Mine Safety Appliances' (MSA) CEO William Lambert on Q2 2014 Results - Earnings Call Transcript

Jul.24.14 | About: MSA Safety (MSA)

Mine Safety Appliances Company (NYSE:MSA)

Q2 2014 Earnings Conference Call

July 24, 2014 10:00 AM ET

Executives

Kenneth Krause – Executive Director of Global Finance

William Lambert – President and CEO

Stacy McMahan – SVP, CFO and Treasurer

Ronald Herring – President, MSA International

Nish Vartanian – VP and President, MSA North America

Analysts

Edward Marshall – Sidoti & Company

Richard Eastman – Robert W. Baird & Co

Walter Liptak – Global Hunter

Brian Rafn – Morgan Dempsey Capital Management LLC

Stanley Elliot - Stifel Nicolaus

Operator

Welcome to the MSA Second Quarter Earnings Conference Call. My name is Polat 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. Ken Krause. Mr. Krause, you may begin.

Kenneth Krause

Good morning everyone and welcome to our second quarter earnings conference call for 2014. Joining us on the call this morning are Bill Lambert, President and Chief Executive Officer; Stacy McMahan, Senior Vice President and Chief Financial Officer; Ron Herring, President of MSA Europe; and Nish Vartanian, President of MSA North America.

Our second quarter press release was issued last night and is available on our website at www.msasafety.com. This morning, Bill Lambert will provide his commentary on our quarter. Stacy will then review our financials and then Bill will conclude with his closing comments. After that, we will open up the call for your questions.

Before we begin, I need to remind everyone 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 Securities and Exchange Commission, including our most recent 10-Q which was filed on April 23, 2014. You are strongly urged to review all such filings for a more detailed discussion of such risks. Our SEC filings can be obtained at no charge at www.sec.gov, our own website, and many other commercial sites.

In addition, we have included certain non-GAAP financial measures as part of our discussion today. These non-GAAP financial measures should not be considered replacements for GAAP results. Reconciliations to the most directly comparable GAAP measures are included in our press release and on the Investor Relations section of our website.

And with that, let me introduce MSA’s President and Chief Executive Officer, Bill Lambert.

William Lambert

\Thank you very much Ken and good morning everyone. As always, I want to begin by saying thank you for joining us this morning on this conference call and for your continued interest in MSA. Presumably, all of you have seen our second quarter press release issued last night and have our financial figures with all comparisons corresponding to the equivalent period in 2013.

I’ll begin this morning by reviewing the highlights of our second quarter and I will talk about some of the exciting new core products that we’ve launched over the past several months. I also will share with you further details about some important corporate initiatives that we continue to focus on and after that, I will turn the call over to Stacy for a more detailed review of our financial results, then we’ll open up the call to your questions.

Second quarter sales were just over $282 million, which as you know includes continuing operations only and excludes $11 million of discontinued operations revenue from our South African distribution business and our Zambian operations. Revenue of $282 million reflects a 1% decline from the same quarter a year ago on both a local currency and reported basis.

When comparing to the same period of 2013, it’s important to keep in mind that the second quarter of last year was particularly strong from a revenue perspective most notably in the product areas of breathing apparatus and fixed gas and flame detection systems where we delivered a large number of mid-size shipments in this time period that drove double-digit core product growth.

Second quarter SCBA sales this year continue to be challenged as we await federal government approval on our new SCBA the G1. As you know, generating profitable growth in our core product areas is an important part of our overall strategy.

As a quick reminder, core products includes fixed gas and flame detection systems, portable gas detection instruments, industrial head protection products and supplied-air respirators where Self-Contained Breathing Apparatus or SCBA is the principal product and fall protection.

In the second quarter, these products represented 73% of revenue and in total declined by 4% on a currency neutral basis. As we have discussed with you on previous calls, delayed federal government product approvals from NIOSH continue to provide a significant challenge for us in the US fire service market. This combined with the timing of delivery of a meaningful number of large FGFD system sales were the leading causes of the overall 4% decline.

Revenues from our other three core product areas increased 4% on strong performance in head protection and in portable gas detection. Emerging market sales reflected 30% of total revenues in the quarter and were relatively flat in local currency terms compared with a year ago.

Lower project business across fixed gas and flame detection in Asia and in Latin America as well as a lower level of SCBA sales in China and ongoing labor unrest in Africa, all had an impact on our international performance in the quarter.

The headwinds I mentioned international notwithstanding, the results we saw in the Middle East and in Eastern Europe provided a sense of optimism. Quarterly local currency sales grew 21% in the quarter in the Middle East while local currency sales in East Europe increased 34% on a smaller base.

In just a bit, Stacy will review our sales by segment and sales by product line in more detail with you. As we have discussed on previous calls, regulatory delays associated with the approval of our revolutionary SCBA products for the fire service market, the MSAG1 SCBA continued to be a significant headwind for us, but one that I still view as temporary.

As you know, the G1 breathing apparatus was designed side-by-side with fire fighters and has been the largest engineering project in MSA’s history resulting in impressive competitive advantages and lower total cost of ownership for our customers. In fact, the feedback we continue to receive from customers is quite promising unless we know that we have hit the mark with this new product platform.

As I have mentioned on past calls, we introduced the G1 to customers at this year’s Fire Department Instructors Conference with a very enthusiastic fire fighter and channel partner response.

During the second quarter, we have produced quantities of fully functional sales samples that are being heavily demonstrated to fire departments in North America and globally in order to keep the momentum going.

We are accepting orders for the G1 and have started to build a very healthy backlog, but of course we cannot begin to ship G1 units until we receive the required certifications for which we are well into the approval process.

The approval process through the federal government test labs has been frustratingly slow. We now estimate that the testing and certification will be complete very late in the quarter providing us with no opportunity to ship G1 SCBA against our mounting book of business within the third quarter.

At this time, we do anticipate to begin shipping G1 units in the fourth quarter echoing our discussion on the first quarter earnings call. Related to this update the tentative interim amendment or TIA issued by NFPA that allowed us to ship M7 SCBA units until June 30 has now expired.

However, our M7XT SCBA was certified as NFPA compliant early in the second quarter and we continue to manufacture and ship the M7XT. In fact, sales of the M7XT have met our expectations in the second quarter and I am pleased with the progress that this product continues to make.

MSA is one of only three major manufacturers able to ship SCBA which are certified and compliant to the requirements of the new NFPA standard. Our M7XT SCBA is that approved product as we await approval and certification of our new G1 SCBA.

Another area of new product development, we continue to develop and launch key products in our other core product categories. In North America, we have launched the new workmen fall protection harness and EVOTECH fall protection harness products that are certified to new standards governing climbers working near energized electrical sources who face special hazards due to sudden unexpected arc flashes that can ignite or melt clothing and protective gear.

New standards have been promulgated that require arc flash certified harnesses to be used by electrical workers. OSHE has stated that their enforcement of these new requirements will escalate sharply beginning in 2015. At the present time, many electrical workers are wearing non-arc certified fall protection harnesses.

So these new performance standards and the accompanying Ocean enforcement investments is anticipated to provide good growth opportunities for our new harness systems while improving safety for these workers.

In addition, we continue to focus on global fall protection opportunities. In the first half of this year, we have launched three new harness platforms that have been certified to European norm requirements included is a new utility harness also certified to arc flash requirements.

A new gravity harness designed for the rope access in rescue markets in Brazil and Australia and a new harness we are calling the Super light which is positioned well for price-sensitive emerging markets.

As you can see our fall protection new product development pipeline is full of exciting launches as we continue to capitalize on the opportunities available within the global fall protection space which we believe represents one of the largest individual and fastest growing sectors in the global safety market.

Looking across the core to head protection, we launched a new push key helmet suspension system for our V-Gard Helmet platform in Brazil. The push key suspension is an easily adjusted and comfortable product that is targeted for the price-sensitive value segment of the market.

At the performance end of the helmet suspension spectrum, we continue to build on our Q1 launch of the Fast Track 3 suspension in North America, with a follow-on Q2 launch of the product in Brazil.

As I mentioned in our last call, the Fast Track 3 is at the pinnacle of comfort and adjustability as reported by customers in blind voice of customer evaluations. We are very excited about this product and our customers’ enthusiastic reaction to it reflective of the Fast Track 3 success in North America.

In the second quarter, sales were up 7% and year-to-date head protection sales were up 10% in North America. So as you can see, our pipeline of innovations within the core are paying off. Sales from products developed and introduced within the last five years reflect 32% of core product sales and 27% of MSA’s consolidated total sales.

Let me peel back the layers a bit more to give you a better idea of where new product developments and efforts are focused at MSA. In head protection, over 60% of sales in the second quarter were from new products reflecting the sound success of the recent Fast Track 3 launch that I just mentioned.

Additionally in portable instruments, that continues to be a source of strength with over 50% of sales coming from new products including our Altair 4X and 5X portable instrument lines which we have discussed with you in the past. With the upcoming approval and the start-up deliveries of the G1 SCBA, we would expect to see continued progress and sales vitality performance.

Organic R&D investment is an important part of our growth strategy in the products that we have launched over the past few years have solidified our position as a market leader.

Now, I’d like to give you an update on another important strategic initiative, what we call the Europe 2.0 on which we continue to execute and make good progress. This is a significant transformational project that has two distinct phases.

As we’ve noted in the past, this initiative involves moving away from the pre-European Union structure of independently managed affiliates to one based on common data and standardized processes enabled by a single IT platform and incorporating a single and transparent logistic systems working out of one location.

I am pleased to report that we have made significant progress on this first phase of the project. To-date, we have completed successful SAP implementations in over 70% of the region moving to a functionally managed organization.

We have reengineered and streamlined business processes and we’ve consolidated several finished goods warehouses to a Central European location with nice progress made on this phase, during the second quarter we continued to focus on phase 2 of the transformation and that is further refining the organizational structure for Europe going forward which we have determined to be in a principal operating company model format.

Ron Herring, President of Europe reviewed the details of this model with many of you at our recent Investor Day. So I won’t spend time talking about the structure here. However, at a high level, the establishment of a principal operating company model in Switzerland provides us a centralized headquarters and a business-friendly environment that allows our European organization to leverage the benefits that we have achieved under the Europe 2.0 restructuring program over the past few years.

I am happy to report that we remain on track with our timeline and we expect to go live in January 2015. Europe 2.0 has been a multi-faceted initiative that is positioned to drive benefits throughout the P&L to enhance shareholder value all while keeping the customer experience as a key priority.

Some benefits that we have already begun to realize as a result of our efforts over the past few years include, improved margins from a more favorable mix of core sales through distribution and benefits from restructuring to rationalize our cost structure with both of these efforts driving a 700 basis point improvement in operating margin over the past four years.

If we look at more recent performance, year-to-date European local currency sales are up 5% and operating margin is up 100 basis points on improved gross profit.

In the future, as a result of implementing the principal operating company model in Europe, we expect to see continued financial benefits such as MSA’s consolidated tax rate declining meaningfully over the next several years.

Although we have and we will see higher SG&A in 2014, as we relocate and incur related expenses the project is expected to drive value for our shareholders over the long-term.

Another exciting news, last month we turned the page on MSA’s 100 Year Anniversary in addition to celebrating with a series of brand ads that highlight MSA’s life saving products, we hosted our Centennial Investor Day near our headquarters in Cranberry Township, Pennsylvania.

The event was a great success for us and we enjoyed sharing further insight about the key pillars of our strategy our new product developments efforts and important strategic initiatives that we are executing across our geographies.

For those of you that attended the event, we want to thank you for taking the time to be with us. And if you were not able to make it, and would like to participate, the archived webcast is still available on www.msasafety.com.

Now, I’d like to turn the call over to our CFO Stacy McMahan to provide an overview of our second financial performance. After Stacy finishes with her report I will provide some closing comments and then we will open up the call to your questions. Stacy?

Stacy McMahan

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

As Bill mentioned, sales from continuing operations in the second the quarter were $282 million down $3 million or 1% from the prior year on a reported and local currency basis.

Stronger growth in head protection, portable gas detection and several key adjacent products was offset by continued regulatory delays affecting SCBA revenues in North America and a lower level of fixed gas and flame detection shipments.

Looking at the sequential quarter comparison, local currency sales have increased by 6% compared to the first quarter, on improved performance across all reporting segments. Notably, North American SCBA and head protection were key contributors to the increase of 15% and 16% respectively, driven by sales of new products such as the M7XT SCBA launched in April and the Fast Track 3 suspension system launched earlier this year.

While order activity was choppy in the quarter, backlog is healthy reflecting strong demand for fixed gas and flame detection and SCBA comprised of both M7XT and G1 SCBA orders.

There were portion of our backlog orders are scheduled for shipment in the next several months, I do expect challenges to persist into the third quarter as we navigate the regulatory approval process in North America and enter the traditional summer holiday season in Europe.

As you may remember from the first quarter, we have streamlined our discussion on sales and I will comment on two views of our sales performance, by product group and by geographic reporting segments.

Let’s start with our core product sales performance in the quarter where local currency sales in our combined five core product groups declined by 4% and reflected 73% of total sales.

As Bill mentioned, we had a very strong second quarter last year in sales of breathing apparatus and fixed gas and flame detection, making this an especially challenging year-over-year comparison.

Results remain across head protection in the quarter increasing 5% with encouraging levels of growth across North America and Europe. We also saw strength in portable instruments increasing 4%.

These bright spots were offset by an 11% decline in supplied air respirators led by a 16% decline in SCBA in North America associated with ongoing delays in new product approvals in the US Fire Service market.

Fixed gas and flame detection sales decreased 7% on a lower level of large order shipments. Fall protection sales growth was flat for the quarter. Excluding sales, of SCBA and fixed gas and flame detection, local currency core product sales were up 4% in the quarter.

We also had strong growth across several of our non-core product lines in the quarter. Fire helmets increased by 14% primarily driven by the successful launch of our new helmet platform in Europe the S1XF that Bill mentioned on the Q4 earnings call, and ballistic helmet’s revenue doubled from last year also driven by strong performance in Europe while we divested our North American ballistics business in 2012 our European ballistics business continues to be an excellent source of value.

As we mentioned in the first quarter, we have a robust backlog of a number of these orders that are expected to clear in the second half of this year and on into early 2015. Next, I will offer more texture on our geographic reporting segments.

In North America, sales in the second quarter were $139 million, down $4 million or 3% compared to prior year. Core sales comprised 79% of total segment sales and were down 4% in the quarter driven by the decline in SCBA shipments due to regulatory delays and timing of larger fixed gas and flame detection shipments that I mentioned earlier.

Excluding revenue in these product groups, the base business remains healthy with core product growth of 5%. We continue to see success in head protection up 7% in the quarter and continued growth in portable gas detection growing 6% driven by our innovative Altair suite of products.

Non-core sales were up 2% on growth in thermal imaging cameras, fire helmets and respirators. Our European segment reported second quarter sales of $79 million, up $8 million or 11% from the same period a year ago in local currency terms on strong results and market verticals such as energy and the military.

Local currency, core product sales represented 64% of total sales and were up 4% on strong invoicing of fixed gas and flame detection orders to the oil and gas market in the Middle East and on head protection growth throughout the region partially offset by a relatively flat level of portable gas detection and SCBA sales.

Non-core sales were up 25% on higher large order invoicing of ballistic helmets to a military customer and an increase in fire helmets across Western Europe on new product sales.

Finally, second quarter continuing sales in our international segment were $65 million reflecting a 9% decline in local currency terms. Local currency core product sales represented 70% of total sales, and decreased by 11% compared to a year ago.

We have a challenging comparison across many of these products in the quarter with last year recording higher fixed gas and flame detection project business in the oil and gas markets at Asia and Latin America and a large SCBA shipment in Asia.

Excluding breathing apparatus and fixed gas and flame, remaining core products grew 2%. Local currency, non-core product sales were down 2% when compared to the same quarter a year ago, as we faced ongoing labor unrest in Africa as well continued weakness in the mining markets of Australia.

Our gross profit rate for this quarter was 45.9%, an increase of 50 basis points from last year. Core product margins continue to be the leading driver of strength, up 180 basis points from a year ago while a favorable product and order mix drove a portion of this improvement, we saw meaningful expansion across every core product on improved pricing and cost management.

Selling, general, and administrative costs were $83 million, increasing 5% or $4 million on a local currency basis compared to last year. The increase was driven by almost $3 million of cost associated with several corporate initiatives, $1 million associated with our Europe 2.0 program as we prepare to launch the principal operating company in early 2015, $1 million of increased legal fees as we pursue collection of our insurance receivable and a $1 million increase in customer facing costs.

These were partially offset by a $1 million decline in stock compensation expense related to time facing of retirement eligibility accounting and a $1 million improvement in pension income on our overfunded pension plan in the United States.

Our investment in research and developments this quarter was $12 million, up nearly $1 million as we continue to invest in innovative new core products like the G1 SCBA and a host of other launches in fall protection, head protection and gas detection.

As Bill indicated, we continue to see meaningful returns from these investments as sales from products launched in the last five years represent 32% of core product revenues in the quarter, up from 22% in the same period a year ago.

We recorded $1 million in restructuring expense from our ongoing initiatives to reduce our footprint in Australia and in the continuing business of Africa. As you know, we have a solid record of realizing payback on restructuring efforts and we are confident that the steps we are taking to streamline the organization including the Europe 2.0 program will be the drivers of value in the coming years.

Operating income or pretax income excluding currency gains, restructuring, interest and other income was $35 million or 12.4% of sales in the quarter, a 130 basis point decrease from the prior year. While quarterly operating margins improved in Europe and North America, we saw a pullback in international on the lower level of sales a less favorable sales mix and higher level of research and development costs.

As I mentioned at Investor Day, we remain committed and are cautiously optimistic about achieving our goal of 15% operating margin by the end of 2015. Our consolidated tax rate this quarter was 30.7%, up 80 basis points from the same period a year ago, primarily because we have yet to see the R&D tax credit enacted in the current year.

Our year-to-date effective tax rate is now 32.9% and we expect this rate to approximate 32% for the full year assuming the R&D tax credit is enacted later this year. Net income from continuing operations was $22 million in the second quarter or $0.59 per basic share, excluding $1 million of pre-tax restructuring and foreign exchange gains, adjusted earnings were $23 million or $0.60 per basic share, a 30% decrease from prior year.

Free cash flow was down $8 million compared to the second quarter of last year on lower net income and a higher level of working capital primarily related to timing of prepaid expenses and to a lesser degree an uptick in inventory levels, as we prepare to launch new products, fill large helmet orders in Europe and align inventory levels for the fall turnaround season in the oil and gas market.

Our cash balance was $96 million at the end of the quarter and compose largely of cash outside of the United States. Total debt was $289 million at the end of the quarter, up $20 million from the end of 2013.

Throughout the first half of this year, Ken has led a significant effort to modernize our capital structure. Along these lines, during the second quarter, his team finalized efforts to secure an additional $100 million of capacity through a senior unsecured term facility bringing our total capacity up to nearly $600 million. We continue to review acquisition scenarios across our core product groups to expand in those areas where have the most knowledge and sustainable competitive advantage.

In closing, the quarterly comp was challenging with a robust level of fixed gas and flame detection product sales in the last year’s second quarter and the continued delays in SCBA approvals in North America impacting our quarterly results. But the backlog remains relatively healthy and reflects solid prospects heading into the second half.

The incoming order pace has been uneven and the ongoing approval situation in the North American SCBA market continues to provide uncertainty as we start the third quarter. Thank you for your attention and I will now turn the microphone to Bill.

William Lambert

Thank you, Stacy. While we continue to face challenges in certain markets in the second quarter and we expect certain conditions to linger into the second half, I continue to believe we are positioned well and our strategy continues to drive improved performance. We view these challenges as mostly temporary and I am cautiously optimistic that we are well positioned to see an uptick in performance as we move towards the end of this year.

We remain deeply committed to our continued focus on driving profitable core revenue growth, developing innovative products with voice of customer feedback, executing key operational excellence programs and completing important strategic initiatives that will enhance shareholder value for years to come.

I want to thank you for your attention and your interest this morning and at this time, Nish Vartanian and Ron Herring have joined Stacy, Ken and me and we are happy to take any questions that you may 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 earnings. Having said that, we will now open the call to your questions.

Question-and-Answer Session

Operator

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

Edward Marshall – Sidoti & Company

Good morning everyone.

William Lambert

Good morning, Ed.

Edward Marshall – Sidoti & Company

So, first one I want to touch, if I could on the operating expenses what have peeled back a little bit but probably not as much as I would have thought. And Stacy, I was wondering, I know in prior quarters, we talked about product liability expenses.

We also broke out in this call about some details of Europe and I am curious if that’s detailed in the restructuring expense or is there additional drag on the operating expenses as well? And then also, if you can quantify any drag to the SCBA efforts now that may subside that you start to see some revenue?

Stacy McMahan

Okay, let me give you some color on the SG&A expenses. First of all, I want to clarify that in this quarter, there were no restructuring expenses for Europe 2.0, although that program is not complete yet. So that just didn’t happen to be any recognition in this quarter.

So what occurred in SG&A however is and some investment in opening an office in our new principal operating company headquarters in Switzerland and some relocation cost you see hitting our SG&A expenses. We also see defense fees for our legal strategy to recover our insurance receivable and in the really – product liability expenses in the quarter.

We continue to have some expenses associated with our corporate restructuring as we execute globally the restructuring plan. And in addition, we have spent some money in the quarter on our rebranding efforts associated with our Centennial Celebration and on strategy refresh work that we are doing. Those are the primary things aside from some marketing cost associated with product launches.

Edward Marshall – Sidoti & Company

Such as the SCBA?

Stacy McMahan

Yes and the other products that Bill and I have talked about in prior quarters.

Edward Marshall – Sidoti & Company

As far as the SCBA, can we quantify any of the drag that’s produced in the quarter, I mean, you just talked about shipping some products, I assume there is some salesmen out there as well and so forth. I mean, is there a product drag in the SG&A line that I should be thinking about?

Stacy McMahan

No, not in the SG&A line, not in the SG&A line, not material.

Edward Marshall – Sidoti & Company

And then secondly, if I talk about the fall protection a sec, and Bill you highlighted a particular product that was rolling out and I am curious you’ve been kind of smaller player in North America relative to some of the other businesses and other segments in the core product group that you sell into.

And I am curious is this particularly product this change in regulation, potential for a competitive advantage for MSA and therefore a share gain or is this just – is there is some unique to your new product that others cannot provide, maybe you can give me a little bit more detail on that?

William Lambert

Yes, sure. I think in the big scheme of things Ed, it’s probably not so unique where we have first mover advantage. All the major competitors have been a part of the new standards that have been promulgated here for arc flash protection for a number of years. So, I would not go so far as to say that we have significant competitive advantage in that regard or first mover advantage in that regard.

All the competitors have been well aware of this and are moving at probably the same pace. But, on the other hand, I would say that there are some new unique and difficult to copy advantages that we have put into our new products that we think can provide us with some competitive advantage.

And so, sure there are some differentiators that we have and how we are then taking our global scale and applying some of these new products to global markets that would have the same kinds of concerns, I think that also provides us with some opportunity to take share.

Edward Marshall – Sidoti & Company

Is it still fair to characterize this business as more of a global focus for you and less – all of your businesses are a bit less on North America here and more so on the global maybe emerging markets kind of area for growth?

William Lambert

It definitely is a global focus for MSA.

Edward Marshall – Sidoti & Company

Okay, and then finally, you talked about the SCBA rollouts, you’ve mentioned just still there is just three producers approved and that means to me that there is still rather large customer not approved ahead of you in the queue? Is there any chance that you guys can kind of leap frog them in the queue or has those discussions kind of transpired or – it seems like that’s for hold up there, right?

William Lambert

Well, it’s one of the many hold ups, that’s right. As I indicated in my comments, the approval process has been frustratingly slow for a number of different reasons there are two major competitors who are also in the queue along with us in the G1 and they do not currently have a product that meets that certification requirement.

So, they are obviously doing all that they can to make sure that they get a product out there in the market. We at least have the M7XT SCBA that we are successfully selling and marketing and two other competitors, one major competitor and one smaller competitor also have approval to the new standard.

As far as leap frogging in the approvals process line with the federal agencies, I think that to my knowledge is impossible. And I am not aware that that is occurring in any way, but for all the things that we have talked about over the last six months where the test agencies had problems in their labs.

They don’t have available resources, they don’t have available manpower. It has just been really, really frustrating for us as well as those competitors who don’t currently have a product approved, I am sure.

Edward Marshall – Sidoti & Company

And just to clarify, the G1 has not been inspected as of yet or hasn’t been looked at all?

William Lambert

Oh, no. It has been looked and it’s in the process. It’s in the process, we had really fully expected it to be approved by now by late July and we meet with our regulator on a fairly frequent basis and they give us updates on where we stand and just recently told us that it would likely now be very late quarter before we get it through the system. That is based entirely on their resources and their capability.

Edward Marshall – Sidoti & Company

Has there been any hold ups on your end I mean there is certain things not been approved and you had to go back and redraft there?

William Lambert

Yes, I mean, there is a bit of iteration that goes on in that sense Ed, but nothing that we feel is of significant nature in others. It’s a fairly complex process both from a hardware standpoint as well as all the documentation and quality plans that they inspect and review and there is always a little bit of iteration that goes back and forth, but I would not say anything that is so major and so significant that was completely unexpected.

Edward Marshall – Sidoti & Company

Fair enough, thanks guys.

William Lambert

Okay, Ed. Thank you.

Operator

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

Richard Eastman – Robert W. Baird & Co

Yes, good morning. Bill, or Stacy, could you just provide maybe a little bit of color on international sales, I mean we hit on a few things but, it would seem to me in this quarter that down 8% in local currency would be a bit of a disappointment and I am just curious what may be surprise to you there and what does the second half trend line look like on the international side?

Stacy McMahan

Well, we are actually down 9% on local currency terms just to reframe that a bit and really it was the timing of the realization of the orders for - the larger orders that are in the pipeline for the fixed gas and flame detection as well as the comparison to the prior year where we had really favorable timing shipments in fixed gas and flame detection as well as a large order that went into China for SCBA.

And those just didn’t repeat this quarter and we tried to explain that our underlying business if you exclude those lumpier businesses or breathing apparatus and fixed gas and flame grew 2%. But that’s in the core products that grew 2%. But lot of those non-core products are down based upon the mining markets in Australia as well as continuing labor unrest in our important market of Africa.

Richard Eastman – Robert W. Baird & Co

So, maybe the non-core is not a surprise, but the core product excluding FGNF and SCBA sales, plus 2%, again that seems to be maybe a loss of momentum sequentially. So, we should again expect better in the second half?

William Lambert

Yes, Rick, let me provide some commentary there. It is a little bit concerning to us that we lost what felt like some momentum in the international markets. I don’t think that there is – we don’t feel that there is any major issue that’s going on in that regard. We don’t believe we are losing market share, we just feel that there has been just - during the second quarter a general slowdown in some of those market areas.

To answer your questions what do we expect for the second half, we don’t expect a hockey stick turnaround in improvement in those international emerging markets but we don’t expect it to get any worse either. There have been some exogenous factors on the international front. Stacy mentioned some of them.

We all know that in Latin America and those of us doing business in Latin America, the World Cup was certainly a bit disruptive not just to our operations, but to the customers that we’re calling and selling the product to. So, we think we get that cleared up and we think that things return back to a maybe a low mid single-digit growth rate in those emerging markets. We don’t think we are off-track there.

Richard Eastman – Robert W. Baird & Co

Okay, all right. And then Bill, you had commented, maybe specifically on a few product lines about backlog, but I am curious outside of the fixed gas and flame back well it sounds like that business still has pretty substantial backlog, Are there any other of the core products that you would flag from a backlog perspective? I guess the SCBA at least achieved one?

William Lambert

Yes, that’s right. Those would be the two major core product areas where we have significant backlog. The third area that I’d mention only because it’s so significant is the European ballistic helmets. We’ve been very successful in winning contracts both in Western Europe and in Eastern Europe for our ballistic helmets and some of the supporting products there and that’s fairly significant and it takes us out into the balance of this year and into 2015 as well.

Richard Eastman – Robert W. Baird & Co

And on the fixed gas and flame, again, I am not trying to pin you down too much here, but, the way it looks to me year-to-date maybe that business is modestly negative year-over-year fixed gas and flame, but we have a big – a significant backlog, does that fixed gas and flame business end up for the full year kind of in a high single-digit growth number? I mean, just and that’s kind of what you target for your core products, that’s why I pick that number. But is the backlog big enough to support that type of growth for the full year in that product category?

William Lambert

Yes, I would not say that it’s high single-digits, Rick. I would probably put it more at moderate and low single-digit growth rates that the backlog and the shipping schedules that we have supporting that, probably takes it in, it’s positive for the year, but probably in the low single-digits, 4% to 5%.

Richard Eastman – Robert W. Baird & Co

And then one quick questions on, Europe’s net income at 8%, a really nice number kind of responded where I guess with the volume and it sounds like absorbed some cost with the Swiss HQ. But, can I ask, was there anything funky at the tax rate line there or what your EBIT maybe in the low double-digits, call it 12% if I just normalize the tax rate?

Stacy McMahan

Not realized any change in tax rate in the quarter, so that’s sort of apples-to-apples versus prior quarters.

Richard Eastman – Robert W. Baird & Co

Okay, so we - okay. And then just lastly, Stacy on the cash flow and I think of free cash flow with all the dividend, but even if you take the dividend out of the cash flow, free cash flow assumption, how does free cash flow shake out for the year? Should we be a positive number here?

Stacy McMahan

We should be a positive number of free cash flow, you mean compared to the prior year?

Richard Eastman – Robert W. Baird & Co

Just should we generate free cash flow, again, you can leave the dividend out if you want to, but I put it in and again year-to-date, with the dividend payments or maybe $15 million negative and I understand you are building some inventory, your receivables are up 2% that might be distribution shift in Europe, but what does our free cash flow look like for the full year?

Kenneth Krause

Yes, Rick, it’s Ken here. So, when you look at our trend line in the past several years and just look at the first six months of this year versus the first six months of last year, we are actually showing a little bit of improvement in terms of working capital management although we have been building a bit of working capital here as Bill alluded to.

The second half has historically been a pretty solid half for us in terms of free cash flow generation. You are right to point out there is some work around inventory and things like that with some really big product launches but our history and our pattern has been pretty robust performance in the second half. So we would expect to see some improvements as we go into the second half of the year.

Richard Eastman – Robert W. Baird & Co

Okay. All right. Okay, thanks so much.

Stacy McMahan

Hey, Rick, I’ve got one slight piece of information on the Europe’s bottom-line. I just want to remind you there was a fairly favorable currency effect for Europe as the euro strengthened, so that certainly did impact the net income performance.

Richard Eastman – Robert W. Baird & Co

Okay, I got you. All right so the translation at the net income line, okay.

Stacy McMahan

Absolutely.

Richard Eastman – Robert W. Baird & Co

Yes, great point. Thank you.

Operator

Our next question comes from Walter Liptak from Global Hunter. Please go ahead.

Walter Liptak – Global Hunter

Hi, thanks. Good morning. I wanted to ask about Europe as well and on the helmet business to a military customer, it sounds as if that’s being – I wonder if you could just provide some more color, maybe on the size of those orders and how much more shifts – how much shipped this quarter? What do we have to go in the back half?

William Lambert

Well, let me provide some commentary on the product, well, this is Bill, and also on the competitiveness over there. We’ve got a very good relationship with customers. We’ve got a very established product in the Western European and Eastern European markets and we’ve been very, very successful for many years without ballistic helmets out of France.

And so, we expect that to continue with, this is both police helmets and military style helmets that we manufacture and sell over there. So we expect that to continue. As far as the size of that backlog, I look to Stacy or Ken maybe on some detail there or Ron perhaps you can provide some input on the level of that backlog and how much of that moves into 2015. Ron?

Ronald Herring

Yes, Bill. Sorry, I am not – I am trying to pull that information up right now. But it is, as you are saying, it’s a sizable backlog. It will probably run through at least the middle of 2015 as it’s scheduled right now. On the order size of 25 million, does that sound about right?

William Lambert

Yes, that’s correct.

Ronald Herring

We don’t have that right here handy, Walt, but order of magnitude it’s about $25 million in revenue.

Walter Liptak – Global Hunter

Okay, thanks for the color and then that helps. And then, saying in Europe, the FGFD business, it sounded like it’s – you are building backlog that there is some projects that they are pushing to the right and I wondered why and then you mentioned the timing in the back half. I wonder if we can get a little bit more color on that as well?

Ronald Herring

I mean, the FGFD business is always dependant on the end-use customer and the major projects that they have in developments, the engineering contracts and procurement providers. So some projects move to the right, Walt, but I wouldn’t say that in general that’s a trend that we are seeing, it’s just the timing of when those projects hit and when the deliveries are scheduled for.

So, I don’t see – we don’t see a tremendous amount of the projects moving to the right being delayed tremendously. It’s just, again, it’s just a timing of those major projects and when they have scheduled delivery of our product to support those projects.

Stacy McMahan

SGFT actually grew in the quarter over 8% and we are really encouraged by the strength of the Middle East market in particular.

Walter Liptak – Global Hunter

Just in Europe, you are referring to?

Stacy McMahan

Yes, that’s a European SGFT, yes.

Walter Liptak – Global Hunter

Right, okay, got it. And then, this is just, I guess, I think is interesting. You mentioned that you built backlog that you wanted, I think you said a healthy backlog. How does that work – customers that have already tested and decided that they want to purchase a product, they place orders, you got your pricing down and then it goes in the backlog just waiting for the certification?

William Lambert

Well, a bit of that Walt. What we typically see happening is that, as I indicated in my call comments that we have developed a large number of samples that we have fully functional samples that we have sent out into the field. We are continuing to build on the momentum that we created at the FDIC show with those samples and holding awareness events and trial run events at fire departments across the country.

And in many, many cases, those fire departments based on their utilization of that fully functional sample and use or placing orders through distributors as well as our distribution channel partners being quite excited by it and they are placing orders on MSA as well.

So, it’s a combination of those and some of the really big fire departments they require a fully certified breathing apparatus before they would put them through a complete evaluation and so there is quite a number of those that were in the queue and we are awaiting for and that the fire departments are excited about trying the G1 SCBA.

But we don’t have orders from some of those. But there is plenty of others where we have been able to win an evaluation so to speak based on the samples, the fully functional samples we’ve provided.

Walter Liptak – Global Hunter

Okay, thanks. So the answer at your Analyst Day was that you might get a little bit of ordering in the fourth quarter and first quarter but it would be second quarter of 2015 where the market would really get going, but after these comments about the healthy backlog for SCBA, I am certain to think that maybe you’ve finally get some renewed sales in SCBA in the fourth quarter and then keep growing from there. You said, an okay way of characterizing it?

William Lambert

Well, I think that’s an okay way of characterizing it. I mean, we are pleased with where we are right now. We are pleased with the backlog, the book of business that we are building.

We are displeased by the approval process that we are mired in. But, depending on when we get those approvals and the configurations of those approvals, we will see – we should see some improvement in the fourth quarter and I think momentum building from there in the first quarter and second quarter of next year just as we described to here.

Walter Liptak – Global Hunter

Okay, thanks very much.

Operator

Our next question comes from Brian Rafn from Morgan Dempsey. Please go ahead.

Brian Rafn – Morgan Dempsey Capital Management

Good morning everybody.

William Lambert

Hi, good morning.

Stacy McMahan

Hi, Brian.

Brian Rafn – Morgan Dempsey Capital Management

Bill, you talked a little bit about, what is the sense of before you started rolling out with the Q1 next year, what is the sense of the M7XT system in its durability of sales, once the G1 is launched?

William Lambert

Well, I think we talked about that in the Investor Day presentation. I think it’s a very, very good question. What we are finding is that the durability of that product in the market is actually quite good and quite strong. I was pleased by the sales performance of the M7XT during the second quarter and we continue to see customers who were M7 customers who have upgraded to or want to continue on that platform of product and go with the M7XT.

So, I guess, it’s better than I expected. It’s my answer Brian. But once the G1 actually gets into the market and it’s available, I guess, that’s when we will determine how much of the M7XT business does the G1 then begin to queue into which is okay by us, because it’s really a revolutionary product and it provides some significant advantages for us and for our customers.

So, but right now, I am pretty pleased with the M7XT and its sustainability, little bit better than I thought it would be by this time of the year.

Brian Rafn – Morgan Dempsey Capital Management

Bill, your thoughts have now obviously they can change, but is the M7XT is still scheduled to be a dual product that runs parallel to the G1 or is at some point the G1 if it cannibalizes enough sales the M7XT would be canceled?

William Lambert

That could occur, but probably not for at least a couple of years, we’d run, I would imagine, we will run the M7XT through the next NFPA approval cycle process. So we probably have another three, four, five years on that product, again, depending on what that cannibalization rate is. But, we’ve got plenty of customers out there who are dependent on the M7 and the M7XT and our past practice has been to run that for at least one five year NFPA recertification cycle.

Brian Rafn – Morgan Dempsey Capital Management

Okay, all right. Back to the G1 Bill, once it gets you going building that, is that G1 with that revolutionary new engineering design, is that a book and ship business or is there a lot of specific engineering customization and iterations that anyone individual fire department might be significantly different from somebody else who you are not building a lot of inventory?

William Lambert

Let me back track, it’s primarily a book and ship business. Now, having said that, there are configurations over time that we develop that required certification and approval and so and there are instances where a certain fire departments, especially large fire departments will like a little bit of customization on that SCBA and that requires us to book the business but then get the certifications through the agencies.

So it flows things down a little bit. But that’s a minor part of the business, Brian. 90% of the SCBA business, once we have our certifications and approval, our foundational approvals, 90% of that is book and ship.

Brian Rafn – Morgan Dempsey Capital Management

And Bill, what if – what might be your thoughts the book and ship, is that sales cycle and shipment and production, is that a period of months or half the year or how fast can that book and ship cycle be defined in, once you get you ongoing?

William Lambert

I’d put at a month or few months at the very most.

Brian Rafn – Morgan Dempsey Capital Management

Okay, all right. Good, good. Well, tell me a little bit about, maybe refresh my memory. What for you is different with the ballistic helmet business in Europe be it, if this is a lot of between the armed force this is a lot of needle standardization between the US and overseas?

Obviously we’ve talked certainly about weakening military budgets under the Obama ministry, what has kept you guys in the ballistic market in the Europe that’s different than America?

William Lambert

I think that’s a very good question. As you know, probably three years ago, I guess it was we began a process to divest ourselves of the ballistic helmet business and ballistic vest business here in North America and for a good reason, the profitability.

And margins for that product were getting thinner and thinner and we had a customer that – I should say, wasn’t, didn’t fit the profile of a kind of customer that we wanted to have going forward and that sounds a little bit harsh, but the fact that the matter is, we had done a lot, we felt we had done a lot in the way of developing and putting a lot into R&D for that customer and not getting a lot out of that in the way of return on our investment.

And so we decided that ballistic helmets and ballistic vests in North America is not where we wanted to put our resources and that we wanted to focus our resources in the core areas of the business. Having said all of that, the European market is quite different and while the helmets are quite similar, they do differ in some meaningful ways and we are able to generate very respectable margins on those products.

We’ve got great relationships with those customers as we develop products for their specific needs and it was just a very different environment. It is just a very different environment over there than it is than we found it to be here. So, we backed away from the market here. We continued to excel and hold a dominant position in quite a few markets over there.

Brian Rafn – Morgan Dempsey Capital Management

Okay, your centralization of your warehouse in Europe with the Europe 2.0, how big is that warehouse and as you consolidate warehouses over there are you going to be carrying any less inventory or is it about a push? It’s only for streamlining that?

William Lambert

We intend to be carrying less inventory.

Brian Rafn – Morgan Dempsey Capital Management

And what is the size of that warehouse by chance to get a square footage on that?

William Lambert

I do not have one. I don’t have that off the top of my head, Brian.

Brian Rafn – Morgan Dempsey Capital Management

Okay, thanks much guys.

William Lambert

Okay, thank you.

Operator

(Operator Instructions) And our next question comes from Stanley Elliot from Stifel Nicolaus. Please go ahead.

Stanley Elliot - Stifel Nicolaus

Good morning everyone. Thanks for taking my questions. A quick question on the European profitability. You guys mentioned the inflation, obviously the volumes helped out. The consolidation to any of the warehousing, did that help or is there a way to split out kind of between the volumes and some of the prior restructuring within that improvement at all?

William Lambert

Stacy, I look to you.

Stacy McMahan

Elliot, we don’t have a meaningful split out of that at this moment to be able to share with you. Certainly, we didn’t see the operating margin improvements on a local currency basis that have a lot – probably more to do with mix. We decide to take another closer look at the inventory levels to get you a good answer there.

Stanley Elliot - Stifel Nicolaus

That’s fair, that’s fair. And some of the new products that we are talking about – you guys talked about in emerging markets, a lot of value type products for those kind of in country-specific, should we assume that those margins on new products on a go forward basis will be at least in line with the company average or maybe even a little bit better than that?

William Lambert

I think that’s a very good assumption to make.

Stanley Elliot - Stifel Nicolaus

And lastly, with the additional capacity on the credit side, any update on M&A activity, maybe kind of refresh us with the target size and some of the areas of focus.

William Lambert

Well, I think as we’ve said on previous occasions, our focus is in those core areas of the business that we’ve described many times in the past and in those growing emerging markets in order to access channels of distribution there. Size of the acquisitions as we said in the past, we completed in 2010 the acquisition of General Monitors.

That was a $285 million acquisition. That was the largest in the company’s history to that point in time and we successfully acquired that company and integrated it well into the organization. So that’s in a comfortable range for us. Bolt-on acquisitions is what we are looking to do.

We’ve got a very active pipeline of evaluations going on and so, core areas, emerging markets of the business in the range that you’ve seen us make in the past bolt-on, accretive, those are some of the principles that we look for as we make acquisitions.

Stanley Elliot - Stifel Nicolaus

Perfect, well, thanks again and best of luck.

Stacy McMahan

Thank you.

William Lambert

Thanks.

Operator

And our last question comes from Richard Eastman from Robert W. Baird. Please go ahead.

Richard Eastman – Robert W. Baird & Co

Sorry, thanks I was thinking back in the queue and save Ken a little time later. The gross profit margin, really given the commentary around the sales mix both geographic as well as by product line.

The gross margin was just – that was a very good number at 45.9% and I am curious it sounds - maybe you got a little bit of help on the inventory build and absorption. But is there any other single factor in there that kind of drove that, the new products I suppose that would be sustainable? Is that’s the primary thing is your vitality index being up in the contribution from those products?

Stacy McMahan

I’d say the order mix is also a fairly significant one. I mean, just the mix of products that we’re selling are more profitable, but having fewer large orders, where the large order usually has a price discount associated with it. Having fewer of those shipped in the quarter, certainly impacted the margin as well. It’s one of the other factors.

William Lambert

But it is – to your point, Rick, it is something that we’ve talked about with you in the past. It’s not just changing the mix to be more focused on core product areas. But it is pricing and the pricing initiatives we have.

It is related to the new product developments process and that improving vitality number that we see for the new products that we are introducing having higher gross margins. It’s a number of those elements and the 50 basis point improvement that we saw in gross margins in the second quarter, I think continue to reflect that.

Stacy McMahan

A good balanced mix of those items, yes.

William Lambert

And Stacy had pointed out in her comments across the core product area, we saw a nice expansion across, just about every one of those categories. So, continued to be a source of strength.

Richard Eastman – Robert W. Baird & Co

Okay, great, great. And then just one last question, just trying to think of the pacing here with the challenges you have and the pacing on the quarters, but typically the third quarter is a bit and revenue is lower than the second and a lot of that has to do with Europe slower. But again the commentary around the G1, the SCBA market, even the backlog sound like they are little bit more weighted towards the fourth quarter.

Again, I would presume that we will see that typical lower third quarter versus second quarter sales pattern that historically has been seasonal, but also seems to be supported by your product commentary. Is that a good starting spot?

William Lambert

Well, I think that’s fair. Yes, Rick.

Richard Eastman – Robert W. Baird & Co

Okay, all right, well, thanks again. Nice profit quarter.

William Lambert

Thanks, Rick.

Stacy McMahan

Thank you.

Operator

I will now turn the call back over to Ken Krause for closing comments.

Kenneth Krause

Seeing that we have no more questions that concludes this morning’s call. If you missed the portion of the conference, an audio replay will be available on our website for the next 30 days as well a transcript of the call.

On behalf of our entire team here, I want to thank you again for joining us and we look forward to talking with you again soon. Have a great day. Good bye.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you participating. You may now disconnect.

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