure those disclosures are reflective of those changes in facts and circumstances.

Perfect. We'll need to leave it there. We're out of time. So it sounds like things are looking quite strong as we -- from the demand side as we head to the end of the year.

True. Sure are. Yes. It's -- we're looking forward to finishing strongly, Rob, but we also are hopeful that these supply chain challenges will start to abate as we go into '22. We're hopeful. We're not confident that they will change, but we are certainly hopeful that we'll see some improvement there.

Absolutely. Well, thanks again, gentlemen.

Thank you.

Take care. Bye.