MSA Safety Inc Q4 FY2023 Earnings Call

Thank you. Good morning, and welcome to MSA Safety's fourth quarter and full year 2023 earnings conference call. With me today are Nish Vartanian, Chairman and CEO; Steve Blanco, President and COO; and Lee McChesney, Senior Vice President and CFO. Before we begin, I would like to remind everyone that matters discussed during this call may include 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 a number of risks, uncertainties, and other factors that may cause our actual results to differ materially from those discussed today. These risks, uncertainties and other factors are detailed in our SEC filings. MSA Safety undertakes no duty to publicly update any forward-looking statements made on this call, except as required by law. We have included certain non-GAAP financial measures as part of our discussion this morning. The non-GAAP reconciliations are available in the appendix of today's presentation. The presentation and press release are available on our Investor Relations website at investors.msasafety.com. Moving on to today's agenda. First, Nish and Steve will discuss key highlights of the fourth quarter and full year 2023. Lee will then review our financial performance and outlook. To conclude, Nish will provide closing comments, at which time we will open up the call for your questions. With that, I'll turn the call over to Nish.

Thanks, Chris. Good morning, everyone, and thank you for your interest in the work we do. I'll start on Slide 4. Our team delivered excellent results in the fourth quarter, with strong growth and operational performance, wrapping up an outstanding 2023 for MSA. Our results are a testament to our passion for our mission and dedication to addressing our customers' toughest safety challenges. Despite the lingering pandemic effects on global supply chains, rising interest rates and dynamic macroeconomic conditions, our team outperformed throughout the year. I'm very proud of our execution and achievements in 2023, and we're carrying that momentum into 2024. Moving on to Slide 5. MSA's sole purpose and mission over its 110-year history has been to protect workers' lives and critical infrastructure in high-hazard environments. And our customers recognize that we at MSA know what's at stake when they put their lives on the line each and every day. This provides us with a unique bond with our customers, and being alongside them on the safety journey allows us to be a true partner in the development of products and solutions like few other companies. Across our many leading firefighter safety, detection, and industrial PPE technologies, we protect more than 40 million workers around the world. We do not take this responsibility lightly. It drives our passion for continuous innovation. Now on Slide 6. Over the past several years, we've been diligently working to build MSA into a higher growth, more profitable company with greater resiliency and durability. With customer centricity at its core, our strategy has focused on accelerating our innovation engine, enhancing our go-to-market strategies and customer-facing activities, and increasing productivity and driving efficiency. To complement our organic efforts, we've effectively deployed capital across several acquisitions to better serve our customers, expand and diversify our end markets, and win in regions where we've been underpenetrated. Our deliberate actions resulted in a high-performing, more agile company with an even greater ability to drive stakeholder value over the long term. Slide 7 summarizes the financial impact of these actions. We have executed on our financial commitments to deliver solid mid-single-digit growth and 490 basis points of margin expansion while compounding earnings at an attractive rate. We've also added to our high-performance talent while continuing to reinforce our culture, putting us in a tremendous position to build on this performance. I'm incredibly proud of our team's accomplishments, which have MSA well-positioned as we move forward. With that, I'll now turn the call over to Steve, who will take you through the key highlights from the quarter and year.

Thanks, Nish, and good morning. I'm on Slide 8. I'm pleased with our performance in the fourth quarter and the year. The team delivered on our growth margin and cash commitments through effective collaboration and excellent execution. Our continuous improvement efforts and MSA Business System, or MBS, initiatives continue to take hold across our global footprint, and we are seeing results. Our team continues to develop and introduce innovative safety solutions, secure new business opportunities and operate with greater efficiency and purpose. We exist to serve our customers and help them solve their safety and compliance challenges. That puts innovation front and center in everything we do. As part of our differentiated development program, we work closely with our customers to deeply understand their processes, pain points and desired outcomes. We're committed to utilizing the latest technologies, cloud connectivity, and AI to develop and deliver products and solutions that delight our customers and have a material impact on efficiency, transparency, and effectiveness of safety programs around the world. With the recent supply chain constraints, our team has done a nice job of being agile and pivoting between product redesign and new product development. Driven by engagement and flexibility, we've been able to work through the supply chain challenges to meet both existing customer demand and deliver on our NPD commitments, introducing several exciting new products like the Sentry io controller and M8 SCBA and achieving 37% product vitality for the year. On the commercial side, we had solid execution across the portfolio and several exciting wins. In firefighter safety, we announced significant contract wins, such as Los Angeles City Fire Department, Pittsburgh Bureau of Fire, the U.S. Air Force and several U.K. fire authorities, including West Midlands Fire and Rescue Authority. We had healthy growth in our firefighter protective apparel and helmets business as well. We also made solid progress in our detection business. We landed new business across our fixed detection products, including Bacharach's multiyear win with the U.S. Navy. We also expanded into new geographies with our recently introduced Altair io 4 portable gas detector. Additionally, we continue to see strong interest in our solutions in the energy markets, including LNG and hydrogen applications. Within industrial PPE, our team drove double-digit growth for the year. Our differentiated fall protection solutions like the V-SHOCK series continue to garner strong customer interest and gain share, and we secured attractive wins in our head protection business. In support of our growth, we drove process improvements supported by our business system to enhance fill rates and get product in the hands of our customers. We also continued our multiyear journey to optimize our global footprint and most recently opened a new modernized manufacturing facility in Morocco to support future growth in our international business. We're seeing results of the deliberate actions to enhance efficiency and productivity across our global operations. Moving to Slide 9. We had a strong finish to the year, demonstrating our ability to execute in dynamic market conditions. The combination of strong execution, our highly differentiated portfolio, and resilient demand resulted in double-digit sales growth, strong margin improvement, and robust cash flow. Demand for our firefighter safety, detection and industrial PPE solutions remained healthy throughout the year, and we were better able to serve our demand as supply chains began to normalize. We continue to operate in a market with secular growth tailwinds, and our unique portfolio positions us to capitalize on these trends. Our enhanced focus on margins and cash conversion provides us with ample resources to invest in attractive growth opportunities and drive sustainable profitable growth. Leveraging our core values, the MSA team continues to raise the bar on performance, with strong commercial execution, product innovation, and operational performance, all while deepening our talent bench. We have a clear trajectory for future growth and margin enhancement, and we will build on our already strong foundation. Before concluding, I want to thank our more than 5,000 associates around the world for their steadfast commitment to advance our mission and drive improvement across our company. I'll now turn the call over to Lee to review our financial results and outlook.

Thank you, Steve, and good morning, everyone. We appreciate you joining the call today. I will now review our differentiated performance in the fourth quarter and full year 2023 and provide color on our 2024 outlook. Let's get started on Slide 10 with the quarterly financial highlights. Sales are $495 million, an increase of 12% over the prior year with positive contributions across our product categories and regions. We had a healthy balance of volume and pricing in the quarter and currency translation added 2 points to the overall growth. Orders also remained solid in the fourth quarter, up mid-single digits, and we are seeing similar trends so far in 2024. Market conditions are generally healthy, and our new business pipeline is very active. Consistent with the normal patterns we see in our business in the fourth quarter, our book-to-bill was below 1x, and we continue to reduce our backlog closer to normal levels. Backlog reduction was largely in our firefighter safety business and, to a lesser degree, in detection. As supply chains began to improve, our team through the implementation of the lean principles of MBS recognized an opportunity to improve our processes and increase customer fulfillment while converting past due backlog and sustainably reducing inventories. As a result, we are seeing meaningful benefits including improved on-time and in-full fill rates, reduced inventory levels, and higher cash conversion. Now moving on to margins. Gross profit in the fourth quarter was 48.1%, up 360 basis points over the prior year. Operating margin on a GAAP basis was 20.6% in the quarter. Adjusted operating margin was 23.3%, up 170 basis points over the prior year and incremental operating margin in the quarter was 37%, at the higher end of our target range. Margin increases were largely due to volume leverage, price cost benefits, improved productivity, and innovation. Our laser focus on driving sustainable margin improvements across all elements of the P&L continue to yield results. GAAP net income in the quarter totaled $76 million or $1.93 per diluted share. On an adjusted basis, diluted earnings per share were $2.06, up 14% over the prior year. The increase was largely due to higher operating profit, which was partially offset by the higher interest expense and a higher adjusted tax rate in the quarter. Now I'd like to review our segment performance. In our Americas segment, sales increased 15% year-over-year with growth across the product portfolio, including double-digit growth in firefighter safety and detection. Currency translation was also a 1% benefit in the quarter. Adjusted operating margin was 29.8%, up 120 basis points year-over-year. Margin expansion was largely driven by volume leverage, price realization, and productivity. We also had solid results in our International segment, where growth was up 6% year-over-year and was well balanced across product categories and regions. Currency translation was a 3% benefit in the quarter. Adjusted operating margin of 18.2% improved by 120 basis points year-over-year, driven by volume leverage, price cost management and a favorable mix. Now moving on to Slide 11, where I'll review our full year results. Broad-based demand drove total net sales of $1.8 billion, up 17% versus last year. We saw double-digit growth in both segments with healthy contributions from price and volume across our product categories. For the year, adjusted operating margin was 22.2%, up 320 basis points from last year. Incremental operating margin was 41%. Adjusted diluted earnings per share were $7.03, up 24% over the prior year. Overall, MSA's performance was very strong, and we continue to identify opportunities to drive further improvement in the years ahead. Now turning to Slide 12. Free cash flow in the quarter was $147 million, representing a conversion rate of 180%. Free cash flow growth benefited from higher earnings and solid execution with working capital, which was reduced by 760 basis points from the prior year. We invested $12 million in CapEx, repaid $145 million in debt and returned $18 million in dividends to shareholders. For the full year, adjusting for the divestiture we completed in January, free cash flow was $397 million compared to $115 million in the prior year. We significantly strengthened our financial position in 2023. At the start of the year, in conjunction with the divestiture of our legacy liability subsidiary, we communicated our intention to prioritize debt reduction in the subsequent 12 to 18 months. Through strong teamwork and collaboration across the company and the use of our MBS principles, we exceeded our commitment finishing the year at 1.0 net leverage. We repaid $289 million of debt since the divestiture as a result of robust cash generation, profitable growth, and disciplined investment strategies. Net debt at the end of the year was $455 million and cash was $146 million. Adjusted EBITDA for the full year was $449 million or 25.1% of net sales. Our overall financial strength enables us to continue investing in the business to drive long-term profitable growth and return excess capital to our shareholders. Now I'd like to move to our 2024 outlook on Slide 13. We've taken a balanced approach in our outlook based on the positive sector dynamics in our industry that underpin demand, the essential nature of our differentiated products and solutions and the stability and diversity of our portfolio and end markets. However, the operating environment continues to be dynamic, with an increasingly uncertain macroeconomic and geopolitical climate. With this backdrop, we remain responsibly optimistic in our outlook, which balances the opportunities and risks we see ahead of us. We expect to generate mid-single-digit sales growth in 2024, with incremental margin and cash flow conversion aligned with our long-term targets of 30% to 40% incrementals and near 100% free cash flow conversion. We expect to have greater visibility in the first half of the year, and we will continue to be agile in the event the operating environment differs meaningfully from our expectations. For modeling purposes, I will provide our view on the below-the-line drivers that impact earnings. We expect our tax rate to be between 24.5% and 25.5% in 2024. Based on current rates, interest expense is expected to be approximately $40 million. Finally, pension and other non-operating income will be similar to 2023 levels. As I now look forward, I'd also like to share my warm congratulations and gratitude to our global team for their solid execution in 2023 and on achieving excellent performance across sales, profitability, and cash flow. We are well-positioned entering 2024 and are firmly focused on delivering on our financial commitments and creating sustainable value for our shareholders.

Thanks, Lee. I'm on Slide 14. Our team delivered a strong quarter to close out an outstanding year in 2023. We continued our purposeful investment across all aspects of our business while also delivering on our growth, margin and cash flow commitments. These actions and the divestiture we made last January further improved our strong financial position, and have provided for greater capital deployment optionality. We have a team of high-performing associates around the world who are driven by our mission. Their commitment to continuous improvement enables MSA to better serve our customers and advance our mission. I'm confident our focus and determination will help drive long-term value creation for our shareholders and continue to make MSA Safety the preferred choice for our customers around the world. One last thing before I wrap up, I'm now on Slide 15. We'll be hosting an Investor Day in New York and via webcast on May 22, where we'll provide a detailed review of our business strategy and financial goals. I'm excited about this event, and I look forward to seeing many of you in New York. With that, I'll turn the call back to the operator for a Q&A.

The first question today comes from Stanley Elliott with Stifel.

Congratulations on the very strong 2023. Could you help us with what you're seeing in the business? You talked about maybe not as much visibility in the second half of the year, and I get it is still pretty dynamic. How should we think about the cadence of maybe first half versus second half? Then any color you could share in terms of how you're thinking about your growth in the Americas or international or even within the new reporting segment structure.

Stanley, one point I want to make quickly about the business pace before handing it over to Steve and Lee for more details is regarding the industrial business, which saw a slowdown of 2%. What's surprising is the strength within the core industrial products. Specifically, hard hats and fall protection showed double-digit growth in Q4, and we're maintaining a good order pace through February in those categories. It's reassuring, as we anticipated a slowdown in the industrial business due to expected recessionary conditions, which did not materialize. Seeing strong order pace in core industrial products as we begin 2024 boosts our confidence in the business moving forward. Now, I'll turn it over to Steve to provide broader insights about the business.

When considering our markets and the diversity of our businesses, particularly in the industrial sector, we have seen some moderation; however, there is still strength as mentioned by Nish. The end markets present a mixed picture. The energy and utilities sectors are performing well, while construction fluctuates, showing strength in some regions of the country. For instance, the U.S. is experiencing notable strength, and Asia Pacific, excluding China, seems to have stabilized. Overall, we feel positive about this market, with a strong incoming performance globally year-to-date. In terms of detection, we have seen very strong results, and the pipeline remains impressive. We also feel optimistic about the fire service, supported by solid funding from governments and municipalities. There is strong visibility for the first half of the year, although we don't have as much insight for the second half yet, which is why our comments reflect that uncertainty. Lee, do you have anything to add?

Yes. Let me add a few numbers, Stanley. We mentioned that orders increased in the mid-single digits in the fourth quarter. If we look back further, over the last 90 days of the second half of the year, we also saw mid-single-digit growth. As I mentioned earlier, we're experiencing a similar positive start to 2024. Additionally, our backlog is approaching normal levels, and we expect it to fully normalize as the year progresses. This presents some opportunities in the first half. In general, let's see how the year unfolds. Since it's an election year in the U.S., the timing of spending bills and other factors will influence things. We'll monitor those developments closely and provide updates throughout the year.

And can you talk about the connected worker platform? How that's progressing? What's been the reception in the marketplace? How are you all thinking about kind of monetizing that on a go-forward basis?

Steve, go ahead and take that.

Sure. When considering connected work, I mentioned in my prepared remarks the io 4, which focuses on connected work. We categorize connected work in two areas: the fire service and the industrial space. In the fire service, we've seen significant progress with more fire departments and firefighters using our connected platform, and we expect this utilization to continue to grow. However, from a revenue standpoint, it's currently low because it takes time for maturity to develop in the fire service sector. In the industrial space, which we refer to as MSA+, we primarily sell it as a subscription service. We had a strong adoption rate in 2023, particularly in the U.S. where we launched first. The encouraging news is that we've expanded market coverage, now available in over 80% of the markets we operate in, especially the larger ones as we move into 2024. We anticipate continued growth, and customer feedback has been very positive. The sales cycle is longer, and the base is still relatively small, but it is becoming a significant part of our detection business.

And I guess lastly, kind of what you're seeing in the backlog? It sounds like the outlook will be favorable again from a mix standpoint. Is there any reason to say kind of what you're seeing in that book of business that we shouldn't see margins expand again and think about nice incremental margins, incremental flow-through again in 2024.

Lee, why don't you take that?

Yes, that's a great question, Stanley. We have indeed made significant progress with our operating margin, largely driven by improvements in gross margin and our ongoing success with SG&A. As you mentioned, we've advanced from the 44% to 45% range to now approaching 47% to 48% in gross margin. This progress is largely attributed to MBS. Our commitment to enhancing productivity, managing prices and costs, and emphasizing innovation with new products has been crucial. Looking ahead to 2024, our aim is to solidify this foundation, and we feel confident about maintaining an approximate 48% margin. There will be variations by quarter, with the first quarter typically being below this exit rate, but we will see improvement as the year progresses. We have solid plans in place, and we expect to see even greater productivity and innovation this year. While the inflation environment is easing, factors like freight and labor costs remain sticky. We've made the necessary price adjustments, and now it’s about executing MBS effectively to secure that 48% gross margin.

The next question comes from Larry De Maria with William Blair.

I want to start with fire. Can you talk about maybe the outlook for potential new fire wins and tenders? Have we seen some wins following the big pillar cities? I know you mentioned some in the U.K., but are there more to come? And related to that, can you speak to the Air Force win, what's in the numbers already? What might still happen and if there's a Phase 2 and if that's in the guide?

Steve, why don't you take that?

Yes, certainly. When discussing fire, I would begin with the comments on new tenders. We have some promising opportunities in our pipeline. I want to focus a bit on the international aspect, especially regarding our expectations with the M1. There are many large opportunities arising in the next 24 months that are important for our customers, particularly the connected platform I mentioned earlier, which helps them tackle issues and maintain strong incident command and situational awareness. We feel confident about our position in that area and have a positive outlook on the overall international market. The same applies to the U.S.; while we have a solid presence here, the market dynamics differ from our growth opportunities. We believe the market will remain robust moving forward, and our pipeline data indicates that the North American market is stable, with the potential for significant opportunities globally.

Any color on the Air Force?

Yes. Regarding the Air Force, we still have about one-third of the invoicing left for the remainder, which is expected to be completed in the first half, primarily in Q1. Lee, can you provide more specific details?

So Larry, to your point, we had our first win, which you benefited from in the third and fourth quarters of 2023. You'll primarily see the remaining portion in the first quarter. There is also an opportunity for Phase 2, but the timing of that is still to be determined. However, we are certainly expecting success there, and it is part of our outlook for the second half. We'll just have to see how the timing works out. This uncertainty is one reason why we are being a bit cautious about the second half, as it could represent a significant amount if it does come through.

I'm curious about Morocco. Have we noticed any gross margin impact from there, or is that something that needs to build up with increased volume and efficiency? Can you discuss the current international footprint and how adding Morocco impacts that? What has been observed so far?

So Lee, why don't you take that?

Yes, sure. So number one, I appreciate the question on ops. Number one, I mentioned it because, as I just said earlier, the gross margin you're going to see productivity even being a bigger part of the story as we go forward here, Larry. So what we did is we opened the site. We're still in, I'll say, final transition from workplace where things are coming from and to. But it's part of what we're doing across shops, pursuing at a higher level of productivity to enable even more commercial success. So I think about Morocco in particular as a really nice example for our fall protection business. So we love the growth we're seeing there, double-digit growth consistently across the globe. But we wanted to serve customers better, and we want to work on the costs. And so that's just one example of many that we have in our outlook for '24. But off and running, for sure, it was a nice kickoff, a very energized team there ready to take on '24.

And then if I could just sneak in one last one. Can you just talk about the pipeline of inorganic options out there, things are real actionable in this year and competition multiples, etc.?

Sure, Lee, go ahead.

Sure. I love this question because you know I can only answer it in a certain way. So I'll start off this way. We have shown again in '23 our inherent ability to generate cash, and it puts us with really a lot of options, which is good. So obviously, first place we focus, Larry, is on the organic side. So whether it's the innovation, activation in the market, investing in our abilities, analytics, accelerating MBS, that's where it goes first. Certainly, we have a great trajectory on dividends, a wonderful track record there. You'll probably see at some point some action on share buyback like we typically do, which we did do last year because of the divestiture. And then that leads us to this optionality with M&A. The entire team is certainly engaged in the market. We've never stepped back from that. But I'll say what I would always do here and it shows up in our track record. We've done four deals in six years. And all in, we beat the odds. We've done better than most companies do there because we're very disciplined in what we are willing to take on. It's got to be a strategic fit. It's got to hit the financial thresholds. If it does that, we'll certainly participate in the process, and we'll see how it works out. But again, we're not going to go overpay. So we're certainly engaged. I do think over the next couple of years, something will come to life. And if it happens this year, great, but it doesn't have to happen for us to be successful this year.

I just wanted to revisit the discussion about the growth expectations throughout the year. If you anticipate mid-single-digit growth for the entire year at this stage, is it reasonable to believe that your confidence suggests the first half would exceed that? And as of now, is the expectation for the second half to fall below that?

Lee, why don't you take that?

Yes, I appreciate that. I believe we're going to approach 2024 similarly to how we did in 2023. We certainly have a clearer outlook for the first half of the year. Your calculations are correct, Rob, in that we anticipate being on the higher end of mid-single-digit growth for the first half. We previously mentioned that we expect backlog to normalize, and the pricing environment is continuing to stabilize. It's primarily about executing in the market. There are larger win opportunities we mentioned earlier, and while we are confident in some of them, we are not certain about all. Additionally, considering it's an election year, I am a bit more cautious about how things might play out in the second half. This is our baseline view, which is also backed by a solid perspective on margins that would allow us to be in the 30% to 40% incremental range. If sales are on the lower side, we will be on the lower side of the incremental range, and if sales are stronger, we could be on the higher side, similar to what we experienced in the fourth quarter. We ended with somewhat higher growth, and you could see us in the upper range of incrementals. We are taking this approach right now because the macro environment is challenging. This has proven to be a wise way to navigate each year and to remain agile.

I want to drill into the detection business a little bit further. Steve, I know you commented that the pipeline looks good there. But could you kind of walk through the various portions of that business, thinking about how replacement activity may be positioned in that pipeline versus more of a CapEx portion versus even some of these newer markets, let's say, newer. But like hydrogen, LNG, I guess, is more in an expansionary mode. But just if you could put a little more color around what's driving detection.

Yes, I'd be happy to. We've discussed the portal space, and we continue to see opportunities there, which operates similarly to industrial PPE. Regarding energy, as you've mentioned, those markets are very strong and are beneficial for our portable business. We anticipate ongoing growth with our connected work platforms. In terms of fixed monitoring solutions, we're seeing a robust base business, and the project business remains solid. It hasn't decreased. Looking ahead, there is a shift toward clean energy opportunities like hydrogen and LNG, as well as significant work in decarbonization. The carbon capture utilization and storage, or CCUS, has been around for a while but is now gaining traction, with considerable international interest. We believe this will present a great opportunity. As we move forward, we see fixed monitoring as a strong growth area, with portables closely following.

I have a follow-up regarding your last question. Steve, your comments about international opportunities in fire safety are understandable given the potential there. I'm wondering, as we approach the 10-year mark since the G1 was introduced to the market, are you beginning to see replacements for those initial units, or is it still too early for that?

Yes, it's a really good question. So we watch that very closely. And the life cycle typically is around 13-ish years on average. Some certainly go sooner than that, some leak out a little bit longer than that, and you may see them past 15. But typically, our team averages at around 13-ish years, so you wouldn't see that play out for a couple more years likely. And we don't have a lot in our pipeline that shows those initial customers coming back up quite yet.

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

Thanks, Betsy. We appreciate you joining the call this morning and for your continued interest in MSA Safety. If you missed the portion of today's call, an audio replay will be made available later today on our Investor Relations website and will be available for the next 90 days. We look forward to updating you on our continued progress again next quarter. Thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.