MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good afternoon, everyone. Thank you all for tuning in, and thank you for joining us here today in person. It's nice to be back at the CSI Conference. My name is Stanley Elliott. For those of you who I've not met, I cover a mix of industrials and machinery names here at Stifel, among other things. I'm very pleased to have MSA Safety here with us today. From the company, we have Nish Vartanian, Chief Executive Officer; and we also have Ken Krause, the Chief Financial Officer. I think what you'll find here with through the presentation is the nice mix of end market, a nice market outgrowth opportunity and nice level of profitability overall. We'll keep this as more of a fireside chat sort of format. But before we do, I'll turn it over to you guys for some introductory comments.

Sure. So I'll just give a quick company overview and then turn things over to Ken to give a business update as to where we stand today. Just a reminder on safe harbor, I know you're all familiar with that. Quick overview on MSA Safety. We're a mission-based company. Our mission hasn't changed for 108 years of protecting people's lives and the environment. We continue to do what we did 108 years ago, and that's leverage technology to protect workers and try to make workers more effective and efficient, and get them home safely at night. Revenue, about $104 billion. The margins 43% -- over 43%, 44%. 100% free cash flow conversion target for us on an ongoing basis. We do a nice job in funding R&D. When you think about the R&D funding, we've spent about $300 million in R&D spend over the last 5 years. And our new product vitality runs around 35%. So that equates to about $450,000 of revenue at greater than 50% margin. So we get a real nice return on that R&D spend where we're able to take some share and get better pricing for our products and good uptake there. Good diversification in the business, sales by geography in the Americas and international and also by product category. So while we're dedicated focus on safety, we have pretty good diversification from a geographical standpoint. We sell into 140 countries and by product category. When you look at the markets and how those products break out, typically, we're #1 or #2 in the product areas that we compete. So firefighter safety, protecting a firefighter from head to toe, that represents about 1/3 of our business. When you think of the fire service business, that's not your traditional industrial type business, right? It's municipal funded along with some federal funding. So that works on its own economic cycle. I don't want to call it recession-resistant, but certainly, it runs on some different cycles. So it's able to balance out our portfolio as we go forward. Gas detection, we have both fixed gas and flame detection. So that's where we install these products and they look for, listen for gas leaks and protect the environment and facilities. And then portable gas detection, which you put on individual workers, offer use in industrial environments, confined-space entry or other applications. And then of course, industrial PPE business, that also represents roughly 1/3 of our business. We're a global leader with industrial head protection, #3 in fall protection with this fairly large category. And then also in industrial PP is some air-purifying respirator products for us that we continue to do quite well in. So leading positions in pretty attractive markets. The second large market for us is oil and gas. So some people like to call MSA somewhat of an ESG play because we protect people's lives, but you also get some exposure when it comes to oil and gas, which is kind of a nice benefit in this environment. Our ESG strategy, we really deliver value for all of our stakeholders. When it comes to our people, we recruit, retain, motivate our people around our mission, and that's protecting people's lives. And it resonates really well across our workforce for both men and women and diversity. We have -- approximately 47% of our workforce are professional women, of our professional workforce is female. So we do a real nice job from a diversity standpoint. 3 of my reports are women, 3 of our Board -- 10 Board members are female, one of color. We do a nice job in our community and working through our community and donations. We donated about $0.5 million of firefighting product to Ukraine to help with that situation, which obviously was very popular with our European associates and obviously focus on our environment. And one of those -- one thing that we've done in that area was an acquisition of Bacharach, which Ken will give you an update on that. From a corporate level, he's got oversight on how we're doing with that acquisition and the integration. Really, we have had a lot of recognition over our history with Western PA and Pittsburgh Post-Gazette as being a top workplace. But what we're particularly proud of is we're starting to get some national recognition from Forbes and Fortune as being a strong workplace and some recognition for the work we do. So we're pretty proud of that. And I'll give Ken the slide to give us an update on our year-to-date performance.

Well, thank you, Nish. And before I do that, on the ESG side of the house, it's really interesting. During the Bacharach acquisition, we were fortunate enough to enter into some long-term financing. One aspect of the long-term financing included our credit facility. And in the credit facility, we incorporated metrics associated with diversity of our workforce safety and lost time incidents. And so it's really good to be able to reflect our commitment to ESG in our capital structure. Transitioning here into the year-to-date performance, couple of things. One, demand remains very robust, demand is strong. We're seeing good demand. It's good to see it not only in some of our businesses in fire service and gas detection, but it's especially good to see it in the hardhats. The hardhat business is really a leading indicator. And we oftentimes will see that business turn sooner than other businesses, whether it be rebounding or decelerating. And we're actually continuing to see good levels of demand here as we start the month of June. Secondly, margin profile remains -- and improving margins remain a focus for us. We continue to drive improved margins across our business. If you've been following us, you'll know that our target is 30% to 40% incremental margins. It was good to see that come through in Q4 of last year as well as to start the year here in Q1. We continue to see good demand -- or I'm sorry, good margin performance. Supply chain is our biggest challenge, quite frankly, at this point. Electronic components -- and the team is doing an exceptional job at really getting in front of it and trying to be proactive with some of the redesign work. And so our team of highly talented engineers is working closely at reengineering some of our products and opening up the supply base a little bit more broadly. That should help us. Here in the second half, we should see some products start to get approved and hopefully provide us even more leverage as we go forward. The only other thing that I would talk about here or want to highlight in terms of current trends is just the FX environment. We are seeing a much stronger dollar today than we had experienced there a year or so ago. And as a result, the first quarter, I think our revenue headwind or translation headwind associated with FX was just south of 2%. We're seeing that creep up here in Q2, maybe another 1 point or 1.5 points of currency headwind coming into the business here in Q2. Our margins are protected. It's really a translation of the revenue back to the U.S. dollar, our reporting currency. As I said, our margins are managed as we do a lot of local manufacturing for those local markets. So there's not -- there is some product being shipped out of the jurisdictions, but a lot of the business stays within a specific jurisdiction. When we look at the long-term outlook, we remain committed to our mid-single-digit growth outlook and targets. We do see an opportunity to drive that a bit higher here if the inflationary cycle stays where it is, if we continue to see the number of price increases that we've been seeing in our business here in 2022 and so that certainly will be a driver of growth for us as we go forward, assuming the cycle stays in the same manner that it is with the inflation. The other thing that really comes into play is our track record around acquisitions. Acquisitions have an opportunity to drive growth for us. This year, we'll probably see 2% to 3% of acquisition-related growth coming through our business. And so that, combined with the pricing and the normal growth that we would see in our portfolio, we should see a growth rate of high single, low double-digit growth here for 2022. And the margin performance, we did take a step back in 2021 with margins, a slight step back to be under 18% for the first time in a few years. And it really was associated with some of the resets we had in our business coming back from the pandemic. We feel like we're positioned well here in 2022 to see margin lift again an improvement in cash flow. Cash flow is a big focus for us. We've been deploying capital successfully for acquisitions, but also maintaining the balance with the dividend. We've been in the market recently buying some of our shares back as well to offset dilution. So I've talked about that a few times here in the month of May and here in the early part of June, trying to offset dilution that we've seen associated with employee stock ownership and stock compensation. So in summary, just in terms of investment in MSA. I think what we've done is a really nice job at really pivoting the story at MSA while remaining focused on safety. We're a purpose-driven company with a focus, a laser focus on safety and protecting -- helping people protect themselves as well as their assets and the environment with the recent acquisition of Bacharach. And innovation has really been core to us. Nish talked about that statistic that I've been speaking about here more recently. But there's been about $450 million to $500 million of revenue driven by $300 million or so of investment in R&D, really strong returns. And not only is that investment driving growth, it's driving good margin performance. Just about every product that we launch is accretive to margins. And so we're really fortunate enough to be able to price that innovation and pass that along in terms of higher prices. We continue to maintain a focus on margins. We're not done yet. Margin improvement has been tremendous over the last 4 years or 5 years. But we think this business should be a business that generates 20% operating margins. With 45 or so percent gross margins, the business, we feel like is positioned to generate 20% operating margins. We've got a number of initiatives from shared services to other things that we're working on when it comes to margin improvement, but we're optimistic in our ability to improve the margins. And then the track record of acquisitions and balance sheet kind of speak for themselves. We have -- we maintain a very -- a lot of focus on keeping our company and maintaining an investment-grade balance sheet. And so the acquisitions last year where we deployed $400 million of capital. We've since delevered down under 2x net debt to EBITDA. I want to say our current leverage ratio is around 1.5x to 1.6x net debt to EBITDA. So it positions us well to weather any downturn one might see in the economy, but also positions us to go after and continue to acquire bolt-on assets to this business model. With that, I'll turn it over to Stanley to you for any questions you might want to walk through with us.

Perfect. great guys. Thank you very much for the overview. It was interesting, looking at the book-to-bill, the order rate. It doesn't look like that you've really seen any material deceleration within order trends, particularly given some of the macro headlines have been a little here lately?

Right. Yes. So the fire service business has been particularly strong. We announced that we booked our largest business, business ever, the largest purchase order ever with LA County fire department, a $23 million order, converting that from a competitive account. And hopefully, down the road, LA City could go along with that, which would be a little smaller in the county. So it's nice to see that business come in to us, the fire service pipeline is fantastic. We've looked at the backlog and the backlog position today for the breathing apparatus and the fire service. And then the AFC funds, which will start to come in the summer, we're really bullish on our fire service business for the balance of the year and into 2023. That business should be quite healthy. And then, of course, oil and gas is quite good. We've seen a typical uptick when oil and gas bounces back the first thing to come back is head protection, right? You're putting hard hats on workers that come back to the oilfield. And then what follows that quickly is portable gas detection, which we've seen that trend continue and then, of course, fixed gas and claim detection comes along later in the cycle. So we expect to see that happen. So when you look at those 2 markets, those will be strong. We believe into 2023. The backlog is healthy and high quality. We won't see cancellation of orders. Fire departments place orders, they're willing to wait. That's a 15-year investment for them. And then on the fixed gas and flame and gas detection, those products are in and have a good understanding of our delivery capabilities. So it's a good, high-quality backlog to have as we go through the year.

And how has labor been? I mean we had some issues in certain product lines in terms of finding people. Has it gotten any better? I mean demand is obviously there. The order book is strong. How has it been finding workers within the facilities?

So that's a good point, Stanley. The only area that we've had issues with labor is in our New Hampshire facility. So in our -- just north of here, in Pittsfield, New Hampshire, there's an extremely low unemployment rate. It's around 2%. And that turnout here, we make the closing for firefighters and that facility -- so we've had challenges with filling that labor force. The good news is, is we are -- as we track the leading indicators of getting more applicants and hiring more people, we're starting to see that improve. And then we're also doing some self-help things to look at some subcontractors to do some workforce in different parts of the country to bring those subassemblies in to help us win that. So we're working around that. In other parts of the business in different parts of the world, labor really hasn't been an issue. We've done a nice job with headcount and our facilities throughout the U.S. and around the world.

You mentioned the L.A. opportunity with SCBA with the new G1, certainly I'll tie into some of the things of new products that we can talk about here in a minute. But maybe explain kind of what's happened within that marketplace, the investments that you've made, how that's repositioned the business? And maybe how much longer do you think you see on this replacement cycle?

So when you think about the fire service market, we launched the G1 breathing apparatus in 2015, and we really moved our market share from around 20%, 25% to 45%, maybe a little bit higher. So we've had a nice movement in market share with the G1 breathing apparatus. Part of the strategy and what's good in there is we have good strength within the channels of distribution, great brand awareness. We made the acquisition of Globe turnout year back in 2017, which only strengthened our position within the fire service. So when you think about our products and our exposure in the fire service between turnout gear, the clothing, fire helmets, the self-contained breathing apparatus, thermal imaging cameras and of course, portable gas detection, 95% or more fire departments in this country use one or more MSA product. So the classic example with LA County, LA County used our thermal imaging cameras and our turnout gear. We built that relationship. We converted them to our fire helmet and continue to work the relationship. And then, of course, when they made their move to breathing apparatus, we did a real nice job with relationships and going through that product evaluation and winning that business. So that's our strategy is to get into those accounts where we have good relationships and continue to broaden our product offering within those fire departments. The longer-term Stanley, what will happen and what will transition is because we've improved the market share position of the G1 breeding apparatus. Longer term, there'll be a G2 breathing apparatus. And what we'll do is make that backwards compatible down the road and be able to go back into fire departments and have them upgrade to the latest NFPA standard breeding apparatus, whether cylinders are still in service. And then they can at a later date, replace their cylinders. So we'll have a long-term strategy to continue to hang on to that market share, drive revenue, improve our margins because when you sell that without a bid and do it as an upgrade, you're not bidding, you're just selling those as upgrades, you're in a much better position. As far as the replacement cycle for breathing apparatus in the fire service, we think the market is very healthy. Our market share position has changed to where it's increased significantly. And when we look at the pipeline, the opportunities are full with some significant opportunities as we go forward. And so we think that business will be healthy with the investment we've made in the product from an R&D standpoint and then also with our market position improving. And then we've made other investments such as a company called Fotokite. So Fotokite is drone technology. So a lot of departments are using drones, which require a licensed pilot to fly drones. And so that's one drawback. You have to get the licensed pilot on the scene. Second drawback is, it takes time to set them up and get them up in the air. And the third drawback is if the wind is blowing more than 10 miles an hour, you can't get a drone up in the air because they'll blow in the buildings. So Fotokite, a company out of Switzerland came out with technology where they have a tethered drone system. And they have FA approval where anybody can fly it because it only goes up 300 feet in the air. So they're able -- a fire department is able to get on a scene, deploy the drone up. So now you get a 360-degree view as to what's happening on the fire scene. So the first arrivals on the scene, typically 4 firefighters in a truck. They can't get eyes all around the building. This is a quick way to get eyes as to what's happening on the fire scene and then give them information to do some work. So we've made investment into Fotokite so that we're working with them from a technological standpoint because we've launched a new world product called LUNAR. LUNAR is a thermal imaging camera, which also has GPS in it and other functionality where it does ranging from one firefighter to another, so you don't get separated or you know where the firefighter is. The one piece that's missing is what's more the firefighters on. So from a GPS standpoint, you know where the person is on the building, but you don't know if they're in the basement or on the 10th floor. So what were -- what we believe we'll be able to do with Fotokite is get technology tied to them and our LUNAR so we can triangulate to find out exactly where that firefighter is. So those are some of the things we're trying to do technology-wise to make firefighters more productive, more effective and obviously, safer.

It's certainly cutting edge for an industry that hadn't really invested a whole lot other beyond just the product and incremental changes at that. So -- but along those lines, I mean you hosted technology day several weeks ago. You highlighted some of the things that you're doing in terms of adding asset connectivity, worker connectivity and some of your other products as well. What are some of the highlights from that event that you could share with the audience?

Yes. No, it's interesting, Stanley, I'll provide a little bit of texture there, and Nish can add on to it as well. But I think something that was some clear takeaways from that day was the fact that we've got an incredibly strong pool of talent. And so first and foremost, the people that we have working at MSA, we have done I want to say a tremendous job at really going after identifying, attracting and retaining and investing in our people. And so what an incredibly talented workforce. Secondarily, I think what was interesting was the amount of technology that's not only in gas detection, which we're all pretty well aware of, but also the technology that's throughout all of the products, all of the software that we've been able to incorporate into our product portfolio is quite impressive. Greg Martin and the team have done a nice job at really shifting the dynamics. It wasn't so long ago where a high degree or a high portion of our engineers were more traditional mechanical engineers. Today, it's completely been flipped and we've got a higher degree of software, electrical engineers in our portfolio of engineers. And it shows the results are really clear, whether it be the SCBA with what we're doing with LUNAR and the connected firefighter, the MSA grid or the Alter-IO-4, which we showcased or the gateways and some of the things we acquired through the Sierra Monitors acquisition, where we were able to go in and acquire gateway technology, field server technologies or even in the fall protection side, where we're able to innovate and provide workers with the ability to remain tied off at all times. And -- but to smoothly past one another without requiring them to disconnect because we know that when you disconnect the risk is increased for the person to get hurt or to fall or just to be sacrificed. And so really, all the things we're doing across that portfolio, I think, were pretty impressive to see, and it provides us, as a management team, a level of optimism for the future. We're really excited about those innovations and what we can do for the market and our customers around the world.

And help us with the pricing trends. I mean, you've been very aggressive this year, really even last year, pushing price. Have you seen any pushback from your customers? How easy is it for you to push price, especially in a situation where the inflation continues to move against you?

Sure. So we got out ahead of the curve when it came to pricing. We were pretty active in North America, we had a price increase of January '21. We did it again in July, and then the third price increase in November of '21. And then now April, we have another price increase coming through. We had one in April. So we've been pretty aggressive from a pricing standpoint, while customers don't like it, they understand it. And the beauty of our product is mission-critical. We have an awful lot of long-term users of our product. They're not going to upset their workforce because remember, workers are wearing our product. They're not going to upset their workforce because we bumped up our price on a hardhat $1 or $2 or we bumped up price on gas detection a bit, really, employers don't want to deal with that, especially in this environment. So we've been pretty effective in getting price. That's -- you see that in the margin profile of the business, and we continue to get aggressive on it. You hear some groaning on it and you worry a bit about demand destruction or if you have some problems with some municipalities possibly. So we keep a close eye on that. But so far, we haven't seen any issues whatsoever.

It's interesting. I think what I would say is it's not aggressive, it's appropriate in terms of the inflation that we're seeing, not only on the material side, but also on the labor side. And so we're trying to really just make sure that we're pricing these products to reflect the value that our customers are seeing. And as Nish indicated, nobody likes to see a price increase and nobody -- I haven't met a sales guy yet that likes to introduce so a price increase. However, it's necessary based upon the inflation that we're seeing in our end markets.

You had a target out there incremental margin, 30%, 40%. I mean pricing obviously is very good. You're richening the mix with all of your new products. What levers do you have to pull to protect those margins if we get a downturn? And most of the consternation we've heard at the conference thus far has been around residential affordability, not really your market. I get that. But what sort of levers do you end up having to pull if we do see markets within the industrial or that bleeding over and to slowdown in the industrial landscape?

Well, we continue to work actively. The European market, we don't expect to grow from a revenue standpoint this year, right? We're all concerned about a recession in Europe. And so we're preparing ourselves for that. So we continue to do some things from a self-help standpoint. We've moved our gas detection manufacturing to Ireland. We have a facility that was pretty successful in Galway. And now we've moved the portable gas detection and then the legacy MSA fixed gas detection into that plant, which we acquired when we purchased general monitors about 10 years ago. So that helps us, and that's the self-help. And then we're also continuing to work on a shared services center in Poland. And that shared service center really helps us to leverage our back office functions in a single location as opposed to multiple locations. And so there's cost savings there that we continue to execute on. So there's some opportunity that we have in the business to continue to improve the margins, and we talk about getting our margins up to the 20% level. So it's both from a gross profit standpoint, improving ourselves and getting value for the product in the marketplace. And then also doing some self-help along the SG&A lines and leverage some of the capabilities we have as we rolled out SAP, about 90% of our business is under SAP, and we do a nice job of leveraging that and pulling some costs back in the corporate. We've done some of that with Bacharach with the recent acquisition and been able to do some things from a cost standpoint with that business. So we continue to look for those opportunities to drive efficiencies.

And we're coming close to the time, but you have to ask about M&A, right? I mean, historically, you've got a very good track record of buying businesses that bring technology, bring margins, bring additions to the portfolio or willingness to take leverage up 3%, maybe even a little bit higher than that and then quickly delever. You're kind of in that sweet spot right now from when you started to do some things of that nature. What does the landscape look like? Preference? Where would it be focused? The Bacharach refrigeration assets that you purchased about a year ago, a little over, it certainly falls into a new branch for you all. How are you thinking about the puts and takes within the M&A marketplace right now?

Yes. I would say there's 3 main areas of focus here. First is around technologies around talent, software engineering, things like that. And so that's not your more traditional acquisition, but that's more focused on a specific need for MSA to fill a need that we have at MSA. The second area is investments in our core businesses, our gas detection business, our fall protection business where we have a distant third market position. And so we're continuing to look at how do we bolster those opportunities and bolster our position in those specific areas. And then third, it's how do we expand the addressable market. How do we go after businesses like Bacharach, which helped us expand our addressable market. As we think about the future, I think it's clear. Our focus is growing. Our focus is continuing to expand our margin profile. And we feel like that if we do realistically think we can get to $2 billion or $2.5 billion in terms of overall revenue, we need to continue to focus on expanding the addressable market. And so that's a focus for us. While it's a focus when we think about expanding that addressable market, we're also mindful of what our core competencies are. So you won't see us move too far to the right or too far to the left, it will make sense, and it will be well in line and in tune with what our core competencies have been at MSA.

Well, perfect. Well, gentlemen, thank you very much. Nish, Ken, appreciate it. Everyone, thanks in the audience. You all take care. Thank you.

Thank you, Stanley. Appreciate it.