Brady Corp (BRC) 2011 Q1 法說會逐字稿

Good day, ladies and gentleman, and welcome to the first quarter 2011 Brady Corporation earnings conference call. My name is Michelle and I will be your operator for today. (Operator Instructions) As a reminder this conference is being recorded for replay purposes. I would now like to turn the conference over to your host, Mr. Aaron Pearce, Vice President, Treasurer and Director of Investor Relations. Please go ahead.

Thanks, Michelle. Good morning, everyone. This is Aaron Pearce, Director of Investor Relations for Brady. Welcome to our fiscal 2011 first quarter conference call. We are very happy you could join us. During the call this morning you'll hear from Frank Jaehnert, CEO and Tom Felmer, CFO, who will review Brady's first-quarter financial results. Also joining us this morning are our three Regional Presidents, Matt Williamson, President of the Americas, Peter Sephton, President of Europe, and Al Klotsche, President of the Asia Pacific region, 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 respective slides throughout the presentation. These slides can be found on our website at www.investor.bradycorp.com. We'll be starting with slide number three. You'll have a few moments to get to those slides while be go through our usual introductory information and Safe Harbor Statements.

Please note that during 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 last Form 10-K filed with the SEC in September of 2010. Also, please note that this teleconference is copyrighted by Brady Corporation and there may be no rebroadcasting of this call without the express written consent of Brady. We will be recording this call and broadcasting it on the internet. Your participation in the Q&A session will constitute your consent to being recorded. Thank you. And now I'd like to turn the call over to Frank Jaehnert.

Thanks, Aaron. Good morning and thank you for joining us. I'm pleased to report that our fiscal 2011 first-quarter diluted EPS excluding our after-tax restructuring charges of $0.05 a share grew 19.6% versus the same period in the prior year to finish at $0.55 per share. Net income in the quarter was up 18.9% versus the prior year to finish at $28.9 million excluding after restructuring charges of $2.6 million. Our improved earnings were primarily due to the positive impact of our ongoing process improvement activities, strategic sourcing and other initiatives related to the Brady business performance system as evidenced by our improved operating margin of 13.7% of sales, versus 12.3% of sales in the prior year.

Our fiscal first quarter 2011 sales grew 3.5%, which included an organic sales increase of 2%, acquisitions accounted for 2% as well, and currency was a head wind of 0.5%. While this is nice improvement in our profitability, we saw only moderate organic sales growth in our first quarter, as our first quarter last year was already the strong quarter with strong hard disk drive related sales in Asia and strong sales of Swine Flu kits in our European Direct Marketing businesses.

Looking at our regional sales results, we saw regularly flat organic sales in our Asia business as we continued our successful strategy of focusing on high end applications and focusing on our MRO business while de-emphasizing lower end commodity paths. This Asian strategy is working as we continue to see increases in both the absolute dollars of segment profit as well as segment profit as a percentage of sales.

In Europe and the Americas, we saw single-digit organic sales growth. That will be explained in more detail by Peter Sephton and Matt Williamson during their respective regional financial reviews. I'll be back later in the call to summarize our results for the upcoming quarters after our business leaders provide more details in their regional updates, but first I'd like to turn the call over to Tom Felmer for first-quarter financial review.

Thanks, Frank. Let's move to slide number three, which is a summary of our first-quarter results. As Frank mentioned, our first-quarter financial performance included an 18.9% increase in net income, exclusive of after-tax restructuring charges and organic sales growth of 2%. We also saw a 50 basis point improvement in our gross profit margin as our first-quarter gross profit margin finished just shy of 50% at 49.9%. SG&A expense declined to 33.2% of sales in the first quarter, compared to 34.1% in the same quarter last year, and operating income increased 140 basis points in the first quarter to finish at 13.7% of sales.

Overall, we are quite pleased with our profitability improvements. These improvements, combined with favorable foreign currency exchange and a positive outlook for the second half of the year, lead us to increase our fiscal 2011 full year earnings per diluted share guidance to $2.05 to $2.25, compared to our previous full year guidance of $1.95 to $2.15 per diluted share. After the regional reports, we'll provide a bit more commentary on our thoughts in the upcoming quarters. Slide four outlines our historical sales.

We are pleased to report that this quarter marks our fourth consecutive quarter of organic sales growth. As you can see on the charts on this slide, our fiscal 2010 first quarter was a strong revenue quarter providing challenging comparables. Acquisitions provided a sales lift of 2% in the quarter and even with the recent weakness in the US dollar versus many other currencies, exchange rates were still a head wind of 0.5% when compared with the first quarter of fiscal 2010.

Slide five shows that our gross profit margin continues to improve as we drive process improvements throughout our businesses resulting in gross profit margin of 49.9% in the first quarter. This marks the highest quarterly gross profit margin that we've seen in the last five years. On slide six, you can see that in absolute dollars, SG&A was relatively flat when compared to the first quarter of last year but down to 33.2% of sales compared to 34.1% last year. As we've discussed in previous calls, reducing our SG&A as a percentage of sales will continue to be a focus area for the organization.

We will also see some of this improvement offset next quarter as we will see annual merit increases for the entire Company go into effect beginning in November. Excluding restructuring charges, operating income was $45.2 million in the quarter, up from $39.2 million in the prior year. As a percentage of sales, operating income was 13.7% in the quarter compared with 12.3% of sales in the first quarter of fiscal 2010. This marks the fourth consecutive quarter of year-on-year increases in operating income.

Slide seven we see that GAAP net income for the quarter was $26.3 million, an increase of 21.3% versus the first quarter of last year resulting in diluted EPS of $0.50 per share. After adjusting for after-tax restructuring charges of $2.6 million, we generated net income of $28.9 million and $0.55 per diluted share. This represents a 19.6% increase in diluted EPS before restructuring when compared to the same quarter in the prior year.

On slide eight we summarize our cash flow and cash position for the quarter. We continue to generate strong cash flow from operating activities and strong free cash flow. However, first quarter cash flow was reduced by the payment of our fiscal 2010 annual bonuses in the first quarter of 2011. We continue to forecast strong cash flow as we anticipate that our full year, our full fiscal 2011 free cash flow will approximate 120% to 140% of net income.

On the first-quarter cash balance walk, we generated $16.2 million of cash from operating activities, invested $2.8 million in fixed assets, and paid $9.4 million in dividends to our shareholders. Currency increased our cash balance by approximately $6.3 million, resulting in an ending cash balance on October 31 of $326 million. We did not make any payments for acquisitions during the quarter; however we did announce the acquisition of ID Warehouse in Australia on November 1.

On slide nine, our gross debt is $451 million and our net debt is $125 million at the end of the first quarter. Our net debt to EBITDA continued to decline finishing at 0.7 to 1. We believe that with our current cash balance, our untapped $200 million line of credit and conservative leverage that we have adequate flexibility to support future growth.

Moving on to slide 10, our first quarter yielded several significant new product launches. New products launched in the first quarter included ToughStripe, printable [fore-] marketing labels for the manufacturing workplace and the easy to use BBP 31, industrial sign and label printer. This printing system allows our customers to easily and intuitively access and print from templates or create their own signs or labels by easily interacting through a touch screen interface or a full keyboard.

As you can see, we continue to invest in research and development, spending $9.9 million or 3% of sales in the first quarter, which is consistent with the first quarter of fiscal 2010. The decrease in R&D spending as a percentage of sales compared to the fourth quarter of fiscal 2010 is due to the timing and spending on certain research projects. Our commitment to the development of innovative products has generated a substantial pipeline of concepts and programs still under development. We believe that our investment in R&D and associated strategic marketing and product management activities will be a key driver of future organic growth and profitability.

And finally on slide 11, we break out our restructuring charges for the quarter; the after-tax impact of this quarter's restructuring charges was $2.6 million or $0.05 per diluted share. Restructuring in the first quarter was comprised primarily of continuing certain facility consolidations that began in fiscal 2010 as well as the implementation of certain initial actions to streamline our SG&A functions. We continue to forecast approximately $12 million to $15 million of pre-tax restructuring charges for the full year of fiscal 2011. I would now like to turn the call over to Matt Williamson for an update on the Americas business. Matt?

Thanks, Tom, and good morning, everyone. Please refer to slide number 12. Americas sales in the first quarter were $146 million, up 7.2% compared to the prior year. Organic sales were up 4.3%. Currency contributed 0.7%, and revenue growth from acquisitions was 2.2%.

In the Brady brand business, our overall sales growth versus the prior year and sequentially over the fourth quarter was solid in the US, Mexico, and Canada driven by the execution of our strategy to develop proprietary consumable products for our hassle free printers and by additional customer applications such as spill control, wire identification, lien compliance and brand protection.

Late in the quarter, we launched two new products that will drive new organic sales. As Tom mentioned, the BBP 31 is a completely new printer for making industrial signs and labels. This is our third printer launched in the past 12 months and like the others, it is shaped by Brady's proprietary system and software technology, making it completely hassle free for our customers to easily make products for signage, pipe marking, control panel labeling, and a variety of other applications from a selection of Brady materials. You can see this printer as well as other new products on our BradyID.com website.

In addition, we launched our ToughStripe floor marking tape, an ultra durable material for use in marking factory and warehouse floors.

In the direct marketing business, the US catalog businesses experienced positive sales growth driven by our targeted strategy to grow its house file of customers, increasing sales over the internet, and improved customer conversion and retention. Our Brazil business continues to yield positive sales growth year-over-year in both MRO and OEM markets as we focus our strategies to drive MRO sales through new distributors and via the internet and bring more overall value to our OEM customers.

Additionally, we continue to integrate the Stickolor business which we acquired last year, which has been performing nicely. Segment profit for the Americas increased 20% to $39.4 million in the quarter. As a percent of sales, segment profit reached 27.0% compared to 24.1% in the prior year.

This quarter marks the Americas highest segment profit as a percent of sales in the last five years. Profitability is being driven by sustainable gross margin improvements from the execution of our direct marketing pricing and growth strategies; continued facility consolidations, as we relocated our Burlington, Massachusetts factory to an existing facility in the first quarter; and execution of our global sourcing strategy; and by our sales volumes over our fixed cost base.

Additionally, we have reduced certain selling expenses in the region as part of our strategy to optimize effectiveness of our sales and marketing teams. We also continue to invest in advertising and our direct marketing business as a part of our strategy to grow our customer files coming out of the recession.

Overall, we are quite pleased with our ability to improve profitability in the first quarter, while at the same time investing in growth initiatives including new products, increased catalogs to design our direct marketing customer base.

Going forward we expect our seasonally adjusted sales and profitability to steadily improve due to our investment in new customer acquisition, new products, E-business, sales productivity, and the execution of other strategic initiatives that will drive profitable sales growth. Now I'll turn the time to Peter Sephton who will report on the European results. Peter?

Thanks, Matt and good morning, everyone. Draw your attention to slide 13. Sales in Europe were $92.1 million for the quarter, down 2.4%. Organic sales were positive by 0.7%, acquisitions added 3.8%, but currency reduced sales by 6.9%.

Overall, most of our businesses are now performing at a slightly higher level than the first quarter of last year. Although the underlying growth rate remains somewhat modest, we take some encouragement that after excluding the impact of non-recurring benefits from last year, our core business is performing above a generally sluggish rate of economic growth in Europe; with a combined Euro-zone, economies grew by just about 1%.

We had an additional factor influencing core growth this quarter because of our sales in the first quarter of fiscal 2010 were boosted by non-recurring sales related to Swine Flu and legislation changes in the UK, making it a tough comparable. This was most noticeable in our European direct marketing businesses where organic growth was flat this quarter due to the absence of the one off revenue we benefited from last year.

Excluding these one-off items, we experienced low single digits underlying core growth in our direct marketing businesses, despite the effects of the reduced public spending in the UK. Although the sales were soft in the UK in countries such as Germany and Central Europe, we show core growth figures in the high single digits and a healthy recovery in our house files. We add new customers. Our recovery in Germany is particularly encouraging, driven mainly by a robust economic recovery which should continue into the future.

Our core business in France remains robust with single digit growth once the effects of the Swine Flu are excluded, and we had such a varied recovery across our economy, we're taking numerous actions to rebalance our contact strategies so that we can take advantage of the variations in economic recovery and improve our overall growth rates.

Moving on to our Brady Brand business, in general it's performed well, with positive single-digit growth revenue in the quarter. The best performers were in Germany and France, two of the countries leading the economic recovery in Europe, but organic growth was also modestly positive in our Brady UK business, which is encouraging given the severity of the public spending cutbacks and demonstrates the success of our market of focus strategy that deploys resources to higher growth opportunities such as food processing and the petrochemical industries.

As in the Americas, new products introductions played a positive role in our performance. Most noticeable were the robust sales of the BMP 21 and BMP 71 printers, which have both received an excellent market reception and continue to beat our sales projections. We've also invested to help us gain an improved understanding of customers' unmet needs through discovery voice of customer resources, which will in turn help us fill our MPD pipeline.

Overall Europe segment profit in the quarter was $24.1 million, which is 3.2% below the same quarter of last year; primarily due to the impact of foreign exchange. Our segment profit as a percentage of sales was 26.1%, versus 26.4% in the same period last year.

In general, the economic recovery in Europe is still somewhat fragile, but is improving. Foreign currency in prior-year comps created some headwinds for sales growth in this quarter, and if we exclude those effects of Swine Flu and low poster sales from the prior year, our underlying growth was in the mid single digits.

Looking forward, generally there is some favorable economic indicators that impact our particular business, mainly related to export growth in new capital investment and despite the woes from Ivan recently.

The UK, however, remains an area of concern. Our earnings as a percentage of sales continue to hold at high levels as we strive for productivity improvements. For instance we're in the early phases of realigning our sales and marketing teams, to better service our customers across the region and gain economies of scale to drive sales growth, and improve our profitability even more.

In summary, we are somewhat confident about our prospects, but remain cautious because of a challenging and sometimes confused economic environment in the region. And I'll just turn it over to Asia Pacific, and Al.

Thanks, Peter and good morning. I'm continuing on slide number 14. Asia Pacific sales in the first quarter were $91.6 million up 4.1% from the prior year. Organic sales declined slightly at 0.3%, while currency had a positive impact of 4.4%. The minimal change in top-line sales was due to our continuing and successful strategy of moving away from lower end commodity parts and replacing them with higher end engineered solutions. Our continual increase in year-over-year profitability during the last four quarters is evidence that the strategy is working well.

Segment profit in the region was $16.8 million, up 11.3% from last year's segment profit of $15.1 million in the first quarter. As a percent of sales, segment profit was 18.4% versus 17.2% in the prior year. Historical top-line trends for growth in our first quarter seemed to be less pronounced this year, somewhat due to delays in a few specific programs at one of our leading OEM customers and inventory levels in the storage market which have resulted in sluggish demand. In the past, I have spoken that some cell phones have had as many as 50 different Brady parts in one device. Our strategy has been to move away from focusing on all of these parts and instead to focus on a smaller number of higher end materials which solve performance problems such as overheating, optical clarity, and sound and vibration damping.

Since building a local R&D team in Asia, we have worked to refocus our commercial resources on markets who value these high end solutions. Because the electronic supply chain is so integrated, we are finding these opportunities both within our traditional markets such as mobile phones and hard disk drives, but also in adjacent applications such as displays and tablet computing. Our success in these newer markets has been driven by a new product development platform strategy.

Examples of this would be specialty materials which passively dissipate heat in tight form factor electronic devices. These films and materials are more replicable across a wide variety of customers and applications than some of our historical parts which were focused on one customer, one application, and one model. Some of these higher end solutions are so complex in form and function that their average selling price can exceed the combined price of 10 or more of the traditional commoditized parts.

After six quarters of pursuing a strategy of margin improvement versus pure growth, we are pleased with the resulting profit improvement. We anticipate it will take one more design cycle or approximately our next three fiscal quarters before our business mix settles into a new equilibrium and more closely tracks market growth rates. While we have sacrificed some organic sales growth over the past four to six quarters in order to focus on more profitable opportunities, we anticipate that the increase in new opportunities will exceed the decline of low margin products, and we will begin to see more positive growth rates in the second half of our fiscal year.

We continue to see nice growth in our Australian business, fueled in large part by the growth in the mining industry. Open cut mines have a significant need for large, industrial safety products. The planned construction of some of the world's largest offshore rigs off the coast of Northwest Australia also offers significant opportunities for Brady's MRO products.

It is also worth noting that we announced the acquisition of ID Warehouse on November 1. ID Warehouse is Australia's leading supplier of people identification products. This represents the fifth acquisition which we will integrate into our core Australian business. Elsewhere in the region, our MRO business is growing nicely based on the success that some of our larger strategic channel partners are having with our proprietary printing systems.

The suite of handheld and benchtop products which we have introduced is helping Brady establish a great position in the marketplace, and is also helping us to generate more new product ideas for the region that we are beginning to fold into our new product pipeline. We believe that creating new products that are designed specifically for Asian markets will help increase our market share across the region, and accelerate our organic sales in the MRO space.

The combination of healthy economies across much of Asia, a robust new product pipeline, and a hard disk drive market that is on pace to work through its inventory issues gives us confidence in fiscal 2011, but the short-term trends around market share shifts and excess inventory levels give us some caution for the remainder of this calendar year. I'll now turn the call back to Tom Felmer.

Thanks, Al. Moving to slide 15, this shows our new guidance for the full fiscal year 2011 of diluted EPS of $2.05 to $2.25 exclusive of pre-tax restructuring charges of approximately $12 million to $15 million or $0.17 to $0.21 per share. This compares to our previous full-year guidance of $1.95 to $2.15 per diluted share. The drivers that lead us to lift guidance for the year are primarily our gross margin and SG&A productivity initiatives, as well as a weaker dollar that should translate into higher sales and profits for the balance of the year.

We are encouraged by our 50 basis point gross margin improvement, and 90 basis point SG&A improvement in the first quarter, as well as plans to reduce SG&A as a percentage of sales and improve productivity throughout the organization through our Lean activities. Some of these benefits will be offset by Company-wide merit increases that go into effect in November. This, combined with softness in the hard disk drive market, may temper some of the improvement in the second quarter.

We believe that approximately one half of our increase in earnings will be driven by productivity improvements throughout the year and the other half of the improvement in earnings will be driven by the lift in sales and profits from the improved exchange rates. Guidance assumptions for capital expenditures, our income tax rate, depreciation and amortization expense and restructuring charges have not changed and are also listed on slide 15.

Overall, as the global economy continues to improve slowly and we are on track to have mid single digit organic growth for the remainder of 2011. Now, I'd like to turn the call back to Frank for his closing comments. Frank?

Thanks, Tom. Our priorities remain unchanged and focused on customer driven growth through market and customer segmentation and multi-channel marketing, as well as improving the productivity and efficiency of our operations and sales and marketing teams around the world. We will also continue to invest in growth initiatives including business acquisitions, both within our core markets and in near adjacencies, in our investment in developing new proprietary products.

We're excited about the success of our recent product launches and the robustness of our new product pipeline. The numerous product launches of last year and those that will come this year demonstrate the commitment we made to invest in organic growth, [securing] the depths of the recession. These products, along with generally improving business climate and customer demand, will form the basis of organic growth in the coming quarters. We thank you for your interest in Brady. We'll now start the Q&A. Michelle? Can you please provide instructions for our listeners?

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

Good morning, everyone.

Good morning.

Congratulations on the strong quarter. First, SG&A. You talked a lot last call about identifying opportunities to reduce SG&A as a percent of sales, then it looked like it held flat as a percent sequentially from Q4, but if I go back to the previous couple of first quarters, it's still about 200 basis points above the 2006 to 2008 fiscal year average for first quarter. So how much do you think we have to go on that front, and at what point would you be satisfied with progress?

As far as how much further do we have to go in terms of --

In terms of reducing it as a percent of sales, how much do you think we have left?

We've been careful not to talk about absolute numbers. As we've said, with the number of business units that we have, it's tough to really say when and how deep those changes or the improvements will show up in the income statement. I think we've said with BBPS, it actually took two to three years before we saw the full effect of our BBPS initiatives on the margin line, and we said that there's some initial investments in the early phases of the process.

But as we look at the first quarter, what we've seen is that we've actually had some early wins, and when you look maybe not sequentially, but clearly compared to our first quarter of last year, and relatively flat sales, 2% organic growth, we did see a 90 basis point improvement. So we feel that things are heading in the right direction, and we're still early days in the process, but it still may take some more time before we understand how much opportunity there really is.

Okay, and was there any one-time expense, obviously a small acquisition, but was there anything related to the Australia in there?

Again, the Australia acquisition was made after the quarter, so nothing shows up in our results from Australia.

We had still some remaining consulting expenses, nothing like what we had in the fourth quarter, but we still had some, and your question regarding compared to maybe a couple of years ago, where do we stand in SG&A. Well certainly, our sales levels are still not back to where they used to be before the recession started, and we intentionally did not cut back in our sales and marketing organization as much as we cut back in other parts of the organization, because we feel this might give us a competitive advantage compared to some of our competitors, who might have had to cut deeper. So we think that's a strategy which is going to pay off as we continue to come out of this economic recession.

Okay, and in the Americas, on 4% core growth, the segment showed very strong profitability improvement. How sustainable a level do you feel this is, and going back historically, Q1 tends to be the strongest quarter, at least on a percentage basis by a fairly wide margin. So can you help me maybe understand what drives the seasonality in that segment, and is there any specific mix shift that occurs throughout the year, or is it really a structural improvement as a result of the productivity initiatives?

Wow. Which of those five do you want me to answer first? Seasonality, there's some seasonality to our business, but not huge. The profitability I think is very sustainable; all the things that we're doing are designed around that, so we think that that's very sustainable going forward.

In terms of mix of products, I think that was another one of the things that you brought up. I would say that there's not anything notable there, but one of the things that is happening is that as we launch more of the printer products that we've been doing over the course of the last year, the whole purpose in that is to drive up a higher mix of consumable products to the printers themselves, with these proprietary consumables, and those carry a higher margin than the printers themselves. So that is something that impacts our margin positively as well. But otherwise, the things that we're doing, facility consolidations, the types of products that we're launching, the types of initiatives in sales and marketing, these should carry the profitability in a sustainable way.

I just would like to make a comment to our seasonality. I do believe that we still cannot talk about a normal economy, and therefore normal seasonality. We believe the economy recovers moderately, but it recovers; that's what we are seeing, that's what we are hearing from our customers. And so because of this, we cannot say that first quarter is typically, historically, our strongest quarter. Actually, we believe that we will see improvement in organic sales, and specifically for the Americas as the economy continues to recover, so therefore the seasonality at this point of time is maybe not so much a guideline as it would be in a normal economy.

Okay, great. And then free cash flow, you'd been generating well above 100% of net income for the last couple of years. This quarter clearly was a lower level, but had some of the bonus comp payout, I'm assuming. Perhaps you could speak a little bit more about working capital needs relative to sales growth?

The working capital needs are primarily going to be tied to receivables, so I don't think that it would be anything material as you look at your models. We still expect to generate cash flow in excess of net income. I think we said 120% to maybe 140% range.

And does the working capital needs change at all if you're not seeing strong inventory restocking at the distributor level?

I don't think it would be material as you look at things going forward.

Okay, great. Thanks. Thanks for taking my questions.

Thanks, Jason.

Your next question comes from the line of Charlie Brady of BMO Capital Markets. Please go ahead.

Thanks, good morning.

Good morning.

With respect to the SG&A expense again, you mentioned in your prepared remarks the merit pay, kicking back in starting Q2. Can you quantify what impact to the SG&A that is going to have?

No, we've never called that out. It's something that -- the only thing that we point out is that just the way that our Company operates, they all go in at the same time instead of being put in throughout the year. So there will be an uptick in expenses beginning with the second quarter. So it might temper the SG&A improvements a little bit in the second quarter, but we still have activities that should continue to work down SG&A following that.

When you talk about the improvements, you're referring to as a percentage of revenues?

Correct.

Okay. And Frank, I just want to go back to a comment you made a moment ago about seasonality in the Americas. There has historically been pretty good seasonality, anywhere sequentially 5% to 10% kind of on average downtick from Q1. Are you saying that because we're coming out of such an unprecedented downturn, that either the seasonality is muted or just non-existent? Would you expect America's sales to be up sequentially in Q2?

Thank you for this question. Absolutely not. I do not expect this. The second quarter from a seasonality, has always been and will also this year be a weaker quarter. It's just because we have Thanksgiving, we have Christmas, we have New Year. It will be weaker, but except for this. I would say that normal seasonality, which the comment was made, first quarter is typically your strongest quarter, and suggesting maybe third and fourth quarter might be weaker. And I think this might not be true this year because we are still coming, we're in the early stages of a recovery. But I still think the impact of all those holidays in the second quarter will have an impact on seasonality, even during a recovery. You will see this.

Okay, that makes sense. I just wanted to make sure.

Thank you for the question. It was great that you asked this question. I didn't want to mislead people on this one.

Right, understood. Can we talk about Asia Pacific for a second. You talked about the MRO opportunity in Asia Pacific, which is relatively small for AP right now, but that's an area of focus. Can you just talk about the opportunity that you see there over, not even just this year, but maybe over the next two or three years?

Yes, I'll let Allan Klotsche here answer this question as he is driving this initiative.

Yes, thanks, Frank. It really depends on what part of the region you're looking at. If we go up to north Asia, China for instance, it's a huge marketplace that is beginning to accept western or modern standards for safety products, and so we've been working really hard on two things. One, educating the marketplace on the importance of safety standards, and then building up a distribution channel, which doesn't exist to the same extent that it does in North America and Europe. So we've been working on that for probably the last couple of years, and we're starting to see some pretty nice [adoptance] and acceptance of the global products which Brady has launched.

And then as I mentioned in the script, we're starting to do some more voice of the customer, and understand maybe some specific needs that Asian customers have or Chinese customers have that are different than the rest of the world. And so have begun the process of developing specific products to meet their needs. So we're excited about the potential in the China marketplace.

If you go over to places like India, it's less developed there. Their infrastructure isn't as rapidly increasing as China, so we think that the growth of MRO products in India probably will be more five to 10 years out than in the immediate future. And then if you go down to Australia, very developed western market, where Brady has a strong position and is recognized as a leader in the safety industry, and we continue to hold our own there, and take advantage of some of the nice opportunities around the export markets, or the export businesses that Australia is focused on.

Thanks. One more, and I'll hop back in the queue. Just on the R&D expense, I just want to make sure I understood you correctly. Did you say that there were some delays in some product development in Q1 that maybe made it a little bit lower than otherwise would have been, that might be made up in Q2 and second half of the year?

Yes, I think the comment is, we've been talking for the last two years that we expect to see R&D expenses tick up a little bit as we invest in the new products in Asia and the Americas. And we're just saying that if you look at spending in R&D, it ticked down a little bit from where it had been, and it will go back up some as we go forward in the year.

Thanks for clarifying that.

Your next question comes from the line of Wendy Caplan of SunTrust Robinson Humphrey. Please go ahead.

Thank you, good morning.

Good morning, Wendy.

A couple of things. First, I don't think I heard you talking about material costs, and if you could kind of give us an update as to what you're seeing in your major categories. And conversely, kind of what pricing you've been able to get to offset some of that?

A material line -- because of the fragmented nature of our products, as you know, we either make or source most of our product in the region that it's sold, but sometimes it's difficult to see what the macro impact is across all the commodities, but historically we do not have anything that materially impacts the material line. We don't have anything that we've called out historically related to steel or any other materials. And I think the commodity that would have the biggest impact on us might be petroleum.

But again, because of the fragmented nature, we're typically able to fight back a fair amount of the cost pressure, and when we do get the price increases, we try and pass those along. As far as pricing impact, I know last year we had minimal price increases across the organization, and we do see passing along price increases again this year across most of our businesses.

And I guess new products represents an opportunity as well, in terms of pricing. Can you address that? And also, the new products that you called out from the first quarter, are they all incremental in terms of sales, or do they take some from prior generations of printers, for example?

Bob, do you want to take this? We are lucky that we have our Chief Technology Officer, Dr. Tatterson with us today, and I think it would be a great opportunity for you, Bob, to maybe address this question.

Yes, good morning. That's a great question, and certainly that's one thing we track very closely is the degree of incrementalism or cannibalism in every product development that we do, specifically the printable floor marking labels, that's a totally new category for us, and historically we've had floor labeling. Last quarter, we introduced the pre-printed floor marking, which is a substantial improvement, so there is some cannibalization with that product relaunch the previous quarter. But with this product, it essentially is a new category for us.

Specific to the printer, we've had a printer historically that had similar capabilities. So there is a degree of cannibalization there, but this product, given its really tremendous ease-of-use and attractive price point, we're expecting significant growth beyond that historical base.

How about some of those products, Bob, in Asia, like the gap filler?

Yes, certainly our focus is to drive absolute organic growth. So we are focusing on products that have minimal cannibalism, and for example, certainly a lot of our products in the electronic space, such as our thermal gap filler materials, those are truly bringing new capabilities to the marketplace, so those would represent 100% incremental opportunities.

Wendy, we look at new product development maybe a little bit different than we have done in the past. In the past, the majority of it was replacement or improvements of prior products, which is nothing wrong. Every car manufacturer brings out a new car with some new features, and that's what we have been doing also. But [really] new product development as a means to achieve two purposes. First, increase our organic growth over time. And second, defend our increase across margins by coming out with something proprietary. That's -- I think you will see over the next couple of years us making progress in this regard.

And I guess, Frank, we wouldn't be wrong to assume that the margin in these new products would be a bit higher than some of the existing products.

Bob?

Yes, certainly, that's an objective, and we look at each project on its own individual financial merits, but I would say it's safe to assume in aggregate that our new products have a higher gross margin mix than the existing product lines.

Okay, thank you, and Al, just a few Asian questions. First, the new product categories that you talked about, the tablets, the displays, are they a meaningful percentage of the total Asian sales at this point, and do we have some sense of where they could go as a percentage?

Well, this is pretty new applications that we're talking about. So I would say at this point in time, they haven't significantly altered our results, but what we've been doing is focusing on these higher end applications, Wendy. And so when we're talking about incrementalism and cannibalism, these new applications that we're working on in some of the new segments are replacing some of the commoditized business in the mobile handset space for us.

So I think as you look at the tail end of our fiscal year, we'll probably be ramping up some of these newer applications in a more significant fashion. And a lot of it, these devices are brand new, so our customers have given us forecasts, but it's really anybody's guess right now in terms of how successful those products will be in the marketplace.

Okay. And finally, is there any -- I haven't had a chance to talk to you since the announcement was made that you were leaving Asia and going to the HR position. Can you talk a little bit about that, and where are we in the process of dare I say, replacing you? I mean that in the nicest way, I hope someone new can come in and do the great job that you've done there.

Well, Wendy, maybe it's better for me to answer this.

Okay.

This question, than for Al to talk about himself. But first of all, let me tell you how excited we are, and when I say we, I'm not just talking about my team and I, about the whole organization, about Al having accepted this job of Senior Vice President of Human Resources. We have ambitious growth plans, and as we grow both organically and through acquisitions, we will have a lot of new people coming to our organization. And we want to make sure that we have the proper tools in place to develop our internal talent, and also attract talent from the outside, and assess the culture and the talent from potential acquisitions.

To us, it's very important because in the end, I've always said, anybody can make signs and labels, but if you want to truly be an out-performing company, the difference is in the people. And so we put a higher emphasis, and that's why we picked Al. Al, like no one else I think, represents the culture of our Company, which we are very proud of. So I'm very excited about this one.

Now unfortunately, this rips a hole into Asia, and this would have been the only reason that I would not have moved forward with Al. But this also gives us an opportunity to add some new talent to the organization, or take somebody from the inside and give this person a new opportunity to grow. And we're going to take our time. We aren't going to rush into this. We want to find a great person to lead Asia, because it's an important region for us, and we are in the initial stages of starting to look, and we have engaged -- we will be engaging outside executive search firm, and have the internal and external candidates run through this firm. And I don't think anything is going to happen here before the holidays. So probably early next year, Spring, we should have somebody.

In the meantime, I want to thank Al for doing double duty. It's really hard. I have done HR for a couple of weeks or months, while we were looking for a replacement. It's hard, and so I want to thank Al for this.

Thank you very much.

Your next question comes from the line of Anthony Kure of KeyBanc. Please go ahead.

Good morning, guys. How are you this morning?

Great, Tony.

Good. Just a couple questions. FX into the guidance, can you just talk about what sort of factored in, is it at current levels, current currency?

Yes, typically, we give our guidance, and we take currency at roughly the date of the guidance, within the last couple of days. So, I think when we gave our last guidance, it would have been early September currency rates, and now it's currency rates within the last couple of days.

Okay, and then can you talk about in Europe, volumes roughly flat, but margins declined somewhat sequentially, and I think the comment was made that some of the impact was FX. Was that most of the impact, or was there a mix shift going on there, too, or is it just mostly FX?

No, FX is most of the impact on that, but it was a very, very marginal mix impact as well with the direct marketing business and the comparables. Some of those one-time events that I mentioned last quarter, Swine Flu and the health and safety law change in the UK are relatively high margin business as well, but that had a small impact. So mainly it was foreign exchange.

Okay, and then maybe more broadly for the Company overall. Could you just talk about how the quarter sort of trended month by month, August to September and October, and was there any meaningful change within any of those months?

That's a very interesting question. At Brady, we don't have any line of sight because we get the orders and ship it either the same day or latest next day. We saw a slowdown in our business during the quarter. However, strange enough now in the first couple of weeks of this month, we saw a strong pick up of orders, so it is kind of still volatile. I think that's an indication that we are still in a fragile economy.

Okay, thanks, and then last question, I just want to make sure I have this right regarding the impact of Chinese New Year. I think it's in the first half of February. Is that correct? Just want to make sure that the comps are correct, because it was in February last year. Am I right on that?

Yes.

Okay, great. Thanks. That's all I have.

Thanks, Tony.

Your next question comes from the line of Chris Weltzer of Robert W. Baird. Please go ahead.

Good morning, guys.

Good morning.

Can you just talk a little bit about sort of the moving pieces within your guidance? I understand that cost savings are accruing faster than you expected. Which segments are you seeing that mostly in? Is that all Americas? Has your organic, the pieces of the organic growth forecast by segment changed at all?

The answers would be -- the first one is, you're looking at the cost improvements throughout the organization. We did see the Americas probably take the lead in that, but we do anticipate improvements across all regions as we go forward. Our BBPS and SG&A initiatives are going forward in all regions. Europe takes a little bit longer because, as you have to take resources out, sometimes that does take a little bit longer. And regarding -- there was a second part of the question?

Organic growth.

Organic growth, I think when we look at the first quarter, what we saw is comps to prior year, I think if you look sequentially, you go into last year's, the Q4 of 2009 into Q1 of F2010, you see I think it's a 10% or 11% lift, and where we had been seeing about 4% sequential growth. So we did see I think a pretty strong Q1 last year, and we talked about the Swine Flu and some of the one-offs, so we think our 2% organic growth was somewhat muted by that, but we see mid single digits for the Company going forward.

We saw strong growth this first quarter in the Americas. And I think Al commented that he expected Asia to grow a little bit faster in the second half of the year. And then Peter, I think we're just kind of, it's kind of a wait and see to see how quickly the European businesses come back.

Yes, you asked about the question in our forecast and our guidance, have we seen any shifts. We have, maybe we are a little bit less. Maybe Europe is a little bit slower than what we would have hoped, but that's about it, right? And I wouldn't read too much into this as well. But overall, we have not changed our overall expectations for sales for the Company.

We had a quarter, which was maybe a little bit weaker than we would have hoped in our organic growth, but had the first couple of weeks in this quarter, were very strong, so you never want to overreact in our business based on one quarter or month or so forth, but no significant change. We still forecast something like middle single digit organic growth for the Company in total.

Okay, that's helpful. And then just a couple quick clarifying questions, or questions to help us modeling. In Europe in the second quarter of last year, if I'm remembering correctly, there was a benefit from the inclement weather going on there. Is that going to be as big of a headwind as say the Swine Flu product was? Should we expect organic growth to get better in the second quarter in that business?

It depends on the weather really, Chris. I don't mean that to sound glib, but you're right. Actually, in the second quarter of last year, Europe had a particularly cold snap, and an unusual amount of snow, and we did capitalize on that. So there is some, if you like, some headwind with the weather.

However, having said that, and Frank made a little bit of reference to this in terms of the strong start to this quarter, we've -- we like to think we've been pretty smart about this. We've anticipated this, so a lot of our promotional activity in the early part of this quarter is regarding winter products to allow our customers to get ahead of that game, because the reason we were able to capitalize on it is because people were really caught on the hop. They didn't have de-icing products, so they had to buy. And there was a lot of short supply. So actually, we couldn't even then capitalize on all of the opportunity because salt ran out in Europe. We were importing salt from far distant parts.

So this year, we got ahead of the game, and we're seeing some benefits. So we should moderate the impact of that by early promotion.

Got it. That's helpful. And then on the cash flow statement, maybe a little bit of help with the size of the incremental bonus payments, would free cash flow have been closer to flat without the incremental headwind?

I think directionally, that's correct.

Okay, thank you, guys.

You have a follow-up from the line of Jason Ursaner of CJS Securities. Please go ahead.

Hi, thanks for taking my follow-up. My original question about the Americas, I've been referring specifically to seasonal variability from an operating profit perspective. Just because this quarter was the highest margin since fiscal year 2006 Q1, and I just want to make sure I'm understanding Matt's comments correctly, about whether this is really a more structural improvement relative to previous years.

And obviously, historically -- I guess Q1 is a more normalized environment. And Frank, I understand your comments that it's not necessarily a normal environment, but Q1 has been 200 to 300 basis points higher than the back half of the year, even when Q3 and Q4 were 10% to 15% higher revenue. So is there a mix shift that drives this throughout the year, or are productivity improvements really creating a fundamental new level of profitability?

Yes, I would say that it's very much your last point. That's what's driving that.

Okay, great. And then just a quick question on acquisitions. We've seen you make a number of relatively small tuck-ins. Can you talk a little bit about size of target acquisitions, and more generally, what you're seeing in the market with price expectations, et cetera?

Yes, you're absolutely right. We made a couple of small acquisitions. We certainly hope that this will not be representative of the acquisitions which we are going to do in the future. We are targeting larger acquisitions than the ones we have made. Now, it doesn't mean that if we find a nice little tuck-in acquisition, which we found some of them, this doesn't mean that we won't do it, but our sweet spot is certainly larger acquisitions.

As far as the climate is concerned, we have not done too many acquisitions for two reasons. First of all, the sellers in the beginning of the recession still wanted to have their original price they were used to in good times, and interesting enough, many of them are still holding on to high price expectations. On the other hand, it was very difficult for us to predict future cash flow, not knowing how long and how severe the recession is going to be.

Now, with the economy moderately recovering, we feel much more confident in our own ability to forecast future cash flows. So we have opened up our pipeline efforts again, and our pipeline is growing, and so hopefully we are going to be successful in this fiscal year yet with some more acquisitions.

Okay, great. Thanks a lot.

If there are no further questions, I would now like to turn the call back over to Aaron Pearce for closing remarks.

We thank you for your participation today, and would like to remind you that the audio and slides from today's call are also available on our website at www.investor.bradycorp.com. The replay of this conference call will be available via the phone beginning at Noon Central Time today, November 18. The phone number to access the call is 1-888-286-8010, or if you're dialing internationally it's 617-801-6888, and the pass code is 15773680, and the phone replay will be available until November 25.

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