Earnings Call Transcript - MSA Q2 2024

Larry De Maria, Executive Director of Investor Relations

Thank you. Good morning, and welcome to MSA Safety's second quarter 2024 earnings conference call. This is Larry De Maria, Executive Director of Investor Relations. I'm joined by Steve Blanco, President and CEO; Lee McChesney, Senior Vice President and CFO; and Stephanie Sciullo, President of our Americas segment. During today's call, we will discuss MSA's second quarter financial results and provide an update on our full-year 2024 outlook. On Slide 2, I'd like to remind everyone that the 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. Turning to Slide 3. We've 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. I'd now like to turn the call over to Steve Blanco. Steve?

Steve Blanco, President and CEO

Thanks, Larry, and good morning, everyone. I'm on Slide 4. In June, we celebrated our 110th year as a purpose-driven company. Over that time, we've remained steadfast in our mission that men and women may work in safety and they, their families and their communities may live in health throughout the world. And I'd like to thank our more than 5,000 associates around the world who are inspired by the singular purpose of safety for our customers each and every day. This was an exciting quarter. Driven by our mission, we delivered solid commercial and operational results in the business through excellent execution and utilization of the MSA Business System. I'm pleased with the continued work on our product launches and operational accomplishments. In May, we held our Investor Day where we discussed our strategy for profitable growth and capital deployment going forward as well as identifying our long-term targets for 2028. Also, earlier this week, we released our 2023 impact report, which I will highlight in a couple of minutes. First, let's review some highlights from the quarter. During our earnings call in April, we discussed supply-chain issues that resulted in an elevated backlog for Detection and Industrial PPE. I'm pleased to report that the team overcame these challenges during the second quarter and reduced our backlog to normalized levels. Previously, we discussed our efforts to optimize our manufacturing footprint as part of our operational excellence initiatives. This quarter, we made significant progress in production transfers at some of our factories in the U.K., Morocco, and Mexico. These changes better position us for growth by enabling a more efficient and productive structure to deliver and serve our customers across the globe. All of these efforts resulted in our ability to maintain our positive momentum through the first half of the year. This is building on strong performance from recent years. The team executed well and delivered net sales growth of 3%, organic constant-currency sales growth of 4% and adjusted earnings growth of 10%. Moving to our product categories and innovation, sales in fire service were up mid-single digits in the quarter with notable growth in turnout gear and fire helmets. The new Cairns 1836 is being very well-received by the market and performance at Globe and Bristol continued to strengthen. We continued to see excellent momentum in international markets with our M1 SCBA and have a solid global commercial pipeline going into the second half of the year. The fire service market remains resilient and the environment for funding around the world is healthy. I'm pleased to note that this month, we were awarded the second tranche in the U.S. Air Force order, which is about $28 million. Our sales in detection were up high-single-digits with solid growth in both fixed and portable detection. The new FL5000 multi-spectrum flame detector launch continues to go well with positive customer feedback leading to a strong start in orders. Portable detection continues to grow both in traditional and connected devices. The io4 continues to gain traction with the expansion in new geographies and new customers, both existing and for new applications. Industrial PPE sales overall were slightly negative on a year-over-year basis. Our head and fall protection products continue to grow and are offset by headwinds in other PPE products such as ballistic helmets and international, as well as respirators. I'm excited by our opportunity to grow our fall protection business, where we continue to see healthy demand. The footprint changes I mentioned earlier will help us better serve our customers in this specific growing category. In May, we continued our leadership in head protection with the launch of the new V-Gard H2 Safety Helmet, which provides superior comfort and versatility while incorporating the latest technology to help protect against lateral impacts and features the optional Mips technology. Turning to Slide 5, I would like to review some of the key points from our 2023 impact report, which I noted earlier. This was released this week. As a safety company, our commitment to operating as a sustainable business is evidenced by our initiatives across the MSA safety pillars of products and solutions, people, and planet, and is captured in the MSA impact metric. This impact metric represents the average number of global workers that use our products and solutions each year. We estimate that MSA helps to protect more than 40 million people annually. Here are a few examples of what can be found in the report. The products and solutions we develop are at the core of our approach to creating a positive impact. Our solutions use technology and connect and detect for safety and sustainability, helping to make work safer and easier as well as more productive. For example, our SCBA simplifies maintenance and reduces waste, and Bacharach refrigeration detection solutions help food and beverage customers reduce their carbon footprint and operating cost. We're also on track to meet our commitments towards our 2030 emissions goals. As you would expect from MSA safety, we maintain world-class employee safety metrics within our facilities. Additionally, we collectively shared that MSA Safety was recognized as one of Newsweek's most responsible companies, USA TODAY America's Climate Leaders, and Forbes Best Employers for diversity. There are many more highlights in this report, so please visit our Corporate Responsibility section on our website to learn more. On Slide 6, I also note to you the 2028 financial targets we launched in May at our Investor Day, underpinned by our strategy to drive profitable growth and create value for our customers and shareholders. We highlighted a set of actions that we believe will enable us to continue to grow the top and bottom line over the near and long term by leveraging such key enablers as the MSA Business System. These include capitalizing on secular trends, targeting growth accelerators, developing additional solutions with recurring revenue streams, and utilizing our strong balance sheet for strategic capital deployment. We look forward to sharing our progress against these targets over the coming years. With that, I will turn the call over to Lee, who will discuss our financial results for the second quarter. Lee?

Lee McChesney, Senior Vice President and CFO

Thank you, Steve, and good morning, everyone. We appreciate you joining the call today. I will now review our performance in the second quarter and provide an update on our full-year outlook. Let's get started on Slide 7 with the quarterly results. Sales were $462 million, up 4% on an organic constant-currency basis and 3% on a reported basis over the prior year, with a balanced contribution from volume and price. Currency translation was a 1% headwind. Across our product categories, detection and fire services contributed healthy growth, up 8% and 4% respectively, partially offset by a 2% contraction in industrial PPE. Globally, it was also encouraging to see these sales trends fueling our Americas and international results. Overall, orders were healthy in the quarter across our business, though there were some trend changes within the months. As I've noted in the past, this is not unusual for our business and orders can vary from quarter to quarter. Our commercial pipeline is encouraging across our product categories and in most of our regions, and we have a nice continuation of activity we're seeing so far in July. In the second quarter, our book-to-bill was slightly below 1 times, but above the prior year period and is just below 1 times for the first half of the year. As we had hoped, our backlog was reduced in the quarter to more normalized levels, principally due to good progress in fire services and detection. Our margin performance continues to be very resilient and our team's commitment to the MSA business system is evident from our results. Gross profit margin in the quarter was 48.2%, up 40 basis points over the prior year. Operating margin on a GAAP basis was 21.6% in the quarter, up 40 basis points over the prior year. Slightly higher SG&A reflects volume, inflation, investments in professional services, and a one-time cost related to a legal matter. Adjusted operating margin was 23.4%, up 20 basis points over the prior year and incremental operating margin was 29%. Margin expansion was largely driven by volume leverage, productivity, and cost price management. GAAP net income in the quarter was $72 million or $1.83 per diluted share. On an adjusted basis, diluted earnings per share were $2.01, up 10% over the prior year. The increase is primarily due to operating profit and lower non-operating expenses. Now moving on to our segment performance. In our Americas segment, sales increased 2% year-over-year with high single-digit growth in detection and mid-single-digit growth in our industrial PPE, partially offset by a modest decline in fire services. The adjusted operating margin was 31.3%, up 60 basis points compared to the prior year. Margin expansion was driven largely by volume leverage, productivity, and cost price dynamics. In our International segment, sales increased 6% year-over-year, strong double-digit growth in fire services and detection was partially offset by declines in industrial PPE. Currency translation was a 1% headwind in the quarter. Adjusted operating margin was 16.4%, a strong increase of 70 basis points year-over-year, driven by volume and SG&A leverage, partially offset by modest FX headwinds. Now turning to Slide 8. Free cash flow in the quarter was $39 million, representing a conversion rate of 49% of adjusted earnings. Second quarter cash flow reflected inventory investments and increased capital expenditures, and we remain on track to deliver our full-year cash-flow objectives of 90% to 100%. As a reminder, we typically generate more cash flow in the second half of each year. Consistent with our strong capital allocation history and our Investor Day goals, capital expenditures were $14 million in the second quarter, including investments to drive productivity and execute production transfers as part of our strategic manufacturing programs. We also repaid $8 million in debt, returned $20 million in dividends to shareholders, and repurchased $10 million in common stock. Net debt at the end of the quarter was $441 million, and our cash balance was $147 million. Our net leverage ratio at the quarter-end further improved to 0.9 times. Adjusted EBITDA for the trailing 12 months ended June 30 at $466 million, or 25.7% of net sales. Now, I'd like to move to our full-year outlook on Slide 9. We entered the second half with good momentum, but are mindful of the dynamics of order timing and macro and geopolitical risks. Our end markets are generally healthy, demand trends remain positive, and we have executed initiatives to bring our backlog down to more normalized levels. Our business has broad diversification across products, geographic regions, and markets and there remain attractive underlying market trends in the safety industry, leading to the resilience we have delivered over time. We remain close to our customers, disciplined on costs, and focus on executing our strategy to deliver profitable growth and generate strong cash flow. Should macro conditions change, we will adapt as needed. As we look forward to the full-year 2024, we are maintaining our sales outlook of mid-single-digit growth, which compounds on top of the 17% growth we delivered in 2023. We believe our second-half growth rates will likely be similar to the first half. We do have to be cognizant of the timing of orders, primarily related to the AFG funding cycle and customer delivery timing as we work through the details of large orders like the U.S. Air Force order, which implies growth may be skewed towards the latter part of the year. Our business is healthy, our pipeline is strong, and we look forward to executing our second half plans and the long-term profitable growth strategy outlined at our Investor Day. With that said, I also want to reiterate my thanks to our associates across the globe who are focused on supporting our customers passionately each and every day. Your continued focus on driving improvement is yielding significant impacts for all of our stakeholders. Well done. With that, I'll now turn the call back over to Steve for concluding remarks.

Steve Blanco, President and CEO

Thank you, Lee. I want to reiterate the resiliency of our business, which continues to benefit from the broad diversity of our products, geographies, and markets. With attractive industry fundamentals, our proven innovation process, and leading positions in our markets, I'm excited by our future. I believe we have the best team in the industry and with our mindset around continuous improvement and the commitment to the MSA Business System, we're well-positioned to create value over the long term for all of our stakeholders. With that, I'll now turn the call back over to the operator for questions.

Operator, Operator

The first question comes from Stanley Elliott with Stifel. Please go ahead.

Stanley Elliott, Analyst

Hi, good morning, everyone. Thank you for your question. Can you elaborate a bit on the full-year guidance, which indicates a mid-single-digit growth? You mentioned a consistent run-rate with possibly a slight acceleration in the second half. While we know that business tends to pick up in Q4, it seems like there are other indicators suggesting that the overall economy may be slowing down, and your order books are becoming more normalized. What gives you the confidence to achieve that second-half run-rate?

Steve Blanco, President and CEO

Yes. Thanks for the question, Stanley. And maybe I'll start here, and Lee, you can jump in if you have some commentary at the end. I think it's the diversity of the business that really helps us. We're a little different than maybe most industrials, as you know. But when we look at our business, I would say that the demand in the end markets remains healthy. Certainly, fire service, energy, and utilities are healthy and stable. And we see a really solid pipeline in fire service and detection. Timing can be lumpy as we've seen before, but the fundamentals are good and the pipeline is solid. From a macro, we think these markets are resilient. We've seen that in the past. They've been resilient. We've been comfortable with that. Industrial PPE is certainly a bit more cyclical, as we saw in the first half, and that's likely to continue. But it's really where the diversity of our markets and geographies helps. So, if the performance continues, if we're able to turn that pipeline into orders, we feel really good about the second half continuing to be a growth category. Lee, you got anything you want to add?

Lee McChesney, Senior Vice President and CFO

Yes, I think that's an accurate summary. As I mentioned earlier, we believe the second half will be similar to the first half. However, if we reflect on the beginning of the year, we were hopeful it could be even better, but that's the reality we face. I think some of the points you raised are valid, but we're still in a strong position. I expect to see a repeat of what we experienced in the first half, where certain segments excel in one quarter and may underperform in another. We can manage that variability and anticipate that Q4 might be stronger than Q3. As Steve mentioned, we have a solid and diverse mix. Moreover, I have consistently indicated that achieving 3% or 4% growth this year comes on the heels of a 17% growth last year. This context is important. Everything we are doing this year is offsetting that, which shows we are performing even better in terms of orders than in sales.

Stanley Elliott, Analyst

Yes, no doubt, it kind of speaks to the breadth of the portfolio. You did mention one thing interesting that the macro conditions changed, you guys could adapt as needed. How quickly could you react if we were to see something? I mean, I think now with the market kind of looking more towards some rate cuts in the back part of this year into next year, I'm not sure that necessarily we would see that, but just give us kind of like the playbook in terms of how you would react.

Steve Blanco, President and CEO

Yes, it's a good question, Stanley. I mean we've done that in the past. I would say it'd be pretty quick. Certainly, we're going to protect our profitability and margin profile. And we have a list of levers that we could pull if we needed to pull to make sure we protected ourselves. And I think we've talked before about our incrementals being 30% to 40%, but we manage our decrementals at a lower level and we would expect that to be the same if we needed to pivot.

Stanley Elliott, Analyst

And the very strong quarter in the detection side of the business, what's driving these gains? Is that more just kind of the product availability and the backlog is getting worked down? And then you also had some interesting comments around some of the new revenue models and the traditional versus connected devices, really interested to see how this connected device platform is starting to shape up.

Steve Blanco, President and CEO

Thank you for your question. We did notice some backlog, and we were pleased to be able to fulfill that elevated backlog for our customers. Regarding our detection business, when we consider the longer cycle fixed monitoring, we feel very confident due to our solid installed base supported by energy demands, including future clean energy needs, and we have a robust pipeline of business in this area. For portable devices, it's a bit more cyclical since it's linked to employment levels, but we are optimistic about our strategy of providing various options in the market. Our traditional platforms, along with the 4XR and 5X, complemented by the connected io4, offer a fantastic combination for our customers. Currently, we are experiencing over a 50% take rate from new customers for the io4, which has been a significant addition. When we consider both elements together, it reinforces our confidence in the detection segment.

Stanley Elliott, Analyst

Great guys. Nice to hear. Congrats and best of luck in the second half.

Steve Blanco, President and CEO

Thank you, Stanley.

Operator, Operator

The next question is from Rob Mason with Baird. Please go ahead.

Rob Mason, Analyst

Yes, good morning. Thanks for taking the question. Steve, you kind of mentioned your incrementals at this 30% to 40% range. Is that just given the growth profile that you're expecting in the second half? I'm just curious how your confidence level is either around the upper or lower bounds of that range, is that the expectation?

Steve Blanco, President and CEO

Lee, you want to hit that?

Lee McChesney, Senior Vice President and CFO

Yes, Rob. So good morning. Yes, I think like we said throughout the first half of this year, you do have some interesting comps. So just to give you some reminder there, we had this incremental 70% in the first quarter, 29% in the second quarter. You're going to see that same type of volatility in the back half. I mean, the third quarter was a very strong quarter. Certainly, a very good revenue quarter, but our absolute highest margin. There was some backlog and mix help that went into that last year that you won't see this year. So, you'll see a lower incremental in Q3 and then you'll see a nice rebound in Q4. I mean, overall, we keep coming back to the 30% to 40% goal. And we're certainly on track to being in that range. And based on where we are so far in the year, maybe slightly higher, but we'll see how it plays out.

Rob Mason, Analyst

Sure. And maybe relatedly, you made mention of the progress that you've made getting some of your manufacturing footprint reconfigured. Is all of the work that's in motion, is that complete? And I'm just curious how you feel about this current scaling of those operations and potential opportunity to see more leverage from those specific moves.

Steve Blanco, President and CEO

Hi, Rob, I'll address that. It's not finished yet. We're more than halfway through, but there's still a significant amount of work remaining in the second half. Our focus is on continuing our strategy of manufacturing in-region to provide the best cost and delivery options for our customers through our operational performance and manufacturing footprint. This is a crucial aspect of our plan and will notably impact areas like fall protection, particularly with the transitions to Mexico and the plant closures we've experienced. We're beyond the halfway point, but we still have more tasks to complete in the second half.

Rob Mason, Analyst

I see. And just one last question, you mentioned that your price and volume were roughly equal in the quarter. I'm curious, as you reached midyear, did you change anything about your price adjustments or your perspective on the effects of inflation right now?

Steve Blanco, President and CEO

We implemented a price increase at the start of the year. One region raised prices early in the second quarter, but this is typical for us. This year, our pricing is more aligned with normal levels as we respond to the inflationary environment and any potential tariffs. We will continue to monitor the situation closely, and as we have in the past, we will make adjustments if necessary. This approach is part of our commitment to improving our business system and operational changes. We aim to internally offset any challenges to ensure we can maintain our price levels and protect our margins, which we believe we have successfully managed in the past.

Rob Mason, Analyst

Excellent. Okay. Thanks for taking the questions.

Steve Blanco, President and CEO

Thank you.

Operator, Operator

The next question is from Ross Sparenblek with William Blair. Please go ahead.

Ross Sparenblek, Analyst

Hi, good morning, guys.

Steve Blanco, President and CEO

Good morning, Ross.

Ross Sparenblek, Analyst

Hi, coming back to the second-half revenue guidance, we're seeing positive read-throughs on order rates for the detection and fire business. I mean, it's implying a reacceleration in the second half and you guys are clearly taking share. So, can we maybe just further delineate what some of these watch items are and what is maybe tempering your expectations for the second half?

Steve Blanco, President and CEO

Yes, thank you for the question, Ross. We feel confident about our position in the market in both areas and believe our pipeline is robust. A factor here is timing, as order timing can be inconsistent, as we've experienced in previous years. We see significant opportunities if we can convert some of that pipeline into orders. Additionally, the funding environment is favorable; however, for example, with the Assistance to Firefighter Grants, they started releasing funds earlier last year. This year, they only initiated the first few tranches last week, and so far, about $62 million out of the $325 million available has been released. It’s crucial for those planning to utilize that funding to have access to it. That’s what we need to ensure comes through. Lee?

Lee McChesney, Senior Vice President and CFO

Yes. Ross, I'll just add a couple of things. So again, you have a dynamic in the back half, for last year, we had some really nice wins. If you remember things like we were shipping to LA last year in the third quarter on the SBA side. In Bacharach, we had nice large wins that had some big chunky orders to it. This year, it looks like some of those things will be more in the fourth quarter than the third quarter. So that's just a subtlety to sort of the outlook being a little bit more back-half of the second half, just to counter it as you kind of look at your model.

Ross Sparenblek, Analyst

Okay. I mean, can you maybe just update us on the supply-chain bottlenecks in the first quarter? I believe that there's maybe 100 basis points slipping in the second half. And then maybe just on that fourth-quarter comment, we could dig into the margins there because it almost seems implied with the guidance that we could see a nice little step down in the third quarter in gross margins.

Steve Blanco, President and CEO

Yes. There are definitely a lot of factors at play. When discussing the second half in terms of sustaining similar growth levels, all of those elements are included. Regarding margins, we expect a smooth continuation. We have mentioned that we anticipate maintaining the 48% level, give or take, throughout the year. Our outlook for the latter half suggests we will hold onto that. Last year, we had an exceptionally robust third quarter, which is not expected to be repeated. However, if we consider our position in the second quarter, which is in the mid-48s, there will be a decline due to influences like European holidays, followed by an improvement again in the fourth quarter. Overall, we are in a solid position. Addressing the earlier question about the increments, we are slightly ahead of our range at the halfway mark, and we anticipate staying in a favorable position for the second half. However, it's worth noting that margin comparisons for the latter half are more challenging than those for the first half. Just one of the influencing factors.

Ross Sparenblek, Analyst

Okay. That's helpful. And then maybe can you just give us a sense of where the recurring revenue shook out as a contribution in the quarter and maybe help parse out also what those growth rates look like? It sounds like it's pretty meaningful.

Steve Blanco, President and CEO

No, I appreciate the question. I would say that we are currently in the 15% zone. We've implemented several initiatives to improve that. At Investor Day, we discussed eventually reaching the 20% zone. While there wasn't a significant change in the third quarter regarding that goal, we did achieve some positive results in the io4 space and the MSA plus area, as well as on a global scale. We are still making progress and growing our business. This has positively impacted our growth rate in portables during the first half of the year, contributing to our optimism. Over the past year and a half, we've secured several solid three and four-year contracts in the io4 sector.

Ross Sparenblek, Analyst

Okay. Got it. And then, maybe then just on the mix, if we could get a sense of what the impact was from international, it does sound like the recurring might have offset a bit of that on the gross margin side.

Lee McChesney, Senior Vice President and CFO

Yes, I would say the mix is fairly neutral. It's notable to consider the margins in the second quarter, which set a record for our margin rate in the Americas for any quarter. This success is driven by our business system, a focus on productivity, ongoing management of prices and costs, along with new product innovations contributing positively. Therefore, those factors are relevant. The mix remains neutral for us, but I anticipate it may pose a small challenge in the latter half of the year, particularly since we had a strong emphasis on detection last year as we worked through that backlog.

Steve Blanco, President and CEO

I believe Ross brings up an important point regarding our international efforts. In light of what we've been doing in terms of innovation, we're observing the fire service performing as anticipated. The fire service and detection sectors, along with international markets, have shown impressive growth, which we expect will continue to shift the mix in the coming years. While we anticipate growth in industrial, we believe these two areas will significantly contribute to international growth.

Ross Sparenblek, Analyst

Got it. So industrial should probably have a seasonally higher step-up in the second half despite the ballistic helmets in the second quarter.

Steve Blanco, President and CEO

I wouldn't expect a significant increase in the industrial space in the second half. It is likely to be somewhat similar to the first half unless there is a noticeable change or acceleration in the economy. I anticipate it will remain fairly consistent with the first half. We faced some tough comparisons in the international ballistic helmet business, so I expect it to maintain that consistency.

Ross Sparenblek, Analyst

Got it. All right. Well congrats on the quarter, guys. Thank you.

Steve Blanco, President and CEO

Thanks, Ross.

Operator, Operator

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

Larry De Maria, Executive Director of Investor Relations

Thank you. We appreciate you joining the call this morning and for your continued interest in MSA Safety. If you missed a 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.

Operator, Operator

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