MSA SAFETY INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
The following discussion and analysis should be read in conjunction with the historical financial statements and other financial information included elsewhere in this quarterly report on Form 10-Q. This discussion may contain forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in the sections of our annual report entitled "Forward-Looking Statements" and "Risk Factors," and those discussed in our Form 10-Q quarterly reports filed after such annual report (such as in Part II, Item 1A, "Risk Factors.")
MSA is a global leader in the development, manufacture and supply of safety products that protect people and facility infrastructures. Recognized for their market leading innovation, many MSA products integrate a combination of electronics, mechanical systems and advanced materials to protect users against hazardous or life-threatening situations. The Company's comprehensive product line, which is governed by rigorous safety standards across highly regulated industries, is used by workers around the world in a broad range of markets, including fire service, oil, gas and petrochemical industry, construction, industrial manufacturing applications, utilities, mining and the military. MSA's core products include breathing apparatus, fixed gas and flame detection systems, portable gas detection instruments, industrial head protection products, firefighter helmets and protective apparel, and fall protection devices. We are committed to providing our customers with service unmatched in the safety industry and, in the process, enhancing our ability to provide a growing line of safety solutions for customers in key global markets. We tailor our product offerings and distribution strategy to satisfy distinct customer preferences that vary across geographic regions. To best serve these customer preferences, we have organized our business into four geographical operating segments that are aggregated into three reportable geographic segments:
Americas, International and Corporate. Americas. Our largest manufacturing and research and development facilities are located in the U.S.We serve our markets across the Americaswith manufacturing facilities in the U.S., Mexicoand Brazil. Operations in the other countries within the Americassegment focus primarily on sales and distribution in their respective home country markets. International. Our International segment includes companies in Europe, the Middle Eastand Africaand the Asia Pacificregion. In our largest International subsidiaries (in Germany, France, U.K., Irelandand China), we develop, manufacture and sell a wide variety of products. In China, the products manufactured are sold primarily in Chinaas well as in regional markets. Operations in other International segment countries focus primarily on sales and distribution in their respective home country markets. Although some of these companies may perform limited production, most of their sales are of products manufactured in our plants in Germany, France, the U.S., U.K., Irelandand Chinaor are purchased from third-party vendors. Within the International segment, during the first quarter of 2022, due to military conflict in Ukraine, we suspended product shipments into Russiaand Belarus. The suspension is indefinite. Customers in Russia, Belarusand Ukrainegenerated approximately $6 millionof sales during the year ended December 31, 2021. Corporate. The Corporate segment primarily consists of general and administrative expenses incurred in our corporate headquarters, costs associated with corporate development initiatives, legal expense, interest expense, foreign exchange gains or losses and other centrally-managed costs. Corporate general and administrative costs comprise the majority of the expense in the Corporate segment. -27- -------------------------------------------------------------------------------- During the fourth quarter of 2021, the Company changed its method of accounting for certain inventory in the U.S.from the LIFO method to the FIFO method. The FIFO method of accounting for inventory is preferable because it conforms the Company's entire inventory to a single method of accounting and improves comparability with the Company's peers. The effects of the change in accounting method from LIFO to FIFO have been retrospectively applied to all periods presented in all sections of this Quarterly Report, including Management's Discussion and Analysis. Refer to Note 4-Inventory of the consolidated financial statements in Part II Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2021, for further information related to the change in accounting principle.
Here is a brief description of each of our main product categories:
MSA's corporate strategy includes a focus on driving sales of core products where we have leading market positions and a distinct competitive advantage. Core products, as mentioned above, include breathing apparatus in which SCBA is the principal product, fixed gas and flame detection systems, portable gas detection instruments, industrial head protection products, firefighter helmets and protective apparel, and fall protection devices. Core products comprised approximately 90% and 89% of sales for the six months ended
June 30, 2022and 2021, respectively. MSA also maintains a portfolio of non-core products. Non-core products reinforce and extend the core offerings, drawing upon our customer relationships, distribution channels, geographical presence and technical experience. These products are complementary to the core offerings and often reflect more episodic or contract-driven growth patterns. Key non-core products include air-purifying respirators ("APR"), eye and face protection, ballistic helmets and gas masks. MSA maintains a diversified portfolio of safety products that protect workers and facility infrastructure across a broad array of end markets. While the company sells its products through distribution, which can limit end-user visibility, the Company provides estimated ranges of end market exposure to facilitate understanding of its growth drivers. The Company estimates that approximately 35%-40% of its overall revenue is derived from the fire service market and 25%-30% of its revenue is derived from the energy market. The remaining 30%-40% is split among construction, utilities, general industrial applications, military and mining. A detailed listing of our significant product offerings in the aforementioned product groups above is included in MSA's Annual Report on Form 10-K for the year ended December 31, 2021. -28-
RESULTS OF OPERATIONS
Three months completed
Net Sales. Net sales for the three months ended June 30, 2022, were $372.3 million, an increase of $31.0 million, or 9.1%, compared to $341.3 millionin the same period last year, driven by acquisitions and the combination of volume growth and price realization. We saw healthy growth across most core products. Please refer to the Net Sales table for a reconciliation of the quarter over quarter sales change. Net Sales Three Months Ended June 30, Dollar Percent (In millions) 2022 2021 Increase (Decrease) Increase (Decrease) Consolidated $372.3 $341.3 $31.09.1% Americas 252.4 217.7 34.7 15.9% International 119.9 123.6 (3.7) (3.0)% Three Months Ended Net Sales June 30, 2022 versus June 30, 2021 (Percent Change) Americas International Consolidated
GAAP reported sales change 15.9% (3.0)%
Currency translation effects 0.3% 8.3%
Constant currency sales change 16.2% 5.3%
Less: Acquisitions(a) (5.8)% (2.9)%
Organic constant currency change 10.4% 2.4%
Note: Organic constant currency sales change is a non-GAAP financial measure provided by the Company to give a better understanding of the Company's underlying business performance. Organic constant currency sales change is calculated by deducting the percentage impact from acquisitions and currency translation effects from the overall percentage change in net sales. Net sales for the
Americassegment were $252.4 millionin the second quarter of 2022, an increase of $34.7 million, or 15.9%, compared to $217.7 millionin the second quarter of 2021. Constant currency sales in the Americassegment increased 16.2% compared to the prior year period with organic constant currency growth of 10.4%. The inclusion of Bacharach drove the acquisition related sales. Organic growth was driven by growth across most core products, partially offset by weakness in fall protection and firefighter helmets and protective apparel. Net sales for the International segment were $119.9 millionin the second quarter of 2022, a decrease of $3.7 million, or 3.0%, compared to $123.6 millionfor the second quarter of 2021. The euro and British pound drove negative currency translation effects. Constant currency sales in the International segment increased 5.3% during the quarter with organic constant currency growth of 2.4%. The inclusion of Bacharach drove acquisition related sales. Organic growth was driven by strength across a number of core products, partially offset by weakness in fall protection and firefighter helmets and protective apparel.
We continued to see strong order growth in the quarter and in July. Our order backlog reached record levels for nearly all commodities due to an acceleration in the pace of orders and continued supply chain and labor constraints.
Looking ahead, we continue to operate in a very dynamic environment. There are a number of other evolving factors that will continue to influence our revenue and earnings outlook. These factors include, among other things, supply chain constraints, raw material or semiconductor availability, the risk of additional COVID lockdowns, industrial employment rates, military conflict, currency exchange volatility, the pace of economic recovery, as well as geopolitical risk, particularly as it relates to energy uncertainty which could affect operations and suppliers based in
Germanyand broader Europe. While we expect sequential improvement in revenue and earnings in the second half of 2022, which could drive high single-digit to double-digit sequential revenue growth, these or other conditions could impact our future results and growth expectations.
Refer to Note 8-Segment information to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q, for information on sales by product group.
-29- -------------------------------------------------------------------------------- Gross profit. Gross profit for the second quarter of 2022 was
$164.4 million, an increase of $11.4 millionor 7.5%, compared to $153.0 millionfor the second quarter of 2021. The ratio of gross profit to net sales was 44.2% in the second quarter of 2022 compared to 44.8% in the same quarter last year. Intangible asset amortization related to acquisitions reduced gross profit by $2.3 millionor 60 basis points in 2022, while inflationary pressures and product warranty charges also negatively impacted gross profit.
We have implemented multiple price increases in response to the inflation we are seeing in electronic components and almost all inputs. We will continue to assess further price opportunities as we continue to deal with inflationary pressures.
Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses were
$86.1 millionduring the second quarter of 2022, an increase of $2.7 millionor 3.2%, compared to $83.4 millionfor the same period a year ago. Overall, SG&A expenses were 23.1% of net sales during the second quarter of 2022, compared to 24.4% of net sales during the same period in 2021. Organic constant currency SG&A increased $4 millionor 5.0%, demonstrating strong leverage on the revenue growth. This increase was driven by annual merit increases and increased costs to support higher business activity, which was partially offset by the absence of the 2021 acquisition related costs. 2021 acquisition related costs included higher stock compensation costs and transaction costs. Current period results also benefited from lower costs resulting from prior restructuring initiatives in our International segment.
Please refer to the Selling, General and Administrative Expenses table for a reconciliation of the change in expenses from quarter to quarter.
Three Months Ended Selling, general, and administrative expenses
June 30, 2022versus June 30, 2021(Percent Change) Consolidated GAAP reported change 3.2% Currency translation effects 2.7% Constant currency change 5.9% Less: Acquisitions and related strategic transaction costs
Organic constant currency change
Research and development expense. Research and development expense was
$15.3 millionduring the second quarter of 2022, an increase of $1.3 million, compared to $14.0 millionduring the second quarter of 2021. Research and development expense was 4.1% of net sales in both periods. We continue to develop new products for global safety markets, including the Altair io 4 and V-Gard C1. During the second quarter of 2022, we capitalized $2.1 millionof software development costs. Restructuring charges. Restructuring charges during the second quarter of 2022 were not significant. This compared to restructuring charges of $7.1 millionduring the second quarter of 2021, primarily related to our ongoing initiatives to drive profitable growth and rightsize our operations. While we saw a reduction in charges in the quarter, we remain focused on identifying and executing programs to optimize our cost structure. Currency exchange. Currency exchange gains were $1.5 millionin the second quarter of 2022 compared to losses of $1.6 millionin the second quarter of 2021. Currency exchange in both periods related to foreign currency exposure on unsettled inter-company balances, primarily associated with the euro and British pound. Refer to Note 16-Derivative Financial Instruments to the unaudited condensed consolidated financial statements in Part I Item 1 of this Form 10-Q, for information regarding our currency exchange rate risk management strategy. Product liability expense. Product liability expense for three months ended June 30, 2022was $2.9 millioncompared to $11.8 millionin the same period last year. Product liability expense for the current period related primarily to defense costs incurred for cumulative trauma product liability claims. The expense during the second quarter 2021 related to an increase in the number of asserted claims pending against MSA LLCand a corresponding adjustment to the reserve. GAAP operating income. Consolidated operating income for the second quarter of 2022 was $61.5 millioncompared to $35.1 millionin the same period last year. The increase in operating income was primarily driven by an increase in sales associated with acquisitions, volume growth, price realization, lower product liability expense and restructuring expense, partially offset by higher SG&A expenses to support higher business activity. Adjusted operating income. Americasadjusted operating income for the second quarter of 2022 was $57.1 million, an increase of $7.8 millionor 15.9% compared to $49.3 millionfrom the prior year quarter. The increase in adjusted operating income is primarily attributable to higher sales volumes driven by both acquisitions and organic business activity, partially offset by higher SG&A to support business growth. -30-
International adjusted operating income for the second quarter of 2022 was
$17.2 million, a decrease of $3.2 million, or 15.8%, compared to $20.4 millionin the prior year quarter. The decrease in adjusted operating income is primarily attributable to lower revenue and gross margins, as a result of unfavorable currency translation and inflationary pressures, partially offset by lower SG&A expenses. Corporate segment adjusted operating loss for the second quarter of 2022 was $8.7 million, a decrease of $2.3 millioncompared to an adjusted operating loss of $11.0 millionin the second quarter of 2021, due to lower acquisition related costs related to the July 1, 2021acquisition of Bacharach. The following tables represent a reconciliation from GAAP operating income to adjusted operating income (loss) and adjusted EBITDA. Adjusted operating margin % is calculated as adjusted operating income (loss) divided by net sales and adjusted EBITDA margin % is calculated as adjusted EBITDA divided by net sales.
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