Mine Safety Appliances (MSA) CEO Discusses Q2 2013 Results - Earnings Call Transcript

| About: MSA Safety (MSA)

Mine Safety Appliances (NYSE:MSA)

Q2 2013 Earnings Conference Call

July 24, 2013 10:00 a.m. ET

Executives

Mark C. Deasy – Corporate Communications Director

William M. Lambert – President & CEO

Dennis L. Zeitler – SVP & CFO

Stacy McMahan – SVP of Finance

Joseph A. Bigler – VP & President, MSA North America

Ronald N. Herring, Jr. – President, MSA International (WEZ and MEZ Zones)

Kerry M. Bove – President, MSA International (APZ and ALZ Zones)

Analysts

Edward Marshall – Sidoti & Company

Richard Eastman – Robert W. Baird

Walt Liptak – Global Hunter Securities

Dick Ryan – Dougherty & Company

Operator

Welcome to the MSA Second Quarter Earnings Conference Call. My name is Allen, 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 that this conference is being recorded.

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

Mark C. Deasy

Thank you Allen, and good morning everybody, I too want to welcome you to our second quarter earnings conference call for 2013. With me this morning are Bill Lambert, President and Chief Executive Officer; Dennis Zeitler, Senior Vice President and Chief Financial Officer; Stacy McMahan, our Senior Vice President of Finance and our three Geographic Segment Presidents, Joe Bigler, Ron Herring and Kerry Bove.

Our second quarter press release was issued this morning at 8:30 and it is available on the home page of MSA’s website at www.msasafety.com. This morning Bill will provide his commentary on our quarter. Dennis will then review our financials and then Bill will conclude his formal remarks with some closing comments. After that we will open up the call 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 the Private Securities Litigation Reform Act of 1995. 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 April 24 of this year.

You are strongly urged to review all such filings for a more detailed discussion of such risks. Our SEC filings can be easily obtained at no charge at www.sec.gov, our own website, and many other commercial websites. That concludes our forward-looking statements.

At this point, I will now turn the call over to Bill Lambert for his comments. Bill?

William M. Lambert

Thank you, Mark and good morning everyone. As always, I want to 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 press release and have our financial figures with all comparisons corresponding to the equivalent period in 2012. I’m going to start by running through some of the highlights of our second quarter earnings and talk about the progress we’re making on some of our strategic priorities.

I will also share some views on the current business environment and how it’s likely to affect us through the remainder of the year before I turn it over to Dennis to run through the actual results. Then we’ll open it up for your questions.

In the second quarter better than anticipated core revenue growth coupled with solid performance in developed markets and continued gains in emerging markets led to record financial performance for MSA. Throughout the first half of the quarter, we saw some very choppy conditions and a somewhat uneven order pace. But, by late May, things had settled down and we saw some strengthening to finish out the quarter.

As I look at where we are, and what we’ve accomplished against our strategic priorities so far this year, I am encouraged by our second quarter financial results. Our ongoing focus and efforts and the gaining share and driving demand of core products in both developed and emerging markets, developing innovative new products and controlling manufacturing and operating costs, all helped us recognize record second quarter continuing sales, operating income and pro-forma net income.

As you saw in our press release, our consolidated sales for the quarter were $300 million. On an as reported basis, sales were up $5 million from a year ago or 2%. However, the second quarter of 2012 included $5 million of ballistic helmet sales in our North American segment. For those of you who are regular participants on our calls, you know, we divested this non-core business in the second quarter of 2012. Additionally, weakening foreign currencies decreased as reported second quarter 2013 sales by $3 million. Excluding this currency effect and the divested business impact, our sales were up 4.5% when compared to the second quarter of 2012.

As we look at where we are in relation to our longer term priorities, we’re seeing tangible benefits of our long term growth strategy and the shift of our revenue mix towards our more profitable core product lines. Dennis will provide more details of our financial performance with a breakdown by end market, by product group and by geographic reporting segment in his comments.

So, this morning I want to discuss and provide some comments regarding our strategy to grow the business and expand our operating margins. Driving demand for core MSA product line, core product lines remains a key element of our long-term strategy. As many of you know well by now, these lines include fixed gas and flame detection instrument systems, portable gas detection instruments, industrial head protection products, supplied air respirators where Self-Contained Breathing Apparatus or SCBA is the principle product and lastly fall protection products.

Sales from these five core product lines comprised 72% of our total second quarter sales and showed local currency revenue growth of 11% when compared to the same period of 2012. I think that’s an important point worth restating that nearly three quarters of our business grew a 11% year-over-year unstated in local currency terms.

Putting a little more texture to the story, the U.S. fire service remains a challenging and competitive environment. But, the results we’re achieving in increasing breathing apparatus were very encouraging in the second quarter. We spoke about this at length in our last investors call.

During the second quarter SCBA revenue remained quite strong and our marketing efforts at this year’s Fire Department's Instructor Conference in Indianapolis or FDIC created strong demand and interest from our distributors and our end users. At that show we launched two new products, the MSA M7XT Air Mask and a new thermal imaging camera called the MSA Evolution 6000.

The FDIC conference also marked for us the launch of a board new marketing campaign built upon our commitment to understanding the unique needs of firefighters and our longstanding partnership with the fire service industry. To underscore that message, our theme for this new campaign is simple and to the point. When you go in, we go in with you. To give you more texture on the fire service and SCBA sales in particular, consolidation SCBA sales to the fire service were up 9% in the quarter led by North America where fire service SCBA sales increased 17% from a year ago.

Our new marketing program along with our ongoing efforts to develop leading edge products for the fire service market was very well received and continues to reinforce our strong commitment to first responders in the global fire service market.

Emerging markets also a key initiative in our corporate strategy were clearly a source of strength for us in the quarter. Our ongoing focus throughout the fire service, the construction, oil and gas, mining and other key industrial markets help drive strong quarterly sales growth in key emerging markets like Brazil and Southeast Asia, where local currency sales increased a very healthy 15% in both Brazil and Southeast Asia during the quarter.

And in China, another emerging market focus area for us, local currency sales increased 19% in the year-over-year quarter. The results we’re seeing in core products and in emerging markets throughout Latin America and Asia are certainly promising and reinforce my optimism as we head into the second half of 2013.

As I’ve noted in the past, we remain deeply committed to developing innovative new core products that enhance the MSA brand and more importantly advance the level of worker safety in the industries we serve. In addition to our efforts to develop pioneering products for the fire service, we continue to develop a number of new and innovative core products for industrial markets. As an example, during the second quarter we launched a new V-Guard headgear system. This new global product provides eye and face protection to workers who are not required to wear head protection, but need eye and face protection nonetheless.

This product is very complimentary to the V-Guard helmet accessory system that we launched around the world just a year ago. I should note this morning that we also continued to see solid progress in our portable gas detection business driven by demand for new products developed and introduced over the past five years. In fact, approximately 50% of our total portable gas detection sales for the second quarter came from new products launched within the last five years. This is particularly encouraging when you consider that portable gas detection sales continued to be one of our fastest growing and most profitable areas with sales growing 20% when compared to the same period a year ago.

This 20% growth has been fueled by the introduction of market leading products and sensors like the Altair 4X and Altair 5X, MSA’s industry leading XL sensor line and our recently introduced GX2 automated testing and calibration system. In a similar way we continue to see strong results from our fixed gas and flame detection business. The investment we made in this area few years ago, when we acquired General Monitors combined with our team’s ongoing focus in developing new products like the soon to be released observer eye ultrasonic gas leak detector continues to deliver robust returns. The observer eye is truly a unique and innovative technology that is generating a lot of market attention, while we won’t formally launch the observer eye detector until later this year, global oil and gas and petrochemical customers who have participated with MSA as part of our product development process are excited about the observer eye’s expanded area coverage, best in class background noise reduction and reduced total cost of ownership.

And in key emerging markets like China, we continue to introduce to innovative low cost new products like a new hard hat suspension system, we call the push key one touch suspension system. In addition to providing customers with a new suspension system option, we believe this product will provide MSA with greater access to an attractive segment of the head protection market in China.

Overall, the results we see from our R&D team continue to be encouraging and reinforce my conviction that innovation and the continuous flow of new product introductions are critical to success in the advanced safety markets that we serve.

The progress we are making in managing manufacturing costs and improving gross profits as a part of our operational excellence initiatives is also a strongly performing element of our strategy. Our efforts to optimize our manufacturing footprint and improve our global supply chain processes continue to yield solid results.

These efforts combined with shifting on a mix focus to our core product lines favorably impact the gross profit margin in the quarter, which increased 250 basis points over the second quarter a year ago. To give you an even longer term perspective of this, gross profit margins have expanded over 700 basis points since 2009, as we have improved our supply chains, improved our focus on the core and developed and introduced innovative and strategically priced products for our markets.

I also want to provide you an update on our Europe 2.0 initiative which as I have discussed with you before is focused on integrating and aligning our SAP IT systems throughout Europe in order to one, simplify our business model there. Two, increase visibility and transparency that drives efficiency. Three, improve customer satisfaction through improved delivery and availability of products and services. And four, improve financial performance through better cost management and centralized sourcing.

In our last call, I informed you we had our first very successful go live with the new system in Germany. In the second quarter, we had our second largest European affiliate in France go live and I am pleased to tell you it’s been our smoothest go live yet. Our two largest affiliates in Europe are now operating under the same system, providing complete visibility of customer data and operational data like product availability.

During the second half of the year, we will be working on MSA Italy and MSA Spain and by the end of the year we will have close to 70% of our European revenues under the new Europe 2.0 SAP operating system. As you know, MSA Europe’s net profit margins are the lowest and most challenged in the MSA family, currently in the mid-single digit. Our goal is to see these net profit margins in the low double-digits when our Europe 2.0 initiative is completed and we believe we’re on track to get there.

Now, I would like to turn the call over to our CFO, Dennis Zeitler who will provide greater insight into our first quarter financial performance. After Dennis finishes with his report, I will provide some closing comments and will open up the call for your questions. Dennis?

Dennis L. Zeitler

Thank you, Bill and good morning. I will share with you my insight into our second quarter financial performance and additional information will be available later today when we file our Form 10-Q with the Securities and Exchange Commission.

As Bill mentioned, continuing sales in the second quarter of 2013 were record $300 million, up $5 million or 2% from the prior year; however, unfavorable currency effects of $3 million and $5 million of divested ballistic helmet sales revenue increased $13 million or 4.5%.

Incoming orders this quarter grew 8% over the first quarter and 7% over a year ago. I will comment on four different ways we look at our sales performance by end markets, by product group, by geographic reporting segment and by emerging markets.

By end markets, our growth was led by our industrial business with local currency revenue growth of 7% and now represents 72% of sales. Global fire service sales were up 3% and were 25% the total. Military sales were 3% of sales down from 6% last year on the divestiture of the U.S. ballistic helmet business.

When we consider our sales by product, our five core product groups deliver growth of a 11% on a local currency basis also making up 72% of total sales. All five core product groups increase led by portable instruments up 20%, fixed gas and flame detection instruments up 14%, fall protection up 12%, breathing apparatus up 8% and head protection up 3%. Several large fixed gas and flame detection and SCBA orders were shipped during the quarter.

The remaining 28% of sales were down 14%, half from the divested business and the remainder across most of our non-core products as we execute the first element of our corporate strategy to focus on core products, our fastest growing and more profitable product groups.

Moving to our reported segment sales performance, in North America sales in the second quarter were up 5% and up 8% excluding the divested ballistic helmet business and the impact of a slightly stronger Mexican Peso. On looking at North American end markets local currency sales to the fire service grew 11% and sales to industrial customers increased 9%, sales through U.S. Military were $1 million in the second quarter.

By product group, our five core product groups represented 81% of sales in North America and were up 14%. Fixed gas and flame detection products led the growth at 21% with several large orders shipped during the quarter followed by the portable instruments at 19% and SCBA sales at 12%, head protection and fall protection each grew 4%.

However, other non-core product groups were down a total of 25% due primarily to the decrease in military sales. Looking onto our international segment, reported sales were down 2%, but local currency sales grew 4% with strong growth in Brazil, Southeast Asia and China offset by lower sales in the developed market of Japan and Australia.

When looking at international end markets, local currency industrial sales were up 5% and comprised 81% of total sales. Fire service, local currency sales were down 4%, and lower sales of thermal imaging cameras compared to last year. Military sales were $2 million in the quarter.

By product group, sales of core products were up 8% for the quarter and grew to 57% of total sales. Fall protection sales were up 32% followed by portable instruments growing at 26% and fixed gas and flame detection instruments up 17%. SCBA sales declined 2% due to a large order that was invoiced in the second quarter of last year and head protection sales fell 1%. All other product groups were down 1%.

Finally, our European segments reported sales were down 1% and down 2% in local currency terms. Europe’s local currency sales to industrial customers represented 56% of total sales and grew 2% driven by our distribution strategy in Western Europe. Fire service sales declined 5% and military sales were down 12%. Core product sales grew 7% this quarter and comprise 68% of total sales. Head protection was up 18% from a small base, portable instruments up 14%, SCBA up 10% and fixed gas and flame detection sales were flat. All other product groups were down 17%.

We end our look at sales growth for the focus on emerging markets. Our corporate strategy includes growing sales in emerging markets where we see strong opportunities for profitable long term revenue growth. We have emerging markets in each geographic reporting segment. Our emerging market sales grew 5% in the second quarter led by 12% growth in our more profitable core product groups.

Emerging market sales represented 30% of total sales in the quarter up from 29% a year ago. Our gross profit rate for this quarter was 44.3% an improvement of 250 basis points over last year. Our double-digit core product sales growth drove this significant improvement and will supplement a buyer continued focus on cost and price. Reported selling, general and administrative costs were up 4% this quarter compared to last year driven by an increase in selling and marketing costs, as we continued to invest in resources focused on driving core product sales around the world.

Our investment in research and development this quarter with $11.4 million up $1.1 million over the last year as we continue to invest in a significant pipeline of new products to be introduced over the next 24 months. There was a $1 million foreign currency loss quarter as well as over $2 million in restructuring in Australia in response to continued challenging business conditions and in Europe as part of our ongoing Europe 2.0 plan.

The resulting operating income absent these onetime items was a record $41 million and 13.5% of sales compared to $35 million and 11.8% of sales last year, a 170 basis point improvement year-over-year. We continue to make solid progress towards our goal of a 15% operating margin by 2015.

Our consolidated tax rate this quarter was 30%, down 200 basis points from last year and at our expected rate for the remainder of the year. The bottom line is reported second quarter net income of $24 million or $0.65 per basic share compared to $0.76 last year, however, absent the $8 million of asset sales in the second quarter of last year and $3 million of restructuring and FX expense this quarter, net income was a record $26 million an increase of 20% over last year with pro-forma earnings per share of $0.71.

Our cash position of $82 million is up $5 million from the prior quarter and is composed mostly of cash outside the United States. Our total debt at the end of the quarter was $300 million, up $14 million from the prior quarter. We did see a significant increase in accounts receivable at the end of the quarter as June was a strong invoicing month. We invested $9 million in capitalized items, and we paid over $11 million in dividends.

In summary, our second quarter continuing sales, our operating income and pro-forma net income are all records for MSA. This performance gives us continued confidence in our corporate strategy to grow sales, improve financial performance and enhance shareholder value.

I will now return the microphone to Bill.

William M. Lambert

Thank you, Dennis. As a look back at the quarter we just completed, I am pleased by our success on many fronts and in executing many of our strategic initiatives. As we move forward into the second half of 2013, we will continue to execute the same strategies that have transformed MSA into a company that has proven itself capable of delivering profitable growth even through challenging economic cycles.

I am maintaining a conservative macro outlook while remaining confident in our ability to deliver solid operating margin expansion just as we have talked to you about in the past. We will maintain our investments in innovation and the high growth markets around the world to continue to drive growth and improve our market share position. To sustain this performance the key will be to maintain our focus on driving demand of core products throughout our markets and geographies, driving down manufacturing and operating costs, all while continuing our investment in and introduction of new and innovative safety technologies. This strategy continues to yield strong results and positions MSA to create value for our stakeholders even in times of uncertainty.

In closing, our quarterly results reflect strong profitable growth, however, we still see a significant amount of uncertainty in the markets. Order activity remains uneven and trends are more choppy then I would prefer. While we’re keeping a close eye on economic and business conditions, I assure you that we remain focused on our strategy and our investing in those areas of our business where we see good opportunities for growth.

Thank you for your attention this morning. At this time, Joe Bigler, Kerry Bove, Ron Herring, Dennis Zeitler, Stacy McMahan and I will be happy to take any questions you might have. Please remember that MSA does not give what is referred to as guidance, and that precludes most discussion related to our expectations for future sales and future earnings.

Having said that, we will now open the call up to your questions.

Question-and-Answer session

Operator

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.

Edward Marshall – Sidoti & Company

Good morning guys.

William M. Lambert

Hi, good morning Ed.

Edward Marshall – Sidoti & Company

Good continued work on the operating margin. I wanted to kind of see if I could get maybe some of the puts and takes, net sale on sequential basis because I know there were some executive compensation that was running through there may be higher than normal and then the legal costs from the insurance. So, I just kind of wanted to dig into maybe the line a little bit further if we could?

William M. Lambert

Yeah, the stock compensation expense in this quarter was about $1.8. Is it 1.8 or 2.8?

Dennis L. Zeitler

$2.8 million.

William M. Lambert

It will be $1.8 million less in the next two quarters. So, the 2.8 absolute number this year, this quarter it will be $1 million each of the next two quarters.

Edward Marshall – Sidoti & Company

Okay.

William M. Lambert

And first quarter would have been…

Dennis L. Zeitler

Yeah, it’s a little north of $5 million, so it’s about $2.4 million lower in the second quarter versus the first quarter.

Edward Marshall – Sidoti & Company

Okay. On the legal?

William M. Lambert

The legal tranche really hasn’t changed from quarter-to-quarter, it still running a little over $2 million.

Edward Marshall – Sidoti & Company

And that supposed to spend this year or…

William M. Lambert

I think, they will still run into next year, hopefully, it will be less next year, but that’s a really tough number to guess.

Dennis L. Zeitler

I think it’s safe to say that our second quarter SG&A rates are about where we would expect them to be for the balance of the year.

William M. Lambert

The SG&A relation will be going up the rest of the year because of the stock comp and because of the benefits from the restructuring charges we took, we will see some benefits on that in the third and fourth quarters.

Dennis L. Zeitler

But, we don’t see $2 million an increase and so many expense due to higher sales, we had about $2 million additional selling expense associated with higher commissions and the better sales that we had in our core product areas.

Edward Marshall – Sidoti & Company

If I just think about this intuitively I mean, just the – your 13.5% which is ahead of 13% I guess, go this year 15% by 15, I have asked before, probably not going to make the same mistake again, but I mean, you’re ahead of the game here it seems and you got some costs rolling off into next year and even the back half of this year. What can you comment around that or just leave it alone?

William M. Lambert

We would probably leave it alone Ed, but, I mean, yeah, we got this as a good quarter, but we’re saying 13% for the full year, okay. So, we had to make up for being below our target in the first quarter, so we have to continue to be well above 13 in order to finish this year at 13.

Edward Marshall – Sidoti & Company

It looks like this would be the run rate for the remainder of the year, this 13.5 or so?

William M. Lambert

That’s I think you would need to get to 13 for the full year, you’re right.

Edward Marshall – Sidoti & Company

The industrial pickup that we saw in North America, I might have missed it, I don’t know if you clarified, but was there something that, was there a large order that ran through because I mean, this has been the highest that we have seen that number for some time?

William M. Lambert

By a significant amount.

Edward Marshall – Sidoti & Company

Or with this broad based across the board North America pickup?

William M. Lambert

I think it was more broad based, there wasn’t anything particularly large single orders in the industrial segment for MSA North America that 9% growth I think Dennis mentioned, we had 9% growth in our core industrial for North America and there was nothing, I am looking at Joe Bigler, but there is nothing that I can remember as being one-off big orders. Maybe in the fixed gas and flame detection area we had some fairly significant orders, but that business by its very definition is little bumpy, big order shipped.

Joseph A. Bigler

No, you’re absolutely right. From an industrial standpoint in North America it’s pretty broad based whether you look at light manufacturing, heavy manufacturing, if you look at the energy market, the automobile industry. We saw some positive signs throughout the whole quarter pretty fairly broad based that really helped to drive the second quarter sales for North America from an industrial perspective.

Edward Marshall – Sidoti & Company

And nothing to mention as far as construction yet, I didn’t hear you mention this?

Joseph A. Bigler

Yeah, I mean, certainly housing has picked up to some extent, but we really don’t benefit that much from the housing market, but we’re starting to see some slight positive effects on the industrial construction and the commercial construction side, so I would say, it certainly improved in the second quarter versus the first quarter and that was certainly a small contributor to our industrial pickup in the second quarter overall.

Edward Marshall – Sidoti & Company

And then, finally, I guess on the SCBA, I mean, there is new standard as we’re all aware, how do you see that business kind of playing out through the remainder of the year, I mean, it continues to march higher and you would have assumed that we would see a kind of a slowdown in front of the new standard but that hasn’t happened?

William M. Lambert

Yeah, I think, it’s worth spending some time on this new standard and the impact it might have on SCBA. The government sequestration has impacted the two government agencies that need to approve the new product. So, none of the SCBA manufacturers have approval to that new standard which was to take effect in August next month. And so, what has happened is that because of some of those delays and that sequestration, there is process in place right now that actually would delay the implementation of that new standard to the end of February of next year. So, it’s about a six month delay.

Edward Marshall – Sidoti & Company

So, what does that mean then to overall SCBA sales?

William M. Lambert

Well, it enables all the manufacturers including MSA to continue to sell their current product line which we view as probably a neutral thing, maybe good to neutral. Anybody that was holding off for the new standard or for the new products now knows that well, they’re going to have wait another six months and do they really want to do that. We saw some good strong buying during the second quarter based on the FDIC show, based on the introduction of some of the new products that we had.

So, we think that the SCBA market is a little bit stronger then what we had planned going into the year but that’s probably a good thing and it’s in-line with our expectation that a lot of SCBA that are in the market right now are approaching that useful life period of ten years or so and in the big heavy AFG years of 2003 and 2004, 2005 you got a lot of breathing apparatus that are now approaching the end of their life and needing to be replaced. And so, we’re seeing some of that play-out in the North America, in the U.S. SCBA market for sure. So, what will the impact be on delaying the new standard? We don’t know for sure, but we don’t see it as a negative thing, if anything it’s probably neutral to perhaps slightly positive.

Edward Marshall – Sidoti & Company

And the new mass that you’re rolling out in relation to the delay and the standard?

William M. Lambert

Well, we are continuing on our track to roll that product out late this year to be introducing it late this year, but obviously it’s all dependant on getting these approval, so there is two government agencies that need to approve the product and they’re without question impacted by some of the sequestration that has gone on. So, we may be delayed by that impact, it’s really hard for us to tell, we have no visibility into these approval agencies.

Edward Marshall – Sidoti & Company

And so there will be no, even if you were delayed, you wouldn’t be able to kind of estimate how long that delay would be I assume?

William M. Lambert

Yeah, that’s right Ed, I really don’t, but it would be measured in months, it wouldn’t be measured in quarters.

Edward Marshall – Sidoti & Company

So, more of a delay then a full postponement or something like that?

William M. Lambert

Yes.

Edward Marshall – Sidoti & Company

Okay, thanks guys.

William M. Lambert

You’re welcome Ed.

Operator

The next question comes from Richard Eastman with Robert W. Baird. Please go ahead.

Richard Eastman – Robert W. Baird

Yes, thank you. Could I just ask about international, we saw nice uptick in some of the international markets, you rattled off a couple of them, China, Brazil, Southeast Asia. Could you just talk maybe a bit about the drivers in those markets, is it industrial and also maybe sustainability there?

William M. Lambert

Sure. The Brazilian market for us has been quite a bit about share gains in our penetration into markets like the oil and gas market and other industrial markets. The rate of growth that we’re seeing and have seen in Brazil far outpaces GDP growth in that country. So, a lot of that growth then is coming from us penetrating new markets and taking share, same thing with Southeast Asia quite honesty. China had an uptick in demand, they had a slow first quarter due to some holiday schedules and the way certain fell on the Chinese calendar, but second quarter was very strong almost 20% growth we saw in China and I think that’s just, that again, also is very broad based in the oil and gas market, construction market and industrial market that we see over there.

But, some of the offsets in the international because we didn’t see that that upside everywhere, some of the offsets were Australia, Australia continues to suffer, the mining industry in Australia, the mining industry in South Africa both under a lot of stress right now, the mining industry in Chile and Peru also under stress right now. So, those were some of the negatives against some of the great positives that we’re seeing broadly in China, Southeast Asia and Brazil.

Richard Eastman – Robert W. Baird

It’s super enough strength in some of these, I guess, the emerging markets that you incorporate into international, is there enough strength in these markets to continue to see growth, local currency growth accelerate in the international?

William M. Lambert

I think, unquestionably.

Richard Eastman – Robert W. Baird

Yes, okay from the second quarter level. And then, also in Europe, could you just dissect it, at one point you were willing to kind of dissect Western Europe from Eastern Europe and just, is all the growth coming out of distribution gains in Western Europe, did Eastern Europe show any growth?

William M. Lambert

Give me a second there Rick to take a look. When I look at Eastern Europe’s performance overall, it was just about flat, up about 1%. Actually the strength that we’re seeing in Europe quite remarkably is in the countries that you hear the most negative news about in the news. So, when you read the newspaper and you hear about France and Italy and Spain and even Germany perhaps, we actually saw some nice solid gains in that part of our business and where we are year-to-date in that part of our business. The U.K., Northern Europe is where we have seen a – that part of the business has been off versus previous years and then as we look over further east into Poland and Hungary and even into Russia, Kazakhstan that part of the business is up, but not where we had expected it to be although we’re starting to see some of these large orders look like they’re going to break free.

Ron Herring, I know you’re on the line, Ron do you want to add anything to that.

Ronald N. Herring

Sure Bill. I mean, talking about that’ll be for Central Europe for example, we're moving from our, one of the strategies we have is moving from government to private and we see a transition moving from there pretty significant, for example, last year I think about 52% of our Central European sales were from the private sector and were tracking at around 55% right now year-to-date and that is mostly from growth going through industrial distribution adding industrial distribution and share gain in those areas.

William M. Lambert

Ron, maybe also, maybe also comment on Middle East Ron, because we have seen some weakness in the Middle East and that’s a part of MSA as a reporting segment.

Ronald N. Herring

Yeah, what we are seeing really is in some of the large orders we’re hoping that falls are being delayed and I think a lot of that has to do with some of the unrest that you see there, but we continue to monitor that very closely and have our adjusting strategies so that were going after the industrial segment and looking at industrial distribution there. But overall, the Middle East is one of those troubling areas that were not performing at a level we’d originally planned for the year.

Richard Eastman – Robert W. Baird

Okay, very good. And then, it was a comment made, I think about orders in the quarter being up about 8% was that comment specific to the five core product groups?

William M. Lambert

That’s an overall comment.

Richard Eastman – Robert W. Baird

Overall quarters…

William M. Lambert

That’s overall consolidated sales.

Richard Eastman – Robert W. Baird

Okay and then I’m sorry, just one last thing any sense for any anticipated restructuring in the second half, is there a number that you might be able to share?

William M. Lambert

It’ll be relatively small number if we have some more restructuring in Europe, but it’ll be small I would thing.

Richard Eastman – Robert W. Baird

We’re done in Australia then?

William M. Lambert

Hopefully.

Richard Eastman – Robert W. Baird

Okay, all right. Thank you very much, very nice next quarter.

William M. Lambert

Thanks Rick.

Operator

(Operator Instructions) The next question comes from Walt Liptak with Global Hunter Securities, please go ahead.

Walt Liptak – Global Hunter Securities

Thanks, good morning guys.

William M. Lambert

Hi, Walt.

Walt Liptak – Global Hunter Securities

So, I wanted to ask about the Europe 2.0 and you outlined 4 points, I want to focus on the forth one and financial performance and so if we get a little more detail about what would you think that should be into kind of that margin for Europe and the timeframe for that?

William M. Lambert

So, that was in my commentary, so I’ll address it briefly and then look to Dennis to add some color to it. Our Europe 2.0 initiative has the four legs of the stool that we talked about or the support roles I should say that we’re trying to achieve there. And the last element there is to improve financial performance through this better cost management and centralized sourcing and purchasing that would be able to go on there as well as consolidation of warehouses and that sort of thing. Right now, as we look at net profit margins for MSA Europe, we are in the low to mid single digits, it is our goal here by the time we are done with Europe 2.0 that our net profit margins would be in a low double digits.

So, up in that 10%, 11%, 12% range well, how long does it take us to get there, we’ll probably midstream right now, so I would imagine that we’ve got another two years until we see some of those kinds of results assuming, of course that that top line growth continues along the path that we are projecting it to be. And we’re getting some good signs in that regard from what we’re doing there. So, I would think we’re midstream and probably another two years as we get into 2015 will begin to and we’ll track this, you’ll see this, this is not going to be a step change this would be somewhat linear quarter-by-quarter, year-by-year. Dennis anything you’d like to add.

Dennis L. Zeitler

I think and Walt, there is two pieces to Europe 2.0, one is to improve the operating efficiency of the business, so you’ll see operating profits up the operating margin as a percentage of sales increased gradually as it has been increasing and improving and there would also be some tax efficiency involved, so as Bill said, it will be linear, you have to be able to follow the improvement in Europe maybe not every quarter, but year-by-year until we get into that range Bill mentioned 11% to 12% net profit in our total European segment.

Walt Liptak – Global Hunter Securities

Okay, that sounds great. Is Europe 2.0 is the final like in this cost reduction and productivity for Europe or is there a still some program of consolidation or whatever behind it?

William M. Lambert

Well, it’s certainly the most of it, the majority of it Walt, the only thing that would remain is as our presence grows in Eastern Europe and into Russia and these higher growth market segments, those segments start to take on more mass, more meat and they need to be under the same kind of operating systems as those in Western and Central Europe do. But, those are multi-year efforts and we will be facing those in overtime, so when we talk about Europe 2.0 and then fairly significant European transformation that we have, have been involved with over the past few years, most of that will be behind us over the next two years.

Walt Liptak – Global Hunter Securities

Okay, thanks very much.

Operator

The next question comes from Dick Ryan with Dougherty, please go ahead.

Dick Ryan – Dougherty & Company

Thank you. See Dennis on the R&D may be a broader comment on operating expenses, significant products coming out over the next couple of years and what do we see for R&D and then your comment about OpEx staying in this range, are you talking absolute or percentage wise?

Dennis L. Zeitler

I’m talking absolute for the next two quarters.

Dick Ryan – Dougherty & Company

Okay.

Dennis L. Zeitler

Okay. As far as R&D goes, we do have a lot of efforts going on right now, we’ve some great new products that are coming out. I would not expect R&D expense to increase over the next two quarters either, but that’s a guess right now.

I mean, it can dip, all these approval fees and all that could send to that R&D numbers are just and there not inexpensive. So, when we are allowed to get approval etcetera I just don’t know.

Dick Ryan – Dougherty & Company

Okay. So, Bill on market share you talked about gaining share and some of these markets, but do you have a more kind of global commentary on what you are able to achieve in market share, is it coming through new products pricing and may be what is the outlook for pricing over the next six months or so?

William M. Lambert

Let me first say that on market share, most of the market share data that we have is secondary research, some primary and some secondary research that we conduct ourselves. So, when we look at market share gains, it’s not validated by outside sources with one exception and that is within the U.S. In the U.S. we’ve some pretty good, we got a pretty good hand on what our market share position is and some of the product lines that -- in some of our core product line areas that’s number one. Number two, I think that the reason for market share gains is multifaceted, one certainly product innovation is an element of that.

Secondly, I think its sales coverage and the efforts that we’ve put into customer satisfaction and customer loyalty and driving the behaviors of this organization to be more customers responsive and to be a better partner with our distributors. So, and we’ve taken that globally Dick, and some of those programs and processes and work procedures are now employed by our organization around the world and we’re seeing the kinds of impacts that we would hope to see from that. I don’t think it’s related to pricing, we are not the least expensive brand out there by a wide margin, in many cases we are a price leader. But quality of our product, the durability of our product, the support and service we provide is among the best in the industry and that’s how we’re gaining market share.

Dick Ryan – Dougherty & Company

Okay. You talked about the kind of the order patterns strengthening late May, is that kind of continuing with the early look into the September quarter?

William M. Lambert

That’s a good try Dick.

Dick Ryan – Dougherty & Company

Well, I can try.

William M. Lambert

We try to hold off on providing some of that, some of those forward-looking statements, so I’m just going to pass on that one.

Dick Ryan – Dougherty & Company

All right, thanks guys. Good quarter.

William M. Lambert

You’re welcome Dick.

Operator

Our next question is a follow up from Richard Eastman with Robert W. Baird, please go ahead.

Richard Eastman – Robert W. Baird

Yes, Bill or may be Dennis. The core product mix in the quarter first thing ancillary products or other, should we think about that as kind of normalizing now around this 72% or call it 75% of sales is that kind of steady state going forward now with ACH divestiture out and so we can build a kind of a growth rate around core products versus ancillary products?

William M. Lambert

Rick, I think that you’ll continue, you will probably see the rate of change decreasing, but overtime, you’ll continue to see that number inch upward.

Richard Eastman – Robert W. Baird

Right.

William M. Lambert

As more and more of our product is, is in the core area of our business and as we give less attention to those peripheral products that are in our product line.

Richard Eastman – Robert W. Baird

But, I would think on a year-over-year basis in the second half then we would start to see a more normalized gross margin given the sales mix is that, is that a fair statement?

William M. Lambert

I think that’s a fair statement.

Richard Eastman – Robert W. Baird

Yeah. And ancillary products is down 13%, you did mention you know half of that is the ACH divested business, is the other half of that declined, is that was like the mining weaknesses shown up and is that may be the biggest single piece there?

William M. Lambert

That’s probably the second biggest piece or may be as big as the ACH business, but we also had a big drop off in gas and that’s for military driven by several million dollars. There’s three things going there, but you’re right, you continue to see that mining difficulty in Chile, in Peru, in Colombia, in Australia and some of it in South Africa.

Richard Eastman – Robert W. Baird

Yeah, okay. And then, may be a question for Joe, I just wanted to follow up on North American SCBA and Bill you give a really good kind of detailed commentary around the push on the standard change. But, we’re curious kind of as we track through the second quarter there was a general feeling that there might be some pre-buy of the old product that or the noncompliant product, I’m just because there was some familiarity with that product, we kind of pick that up in the market place and I’m curious now with the standards pushed. Do you feel like the order pattern or demand pattern, May still fall off and September or is there any indication of what that quarter-to-quarter order and sales pattern could look like for North American SCBA.

Joseph A. Bigler

That’s a challenging question, I would say in the second quarter we did see a slight bump in some departments, in some of our distributors picking up and what we call our current unit, the unit that doesn’t meet the new standard, so that was a contributor in the second quarter to some extent. I really think as Bill mentioned, the third and fourth quarter depending upon what happens with this extension that would allow us to sell the current unit as well as the new approved unit whenever the government approves that, it really is, it’s going to, it’s a challenge to call what the order pattern is going to look like. It really could be a good third and fourth quarter, it could be slower than what we expect, it really is a tossup, I think the manufactures will know a lot more come the very end of August, beginning of September because will know by, should know by the end of August as to whether or not we can continue to sell the existing unit until the end of February and we have a lot better understanding as to when manufactures will receive approval on the new unit and can really move forward on the new unit.

Richard Eastman – Robert W. Baird

Because it’s looking at the sequestered impact and the push and the standard and kind of the order pattern or sales pattern, if you look at and I’m sure you do that but this safer grounds and the fire grounds, the number is down in absolute terms and the funds granted against that lower number have been really slow as well.

Joseph A. Bigler

Yeah, they have.

Richard Eastman – Robert W. Baird

And that’s part of the sequester impact in this issue?

Joseph A. Bigler

It is to some extent, some of the funding, the funding for the AFG program is about $320 million when you look at the real absolute numbers, most of the 2012 money has all been given out, the 2013 grants hopefully are going to start sometime the end of this year and will go into next year, but funding there’s about $320 million for AFG both what we gave out this year, which is basically all depleted and the new grants that will be forthcoming and in fact the Senate just approved approximately the same amount tentatively for 2014.

So, there’s been some affect on the sequestering, but for the most part AFG money has held firm at about $320 million. I will say that the demand in the fire service is there, it’s coming for all the reasons that we’ve talked, Bill has mentioned as a new standard units being old from 9/11. So it does seem to be a focus of the lot in North America Fire Department that they are taking a look at their SCBA, it’s just the timing of that demand over the next 12 to 18 months I think is a real, is a real question.

Richard Eastman – Robert W. Baird

Understand, okay. And then, just a last question, Dennis can you just kind of talk to the free cash flow and again, year-to-date, you did address the receivables, but I’m curious do you expect a significant improvement in the free cash flow in the second half of the year?

Dennis L. Zeitler

Yeah absolutely, just like we had last year. Second half of the year and now that we’re probably at a peak for receivables, we had a really strong invoicing month in June, once you get to the end of the year there’s last couple of weeks December don’t go lot of invoicing, so receivables will be down, our insurance receivables probably not be increasing much and inventory that have been built up for shipment will be down. So yeah, I think it will like a lot like last year’s pattern where we were weak towards the middle year and finished the year with a very strong free cash flow.

Richard Eastman – Robert W. Baird

Okay, okay. All right, thank you. Thank you again for the follow ups.

Operator

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

Mark C. Deasy

Okay, thank you Allen, and given that we do not have any more questions that will conclude this morning’s call. I just want remind everybody if you miss the portion of the conference an audio replay will be available on our website for the next 30 days as well the transcript of the call. So on behalf of Bill, Dennis, Deasy, Joe, Ron and Kerry again I want to thank you for joining us this morning and we look forward to talking with you again soon. Hope that everybody has a great day. Take care.

Operator

Thank you ladies and gentlemen, this concludes the MSA’s Second Quarter Earnings Conference Call. Thank you for participating. You may now disconnect.

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