Brady Corp (BRC) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2010 Brady Corporation earnings conference call. My name is Chanell and I will be your coordinator for today. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Aaron Pearce, Vice President, Treasurer and Director of Investor Relations. Please proceed.

Thank you, Chanell. Good morning, this is Aaron Pearce, Director of Investor Relations for Brady Corporation. Welcome to our fiscal 2010 third quarter conference call. We're pleased you could join us. During the call this morning, you'll hear from Frank Jaehnert, CEO and Tom Felmer, CFO, presenting Brady's quarterly financial review. Also joining us this morning are our three regional Presidents, Matt Williamson, President of Brady Americas; Peter Sephton, President of Brady Europe; and Al Klotsche, President of Brady Asia-Pacific; who will all provide their respective regional reports. As usual, after brief presentations by the team, we'll open up the floor to questions.

We encourage you to follow along with the slides, located on the Internet, as we'll be referring to the individual slides as we proceed throughout the presentation. These slides can be found on our Website at www.investor.bradycorp.com. We will start with slide number three. You have a few moments to get to those slides while we go through our Safe Harbor statement and other usual introductory information. Please note that in this call, we may make comments about forward-looking information. Words such as expect, believe and anticipate are a few examples of words identifying a forward-looking statement. It's important to note that forward-looking information is subject to various risk factors and uncertainties, which could significantly impact expected results.

Risk factors were noted in our news release this morning and in Brady's Form 10-K, filed with the SEC in September of 2009. Also, please note that this teleconference is copyrighted by Brady Corporation and there may be no rebroadcasting of this without the express written consent of Brady. Note also, that Brady will be recording this call and broadcasting it on the Internet and your participation in the question-and-answer session will constitute your consent to being recorded. Thank you. And now, here's Frank Jaehnert.

Good morning and thank you for joining us. I am pleased to report that our quarterly sales grew 16.3% to $321.9 million, compared to the same period in fiscal 2009. Organic sales increased by 8.5%, acquisitions accounted for 2%, and currency added another 5.8%. Excluding the after tax impact of restructuring charges, our net income in the third quarter was up 30% to $25.4 million, and earnings per diluted share were also up 30% to $0.48. Both a solid improvement over the same period last year, where our net income and diluted EPS before restructuring were $19.6 million and $0.37 respectively.

We are pleased to see both a return of core growth in all regions and an improvement in our profitability. Our ongoing restructuring and process improvement activities continued to have a positive impact on our gross margins in the quarter, which increased to 49.8%, from 48.5% in the same quarter last year. We remain committed to investing in key initiatives to drive organic growth, as well as growth through acquisitions. In particular, we continue to invest in new product development and other organic growth programs, expanding our product offerings and enabling deeper penetration into our markets. During the quarter, we acquired, Securimed, a direct marketer of first aid supplies in France.

We are also investing in strategic initiatives to drive down our SG&A costs over the long term, as we apply similar techniques to SG&A that we have been applying in our operations area. I'm pleased with the progress that we have made in fiscal 2010. As we look to the fourth quarter and to fiscal 2011, we are cautious with respect to the global economic recovery and the impact that the recent declines in the euro will have on our financial results. I'll be back later to summarize our thoughts for the remainder of fiscal 2010. And here's Tom Felmer with a review of the financials. Tom.

Thank you, Frank. And good morning, everyone. Moving on to slide number four, we show our third quarter income statement compared with prior year. Frank just reported on our sales gross margin and net income. And we're very pleased with our return to core growth in all regions and our gross margin continues to be the highlight of our performance. On slide five here, you can see our quarter-over-quarter sales growth and our gross margin, which continues to improve as we return to growth following last year's economic downturn. This quarter's gross margin expansion to 49.8% compares to 48.5% in the third quarter of last year. It's a continuation of the trend that we've seen as we continue to drive process improvements in our operations areas through lean and the Brady business performance system.

On slide six, you can see a $2 million increase in our SG&A from second quarter to third quarter of fiscal 2010. The sequential increase was due primarily to having three more business days in the third quarter versus the second quarter. And when comparing SG&A to prior year, the SG&A was up $16 million in absolute dollars, but flat as a percentage of sales. The increase was primarily due to the return of incentive compensation this year, as well as an increase due to exchange rates.

Also in last year's third quarter, we experienced reductions in SG&A due to the reversal of previously accrued bonuses, which were not paid in the year. Excluding restructuring charges, our operating income was $38 million in the quarter, up from $32 million in the prior year. Both our gross margin and operating margins in the quarter were helped by cost savings that we generated from restructuring and ongoing process improvement initiatives. In last quarter's call, we commented that we are expanding the focus of BBPS and lean to our SG&A functions. While we expect to see improvements in SG&A over time from these efforts, it will require some incremental investment in training and other resources over the next one or two quarters.

On slide seven, our GAAP net income for the quarter was $23.7 million, resulting in diluted EPS of $0.45 per share. However, when adjusting for after tax restructuring charges of $1.7 million, we generated net income of $25.4 million, and $0.48 per diluted share, up 29.7% over the same quarter in the prior year. The improvement in net income and diluted EPS is due to increased global sales volume as well as results from our continuous improvement initiatives. On slide eight, we break out our restructuring charges for the current quarter in both F10 and fiscal 2009. The after tax impact of this quarter's restructuring charges was $1.7 million or $0.03 per share. We remain on plan to take approximately $15 million in restructuring for the year, as announced in our F10 guidance.

Moving on to slide nine, we summarize our third quarter cash flow. We continue to generate strong cash flow from operating activities and strong free cash flow in excess of net income. Free cash flow for the quarter was approximately $44.2 million or 186% of net income. On the cash balance walk, we generated $50.2 million of cash from operating activities. We invested $10.1 million of this cash in business acquisitions and we invested $6 million in capital expenditures in the quarter. We paid $9.2 million in dividends to our shareholders and made principal payments of $26.1 million to reduce our debt. The impact of currency on our cash balances were minimal in the quarter, resulting in an ending cash balance on April 30 of $207.1 million, which we believe gives us adequate flexibility for future growth.

Moving on to slide ten, our gross debt of $365 million and net debt is approximately $158 million at the end of the quarter. And just last week, we announced the completion of a debt offering totaling EUR75 million, with an all-in weighted average interest rate of 4.09%, which will provide us with additional flexibility for growth.

And finally, on slide 11, you can see that we continue to make investments in R&D. In absolute dollars, our investment in R&D was relatively flat at third quarter, at $10.7 million, up from $10.6 million in the second quarter. The decrease in R&D as a percent of sales is due to our increased sales volume in the third quarter when compared to the second quarter. We've also outlined several new products that were introduced in the quarter on this slide. These include a new advanced adhesive marking film, new temperature indicating labels and an upgrade to our LabelMark printing software for laboratory applications. Brady is also the first supplier in the consumer electronics market to now offer halogen-free thermal transfer printer ribbons. I would now like to turn the call over to Matt Williamson for an update on the Americas business. Matt.

Good morning, everyone. Thanks, Tom. Please refer to slide number 12. Americas' sales in the third quarter were $144.4 million, up 14.9% compared to the prior year. The organic sales increase of 9.7% accounted for the majority of the sales growth, along with a positive impact from currency of 3.1%, and 2.1% growth from the acquisition of Stickolor in Brazil. Sales grew year-over-year in the third quarter, driven largely by strong performance in our Brady brand business, across the region, in all markets.

In the Brady US business, our MRO sales grew slightly over the prior year, as end user and distributor demand continues to pick up, as the general economy improves and we enjoy success with our strategic marketing initiatives and the new products launched this year. Sales in OEM markets have continued to improve and have contributed significantly to our growth in the quarter. Other areas of focus continue to include increasing sales of new printing system and consumables, plus the introduction of new MRO services to our customers.

Outside the US, we continue to see improving results with growth in Canada and Brazil. Our December acquisition of Stickolor in Sao Paolo, Brazil has performed very well initially and had a record sales month during the quarter. Our Mexico business has shown consistent top line growth throughout fiscal 2010. Our direct marketing business has improved slightly quarter-over-quarter but is still lagging behind our US distribution businesses.

As mentioned last quarter, this business has been negatively impacted by employment losses at US companies. To drive growth in these businesses, we continue to focus on new customer acquisition, E-business initiatives and new product introductions. As part of our overall strategy to drive business on the Internet in the region, we have now launched all of our major Websites on a new platform and are excited about the response.

Segment profit for the Americas increased 18.6% to $33.9 million in the quarter. As a percent of sales, segment profit increased to 23.4%, compared to 22.7% in the prior year. we are benefiting from our strategy to improve gross margin, which is unchanged. We also continue to drive productivity improvements with lean and manufacturing, in addition to numerous facility consolidations concluded or in process. Plus, other operational improvement initiatives. Going forward, we expect organic growth to continue due to improvements in the overall economy and execution of our strategic initiatives. Peter Sephton will now report on the European results. Peter.

Thanks, Matt. Good morning, everybody. I'll draw your attention to slide 13. Sales in Europe were $98.2 million for the quarter, up 15.2% versus the prior year. We are pleased with the return to organic sales growth, which were up 6.1% against the same quarter of the previous year. Acquisitions added 3.5% and currency contributed another 5.6%. In general, our business performed slightly better in the third quarter than we had expected, sustained by our continued focus on profitable and sustainable market segments, and helped by some modest economic recovery.

The Brady brand continued the improvement generated in the second quarter, with sales exceeding those of fiscal 2009 for the first time this year. Slow recovery of European exports and a general reluctance among main industry players to commit to new capital investment persists. We've seen some general improvement in growth in our MRO businesses, benefiting from our second focus on process industries and laboratory identification. But this is somewhat inconsistent across the region.

For instance, our businesses in France, Germany, Benelux and Italy were encouraging but our results in the UK were less encouraging. And as we reported last quarter, our business in eastern Europe and some newer markets, such as Turkey and the Middle East generally, continued to grow at double-digit rates. We continue to sustain our sales efforts with a drive towards greater selling effectiveness by improving core rates and quarters core ratios, driven by our system of salesforce.com. We also have an accelerating flow of new product launches for both the median and low end of the market. The success of the new product launches in Europe continued this quarter, with introduction of the BMP71 printer into our product offering. The initial orders for which exceed our prelaunch estimates.

Moving on to our direct marketing businesses. These continued at levels slightly above the same period in fiscal 2009, excluding currency and acquisitions. However, our profits increased more strongly through our continuous cost reduction programs. Our sales through the Internet continues to grow month after month at double-digit rates, as we continue to roll out new applications aimed at online buyers. During the quarter, we acquired Securimed, a direct marketing business in the industrial first aid supply sector, at the end of March. This business is expected to commence contributing to our existing French direct marketing business in the next quarter.

Europe's segment profit for the quarter was $27.5 million, which was 15.6% above the same quarter of last year. We continue to maintain our high percentage of profits to sales and managed to increase segment profit from 27.9% in the prior year, to 28% in the current year, as we continue to drive productivity from our cost base. Overall, we're encouraged to see a return to growth achieved in a macroeconomic environment, which remains uncertain and somewhat challenging.

Public spending will fall in the UK and other parts of the Eurozone, following elections earlier this month and uncertainty over budgetary control in the weaker economies of Europe, which has caused turmoil on stock exchanges and general insecurity worldwide. Whether this will spread into the economy as a whole remains unlikely but somewhat uncertain. For Brady, in Europe, this translates into a market cautious to invest in capital and other growth investments. And as a result, we continue to remain cautious in our outlook for the remainder of the year. And now, we'll move on to Asia-Pacific. I'll hand over to you, Al.

Thanks, Peter. Please refer to slide number 14. Asia-Pacific sales for the third quarter were $79.3 million, up 20.4% from the prior year. Organic sales increased 9.4%, while currency had a positive impact of 11%. We were pleased to see that our focus on proprietary engineered solutions and growing our MRO business continues to be successful. Our growth in the consumer electronics segment was very much on pace with our expectations. We continue to focus our selling and marketing efforts on engineered solutions, which are solving the more challenging applications such as heat management, optical clarity and sound and vibration dampening.

While the number of total parts in handheld electronics continues to rise, we are focusing our efforts on a subset of these applications where our engineering and new product development capabilities are valued by OEM design centers. As you may recall, we have made significant investments in new product development and localized R&D over the past few years. It's very reassuring to see our customers valuing and using these capabilities. Pressure from local competition is as strong as ever but less so on these higher end engineered solutions. We have designed in many new solutions with worldwide design centers, which we'll begin ramping up in our fourth quarter and again into the first quarter of fiscal 2011.

We continue to see a nice runway of opportunities with our leading customers, who are designing more power and functionality into a smaller form factor, both of which provide nice opportunities for innovation. Sales across the region remained strong to the computer and storage industries, where OEM's are still working to refill depleted inventories. This industry is another good example of one which values our unique material solutions and converting capabilities. With much of this industry centered in southeast Asia and specifically, Thailand, their recent political unrest is something that has not significantly impacted our supply chain but we continue to watch this closely.

This quarter, we saw continued healthy increases in growth in our MRO business due much in part to the increased focus we have had on finding and growing effective channel partners. Unlike parts of the Western world, where very large distributors with wide reaching industry focus exist, in much of Asia, distributors are more focused on a specific geography or market. So, while it is taking a bit longer to build the right portfolio of channel partners, we clearly are making good progress in this area. The continued infrastructure expansion, especially in North Asia, is providing lots of opportunities for existing and new solutions for facility and safety identification.

As mentioned last quarter, we continue to see a strengthening of the Australian economy, led by the mining industry in Western Australia. Our local presence in Western Australia allows us to effectively service this region and develop unique custom safety solutions. The boom in construction of off-shore rigs and the reopening of many of the mines will provide nice opportunities for the foreseeable future.

Segment profit in the region was $12.8 million, up 83% from last year's segment profit of $7.0 million in the third quarter. As a percent of sales, segment profit was 16.1%, versus 10.6% in the prior year. Much of our profit improvement has come from our focus on driving waste out of all of our business processes, better facility rationalization, and the benefits of newly launched products. Looking forward, we expect to see continued growth coming from our targeted customer segments, driven primarily through differentiated engineered solutions. Much of our growth will be driven by the increase of mobile device sales in the electronics market and opportunities coming from the continued growth in infrastructure across North Asia. I'll now turn the call back to Tom Felmer.

Thanks, Al. Moving on to slide 15, we reconfirm our guidance for fiscal 2010, which remains unchanged from the last quarter. While we have experienced improving results over the past two quarters, we remain cautious about the global economic recovery, in particular, Europe. And also, we're concerned with the volatility of the currency markets. Our guidance assumptions for restructuring, capital expenditures and depreciation and amortization have not changed and are also listed here on slide 15. We did decrease our tax rate forecast slightly for fiscal 2010, from 27% to 26%, due to the change in mix of profits in low and high tax countries, as well as favorable resolution of foreign and US income tax audits. And now, I'd like to turn the call back to Frank for his closing comments. Frank.

Thanks, Tom. To reiterate, we are pleased with the direction of our business and we are pleased to be reporting core growth in all of our regions. As we have noted in previous quarters, our cost reduction efforts continue to impact our business positively, as reflected in our gross margin performance. We have also begun focusing efforts to streamline our SG&A functions through lean and BBPS. However, this may take some time before it is reflected in our income statement. We will also continue to invest in growth initiatives, especially our investment in developing new proprietary products, as well as growth through business acquisitions. We are optimistic about the momentum we have built and we'll do what we can to ensure it continues as we finish our fiscal 2010 and enter 2011. We thank you for your interest in Brady and we'll now start the Q&A. Chanell, can you please provide instructions for our listeners?

(Operator Instructions) Your first question comes from the line of Jason Ursaner of CJS Securities.

Good morning.

Good morning, Jason.

I know you've spoken a little bit before about translational versus transactional impact on your business. But I was wondering, if you could maybe give a little bit more information on your manufacturing base and your cost structure, obviously particularly in Europe with the euro and where that comes from and how it eventually impacts the bottom line?

Let me maybe kick this off and since you asked specifically about Europe, maybe Peter can add some additional comments. Our philosophy has always been to manufacture where our customers are. So in most of our countries, we have manufacturing operations for those countries, primarily for instance, China and Thailand, that's where all the consumer electronics are being made. So, all of our manufacturing for mobile phones, most of it is in China. For the hard disc drive industry, it's in Thailand because that's where the manufacturing are. And then for other products, MRO and so forth, we try to be in the countries, close to the customer.

One of the exceptions is our coating operations where we make base materials for the world. These are higher capital intensive investments, which we have primarily in Milwaukee. And then, we have some of our printer operations, which we manufacture in Asia for the world. And we have some low cost country manufacturing for standard stock products. But in general, we try to be close to our customers to shield ourselves against exchange rate swings, except for those exceptions mentioned. And Peter, in Europe, how much of your sales in Europe would you say is locally manufactured or locally sourced?

The vast majority. Now, you look at our direct marketing business, pretty well all of that is locally sourced or locally manufactured. Most of it is actually sourced because it's a distribution based business. If you looked at the other business stream, our Brady business, then we have principal manufacturing sites in the UK in Stockport, in Zele in Belgium, in Germany. So, we're somewhat protected from currency. But as Frank said, there's a proportion of our business on the Brady, of our printers, printer systems that we import from the US. So, we have some limited exposure there. Most of it's manufactured locally.

What we are protected against is translational impact of the exchange rate. So if we have a profit in Europe, let's say of 100 and the euro and dollar exchange rate moves, then it either helps us or it's against us.

Sure. And just following up with Peter, taking maybe a step back from the weaker euro. Last quarter, you spoke about an expectation for more flat growth and were you cautious on unemployment and lingering credit and capital formation offsetting the economic recovery. But this quarter showed a 6% core volume growth, which will be the first positive results in, I thin, two years. Then, you mentioned the UK was less encouraging. Do you think it's just the weak euro helping to advance the recovery or is business really improving and there's more confidence among your customers?

There is a little bit more confidence. Well, certainly up until last week, there was more confidence amongst our customers. I know how quickly things change. So, we just have to see how this sort of pans out. But the improvement, as I said, was not exactly a surprise. It was more encouraging than we'd anticipated and it's driven by a general improvement in the economic environment. But I think more so, are the fact that we've just done a lot to focus our resources on more sustainable, long-term industries. Now, oil and gas exploration, the oil prices are high, there's still lots of money for us to make in that market segment, laboratory, some other sectors. We've really done a lot over the past couple years to deploy our resources in those more sustainable, higher margin segments.

My guess would be, to finish this question up, that the weaker euro, i.e. more competitive euro, this will take some time until it will be reflected in our sales number, by just people exporting more out of Europe into other countries.

Yes.

Germany takes awhile.

Yes, it could help Germany, that's for sure.

Exactly.

And just for Frank, you've talked in the past, you have sufficient capacity, obviously, to take on debt if you choose to invest in additional acquisitions. With the debt euro denominated, do you see this as kind of the time to be investing in Europe? Is this an indication that you think Europe should be a favorable opportunity?

All our acquisitions are driven by our strategy and not so much by exchange rates. Now, there would be an add-on benefit if exchange rates move in one direction or the other. But it's very difficult for us to predict where the exchange rates are going to be in a couple of years because our acquisitions are -- if we buy a company, we own it for many years. So, we would not make decisions on acquisitions based on where the currency is at any particular moment. If it's a strategic fit, it's a strategic fit. And if the currency is favorable, that's even better.

I was asking, excluding the currency, should we just assume, since the debt is euro denominated that this is kind of the region you're focusing on?

We have our Treasurer here as well, Aaron Pearce. And maybe you can -- could you talk about the logic, why we didn't take a US dollar denominated debt but a euro denominated debt?

Hi, Jason. I would say the answer to your question is, no, I would not automatically make that assumption. The taking on of euro denominated debt is unrelated to acquisitions in Europe. Frankly, it comes down to the fact that we have a very significant asset base denominated in euros today and a very significant piece of our net income comes from Europe as well. So, taking out euro denominated debt is simply a hedge against -- a natural hedge, if you will, against our net investment in euro and the cash flow that comes out of Europe.

Got you. And then, just last question for you, for Al. In Asia-Pacific segment, you talked last quarter about the strategy to increase spec-in with higher value add technology. And as we get through the design period for the next build cycle, how do you feel you've been executing on that strategy?

Yes, quite good. We're pretty comfortable with the position that we have with all of the OEM's. Their market shares are jockeying around a little bit and so, we're adjusting our focus representatively. But we feel very good coming out of the spec-in period that typically exists in the front half of the year.

And the segment profitability, is this already having an impact or that was really just the lean initiatives that you mentioned?

Well, it's both the lean initiatives, plus some new products that we've introduced in the last six to nine months.

Okay, great. Thanks a lot, guys.

Your next question comes from the line of Charlie Brady at BMO Capital.

Hi, thanks. Good morning, guys.

Good morning.

The organic sales, as been mentioned, it was pretty strong and probably a little bit stronger than I would have thought in the quarter, which is certainly good news to see and the guidance is unchanged. And my read on that is that your expectation, given where the currency is gone, particularly the euro, am I correct in assuming that that has kind of tempered, you're kind of factoring that maybe not as positive effect as you've seen recently, was why the guidance doesn't go up any? Or is there something else? Particularly on -- the America sales was pretty strong. I'm just wondering why the expectation, given that we've got 2.5 months left in the quarter, what's sort of your visibility or what's driving your thinking on why you're not maybe a little bit more positive on the outlook, particularly for the Americas?

Charlie, this is, Tom. When you look at our business operations, certainly through the quarter, we feel good about what we've seen operationally. It's just in the last couple of weeks, ten days, two weeks, three weeks, clearly the decline in the euro and frankly, all of the foreign currencies, against the dollar is concerning to us. We have over 50% of our business is outside of the US. So, that will have a negative translation impact and then it's just the general uncertainty that we're sensing. We just didn't feel comfortable with having a good handle on the external factors as to what that would lead to in the next quarter.

Okay. Fair enough. With respect to the Securimed acquisition, can you give us a sense, if not specifically, at least maybe generally, kind of where the margins on that business look relative to the rest of the business, particularly the European division?

I can give you a generic answer. We usually don't comment on profits or margins on particular businesses. Now, this business had sales of $10 million or something like this -- $12 million. It's immaterial, so, we would not talk profits. So, I hope you understand.

Okay. Fair enough. And one final question. Is there any material exposure to Venezuelan currency?

I don't think we have any. I would say it's less than material, probably zero.

Yes, okay, thanks.

Your next question comes from the line of Allison Poliniak of Wells Fargo.

Hi, good morning.

Good morning.

Tom, you talked about near term cost, over the next quarter or two, increasing to reduce the sort of SG&A longer term. Can you quantify that or how should we be thinking about that over the next quarter or two?

Right now, we're working on the initiative and as we did with the -- when we first launched our BBPS initiatives, there's some dedicating of resources, some consulting costs and so forth. So we're calling it out, we're working through the programs right now. So, it's not something that we're willing to call out right now but we just do want to flag that. There will likely be a quarter, maybe two, of some additional expenses.

And let me just, Allison, maybe add some additional comments here. We have made good experience, I would even say, well beyond our expectations, with our investment in the Brady business performance system. We signed up with a consultant and had this consultant for quite a couple of months. And we are reaping the benefits, as you can see. Even in the last two years, when our sales declined by about 20%, our gross margins held close to 50%. We would like to repeat the success, which we had in operations in SG&A. And so, equally, we have signed up with a consultant to help us identify opportunities.

We do realize that our SG&A, compared to some of the companies we benchmark against, is high. And we see that as a great opportunity. But short term, this is going to lead to higher costs and I think it's going to be especially in the fourth quarter because that's when we have most of the consulting work being done. So, it's not going to help us short-term but we certainly think there's going to be an impact in fiscal 2011 and going forward.

Great. And then, the research and development costs was relatively flat sequentially. Should we be looking at that as a good run rate going forward, at least near term?

I would say, near term, it's probably a good run rate. Long-term, we stick to the comments we have made earlier. I have said on other conference call and I want to repeat this because it's still our strategy. We'd like to see everything in our P&L, as a percent of sales, to go down, cost of goods sold, SG&A as a percent of sales should go down. But net incomes to new product development and that's partially reflected in R&D and in strategic marketing, we would not mind if this goes up. Now, of course, we're not just going to give a blank check to our Chief Technology Officer. They have to have a project, which have a return But if we go up in R&D over the next couple of years, this would not be a coincidence. It would be intentional.

Great. Thank you.

Your next question comes from the line of Wendy Caplan of SunTrust Robinson.

Hi, good morning.

Good morning, Wendy.

Al, I have a question about Thailand. I am admittedly geographically challenged but it's an important market for us, I know. Can you talk about -- we've all read in the paper about the violence. You've mentioned in your remarks that it hadn't yet impacted the business. How would you expect that to show? And what kinds of contingency plans have you built in in case the violence continues and starts to impact the business?

Well, let me start with how we see things on the ground. And as I talk to my team over there, there's a little bit of sensationalism in Western media relative to some of the conflict that exists there. Thailand, in general, is a very peaceful country and the people have a very peaceful attitude in general. However, we're seeing the unrest that exists and a lot of it is based on the political turmoil. The power of the King in Thailand is not as strong as it used to be and I think that's one of the reasons why you've seen some of the political factions increase their activities.

What we look at is, is there going to be a disturbance to the supply chain, which means airports and trucking, is that impacted? And as strange as it is, and I certainly don't have any inside information here, but it seems like those that are creating unrest have this side bar agreement not to disrupt commerce in the area. And so far, they've done a pretty good job of that. In the past, they've closed the airport and they've recognized the significant impact that that has had. So far, those are -- the supply chain just has not been impacted by this. The good news is, when you talk about contingency plans, we have redundant manufacturing in very neighboring locations in Singapore and Malaysia. And if that wasn't enough, we could also cover it in China. So, I really don't have too much of a concern from a contingency standpoint. I just hope that, for everybody's sake, this unrest dies down in the next quarter or two.

Sure, that's very helpful. Thank you. And Frank, can you talk about where we are in the cycle in terms of layoffs and hiring across the Company? Are we still selectively laying off and are we selectively hiring? What are we seeing today?

Okay, absolutely Wendy, I just would like to make one comment. I know you know the answer but some of the listeners, which may be newer to our Company, I just want to make sure that everybody understands, Thailand, our customers in Thailand are multinational companies. Companies such as Seagate or Western Digital who make hard disc drives. So, it's not the Thai economy which impacts our sales there. It's the global demand for hard disc drives. And many of you know this but as I said, some people might not.

So then, the second question about hiring. Well, in general we are beyond, I would say, the adjustment due to the economic recession. So, I think we are done in that regard. We are not at a point yet that we have to make material investments in hiring new people because we still have productivity improvements, which we can roll out through -- primarily, through our BBPS system. And we will continue that productivity enhancement across all functions of the Company. So, I would assume that our sales per employee will go up over time as our productivity increases. Even if the economy bounces back strong, we might have to hire some selectively, I think our sales per employee still has some opportunity to improve. So no major hiring, no major layoffs planned right now.

Okay. And while I have you, Frank, several times you mentioned your new Internet distribution opportunity. Can you share with us how large, across Brady, that is today and where your expectation is in terms of growth in that distribution channel?

This really varies country by country and we have e-commerce activities all over the place. We have it especially strong in our direct marketing, our catalog business, where we see users want to buy more through the Internet. And we see increases in our sales through the Internet. But we also see a lot of people coming on our Website, going through search engines, so we work with search engine optimization and then, place the order, maybe by the phone. So then, it's not really e-commerce sales or e-commerce Website.

So, I would say it's more -- I would characterize it more as multi-channel. We don't kind of abandon the catalog from today or tomorrow. We just have additional channels to the market. The Internet is an additional channel. We are on YouTube. We are in forums. We are on Twitter and so forth. It's becoming a more multi-channel approach. Even so, we talk about e-commerce and the reason we talk about it because that's a newer, more pop area we're more focused on. Does anybody want to add something in their specific area? It doesn't look like. Bentley, our Chief Information Officer, Bentley Curran, is here as well. Maybe he --?

I would also say that e-commerce channel strengthens our other channels. In other words, it provides another opportunity for our customers to find our products, figure out what the best part is to solve their problems and place the order in the most economical way. And sometimes, like Frank says, they may get a mailing. They may check our Website out and they may call customer service. But we have multiple channels that we can address our customers' needs and move in that way. And we are focused on e-commerce in all of the major marketplaces. So, it is an area that we are continuously improving to make sure that we take advantage of the opportunity that exists in the Internet place.

I want to add one other comment to what Bentley just said. This is Matt Williamson. And that is, what's hard to predict here is the cannibalization, the impact that we would get on sales through our distributors or through the catalog or through telesales. So, our hope is that we'd drive improved traffic, improved conversion and we'd get new organic sales growth from customers. But at this point, it's very difficult to predict how much of that might cannibalize sales that we're already getting from other channels.

Sure. That makes sense. And I must say I never thought I'd have to write a research report that talked about Twitter but maybe I will. One last question for you, Peter. You mentioned some of the countries that seem to be doing better. And when you look at those, can you kind of give us some sense of the shape of the demand curve, is it jagged business? During the quarter, specifically, did business pick up a bit and then fall back and pick up and fall back? Or are we seeing kind of a smoother, albeit uncertain recovery?

No, during the quarter, it was somewhat smooth. And I talked about our success in Germany and the Benelux in France, as opposed to the UK. The UK went through an election and there was a bit of uncertainty, so that probably impacted the UK sales. So, it was somewhat smooth. And Wendy, in some part, I made mention of this, a small part of it due to economic recovery. A major part down to focusing on better parts of the market where we have more sustainable growth. And I've mentioned it in pretty well every review that we've had about our focus on process industries, oil and gas, food processing.They're very stable industries, good long-term growth prospects for our products in those industries and that's really what is driving the success.

Thank you all very much.

Your next question comes from the line of Paul Mammola of Sidoti & Company.

Hi, good morning, everyone. In terms of product lines, I would assume that facility ID is driving the organic improvement in the developed regions. But could you also comment maybe on wire ID and people ID?

Wire ID is very strong right now, particularly in the US and in Canada, across the OEM markets. We've had a lot of focus on that. So, that's very strong. And not only tied to just the core consumable products but the placement of systems, which are driving improved loyalty to the Brady brand. People ID remains a business that is lagging behind the rest of the business, we're talking about products that are driven by a couple of things. Capital investment in systems in a facility, either for a visitor or employee access control. and that's continued to be relatively slow.

And at the same time, a large portion of the people ID business are consumables, which are directly tied to the number of employees or the number of attendees at conventions and different events. And as a result of the slowness in those areas and the overall employment situation in North America, those have lagged behind, I would say, our overall core OEM and MRO business. But definitely, something we're seeing some improvement but not at the same rate as the core Brady brand business.

Okay. And then from a broader perspective, do you have a sense of what inventories are like at the distribution level and if the inventory restock opportunity, so-to-speak, is complete?

Yes, I would say that's pretty accurate.

That it's -- that restock is wrapped up?

Yes.

Okay. And then Tom, in terms of material costs, I would assume, given what pulp has done, that you've seen some rise in costs but has it been meaningful or anything that we should be cautious of over the next couple quarters?

You're referring to paper costs for our catalog?

Yes. Well, in terms of catalogs and then some of the labeling products, I would assume incorporate types of paper.

We haven't seen anything that's material to our results.

Okay. Thanks for your time.

(Operator Instructions) Your next question comes from the line of Anthony Kure of Keybanc.

Good morning, everyone. Just a couple quick questions. On that SG&A line, one sort of near term and then one longer term. I understand the incremental expense here sequentially, some of the programs you're talking about, but currency actually moved against you on the SG&A line in prior quarters. Could that actually help offset SG&A expense, some of this incremental expense, going into the fourth quarter?

Well, if you just stick to the SG&A line sequentially, yes. But as a percent of sales, the percent of sales would remain the same. So, it wouldn't be enough to offset it.

But the dollar impact, since -- we had a negative impact in the quarter because of the dollar weakening. Now, the dollar's going the other direction. So from an absolute dollar point of view, it would help us. Absolutely, Tony, you are right.

Sales are going to drop as well.

Yes, sales are going -- yes, from a sales basis, it doesn't make a difference. But if you just look at SG&A dollars, absolutely.

Okay. And then as far as the longer term outlook, just given all these programs and investments, I was looking back at 2006 and 2007, SG&A as a percentage of sales was about 33%. And that was before this cost reductions and salary bonus freezes. So, it's kind of excluding these things coming back here more in the last year or so. So, why wouldn't or would SG&A -- are you looking for that to -- maybe is there a threshold where we're looking at that 33% again here, as we move into next year and beyond? Or could it be possible that you'd actually start ticking down below that percentage of sales?

Well, Tom and I are looking at each other as to who is going to answer this question because we actually don't want to answer this question. What we have historically said and I think we're going to stick to that, is we would like to increase our operating income or net income as a percent of sales. And if you look at our gross margins being at 50% and you look at our SG&A being at 35%, we believe there might be more opportunity in our SG&A line than in our gross margin line. Not that we are are giving up on gross margin but we think there's more opportunity. And then, of course, it is -- SG&A and gross margin is very much impacted by acquisitions. So, if we were to make an acquisition in some of our higher margin businesses, many of those, let's say our direct marketing business, they have higher SG&A as well.

So, that's why we always kind of stay away from making comments about SG&A but we do think our SG&A rate, where it is right now, is not where we want it to be. We want it to be lower. I just want to tell you, certainly, we have internal targets. And over the next couple of months and years, I think we can be able to figure out how far we can take it. I can tell you this much. On gross margins, I think we surprised ourselves a little bit, how much improvement we were able to make, in spite of a recession, basically keeping the gross margin at close to 50%. So, we surprised ourselves with the Brady business performance system and we hope we can surprise ourselves, as well, on the SG&A line.

Okay. And then, in Europe, the caution that's being talked about here moving forward, is that due to what you've really seen towards the end of April and now into May? Or is it just sort of reading the news and extrapolating what we're seeing here, watching the currency charts and things like that?

I think it's the latter. It's more sort of reading the papers and various press. And it's not so much what we've seen in our results.

Okay. In Asia, up about 2% sequentially. Typically, the third quarter is stronger than that sequentially and I assume that has that Chinese New Year impact falling in the third quarter versus the second. So going forward, does that mean we could maybe see a slightly stronger, at least, according to historical patterns sequential trend into the fourth quarter?

I don't know that I'd say stronger. I think it will be representative of prior years. The thing that we're focusing on, that we talked about in the past, was profitable growth. So, we're not chasing down every opportunity. We're going after -- we're putting a lot of energy into providing unique and differentiated solutions to our customers. And so, those are the one that's we're really celebrating the successful wins at the marketplace. But I think that our fourth quarter bump will be representative of prior years.

Okay. And last question, is just with the recent debt offering and then the debt repayment, how does that impact interest expense into the fourth quarter and maybe in next year? Are we still looking at about $5 million per quarter on the expense line there?

Yes, that's correct.

Okay. Thank you.

Your next question comes from the line of Robert McCarthy of Robert W. Baird.

Good morning, everybody. Can you hear me okay?

Yes, we can hear you.

So, I got distracted for a minute there, Frank. Are you tweeting or blogging?

(Laughter) I think we are doing both.

Okay, all right. I'll get back with you on how to find that.

You can also find us on YouTube. I checked -- yesterday evening looked at a YouTube video, how to mount a sign on a fence. So, if you ever want to know how to do this, go to www.emetco.com and there's a little Emetco TV and you click on it and it shows you all kinds of stuff.

And so, I gather this is -- Frank shows you how to do these things, this is part of your strategic marketing initiatives?

Nobody has asked me yet to do this. I'm not sure if I would be -- I think there's more attractive salespeople than me.

Okay. I just have a couple of follow-up questions. On the whole euro question, maybe I can simplify. Peter, can you simply tell us what proportion of your sales are transacted in euros and does that vary much quarter to quarter?

The majority of our sales are --.

Well, I realize that. But can we get it closer to -- is it 60% or 80%?

Euros and pounds. So, Robert, go on, ask the question again, so I understand what you're trying to --.

what proportion of your sales are transacted in Euros? And does that proportion, does it vary much?

It doesn't vary quarter to quarter too much.

Okay. And I'm trying to narrow the answer from a range of 50% to 100%.

It's about 2/3, Rob.

So, the majority is in euros.

And then, another big majority is pound.

Sterling.

Pound sterling and the rest is negligible.

Okay. Very good. I think that's helpful. And as long as I'm -- we're talking about Europe. The Belgian volcano, net negative or net positive?

Well, it's positive if it allows me to get back to the UK.

Fair enough. Seriously, is there -- you guys have turned some very interesting things into sales opportunities. I just wondered if there's a --?

(Laughter) We haven't found that one. That's a good idea, though. Sort of, dust cloud extractors, I don't know, maybe we can come up with something.

An opposable bib for airplanes or something like that.

Well, we'll put some thought into that. We haven't found it.

Okay. And after -- if we covered all the ground on what you're doing strategically right now, Frank and Tom, the answer to the; Why didn't we bring up the low end of guidance range on earnings or something with only one quarter to go? Is, sure, the euro, this currency situation is an issue. But you've also made some incremental decisions to spend money on attacking SG&A, for example. Is there anything else that has been added to your short-term expense outlook beyond that?

No, I think you nailed it.

Okay. And it Seemed like I had one more here. Allan, a very high level. I thought a surprising comment, maybe it wasn't intended to be terribly specific. But in talking about the competitive environment for the MRO business -- I'm sorry, the OEM business in Asia-Pacific, you said there's been no real change in the competitive environment. But we just came through the worst couple of years for the mobile device market since they invented mobile devices. And I had thought I'd understood that a number of smaller commodity focused Chinese players had gone out of business. So, is it maybe a little different and we just need to be talking about a longer time frame? Or were you conveying, in part, that we're moving our market away from some of that, where we would have gotten some benefit probably?

Well, just to be clear, I want to make sure that you heard me correctly. What I meant to say, if I didn't, is pressure from competition is as strong as it's ever been. What we're doing is ducking some of that in what we would call the commoditized space. So, parts that maybe there's maybe five to ten companies that could manufacture, that gets into more of a pricing war. And so, where our customers have candidly told us that we provide more value to them is when we come in and we solve their more difficult solutions. And that's where we march our new product development teams and our marketing teams in with blank sheets of paper. And we get on a white board and we help them solve their problems through a combination of developing new high performance materials and converting and assembling those in unique fashion. So that's -- if there is a little bit of breathing room, it's that we differentiate ourselves and we have less competition at the high end of the marketplace.

Rob, you said of those low cost start-up manufacturers might have left the scene, they might have maybe ceased to exist. I'm not sure if this is a correct statement because if some of those -- this happened, maybe some new ones emerged at the same time. And we'd be focused on this lower end, maybe we could have had some benefits but that's really not our strategy. Our strategy is to move into higher, more profitable solutions. And Al has been communicating this now for a couple of months. And we are really making progress in this. And I think he has also said that we are sacrificing sales growth in order to increase profitability of our business, in this region, in those product lines. So, I think we could show higher organic sales growth if we want to play more and stronger or continue to play strong in the commodity segment. But we have made a conscious decision to sacrifice organic sales growth in order to become more profitable in this segment.

Well, Frank, I think everybody is comfortable that you've got the right strategy there. We're anxious to see strong profitability resulting from it. I kind of got the impression when Allan made a comment about volume growth on a per handset basis continues to grow but then distinguished the fact that you're not chasing all of that. Are you in an environment where there isn't simply a lot of volume growth for the kind of product that you want to go after and so you need a higher hit ratio?

No, not at all. Take a high end SmartPhone, for instance, and there's perhaps upwards of 55 parts that Brady could manufacture in there. We're looking at the 55 parts and saying, "Which subset of those are the really difficult ones that either no one else can supply or very few people can supply?" And going after that. And typically, those tend to be higher priced and higher margin because of the capabilities that are required to go after it. But if there's 1.1 billion phones that are manufactured and let's say 300 million are SmartPhones and those are growing at 25%. Then, that subset that we're chasing in the SmartPhone market has very attractive growth figures associated with it.

And in a situation where there is a population of 55, just to help us all understand, what kind of focus we're talking about. Is this a world where you're really focused on ten or fewer parts?

How about 20 or fewer.

Okay, that's helpful. And then, as long as we've got a little dialogue on how your business is developing there. On the slide, good position on key product specifications for fall build cycle. This is the most optimism that I've seen you guys willing to commit to in this market since I've been covering the stock. And I don't think that's a mistake. I'm asking you to confirm that you're feeling better about this business than you have in -- you've been talking about a strategic shift for several quarters. I get the impression you feel better about this business than you have since, perhaps right after you did the big acquisitions in 2007.

Well, I can't say that I feel wildly different about our wins at the design centers this year versus prior years. We've done well in the past and we continue to do well. I'm very pleased that the -- we spent a fair amount of money chasing down some of these high end solutions. Understanding what the needs of the marketplace are with our marketing team. And then, developing products and solutions. And so, it's very reassuring to see that those solutions are being well accepted and hard speced into our customers. I'm optimistic but relative to our wins at the design centers, my optimism would be equal to prior years.

If I could maybe give the CEO's view here. I totally understand where you're coming from. We had discussions over discussions with analysts and investors about this segment because within two months, we tripled our presence in mobile phones. And at the same time, the price competition between the major mobile phone manufacturers just heated up tremendously. And then, I'm sure many of them or their subcontractors were very cautious in placing orders with us. Because we had a major restructuring going on by trying to get three businesses together, closing operations and so forth. So, we probably lost some share. And so, it was very difficult to be optimistic and positive with all the changes there and the deteriorating profitability. Our profitability has improved. We have made significant investments in R&D.

I'll just give you an idea. We had five people in R&D two years ago or three years ago. Now, we have about 70. They're not only working on this but also working on MRO in Asia but also working mobile phones, hard disc drives and so forth. And we also know that some of our businesses are pretty profitable. I think lean has helped us become more profitable. So, we have a combination of more proprietary products in the high end market, a leaner operations. And you put this together with the fact that we have the restructuring and the turmoil by tripling our size behind us, you put this together, all of a sudden, absolutely, we feel more positive about the space. This is a fast growing space. And if you can figure out how the to make this a more profitable business and I think we are on the way to doing this, absolutely we feel better about it.

Just by way of closing out, I did not mean to suggest that you've not been able to demonstrate good progress here. And I think Al and you and your team deserve some credit for -- you guys have done well. Anyway, all very helpful. Thank you very much.

And your final question comes from the line of Jason Ursaner with CJS Securities.

Hi, just very quickly because I'm aware how long the call is going. Two quick follow-ups. On SG&A, with a deep pipeline of potential targets for the various businesses, is there a quantifiable expense you could break out for acquisition related resources, accounting, consulting, et cetera, that was incurred in the quarter?

We don't have this information right now here. I think -- haven't there been some accounting changes, as well, that we now have to expense more than we had to do historically?

There was expenses that added to a sequential SG&A but it's not material.

Okay. And the reversal of bonuses last year, was that -- can you quantify that, how much it lowered it?

No, what we can say, we had about a swing of $10 million reversal of bonuses last year and accrual of bonuses this year. And it's about 50/50.

Okay. And then last question. Just a little bit more serious look at the long-term impact of the multi-channel approach. It really allows you to get a much deeper reach into your customers and channels but at the same time it seems almost conflicting from what we hear from large distributors about strengthening their almost entrenchment at large enterprise clients. And Frank, I know you've spoken about a real focus on these larger macro trends. So, how do you see these channels eventually impacting your distributors? And do you get a sense that end customers, maybe even retail customers, are they more willing to seek you out directly on the Internet through a search? And how do you eventually see this impacting margins?

I think that's a question, which goes beyond this conference call. It's a great question. I think the answer would be a very long answer. But you are absolutely right, there's a trend that some customers want to deal directly with us. They want to place orders with us and they historically, maybe they have gone through distribution and now, maybe they want to work directly with us. So we have to work with our distributors to take advantage of this because what we are actually after are those maybe additional new customers, which we would like to get, which neither our distributor nor we could have gotten in the past. By having a Web presence, where they could come directly to us and then, somehow with our distributors with us, can share the business. I don't want to be too specific because we're working on this right now. Actually, we have been pretty active in this area. But I think it's a very long discussion, which I don't think we want to go into details. But you have your finger on the right point.

That's fine. Thanks very much for taking my follow-ups.

That concludes the Q&A session. I would now like to turn the call back over to Mr. Aaron Pearce.

We thank you for your participation today and would like to remind you that the audio and slides from this call today are available on our Website at www.investor.bradycorp.com. And the replay of this conference will be available via the phone beginning approximately 12:00 noon Central Time today, May 19. The phone number to access the call is 1-888-286-8010 or for international callers, it's 617-801-6888. And the pass code is 93426255. And the phone replay will be available until May 26. As always, if you have any questions, please feel free to contact us. Thank you for your interest in Brady and have a great day. Chanell.

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.