Business context and reporting period
MSA Safety Incorporated filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The company sells safety equipment, including breathing apparatus, gas detection, head protection and fall protection products. In 2016 it reorganized reporting into Americas and International segments; prior-year segment figures were recast. The South African distribution business and Zambian operations, sold in February 2016, are reported as discontinued operations.
Financial performance
Amounts below are in millions except per-share data. Comparisons are with the corresponding 2015 periods.
- Second quarter: Continuing-operations sales were $296.0, up 3% reported and 5% at constant currency; organic constant-currency growth was flat. Gross profit was $135.9, with a 45.9% gross margin versus 45.5%. Operating income rose 26% to $47.9 (16.2% of sales versus 13.3%). Continuing-operations income attributable to MSA was $29.3, up 24%; diluted EPS from continuing operations was $0.77 versus $0.62. Net income attributable to MSA, including discontinued operations, was $31.1.
- First half: Continuing-operations sales were $575.3, up 6% reported and 9% at constant currency, including 6% acquisition-related growth and 3% organic constant-currency growth. Gross profit was $256.6; gross margin declined to 44.6% from 45.5%, partly due to product mix and large orders. Operating income increased 19% to $76.6 (13.3% of sales versus 11.9%). Continuing-operations income attributable to MSA was $42.0, up 27%; diluted EPS was $1.11 versus $0.87. Net income attributable to MSA, including discontinued operations, was $42.8.
- Costs and taxes: Second-quarter SG&A fell 2% reported, with organic constant-currency SG&A down 5%; R&D declined 15% to $11.1. First-half SG&A fell 3% reported and R&D fell 10% to $21.5. The effective tax rate was 33.8% for Q2 and 39.2% for the first half; the latter included 5.1 percentage points of European reorganization exit taxes.
- Cash flow and liquidity: First-half operating cash flow was $12.5 versus $7.7; investing provided $6.4 versus using $8.0, and financing used $24.5 versus $12.9. Cash declined $2.8 to $103.1. Capital expenditures were $10.6 and dividends paid were $24.3. Cash and equivalents included $97.5 held by foreign subsidiaries and considered indefinitely reinvested.
- Debt: Total debt was approximately $453.9 at June 30, including $6.8 current and $447.1 long-term, versus approximately $464.7 at year-end. The $575.0 revolving facility had $328.8 unused, including letters of credit; the reported revolver interest rate averaged 1.97%. The company reported compliance with debt covenants.
Material changes and management commentary
- Q2 Americas sales declined 1% reported, with flat organic constant-currency sales; strong U.S. G1 breathing apparatus and utility portable-gas demand were offset by weakness in energy-related and emerging markets. International sales rose 10% reported, largely reflecting acquisitions; organic constant-currency growth was 1%.
- For the first half, Americas organic constant-currency sales rose 4%, driven by G1 SCBA. Management expects strong fire-service demand to continue but said SCBA growth should moderate in the second half. International organic constant-currency sales rose 2%; acquisitions materially contributed to reported growth.
- Management attributed Q2 margin improvement to G1 SCBA value engineering and accessory mix. First-half gross margin was lower because of less favorable mix, including higher SCBA shipments and large, lower-margin orders. Cost-reduction benefits supported lower operating expenses.
- Latchways, acquired in October 2015, contributed $13.2 of Q2 sales and $28.9 of first-half sales. First-half interest expense increased to $8.1 from $5.0, primarily associated with the acquisition.
Outlook, unusual items and risks
- Management expected full-year 2016 R&D expense to be 4.0%–4.5% of sales and a new fixed gas and flame detection platform launch in Q4 2016. The filing provides no broader quantified earnings or sales guidance.
- Q2 discontinued-operations income included a roughly $2.5 gain from correcting the calculation on the South African and Zambian divestiture. The gain should have been recorded in Q1; management concluded the correction was not material to Q1 or earnings trends and said it did not affect cash flows or covenant compliance.
- MSA LLC had 1,937 cumulative-trauma product-liability lawsuits outstanding. The related reserve was $20.8 at June 30, down from $50.1 at year-end; the company recorded a $2.3 reduction in the reported-claims reserve during Q2. Management cannot reasonably estimate liability for incurred-but-not-reported claims.
- Insurance receivables for cumulative-trauma claims were $248.2, up from $229.5 at year-end. Collection timing and amounts depend partly on insurer negotiations and coverage litigation. The filing warns that MSA LLC may become largely self-insured for these claims in coming years.
- A Kentucky jury awarded $7.2 in a coal-dust product-liability case. The company planned to appeal and assessed a loss as reasonably possible, not probable, so it did not accrue the verdict. If the appeal is unsuccessful, the $4.0 punitive portion is uninsured; the $3.2 compensatory portion is expected to be covered, subject to recovery.
- Other noted exposures include foreign-exchange movements, variable-rate debt, and $13.1 of gross unrecognized tax benefits. A hypothetical 10% currency move was estimated to change quarterly reported sales by about $13.5 and net income by about $1.0.
Important facts for investors to verify
- Whether organic sales growth and G1 SCBA demand persist as management expects, particularly as SCBA growth moderates and energy-related markets remain weak.
- Whether Latchways integration, acquisition-related interest costs and anticipated synergies develop as planned.
- The recoverability and timing of the $248.2 insurance receivable, and the potential financial impact of coverage disputes and future self-insurance.
- The outcome of the Kentucky verdict appeal and any changes to product-liability reserves or defense costs.
- Cash availability, given the concentration of cash abroad, debt maturities and variable-rate borrowings.