MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the CJS Securities 22nd Annual Winter Conference. I'm Stefanos Crist, research analyst with CJS Securities. Our next presentation today is with MSA Safety. It is my pleasure to introduce Ken Krause, Chief Financial Officer; and Chris Hepler, Executive Director of Corporate Development and Investor Relations. We'll start today with some high-level comments from the company. Following that, I'll host a Q&A session. [Operator Instructions] With that, Ken, thank you for taking the time to join us today.

Well, it's great to be here, Stef, and I'll turn it to Chris. He can walk through the first couple of slides, and then I'll speak at a high level about the company and some of our market position.

Thanks, Ken. I just wanted to introduce today. My name is Chris Hepler. I'm the Executive Director of Corporate Development and Investor Relations. I want to start here with the safe harbor. We may make forward-looking statements today and present non-GAAP measures. You can refer to our website at investors.msasafety.com for a reconciliation of the non-GAAP measures and also refer to our Form 10-K for risk factors related to our business. With that, I'll turn it over to Ken to kick off with an overview of our company.

Great. Thanks, Chris, and good morning everyone. Great to be back at the CJS Conference, albeit for the second year in a row virtually. Hopefully, that will change as we go into next year, and we see improvements. But nonetheless, it is really good to be back at the conference and to speak about the company. I'll walk through some high-level slides and provide some high-level observations before we turn it over to Q&A. We, at MSA, are focused on safety. Our mission has not changed in over 100 years, and that mission that men and women may work in safety and the day, their families and their communities may live in health throughout the world has never been any more important than it is today in today's socially responsible world. We are very much global in nature with roughly 1/3 of our business in our International segment, but over 60% or so of our business outside of the borders of the United States. We are a leader in just about every one of our markets that we participate, and the portfolio is very much not only globally diversified, but it's diversified by end markets and product areas. We focus on 3 broad areas: industrial safety, fire safety and protecting infrastructures with the use of our fixed gas and flame detection instruments. As we look a little bit closer at the portfolio, we do have, as I said previously, leading positions in many of our markets. We have continued to see strengthening in those market positions as we navigated the challenges of the pandemic and the recession early on associated with the pandemic. Those market-leading positions have only gotten stronger and have been enabled through a combination of investments in R&D and organic investments. Acquisitions. This past year in 2021, we made acquisitions in excess of $400 million. And also partnerships, partnerships that are really important with leading technologies and technologies that help enable our portfolio and ensure that we are going to where the [ puck ] is ultimately going. And so we continue to make investments across the spectrum. A brief business update. We continue to see very strong growth across our core product portfolio. Customer demand is very much intact with robust order pace. We are working through elevated backlog that has been driven by the demand I just spoke about, but also supply chain challenges that just about all of us are dealing with in today's market. We, as we reported in Q3 and continued to execute in Q4, are successfully executing on the price/cost equation. We are able to effectively introduce additional price increases as we see inflation increasing, and cash flow generation has been strong and has enabled us to really invest in our portfolio. We're in the process of finalizing the fourth quarter results. I'm not going to spend a lot of time on the fourth quarter. We'll talk about that in a month or so when we have our call, but I can tell you, demand has been very strong. Demand is intact, and the business is doing pretty well. We're also looking at, as we do this time every year, our annual product liability assessment, and we're working through that. We'll be providing an update on that area. Also, when we announced our results in February for the fourth quarter and the full year of 2021. But looking ahead, our intent here and our focus is really operational excellence and not only operational excellence, but driving growth. From an operational excellence perspective, that incremental margin profile that we have enjoyed for some time now is really our focus. That 30% to 40% incremental margin profile is certainly within reach and is very much achievable. We think this business should be a business that generates 20% operating margins. It should be a business that generates 30% to 40% incremental margins and also generate cash flow conversion in excess of 100%. Our capital allocation priorities very much are unchanged, and we intend to continue to deploy our balance sheet with a balance of and focus across the spectrum of growth and returning capital to shareholders. I'll open it up now, Stef, for any questions you might have. We might want to walk through with respect to our company and our mission and the longer-term outlook.

That's great, Ken. [Operator Instructions] I just want to start, I think, with COVID. Can you maybe -- for those unfamiliar, can you walk us through how COVID has impacted the business, steps you've taken to come back over the last 2 years?

Yes, sure. We, like everybody else, have been impacted by COVID. And first and foremost, I just want to start with our employee base. Our employee base is incredibly important to us at MSA. And we took steps early on to ensure that we had a safe environment for our employees. And we've been able to provide a very safe environment in an environment that allowed our employees to continue to come to work on the factory floor to provide their essential services for our customer base. So I want to say thank you to our employees, and I also just want to emphasize all the work we did with respect to our employees early on and continuing as we battle the Omicron variant, and others are battling that. We continue to remain focused on providing our employees with a safe environment to go to work. From a portfolio perspective, we've continued to invest in our portfolio. We've made significant acquisitions through the pandemic. The Bacharach acquisition preceded by the Bristol acquisition last year about the same time. So we've continued to invest. And the portfolio, I think, and as I said earlier, has been -- has remained very strong. Our market positions have remained very strong as we've invested in our portfolio. Not only have we invested in the product portfolio, but we've also invested in new and innovative ways to engage with our customer base. Digital marketing was a really important part of our strategy going into the pandemic, and thankfully, it was because we've been able to leverage all of those investments that we've made over the last several years to ensure that we stay in front of customers and stay relevant and help us be effective in introducing new and innovative technologies to our customers. And so those are a few highlights, a few touch points. Anything else, I'll let you go into more detail on any one of those areas, but that's a general high-level summary of how we've navigated this pandemic.

No, that's great. Maybe if you can give us a little more detail on what you've seen in labor, in particular, wages and then also turnover.

Yes. Labor is definitely a challenging area. When I think about the labor front, I step back and I look at the supply chain front. Supply chains have been constrained, and it's been a challenge here for the better part of 2021. And we expect that these supply chain challenges to persist here into 2021 (sic) [ 2022]. Hopefully, we will see some improvement, and we are seeing some light at the end of the tunnel that provide some indications of improvement, but nonetheless, it is a very challenging environment. From a labor perspective, we have some labor constraints in certain areas of our business. I would not classify it as overly material to our overall business at this point. We're taking very proactive steps with respect to inflation and merit and compensation, and we're really taking a very creative and close look and how we can provide not only employees with compensation that's competitive, but also a workplace that provides a high level of engagement. We're happy to say, during the course of the last year, we were recognized on a number of fronts for the workplace that we provide our employees to come to work each and every day with awards that recognize the engagement level of those associates throughout our business. And so we really feel like we're navigating it well. We're not unscaled by any stretch. We're like a lot of folks out there that deal with these issues. But I want to classify the nature by which we are dealing with them is being very successful. I mean we do see some turnover, but it wouldn't be -- I wouldn't classify it as abnormally high, and we continue to take steps to mitigate those exposures as we move into 2022.

Got it. And I think this last one on COVID. Have you seen any impact from the recent Omicron variant that investors should think about?

There's nothing. I don't think that we would want to raise to the investors' attention at this point on Omicron. We just -- we're trying to be very flexible when it comes to managing through the Omicron variant, being smart as well. I think it's something that we're all dealing with not only in our professional lives, but our personal lives as well. So I don't think there's anything at this point though that I'd want to call out for investors with respect to Omicron.

Great. So maybe just high-level overview. Can you just talk about MSA's primary competitive advantage and also just the barriers to entry across its different end markets?

Yes. Sure, Stef. That starts really with our mission. As I mentioned in the prepared commentary, our mission has been our foundation for over 100 years. Safety is all we do. It's where all of our energy, quite frankly, is placed. And that creates a unique bond with our customers and allows us to remain agile and very much innovative on the R&D front, developing technologies that specifically address our customers' safety needs. We lead on developing best-in-class technology solutions for the industry and that's something we're very proud of. We invest over 4% of sales in R&D to develop innovative technologies for our customers. I really feel that when we think about the future of MSA, it's about being a safety technology leader. We talked about that in the fall of 2019 at our last face-to-face Investor Day, and it very much remains a focus for us as we executed through the pandemic and hopefully are coming out of that situation. We have a passionate team of over 5,200 associates that work every day to carry out our mission. Across our functions and locations, our associates really deeply care about our mission of protecting workers and getting them home safely. The employee passion engagement is really a true differentiator in our business. And we've built leading market positions, as I said earlier, with significant IP and strong brand equity across our portfolio. Safety is a highly regulated industry that creates natural barriers to entry. We compete on technology features, comfort, delivery, brand equity and total cost of ownership. And as a result, that has enabled us to really maintain our gross margins through this pandemic. It allows us to pass along price. We're allowed to price -- allows us to price that value into our product offering.

No, that's great. Just a little more detail on your end markets. Can you just discuss recent trends across those fire safety, industrial, energy?

Yes, sure. As I said in the prepared commentary, business has been pretty healthy. When I look at the specific trends in each of those end markets, we're really seeing healthy demand across the portfolio. Our strong brand, as I mentioned earlier, the innovation, it really is driven -- it's a differentiator for us in our markets. Recent trends in our order books are very encouraging, and we're pleased to see macro indicators improving a bit in many of our end markets, which positions us well as we head into 2022. Across these end markets, a focus on the connected worker continues to gain momentum. It's an area that we've been excited about for a while, and we've talked about very openly on past investor calls and past investor interactions. We've introduced a number of different new-to-world technologies over the last year, and we're really excited about it. The LUNAR technology, the ALTAIR io4, just a couple to name a few. Despite the healthy demand across our portfolio, the near-term outlook is not without its challenges due to the ongoing pandemic, the availability of electronic components and inflation. The key variable for us right now, Stef, is really the supply chain. We're in a really strong position. We have a healthy order backlog and demand, and we have the product innovation, and we're confident in our ability to realize savings from restructuring programs and pass along price increases. So we feel positioned pretty well. Demand is very much intact. We're doing a really good job on the inflationary perspective and passing along price and engaging and interacting with our customer base.

Great. And I do want to touch on the backlog you just mentioned. It remains elevated due to strong demand, but also supply chain challenges. So can you discuss what's going on there? And any realistic time frame to work through your orders and reach a normalized backlog level?

Yes. It's an interesting area that we continue to analyze and many are dealing with. I look at it from 2 perspectives: One is demand, and two is just supply chain. As I said earlier, demand is very much intact and that demand is really driving the backlog up. The supply chain challenges are certainly there. If those weren't there, I think that we would be in a very good position. We, quite frankly, are in a very good position, but the demand is intact. The supply chain challenges are really focused in on the fixed gas and flame detection, the electronic components that might be going into SCBAs. Those sorts of areas are really where we're seeing the most amount of supply chain challenges. We're not seeing supply chain challenges abate meaningfully at this point, but we are navigating through it. We're finishing the -- we hope to finish the year here pretty healthy. It's really hard to forecast when they'll improve, but we're hopeful that they'll improve as we move throughout the first half of the year. We do expect to continue to carry an elevated backlog as we start the 2022, but we're hopeful that those supply chain challenges will abate as we move throughout the first half of the new year.

Got it. Could you maybe talk, what steps are you taking to bring International segment margins in the low mid-teens, closer to margins in the Americas, which are mid-20s?

Yes, sure. It's been an area of focus for Bob and his team for some time, and they're doing an exceptional job at really improving that business. They've had a strong focus on improving the cost structure of the segment over the last several years, and we're seeing those benefits coming through in our results. Among the key areas of focus for us are around shared services, footprint rationalization and simplification, headcount rationalization and a greater focus, quite frankly, on price. And the team is doing a really good job there. We had a price increase go on January 1, and we'll continue to analyze that as we move forward, but we've seen some good results thus far from the price side of the equation. While we sell benefits of many of the cost measures, the economic rebound in International and notably, in Europe, has been less robust than it has been in our Americas business. However, we're beginning to see some progress in certain regions, and we're continuing to watch the impact of this recent Omicron variant and its impact on our business. We look at the pipeline for business international. Demand trends are improving, as I said. We have a good view of the pipeline of business and opportunities that we have around the world, and we're seeing good progress, and the business is positioned well for increased volumes. The Bristol business we acquired a year or so ago, which presents us with some nice opportunities to really take a strong line of turnout here in the U.K. and move that through our channels of distribution in the international area. The Bristol acquisition really complements and builds on that Globe acquisition that we made a few years ago. That's done very well for us. We see some nice opportunities with Bristol, and that's starting to show up in our results.

Got it. [Operator Instructions] Ken, can you discuss the progress with the Bacharach integration?

Sure. As many of you know, I'm really inherently involved in that integration effort. And what I can say is it's proceeding very much on plan and on schedule. We're about 6 months into owning the company, and we're very much encouraged by the opportunities that we have in the business, both -- not only on the financial perspective, but also on the people perspective. We've seen -- we've been pleasantly surprised with the acquisition and not only what the acquisition can do for us financially and strategically in our marketplace with our customers, but the employees that we're getting as part of that acquisition are certainly pretty valuable as well, and it's exciting. We always -- that's an area of focus for us when we do M&A and this Bacharach acquisition is providing some nice opportunities from an employee perspective for us. As we announced in the acquisition and as I said earlier, I'm spending more time on -- more percentage or higher percentage of my time on the acquisition and the integration. I'm working closely with Aaron Tufts, who previous to this role, headed up our global fixed gas and flame detection business, and we're seeing some good results there. The business is performing, and I'm very much excited about the prospects for Bacharach and what we can do with that business in years to come.

Perfect. And Ken, for those unfamiliar, can you just walk us through the balance sheet? I mean any target leverage or other goals you have?

Yes, sure. Coming into the pandemic, we passed on a couple of acquisitions because we saw -- we didn't see the pandemic necessarily, but we saw an economic cycle which was maybe a little bit long in the tooth, and acquisitions were very much priced to perfection as we entered the pandemic. We entered the pandemic with a very healthy balance sheet of about 1 to 1.2x of leverage. At the end of Q3, after 2 acquisitions, totaling $400 million, our leverage ratio was 1.8x. Acquisitions remain very much a key part of our growth strategy. I wouldn't classify us as a serial acquirer, but we're very much a strategic acquirer. We completed the 2 acquisitions over the last year, and we continue to be very active in going into this year with evaluating additional opportunities and deals. We believe there are ample opportunities in our core market, and we continue to evaluate opportunities to expand our addressable market. Acquisitions like Globe and acquisitions like Bacharach. It's an area that we know very well, but it really helped expand some of the addressable market that we had with our gas detection products. The valuations, as many of you know, have moved up materially over the last year, and that's made some discussions more interesting. We're going in to remain disciplined. We'll always be disciplined on price and very thoughtful about the businesses we acquire. When we think about acquiring businesses, we want to buy businesses that we can make better and they can make us better as well. And so we're really focused on acquisitions through that lens.

I'd actually like to focus a little more on M&A. Can you maybe talk about the qualities of an attractive acquisition target? Are you looking for smaller tuck-ins, bigger acquisitions, expanding geographies? A little more detail there would be great.

Sure. We look across the spectrum when we think about M&A. It's about technologies, it's about channels and distributions, it's about geographies. And so when you look over the past several years at some of the acquisitions that we've done and have been fairly successful with, it's all about how do we bring businesses into our portfolio that we can leverage or that can open up opportunities for channels for our product portfolio. And so strategically, those are some of the things we think about. Financially, we not only look at earnings accretion, but we try to buy businesses that make us better, businesses that will accrete to our margin profile, that will help us move towards that longer-term target of margins with a 2 handle on it. And so we continue to look at acquisitions through that lens and Bacharach was a great example of an acquisition on -- with the financial characteristics of those natures -- of that nature. And so earnings accretion, margin accretion, cash flow accretion. You look at cash flow, so many times people invest in businesses that use more cash than their organic business. We try not to do that. We try to really focus on capital light sort of businesses that provide meaningful levels of cash flow. I mean that Globe acquisition that we made a couple of years ago is a great example. The cash flow that we've been able to generate to kick off of that business has been very meaningful. And so we like to buy businesses like that, that will provide more cash flow that will allow us to continue to maintain the balanced capital allocation, but also reinvest for future growth in our portfolio.

No, that's great. And staying on capital allocation, will you ever use share buybacks for more than just offsetting dilution, especially given recent share price movement?

Historically, as you mentioned, we've used our share repurchase program to offset dilution related to our stock compensation program. We've taken a fairly balanced approach to capital allocation. The first focus of the capital allocation though is very much growth, and we're constantly evaluating opportunities to build a stronger and more robust business. That said, we have paid an increasing dividend to our shareholders consecutively for well over 50 years, and we also returned capital through the repurchase of shares. I wouldn't say that we would change our focus and ramp up the intensity of the share repurchase program, but our intention is to continue to remain very much balanced across all categories of capital allocation.

Great. Coming down to my last few questions. Could you talk about what you see MSA as a company looking like in the next 3 to 5 years?

Sure. That's a great question. First and foremost, our mission will not change. Our mission that I mentioned earlier of safety has never been more important and will remain the focus for us for years to come. But what I think will change is the intensity by which we focus on technology. How do we enable our customers to be more efficient and compliant while keeping their customers or their employees safe and allowing them to return home each and every day. And so when you look at some of the things we've done over the last year, it really emphasizes the way that our focus continues to evolve in our portfolio. We've talked openly about engineering. Software engineering has ramped up in terms of our focus and the composition of software engineers has changed considerably at MSA. The composition of engineers with a higher degree of software engineering, and so we continue to ramp up the intensity around that. We continue to ramp up the intensity around the connected worker. And those are areas that we intend to continue to ramp up the focus on. I wouldn't be surprised to see that the portfolio continue to evolve and change as we move forward, not only from a product portfolio perspective, but also a go-to-market strategy perspective. Something that we've learned through the course of the pandemic is the importance of touching our customers in a digital fashion, and the digital strategy that we've continued to invest in, I think, is going to continue to be a focus for us as we go forward. We made considerable investments across the portfolio and our go-to-market strategy, and we intend to continue to make those types of investments as we go forward to allow us to be more efficient and more effective when interacting with our customer base.

That's great. That's really good to hear. I do have a question from the audience. Basically, what are you seeing with your COVID impact in the Americas versus your international markets?

Steve Blanco is here with me as well. And I'll answer at the start, but I'll also ask him to provide a bit of context around and texture around that as well. But what I can tell you is, it's interesting. This thing comes in very much comes in waves. And when we look at the variants, whether it be the original COVID variant that we all dealt with almost 2 years ago or the delta variant or now the Omicron variant, it very much comes in waves across the business. And so we see the impact in certain geographies more early than other geographies. So for example, Omicron more recently, we probably saw the impact of that. Pretty early on in the Americas, we're starting to see it kind of now shift throughout the world in our business and starting to impact other areas of our business in Europe, but it's really very much coming in waves across the portfolio. But I'll say, I feel like we've been very successful at navigating that not only from a business perspective, but from an employee perspective. Steve, do you have anything you want to add on that?

Yes. Thanks, Ken. And just a couple of things I'd add. As Ken said, initially, really, we start with our employees. And I think we feel really good about where they're at, and their safety comes first and foremost. Just, I think, as everybody else in the industries that we support, look at this as well. For Omicron, I think it's really early for us to indicate that there's any negative impact from an operational perspective or customer support and the customer demand. We have not seen anything material that's changed economically, both in North and South America. We've seen continued strong demand as we have -- as Ken indicated, as we had seen in the last half of last year. So that demand hasn't slowed down. I think we'll have to just watch and see if that changes. But at this stage, economically, we really haven't seen any significant change.

And it looks like we're coming up at the end of time amount of questions. I would love to just give you any closing remarks. Thank you so much for the presentation. If you have anything else to add, please feel free.

No, I just -- closing it out, I just want to step back and thank you, CJS, for inviting us again to the conference. It's great to participate in the conference. Great to talk about MSA. And when we think about MSA, 2 or 3 things I just want to highlight. One, financially, we've never been in a better position. Our balance sheet is incredibly strong, and we continue to evaluate additional growth opportunities for our portfolio. Secondly, our product portfolio has also never been any stronger, and our market positions have never been any stronger, whether it be the work that Greg Martin is doing on the R&D front or Dave McArthur is doing on the go-to-market strategy, it's working and we're seeing great results. And last but not least, our people. Our people remain very highly engaged in executing on our mission each and every day. And for that reason, we continue to see very strong results and enjoy a tremendous amount of success across the portfolio. So I just wanted to say -- just wanted to highlight those 3 key areas, and there is a really, what I call, differentiators in our business.

Great. Thank you so much. I really appreciate the time. Thank you to our listeners as well.

Thank you. Appreciate it. Thanks, everybody.