MSA Safety - 10-Q quarterly report FY

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

MINE SAFETY APPLIANCES COMPANY
(Exact name of registrant as specified in its charter)

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   o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

        Yes   x      No   o

As of July 31, 2003, there were outstanding 12,237,755 shares of common stock without par value, not including 1,333,245 shares held by the Mine Safety Appliances Company Stock Compensation Trust.

PART I FINANCIAL INFORMATION
MINE SAFETY APPLIANCES COMPANY
CONSOLIDATED CONDENSED BALANCE SHEET
(Thousands of dollars, except share data)

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See notes to consolidated condensed financial statements.

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MINE SAFETY APPLIANCES COMPANY
CONSOLIDATED CONDENSED STATEMENT OF INCOME
(Thousands of dollars, except per share amounts)

See notes to consolidated condensed financial statements.

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MINE SAFETY APPLIANCES COMPANY
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(Thousands of dollars)

See notes to consolidated condensed financial statements.

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MINE SAFETY APPLIANCES COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
UNAUDITED

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Reportable segment information is presented in the following table:

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Reconciling items consist primarily of intercompany eliminations and items reported at the corporate level.

At December 31, 2002, accounts receivable of $66.2 million were owned by Mine Safety Funding Corporation. The company held a subordinated interest in these receivables of $36.5 million, of which $35.5 million is classified as other receivables. Net proceeds to the company from the securitization arrangement were $29.0 million at December 31, 2002.

The key economic assumptions used to measure the retained interest at June 30, 2003 were a discount rate of 3.3% and an estimated life of 2.6 months. At June 30, 2003, an adverse change in the discount rate or estimated life of 10% and 20% would reduce the fair value of the retained interest by $43,000 and $87,000, respectively. The effect of hypothetical changes in fair value based on variations in assumptions should be used with caution and generally cannot be extrapolated. Additionally, the effect on the fair value of the retained interest of changing a particular assumption has been calculated without changing other assumptions. In reality, a change in one factor may result in changes in others.

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Stock options granted in 2003 vest in one year. Options granted in 2002 vested in six months.For purposes of the proforma disclosure, the estimated fair value of the stock options is amortized over the vesting period. The fair value of the options granted was estimated at the grant dates using the Black-Scholes option pricing model and the following weighted average assumptions for options granted in 2003 and 2002, respectively: risk-free interest rate of 4.0% and 5.3%; dividend yield of 2.1% and 2.0%; expected option life of 9.9 years and 9.9 years; and expected volatility factor of 23% and 23%.

The results of the Callery Chemical Division, as summarized below, have been classified as discontinued operations for all periods presented.

Net assets of Callery Chemical Division classified as held for sale include inventory and property expected to be sold to BASF and accounts receivable and other current assets that will be liquidated.

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service, as well as head protection for the police and military. The acquisition of Gallet complements the company’s strong existing line of fire service products and provides the opportunity to capitalize on opportunities in other areas where Gallet is strong – such as the law enforcement, military, and aviation markets. Gallet has been integrated into the company’s operations and its products are being marketed under the MSA Gallet name. Gallet’s results of operations have been included in the company’s consolidated financial statements from the acquisition date.

The following pro forma summary presents the company’s consolidated results as if the Gallet acquisition had occurred at the beginning of 2002. The pro forma information does not necessarily reflect the actual results that would have occurred and is not necessarily indicative of future results of operations for the combined companies.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Forward-looking statements

Certain statements contained in this discussion and elsewhere in this report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from expectations contained in such statements.

Factors that may materially affect financial condition and future results include: global economic conditions; the impact of unforeseen economic and political changes, including the threat of terrorism and its potential consequences; the timely and successful introduction of new products; the availability of funding in the fire service and homeland security markets; fluctuations in the cost and availability of key materials and components; the company’s ability to generate sufficient cash flow to support capital expenditures, debt repayment, and general operating activities; the company’s ability to achieve sales and earnings forecasts; the company’s ability to successfully integrate acquisitions and complete divestitures; and interest and currency exchange rates.

The foregoing list of important factors is not exclusive. The company undertakes no obligation to publicly update or revise its forward-looking statements.

Corporate Initiatives

During July the company agreed to sell certain assets of the Callery Chemical Division to BASF for approximately $65 million. The transaction is expected to be completed by the end of the third quarter of 2003, subject to required regulatory approval and the satisfaction of various closing conditions, for an estimated after-tax gain of approximately $13 million. The Callery Chemical Division develops, manufactures, and sells specialty chemicals, including alkali metal strong bases and borane chemicals for use in pharmaceuticals, agricultural chemicals, plastics, and a number of other applications. The divestiture of the specialty chemical business will better position the company to focus on its core safety business. The results of the division and the assets expected to be sold or otherwise liquidated have been reported as discontinued operations and assets held for sale in the accompanying financial statements.

Results of operations

Three months ended June 30, 2003 and 2002

Sales for the second quarter of 2003 were $175.9 million, an increase of $34.0 million, or 24%, from $141.9 million in the second quarter of 2002.

Second quarter 2003 sales for North American operations of $111.4 million were $17.5 million, or 19%, higher than in the second quarter of last year. The sales improvement in North America was related to strong shipments of breathing apparatus to the fire service market and gas masks to military and homeland security markets. During the second

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quarter of 2003, the company changed its standard shipping terms to U.S. distributors. The effect of this change was to delay revenue recognition on the affected shipments, which reduced second quarter 2003 sales and gross margins by approximately $2.6 million and $1.3 million, respectively.

In Europe, second quarter 2003 sales of $36.6 million were $7.4 million, or 25%, higher than in second quarter 2002. The increase includes a full quarter’s sales for MSA Gallet, following its acquisition on April 30, 2002. When stated in U.S. dollars, European sales in the current quarter also benefited from the favorable currency translation effect of the stronger Euro.

International sales of $27.9 million in the second quarter of 2003 were $9.2 million, or 49%, higher than in second quarter 2002. Sales growth occurred primarily in Latin America and the Asia Pacific region. Current quarter sales included large shipments of breathing apparatus to the Royal Australian Navy.

Gross profit for the second quarter of 2003 was $67.8 million, an increase of $15.9 million, or 31%, from $51.9 million in second quarter 2002. The ratio of gross profit to sales was 38.5% in the second quarter of 2003 compared to 36.6% in the corresponding quarter last year. The higher gross profit percentage in the current quarter was due to a favorable adjustment related to a change in the vacation vesting policy for U.S. employees and product mix changes. Under the vacation policy adopted during the current quarter, employees earn their vacation entitlement during the current year. Previously, vacation vested on the last day of the prior year. The policy change resulted in a favorable adjustment to cost of sales of $1.6 million during the second quarter of 2003. This change is expected to result in additional favorable adjustments to cost of sales of approximately $1.0 million in both the third and fourth quarters of 2003.

Selling, general and administration expenses in the second quarter of 2003 were $42.2 million, an increase of $5.6 million, or 15%, compared to $36.6 million in second quarter 2002, but improved as a percentage of sales to 24.0% in the second quarter of 2003 compared to 25.8% in the corresponding quarter last year. The increase in selling, general and administrative expenses reflects higher insurance and selling expenses, and the exchange effect of strengthening international currencies, particularly the Euro. Selling, general and administrative expenses for the second quarter of 2003 include a favorable adjustment of approximately $800,000 related to the previously discussed change in the vacation vesting policy for U.S. employees. This change is expected to result in additional favorable adjustments to selling, general and administrative expenses of approximately $500,000 in both the third and fourth quarters of 2003.

Depreciation and amortization expense in second quarter 2003 was $5.7 million, an increase of $338,000, or 6%, from $5.3 million in the corresponding quarter last year. The increase relates to property additions.

Currency exchange gains were $651,000 in the second quarter of 2003 compared to gains of $1.1 million in the same quarter of last year. Current quarter gains were primarily due to the strengthening of the Euro and the Canadian dollar. The second quarter 2002 gain

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related primarily to the strengthening of the Euro and Canadian dollar, partially offset by weakening of the Argentine Peso.

Other income was $434,000 in the second quarter of 2003 compared to $2.3 million in the same quarter last year. Other income in second quarter 2002 included a gain of $2.1 million on the sale of real estate development property in Pittsburgh.

Income from continuing operations before income taxes was $19.8 million for second quarter 2003 compared to $12.1 million in second quarter 2002, an increase of 63%.

The effective income tax rate for the second quarter of 2003 was 38.5% compared to 35.0% in second quarter 2002. The lower rate in second quarter 2002 related to proportionately higher income in lower tax rate jurisdictions and permanent differences.

Net income from continuing operations in the second quarter of 2003 was $12.2 million, or $1.00 per basic share, compared to $7.9 million, or 65 cents per basic share, in the second quarter of last year.

Net income from discontinued operations, for which further information is contained in note 12, was $1.3 million for the second quarter of 2003, a decrease of $314,000 from income of $1.6 million in second quarter 2002. The decrease in 2003 was related to lower sales volumes, partially offset by the absence of depreciation expense on property classified as held for sale.

Net income for the second quarter of 2003 was $13.5 million, an increase of $4.0 million, or 42%, from net income of $9.5 million in the second quarter of 2002. Basic earnings per share improved to $1.10 compared to 78 cents last year.

Six months ended June 30, 2003 and 2002

Sales for the six months ended June 30, 2003 were $336.3 million, an increase of $66.4 million, or 25%, from $269.9 million for the six months ended June 30, 2002.

North American sales for the six months ended June 30, 2003 of $218.2 million were $34.8 million, or 19%, higher than the same period last year. Higher shipments of breathing apparatus to the fire service market and gas masks to military and homeland security markets accounted for a significant portion of the improvement.

Sales in Europe for the six months ended June 30, 2003 of $71.3 million were $19.5 million, or 38%, higher than the same period in 2002. The improvement in local currency sales reflects the addition of Gallet sales, following its acquisition during the second quarter of 2002. When stated in U.S. dollars, European sales in the current period also benefited from the favorable currency translation effect of the stronger Euro.

International sales for the first six months of 2003 of $46.9 million were $12.2 million, or 35%, higher than in the same period last year. Sales growth occurred primarily in Latin America and the Asia Pacific region. Current period sales included large shipments of breathing apparatus to the Royal Australian Navy.

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Gross profit for the six months ended June 30, 2003 was $129.3 million, an increase of $26.7 million, or 26%, from $102.6 million in the first six months of 2002. The ratio of gross profit to sales was 38.4% in the six months ended June 30, 2003 compared to 38.0% in the corresponding period last year. The higher gross profit percentage in the current year includes a favorable adjustment related to a change in the vacation vesting policy for U.S. employees. Under the vacation policy adopted in 2003, employees earn their vacation entitlement during the current year. Previously, vacation vested on the last day of the prior year. The policy change resulted in a favorable adjustment to cost of sales of $1.6 million during the six months ended June 30, 2003. This policy change is expected to result in additional favorable adjustments to cost of sales of approximately $1.0 million in both the third and fourth quarters of 2003.

Selling, general and administration costs for the six months ended June 30, 2003 were $81.3 million, an increase of $14.0 million, or 21%, from $67.3 million in the same period last year, but improved somewhat as a percentage of sales to 24.2% in the first six months of 2003 compared to 24.9% in the corresponding period last year. The increase includes higher insurance and sales expenses, the post-acquisition expenses of Gallet, and the currency translation effects of the stronger Euro. Selling, general and administrative expenses for the six months ended June 30, 2003 include a favorable adjustment of approximately $800,000 related to the previously discussed change in the vacation vesting policy for U.S. employees. This change is expected to result in additional favorable adjustments to selling, general and administrative expenses of approximately $500,000 in both the third and fourth quarters of 2003.

Depreciation and amortization expense was $11.1 million in the six months ended June 30, 2003, an increase of $689,000, or 7%, from $10.4 million in the same period last year. The increase is primarily due to a full six month’s depreciation expense on Gallet assets, the translation effect of the stronger Euro, and property additions.

Interest expense for the six months ended June 30, 2003 was $2.3 million, a decrease of $119,000, or 5%, from $2.4 million in the same period last year. Lower interest expense in 2003 related to lower short-term borrowings.

Currency exchange gains were $1.8 million in the six months ended June 30, 2003 compared to gains of $552,000 in the same period last year. Current period gains were primarily due to the strengthening of the Euro and the Canadian dollar. The 2002 gain related primarily to the strengthening of the Euro and Canadian dollar, partially offset by weakening of the Argentine Peso.

Other income was $530,000 for the six months ended June 30, 2003 compared to $2.2 million in the first half of 2002. Other income in the first half of 2002 included a gain of $2.1 million on the sale of real estate development property in Pittsburgh.

Income from continuing operations before income taxes was $37.0 million for the six months ended June 30, 2003 compared to $25.3 million in the first six months of 2002, an increase of $11.7 million, or 46%.

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The effective income tax rate for the six months ended June 30, 2003 was 38.6% compared to 38.3% in the same period last year.

Net income from continuing operations was $22.7 million for the six months ended June 30, 2003 compared to $15.6 million in the first half of 2002, an increase of $7.1 million, or 45%.

Net income from discontinued operations, for which further information is contained in note 12, was $2.8 million for the first half of 2003, an increase of $940,000 from income of $1.8 million in same period last year. The income improvement in 2003 includes the favorable effect of the discontinuance of depreciation expense on property classified as held for sale.

Net income for first half of 2003 was $25.5 million, an increase of $8.0 million, or 46%, from net income of $17.5 million in the first half of 2002. Basic earnings per share improved to $2.08 compared to $1.44 last year.

Liquidity and Financial Condition

Continuing operations provided $1.1 million of cash during the six months ended June 30, 2003 compared to providing $18.6 million in the same period last year. Increases in operating assets, particularly trade receivables and inventories associated with higher sales volumes, used $28.9 million of cash during the first six months of 2003. In the same period last year, changes in operating assets and liabilities used $3.5 million of cash.

Discontinued operations provided $5.6 million of cash in the six months ended June 30, 2003 compared to providing $338,000 in the same period last year. Higher cash provided by discontinued operations in 2003 was primarily related to reductions in trade receivables.

Investing activities used cash of $9.0 million in six months ended June 30, 2003 compared to using $22.6 million in the same period last year. In 2002, net cash of approximately $14.5 million was used for the acquisition of CGF Gallet.

Financing activities used $14.2 million of cash in the six months ended June 30, 2003 compared to using $2.9 million in the same period last year. The higher use of cash for financing activities in 2003 related primarily to reductions in debt, lower sales of common stock and increased dividend payments.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in the company’s financial instrument market risk during the six months ended June 30, 2003. For additional information, refer to page 19 of the company’s Annual Report to Shareholders for the year ended December 31, 2002.

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Item 4.  Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures within 90 days before the filing date of this quarterly report. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

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(b)   Reports on Form 8-K

         The Company filed a Form 8-K on May 1, 2003 under Item 5 - Other Events.
         The Company filed a Form 8-K on May 7, 2003 under Item 9 - Regulation FD Disclosure.

SIGNATURES

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.

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