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Mine Safety Appliances Company (NYSE:MSA)

Q2 2009 Earnings Call Transcript

July 28, 2009 10:00 am ET

Executives

Paul Uhler – VP, Global Human Resources

Bill Lambert – President and CEO

Dennis Zeitler – SVP and CFO

Rob Cañizares – EVP and President, MSA International

Joe Bigler – VP and President, MSA North America

Analysts

Walt Liptak – Barrington Research

Brian Ruttenbur – Morgan Keegan

Richard Eastman – Robert W. Baird

Dick Ryan – Dougherty & Company

Jason Rogers [ph] – Great Lakes Review

Operator

Good morning, ladies and gentlemen, and welcome to the MSA second quarter earnings conference call. At this time, all participants are in a listen-only mode, and later we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Paul Uhler. Mr. Uhler, you may begin.

Paul Uhler

Good morning, everyone, and welcome to our second quarter earnings conference call. As Hilda said, I’m Paul Uhler, Vice President of Human Resources and Corporate Communications, and I am filling in today for our Communications Director, Mark Deasy, who is on vacation. Joining me on the call today are Bill Lambert, President and Chief Executive Officer; Dennis Zeitler, Senior Vice President and Chief Financial Officer; Joe Bigler, President of MSA North America; and Rob Cañizares, Executive Vice President and President of MSA International.

Our second quarter earnings release was issued this morning at 8:30 and we hope everyone has had an opportunity to review it. The release is posted on the home page of our web site at www.msanet.com. This morning Bill will provide commentary on our second quarter. He will be followed by Dennis, who will review our financials. And after Dennis' comments, we will open up the call for questions and plan to adjourn by about 10:45.

Before we begin, I need to remind everyone that the matters discussed on this call, with the exception of 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 Securities and Exchange Commission, including our most recent Form 10-Q, which was filed on April 30, 2009.

We strongly urge you to review all such filings for a more detailed discussion of such risks and uncertainties. Our SEC filings can be easily obtained at no charge at www.sec.gov or www.msanet.com and a number of other commercial web sites. That concludes our forward-looking statements. At this point, I will turn the call over to Bill Lambert for his comments. Bill?

Bill Lambert

Thank you, Paul, 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 second quarter earnings release and have our financial figures with all comparisons corresponding to the equivalent second quarter of 2008. Our second quarter results show the impact of the ongoing economic recession and its effect on MSA's businesses. As you saw in our press release, consolidated sales in the quarter were $227 million, decreasing 66 million or 22% compared to the same period a year ago. About one third of this decrease was due to weakening foreign currencies this quarter versus a year ago and another third due to decreased US military sales, which I will discuss in greater detail in just a minute.

MSA gross profit as reported decreased 26.3 million due to the significant decrease in sales as well as a decrease in sales of higher margin product lines. Reported net income decreased 38% to $7.5 million on a 22% sales decrease. Comparing quarters between years, we saw significant devaluations of major global currencies and regions where MSA conducts business. On a currency adjusted basis, our consolidated sales decreased $45 million compared to second quarter of a year ago or about 15%. Sales decreased most significantly in North America where sales were down 24% from a year ago. Europeans sales in local currency were down 7.5% and international when stated in local currencies were flat from a year ago.

Overall consolidated gross profit showed a moderate 60 basis points decrease. European and international segment gross margins are experiencing downward pressure caused by two major factors. The first relates to a product line that continues to be heavily weighted towards large government contracts that typically have lower gross margins. And the second factor relates to intensifying price competition. All of our regions, outside of North America, are reporting greater competitive pricing pressures.

In North America, the gross profit percentage actually improved slightly with the effect of the lower sales of high margin products like fire services SCBA being offset by a sharp decline in lower margin military helmet sales. Given the many and cumulative negative effects of the ongoing global recession, our cost containment initiatives, which were put into place in the fourth quarter of 2008 and the first quarter of 2009 continue to be directionally in sync with the reduced sales volumes that we are seeing. In particular, our SG&A expenses were 12.9 million below a year ago, showing a 19% reduction.

Looking specifically at our geographic segments, North American operations showed the results of exceptional cost control this quarter coming in over $7 million lower than a year ago, which is a 25% reduction. We discussed many of those cost control measures during our last quarterly investors conference call and I won't repeat those now. International showed decent cost control as well during the quarter with certain affiliate companies initiating strong actions during the quarter to aggressively decrease costs, especially in Latin America and in Australia, two areas that have been hit hard by the recession and experienced sharp decreases in mining activity.

In Europe, specific cost reduction measures have already been implemented and will show greater impact during the third quarter. I will talk more about those actions in a moment but clearly Europe is now feeling the impact of the global recession as it affects were more fully evident in the second quarter and we are responding appropriately. To give you a bit more insight into the results of our three geographic segments, I will start with North America. As I stated earlier, North American sales showed a 24% decrease versus last year. Our North American commercial industrial business continues to be off significantly due to high unemployment in the industrial sectors where product demand for hardhats, respirators and fall protection is closely tied to employment and activity.

Lower invoicing in North America was the result of two key factors, first a sharp decrease in military sales and second, the impact on industrial sales related to the recession and lower employment levels. North American military sales, which includes the US and Canada, were off $23 million or 63% from a year ago. Last year, we saw strong second quarter invoicing of helmets to the U.S. Army and to Canadian Defense forces, and strong SCBA invoicing to the U.S. Air Force.

From an industry perspective, we had $12 million less in our core industrial business, reflecting a 16% decline due to the effects of the economic recession and resulting unemployment. The slowdown has reduced end-user demand across most markets but particularly in the construction and oil and gas industries. Operating expenses in North America were well below a year ago, showing a 25% reduction versus second quarter 2008. The reductions continue to reflect excellent results from the focused expense reduction efforts of North American management team and the voluntary retirement program we discussed in our last quarterly conference call.

Shifting my focus now to Europe, the economic downturn, which began later in Europe, is now visibly impacting our business as I noted previously. As you might remember from our last call, we have commented that we did not yet feel the recessionary impact in Q1 in Europe as acutely as we had in the US. However, by the second quarter, we certainly have. We reported an overall reduction in sales for Europe during the quarter of $21 million or 27%. However, when stated in local currencies, sales were down 7.5% from a year ago. A continuing slide of industrial order activity is being seen as industries across Europe adjust to the global recession and distributors there reduce purchases to draw down and rebalance their inventory levels.

We continue to closely monitor the changes in frequency and size of orders from our European distributors. Additionally, all regions in the Europe are reporting broadly that markets are becoming more price sensitive, especially in Eastern Europe, and competition has become much more aggressive in pricing in those areas. European gross margins were 260 basis points below a year ago, reflecting the impact of shipments of backlog orders at prior-year prices and a product mix more heavily weighted towards large government orders that typically have lower margins. The lower volume sales and lower gross margins in Europe resulted in an operating income being 64% lower than in the second quarter of 2008.

Given these combined challenges, we have intensified and accelerated our cost control effects throughout Europe as I mentioned a minute ago. In short, we are taking steps similar to those implemented in North America and other parts of the world to maintain the strength and profitability of MSA. This is very much a global focus of ours. For example, early this year, we have implemented a hiring freeze throughout Europe. At our factory in Berlin during the second quarter, we completed the necessary workers' council requirements and government approvals necessary to implement a short work week program, which began there in July. And we have now completed the necessary actions to do the same at our facility in Saint-Ouen, France, which are scheduled to begin in September.

We have implemented tight restrictions on travel and all discretionary spending and effective in June we implemented a temporary management salary reduction plan that mirrors the program implemented with our management team in North America during the first quarter. While these actions create hardships for our employees and are difficult actions to take, they are indeed necessary to offset the slide in sales activity that during the second quarter has become more evident throughout many of our European markets.

Now looking at our international segment, we reported an overall reduction in sales of 8.6 million or 13% from a year ago. However, when stated in local currencies, sales in this segment of our business were essentially flat quarter to quarter. I am pleased to report that we did continue to see improvements in areas related to our emerging market focus. For example, in China, sales increased 85% from a year ago. And in the Middle East, we saw a 38% increase in sales. These areas of improvement however were offset by sharp decreases in sales in Australia and Latin America and in Africa. These areas felt the rapid reaction to the global recession with cutbacks in mineral mining, precious metals mining related to the auto industry, and were affected by the de-stocking initiatives by distributors seeking to preserve cash flow.

Accordingly, operating expenses throughout international operations were held in check and adjusted downward in line with the reduced sales. Overall, MSA had several successes during the quarter, which are worth noting. We have seen continued success with our factory and technology center in Suzhou, China. All products have been successfully re-certified upon transfer into this new facility and more transfers are planned throughout the balance of this year and into next year. As I noted, we continue to see strong improvements in China, with significant sales successes in the fire service customer segment, and strong sales of permanent gas detection to the oil and gas industry there.

We improved the overall gross profit percentage in North America through strategic pricing initiatives and the strength of the MSA brand in the marketplace. As we announced just last week, MSA also received a $4.1 million contract for the development phase of the enhanced combat helmet, which is the army's and marines' next generation of helmet beyond the ACH. We saw continuing progress in our working capital improvement programs where global inventories have been reduced by $21 million since the beginning of the year and generation of free cash flow has been strong, which Dennis will comment on in just a few minutes.

As our operating expenses in the second quarter indicate, we are benefiting from significant cost control measures to reduce expenses across MSA. I want to assure investors that management continues to focus efforts on cost reduction initiatives around the world. In some areas of the world in which we operate, our ability to implement cost reductions quickly are unencumbered. However, there are significant parts of our operations where heavy social costs and legal requirements inhibit our ability to implement certain cutbacks and see results quickly. But I assure you we are making progress and we will see continued improvement.

I'm very thankful and grateful to the MSA team around the world for the way they have responded to this economic downturn in order to maintain and enhance the long-term strength and profitability of MSA and in the way they have continued to serve our customers. As I said before, what we will not cut during this recession is our passion and drive to grow the MSA brand throughout the world, nor the key elements of our strategic plan for growth. I believe MSA is well positioned for long-term growth in earnings and sales once the global economy rebounds. We have a strong balanced and diversified portfolio of leading safety products and a strategic plan that we continue to implement to strengthen the long-term performance of our company for the benefit of our customers and shareholders.

Certainly, there are challenges in the upcoming quarters and by most estimates, a sustained recovery of the global economy is at least two or more quarters away. But MSA has responded in appropriate ways to the economic downturn and we continue to be responsive and flexible to the challenges before us. And we're prepared to do much more if necessary. I firmly believe that the future of MSA is solid and secure and in this I remain very confident. This economic recession will not last forever and the measures we have taken will enable us to not only weather this current storm but help us remain focused to emerge stronger in a way that increases shareholder value over the long-term.

My confidence is bolstered because of what I have seen in my recent visits to many MSA plants around the world. We are addressing the challenges of the current recession together, with a strong spirit of teamwork that no recession can diminish. I have seen this spirit and our team's dedication to customer service, in the long hours they put forth to complete a project on time, and in their unwavering focus on quality. I want to thank each MSA associate for the effort they put forth everyday to serve our customers and to keep our company strong and vibrant. I commend their dedication and I'm most grateful for it during these challenging times.

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

Dennis Zeitler

Thanks, Bill. Good morning, everyone. I would like to give you some further insight into our second quarter performance and comment on the balance sheet and cash flow statements. Additional information will be available later today when we file our form 10-Q with the Securities and Exchange Commission. As Bill mentioned, sales in the second quarter of 2009 were $227 million. Compared to the second quarter of 2008, sales were down 22% with decreases in each of our three geographic segments. However, when you adjust our sales for the relative strength of the US dollar compared to the second quarter of 2008, our sales are down 15% in total, which is a combination of North American sales down 24%, Europe down 11%, and no change in international.

By markets, the fire service is down 5%, military down 53%, and core industrial business was down 20%. Adjusted for currency rate changes, fire service is up 2%, military is down 51%, and industrial is down 11%. Not to confuse anyone, but another useful comparison is to look at the sequential change in sales since the first quarter of this year. On this basis, consolidated sales actually increased by 4% while military sales were down 27% compared to the first quarter. Reflecting the transition to the new ACH contract, fire services inched up 1% and industrial sales increased 15%.

As I mentioned, North America sales in the second quarter were down 24% compared to 2008 comprised of a 3% decrease in fire service, a 63% decrease in military, and a 16% decrease in industrial sales. As we discussed in April, there is a gap in ACH production as we transition from the old contract, which ended in mid May to the new contract that will begin production later this year. Our international sales were down 13% this quarter. Although fire service sales were up 59% and military was up 22%, our industrial sales which represents 77% of our international segment sales were down 22%. Without the change in currency rates, our international sales were flat overall with the fire service up 71%, military up 38%, and industrial town 11%.

In Europe, our sales were down 27% compared to the same quarter last year with the fire service down 24%, military down 36% and industrial sales down 26%. Without the currency changes, sales are down 11% overall in Europe, with the fire service off 12%, military down 25%, and our industrial business down 2%. The other view of our sales performance is to separate the two portions of our business that historically have been the most volatile, the US fire service, and the US military from everything else. Our U.S. fire service of $30 million was an increase of 1% and our US military sales of $12 million was a decrease of 60%. Then when we look at all of our other globally diversified sales, which comprise 81% of our total sales this quarter, these sales were down 20% at current exchange rates on down 11% when you exclude currency rate changes.

Our gross profit rate for this quarter was 37.5%, down slightly from 38% last year. Our success with strategically pricing the MSA brand, especially in North America, along with our continuing global effort to reduce manufacturing costs and this quarter's disproportionate reduction in lower margin military sales all worked to significantly improve our gross profit rate. However, all those improvements were offset by the overall 22% reduction in factory throughput and pricing pressure outside of North America (inaudible) last year. But in terms of absolute dollars, we have decreased operating expenses by 19%, which is a reduction of $15 million. The actual savings this quarter without the impact of exchange rates is $10 million. Although we have announced several specific cost-saving programs this year, a large portion of our actual savings is because we're being more prudent and thoughtful about every dollar we spend, from travel to advertising to consultants and so on. It is worthy to note that operating expense as down over $2 million in local currencies compared to the first quarter of this year as we recognized the full benefit of the cost reductions that were implemented during the first quarter.

In addition, in the third quarter, we will recognize the full benefit of actions taken in the second quarter, such as the previously announced reduction in management salaries that began in June, the suspension of contributions to the 401(k) program, and a shorter work week in Germany. Our plan is that operating expenses in the third quarter will be less than the second quarter. The resulting operating income excluding restructuring charges and currency gains is $22 million, a 34% decrease from the second quarter of 2008. As a percent of sales, this is 10% this quarter versus 11% in the second quarter of last year, and 12% for the full year of 2008.

Our consolidated tax rate in this quarter was 36% versus 37% last year reflecting this year's inclusion of the R&D tax credit. The bottom line is net income of $12.5 million or $0.35 per basic share compared to $0.56 last year. On a pro forma basis, which would exclude restructuring charges and currency losses, our net income would be 13.5 million, which is $0.38 per share. Some more good news on the balance sheet and cash flow statement, our cash position increased $13 million since the end of March being $63 million at the end of June. We reduced the balance on our bank debt by $7 million during the quarter and another $9 million in the middle of July. We have reduced our receivables and inventory by a total of $27 million this quarter and $50 million for this year to date. We have significant ongoing efforts underway to further reduce inventories and to improve our accounts payable performance. Our most significant cash outflow this quarter were for dividend and capital equipment.

Those are my comments. At this point, Bill, Rob Cañizares, Joe Bigler and I would 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. (Operator instructions). And our first question comes from Walt Liptak from Barrington Research.

Walt Liptak – Barrington Research

Hi, thanks. Good morning guys.

Bill Lambert

Hi, Walter.

Walt Liptak – Barrington Research

You know I guess the first question, in Dennis' comments, you know he was talking about the price competition and the business has got more competitive, it sounds like especially in Europe. And I'm a little bit confused because on the flipside, Dennis you talk about you now the some of the improvements with cost take outs. So I guess my question is, is the gross margin at 37.5%, is that sustainable you know with the military running off in the face of you know some of these increased pricing and throughput issues?

Dennis Zeitler

Hi, Walt. That is a tough question. Going forward, we saw a lot of price pressure in the second quarter. Whether we should anticipate it to be worse in the third or fourth quarter, I couldn't make that call. The military business will ship more in the second half, that will have some impact, but if you're looking for a forecast for the gross margin rate for the second half of the year…

Walt Liptak – Barrington Research

Okay, that helps. You had the pricing pressure already in the second quarter, you're not talking about this, this is something that is trending worse?

Dennis Zeitler

I'm looking at my two geographic presidents to see if they think it is going to trend worse in the second half than it was in the second quarter?

Joe Bigler

I think from North America's perspective, on the commercial side with our brand and our strategic pricing and some of the cost improvements we have seen, I would expect our margin to maintain what was seen in the second quarter. However, there'll be increased military shipments in the second half of the year that could have an effect negatively on the gross margin to some degree.

Rob Cañizares

On the international side, Walt, the significant effect is due to some big devaluations that occurred in certain countries. Since we ship products from Germany and from the US into countries like the UK and Eastern Europe which have separate currencies and they also have local suppliers, some of the pressure comes because of the dislocation that occurs related to those exchange rates. Luckily those rates have turned back in the right direction in the last quarter, but we really can't tell that it will happen in the next one. The same happened in Latin America, South Africa and Australia in the first quarter, and they improved a little bit during the second quarter, but again we can't really predict what exchange rates will do.

Walt Liptak – Barrington Research

Okay. So it sounds like – can we now with North America and Europe that maybe things are about the same and you might have, if you're really going to have a lower gross margin because of increased military?

Dennis Zeitler

That's a good reason you are going to get from us, I think.

Walt Liptak – Barrington Research

Okay. And then let me ask another one about US fire which trended roughly flat and international credit trended well too, you know, and if you – and what that might look like given the AFG funding trending down for the 2010 period?

Dennis Zeitler

Well first, as you know, the 2008 funding, Walt, is just about done. I think that were a few hundred thousand dollars on supplemental funds but 2008 AFG funding is complete. I would expect going into third quarter here there will be a relatively slow period for municipal spending because the budget cuts and AFG 2009 has not been released yet. The latest word on 2009 being released, it could be as early as this Friday, July 31. On the other hand, it could really get into late August or even into the beginning of September, really don't have any additional information as to when the 2009 funding will be released.

As far as 2010 is concerned, both the Senate and the House Committee have proposed about $390 million; that certainly is a pretty significant decline from the 545 million that was in the 2009 program, and they are – that hopefully will be released, you know who knows, July, August, September of 2010. But that is only a proposal that went through both the Senate and House Committees, that 390 million. And I do know there is some work that is being done to try to increase that. We will have to see where 2010 goes. I think everyone is anxiously awaiting for the 2009 money to be released, which is really a sauce up (ph).

Walt Liptak – Barrington Research

Okay, thanks guys.

Bill Lambert

You're welcome.

Operator

Our next question comes from Brian Ruttenbur from Morgan Keegan.

Brian Ruttenbur – Morgan Keegan

Great. Thank you very much. This is Brian. On your cost reductions that you're talking about, 401(k), short work week, cuts in management, what was the annual cost that you saved on those recent cuts?

Dennis Zeitler

The one we did in the first quarter, North America, the voluntary retirement program, that was about $5 million annually in cost savings. The ones we did in June which was a management pay cut which was a global thing and the 401(k) suspension in the US, that was about $400,000 per month. So on an annualized basis, it'll be another 5 million bucks, but of course we didn't have the benefit for the full year. In the third quarter, the short work week in Germany is roughly $250,000 to $300,000 a month, and the French one will be somewhere in the range of $100,000 a month, and that won't be until September, maybe October 1. Those are the specific program's Brian. But as I mentioned, we actually get at least that same amount of savings just by controlling our other costs, advertising, travel, consultants, everything on everybody's budget. They have done an extremely good job of being very prudent in their spend. So it is not just the special programs. It is some really good cost control.

Brian Ruttenbur – Morgan Keegan

So on the SG&A side, do you think the logic using second quarter numbers of you had 56 million in SG&A expense, the SG&A expense in third quarter should be down 2 million to 3 million, is that logically right, or am I missing something?

Dennis Zeitler

From the specific programs, you would see about another 2 million, assuming that we can hold on to all the other cost savings that we are doing.

Brian Ruttenbur – Morgan Keegan

Okay. And then R&D, it is just going to be potentially flat lying around these levels?

Dennis Zeitler

I think there is some holdback on R&D in the first half of this year, I think we will see – it won't be back up to last year's levels but I don't think you're going to see a $1 million a year – $1 million per quarter reduction.

Brian Ruttenbur – Morgan Keegan

Okay, but you did…

Dennis Zeitler

It'll still be below – it'll be below last year's numbers, yes.

Brian Ruttenbur – Morgan Keegan

It'll be below last year's numbers but higher than second quarter's numbers?

Dennis Zeitler

Right.

Brian Ruttenbur – Morgan Keegan

Okay, what is the R&D spend on research in the next SCBA, what is the spend on in that area?

Bill Lambert

We have got a lot of different activities going on, Brian. Next-generation SCBA, next-generation sensors and for gas detection products, next-generation helmets for the military, next generation helmets for fire service, so it is in a broad area across our product lines to improve the performance of our product and competitive advantages that MSA can achieve.

Brian Ruttenbur – Morgan Keegan

Okay. The tax rate for the third quarter and the rest of the year should be at these levels or lower, higher?

Dennis Zeitler

36% is probably a good a guess as any at this point.

Brian Ruttenbur – Morgan Keegan

Okay. And then your inventories and your AR, great job there by the way, where can you take this to?

Dennis Zeitler

Well, a lot of what we have done so far in receivables of course is because of the decrease in sales. But we have been successful in actually reducing our days sales outstanding in most geographic not by a lot but (inaudible).

Brian Ruttenbur – Morgan Keegan

Where are DSOs running right now?

Dennis Zeitler

They vary dramatically by region but it is something like 60 days in North America, and a little more than that in international, less than that in Europe. It averages out to around 60 some days.

Brian Ruttenbur – Morgan Keegan

And the goal is to get to a certain days or?

Dennis Zeitler

Well, you know, we're not actually – right now we're just trying to control receivables and bad debt, potential bad debt expenses. The inventories are where we have to grow opportunity. We've hired some very good new people to manage logistics, both on the front end and back and, finished goods as well as purchasing, and work in process. They have done some very good things in a way of quick fixes they can find, but there is some substantial process changes that I would expect us to see over the next couple of years that will continue to drive down inventory. So we have made some quick fixes but you should see a gradual decrease from process improvement. There might be some offset as the business picks up, but we will continue to make improvements in inventory and in payable which is a smaller number.

Brian Ruttenbur – Morgan Keegan

Are there – and then final question, any plans given the good cash flow and the beaten up stock to start aggressively buying back down your own stock or do you want to make acquisitions, what is the plan to use to you capital on your balance sheet?

Dennis Zeitler

The stock repurchase plan is something that the board of directors discusses at each meeting and that won't be discussed again until the August board meeting, but I really couldn't comment.

Bill Lambert

And I would only comment on the inorganic growth side Brian that we continue to evaluate opportunities. We have a strategic plan that we have put together that we established last year, has an organic growth focus to it, but we continue to evaluate other opportunities, especially in these economic times as we can. So I'm trying to be as non committal there as I can possibly be and as vague, but to let you know that we are evaluating them but that is not the emphasis of our strategic growth plan.

Brian Ruttenbur – Morgan Keegan

Thank you very much.

Dennis Zeitler

You're welcome, Brian.

Operator

Our next question comes from Richard Eastman from Robert W. Baird and Company. Please go ahead.

Richard Eastman – Robert W. Baird

Yes. Good morning everybody.

Bill Lambert

Hey, Rick.

Richard Eastman – Robert W. Baird

Just a quick question on Europe, maybe for Rob, but given the trend in the business there, the pricing pressure there, as we move into the second half of the year, is there an absolute commitment to keeping Europe profitable?

Rob Cañizares

Yes.

Richard Eastman – Robert W. Baird

So with the cost reductions that we have taken out and may be the backlog, is that up at all or…

Rob Cañizares

No, Rick. That backlog is pretty stable at this point.

Richard Eastman – Robert W. Baird

Okay.

Dennis Zeitler

But we should be able to keep it profitable at this time.

Richard Eastman – Robert W. Baird

Okay. And then also could you just remind us what was the restructuring costs absorbed in the quarter?

Dennis Zeitler

Restructuring costs right around a million dollars, I think it was 966.

Richard Eastman – Robert W. Baird

Okay. So 966, okay, was absorbed in the quarter, and was most of that in the operating expense line or --?

Dennis Zeitler

We would put that as a separate line on the P&L.

Richard Eastman – Robert W. Baird

Okay, I'm sorry.

Dennis Zeitler

You are right. It is in manufacturing locations.

Richard Eastman – Robert W. Baird

Okay, my mistake. And then, Bill, as you move forward, you know again I'm just thinking of the US fire service business and maybe the prospects there, we have got an 2009 AFG program that is flattish perhaps followed on by some reductions there, does that trend play into your planned cost restructuring efforts? I mean are you able to offset that projected lower volume in the higher margin business?

Bill Lambert

Well, I think we can. I mean the short answer to your question, Rick, is yes, it plays into our planning for sure. There are a couple of opposing forces here that are going on in the US fire service. On the one side, you have got AFG funding which is downward pressure on available funding. As Joe commented, for this year, the funding level was – or for this year will be 540 million for 2010. It is not yet been established, but there is some indication it will probably be around 400 million, 390 million to 400 million in that range. So there is downward pressure from Congress and certainly from the President on spending on this program.

You also have a bit of downward pressure in the municipalities because of the tax revenue situation and they just don't – they have become very, very dependent on this government funding. Now on the upward pressure, what you have is, you have most of these large SCBA purchases were made back in the 2003, 2004, somewhat 2005 time period. And so you have got SCBA now that are approaching, especially in fire departments (inaudible) got SCBA that are approaching limits on their life and conditions. And so as we have got certain headwinds developed from available funding, we have also got the pressures on the other side where the equipments just simply needs to be replaced and upgraded to meet some of the new standards that are out there.

So and I think longer term, we will revert back to maybe something, growth rates in the fire service that were pre-2003, maybe even pre-2002 levels, which were nice solid steady increases and gains in market share because of technology advantages that we bring forward. AFG funding and as a result of the 9/11 attacks, certainly increased focus on municipal fire departments and they bought a lot of new equipment. But that new equipment doesn't last forever and has a replacement cycle associated with it.

Richard Eastman – Robert W. Baird

Okay. And just on the military side, are we back in full production on ACHs?

Bill Lambert

Not yet, Rick. Not yet. We have got a contract that we announced earlier this year, $45 million contract for the ACH, and we have had some delays in our first-order approval. We had expected to be back in full production during the month of July or certainly by early August, and it looks like we are probably still a month away from that. I look for Joe Bigler maybe to provide some more color on that.

Joe Bigler

Yes. I think the best estimate is that we expect to be into production in the – sometime here in the third quarter as we work through the first article testing and some of the production set up, initial setup, and begin to look at chipping against that contract in the fourth quarter.

Richard Eastman – Robert W. Baird

Okay. And so one more question for Dennis, could you give us a sense of what the FX, the currency impact on the EBIT line was in the quarter? Would you have that?

Dennis Zeitler

No, I can't say I have that right on my finger tips.

Richard Eastman – Robert W. Baird

Would it likely convert to kind of the corporate rate, is that reasonable?

Dennis Zeitler

You know when it comes right down to – well, when you look at the quarter, there wasn't much EBIT in Europe, and the euro is one that really moved against the dollar, right?

Richard Eastman – Robert W. Baird

Yes, okay.

Dennis Zeitler

We're not talking about much there, so the international segment had a little bit over a $1.5 million worth of income, and you can look at something there that is say was about a 10% chip, but it is just not a big number overall.

Richard Eastman – Robert W. Baird

But presumably that European EBIT that you show in the press release was impacted by the big currency impact there, correct? I mean it would be a negative impact, so is that profit understated in Europe? Local currency would be higher, correct?

Dennis Zeitler

Yes. I mean because all the way down through the P&L, I mean your sales are impacted, but all your expenses are impacted too, so it is still just the EBIT number itself. So you have factored just the EBIT by the change in the currency rate, it is just not a big number.

Richard Eastman – Robert W. Baird

Okay, all right. Thank you.

Operator

Our next question comes from Dick Ryan from Dougherty & Company.

Dick Ryan – Dougherty & Company

Hi, good morning guys.

Bill Lambert

Good morning.

Dick Ryan – Dougherty & Company

So Bill, can you talk about on the military side the IOTV and then maybe the down select orders for the new UCH helmet, what the timeline is going forward on that, what should we expect in Q3 as far as upcoming testing and going into the end of the year?

Bill Lambert

Sure. I can provide some color on that but I would really look to Joe who has got more detail. Regarding the IOTV, the original IOTV hid for 736,000 vests, a decision on the original IOTV bid has not yet been made. We remain in the running for that business or at least a piece of that business and the latest information we have on the IOTV indicate that a decision is probably expected sometime within the next week or two, but I know that is getting to be a stale story, because every quarterly call that we have with investors, this IOTV award continues to just hang out there, and it doesn't seem to be much progress on that front.

With regard to the enhanced combat helmet, the ECH and what we will see, we announced last week about a $4 million contract that we have received from the military, from the U.S. Army Marines to develop this next generation advanced enhanced combat helmet. And there are a series of steps here in that contract that MSA was not the only one. Let we also add, we were not the only ones to receive a contract at this point in the program. There are others who have also received developmental portion of the contract. And so we will all be then working diligently here to produce the helmet that we need to for them to go through some testing. And then assuming success in that regard then, we would then go into field evaluations. So production contracts on the ECH are far off, they are a number of quarters away from making that kind of a decision. So that is what I can tell you very briefly. And Joe, I would hand it over to you and ask you to fill in any other details you might have.

Joe Bigler

Well, as far as the IOTV, I can tell you we have been in touch with the military and the contracting officer. Our pricing with on the IOTV is firm through this product and we have been advised that we will hear something very very soon. So bottom line is I would expect to hear something on the IOTV this week. And as Bill said, on the advanced combat helmet, that is a 2 year contract for the Army and Marines. The maximum quantity in that contract is about 246,000 to 247,000 helmets is the maximum they can order over a two-year period. So that could be anywhere from $50 million up to $200 million, just depending upon how the Army and the Marines issue that contract to one supplier, two suppliers or whatever.

And there is a number of phases to that contract. This is the first phase, the developmental side, there then is a field testing and more ballistic testing that goes on, probably know something about that, the results of that some time at the beginning of the fourth quarter. And then you actually get into first article testing if you make it through that, and that probably goes into February or March. So best guess as Bill said, we are several quarters away. If we were to get a production order and be successful, which we think we are well positioned for that, most likely that will happen the end of the first quarter, beginning of the second quarter, and effective probably in the third and fourth quarter of 2010.

Dick Ryan – Dougherty & Company

Great, greet. Okay, Bill, on the international front, or maybe Rob, you talked about lower sales in Latin America, Australia, Africa, have you seen any turn in those regions as of yet?

Bill Lambert

I was just down there actually, I was just down in Latin America, and spent a considerable amount of time with our Latin American customer focus team and sales managers down there. I think I can say that we're seeing some slight improvements in the Latin American area. I think that the consensus is the worst is behind us in some – in that region of the world. Certainly in areas like China and the Middle East and some emerging market areas that we are focused on, the worst is very definitely behind us in those areas, and we are seeing some nice improvement. South Africa, the mining market there is tied very much to some precious metals mining, mineral mining, and platinum for instance out of South Africa is very tightly tied to the auto industry, and so as we begin to see the auto industry globally strengthen somewhat, then we're starting to see some improvement in that part of the business. But Rob, I will ask you to add anything more to that.

Rob Cañizares

I think you said it, Bill. In Australia, we haven't really seen any turn around yet. Latin American seems to have bottomed out. We're not only beginning to see a lot of increase but we had a couple – three or four months of about the same level of activity. And South Africa – the results are relatively stable. So we haven't really seen the pickup but it seems to have slowed down the decline.

Dick Ryan – Dougherty & Company

Great, thank you.

Bill Lambert

You're welcome.

Operator

Our next question comes from Jason Rogers [ph] from Great Lakes Review. Please go ahead.

Jason Rogers – Great Lakes Review

Hello?

Bill Lambert

Hi, Jason.

Jason Rogers – Great Lakes Review

Dennis, the $0.38 pro forma numbers you mentioned, are you taking out the restructuring charge and the currency loss?

Dennis Zeitler

Exactly.

Jason Rogers – Great Lakes Review

Okay. And did you mentioned a cash flow from operations either for the quarter or the six months?

Dennis Zeitler

Yes. I can give you both of those. Cash flow from operations for the six months is 55 million bucks and that is roughly – I mean roughly half of that was in the second quarter.

Jason Rogers – Great Lakes Review

Okay, thanks a lot.

Dennis Zeitler

You're welcome.

Operator

Your next question comes from Edward Marshall from Sidoti & Company.

Edward Marshall – Sidoti & Company

Good morning, everyone.

Bill Lambert

Good morning.

Edward Marshall – Sidoti & Company

I'm looking for the turn from the distributors, I have heard a few of these comments already this quarter, but you know it looks like the de-stocking kind of hit the bottom in April, have you seen any change in the behavior from buying patterns in your distributors in North America?

Bill Lambert

Well, I don't think that we have seen any kind of a strong behavioral change in our distributors. That was just with a couple of our largest distributors yesterday and talking to them about what they're saying, and I think that they are still being somewhat conservative in cash management and somewhat hesitant to restock at any strong levels at this point in time. The federal stimulus plan which everybody is anticipating will have some sort of an impact here in the US certainly, is I think that effect is still at least a couple of quarters off.

The reason I say that is, out of that $770 billion in federal stimulus, only 11% is expected to be doled out this year in 2009. Maybe another 40% is expected to be doled out in 2010. So really not yet seeing anything impact out of the federal stimulus plan. But there are certain areas, certain industries, the auto industry in particular, which has greater activity now than it did a quarter ago, where they had the plants closed and shutdown, but are not yet seeing distributors all of a sudden turn the spigot on in some strong meaningful way. Joe, I will look to you to add any color there?

Joe Bigler

Well, no, I think that is accurate. I think the aggressive de-stocking activities have really ceased to some extent, I think we are seeing a flattening out of that. Tremendous focus by major distributors in really shortening their supply chain, so they are not carrying as large an inventory as they receive orders from end users and manufacturers, we begin to see that much more quickly than before. And I think that trend will continue. So I think the worst is over in terms of de-stocking but certainly not a strong upward trend in stocking activities by the distributors.

As far as the stimulus package, I think there has been generally some disappointment in that as Bill said, only about 10% to 11% of that money is out there. Where we have some effect is primary in highway construction. Apparently non residential construction, we have not seen major projects really take off yet, mostly it has been smaller projects that affected the highway market, highway construction to some extent, and DOE facilities. There has been some pretty good money that has been let out for DOE facility cleanup which we have participated in.

Bill Lambert

And then also just on the comment, that when we look at what is happening in the manufacturing sector and we look at what is happening in the construction sector, and you look at employment statistics, which the government provided some pretty accurate information, while we are seeing employment, the rates of decline are decreasing. That is the decreases in employment there are starting to bottom out somewhat. There are still declines. Unemployment in those areas, at least in the US, and as you well know is a lagging indicator, continues to shed jobs. So really not until we start to see this job shedding, if you will, stop and now start to add some jobs that I think we will really start to see distributors responding. Once they feel confident that the economy has – is not going to get any worse, I think that is when the distributors will really start to see – turn the valves back on.

Edward Marshall – Sidoti & Company

So in North America what percentage of your sales is non residential construction or if you can break it out that way or maybe from the core industrial as a percent, however you have them?

Dennis Zeitler

You said how much of our North American business?

Edward Marshall – Sidoti & Company

Or I mean if you can do it North America or if you can do a total core sales, however you guys break it out for non residential construction?

Dennis Zeitler

Yes. Residential construction is not even on our radar screen. It is just not a big factor.

Edward Marshall – Sidoti & Company

Non residential?

Dennis Zeitler

Residential. I'm am just stating the fact.

Edward Marshall – Sidoti & Company

All right.

Dennis Zeitler

In North America, roughly 60% of our business is what we call core industrial business, nonmilitary, non fire service. Of that 60%, a number of something like 15% to 20% would be commercial construction, infrastructure construction, you know highways, commercial buildings, et cetera. So that is about as rough a guess as we can do because we sell off through distributors, that is a large number of distributors, we don't have a certain set of distributors that only do construction projects.

Edward Marshall – Sidoti & Company

Has that slowed down you yet? I mean listen to some of the distributors you know that could offer a second leg down in the de-stocking, have you seen that already trend at low levels?

Dennis Zeitler

Yes, In North America, we certainly have.

Bill Lambert

In fact that is the point I was trying to make, when you look at sequential quarters, our core industrial businesses are actually up somewhat from the first quarter.

Joe Bigler

Yes, if you look at unemployment within the construction market, just in the US, it is down 17% here in June versus 8% June of 2008 and about 5% versus 5% unemployment in June of 2007. So it is still set. The construction market is still headed down, it is just not headed as down as quickly. In terms of non residential construction, the latest projections on that is for 2009, we would be down about 3% to 9%, and going into 2010, will probably be somewhat flat to maybe perhaps 5% down. So the outlook on not residential construction although better in 2010 in major projects is not really a bright spot, but I don't see it getting any worse than the second half of this year than what was already seen in the first half.

Jason Rogers – Great Lakes Review

Okay, good. And then lastly, Dennis, on the inventory reduction of 21 million, is that attributable to – is there any effect of currency to the decrease in inventory from the translation effects depending upon where you hold your inventory?

Dennis Zeitler

Now that is non currency. That is not right off the cash flow statement. Our cash flow statement strips out the currency impact.

Jason Rogers – Great Lakes Review

Excellent. Thank you guys very much.

Dennis Zeitler

You're welcome.

Operator

We have no further questions at this time. I would like to turn the call over to Mr. Uhler for any closing remarks.

Paul Uhler

Thank you, Hilda. I just want to again thank everyone for joining us today. Also I want to remind everyone that an audio replay of today's call will be available on the MSA website for the next 30 days. So if there is anything you missed, please feel free to visit our site.

Operator

Thank you. Ladies and gentlemen, this concludes this conference. Thank you for participating. You may now disconnect.

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