MSA Safety Incorporated (MSA) Earnings Call Transcript & Summary

Thank you for joining us for the MSA Safety presentation. I'm Rob Mason, the senior analyst at Baird, covering advanced industrial equipment, which also includes MSA Safety, which is a leading provider of pure -- in a pure play of sophisticated safety equipment products. The company targets high-end personal protection application in 6 core product areas in which it has leading market shares and where it's earned tremendous brand loyalty from its customers. So with us this morning, we have Nish Vartanian, who is the Chairman and CEO of MSA; and Lee McChesney, who is Senior Vice President and CFO. Both up on stage with me, I should mention Steve Blanco, the President and COO, is also in the audience with us and then as well as Chris Hepler who heads up Corporate Development and Investor Relations for MSA. Nish is going to open and Lee as well will open with a few comments, and then we'll be able to take your questions up here on stage. And if you have any of those, feel free to send those up via the iPad. So Nish, I'll turn it over to you for a great few remarks.

All right. Thanks, Rob, and thanks for your interest in MSA and taking time to get to a little bit -- get to know a little bit more about us. Excellent. And the -- before I get kicked off, just a couple of quick words about MSA, a few takeaways for you before I get into the presentation. Number one, we're a mission-based company. So our mission is that men and women may work in safety and that they, their families and communities may live in health throughout the world. That's been our mission for over 110 years and that hasn't changed. We recruit, retain and motivate our workforce through that mission. So we get up in the morning, every day, our feet hit the ground, we think about how we protect people and how we protect the environment. And so that's number one. Number two is, while we're focused on safety, we're very diversified in the markets we serve and in the business that we have. So the business is very durable. Number one, the largest market segment we have is the fire service market, which represents about 37%, 38% of our business. That's with the funding there is municipal funding, municipal-based funding, recessions, industrial recessions really don't impact that business in the business cycle. We've got a strong #1 position in protecting firefighters head to toe on a global basis. The second segment that's important to us is detection. So that's looking for, smelling for, listening for gas leaks. Those gas leaks prevent hazards from getting into the environment and also protecting individuals. And those products are used anywhere from utility plants, underground mines, refineries, chemical plants, pharmaceutical facilities, refrigeration systems where we protect Freon, where you have refrigeration. And that's a segment that also represents about 35% of our portfolio. And the last part of our portfolio is industrial PPE products, that's industrial hardhats, fall protection, respiratory protection, and that represents mid-20s of our portfolio. So really well diversified in the products, geographies, markets we serve. And then the third component is as you look at our balance sheet, it's really strong. We're in a strong position with the balance sheet to continue to invest in this business as we go forward. So we're well positioned, we believe, going into what could be a recession or if nothing else, an economic slowdown, we think the balance in the portfolio protects us really well. Next slide. Just real quick to remind everybody on safe harbor, safe harbor, and this is also being webcast. Just a quick reminder on that before I get to the next slide, next slide, Lee. Revenue, about $1.7 billion, margins, 46.7% on our gross profit. We work really hard from a continuous improvement standpoint to improve our business from a margin standpoint when we get to the MSA business system. Adjusted op margins have improved nicely over the last few years. We reinvested in this business through R&D. We really work hard to find unique solutions to our customers' progress. So when you go through our product portfolio, we have a number of patents, typically, we get 20 to 30 patents per year. We have over 200 active patents today. And that R&D piece is critical for us in getting new products to market to solve customer problems to gain some market share. Over 5,000 employees, we paid a dividend for over 50 years, I believe, 54 years and running now an increasing dividend. So really a resilient market. Next slide. As I talked about with the segments of the business, the fire service market, we're #1 across the board in these product categories that we serve, self-contained breathing apparatus, thermal imaging cameras, fire helmets, turnout gear. We have unique distribution on a global basis to penetrate markets. We have a discrete sales force that sells specifically to the fire service as we take those to market. The gas detection business, we -- that business started in the underground mines with the rest of our business where we're looking for methane and CO. Today, as I mentioned, we use those detection products in a broad range of areas in odd places like the Smithsonian Institute all the way up to the space station where we're looking for hydrogen leaks up in the space station for NASA and other unique applications like that. We continue to innovate within the gas detection area. Some of the key things that customers are looking for is quick response time on sensors, longer-life sensors and, of course, ease of use and less calibration time and maintenance on those products. And then, of course, the industrial PPE, you'll often see the iconic V-Gard hardhat. That's a hardhat that has a V molded in it. You open up the Wall Street Journal and see industrial workers, that's part of the industrial work uniform. You'll see that be displayed prominently or if you're just driving down the road and you see roadway construction, you'll typically see some V-Gards in the construction area. And then, of course, fall protection. Fall protection is a unique opportunity for us, and that's the one category that we're #3 in that category. We think we have a long way to go to gain some market share. We've shown some good double-digit growth and gained some share. We've doubled our market share over the last 5 years. We think we have some room to run there to continue to bring unique solutions to our customers to help protect workers and that falls are still the #1 killer for construction workers. And we think that there's a nice opportunity and unique things we can bring to market to help that. With that, I'll flip things over to Lee to talk a little bit about the business and how we performed here.

Yes. So throughout the year, we've been updating our sales outlook. So we go back at the beginning of the year, we talked about our core investment thesis, which is mid-single-digit growth, 30% to 40% incrementals and then really nice robust cash flow. Through the year, we've -- those businesses and is just walking through have performed well. So the fire business markets are still doing quite well. The detection space is our highest growth segment. We continue to grow that business, which also is our highest margin category. And then you have the head and fall protection business, which has turned out to be stronger than we expected. That was a business we probably thought this year was going to be quite flattish just given the economic cycle. I think as we've all seen that turned out to be better. So that business is performing better. We've actually made some really nice progress on the supply chain. We continue to do a good job with just managing through price and cost environment, and we've elevated our sales outlook for the year to being in this mid-teens area. With that as well, we've made a lot of progress on margins. It's a multiyear journey. We touched a little bit earlier just on the business system. We've been bringing that to life. At first, that was how we combated through COVID and FX challenges and things like that and kept our gross margin still in a healthy place and in many cases, stable, growing a little bit. And then you've really seen in the last 18 months, this progress with pricing, with productivity, with continued progress in SG&A to really a nice level where we've now crossed into an operating margin territory in the low 20s, which was one of our goals we had set several years ago. So certainly a good year. As we look forward, we're still confident in that investment thesis. Over a cycle, we're a mid-single-digit growth company. We have a very resilient portfolio that fire business typically does well, really no matter what's going on in the macro cycle. Within the detection business, we had the fixed detection business, which is attached to a building. So a lot of recurring revenue that comes to that business. You attach that to a building. There's a 10-year-plus cycle. So again, no matter what's going on in the economy, you still got to protect in these critical safety environments we're in. And then we'll see how the industrial PPE business does. But in the end, that really is sticky part of the business still persevere, and we end up typically in still a positive growth environment even in a challenged macro environment. So that's the business today. Again, I come back to -- we are 100% focused in these 3 safety businesses. We've really built the business system out to really improve just how we perform in that. But in the end, we are focused on keeping people safe, keeping places safe and doing it in a really good way for the environment. With that, I'll pass it to -- for Q&A.

Perfect. Again, if anybody has any questions, send those up, we're at [email protected]. Lee, you kind of touched on it, but maybe just get your thoughts overall as the year has played out, it's played out better than we were talking about at the beginning of the year. We came into the year with some elevated backlog that the orders -- by and large, the orders have kind of matched sales closely -- relatively closely moving through the year. So as we think about the momentum in each of those 3 areas as you go into '24, maybe industrial PPE is one that has, I guess, the biggest question mark, maybe the shortest level of backlog. Is that fair as well?

It's fair. I mean, overall, the book-to-bill for 3 quarters of the year is just slightly over 1. So we've had a healthy orders environment. Again, I think that speaks to the resilience of the business. But you're right. The fire detection business has been -- it's a really good, healthy funding environment. That's still planning to continue. That's our mindset as we look forward here. In the detection business, certainly, the fixed piece is -- has the dynamics I talked about it earlier. The portable could have a little bit of flex depending on what goes on with projects and things like that. But the head and fall protection business does move with the macro world. As Nish noted, the hardhat business, we serve a lot of spaces. So it's not just about one segment. So you could have maybe some manufacturing softness. But if the infrastructure projects to continue, as Nish mentioned, you see a hardhat. But fall protection is also a space where we can grow some share and that could actually have us perform a little bit better than maybe the macro does as well. But that is our cautionary as we look forward.

Okay. Maybe to start a deeper discussion just around the fire service business because that has been the standout business this year. Do you think you've gained some share this year? And if so, the sources of that share? And then -- well, maybe I'll stop there. I just have a follow-up, but go ahead.

Sure. So in the fire service business, we continue to do well in that space. The G1 breathing apparatus, which we launched in 2015, has performed really well in the marketplace. Those are long buying cycles for the fire service. That product is -- you typically buy a product like that and keep it for 12 to 15 years. So we've done really well as new opportunities have popped up. Some of you have followed the story probably have seen LA City, LA County and a number of other London Fire brigade. So we've had a number of nice wins, but that also helps us with winning call it halo effect of winning other businesses within that geography in the smaller departments in the surrounding communities within those areas. We continue to do really well in retaining the share that we have. So what we like to look at and the performance of that, 1 out of every 2 wins that we've had is a competitive conversion. So we've done a nice job in improving our market share, and that continues here into 2023, and we think we'll continue to have success in '24. The budgets remain really well. And Globe this year, with our Globe, our turnout gear, we've done a nice job in gaining some share there. We're excited about some new products we'll be launching for the fire service that will enhance our position in a couple of areas. So we think fire has a bright outlook for it in '24 regardless as to what the economy does. We think funding is going to remain in place, be solid. There's federal funding that comes into the market, and that's all well intact, and we think we'll be in a good position to reap some of that. Not just here in the North American market, but on a global basis with some of the key wins that we've had, there's a few more coming up that we think we can have success with.

Historically, just looking at the SCBA business, you mentioned the funding environment being very healthy, consistent as well. Just optically though, you look at the performance, a step-up, typically, the next year may have a pause and then another step up, is that -- I'm not fully understanding what always drives that dynamic funding and just timing of awards and the like. Is that -- is there a reason to think that cadence could continue? Or is -- we show a different trajectory on that?

No, we think the cadence will continue. And as far as the funding that's available in the fire service market, that's federal funding that's been in place for a number of years. I certainly don't think -- we certainly knew coming into the bid in years that, that wouldn't back off and that's been enhanced slightly. We think going forward that the funding will remain intact, not just at the federal level but also state and municipal level, funding will continue to be strong. And the number of firefighters remains fairly consistent. What's changed is, so we have about 1.1 million firefighters in the North American market. But what's changed is the dynamic of more paid firefighters. When you get more professional and paid firefighters, the equipment purchases tend to be at the higher end of the scale when it comes to some accessories, and we do a little better with those markets. So we think that will continue. So the buying cycle and replacement of breathing apparatus, every 12 to 15 years, turnout gear, you'll see replacement on that. Every 5 or 6 years, they'll buy turnout gear, and that's just real steady business where fire departments give us orders of 4 to 6 sets of turnout gear clothing for a firefighter. And that's a real stable business and it's almost a razor-blade type business once you're established in a fire department. And of course, the helmet business goes along with the turnover here.

Yes. And you made the comment around 50% of the wins competitive conversions. When you drill into that, is that the result of competing against kind of current competitors versus competitors that have exited the market, has that provided a little extra runway?

Sure. The competitors that have exited the market have created, obviously, a nice opportunity for us. So -- but it's pretty well split between those players that are still in the market and those who have exited. So we've had a few competitors who no longer have NFPA-compliant breathing apparatus that compete in the marketplace. So we've seen 2 competitors out of 6 fall out of the market. One came out of the market for 3 or 4 years and then came back and finally we got their NFPA approval. So they're back in the space. But for the most part, there are 2 players that have the majority of the business, and that's us and one other competitor.

Right. And just to -- and we talked earlier, just the NFPA standard cycle itself has in the past, had some influence on the cadence of the business. Is that -- as you look over the next 12, 24 months, is that likely to have an influence?

That's correct. Yes. So NFPA standards, you typically see those promulgated every 5 years on a 5-year cycle. And municipalities don't like to be more than 2 cycles out on NFPA standard, so they'll buy. And if there are 2 NFPA standards, they'll typically buy before that third standard hit. So that's another piece that drives the replacement cycle of the breathing apparatus. And then also those standards create significant barriers to entry. I talked about other competitors dropping out of the market. The fact of the matter is their share fell to a point and the investment required to meet those standards. It just didn't make sense for them to be in the marketplace so they fell out. So the barriers that come into the space of self-contained breathing apparatus and helmets, quite frankly, the fire helmets -- that's significant. So that's a nice moat around the business for us as you look at that business going forward.

Your detection businesses, certainly on the fixed gas side tends to have some longer sales cycles, also lead times and backlog as well. As we look at the backlog position right now, again, it looks a little elevated relative to historical position. Is that mainly because it's got more fixed gas in it? And how should we think about that in the context of looking out the next 12 months or so?

Right. So the dynamic around the gas detection piece, you have 2 pieces. You have fixed gas and flame detection. That fixed gas piece has that longer buying cycle and also replacement cycle. So when you think about fixed gas detection, you're putting detectors up in a facility to look for, listens for, smell for leaks, in that facility. They're in place and they keep them in place for 12, again, similar to a breathing apparatus, 12 to 15 years. And every 3 or 4 years, you're replacing sensors. So there's a nice replacement market component of that. And also once a facility is established on our detection, they don't replace it. So when they're adding points of detection or they're doing a turnaround or they're doing some enhancements in the facility, they'll continue to buy more additional units. So you have a nice replacement cycle and recurring revenue from those facilities that when you get those units installed. The backlog really around both fixed and portables, that was really about components, electronic components. And we've worked our way out of that. That continues to improve. We do have a nice backlog. The backlog goes into some of the greenfield and brownfield projects. We have a good rhythm of what will happen there, and that business continues to do well. On the portable gas detection side, those are detectors that you hang on individual industrial workers or even firefighters for that matter. They go into a number of industries. The replacement cycle on those products are typically 5 and 6 years. And again, the replacement sensors are about every 3 years. So what you might find is a customer will buy those products, they'll run them, they replace the sensors one time and then after a 5- or 6-year period, they want the latest technology in the market, so they'll replace their fleet with new devices.

You've referenced in the past, gas detection overall as being one of the more fruitful opportunities for inorganic opportunity for MSA. Is that still the case? You've added some capabilities with Bacharach, but is that...

It is. Yes. So in the detection area, we've made 3 acquisitions, really 4, but 3 key ones. One was a technology play. So in 2010, we acquired a company called General Monitors, did a real nice job in diversifying our product portfolio by geography, by product and by market. It got us into some unique markets. But the manufacturing products are typically the same. And that was a real successful acquisition we've done in 2010. The next one we did in gas detection was a small company named Sierra Monitor. Sierra Monitor had some gateways that help short cycle some of our development costs. There's a real nice gross margin business, they lost money. So we were able to take out that SG&A and plug that into our business. and enhance that business and with our sales force, expand some of the sales and the margin fell through into the bottom line, of course, which helped us profitability-wise. We made an acquisition of a real small company called Senscient in Europe, which is point-to-point detection type technology, and that was really a technology play for us to acquire, to help us with some technology we'd like to introduce in the future. And then recently, we made the Bacharach acquisition about 2.5 years ago. We sold about $10 million of product into the HVAC refrigeration market and our decision was we're going to continue to invest in that product area or just spin that out and the decision was to make an investment in the area to make the acquisition of Bacharach. Again, a real nice margin profile business. We think that, that's a nice opportunity to grow the business because of refrigeration markets and monitoring for refrigerants is really important because those refrigerants are changing in a significant way. The older refrigerants that are used are just really harsh on the environment. They're nasty on the environment. And obviously, customers don't like releasing those in the environment for greenhouse gas effect. So there's a lot of monitoring that goes there. The new gases that are being introduced are really expensive. So the customers don't want to lose that product because it's really expensive for them to replace it. And then the second piece is they're highly flammable. So monitoring those is really important. So the detection piece around refrigerants, whether you're in a Whole Foods or a Walmart, wherever you see refrigeration or industrial refrigeration, there's a lot of refrigerants that are being used and detectors to monitor those. So we think that that's a nice opportunity for us. And we think that there are other opportunities within that detection space that we can invest in, whether it's organically or inorganically to find some opportunities to continue to enhance that business.

Real quickly, just to hit on industrial PP&E. Again, I think of that as more a headcount-driven business. Is there employment levels influential there? Any reason to think about that differently as we come -- go through the next several...

No, no, that's the way to look at it. And obviously, you need -- for hardhats, you need heads to put them on. And so that fluctuates with employment. One of the things that's interesting is, as I mentioned, you don't build anything anywhere without hardhats, fall protection and even portable gas detection, right? So whether you're building bridges, tunnels, roadway construction, you'll see hardhats, fall protection on those sites. So that presents some opportunities for us beyond just the industrial work area. But that is driven predominantly by employment. One of the unique things is the hardhat market share for us is really strong. Fall protection, we're a #3 player. So even if we see a slowdown in the market, our belief is we can continue to gain some market share and continue to see some growth in fall protection. We invested in that space heavily through COVID. We had -- before COVID, we had 3 years of double-digit growth in fall protection. During COVID, we had some real difficulty with supply chain. We just didn't have scale. We had trouble coming out of that. But we developed a lot of new products. And as we came out of COVID, we've seen some nice double-digit growth with fall protection, and we think we're doing a nice job in gaining market share. We think that, that pattern will continue as we go forward. So we think that even if there's somewhat of a slowdown, we can protect ourselves a bit with some share gain in fall protection because we are a distant #3 player.

Okay. The operating model, as you articulated, Lee, again, think -- consider mid-single-digit top line, 30% to 40% incrementals. We've been seeing that flow through on the incremental side, if not even better. Gross margins have been a big contributor there. Stepped up as we go forward, how to think about the contribution to that 30% to 40% where it comes from, if there's a regional distinction to be made also?

Well, I think if you think about the mid-single-digit growth, it's going to be in the similar mix we've seen in the past, which in its own nature helps because they're mixing into higher-margin categories. But we've -- it's really nice to see the progress to get to the 47 to 48 zone. There's certainly been a little bit of benefit from sales growth. That could be a little bit of a challenge, if that was the macro was to deteriorate. But underneath that is the business system. And the business system is focused on the entire P&L and the balance sheet. So we've built out a pricing capability that frankly goes back a number of years now. Our team is in the excess of over 10 people for us. Productivity was going on across the organization, but we've really focused on globalizing that and bringing that to life across the entire organization. NPE that makes sure it has an appropriate lift to it as well because, again, if you bring the right solution to market, you can price it from a value perspective to a solution you're solving. And then as Nish talked about earlier, we've seen really nice progress also just on applying it within working capital. Seeing it again, quickly that how quickly we can generate cash and then use that to continue to invest in the business organically or through acquisitions as well. So as we look forward, I mean we're happy where we are, but we think there's still an opportunity to have 50 basis points of operating margin lift each year, and it would come from both gross margin and SG&A, whereas in the past, you probably were seeing more lift just from SG&A. In the last couple of years, I think show that we've built that muscle to do it. And frankly, in a more challenged volume world, that's going to be even more important that we have that muscle in place now.

I wanted to return to just real quickly, we had a question from the audience around fall protection. Your market share there stated is #3, but obviously room to move up. Just how product innovation will contribute to that aspect as well as maybe your strategy around pricing in that area to the extent it may differ from pricing strategy where you have leading shares?

So from a technology standpoint, there's some real unique solutions that we've introduced here over the last few years. One of them is a [ iHook ]. So if you think about a picker who works in a warehouse and they go up and these pickers and they're up high off the ground. Tragically, what's been happening is, is these pickers are working fast, they're trying to fulfill orders. They reach and they fall. And there's been some deaths in some of those cases. And it's not for lack of training or good intention on the part of the employer. The fact of the matter is workers just don't wear the fall protection that they're provided and they're not using it properly. So we've developed an [ iHook ], Snap Hook, that ties into these pickers. And if it's not connected to the machine and they're not tied off, the picker won't move. It won't operate. So this is a solution we have to help safety managers ensure that workers are wearing your equipment. If you go on a construction site, it's easy to see if someone is wearing a hardhat or safety glasses. If you go to a fire scene, you can see they have their helmet on and their breathing apparatus. It's really hard to see whether a worker is actually tied off. Somewhere where you might see it is you'll see someone doing roofing work in a residential area, they will be wearing fall protection and they're not tied off on anything. And usually, that's what leads to high injury, fall and death. And so that's a solution that we came up technology-wise to help solve that problem. Another one is Horizontal Lifeline. So there are temporary horizontal lifelines that you put up on a construction site when you're on your leading-edge type construction and you set that up. And when you get done with that one floor, you wrap it up and then you go up to the next floor to do some work. MSAs and all of our competitors, those horizontal lifelines were super heavy, 75, 80 pounds, you're lugging them up steps. It would take 2 people to set those up with screw drivers and wrenches and there was a lot of downtime, and we were able to develop a horizontal lifeline, one person can set it up, super-lightweight. In fact, the engineer was a woman. And to make her point, she would walk in with heels, carrying it, set it up herself, no tools are required. And from a cost standpoint, it has a price point that's very similar to what we were selling and our competitors were selling in the past. So it's finding those pain points that our customers have and finding unique solutions to help them with higher levels of protection, and obviously, more productivity. And we look -- when we focus on that, whether it's in that category or even in a hardhat, heat stress is a major problem for workers, and it's a high OSHA's citation area. So one of the things we did, we developed what's called the C1 Hard Hat, which is a cooling hardhat. It takes a temperature inside the hardhat down 15 degrees. We have a patent way that we do this within the helmet, and we get a nice price premium for that product. So we use technology in even the simplest products to better protect workers and make them safer so they can get home.

We just about to conclude, maybe in 30 seconds, with leverage having come down quite a bit from where you started the year. What is the appetite for M&A at this point given what you also see in the marketplace around valuations and higher rate?

So innovation has been an important part of the equation for MSA. So we've done 4 transactions in the past 5 years. Balance sheet today certainly puts us in a good place. We've got the debt leverage down to low 1s. The market is active. Certainly, the bolt-on acquisitions in the spaces that we're in today makes sense, but we're disciplined. They got to hit the financial thresholds we're looking for, but it would make sense, you're going to see some more of that play out over the next couple of years. But we'll see about the timing and again, making sure we remain disciplined.

Perfect. Well, we need to break here. Thank you.

All right. Thank you.

Thank you.