MSA Safety Incorporated — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. MSA develops and sells safety products to industrial, fire service, construction, utilities, mining, and other markets. Results are unaudited.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $296.1 million | $278.2 million | $850.7 million | $853.5 million |
| Gross profit / margin | $132.5 million / 44.7% | $128.8 million / 46.3% | $385.8 million / 45.4% | $385.3 million / 45.1% |
| Operating income | $40.6 million | $40.0 million | $74.3 million | $116.6 million |
| Net income attributable to MSA | $32.1 million | $24.2 million | $59.0 million | $67.0 million |
| Diluted EPS | $0.83 | $0.63 | $1.52 | $1.76 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $189.2 million | $31.4 million |
Q3 sales rose 6.4% year over year; Americas sales increased 13.0%, largely reflecting the Globe acquisition, while International sales fell 3.3% as reported and 6.6% in constant currency. Nine-month sales were nearly flat: Americas grew 3.5% and International declined 6.1% as reported. Management cited lower European military helmet and other product volumes, partly offset by growth in head protection and fixed gas and flame detection.
Q3 gross margin declined, which management attributed to acquired-product margin dilution and less favorable non-core product mix. For the first nine months, improved margins in core products more than offset acquisition-related dilution. Q3 operating income was approximately flat; nine-month operating income declined mainly because of product-liability expense and restructuring charges. Adjusted operating income, a non-GAAP measure, was $47.7 million in Q3 versus $42.7 million a year earlier, and $128.2 million for nine months versus $122.8 million.
Liquidity, debt, and capital allocation
- At September 30, cash and equivalents were $112.2 million, versus $113.8 million at year-end 2016. Approximately $99.3 million was held by foreign subsidiaries and could incur additional taxes if repatriated.
- Total debt was $472.4 million, up from $390.5 million at year-end 2016, primarily reflecting borrowing to fund Globe. The revolving credit facility had $301.6 million of unused capacity, including letters of credit; the company reported covenant compliance.
- Nine-month investing cash outflow was $225.0 million, including $214.0 million for acquisitions, net of cash acquired. Financing activities provided $32.6 million. Dividends paid were $39.2 million; the company also repurchased shares.
- Management expected to repay approximately $30 million of long-term debt in Q4 2017. The company reported a 2.22% weighted-average rate on revolving-facility borrowings.
Material changes and unusual items
- MSA acquired Globe, a firefighter protective clothing and boots provider, on July 31, 2017, for approximately $215 million in cash, funded through revolving-credit borrowings. Globe contributed $19.7 million in sales and $1.7 million in net income from the acquisition date through September 30. Purchase-price allocations remained preliminary.
- Q3 included $3.3 million of other operating expense, primarily defense costs for uninsured asserted cumulative-trauma claims. Nine-month other operating expense was $33.0 million, largely related to claims settlements and the increase in the legacy product-liability reserve.
- The cumulative-trauma reserve was $91.6 million at September 30, versus $11.1 million at December 31, 2016. A $75.2 million settlement of asserted claims was agreed in August; $3.2 million was paid in Q3, $22.0 million was expected in Q4, and the balance was expected to be paid over seven quarters beginning in Q1 2018. The reserve excludes incurred-but-not-reported claims.
- Insurance receivables were $108.7 million and notes receivable from insurers were $78.4 million at September 30. MSA said it is now largely self-insured for cumulative-trauma claims. Insurance recovery timing and amounts remain exposed to insurer disputes, litigation, and insurer solvency.
- Effective tax rates were 14.4% for Q3 and 9.6% for nine months, influenced by tax benefits including share-based-payment benefits and reductions in European exit taxes. Nine-month share-based-payment adoption benefits were approximately $6.9 million.
- Nine-month restructuring charges were $16.9 million, including $11.4 million of non-cash special termination benefits related to a voluntary retirement program. Dividends per common share were $0.35 for Q3 and $1.03 for nine months.
Outlook and risks
- Management expected 2017 R&D expense of 4.0%–4.5% of sales, a full-year effective tax rate of 28% excluding specified share-based-payment and European exit-tax benefits, and a 2018 effective tax rate of 29%–31%, subject to geographic profit mix.
- Management described International backlog as healthy entering Q4. The filing provides no specific revenue or earnings guidance.
- Key risks include uncertain cumulative-trauma claims, potential unreserved IBNR losses, and recovery of insurance receivables. MSA disclosed 1,435 open lawsuits comprising 2,271 asserted claims at quarter-end. It warned that claim outcomes and reserve adjustments could materially affect results and liquidity.
- Other disclosed exposures include foreign-exchange and interest-rate movements, product liability and potential recalls, and the integration and preliminary valuation of the Globe acquisition.
Important facts for investors to verify
- Progress on cumulative-trauma settlements, the adequacy of the $91.6 million reserve, and whether MSA can estimate or must reserve for IBNR claims.
- Collection of the $108.7 million insurance receivable and $78.4 million insurer notes, including developments in the remaining coverage litigation and appeals.
- Globe integration, realized synergies, acquired margins, and final purchase-price allocation.
- Underlying sales and margin trends excluding acquisitions, particularly International performance and core-product profitability.
- Debt repayment, revolving-credit availability, covenant compliance, and the sustainability of cash generation and dividends.
- Normalization of the unusually low 2017 effective tax rate and the effects of discrete share-based-payment tax benefits.