MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Excellent. My name is Robert Lariviere. I'm Managing Director on the Investment Banking side from Morgan Stanley. This session is designed to introduce both Nish and Lee from MSA Safety. Both have an extensive background with the company. Why don't you give a little bit of an overview on MSA because I think this is the first time in at least in a couple of years we've had the company come present? And we can go through. I have a few questions, and I'm sure some others do as well. But Nish, do you want to...

Sure. Thanks, Robert, and thanks for coming to the conference today. Just a couple of quick things on MSA, key takeaways that I'd like you to have before we get into the question-and-answer session. Number one is MSA is a mission-driven company. We recruit, retain and motivate our workforce through the MSA mission of protecting lives of workers around the world. We -- that's a single mission that MSA has had in 109 years, and it's the mission that drives the organization today. When we get out of bed and our feet hit the ground in the morning, we think about how we can come up with greater solutions for our customers to help protect lives and get people home safely at the end of the workday. Number two, the way we get that done and drive the performance of the business is by staying close with our customers. Getting voice of customer and everything we do is essential to our success. And finding solutions through the voice of customer and investment through R&D, we spend about 4%, 4.5% of our revenue in R&D over the last 12 months. That's about $70 million to come up with exceptional solutions for our customers' greatest challenges. And when we do that effectively, we're able to drive a good margin profile business. So our op margin runs at just over 21% over the trailing 12 months. EBITDA, adjusted EBITDA runs at 24% for the trailing 12 months. And really, that's a result of coming up with fantastic solutions for our customers' greatest challenges. And number three, the business, while we're focused on safety and that's all we do, the business is diversified by product, by market and by geography. And we try to find a good balance in that so we can have resiliency in the product portfolio through economic cycles, which has proven out quite nicely here in this economic cycle as the business continues to strengthen.

That's a perfect segue into the first question as MSA's had a really good start to the year. As you look out both in terms of the medium term and long term as you look at the overall demand drivers and the mix across the portfolio on the fire safety side, the gas detection side and industrial PP&E, what's kind of your outlook? What are you hearing from customers?

Yes. The exciting thing for the businesses is that the fire service business, as expected, continues to be very strong. We expect that trend to continue through '23 and into '24. There's nothing that indicates that, that business will soften. That business is driven primarily by local funding, state funding and federal funding, and that funding is in place and well established. And we think that, that business will be healthy regardless of the economic cycles we may go through. And that represents about 40% of our business. In the detection business, the detection business continues to be solid across the multiple industries that we serve with that business. The margins continue to be strong and the growth continues to be solid in that area. Most surprisingly for us is the industrial PPE business, and that represents the smallest part of our business, about 27% of our business. And that business has been stronger than we anticipated. Coming into 2023, we expected that business to turn down with an industrial recession of some sort that was anticipated for '23. And that business has been more resilient than anticipated, which has been a bit of a surprise for us on the upside, which has been positive for the business. So that business, we still anticipate that slowing down some as we get into the back half of '23 and into '24, but that hasn't proved out yet.

And we were catching up a little bit on this last night. How are you seeing inflation impact the business as well as the ability to pass through pricing?

Yes. So inflation has certainly been challenging the last couple of years, I think, for every business. But we've handled it quite well. Fortunately, we -- the business Nish just walked through, we have a pretty good market share in almost everything we do. So in many cases, we're leaders in those space in terms of what the product solution is. So we've been able to go to market in a way that we can, in many cases, cover that challenge of inflation. And as we look forward though, I think we're looking at more of a normalized version of inflation. There's certainly some things that are down, but things like labor and some of the other transportation exactly that are up. So it's not hyperinflation but it's not deflation. It's going to be more of that. So that all fits into a scenario where I think we feel pretty good. It gives us then a platform to really bring other elements of our business system to life and continue to work on moving our margins forward here. But I think it's gotten everyone, it's gotten us, it's gotten, I think, a lot of companies in a position where we understand where all our costs are certainly more than ever before, and we can pivot and navigate as different things come out as today. I think we certainly leave kind of this COVID era in a more capable place and then we're focused on moving forward.

And that kind of naturally dovetails into the supply chain question. Any key lessons learned? And kind of how does the business stand today versus perhaps 18 months ago?

Yes. Well, I think it's a continuation of what we're just talking about here. We were in a pretty good place. But if you go back to the mission, what we're here for is to keep people safe. And we run the business with that mindset, so having a high fill rate is critically important, it keeps people safe, keep buildings safe, keeps the environment safe. So we certainly have adapted. We have certainly more information available to us than we ever had before. And we've made some supply chain adjustments. So we have -- we've made a different decision today on what electronics, what chips we use in some of our solutions. We've redesigned those products. And instead of just maybe softening for the immediate solution, we've given ourselves flexibility so we could have a couple of different chipsets work in our solutions and things like that. But we have a model where what we design, what we bring to market, we can make what we bring to market. And we're constantly refining our manufacturing footprint. But we feel like we're in a good place, that no matter what happens to the supply chain, the supply chain has calmed down. A year ago, it was unpredictable. Today, it's not where we want it to be but at least it's predictable, and we can make -- we can deliver our commitments to our customers.

Yes, that makes sense. And pulling yourselves back, as we think about and frame particularly for new investors, what are some of the mega-trends that are impacting the business and demand over the next couple of years?

So clearly, safety from an ESG standpoint and a secular standpoint is more important today than ever. And there's not a CEO in the world and the CEO letter does not mention their safety record and the safety of their employees. And so when you think about the spend around safety, there's a high focus around higher protection levels for workers. And whether it's a firefighter, and we talked about the funding for firefighter, there's not a municipality in the U.S., certainly or Canada or some other areas where the city fathers would pull money from protecting firefighters, protecting the protector, so to speak. They'll find other areas in their budget to cut. But when it comes to time to buy PPE for firefighters that protect the citizens of the community, there's always dollars that are found. So from a secular standpoint, within the fire service, the funding continues to be very strong. And then across all the industries, all the industries that we serve, there's a real focus on higher levels of protection. There are some solutions we're bringing to market. One of the biggest challenges now in the industrial environment is heat stress, heat stress for workers. And so we've developed a product that reduces the temperature inside the hard hat by 20 degrees. We got a price premium for that. It's a patented hard hat, and bringing those solutions to our customers helps in those secular trends.

It's almost like you know the questions I'm going to ask next. So you mentioned at the beginning R&D is about 4% or so of overall revenue. And from everything outside looking in, innovation's at the very core of MSA's DNA. What are some of the key areas outside of the one you just mentioned where you think there is that new product development, where there is that new investment return opportunity?

Well, a keen area of focus for us has been around the connected worker. Connected worker, in the past, probably 85% of our engineers were mechanical engineers. Today, half of our engineers are software and electrical engineers. And finding solutions around the connected worker does help us to make safety simple for the customer. So from a documentation standpoint and efficiency standpoint and higher levels of protection, getting better data around what the detectors have seen or monitoring usage of the product all leads to a safer work environment. So there's a lot of investment around the connected worker today that will certainly help us in the future with our business and help protect workers.

Are there any alternative revenue models? Any recurring subscription services that could be weaved in over time with some of the connected solutions that are being considered?

Yes, it's a good thought. So I think you go with what Nish just talked about, we brought to life really across the entire platform this cloud-based software capability. And how it plays out is debated. I think we've gotten the roots in place in all these businesses. So today, directly linked to your question in the industrial space, not surprising, probably willing to move into this opportunity a little bit more. So today, we brought to market just about a year ago, io 4, which is a multi-gas portable gas detector worker wear. It is fully connected. It's kind of our -- it's our best multi-gas detector. Why it's being used, everything is being tracked. So I know hours on it. I know I can keep track of who's using it, who used it today, who used it yesterday. When does it need to be -- go through service? But it's also we brought to market through what we call MSA+. MSA+ is essentially a subscription-based model. So we can offer 3-, 4- or 5-year agreements. And for those of you who know that market well, it's an interesting offering, right? So I can -- if I'm not familiar with MSA, I don't have to make some type of big capital decision. I can make a trial out on some of this product and bring it to life. And what do you get? You get assurance. I pay this amount and you get essentially something that's always going to work. It stops working, you get an immediate replacement and things like that. So that would be, I think, on we see a lot of potential there is going to come into place early. It's about a year into it for us, but it's one of those things where every month, it's kind of growing exponentially. And so that will be something I think we'll start talking about in the coming year as well. So I think it's everything from there all the way back to the wins we've had in fire services. And I get the question a lot of times about how did you win the London Fire Brigade when you didn't really have share there? And they'd say, well, was it because of the SCBA? Was it because of the fact it's cloud based? Is it because everything in between? The answer is all of those things. And so I think again, these roots are in the ground, and it come out as a completely different revenue model or it's going to help us, frankly, sell even more of the traditional products we have today. But again, those traditional products are fully connected. We're collecting all that data and we can aggregate even a better solution going forward.

Getting a real sense of a solution ecosystem with connective tissue and technology across the entire portfolio. Definitely hearing that. How about on Bacharach? There've been a sizable contract on the refrigerant detection side. How has that acquisition played out here? Any key lessons learned?

So Bacharach's been an excellent acquisition for us. It's an area where we saw an opportunity to expand our total addressable market and then expanding into an area where we had a small piece of our business. So it's the HVAC refrigeration market, where we had about $10 million of revenue in that space. And we just saw Bacharach as an opportunity to add a $70 million acquisition into that space to really strengthen our position within HVAC and refrigeration. Refrigeration piece is an interesting play in that it's an ESG play from an environmental protection standpoint, where the refrigerants that are used for cooling refrigeration systems are bad for the environment and also very expensive. So the users of those product don't want to lose the product that's doing refrigeration work to protect the environment and also from a cost standpoint. And so Bacharach comes in and monitors those refrigeration systems for them. And it's turned out to be a nice margin business for us with a lot of upside. So when you think about application, for instance, Whole Foods is a very big customer of ours. Walmart is another customer. So there's significant potential for upside with that business as we look for opportunity to expand what we're doing in that area.

And does the success of integrating and bringing Bacharach into the portfolio, does that change your thinking or reinforce your thinking on M&A and future capital allocation going forward?

Sure, it does. So it opens up the avenue within the refrigeration market for more opportunity in that space, along with some other areas. So when you think about the traditional detection business that MSA has, and we were fairly narrow in our thinking and strictly in industrial detection. And now this is broadening our thinking into more retail space and into the restaurant, the fast-serve restaurant is another opportunity for us. And so it obviously opens up some opportunities for us in some other areas.

And Lee, maybe this is a question for you. How do you think about the trade-off between organic investments and inorganic M&A-related ones?

Yes. So that's a good question. So I mean, I think fundamentally, we're initially focused on organic. If you look at our history, it's what we want to do. We want to -- we talked about this a little bit before. We want to grow mid-single digits organically. We have really nice incrementals, 30% to 40%. And the businesses that we're in today, really good businesses, very strong cash flow positive businesses that enable us to do acquisitions. And we've done 4 acquisitions in 5 years and they've played an important role. If you look at our growth over the last several years, a couple of points of growth will come from those acquisitions. But again, it's on top of this mid-single-digit organic orientation. So it's important, but I also think, again, think about who we are. We're a safety company. We bring a lot of discipline to what we do. It's got to be the right acquisition. It's got to be a complement to the businesses we have today. It's either going to accelerate us from maybe a geographic perspective, maybe a technology perspective. But we're also very disciplined. We don't reach -- if you look at the deals we've done very quickly, we've got them to be accretive and created a ton of value. So a little bit toward [ Nish discussed ] before, if it's clearly in this widening detection space that we're focused on in terms of all these markets, certainly, the fire services and then there could be an opportunity also in the fall protection business. That's squarely where we're focused and we're engaging accordingly. And if something comes available and kind of hits all those thresholds, we would do something. But we're not looking to do something, we're trying to find the right thing to add to the portfolio.

That makes eminent sense. So on the competitive side, as you look across your 3 markets, how would you guide investors, new and current, to think about your current competitive set? And then what sort of investments are they making in each of those respective markets?

Okay. Well, I would say this. For -- since 1914, we've been focused on safety, and that's fundamentally what we've been doing. The last -- I can speak to the last 5 years, the last 10 years, we've watched others come into the space with a similar level of interest. And it's been good for us because they're large companies that probably helped us even be more focused and maybe even go a little bit faster. I think we've all found a good space. We certainly -- if you look at the last 5-year track record, we leave in -- we're in a pretty -- our share is in a very good place. It's continued to mature. And we've also, again, benefited from them being in that space. I think as we look forward here, we have -- almost every business is either kind of #1 or #2, and we have -- where businesses aren't, we're focused on growing it even more.

And just to add to that, we really look at staying close to the customer. I'd just bring you back to, our success is around staying close to the customer, finding their pain points and in finding unique solutions for those customer pain points. That's what's driven success for MSA, and I believe that, that will continue to do so in the future.

So switching over to revenue and margin targets. I think historically, MSA has talked about mid-single-digit revenue targets in the past. What gives you confidence in that? And then with all of the secular growth themes that we've talked about so far, what is in the art of the possible?

Okay. Well, we'll give some general guidance today on the live stream. We've made some good progress. Actually, I think if you go back a few years ago, we talked about we had more of a history of kind of low single digits. And then we've made some nice progress in the portfolio that we now talk about, mid-single-digit growth. And you think about how that breaks down, I mean, the fire services businesses, as we talked about earlier, pretty resilient, has the capacity to kind of be in that mid zone. The detection business has an opportunity to be, on a day in and day out basis, higher than that. So there's been a purposeful shift in the portfolio to bring that further forward. It also has some nice margin dynamics and things like that. The industrial worker, that can swing a little bit. And so when things are going well, like in terms of the macro, that can be enhanced there, it can also sometimes be a little bit of a pullback. But that's the balance today. I mean when we look forward, there's an element of price, there's an element of GDP. And then that's what we're doing with innovation and with just growing the business. The investment thesis for us based on those markets is mid-single digits. Obviously, when we're performing at our best, it could be more than that. But I think that's our mindset. When we look out the next couple of years, what's so nice about our portfolio is it's very sticky. That fire business, the fixed gas business, really no matter what happens in the macro, we have proven to be very resilient there. So I think that's our comfortable level as we look forward. If the macro cooperates, maybe it will be a bit more, but that's the mindset and that's what we commit to the -- to our investors.

And then front-running some questions I expect we'll get later on, how does that then dovetail into margin targets over time? Is there additional room to drive incremental margin going forward?

Yes. So I mean, I think I'll bring that to life under our business system. So we've talked about this a bit more this year. It's been going on for several years. This mindset, if you think about the business system of behaviors, processes we're bringing to life across the organization, it can help us in price. It can help us with operations. It can help us with our SG&A efficiency. If you think about those incrementals of 30% to 40%, our mindset is those come to life with both a gross margin enhancement and it's the further progress with SG&A. We've moved the margins from, if we go back not too long ago, low double digits to the teens. We've crossed now into the low 20s. Our mindset is to continue to make progress on that over the next several years. And again, it would be a nice complement of both the gross margin and SG&A for us.

Excellent. Now the natural question, given all of the noise in the macro economy, what's your downturn playbook in the event there is a recession? Albeit right now, it looks like we're on pretty steady footing. But if it does happen, how do you think MSA would respond? How do you think you would weather it?

Yes. So let's continue with the resiliency theme. So this is what's interesting about us. We're not your average industrial company. We don't just kind of ride with the macro market. You're getting this resiliency of the fire business, the fixed gas business. I mean we just have also a very sticky relationship because of safety. Safety is not something you just turn off because the macro changes. In those scenarios, we're not typically managing any significant swings in revenue. If you actually go back to some of the more challenged times over the last 20 years, we still have actually netted, in many cases, to a positive growth scenario. So that gives you some flexibility out of there. And then we flex the business like you would expect us to do. We know what's expected here. We look at -- we have variable costs in SG&A, we can move. We can go back to the COVID era. When the growth slowed down, we flexed. We did all the things you would imagine you would do with indirect costs and making sure we realize all the benefits in operations. In many cases, we're able to either maintain or actually enhance our margin rates even in that challenged time frame. That's the playbook we have. It's interesting. This year, depending on who you listen to, you assume doom and gloom for '23, and we have a playbook for that. And then we also had a playbook for what happens if we ended up at double-digit growth. I'm glad we used that playbook this year, but we're prepared either way going forward.

So lining up with the double-digit growth playbook, you joined us from South America. Any thoughts that you could share with investors on what you're seeing and what you're hearing most recently from that trip?

Yes. So last week, I did business reviews throughout South America and just really a lot of excitement around the business. There's a lot of enthusiasm, as you would imagine, in the areas where there's mining, whether for lithium in Chile or the business that we're seeing in the fire service business. The team in Latin America has done a fantastic job in our go-to-market strategies and realizing some good growth, margin improvement. And they don't see any stop to that as they go forward into balance of '23 and into '24. So there's certainly a lot of enthusiasm around the business in Latin America, which is it's an important part of our business. We've been in Mexico for over 65 years, and that business with pretty well diversified in the mining industry. PEMEX and, of course, general industrial business. The team has done a really nice job in diversifying that business and had a real nice margin profile.

Excellent. Well, I think those are all the questions that I have. Any questions from the audience for either Nish or Lee?

[indiscernible] maintaining high growth rate. [indiscernible] What does that mean?

Yes. So I'll repeat the question so quick. A little discussion around just our mindset around fill rates, maintaining good fill rates, improving fill rates and also what happened with working capital. So again, I'll come back to what you'll hear everybody talk to Nish and I and anyone on our team, we'll keep talking about our mission of keeping people and keeping facilities safe. So we definitely orient towards that. We want to make sure we can serve those customers because it's critical to them. So we certainly invested in inventory during the supply chain challenges the last couple of years, and that enabled us to do a fair job, we'll say. We avoided any big disasters. But as we look forward here, we certainly entered '23 with an elevated level of inventory. And we -- I talked a little bit earlier about our business system and just bringing more focus on how can we be even more efficient. But we did -- when we think about inventory, we did that with an absolute mandate it would not come at any expensive fill rates. So this year, we've made some good progress, even probably progress a little bit faster than we imagined on getting working capital more efficient. We've done that without any impact to fill rates. And in many cases, we've actually made some nice progress. So it's -- how do you do that? Well, you do that with following the data and making sure -- I mean, honestly, clearly that the mission's understood that we would never jeopardize serving the customer to make -- to get inventory into the place that we want to long term. We think there's a couple of years of runway accordingly on working capital, including elements like inventories. So we'll do that again with the balance of the mission in mind as well.

So what's interesting, when you think about the business too, with the nature of the business, it's very sticky and it's very difficult for our customers to switch products from brand A to brand B. And delivery, if you can't get product in their hands, forces one of those issues. And when you think through even an item that some look at as a commodity item such as a hard hat, the requirement within our industrial customers is OSHA requires training on the hard hats specific to the manufacturer of the hard hat. So if they buy another hard hat and you're a large industrial user and you have 15,000 users of the hard hat, you have to train your employees with -- on that other hard hat. So it becomes very expensive for our customers to swap out product, which makes the product very sticky. And so we're willing to take on some more inventory to make sure we can get delivery to our customers, to please those customers and not cause them pain to have to change our product. So with our margin profile, we can certainly afford to invest in inventory to make sure we please those customers for the future.

Any other questions from the audience?

[indiscernible]

It is, yes. You'll see the resiliency within the U.S. markets and outside the U.S. across our product portfolio, including fire service. What's interesting when people talk about resiliency within fire service, brand matters a lot in the fire service. At MSA, when you look at our brand across the 3 important areas or key areas in the fire service, the breathing apparatus, the helmet and the turnout gear, MSA has a leading brand in those areas throughout the world. And so our brand is quite strong in the fire service business, which really helps us from a resiliency standpoint and market share throughout the world.

[indiscernible]

I'll repeat the question. Just regulations and how important it is in the product across that.

Tremendous, yes. So the -- there's a lot of moats around the business in that there are standards and regulations for all the products that we sell. And some of the most challenging standards to meet are NFPA standards for the fire service. There's actually 2 standards that impact breathing apparatus. One is NIOSH, which is National Institute for Occupational Safety and Health. OSHA requires that a NIOSH-proofed breathing apparatus be used. And then NFPA standards, which bring those standards to a much higher level of performance. And to meet NFPA, you must also meet NIOSH requirements. So across all our product lines, there's a lot of standards and regulations to meet. So for instance, with NFPA-compliant breathing apparatus, there were 6 manufacturers in that space. Today, there are 4. A couple of them dropped out because the standards are very difficult to meet. There's a lot of costs involved from an engineering standpoint to meet those standards. So there's some nice moats around the business in all of our product categories.

[indiscernible] how do you add value [indiscernible].

So that is one of the key areas. Lee, maybe you can add on after I make my comments. But typically on the acquisitions, obviously, we stay focused on our mission of protecting lives, and we like to expand that total addressable market as we've done with Bacharach. We do like to acquire leading brands with a strong position in the marketplace where we think we can make that organization a better company or somehow, they can improve us as an organization.

Yes. I think to Nish's point, we're disciplined in what we do, so we look for companies that have a true advantage. And frankly, they're going to accelerate maybe what we're already doing today, but it has to be near and dear to what MSA is about. And obviously, with that said, we certainly focus on the core principles of acquisitions, focus on the value for us, make sure it very quickly becomes a positive contributor to the MSA story here. M&A success. Well, certainly, I guess there's a strategic side as well. We'll start with that in terms of making sure it aligns to the mission. And then obviously, financial, we want it to be certainly by year 3, really above our cost of capital and then really moving more into like how do we get it up to low double digits over the 5 years.

So with that, I think we'll have to close out the questions. But Nish and Lee, thank you very much for your time today and to the audience as well.

Thank you.

Thank you, Robert. Thank you.