MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

All right. Let's get started. Thanks. Good afternoon, everybody. I'm Larry De Maria. Thanks for coming to the MSA Safety presentation. I'm the research analyst here that covers MSA and required to inform you that for a full list of disclosures and potential conflicts of interest, please visit our site at www.williamblair.com. Today from MSA, we have Nish Vartanian, President, Chairman and CEO; and Ken Krause, Senior Vice President, Chief Financial Officer and Treasurer. As many of you know, MSA Safety is a global manufacturer of advanced safety equipment in multiple industrial end markets, including energy and industrial broadly, firepower helmets as well and firefighter safety. So with that, I'm going to turn it over to Nish for a discussion for a presentation. And then if for some time, we'll do some Q&A and then move on to the [indiscernible] room after this for a breakout session.

Thank you. We have to advance to the next slide. Welcome, everybody. It's fantastic to be back in person and see everybody in person. We're able to lead things off, which is great to see. Just real quick, a quick overview on MSA Safety. We're a mission-based company. We're about protecting lives. Our first product was founded in 1914 by Thomas Edison. He founded a cap lamp or MSA, leveraging the latest technology to give miners light without a flame in underground mines, and deaths in underground mines went down significantly with the introduction of that product. Today, we still work around the same fundamental basis of protecting lives and environment in dangerous industrial workplaces. We leverage technology to do so. So we're a company that has over 1,100 patents, 200 patents pending. So there's a lot of IP around the products that we have, which give us real good moats. Hence, the good gross margin profile, good operating margin profile. As a company, we operate well with 100% free cash flow conversion. R&D spend is about 4% of our revenue, and we continue that pipeline of bringing new-to-world products to protect life and increase productivity of our workers. So there's just a lot of focus on that. And safety is all we do. When 5,100 of our employees around the world get up and their feet hit the ground in the morning, we're focused on protecting life and environment around the world where we generate about $1.4 billion in revenue. So when you think of our business, you kind of break it into 3 different segments. Number one is protecting the firefighter where we're #1 in the world when it comes to head-to-toe protection of a firefighter and that business is really municipal budget type funding that drives that business. So it's very stable, and it works on its own economic cycle, just uncoupled from the rest of the cycles that we see in the business environment. Protecting firefighters is obviously critical on a global basis and typically municipalities, even when things are in tight times, they'll buy new breathing apparatus, fire helmets and turnout gear to protect the protector, so to speak. So we're #1 in the market on a global basis. Some exciting news that we received just recently this week, we'll be booking the largest order in the history of our company from a commercial standpoint. L.A. County Fire Department just placed an order to convert all their breathing apparatus to MSA, which is about a $23 million order. So we're pretty proud of winning that, having Chicago, having Boston and others. It's just nice to get a big piece of business like that in the pipeline for us. When we look at that business in that segment, the outlook is very good. That -- there's some federal funding, called the Assistance to Firefighter Grants that funds -- helps to fund that market. Under current administration in D.C., they've increased the funding by $100 million. That funding gets released in the back half of this year. So we think that the business will be strong for the balance of '22 and well into 2023. Oil and the gas detection space, so we make both portable and fixed gas and flame detection products, the portable gas detection are products that you put on individuals to listen for, look for gas leaks to protect workers in confined spaces or hazardous and then fixed gas and flame detection that's on the wall in place, protecting pipelines, upstream, downstream, midstream in the oil and gas industry or utilities and other environments. We've made a recent acquisition of a company called Bacharach and Ken's going to come up and talk about that a bit. And that's more of an environmental play, an ESG play where that company is really focused on measuring for refrigerants and making sure that refrigerant don't escape in the atmosphere. So that's a recent acquisition that we made. Really a lot of similar technologies in manufacturing processes. So we've been able to tuck that business in very nicely with the rest of our business. And the third segment is the industrial PPE business. So our hardhats have a #1 position on a global basis. When you're driving or traveling throughout the country, you'll often see the V-Gard hardhat. It has a trademark with the V mold in top of the hardhat. You'll see that on construction workers. Some believe that we have upwards of 60% market share in the North American market when it comes to industrial head protection, over half of those are logoed or customized, which also enjoyed quite nice gross margin. The one core area where we have the lowest market share, we're #3 in the world in fall protection, but that happens to be the biggest space we compete and also one of the fastest-growing spaces. Falls to deaths and injury is the #1 killer for construction workers, and there's an increased focus around fall protection. So we see that as a nice growth opportunity going forward. Our ESG strategy really drives value for all of our stakeholders. When we think of our ESG pillars, it's something that we've always been focused on. Number one, our people. We have a fantastic culture at MSA with a lot of tenured -- long-tenured employees, who really have a good understanding of the mission and the vision of what we're trying to accomplish as a company. Really, we focus our recruitment around the mission of the company of protecting people's lives, and we motivate our workforce around that. We've always been involved with our communities, our environment and integrity. Really, we have best-in-class safety metrics. We're really proud of the fact that within our company, we're a leader when it comes to safety and protecting people's lives within our own facilities and try to be a role model for the rest of industrial players. And then 34% of our executive leaders are diverse, and we do a real nice job from a diversity standpoint, 3 of our 10 board members are women, one of color and then 3 of my direct reports are female. So we have a company that does a real nice job from a diversity standpoint. We've been recognized by the Pittsburgh Post-Gazette as a top employer in Western Pennsylvania, but what's great is over the last couple of years, we've been recognized more so on a national basis by Forbe's and Fortune magazines and as being the top place for employment. So I'll turn things over to Ken to talk a little bit about the Bacharach update and a little bit about the financial metrics.

Thank you, Nish. Great to be here and to speak about MSA safety and all that we're doing in MSA Safety. Before moving into the Bacharach discussion, just to highlight about ESG. In addition to all the things that Nish mentioned, we also recently renegotiated our credit facilities just about a year ago as part of the Bacharach acquisition. And in doing so, we incorporated diversity metrics as well as safety metrics as part of the pricing model and the pricing grid. So it was really good to be able to reflect our commitment to ESG and our credit facility and our capital structure. Looking at the Bacharach acquisition, we've continued to progress very nicely with our plans around the integration of Bacharach. It was an exciting opportunity for MSA to go after and acquire this great business. We're making great strides on the talent side. We've been able to identify a significant amount of new talent that we're bringing into the organization. We've had a strong track record when it comes to talent as part of acquisitions. Also strategically, the business is doing well. It was a great acquisition for us. It was in a space -- a new space that helped to expand our addressable market. But in addition to expanding our addressable market, it was in product areas that we knew fairly well. So that gives us an opportunity to go after and realize some nice synergies in our portfolio. We implemented SAP to close out the first quarter, and that's allowing the enablement of further synergies and complexity reductions across the business. So it's been a really nice success thus far. We're making great progress. It's not surprisingly struggling with supply chain challenges just like many of our businesses that are focused in on technology and electronic components. And so we do see a bit of a build in backlog, but demand has been very strong across this business. When we look at the capital allocation, although I do talk a lot about acquisitions, I have to touch upon our investment in R&D. We've continued to make significant investments in R&D. Nish spoke about our commitment to R&D at about 4% of sales. Over the last 5 years -- a statistic for you. It's interesting. Over the last 5 years, we've invested upwards of $300 million in R&D. Our sales vitality today is around of 35%. So that correlates to about a $450 million to $500 million revenue generation on a $300 million investment. So you can see we're seeing nice progress and nice returns on the R&D investments that we continue to employ at MSA, but we also continue to look at acquisitions. We're positioned very well when it comes to our balance sheet with net leverage of about 1.5x after deploying over -- almost $400 million of capital in 2021 to bring on acquisitions like Bacharach as well as Bristol. Going further back, we've made nice acquisitions with the globe turnout gear business as well as Sierra Monitor and then of course, General Monitors almost a decade ago now. It's not a capital-intensive business. It does not take a lot of capital to drive the business. CapEx is about the same level as depreciation and amortization. And furthermore, we have continued to pay a very healthy dividend. We've been increasing our dividend for well over 50 years. Our yield is below 2% today, but we continue to increase that dividend. We recently increased it in May. And we also, from time to time, repurchased shares, primarily to offset dilution. We were in the market recently over the last couple of weeks deploying capital to repurchase shares and to offset dilution, and we continue to focus on maintaining this balanced approach to capital allocation. From a performance update year-to-date, business is doing very well. Demand is exceptionally strong. We continue to see good growth in our business. First quarter, we reported about 9% growth. Our incremental margins of around 30%. If you followed MSA, incremental margins have been a really big part of our discussion with the investment community, and we continue to see nice performance on that front. Our book-to-bill ratio is fairly strong. Our backlog is exceptionally strong, and it's running at record levels. And so we continue to see good performance. Looking at business through April and May, the hardhat business, Nish talked about our strong position in the hardhat market, that market and that business is something we look at as a leading indicator for our business. And today or through May, that business both on an orders as well as on a revenue basis was growing at 10%. We're not really struggling with supply chain challenges in that market, but we continue to see good demand and we continue to deliver on that good demand. The fixed gas and flame detection business and the gas detection business is really where we're seeing some of the challenges when it comes to supply chain, electronic components and shortages as well as the globe business with some labor constraints and challenges there. But overall, the business is really healthy. We continue to see good demand, and our focus on margins have never been greater. From a long-term outlook, we've consistently talked about mid-single-digit growth. In the pricing environment that we're in today, we think that there is an opportunity to see that step up a bit as we think about pricing opportunities in our market, but also not only on pricing opportunities, but on acquisitions. We've consistently deployed capital over the last 5 to 6 years for acquisitions. And if we continue to do that, there is no reason to not believe that we couldn't expect to see high single-digit growth going forward. Incremental margins, the 30% to 40% incremental target remains intact. We did struggle a bit in 2021 as we saw a number of our cost reset coming out of the pandemic, but it was good to see us finish off the fourth quarter and then start the first quarter of this year with really healthy incremental margins. And then cash flow and capital deployment remain very strong. The capital intensity of the business is not changing. It continues to be a low CapEx business, and we continue to focus on generating cash flow at or above the level of net income. When we think about investing in MSA and some of the reasons why we look at MSA as a very attractive investment, I think it all starts first and foremost with our culture and with our mission. As Nish indicated, we are a purpose-driven company. When we wake up each and every morning, our focus is on how do we help workers go to work and return home safely. Innovation is critical. When we look at the R&D investments we've made in MSA over the last 5 or 6 years or even going further back, innovation is really the lifeblood of the organization. It's about how do we bring new technologies to bear that allow us to help our workers go to work more safely but even so more -- in a more productive manner. We continue to diversify the business across a number of new end markets. The Bacharach acquisition was a really appealing investment for us because it gave us an opportunity to really expand the addressable market, but also diversify into some new end market opportunities. We have a strong track record continuing to deploy capital and bringing on acquisitions that enhance our brand, enhance our portfolio and allow us to provide even more innovative products to our customer base. And then our balance sheet remains strong. We've consistently focused on maintaining an investment-grade balance sheet, and we can -- we have done that through a number of acquisitions as well as through a number of cycles. With that, Larry, I'll turn it over to for any questions you might have or the group in the audience.

Thanks. Thanks, gentlemen. And we're going to move on in about 10 minutes or so to the [indiscernible] room, but we can take some questions here. Let's start us off. I think it's fairly new and remarkable day at L.A. County order. That's nice news. Can you maybe elaborate on that in terms of maybe a little bit of the timing, a little bit about what led to getting that order and you differ from your competitors a little bit, I think, in how you approach the market. But any further color on that because that was obviously a pretty remarkable order?

Yes. So we're really pleased with the win at LA County. We -- that's customer that we had picked up some business with over the last couple of years, whether it was thermal imaging cameras or our fire helmets. So we've started building a good relationship with them when they started to buy our fire helmets, turnout gear and then we started to position ourselves for an evaluation that we knew was coming. So about every 12 to 15 years, fire departments replace their self-contained breathing apparatus that's driven by government standard. And typically if they get 2 standards away from approval, they typically replace the breathing apparatus. So we knew they were coming along in that cycle. And as we build a relationship with them over time from the corporate level and our local people, we did a really nice job of bringing them along with the technology that we have in our G1 breathing apparatus and how that product is differentiated from competitors. They went through a fairly extensive evaluation for about a year and then settled in on MSA, which we're really pleased with. And that's going to be a good margin business for us. It should ship at some point this year. We'll work out the delivery schedule. As you would imagine, when you're putting several thousand breathing apparatus and service to the fire department, they have to have a good plan to phase that in and make that transition. So we're working through with that and really proud of it, and we'll probably have some sort of a halo effect on that when you get a major department like that in a part of a geography like that, you typically get other departments that come along with it. So we certainly expect to see some follow-on orders that will come. When we receive Boston Fire Department, we really kind of rolled the New England effectively and picking up a lot of departments in that part of the country. So we're looking forward to just not getting that business, but also some additional business that will come along with it.

You could pull some product incremental product through into that market as well?

Yes. Yes. So that's kind of the strategy, right, with the fire service. When we talk about protecting the firefighter from head to toe, MSA had -- has always had a pretty good market position with breathing apparatus. We've grown that position significantly since the introduction of our G1 breathing apparatus in 2015, where our share has grown significantly, 1 out of every 2 orders we receive are competitive versions. And so we've grown our share well there. And then we had the fire helmet and then the thinking was bring along the turnout gear. So our strategy with the fire service is really when you think across -- just think of the U.S. market. The U.S. market, about 95% of the fire departments in this country use one of our products, whether it's fire helmet, turnout gear, breathing apparatus, thermal imaging camera, gas detection, boots, they're using an MSA product. And so we're able to leverage that and get into that department and sell more products in that department once we're there. So that's been our strategy in the fire service that's worked effectively, and we're really pushing to do that on an international basis. The Gallet fire helmet, which is the Gallet branded helmet that we have, that has very strong market share throughout the world outside of North America and then our M1 breathing apparatus does quite well. And we just made an acquisition of company called Bristol Uniforms that Ken mentioned, and we're starting to lever that into our business on a global basis through our network of distribution and try to sell that effectively. So we're pretty optimistic about the fire service business as you go forward. There's -- it's on a very different economic cycle from the rest of the business, whether it's oil and gas or general industrial business. As I mentioned, the funding, there's a funding tool called the assistance to firefighter grants. That's been at a level of about $500 million over the past several years. President Biden has bumped that up to $600 million going into year. And so that certainly should help us. And the backlog is really healthy. At this time of year to have a healthy backlog for breathing apparatus is a little unusual because it's typically a lull in the market before the AFG grants are released in late summer. So today, we have a very big backlog for breathing apparatus. And we know those AFG funds are coming in, they'll start seeing wins from that in July and August, and that will just continue to build our business through the end of the year and into 2023. So optimistic about that.

Obviously, fire safety and a lot of other industries you're in is very sticky because of safety and its tradition. I think you're selling more and more solutions and you're moving towards that approach a little bit. But maybe you could talk a little bit about the connectivity approach and how -- where is the recurring revenue now? And as you layer in this connectivity, where can the recurring revenue could go?

So there's nice opportunity with the connected worker. And so our avenue into the connected worker is really around portable gas detection. So some people look at connected worker and selling a new device to an industrial customer for connecting that worker. We have a platform today where we have, on a global basis, approximately 30% market share for portable gas detection that's used on industrial workers throughout the world. And so now we're working on connectivity through that device, and there's a couple of fantastic benefits we have in that product is -- there's something called a sign out. When you go in and there's a plant turnaround at a plant and 300 workers might need to have a portable gas detection device on them when they're working. They have to go sign that out, and there's a lot of paperwork and documentation that's tied into that. So we've worked on something with io for gas detector, where all of that is automated. So the worker walks up, picks up their device, taps it, it tags them, it registers that worker to that device and they're able to monitor all the readings that, that worker sees throughout the day -- throughout the project, and it downloads everything for the work -- for them to see that back at the control center. They're able to monitor that worker 24/7. So it's really good for remote work throughout the plant and being able to upload and do some data logging. We also are able to push out software upgrades to that gas detector. So when they put it back in the charging station overnight, it calibrates. And if we want to push any updates to it like your iPhone, we're able to push updates to that device. We're also able to do some diagnostics to determine the sensor life and whether the sensors need to be replaced and to give the owners heads up as to when to replace those sensors. So that's a growing piece of the business. It's not significant from a total dollar revenue standpoint today, but we see that as being fairly significant as we go forward as a number of companies are moving in that direction to have connected workers. So we have a connected worker from that platform on portable gas detection. And then within the fire service business, we've also developed a product called LUNAR, which has GPS location, a thermal imaging camera and then also ranging from one firefighter to another, so you have an understanding as to where the other firefighters are within a facility with you. And all of that information is uploaded to the cloud. So the command center can see where the firefighters are within the scene. So we're trying to tie in a lot of technology today in our products where we can better protect workers and also drive higher efficiency in the work that they're doing.

Larry, I was just going to comment. Nish talks a lot about the technology and the software that we're launching. The other thing that we've always enjoyed is replacement parts and sensors and things of that nature. And so, for example, in fixed gas and flame detection, it might sit on a rig or a refinery for 10 or 15 years. But over that time period, what happens is you're replacing parts, you're replacing sensors. So -- and that recurring revenue has a very attractive margin profile to it, and that represents maybe 20% to 30% of our overall business is that replacement parts. But what's exciting is what Nish alludes to is all the exciting things that are coming with respect to the connected worker, not only on the portable gas side, but we enjoy such a strong position on the worker that it allows us to leverage and to monetize that position quite nicely.

So it sounds like, obviously, orders are very strong, obviously, through May, even notwithstanding the large order that you talked about. Is there any pushback yet on price? And what are -- obviously, we're all here trying to understand what's going on in the macro world and how it ties into the company as we presented today. Are there any warning signs out there yet? And how do you think the company will perform in a recession? Obviously, it's time to employment, but you have a very good, sticky business as well.

So from a pricing standpoint, we've been able to execute on price increases very effectively. So in 2021, we had 3 price increases January, July and November, then have another one coming here in 1st of April. So there hasn't been a lot of pushback on price increases. Customers understand it. The beauty of safety is that today, from an ESG standpoint, protecting workers is top of mind for every CEO and everybody in business. And on top of that, you have a really tight labor market. So the last thing a company is going to do is upset their workforce by swapping out product to go to something at a lower cost when you've been using a product for a long period of time. Our industrial hardhats, our portable gas detection, when you look at our MSA in the industrial space, we've been around for 108 years. I've been with MSA 37 years. I could rattle off customers that have been using our gas detection and hardhats for longer than I've been with MSA. They're not going to change those products because we're bumping our price at 5% or some reasonable number. And we do a nice job of that and we execute effectively there, and you see that in the margins of our business. So it's a very sticky business. And it's important. It's mission-critical business for our customers so that they can go on and do their jobs in a safe manner.

I know you're dealing with supply chain challenges like everybody else. I think you guys have handled it perhaps better than a lot of other companies. And that might be because I know you guys make a lot of your own sensors, a lot of your own integrated circuits, et cetera. Is there any hope on the supply chain at this point? Are you seeing anything -- any movement? And how do you guys differ?

So we do. We actually leverage our mission with our supply chain. So we have some customers pulling back on delivery, we'll talk about the mission-critical nature of our product, the fact that we protect firefighters or our fixed gas inflamed detection is used in the pharmaceutical industry where they're making some vaccination in other material. And that helps us. I don't know if we do better than everyone else, but we've done a nice job in managing that. And we also control components of our own supply chain. We make our own printed circuit boards in-house. So we're not relying on contractors to do that work for us. So we're able to manage that, but we are being impacted. Clearly, with ICs and chips, we've had some constraints there. And that's what's really led to the backlog we have of -- it's now twice what we normally have in backlog. So we see that as somewhat of a buffer in an economic downturn. But the fact of the matter is, I'm not at all concerned about a recession for our business. I think the fire service business is going to continue to be strong through 2023, regardless of what the economy does. I believe oil and gas will continue to be strong because there's a lot of demand. The world is using over 100 million barrels of oil today. The supplies are at an all-time low. And I believe that there's going to be demand for oil and gas going forward, and that will drive need to protect those workers in those markets for us as we go forward.

Fantastic. I think we're out of time. We're going to end here. Thank you very much, and we're going to move to the [indiscernible] room in about 5, 10 minutes for further Q&A for those that can join us. Thank you very, very much.

Thank you.

Thank you.