SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2010
Commission File No. 1-15579
MINE SAFETY APPLIANCES COMPANY
(Exact name of registrant as specified in its charter)
| Pennsylvania | 25-0668780 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
121 Gamma Drive RIDC Industrial Park O’Hara Township Pittsburgh, Pennsylvania | 15238 | |
| (Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (412) 967-3000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
| (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
On July 23, 2010 there were 36,274,071 shares of common stock outstanding, not including 1,811,711 shares held by the Mine Safety Appliances Company Stock Compensation Trust.
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
MINE SAFETY APPLIANCES COMPANY
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
Unaudited
| Three Months Ended June 30 | Six Months Ended June 30 | ||||||||||||||
| 2010 | 2009 | 2010 | 2009 | ||||||||||||
Net sales | $ | 237,173 | $ | 227,232 | $ | 449,607 | $ | 445,407 | |||||||
Other income | 15 | 672 | 1,320 | 1,531 | |||||||||||
| 237,188 | 227,904 | 450,927 | 446,938 | ||||||||||||
Costs and expenses | |||||||||||||||
Cost of products sold | 146,947 | 141,917 | 276,928 | 277,115 | |||||||||||
Selling, general and administrative | 60,912 | 56,041 | 122,820 | 112,861 | |||||||||||
Research and development | 8,282 | 7,273 | 16,018 | 14,286 | |||||||||||
Restructuring and other charges | 2,618 | 966 | 9,427 | 9,061 | |||||||||||
Interest | 1,685 | 1,914 | 3,225 | 3,761 | |||||||||||
Currency exchange (gains) losses | (1,477 | ) | 579 | (3,635 | ) | (347 | ) | ||||||||
| 218,967 | 208,690 | 424,783 | 416,737 | ||||||||||||
Income before income taxes | 18,221 | 19,214 | 26,144 | 30,201 | |||||||||||
Provision for income taxes | 6,287 | 6,986 | 9,090 | 10,600 | |||||||||||
Net income | 11,934 | 12,228 | 17,054 | 19,601 | |||||||||||
Net (income) loss attributable to noncontrolling interests | (107 | ) | 230 | (321 | ) | 78 | |||||||||
Net income attributable to Mine Safety Appliances Company | 11,827 | 12,458 | 16,733 | 19,679 | |||||||||||
Earnings per share attributable to Mine Safety Appliances Company common shareholders | |||||||||||||||
Basic | $ | 0.33 | $ | 0.35 | $ | 0.47 | $ | 0.55 | |||||||
Diluted | $ | 0.32 | $ | 0.35 | $ | 0.46 | $ | 0.55 | |||||||
Dividends per common share | $ | 0.25 | $ | 0.24 | $ | 0.49 | $ | 0.48 | |||||||
See notes to condensed consolidated financial statements.
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MINE SAFETY APPLIANCES COMPANY
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except share amounts)
Unaudited
| June 30 2010 | December 31 2009 | |||||||
Assets | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 60,141 | $ | 61,983 | ||||
Trade receivables, less allowance for doubtful accounts of $6,893 and $6,866 | 182,184 | 173,355 | ||||||
Inventories | 130,364 | 123,944 | ||||||
Deferred tax assets | 20,128 | 25,109 | ||||||
Income taxes receivable | 7,027 | 4,054 | ||||||
Prepaid expenses and other current assets | 32,759 | 45,580 | ||||||
Total current assets | 432,603 | 434,025 | ||||||
Property, less accumulated depreciation of $302,544 and $306,170 | 135,594 | 144,575 | ||||||
Prepaid pension cost | 112,332 | 105,812 | ||||||
Deferred tax assets | 11,201 | 10,870 | ||||||
Goodwill | 82,439 | 84,727 | ||||||
Other noncurrent assets | 115,450 | 95,219 | ||||||
Total assets | 889,619 | 875,228 | ||||||
Liabilities | ||||||||
Current liabilities | ||||||||
Notes payable and current portion of long-term debt | $ | 54,677 | $ | 16,326 | ||||
Accounts payable | 62,719 | 43,487 | ||||||
Employees’ compensation | 25,986 | 25,811 | ||||||
Insurance and product liability | 16,666 | 24,164 | ||||||
Taxes on income | 5,702 | 10,090 | ||||||
Other current liabilities | 41,509 | 48,572 | ||||||
Total current liabilities | 207,259 | 168,450 | ||||||
Long-term debt | 82,111 | 82,114 | ||||||
Pensions and other employee benefits | 118,583 | 125,387 | ||||||
Deferred tax liabilities | 44,841 | 44,800 | ||||||
Other noncurrent liabilities | 14,259 | 15,077 | ||||||
Total liabilities | 467,053 | 435,828 | ||||||
Shareholders’ Equity | ||||||||
Mine Safety Appliances Company shareholders’ equity: | ||||||||
Preferred stock, 4 1/2% cumulative — authorized 100,000 shares of $50 par value; issued 71,373 and 71,373 shares, callable at $52.50 per share | 3,569 | 3,569 | ||||||
Second cumulative preferred voting stock — authorized 1,000,000 shares of $10 par value; none issued | — | — | ||||||
Common stock — authorized 180,000,000 shares of no par value; issued 62,081,391 and 62,081,391 shares (outstanding 36,274,071 and 35,972,518 shares) | 78,387 | 74,269 | ||||||
Stock compensation trust — 1,811,711 and 2,174,204 shares | (9,457 | ) | (11,349 | ) | ||||
Treasury shares, at cost: | ||||||||
Preferred — 52,878 and 52,878 shares | (1,753 | ) | (1,753 | ) | ||||
Common — 23,995,609 and 23,934,669 shares | (258,050 | ) | (256,283 | ) | ||||
Accumulated other comprehensive loss | (66,073 | ) | (45,856 | ) | ||||
Retained earnings | 673,030 | 674,019 | ||||||
Total Mine Safety Appliances Company shareholders’ equity | 419,653 | 436,616 | ||||||
Noncontrolling interests | 2,913 | 2,784 | ||||||
Total shareholders’ equity | 422,566 | 439,400 | ||||||
Total liabilities and equity | 889,619 | 875,228 | ||||||
See notes to condensed consolidated financial statements.
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MINE SAFETY APPLIANCES COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Unaudited
| Six Months Ended June 30 | ||||||||
| 2010 | 2009 | |||||||
Operating Activities | ||||||||
Net income | $ | 17,054 | $ | 19,601 | ||||
Depreciation and amortization | 13,726 | 13,431 | ||||||
Pensions | (2,065 | ) | 2,231 | |||||
Net (gain) loss from investing activities | (707 | ) | 248 | |||||
Stock-based compensation | 4,404 | 3,374 | ||||||
Deferred income tax (benefit) provision | (1,644 | ) | 243 | |||||
Other noncurrent assets and liabilities | (24,155 | ) | (17,590 | ) | ||||
Currency exchange gains | (3,635 | ) | (347 | ) | ||||
Other, net | (3,948 | ) | (2,800 | ) | ||||
Operating cash flow before changes in working capital | (970 | ) | 18,391 | |||||
Trade receivables | (15,976 | ) | 28,962 | |||||
Inventories | (15,846 | ) | 21,145 | |||||
Accounts payable and accrued liabilities | 11,523 | (23,219 | ) | |||||
Income taxes receivable, prepaid expenses and other current assets | 9,270 | 9,486 | ||||||
(Increase) decrease in working capital | (11,029 | ) | 36,374 | |||||
Cash flow from operating activities | (11,999 | ) | 54,765 | |||||
Investing Activities | ||||||||
Property additions | (8,777 | ) | (14,606 | ) | ||||
Property disposals | 138 | 221 | ||||||
Other investing | 1,250 | 9 | ||||||
Cash flow from investing activities | (7,389 | ) | (14,376 | ) | ||||
Financing Activities | ||||||||
Proceeds from (payments on) short-term debt, net | 38,364 | (12,123 | ) | |||||
Cash dividends paid | (17,722 | ) | (17,240 | ) | ||||
Company stock purchases | (1,766 | ) | (107 | ) | ||||
Exercise of stock options | 1,835 | 70 | ||||||
Excess tax provision related to stock plans | (230 | ) | (495 | ) | ||||
Cash flow from financing activities | 20,481 | (29,895 | ) | |||||
Effect of exchange rate changes on cash | (2,935 | ) | 1,279 | |||||
(Decrease) increase in cash and cash equivalents | (1,842 | ) | 11,773 | |||||
Beginning cash and cash equivalents | 61,983 | 50,894 | ||||||
Ending cash and cash equivalents | 60,141 | 62,667 | ||||||
See notes to condensed consolidated financial statements.
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MINE SAFETY APPLIANCES COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
(1) Basis of Presentation
We have prepared the condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include certain information and disclosures required for comprehensive financial statements.
The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The other information in these financial statements is unaudited; however, we believe that all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of these interim periods have been included. The results for interim periods are not necessarily indicative of the results to be expected for the full year.
The condensed consolidated financial statements include the accounts of the company and all subsidiaries. Intercompany accounts and transactions have been eliminated.
Certain prior year amounts have been reclassified to conform with the current year presentation.
Management’s Discussion and Analysis of Financial Condition and Results of Operations that is included elsewhere in this report contains additional information about our results of operations and financial position and should be read in conjunction with these notes.
(2) Restructuring and Other Charges
During the three and six month periods ended June 30, 2010, we recorded charges of $2.6 million ($1.7 million after tax) and $9.4 million ($6.4 million after tax), respectively. European segment charges of $6.8 million for the six months ended June 30, 2010 related primarily to a focused voluntary retirement incentive program in Germany (German VRIP). During the first quarter of 2010, 27 employees made irrevocable elections to retire under the terms of the German VRIP. German VRIP termination benefit expense of $5.0 million was recorded in March 2010. North American segment charges for the six months ended June 30, 2010 of $1.8 million included stay bonuses and other costs associated with our ongoing initiative to transfer certain production activities. European and International segment charges for the six months ended June 30, 2010 of $1.8 million and $0.8 million, respectively, were primarily related to our ongoing efforts to reorganize our European operations and for severance costs associated with staff reductions in South Africa and China.
During the three and six month periods ended June 30, 2009, we recorded charges of $1.0 million ($0.7 million after tax) and $9.1 million ($5.8 million after tax), respectively. North American segment charges of $8.3 million for the six months ended June 30, 2009 related primarily to a focused voluntary retirement incentive program (North American VRIP). During January 2009, 61 North American segment employees made irrevocable elections to retire under the terms of the North American VRIP. North American VRIP non-cash special termination benefits expense of $6.7 million was recorded in January 2009. The remaining $1.6 million of North American segment charges related to layoffs and stay bonuses and other costs associated with our ongoing initiative to transfer certain production activities. International segment charges of $0.8 million were primarily for severance costs related to staff reductions in Brazil, Australia and South Africa.
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(3) Comprehensive Loss
Components of comprehensive (loss) income are as follows:
| Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||
(In thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Net income | $ | 11,934 | $ | 12,228 | $ | 17,054 | $ | 19,601 | ||||||||
Foreign currency translation adjustments | (14,213 | ) | 17,461 | (20,217 | ) | 9,518 | ||||||||||
Comprehensive (loss) income | (2,279 | ) | 29,689 | (3,163 | ) | 29,119 | ||||||||||
Comprehensive loss (income) attributable to noncontrolling interests | 205 | (935 | ) | (129 | ) | (1,076 | ) | |||||||||
Comprehensive (loss) income attributable to Mine Safety Appliances Company | (2,074 | ) | 28,754 | (3,292 | ) | 28,043 | ||||||||||
Components of accumulated other comprehensive loss are as follows:
(In thousands) | June 30 2010 | December 31 2009 | ||||||
Cumulative foreign currency translation adjustments | $ | (6,306 | ) | $ | 13,911 | |||
Pension and post-retirement plan adjustments | (59,767 | ) | (59,767 | ) | ||||
Accumulated other comprehensive loss | (66,073 | ) | (45,856 | ) | ||||
(4) Earnings per Share
Basic earnings per share is computed on the weighted average number of common shares outstanding during the period. Diluted earnings per share assumes the exercise of stock options and the vesting of restricted stock and performance stock, provided in each case that the effect is dilutive.
| Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||
(In thousands, except per share amounts) | 2010 | 2009 | 2010 | 2009 | ||||||||
Net income attributable to Mine Safety Appliances Company | $ | 11,827 | $ | 12,458 | $ | 16,733 | $ | 19,679 | ||||
Preferred stock dividends | 10 | 10 | 20 | 20 | ||||||||
Income available to common shareholders | 11,817 | 12,448 | 16,713 | 19,659 | ||||||||
Basic earnings per common share | $ | 0.33 | $ | 0.35 | $ | 0.47 | $ | 0.55 | ||||
Diluted earnings per common share | $ | 0.32 | $ | 0.35 | $ | 0.46 | $ | 0.55 | ||||
Basic shares outstanding | 35,839 | 35,672 | 35,768 | 35,652 | ||||||||
Stock options and other stock compensation | 642 | 146 | 584 | 169 | ||||||||
Diluted shares outstanding | 36,481 | 35,818 | 36,352 | 35,821 | ||||||||
Antidilutive stock options | 776 | 951 | 776 | 951 | ||||||||
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(5) Segment Information
We are organized into three geographic operating segments: North America, Europe, and International. Reportable segment information is presented in the following table:
(In thousands) | North America | Europe | International | Reconciling Items | Consolidated Totals | ||||||||||||
Three Months Ended June 30, 2010 | |||||||||||||||||
Sales to external customers | $ | 116,774 | $ | 56,406 | $ | 63,993 | $ | — | $ | 237,173 | |||||||
Intercompany sales | 20,767 | 20,890 | 4,122 | (45,779 | ) | — | |||||||||||
Net income (loss) attributable to Mine Safety Appliances Company | 10,834 | (3,131 | ) | 3,024 | 1,100 | 11,827 | |||||||||||
Six Months Ended June 30, 2010 | |||||||||||||||||
Sales to external customers | $ | 215,888 | $ | 113,030 | $ | 120,689 | $ | — | $ | 449,607 | |||||||
Intercompany sales | 38,672 | 43,666 | 7,470 | (89,808 | ) | — | |||||||||||
Net income (loss) attributable to Mine Safety Appliances Company | 14,269 | (6,946 | ) | 6,949 | 2,461 | 16,733 | |||||||||||
Three Months Ended June 30, 2009 | |||||||||||||||||
Sales to external customers | $ | 112,358 | $ | 61,292 | $ | 53,582 | $ | — | $ | 227,232 | |||||||
Intercompany sales | 15,270 | 20,528 | 4,061 | (39,859 | ) | — | |||||||||||
Net income (loss) attributable to Mine Safety Appliances Company | 10,912 | 994 | 902 | (350 | ) | 12,458 | |||||||||||
Six Months Ended June 30, 2009 | |||||||||||||||||
Sales to external customers | $ | 223,079 | $ | 121,674 | $ | 100,654 | $ | — | $ | 445,407 | |||||||
Intercompany sales | 28,866 | 45,524 | 5,488 | (79,878 | ) | — | |||||||||||
Net income attributable to Mine Safety Appliances Company | 14,636 | 3,215 | 1,365 | 463 | 19,679 | ||||||||||||
Reconciling items consist primarily of intercompany eliminations and items reported at the corporate level.
In 2010, we changed the composition of our European and International segments to reflect new management responsibilities. Under the new structure, our operations in the Middle East, Egypt and India are reported in the European segment. Previously these operations were reported in the International segment. Comparative 2009 amounts have been revised to conform to the current year presentation. The effect of the revisions for the three months ended June 30, 2009 increased European segment sales and net income by $5.5 million and $0.6 million, respectively, and decreased International segment sales and net income by the corresponding amounts. The effect for the six months ended June 30, 2009 increased European segment sales and net income by $8.9 million and $0.7 million, respectively, and decreased International segment sales and net income by the corresponding amounts.
-7-
(6) Pensions and Other Postretirement Benefits
Components of net periodic benefit (credit) cost consisted of the following:
| Pension Benefits | Other Benefits | |||||||||||||||
(In thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Three months ended June 30 | ||||||||||||||||
Service cost | $ | 1,936 | $ | 1,981 | $ | 190 | $ | 181 | ||||||||
Interest cost | 4,683 | 4,674 | 433 | 470 | ||||||||||||
Expected return on plan assets | (8,644 | ) | (8,892 | ) | — | — | ||||||||||
Amortization of transition amounts | 1 | 2 | — | — | ||||||||||||
Amortization of prior service cost | 26 | 36 | (139 | ) | (88 | ) | ||||||||||
Recognized net actuarial losses | 137 | 59 | 210 | 262 | ||||||||||||
Termination benefits | — | 21 | — | — | ||||||||||||
Net periodic benefit (credit) cost | (1,861 | ) | (2,119 | ) | 694 | 825 | ||||||||||
Six months ended June 30 | ||||||||||||||||
Service cost | $ | 3,873 | $ | 3,891 | $ | 381 | $ | 362 | ||||||||
Interest cost | 9,366 | 9,263 | 865 | 940 | ||||||||||||
Expected return on plan assets | (17,288 | ) | (17,523 | ) | — | — | ||||||||||
Amortization of transition amounts | 2 | 3 | — | — | ||||||||||||
Amortization of prior service cost | 52 | 69 | (278 | ) | (176 | ) | ||||||||||
Recognized net actuarial losses | 273 | 117 | 420 | 524 | ||||||||||||
Settlement loss | 285 | — | — | — | ||||||||||||
Termination benefits | 1,372 | 6,411 | — | 250 | ||||||||||||
Net periodic benefit (credit) cost | (2,065 | ) | 2,231 | 1,388 | 1,900 | |||||||||||
We made contributions of $2.3 million to our pension plans during the six month period ended June 30, 2010. We expect to make total contributions of approximately $4.6 million to our pension plans in 2010.
(7) Goodwill and Intangible Assets
Changes in goodwill and intangible assets, net of accumulated amortization, during the six months ended June 30, 2010 were as follows:
(In thousands) | Goodwill | Intangibles | ||||||
Net balances at January 1, 2010 | $ | 84,727 | $ | 13,543 | ||||
Amortization expense | — | (1,166 | ) | |||||
Currency translation and other | (2,288 | ) | (92 | ) | ||||
Net balances at June 30, 2010 | 82,439 | 12,285 | ||||||
At June 30, 2010, goodwill of approximately $63.5 million, $15.3 million, and $3.6 million related to the North American, European, and International operating segments, respectively.
(8) Inventories
(In thousands) | June 30 2010 | December 31 2009 | ||||
Finished products | $ | 64,497 | $ | 54,958 | ||
Work in process | 16,419 | 13,640 | ||||
Raw materials and supplies | 49,448 | 55,346 | ||||
Total inventories | 130,364 | 123,944 | ||||
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(9) Stock Plans
The 2008 Management Equity Incentive Plan provides for various forms of stock-based compensation for eligible employees through May 2018. Management stock-based compensation includes stock options, restricted stock and performance stock units. The 2008 Non-Employee Directors’ Equity Incentive Plan provides for grants of stock options and restricted stock to non-employee directors through May 2018. Stock options are granted at market value option prices and expire after ten years. Stock options are exercisable beginning three years after the grant date. Restricted stock is granted without payment to the company and generally vests three years after the grant date. Certain restricted stock for management retention vests in three equal tranches four, five, and six years after the grant date. Unvested restricted stock for management retention is forfeited if the grantee’s employment with the company terminates for any reason other than death or disability. Restricted stock and performance stock units are valued at the market value of the stock on the grant date. The final number of shares to be issued for performance stock units may range from zero to 200% of the target award based on achieving a targeted return on net assets (RONA) over a three year performance period relative to a pre-determined peer group of companies. We issue Stock Compensation Trust shares or new shares for stock option exercises, restricted stock grants, and performance stock unit grants.
Stock compensation expense was as follows:
| Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||
(In thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||
Stock compensation expense | $ | 1,902 | $ | 1,232 | $ | 4,404 | $ | 3,374 | ||||
Income tax benefit | 706 | 452 | 1,579 | 1,197 | ||||||||
Stock compensation expense, net of income tax benefit | 1,196 | 780 | 2,825 | 2,177 | ||||||||
A summary of stock option activity for the six months ended June 30, 2010 follows:
| Shares | Weighted Average Exercise Price | |||||
Outstanding at January 1, 2010 | 2,085,075 | $ | 25.01 | |||
Granted | 323,978 | 25.06 | ||||
Exercised | (214,060 | ) | 8.57 | |||
Expired | (2,189 | ) | 50.25 | |||
Outstanding at June 30, 2010 | 2,192,804 | 26.60 | ||||
Exercisable at June 30, 2010 | 1,235,560 | 26.73 | ||||
A summary of restricted stock activity for the six months ended June 30, 2010 follows:
| Shares | Weighted Average Grant Date Fair Value | |||||
Unvested at January 1, 2010 | 338,206 | $ | 28.99 | |||
Granted | 170,724 | 25.07 | ||||
Vested | (44,912 | ) | 40.28 | |||
Unvested at June 30, 2010 | 464,018 | 26.46 | ||||
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A summary of performance stock unit activity for the six months ended June 30, 2010 follows:
| Shares | Weighted Average Grant Date Fair Value | |||||
Unvested at January 1, 2010 | 61,974 | $ | 17.83 | |||
Granted | 41,984 | 24.63 | ||||
Performance adjustment | (15,493 | ) | 17.83 | |||
Unvested at June 30, 2010 | 88,465 | 21.06 | ||||
(10) Derivative Financial Instruments
As part of our currency exchange rate risk management strategy, we enter into certain derivative foreign currency forward contracts that do not meet the GAAP criteria for hedge accounting, but which have the impact of partially offsetting certain foreign currency exposures. We account for these forward contracts on a full mark-to-market basis and report the related gains or losses in currency exchange gains or losses. At June 30, 2010, the notional amount of open forward contracts was $7.6 million and the unrealized loss on these contracts was $0.1 million. All open forward contracts will mature during the third quarter of 2010.
The following table presents the balance sheet location and fair value of assets and liabilities associated with derivative financial instruments:
| Asset Derivatives | Liability Derivatives | |||||||||||||
(In thousands) | Balance Sheet | Fair Value at June 30, 2010 | Fair Value at December 31, 2009 | Fair Value at June 30, 2010 | Fair Value at December 31, 2009 | |||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||
Foreign currency forward | ||||||||||||||
contracts | Other current liabilities | $ | — | $ | — | $ | 67 | $ | 289 | |||||
The following table presents the income statement location and impact of derivative financial instruments:
| Amount of Loss Recognized in Income | ||||||||
| Six Months Ended June 30 | ||||||||
(In thousands) | Income Statement Location | 2010 | 2009 | |||||
Derivatives not designated as hedging instruments: | ||||||||
Foreign currency forward contracts | Currency exchange (gains) losses | $ | 748 | $ | 2,388 | |||
(11) Income Taxes
At June 30, 2010, we had a gross liability for unrecognized tax benefits of $9.1 million. We have recognized tax benefits associated with these liabilities of $7.4 million at June 30, 2010. These balances are unchanged since December 31, 2009. We do not expect that the total amount of the unrecognized tax benefits will significantly increase or decrease within twelve months of the reporting date.
-10-
We recognize interest related to unrecognized tax benefits in interest expense and penalties in operating expenses. Our liability for accrued interest and penalties related to uncertain tax positions was $0.7 million at June 30, 2010.
(12) Fair Value Measurements
On January 1, 2008, we adopted the Financial Accounting Standards Board (FASB) statement on fair value measurements, as it relates to financial assets and liabilities that are remeasured and reported at least annually. On January 1, 2009, we adopted the FASB statement on fair value measurements as it relates to nonfinancial assets and liabilities that are recognized and disclosed at fair value in the financial statements on a nonrecurring basis.
The FASB statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Our adoption of this statement, as it relates to financial and nonfinancial assets and liabilities, had no impact on consolidated results of operations, financial condition or liquidity.
The FASB statement defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This standard is now the single source under generally accepted accounting principles for the definition of fair value, except for the fair value of leased property. The FASB statement establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:
| • | Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities. |
| • | Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means. |
| • | Level 3 - Inputs that are both significant to the fair value measurement and unobservable. |
The valuation methodologies we used to measure financial assets and liabilities within the scope of the FASB statement were limited to the derivative financial instruments described in Note 10. We estimate the fair value of these financial instruments, consisting of foreign currency forward contracts, based upon valuation models with inputs that generally can be verified by observable market conditions and do not involve significant management judgment. Accordingly, the fair values of these financial instruments are classified within Level 2 of the fair value hierarchy.
(13) Fair Value of Financial Instruments
With the exception of fixed rate long-term debt, we believe that the reported carrying amounts of our financial assets and liabilities approximate their fair values. At June 30, 2010, the reported carrying amount of our fixed rate long-term debt was $84.0 million and the fair value was $89.5 million. The fair value of our long-term debt was determined using cash flow valuation models to estimate the market value of similar transactions as of June 30, 2010.
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(14) Contingencies
Various lawsuits and claims arising in the normal course of business are pending against us. These lawsuits are primarily product liability claims. We are presently named as a defendant in approximately 2,500 lawsuits, primarily involving respiratory protection products allegedly manufactured and sold by us. Collectively, these lawsuits represent a total of approximately 11,800 plaintiffs. Approximately 90% of these lawsuits involve plaintiffs alleging they suffer from silicosis, with the remainder alleging they suffer from other or combined injuries, including asbestosis. These lawsuits typically allege that these conditions resulted in part from respirators that were negligently designed or manufactured by us. Consistent with the experience of other companies involved in silica and asbestos-related litigation, in recent years there has been an increase in the number of asserted claims that could potentially involve us. We cannot determine our potential maximum liability for such claims, in part because the defendants in these lawsuits are often numerous, and the claims generally do not specify the amount of damages sought.
With some limited exceptions, we maintain insurance against product liability claims. We also maintain a reserve for uninsured product liability based on expected settlement charges for pending claims and an estimate of unreported claims derived from experience, sales volumes, and other relevant information. We evaluate our exposures on an ongoing basis and make adjustments to the reserve as appropriate. Based on information currently available, we believe that the disposition of matters that are pending will not have a materially adverse effect on our results of operations or financial condition.
In the normal course of business, we make payments to settle product liability claims and for related legal fees and record receivables for the amounts covered by insurance. Various factors could affect the timing and amount of recovery of insurance receivables, including: the outcome of negotiations with insurers, legal proceedings with respect to product liability insurance coverage, and the extent to which insurers may become insolvent in the future.
We are currently involved in coverage litigation with The North River Insurance Company (North River). We have sued North River in the United States District Court for the Western District of Pennsylvania, alleging that North River breached one insurance policy by failing to pay amounts owing to us and that its refusal to pay constitutes bad faith. The case was assigned to the Court’s mandatory Alternative Dispute Resolution program, in an attempt to resolve the dispute. The mediation was unsuccessful and the case will proceed to trial. We believe that North River’s refusal to indemnify us under the policy for settlements and legal fees paid by us is wholly contrary to Pennsylvania law and we are vigorously pursuing the legal actions necessary to collect all amounts.
On April 9, 2010, North River filed a complaint against us and two excess insurance carriers in the Court of Common Pleas of Allegheny County, Pennsylvania seeking a declaratory judgment concerning their responsibilities under three additional policies shared with Northbrook Insurance Company. We believe that Pennsylvania law supports our position that North River has insurance responsibilities to indemnify us against various product liability claims to the full limits of these policies.
During May 2010, we resolved the coverage litigation with Century Indemnity Company through a negotiated settlement. As part of this settlement, both parties dismissed all claims against one another under the previously-filed coverage litigation. The settlement did not impact our operating results.
We regularly evaluate the collectibility of insurance receivables and record the amounts that we conclude are probable of collection based on our analysis of our various policies, pertinent case law interpreting comparable policies and our experience with similar claims. Insurance receivables totaled $73.6 million at June 30, 2010, all of which is reported in other non-current assets. Insurance
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receivables totaled $91.7 million at December 31, 2009. Based upon our evaluation of applicable insurance coverage and our ongoing insurance recovery efforts, we believe that the recorded balances are fully recoverable.
(15) Recently Adopted and Recently Issued Accounting Standards
In December 2007, the FASB issued a statement that requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest is to be included in consolidated net income on the face of the income statement. The statement also amended certain consolidation procedures and expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. The adoption of the new statement on January 1, 2009 is reflected in these financial statements and did not have a material effect on our consolidated results of operations or financial condition.
In March 2008, the FASB issued a statement that requires companies to provide disclosures about (a) how and why derivative instruments are used, (b) how derivative instruments and related hedged items are accounted for, and (c) how derivative instruments and related hedged items affect the company’s financial position, financial performance, and cash flows. We adopted the new statement on January 1, 2009. See note 10 for disclosures related to derivative instruments and hedging activities.
In April 2008, the FASB issued a staff position that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The objective of this staff position is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. This staff position applies to all intangible assets, whether acquired in a business combination or otherwise, and is to be applied prospectively to intangible assets acquired on or after January 1, 2009. The adoption of this staff position did not have a material effect on our consolidated financial statements.
In April 2009, the FASB issued a staff position that requires disclosures about the fair value of financial instruments for interim reporting periods as well as in annual financial statements. We adopted this staff position for our second quarter 2009 interim reporting period. See note 13 for disclosures related to the fair value of financial instruments.
In May 2009, the FASB issued a statement that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, the statement sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Our adoption of the new statement on June 30, 2009 had no impact on the financial statements as management already followed a similar approach prior to the adoption of this standard.
In June 2009, the FASB issued a statement that removes the concept of a qualifying special-purpose entity and clarifies the objective of determining whether a transferor and all of the entities included in the transferor’s financial statements being presented have surrendered control over transferred financial assets. The adoption of this statement on January 1, 2010 did not have a material effect on our consolidated financial statements.
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In June 2009, the FASB issued a statement that amends the consolidation guidance applicable to variable interest entities. The adoption of this statement on January 1, 2010 did not have a material effect on our consolidated financial statements.
(16) Subsequent Events
During July 2010, we resolved the coverage litigation with Columbia Casualty Company through a negotiated settlement. As part of this settlement, both parties dismissed all claims against one another under the previously-filed coverage litigation. The settlement did not impact our second quarter operating results.
On July 26, 2010, we filed a complaint in Delaware state court seeking declaratory and other relief from the majority of our excess insurance carriers concerning the future rights and obligations of MSA and our excess insurance carriers under various insurance policies.
Management has evaluated subsequent events and has concluded that all events that would require recognition or disclosure are appropriately reflected in the financial statements.
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| Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis should be read in conjunction with the historical financial statements and other financial information included elsewhere in this report on Form 10-Q. This discussion may contain forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business, and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors. These factors include, but are not limited to, spending patterns of government agencies, competitive pressures, product liability claims and our ability to collect related insurance receivables, the success of new product introductions, currency exchange rate fluctuations, the identification and successful integration of acquisitions, and the risks of doing business in foreign countries. For discussion of risk factors affecting our business, see Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009.
BUSINESS OVERVIEW
We are a global leader in the development, manufacture and supply of products that protect people’s health and safety. Our safety products typically integrate any combination of electronics, mechanical systems, and advanced materials to protect users against hazardous or life threatening situations. Our comprehensive lines of safety products are used by workers around the world in the fire service, homeland security, construction, and other industries, as well as the military.
We are committed to providing our customers with service unmatched in the safety industry and, in the process, enhancing our ability to provide a growing line of safety solutions for customers in key global markets. Four strategic imperatives drive us toward our goal of building customer loyalty by delivering exceptional levels of protection, quality, and value:
| • | Achieve sustainable growth through product leadership; |
| • | Expand market penetration through exceptional customer focus; |
| • | Control costs and increase efficiency in asset utilization; and |
| • | Build the depth, breadth, and diversity of our global team. |
We tailor our product offerings and distribution strategy to satisfy distinct customer preferences that vary across geographic regions. We believe that we best serve these customer preferences by organizing our business into three geographic segments: North America, Europe, and International. Each segment includes a number of operating companies. In 2010, we changed the composition of our European and International segments to reflect new management responsibilities. Under the new structure, our operations in the Middle East, Egypt and India are reported in the European segment. Previously these operations were reported in the International segment. Comparative 2009 amounts have been revised to conform to the current year presentation. In 2009, approximately 48%, 28%, and 24% of our net sales were made by our North American, European, and International segments, respectively.
North America. Our largest manufacturing and research and development facilities are located in the United States. We serve our North American markets with sales and distribution functions in the U.S., Canada, and Mexico.
Europe. Our European segment includes well-established companies in most Western European countries and more recently established operations in a number of Eastern European and Middle Eastern locations. Our largest European companies, based in Germany and France, develop, manufacture, and sell a wide variety of products. Operations in other European segment countries
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focus primarily on sales and distribution in their respective home country markets. While some of these companies may perform limited production, most of their sales are of products that are manufactured in our plants in Germany, France, and the U.S., or are purchased from third party vendors.
International. Our International segment includes operating entities located in Argentina, Australia, Brazil, Colombia, Chile, China, Hong Kong, Indonesia, Japan, Malaysia, Peru, Singapore, South Africa, Thailand, and Zambia, some of which are in developing regions of the world. Principal manufacturing operations are located in Australia, Brazil, South Africa, and China. These companies develop and manufacture products that are sold primarily in each company’s home country and regional markets. The other companies in the International segment focus primarily on sales and distribution in their respective home country markets. While some of these companies may perform limited production, most of their sales are of products that are manufactured in our plants in the U.S., Germany, and France, or are purchased from third party vendors.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009
Net sales. Net sales for the three months ended June 30, 2010 were $237.2 million, an increase of $10.0 million, or 4%, compared with $227.2 million for the three months ended June 30, 2009.
| Three Months Ended June 30 | Dollar Increase (Decrease) | Percent Increase (Decrease) | |||||||||||
(In millions) | 2010 | 2009 | |||||||||||
North America | $ | 116.8 | $ | 112.4 | $ | 4.4 | 4 | % | |||||
Europe | 56.4 | 61.3 | (4.9 | ) | (8 | ) | |||||||
International | 64.0 | 53.6 | 10.4 | 19 | |||||||||
Net sales by the North American segment were $116.8 million for the second quarter of 2010, an increase of $4.4 million, or 4%, compared to $112.4 million for the second quarter of 2009. Sales of head protection and instruments were up $4.3 million and $4.7 million, respectively, on improved demand in industrial markets. These increases were partially offset by lower ballistic helmet and ballistic vest sales in military markets, down $2.9 million and $1.6 million, respectively.
Net sales for the European segment were $56.4 million for the second quarter of 2010, a decrease of $4.9 million, or 8%, compared to $61.3 million for the second quarter of 2009. Local currency sales in Europe decreased $1.7 million during the second quarter of 2010. In France, local currency sales were $2.2 million higher in the current quarter, reflecting improved shipments of ballistic protection and fire helmets to the law enforcement and fire service markets. Local currency sales in other European segment markets were down $3.9 million in the current quarter, reflecting the continuing effects of the recession. The unfavorable translation effects of a weaker euro in the current quarter decreased European segment sales, when stated in U.S. dollars, by approximately $3.2 million.
Net sales for the International segment were $64.0 million in the second quarter of 2010, an increase of $10.4 million, or 19%, compared to $53.6 million for the second quarter of 2009. Local currency sales in the International segment increased $6.0 million in the current quarter, reflecting strong sales in Africa and Latin America, primarily in mining markets. Currency translation effects increased International segment sales, when stated in U.S. dollars, by $4.4 million, primarily related to a strengthening of the Australian dollar, South African rand, and Brazilian real.
Cost of products sold.Cost of products sold was $146.9 million in the second quarter of 2010, compared to $141.9 million in the second quarter of 2009. Cost of products sold, selling, general and administrative expenses, and research and development expenses include net periodic pension credits during the second quarters of 2010 and 2009 of $1.9 million and $2.1 million, respectively.
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Gross profit. Gross profit for the second quarter of 2010 was $90.2 million, which was $4.9 million, or 6%, higher than gross profit of $85.3 million in the second quarter of 2009. The ratio of gross profit to net sales was 38.0% in the second quarter of 2010 compared to 37.5% in the same quarter last year. The higher gross profit ratio in the second quarter of 2010 was primarily related to sales mix.
Selling, general and administrative expenses.Selling, general and administrative expenses were $60.9 million during the second quarter of 2010, an increase of $4.9 million, or 9%, compared to $56.0 million in the second quarter of 2009. Selling, general and administrative expenses were 25.5% of net sales in the second quarter of 2010, compared to 24.7% of net sales in the second quarter of 2009. Second quarter selling, general and administrative expenses in the North American segment were $1.4 million, or 6%, higher than in the same quarter last year. The increase in North American segment selling, general and administrative expenses was primarily related to legal fees and other professional services associated with our ongoing insurance coverage litigation and higher selling expenses to support increased sales activity. Local currency selling, general and administrative expenses in the European segment were flat quarter-to-quarter. Local currency selling, general and administrative expenses in the International segment were $3.0 million higher, primarily to support increased sales activity. Currency exchange increased second quarter 2010 selling, general and administrative expenses, when stated in U.S. dollars, by $0.3 million.
Research and development expense. Research and development expense was $8.3 million during the second quarter of 2010, an increase of $1.0 million, or 14%, compared to $7.3 million during the second quarter of 2009. The increase reflects our continued focus on developing innovative new products.
Restructuring and other charges.During the second quarter of 2010, we recorded charges of $2.6 million ($1.7 million after tax). North American segment charges of $0.8 million related to stay bonuses and other costs associated with our ongoing initiative to transfer certain production activities. European and International segment charges of $1.5 million and $0.3 million, respectively, were primarily related to ongoing efforts to reorganize our European operations and severance costs associated with staff reductions in China.
During the second quarter 2009, we recorded charges of $1.0 million ($0.7 million after tax). Substantially all of these charges were incurred in North America and related to stay bonuses and other costs associated with our initiative to transfer of certain production activities.
Currency exchange. We reported currency exchange gains of $1.5 million in the second quarter of 2010, compared to losses of $0.6 million in the second quarter of 2009. The gains in the second quarter of 2010 were largely unrealized and related to the effect of a weaker euro on inter-company balances. The loss in the second quarter of 2009 was primarily related to the euro and the Mexican peso.
Income taxes.The effective tax rate for the second quarter of 2010 was 34.5%, compared to 36.4% for the same quarter last year. The lower effective tax rate in the current quarter was primarily due to the domestic production deduction in the U.S. and a more favorable mix of non-U.S. income.
Net income attributable to Mine Safety Appliances Company. Net income attributable to Mine Safety Appliances Company for the second quarter of 2010 was $11.8 million, or $0.33 per basic share, compared to $12.5 million, or $0.35 per basic share, for the same quarter last year.
North American segment net income for the second quarter of 2010 was $10.8 million, a decrease of $0.1 million, or 1%, compared to $10.9 million in the second quarter of 2009.
The European segment reported a net loss for the second quarter of 2010 of $3.1 million, compared to net income of $1.0 million during the second quarter of 2009. The decrease in European
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segment net income during the second quarter of 2010 includes after-tax charges of $1.0 million related to our ongoing initiative to reorganize European operations. The remainder of the decrease was primarily due to the previously discussed decrease in sales and lower gross profits.
International segment net income for the second quarter of 2010 was $3.0 million, an increase of $2.1 million, compared to $0.9 million in the same quarter last year. Higher net income was primarily related to higher sales and improved gross profits. Higher gross profits reflect a more favorable product and geographic sales mix. These increases were partially offset by higher selling, general and administrative expenses.
Income reported in reconciling items for the second quarter of 2010 was $1.1 million compared to a loss of $0.4 million in the second quarter of 2009. The improvement was primarily related to unrealized currency exchange gains on inter-company balances.
Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009
Net sales. Net sales for the six months ended June 30, 2010 were $449.6 million, an increase of $4.2 million, or 1%, compared with $445.4 million for the six months ended June 30, 2009.
| Six Months Ended June 30 | Dollar (Decrease) Increase | Percent (Decrease) Increase | ||||||||||
(In millions) | 2010 | 2009 | ||||||||||
North America | $ | 215.9 | $ | 223.1 | ($7.2 | ) | (3 | %) | ||||
Europe | 113.0 | 121.7 | (8.7 | ) | (7 | ) | ||||||
International | 120.7 | 100.7 | 20.0 | 20 | ||||||||
Net sales by the North American segment were $215.9 million for the six months ended June 30, 2010, a decrease of $7.2 million, or 3%, compared to $223.1 million for the same period in 2009. Sales of SCBAs were $13.4 million lower during the first half of 2010. Shipments of SCBAs in the first half of 2009 included $9.4 million in shipments to the U.S. Air Force. Excluding these shipments, SCBA sales were $4.0 million lower in the current period, reflecting first quarter delays in the release of funds under the U.S. federal government’s Assistance to Firefighters Grants program. Shipments of Advanced Combat Helmets to the U.S. military and CG634 helmets to the Canadian Forces were $5.5 million and $1.6 million lower, respectively, as certain contracts wound down or were completed. Shipments of ballistic vests were $2.0 million lower in the current period. These decreases were partially offset by higher shipments of head protection and instruments, up $6.2 million and $8.1 million, respectively, on improved demand in industrial markets.
Net sales for the European segment were $113.0 million for the six months ended June 30, 2010, a decrease of $8.7 million, or 7%, compared to $121.7 million for the same period in 2009. Local currency sales in Europe decreased $10.1 million for the six months ended June 30, 2010. In Germany, local currency sales were $1.0 million lower for the six months ended June 30, 2010, reflecting a $2.8 million decrease in shipments of gas masks and ballistic helmet shipments to the military, partially offset by a $1.4 increase in SCBA shipments. Local currency sales in other European segment companies were down $9.1 million for the first half of 2010, reflecting the continuing effects of the recession in most markets. Translation effects of stronger non-euro currencies in the first half of 2010 increased European segment sales, when stated in U.S. dollars, by approximately $1.4 million.
Net sales for the International segment were $120.7 million for the six months ended June 30, 2010, an increase of $20.0 million, or 20%, compared to $100.7 million for the same period in 2009. Local currency sales of the International segment increased $6.1 million during the six months ended June 30, 2010. Local currency sales in Latin America were up $12.3 million, reflecting higher sales of head protection and instruments, primarily in industrial and mining markets. This increase was partially offset by a $5.6 decrease in sales in Hong Kong, primarily due to lower shipments of SCBAs. SCBA shipments
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during the first half of 2009 included a large order from the Hong Kong Fire Service. Currency translation effects increased International segment sales, when stated in U.S. dollars, by $13.9 million, primarily related to a strengthening of the Australian dollar, South African rand, and Brazilian real.
Cost of products sold. Cost of products sold was $276.9 million for the six months ended June 30, 2010, compared to $277.1 million for the same period in 2009. Cost of products sold, selling, general and administrative expenses, and research and development expenses include net periodic pension credits during the six month periods ended June 30, 2010 and 2009 of $3.4 million and $4.2 million, respectively.
Gross profit. Gross profit for the six months ended June 30, 2010 was $172.7 million, which was $4.4 million, or 3%, higher than gross profit of $168.3 million for the same period in 2009. The ratio of gross profit to net sales was 38.4% in the six months ended June 30, 2010, compared to 37.8% for the same period last year. The higher gross profit ratio in the six months ended June 30, 2010 was primarily related to sales mix.
Selling, general and administrative expenses.Selling, general and administrative expenses were $122.8 million during the six months ended June 30, 2010, an increase of $9.9 million, or 9.0%, compared to $112.9 million during the same period in 2009. Selling, general and administrative expenses were 27.3% of net sales for the six months ended June 30, 2010, compared to 25.3% of net sales for the same period in 2009. In the first half of 2010, selling, general and administrative expenses in the North American segment were $2.9 million, or 6%, higher than in the same period last year. The increase in North American segment selling, general and administrative expenses was primarily related to legal fees and other professional services associated with our ongoing insurance coverage litigation and higher selling expenses. Local currency selling, general and administrative expenses in the European segment were up $0.5 million. Local currency selling, general and administrative expenses in the International segment were up $2.8 million, primarily to support increased sales activity. Currency exchange increased selling, general and administrative expenses for the six months ended June 30, 2010, when stated in U.S. dollars, by $3.7 million, primarily related to the strengthening of the Australian dollar, South African rand and Brazilian real.
Research and development expense. Research and development expense was $16.0 million during the six months ended June 30, 2010, an increase of $1.7 million, or 12%, compared to $14.3 million during the same period in 2009. The increase reflects our ongoing focus on developing innovative new products.
Restructuring and other charges. During the six months ended June 30, 2010, we recorded charges of $9.4 million ($6.4 million after tax). European segment charges of $5.0 million for the six months ended June 30, 2010 related primarily to a focused voluntary retirement incentive program in Germany (German VRIP). North American segment charges for the six months ended June 30, 2010 of $1.8 million included stay bonuses and other costs associated with our ongoing initiative to transfer certain production activities. European and International segment charges for the six months ended June 30, 2010 of $1.8 million and $0.8 million, respectively, were primarily related to our ongoing efforts to reorganize our European operations and for severance costs associated with staff reductions in South Africa and China.
During the six months ended June 30, 2009, we recorded charges of $9.1 million ($5.8 million after tax). North American segment charges of $8.3 million related primarily to a voluntary retirement incentive program (North American VRIP). During the first half of 2009, we recorded North American VRIP non-cash special termination benefits expense of $6.7 million. The remaining $1.6 million of North American segment charges related to layoffs and stay bonuses and other costs associated with our ongoing initiative to transfer certain production activities. International segment charges of $0.8 million were primarily for severance costs related to staff reductions in Brazil, Australia and South Africa.
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Interest expense. Interest expense was $3.2 million during the six months ended June 30, 2010, a decrease of $0.6 million, or 14%, compared to $3.8 million during the same period last year. The decrease in interest expense reflects lower levels of both long and short-term debt.
Currency exchange. We reported currency exchange gains of $3.6 million during the six months ended June 30, 2010, compared to gains of $0.3 million during the same period in 2009. Currency exchange gains during the first half of 2010 were mostly unrealized and related primarily to the favorable effect of a weaker euro on inter-company balances.
Income taxes. The effective tax rate for the six months ended June 30, 2010 was 34.8%. compared to 35.1% for the same period last year. The lower effective tax rate in the current period was primarily due to the domestic production deduction in the U.S., partially offset by the expiration of the research and development tax credit.
Net income attributable to Mine Safety Appliances Company. Net income attributable to Mine Safety Appliances Company for the six months ended June 30, 2010 was $16.7 million, or $0.47 per basic share, compared to $19.7 million, or $0.55 per basic share, for the same period last year.
North American segment net income for the six months ended June 30, 2010 was $14.3 million, a decrease of $0.3 million, or 3%, compared to $14.6 million in the same period last year. North American segment net income for the six months ended June 30, 2009 included a $4.4 million after-tax charge related to the voluntary retirement incentive program in the U.S. Excluding this one-time charge in 2009, North American segment net income was down $4.7 million in the first half of 2010. The decrease reflects lower sales volumes and higher operating expenses in the current period.
The European segment reported a net loss for the six months ended June 30, 2010 of $6.9 million, compared to net income of $3.2 million during the same period in 2009. The decrease in European segment net income during the first half of 2010 includes after-tax charges of $4.8 million related to the German VRIP and cost associated with our ongoing efforts to reorganize European operations. The remainder of the decrease was primarily due to the previously discussed decrease in sales and lower gross margins. Currency translation effects of stronger non-euro currencies in the first half of 2010 increased current period European segment net income, when stated in U.S. dollars, by $0.8 million.
International segment net income for the six months ended June 30, 2010 was $6.9 million, an increase of $5.5 million, compared to $1.4 million in the same period last year. Higher local currency net income was primarily related to higher sales and improved gross profits. Higher gross profits reflect a more favorable product and geographic sales mix. The increases were partially offset by higher selling, general and administrative expenses. Currency translation effects increased current period International segment net income, when stated in U.S. dollars by approximately $0.7 million.
Income reported in reconciling items for the six months ended June 30, 2010 and 2009 of $2.5 million and $0.5 million, respectively, was primarily related to unrealized currency exchange gains on inter-company balances.
LIQUIDITY AND CAPITAL RESOURCES
Our main source of liquidity is operating cash flows, supplemented by borrowings to fund significant transactions. Our principal liquidity requirements are for working capital, capital expenditures, acquisitions, principal and interest payments on debt and dividends. We believe that our financial strength has been evident during the recession and the early stages of the recovery. Our long-term debt is primarily at fixed interest rates with manageable repayment schedules through 2021. We currently have approximately $42.0 million in unused short-term bank lines of credit at competitive interest rates. All of our long-term borrowings and substantially all of our short-term borrowings originate in the U.S., which has limited our exposure to non-U.S. credit markets and to currency exchange rate fluctuations.
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Cash and cash equivalents decreased $1.8 million during the six months ended June 30, 2010, compared to increasing $11.8 million during the same period in 2009.
Operating activities used cash of $12.0 million during the six months ended June 30, 2010, compared to providing cash of $54.8 million during the same period in 2009. Significantly lower operating cash flow in the first half of 2010 reflects a $47.4 million unfavorable change associated with working capital and a $19.4 million decrease in operating cash flow before changes in working capital. Lower operating cash flow before changes in working capital was primarily due to lower net income and less favorable adjustments for non-cash items. Trade receivables were $182.2 million at June 30, 2010, compared to $173.4 million at December 31, 2009. LIFO inventories were $130.4 million at June 30, 2010, compared to $123.9 million at December 31, 2009. The $8.8 million increase in trade receivables reflects a $16.0 million increase in local currency balances, primarily in North America, partially offset by a $7.2 million reduction, when stated in U.S. dollars, due to currency translation effects. The increase in trade receivables occurred primarily in North America and reflects higher sales. The $6.5 million increase in inventories reflects a $15.8 million increase in local currency inventories, partially offset by a $9.3 million reduction, when stated by U.S. dollars, due to currency translation effects. Increased inventory levels are primarily in anticipation of higher customer demand.
Investing activities used cash of $7.4 million during the six months ended June 30, 2010, compared to using $14.4 million in the same period last year. The decrease related primarily to lower property additions in the current period. During the six months ended June 30, 2010 and 2009, we used cash of $8.8 million and $14.6 million, respectively, for property additions. Higher property additions in the first half of 2009 were related primarily to production equipment and software purchases in North America.
Financing activities provided cash of $20.5 million during the six months ended June 30, 2010, compared to using $29.9 million during the same period in 2009. The change was primarily related to borrowing on our short-term line of credit. During the first half of 2010, we borrowed $38.4 million, compared to making payments of $12.1 million for the same period last year. We paid cash dividends of $17.7 million and $17.2 million in the first half of 2010 and 2009, respectively.
CUMULATIVE TRANSLATION ADJUSTMENTS
The position of the U.S. dollar relative to international currencies at June 30, 2010 resulted in a translation loss of $20.2 million being charged to the cumulative translation adjustments shareholders’ equity account during the six months ended June 30, 2010, compared to a gain of $9.5 million during the during the same period in 2009. The translation loss during the six months ended June 30, 2010 was primarily related to the weakening of the euro. The translation gain during the six months ended June 30, 2009 was primarily related to the strengthening of the South African rand, the Brazilian real and the Australian dollar.
COMMITMENTS AND CONTINGENCIES
We expect to make net contributions of $4.6 million to our pension plans during 2010.
We have purchase commitments for materials, supplies, services, and property, plant and equipment as part of our ordinary conduct of business.
In September 2006, we acquired Paraclete Armor and Equipment, Inc. Under the terms of the asset purchase agreement, we issued a $10.0 million note payable to the former owners of Paraclete. The note is non-interest bearing and is payable in five annual installments of $2.0 million beginning September 1, 2007. We recorded the note at a fair value of $8.5 million at the time of issuance. The discount of $1.5 million is being amortized over the term of the note.
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During 2003, we sold our real property in Berlin, Germany for $25.7 million, resulting in a gain of $13.6 million. At the same time, we entered into an eight year agreement to lease back the portion of the property that we occupy. Under sale-leaseback accounting, $12.1 million of the gain was deferred and is being amortized over the term of the lease.
Various lawsuits and claims arising in the normal course of business are pending against us. These lawsuits are primarily product liability claims. We are presently named as a defendant in approximately 2,500 lawsuits, primarily involving respiratory protection products allegedly manufactured and sold by us. Collectively, these lawsuits represent a total of approximately 11,800 plaintiffs. Approximately 90% of these lawsuits involve plaintiffs alleging they suffer from silicosis, with the remainder alleging they suffer from other or combined injuries, including asbestosis. These lawsuits typically allege that these conditions resulted in part from respirators that were negligently designed or manufactured by us. Consistent with the experience of other companies involved in silica and asbestos-related litigation, in recent years there has been an increase in the number of asserted claims that could potentially involve us. We cannot determine our potential maximum liability for such claims, in part because the defendants in these lawsuits are often numerous, and the claims generally do not specify the amount of damages sought.
With some limited exceptions, we maintain insurance against product liability claims. We also maintain a reserve for uninsured product liability based on expected settlement charges for pending claims and an estimate of unreported claims derived from experience, sales volumes, and other relevant information. We evaluate our exposures on an ongoing basis and make adjustments to the reserve as appropriate. Based on information currently available, we believe that the disposition of matters that are pending will not have a materially adverse effect on our results of operations or financial condition.
In the normal course of business, we make payments to settle product liability claims and for related legal fees and record receivables for the amounts covered by insurance. Various factors could affect the timing and amount of recovery of insurance receivables, including: the outcome of negotiations with insurers, legal proceedings with respect to product liability insurance coverage, and the extent to which insurers may become insolvent in the future.
We are currently involved in coverage litigation with The North River Insurance Company (North River). We have sued North River in the United States District Court for the Western District of Pennsylvania, alleging that North River breached one insurance policy by failing to pay amounts owing to us and that its refusal to pay constitutes bad faith. The case was assigned to the Court’s mandatory Alternative Dispute Resolution program, in an attempt to resolve the dispute. The mediation was unsuccessful and the case will proceed to trial. We believe that North River’s refusal to indemnify us under the policy for settlements and legal fees paid by us is wholly contrary to Pennsylvania law and we are vigorously pursuing the legal actions necessary to collect all amounts.
On April 9, 2010, North River filed a complaint against us and two excess insurance carriers in the Court of Common Pleas of Allegheny County, Pennsylvania seeking a declaratory judgment concerning their responsibilities under three additional policies shared with Northbrook Insurance Company. We believe that Pennsylvania law supports our position that North River has insurance responsibilities to indemnify us against various product liability claims to the full limits of these policies.
During May 2010, we resolved the coverage litigation with Century Indemnity Company through a negotiated settlement. As part of this settlement, both parties dismissed all claims against one another under the previously-filed coverage litigation. The settlement did not impact our operating results.
We regularly evaluate the collectibility of insurance receivables and record the amounts that we conclude are probable of collection based on our analysis of our various policies, pertinent case law
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interpreting comparable policies and our experience with similar claims. Insurance receivables totaled $73.6 million at June 30, 2010, all of which is reported in other non-current assets. Insurance receivables totaled $91.7 million at December 31, 2009. Based upon our evaluation of applicable insurance coverage and our ongoing insurance recovery efforts, we believe that the recorded balances are fully recoverable.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. We evaluate these estimates and judgments on an on-going basis based on historical experience and various assumptions that we believe to be reasonable under the circumstances. However, different amounts could be reported if we had used different assumptions and in light of different facts and circumstances. Actual amounts could differ from the estimates and judgments reflected in our financial statements.
The more critical judgments and estimates used in the preparation of our financial statements are discussed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2009.
RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2007, the FASB issued a statement that requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest is to be included in consolidated net income on the face of the income statement. The statement also amended certain consolidation procedures and expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. The adoption of the new statement on January 1, 2009 is reflected in these financial statements and did not have a material effect on our consolidated results of operations or financial condition.
In March 2008, the FASB issued a statement that requires companies to provide disclosures about (a) how and why derivative instruments are used, (b) how derivative instruments and related hedged items are accounted for, and (c) how derivative instruments and related hedged items affect the company’s financial position, financial performance, and cash flows. We adopted the new statement on January 1, 2009. See note 10 for disclosures related to derivative instruments and hedging activities.
In April 2008, the FASB issued a staff position that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The objective of this staff position is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. This staff position applies to all intangible assets, whether acquired in a business combination or otherwise, and is to be applied prospectively to intangible assets acquired on or after January 1, 2009. The adoption of this staff position did not have a material effect on our consolidated financial statements.
In April 2009, the FASB issued a staff position that requires disclosures about the fair value of financial instruments for interim reporting periods as well as in annual financial statements. We adopted this staff position for our second quarter 2009 interim reporting period. See note 13 for disclosures related to the fair value of financial instruments.
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In May 2009, the FASB issued a statement that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, the statement sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Our adoption of the new statement on June 30, 2009 had no impact on the financial statements as management already followed a similar approach prior to the adoption of this standard.
In June 2009, the FASB issued a statement that removes the concept of a qualifying special-purpose entity and clarifies the objective of determining whether a transferor and all of the entities included in the transferor’s financial statements being presented have surrendered control over transferred financial assets. The adoption of this statement on January 1, 2010 did not have a material effect on our consolidated financial statements.
In June 2009, the FASB issued a statement that amends the consolidation guidance applicable to variable interest entities. The adoption of this statement on January 1, 2010 did not have a material effect on our consolidated financial statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of adverse changes in the value of a financial instrument caused by changes in currency exchange rates, interest rates, and equity prices. We are exposed to market risks related to currency exchange rates and interest rates.
Currency exchange rate sensitivity. We are subject to the effects of fluctuations in currency exchange rates on various transactions and on the translation of the reported financial position and operating results of our non-U.S. companies from local currencies to U.S. dollars. A hypothetical 10% strengthening or weakening of the U.S. dollar would decrease or increase our reported sales for the six months ended June 30, 2010 by approximately $23.4 million.
When appropriate, we may attempt to limit our transactional exposure to changes in currency exchange rates through contracts or other actions intended to reduce existing exposures by creating offsetting currency exposures. At June 30, 2010, we had open foreign currency forward contracts with a U.S. dollar notional value of $7.6 million. A hypothetical 10% increase in June 30, 2010 forward exchange rates would result in a $0.8 million increase in the fair value of these contracts.
Interest rate sensitivity. We are exposed to changes in interest rates primarily as a result of borrowing and investing activities used to maintain liquidity and fund business operations. Because of the relatively short maturities of temporary investments and the variable rate nature of industrial development debt, these financial instruments are reported at carrying values that approximate fair values.
We have $84.0 million of fixed rate debt which matures at various dates through 2021. The incremental increase in the fair value of fixed rate long term debt resulting from a hypothetical 10% decrease in interest rates would be approximately $1.4 million. However, our sensitivity to interest rate declines and the corresponding increase in the fair value of our debt portfolio would unfavorably affect earnings and cash flows only to the extent that we elected to repurchase or retire all or a portion of our fixed rate debt portfolio at prices above carrying values.
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Item 4. CONTROLS AND PROCEDURES
| (a) | Evaluation of disclosure controls and procedures.The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures, as of the end of the period covered by this report, were effective and provided reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. |
| (b) | Changes in internal control. There were no changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. |
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PART II. OTHER INFORMATION
| Item 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
| (c) | Issuer Purchases of Equity Securities |
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased As Part of Publicly Announced Plans or Programs | Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs | |||||
April 1 – April 30, 2010 | — | $ | — | — | 1,657,034 | ||||
May 1 – May 31, 2010 | 50,661 | 29.46 | — | 1,779,979 | |||||
June 1 – June 30, 2010 | — | — | — | 1,965,303 | |||||
In November 2005, the Board of Directors authorized the purchase of up to $100 million of common stock from time-to-time in private transactions and on the open market. The share purchase program has no expiration date. The maximum shares that may yet be purchased is calculated based on the dollars remaining under the program and the respective month-end closing share price.
We do not have any other share repurchase programs.
Shares purchased during May 2010 related to stock compensation transactions.
| Item 6. | EXHIBITS |
(a) Exhibits
| 10.1 | Trust Agreement, effective June 1, 1996, as amended through May 15, 2010, between the registrant and PNC Bank, N.A. re the Mine Safety Appliances Company Stock Compensation Trust. | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) | |
| 31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) | |
| 32 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. (S)1350 | |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| MINE SAFETY APPLIANCES COMPANY | ||
July 28, 2010 | /s/ Dennis L. Zeitler | |
| Dennis L. Zeitler | ||
Senior Vice President — Finance; Duly Authorized Officer and Principal Financial Officer | ||
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