Brady Corp (BRC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter Brady Corporation earnings conference call. My name is Jennifer, and I will be your operator for today. At this time, all participants are in listen-only mode, and later, we will conduct a question-and-answer session. (Operator Instructions).

I would now like to turn the conference over to your host for today, Mr. Aaron Pearce, Vice President, Treasurer, and Director of Investor Relations. Please proceed.

Thank you, Jennifer. Good morning, everyone.

This is Aaron Pearce, Director of Investor Relations for Brady Corporation. Welcome to our 2011 third quarter conference call, and thank you for joining us. During the call this morning, you'll hear from Frank Jaehnert, Brady's CEO, and Tom Felmer, Brady's CFO, who will review Brady's third quarter financial results. Also joining us this morning for a review of their respective regions are our three regional presidents, Matt Williamson, President of the Americas region; Peter Sephton, President of Europe; and Stephen Millar, our recently appointed President of Asia-Pacific.

As usual, after the prepared remarks by the team, we'll open up the call to questions. We encourage you to follow along with the slides located on the Internet, as we will 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 we go through our usual introductory information and our 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 is 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 latest Form 10-K, which was 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 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. Frank?

Thanks, Aaron. Good morning, and thank you for joining us.

Despite some challenges in Asia, Brady's fiscal 2011 third quarter diluted EPS, excluding after-tax restructuring charges, grew 14.6% to $0.55 per share. That income, also excluding after-tax restructuring charges, was up 16.1% versus the prior year to finish at $29.5 million. Improvement in earnings was primarily due to the positive impact of our ongoing process improvement activities, including BBPS.

In total, our third quarter sales grew 4.9%, which included organic sales growth of 1%, sales growth from acquisitions net of divestitures of 0.4%, and a 3.5% increase from foreign currency translation. On a regional basis, we experienced segment profit growth in the Americas and Europe but saw a decline in Asia-Pacific. While we see continued growth in the majority of our businesses, we faced a drop in sales in Asia, due to combination of Japan-related supply chain issues as well as reduced demand from one of our large, mobile handset customers, who experienced a significant drop of its market share. Stephen Millar, our new President of Asia-Pacific, will provide more color on this later in the call.

To give you a bit of background on Stephen, he joined Brady in 1999 and served as Managing Director of Brady Australia until 2008. Under his leadership, Brady's base business in Australia nearly tripled. In 2008, Stephen joined Brady America's leadership team as Vice President and General Manager responsible for the portfolio of people identification, medical, and education businesses. In 2010, he returned to Asia in a newly-created role of MRO Director for the region, where he was leading our initiative to increase MRO sales in A-Pac. He assumed his present position as President, Asia-Pacific on April 1 this year. We are very excited about having Stephen in this new role.

I'll be back later in the call to summarize our thoughts for the upcoming quarters, after our business leaders provide more detail in their regional updates. But first, I'd like to turn the call over to Tom Felmer for a review of our third quarter financials. Tom?

Thanks, Frank.

Let's start on slide three, which is a summary of our third quarter results. As Frank mentioned, we are reporting a 14.6% increase in diluted earnings per share, exclusive of after-tax restructuring charges. Our third quarter gross profit margin finished at 49.6%, versus the prior year gross profit margin of 49.8%. SG&A expense was down 60 basis points to finish at 34% of sales when compared to the 34.6% in the third quarter of last year. On a GAAP basis, even with the weakness in the Asia segment, that we were able to generate 20.7% increase in net income this quarter when compared to the prior year and an increase of 20% in diluted earnings per share to finish at $0.54 per share.

We also continued to generate strong cash flow during the quarter. We generated $52.8 million of cash from operating activities and ended with a total cash balance of $374 million at April 30. As we look towards our fourth quarter, we are tightening our full-year -- full fiscal year 2011 guidance range for earnings per diluted Class A common share from between $2.15 and $2.35 per share to $2.20 to $2.30 per share, exclusive of after-tax restructuring charges.

Slide 4 provides a summary of our quarterly sales trends. As you can see from the chart, we have settled into a pattern of steady growth that we believe will continue at mid single-digit levels. We generated 1% organic sales growth this quarter. This is below the 10% organic growth that we saw in our second quarter. The primary driver for the modest organic sales growth was a weakness in our Asian OEM business. Acquisitions, net of divestitures, provided a sales lift of 0.4% in the quarter, and the impact of exchange rates increased sales by 3.5% when compared with the third quarter of fiscal 2010.

Slide 5 shows the trending of our gross profit margin. As I just mentioned, our third quarter gross profit margin was 49.6%. We were able to offset raw material costs with more effective procurement strategies and improved productivity throughout our operations in a challenging input cost environment. Going forward, we will continue to focus on driving gross profit improvement through BBPS lean and strategic sourcing initiative in an effort to offset these rising input costs.

On Slide 6, you can see that SG&A as a percent of sales decreased from 34.6% last year to 34% this year. It is also worth noting that, excluding the impact of currency, our SG&A costs are up less than 1% compared to last year and are approximately even with our second quarter levels. As we've discussed in previous calls, we remain focused on driving down SG&A expense as a percent of sales through increasing the effectiveness of our sales force as well as reducing G&A expenses by simplifying, standardizing, and automating processes where feasible. Overall, we are pleased with the continuing improvements in SG&A expenses as a percent of sales, and we are confident that the structural changes that we've made in SG&A functions will enable us to better leverage future organic growth and increase net income.

Excluding restructuring charges, operating income was $42.1 million in the quarter, up from $38.3 million in the prior year. As a percentage of sales, operating income was 12.5% in the quarter, compared to 11.9% of sales in the third quarter of fiscal 2010. This marks the sixth straight quarter of year-on-year increases in operating income.

Slide 7, our GAAP net income for the quarter was $28.6 million, an increase of 20.7% versus the third quarter of last year, resulting in GAAP diluted EPS of $0.54 per share. After adjusting for after-tax restructuring charges, we generated net income of $29.5 million and $0.55 per diluted share. This represents a 14.6% increase in diluted EPS before restructuring expense when compared to the same quarter in the prior year. As mentioned previously, the continued improvement in SG&A as a percent of sales when compared to the prior year is a major driver for our increased profitability.

On Slide number 8, we summarize our cash position and cash generation in the third quarter. We continue to generate strong cash flow from operating activities and strong free cash flow, with cash flow from operating activities at $52.8 million or 185% of net income and free cash flow of $48.2 million or 169% of net income in the third quarter of fiscal 2011. Year to date, free cash flow is $96.8 million or 122% of net income. We continue to focus on cash generation and are forecasting strong cash flow for the remainder of fiscal 2011.

We anticipate that our full-year fiscal 2011 free cash flow will approximate 120% to 140% over net income. On the third quarter cash balance walk, you can see that we invested $4.6 million in fixed asset additions, returned $9.5 million to shareholders in the form of dividends, and made $42.5 million of debt principal payments, all resulting in an ending cash balance on April 30 of $374 million. Overall, our priorities for cash remain unchanged. We will continue to invest in organic growth opportunities, return a dividend to shareholders, and invest in value-creating acquisitions.

On slide number nine, our gross debt is at $413 million and our net debt is $39 million at the end of the third quarter. Our net debt to EBITDA continues to decline, finishing at 0.2 to 1. We believe that with our current cash balance of $374 million and our untapped line of credit, that our conservative leverage profile provides us with adequate flexibility to support future organic and inorganic growth opportunities.

Moving on to Slide 10, the positive momentum that we've enjoyed in the development and launch of new products continued in the third quarter. Over the past few quarters, we have highlighted the launch of several new sign and label printing systems. While we continue to sell these unique printing systems around the world, it is also important that we introduce innovative materials to increase the usage of installed base of printing systems.

An example of these new materials include the third quarter launch of our B-595 adhesive marking film. This is a thermal transfer printable low-shrink vinyl that delivers longer outdoor life that can be used in a full range of Brady portable and bench top printing systems. Also launched was the latest IDenticard PremiSys access control software with integrated video features designed to maximize operating efficiency while elevating the level of security for customers, staff, and facilities.

We remain committed to investing in research and development, spending $10.6 million or 3.1% of sales in the third quarter, which is essentially flat versus the third quarter of our fiscal 2010 and fairly consistent with our recent run rate. Our commitment to the development to proprietary and innovative products is a critical component of our organic sales growth initiative and has generated a substantial pipeline of concepts and programs still under development.

I would now like to turn the call over to Matt Williamson for update on the Americas business. Matt?

Thanks, Tom, and good morning, everyone.

Please refer to slide number 11. Sales in the Americas in the third quarter were $149.2 million, up 3.3% compared to the prior year. Organic sales were up 2.7%. Currency added 1.3% in the sale of Teklynx software reduced revenues by 0.7%. Our sales growth was up across both the OEM and MRO segments throughout the Americas.

Year-over-year growth in sales in the third quarter was driven largely by the positive results for our target organic sales growth strategies. Specifically, our ongoing investment in R&D has yielded a number of new products that have been well received over the last year that benefited the Brady businesses in North America. These product sales, combined with our ongoing optimization of sales and marketing functions to focus on the customers with the highest potential contributed to our sales growth. Our Brazil business saw positive results with automotive and MRO customers, offset by weaker results with Nokia, our largest mobile phone customer in Brazil. We also expect a softening in the upcoming quarter with Japanese automotive customers in Brazil.

Our direct marketing and people ID businesses in the US continued to show improvement in the third quarter, with growth in manufacturing -- with manufacturing market customers being offset by customers in the education, construction, and government markets. We had a particularly strong quarter in our personnel concepts business, led by the improving sales efficiency and new products. In the direct marketing business, our strategies remain focused on increasing sales over the Internet, improving sales productivity, growing our customer files, improving all aspects of our customers' experience, and improving customer conversion and retention.

Our overall strategy to improve our traffic and sales on the Internet continues to yield positive results across most of our businesses. Segment profit for the Americas increased 13.1% to $38.3 million in the quarter. As a percent of sales, segment profit was 25.7%, compared to 23.4% in the prior year. Profitability is being driven by a combination of our organic sales growth along with improved gross margin in the region. In cost of goods sold, our operational strategies of lean and continued execution of facility consolidations have enabled us to better utilize capacity, thus reducing our overhead costs and get internal synergies across businesses.

This quarter, we saw a ramp up in inflation in a number of oil-related raw materials and freight. Our global and regional sourcing actions, plus pricing initiatives, are yielding benefits and offsetting the negative impact of increasing raw material costs. To further offset the impact, we are moving up price increases across most business units to our fiscal quarter four. Selling expenses were flat compared to the prior year in the quarter. Current focus is on improving productivity and processes of inside sales, field sales, inquiry management, optimizing our Internet results, and improving the segmenting of our customers.

Going forward, we will focus on organic sales growth opportunities in our best customer segments, continuing to improving our customers' experience in doing business with us, driving Internet sales across all of our businesses, launching new and differentiated products that add customers value, and increasing advertising in our direct marketing businesses, our strategies that grow our customer files. In the fourth quarter, we expect modest organic growth, as we have a difficult comparable to last year's one-time sales of our SPC Sorbent Products used in the cleanup of the Gulf oil spill.

Now I'll turn the time to Peter Sephton, who will report on European results. Peter?

Thanks, Matt. I will continue now on Slide 12.

Sales in Europe were $105.9 million in the third quarter, up 7.9% compared to the prior year. Growth from ongoing businesses was approximately 4%, acquisitions added a further 2%, and the divestiture of Teklynx in January reduced revenues by 2%. We had the benefit of currency in this quarter adding a further 4%. As we mentioned during last quarter's call, we are expecting moderate organic growth in this quarter, due to tougher comparables from the prior year and the press conditions in the UK economy diluting some really good growth from Germany and Central Europe. We also benefited in this year's Q2 from an early and exceptional cold snap, followed by an exceptionally warm spring. This influenced sales sequentially between the two quarters. Overall, our organic sales growth of 4% was reasonably consistent with our expectations, although our UK business continues to struggle. We are pleased by the ongoing improvement in all other business streams and in virtually all other geographic locations.

The European Brady business continued its strong performance, posting approximately 10% organic growth. Geographically, growth was highest in Germany and in southern Europe, the latter helped by robust recovery in our DM business, our direct marketing business, and the former by continued strong economic growth in Central Europe, also performed very well. This continued sales growth is caused by a combination of an improved economy and positive results of our various organic sales growth strategies.

Specifically for our Brady offer, as one of our three business streams in Europe, we continue to focus on deeper market penetration and emerging markets in Middle East and Eastern Europe, where sales in some pockets are nearly double that of last year. We also continue our emphasis on three main strategic growth areas. First, we are focusing heavily on the process industries. Second, we're aggressively focusing more selling time to recently launched product solutions. And thirdly, we are driving coordinated printer sales campaigns to provide deeper market penetration for our consumable downstream sales.

Moving on to our direct marketing business. In our direct marketing business, we had flat organic growth in the quarter, with strong results throughout northern and southern Europe being offset by the previously mentioned weakness in the UK. We are, however, seeing the benefits of our recently integrated regional direct marketing management structure, where we created a more nimble organization, and we are also seeing the benefits of an increased customer file and the resultant increase in profitability.

Our direct marketing growth strategies are focused around three main themes. First, rebuilding our customer file in our traditional markets in Western Europe and expanding our direct marketing business deeper into countries such as Switzerland and several Eastern European countries where our historical penetration has been low. Second, we're increasing the sales over the Internet to gain both new customers, as well as to strengthen existing relationships. Thirdly, we're improving conversion and customer retention rates by better understanding the specific needs and wants of both customers and prospects.

To give some color to this, our sales by the web increased more than 20% over the previous quarter. Segment profit in the European segment increased 5.3% to $28.9 million, and as a percent of sales, that segment profit was 27.3%, compared to 28% last quarter. In cost of goods sold, our operational strategies, which are focused around lean, are enabling us to optimize capacity, both reducing our overall overhead as a percentage of sales and freeing up capacity for future growth. We are, however, seeing some inflationary pressure on raw materials and shipping costs, and we are attempting to mitigate these with better sourcing and pricing management. We are seeing the improvement from our first quarter reorganization into business streams, as I said before, and this allows us to focus resources and investments to those economies in continental Europe that have the best growth opportunities. This has and will continue to be a primary driver of organic growth, as we take advantage of the differing pace of economic recovery between major countries.

Looking forward, we remain confident in our ability to continue organic sales growth through our more agile organizational structure that can quickly capitalize on opportunities and better leverage off its cost. We also anticipate the trend of ongoing moderate improvement to the economic environment in most of western Europe, although we do remain concerned about the underlying weakness of the UK economy. We will continue to focus our organic sales growth opportunities, including driving Internet sales across all of our businesses, driving new product development, expanding our geographic reach deeper into Eastern Europe and other emerging economies, as well as our ongoing focus on deeper penetration into selected vertical markets. We expect these organic growth opportunities, along with our continued drive to improve operational efficiency, to result in mid single-digit organic growth in the fourth quarter.

I'll now hand the call over to Stephen Millar, who will talk about Asia-Pacific. Over to you, Stephen.

Thanks, Peter.

Continuing on Slide 13, sales in the Asia-Pacific region in the third quarter were $82.8 million, up 4.4% from the prior year. Organic sales were down 5.1%, while currency had a positive impact of 7%, and acquisitions contributed to 2.5% to sales growth.

During the quarter, we experienced several issues impacting our sales growth. First, we experienced a decline in revenues from one of our largest customers in the mobile handset industry, a slight loss of market share to other OEMs where our content per phone is generally not as high. Second, towards the end of the quarter, we saw supply chain disruptions across our electronic customers due to the earthquake in Japan, thus temporarily decreasing our sales volumes. Looking at our [spec-in] position and our customers' forecasts for these programs to ramp up during the late summer, this will lead us to believe that this is a one- to two-quarter anomaly. We are obviously monitoring this very carefully and managing our supply chains accordingly.

Our sales into the hard disk drive market were down slightly, due to all of the platforms being replaced by new ones, where some of our proprietary new products are taking longer than expected for full-scale adoption. These sales headwinds were somewhat offset by our continued end-customer diversification in both the OEM and MRO markets.

Our growth strategies in the OEM space are focused on two main strategies. First, expanding our product offering into nearby adjacencies, including display manufacturers and tablet manufacturers, where our differentiated solutions for heat management and optical displays give us a competitive advantage. As these issues become more pressing in the electronics market, our customers are seeing greater value in our analytical capabilities, which we can apply to help them optimize performance. Second, through our R&D efforts, we continue to focus on the development of unique, value-added solutions that add significant value to our customers, so as to set us apart from our competitors.

In the MRO business, we saw core growth in the third quarter. Our MRO growth strategy is primarily focused on strengthening and expanding our distribution network in key markets such as China, where the market is rapidly maturing, thus providing increased channels to market for our unique MRO product offering. As we move forward, we will leverage our strong OEM footprint to support our growing MRO business. Our infrastructure and processes, coupled with our growing R&D capabilities, provide a solid platform for us to support the expansion of our MRO business, as we identify growth opportunities in this market.

In Australia, both our core business and the recently acquired ID Warehouse business had a strong quarter. Segment profit in the region was $10 million, down $2.8 million from last year's segment profit of $12.8 million in the third quarter. As a percent of sales, segment profit was 12.1%, versus 16.1% in the prior year.

We have previously talked about our shift to focus more on higher-end products, where we have the opportunity to sell more differentiated, higher-value parts. In previous quarters, we have seen the positive impact of this strategy on segment profit. In the current quarter, the impact of the strategy is not apparent on segment profit, due to the overall impact in the decline in sales to our large mobile handset customer and the effect of the Japan earthquake. We continue to focus on driving operational improvements through lean as well as strategic sourcing initiatives. However, the benefits from these initiatives have been more than offset by the negative organic sales growth and inflationary pressures on raw materials.

Looking forward, assuming that some key programs that we are involved in do successfully launch, we expect to see a return to organic growth in the fourth quarter and in fiscal 2012, driven by differentiated production and design capabilities. The success of these new products, along with the further acceleration of the growth in the MRO space, also is expected to improve our overall segment profit in coming quarters. Although we were clearly disappointed with the third quarter performance in Asia, we are confident that our strategies are well developed and that our focused execution ensures that we have a strong foundation in place for future profitable growth.

I'll now turn the call back to Tom.

Thanks, Stephen.

Let's move on to Slide 14, which is -- which shows our guidance for the full fiscal year of 2011. As I previously mentioned, we are tightening our full-year fiscal 2011 guidance range from $2 -- to $2.20 to $2.30 per diluted share from the $2.15 and $2.35 per diluted share, exclusive of after-tax restructuring charges. Our guidance assumes sales growth rates consistent with the average for our first three quarters of fiscal 2011, and our assumptions for capital expenditures, income tax rate, depreciation, and amortization expenses, as well as restructuring charges, are also listed here on Slide 14.

You heard a lot of information from each of the three regional presidents. Let me summarize some of the key points of our third quarter performance before handing the call over to Frank.

With respect to revenues, new products are delivering revenue growth throughout the world in our Brady MRO businesses. Our direct marketing businesses are rebounding around the globe as we rebuild house files that dropped through the recession. We are, however, continuing to see declining business in the UK, which is muting the recovery of continental Europe.

In our Asia -- Asian OEM business, organic growth was negative in Q3. We do believe that we will return to low single-digit organic growth in our Asia-Pacific business in the fourth quarter, as our strategy of moving away from lower-end commoditized parts is nearing completion, and we look to improve our position with OEM customers as we enter the new mobile handset and electronics build season. On the cost side, we have been able to offset many of the commodity cost increases and held our gross margin percentage approximately even with the prior year. And our SG&A, when adjusted for currency, is up less than $1 million versus our prior-year third quarter.

With that, I would now like to hand the call back to Frank for his closing comments. Frank?

Thanks, Tom.

As you have heard from each of the each of the three presidents, we are very much focused on both expanding our organic sales growth, as well as continuing to improve productivity. Overall, our priorities remain unchanged, as our strategies are focused on driving organic sales growth through the development of proprietary new products, market and customer segmentation, and the expansion of Internet sales and multi-channel marketing, as well as a deeper penetration of sales in the selected emerging markets, such as Eastern Europe and China.

We also remain focused on driving cost reductions and productivity improvements throughout the organization through strategic sourcing and reducing SG&A as a percentage of sales, also various lean techniques aimed at improving the efficiency of the selling as well as admin functions. We believe that our focus on organic sales growth, combined with a focus on holding expenses in check, will be a catalyst for a continued improvement in net income in Q4 and beyond.

We also remain committed to using our strong cash position to drive future growth through acquisitions, both in our core markets as well as in near adjacencies, and we see acquisitions as an additional driver for accelerating future sales net income growth.

We thank you for your interest in Brady, and we will now start the Q&A. Jennifer, can you please provide instructions to our listeners?

(Operator Instructions).

Allison Poliniak from Wells Fargo.

Hi. Good morning.

Good morning, Allison.

On the SG&A side, there was a 60 basis point improvement this quarter. I know you guys are not giving sort of a long term goal for that number, but is that a rough pace that we can expect over the next few quarters in terms of improvement?

I think what we talked about last quarter on this call, Allison, is it looks like we have entered into a range of selling or expenses on the SG&A line, and we have been trying to hold within that range. And so it is really going to be dependent more on holding that relatively constant and improving revenues that is going to drive the improvement in SG&A as a percentage of sales.

Great.

And then just turning to Asia, and I know you talked about the high -- hard disk drive platform and not getting the penetration you thought. Can you talk about the life cycle of those products and when potentially you can start making up that share?

Sure, Allison, it's generally a 1- to 2-year product life cycle on those -- in those products. So, and I think we're -- I guess we wouldn't be expecting to see an immediate impact on them, in that time frame.

Okay. Great.

And then just last on the Nokia comment, is there any way to quantify that impact, and are you going to be able to make that up in other -- with other -- I guess cell phone manufacturers at this point?

Allison, I don't think we can -- we can't quantify the impact of that. Obviously, we continue to monitor the whole mobile handset industry, and as you would expect, are looking for every opportunity we can to grow in other parts of the market.

Okay. Great. Thank you.

Charley Brady from BMO Capital Markets.

Okay. Thanks. Good morning.

Good morning.

Could we just dig a little bit more into the Asian supply channel issue and kind of the -- and your guidance into Q4 for modest organic growth, and kind of your expectations? It sounds as though some programs have to kind of come back online or have to happen to get there, and kind of what your visibility is into that happening. I'd just like a little more detail on what you're seeing into that supply chain, more specifics on what the issues within the supply chain were, what kind of programs.

Sure, Charley.

I think there is 2 things we singled out this morning. One is just general softness with one of our largest customers, and then there is the question of what the Japanese earthquake has impacted.

I think with visibility to any customer, it's as good as what the customer can share with us and their own projections of what's happening with them. We do believe we're at the bottom of the cycle and should be seeing some upturn.

In terms of the impact of the Japan earthquake, as we -- as we listen to other peer suppliers and other people in the industry, and with what we read, I think everyone is having problems really quantifying the impact in terms of actual dollars but then timing as well. We anticipate that we would continue to see some impact from this into the fourth quarter, but it is very hard to quantify that.

Is it your suppliers for products that you are making, or is it supply chain issues for customers that you are supplying that they're not getting it, and so therefore they're not ordering from you?

Yes, that's a great question.

It's actually not supply issues to us. So it is broader supply chain issues. It is pretty well affecting across the electronics industry that we supply into. There's various components, such as flash memory, which are used in a large number of differing devices these days, and those shortages are slowing down production further down on the supply chain, which is just reducing demand for us. So that's where -- partly where the level of uncertainty comes in. It is pretty diverse.

Okay.

And then on the SG&A issue, again, it was a little bit higher than I guess I would have modeled in. Was there anything unusual in Q3 SG&A? It was down as a percent of sales year-on-year, but I'm wondering, would you expect on a percentage of sales to see a sequential decline going into Q4? Generally, it looks as though it has kind of declined as a percent of sales Q3 to Q2, which wasn't the case this quarter.

When you're looking at it sequentially, what you have -- there is a pretty significant impact from currency. In fact, when you look at sequentially Q2 to Q3, the majority of the increase or nearly all of the increases, is due to currency. We did have a lift in some expenses, maybe catalog-related, primarily, but those were offset by other productivity initiatives. So, as I said, in constant currency, we're looking at holding them relatively flat. We have been successful in doing that for a number of quarters, so it is probably difficult for you to build in your models what that impact of currency is, but the majority of that impact is currency-related.

Okay.

And then in terms of gross margin, are you -- if I look at Q4 to Q3, does your model -- does your guidance assume an improving gross margin, given that you've accelerated some of your price increases into Q4?

Again, with the -- we talked at the last call that we are starting to see input costs go up, and we actually feel pretty good that we have been able to hold that margin, just with our productivity initiatives and in a lot of our strategic sourcing programs. It's difficult to really project what that impact is going to be into the fourth quarter. We would expect it to be at similar rates. We're not projecting any major shifts.

If you look at the margins and percent of sales, it has held in a pretty narrow range for some time now. It has been improving through the recession, but I think the improvements have slowed some. But now I would expect the trend that we're on to hold pretty consistent.

The bigger concern would have been a big negative impact this quarter from the cost increase. I think we were able to hold that off.

All right. One more, and then I'll hop back in the queue.

Your CapEx for this year, 25 to 30, you pulled that in a little bit from what it was. Anything significant to that, just push some programs out into next year?

As you look at all of the initiatives that we are driving, primarily through the BBPS, I know we have spoken in the past about facility consolidations and so forth. We're seeing our footprint shrink, and you just need lots of CapEx to support it. We still feel very good about our infrastructure. It is not like -- I don't feel that we're putting -- pushing any programs off or pushing anything out. This is, you know, right now just a pretty natural run rate for CapEx for us.

Great. Thank you.

Jason Ursaner from CJS Securities.

Good morning.

Just a simple question, first. Teklynx is coming out of the Americas, but I thought this was headquartered in France.

Yes, it was headquartered in France, but there were sales that were booked both on Europe and in the Americas, so I think we commented on the impact for both regions.

Okay.

And for Peter, you talked about the moderation in core growth, given the weather-related bundles. You mentioned continued strength in the established markets. Can you talk a little bit about intra-quarter trends by month and whether you saw a change in customer order patterns in April?

We saw a change in customer order patterns due to that sequential change in -- when the cold snap came. If you exclude that, and if you look -- I think I made comment on this in northern Europe, eastern Europe, and in southern Europe, especially, we saw improving order books in southern Europe. So up until second quarter, we've seen right from the beginning of the year that there was a really robust recovery in Germany other economies lagging behind. And now we are seeing other economies pick up, in particular, France, that was very encouraging.

I will just reiterate what I said about the UK. The UK was weak and we are still pretty uncertain how long it will take to recover.

But for the ones that were strong, you saw kind of a build throughout the quarter.

Certainly in France and southern Europe, we did.

Okay.

And for Matt, did the severe weather in the US help add at all to core growth at all in the quarter? Is there less of an opportunity there than there is in Europe to capture some of those sales?

Yes, I would say it had no impact in the Americas.

Okay. And if I'm thinking for next quarter about the comp to last year, how much did SPC add to core growth for last year?

It would be about 3.5%.

Okay.

And then just a few final questions, I guess, for Stephen. First, congratulations on the appointment. But for demand in Asia, were you also impacted at all by a more pronounced Lunar New Year?

No, I don't think anything different than normal there, Jason.

Okay.

In terms of margin, you mentioned the impact is not yet apparent, but that I guess it should be a little more apparent when you exit the current design cycle. When it is more apparent, is this still a high teens, low 20% margin business, or is it not going to really be at that level because it is absorbing higher levels of R&D now?

Yes, Jason, I don't think I can comment on the specific numbers, other than we obviously expect to see the shift upwards.

Okay.

And then just lastly in terms of MRO in Asia, I appreciate that it's kind of a long process, but given the size of the opportunity, could you provide any long-term targets or maybe key milestones that investors can hang their hats on?

It feels that we're so early in the cycle here, I would be reluctant to put that up. You have correctly identified it is a huge long-term opportunity. But, you know, the stage of development now, what we're expecting to see is some sort of exponential growth in terms of the market opportunities, put it that way. A longer-term target for the Asia-Pacific region would be to try to get a 50-50 balance on our portfolio between our OEM and MRO business, if that is helpful.

Yes. Great.

And as the former director -- should we expect more of a focus on that going forward, or is there anything you can do to accelerate the timetable there?

We need to be careful on that one. Obviously, we have a strategy which was in place before I went back into the region to have -- to get this balanced portfolio that I've just talked about. It is very important for us that we want to grow the MRO business, but not at the expense of our OEM business. So it really is a rebalancing. Obviously, the MRO business comes from a lower starting point in terms of absolute dollars, so you would expect there would be a more aggressive focus on growth there.

Okay. Great. Thanks for taking all my questions.

Robert McCarthy from Robert W. Baird.

Morning, everybody.

Good morning.

Good morning.

I'm afraid I need a little bit more help with the Asia-Pacific situation. In regards to your comments that you think that the customer market share loss will turn out to be a short-term issue, are we -- I'm trying to understand why you believe that would be the case. Is the problem in the quarter really more of an inventory problem? In other words, production volumes didn't live up to expectations, so you had an inventory backup and that is what created the problem, and since inventories are rebalanced in the channel, now it won't be a drag? Or am I missing something else?

Yes. Okay, Robert, thanks.

I might have slightly created the wrong impression. When a customer has a market share loss, there is an issue for them there about how they recover that. In term of what it means for us, we've seen our sales to the customer decline as they have seen their own decline. I wouldn't say that we're in a position to say whether they've seen the end of their decline or whether they're returning. What we do know is that they're projecting higher levels of sales going forward. They have some things happening themselves that they have in place which give us some comfort that they will see a return to growth.

So we're really basing our projections off the fact that they're expecting some return to growth. Not necessarily that they will regain market share. Recall the market in absolute terms is still growing.

And there is no question here in my mind here, Robert, there must be some inventory impact. If a customer all of a sudden experiences a sudden reduction, say, it's beyond their prior expectations, you know, there will be an inventory effect you have in every case when the economy slows down. So I think we had a aberration because of -- is aberration the right word? -- because of the de-stocking or just not ordering from us because they had enough inventory on hand. So this certainly should be a temporary thing, the inventory adjustment. Once inventory adjusts, it will be more closer related to what they see in the market. As Stephen said, we have seen an increase in the forecast to us.

As you -- as you accommodate that forecast, Frank or Stephen, into your own forecast, given the experience that you just had, are we looking at a forecast from you that has a little less, from them, than you would normally count on? Do you know what I mean? Are you haircutting what you are seeing from them?

We use our best judgment.

We always apply our best judgment. Forecasting is forecasting.

Sure.

And so you obviously want to take in good faith what your customers tell you, and sometimes you need to apply some other judgment.

I think the other comment that's worth making, with the customer we're talking about, part of their decline has been around some uncertainty around some platforms of their own. I think that has been clarified somewhat in the last 4 to 6 weeks, and I think the market -- their customers are potentially getting more comfortable with the direction they're heading. And that is one of those commercial judgments we have to apply when we look at their forecasts about the amount of volatility that might be in those forecasts going forward.

Yes, yes, okay. And as regards to supply chain problem, you believe that it moderates in this coming quarter, or it accelerates before it gets better?

Yes, that's -- based on the information we have, moderates is probably the right word. We don't believe it accelerates. I don't think the impact on us will be any less than it was.

Okay.

But it is very uncertain, because there is a multitude of customers and supply issues and things that are impacting the supply chain, and it is quite volatile.

Yes, I would say, Robert, we have not planned a significant increase in our business because of an improvement of the situation in the fourth quarter. Now, it might take another quarter until this stabilizes more.

Yes, I understand.

Certainly not an uptick in the fourth quarter because of this.

All right. Thank you. That helps.

And when there was some discussion, I guess by you, Stephen, about the ongoing transition of the business, or the efforts to push the OEM offering towards more value-added applications and reduce your exposure to commoditize. I actually thought I heard something along the lines of a process that we think will be largely complete by the end of the third quarter, or something like that. So are we talking about a handful of very specific programs that you've been waiting to roll off that now create the opportunity for a visible change in profitability going forward?

I don't think so, Robert. I think we think we have been talking for the last 4 to 6 quarters, probably, about the --

Longer.

Longer, yes. Obviously a process, you know, when you are going through a process of focusing on a different part of the market or bringing it a slightly different strategy to bear. It is not an overnight thing. I think we have seen the impact of that. I think -- I can't recall the specific comment I made that you referred to, but I think we do know that in the current quarter, the impact of what has been -- is being a successful strategy for us has been obscured by some of these other things.

But, you know, we're coming out of a -- we're coming towards the end of a comparative period now where, since we instituted this strategy, where some of those lower-margin products are out. So I think we'll see some equilibrium coming out into calendar '12.

Yes, I would say, maybe I can just give you my view, being a little bit further away from it and not in the day-to-day business. As Stephen said, some of the phasing out of lower-end commodity parts, they now have -- are hitting their 1-year anniversary. [Which would have all] organic growth, number one. And number two, we have several products in the late evaluation stages at customers, testing it, and, are pretty close to making a decision whether they want to roll it out and then in what kind of volumes and so forth. I'm not just talking about one. There are several.

Of course, it is always difficult to say how long it takes for them to finally make the decision, which program they're going to implement it on, what kind of volumes they're going to have on this one. But we have several in the evaluation phase at customers right now, because we have started, as you said, a couple of quarters ago like this. And we also have a pretty good pipeline of new products at various stages of launch with our customers in the OEM business. So I think this is a strategy which sooner or later should be visible in our results. It is just a question when exactly does it hit.

I would say when you look at Asia-Pacific, you step back and look at Asia-Pacific, the strategy of adding new product at the higher end of the value chain and the removing commodities, it's a delicate balance. You cannot perfectly time how much business you're going to lose because you're not going to take any business at any price. So you might lose a bit more, a little bit less, per quarter. It is very difficult to pinpoint. And then the timing exactly of when a new product is going to be launched and put in new programs by customers, is also difficult to judge. I think we have a little bit of this, kind of a timing issue, and so -- but I think over the next couple of quarters, it should stabilize, especially on the lower end of the commodity end, because we are almost done like making our major adjustments there.

Thanks, Frank. That is very helpful.

If I could, I would like to switch over to the Americas and just ask a couple of sort of quantified or quantification-oriented questions. We identified education, government, and construction as specific end markets that have been particularly weak in the quarter. Can you give us some kind of ballpark round number on how much the revenue base that accounts for?

Yes, that's a tough thing to do, because we serve those markets across a number of different businesses, from the business that's specifically in education to part of our direct-marketing business. So it's tough to do.

But what I can say, I want to help you here. You said education, non-residential construction, and what was the other one?

Government.

Government. I just throw something out and, Matt, you correct me if I'm wrong. I would say non-residential construction probably is the largest segment, and of course, as you know, it is still declining in the US.

Yes.

And even if it starts picking up, a sign is probably not the first thing they put in there. People who pour concrete are probably the first people, and then the people who put up shelves and so forth, and then put machinery and equipment in there. And in the end, before they start producing something, they might put a sign in.

You need something to hang the sign on, right?

Exactly. That's right. You first need to have a wall, right?

So I think from this -- in that regard, we are probably not leading. We are probably lagging non-residential construction. It is still declining. Now this is, of course, not all of our business, because there is constant replacement and there is lean projects where people need new signage. Certainly if non-residential construction were to pick up, the time lag, we will follow.

I think education is probably the smallest portion as it relates to our business, and Matt has confirmed. And government, I would say, is pretty close to education, a little bit larger, probably, than education. But non-residential construction is by far larger. So maybe this helps a little bit.

We'll try one more level of refinement, if we could, Frank. Do you think we could say that together, they're less than 20% of your total business in the Americas?

Yes.

And then, how big of a drag does the -- specifically the oil spill create on fourth quarter organic growth?

Okay. The question was asked previously, and I had said it was a 3.5% impact.

For the full year, I thought that was?

Yes, that's correct.

Okay.

No, I'm sorry. That's for the quarter.

It is?

Yes, that's for the quarter. I redid the math after that, and it is 4%.

That was the impact of the oil spill in the fourth quarter organic growth.

Correct.

So in other words, had we not had the organic growth -- had we not had the oil spill, our organic growth would have been 4% lower last year in the fourth quarter.

Okay. Got it.

Lastly, there was some discussion of working on price increases in the Americas to offset what you've seen on the material cost side. Is that something that we can realistically expect to see any impact of in the fourth quarter, or are we really talking about something that is more of an FY '12 initiative?

Well, the main point there is that we're doing everything we can to hold our own when you look at the things that are impacting our cost of goods sold and trying to do everything we can, too, with our sourcing and our pricing. And so I would -- I would say you wouldn't want to build in any positive impact there.

Fair enough. Thank you.

George Staphos, Banc of America/Merrill Lynch.

Hi, guys. This is actually Benjamin Wong calling in for George.

When I take the midpoint of your updated guidance and back into 4Q, it looks like you're guiding 4Q to about $0.67. Can you just talk more about the key assumptions in arriving at the guidance, especially given the tougher year-over-year comps and some of the ongoing challenges you called out in Asia?

I think we walked through a lot of those already, but we talked about having growth rates comparable to the average of the first 3 quarters. So you're looking at 4% or 5% -- probably 4% to 5% organic growth. You know, we've talked about our SG&A being, held relatively flat within a range we have been over the last number of quarters in absolute dollars. And we've talked about margins maintaining fairly steady. I think those are probably 3 of the key elements that we've talked about.

Okay. Thanks.

And then just going back to Asia, what factors would need to come together to get margins in that segment back to levels you've seen in the past, and let's just say 18% to 20%, kind of on a sustainable basis. Is that to some extent stabilization in the commodity products that you talked about earlier, and also some execution on your longer-term strategy of focusing on higher-margin products?

Let me take this question.

For our strategy to work, I think we have the strategy in place. It is just a question of execution of the strategy to work out.

Okay. Thanks.

Excuse me?

I think volume is the other.

Volume, sure.

Strategy and the volume up is the key thing.

Yes.

Okay. Thanks.

Anthony Kure from KeyBanc.

Hi. Good morning, gentlemen.

A couple of questions. The Japan impact, I just want to make sure I understand. I think the comment was it should span a couple -- 2 quarters. Does that mean that the 2 quarters are a third quarter and then this fourth quarter, or does that mean fourth quarter and first quarter of fiscal '12?

What we know, as you correctly say, Tony, it could be 2 quarters. It will be fourth quarter of fiscal '11 and if it continues, and then it would be into fiscal '12. There is nothing -- this is such an open-ended situation that, right now we would just say fourth quarter of fiscal '11.

Okay.

And then the challenges in Asia are related to the handset manufacturer. First, is this the first quarter you've seen this impact, or did you start to see this last quarter?

We started to see it last quarter, but it is been exacerbated. Their own demand from us is has decreased more significantly in the last quarter, and, the -- I don't want to keep on [playing] the same thing, but the Japan earthquake has impacted them as much as anybody else. So that is like a double whammy there.

Okay. So, the second quarter to the third quarter Asia revenues declined 6% -- I'm sorry, $6 million sequentially, just looking at things here. Of that $6 million sequential decline, can you provide some scale around, first, the Japan impact overall, and then the impact of this 1 particular customer? Can you just give us a feel for how much of that contributed there?

They are so inter-related, I would be reluctant to try and do that, in the sense that we know our orders are down because of the Japan situation. We know orders are down because of individual customer issues. But even getting the customer to give the split between those is a very hard thing to do, so the only -- I guess the only direction I can give you there is I think on balance, the impact of the earthquake would be less than the impact of the other issues.

Okay. So I guess to approach it a different way, of the $6 million decline would those 2 issues combined account for all of that?

Yes, the majority of it. Correct.

Okay.

Raw materials now starting to come down here. Is that improved -- just using oil as the proxy, is that improved raw material situation factored into your guidance, or are you assuming the same raw material environment as you endured in the third quarter?

I would say it's probably similar. These things take a while to come through the supply chain. So we may be offsetting some that we've seen already, but some may not have reached us yet. It is a little bit more difficult to see the impact through the supply chain and the thousands of SKUs that we have.

Okay. And along the lines of the price increases, when did those go into impact -- or into effect -- and was it across the board or across all regions, or is it more focused on Europe or the Americas? Just provide some color there, maybe.

He's asking a global question. I'll speak for the Americas.

No, there's -- these are -- because we have different businesses that go to market in different ways, it -- we have different abilities to implement price increases at a time when we get the increases. So, for example, in the core Brady business, we have a commitment with our distributors. We have contracts. We have a time frame that we have to communicate in advance, so that they can get this in their system. So this is -- this is something that -- we give our distributors 90 days. For example, our direct marketing business, we have prices in our catalogs, and these catalogs are already in the market, and so it's difficult to increase our prices. If that's the case, you have to wait for a catalog reprint. However, because of the impact in freight surcharges, where we've had a big impact, we have increased, already, our freight charges in our direct marketing business.

In other more custom-orient things, where we're pricing one-off, those sort of things have been implemented already. So I would say the majority of pricing is still in front of us to offset the things that we're seeing from the market.

Okay. So was the price increases only in America, or was it in Europe and Asia also?

I can comment, Anthony, on Europe.

I made mention of this in the discussion on Europe. We did have a plan to just do a blanket price increase in Europe, but we've invested quite a lot of it beginning in this year and have a new pricing team and some new pricing tools. So we're getting much more -- much better traction now, where we can balance margin versus volumes, so we'll continue with that.

But just to echo Matt's comments as well, we have an opportunity with custom-specific, custom products to reflect increased material costs in those prices and likewise, freight. But our policy in Europe is really to get very smart about our price volume mixes, as well. So we'll continue with that.

And, Tony, with respect to Asia, as you know, so much about this is custom, so we really manage these sorts of things on a deal-by-deal basis.

Okay. So it sounds to me like this pricing impact to the positive side will play out more in 2012, and I think somebody may have addressed that. Am I getting the right impression there?

Yes.

Okay.

And then just in terms of the SG&A spend, year-over-year, I think you said it would, if you exclude FX, it would have been flat, or it would have been higher. If you could just clarify that, and did you mean in dollars or did you mean in percentage of sales?

Dollars.

Go ahead, I'm sorry.

In absolute dollars.

It would have been flat without currency.

We said that the delta between last year's third quarter and this year's third quarter is primarily currency. And I also mentioned that we had maybe wage increases and advertising spend increases, but they were offset by other productivity initiatives.

Okay. So it would have been flat on dollars. Okay.

Yes.

Great. Thanks so much.

Thanks, Tony.

We are now an hour and five minutes into the conference call. We probably should -- maybe can take one or two more questions.

All right. So, do we have further questions, Jennifer?

Charley Brady.

Thanks. I'll be quick on this.

I don't want to beat a dead horse on this key issue, but I want to make sure I really understand your assumptions. So you had -- Nokia is losing market share, no surprise there. They have reduced the orders from you guys because of that. But your expectation is that they are going to recover some of that market share, and then their order pattern should return back to a more normalized rate at some point, either fourth quarter or in your fiscal '12. Am I correct in that assumption?

We're assuming some recovery there. They've announced -- I think I referred to the Symbion platform, there was some uncertainty around what might happen with their operating system. I think our read is the market is feeling more comfortable there. So I think their priority, which would be ours, that we would expect to see them stabilizing there and expecting to recover. And that's I think that's the way we're projecting it.

Are you building your assumptions off of conversations with Nokia on some of their product forecasting? How much visibility into their order patterns do you get from them?

We get visibility into order patterns at the individual -- let me rephrase that, we get forecast schedules, and then their actual ordering patterns in the normal course of events would follow pretty closely. But like any business, I guess, when things get uncertain, the ordering pattern might differ from the forecast.

Yes.

But we talk pretty closely to them and other people in the supply chain. So, I think our own forecasts are based on what we are seeing from them, from their subcontractors, and then applying our own commercial judgment.

Okay. Very good. Thank you.

Mr. Rick Lane from Broadview Advisors.

Good morning, guys.

Good morning, Rick.

Just a quick comment and then a question. It seems to me that you have done a good job on SG&A of -- assuming that you wouldn't have had that currency impact, that the absolute dollars of SG&A would have been flat now for almost 6 quarters. So one the one hand, that's good. The percentage looks inflated, or maybe the progress obscured, if you will, because, Asia revenues were a little weak. I personally was expecting a little bit more organic growth in the Americas and in Europe, too, all of which might have served to have gotten the SG&A ratio maybe down to 33%, or maybe even below. And it seems like we would be poised for that to happen as we go into '12, because you are going to get some pricing versus raw material, benefit, and ostensibly maybe you would get some more organic growth.

My question is, how -- because there is some funny comparisons in Europe, there are some funny comparisons in the Americas, because of, Sorbent and, the weather swing in Europe. I didn't hear much discussion about how you guys feel about just your basic business in the Americas and Europe, from an economic standpoint. And I would be curious what you're thinking there, just -- what is the tone of business feel to you?

Maybe take this by Matt and Peter. Matt?

Okay. First, the largest business is the core Brady business, and the tone of that, Rick, feels pretty good. We've had good growth there in line with the major distributors that you see, so we feel pretty good about that. And the next biggest segment is our direct marketing business, and based on the things that we're doing there, other than the number of their core customer segments, I would say that the tone in that is good, as well. It's just that they have a number of segments, as I commented on earlier, that really hurt them. And it's also a slower business to rebound, as we are trying to get to via the catalogs, a house file that's gradually ticking up, and so you have -- that feels pretty good but offset by those other market concerns. And at the same time, a nice, positive shift to growing business on the Internet. That feels pretty good as well, particularly if we can shift over and get more growth in unbranded Internet-type business, if you understand what I mean by that.

So those are the areas I would say we feel, that our core business, of -- and how I feel about that.

Peter?

Yes, Rick, I'll just echo that. We feel pretty good about what we see in Europe. And to add some color to it, if we are getting really granular about this, and I was giving you a greater granularity, I think you would as well -- you would see really nice results pretty well everywhere in Europe except the UK. And I may have mentioned that in our script, and that will continue. I think the UK will continue to struggle, and we'll see good results in northern Europe and certainly parts of southern Europe and certainly France.

There was 1 other dimension that maybe I didn't make mention of, as well, is that was the April effect. We had a -- the way Easter fell this year across all our businesses, it did have an impact towards the tail end of the quarter. And, again, that was exacerbated in the UK. You probably know we had the illustrious royal wedding in the UK, and we announced another public holiday. And that did mean that for 3 vacation days for a UK employee, you could take, effectively, an 11-day vacation. And a lot of people -- outside of Brady, I hasten to add -- a lot of people did. That did have an impact on our business. But, you know, these are transient events. Okay? So maybe that adds a little bit more color, so we feel pretty good.

Rick, maybe I just summarize, and I think you are the last caller, anyway. This would be basically a concluding remark. I look at our business in the Americas and Europe. I feel it's moderately improving, you know, it kind of feels good. Even so, I agree with you, the third quarter organic growth in Europe and in the Americas was less than what we expected, as well. But in general, it feels that things are getting better. And then I should leave it at that.

Thanks, Frank.

There are no further questions at this time. I will now turn the call back over to Mr. Aaron Pearce for closing remarks.

Thank you for your participation today, and we 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 also be available via the phone beginning at 12.30 Central time today, May 18. The phone number to access the call is 888-286-8010 or 617-801-6888. And the passcode is 11-68-3091, and the phone replay will be available until May 25. As always, if you have a question, please contact us.

Thank you and have a great day. Jennifer, can you please disconnect the call?

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.