MSA Safety Inc Q1 FY2020 Earnings Call

Good day and welcome to the MSA Q1 2020 Earnings Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Elyse Lorenzato. Please go ahead.

Thank you, Brandon. Good morning everyone and welcome to MSA's first quarter earnings conference call for 2020. Joining me on the call today are Nish Vartanian, President and CEO; and Ken Krause, Senior Vice President, CFO, and Treasurer. Before we begin, I'd like to remind everyone that the matters discussed on this call, excluding historical information, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, all projections and anticipated levels of future performance. Forward-looking statements involve risks, uncertainties, and other factors that may cause our actual results to differ materially from those discussed here. These risks, uncertainties, and other factors are detailed in our filings with the SEC, including our most recent Form 10-K filed in February of this year. MSA undertakes no duty to publicly update any forward-looking statements made on this call, except as required by law. We've included certain non-GAAP financial measures as part of our discussion this morning and the non-GAAP reconciliations, as well as our Q1 press release, are available on our Investor Relations website at investors.msasafety.com. With that, I'll turn the call over to our President and CEO, Nish Vartanian.

Thanks, Elyse and good morning, everyone. Since our last earnings call in February, the COVID-19 pandemic has impacted our families, our communities, our workplaces, our economy, and our world. Like you, we all hope we're beginning to move toward the downside of this crisis. As we navigate through this environment, I want to start off by expressing my deep appreciation to the associates of MSA. As I've said many times before, our mission is the foundation of our success. The importance of our mission and our employees' dedication to it is today more relevant and clearer than it's ever been. The reaction by our people, working with speed and agility across the enterprise has been a reflection of a highly engaged workforce, ensuring operations continued through the crisis, with minimal disruptions to providing essential products, services, and support for our customers. As a leader in safety, MSA is an essential business. Each and every day that our associates come to work in our plants around the world, they take great pride in making equipment that helps protect the world's first responders, energy and utility workers, and many others who are on the frontlines of this COVID-19 outbreak. During our investors' conference last year, I highlighted that with the world's increasing focus on environmental and social issues, including safety, protecting workers will become an even greater priority for our businesses. The situation with COVID-19 sharply underscores that living and working safely has a profound impact on business conditions and that there is a very basic human desire to protect the world's workers. That is MSA's mission, and it's never been more important. To say I'm proud of our entire MSA team would be an understatement. I would also like to thank our supply chain partners who are also essential stakeholders in protecting the world's workers. In just a moment, I'll provide insight into how we're managing our business through this crisis and the near-term priorities we've set. This effort dates back to January when our team in China began to assess and address the situation, and we're in active communication with our corporate headquarters on issues like employee protection protocols, business continuity and supply chain, as well as potential mitigations. After that, we expanded our COVID-19 rapid response team to be global in scope. Our early start had a clear and positive impact on our first quarter results and positioned us to better respond to the situation. For the first quarter, our revenue grew by 7%. Air-purifying respirators were a key source of growth in the quarter, which is largely reflective of the global PPE shortage from COVID-19. Fixed Gas and Flame Detection was a strong performer in the quarter. Our SCBA, portable instruments, and head protection lines also performed well, with low single-digit growth. I'm also pleased that the International segment margins continue to expand and reflect the great progress we've made on commercial excellence and cost structure programs. Against those highlights, I'll now provide more texture on how we're managing through the COVID-19 situation and the priorities we've rallied around. Let me begin by saying that we're seeing the benefits of having a seasoned executive team in place, and leaders at all levels of the organization who have steered the company through a number of macroeconomic downturns before, such as the recessions of 2009 and 2015. Our teams also responded in the wake of the tragic events of 9/11, where many of our associates were directly involved in helping first responders at Ground Zero and the ramp-up effort to help fortify national stockpiles with gas masks. With those experiences in mind, we are responding to this pandemic and operating our business around four key priorities. First, the health and safety of our workforce is our top priority. Our second priority is business continuity. Third, we're focused on expanding manufacturing capacity of our existing air-purifying respirator products. And our fourth priority, which Ken will cover in greater detail, is managing our capital structure and expenses. We prepared cost levers to respond to various potential scenarios in the business while still investing at planned levels for new product development. Focusing first on the health and safety of our workforce. Know that tens of millions of workers rely on MSA products every day, and we're dedicated to safely getting our products into the hands of those who need them most. Consistent with our mission and internal safety culture, we've taken a number of steps to provide a safe environment for our associates who are continuing this essential work. In our factories and worksites, we continue to follow CDC recommendations for social distancing and disinfecting. We've enhanced cleaning protocols, instituted temperature monitoring, modified work cells to ensure proper distancing. Our back office and administrative teams have been working from home since mid-March and are leveraging technology to effectively drive productivity. Despite the distance, our people are staying connected with each other and with our customers. I'm heartened by the fact that the number of interactions with customer service have actually increased and our level of customer support is at the same levels pre-COVID-19. This is a real compliment to our customer service, management, and IT teams. We've also taken proactive steps to protect the health and safety in our local communities through this crisis. To support this effort, MSA donated or is in the process of donating more than 140,000 disposable masks sourced from third parties to hospitals and healthcare systems and communities where we operate around the world. Regarding our second priority, business continuity, our teams around the world have been hard at work to keep our factories running and our supply chains moving. All MSA factories throughout the world are open and running. We continue to work closely with our suppliers, and supplier disruptions have been handled on a case-by-case basis as needed. Our corporate and local teams have done an excellent job in managing through these challenges and our focus is ongoing in this area. The third area I want to discuss is MSA's manufacturing response regarding air-purifying respirators. While the disposable N95s, that are mentioned so often in the news, are not manufactured by MSA, we produce advanced air-purifying respirators, such as elastomeric half-mask, full facepiece respirators and powered air-purifying respirators with a full complement of filtration capability. These products have been part of MSA's portfolio for many years and they've been used in industrial applications. These air-purifying respirator products reflected 8% of total sales in the first quarter and increased by more than 60% in dollar terms from a year ago. Later in the quarter, we saw higher levels of demand for respiratory products, largely from our existing industrial and first responder customer base. With the urgent market needs and related surge in respiratory orders that we've seen in March and in April, we've made the decision to invest $11 million to $13 million of CapEx to expand manufacturing capacity for respiratory products at the Jacksonville, North Carolina plant. We've started to make investments and have already hired and trained dozens of workers to support this project. We're doing everything we can to reach our goal levels of capacity later this year. While the APR backlog is strong and growing, the fulfillment will shake out over the next several quarters. I've often said, MSA's portfolio has a defensive element to it based on our diversified exposure across many end markets and geographies. I think this attribute is evident again, particularly against the backdrop of this challenging environment. For example, in April, incoming orders are up more than 10% overall as strength in our respiratory business and fire service was more than enough to offset declines in industrial products. Accordingly, we intend to invest in our respiratory business and increase our output substantially there. We've lowered our near-term growth expectations for industrial and energy-based PPE products that are tied to employment and protecting the individual worker, like portable gas detection, head protection and fall protection. April orders for fire service products were healthy and we built some backlog so far in Q2. As always, with the fire service, these products can have longer lead times and take a couple of quarters to deliver. So, when you look at the business from a high level, April orders were healthy. We built backlogs in areas that typically have longer lead times or will require manufacturing investment to deliver, while employment-driven PPE business has weakened. The extent of economic damage from the virus and timing of recovery is unclear. However, our first quarter was reflective of a highly engaged workforce that has a clear connection with our purpose and mission. And looking forward, it's encouraging to see our diversified portfolio supporting our overall business despite the downturn in certain end markets. With that, I'll now turn the call over to Ken to continue to review our COVID-19 priority areas and provide more insight into the impacts on our business in the near term.

Thanks, Nish and good morning, everyone. Before I begin the P&L review and discuss the cost structure and liquidity aspects of our COVID-19 response plans, I want to step back and provide a few performance highlights. First, we started the year very strong with 7% revenue growth in constant currency. We had good growth across a substantial portion of the portfolio, driven by a very strong finish in March. While we have seen a shift in product mix within the order book late in the quarter and into April, orders in April were healthy overall and we have a sizable backlog of business to start the second quarter. We remained favorable on the price cost equation and saw healthy product margins in the quarter. Coupled with diligent cost control, we realized incremental margins of 37%. Adjusted operating income was up 10% on a reported basis or two times the revenue growth rate. We continue to execute around the balanced capital allocation strategy. During the first quarter, we funded $16 million of dividends to shareholders and deployed $20 million to repurchase 175,000 shares to offset dilution. Leverage remains very manageable at 1.3 times EBITDA or less than one times on a net debt basis. Our efforts and responsible approach to leverage as we finished 2019 and started 2020 has positioned us well to maintain a very balanced approach to capital allocation. Now, I'd like to walk you through our first quarter results and provide more insight into how we are managing our cost structure and balance sheet through these uncertain times. Total revenue increased 7% on a constant currency basis on growth across much of the core product portfolio, as well as strong growth in air-purifying respirators or APR, which are complementary to our core offering and included in what is defined as non-core in our public filings. In the fire service, we realized solid growth in the Americas SCBA area, as we worked down our backlog from the pent-up demand associated with the approval delays last fall. We had indicated that revenue would shake out over a couple of quarters and that's exactly what happened. Demand remains relatively healthy in this area in April. Fixed Gas and Flame Detection had a strong quarter with good momentum on our new products across the U.S. and the Middle East. The FGFD line is a very global line with strong market share in both the U.S. and in the Middle East, as well as a sizable recurring revenue stream on the installed base and those qualities continue to help us navigate a challenging energy market. This business continues to hold up well and has held strong in past slowdowns. Emerging market revenue was up 12% in the quarter. While China had a slow start due to the COVID-19 outbreak, we realized very strong growth in the Middle East FGFD and Latin American fire service and head protection product lines. China has started to rebound in March and we are seeing improved results in April in that area of our business. From an FX perspective, we had a 2% headwind on revenue related to the weaker euro and Brazilian real compared to this time a year ago. Gross profit increased 10 basis points in the quarter as pricing held up nicely and offset higher indirect costs such as COVID-related expenses of about $800,000. It was particularly encouraging to see strong product margins in our International segment this quarter. As we discussed at Investor Day back in November, strategic pricing has been a major focus for our European business. And it's good to see the traction there in both the second half of 2019 and again here in the first quarter. It's good to see pricing holding up well as we continue to provide customers a cost of ownership advantage. SG&A expense of $80 million was up 2% on a reported basis or 3% in constant currency organic terms on the mid-single-digit revenue growth. We continue to realize the expected returns from previously executed restructuring programs, particularly in international where operating margin is up 170 basis points. In that area of our business, constant currency SG&A was down 4% in the segment on revenue growth of 1% and we continue to see solid leverage in the Americas segment as well. As we discussed in our year-end call in February, we entered 2020 with a focus on productivity and back-office cost rationalization based on the uneven environment. When we started to see the economic downturn in March related to coronavirus, we became more active in identifying a number of short-term cost reduction measures. In addition to savings from reduced travel costs, we implemented a hiring freeze with very minimal exceptions. We also have expense controls in place around professional service engagements and other discretionary costs. Controlling our cost structure is a key priority of our COVID response plan, so we are watching this area very closely. We plan to maintain hiring and discretionary cost controls through the second quarter, as we manage through this uncertainty. There are a number of other short-term cost reduction measures that we currently have prepared and are on the shelf. We can and will pull those levers as needed based on the order book, which we monitor daily. From a longer-term perspective, we plan to continue to execute our roadmap of European cost reductions that we laid out at Investor Day. We also continue to evaluate programs to improve our global footprint and optimize our business structure. Strong product margins and cost control drove an 80 basis point improvement in adjusted operating margin from a year ago, with improvements across both the International and Americas segments. Also, our most recent acquisition, Sierra Monitor, which we acquired in the second quarter of 2019, has become accretive to the MSA consolidated operating margins in less than a year. In addition to inventory step up rolling off after Q4, we've been able to drive efficiencies throughout that business. Our adjusted effective tax rate was 25% in the quarter, which increased about 100 basis points from a year ago as we had higher losses in jurisdictions where we cannot take tax benefits. Adjusted earnings were $1.18 per share or 4% higher than a year ago. We indicated on the February call that we expected an $8 million full year headwind in 2020 from non-cash pension expense. That had a $0.04 impact on adjusted earnings in the quarter as expected. Similar to many companies, we added discrete costs associated with the virus back to adjusted operating margin and adjusted earnings metrics. As Nish had mentioned, managing our liquidity position is a key focus area for our team in response to the economic downturn. Our balance sheet is strong and positions us well moving forward. The level set on our position at the end of March, we have cash on the balance sheet of $123 million. Our current debt balance is $372 million or less than one-time on a net debt basis versus a covenant of 3.5 times. Our next principal payment on our senior notes is $20 million in the fourth quarter of this year, which is not overly material to our cash flow. We have ample capacity on our credit facilities and shelf facility agreements as well. At the end of the quarter, we have more than two turns of EBITDA available on our covenants, which provides plenty of flexibility. To manage cash flow, we have already begun applying best practices to drive improvements in receivables and payables. Working capital ended the quarter at 26.1% of sales, relatively consistent with a year ago. The increase from year-end is primarily related to the timing of receivables, as we had our strongest invoicing month of the quarter in March, combined with an increase in inventory, which was partially offset by improvements in accounts payable. We have not noted any material credit issues to date and we have a team that is closely monitoring this area. The balance sheet is very strong and our capital allocation priorities remain very much intact. We remain focused on investing in our business and funding our dividend while maintaining an investment-grade balance sheet. Nish had mentioned the investments we plan to make for the respirator manufacturing ramp-up and we plan to continue funding R&D in line with previous expectations in 2020. We are positioned well to manage the challenges we all are facing and to pursue growth opportunities when appropriate. To wrap up, let me step back and summarize the operating environment as it stands today. Our factories are open and our supply chains are moving. We do continue to work through logistics and materials challenges, but we have not seen any major disruptions to date. Our diversified portfolio positions us better than most in this environment. Just looking at our April orders, we have seen significant declines in short-cycle industrial and energy-related products. However, that is being more than offset by higher demand for firefighter safety products and respirators. So, in total, after a strong March, April orders are up more than 10% versus a year ago, as we see this shift in product mix play out. While this can change quickly and it will take some time and investment to ramp up our respirator capacity and get that backlog out the door in coming quarters, our business is very much holding up in April. The defensive nature of the portfolio that we've built is providing great support to finish the first quarter and to start the second. While the business continues to hold up well through April, there is a great deal of uncertainty in many moving pieces, among them are the conditions in the energy market, the timing of when construction products may resume, when the broader economy might open up and how the demand patterns evolve for respirators in the back half of the year. Like many others, our line of sight for the full year is just not clear. This makes it very difficult to provide expectations for the full year growth rate. What we do know, however, at this point is we've had great growth in the first quarter, which was heavily influenced by healthy orders and strong invoicing in March. Orders are strong in total for April, notably in our respirator and fire service lines where we're building backlog. This is helping to offset weakness in hard hats, fall protection, and portable gas, areas that often book and ship very quickly. Backlog levels are healthy and should provide support in the coming months and quarters. When you think about the composition of backlog and how it impacts the near term, it's important to note it will most likely take us into the third quarter before we are able to see backlog moderate in fire service and respirators. For respirators, in particular, we expect to make progress on that front as we ramp up our manufacturing capacity in the coming months. We've modeled a number of scenarios internally for 2020 and we have a playbook ready for a range of potential outcomes. We have a number of initiatives that we are executing and can launch to improve productivity and reduce our cost structure. While there is a great deal of uncertainty in the global economy, we had a strong start to the year with 7% revenue growth and 37% incremental operating margins. Our business leaders are executing our growth and productivity plans across both of our operating segments and we're seeing very strong results. Looking ahead, we have a response plan in place to manage our cost structure and liquidity position through the economic downturn. As always, we are committed to being proactive operators through this crisis and controlling the controllable. We are well-positioned with a flexible cost structure and a strong balance sheet to manage through and maintain our solid fundamentals over the long term. With that, I'll turn the call back over to Nish for some concluding commentary.

Thanks, Ken. The strong revenue growth and incremental margin profile in the first quarter provide a solid foundation to start the year. Our portfolio is diversified, and we're well-positioned from a cost structure and balance sheet perspective to manage through these times. We'll continue to focus on protecting the health and safety of our workforce, enabling business continuity in our plants and throughout our supply chain, and ramping up our manufacturing of our existing respiratory portfolio to do our part in supplying much-needed PPE. Over our long history, MSA has faced many periods of turmoil and economic challenge, but we've always emerged a stronger organization and I'm confident that we're going to do that again. At this time, Ken and I will be glad to take any questions you may have. Please remember that MSA does not give guidance. Having said that, we'll now open up the call for your questions.

We will now start the question-and-answer session. Our first question comes from Stanley Elliott with Stifel. Please go ahead.

Good morning, everybody. Nice to hear your voices. Thank you for taking the question.

Thank you, Stanley.

Hey, I have a question for you. Regarding municipal customers, have you heard any concerns about funding at that level in relation to the fire service, especially in light of what you've observed with sales tax receipts? You mentioned having good visibility through the third quarter. Additionally, is there anything in the CARES Act that could aid that segment of the market or benefit MSA overall?

Sure. There's actually an additional $100 million in the CARES Act allocated for the assistance to firefighter grants, aimed at COVID-related products. We are well-positioned to benefit from this, particularly with our APR adapters for the G1 and M7 facepieces. We have other opportunities within the fire service as well. The fire service has not shown any signs of pulling back. Our bookings in April for the fire service were quite strong, with significant business and good conversions happening with the G1, contributing to a solid backlog across all three product lines. Bookings for breathing apparatus, turnout gear, and fire helmets were all strong in April. While there is some concern about tax receipts affecting municipal budgets, it's important to remember that protecting firefighters is a priority. History has shown us that fire departments typically find a way to secure funding for necessary equipment like breathing apparatus. We do have concerns, especially regarding potential delays due to meetings not being held, but overall, the fire service remains strong. We are optimistic about our position in the market and the products we have, maintaining a positive outlook for the remainder of the year.

I appreciate the insights from April. Can you provide more details on what a substantial decline would imply for head protection or employment-driven areas? Additionally, regarding respirators contributing more significantly to revenues in the latter part of the year, how should we assess the incremental or decremental impacts with the new products being introduced?

Let me describe the business for you, Stanley, as that might provide some clarity. It could be helpful to review what occurred in our business during 2015 and 2016. I wouldn't be surprised if we see a similar decline in some short-cycle PPE products, particularly in head protection and portable gas detection, along with fall protection. These three areas will be affected by the slowdown we've experienced. In April, we noticed a decline due to the oil and gas sector, and many construction sites worldwide have shut down, which significantly impacted hard hats and fall protection. I don't expect this situation to persist for the rest of the year. The circumstances we observed in April might represent the lowest point, and as construction resumes in the spring, we could see a recovery in head and fall protection, but likely not in portable gas detection. Looking back at 2015 and 2016 may provide some insight into the performance of those short-cycle products that we book and bill within the same quarter. The orders we received in April, along with those from late March, are primarily for fixed gas and flame detection, self-contained breathing apparatus, and various fire service products, alongside air-purifying respirators. Typically, fixed gas and flame detection and fire service products are shipped over two to three quarters. Meanwhile, we are increasing our capacity for air-purifying respirators. I hope this gives you a clearer understanding of our current situation and what we're experiencing.

It’s great. Thank you guys very much. Best of luck.

Thank you.

Our next question comes from Richard Eastman with Robert Baird. Please go ahead.

Yes. Good morning and very nice quarter. Congrats to your whole team there, Nish.

Thanks.

Nish, a couple of things that you had mentioned around backlog and strength. Does the same strength in the same product lines apply to the International business? Or will we going forward see some bifurcation between growth rates between International and North America?

Off the top of my head, Rick, and I think Ken might have more insight into this, it was fairly consistent. We saw more strength in the air-purifying respiratory products here in the Americas than we did internationally. But internationally, we also saw some good buildup and ramp-up of the APR products. So, we saw some consistency there. Really, the fixed gas and flame-detection products were stronger in International from a booking standpoint, and that's really on the strength of the Middle East. The Middle East, we've seen really good activity for our new transmitter. The X&S 5000 has performed really well in that market as customers have a good understanding of the cost savings they can have when they get that product in place and it's been taking share and doing a nice job. In fact, one of our biggest customers just approved a new technology that we acquired a couple of years ago with Senscient, open path, hydrogen sulfide detection, which was a big breakthrough for us. Getting that new technology into that major customer of ours was about a year testing that they had performed on that product and it was really exciting that they didn't back off that in this downturn for oil and gas. So, International saw more with fixed gas and flame. I would say that the Americas a little bit stronger on the APR products. But on short cycle products, from a booking standpoint, they all declined fairly similar across the board. From an invoicing standpoint in the first quarter, the International fall protection was off significantly where I think the Americas was up maybe 1% or down 1%. The International is down so much and that's really the nature of the business there. There's a lot of engineered systems that are sold, especially in Europe and that's kind of construction type business that we weren't able to install. So, that's why you saw a much deeper decline in fall protection in the first quarter than you had in the first quarter for the Americas.

I see. Okay. I wanted to clarify if the sales mix going forward could pressure gross margin a bit. I'm referring to Ken's comments on this. Our general understanding is that SCBA and APRs may not achieve the same gross margin that short cycle products could. I'm just curious if this is something we should be mindful of as we begin to model the mid-section of the year.

No. Rick, the APR is actually a pretty good gross margin product line. That's right in line with the rest of our business. It's actually better than the fire service business, not quite as good as the gas detection. But no, that's a good healthy margin business for us.

Okay. And just the last thing regarding APR. Do you consider the end market for the APR products to be more aligned with SSC rather than PPE? What is the end market for that? Also, it seems you have enough in-house capacity to significantly grow the business year-over-year, not quite doubling it, but you're projecting a 60% increase. Will the capacity coming online support growth in the second half of the year, maintaining or exceeding that 60% growth rate?

Let’s see. On the APR side, regarding the ramp-up, we don’t provide guidance, but we are increasing significantly. The 60% figure isn’t conservative, considering we didn’t have a full quarter in the first quarter. Doubling the business seems realistic for the full year. The application for our product is quite extensive across all manufacturing types. I saw a video of workers decontaminating an airplane while wearing our Advantage 200 mask. Our half masks, full facepieces, and powered air-purifying respirators, as well as the APR adapters for firefighters, are used across a wide variety of industries including utilities and general industrial sectors.

I see. Okay. Okay. Very good. And that meets all standards for what we would find in Europe as well?

Correct. So, we have products that meet both CE and NIOSH standards, of course.

Okay. Awesome. Thank you. Congrats again to your team.

Thank you. Appreciate it.

Our next question comes from Larry De Maria with William Blair. Please go ahead.

Thanks. Good morning, everyone. I’d like to clarify the situation regarding APR. Since most of this has been outsourced and is considered non-core, and now you are increasing your production capacity to make it a core part of the business, could you provide an estimate of the business potential based on this capacity output? Do you see this becoming a sustainable business rather than just a short to medium-term increase? That's my first question.

We have not considered classifying air-purifying respirators as core products. Initially, core products represented about 55% to 60% of our revenue. Now, that figure has increased to between 85% and 90%. Non-core products include items like air-purifying respirators and ballistic helmets, which both contribute significantly to our gross margins. We will invest in these areas when we identify strong business opportunities. However, categorizing them as core or non-core is not a major concern for us internally. Looking ahead three to seven years, our investment priorities focus on gas detection, breathing apparatus, and fall protection. These are areas where we can differentiate our products, enhance margins, expand market share, and deliver value to our customers and shareholders. After we navigate this cycle, the majority of our investment will continue to go into our traditional core products.

To your question too, Larry, you had asked about manufacturing. We do manufacture these respirators. We've historically manufactured these. The disposable respirator is something we do not manufacture, but we do manufacture the ballistic helmet that Nish spoke to as well as this respirator line. Part of the investment we're making on the CapEx side is just modernizing our equipment as well. We certainly see the opportunity and we see the demand coming through for respirators, but we also see the opportunity to update and modernize our manufacturing facility. And so, that's part of the process as well.

Okay. Fair enough. That's helpful. Thank you. Now, I don’t know, maybe address the energy elephant in the room, which you talked a little bit about if I can go back to 2015, I guess. But this project's in place and we're probably not seeing the potential for downside in energy given where oil prices are. Can you give us a better idea of how maybe you think that plays out if oil may not stay where it is right now, but it's not to say also going to go back to $50 either, which would be positive. So, how do you see that play out? When does that impact you guys more? Is it second half? Or is it 2021? And if you could just talk a little bit more holistically about the energy exposure so we investors can get a better handle on how this plays out over time, if energy prices stay depressed if this structurally impacted or not.

Sure. The energy business has experienced cycles, with prices fluctuating significantly over the years. Currently, we're at a low point, but eventually, supply will tighten, demand will increase, and the market will rebound. It's important to note that most of our business in the oil and gas sector is downstream, primarily in refineries, which will continue operating and needing equipment for maintenance and turnarounds. This will create opportunities for us, particularly during peak times in the fall and spring. While upstream activities will feel the effects of current market conditions, construction remains a strong market for us, especially for fall and head protection. Should demand for construction surge, possibly due to government funding, we expect a favorable environment for our products. However, portable gas detection in construction has a smaller market compared to oil and gas, which presents some challenges. Nevertheless, we are gaining market share in the fall protection segment, and we anticipate a potential increase in sales as we move into the fall months.

I want to provide some additional context regarding our growth rates in recent years, particularly referencing 2015 and 2016. Currently, we are not comparing our situation to the recession of 2008/2009; rather, we view it as a blend of the circumstances from 2015 and 2016, particularly with respect to the declines in the energy market and the demand for our safety products following 9/11. There isn't a single recession that fits our current issue, but if we consider the industrial recession of 2015 when oil prices fell from over $100 a barrel to $37 in the fourth quarter, our fixed gas and flame detection business remained stable, staying flat during 2015 and 2016 due to the global nature of our portfolio. As I mentioned earlier, we did observe weaknesses in our portable and head protection products, with portables declining around 13% to 15% and head protection also experiencing double-digit declines. In April, it's difficult to draw comparisons due to the severe economic downturn, but we are seeing continued weakness in short cycle employment-related products. However, it is encouraging to see our fixed gas business holding steady.

Okay, I don't want to put words in your mouth, but based on your comments about April, it seems the short term looks reasonably stable considering some offsets. Can we expect organic growth in the first half overall, followed by declines in the second half as some trends unfold? Is that what you are suggesting?

In the short term, particularly for the second quarter, forecasting growth is somewhat challenging due to our current backlog. We have a record backlog, which is up about 10% compared to a year ago. The items in this backlog will be shipped over the next two to three quarters. However, we also have a significant amount of products, such as head protection, fall protection, and portable gas detection, that are not part of this backlog and will generate revenue within the same quarter. This is where we may see some softness in the second quarter. Looking ahead to the second half of the year, the outlook becomes more uncertain. There are many potential scenarios for our business, making it difficult to predict outcomes. It's tough to determine if we will revert to normal business operations or if COVID-19 could pose further challenges as the year progresses. Consequently, we lack a clear outlook and find it hard to confidently project organic growth for the year or any specific quarter. This situation is indeed challenging for us. The management team has effectively adapted by delivering air-purifying respirators and addressing gaps in our product offerings. While we control certain factors well, external macroeconomic conditions raise concerns.

Okay. Fair enough. I was just trying to make sure I understood your messaging. And thanks, good luck and nice quarter.

Thank you.

Thank you.

Our next question comes from Edward Marshall with Sidoti. Please go ahead.

Hey, Nish and Elyse, how are you? Good morning.

Good.

Well, great job operating in one of the more challenging environments we've encountered. We've come to expect high performance from your team. I wanted to revisit APR for a moment, as I believe it was the longest discussion we’ve had on any call that I can recall. We can concentrate on the non-core product line, which ties back to my question. As you allocate around 30% of your average CapEx over the past few years to a project, I wanted to understand your rationale. You're not adjusting your R&D spending, and the margins appear to be consistent with the overall business. I’m curious about your perspective on whether this spending could provide a short-term boost in sales, or if you see it as part of a broader shift in how business is conducted, leading to a more sustainable revenue stream in the long term.

I think from a market perspective, there's a strong demand for air-purifying respirator products, which we expect to continue at elevated levels into 2021 and possibly beyond. The impact of recent events on the economy will change how businesses approach respiratory protection, leading them to maintain stockpiles and ensure product availability in the future. Consequently, we anticipate sustained demand into 2021. A significant portion of our capital expenditure is aimed at upgrading our equipment, which is part of our five-year capital expenditure outlook. We're accelerating certain projects to quickly ramp up production in response to this demand spike. As we move towards normal operations, we expect the new normal to be better than historical levels, positioning us to meet future needs effectively. Ken, could you elaborate on the capital expenditure aspect?

Yeah. Sure. As I spoke about one of the questions previously, we are certainly compelled to make this investment. And the reason I say we're compelled is because when we look at the returns, for example, in the month of March, my reference to $7 million to $10 million of additional revenue in that month, if we just play that forward and use that as a run rate going forward, which oftentimes can be hard to do. But even if you just look at the order pattern in April, this investment has an opportunity to pay for itself in a very short time period. And so, we couldn't pass up that opportunity to make this investment in a line where margins are very healthy. And so, we decided to go forward and make this investment into an area that needed some investment. It was an area that we saw an opportunity to modernize and upgrade some of our equipment.

It seems like all the requirements are met, which is encouraging as it suggests that the plans are accelerating. I wanted to ask about the recent layoffs and furloughs in manufacturing and construction. Can you explain the new spending as those workers return? Will they just resume their previous roles, or could you walk us through how spending works as blue-collar workers come back to the job? Thank you.

That's an interesting question and you raise a valid point. When we analyze the various cycles related to short cycle products, we observe that during declines, the decreases are always more significant than the GDP decline. This happens because the supply chain halts, leading to a notable decrease in purchases of items like hard hats, replacement suspensions, and fall protection gear. Consequently, the entire supply chain slows down and we face an accelerated downturn. However, when the market rebounds, it rebounds strongly. Contrary to what you might think, construction workers do not keep their hard hats or fall protection products; they typically need to buy new ones when they return to work. This initiates a replenishment in the supply chain, which positively affects the business as end-users restock their inventory, channel partners increase their inventory, and we see robust growth and recovery in head protection sales. If we review the growth patterns for hard hats and similarly for fall protection, we will see this trend. Although we may experience some depressed sales in portable gas detection, we are confident that this market will recover. When it does, and if companies have some extra funds, they will likely replace their entire fleet of portable gas detection equipment, particularly in the oil and gas sector. The timing of this rebound could be in 2021 or 2022; I'm uncertain precisely when. However, a rebound in short cycle products is likely. Furthermore, as we examine safety and head protection, some standards may evolve, which could benefit us. Recently, notable changes have occurred; for example, France's construction sector will require face shields for all returning workers. MSA is in a strong position with a product called the V-Gard 950, manufactured in Châtillon, France, specifically for our European market. This product features an integral facepiece that folds into the helmet, showcasing an elegant design and presenting a significant opportunity as it costs five times more than a typical hard hat. A compelling example of this was shared through a YouTube video from Shell regarding their Rotterdam Refinery. Upon bringing back their workforce, they opted for V-Gard 950s for every worker. The video features the plant manager discussing the critical nature of their operations and demonstrating how they protect their workers by utilizing the face shield. This shift in safety perceptions may create promising opportunities for us moving forward.

There's a lot to consider regarding this, and I need to spend some time really analyzing it. Regarding distributors, we've been on several calls this earnings season discussing de-stocking. Looking at your supply chain and product lines, it seems you are not experiencing any signs of de-stocking. Do you anticipate that happening in the future, or do you think health and safety is more of a defensive product, allowing you to bypass the de-stocking phase in your supply chain?

We haven't observed any de-stocking in our products. In fact, we were quite surprised by the strong performance of hard hats in the first quarter. Our hard hat business saw an overall increase of 1%, which was unexpected. We thought there might be some de-stocking and a decline in business, but that hasn't happened. Some well-funded distributors have mentioned that they anticipate a rebound in construction and want to be prepared with inventory moving forward. A few distributors are strategically positioning themselves in anticipation of this potential recovery in the construction sector.

There is not a significant amount of inventory in the channel. Much of our business is processed and shipped quickly to the end-user, so there isn’t a large quantity of inventory lingering in those channels.

Got it. I want to squeeze one more in. I think you handle many transactions through M&A and often focus on privately held businesses. Considering the potential challenges we might face over the next year, are you looking for opportunities? Do you believe some family-run businesses might see the coming year as a pivotal moment? Where do you stand on M&A discussions? How do you plan to utilize your balance sheet in a potentially weak environment over the next year?

We have a meeting scheduled to discuss our M&A pipeline right after this meeting to provide updates on our current status and activities. We are actively managing and assessing the pipeline. Our balance sheet is a significant strength for us in challenging times. We have the experience to navigate difficulties effectively. We intend to leverage our resources and the power of our balance sheet to grow our business when opportunities arise. A noteworthy decision in our history was in 2009, during the uncertainty following the Great Recession, when we completed our largest acquisition of General Monitors. At that time, we leveraged our EBITDA by about three and a half to four times, which significantly transformed our business. We are committed to the long term and will approach opportunities judiciously, ensuring we spend wisely to meet our customers' needs, fulfill our mission, and deliver solid returns for our investors.

The same goes for Latchways in 2015. When we acquired Latchways, it was during the industrial recession. And so, we've taken the opportunity during past downturns to use our balance sheet. And we are positioned well to go on the offensive when appropriate when we see that opportunity and have that clarity in terms of go-forward direction.

Great. Great. Thanks for all your responses. Good work this quarter, and hope everyone stays safe and well. Appreciate it.

Thank you.

Thank you.

Our next question comes from Garo Norian with Palisade Capital Management. Please go ahead.

Hey, everyone. I have two quick questions about the APR investments. First, how confident are you in obtaining the equipment you need to install and in getting the necessary service personnel to bring it into the facility? Second, should we view this as a series of different investments rather than having a gradual ramp-up that culminates in a sudden big launch when everything is in place? Thanks.

So, Garo, what I'll do is I'll answer some of this and Steve Blanco will join us. And Steve, as most of you know, is Vice President of MSA Operations for several years before becoming President of the Americas. And Steve has obviously been intimately involved in this and has real depth of knowledge around what we're doing with the investment. But what I'll say, Garo, is we've got a lot of senior people, veteran people who are on this project. One person, in particular, has been with us for 35 years. He started, I think, a month or two I did. And he is intimately involved in what we're doing. And in fact, we are actually bringing a couple of retirees who have tremendous knowledge in building the line of APR and they are here to help us, which is fantastic. So, we have a high degree of confidence of being able to do this. Originally, we thought it would be a four to six-month period to ramp-up. And I'll let Steve comment more around that. We're just looking now like around 4.5 months. We're already seeing some investment show some yield improvements. So, there's a series of investments that we're making that will help over a period of time. There is one component of it, which will make a significant improvement and that will be somewhat the last piece that will come later this summer. But why don't I have Steve chime in here and give a little more color around that?

Thanks, Nish. Garo, when considering our ramp-up, it's important to view it in phases. This approach will extend into and throughout the third quarter, potentially into the fourth quarter as well. It's not just about capital equipment; our team has excelled in hiring new employees, as Nish mentioned earlier. We have onboarded dozens of new team members, and we plan to continue this trend. Training is essential, and we aim to ensure that the right people are assigned to the right tasks. I believe the team anticipates this throughout the year.

Okay. Thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Nish Vartanian for any closing remarks.

I would like to conclude today's call by sharing a few final thoughts. First, I want to express my gratitude for everyone's interest in MSA, which we greatly appreciate. Second, it's important to acknowledge that we're in a significantly different environment compared to our last earnings call in February. Our team did a commendable job of adapting and executing in Q1, but the business environment remains challenging. Like many organizations, our visibility into the second half of the year is not as clear as it was at the start of the year. However, I am confident that MSA has a diversified range of products and markets we serve. Our experience in defense development has been beneficial during previous market downturns, including the last one in 2015. Our brand and market position have never been stronger, and our product portfolio and new product development pipeline are more robust than ever. Our financial stability is at its best and employee engagement is as high as it has ever been. The mission of protecting lives has, over the past 106 years, never been more crucial or relevant worldwide than it is today. The world continues to operate, and the demand for safety equipment remains high. In fact, it’s more critical than ever before. A recent illustration of this is the CARES Act, which allocates $100 million to the fire service for COVID-19 related products. Organizations around the globe in various markets are consistently purchasing safety equipment, and it’s our responsibility to ensure they choose MSA. Thank you again for joining us today, and please stay safe.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.