Mine Safety Appliance Company Q1 2008 Earnings Call Transcript

May.19.08 | About: MSA Safety (MSA)

Mine Safety Appliance Company (NYSE:MSA)

Q1 2008 Earnings Call

May 1, 2008 10:00 am ET

Executives

John T. Ryan III - Chairman of the Board and Chief Executive Officer

William M. Lambert - President and Chief Operating Officer

Dennis L. Zeitler - Senior Vice President and Chief Financial Officer

Joseph A. Bigler - Vice President and President, MSA North America

Roberto Cañizares - Executive Vice President and President of MSA International

Mark C. Deasy – Communications Director

Analysts

Richard Ethan - Robert W. Baird

Brian Ruttenbur - Morgan Keegan

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

Ray Culter – Great Lakes Review

Edward Marshall – Fedaddi and Company

Walt Liptak – Barrington Research

Operator

Good morning, ladies and gentlemen, and welcome to the MSA First Quarter Earnings Conference 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 C. Deasy.

Mark Deasy

Thank you, Jaime.

Good morning everybody and welcome to our first quarter earnings conference call for 2008. As Jaime said, I’m Mark Deasy, Communications Director, and with me today are John Ryan III, Chairman and Chief Executive Officer; Dennis Zeitler, Senior Vice President and Chief Financial Officer; Bill Lambert, President and Chief Operating Officer; Joe Bigler, President of MSA North America; and joining us for your conference call from Berlin is Rod Cañizares, Executive Vice President and President of MSA International.

Our first quarter earnings release was issued this morning at 8:30. We hope everyone had an opportunity to review it. If you haven’t seen it, the release is posted on the home page of the MSA website.

As some of you know, today’s teleconference marks the last quarterly call in which John Ryan will participate as MSA’s CEO. John will retire at the end of June and will officially turn over CEO responsibilities to Bill Lambert on May 13th as part of a planned management succession.

As such, we’re going to do things a little bit differently this morning. We will begin the call with Bill Lambert, who will provide commentary on our first quarter. Bill will be followed by Dennis, who will review our financials. And after Dennis, John would like to offer some parting thought as he heads towards this next and very deserving days of his life. After John’s remarks we will then open up the call to questions and plan to adjourn by about 11:00.

At this point, I would like to remind everyone that the matters discussed on this call, with the exception of historical information, our forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended as Section 21E of the Securities Exchange Act of 1934 as amended.

Forward-looking statements, including without limitation, of projections in anticipated levels of future performance involve risks, uncertainties and other factors that may cause our actual results to differ materially from those discussed here. These risks, uncertainties and other factors are detailed from time to time in our filings with the Securities and Exchange Commission, including our most recent Form 10-K which was filed on February 29th.

We strongly urge you to review all such filings for a more detailed discussion of such risks and uncertainties. Our SEC filings can be easily obtained at no charge at www.sec.gov, our own website, and a number of other commercial websites. That conclude our forward-looking statements at this point. I will turn the call over to Bill Lambert for his comments on our first quarter.

William M. Lambert

Thank you very much, Mark, and good morning everyone. I would like to thank all of you for joining us today and I also want to congratulate John on his upcoming retirement.

To say it’s well deserved would be an understatement. Over the last 17 years while John Ryan has been MSA’s CEO and through his determined leadership, MSA has transformed itself and has grown impressively. We’ve expanded our footprint globally. We are in new markets. Our consolidated sales have nearly doubled and our annual earnings have nearly quadrupled over his tenure. And John has led the company to achieve consistent record results over the past several years. He has helped this company navigate through very tough periods that admittedly were challenging to the company. And through it all, John Ryan has maintained the character, integrity and essence of this company and all that MSA has stood for for over nine decades. Well done, John, and congratulations on your upcoming retirement.

As I move into my new role, the one thing I certainly hope to do as well as John is to follow his lead in terms of how MSA has been led, with great integrity and a personal commitment to the health and safety of all those who depend on our products to protect them and to our shareholders.

As Mark indicated, John will very shortly share with us some parting words and thoughts. So let us now move on to review the company’s performance during the first quarter.

Presumably, all of you have seen our earnings release and have our financial figures with all comparisons being with the improvement period in 2007. Overall, we were very pleased with our first quarter operating performance. Our consolidated sales increased a very healthy 18%. And on the strength of these sales and continued operation improvements, I’m also pleased to report that first quarter operating income, extra structuring interest, taxes and effects increased 25% from a year ago.

Our operating performance in North America and in International markets outside of Europe met our expectations and showed very strong improvements over a year ago, with North American sales increasing 19% and International markets outside of Europe also increasing 19%. While clearly, there were some unusual items in the quarter that affected our net income, particularly the negative and unprecedented impact of unrealized currency exchange losses on intercompany balances.

The underlying strength of MSA’s business and the growth we’re seeing in our core markets is quite sound. In North America, we were pleased with the rebound we saw in our US Fire Service business. While we fought often and long about this expected improvement, I’m delighted to say it finally did happen and shows in the reported results for North America. Specifically, on North American Fire Service sales increased dramatically by more than $17 million from a year ago, representing a 55% improvement. As you might expect, the major driver of this increase was sales of our new NFPA compliant Firehawk M7 breathing apparatus, which grew at nearly 60% over quarter.

But we also saw improvements in other Fire Service product areas. North American sales, in fact, in cameras increased $2.8 million in the quarter, a 76% increase. Sales of fire helmets increased $1.1 million with 21% from a year ago.

Supported by the availability of AFG funding and the competitive advantages of MSA’s Firehawk M7 breathing apparatus, I’m please to report we were able to achieve greater than expected gains and new fire departments who have switched from a competing brand to MSA’s Firehawk SCBA during the first quarter.

It is clear to us from these results that MSA’s Fire Service and our distributor partners are making good progress in our market strategy to drive growth from within our US Fire Service.

Looking ahead, the AFG program will continue to be an important, but certainly not the only driver of our Fire Service success in the US. Our Firehawk M7 SCBA and its competitive positioning is also a major driver.

Significant AFG dollars remain to be spent in 2008 but the end of the jewel level of awards are likely to be smaller as the AFG’s administration strives to distribute federal funds to the greatest number of fire departments possible.

Most certainly, other highlights in the first quarter included a 39% increase in North American Military sales. The driver of this improvement was strong shipments of ballistic helmets to both the US and the Canadian military. To be sure, this is only one quarter out of four, but it certainly represents a very positive start to the year for MSA North America.

Our sales in Europe, stated in US Dollars, showed an increase of $7 million or 14%. Improvement, however, was entirely related to the currency translation effects of a strong Euro. But stated in local currencies, our sales in Europe actually declined 5%. More on this in just a minute.

The overall effect of foreign exchange losses over the quarter did have a significant impact on net income. Dennis and I will both touch on that subject but the net income on our bottom line was a foreign currency exchange loss of about $3.3 million.

In our International segment, sales increased $9 million or 19%. The strong performance of MSA operations were South Africa, Latin America and Australia, where local currency sales were up $3 million, $2 million, and $1 million respectively. The improvements in South Africa was primarily due to strong growth in sales to the mining industry. In China, which we know is always a region of interest for our shareholders, our sales declined about $2 million from a year ago. A lower level of large orders to the Fire Service and in GAAP protection systems were the major reasons for this drop.

To provide you a little more texture on this, MSA China’s first quarter last year included substantial invoicing in the amount of $1.8 million for SCBA to the Beijing Fire Bureau, which did not repeat in 2008. Additionally, unusual weather conditions of snowfall mounts disrupted much of January’s business across China. Despite these factors, Chinese orders for other personal protective equipment products increased 10% over the same period in 2007.

We remain very encouraged by the prospects with increasing safety equipment sales in China and it remains an area of focus for the company. I’m also pleased to report the construction of our new factory in Suzhou. It’s making good progress and is on schedule for completion by the fourth quarter of this year.

Excluding that slightly slow start in China, first quarter International net sales grew by about 25% from a year ago, demonstrating broad geographical strength in our underlying International business. As John had said on many occasion, our International business, those areas outside of North America and western Europe, represent the greatest growth opportunity for MSA. So we were very pleased to see International sales activity, less China, keep pace with the robust activity we saw in North America.

Turning our attention back to Europe, and as noted in our release, European sales results were below our expectations for the quarter. My disappointment was not in our ability to generate sales orders but rather by the delays we experienced in shipments due to a variety of production-related issues. In particular, continuing supply issues with an important chemical compound which we purchased from a single source significantly hampered our shipments of our European Mine Rescue breathing apparatus.

Additional supply chain issues in other product areas also restricted our ability to ship certain head and hearing protection products and some permanent instrument orders. While I was disappointed with our ability to resolve these issues in a timely fashion during the first quarter, I assure you they are only temporary impediments and good progress is being made to address each of them.

The very encouraging news in Europe is that incoming orders over the first quarter were well above our expectations. This included over $20 million in orders received for military and law enforcement products and $12 million in orders for gas masks and SCBA, which are all scheduled for delivery throughout the remainder of this year. As you would expect, our focus in Europe right now is addressing the production issues we face and clearing our backlog while continuing to generate strong incoming order bookings.

Finally, I would be remised if I did not mention the significant improvement we have seen in operations performance over the first quarter. A key element of this improvement is progress in our Project Magellan Initiative which is clearly helping us improve the efficiency of our North American operations.

As a percent of sales, North American showed strong directional improvements in operating margin performance, about a 260 basis points improvement. As sales increases, those margin improvements and operational excellence initiatives all combine to deliver strong and desired results.

The one area of our income statement which had significant and adverse impact to reported earnings was the loss due to currency exchange. And I said it was unprecedented but should not take away from the many improvements we’ve seen in the operating entities of our business. Overall, currency exchange gains minus losses resulted in about a $3 million after-tax expense for the quarter. This expense was related to an 8% decline in the US dollar against euro dominated liabilities of our intercompany financing entity in Ireland, a foreign South African rand, and the effect of a moderately weakening Canadian Dollar on receivables related to large orders shipped during the quarter.

The significant impact of these currency exchange movements which, to a certain degree, equated to a perfect storm of intercompany currency exchange losses was new to MSA and something we haven’t experienced to this magnitude at any time over the past twelve years.

Lastly, our effective tax rate was 4% points higher than a year ago, resulting in over a $1 million increase in taxes. This issue relates to the still unrenewed R&D tax credit in the US, our inability to tax effect losses in Japan and a run off recent tax law change in Germany. The result of all of these was a higher effective tax rate.

Dennis will address these issues and provide greater detail on both the foreign exchange losses and the increase seen in our first quarter effective tax rate in just a few moments.

As I stated earlier, if we look at the underlying operating entities of MSA and the market and regional successes we are seeing, and exclude the foreign exchange losses and certain other expenses like restructuring charges and tax issues. Our earnings before these charges were $33.8 million, showing a 25% increase in operating profit over the first quarter of 2007.

In conclusion, we’re pleased by the first quarter operating results. We believe the overall story here is that MSA business across the board was strong for the first quarter, with long anticipated improvements in the North American Fire Service market finally coming to fruition.

Additionally, International sales showed good gains from a year ago and our incoming order bookings in Europe were well above last year. With one good quarter now behind us, we have three important ones to go and our focus will remain on continued and sound execution of the growth strategies that helped drive our first quarter results.

At this point, I’ll now turn the call over to Dennis Zeitler, who will provide a little more insight into our reported first quarter financial results.

Dennis Zeitler

Thank you, Bill. Good morning, everyone. I would like to give you some further insight into our first quarter performance and comment on the balance sheet and cash flow statements. Additional information will be available later today when we file our Form 10Q with the Securities and Exchange Commission.

As Bill mentioned, sales in the first quarter of 2008 were a record $266 million, compared in the first quarter of 2007. Sales increased 18% with strong growth in both our North American and International segments.

North American sales are up 19%, led by a 48% uncrease in the United States Fire Service sales and a 20% increase in the United States military sales. The remainder of our North American sales grew 10%

Our International sales grew 19% this quarter, across a broad range of our products and market and our European sales are up 14% from the same quarter last year. But that is solely due to the stronger Euro.

Our global sales were also higher in each of our three market categories: the core industrial market, which is approximately 57% of our total sales is up 7% this quarter. Our service is up 37% and military is up 33%.

The other view of our sales performance is to separate the two most volatile segments, US Fire Service and Us Military from everything else. As I already mentioned, our US Fire Service sales of $40 million, is an increase of 48% and as US Military sales of $19 million are up 20%.

Then when we look at all of our other globally diversified sales that comprise 78% of our total sales this quarter. These sales from 13%.

Our expectations for SCBA sales in 2008 continue to be good as well as for military sales. We also expect to make up some ground by shipping more of our European backlog during the remainder of 2008. The balance of our business continues to be strong but if some of these subject that globally economic condition and the slowing economy around the world.

Our gross profit rate for this quarter was 40%, up half a percent from last year. Our continuing efforts to reduce manufacturing costs were mostly offset by more competitive pricing in the Fire Service market and the lower margins on US Military sales.

Following in administrative costs in the first quarter were 25% of sales, unchanged from last year. Our R&D expenses are up 24% this quarter, as we continue to invest in new technology and products that will continue to grow our organic sales in the year to come.

The resulting operating income, excluding restructuring charges and currency losses, is $34 million, an increase over the first quarter of 2007 of 25%. As of percent of sales, this is 13% this quarter versus 12% in the first quarter of last year and 10% for the full year of 2007.

During the first quarter of this year, we recorded in our income statement an unrealized after-tax currency loss on intercompany activity of approximately $3 million. Generally, we lend our available euros to various MSA affiliates to minimize our bank debt and to minimize the significant tax costs of repatriating this cash to the United States. When we lend Euros to a non-Euro MSA company, we create a liability run company and a non-euro asset in the other.

Historically, these currencies have moved in the same direction versus the dollar, hence the movement in euro would be offset, those up or down, by the movement in the other currencies. However, in the month of March, the euro continues to strengthen while the Canadian dollar, Australian and South African rand each weakened versus the US dollar.

We do actively manage our currency exposure by a combination of balancing our portfolio currency and the purchase of forward currency contracts. Usually, we have managed to offset our gains and losses over a full year, thus the result in modest gains and losses each year. In the past twelve years, we’ve had only one when this line exceeded $1 million. And the currency losses we reported for the entire twelve years is less than $1 million.

As Bill indicated, what we saw in the month of March was unprecedented for MSA. Furthermore, for the month of April we recorded a currency gain on the same company balances of roughly $2 million.

We do have over £40 million on our balance sheet, which increased in value more than $5 million this quarter. But that, in fact, does not flow through the income statement but rather flows directly to shareholder’s equity and then increase in accumulated other comprehensive income. Other comprehensive income not reflected in the income statement increased $11 million this quarter.

Our consolidated tax rate in the first quarter was 39% versus 35% last year. We had several factors that resulted in approximately $1.4 million of incremental taxes this quarter. Some of these issues, such as the failure of the US Congress to renew the R&D tax credit and a high effective tax rate in Europe, should resolve in sales during the remainder of this year. Other, such as our inability to tax defect our office in Japan and Ireland, will resolve in some over time as we turn both of those affiliates to profitability.

Lastly, the one time 3% tax imposed by the German authority as part of the select cost and retained earnings, is a one-time cost that will not be recovered.

The bottom line is net income is $16 million or $0.45 per basic share. The same as last year. However, the combined effect of currency losses, special tax items and restructuring charges reduced our earnings per share this quarter by $0.15.

Some comments on the balance sheet and cash flow statement:

Our cash position decreased $8 million this quarter to $67 million. Our networking capital increased $65 million compared to a year ago, of which $21 million is due to a lower dollar. Our cash out close this quarter were from manufacturing assets and dividends. Our capital expenditures plan for 2008 are higher than 2007, due to the new Chinese factory that’s under construction, as well as, major improvements that are underway at our Australian and Brazilian factories.

Those are my comments. At this time, I have the distinct honor of turning this call over to John Ryan.

John has led this company to record levels of success by his hard work, intelligence and compassion for both MSA employees and our customers. It has been my great privilege to work for him and I wish him all the most enjoyable retirement.

John T. Ryan III

Thanks very much, Bill and Dennis. At moments like this, I keep in the mind the words of Adlai Stevenson. Praise is fine, as long as, you don’t inhale.

To conclude, we have a really good quarter in incoming orders. Our European invoicing is disappointing but into the last couple of years we feel that we will catch up in our invoicing in Europe by year end. Our income from operations were strong, up by 25%. However, we lost a profit gain for the quarter due to these non-operational areas: foreign exchange, restructuring and taxes, which have been discussed.

As you know from many of these previous calls, I have felt that our US breathing apparatus in Fire Service sales would improve to a very fast factory level for reasons I’ve long expressed. Using some poetic license here, I could say that I felt I had to keep working and I couldn’t retire until we would realize this expectation. Happily, we achieved three straight months of strong US and North American Fire Service income in January, February and March. And so I can now go away for the summer and retire.

As previously announced, I will retire as active employee and CEO of the company in a few weeks. I do plan to maintain my life-long deep interest in this organization. I will do so at the Board level and at the shareholder level. I was extremely well instructed on how to fulfill my new relationship with the company by the role model set by my father and his associate, Jane Mary, after they retired as CEOs. It’s like transitioning from being a parent to a grandparent. You have great interest but you express it in different ways.

At any company, there can be only one boss and that will be Bill Lambert. I will not be participating in these calls in the future as a speaker but I will be listening in as an interested shareholder.

I’ve been CEO for 16.5 years, which is about four times the average in a US public company. It’s been a memorable ride. We have lived in interesting times. Some time, and the Chinese meaning of this term, which is a curse, and sometimes in the Western meaning of the term, which is a blessing. We outlived the era of business in the ‘90s. Those times of fellows’ names [? Chain Sorralle] and Neutron Jack. And also we outlived the era of a good number of other executives, whom I never liked in the first place, who are now in jail or on the way there.

In the speech given earlier, I used the quote of Abraham Lincoln: “I am not bound to win but I am bound to be true. I am not bound to succeed but I am bound to live up to the light that I have.”

This is what I’ve tried to do. I would define victory and success as greatness in the performance of the organization in achieving this mission, that men and women may work in safety and their families or communities may live in health throughout the world. And also in how well the organization work together for the well being of all. Strongly due to the help of my colleagues, present and retired, at all levels of the company, I think we did achieve these goals. If one defines success as star performance, we did pretty well at that too. Of seven times of change in these 16 years, up almost five times since June of 2000. And what we did, we did the right way and maintained there on.

I have a very capable successor, Bill Lambert, and he has been excellent theme. Times won’t always be there in the future. I told Bill that when times get tough, as they occasionally do in real life, I remember how difficult some stretches were for me and that showed considerable empathy.

I’ll conclude now with a word of a character of a George Bernard Shaw play. This is the true joy in life, being used for a purpose recognized by yourself as a mighty one. Life is no brief candle for me. It is a sort of splendid torch which I have got hold of for a moment and I want to make burn as brightly as possible before handing it on to a future generation.”

Moving on to a sport saying Gone now north to the boys, I would say to Bill and our colleagues: To you, I pass on the torch. Be it yours to hold on and I know he and they will. Thank you.

Mark C. Deasy

Thank you, John. That concludes our formal comments. At this point, John Ryan, Bill Lambert, Rob Cañizares, Joe Bigler and I are more than glad to answer whatever questions you may have. Please remember that MSA did not give what’s referred to the guidance and since most discussions related to our expectations for future details and earnings. As I said that, we’ll now open the call for your questions.

Question and Answer Session

Operator

Thank you. We will now begin the Question and Answer Session. [Operator Instructions]

Our first question comes from Richard Ethan from Robert W. Baird.

Richard Ethan - Robert W. Baird

Could you talk for a minute or two about your confidence level in your ability to clear the backlog in Europe as the year unfolds? And I guess part of your question is is that within your control? In other words, you have some of these chemical supply issues, is it in your ability to clear that backlog for the balance of the year?

William M. Lambert

Hi Rick. Sure, I think it is within our control. We have these issues with this one particular supplier and I think that I can very confidently say that the issues that we experienced in the fourth quarter and into the first quarter of this year are behind us and that that supplier has made necessary improvements. We’ll be making further improvements. And certainly over the balance of this year, I would expect that we would be able to clear the back order, at least any back order that’s associated with problems that we’re aware of right now. So, I feel very confident that we’ll be able to do that.

Richard Ethan - Robert W. Baird

Then just quickly into the US Fire Service for a minute then the AFG program, we’re obviously seeing some of the ’07 dollars now getting into the marketplace and I presume that will continue into June and even September. But how do you feel about the ’08 application process and perhaps—just the confusion that’s been in the marketplace, has that cleared up and will those dollars potentially at least get to the marketplace in a more regular fashion here?

William M. Lambert

Let me answer that and then I’ll ask Joe Bigler to add a little bit of color to it as well since he knows that market extremely well.

You’re right. I think the 2007 monies are working their way into the market nicely now and certainly we saw some pretty strong performance in the first quarter due to that. The 2008 AFG monies have been a little bit confusing. We’ve talked about that at the last Investor’s Conference Call and there is this issue of downward price pressure because the AFG is looking to cap the amount of money for new SCBA at $5,000 a piece.

So, we’ve had to wrestle with that. We’ve also had to wrestle with trying to clear up some of the confusion that might exist with regards to applications and what’s permitted, what’s not permitted. And I guess the third issue here is the idea that the AFG is trying to spread the money to as many fire departments as possible. And so that then also has a bit of an effect on some of the fire departments that are larger and have really relied upon AFG funding in the past.

Is it still confusing out there? Perhaps a little bit but I think it’s working its way out. I think the bigger issues right now is the issue of the $5,000 cap from the AFG on SCBA purchases and what that’s doing from a dollar pressure price standpoint for all the competitors. Nearly all the competitors have the necessary approvals which really hindered evaluations in the fourth quarter last year. So, broadly the competitive landscape now is quite full and so in many cases, we’re able to go head to head against competing brands for the SCBA through fire ground evaluations and fire departments have been able to make their decisions without any kind of a delay in waiting to test their trial a unit from a competing brand.

Joe, I’ll ask you if you want to add anything to that.

Joseph A. Bigler

Yes, not a whole lot but I think you summarized it well. I think going back, Rick, to your first question in terms of 2007, there’s been a couple of surveys done in 2007 AFG monies, probably about 20 times or 15% {33:08} of that money has already been spent and purchased in the first quarter. So you probably have about half of that 2007 money will be spent probably throughout the second and third quarter. So we expect continued good growth in that market.

As far as the 2008 money, what we’re hearing is that the release of that money hopefully will occur in that July/August timeframe and things seem to be somewhat on track. And although there is a lot of confusion out there, I think there are a lot of seminars going on, there’s a lot of discussions going on, there’s a lot of individual meetings going on, and I think a lot of the confusion is really getting cleared up. And departments of the agencies are starting to understand what needs to be done and the process that the smaller departments probably getting a bigger share of the money but more grants on what the focus is going to be. So I think a lot of those questions are clearing up and we expect and hope that the money will begin flowing in that July/August timeframe.

Richard Ethan - Robert W. Baird

Do you closely track market share gains? Is there a metric that you look at other than just sales grow better than competitors perhaps, but just some kind of a department wind metric or something like that? Can you document the fact that you’ve been gaining shares by department?

Joseph A. Bigler

Yes. We have in a good year build a giant mentioned in the previous comments. We have a gain share program that has been quite successful and we track the AFG money. We tried to track how many breathing apparatus are being purchased by various departments and keep pretty accurate count as far as all the departments within the United States as well as Canada; the number of SCBA helmets, thermal imaging cameras that they have, whose they’re using, when they’re going to replace it, have they replaced it. So we have a pretty good handle in municipal fire departments and what’s our bearing, what’s being evaluated and what’s coming.

Richard Ethan - Robert W. Baird

Okay, and just a last question and I’ll drop off here. Are we either shipping or getting ready to ship on the AF SCBA contracts?

William M. Lambert

Yes, in fact, we did not have any shipments during the first quarter. We actively began shipping this week, in fact, yesterday against the Air Force contracts.

Richard Ethan - Robert W. Baird

Great. Thank you.

Operator

Our next question comes from Brian Ruttenbur from Morgan Keegan.

Brian Ruttenbur - Morgan Keegan

Thank you very much. First question I have is about, kind of going forward, second quarter it looks like, at least what you’re saying, as I understand is North American because the firefighter grant could be a little bit weaker from first quarter. Is that correct?

Joseph A. Bigler

I don’t know that I would say that necessarily. I don’t think that we’ve given you that indication but as you know we don’t really provide guidance or looking forward to any great degree. But I wouldn’t necessarily say that the second quarter has to be weaker because of AFG monies so I’m not sure how you ended with that conclusion, Brian.

Brian Ruttenbur - Morgan Keegan

Okay, then how about Europe is going to be stronger in the second quarter than the first quarter?

Joseph A. Bigler

Yes, I would say that’s a good expectation based on the fact that the first quarter was struggle from a production standpoint to get the shipments out the door that we had the orders for.

Brian Ruttenbur - Morgan Keegan

Okay and then gross margin, is there any reason that you shouldn’t be maintaining, with all the changes you’re making, a 40% gross margin?

William M. Lambert

We’re getting too close to guidance now.

Brian Ruttenbur - Morgan Keegan

I’m working it. I’m working it. How about I go down to the next line item then since I was stopped on that. SG&A was up dramatically in the first quarter from the fourth quarter. That $66 million, is there any one-time items in there or should we assume that’s kind of going forward? Or did you throw John Ryan one heck of a party that I wasn’t invited to?

William M. Lambert

The only thing that’s in the first quarter that won’t be in the following quarter is the stock compensation. It’s a little bit of a bump in executive compensation in the first quarter and that’s the only thing that I can think of.

Joseph A. Bigler

It’s always, of course, you’ve got the continuing strength of the euro which gives you sales on one side and help on progress because it makes your SG&A look better.

Brian Ruttenbur - Morgan Keegan

Okay, very good. Thank you very much.

Operator

Thank you. Our next question is from Brian Butler from FBR.

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

Good morning, guys. Just wanted to congratulate John on your tenure. Hope you’re going to be enjoying your retirement.

John T. Ryan III

Okay, thanks very much.

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

And then question-wise, I guess I’ll ask a margin question maybe a different way. When you work through the backlog on the European side of the business, is that going to be a head win margin in the second quarter?

William M. Lambert

Generally, our margins, I think you can see it in the same with data, our margins were actually higher in Europe as they are North America. You can’t see that in the segment information but we actually a large dollar amount of our sales in Europe is still whole direct.

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

I guess I just wanted to make sure this isn’t going to get fire sales, that backlog, if you work it out.

William M. Lambert

No, not at all.

Roberto Cañizares

On the other side, this is Rod Cañizares, as we begin to ship more of the military orders, those have lower margins, so when in average will come down somewhat.

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

Okay and then on the military side, can you kind of talk about again your opportunities. Have they changed since the fourth quarter specifically I guess on the body on the side on the world? Are there anything else occurring in that environment that you can provide a little bit more color on?

Roberto Cañizares

Well, there’s a number of opportunities as you’re probably aware of, Brian. Just kind of really going through them, first of all we have on the Plate business, the Armor Plate business; you have the E-SAPI and X-SAPI contracts. Those are $100 million contracts over a five year period. The E-SAPI and X-SAPI was really due back in February. Then were submitted and now going through evaluation by the government donned at Aberdeen as they get their new laboratory set up.

At one time, we thought contractors would hear the results of that in August. Now we hear that that may be moved up in June. So, that certainly is a very big contract that we believe hopefully we’ll be participating in and should hear something geared in that timeframe between May and August.

If you look at the Outer Tactical Vests and the Improved Outer Tactical Vests, we refer to as the OTV and IOTV, there’s another big contract that was really due just couple of weeks ago for the IOTV. That again is very significant. That’s about $40 million over a few year period, involving about 75,000 OTVs. We’re participating in that. That bid was actually submitted. There actually is another bid that DLCP is putting out, another 75,000 OTVs. That is coming up here in May so we are getting ready for that.

The Advanced Combat Helmet would be the next area. And if you look at the Advanced Combat Helmet, DLCP exempts supply is looking at a whole new specification. A lot of questions are coming from the bidders so there really was a release here just a few weeks ago about 105,000 standard ACHs, which we were pleased that we got our fair share of that, as DLCP really looks into answering a lot of questions and putting out their requirements over a two year period for kind of a revised ACH with some changes. So we expect those questions to be answered and that to probably get big during the third or fourth quarter.

Then of course you probably heard there’s an awful lot of work being done on several plastic helmets where the government is looking at providing a helmet on a thermal plastic material that provides greater protection. There’s also a version that they wanted to be lighter weight than the current ACH. Then there’s another version that they want fragment protection but at the same weight of the current ACH. So there are three different thermal plastic helmets that I believe right now there are four contractors that have the development contract that which we are one and diligently working on all three versions of that and we’ll see where that goes by the end of the year.

Also the thermal plastic helmets with providing a higher level of protection could very well be a replacement for the traditional ACH over the coming years. So between the traditional ACH, the thermal plastic, E-SAPI, X-SAPI, and the Outer Tactical Vest and the IOTV, Improved Outer Tactical Vest, there is a lot going on and a lot of things that we’re doing and hopefully we’ll be participating in throughout the rest of this year and beyond.

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

Thanks. That’s very helpful. One last question: On the E-SAPI, do you guys actually manufacture the ceramic plate or you’re getting that from somewhere?

William M. Lambert

We don’t manufacture the raw ceramic plate. We take the plate from various suppliers and we lay it up with the other advanced ceramic fiber materials and laminate it and we do the assembly fabrication. We do not have the raw ceramic plate capability.

Brian Butler - Friedman, Billings, Ramsey Group, Inc.

Okay, thank you very much guys.

Operator

Our next question comes from Ray Culter from Great Lakes Review.

Ray Culter – Great Lakes Review

Good morning and thank you for taking my questions.

I think on the last call you talked about the approval for the upgrade kit and just wondering if you could give us an update there regarding the SCBA.

William M. Lambert

We do not have approvals of the upgrade kits. None of the manufacturers do. The approval agencies have focused on the SCBA assemblies to this point in time but we are pursuing that avenue and we would hope that over the coming quarters, and again we don’t know how much time it would take at the approval agencies, but we are pursuing that avenue. And over the coming quarters, we would expect to have upgrade kits that would allow users of SCBA that were purchased over the past couple of years to meet the latest standards of the NFPA SCBA requirements.

Ray Culter – Great Lakes Review

Okay and I know you made comments about the thermal imaging cameras being up year over year, and fire helmets. You have the same figures on year over year basis for SCBA as well as head protection?

William M. Lambert

Head protection, hard hats head protection, is up about $1.6 million.

Ray Culter – Great Lakes Review

In percentage terms, I mean.

William M. Lambert

Percentage terms…I don’t have that handy.

John T. Ryan III

That’s doing well. It’s the only way to do it. I mean, Bill gave you numbers and just comments about hammers and helmets of a total of about $3 million and I’d say Fire Services sales are up $40 million. So that’s a $37 million increase in SCBA. That’s the three products that make up our Fire Services.

Ray Culter – Great Lakes Review

All right and relative to the Sherry purchase, anything occur in the quarter?

William M. Lambert

No.

Ray Culter – Great Lakes Review

You still have an active program though, correct?

William M. Lambert

Relative to the shortages of the key chemical over in Europe, and I know you said you’re using one supplier, is there additional suppliers available or an alternative chemical that could be used?

William M. Lambert

There is not. There are alternate suppliers of this chemical on a global basis. Less than a handful but we have evaluated those other suppliers in the past. We have found this supplier to provide the highest quality, most consistent quality that we want to use in our device and we just think that it’s a matter of them and us working together to work them through the production issues that they have.

And as I said in my comments, there was nothing here that I see as any more than temporary and temporary impediment and I fully expect us to work through these issues with the supplier. Focus a little bit longer to address all of the issues, but I think we have and it’ s my understanding that the supplier’s making good process in meeting our needs now. It’s just a matter of us getting every thing that we need, converting it in our factories and getting the professional products out the door.

Ray Culter – Great Lakes Review

Great and I presume that commentary applies to the other areas where you had delays as well.

William M. Lambert

That’s correct.

Ray Culter – Great Lakes Review

And that’s a different product and/or product?

William M. Lambert

That’s correct.

Ray Culter – Great Lakes Review

And Dennis, I know the tax rate 39% versus 35%. Do you expect it to remain at that type of level throughout the year?

Dennis L. Zeitler

No. As I mentioned, most of that should come back to us except for that one-time German tax thing so typically, I think we indicated a target tax rate of 33-34% for the year. So it’s probably going to be a little bit higher than that just because of the one-time item that processed about $430,000.

Ray Culter – Great Lakes Review

So maybe 34-35%?

Dennis L. Zeitler

Good ballpark. Yes, assuming that they renewed the R&D tax credit sometime this year. Last time, it was like last quarter in December or something.

Ray Culter – Great Lakes Review

And Bill, you had mentioned that your capital spending would be higher than ’07. Do you care to venture on a dollar amount or a range for ’08?

William M. Lambert

Yes, I think Dennis.

Dennis L. Zeitler

I think I gave that number at some point. We’re actually looking at it. In ’08, it’s something like $40 million in cap ex this year.

Ray Culter – Great Lakes Review

And would you expect that to come down in ’09?

Dennis L. Zeitler

Yes, not down as low as it has been in the past but probably something like right now the ballpark of $30 million in ’09 and then back down after that, as far as I can see right now, down in the mid $20 million.

Ray Culter – Great Lakes Review

Okay, great. Thank you.

Operator

Our next question comes from Edward Marshall, [? Fedaddi ?] and Company.

Edward Marshall – Fedaddi and Company

Good morning, gentlemen.

Look like the military sales look pretty good. We know those tend to be lumpy from time to time and I’m just curious if there was a push out or pull forward from one of the previous quarters or the second quarter here? Just kind of how do we look at that?

William M. Lambert

Really, I don’t think that there is some, looking at Joe Bigler as well here, but I don’t think that there was any kind of a pull forward by any stretch. This was against awards that we had received and against the shipment schedules that we have.

Joseph A. Bigler

That’s correct.

Edward Marshall – Fedaddi and Company

Okay and just a couple of technical questions, I guess, the restructuring charge $1 million. What was the after-tax impact?

Dennis L. Zeitler

$600,000.

Edward Marshall – Fedaddi and Company

And it looks like the currency loss expected to reimburse itself somewhere throughout the year, that $2 million reversal that you saw that happened in April, is that assuming that that’s a pre-tax benefit at this point?

Dennis L. Zeitler

That’s the after-tax. That’s comparable to the $3 million after-tax loss. So in April, we had a $2 million after-tax gain.

Edward Marshall – Fedaddi and Company

Do we have a share count of the year for the quarter? I know that’ll be out this afternoon but—

William M. Lambert

Shouldn’t be much different. I don’t think it would’ve changed much during the quarter but maybe Dennis has that—

Dennis L. Zeitler

Yes, average basic shares outstanding $35, 540,000. Diluted $36,000,021.

Edward Marshall – Fedaddi and Company

Good. Thank you guys very much.

Operator

Our last question comes from Walt Liptak from Barrington Research.

Walt Liptak – Barrington Research

Thanks. Good morning, everyone, and good morning, John. Congratulations on your leaving a legacy of safety.

John T. Ryan III

Thank you very much.

Walt Liptak – Barrington Research

I just want to go over these one more time. With the Fire Services, you said that was 48%?

Dennis L. Zeitler

US Fire Services.

Walt Liptak – Barrington Research

How much were up 21%? I’m trying to get how much SCBA were up year over year?

William M. Lambert

A lot. I have the number right here. The fire helmets, Walt, are you asking for?

Walt Liptak – Barrington Research

Yes, all three of them, Thermal Imaging Cameras, Helmets, SCBAs.

William M. Lambert

Right. In my commentary, I provided that to you. The fire helmets are up 21% from a year ago and the North American Thermal Imaging Cameras are up 76% from a year ago.

Walt Liptak – Barrington Research

Okay, how much are SCBAs up?

William M. Lambert

SCBAs in North America were up 55%.

Walt Liptak – Barrington Research

How much is the advantage price and how much is volume?

William M. Lambert

Joe, I’ll give that to you.

Joseph A. Bigler

We have none.

William M. Lambert

Price is probably in the range of, as what’s said in previously calls, probably in that range of 12-15%.

Joseph A. Bigler

It’s primarily in SCBA though, not fire helmets and imaging cameras. There weren’t those kinds of changes in pricing to fire helmets and thermal imaging cameras.

William M. Lambert

Because the standards didn’t change. You were asking about SCBA?

Walt Liptak – Barrington Research

Yes, you took prices out for the new SCBAs. They’re more expensive because of NSPA standards but it looks like your volumes are up 30-40% year over year, which is quite a bit better than anyone your competition which are showing flat volumes. I have a question about SCBA backlog. Did you build backlog in SCBA that you’ll ship in the next quarter or two?

William M. Lambert

Well, the primary backlog that we have is related to the US Air Force contract and we added some modest amount of backlog on the commercial side for municipal fire departments but not a lot. Is that correct, Joe?

Joseph A. Bigler

Yes, there is some, the commercial verge of the M7, we have a inflammatory version of that and we have some backlog of that. It should take off on the Air Force unit so there’s some obviously backlog on the Air Force and there’s some backlog on the inflammatory version of our M7 that’s going to municipal fire departments that we built during the first quarter.

Walt Liptak – Barrington Research

And there’s no delays in shipping the Firehawk that you book and ship at this point?

Joseph A. Bigler

Absolutely not. It was one of the significant accomplishments that’s really been accomplished over the last three to four months, is getting ourselves into excellent serial production of the M7.

Walt Liptak – Barrington Research

This $5,000 limit for SCBA, the fire grant, they said that they’ve taken care of that right away, that the fire departments has to go on and get three bids and then they provide the difference between the lowest bids and the $5,000, and that there shouldn’t be any confusion out there. Are you saying that there’s something that’s changed and they’ve taken that out?

Joseph A. Bigler

No, what I’m saying is there’s still some confusion out there but as I mentioned before while [inaudible] getting itself cleared up. There’s a lot of conversation. If you submit the three bids, there are ways you can get additional dollars. So that really is beginning to clarify itself.

Walt Liptak – Barrington Research

Okay and Dennis, the gain that you’re talking about, the $2 million after-tax in April, we’re going to have trouble all year trying to deal with the foreign currency issue. How should we think of it for the full year, especially with the dollar strengthening a little bit off the bottom.

Dennis L. Zeitler

I don’t know. I would hope that it works itself out over the year. I think the impact that it had on the first quarter was so significant that we may need to pull back a little bit on our long-term strategy and do just a little bit more hedging so not quite quarter to quarter. We’ll try to minimize that volatility without giving up. It cost a lot of money to hedge an entire portfolio and that’s why banks get rich. I really don’t like to do that.

Walt Liptak – Barrington Research

Right. Well, it looks like this is reversing right now.

Dennis L. Zeitler

Right and if I start hedging now, opportunities going to be lost.

Walt Liptak – Barrington Research

Right because you could make up that $0.11 or whatever the approximation is of the gain in the second quarter and maybe even more if the dollar keeps strengthening.

Dennis L. Zeitler

That’s totally right.

Walt Liptak – Barrington Research

Okay. Great quarter. Congratulations, guys. Thank you to North American Fire Service.

Operator

There’s no further questions.

Mark C. Deasy

Okay, thank you Jaime.

Just like to once again, thank everybody for joining us today. We do appreciate your interest in the company and on behalf of John, for one last time, as well as Dennis, Bill, Joe and Rob, we look forward to talking with everybody again soon and hope everybody has a great day. Thank you.

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