Mine Safety Appliances' CEO Discusses Q4 2012 Results - Earnings Call Transcript

Feb.13.13 | About: MSA Safety (MSA)

Mine Safety Appliances Co (NYSE:MSA)

Q4 2012 Earnings Call

February 13, 2013 10:00 am ET

Executives

Mark Deasy – Corporate Communications Director

Bill Lambert – President, Chief Executive Officer

Dennis Zeitler – SVP, Chief Financial Officer

Joe Bigler – President, MSA North America

Ron Herring – President, MSA International

Analysts

Ed Marshall – Sidoti & Company

Richard Eastman – Robert W Baird

Brian Rafn – Morgan Dempsey Capital Management

John Cooper – BB&T Capital Markets

Operator

Welcome to the MSA Fourth Quarter Earnings Conference Call. My name is Elen, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded.

I will now turn the call over to Mark Deasy. Mr. Deasy, you may begin.

Mark Deasy

Thank you, Elen; and good morning, everybody. I too would like to welcome you to our Fourth Quarter and Year-End Earnings Conference Call for 2012. I’m Mark Deasy, Corporate Communications Director and with me this morning are Bill Lambert, President and Chief Executive Officer; Dennis Zeitler, Senior Vice President and Chief Financial Officer; Joe Bigler, our President of MSA North America; Ron Herring, President of MSA International, who is responsible for our business in Europe, Russia, the Middle East, India and Northern Africa; and Kerry Bove, President of MSA International, responsible for Latin America, Asia, Australia, Sub-Saharan Africa.

Our Fourth Quarter Press Release was issued this morning at 8:30, and we hope everybody has had an opportunity to review it. The release is available on the Homepage of MSA’s website at www.msasafety.com. This morning, Bill will provide his commentary on our quarter and year end result and then Dennis will review our financials in more detail. And after Dennis’s comments, we’ll open the call up for your questions.

Before we begin, I want to remind everybody that the matters discussed on this call, excluding historical information, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended. Forward-looking statements, including without limitation all projections and anticipated levels of future performance, 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 from time to time in our filings with the SEC, including our most recent Form 10-Q, which was filed on October 24, 2012. You are strongly urged to review all such filings for a more detailed discussion of such risks. Our SEC filings can be obtained at no charge at www.sec.gov, our own website and of course many other commercial sites. That concludes our forward-looking statement.

So at this point, I’ll turn the call over to Bill Lambert for his comments. Bill.

Bill Lambert

Thank you, Mark, and good morning everyone. Let me begin by saying thank you for joining us today on this conference call and for your continued interest in MSA. Presumably, all of you have seen our fourth quarter press release and have our financial figures with all comparisons corresponding to the equivalent period in 2011.

To begin, I want to say at the onset that I’m pleased to report today’s quarterly and full-year results, which I believe demonstrate solid performance by the MSA team. While economic and business conditions were uneven throughout much of 2012, I’m encouraged by the fact that our corporate strategy continues to gain traction around the world as indicated by many of our key metrics for success. For example, we continue to see improving performance in our five core product groups throughout emerging and developing markets. And I’ll provide more texture on that in a moment.

Additionally, the results we continue to see from our new product development efforts, our ongoing focus and closer management of manufacturing and operating costs, and continued success from General Monitors in our overall fixed gas and flame detection business are likewise very encouraging to see. The focus and performance of the team across these key areas of our corporate strategy helped MSA recognize solid growth in revenues, record cash flow and record profitability in 2012, while building a strong foundation for 2013. While we continue to experience persistent uneven economic uncertainty in global markets year at the start of 2013, I’m starting to feel a growing sense of optimism and momentum building in the outlook for many of our markets. The growth MSA has seen in core product sales combined with improved margin levels further support my optimism for the business.

I want to assure you that we remain committed to executing our strategic plan. These strategies continue to provide shareholders and customers with value and our fourth quarter and full-year financial results reflect the results of this commitment. As you saw on our press release, our consolidated sales for the quarter were $294 million, on as reported basis sales were down $10 million from a year ago. However, when analyzing the sales results, it’s important to consider the divestiture of our North American ballistic products business and the impact of weakening foreign currencies on the year-over-year comparison.

The fourth quarter of 2011 included $16 million of ballistic protection product sales in our North American segment. These non-core North American ballistic vest and ballistic helmet businesses were divested late in 2011, and during the first half of 2012 respectively. Additionally, weakening foreign currencies decreased as reported fourth quarter 2012 sales by $4 million, therefore excluding the currency effects and the divested business impacts tax, our sales were up $10 million, representing an increase of 4% for the quarter.

The increase in local currency revenue in the fourth quarter was driven by the focus; our team continues to place on driving demand for core MSA product lines which, as you well know by now and is a key element of our long-term strategy. These core product lines include fixed gas and flame detection systems, portable gas detection instruments, industrial head protection products, supplied-air respirators, and fall protection products.

Sales from those five core product lines comprise 68% of our total fourth quarter sales, and had local currency revenue growth of 10% when compared to the fourth quarter of 2011. Sales across these same core product groups in the emerging markets grew by 27% in the quarter. For the full year, local currency sales of our core products increased 10% overall and 21% in the emerging markets.

Our core product business accounted for 65% of total 2012 MSA sales, that’s up from 60% in 2011 and up from 55% back in 2009. We continue to see solid growth opportunities for these core product lines and for this reason, we remain focused on advancing this initiative around the world.

I’m especially proud of the progress we’re making in managing manufacturing costs and improving gross profits as part of our operational excellence initiatives. Our efforts over the past four years to optimize our manufacturing footprint and improve our supply chain processes globally continue to yield major results.

Overall, our focus on core products as well as our operational excellence initiatives contributed to the 480 basis point improvement in gross profit margin that we saw in the fourth quarter. The emphasis we’re placing on improving our sales mix via heightened focus on higher margin more profitable core products coupled with our ongoing focus on strategic pricing and managing manufacturing costs is clearly improving gross profit.

While the percent of total sales in core products have improved from 55% of sales in 2009 to 65% of sales in 2012, I’m pleased to report that over that same 4-year period, our gross margin levels of core products have improved by 460 basis points. And for the year just completed gross margin of core products improved 170 basis points. While we still have more to accomplish in this regard, I do view this as solid evidence of progress and I’m proud of the accomplishments our team continues to make in this area. Shifting gears and now looking at our expense management, our SG&A expenses were higher in the quarter.

While we did see higher selling and administrative expenses on the higher level of sales and profitability, higher legal expenses associated with our ongoing insurance receivable collection efforts, and lower pension income which Dennis and I noted on our third quarter call, also had an impact. Therefore, our as reported operating margin for the quarter was 11.7%, a 130 basis point improvement over the same period a year ago. Dennis will provide more detail on operating margins and our fourth quarter SG&A expenses in his comments.

As we noted in the past, we’ve remained committed to developing innovative new core products that enhance the MSA brand and advance the level of worker safety in the industries that we serve. Quarterly research and development expense was $11 million, increasing 17% from the same period of a year ago. For the full year, R&D was up 4.2%. This investment allowed us to design, develop and launch several new core products throughout 2012, including an innovative Escape Respirator to protect the oil and gas workers from the rigorous elements of the Caspian Sea where temperatures of minus 30 degree Celsius are common. MSA shipped this breakthrough order totaling $6.5 million in the fourth quarter of 2012. Before I move on another great example of an MSA innovation that I want to mention, is the industry’s first Green Hard Hat. I don’t mean the color. We’ll have a press release coming out later today about this product, but we believe it is the first safety product produced from nearly 100% renewable resources.

The V-Gard Green is an extension of our market leading V-Gard line of hard hats, but it is special because the helmet shell has manufactured from a high-density polyethylene sourced entirely from sugarcane. In using sugarcane as a source, we are actually reducing the overall carbon footprint associated with the entire life cycle of this particular product. So now workers have the option of using a hard hat that not only helps to protect their head, but protects the environment as well. I continued to be encouraged by the performance of the new product development team as we develop innovative new core products that drive higher levels of sales and profitability.

Let me give you a sense of the impact of new product introductions are having on our business. When you factor in these launches with our strategic pricing efforts and lower manufacturing costs in our combined gas detection product lines, that’s fixed gas and flame detection and portable gas detection instruments. Sales increased 11% for the year while gross margins improved by over 200 basis points from a year ago. In a similar fashion, our new product introduction efforts and fall protection have increased margins 400 basis points from a year ago in that product line.

Well, it’s true competition in the markets we serve is fears. Our new product development efforts, our strategic pricing efforts and our operational excellence initiatives to lower costs are helping us to grow sales, improve profitability, and improve our position in the markets that we serve. 25% of our consolidated sales in 2012 were from products introduced in the last five years, and that’s an improving trend that we intend to continue.

As I have highlighted on previous calls, cash flow is another key area focus for the management team. Our cash flow from operations in 2012 was $150 million, compared to our $85 million in 2011. This was a record for MSA. We use this cash to continue to invest in the business to increase our dividend and to pay down our debt. Including the special dividend paid in December, we paid shareholders a record $51 million in dividends during 2012.

Once again, Dennis will be providing more details on cash flow in his commentary. But I think it’s important to point out that this was a record year for MSA and our shareholders on many fronts.

Before I turn the call over to Dennis, I’d like to briefly review the results for each of our geographic reporting segments. I’ll start with MSA North America. Sales in our North American segment were down 9% primarily to the divestiture of the ballistic helmets and ballistic vest business that I noted earlier. Excluding these in the year-over-year comparison, sales increased 1% on improving strength in industrial markets. Industrial market sales represented 69% of our full year North American business, up from 64% of the business in 2011.

For the quarter, industrial sales increased 5% on the strength of portable gas detection and fixed gas and flame detection product sales. To get a bit more granular, our North American sales of fixed and portable gas detection products increased 9% for the quarter, while full-year sales of these product lines increased 13% in North America. As I have discussed with you on previous calls, the North American fire service segment bottomed out in 2011, but began to rebound slightly in 2012. Full year North American fire service sales increased a modest 1%. Fourth quarter sales declined 4% from the prior year, but we don’t see that as a trend. We continue to believe that North American fire service markets worst days are behind us, and we are positioning ourselves for solid growth opportunities late this year and into 2014 and 2015.

We continue to make solid progress in expanding gross profit margins in North America. Overall, gross profit margins improved 670 basis points in North America on a greatly improved mix with less military product sales coupled with improvements in pricing and lower manufacturing costs.

Now turning our attention to Europe, it’s accurate to say the ongoing economic uncertainty and governmental austerity measures continue to provide headwinds, across many parts of our Pan-European business, but I was pleased that for the quarter MSA Europe local currency sales were up 11% with local currency industrial market sales up 28%. This is far in excess of what we think is sustainable for Europe, but I see this as a solid evidence that our strategy to strengthen industrial distribution activities across Europe, and to grow our business in the growth regions of the East Europe, Russia and the Caspian Sea, and down into the Middle East is yielding solid results.

For the year, local currency sales for MSA Europe have increased 8% as we further expand our channels of distribution and increase our presence across industrial markets in Europe. MSA Europe remains a tale of two regions; Western Europe, where we see austerity and slow growth, and Eastern Europe, Russia, the Caspian Sea region and down into the Middle East, where we see significant growth opportunities.

The $6.5 million special SCBA escape respirator order for an oil and gas consortium in Kazakhstan, I mentioned earlier, is a great example of us winning business in these emerging market growth regions. We saw an improvement in revenues during the quarter in Western Europe where local currency sales increased 6% for the quarter and increased 2% for the full year. This is great performance by our teams in Western Europe, and an economic zone where significant challenges remain. Recognizing the challenges, we understand we must continue to exercise cost discipline across much of the Western European region as we look for those pockets of growth opportunity and improve profitability. And that is exactly what we’re doing there.

Local currency operating costs for Western Europe are down 9% for the year and down 13% in the quarter. At the same time, we are continuing to make investments in the emerging markets across Russia, Eastern Europe and the Middle East where sales grew 28% in the quarter and were up 23% for the full year. While the environment remains challenging across Europe, the progress we are making towards improving profitability across our entire European segment is encouraging.

For instance, MSA Europe as reported net income was up 74% in the fourth quarter and up 76% for the full year. The cost control we maintained across Western Europe coupled with the growth we’re seeing in areas like Russia, and the Caspian Sea Region are providing solid returns for our shareholders. This was the eight consecutive quarters where we’ve reported increasing net income for MSA Europe over the prior-year result.

The last segment I’d like to cover is our business across International segment, which includes the geographies of Asia, Sub-Saharan Africa, Australia and Latin America. Our ongoing focus on emerging markets and the efforts we’re putting forth in this segment have shown solid results throughout 2012.

For the quarter, local currency sales improved 13% in Latin America with local currency core product group revenues increasing 36% due to strong demand for industrial head protection products and in part to large orders, such as our SCBA contract with the Chilean National Council of Firefighters’. During the quarter, we shipped $2 million of SCBA on this order. As you may recall we shipped $7 million earlier in the year to the Chilean Fire Service.

For the year, local currency sales across Latin America were up 18% with core product sales improving 28%. While the results in Latin America are very encouraging for MSA International, economic and business conditions in Asia and the ongoing disruptions in the mining markets across Sub-Saharan Africa tempered my overall optimism as we head into 2013.

For the fourth quarter, local currency sales across the Asia Pacific region increased a modest 4% with 3% growth seen in China and a 11% growth in Southeast Asia. Candidly incoming order activity throughout the Asia Pacific region in the third and fourth quarters of 2012 was a bit slower than expected, much of this had to do with slowdowns in China’s industrial output, and the ripple effect seen in the Australian and Southeast Asian mining markets in response to China’s slowdown.

Although we’ve implemented some restrictions on discretionary spending and have initiated other cost controls to help us navigate these conditions in Asia. We believe they are only temporary and we remain very committed to this growth region. I expect it to be a source of long-term profitable growth for MSA. So what’s in store for 2013, the revenue earnings and cash flow improvements we have reported over the past several quarters, I believe demonstrate the traction that we are gaining when it comes to implementing our corporate strategy.

We remain committed to staying this course, focused on our core profitable product lines and focused on emerging market growth opportunities. In spite of what I characterize as uncertainty, but somewhat improving business conditions at the beginning of 2013. We continued to closely monitor economic conditions, especially in Western Europe and throughout Asia, while ongoing disruptions in the mining markets across Sub-Saharan Africa are raising some concern. But I think agility is the key, and I assure you that we remain focused on those areas of our business where we are seeing stability and we have good growth opportunities. This agility will enable us to profitably grow increase market share and ensure the company’s long-term success.

Now I’d like to turn the conference call over to Dennis Zeitler, our CFO, who will provide you with more insight into our quarterly financial results. Dennis?

Dennis Zeitler

Thanks, Bill. Good morning. I’d like to give you some further insight into our fourth quarter performance and comment on the balance sheet and cash flow statements. Additional information will be available next week when we file our Form 10-K with the Securities and Exchange Commission.

As Bill mentioned, sales in the fourth quarter of 2012 were $294 million, a decrease of 3% compared to the fourth quarter of 2011. However in the fourth quarter of the prior year, we had $16 million of ballistic sales in North America businesses that we have since sold. This had a 6% impact on our global sales in this quarter and a stronger dollar had another 1% impact. The result is that our comparable sales actually grew 4% versus the reported 3% decrease. Using the same basis for comparison purposes, North American and International segment sales were both flat this quarter, and our European sales were up 11%. By markets, the fire service is down 4%, military down 52% as we have exceeded most of this business, and our core industrial business, which was nearly 70% of our business, was up 7%.

Our North American segment sales in the fourth quarter were down 9% compared to 2011 due to the 84% decrease in military sales as mentioned earlier, a 4% decrease in the fire service, and a 5% increase in the 71% of our business represented by our broadly defined industrial sales.

In our core product groups, portable gas detection was up 15%, fixed gas and flame detection was up 6% and both head protection and fall protection were up 5%. Our International segment sales were down 3% compared to the last year and flat when you include the weakness in a number of foreign currencies. In local currency terms, the fire service was up 19%, military was down 12% on a very small base, and industrial sales, which are 79% of our international sales. We were down 4% in local currencies and down 7% in U.S. dollars. Although, we saw 13% growth in at Latin America and 4% across Asia, our South Africa business was of 12%, due to the recent labor disruptions there and our Australian business was down 20% as a result of decreased demand from China for Australian coal and a large respirator sale in 2011 that did not repeat in 2012.

In Europe, our local currency sales were up 11% this quarter, and in U.S. dollars they were up 9%. With that the currency impact, our European Fire Service sales decreased 14%, Military was up 26% and industrial sales were up 28% over the same quarter in 2011. About half of the these $11 million increase in industrial sales was an order for supplied-air respiratory products for their oil fields in Kazakhstan, and the remainder we attribute to our increasing use of industrial distributors.

Our gross profit rate for this quarter was 44.3%, up 480 basis points from 39.5% last year. Our global efforts to reduce manufacturing cost, the increase production volume in our factories, more effective pricing and our focus that are more profitable core products, all contributed to this gross profit improvement. It is our expectation that we will continue to improve our gross profit margin performance in 2013 by higher volumes, cost discipline, product mix hand value-based pricing.

Selling and administrative costs in the fourth quarter were up $6 million compared to last year and up $3 million compared to the third quarter of 2012. Over half of this amount is related to less pension income and more insurance litigation costs, as I mentioned last quarter. And the remainder is selling in commission expense, an increasing level of local currency sales for the year. The $2.8 million of restructuring expense in this quarter was driven by staff reductions in North America and Europe as we realigned our resources to focus on our core product groups and to drive sales in the industrial and fire service markets.

The resulting operating income excluding those restructuring charges and currency expense is $35 million, an increase of 10% over the fourth quarter of 2011, that is 12% of sales in the fourth quarter and an average of 12% for the full year, that is 140 basis points higher than the full-year of 2011. And our plan for 2013 is for our operating income as a percentage of sales to again increase significantly. Our consolidated tax rate this quarter was 36% due to a couple of tax adjustments in the quarter, one of which affected the full year and the other was a one-time adjustment in South Africa.

For the full year, the tax rate was 32%. In the first quarter of 2013, we will account for the $1 million R&D tax credit from 2012, and we’ll be accounting each quarter this year for the 2013 R&D tax credit. Therefore, our effective tax rate for 2013 will be closer to 30%. The bottom line is reported net income of $19.5 million or $0.53 per basic share compared to $0.46 last year. Pro forma net income for the quarter was $21.8 million or $0.59 per share based on our $35 million of operating income and an average tax rate of 32%. For the full year, we had a record earnings of $91 million, $2.45 a share and 30% higher than the prior year.

As for the cash flow statement, we also had a record year. Our cash and short-term investments increased $28 million over the year, an outstanding $88 million composed almost entirely of cash outside the United States.

Our total debt at the end of 2012 was $279 million, down $63 million during the year. Although local currency sales were up $38 million in 2012, we actually reduced working capital by $17 million with positive cash flow from payables, receivables and inventory.

Our net spend for capital equipment purposes during 2012 was only $12 million due to some significant asset dispositions and we paid $51 million in dividends, including a special dividend late in December.

In summary, our net cash flow for the year was $138 million, which is over 150% of our net income. Those are my comments. At this point, Bill, Joe Bigler, Ron Herring, Kerry Bove and I will be more than glad to answer whatever questions you may have. Please remember that MSA does not give what is referred to as guidance and that precludes most discussions related to our expectations for future sales and earnings. Having said that, we will now open the call to your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session (Operator Instructions). Our first question comes from Edward Marshall with Sidoti & Company. Please go ahead.

Ed Marshall – Sidoti & Company

Good morning.

Bill Lambert

Hi.

Mark Deasy

Hi good morning Edward.

Ed Marshall – Sidoti & Company

It’s good to hear Douche company put saying momentum is building and looking out kind of the cost structure of the business is in they have the strength that the quarter that you had even with the higher SG&A and even R&D expense. And that’s going to be my first line of questing, I know you mention that $2.8 million of restructuring, I don’t know that you quantified or legal expense hopefully we can do that quantify the increase to legal expense in the quarter, and may be touch on what’s going on with the R&D?

Bill Lambert

The legal expense that was about a $1.5million greater in the fourth quarter of last year. And the pension income was about $2 million less in the fourth quarter of last year.

Ed Marshall – Sidoti & Company

And what was the after share impact on legal expense?

Bill Lambert

It was about $0.3.

Ed Marshall – Sidoti & Company

$0.3. Okay. And the R&D I’d know touched a bit on what’s going on there, is it’s a new run rate or is this just something extraordinary I the fourth quarter here?

Bill Lambert

Edward, this is Bill. I don’t see that as the new run rate, there was mixed organic expenses in the fourth quarter of last year so it was quite a bit heavier than normal but I know we’ve mentioned this in the past but going forward, looking at a high 3% up to 4.5% of sales as a run rate for R&D is above rate.

Ed Marshall – Sidoti & Company

Okay. Also I forgot to mention the necessity to ask, could the tax adjustment in the quarter, what was there, what was that pursued impact, or what was that number?

Bill Lambert

Yeah, the actual number was $1.4 million.

Ed Marshall – Sidoti & Company

$1.4 million.

Bill Lambert

It was an adjustment in the fourth quarter that should have been spread across the fended part earlier. $400,000 was a one time that will now repeat.

Ed Marshall – Sidoti & Company

But the full impact of the fourth quarter was $1.4 million or?

Bill Lambert

Right $1.4 million in the quarter.

Ed Marshall – Sidoti & Company

Okay. So $400,000 in the quarter, I see which is same right. So full impact.

Bill Lambert

Quarter $200,000 of the $1 million, only $250,000 of the $1 million should hit in the quarter.

Ed Marshall – Sidoti & Company

All right, I see. Okay.

Bill Lambert

Got it, or still confused.?

Ed Marshall – Sidoti & Company

Yeah., no I understand. I want to touch base on the green hard hat it, if I will?. Sugar cane versus an off line product is any cost-saving to you that would hit either in pricing structure or hit anything that we can comment on about kind of sourcing and then ultimately to customer pricing that would ultimately affect in the margin, involved together?

Bill Lambert

Yeah, I think that I won’t comment on cost side of things it does provide some opportunities from pricing perspective for those customers who are very concerned about and have ongoing activities in sustainability and whether they are looking to be able to earn credits, carbon credits for their sustainability initiatives. So we do see that there is some opportunity for us there. I wouldn’t say that it would be some material that you’d actually see it. Ed, in our financial results. It -- we think it’s an innovation, we’re glad to be a part of that. We’re already marketing and selling the product in Brazil, in Latin America and we’re expanding that to global markets around the world.

Ed Marshall – Sidoti & Company

But it’s fair to characterize it. This is just an example of something you guys have been doing to improve, not only your sourcing, but also improve the pricing of products et cetera through innovation.

Dennis Zeitler

Yes.

Ed Marshall – Sidoti & Company

Okay. And then finally, we had some 2015 targets out there for our operating margin, I think it was over 15% by 2015. We are obviously trending much faster than that. Any kind of update or so, maybe your plans, your thoughts surrounding that 15%, and obviously seems much more achievable here.

Dennis Zeitler

At this point, I guess, we did better than 12% in 2012. We are significantly improving in 2013. And we, -- I certainly think we’re on -- we’ll able to meet, make our 15%, but we’re not updating -- we are not changing that target at this point Ed.

Ed Marshall – Sidoti & Company

Would you be surprised to hit that earlier?

Dennis Zeitler

Probably not.

Ed Marshall – Sidoti & Company

Okay. Dennis, usually break down the sales and I know that the structures change with North America fire service, North American military, which I know it’s so minimum now, and then everything else.

Dennis Zeitler

But, at the year end, I took it out because we have so little military sales left, but the North American fire service in the quarter was $36 million.

Ed Marshall – Sidoti & Company

Okay. And North American military, I’m assuming, is $2 million or $3 million.

Dennis Zeitler

We got a $3 million.

Ed Marshall – Sidoti & Company

$3 million; Okay, perfect. Thanks guys.

Dennis Zeitler

You’re welcome. Thanks Ed.

Operator

The next question is from Richard Eastman with Robert W Blair. Please go ahead.

Richard Eastman – Robert W Baird

Oh, yes, good morning.

Dennis Zeitler

Good morning, Rick.

Richard Eastman – Robert W Baird

Nice quarter.

Dennis Zeitler

Thanks.

Richard Eastman – Robert W Baird

Hey, can I just ask Dennis, on the gross margin, I know, you give a couple explanations, your volume pricing focus on the core products. When I am looking at the gross margin sequentially from Q3 to Q4, there’s almost 100% conversion, on the sales increase from Q3, Q4. Is that just a really generous mix or how do we -- how do we get to the sequential, the conversion rate there?

Dennis Zeitler

Now, you characterized it pretty well. The self-contained supplied respiratory business we had in the fourth quarter was it very good rates.

Richard Eastman – Robert W Baird

Okay. So that’s a mix issue. Okay, all right. And then may be Bill, how do when you look at the core products, and I think for the year you comment it’s about 65% of sales for the five core product groups. When you think about that 65% of sales of those products into 2013. I know you don’t give guidance, but is the expectation for those core product groups to grow at a similar rates, kind of again maybe a double-digit rate of 10% or can you putting so much focus on that. So can you at least maybe just characterize your growth expectation for those key core products?

Dennis Zeitler

And it is, I mean -- Rick excuse me. It is the heart and soul of our strategy here is to focus in on these core products and grow those sales, and also the focusing on the emerging markets. And so when you look at our percent of sales percent of emerging market sales, which our core product lines, that’s growing at a much higher rate up north of 20% per year growth rates.

So overtime that 65%, actually I think there was 69% in the quarter, overtime we expect core product sales to become a greater and greater percentage of our overall consolidated sales. I mean that’s the game plan and we’re seeing that trend continue because of where we are seeing growth in the emerging markets, more and more of that is in the core product line areas. You combine that with North America with less sales in the adjacent product lines or the periphery product lines or the divestiture of products, non-core products like the ballistic protection business, you see increasing trends in the North American fire service. You combine all that together and we have every expectation to see improving increasing core product sales for MSA as we move forward.

Richard Eastman – Robert W Baird

Okay. So all right. So, if I think you maybe a secular growth rate for high-end personal protection is being a five or six number. These core products to grow faster. And then the ancillary products grow slower, and that’s kind how we get to the five, six number?

Dennis Zeitler

Yeah, let me -- you’re exactly right. This not makes me little more color on the five core product groups, because one element self -contained breathing apparatus, and we have this issue with the new standard in North America and the new products come out in August and that’s out of -- we can’t sell the old products before August. Our new product comes out in the second quarter. So that’s as a -- the SCBA business in North America isn’t going to grow as much the other core product groups. But you’re absolutely right.

Richard Eastman – Robert W Baird

Okay.

Dennis Zeitler

There other four product groups are going to grow nicely, SCBA is sort of a known – what we call adjacent product groups are going to grow much slower.

Richard Eastman – Robert W Baird

And Bill you’d mentioned I think kind of post third quarter that some of the fixed gas, I think the comment was more on a fixed gas and flame side that you would seen globally some orders pushed for 2013 towards the back portion of 2013 versus the front half, despite the fact that fourth quarter would be good and it appears to be, is that commentary still accurate, because you also have so kind of a tough first half in gas detection as well. So is that business get off to a slower start in 2013?

Bill Lambert

Has it gotten off to a slower start -- we’re only into our 6 or 7th week here of the year. I would not characterize it as a slow start versus our expectations for the year. I would say it’s lower than last year, because last year came out of the gate so strongly.

Richard Eastman – Robert W Baird

Okay.

Bill Lambert

So, I -- we don’t have concern for the fixed gas and flame detection part of the business. But on a comparative basis, it’s -- relatively it’s lower than last year, but last year was just so strong out of the gates. But I don’t see any concern. We’re not seeing orders that we had expected to flow in the first quarter of this year or that had been delayed once being delayed a second and the third and the fourth time, we’re not seeing that.

Richard Eastman – Robert W Baird

Okay. And then just a last question for Dennis. The pension gain that you’re able to apply to SG&A for the full year of calendar 2012. What was that number and what does it look like for 2013?

Dennis Zeitler

At the point 2013 is (inaudible), I think its $1 million we’ve budgeted for 2013.

Richard Eastman – Robert W Baird

Okay.

Dennis Zeitler

And for the full year, we had $5 million for the full year.

Richard Eastman – Robert W Baird

Okay, all right, just it’s okay.

Dennis Zeitler

And we get going down the $1 million next year.

Richard Eastman – Robert W Baird

Next year? Okay. Great, thank you, again and very nice quarter.

Dennis Zeitler

Thanks, Rick.

Operator

The next question comes from Brian Rafn with Morgan Dempsey Capital Management. Please go ahead.

Brian Rafn – Morgan Dempsey Capital Management

Good Morning, guys.

Bill Lambert

Hi, good morning, Brian.

Brian Rafn -- Morgan Dempsey Capital Management

All right, Bill, talk a little bit about you got your new fire service, the new SCBA standards set in August. How do see those standards in product rolling out and where are some of the early adopters, I met some of the larger class A how do you see that product kind of launching in 2013 and then in 2014?

Bill Lambert

Yeah, with the new standards that has been issued by the NFPA, we get to ask this question quite often, which is how big an impact we think that’s going to be, and I -- we don’t expect to see a strong impact in 2013 due to that new standard. I think that this is going to be a year broken into two halves. The first half of the year is probably going to be fairly strong. You’ll see some fire departments that understand the standard is coming and they just simply want to buy, perhaps even pre-buy the equipment that they’re very familiar with right now. After August, manufactures have to stop selling the old units. So for the first half of the year, maybe leaking into the third quarter we’ll see some -- we’ll see some accelerated sales as fire departments by up the older version. It’s typically what we see.

And from August through the balance of the year, there is probably going to be a lot of window shopping and entire kicking, if I can describe it as such during that portion of the year, folks -- fire requirements are going to want to understand the standard differently, understand what’s the difference in the breathing apparatus, understand how manufacturers are responding to that new standard with all new platform products like the kind of SCBA products, we’ll be introducing in the back half of this year.

We’ll have ample opportunity then to put that product in the field trials and get them more accustomed to what the changes are, what the new platform is and the new developments. So, I don’t see it having -- we don’t see it having a major negative impact or a major positive impact for us this year that being the new standard by NFPA, and I think we’ll probably end up having and what we’re seeing is fairly healthy, first half of the year into the third quarter, but late in the third quarter, in fourth quarter, we’ll probably see a lot of window shopping, entire kicking.

Brian Rafn – Morgan Dempsey Capital Management

And in sense without exposing some of your strengths, according to the routine and new standards, do you see new technology for the new fire apparatus to be revolutionary or is it more of just an incremental iteration upgrade?

Bill Lambert

Probably more on the incremental side, I would expect that driven by the standard is definitely incremental because we’re coming out with a new platform. I’d like to say that our incremental is probably more than what I expect out of competitive improvements in the product, more of a step change. I would not necessarily call revolutionary at this point in time.

Brian Rafn – Morgan Dempsey Capital Management

Yeah, okay and If you look at and you talked about the first of the year and some of the department’s buying ups -- pretty buying ups by some of the older legacy equipment. Is there a discounting in that and that you are coming up to the obvious window and departments may be looking into discounts, so how is that pricing go? Is there any kind of come up to the new standard?

Bill Lambert

If I would have looked at historical practice year as a guide, I would expect no significant discounting as we come up to that date.

Brian Rafn – Morgan Dempsey Capital Management

Okay. And then if you look at the new applied formula equipment, do you get any pricing, placing and capacity at all with the new 2013 equipment?

Bill Lambert

Yes, I believe, we do.

Brian Rafn – Morgan Dempsey Capital Management

Okay.

Bill Lambert

Okay.

Brian Rafn – Morgan Dempsey Capital Management

Okay, talk a little about, you mentioned a little bit in China, Sub-Saharan Africa, when you look at some of the safety equipments, specifically people are mining in that. Are you seeing it, maybe in broader and the industrial and the emerging markets recovered by core products? Are you seeing safety standards and being driven by statutory regulation or there’s always following some episodic disasters?

Bill Lambert

Well, I don’t think it’s limited to South Africa and China, what we typically see happening. What we saw happen in the US over many decades, is it tends to be more episodic, something horrible happens, workers lose their lives and standards change regulations, get beefed up quite a bit. So I think just in general, it tends to be episodic.

The advantage I think so, that emerging markets have is they can look to Western Europe and they can look to the US as having standards that are very well develop, that are very severe and they can adopt those kinds of standards and that’s what we have seen in China do. That’s what we’ve seen happen in South Africa as well. So some of the developed markets of the world have the most rigorous standards -- product performance standards and regulations and you see the emerging markets and adopt some of those.

Brian Rafn – Morgan Dempsey Capital Management

How is it a kind of characterize the regulatory from the standpoint of actually policing some of the standards in the developing world. Obviously, the developing world, if you violate that also, whatever certainly are some penalties. How do you see the actual follow up kind of policing in the developing world?

Bill Lambert

There is great opportunity for continued improvement.

Brian Rafn – Morgan Dempsey Capital Management

All right, enough. What anything the standpoint of rubber, plastics, metals, kind of commodity inflation, what do you see kind of going into 2013?

Bill Lambert

Dennis, any comments for them?

Dennis Zeilter

We’ve got no indication of significant cost increases as we develop across for the year.

Brian Rafn – Morgan Dempsey Capital Management

Okay. Okay. When you look into 2013, are there any products in your – you talked certainly focused on your core mix, the 69%. How much pricing inflation might there be Bill if your expectations are such that you’re being in a little more to be optimistic, or is sales revenues still a function of unit volume growth?

Bill Lambert

I think that when you look, I’m not sure, O’Brien If you’re looking for a specific number from me. But when you look at the 480 basis point improvement in fourth quarter margins as Dennis indicated in his commentary earlier, a big portion of that is because of mix. We have a nicely improved product mix in that margin, but also a nice contributor there is lower costs that we’re seeing improved, operational effectiveness in the factories and all the activities we have going on there that effect costs.

The third element is really though the strategic pricing. It’s a lesser percent, it’s a lesser impact at this point in time, but because our strategic pricing efforts are focused really on some of the new products coming out the door and how are we properly positioning those, this is something that we’ll see begin to have a greater impact over time. So I don’t know if you want a particular number, or Dennis, maybe you can put finer point on that.

Dennis Zeitler

The good news is it’s not just one thing that we’re depending on to improve that gross profit rate. I mean, we’re not adding any significant capacity at any factory, so all the incremental volume that goes through those factories has no fixed costs related to it. So our costs are under control. As Bill mentioned, we do expect to have some pricing power gain. And the product mix is definitely a factor, so it could be a third each if you want to pick something.

Brian Rafn – Morgan Dempsey Capital Management

Yes. Okay. That’s fair. What are your plans to look across the entire state of the company? What might be your head count hiring? If Bill comment is a little more optimistic and things play out, you start getting some growth. How are you on the hiring side given that the property plans equipment somewhat fixed?

Dennis Zeitler

That’s a good question. I know when we went through the budgets for the year, we saw some numbers on total head count, but actually at this point in time, we have hiring freezes across most of our business. Are there any?

Bill Lambert

In international, not in international, North America. The emerging market areas to growth areas, we continue to hire.

Dennis Zeitler

North America head count is basically neutral because we did some restructuring in the fourth quarter that was mentioned and actually reduced head count and then we’ll replace those skills and capabilities here in 2013. So the head count in North America remains fairly neutral.

Brian Rafn – Morgan Dempsey Capital Management

Okay. On the North American head count, given the President’s comment last night about the $9 minimum wage, how material was that to your business or is minimal wage really at 9 bucks, not really applicable?

Dennis Zeitler

It’s paid for minimum wage. Most of our labor is more skilled and is above that $9 minimum wage. So I don’t think that has -- we don’t foresee that as being a major impact to us.

Brian Rafn – Morgan Dempsey Capital Management

Okay. And then one more. you guys invested, and this is for my clarification, the domestic U.S. Army or U.S. Military ballistic helmet, did you retain the ballistic helmet manufacturer internationally?

Dennis Zeitler

Yes, we did.

Brian Rafn – Morgan Dempsey Capital Management

Okay. So that would be with needle, swords that type of thing, please?

Dennis Zeitler

I’m sorry. Say that again Brian.

Brian Rafn – Morgan Dempsey Capital Management

Bill, would that be needle or its foreign police department, what would be your end market?

Bill Lambert

Its foreign police and military organizations that are looking for that kind of helmet. For instance, in France, in the North Africa, we produce those riot-control helmets, police helmets and some military helmets for those forces.

Brian Rafn – Morgan Dempsey Capital Management

Okay. Congratulations on great quarter guys. Thanks.

Bill Lambert

Thank you.

Operator

The next question comes from John Cooper with BB&T Capital Markets. Please go ahead.

John Cooper – BB&T Capital Markets

Thank you. Good morning.

Bill Lambert

Hi, John.

John Cooper – BB&T Capital Markets:

ust quick little question here, talking about the European distribution channel build out. Just want to get a sense now where you guys are at, I guess in terms of the volume getting through that channel and it’s been a nice driver of, I guess, softening the impact in Europe being able to go through this channel. I guess, what’s kind of the longevity of that you guys think in terms of being able to mitigate any weakness that is going on over there. And then I guess secondly, I guess more importantly, what -- now that you got that volumes in, how are you guys starting to address, I guess, the cost structure there now and what is that, I guess, kind of timeframe look like in progress there?

Bill Lambert

Well, let me -- you asked a number of questions there. Let me try to address those if I can remember all of them. The number of distribution channel partners and outlets we added in Europe, across Europe and that would be for the entire organization, was over 150 last year. Adding new distributors and culling out the sub-performers is an ongoing process. So I would expect us to see this continual refresh, now are we approaching a point where that’s slows down in Western Europe, absolutely. So it now becomes a matter of really managing those channel partners and assuring that they’re getting the kind of sales goals and growth goals that we have in mind for them. But we do on an ongoing basis will pull out, call out, the performers that aren’t hitting our goal for the channel partners that are not hitting our goals and we’ll add new channel partners to that mix.

As we look though East from Western Europe, as we look in the Eastern Europe, as we look into Russia, the Caspian Sea region down into the Middle East, there’s still plenty of opportunity there for us to add distribution channel partners, which also impacts our overall MSA Europe business. So I think we’re very much in the early stages there of what we can actually do and how we can add to our distribution channel mix.

So I would say there’s still continues to be opportunity into high growth regions and we’ve got more work to do in that regard. Whose is back half of these questions?

Brian Rafn – Morgan Dempsey Capital Management

Cost reductions.

Dennis Zeitler

Oh, the cost reductions in Europe. Well, we have seen as John. We’ve had as a focus of ours, the efforts to reduce costs, to restructure in Western Europe, our operations primarily in Western Europe. We’ve done a lot of that already and we’ve taken that those as charges in the past. What I see happening for us going forward there is, this next phase of our European transformation, what we’ve called on previous calls. What we referred to on previous calls as Europe 2.0. That’s very much technology and process focused. It’s that next critical phase for us in European transformation efforts. And what we’re doing there in that initiative is trying to achieve what we call these five pillars of transformation

One, grow the business. Two, focus on the customer. Three, reduce costs through some improved efficiency and reduced organizational complexity. And lastly to improve our levels of employee engagement across Western Europe. That’s an initiative, so it has primarily an IT initiative to it. It’s a multi-million dollar investment that we’ve made. The first half of that’s been cover investment in SAP fully aligning, best practices across our in PDOP in operation. And the rest of that million dollar investment -- multi-million dollar investment is people expense. I think we’ve indicated on previous calls that were around $10 million. Half on the IT cost, half in people restructuring costs as we simplified the organization. So that’s all under Europe 2.0, we’re well into it, we’re showing some good progress with it all the while managing the business, growing our sales over there and improving profitability, so is that I answered your question John.

Brian Rafn – Morgan Dempsey Capital Management

Yeah, now that’s great, I appreciate you color, thank you.

Dennis Zeitler

You’re welcome John.

Operator

We have no further questions at this time. I will turn the call back to Mark Deasy for closing remarks.

Mark Deasy

Okay thank you Ellen and given than we had no buddy in the queue, that will concludes today’s call. I want to thank you everybody again for joining us and for your interest. And as a reminder if you miss the portion of this morning’s conference and audio replay, it will be available on our website for the next 30 days and you can find that on the home page of our website.

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