Good day, and welcome to the MSA Q3 2021 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Chris Hepler. Please go ahead.

Thank you, Sarah. Good morning, and welcome to MSA's Third Quarter Earnings Conference Call. Joining me today are Nish Vartanian, Chairman, President and Chief Executive Officer; and Ken Krause, Senior Vice President, Chief Financial Officer 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 Form 10-K filings with the Securities and Exchange Commission. MSA 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, and the non-GAAP reconciliations as well as our third quarter press release are available on our Investor Relations website at investors.msasafety.com. With that, I'll hand the call over to Nish.

Thank you, Chris, and good morning, everyone. This morning, I'll provide an overview of how we're continuing to execute our strategy in this dynamic environment, and some insight into the steps we're taking to strengthen our market position. Ken will then provide a quarterly financial review and give more texture on the strength we're seeing in the demand trends across our portfolio. After that, we'll start the Q&A session. So let's start with quarterly results. Our revenue was $340 million, up 12% overall and 3% on an organic constant currency basis. Our core organic product revenue increased 9% and driven by growth across our fire service and industrial PPE segments, partially offset by lower fixed gas and flame detection business, which was impacted by supply constraints. Looking more closely at the quarterly comparison, I want to note that our 2020 third quarter benefited from higher pandemic-driven demand for air-purifying respirators. In the current quarter, we saw our APR business return to more normal levels, which was a headwind to overall growth. I noted on our second quarter call that our order book was strengthening, and that continued to be the case in the third quarter. As an example, our backlog has increased $50 million, year-over-year. Notably, the backlog across our gas detection as well as our firefighter apparel is trending at record levels. Overall, our business remained healthy in the quarter, but supply chain disruptions in electronics and, to a lesser degree, labor shortages, did have impact on our delivery capabilities for some products. In addition, our quarterly profitability was impacted by variable compensation resets and higher selling commissions along with discretionary costs as business conditions improve relative to last year. Lastly, in this inflationary environment, pricing continues to be a key area of focus for us. We implemented off-cycle…

Thanks, Nish, and good morning, everyone. I'll start the discussion with financial highlights centered around revenue, profitability and cash flow. Revenue growth was healthy in the third quarter with core revenue growth of 19%. This included 9% growth in organic core revenue on a constant currency basis. We're seeing robust customer demand, especially in the Americas segment. However, the persistent electronic component shortage, and labor challenges to a lesser extent, have impacted our ability to fulfill orders and is driving backlog to record levels. Adjusted operating margin was 15% in the quarter, which was down year-over-year driven by -- driven primarily by variable compensation resets and higher selling commissions and discretionary costs. These costs are resetting from an abnormally low base in 2020. Cash flow performance was very healthy in the quarter and continues to support ongoing investment in growth opportunities and return of capital to our shareholders. We're managing working capital well, and that resulted in strong improvements in quarterly cash flow. Now let's take a closer look at the financial results in the third quarter. I'll start with a focus on revenue. Quarterly revenue of $340 million was up 12% overall and 3% on an organic constant currency basis. While our noncore business was off considerably on the lower level of APR revenues, it was encouraging to see core product revenues up 19% with 9% organic growth in the quarter. We are seeing robust demand in the Americas segment, while revenue in the International segment is being impacted by the prevalence of COVID-19, resulting in a very uneven economic recovery across those regions, with particular weakness in the emerging markets in the International segment. The quarterly book-to-bill was above 1x in the quarter. While order pace strengthened throughout the quarter, supply chain constraints around electronic components, and labor…

Thanks, Ken. For all of us at MSA, safety is our mission, our passion and it's our purpose. And that's 1 reason I wanted to conclude my comments this morning with 1 more recognition of our team. It goes to our associates who work at our Cranberry Township production facility and corporate center. This team recently surpassed a remarkable 10 million hours without a lost time incident. This means it's been more than 5 years since we've had an LTI at our Cranberry Township campus. So I want to congratulate and thank every associate who works at our Cranberry facility for such a great commitment to the mission of MSA right here at home. While the balance of 2021 will continue to present us with various challenges, I have tremendous confidence in our strategy and the team we have executing it. Our business has demonstrated, its resiliency through a number of economic cycles today our products, people and passion position us to manage through this current cycle. As I've communicated to our global workforce, I believe we are positioned extremely well as the leader in safety technology, ready to emerge as an even stronger organization in 2022 and beyond. Thank you for your interest this morning. 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.

[Operator Instructions] Our first question comes from Stanley Elliott with Stifel.

I guess starting off, could you all talk a little bit more about the subscription services? How you envision this kind of developing whether it's going to be on like a monthly charge? Is it going to be based into the price of the product upfront? Curious to see how you think about this evolving.

Stanley, and thanks for the question and your interest. Yes. The io4 is really an exciting device for us, right? You have cellular connectivity, which will be fully connected on demand of the product, fleet management software, live monitoring software, location, bumper-to-bumper warranty. And that will be available through a number of different subscription services. Those subscriptions will be done on a monthly basis. They'll be paid for on a monthly basis by our customers. And it really presents us with a new tool for our customers to simplify the documentation for the safety programs that they have. And it will really improve their efficiency. What's great about the product, Stanley, is today, when an employee goes to sign out a multi-gas device at a site. There's a lot of paperwork involved. With the io4, we have it set up from a software system where it's connected to that employee. It knows the employees that's using the device maintains all of its readings. And then when the employee puts the device back into its station and automatically calibrates and updates the device for the workers and downloads all the information. So everything is real-time monitoring, and we're really excited about the efficiency that we're going to drive with our customers as we introduce this product.

That was very exciting. And switching gears to the supply chain piece. I mean when would you anticipate being kind of price/cost neutral? It sounds like fourth quarter might have a little bit of headwind, maybe first part of next year before you're kind of getting level set. And then I guess as a second piece to that, the supply chain disruptions that you're seeing right now, seasonally, your business picks up 10% to 20% sequentially, third quarter to fourth quarter. Should we not expect that sort of a historical or seasonal ramp kind of given what you're seeing from the supply chain?

Yes. So you have a couple of things in there, so I'll hit a few of them, and then Ken will add some more color. From a supply chain standpoint, obviously, there are a number of challenges, right? So it hits across a number of areas, the electronics, metals, textiles, cylinders, packaging. We have an intense focus around that. We've got great teams that are monitoring critical components, managing and prioritizing mitigation plans that we have around that. We're working with suppliers on a 12-month rolling demand plans and working with second-tier suppliers to give them better line of sight to what we're seeing from a demand standpoint. And we're qualifying alternative parts where we can from an engineering standpoint to give us some better flexibility and expanding our second source suppliers. So as mentioned, we've been taking a lot of pricing action throughout the year. We've tightened up on special pricing requests. We've implemented off-cycle price increases. And typically, those will lag a bit when it comes to catching up to the price increases we're seeing on the inputs. But when you look at the margins here for Q3, they've held up really well. When you pare back, and Ken talked a bit about the gross profit side of the business, we did a nice job in offsetting things. I certainly expect you'll see sequential improvement in our business from the third quarter to the fourth quarter. From a revenue standpoint, we'll see some nice improvement there. We've got a nice backlog in place, the demand for our products continue to be really strong. So we'll work our way through this. We -- 1 area where we've excelled from the standpoint of supply chain is resins for the industrial hard hats. We're going through that entire situation with the resin shortage throughout 2021. We didn't have a single stock out on our hard hats -- industrial hard hats. And we believe we're able to pick up some market share with that. And we're running 3- to 5-day delivery on logoed hard hats today. So that's been a real bright spot for us where we've managed that supply chain really effectively. And we hope to do that as we go forward as the resin situation is getting a little bit better. Electronics will probably be battling through 2022. Ken, do you want to add to that?

Sure. Let me put a finer point on the price/cost equation, Stanley. So you had asked about price/cost. First and foremost, I just want to emphasize how well the team is doing on the price/cost equation on the gross margin. We saw -- actually, in our organic business, we saw improvements in gross margin in both the Americas as well as the International segment. And so despite seeing a challenging operating margin, the gross margins are holding up in our business. And really what's weighing down the operating margin are all of the SG&A resets that we saw coming back into the business in the quarter. So the team is doing a really good job on the price/cost. As Nish as well pointed out, there is risk in the backlog with a backlog that is growing considerably both versus last year but also versus the more normalized environment of 2019. There is a risk that we will deliver orders that are priced at yesterday's terms with today's cost. So that's something we're paying attention to. Secondly, you had talked -- or asked a little bit about expectations going forward, sequential uplift. You're exactly -- you're spot on with respect to 10% to 20% normal seasonality lift. What I'll say is we don't expect to be at that 20% range. We're probably closer to that 10% range of seasonal uplift, but there is a significant amount of risk with respect to the supply chain. So I'll turn it back to everybody to Stanley for any additional questions you might have at this point.

No. That's great color.

Our next question comes from Brendan Popson with CJS Securities.

I just wanted to ask about the -- just the cost pressures and the supply chain impact, specifically the product groups. Can you go through which -- is it kind of equal across the board? Are there specific product groups that are getting hit more than others?

Brendan, yes, so it's been uneven to be frank. We saw some spiking in the resins for hard hats as we saw some shortages due to the winter storm down through Texas. But that's beginning to plateau and normalize a bit. The electronic components are probably the area that give us the greatest frustration today. That's where we're seeing some real spikes in certain components. There's certainly a supply/demand imbalance. And we're seeing a lot of pricing pressure in that area. So that's where we've had some off-cycle price increases to really tighten up our special price request. And we've also had some off-cycle increases here in the month of July, we had an increase in North America. So we continue to deal with that. We'll continue to make adjustments as we go forward. We're watching and monitoring the aluminum, the textiles, cylinders and some other components very closely, and we'll make adjustments as we go forward. But it's uneven. It's not across the board. We're not seeing similar price increases with resins as we are with the electronic components. We'll continue to work through that as we progress.

Great. And then on this time frame, you talked about these pressures going well in 2022. Do you have a -- what's a realistic time frame to really reach normal backlog levels? And will that take even a little bit longer potentially, just for the orders to flow through? Or what's your view on the backlog?

That's a really good question. We have plenty of capacity in our plants. And so from a labor standpoint, if we get ourselves ramped up from a labor standpoint in certain areas where we have some shortages of labor. And then we get the supply chain ramped up. We can work through our backlog over a matter of 2 to 3 months' time. But that's -- I think we're going to be dealing with some of these supply chain issues into 2022. So I think we're going to be dealing with elevated backlog to a certain degree throughout '22. How severe that is or the challenges with the different product groups, we just don't have real good line of sight to that right now.

Brendan, there's 2 recent areas we're running through in the business with respect to that. Nish pointed out 1 where you could work through in 2 to 3 months. That certainly is very optimistic. Another scenario could be middle part of the year, things start to free up. You hear others talk about supply chain challenges, maybe abating into the second half of next year. So that could be another scenario. And the worst-case scenario could be this persists into '23. And so we're certainly trying to do everything we can to manage around this, but it is very -- a very fluid environment and a very challenging environment.

And just a quick follow-up to that, just thought of with the capacity you're talking about, obviously, get those orders done at some point. Is there any -- I guess is there any risk to labor availability? Obviously, we have the mandate coming in place. And do you guys -- how is that going? And do you have a plan for that? Do you expect to see an impact on labor there?

Well, at this point, our vaccination rates are reflective of society in general. So our vaccination rates, it's decent across the board and improving. We continue to have employees vaccinated. There's always a little bit of risk with the workforce. And if there's a mandate from OSHA that all employees vaccinate, there could be some risk with some fallout in the workforce, but we think we'll continue to deal with that and offset that with new hires and finding new people. We do a nice job of attracting employees. We've got a fantastic mission of the organization rallies all around. People feel there's a purpose to working with MSA, a higher purpose, so to speak, in working with MSA, and we do a nice job of attracting and developing our people and retaining those individuals for long periods of time. So we think we'll work through it as the employment and the labor situation begins to improve.

Our next question comes from Rob Mason with Baird.

I wanted to start -- just wanted to see if you could comment around the fixed gas flame business or maybe just the broader energy-related businesses, just given some continued improvements, and certainly in commodity prices and whatnot. How you're seeing the order book shape up there? I know you had a very large order earlier this year, but just speak to how that sector is trending for you?

Well, in general, the oil and gas space for us has really improved nicely. So we -- hard hats -- we've seen demand for hard hats, portable gas detection, fall protection. And of course, fixed gas and flame detection really ramp up throughout the third quarter and in here through the fourth quarter. So we're seeing some nice demand there, not only here in the U.S., but also in the Middle East. The demand is beginning to pick up. We think that will continue. That's -- the fixed gas and flame detection space is the area that we struggled most with getting product into the hands of our customers. And we continue to work through that. But demand around that area has improved nicely. We've seen demand across the entire portfolio for oil and gas improved nicely. So we've always had to believe that the oil and gas prices would come back with the economy, and demand would come back, and we've seen that. What's really interesting is that we're beginning to see some breathing apparatus orders -- significant breathing apparatus orders go into oil and gas, which really tells us that their capital equipment budgets are in really good shape. So we think that, that space is healthy, and we'll see some good spend as we go forward, and we'll begin to see some benefit there.

Just given where the supply constraints, maybe are most concentrated on this, is it fair to assume fixed gas wouldn't be at the lower end or below any other seasonal increase in the fourth quarter?

I'm not sure. The fixed gas typically -- it's a later cycle product for us, so it comes in as capital budgets improve. And typically, customers are willing to wait for delivery on fixed gas and flame detection because they're installing that and we'll keep it on site for upwards of 15 years and replace sensors. So we start to see that later in the cycle. And I think that's proven to be the case. As we watch the incoming business improve, the fixed gas and plain detection has a later cycle. Ken, do you want to add to that?

Yes. The only thing I would say, I think, Rob, your question is getting to the point around electronic component shortages and ability to deliver in Q4 relative to other product categories. I think that's a fair statement. I mean this is a business we certainly do have some large projects that we're looking at potentially delivering. But this business, for the most part, is being hampered more so than other businesses. So I think it's a fair assumption that the growth will be a little bit challenged relative to other areas, like, for example, hard hats that Nish called out.

Okay. Fair. Just last question. The -- Ken, I think you noted there was some onetime or acquisition-related expenses in the gross profit behind the cost of goods sold line. Overall, you called out about $7.4 million or so of acquisition-related costs. Where exactly does that $7.4 million show up is -- just the 120 basis points in gross profit. And then relatedly, to the extent you're reporting $0.94 of adjusted earnings. How is that distributed relative to the $0.94 between SG&A, cost of goods sold? And how much of that should we think about as ongoing, relates to amortization versus just onetime?

Yes. Sure. Great question, and thank you for the question, Rob. The $7.4 million, approximately $4 million of that is in gross profit, and the remainder $3.5 million or so is in your SG&A line item. $3.5 million that's in SG&A will not repeat. That was related specifically to the deal, and closing out the deal that was in SG&A. Roughly half of the cost of goods sold impact is amortization, which will go on for some time, noncash-related charges. The residual is a step up in backlog, which, for the most part, falls off here in the early fourth quarter.

Okay. Okay. And how do you feel about Bacharach's gross profit margin? That was thought to be not above MSA overall when you purchased the business, but is it still at that level, has it inflation or the supply chain constraint that they're dealing with eat into that? And how should we think about, I guess, modeling that out in the near term?

Yes. It certainly is still very attractive. And when you peel back the onion with some of these noncash charges, it's actually accretive on the gross line as well as the operating line to MSA's profile. Just stepping back a few comments on Bacharach in the quarter. Very robust order growth. Book-to-bill was north of 130%. And we're seeing good demand in our organic business, but also new opportunities in that -- in the portfolio. So we're pretty excited about what we can continue to do with that business and the growth dynamics.

[Operator Instructions] Our next question comes from Ryan Danisavage with Sidoti.

Two questions today. The first one, given the changes in the regulatory environment around sustainability and packaging in the United States. And while early, has this sparked greater conversations with potential customers?

Ryan, yes, we continue to look at our packaging, for instance, and how we package our product. We think that there's some nice opportunity for us from that standpoint. ESG is really driven us to take a look at some of those opportunities. From an engineering standpoint, we're looking at repackaging. And the beauty is as we've looked at this and gone down the path, there's actually some cost savings associated with that. So it's one of the great examples of how ESG makes us a better organization, more efficient, helps to drive some profitability as a company. So we continue to look at those opportunities as we go forward. And certainly, with new products that we're introducing in the market, we're looking at the packaging of those products as we go forward.

Great. Great. And just one sort of follow-up. And have you seen any change in the competitive landscape around sustainability at all? That would be my second.

No. Ryan, I don't think we have seen anything from a customer standpoint and what they're bringing to market or any dynamics that are pushing things. What I will say, though, is that with ESG, safety certainly has continued to come to the forefront of importance for protecting workers. With what we've gone through with COVID and with ESG and the highlight around that. Protecting workers has never been more important. And with tight labor force, companies are certainly doing everything they can to make sure that they protect workers and create a work environment for their workforce that provides them a high level of safety equipment, and we benefit by that. We benefit when customers are looking for high-value products to better protect our employees. That well-educated customer who's looking for high-value products is typically our best customer. So we think the environment overall will be beneficial for MSA.

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

Thank you. On behalf of our entire team here, I want to thank you for joining us this morning. If you missed a portion of the conference call, an audio replay and transcript will be available on our Investor Relations website for the next 90 days. We look forward to talking with you again soon. Thank you.

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