MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Good afternoon. I'm Rob Mason, the senior analyst at Baird, covering the advanced industrial equipment sector, of which MSA Safety is a core part of that coverage MSA Safety is the leading provider in a pure play of sophisticated safety equipment products globally. The company targets high-end personal protection applications in 6 core product areas in which it has market-leading shares and where it has earned tremendous brand loyalty from its customers. Pleased to have with us this afternoon, Nish Vartanian, the Chairman, President and CEO of MSA Safety. Nish is going to take us through a couple of slides, make a few remarks, and then we'll take your questions thereafter. And if you have any questions, feel free to send those up via the iPad, and we'll work those into the conversation. So Nish, I'll turn it over to you.

Thanks, Rob. Good afternoon, everybody. So I know it's the end of the day. You guys have seen a lot of presentations. I see Scott's over here, yawning, rubbing his eyes falling asleep a little bit. So we'll -- I'll hit this hard and fast. And what I want you to do, one key takeaway. If you take nothing else away from this presentation, take this away. We're a mission-based organization. We have 1 mission 1 passion and 1 purpose at MSA, and that's to protect people's lives and high-risk environments. And we recruit people, retain them and motivate them. And we recruit, retain and motivate our people through our mission. And what we find is that people will put in the extra effort when they know that the work they're doing is something that's important to make sure somebody gets home at the end of the workday. So when you think about protecting firefighters and making sure they get home safe at night, that's what motivates us. That's the 1 takeaway. And there's some great rewards for this. So trailing 12 months, some key stats, $1.5 billion in revenue. Gross margins, we get paid well from a margin standpoint and pricing standpoint when it comes to our products. Our products are essential to the users that use them to make sure that they get home safe. Operating margin of 18.4% over the last 12 months, we continue to drive that through our incremental margins run 30% to 40%. So we think that there's some nice runway from a margin standpoint to continue to expand the margin of this business. Our targets free cash flow conversion of 100%. We spent about $60 million a year in R&D. R&D is where we solve our customers' most difficult problems. And we have over 1,100 patents that are active patents today and those patents help us in developing products and technologies that get people home safe each and every night. And we stay close to our customers to make sure we solve their problems. Then I'll talk a little bit more about that as we get in the product. Sales vitality is 35%. So 35% of our revenue comes from products that we developed over the last 5 years. Those are traditionally higher gross margin products than the products that they replace or we add higher margin as we introduce those products. We've got a strong balance sheet, 1.4x net debt to EBITDA in a good balanced capital allocation program. We paid an increasing dividend for over 50 years. We've paid down our debt. When we make acquisition, we typically pay down pretty quickly. As I mentioned, we spent about $60 million in R&D. And we also will buy back stock to offset dilution and then obviously, look for acquisitions to obviously expand ourselves in certain markets or bring technology into the company, and we've had a lot of success with those acquisitions. When you look at our product portfolio, I like to break the portfolio into 3 key areas. Number 1 is firefighter safety. Firefighter safety represents about 40% of our business. We're #1 in the world when it comes to protecting the firefighter from head to toe. We're #1 in helmets, #1 in breathing apparatus, #1 in turnout gear and their clothing. There are moats around that business. There's high barriers to entry and standards and regulations. Just in the North American market, we had 6 competitors in the fire service market. About 10 years ago, today, we only have 3. Really tough entry, really tough standards to meet. We have very strong market share, which provides us with good pricing power in the space. And we continue to gain market share, 1 out of every 2 breathing apparatus deals we sell are competitive conversions. So we continue to eat in the market share. We've expanded that into the international market, where we're doing quite well internationally. Recently won the London Fire Brigade, which will help us in the U.K. fire service market, along with some other opportunities that we have going there. The beauty of the fire service, which represents 40% of our business is that it runs on a different economic cycle than the rest of the industrial world. So we're categorized as an industrial manufacturer. But the fire service market is supported by municipal budgets, federal budgets, state budgets and then local fundraising. And if there's an economic downturn, this business doesn't get impacted. You go back and look at '15 and '16, '15 and '16, our oil and gas business got slaughtered like everybody else's. But our fire service business filled the gap and our top line revenue didn't decline. So while we're dedicated to safety and when our feet hit the ground in the morning, we're thinking about protecting workers and developing products to do that, we diversify our business by market, geography and products, and we're very conscientious about what we do with the fire service market because we know that's a real good buffer in an economic downturn. Pipeline for this business remains great. Backlog for this business is very good. Gas Detection business break -- that's about 1/3 of our business, break that into 2 categories. There's fixed gas and flame detection, fixed gas and flame detection. Those are products that you install to protect assets, infrastructure and the environment. You typically put those in place, they stay in place for about 15 years. They're engineered in to protect those assets, have about a 15-year life, you replace sensors every 3 or 4 years or we upgrade those products. And so it's really stable business that's used from anything from the Library of Congress, where we sell a large number of CO monitors to protect that asset, all the way up to the space station where we sell hydrogen detection to protect the space station, then obviously oil refineries, pipelines, et cetera. And then there's portable gas detection. Portable gas detection are the detectors that you hang on individuals who may be going in the confined space, working in hazardous environments, that business is about $150 million of our business. The fixed gas and flame is around $350 million of our business. Obviously, all global. Again, high technology, a lot of patents around this business. Key things that customers look for is response time and sensors, right? You want to get a quick response time to know if there's a combustible gas in the environment or high levels of hydrogen sulfide, long-lasting sensors. Sensors that stand up and don't have to be calibrated every week or every month because that's time and effort. So we build in technology in these products to solve some of those problems for our customers. We've recently -- oil and gas is a heavy part of this business or a strong part of this business. We recently made an acquisition of a company called Bacharach. Bacharach uses similar technology, but they sell into different markets. So the -- what their market strength was HVAC refrigeration. So it was our play to diversify away from oil and gas and get into more of an environmental play because a lot of the refrigerants are bad for the environment and very expensive. So people like Whole Foods, they don't want to lose that product when they're refrigerating. So that's what Bacharach does quite well using similar technologies. We had about $10 million of business in that space. We thought either invest in it or diversify it or sell it off. And so we decided to invest in that area, and that's been a real nice acquisition that's been accretive to our margins and our profitability, and there's some nice opportunity for that business as we go forward. And then there's the industrial PPE business, which represents about 28%, 30% of our business. That's hard hats, industrial head protection, fall protection, air purifying and respirators. So that business, we have really strong market share when it comes to head protection. What I'd like to tell you to do is take -- when you're out walking the streets or you see Con Edison working or some of the other utilities look for the V on the top of the hard hat, that's the MSA V-Guard that's trademarked. Clearly, the most popular hard hats sold in North America and the world. We logo over half of those. So we logo mass customization of millions of hard hats that come out of our plant in Murrysville, PA. We do that in 3 to 5 days. And really, our competitors have a real difficult time to scale to what we have because of our market share in that arena. So the market share is really strong. Surprisingly, you would think it's a molded piece of plastic. Commodity item, it's not. When you go down to the oil patch or you look on construction sites, you'll see the V-Guard. The V-Guard is by far the most popular hard hat. It's part of the work uniform that you see industrial workers wear. And fall protection is our smallest category. That's where we're distant #3 on a global basis. Falls are the #1 killer of construction workers here in the U.S. We think that there's some opportunity to invest in R&D and come up with better solutions for customers and users to better protect their lives on the job site. So that's an area that pre-COVID we had 3 consecutive years of double-digit growth. Post-COVID, we're getting a little difficulty getting traction there, but I expect that business to come back as we go forward. From an ESG standpoint, you can look at this material and we have some really good ESG documentation. The 1 takeaway I'd like you to have from an ESG standpoint is we look at it from an ROI standpoint. So Stephanie Shull in the back of the room, -- she runs our ESG program. And the first thing she talks about when she talks about ESG is ROI. And we only go after areas where we think we can have good ROI as an organization. The second is women, women in our workforce, our diverse workforce. So as an industrial manufacturer with 42% of our executives are female. It's a great environment to work. It's a great environment where we don't have a glass ceiling. 3 of my 8 reports are female. We have 3 female Board members. And so it's a fantastic environment. And what I hear from investors who come through the facility, visit with our people on a regular basis is for a company our size, we have tremendous talent. And I believe that we'd never have the talent we have if we didn't have the women in our workforce that are motivated to help protect people's lives, from engineering to manufacturing. Across the organization, we have 3 plant managers that are female, all play really important roles in our company to contribute significantly. Business update. We had a pretty good third quarter, could have been better. Supply chain kind of nipped us on portable gas detection, I couldn't get some of those out because of electronic components, had a couple of other one-off charges up in ocost. But really good growth at 16% constant currency. We got peeled back by about 4% due to FX. Op margin, 19.7%, at 19.7% op margin in our business, I believe we can get up above 20%. And we're -- we said a trailing 12-month run rate was 18.4%. I think it was on that slide. I think that, that's representative of where we'll probably finish the year, and I think we can continue to improve that as we go forward. The backlog we have is at an all-time record. We got a backlog that's tremendous. So while we had tremendous growth in the third quarter, we're going into the fourth quarter with a super strong backlog. We expect that backlog to come out over the next maybe 3, 2 or 3 months, probably 3 months, we'll see that backlog start to come out. That's all supply chain that we're seeing having some challenges with, which is improving. We're seeing some improvement in supply chain, but that's not completely solved at this point. As I mentioned, we had some problems with portable gas detection. So key end markets are super strong. Business is really good whether it's the fire service market, oil and gas, we look at the oil and gas price, anything above $75 spend typically is pretty good in our space. As we go into '23, my guess is we're going to need about 100 million barrels of oil on a global basis. We'll see oil prices around $75. That business should be good. It's about 20% of our business. So when I look at the business, Fire service should be good, 40% of our business, oil and gas should be good going into next year. We've got a record backlog going into the fourth quarter, which I think will carry into 2023. So we're really focused on driving the incrementals and cash conversion as we go forward. So we think we're in pretty good shape. Pricing, we've done a really nice job on the price/cost equation where we have really done a good job in keeping pace with cost. And so we haven't seen any degradation in that margin piece. We've actually started to show the turn on the margins. We had a price increase on October 1 on a global basis, so we'll start to see that come through as we go forward. And with that, Rob, I'll turn things over to you for questions.

Maybe we would just stick real quick on the [indiscernible] business. So orders -- I mean, clearly some strength coming through in your commentary. Orders in the third quarter were up 20%. And I think even within some of the shorter-cycle businesses, EMI is getting closer to 50%, short-cycle was still pretty good. And I guess what's your confidence level around that part of the business? What's keeping it strong? And then confidence level on the shorter cycle as we go forward?

Sure. So yes, business has been strong across the board. It's surprisingly robust to us across the board. All of the market segments have been really strong. So when you think about our products, that fire service business, you have really good pipeline, a good look at the pipeline of the business. So when a fire department is swapping out breathing apparatus or going through an evaluation, that's kind of a long sales cycle. So we get to see that pipeline real well. And the pipeline for business and the fire service remains really strong as we go into 2023. The other area that we see good strength is in fixed gas and flame detection. Again, that's a late cycle product that you're putting into plants and facilities goes in at the end of those plants. And so the pipeline for that business remains well. So those 2 kind of late cycle or long sales cycle products are doing really well. Surprisingly, hard hats have done well. Hard hats is kind of the canary in the coal mine for us. That's the first product to turn down, right? If you're not hiring people or you're letting people go on construction sites, you're not buying hard hats. So that's where we typically see an economic slowdown first. We haven't seen that business slow down at all, as you saw in our revenue for that short-cycle head protection business. We'll go into a seasonal slowdown. November, December, January, February are typically about 15% lower than the other months of the year because of wet cold weather. But when you look at it on a comparison on a month-to-month basis, year-over-year, the hard hat business has been really strong for us. So we haven't seen any slowdowns at this point. We're going into '23 cautiously optimistic. When you consider the fact that we have a significant backlog, we just put a price increase through and the markets are pretty strong. We think that fire service oil and gas should be strong. What we do expect is the nonresidential commercial construction business will probably slow down at some point in '23. They'll wrap up some projects, and that will probably nip our hard hat sales and maybe fall protection sales a little bit. But what could offset that is if we see federal spending come down from the infrastructure spend. So we do quite well in the utility business or any infrastructure, roads, bridges, dams, you can't build anything without hard hat and fall protection. So that could help us as we get into '23, offset some of that commercial construction business.

If channel inventory started to anticipate any of that slowing Or where do you think channel inventory to?

So from an inventory standpoint with our channel partners, the only place you really have inventory is with head protection. Our -- the rest of the products are, for the most part, made to order. So whether it's a breathing apparatus in the fire service, a portable gas detector, a fixed gas or flame detector. All of those products are made to order with very unique configurations. So we don't have a lot of product within the channel with the exception of head protection, where we have just very strong share. So of course -- some of our distributors have the Chevron business or Con Edison business, they'll have hard hats in the pipeline. And that's not overstocked. They're pretty consistent with keeping up with that business and staying close. So we won't -- don't see a big destocking impact of our business when we go forward.

So your guidance for the fourth quarter kind of up low single to mid-single digit year-over-year, but that's -- that would be a record quarter revenue-wise for you. Where does your business sit right now from a utilization standpoint, production utilization standpoint, your ability to get more revenue out the door and so on beyond?

So we have plenty of capacity. We had this conversation earlier today in that. Capacity is not our problem. Our problem is supply chain. So if we can get the supply chain and get a steady flow of parts, we can go through that backlog in a couple of months, fairly easily. So that's not an issue for us. The only area where we have a bit of a challenge with capacity is in turnout gear for firefighters in North America. That's where we're paced a bit because of our scale, size of plant, that would take probably 3 months to work through and get in a good spot if we continue with the production levels we're at today. But for the rest of the business, we had a nice third quarter with breathing apparatus. So we could up that by about 50% by adding a shift or 2. We could get into a third shift and increase our capacity there. So capacity is not an issue.

The opportunity to gain share is I think you've proven that innovation in this industry can drive share gains, certainly seen it in the power service SCBA area but you've made some investments in and around gas detection. You mentioned fall protection is maybe slower to come around just yet. But where do you think you stand across your various businesses in terms of ability to capture share what you've captured year-to-date, maybe and it shows up in an order rate that's -- I think your orders are pie-teens or something?

You are right. Yes. So we feel we have captured share. And really, the way we capture share is finding those solutions for our customers. And customers are willing to pay up for those solutions. So for instance, in the construction arena, in the construction market, OSHA is all over construction companies due to heat stress. A lot of workers have been going down with heat stress. And so they're doing a lot with fluids replacement. But 1 area is how do you keep a construction worker cool? Well, we've got a hard hat under head and we just introduced the C1 helmet. C1 Helmet has an aluminized interior of the hard hat. It reflects the sunlight and sun heat and it reduces the temperature inside the hard hat by about 20 degrees. We charge 3x our standard hard hat for that hard hat. And we have customers buying that because they need to keep their workers cool and highly productive. And so we're able to sell a product and get a healthy margin, more dollars out of it and obviously protect the worker. So we look for those opportunities where we can find better solutions to protect workers and obviously increase our share and our market position. And we think that we can do that across many areas of our product line, finding those unique solutions. When you get from a technology standpoint, what we can do around gas detection, as far as quicker response time and lower levels of maintenance or increased worker productivity by reducing documentation that a work site has to go through for a worker can certainly help us from a competitive standpoint.

Maybe just walk through the demand environment that you're seeing geographically as well. Maybe it's a little -- my sense was it's a little more mixed than what we're seeing domestically, although Asia, I think, is perked up a little for you, but Europe, a lot of people are watching as well, your exposure there in Western Europe, which products where you have that exposure?

So the North American market has been really strong. So from an incoming bookings basis, North America, Latin America business has been good. Latin America as opposed to North America, is really more base material focused, right? So you think about Mexico, Chile, Brazil, Argentina, you had a lot of base materials there. And that business continues to do real well for us. So a lot of head protection, portable gas detection, fall protection in those markets. That tends -- is doing well. The Middle East is really strong with oil and gas. That's a strong fixed gas and flame detection market for us. In Asia, as you mentioned, continues to be a real good market for us. We're starting to see some nice orders come out of China for the fire service. We do -- we have a nice position in China across all of our business, but the fire service business, in particular, is pretty strong in China. And that business was delayed due to COVID, and we started to see those orders flow in. Where we are seeing some slowdown is in our Western Europe industrial business, as you would imagine, right? So the aluminum plants, which are energy-intensive, the fertilizer plants, which are also energy intensive, those businesses are not competitive today. So we're not seeing as much product flow through those businesses in Western Europe. So we're seeing a bit of a slowdown there. But what's surprising with Western Europe is the fire service market, right? So we have the London Fire Brigade order, which we just won, that will ship some in the fourth quarter, mostly in the first and a little bit in the second quarter that fire service business continues to do well, even though the municipals a little bit weak. So we hope to see some volume come back in Europe. We've done a lot of hard work in getting our cost structure in place. We've gone through and done a number of restructurings over the last 4 years. We think we have our cost structure in place. We have a shared services center that we've set up in Poland, getting that up and running. So we think we're in a good position to get those margins back up into the mid-teens, where we've seen that drop off because of the volume and obviously the FX rate. So we do expect to see some improvement in Europe as time goes on.

So the London Fire brigade, I know that was an opportunity that you've worked over a long period of time. I guess the question often comes up, though, how willing is other -- how willing are other regions to pay up for the technology MSA provides in the fire service relative to North America? You just mentioned China as well, starting to perk up. So how are you hitting those markets with different features, different price points versus what you serve in the USA?

So the U.S. market, the breathing apparatus in the U.S. is the G1 breathing apparatus, which is a device that sells all in with spare cylinder facepiece, ballpark $7,000 a unit, depending upon the configuration, et cetera. The European device is around a $2,500 device. It's not as sophisticated as a North American device, but it's modular in design where we can add some components to it. So we developed the M1 breathing apparatus very much to go after that space, and we've had a lot of success. So London is the first apartment to fall in the U.K. for us. And now that we've got London, where we have several other evaluations going. We think we'll have some success there. And London has the footprint and profile where we have a number of departments around the world who look to that win and really want to take a hard look at the M1 breathing apparatus. So it is opening up some other opportunities for us beyond Western Europe in the parts of Asia and some other areas. But yes, in the China market has been strong for us for about 4 or 5 years. That continues to go well.

Mission was to flip to the discussion around margins. The -- you've seen a positive trend in gross margin moving through this year. It started out with supply chain challenges, price costs, et cetera, just kind of weighing on that. Those have started to correct. Where you exited, I think, in the third quarter, there were some charges there. But -- in the gross margin, but -- or gross profit. But if you pull those out, I mean, your gross profit was around 46%, which is a high level. And you got the sense you're still not optimized there. So I guess, how should we think about gross margins going forward, puts and takes against that where the upward biases could come from? And is there anything else in the 46% that maybe wouldn't repeat or that was a good guide?

No, I think when you look at the third quarter, it's indicative of what we can do, and I do think we can do better. I believe that this business -- we can pick up a couple hundred basis points of gross margin in the gross profit line with a little better pricing. We can do a better job with some of the spares and some of the new products that we introduced. The connected worker. And as that business grows, that should give us some wind to our back on our margins. And then on the SG&A side, I think that there's some opportunity there. We've done a nice job of taking SG&A down from 27% to 23% in from maybe 15% till today. We think that 90% of our business is on SAP, and we just put Oracle in place. So -- and CRM is ramping up as we Salesforce. we think we can leverage a lot of technology that we have to continue to scale from an SG&A standpoint and hopefully get a couple of hundred basis points out of SG&A. So as we go more towards our shared services model that we developed in Poland, and we execute in that area, I think that there is some opportunity there. So I do see the business model -- I certainly don't expect 16% growth quarter-over-quarter. As you go forward, that's not what you invest in MSA for. You invest in MSA for low, mid-single-digit growth and we can leverage that to the bottom line on the margin side. And we think that, that holds true as we go forward in the business because we bring tremendous value to our customers.

That SG&A leverage and the opportunity to do better on that front. Should we -- should that be biased to the international part of the business? Because I know there's a concerted effort there to improve margins. If you got right now, maybe a little bit of an FX challenge to work through as well? And I'm curious how you're addressing that or plan to?

There's a little more in international, but there's certainly opportunity around the world. There's opportunity everywhere from an SG&A standpoint to better leverage the systems that we have in place.

What would be an expectation on international margins over the next, say, 12 months from where we sit today?

Longer term, I'd look for margins in the international area to be in the 15% range. We'll get back up into that range.

Speak just a second around some of the innovation efforts. You touched on it just briefly around some of the connected products, but that was a bigger push to get some new products into the market on the connected side, connected worker side. Can you talk about the uptake there, what you've seen from those? Because those tend to be in the gas detection area, and you're starting to see an up cycle where you think -- I'm detecting from your comments some more strength in that part of the business, how those products are being received?

Yes, specifically to the IL-4. The IL-4 is our latest connected product device, which is a 4 gas -- a portable gas detector. And that is really a product that should catapult our connected worker platform and recurring revenue, which we call MSA plus. So it's part of that whole ecosystem of MSA plus where we think that product will do a really nice job of not only better protecting the worker, but also making the worker more effective, efficient and documentation easier for the employer. So if you think about a portable gas detector maybe about the size of a cell phone, today, when a worker goes in, if there's an outage at a facility, you're at an oil and gas facility and there might be 150 workers that need to wear a multi-gas detector. They come into work, they punch in, then they go get their gas detector, they have to stand in line. and you have 150 individuals waiting in line, while somebody either on an Excel spreadsheet or a piece of paper, they're writing down that you got the 4XR serial number this. Your name is Nish Vartanian, it's been calibrated, you're good to go. Go ahead. You could wait for half an hour in line and that's not productive time for anybody. With the IL-4, you can take the device out of its charging station, tap it to your badge, that unit is now assigned a Nish Vartanian, you go to work. All the documentation is right there. When we show this to industrial safety and health managers, they just look at us and say, that's a game changer. That changes everything from a productivity standpoint, and we want in on that. So when we look at the pipeline and opportunity for this product, that's scaling up significantly. The take-up will be a little slower because obviously, it's systems, IT, you're going to work through their IT group, but we're really optimistic about what that product is going to do from a productivity standpoint for the plant from a documentation standpoint for the safety manager and safety program and obviously, protection for that worker.

Excellent. Well, we're out of time, so we'll break there. Thank you, Nish.

You bet. Appreciate it, Rob. Thank you.